##### Table of Contents



UNITED STATESSECURITIES AND EXCHANGE COMMISSIONWashington, DC 20549

FORM 20-F

o
    
    REGISTRATION STATEMENT PURSUANT TO SECTION 12(B) OR 12(G) OF
THE SECURITIES EXCHANGE ACT OF 1934orx
    
    ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934For the fiscal year ended August 31, 2003oro
    
    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, 2003: 604,959,787



---



Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.

Yes x         No o

Indicate by check mark which financial statement item the registrant has
selected to follow.

Item 17 o         Item 18 x

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##### Table of Contents



CONTENTS

CURRENCY TRANSLATION
    
    
    3FORWARD-LOOKING STATEMENTS
    
    
    3PART IITEM 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
    
    
    19ITEM 5.
    
    OPERATING AND FINANCIAL REVIEW AND PROSPECTS
    
    
    43ITEM 6.
    
    DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES
    
    
    63ITEM 7.
    
    MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS
    
    
    71ITEM 8.
    
    FINANCIAL INFORMATION
    
    
    73ITEM 9.
    
    THE OFFER AND LISTING
    
    
    76ITEM 10.
    
    ADDITIONAL INFORMATION
    
    
    79ITEM 11.
    
    QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
    
    
    87ITEM 12.
    
    DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES
    
    
    87PART IIITEM 13.
    
    DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES
    
    
    88ITEM 14.
    
    MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND
USE OF PROCEEDS
    
    
    88ITEM 15.
    
    CONTROLS AND PROCEDURES
    
    
    88ITEM 16.
    
    [RESERVED]
    
    
    88PART IIIITEM 17.
    
    FINANCIAL STATEMENTS
    
    
    89ITEM 18.
    
    FINANCIAL STATEMENTS
    
    
    89ITEM 19.
    
    EXHIBITS
    
    
    89


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$7.7995,
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 29, 2003. On February 24, 2004 the noon buying rate was
US$1.00=HK$7.7780. 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 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:



| |  |  | increased competition in both the telecommunications and
Internet markets;
| | - |  | --------------------------------------------------------------------------



| |  |  | our ability to maintain growth and successfully introduce new
products and services at the same time; and
| | - |  | ---------------------------------------------------------------------------------------------------------



| |  |  | the continued development and stability of the technological
infrastructure we use to provide our telecommunications and Internet
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 28, 2003 through and including
February 26, 2004.

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, 1999, 2000, 2001, 2002 and 2003. 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 311999
    
    2000
    
    2001
    
    2002
    
    2003
    
    2003HK$
    
    HK$
    
    HK$
    
    HK$
    
    HK$
    
    US$(Amounts in thousands except per share data)Consolidated Statement of Income
Data:Hong Kong GAAPRevenues:International telecommunications
    
    
    947,180
    
    
    
    1,119,148
    
    
    
    861,338
    
    
    
    908,981
    
    
    
    875,802
    
    
    
    112,290Fixed telecommunications network
services(1)
    
    
    98,516
    
    
    
    109,019
    
    
    
    154,262
    
    
    
    241,219
    
    
    
    423,107
    
    
    
    54,248Content and e-commerce
    
    
    
    
    
    
    5,960
    
    
    
    1,034
    
    
    
    
    
    
    
    
    
    
    
    Total operating revenue
    
    
    1,045,696
    
    
    
    1,234,127
    
    
    
    1,016,634
    
    
    
    1,150,200
    
    
    
    1,298,909
    
    
    
    166,538




---

|(1) |  | In this annual report on Form 20-F, we use the term fixed
telecommunications network services to refer to the services we provide
using the telecommunications network we began installing following receipt
of our fixed telecommunications network license in February 2000. These
services include the provision of dial-up and broadband Internet access,
local telephony services and pay-TV services.
|--- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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As of and for the year ended August 311999
    
    2000
    
    2001
    
    2002
    
    2003
    
    2003HK$
    
    HK$
    
    HK$
    
    HK$
    
    HK$
    
    US$(Amounts in thousands except per share data)Hong Kong GAAPCosts and expenses:Costs of services
    
    
    (643,672
    )
    
    
    (888,608
    )
    
    
    (584,352
    )
    
    
    (457,963
    )
    
    
    (322,753
    )
    
    
    (41,381
    )Sales and marketing expenses
    
    
    (160,230
    )
    
    
    (151,225
    )
    
    
    (86,574
    )
    
    
    (168,441
    )
    
    
    (182,471
    )
    
    
    (23,395
    )Other expenses
    
    
    (228,462
    )
    
    
    (355,767
    )
    
    
    (328,561
    )
    
    
    (434,711
    )
    
    
    (525,020
    )
    
    
    (67,315
    )Total operating costs
    
    
    (1,032,364
    )
    
    
    (1,395,600
    )
    
    
    (999,487
    )
    
    
    (1,061,115
    )
    
    
    (1,030,244
    )
    
    
    (132,091
    )Income (loss) from operationsInternational telecommunications
    
    
    65,939
    
    
    
    82,941
    
    
    
    146,611
    
    
    
    222,651
    
    
    
    340,523
    
    
    
    43,660Fixed telecommunications network
services
    
    
    (52,607
    )
    
    
    13,284
    
    
    
    (72,123
    )
    
    
    (121,686
    )
    
    
    (61,627
    )
    
    
    (7,901
    )Content and e-commerce
    
    
    
    
    
    
    (33,852
    )
    
    
    (10,968
    )
    
    
    
    
    
    
    
    
    
    
    13,332
    
    
    
    62,373
    
    
    
    63,520
    
    
    
    100,965
    
    
    
    278,896
    
    
    
    35,759Net income
    
    
    27,481
    
    
    
    70,001
    
    
    
    53,927
    
    
    
    91,129
    
    
    
    257,822
    
    
    
    33,056Net income per share (cents)
    
    
    6.8
    
    
    
    14.9
    
    
    
    11.0
    
    
    
    18.4
    
    
    
    46.7
    
    
    
    6.0Weighted average number of shares
    
    
    401,448
    
    
    
    468,946
    
    
    
    490,679
    
    
    
    495,181
    
    
    
    552,600
    
    
    
    552,600Diluted net income per share (cents)
    
    
    6.7
    
    
    
    14.6
    
    
    
    10.9
    
    
    
    16.1
    
    
    
    41.9
    
    
    
    5.4Diluted weighted average number of
shares
    
    
    409,724
    
    
    
    478,051
    
    
    
    494,449
    
    
    
    565,889
    
    
    
    615,102
    
    
    
    615,102Dividend per share (cents)
    
    
    4.5
    
    
    
    
    
    
    
    1.0
    
    
    
    
    
    
    
    12.5
    
    
    
    1.6


As of and for the year ended August 311999
    
    2000
    
    2001
    
    2002
    
    2003
    
    2003HK$
    
    HK$
    
    HK$
    
    HK$
    
    HK$
    
    US$(Amounts in thousands except per share data)U.S. GAAPTotal operating revenue
    
    
    1,045,696
    
    
    
    1,234,127
    
    
    
    1,016,634
    
    
    
    1,150,200
    
    
    
    1,298,909
    
    
    
    166,538Total operating costs
    
    
    (1,040,621
    )
    
    
    (1,398,325
    )
    
    
    (1,000,690
    )
    
    
    (1,082,655
    )
    
    
    (1,026,448
    )
    
    
    (131,604
    )Net income from continuing operations
    
    
    18,775
    
    
    
    69,237
    
    
    
    65,389
    
    
    
    69,317
    
    
    
    264,151
    
    
    
    33,868Net income from continuing
operations per share (cents)
    
    
    4.7
    
    
    
    14.8
    
    
    
    13.3
    
    
    
    14.0
    
    
    
    47.8
    
    
    
    6.1Net income/(loss) from discontinued
operations
    
    
    (2,509
    )
    
    
    (3,087
    )
    
    
    (11,423
    )
    
    
    (352
    )
    
    
    83
    
    
    
    11Loss arising from disposal of
discontinued operations
    
    
    0.0
    
    
    
    0.0
    
    
    
    0.0
    
    
    
    0.0
    
    
    
    (2,695
    )
    
    
    (346
    )Net loss from discontinued
operations per share (cents)
    
    
    (0.6
    )
    
    
    (0.7
    )
    
    
    (2.3
    )
    
    
    (0.1
    )
    
    
    (0.5
    )
    
    
    (0.06
    )Weighted average number of shares
    
    
    401,448
    
    
    
    468,946
    
    
    
    490,679
    
    
    
    495,181
    
    
    
    552,600
    
    
    
    552,600Diluted net income from continuing
operations per share (cents)
    
    
    4.6
    
    
    
    14.5
    
    
    
    13.2
    
    
    
    12.3
    
    
    
    42.9
    
    
    
    5.5Diluted net loss from discontinued
operations per share (cents)
    
    
    (0.6
    )
    
    
    (0.6
    )
    
    
    (2.3
    )
    
    
    (0.1
    )
    
    
    (0.4
    )
    
    
    (0.05
    )Diluted weighted average number of
shares
    
    
    409,724
    
    
    
    478,051
    
    
    
    494,449
    
    
    
    565,889
    
    
    
    615,102
    
    
    
    615,102Dividend per share (cents)
    
    
    5.0
    
    
    
    2.0
    
    
    
    1.0
    
    
    
    0.0
    
    
    
    12.5
    
    
    
    1.6


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As of and for the year ended August 311999
    
    2000
    
    2001
    
    2002
    
    2003
    
    2003HK$
    
    HK$
    
    HK$
    
    HK$
    
    HK$
    
    US$(Amounts in thousands except per share data)Consolidated Balance Sheet Data:Hong Kong GAAPTotal assets
    
    
    639,921
    
    
    
    1,221,050
    
    
    
    1,144,618
    
    
    
    1,327,285
    
    
    
    1,548,534
    
    
    
    198,543Total liabilities
    
    
    (371,822
    )
    
    
    (443,495
    )
    
    
    (328,905
    )
    
    
    (417,102
    )
    
    
    (364,085
    )
    
    
    (46,681
    )Net assets
    
    
    268,099
    
    
    
    777,555
    
    
    
    815,713
    
    
    
    910,183
    
    
    
    1,184,449
    
    
    
    151,862Minority interest
    
    
    
    
    
    
    (24,131
    )
    
    
    (10,407
    )
    
    
    
    
    
    
    
    
    
    
    Total shareholders equity
    
    
    268,099
    
    
    
    753,424
    
    
    
    805,306
    
    
    
    910,183
    
    
    
    1,184,449
    
    
    
    151,862Share capital
    
    
    40,350
    
    
    
    48,960
    
    
    
    49,107
    
    
    
    50,086
    
    
    
    60,496
    
    
    
    7,756Share premium
    
    
    161,603
    
    
    
    568,945
    
    
    
    569,180
    
    
    
    572,656
    
    
    
    615,886
    
    
    
    78,965Reserves
    
    
    66,146
    
    
    
    135,519
    
    
    
    187,019
    
    
    
    287,441
    
    
    
    508,067
    
    
    
    65,141Total shareholders equity
    
    
    268,099
    
    
    
    753,424
    
    
    
    805,306
    
    
    
    910,183
    
    
    
    1,184,449
    
    
    
    151,862U.S. GAAPTotal assets
    
    
    637,581
    
    
    
    1,224,445
    
    
    
    1,146,994
    
    
    
    1,329,707
    
    
    
    1,552,021
    
    
    
    198,990Total liabilities
    
    
    (366,762
    )
    
    
    (449,308
    )
    
    
    (333,476
    )
    
    
    (422,297
    )
    
    
    (369,359
    )
    
    
    (47,357
    )Net assets
    
    
    270,819
    
    
    
    775,137
    
    
    
    813,518
    
    
    
    907,410
    
    
    
    1,182,662
    
    
    
    151,633Minority interest
    
    
    
    
    
    
    (24,131
    )
    
    
    (10,407
    )
    
    
    
    
    
    
    
    
    
    
    Total shareholders equity
    
    
    270,819
    
    
    
    751,006
    
    
    
    803,111
    
    
    
    907,410
    
    
    
    1,182,662
    
    
    
    151,633Share capital
    
    
    40,350
    
    
    
    48,960
    
    
    
    49,107
    
    
    
    50,086
    
    
    
    60,496
    
    
    
    7,756Share premium
    
    
    162,578
    
    
    
    578,380
    
    
    
    578,799
    
    
    
    603,861
    
    
    
    615.886
    
    
    
    78,965Reserves
    
    
    67,891
    
    
    
    123,666
    
    
    
    169,305
    
    
    
    253,463
    
    
    
    506,280
    
    
    
    64,912Total shareholders equity
    
    
    270,819
    
    
    
    751,006
    
    
    
    803,111
    
    
    
    907,410
    
    
    
    1,182,662
    
    
    
    151,633


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As of and for the year ended August 31, 20031999
    
    2000
    
    2001
    
    2002
    
    2003Other Data:International Telecommunications SubscribersRegistered IDD Subscribers  Residential
    
    
    681,705
    
    
    
    842,000
    
    
    
    906,388
    
    
    
    1,056,759
    
    
    
    1,495,229Registered IDD Subscribers  Corporate
    
    
    36,716
    
    
    
    63,984
    
    
    
    76,067
    
    
    
    90,930
    
    
    
    93,959Registered IDD Subscribers  Total
    
    
    718,421
    
    
    
    905,984
    
    
    
    982,455
    
    
    
    1,147,689
    
    
    
    1,589,188IDD Outgoing Minutes (in 000s)
    
    
    301,500
    
    
    
    505,000
    
    
    
    580,000
    
    
    
    916,000
    
    
    
    888,000Registered Broadband Internet Subscribers
    
    
    
    
    
    
    2,850
    
    
    
    17,700
    
    
    
    129,300
    
    
    
    172,000Registered Fixed Lines (Local Telephony)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    21,800
    
    
    
    146,000


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.

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$1998
    
    
    7.7476
    
    
    
    7.7465
    
    
    
    7.7595
    
    
    
    7.73551999
    
    
    7.7591
    
    
    
    7.7460
    
    
    
    7.7758
    
    
    
    7.77402000
    
    
    7.7960
    
    
    
    7.8010
    
    
    
    7.7770
    
    
    
    7.79902001
    
    
    7.7997
    
    
    
    7.8004
    
    
    
    7.7970
    
    
    
    7.79802002
    
    
    7.7997
    
    
    
    7.8095
    
    
    
    7.7970
    
    
    
    7.7988August 2003
    
    
    7.7990
    
    
    
    7.7998
    
    
    
    7.7920
    
    
    
    7.7995September 2003
    
    
    7.7850
    
    
    
    7.7999
    
    
    
    7.7444
    
    
    
    7.7445October 2003
    
    
    7.7427
    
    
    
    7.7684
    
    
    
    7.7085
    
    
    
    7.7684November 2003
    
    
    7.7637
    
    
    
    7.7692
    
    
    
    7.7475
    
    
    
    7.7660December 2003
    
    
    7.7645
    
    
    
    7.7670
    
    
    
    7.7628
    
    
    
    7.7640January 2004
    
    
    7.7663
    
    
    
    7.7775
    
    
    
    7.7632
    
    
    
    7.77752004 (through February 24)
    
    
    7.7732
    
    
    
    7.7780
    
    
    
    7.7686
    
    
    
    7.7780




---

|(1) |  | The average of the noon buying rates on the last day of each month during
the relevant period.
|--- |  | ----------------------------------------------------------------------------------------------

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##### Table of Contents



Risk Factors

You should carefully consider the risks described below and the other
information in this annual report before deciding to invest in City Telecom.

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.

Our main competitors for international telecommunications, local telephony
and Internet services are PCCW-HKT Telephone Limited (PCCW-HKT), Hutchison
Global Communications Limited, New World Telecom Company Limited, Wharf T&T
Limited, iCable and Netvigator. These competitors are well established and
have substantially greater financial resources than we do. Some are
subsidiaries of business conglomerates in Hong Kong. Certain areas of the
international telecommunications and Internet 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 Markets.

The Hong Kong government has taken several steps over the past few years
to liberalize and deregulate the telecommunications industry in Hong Kong,
including issuing new wireless and wire-line fixed network 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 manner of issuing
network licenses, it no longer requires recipients of new fixed network
licenses to meet predetermined milestones or to post a performance bond to
support roll-out targets. In addition, as of February 2, 2004, 223 public
non-exclusive telecommunications service licenses (each a PNETS License) 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. They include Singapore Telecom from
Singapore, KDDI Corporation (KDDI) from Japan, British Telecom from the
United Kingdom, AT&T from the United States, and China Unicom and China Netcom
from the Peoples Republic of China (China). Increasing liberalization of
the international telecommunications market in Hong Kong may further attract
new local and foreign entrants to the market and broaden the variety of
international 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 number of companies that provide Internet services in Hong Kong has
grown from 56 in 1995 to 202 as of December 2003. Among the Internet service
licensees are such recognized foreign companies as MCI Worldcom, AT&T,
Singapore Telecom and KDDI. While most of these companies have not been
actively developing their Internet business in Hong Kong, they could pose a
significant threat to our
business if and when they commit substantial resources to doing so. In
addition, we compete with other

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integrated Internet service providers in Hong
Kong such as Netvigator, iCable and Hutchison. If we are not able to compete
successfully with them, our Internet business may not become profitable.

We Rely on Third Parties to Provide a Substantial Portion of Our
International Telecommunications and Internet Services. Our Transmission
Costs Could be Increased by Changes in Our Relationships with Them.

We depend on our contractual relationships with and the network
infrastructure of local network operators, such as PCCW-HKT, which own undersea
cables, and overseas telecommunications carriers in providing
telecommunications and Internet services to our customers. Some of these third
parties are our competitors in our telecommunications or Internet services, or
both. For the year ended August 31, 2003, payments to our top five overseas
carriers and local network operators accounted for approximately 77% of our
total gross costs of transmission. The terms and conditions of the local and
international arrangements currently in place could be subject to changes or
modification upon renewal of the terms 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 could increase
significantly.

If We are Unable to Continue to Lower Our Cost of Transmitting International
Calls, We May Not be Able to Maintain the Profitability of Our International
Telecommunications Service.

The international telecommunications industry in Hong Kong is extremely
competitive. To maintain or grow our market share, we must continue to offer
our subscribers international telecommunications services at or below the price
offered by our competitors. 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 cost levels.
If we fail to do so, our operating results could be adversely affected.

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
the Internet and international and local telecommunications businesses. As
part of this strategy, we have invested in undersea cables for Internet and
international telecommunications transmissions. In addition, we continue to
invest in the local fixed telecommunications network we use to deliver Internet
access, local telephony and pay-TV services. The deployment of these projects
has resulted and will result in greater 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;
| | - |  | ---------------------------------------------------------------------------------------------



| |  |  | 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
| | - |  | ------------------------------------------------------------------------------------------------------



| |  |  | maintain high traffic volume and offer competitive prices to
customers.
| | - |  | -----------------------------------------------------------------------

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| |  | Our failure to achieve any of the above in an efficient manner and at a
pace consistent with the growth of our business could have an adverse effect on
the quality of our services and increase our costs of operation.
| |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Our Fixed Telecommunications Network Business has Incurred Losses since
Inception and We Expect It to Incur Future Losses.

For the year ended August 31, 2003, we incurred an operating loss of
approximately HK$62 million from our fixed telecommunications network service
operations. While our financial performance is improving, 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 services, local telephony services and pay-TV services. We
cannot assure you that we will achieve or sustain profitability in our fixed
telecommunications network operations.

Because Some of Our Businesses are Still at an Early Stage of
Implementation, Evaluation of Our Business and Our Prospects is Difficult.

Because of the short operating history of our local telephony and our
pay-TV services, our historical financial data may not be a meaningful basis
for you to evaluate us and our prospects. These businesses 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.

Growth of Our Fixed Telecommunications Network Business Could be Adversely
Affected if Internet Usage in Hong Kong Does Not Continue to Increase.

Our business strategy in part depends on the number of Internet users in
Hong Kong increasing as well as increases in the types of products and services
that Hong Kong consumers rely on the Internet to provide. We cannot be certain
that Internet growth in Hong Kong will continue at as fast a rate as we expect.
If Internet usage fails to increase or evolves away from the products and
services we provide, the amount of revenues that we are able to derive from our
Internet business will be limited.

The Development of a Fixed Telecommunications Network and International
Transmission Facilities 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.

Since our application to provide wireless fixed network telecommunications
services was approved on February 3, 2000, we have been spending, and will
continue to spend, a significant amount on constructing base stations in
various key locations in Hong Kong, installing systems onto each connected
building and obtaining access rights to these buildings. We commenced the
installation of in-ground fibre optic cable in certain high-population density
areas in Hong Kong in January 2003, and we invested in two undersea cables as
part of our strategy to establish our own international transmission facilities
and limit our reliance on third party infrastructure. Finally, we have made,
and will continue to make, capital investments in the development of our local
telephony service and pay-TV service.

We incurred capital expenditures of approximately HK$250 million in fiscal
2003 and expect to incur capital expenditures of approximately HK$350 million
in fiscal 2004 and HK$200 million in fiscal 2005,
respectively, in connection with these projects and the development of our
business. If capital requirements vary materially from those currently
planned, we may require additional financing sooner

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than anticipated. While we
intend to fund such expenditures by using our currently available cash as well
as cashflow from operations, we may not have adequate capital to fund these
expenditures, in which case we may need to seek to raise additional capital
through debt or equity financing or other means. Any such additional equity
financing may be dilutive to our shareholders, 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.

PCCW-HKT has Applied to Become a Non-Dominant Carrier

In 2003, PCCW-HKT applied to OFTA for a declaration of non-dominance in
the markets for residential and business direct exchange line services. OFTA is
now holding various rounds of public consultation on this application. If this
request is granted by OFTA, tariff ceilings and various other controls that
currently apply to PCCW-HKT, as the dominant carrier, would no longer be
applicable. We anticipate this development will increase competition further
in an already competitive market, which may adversely affect our revenues and
profitability.

Internet Security Concerns Could Limit Our Ability to Develop Revenues from
Internet Access Services.

We hope to develop our Internet access services, particularly our
broadband Internet service, as a significant source of our revenue. However,
customers concerns over the security of confidential information and the
uninterrupted provision of Internet access service could limit our ability to
sustain or develop this business in the future. Furthermore, confidential
information and the provision of Internet access services could be affected by
computer viruses, break-ins and other inappropriate or unauthorized uses of our
network, such as e-mail spamming or junk e-mail. Computer viruses, break-ins
or other problems could have the following effects on our Internet business:



| |  |  | it could result in interruption, delays or cessation in
Internet access 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.

Our Pay-TV services may not become profitable, and may adversely affect
our operating results.

We began to produce, market and offer a pay-TV service via our fixed
telecommunications network in 2003. This service is currently comprised of (i)
a 24-hour news channel and other recreational channels that we produce, and
(ii) other channels whose content is purchased 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.

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Expanding Our Local Telephony and Pay-TV Services Will Require Us to Expend
Financial and Administrative Resources. We May Not be Able to Successfully
Compete Against Hong Kongs Existing Local Telephony and Pay-TV Providers.

As part of our plan to expand the fixed telecommunications network
services that we provide, we began offering local telephony services in April
2002 and pay-TV services in August 2003 through Hong Kong Broadband Network
Limited (HKBN). We have limited experience in offering these services and we
may experience problems with the roll-out that we do not currently anticipate.
These problems could cause our expenditures to be greater than we expect, could
delay the installation of the required equipment, or otherwise limit our
ability to add local telephony and pay-TV subscribers. Further, we will be
required to devote considerable managerial and technical resources to this
roll-out in order to successfully develop competitive local telephony and
pay-TV services. Allocation of financial, managerial and technical resources
to develop our local telephony and pay-TV services will reduce the resources we
might otherwise devote to Internet access or our other services.

There are currently a number of local telephony providers in Hong Kong,
including PCCW-HKT, New World Telecom Company Limited and Hutchison Global
Communications Limited, among others, that have more experience at providing
these services. We cannot be sure that our services will be able to compete
effectively against the more established local telephony providers. If we are
not able to successfully build market share in local telephony, our ability to
generate profit from this business will be limited.

There are currently five pay-TV operators in Hong Kong, most notably Cable
TV and Now Broadband TV, that have more experience at providing these services.
We cannot ensure that our services will be able to compete effectively against
them. If we are not able to successfully build market share in pay-TV, our
ability to generate profit from this business will be limited.

We Depend on Key Personnel and the Quality of Our Management Would be
Affected by the Loss of Their Services.

Competition for qualified employees and personnel in the
telecommunications and Internet services industry is intense and there are a
limited number of Chinese-speaking professionals with knowledge of and
experience in these industries. Our success depends to a significant degree
upon our ability to attract and retain qualified management, technical,
marketing and sales personnel and upon the continued contributions of such
management and personnel. 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 their unique services.

We are Involved in Several Legal Proceedings That, if Decided Unfavorably to
Us, Could Adversely Affect Our Profitability

We are currently involved in a number of legal proceedings in Hong Kong.
If these proceedings are resolved in a manner adverse to City Telecom, our
business and profitability could be harmed. The most significant proceedings
are:



| |  |  | A case in which the plaintiff alleges that we were not
entitled to delivery fees and were liable for interconnection fees,
totaling approximately HK$96,400,000, pursuant to a carrier services
agreement and a telecommunications service agreement between City
Telecom and the plaintiff.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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| |  |  | A case 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 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$3,600,000.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

In each of the proceedings mentioned above, we are vigorously defending
City Telecom 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.

We have more fully set forth the facts and current status of these
proceedings in this annual report under the heading Item 8 Financial
InformationLegal Proceedings.

Risks Relating to Our Technological Infrastructure

Slow System Performance 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. Our ability to
increase our handling capacity, and increase the networks performance, will
depend upon:



| |  |  | the successful expansion of our own local fixed network, and
| | - |  | ------------------------------------------------------------



| |  |  | our ability to secure more leased lines from PCCW-HKT and/or other network operators.
| | - |  | -------------------------------------------------------------------------------------

We cannot be sure that we will be able to increase the performance of our
Internet system. If we do not, our customers may subscribe to other Internet
access services provided by our competitors.

If We Experience System Failure or Shutdown in Communications Networks, We
May Not be Able to Deliver Our Services.

Connections for our international telecommunications, local telephony,
Internet and pay-TV services are carried through the circuits of local fixed
network operators or privately leased lines from PCCW-HKT, international cable
lines, our own switching systems and other network related infrastructure. Our
provision of such services depends largely on the stability of this network,
portions of which are outside of our control. The network may be vulnerable to
damage or interruptions in operation due to fire, power loss,
telecommunications failures, network software flaws, virus attacks,
transmission cable cuts and similar events. In general, any failure of our
network, our servers, or any link in the delivery chain that results in an
interruption in our operations, whether from operational disruption, natural
disaster or otherwise, could damage our reputation, reduce our ability to
attract and retain subscribers and adversely affect our results of operations.

Our local telephony service uses voice-over-Internet-protocol technology.
We believe that we are one of the first companies to offer local telephony
using this technology in Hong Kong. As a result, we may experience problems
achieving the level of quality that consumers expect from local telephony
service. If technical or other problems cause our local telephony service to
fall below customers expectations, we

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may not be able to achieve the
subscriber targets that we have set, or operate this segment of our business
profitably.

We Will be Limited in Our Ability to Expand Our Telecommunications Business
Unless We Obtain Additional Network Capacity.

Following network upgrades completed in fiscal 2003, our international
telecommunications network has the capacity to handle monthly traffic of
approximately 150 million minutes. Our ability to continue to increase traffic
volume depends on our ability to expand the network on a timely basis, which in
turn is subject to:



| |  |  | the availability of international leased lines from PCCW-HKT
or other international carriers at favorable rates; and
| | - |  | --------------------------------------------------------------------------------------------------------------------



| |  |  | the development of our own telecommunications facilities.
| | - |  | ---------------------------------------------------------

If we fail to increase the capacity of our telecommunications network, our
ability to increase our international 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.

Internet 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, such as replacement of traditional fixed line home
telephones with mobile telephones, could have an adverse effect on the services
we currently offer. 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.
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 responding to these changes or
in continuing to offer the products and services demanded by our customers.

Environmental Factors in Hong Kong Could Limit Our Ability to Make a Profit
on Wireless Internet Services.

Wireless transmission of information is subject to environmental
influences, which could increase our costs of 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.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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Each of these factors may cause us to install a larger number of antennas
than we anticipate to provide quality service over our coverage areas.
Installation of a greater number of antennae than we plan for could
considerably increase our costs and affect the profitability of providing
wireless services.

Risks Relating to the Regulatory, Political and Economic Environment

Our Revenues May be Adversely Affected by Increases in Tariffs Mandated by
the Chinese Government.

Chinas Ministry of Information Industry (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 were based, among other things, on the tariffs determined by
these agencies with respect to the calls our subscribers make to persons in
China. In October 2002, the MII substantially increased one of these tariffs,
the termination rate for incoming telephone traffic from all countries and
regions into China, as of November 1, 2002. 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. The MII may make additional changes
to termination rates and related tariffs in the future, which we would expect
to affect the costs of termination and the rates we charge our customers for
calls into China. We cannot predict the timing, likelihood or magnitude of
this, or any other tariff adjustment generally; 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 for calls into China, reduce
our revenues and adversely affect our business and results of operations.

Our Revenues May be Adversely Affected by the Trend of Increases in
Tariffs.

Following the China termination rate increase that occurred in November
2002, Philippines-based carriers raised their inbound termination rates. Some
European mobile carriers have also made such
increases in recent years, and other international carriers may follow these
examples by raising their inbound termination rates. The effects of such
increases are somewhat hard to predict, but if we are unable to pass the
increased charges onto our customers, it would have an adverse effect on our
profit margins.

We Require Licenses From OFTA 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 are able to provide international telecommunications services pursuant
to a public non-exclusive telecommunications license for external
telecommunications service operators issued by the Office of Telecommunications
Authority (OFTA) on November 10, 1998. Our dial-up Internet services operate
under a PNETS license for international value-added network service operators,
issued by OFTA on December 7, 1993 and amended to include Internet services in
1998.

Our subsidiary, HKBN, launched our broadband Internet service pursuant to
a wireless fixed telecommunications network services license (FTNS License)
awarded in February 2000 by OFTA. We operate our satellite base station
pursuant to a fixed carrier license, valid for 15 years, that was granted by
OFTA in May 2001. This license was upgraded to a cable-based External Fixed
Telecommunications Services License in March 2002. HKBNs wireless FTNS
License was modified to include wireline-based fixed telecommunications network
services in April 2002 by OFTA and to include external

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telecommunications
services based on an external cable network or a non cable-based external
network in May 2003. Each of these licenses is subject to OFTAs review
annually.

OFTAs failure to renew or its revocation of any of these licenses would
have a significant adverse impact on our future growth and profitability. In
addition, future changes in Hong Kongs telecommunications and Internet
regulations or policies could have an adverse impact on our operations.

PCCW-HKT May Not Refund to Us a Portion of Our Expected Refunds of Universal
Services Contributions.

Pursuant
to the terms of the Statement on Universal Services Contribution  Confirmed Level for 2000 and Provisional Level on and after January 1, 2001,
and Confirmed Level for 2001 and Provisional Level on or after July 1, 2003
issued by OFTA on November 30, 2002 and October 20, 2003, respectively, we are
entitled to receive a provisional refund in respect of the period from January
1, 2002 to June 30, 2002 in the sum of approximately HK$16 million. However,
this refund remains a provisional amount; thus, were PCCW-HKT to dispute the
amount of the refund, OFTA could determine that we are only entitled to a
refund of a lesser amount, or to no refund at all, which would adversely affect
our financial position for fiscal 2004. For an explanation of universal
services contributions, please see Item 5 Operating and Financial Review and
Prospect  Overview  Our Expenses  International Telecommunications.

Fluctuations of the Hong Kong Dollar May Increase Our Operating Costs.

A major portion of our operating costs are 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. Any depreciation of the Hong Kong dollar, against the U.S. dollar
or other currencies, would increase our operating costs and adversely affect
our profitability.

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.

The Majority of Our Cash Deposits are in U.S. dollars.

Approximately 80% of our cash deposits are in U.S. dollar time deposits.
The value of such deposits in relation to many currencies has dropped
considerably in fiscal 2003. We cannot predict the future movements in the
U.S. dollar relative to other currencies, nor can we be certain that we will be
able to convert our U.S. dollars into HK dollars or other currencies at
favorable rates in the future.

The State of Hong Kongs Economy May Affect Our Profitability.

As we are principally engaged in the provision of international
telecommunications, local telephony and Internet services in Hong Kong, our
financial position and the results of our operations will be affected

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by the
conditions of the telecommunications and the Internet markets in Hong Kong,
which may in turn be influenced by the general state of the Hong Kong economy.
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.

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
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.

You May Have Difficulty Enforcing Judgments Against Us or Our Management.

City Telecom is incorporated in Hong Kong. All of City Telecoms
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 Hong Kong courts 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.

Risks Relating to the Shares and the American Depositary Shares

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 ranged
from HK$0.420 to HK$8.950. Our share price and the price of the 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;
| | - |  | -----------------------------------------------------------------------

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| |  |  | 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 January 31, 2004, we had 610,539,693 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. 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.

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ITEM 4. INFORMATION ON THE COMPANY

City Telecoms History and Development

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, pay-TV and other fixed
telecommunications network services in Hong Kong. We believe that one of our
most important competitive strengths 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 major events of our history and
development have been:



| |  |  | 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.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | In May 1993, we obtained a PNETS License.
| | - |  | -----------------------------------------



| |  |  | 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 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 OFTA for the provision of
virtual private network services, catering to the needs of
multinational corporations.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | In August 1997, we completed the initial public offering of
our shares, which were listed on the Stock Exchange of Hong Kong.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------



| |  |  | 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 November 1998, PCCW-HKT lost its monopoly over voice
transmission using international simple resale. That same month we
became the first Hong Kong company to obtain a public, non-exclusive
telecommunications service license covering the provision of
international telecommunications services using international simple
resale.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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| |  |  | In January 1999, we launched a new direct calling service for
our international telecommunications operations with the access
number 1666, supported by the international simple resale
arrangement.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | In July 1999, we began offering free Internet access to new
subscribers.
| | - |  | ------------------------------------------------------------------------



| |  |  | In August 1999, we launched iChannel, one of the first
multimedia channels on the Internet catering to Chinese Internet
users globally.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------



| |  |  | In November 1999, we successfully completed a global offering
of shares and listed our American depositary shares on the Nasdaq.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------



| |  |  | In February 2000, HKBN, our wholly owned subsidiary, obtained
a wireless fixed telecommunications network services license from
the OFTA.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------



| |  |  | In March 2000, KDDI Corporation, formerly known as KDD
Corporation, purchased a 15% stake in HKBN, forming a strategic
partnership with HKBN to develop our wireless broadband network. In
the same month, HKBN launched its wireless broadband Internet access
services and network in Hong Kong.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | In May 2001, the OFTA awarded us a satellite-based fixed
carrier license.
| | - |  | -------------------------------------------------------------------------



| |  |  | In January 2002, pursuant to a rights issue by HKBN, we
subscribed for shares sufficient to increase our beneficial interest
in HKBN to approximately 96%.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | In March 2002, we were awarded a cable-based external FTNS
license. In the same month, we bought KDDI Corporations remaining
4% stake in HKBN, making HKBN our wholly owned subsidiary.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | In April 2002, HKBN became a wireline-based FTNS licensee and
officially launched its fixed line local telephony services in Hong
Kong.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------



| |  |  | In May 2002, we started operation of our Asia-Pacific Cable
Network 2 (APCN 2) and Japan-U.S. undersea cables for
international calls and broadband Internet access.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | In June 2002, we launched a new access number 0030 under
HKBN for our international telecommunications services, which offers
international direct dialing at competitive calling rates.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | In July 2002, we established a subsidiary in Guangzhou, China
to provide back office customer support services.
| | - |  | ---------------------------------------------------------------------------------------------------------------



| |  |  | 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 August 2003, HKBN officially launched its pay-TV service.
| | - |  | ------------------------------------------------------------

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Business Overview

We provide international telecommunications, local telephony, Internet and
pay-TV services in Hong Kong. We were incorporated in 1992, following the Hong
Kong Governments decision to introduce competition into Hong Kongs local and
international telecommunications markets. Since our incorporation, we have
aggressively marketed our brand name and the services that we provide to
capitalize on the growth, deregulation and profitability of the Hong Kong
telecommunications market.

We believe that we benefit from several key competitive strengths that
will drive our continued growth:



| |  |  | Market position.We are one of the largest providers of
international telecommunications and Internet services in Hong Kong.
Our large subscriber base enables us to reduce the per-subscriber
costs associated with providing our services and will enhance our
ability to enter into favorable arrangements with network equipment
providers and operators;
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Innovative management team/strong research and development
staff.Our management team has demonstrated its ability to quickly
capitalize on developments in the Hong Kong regulatory environment
which allow us to expand our service offerings. Our experienced
research and development personnel provide us with the technological
expertise to continually expand our product range and improve the
quality and reliability of our services;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Metro Ethernet broadband network.Our broadband network
deploys Metro Ethernet technology provided by Cisco Systems, and
covers approximately 60% of Hong Kongs population, including much
of its most densely populated areas. This technology is highly
scalable, and has allowed us to add local telephony as well as
pay-TV services over our fixed telecommunications network without
incurring the large capital expenditures and costs often associated
with providing such services;
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Brand name recognition.We have an established brand name
that is identified with high-quality and competitively priced
telecommunications and Internet services in Hong Kong; and
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Aggressive marketing team.Our established distribution
network of promoters, sales agents and retail stores, together with
our own experienced sales force, enable us to reach a wide customer
base;
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

We believe our operating efficiency and cost controls resulted in
favorable operating results in fiscal 2003, despite the competitive environment
in Hong Kongs telecommunications market. While our international
telecommunications revenues declined slightly, our fixed telecommunications
network service revenues increased significantly.

In 2003, expansion of our fixed telecommunications network services
business was our principal focus. By using aggressive marketing strategies,
frontline telemarketing and active promotion teams, we acquired new customers
for both broadband Internet access and local telephony services, particularly
with residential customers. We also established a presence in the corporate
sector.

We have largely completed the development of our network infrastructure
and achieved a goal set last year of extending our network coverage to 1.2
million home-passes and 550 commercial buildings. In
order to further our ability to deliver comprehensive telecommunications
services, we continue to expand our own fibre backbone, which connects
buildings and areas currently covered by our cable system.

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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 31,2001
    
    2002
    
    2003HK$
    
    HK$
    
    HK$RevenueInternational telecommunications services
    
    
    861,338
    
    
    
    908,981
    
    
    
    875,802Fixed telecommunications network services(1)
    
    
    154,262
    
    
    
    241,219
    
    
    
    423,107Content and e-commerce
    
    
    1,034
    
    
    
    
    
    
    
    Total operating revenue
    
    
    1,016,634
    
    
    
    1,150,200
    
    
    
    1,298,909




---

|(1) |  | Includes internet access, local telephony services since April 2002 and
pay-TV services since August 2003.
|--- |  | ----------------------------------------------------------------------------------------------------------

International Telecommunications Service

We were among the first companies to be granted a PNETS license by the
OFTA to provide international calling card service in Hong Kong. Since we
first began providing international telecommunications services in 1992, we
have greatly expanded our range of products and services. We now offer a
variety of international direct dial services to our customers at competitive
rates. We believe that our ability to deliver a range of services with varying
features that cater to different customer needs has been one of the key factors
of our success.

We currently offer to our customers the following international
telecommunications products:

Product
    
    DescriptionIDD 1666.
    
    Provides subscribers with international direct dial using the access number 1666 in Hong KongIDD 0030.
    
    Provides subscribers with international direct dial using the access number 0030 in Hong Kong888 International Calling Card
    
    Allows cardholders to place international calls from Hong Kong and 30 other locations.GlobaLink International Calling Card
    
    Offers a convenient prepaid calling card to users that allows them to place international calls.Mobile Call Forwarding Services
    
    Allows call forwarding of HK mobile numbers so that subscribers can
receive calls while overseas.


We aggressively price and market our telecommunications products to
increase our market share and build our brand name awareness as one of Hong
Kongs leading telecommunications companies. In fiscal 2002, we achieved a
large increase in total international telecommunications traffic, which grew to
915.9 million minutes from 579.9 million minutes in fiscal 2001. In fiscal
2003, however, we made the strategic decision to focus more on our
profitability, and therefore maintained our pricing at levels higher
than the prices offered by certain of our competitors. As a result, our
traffic dropped to 880.0 million minutes in fiscal 2003. Similarly, our market
share grew from 20% in fiscal 2001 to 24% in fiscal 2002, but dropped slightly
to 22% in fiscal 2003. At present, our long distance call rates are comparable
to those quoted by

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the other four major local fixed network operators and other
telecommunications providers for transmissions originating in Hong Kong to many
destinations, such as the United States, Canada, the United Kingdom and China.

Our international telecommunications customer base consists of a mix of
residential and corporate subscribers. While we continued to focus on the
residential sector in 2003, and achieved success with our IDD 0030
international calling service, we have also emphasized the development of our
corporate customer services. As of August 31, 2003, our registered customer
base had increased by 38% to 1,589,188 compared to August 31, 2002. The
following table shows the composition of our international telecommunications
subscribers over the past five years:

As of August 31,Type of Subscriber(1)
    
    1999
    
    2000
    
    2001
    
    2002
    
    2003Residential
    
    
    681,705
    
    
    
    842,000
    
    
    
    906,388
    
    
    
    1,056,759
    
    
    
    1,495,229Corporate
    
    
    36,716
    
    
    
    63,984
    
    
    
    76,067
    
    
    
    90,930
    
    
    
    93,959Total
    
    
    718,421
    
    
    
    905,984
    
    
    
    982,455
    
    
    
    1,147,689
    
    
    
    1,589,188




---

|(1) |  | Subscribers refer to international telecommunications customers that have
submitted complete application materials to us and therefore have a valid
account. Subscribers may or may not be active users of our services.
|--- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Competition

PCCW-HKT, Hutchison Global Communications Limited, New World Telecom
Company Limited, and Wharf T&T Limited are the main competitors in our
international telecommunications business. As in previous years, City Telecom
experienced fierce price competition in Hong Kong during fiscal 2003. This
competition was particularly affected by price reductions offered by the
dominant telecommunications companies. We expect this price competition to
continue into fiscal year 2004. In order to maintain our market share and high
traffic volume, we have significantly reduced some of our international
telecommunications rates and introduced new marketing and promotional offers
from time to time. 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 back office supporting services, and
developing our own international telecommunications infrastructure. Further,
during most of 2003, we benefited significantly from increasing liberalization
and price competition among leased line providers in China, which lowered the
prices we pay to connect our subscribers calls to destinations in China. For
these reasons, despite continuing price competition, we achieved a reasonable
gross profit margin in our international telecommunications operations.
However, recent developments in China have affected our margins for some calls.
Please see the discussion in Item 3 Key Information  Risk Factors  Risks
Relating to the Regulatory, Political and Economic Environment  Our Revenues
May be Adversely Affected by Increases in Tariffs Mandated by the Chinese
Government.

Customer Retention

We have two customer service teams that monitor the usage patterns of our
corporate and residential customers, respectively. Members of these teams
telephone customers when our records indicate a significant decline in
telecommunications usage by such customers. During the call, they attempt to
determine a reason for the decline, and learn about the customers perception
of our call quality, prices,
and general level of customer service. We seek to address any concerns that
the customer raises and return the account to previous usage levels.

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We offer customized special discounts to corporate subscribers. In
addition, we maintain a price guard program for our residential subscribers
whereby, for a premium charged monthly, the monthly telecommunications fees we
charge our subscribers that join the program will be the lowest among the other
four major fixed network operators in Hong Kong, subject to the terms of the
program. To foster loyalty among our existing subscribers and increase our
subscriber base, we occasionally give out gift items and free international
calling minutes for subscribers who maintain certain usage levels or refer our
services to new customers.

Telecommunications Network

Our telecommunications network currently has a monthly handling capacity
of approximately 150 million minutes. We believe that the continuing
improvement of our telecommunications network is important in supporting the
growth in our subscriber base and the expansion of our range of services. To
help us accomplish this goal, we continued to upgrade our telecommunications
network in fiscal 2003 and plan to continue making further upgrades in fiscal
2004.

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; and
| | - |  | --------------------------------------------------------------------------------------------------



| |  |  | 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.

There are four ways of connecting calls under the international simple
resale arrangement:



| |  |  | Direct Exchange of Traffic
| | - |  | --------------------------

We connect calls with the direct exchange of traffic method utilizing
both our own underseas cables, whereby we deliver calls directly to
overseas telecommunications companies, and the international transmission
circuits we lease from either PCCW-HKT or other overseas
telecommunications providers at a fixed monthly rate to deliver such
calls. We currently have bilateral or servicing agreements with major
telecommunications providers in Canada, China, Japan, Macau, Singapore,
Taiwan, Thailand, the United Kingdom and the United States. Under these
agreements, we have agreed to deliver each others outbound international
calls to the
ultimate end users at their location. We refer to this delivery as call
termination. In the majority of these agreements, a monthly settlement
payment is owed by the party whose outbound international traffic minutes
are greater during the month than the inbound international traffic
minutes received from the other party.

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| |  |  | Re-routing of Traffic
| | - |  | ---------------------

For connections to call destinations where we cannot use our undersea
cables and do not have bilateral or servicing agreements or switching
systems in place, we have two ways of re-routing traffic through our
arrangements with overseas carriers. The overseas carriers can
re-transmit calls from our switching systems in Canada or the United
States. Alternatively, the overseas carrier can re-transmit calls from a
country in which we have a bilateral agreement. For such calls, we pay
interconnection charges to these overseas carriers.



| |  |  | Resale of Traffic
| | - |  | -----------------

We also deliver our traffic to overseas switches through facilities
operated by other Hong Kong local fixed network operators when these
operators can deliver the call to the foreign destination for a price
lower than our current rate or when our primary transmission method lacks
capacity. In this case, we pay the local fixed network operators for
access to their systems to connect to the international switches and
deliver the call to the destination.



| |  |  | Direct Delivery of Traffic to Local Points-of-Presence for
Overseas Carriers
| | - |  | ----------------------------------------------------------------------------

Many overseas carriers have begun building points-of-presence in Hong
Kong. This allows us to deliver our traffic for certain overseas
destinations directly to the appropriate local point-of-presence for the
relevant overseas carrier. These carriers provide their own
international facilities back to their home countries. This direct
delivery method achieves savings in the International Private Leased
Circuit (IPLC) cost and better service quality with a direct connection.

Interconnection Arrangements

We have entered into interconnection arrangements with local fixed network
providers in Hong Kong and overseas carriers to transmit calls between Hong
Kong and overseas destinations. 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 interconnection 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. We negotiate the
interconnection charges we pay with the overseas carriers, and the
interconnection charges vary from one overseas carrier to another. All of the
interconnection charges we pay to local fixed network operators and overseas
carriers 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 dollars and substantially all the interconnection charges we pay to
overseas carriers are denominated in United States dollars.

For the year ended August 31, 2003, payments to our top five local fixed
network operators and overseas carriers represented approximately 77% of our
total gross transmission costs.

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International Telecommunications Switching Systems

We own three international telecommunications switching systems in Hong
Kong and two in Canada (one each in 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 NortelNetworks switching
equipment and compression units supplied by Cisco Systems and ECI. 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.

Monitoring

To ensure reliability of our telecommunications network, our
monitoring system involves:



| |  |  | back-up systems for all of our switches;
| | - |  | ----------------------------------------



| |  |  | 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 pagers;
| | - |  | -----------------------------------------------------------------------------------------------



| |  |  | 24-hour system administration services; and
| | - |  | -------------------------------------------



| |  |  | a 24-hour stand-by team for emergencies.
| | - |  | ----------------------------------------

External Facilities Development

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 (APCN 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 call and broadband Internet services.

In April 2002, HKBNs original wireless FTNS License was upgraded to
include wire-line based fixed telecommunications network services. In May
2003, this license was further amended to include external telecommunications
services based on external cable networks or non-cable based external networks.
This license allows us to develop our own fibre-based backbone for our fixed

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telecommunications network. Generally, fibre-based backbones offer certain
advantages over wireless systems, such as higher capacity, that are beneficial
in areas of high population density. We therefore commenced installation of
our fibre-based backbone in certain densely populated areas which we will use
to supplement or replace our existing wireless/leased wireline backbone in
these areas. We believe this fibre-based backbone will allow us to achieve
cost savings and provide additional capacity for further growth.

In January 2000, we were granted a letter of consent by the OFTA to
construct and operate our own satellite earth station, and we were awarded a
satellite-based fixed carrier license by the OFTA in May 2001. Construction of
the base station started in the fourth quarter of 2000 and was completed in May
2001 at a total cost of approximately HK$7.0 million. We also entered into an
agreement with COMSAT World Systems, an international satellite services
company, to lease transponder space on its satellite for use in connection with
the operation at our earth station. The earth station provides significant
additional international transmission capacity that we now use as back-up for
telecommunications and Internet traffic when our traditional transmission
methods do not have adequate capacity or experience technical problems.

Our undersea cables, our back-up satellite base station, and our
fibre-based fixed telecommunications network backbone enable us to better
control international transmission speed and quality, and reduce the costs
associated with international transmission and our reliance on third party
infrastructure.

Fixed Telecommunications Network Services

Internet Access

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. We expanded our registered subscriber base to
approximately 185,000 broadband subscribers as of January 31, 2004.

We currently offer three types of Internet access service:



| |  |  | broadband Internet access;
| | - |  | --------------------------



| |  |  | 56k dial-up Internet access; and
| | - |  | --------------------------------



| |  |  | Internet access via Megalink / Mega-access.
| | - |  | -------------------------------------------

Broadband Internet Access

In February 2000, we were awarded a wireless FTNS License by OFTA to
provide fixed network services in Hong Kong using wireless technologies such as
local multi-point distribution systems.
Following the receipt of this license, we launched our broadband Internet
services in March 2000 through our subsidiary HKBN.

We currently provide broadband Internet access to our residential and
corporate customers at access speeds of up to 10 Mbps. As of January 31, 2004,
our registered broadband customer base consisted of approximately 185,000
users. We are continuing to expand the coverage of our fixed
telecommunications network and currently provide broadband Internet access to
approximately 1.2 million home-passes, representing approximately 60% of Hong
Kongs households.

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As of January 2004, we offered a basic broadband Internet service plan to
residential customers with unlimited Internet usage for a monthly fee of HK$96.

All broadband packages offer a free e-mail service that provides up to 10
megabytes of memory. 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, 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.

To provide broadband access, our base stations transmit information via
microwaves to antennas placed on the roof of each building. Accordingly,
securing access rights for our microwave transmission dishes and relevant
equipment and cable systems is a crucial step in the development of our fixed
telecommunications network. We attempt to select buildings near high-density
population areas on which to locate base stations to maximize the number of
customer buildings that will have line of sight to the base station. From the
rooftop transmission dishes, the signal is transferred via fibre cable to a
router, which then directs information to individual households or offices via
cable system that we have installed within the building.

In January 2003 we began to install our own fibre-based backbone to
replace the existing wireless/leased wireline-based backbone in some locations.
Thus far, we have installed fibre-based backbone in areas that include
approximately 200,000 home-passes. We select locations based primarily on
their relative population density, as we believe that installing our own
fibre-based backbone will increase our capacity to handle the high traffic
volume in such locations. We intend to continue to make such replacements in
locations where we deem the population density sufficiently high to make such
replacements cost-effective. As an interim measure, we are currently leasing
asynchronous transfer mode, or ATM, lines from PCCW-HKT, among others, in a
small number of locations to provide transmission services until we complete
construction of our own transmission facilities.

We spent approximately HK$440 million in fiscal 2002 and HK$229 million in
fiscal year 2003, and plan to further spend approximately HK$350 million in
fiscal 2004 to upgrade our network to provide local telephony and pay-TV
services, and expand our fibre-based backbone. Notably, HKBN has been able to
use our growing knowledge in developing the network infrastructure to
continuously decrease the per home-pass amount of equipment and expense
necessary to provide broadband service, which has led to considerable savings.

Dial-up Internet Access

In addition to our broadband Internet access services, we currently
provide 56K dial-up Internet access for residential subscribers. Our basic
Internet package provides subscribers with unlimited Internet usage for a
monthly fee of HK$68. The basic package also provides a number of features
including easy to use Internet access software, e-mail and web-browsing, fax to
e-mail/e-mail to fax services, personal homepage hosting and international
roaming. We also offer an Internet package to customers in which subscribers
are billed HK$4 per hour of Internet usage, with a maximum monthly charge of
HK$108. This hourly package also provides the same additional features as our
basic Internet package.

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While our dial-up Internet access business remains a source of revenues,
we currently are focusing our marketing efforts on our high-speed broadband
service.

Data transmission for our dial-up Internet subscribers is carried through
local circuits of fixed network operators to and from our two operations
centers in Hong Kong. Upon arrival at our operations centers, modems direct
data transmission to a number of Internet servers that organize and process the
data. After the data is processed in the Internet server, it is forwarded to
our switching systems for direction into the appropriate local or international
leased circuits.

Internet access via Megalink / Mega-access

In addition to broadband and dial-up access, we offer our corporate users
Internet access via resales of PCCWs Megalink / Mega-access services. We
offer prepackaged plans that provide access at speeds between 1.5Mbps to
6.0Mbps and, like our broadband offerings, include on-site training, on-site
maintenance support, high capacity data transfer and e-mail services.
Corporate customers pay a fixed monthly rate, which varies from HK$218 to
HK$4,850 based on factors such as type of line, access speed, the number of
users and amount of usage that we provide.

Competition

The principal competitors of our Internet access business are Netvigator,
provided by PCCW-HKT and iCable.

Reliability

To ensure reliability and speed, our Internet monitoring system involves:



| |  |  | backup systems for critical software and hardware components;
| | - |  | -------------------------------------------------------------



| |  |  | individual self-reporting mechanisms for all essential servers;
| | - |  | ---------------------------------------------------------------



| |  |  | scheduled performance tests on all network infrastructure;
| | - |  | ----------------------------------------------------------



| |  |  | 24-hour system administration services; and
| | - |  | -------------------------------------------



| |  |  | a 24-hour stand-by team for emergencies.
| | - |  | ----------------------------------------

Local Telephony

In April 2002, we began the installation of our local telephony services
in Hong Kong. To provide local telephony service, we install IP-based voice
switching equipment in locations already wired with our broadband network.
Voice signals are transmitted by the voice-over-IP switches into the cable
system installed in the subscribers building. As the capital cost for the
installation of voice-over-IP switches is not significant, the scalability of
our broadband network allows us to provide new services over existing
infrastructure with only minimal additional capital expenditure. Currently,
the cost to install the equipment needed to provide local telephony services
using voice-over-IP averages approximately HK$600 per subscriber. In addition,
we now install such voice switching equipment together with our new
installations of broadband equipment in some buildings. We expect a full
roll-out of this service to be completed by the end of 2004.

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As of January 31, 2004, we had over 182,000 local telephony lines
installed. We currently charge HK$78 per month for our basic local telephone
services plan, and we offer a number of value added services, including call
waiting, caller display, conference call and block-the blocker services, for an
additional HK$20 per month. We also began providing local telephony services
to our corporate customers and had over 10,000 lines installed as of January
2004.

Research and Development Activities

We commit considerable resources to our research and development
department in order to continuously improve our products and services and
improve our market position. Our research and development expenditures were
approximately HK$2,971,000, HK$2,166,000 and HK$2,622,000 for the years ended
August 31, 2001, 2002 and 2003 respectively.

As of January 31, 2004, our research and development department in Hong
Kong consisted of six staff members experienced in systems design, engineering,
telecommunications and computer programming. It has primary responsibility for
assessing new services offered by telecommunications and Internet companies in
the United States and elsewhere. Where products or services are identified
that we should consider offering to our subscribers, the research and
development department brings these products and services to the attention of
management. It may also prepare preliminary feasibility reports and perform
testing and servicing functions.

To identify and develop new market opportunities, the research and
development department works closely with our marketing department, which
regularly provides up-to-date market information and monitors customer demand
and sales. In connection with their established relationships with various
manufacturers of telecommunications equipment, our research and development
staff attend conferences where industry professionals discuss new
telecommunications technologies and trends.

Sales & Marketing

Our primary marketing goal is to further City Telecoms brand name as one
of Hong Kongs leading telecommunications companies, and build HKBNs brand
name as a leading Internet and pay-TV 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 subscribers
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
continue to make 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.

For the years ended August 31, 2001, 2002 and 2003, our marketing expenses
amounted to approximately HK$86,574,000, HK$168,441,000 and HK$182,471,000
respectively, representing approximately 8.5%, 15% and 14% of our total
revenue, respectively. The majority of our marketing activity in fiscal 2003
was directed at promoting our local telephony services.

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. Our residential sales force for selling our
international telecommunications services and Internet services consists of:



| |  |  | 380 commission-based agents responsible for on-the-street and door-to-door sales;
| | - |  | ---------------------------------------------------------------------------------

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| |  |  | 780 full-time telemarketing staff; and
| | - |  | --------------------------------------



| |  |  | 180 contract telemarketing staff.
| | - |  | ---------------------------------

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 24 months. We have also greatly
benefited from our use of on-the-street and door-to-door sales agents who
meet Hong Kong residents in popular outdoor shopping areas and residential
areas and encourage them to sign up with us.

INC, the division of our company responsible for corporate customers,
coordinates our corporate marketing and sales efforts. We believe INC has one
of the largest sales forces targeted at corporate users of telecommunications
and Internet services in Hong Kong. Our INC division has a staff of 340
persons who design marketing and sales promotions specifically tailored to
address the concerns of business users. It 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, accessible customer service system.

To support our international telecommunications services, we provide a
24-hour per day hotline to handle complaints, telephone and written
subscription applications and queries relating to account balances, pricing,
billing and service 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.

For our Internet services, we provide a hotline that responds to general
customer service calls and answers questions relating to our Internet services,
including problems of a more technical nature.

We have a dedicated customer service team to provide service to our
corporate subscribers primarily during office hours. This team handles
complaints, subscription applications and queries relating to technical
operation, account balances, tariff rates, billing and service information. We
also provide
corporate customers with 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. This
facility enables us to lower our operating costs while continuing to increase
our customer service capabilities.

We further expanded the Guangzhou customer service facility in fiscal year
2003, which now has approximately 1,700 employees.

Billing and Collection

Our account collection department is responsible for securing prompt
payment from subscribers. Invoices are issued on a monthly 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

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subscribers are denominated in Hong Kong dollars and are made by way of cash,
cheque, 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 1% of our
revenue for each of the three years ended August 31, 2001, 2002 and 2003.

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 45 days and 60 days after the due date, respectively, we
terminate the subscribers account. For broadband Internet access services and
local telephony 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.

Hong Kong Regulatory Overview

The following is a brief summary of the Hong Kong laws and regulations
that currently materially affect the international telecommunications and
Internet services 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 services industries. In particular, the regulatory
principles relating to the pricing of international telecommunications services
provided in Hong Kong are relatively complex and are the subject of regular
review by OFTA. Accordingly, the following is not a summary of all the
principles pursuant to which international telecommunications services are
priced in Hong Kong, either on a wholesale or retail basis, nor the principles
for pricing services provided by one telecommunications service provider to
another.

Regulatory Environment

Under the Telecommunications Ordinance (Chapter 106 of the Laws of Hong
Kong) (the Ordinance), it is an offence to establish or maintain a means of
telecommunications (including the ownership or leasing of facilities that may
be used for the provision of telecommunications services) without an
appropriate license issued by the Chief Executive in Council or OFTA headed by
the Director of Telecommunications. OFTA administers the Ordinance and
regulates all forms of telecommunications.

Licensing  Old Regime

Prior to April 1, 2000, telecommunications regulation in Hong Kong in
relation to fixed line telecommunications took a two-pronged approach. OFTA
issued FTNS Licenses to facilities-based operators and issued PNETS Licenses to
services-based operators.

A FTNS License entitled the licensee to provide:



| |  |  | local fixed network services; and/or
| | - |  | ------------------------------------

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| |  |  | external infrastructure facilities for overseas telecommunications.
| | - |  | -------------------------------------------------------------------

The FTNS License, which allowed a license holder to provide wireless local
fixed telecommunication network services was valid for a period of up to 15
years, and was renewable for a further 15 year period at OFTAs discretion.

A PNETS License entitled the licensee to provide public non-exclusive
telecommunications services, including:



| |  |  | external telecommunication services over the external facilities of
the wire-line based FTNS licensees (but excluding the hybrid fibre
coaxial cable network of Hong Kong Cable Television Ltd.) or other
licensed external facilities providers; and
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | value added services using the fixed telecommunication networks
operated by licensed operators including international value added
services.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------

Licensing  Current Regime

The Ordinance was amended by the Telecommunications (Amendment) Ordinance,
2000 (Amendment Ordinance), which took effect from April 1, 2000. Under the
new regime, licenses issued to all telecommunications operators (both wire-line
and wireless) fall into four categories namely, exclusive licenses, carrier
licenses, class licenses and miscellaneous licenses that fall outside these
three categories.

A Carrier License is defined widely in the Ordinance to cover a number
of licenses, including FTNS licenses (for wire-line operators) and Public
Radiocommunications Services licenses (for wireless operators). OFTA no longer
grants FTNS licenses, but instead grants Fixed Carrier licenses (for wire-line
operators) and Mobile Carrier licenses (for wireless operators). OFTA is
pursuing a gradual program of replacement of expired or surrendered FTNS
licenses under the old regime with Carrier licenses.

The conditions of the Fixed Carrier license are essentially the same as
the corresponding FTNS license conditions, except that some of the General
Conditions have become Special Conditions (in order to make the General
Conditions consistent for both Fixed and Mobile Carriers). The General
Conditions are specified in a Schedule to the Telecommunications (Carrier
Licences) Regulation which came into force on April 1, 2001. The Carrier
Regulation sets out the types of carrier licenses (including restricted and
unrestricted), the General Conditions, periods of validity and license fees
applicable to those licenses. The Special Conditions of a Carrier license vary
according to the type of service being provided by the Carrier.

At the time of writing, OFTA has issued FTNS or Fixed Carrier licenses for
operators providing wireline-based fixed telecommunications network services
(for example, HKBNs license has been modified from a local wireless FTNS
license on April 16, 2002 to include the operation of local wireline-based FTNS
as from January 1, 2003; and a brand new license was issued on January 20,
2003 to CM Tel (HK) Limited after the full liberalization of the fixed
telecommunications market as of January 1, 2003), licenses for operators
providing satellite-based and cable-based external telecoms services; and
licenses for operators providing both local wireless FTNS services and external
telecommunications services. Both the HKBN license and the CM (HK) Limited
license were amended in 2003 to also allow for the provision of external
telecommunications services. Amendments were also made to clarify that certain
General Conditions do not apply to either HKBN or CM (HK) Limited, since
neither is considered to be in a dominant position with respect to any market
for telecommunications services.

The PNETS Licenses continue to cover service-based operators.

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In terms of Class Licenses, so far OFTA has created two Class Licenses,
namely Class License for In-Building Telecommunications Systems and Class
License for the Provision of Public Wireless Local Area Network Services.

Competition and Consumer Protection Provisions

As noted above, there were significant amendments made to the Ordinance by
the Amendment Ordinance in 2000. The most important component of the Amendment
Ordinance was the introduction of competition provisions (some of which had
previously appeared in FTNS and PNETS license conditions) into the Ordinance
itself. Some of the key changes included the following:



| |  |  | licensees are required under the Ordinance to ensure that they do not
engage in anti-competitive conduct, abuse of dominant position in a
market or misleading and deceptive conduct by licensees;
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | a third party suffering loss or damage from breach of such
anti-competitive provisions in the Ordinance may bring an action for
damages or seek other appropriate remedies; and
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | there is a right of appeal to a newly established telecommunications
appeal board in connection with the anti-competitive provisions of the
Ordinance (the Competition Affairs Branch of OFTA was formed on June
11, 2001).
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Since introducing the new provisions, OFTA has taken its role in
administering them very seriously and has developed codes to ensure their
compliance. For instance, in October 2001 OFTA issued a Code of Practice for
Mobile Service Contracts, which was the first of its kind to ensure the
adoption of fair trade practices. It would not be surprising to see OFTA
impose similar codes on Fixed Carriers in the
near future, particularly in light of the full liberalization of the fixed
telecommunications services market as of January 1, 2003.

On June 17, 2002, OFTA in conjunction with the Hong Kong Consumer Council,
the Independent Commission Against Corruption (ICAC) and the Office of the
Privacy Commissioner of Personal Data issued a Code of Practice on the
Protection of Customer Information for Fixed and Mobile Service Operators (the
Code). The Code applies to fixed and mobile operators and its objective is
to offer guidelines for such operators in protecting the personal data of
customers (that is a customers telephone number, residential address and
details of call history).

The Code is voluntary and the suggested guidelines are not mandatory but
merely underline good practices for fixed and mobile service operators for the
protection of customer information in light of existing sanctions in Hong Kong
legislation for the unauthorized disclosure of such information to third
parties.

In May 2003, OFTA introduced Guidelines in relation to Misleading or
Deceptive Conduct in Hong Kong Telecommunications Markets (the Guidelines).
The objective of the Guidelines is to provide practical guidance on the
application of Section 7M, introduced by the Amendment Ordinance, which relates
to the enforcement of the prohibition on misleading or deceptive conduct in the
telecommunications sector.

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Domestic Facilities and Services

Prior to July 1995, one of PCCW-HKTs wholly owned subsidiaries was the
exclusive provider of domestic fixed wire-line telecommunications network
services in Hong Kong under an exclusive franchise granted to it under the
Ordinance. On July 1, 1995, the Hong Kong Government introduced limited
competition in these services by granting three new FTNS Licenses to each of
Hutchison Global Crossing Limited (Hutchison), New T&T Hong Kong Limited (now
known as Wharf T&T Limited) (New T&T) and New World Telephone Company Limited
(New World), which allowed them to provide and operate these services. The
Hong Kong Government also agreed to a three-year moratorium on the granting of
additional Wire-line Based Local FTNS Licenses.

On May 5, 1999, the Hong Kong Government announced its decision to extend
the moratorium on granting additional Wire-line Based Local FTNS Licenses until
December 31, 2002, subject to the satisfactory binding commitments by each of
Hutchison, New T&T and New World to roll-out additional local network
infrastructure and services.

In order to further liberalize the market, the Hong Kong Government
granted further FTNS Licenses in different categories prior to December 31,
2002. It granted five Local Wireless FTNS Licenses, including one which was
issued to HKBN, for the provision of fixed telecommunications services using
non-wireline based networks (commonly known as wireless local loop). Hong
Kong Cable Television Limited was also granted a FTNS License to offer
telecommunications services over its hybrid fibre 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.

HKBNs Local Wireless FTNS License was modified on April 16, 2002 to
include the operation of local wireline-based FTNS as from January 1, 2003.

Under the new fully liberalized regime for the FTNS market, the new FTNS
carrier licenses no longer come with performance bond requirements, such as
minimum network roll-out and capital expenditure. To ensure a level playing
field in the FTNS market, OFTA has decided to waive all financial commitments
for operators (including HKBN) with existing performance obligations due in
2003, as of January 1, 2003.

International Facilities and Services

Prior to March 31, 1998, PCCW-HKT was the exclusive provider of all
external telecommunications facilities and services in Hong Kong. In May 1993,
OFTA began issuing PNETS Licenses, which allowed licensees to provide
subscribers with access to PCCW-HKTs external telecommunications services
using a transmission method commonly known as call-back.

On March 31, 1998, PCCW-HKT surrendered its exclusive license to provide
all external telecommunications facilities and services under the terms of a
framework agreement entered into with the Hong Kong Government on January 20,
1998. Full liberalization of external services commenced on January 1, 1999
and competition of external facilities commenced on January 1, 2000. PCCW-HKT
holds a FTNS License that authorizes it to operate both local and external
fixed telecommunications network services. The FTNS Licenses of the three
other domestic fixed network operators were amended to cover external fixed
telecommunications network services from January 1, 1999 and external
facilities from January 1, 2000.

FTNS Licenses have also been granted to licensees for non-cable based
external telecommunications facilities (i.e. satellite or other wireless
facilities) and for external telecommunications facilities based on

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undersea or
land cables, but only to those who invest in bringing physical cables directly
to Hong Kong. OFTA has indicated that it will not, before 2003, license
external facilities providers who rely on indefeasible rights of use to provide
their services.

This liberalization in the external telecommunications market has seen a
number of new entrants into the market. At the time of writing, there were
four Satellite Based External FTNS licensees and seventeen Cable-Based External
FTNS licensees. The local wireless FTNS license obtained by CM Tel (HK)
Limited was modified on October 9, 2003 to include the operation of local
wireline-based FTNS as from January 1, 2003. The local wireline-based FTNS
license held by HKBN as of January 1, 2003, was modified on May 22, 2003 to
include the operation of external FTNS.

Full Liberalization of the Fixed Telecommunications Services Market

Full liberalization of the local FTNS market occurred as of January 1,
2003. In summary, the key implementation details are as follows:



| |  |  | From January 1, 2003, the local and external FTNS market have been
fully liberalized and there are no pre-set limit for the number of
fixed carrier licenses for the operation of local wire-line-based
fixed networks as well as other forms of FTNS and EFTNS.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | as of January 1, 2003, OFTA has been allowing parties that have
purchased Indefeasible Rights of Use of submarine or land cables to
apply for and obtain EFTNS licenses. Operators holding EFTNS licenses
may apply for modifications of their licenses to extend their scope of
services to operate their own back-haul services from the cable
station to the local point of presence facility;
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | there are no rollout or capital expenditure commitments required from
licensees that are licensed to operate from January 1, 2003 of local
wire-line based 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 operators that are due on
or after January 1, 2003 as initially committed to in the licenses
granted have been waived;
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | OFTA will not grant any fixed carrier licenses to operate local
wire-line based fixed networks to applicants who intend to rely
primarily on the interconnection with, and access to, the
infrastructure of other operators or fixed carrier licensees to roll
out their networks or provide their services;
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | newly licensed local wire-line-based fixed network operators obtain,
on a case-by-case basis and subject to certain conditions, rights for
access to buildings and road opening under section 14(1) of the
Ordinance; and
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | local wireless FTNS and external FTNS operators are entitled to apply
for the extension of the scope of services under their existing
licenses to operate local wire-line based fixed networks and other
forms of fixed telecommunications network services.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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Public Non-exclusive Telecommunications Services

PNETS Licenses are issued by OFTA to cover a wide range of basic services
including international simple resale (whether voice, facsimile or data), or to
provide international value-added services including call-transit services
(call-back), store-and-forward transmission services, virtual private network
services, Internet access and electronic mail.

During the mid 1990s, we were initially issued with three PNETS Licenses
including a license to provide calling card services (CCS License), a license
to provide international simple resale services for facsimile and data services
(ISR License) and a license to provide virtual private network services (VPN
License). We also have an International Value-Added Network Services License
(IVANS License) allowing us to provide international value-added network
services, including acting as an Internet Service Provider. Each of these
licenses was originally issued for a period of 12 months, renewable on the
payment of a prescribed fee at the discretion of OFTA.

In 1998 we were issued an external telecommunications services PNETS
license (ETS License), replacing the CCS, ISR and VPN Licenses. The ETS
License allowed us to continue providing CCS, ISR and VPN services along with a
number of other international telecommunications services. From January 1,
1999, licensees for the provision of external telecommunications services under
a PNETS License were allowed to provide external telecommunications services
over the external facilities of PCCW-HKT and, since January 1, 2000, over the
facilities of licensed external facilities providers.

Under the terms of ETS and IVANS Licenses, we are required to comply with
certain conditions relating to technical and reporting matters, including
technical directions and specifications for the operation of our network as set
forth by OFTA. Additionally, we are prohibited from engaging in any conduct
that, in the opinion of OFTA, has the purpose or effect of restricting
competition in telecommunications services.

Non-compliance with the Ordinance, any regulations made pursuant to it, or
any of the conditions of our PNETS Licenses, could result in our having one or
more of our PNETS Licenses revoked or
suspended. In addition, the Chief Executive in Council has the authority to
revoke a PNETS License at any time if it is in the public interest to do so.

Regulation of City Telecoms Pricing

Under the terms of our licenses, we are required to publish tariffs for
the services we offer, and must charge no more for those services than the
published tariffs. Additionally, we are prohibited from entering into any
agreement or arrangement, which will in any way prevent or restrict competition
in relation to the operation of our services or any other telecommunications
services licensed by OFTA. Please see the discussion under - Competition and
Consumer Protection Provisions.

As a provider of external telecommunications services, our licenses
require us to pay the local network operators local access charges that are
agreed between us and those relevant local network operators, or as are
determined by OFTA from time to time. OFTA has powers under the Ordinance to
determine interconnection charges. At present, it determines the amount of the
local access charges imposed by PCCW-HKT and has indicated that it will
determine local access charges imposed by other local fixed-line network
operators if it is in the public interest to do so. External
telecommunications service providers may seek such a determination by OFTA.

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Additionally, as a provider of external telecommunications services, we
are required to pay the universal services contribution (USC) to PCCW-HKT, at
such a level as may be determined by OFTA from time to time. On November 30,
2002, OFTA issued a statement (the November 2002 Statement) on the USC that
confirmed the actual USC payable by USC contributing parties for the calendar
year 2000. As a result of the November 2002 Statement, City Telecom received a
refund of USC paid for the period from January 1, 2000 to December 31, 2000 of
approximately HK$41 million. In March 2003, City Telecom also received in
advance a sum of approximately HK$56 million from PCCW-HKT as the estimated
refund of USC paid for the period from January 1, 2001 to June 30, 2002 on a
provisional basis (the Provisional Refund). On October 20, 2003, OFTA issued
another statement in relation to USC, confirming the USC level for 2001 and
Provisional level after July 1, 2003. The USC level for 2001 was determined by
OFTA to be lower than the provisional USC for 2001 that was previously
anticipated by OFTA. Following the issue of the OFTAs Statement in October
2003, PCCW-HKT was requested to provide an additional refund to the USC
contributing parties for the 2001 calendar year. We are therefore entitled to
an additional refund from PCCW-HKT of approximately HK$3 million for the 2001
calendar year and such sum was received at the end of 2003. Approximately
HK$16 million of the Provisional Refund received by City Telecom is still
subject to confirmation by OFTA, since this portion is the provisional refund
of USC for the period from January 1, 2002 to June 30, 2002. As an Internet
service provider, we are also required to collect the PNETS charge from our
dial-up Internet access subscribers on behalf of local fixed-line network
operators.

Current Issues in Hong Kong Telecommunications Regulation

In recent years OFTA has introduced various measures as part of its
deregulation of the Hong Kong Telecommunications market. The most important
changes have included the full liberalization of the local FTNS market and the
introduction of general competition provisions in the Ordinance.

As part of this ongoing process, OFTA is looking to introduce new measures
to deal with the new telecommunications marketplace in Hong Kong. The most
important issues on OFTAs agenda for 2003/2004 include:



| |  |  | review of the long-term development of Type II
interconnection policy;
| | - |  | ----------------------------------------------------------------------



| |  |  | regulation of mergers and acquisitions in the
telecommunications industry (see discussion below of the
Telecommunications (Amendment) Ordinance 2003;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | review of licensing of mobile services on the expiry of existing 2G licenses; and
| | - |  | ---------------------------------------------------------------------------------



| |  |  | review of the principles and costing methodology of the local access charge.
| | - |  | ----------------------------------------------------------------------------

Telecommunications (Amendment) Ordinance 2003

After a legislative history of more than two years, the Telecommunications
(Amendment) Ordinance 2003 (the 2003 Amendment) was approved by the
Legislative Council on July 9, 2003. The 2003 Amendment was passed on July 18,
2003 and is yet to come into force at a later date when the Guidelines on
Mergers and Acquisitions, drafted by OFTA, are finalized. The 2003 Amendment
provides a legislative framework for the regulation of merger and acquisition
activities for the telecommunications sector in Hong Kong. Under the 2003
Amendment, OFTA may direct a carrier licensee to take such actions as OFTA
considers necessary to eliminate any anti-competitive effect where OFTA
determines that a change in the ownership or control over a carrier licensee
has, or is likely to have, the effect of substantially lessening the
competition in a telecommunications market.

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Alternatively, a carrier licensee may also seek the prior consent of OFTA
on a voluntary basis to the proposed change in ownership or control. The
regulatory regime establishes an ex post factoregime, whereby regulatory
control will be exercised by OFTA after a merger and acquisition has been
completed.

The key features of the 2003 Amendment are as follows:



| |  |  | Where OFTA is of the opinion that a change in relation to a carrier
licensee has occurred, OFTA has the power to investigate and act.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------



| |  |  | A change in relation to a licensee occurs when:
| | - |  | -----------------------------------------------

(i) Material
influence  a person, or a person and its associates,
becomes the beneficial owner(s) of more than 15% of the voting shares in
a carrier licensee (N.B. an exception exists for a person who
concurrently holds not more than 5% ownership or voting control in
another carrier licensee).

(ii) Effective
Control  a person, or a person and its associates,
becomes the beneficial owner or voting controller of more than 30% of the
voting shares in a carrier licensee.

(iii) Majority
Control  a person or a person and its associates 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.



| |  |  | OFTAs powers under the 2003 Amendment include the power to order
the complete or partial divestiture of the respective parties
interests in the merged entity. Failure to take action would
constitute a breach of the relevant provisions of the Telecommunications
Ordinance and could trigger any of the sanctions available under the
Telecommunications Ordinance (including further directions, financial
penalties, suspension or cancellation of licenses) could then be imposed
upon the carrier licensee.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Alternatively, prior to a proposed change in ownership or control,
a carrier licensee may on a voluntary basis seek the consent of OFTA to
the proposed change. This will give a choice to the carrier licensees
whether to seek prior consent or not, taking into account the risk of
being penalized subsequently if the activity is found to be
anti-competitive. OFTA has the power to grant consent, refuse consent,
or grant conditional consent.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Any decision made or direction issued by OFTA under the merger and
acquisition provisions is subject to appeal to the Telecommunications
(Competition Provisions) Appeal Board.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | A public benefits counterbalancing criteria has been introduced.
What this means is that even where the M&A transaction may be found by
OFTA to substantially lessen competition, it may still get the approval
of OFTA if there is a public benefit that outweighs any detriment
caused by a reduction in competition.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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Before the 2003 Amendment can come into force, OFTA is required to
formulate a set of criteria on the matters it will consider in determining
whether a change or proposed change has, or is likely to have, an
anti-competitive effect and issue guidelines in this respect.

OFTA released a Consultation Paper on August 4, 2003 containing the Draft
Merger Guidelines for the Hong Kong Telecommunications Market. The purpose of
the Guidelines is clarify the issues that OFTA will take into account when
considering mergers and acquisitions under section 7P of the 2003 Amendment.

Submissions have been made on the Guidelines by several major carriers as
well as the Consumer Counsel and the Law Society. A further draft of the
Guidelines was issued on December 23, 2003. The consultation period for this
second consultation paper ends on February 3, 2004. One of the major changes
in this second draft is that mergers which result in the top four mobile or
fixed line operators controlling more than 75% of the market would invite
regulatory intervention.

The Internet & Electronic Commerce

The Electronic Transactions Ordinance (Chapter 553 of the Laws of Hong
Kong) facilitates the use of electronic transactions in Hong Kong. It
recognizes the legal status of electronic records and digital signatures and
covers the setting up of certification authorities for digital signatures and
the admissibility of electronic records in court. Other ordinances (such as
the Personal Data (Privacy) Ordinance (Chapter 486 of the Laws of Hong Kong)),
though not specifically aimed at regulation of Internet and electronic
commerce, do impact on the use of the Internet and electronic commerce in Hong
Kong.

A Privacy Commissioner monitors and supervises compliance of this
ordinance. This ordinance applies to data users in Hong Kong and regulates
the collection, storage and use of data relating to living individuals where it
is reasonably practicable to identify those individuals. A data user is
defined as a person who, either alone or jointly or in common with other
persons, controls the collection, holding, processing or use of this data.

In relation to clicktrails information, the Privacy Commissioner has
indicated that customer site activity stored on an Internet service providers
log is personal data if it is possible to associate these clicktrails with an
individual customer.

Generally, companies that use web sites to sell products to the public
must also comply with applicable Hong Kong consumer protection laws (for
example, the Sale of Goods Ordinance (Chapter 26 of the Laws of Hong Kong)),
Control of Exemption Ordinance (Chapter 71 of the Laws of Hong Kong), Supply of
Services (Implied Terms) Ordinance (Chapter 457 of the Laws of Hong Kong),
Unconscionable Contracts Ordinance (Chapter 458 of the Laws of Hong Kong).

In addition, Internet companies may be subject to the Control of Obscene
and Indecent Articles Ordinance (Chapter 390 of the Laws of Hong Kong), which
specifies a number of offenses, including any person who publishes, possesses
for the purpose of publication or imports for the purpose of publication any
obscene article, whether or not this person knows that it is an obscene
article, commits an offence and is liable for a fine of HK$1,000,000 and
imprisonment for three years.

It is also an offence to publish any indecent article to a person who is a
juvenile, whether it is known that it is an indecent article or that a person
is a juvenile. This offence could result in a fine of HK$400,000 and
imprisonment of 12 months. A subsequent conviction could result in a fine of
HK$800,000 and imprisonment of 12 months.

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Organizational Structure

The following chart sets forth our principal subsidiaries (as of January
31, 2004):

(ORGANIZATIONAL STRUCTURE CHART)



---

|(1) |  | The company only registered its Chinese name, the English name is an
unregistered translation.
|--- |  | ----------------------------------------------------------------------------------------------

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The jurisdiction of incorporation and our ownership percentage of these
subsidiaries as of January 31, 2004 was as follows:

Percentage ofJurisdiction of
    
    Interest held byName
    
    Incorporation
    
    City Telecom (%)963673 Ontario Limited
    
    Canada
    
    
    100Attitude Holdings Limited
    
    British Virgin Islands
    
    
    100Automedia Holdings Limited
    
    British Virgin Islands
    
    
    100City Telecom (B.C.) Inc.
    
    Canada
    
    
    100City Telecom (Canada) Inc.
    
    Canada
    
    
    100City Telecom Inc.
    
    Canada
    
    
    100City Telecom International Limited
    
    British Virgin Islands
    
    
    100Golden Trinity Holdings Limited
    
    British Virgin Islands
    
    
    100Credibility Holdings Limited
    
    British Virgin Islands
    
    
    100Hong Kong Broadband Network Limited
    
    Hong Kong
    
    
    100CTI Marketing Company Limited
    
    Hong Kong
    
    
    100CTI Guangzhou Customer Services Co. Limited(1)
    
    PRC
    
    
    100IDD1600 Company Limited
(formerly Seabright Associates Limited)
    
    Hong Kong
    
    
    100




---

|(1) |  | The company only registered its Chinese name, the English name is an
unregistered translation.
|--- |  | ----------------------------------------------------------------------------------------------

Property, Plants and Equipment

We own three switching systems in Hong Kong and two in Canada (one each in
Vancouver and Toronto). In October 2002, we closed our switching system in
Buffalo, New York in the United States, and in July 2003, we disposed of our
switching system in Tokyo, Japan.

In addition, we lease a retail shop and switching center and own a
customer service center in Hong Kong. Moreover, HKBN, our wholly owned
subsidiary, owns a 125,000 square foot office and switching center in Kwai
Chung, Hong Kong.

We have invested in two undersea cables, the Japan-U.S. cable and the
Asia-Pacific Cable Network 2 cable, for use as international transmission
facilities, both of which have been completed and in operation since May 2002.

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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

City Telecom provides international telecommunications, local telephony
and Internet services in Hong Kong. We were incorporated in May 1992,
following the Hong Kong Governments decision to introduce competition into
Hong Kongs local and international telecommunications markets, and we began
offering international telecommunications services in September 1992. We
incorporated HKBN in Hong Kong in August 1999 and launched our broadband
Internet access network and services in March 2000. In addition, we began to
provide local telephony services using our fixed telecommunications network in
April 2002. Moreover, we launched our pay-TV services via our fixed
telecommunications network in August 2003.

In addition to our operations in Hong Kong, we also provide international
telecommunications services in Japan and Canada. In Japan, these services were
provided through City Telecom (Japan) Co. Ltd. We established this company in
February 1997 to compete in the Japanese international telecommunications
market. However, our operations in Japan were discontinued following the
disposal of our Japanese subsidiary in July 2003.

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 formation or acquisition by City Telecom. However, as of August 31,
2003, none of these subsidiary companies located outside of Hong Kong has made
a material contribution to our revenues or expenses.

Our international telecommunications operations

From September 1992 until December 1998, we relied on the circuits of
local network operators, PCCW-HKT and other overseas carriers to transmit our
international calls. This type of international telecommunications service is
commonly referred to as callback. A change to 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. 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. International simple resale has had
a positive effect on our international telecommunications revenues and profits.
Additionally, in part due to use of the APCN 2 undersea cable, the quality of
the service we provide has improved and our transmission costs have decreased.

Until fiscal 2003, our international traffic volume had increased each
year since we began providing international telecommunications services. In
2003, we were faced with significant competitive pressures
from both new market entrants and existing players that have adopted aggressive
pricing strategies, which

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created huge downward pressure on the tariff rate in
the marketplace. In the interest of improving our profitability, we made the
strategic decision to maintain our average tariff for the year at a level
comparable to that of fiscal 2002. As a result, traffic handled by us
decreased by approximately 3% from 916 million minutes to 888 million minutes.
However, our profits and profit margins in the international telecommunications
business increased in 2003 versus 2002. In terms of traffic routes, China is
still the single largest contributor to our international telecommunications
revenues and accounted for 65% of our total traffic in fiscal 2003. The second
and third most popular routes remained the United States and Canada.

We have continued to increase the percentage of corporate customers among
our international telecommunications subscribers. 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 to market aggressively our
international telecommunications services to corporate customers in fiscal
2004. We further intend to continue to solidify our market position by
offering competitive tariffs and expect to enjoy continuous cost reductions
brought about by the ongoing liberalization of the international
telecommunications market.

Our fixed telecommunications network operations

The wireless fixed telecommunications network services license that HKBN
obtained from OFTA in February 2000 provided HKBN with the authority to begin
installation of the wireless network that we use to provide broadband Internet
access services. In addition, to enable HKBN to provide fixed
telecommunications network services using wire-line technology in addition to
the wireless technology that it used to employ, we applied with OFTA for a
wireline-based FTNS license. HKBN was upgraded as a wireline-based FTNS
licensee in April 2002. This upgrade allows us to develop our own fibre-based
backbone to supplement the existing wireless/leased wireline based backbone in
densely populated areas to achieve cost savings and provide additional capacity
for further growth.

During fiscal 2003, we devoted considerable resources to marketing our
fixed line and Internet access services. As a result, our revenues from fixed
telecommunications network services grew by 75% compared to fiscal 2002.
Telephony service was a key focus of our marketing efforts and our number of
registered local telephony lines reached 180,000 in fiscal 2003. Our customers
are widely distributed across the territory, although we devote most of our
marketing efforts to adding subscribers in Hong Kongs more densely populated
residential areas.

Our Expenses

International telecommunications.The expenses we incur for our
international telecommunications business consists of costs related to
transmission, or cost of services, and other expenses. Our cost of services
currently comprises four components:



| |  |  | Universal Services Contribution (USC).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.
OFTA 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$1.3
cents per minute as of August 31, 2003.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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| |  |  | Local Access Charges.In addition to USC 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 (LAC). Our
LACs are calculated on a per-minute basis and vary among the different
network carriers that we use to transmit our calls.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Charges for our international leased lines.We lease
international transmission circuits from PCCW-HKT and 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 PCCW-HKT and
the other international carriers in connection with these circuits.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | 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.
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.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

In fiscal 2003, we made significant progress on our plan to reduce our
reliance on transmission facilities owned by third parties and lower our cost
of services. Specifically, we began to capitalize 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 Asia-Pacific Cable Network 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.

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 charges.

Fixed Telecommunications Network Services.To provide Internet access,
local telephony and pay-TV services, we incur transmission costs and line
rental charges, which we currently pay to PCCW-HKT and other local fixed
telecommunications network operators, with respect to the fixed lines that
carry the data between the subscribers premises, our broadband network hub
sites and our switching centers in Hong Kong. We also incur expenses in
connection with the leased lines that carry the data from our switching centers
to overseas destinations. However, as we continue to develop our local fixed
network, we reduce our reliance on transmission capacity leased from other
local fixed network operators to provide Internet access services. As of
January 31, 2004, our expanded in-building block-wiring network covered 3,000
residential buildings, with approximately 1.2 million homes passed, and
approximately 550 commercial buildings.

We continue to incur significant operating costs related to our efforts to
promote our broadband Internet access and local telephony services. During the
year ended August 31, 2003, we spent approximately 24% of our fixed
telecommunications network services revenues on sales and marketing.

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We expect
to incur additional promotional expenses in 2004, particularly as we begin to
more extensively market our pay-TV service.

Other operating costs related to our fixed telecommunications network
services include salaries and related costs, office, general and administrative
costs and depreciation. Our salaries and related costs include those employees
working on our Internet access service businesses, particularly those involved
in the roll-out of our broadband Internet service and the local fixed network.

We made capital expenditures of approximately HK$229 million in connection
with our fixed telecommunications network services, primarily for ongoing
broadband network construction, during fiscal 2003.

Because of the various changes to our business discussed above, 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
revenues. If such efforts do not significantly increase our revenues, our
business, operating results and financial condition will be adversely affected.

Results of Operations

The following table sets forth, for the years indicated, our results of
operations.

Year Ended August 31,2001
    
    2002
    
    2003(HK$ in thousands)Statement of Income Data:RevenuesInternational telecommunications
    
    
    861,338
    
    
    
    908,981
    
    
    
    875,802Fixed telecommunications network services
    
    
    154,262
    
    
    
    241,219
    
    
    
    423,107Content and e-commerce  Internet
Advertising  see segment note
    
    
    1,034
    
    
    
    
    
    
    
    Total operating revenue
    
    
    1,016,634
    
    
    
    1,150,200
    
    
    
    1,298,909Cost of Services
    
    
    (584,352
    )
    
    
    (457,963
    )
    
    
    (322,753
    )Gross Profit
    
    
    432,282
    
    
    
    692,237
    
    
    
    976,156Operating expenses:Salaries and related costs
    
    
    (149,237
    )
    
    
    (196,158
    )
    
    
    (220,350
    )Sales and marketing expenses
    
    
    (86,574
    )
    
    
    (168,441
    )
    
    
    (182,471
    )Office, general and administrative expenses
    
    
    (86,814
    )
    
    
    (99,478
    )
    
    
    (109,335
    )Depreciation
    
    
    (82,847
    )
    
    
    (128,290
    )
    
    
    (174,955
    )Provision for doubtful accounts receivable
    
    
    (9,663
    )
    
    
    (10,277
    )
    
    
    (17,685
    )Total operating expenses
    
    
    (415,135
    )
    
    
    (602,644
    )
    
    
    (704,796
    )Income from operations
    
    
    17,147
    
    
    
    89,593
    
    
    
    271,360Bank interest income
    
    
    35,438
    
    
    
    10,870
    
    
    
    3,163Interest expense
    
    
    (4,542
    )
    
    
    (3,504
    )
    
    
    (601
    )Loss on disposal of a subsidiary
    
    
    
    
    
    
    
    
    
    
    (2,695
    )Other income, net
    
    
    10,935
    
    
    
    502
    
    
    
    4,373Income before taxation
    
    
    58,978
    
    
    
    97,461
    
    
    
    275,600Provision for income taxes
    
    
    (18,775
    )
    
    
    (14,566
    )
    
    
    (17,778
    )Income after taxation
    
    
    40,203
    
    
    
    82,895
    
    
    
    257,822Minority interest
    
    
    13,724
    
    
    
    8,234
    
    
    
    Net income
    
    
    53,927
    
    
    
    91,129
    
    
    
    257,822


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Year Ended August 31, 2003 Compared to Year Ended August 31, 2002

Revenue.In fiscal 2003, our total revenue grow by 13% 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.

Faced with new market entrants and existing players who adopted aggressive
pricing strategies, we made the strategic decision to maintain pricing with
respect to international telecommunications services at a level approximately
equal to our pricing in fiscal 2002 with the objective to improve our
profitability. This affected our turnover slightly as sales slipped 4% from
HK$909.0 million in fiscal 2002 to HK$875.8 million in fiscal 2003.

Fixed telecommunications network services recorded significant revenue
growth, and these businesses 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% growth. Growth in our
broadband Internet access service revenues has stabilized somewhat following
rapid growth in previous years. Despite intense market competition with many
operators competing on price, our broadband customer base still increased
throughout fiscal 2003. Revenue generated by broadband access services was
HK$330.5 million in fiscal 2003 compared to HK$239.2 million in fiscal 2002,
representing 38% growth. Our local telephony services recorded significant
growth as a result of our strong marketing efforts and strong brand
recognition. In fiscal 2003, our local telephony services generated revenues
of HK$92.6 million, compared to HK$2.0 million for six months operations in
fiscal 2002.

We launched pay-TV services in August 2003, but these services did not
generate revenues in fiscal 2003.

Cost of Services.Cost of services decreased by 30% from HK$458.0 million
during fiscal 2002 to HK$322.8 million during fiscal 2003. Both our
international telecommunications services and our fixed telecommunications
network services contributed to our cost savings in fiscal 2003.

Cost of services for our international telecommunications operations
decreased by 40% from HK$407.2 million in 2002 to HK$245.9 million in 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 (please see the discussion in
Item 3 Key information  Risk factors  risk relating to the regulatory,
political and economic environment  PCCW-HKT may not refund to us a portion of
our expected refunds of USC and in Item 5 Operating and financial review and
prospects  Critical Accounting Policies  critical accounting estimate below)
as well as our continuing efforts to reduce our international
telecommunications costs. While we expect to receive an additional refund of
HK$16 million in fiscal 2004, we may not receive such refunds in future
periods. The average IDD cost excluding the USC refund per minute dropped by
16% compared to fiscal 2002. The expenses incurred for our international
telecommunications operations were 76% of the total cost of services in fiscal
2003, compared with 89% in fiscal 2002.

Cost of services for our fixed telecommunications network services
increased by 51% from HK$50.8 million in fiscal 2002 to HK$76.9 million in
fiscal 2003, and represented 24% of the total cost of services. By utilizing
our own fixed network we were able to add subscribers and grow revenues cost
effectively, and our increase in cost was much lower than the increase in
revenue.

Gross Profit.Our gross profit increased by 41% from HK$692.2 million
during fiscal 2002 to HK$976.2 million during fiscal 2003. This increase
resulted from:

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| |  |  | significantly higher revenue from the more profitable fixed
telecommunications network services;
| | - |  | ------------------------------------------------------------------------------------------------



| |  |  | cost effectiveness achieved from sharing the existing IP network
among the different revenue streams of our fixed telecommunications
network services;
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | continuing favorable traffic cost obtained by leveraging our high IDD traffic volume; and
| | - |  | -----------------------------------------------------------------------------------------



| |  |  | the HK$84.1 million USC refund.
| | - |  | -------------------------------

Operating Expenses.Our operating expenses increased by 17% from HK$602.6
million during fiscal 2002 to HK$704.8 million during fiscal 2003. The charge
was due in large part to increased depreciation expenses, as well as increased
salaries and sales and marketing expenses.

Salaries and related costs.Salaries and related costs increased by
12% 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
telephony customer base. Our total number of employees increased from 1,820
as of August 31, 2002 to 2,700 as of August 31, 2003, of which 1,400 were
located in Guangzhou, while 1,300 were located in Hong Kong. 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%, 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
investments 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 that
are directly related to our revenue growth.

Office, general and administrative expenses.Office, general and
administrative expenses, excluding depreciation, increased by 10% from
HK$99.5 million in fiscal 2002 to HK$109.3 million in fiscal 2003. This
increase was due to the ongoing expansion of our operations.

Depreciation.Depreciation expenses increased by 36%, from HK128.3
million in fiscal 2002 to HK$175.0 million in fiscal 2003. Although
depreciation expense relating to our international telecommunications
business remained relatively stable at HK$34.3 million in fiscal 2003,
compared to HK$33.0 million in fiscal 2002, the roll-out of our fixed
telecommunications network caused a 48% increase in depreciation expenses in
that segment of our business, from HK$95.3 million during fiscal 2002 to
HK$140.7 million during fiscal 2003.

Provision for doubtful accounts receivable.Provision for doubtful
accounts receivable increased by 72% from HK$10.3 million in fiscal 2002 to
HK$17.7 million in fiscal 2003. This was primarily due to increased
subscribers 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
203%. Operating profit from international telecommunications operations
increased by 54%, from HK$216.3 million in fiscal 2002 to HK$335.7

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million in
fiscal 2003. Our fixed telecommunications network services recorded a
reduction of operating loss, from HK$126.7 million in fiscal 2002 to HK$64.3
million in fiscal 2003. This loss was due to continued costs associated with
acquiring new local telephony subscribers and a large amount of depreciation
expenses related to capital expenditures on our local fixed telecommunications
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 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 (net).Our other income and expense (net) was
HK$4.4 million in fiscal 2003 compared to HK$1.0 million in 2002.

Provision for Income Taxes.Provision for income taxes was HK$17.8
million for fiscal 2003 compared to HK$14.6 million during fiscal 2002.
Provision for income tax is based on our estimated assessable profit during
each period. Our effective rate decreased from 15% in fiscal 2002 to 6% in
fiscal 2003 as a result of the utilization of 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 183%
from HK$91.1 million in fiscal 2002 to HK$257.8 million in fiscal 2003.

Year Ended August 31, 2002 Compared to Year Ended August 31, 2001

Revenue.During fiscal 2002, we continued to experience substantial
growth in our international telecommunications business while also
significantly increasing revenues from our fixed telecommunications network
services. Total revenue increased by 13% from HK$1,016.6 million during fiscal
2001 to HK$1,150.2 million during fiscal 2002. International
telecommunications services experienced a 58% increase in traffic volume, from
579.9 minutes in 2001 to 915.9 million minutes in 2002. However, this increase
in volume was off set by a decrease of 30% in the average tariff charged. As a
result, international telecommunications revenues increased by only
6% from
HK$861.3 million in fiscal 2001 to HK$908.9 million in fiscal 2002.

Fixed telecommunications network services become an increasingly important
revenue contributor, accounting for 21% of total revenue in fiscal 2002. This
was principally due to our aggressive marketing activities focused on enlarging
our broadband customer base during the year. Revenues from Internet access
services were HK$239.2 million in fiscal 2002, representing a 55% increase from
revenues of
HK$154.3 million in fiscal 2001. Our dial-up Internet access business, while
not experiencing subscriber growth, contributed 6% of total revenue. We expect
that dial-up Internet access will decrease its contribution to our revenues in
fiscal 2003, as a higher percentage of our Internet access customers utilize
broadband.

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We began offering fixed line local telephony services in the second half
of fiscal 2002, although local telephony services contributed only HK$2.0
million, or less than 1%, to our revenues in fiscal 2002. We expect these
services to begin generating additional revenue in the near future.

We stopped offering content and e-commerce services in fiscal 2002.

Cost of Services.Cost of services decreased by 22% from HK$584.4 million
during fiscal 2001 to HK$457.9 million during fiscal 2002. Both our
international telecommunications services and our fixed telecommunications
network services contributed to our cost savings in fiscal 2002.

Cost of services for our international telecommunications operations
decreased by 21% from HK$514.2 million in 2001 to HK$407.2 million in 2002,
despite a 58% increase in traffic. This was principally due to the successful
reduction of international telecommunications costs caused by our ability to
negotiate lower cost traffic capacity with our service partners due to our
increasing traffic volumes. We also benefited from falling traffic charges in
the China market during fiscal 2002, where approximately 63% of our traffic was
directed during that period. The average IDD cost per minute dropped by 40%
compared to fiscal 2001. The expenses incurred for our international
telecommunications operations were 89% of the total cost of services in fiscal
2002, compared with 88% in fiscal 2001.

Cost of services for our fixed telecommunications network services also
decreased, by 26%, from HK$69.1 million in fiscal 2001 to HK$50.8 million in
fiscal 2002, and represented 11% of the total cost of services. This decrease
corresponded to the continued roll-out of our own network, which reduced our
reliance on leased capacity from third parties. Moreover, the completion and
implementation of our two undersea cables also reduced the leasing costs we
have historically paid for international capacity.

Gross Profit.Our gross profit increased by 60% from HK$432.3 million
during fiscal 2001 to HK$692.2 million during fiscal 2002. This increase
resulted primarily from the improved gross profit margin of our fixed
telecommunications network services as we successfully enlarged our broadband
subscriber base while lowering costs. In addition, our IDD services continued
to enjoy increasing economies of scale as the volume of calls increased.

Operating Expenses.Our operating expenses increased by 45% from HK$415.1
million to HK$602.6 million during fiscal 2002. The charge was due in large
part to increased sales and marketing expenses, as well as increased salaries
and depreciation expenses.

Salaries and related costs.Salaries and related costs increased by
31% to HK$196.2 million during fiscal 2002 from HK$149.2 million during
fiscal 2001. 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 2002 were customer service and
customer installation employees that corresponded with our expanding
broadband customer base. Our total number of employees increased from 851
as of August 31, 2001 to 1,820 as of August 31, 2002. Of the increase, 500
were hired to work at our newly established call center in Guangzhou.
During fiscal 2002, we spent HK$2.2 million for research and development
compared to HK$2.8 million during fiscal 2001.

Sales and marketing expenses.Sales and marketing expenses increased
95% from HK$86.6 million during fiscal 2001 to HK$168.4 million during
fiscal 2002. This increase was primarily due to fixed telecommunications
network services customer acquisition and installation activities. We
believe this investment in customer acquisition will benefit our revenues in
the following fiscal years. We focused our marketing activities on direct
customer sales, including door-to-door sales, street

50Table of Contentspromoters and
telemarketing. Most of these expenses were due to sales commissions and are
directly related to our revenue growth.

Office, general and administrative expenses.Office, general and
administrative expenses, excluding depreciation, increased by 15% from
HK$86.8 million in fiscal 2001 to HK$99.5 million in fiscal 2002. This
increase was proportional with our revenue growth.

Depreciation.Depreciation expenses increased by 55% from HK$82.8
million in fiscal 2001 to HK128.3 million in fiscal 2002. Although
depreciation expense relating to our international telecommunications
business decreased from HK$37.2 million in fiscal 2001 to HK$33.0 million in
fiscal 2002, the rollout of our fixed telecommunications network caused a
110% increase in depreciation expenses in that segment of our business, from
HK$45.4 million in fiscal 2001 to HK$95.3 million during fiscal 2002.

Provision for doubtful accounts receivable.Provision for doubtful
accounts receivable increased by 6% from HK$9.7 million in fiscal 2001 to
HK$10.3 million in fiscal 2002. However, this increase was lower than the
increase in revenue for the corresponding period, illustrating our efforts
to limit delinquent accounts.

Income from Operations.Operating profit was HK$89.6 million in fiscal
2002, compared to HK$17.1 million in fiscal 2001, representing an increase of
424%. Operating profit from international telecommunications operations
increased by 101% from HK$107.7 million in fiscal 2001 to HK$216.7 million in
fiscal 2002. However, this was offset by our loss from operations related to
our fixed telecommunications network service of HK$126.7 million. This loss
was due to continued costs associated with acquiring new broadband Internet
access subscribers and a large amount of depreciation expenses related to
capital expenditures on our local fixed telecommunications network.

Interest Income and Expense.Our interest income was HK$10.9 million in
fiscal 2002 compared to HK$35.4 million in fiscal 2001. Interest income was
less than in fiscal 2001 due to lower interest rates and our decreased cash
balance resulting from the continued development of our fixed
telecommunications network. We derive interest income from our deposit of
surplus capital in interest-bearing accounts at commercial banks. Interest
expense was HK$3.5 million for fiscal 2002.

Other Income and Expense (net).Our other income and expense (net)
continued to decrease significantly, to HK$1.0 million for fiscal 2002,
compared with HK$10.9 million for fiscal 2001. This decrease was primarily due
to the fact that in fiscal 2001, we wrote back HK$5.9 million of over-accruals
of services cost paid to one of our supply carriers, which did not recur in
fiscal 2002. In addition, we benefited from a HK$2.6 million gain on exchange
in fiscal 2001, compared to a loss of HK$508,000 in fiscal 2002.

Provision for Income Taxes.Provision for income taxes was HK$14.6
million for fiscal 2002 compared to HK$18.8 million during fiscal 2001.
Provision for income tax is based on our estimated assessable profit during
each period. The effective rate change from 32% to 15% was due to a write-back
of overprovision of taxes in prior years. Without this over-provision, the
effective rate of fiscal 2001 would have been 21%.

Minority Interest.We sold a 15% interest in HKBN to KDDI in March 2000,
which was reduced to a 4% interest in January 2002. We purchased KDDIs
remaining interest in March 2002, making HKBN our wholly owned subsidiary. We
record a minority interest equal to KDDIs share of the loss incurred by

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HKBN
each year. In fiscal 2002, the minority interest was HK$8.2 million compared
to HK$13.7 million during fiscal 2001.

Net Income.For the foregoing reasons, our net income increased by 69%
from HK$53.9 million in fiscal 2001 to HK$91.1 million in fiscal 2002.

Year Ended August 31, 2001 Compared to Year Ended August 31, 2000

Revenues.Revenues decreased by 18% from HK$1,234.1 million during fiscal
2000 to HK$1,016.6 million in fiscal 2001. This decrease was due primarily to
a 23% decrease in international telecommunications revenue, from HK$1,119.1
million in fiscal 2000 to HK$861.3 million in fiscal 2001. The decrease in
international telecommunications revenue was principally caused by a drop in
average tariff rates of approximately 33% during the year and occurred despite
a 15% increase in international telecommunications traffic volume, from 505
million minutes during fiscal 2000 to 580 million minutes in fiscal 2001.
International telecommunications service continues to be the principal source
of our revenues, contributing 84.7% of total revenues in fiscal 2001.

Our revenues from fixed telecommunications network services improved
significantly during fiscal 2001, primarily as a result of our aggressive
promotion of our broadband Internet services. Revenues from Internet access
services were HK$154.3 million in fiscal 2001, a 42% increase from revenues of
HK$109.0 million in fiscal 2000. Internet access revenues accounted for 15.2%
of total revenues in 2001, compared to only 8.8% in fiscal 2000. We intend to
continue to expand our Internet access revenues in fiscal 2002 by promoting our
broadband services and maximizing the revenues we receive from our dial-up
customers and introducing more services such as local telephony service.

Consistent with our plan to focus on our core businesses, our Internet
content and e-commerce business generated revenue of just HK$1.0 million,
representing less than 0.1% of our total revenues during fiscal 2001.

Cost of Services.Cost of services decreased by 34% from HK$888.6 million
during fiscal 2000 to HK$584.4 million in fiscal 2001. The decrease in cost of
services was due to the significant decrease in cost of services relating to
international telecommunications services and our Internet access operations.

Cost of services for our international telecommunications operations
decreased by 33% despite an increase in telecommunications traffic by 15%. The
decrease in cost of service for consumers on a per-minute basis was principally
caused by our ability to negotiate lower cost traffic capacity with our service
partners due to our increasing traffic volumes. We also benefited from falling
traffic charges in the China market, where more than 50% of our traffic was
directed in fiscal 2001. The expenses incurred for international
telecommunication operations was HK$514.2 million, or 88% of the total cost of
services.

Cost of services relating to our Internet access operations decreased by
39% from HK$112.7 in fiscal 2000 to HK$69.1 in fiscal 2001, and represented 12%
of the total cost of services. This decrease corresponded to the continuous
effort to roll-out our own network to reduce our reliance on leasing other
operators facilities. The expenses we incur for Internet operation are mainly
costs related to the charges we pay international carriers to transmit data to
and from Internet backbones, and local fixed network operators to transmit data
to and from our subscribers premises. Internet content and e-commerce
services had a cost of services of HK$1.1 million, or less 1% of our total cost
of services during fiscal 2001.

Gross Profit.Our gross profit increased by 25% from HK$345.5 million
during fiscal 2000 to HK$432.3 million during fiscal 2001. The increase
resulted primarily from the improved gross profit

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margin of our Internet access
business as we shifted our customer base away from free dial-up Internet access
plans to revenue producing dial-up plans and broadband access. Further, our
international telecommunications business maintained its strong gross profit
margins as decreases in cost of services more than offset decreased average
tariff rates.

Operating Expenses.Our operating expenses decreased by 18% from HK$507.0
million during fiscal 2000 to HK$415.1 million in fiscal 2001.

Salaries and related costs.Salaries and related costs decreased by
20% from HK$186.2 million during fiscal 2000 to HK$149.2 million during
fiscal 2001. The decrease was the result of the continuing contraction of
our content operations and human resource restructuring that occurred during
fiscal 2001 to better manage our costs and improve profitability. Our total
number of employees increased from approximately 800 as of August 31, 2000
to 851 as of August 31, 2001. In addition, we include our research and
development costs in this line item. During fiscal 2000 and fiscal 2001,
our research and development expenses were HK$3.8 million and HK$2.8
million, respectively.

Sales and marketing expenses.Sales and marketing expenses consist
primarily of advertising costs in various media, costs of promotional
materials, salaries, benefits and other costs of our part-time sales
personnel, and sales commissions. Sales and marketing expenses decreased by
43.0% from HK$151.2 million during fiscal 2000 to HK$86.6 million during
fiscal 2001. During 2001, we made the decision to focus more on direct
marketing, such as telesales and street promotions, and de-emphasize more
expensive television advertising. The major promotional activities during
fiscal 2001 related to the expansion of our broadband services and price
promotions for international telecommunication services.

Office, general and administrative expenses.Office, general and
administrative expenses, excluding depreciation, decreased by 18% from
HK$106.5 million during fiscal 2000 to HK$86.8 million during fiscal 2001.
The decrease was due primarily to the successful implementation of cost
control measures designed to improve our profitability.

Depreciation.Depreciation expenses increased by 57% from HK$52.6
million during fiscal 2000 to HK$82.8 million during fiscal 2001. The
increase principally reflected the roll-out our fixed telecommunications
network by HKBN during the year in connection with our broadband Internet
access services. The increase also reflected the purchase of new switching
equipment and routers for the upgrades in our international
telecommunication network.

Provision for doubtful accounts receivable.Provision for doubtful
accounts receivable decreased by 7.0% from HK$10.4 million during fiscal
2000 to HK$9.7 million during fiscal 2001. This decrease was related to our
efforts to exercise greater control over, and more aggressively pursue,
delinquent accounts.

Income from Operations.Operating profit from our international
telecommunications operations increased by 115% from HK$50.2 million during
fiscal 2000 to HK$107.7 million during fiscal 2001. This increase was mainly
due to our efforts to reduce costs associated with our telecommunications
operations. The operating profit from our international telecommunications
business was offset by our loss from operations related to our fixed
telecommunications network services in fiscal 2001 of HK$79.1 million.
However, this loss represented a 56% decrease from a loss of 177.7 million in
fiscal 2000, resulting from increased numbers of broadband subscribers and
decreased numbers of free dial-up Internet access subscribers.

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Additionally, our Internet content business incurred an operating loss of
HK$11.4 million in fiscal 2001, compared with an operation loss of HK$33.9
million in fiscal 2000 due to the scale-down of our involvement in content and
e-commerce services in fiscal 2001.

As a result of the foregoing, we recorded operating income of HK$17.1
million in fiscal 2001, a significant improvement compared to a loss from
operations of HK$161.5 million in fiscal year 2000.

Interest Income and Expense.Our interest income increased by 11% from
HK$31.9 million during fiscal 2000 to HK$35.4 million during fiscal 2001.
Interest expense was HK$4.5 million in fiscal 2001, a decrease of 27% from
interest expense of HK$6.2 million during fiscal 2000. Interest expense
consists primarily of finance costs related to bank overdrafts and finance
leases.

Other Income and Expenses (net).Our other income and expenses (net)
decreased significantly from HK$192.0 million during fiscal 2000 to HK$10.9
million during fiscal 2001. This decrease was mainly due the fact that other
income in fiscal 2000 reflected a gain of HK$185 million from the sale of a 15%
interest in HKBN to KDDI for HK$225.0 million in March 2000. Other income
generally consists of late payment charges that we collect on subscriber
accounts paid more than 15 days after their due dates.

Provision for Income Taxes.Provision for income taxes was HK$18.8
million during fiscal 2001, compared to HK$1.2 million in fiscal 2000.
Provision for income tax is based on our estimated assessable profit during
each period. The provision in fiscal 2001 was greater than fiscal 2000 as the
income before taxation in fiscal 2000 included the gain on the sale of the 15%
interest in HKBN that was not subject to Hong Kong profit tax.

Minority Interest.We sold a 15% interest in HKBN to KDDI in March 2000.
We therefore record a minority interest equal to KDDIs share of the loss
incurred by HKBN each year. In fiscal 2001, minority interest was HK$13.7
million, compared to HK$15.1 million in fiscal 2000.

Net income.For the foregoing reasons, our net income decreased by 23%
from HK$70.0 million during fiscal 2000 to HK$53.9 million during fiscal 2001.
However, if the gain relating to the sale of a 15% interest in HKBN in fiscal
2000 was excluded, our fiscal 2001 net income would exceed fiscal 2000s net
income by HK$169.7 million.

Liquidity and Capital Resources

Our main source of liquidity historically has been cash flow from
operations. In November 1999, we completed a global offering of 80,000,000 new
shares and our American depositary shares were listed on the Nasdaq. We
received net proceeds of approximately HK$416.0 million from this offering.

As of August 31, 2003, we had cash and cash equivalents of HK$383.9
million, compared to HK$290.4 million at the end of fiscal 2002.

Net cash provided by operating activities amounted to HK$414.5 million
during fiscal 2003, compared to net cash provided by operating activities of
HK$288.4 million during fiscal 2002. Net cash used in investing activities was
HK$309.6 million and HK$475.2 million during fiscal 2003 and 2002,
respectively. During fiscal 2003, investing activities of HK$250.2 million
primarily consisted of purchases of fixed assets, including approximately
HK$229.0 million spent to develop our fixed telecommunications network in Hong
Kong. Approximately HK$20.7 million was spent to maintain the international
telecommunication facilities.

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Net cash used in financing activities was HK$10.3 million in the year
ended August 31, 2003 compared to net cash provided in financing activities of
HK$9.1 million in the year ended August 31, 2002.

In order to continue the development of our fixed telecommunications
network, we plan to make total capital expenditures of approximately HK$550
million in fiscal 2004 to 2005. In particular, we plan to spend approximately
HK$250 million to expand the fibre-based backbone that we will use to provide
fixed network services in high-density areas. Our required capital
expenditures will be influenced to a significant degree by the rate of growth
in the subscriber base for our services, the expansion of our network coverage
and any changes to our business plan. The principal components of our capital
investment plan are:



| |  |  | the construction of fixed network and related facilities for use in
providing broadband Internet services, local telephony services and
pay-TV services;
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | the construction of international transmission facilities for use
in our international telecommunications business; and
| | - |  | -----------------------------------------------------------------------------------------------------------------------



| |  |  | the upgrading of our existing network infrastructure.
| | - |  | -----------------------------------------------------

As of August 31, 2003, we had capital commitments contracted but not
provided for relating to the purchase of telecommunications, computer and
office equipment of HK$122.5 million. In addition, we had commitments under
non-cancelable operating leases relating to land, buildings, telecommunications
facilities and computer equipment of HK$44.9 million, of which HK$33.2 million
is due in fiscal year 2004. As of August 31, 2003 we had total amounts
available under banking facilities of HK$232.0 million under which HK$18.2
million was outstanding and due in fiscal year 2004.

In December 2003, we drew down HK$100,000,000 of a HK$200,000,000 loan
facility made available by HSBC as of October 9, 2002.

Our working capital as of August 31, 2003 was HK$211.4 million, which we
believe is sufficient for our current requirements. 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 OFTA,
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 various operating and capital leases and amounts
due under banking facilities.

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 and intangible assets.
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

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of assets and
liabilities that are not readily apparent from other sources. Actual results
may differ from these estimates under different assumptions.

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 GAAP we also align our
accounting policies with U.S. GAAP. This reduces the number of Hong Kong
GAAP/U.S. GAAP reconciliation differences required to be adjusted in note 29(a)
to our financial statements. 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 critical accounting policies we apply in producing
our Hong Kong GAAP financial statements.

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, undiscounted and without interest, 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.

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, managements 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.

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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. 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
operations. Changes in the collectibility of accounts receivable for which
provisions are not made could significantly change the calculation of such
provision and the results of our operations.

Deferred Taxation

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 accounts to the extent that a
liability or an asset is expected to be payable or recoverable 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.

U.S. GAAP.We are required to recognize deferred tax assets and
liabilities for the expected future tax consequences of all events that have
been included in the financial statements 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
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 investment and goodwill

We assess the carrying value of our investments in subsidiaries, including
acquired goodwill, for impairment at least bi-annually 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, 2003 our goodwill is recoverable at the amounts at which they
are stated in our financial statements.

Critical accounting estimate

Our management make 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

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estimate is made
based on the provisional rates announced by OFTA and is effective up to the
date of the release of our financial statements. OFTA 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 City Telecom (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.

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 OFTA, is recorded in other payables and accrued charges in our
balance sheet.

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 312001
    
    2002
    
    2003HK$000
    
    HK$000
    
    HK$000Net incomeAs stated under H.K. GAAP
    
    
    53,927
    
    
    
    91,129
    
    
    
    257,822U.S. GAAP adjustments:Compensation benefit cost associated with
share options
    
    
    (184
    )
    
    
    (21,586
    )
    
    
    2,731Amortization of goodwill (acquired prior
to June 30, 2001)
    
    
    (1,019
    )
    
    
    (1,019
    )
    
    
    Reversal of amortization of goodwill
(acquired after June 30, 2001)
    
    
    
    
    
    
    1,065
    
    
    
    1,065Deferred tax on accelerated depreciation
    
    
    1,242
    
    
    
    (624
    )
    
    
    (79
    )Net income under U.S. GAAP
    
    
    53,966
    
    
    
    68,965
    
    
    
    261,539Profit from continuing operations (less
taxation 2003: HK$17,778,000, 2002: HK$14,562,000,
2001: HK$18,770,000)
    
    
    65,389
    
    
    
    69,317
    
    
    
    264,151(Loss)/income from discontinued
operations (less taxation 2003: HK$Nil,
2002: HK$4,000, 2001: HK$5,000)
    
    
    (11,423
    )
    
    
    (352
    )
    
    
    83Loss arising from disposal of
discontinued operations
    
    
    
    
    
    
    
    
    
    
    (2,695
    )Net income under U.S. GAAP
    
    
    53,966
    
    
    
    68,965
    
    
    
    261,539


Year ended August 312001
    
    2002
    
    2003Earnings/(loss) per share under U.S. GAAPBasic:Continuing operations
    
    13.3 cents
    
    14.0 cents
    
    47.8 centsDiscontinued operations
    
    (2.3) cents
    
    (0.1) cents
    
    (0.5) centsTotal
    
    11.0 cents
    
    13.9 cents
    
    47.3 centsDiluted:Continuing operations
    
    13.2 cents
    
    12.3 cents
    
    42.9 centsDiscontinued operations
    
    (2.3) cents
    
    (0.1) cents
    
    (0.4) centsTotal
    
    10.9 cents
    
    12.2 cents
    
    42.5 cents


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Year ended August 312001
    
    2002
    
    2003HK$000
    
    HK$000
    
    HK$000Total shareholders equityAs stated under H.K. GAAP
    
    
    805,306
    
    
    
    910,183
    
    
    
    1,184,449U.S. GAAP adjustments:Goodwill
    
    
    5,092
    
    
    
    5,092
    
    
    
    5,092Accumulated amortization of goodwill
    
    
    (2,716
    )
    
    
    (3,735
    )
    
    
    (3,735
    )Reversal of amortization of goodwill
    
    
    
    
    
    
    1,065
    
    
    
    2,130Deferred tax liabilities
    
    
    (4,571
    )
    
    
    (5,195
    )
    
    
    (5,274
    )Total shareholders equity under U.S. GAAP
    
    
    803,111
    
    
    
    907,410
    
    
    
    1,182,662


The principal reasons for the difference between net income as reported
under Hong Kong GAAP and U.S. GAAP for the year ended August 31, 2003 is the
recording of compensation cost of share options issued to employees in
accordance with the requirements of U.S. GAAP, the capitalization and
amortization of goodwill under U.S. GAAP, and the full provision of tax
liabilities under U.S. GAAP.

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 and
related interpretations or the fair value method prescribed by Statement of
Financial Accounting Standards No. 123. We apply the intrinsic value method
prescribed by APB Opinion No. 25 and related interpretations and disclose in
our consolidated financial statements the pro forma effect that the adoption of
the fair value method would have on our net income and earnings per share.
Some of our options have been granted at an exercise price that is less than
the market value on the date of grant. The Company also cancelled and reissued
certain options granted during the year ended August 31, 2001. The
reissued options are required to be accounted for in accordance with the
requirements of Interpretation 44 of the Financial Accounting Standards Board
(FIN 44) as variable options.

The compensation cost for stock options under U.S. GAAP represents the
difference between the exercise price of the options 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. This amount is amortized over the vesting period
of the options. The charge for compensation expense in the year ended August
31, 2003 primarily relates to the variable options.

Goodwill and accumulated amortization comprises goodwill arising on the
acquisition in 1999 of the 963673 Ontario Limited group of companies. Under
Hong Kong GAAP, such goodwill was previously charged against available
reserves, whereas under U.S. GAAP, it was required to be recorded as an asset
on the balance sheet and amortized over its estimated useful life of five
years. In accordance with the change in accounting standards of Hong Kong
GAAP, goodwill on acquisitions occurring on or after September 1, 2001 is now
shown separately on the consolidated balance sheet 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 5
years. The Company has taken advantage of the transitional provisions of Hong
Kong SSAP 30 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. Effective
from fiscal 2003, goodwill under U.S. GAAP will no longer be amortized and is
subject to annual impairment tests. We

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have performed the transitional
goodwill impairment tests on the goodwill recorded prior to and after June 30,
2001, and no impairment loss was identified. We have 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
fiscal 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 financial statements 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 tax 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,
we have determined that on August 31, 2003, a provision was not required with
respect to deferred tax liabilities amounting to HK$5.3 million. The
corresponding amounts on August 31, 2002 and August 31, 2001 were HK$5.2
million and HK$4.6 million, respectively. Under U.S. GAAP, deferred taxation
for such liabilities is required to be provided for in full.

New Effective Standards/Recent Accounting Pronouncements

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:

New effective standards



|(a) |  | In November 2002, the FASB issued FASB interpretation No. (FIN) 45,
Guarantors Accounting and Disclosure Requirements for Guarantees,
Including Indirect Guarantees of Indebtedness of
Others. FIN 45 requires that an entity issuing a guarantee (including
those embedded in a purchase or sales agreement) must recognize, at the
inception of the guarantee, a liability equal to the fair value of the
guarantee. The recording of this liability is not dependent on the
probability that the payments will be required. The offset to the liability
will depend on the circumstances under which the guarantee was issued, but
could include: cash/accounts receivable if it is a standalone transaction,
net proceeds in a sales transaction, or expense if no compensation is
received. FIN 45 also requires detailed information to be disclosed about
each guarantee or group of guarantees even if the likelihood of making a
payment is remote. The recognition and measurement provisions of this
interpretation are applicable on a prospective basis to guarantees issued or
modified after December 31, 2002. The disclosure requirements of this
interpretation are effective for financial statements of periods ending
after December 15, 2002.
|--- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | We have evaluated the requirements of the above statement and believe that
we have no transactions that should be disclosed or accounted for in
accordance with this new standard.
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(b) |  | In December 2002, the FASB issued the Statement of Financial Accounting
Standard (SFAS) No. 148 Accounting for Stock-Based Compensation -
Transition and Disclosure  an amendment of FAS 123. SFAS 148 amends
FASB Statement No. 123 Accounting for Stock-based Compensation (SFAS
123) to provide alternative methods of transition for an entity that
voluntarily changes to the fair value based method of accounting for
stock-based employee compensation. It also amends the disclosure
provisions of SFAS 123 to require prominent disclosure about the effects
on reported net income of an entitys accounting policy decisions with
respect to stock-based employee compensation. Finally, SFAS 148 amends
APB Opinion No. 28 Interim Financial Reporting to require disclosure
|--- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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| |  | about those effects in interim financial information. SFAS 148 is
effective for financial statements for fiscal years ending and for interim
periods beginning after December 15, 2002.
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | As of August 31, 2003, the Company had no immediate plans to change to the
fair value based method of accounting for stock-based employee compensation,
and was therefore not affected by the transition provision of SFAS 148.
| |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(c) |  | In April 2003, the FASB issued SFAS No. 149, Amendment of Statement 133
on Derivative Instruments and Hedging Activities. This statement amends
and clarifies the accounting for derivative instruments, including certain
derivative instruments embedded in other contracts and hedging activities
under SFAS No. 133, Accounting for Derivative Instruments and Hedging
Activities. This statement clarifies when a contract with an initial net
investment meets the characteristic of a derivative and when a derivative
contains a financing component. This statement also amends the definition
of an underlying asset to conform to the language contained in FIN 45.
This statement is effective for contracts entered into or modified after
June 30, 2003, and for hedging relationships designated after June 30,
2003.
|--- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | We have evaluated the requirements of the above statement and believe that
the adoption of this new standard would not have a material impact on its
financial position or on our results of operations.
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(d) |  | In May 2003, the FASB issued SFAS No. 150, Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and
Equity. The new statement requires that certain financial instruments
that, under the previous guidance, could be accounted for as equity by
issuers, be classified as liabilities in statements of financial position.
SFAS No. 150 affects the issuers accounting for three types of
freestanding financial instruments. One type is mandatorily redeemable
shares, which the issuing company is obligated to buy back in exchange for
cash or other assets. A
second type, which includes put options and forward purchase contracts,
involves instruments that do or may require the issuer to buy back some of
its shares in exchange for cash or other assets. The third type of
instruments that are liabilities under this statement is obligations that
can be settled with shares, the monetary value of which is fixed, tied
solely or predominantly to a variable such as a market index, or varies
inversely with the value of the issuer shares. SFAS No. 150 does not apply
to features embedded in a financial instrument that is not a derivative in
its entirety. In addition to its requirements for the classification and
measurement of financial instruments in its scope, SFAS No. 150 also
requires disclosures about alternative ways of settling the instruments and
the capital structure of entities, all of whose shares are mandatorily
redeemable. Most of the guidance in SFAS No. 150 is effective for all
financial instruments entered into or modified after May 31, 2003, and
otherwise is effective at the beginning of the first interim period
beginning after June 15, 2003.
|--- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | We have evaluated the requirements of the above statement and believe that
we have no transactions that should be disclosed or accounted for in
accordance with this new standard.
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Recently issued pronouncements

In November 2002, the Emerging Issue Task Force (EITF) reached a
consensus on EITF 00-21, Revenue Arrangements with Multiple Deliverables,
related to the timing of revenue recognition for arrangements in which goods or
services or both are delivered separately in a bundled sales arrangement. The
EITF requires that when the deliverables included in this type of arrangement
meet certain criteria they should be accounted for separately as separate units
of accounting. This may result in a difference in the timing of revenue
recognition but will not result in a change in the total amount of revenue
recognized in a bundled sales arrangement. The allocation of revenue to the
separate deliverables is based on the relative

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fair value of each item. If the
fair value is not available for the delivered items then the residual method
must be used. The residual method requires that the amount allocated to the
undelivered items in the arrangement is their full fair value. This would
result in the discount, if any, being allocated to the delivered items. This
consensus is effective prospectively for arrangements entered into in financial
periods beginning after June 15, 2003.

We have evaluated the requirements of the above statement and believe that
the adoption of this new standard would not have a material impact on our
financial position or on our results of operations.

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ITEM 6. DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES

Directors, Senior Management and Supervisors

Our board of directors consists of nine directors, three of whom are
independent non-executive directors. 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 three
independent non-executive directors are Mr. Cheng Mo Chi, Moses, Mr. Lee Hon
Ying, John and Dr. Chan Kin Man.

The following table sets forth certain information concerning our
directors and senior management as of January 31, 2004.

Date First Electedor AppointedName
    
    Age
    
    Position
    
    Director or OfficerWONG Wai Kay, Ricky
    
    
    42
    
    
    Chairman
    
    
    1992CHEUNG Chi Kin, Paul
    
    
    46
    
    
    Managing Director
    
    
    1992CHONG Kin Chun, John
    
    
    41
    
    
    Director, Corporate Division
    
    
    1997FUNG So Mui, Fion
    
    
    41
    
    
    Business Development Director
    
    
    1997SIO Veng Kuan, Corinna
    
    
    36
    
    
    Finance Director
    
    
    1997TO Wai Bing
    
    
    42
    
    
    Director, International Business
    
    
    2000CHENG Mo Chi, Moses
    
    
    53
    
    
    Non-Executive Director
    
    
    1997LEE Hon Ying, John
    
    
    57
    
    
    Non-Executive Director
    
    
    1997CHAN Kin Man
    
    
    44
    
    
    Non-Executive Director
    
    
    1997CHOY Mei Yuk, Mimi
    
    
    39
    
    
    Administration & Human Resources Director
    
    
    1998LEUNG Kim Ming, Sam
    
    
    36
    
    
    Technical Director
    
    
    1997LO Sui Lun
    
    
    39
    
    
    Network Operation Director
    
    
    1999SIN Siu Fun, Annie
    
    
    44
    
    
    Customer Service Director
    
    
    1997TANG See Tin, Stanley
    
    
    46
    
    
    Executive Director, Pay-TV
    
    
    2003LEUNG Yau Man, Haily
    
    
    35
    
    
    Director, Pay-TV
    
    
    2003LEUNG, Eva
    
    
    34
    
    
    Secretary and In-House Legal Counsel
    
    
    2000


Executive Directors

Mr. WONG Wai Kay, Ricky, aged 42, 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 16 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 of City
Telecom. Mr. Wong is a first cousin of Mr. Cheung Chi Kin, Paul, our managing
director.

Mr. CHEUNG Chi Kin, Paul, aged 46, 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
from Herzing Institute, Canada. He has more than 19 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 of City Telecom. Mr. Cheung is a first cousin of Mr. Wong Wai Kay,
Ricky, our chairman.

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Mr. CHONG Kin Chun, John, aged 41, is the 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 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 41, is our business development director for
our fixed telecommunications network services. She holds a bachelors degree
in business administration from the University of Wisconsin, Madison in the
United States. Ms. Fung is currently leading the development of our fixed
telecommunications network businesses, the expansion of network coverage in
Hong Kong and regulatory affairs. Prior to joining the fixed
telecommmunications network service team, she was responsible for the 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.

Ms. SIO Veng Kuan, Corinna, aged 36, is our finance director. She is in
charge of City Telecoms financial operations. Ms. Sio joined City Telecom in
January 1993 and is an associate member of the Hong Kong Society of Accountants
and 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 42, is our director of international business. She
jointed City Telecom in September 1998 and is in charge of international
business development and oversees international telecommunications network
operations, external facilities planning and quality. Ms. To worked in
PCCW-HKT (then Cable & Wireless HKT) 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. She has been an Executive Director
since October 4, 2000.

Non-executive Directors

Mr. CHENG Mo Chi, Moses, aged 53, is a senior partner of P.C. Woo & Co., a
firm of solicitors and notaries in Hong Kong, the Founding Chairman of the Hong
Kong Institute of Directors, the Chairman of the Council and Court of the Hong
Kong Baptist University and the Football Betting and Lotteries Commission. He
was appointed a member of the Legislative Council of Hong Kong from 1991 to
1995. Mr. Cheng has been a director of City Telecom since June 1997.

Mr. LEE Hon Ying, John, aged 57, 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 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.

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Dr. CHAN Kin Man, aged 44, 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.

Senior Managers

Ms. CHOY Mei Yuk, Mimi, aged 39, 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 36, is our technical director. Mr. Leung
joined City Telecom in September 1992 and is responsible for the new
development of telecommunications network, Internet and pay-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 39, is our network development director. He is
responsible for the engineering and development of our fixed telecommunications
network. He joined City Telecom in September 1998. Prior to joining City
Telecom, Mr. Lo worked for PCCW (formerly known as Cable & Wireless 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 44, is our director of customer service. Ms.
Sin joined City Telecom in February 1995 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.

Ms. LEUNG Eva, aged 34, is our Company 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.

Mr. TANG See Tin, Stanley, aged 46, is the executive director of our
pay-TV services. He is responsible for development, overall management and
operations of our pay-TV business. Prior to joining City Telecom in December
2003, Mr. Tang had worked for the largest TV station in Hong Kong in various
senior management positions for more than 15 years, successfully developing and
diversifying the company business from a traditional free-to-air TV service to
diversified pay-TV services in Hong Kong and in the region. He recently worked
on the launch of two pay-TV channels, an advanced teleport and a 40-channel
pay-TV platform for the station in Hong Kong, serving as its director and chief
operating officer. Before joining the TV industry, he had worked for a
government subsidized organization in the areas of economic and market
research, consultancy and administration for seven years. Mr. Tang graduated
from the Hong Kong Baptist University with a diploma in Economics and is a
member of ICSA in the UK.

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Ms. LEUNG Yau Man, Haily, aged 35, is a director of our pay-TV services.
Ms. Leung joined City Telecom in April 2003 and is responsible for the overall
planning and development of City Telecoms pay-TV business. She graduated from
the University of Hong Kong and holds a bachelors degree in arts. Prior to
joining City Telecom, Ms. Leung has worked in various large corporations
including a television broadcaster, a mobile company and a telecommunications
company.

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, 2003 was approximately HK$29,828,000. We paid
approximately HK$1,461,000 as our contribution to the pension schemes of the
directors in the year ended August 31, 2003. In addition we paid our
independent non-executive directors fees of approximately HK$336,000 during the
year ended August 31, 2003.

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 City Telecoms
financial performance during the year in question.

No share options were granted to our directors and senior managers under
any of our share option schemes during the period from September 1, 2001
through January 31, 2004. The total number of share options outstanding under
the 1997 Scheme (as defined under - Share Option Schemes below) as of August
31, 2003 was 1,240,000, of which 500,000 were held by Mr. Leung, and 250,000 by
Ms. Choy.

Except as discussed herein, no other payments have been paid or are
payable, in respect of the year ended August 31, 2003, 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, 2003 was approximately
HK$6,584,000.

For the year ended August 31, 2003, the aggregate amount accrued by us to
provide pension retirement or similar benefits for our directors, senior
management and other employees was approximately HK$15,843,000.

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

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the initial term until termination with prior notice. After the initial
term, the agreements with Messrs. Wong and 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 anytime with three months advance
notice. 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 the three independent, non-executive directors,
namely, Mr. Cheng Mo Chi, Moses, Mr. Lee Hon Ying, John and Dr. Chan Kin Man.
The Audit Committee 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 (the
Remuneration Committee) to ensure the supervision of the remuneration
packages payable by the Company to our executive directors. The Remuneration
Committee is comprised of our three independent non-executive directors, our
finance director and the 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.

Employees

As of December 31, 2003, we had a total of 3,264 employees. The following
chart sets forth the number of our employees by functional area as of December
31, 2003:

EmployeesInformation technology and engineering
    
    
    478Sales and marketing
    
    
    1,532Customer service
    
    
    938General administration and others
    
    
    316Total
    
    
    3,264


The following chart sets forth the number of our employees by geographical
region as of December 31, 2003.

EmployeesHong Kong
    
    
    1,460Guangzhou
    
    
    1,775Canada
    
    
    29Total
    
    
    3,264


As of August 31, 2001, 2002 and 2003, we had approximately 851, 1,820 and
2,700 employees, respectively. In connection with the transfer of our calling
center operations to Guangzhou, PRC, we have hired over 1,700 customer service
representatives to staff that facility. We also substantially increased the
size of our sales and marketing force during fiscal 2003. As a result, our
total number of employees

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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 director and senior management share
ownership in City Telecom as of January 31, 2004.

Percentages ofShares Beneficially
    
    Shares BeneficiallyTitle of Class
    
    Identity of Person or Group
    
    Owned
    
    Owned (%)(3)
    
    Share Options(4)
    
    WarrantsOrdinary Shares
    
    Wong Wai Kay, Ricky
    
    
    332,636,999
    (1)
    
    
    54.48
    
    
    
    
    
    
    
    Ordinary Shares
    
    Cheung Chi Kin, Paul
    
    
    329,024,999
    (2)
    
    
    53.89
    
    
    
    
    
    
    
    Ordinary Shares
    
    Chong Kin Chun, John
    
    
    n/a
    
    
    Less than 1.0
    
    
    
    
    
    
    Ordinary Shares
    
    Fung So Mui, Fion
    
    
    n/a
    
    
    Less than 1.0
    
    
    
    
    
    
    Ordinary Shares
    
    Sio Veng Kuan, Corinna
    
    
    n/a
    
    
    Less than 1.0
    
    
    
    
    
    
    Ordinary Shares
    
    To Wai Bing
    
    
    n/a
    
    
    Less than 1.0
    
    
    
    
    
    
    Ordinary Shares
    
    Leung Kim Ming, Sam
    
    
    n/a
    
    
    Less than 1.0
    
    
    
    
    
    
    602Ordinary Shares
    
    Lo Sui Lun
    
    
    n/a
    
    
    Less than 1.0
    
    
    
    
    
    
    Ordinary Shares
    
    Other directors and senior
    
    
    
    
    
    
    
    
    
    
    250,000
    
    
    
    managers(5)


All shareholders own ordinary shares and enjoy the same voting rights with
respect to each share.

Share Option Schemes

We adopted a new share option scheme (the New Scheme) on December 23,
2002 and terminated the share option scheme adopted and in effect since July
12, 1997 (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 New Scheme, our
board of directors (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 ordinary shares of City
Telecom.



---

|(1) |  | Of the 332,636,999 shares, 318,516,999 shares are beneficially owned through
Mr. Wongs 34.7% interest in Top Group International Limited (#Top Group#),
1,346,000 shares are held by Bullion Holdings Limited, which is wholly owned by
Mr. Wong and his spouse, 1,524,000 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.                                                                                                                                                                                                                                                                                          
|   
|(3) |  | Percentage ownership is based on 610,539,693 shares issued as of January 31,
2004.                                                                                                                                                                                                                                                                                                                                                                                       
|   
|(4) |  | A total of 21,100,000 shares were issued and allotted to such directors and
senior managers as a result of their exercise of share options in fiscal
2003 (and through January 31, 2004) and such interests have been reflected
in the column Shares Beneficially Owned against the relevant person or
group, as applicable.                                                                                                                                           
|   
|(5) |  | The following non-executive directors and senior managers do not
beneficially own our shares, options or warrants: Cheng Mo Chi, Moses, Lee Hon
Ying, John, Chan Kin Man, Leung, Eva and Sin Siu Fun, Annie. The following
senior manager does not beneficially own our shares or warrants, but does own
options: 250,000 options were granted to Choy Mei Yuk, Mimi on October 20, 2000
at an exercise price of HK$0.58 per share, exercisable on or after June 2,
2001.

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The maximum number of ordinary shares which may be issued upon exercise of
all options to be granted under the New Scheme and any other share option
schemes of City Telecom must not exceed 10% of the ordinary shares in issue on
December 23, 2002. 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 (the
Listing Rules). Notwithstanding the foregoing, the ordinary shares which may
be issued upon exercise of all outstanding options granted and yet to be
exercised under the New Scheme and any other share option scheme(s) of City
Telecom at any time shall not exceed 30% of the 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 the New Scheme and any other
share option scheme(s) of City Telecom (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 New Scheme will be determined by
the Board in its absolute discretion, except that such price will not be less
than the highest of (a) the closing price of the ordinary shares as stated in
SEHK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
SEHK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 a director, chief executive or substantial
shareholder of City Telecom or any of their respective associates (as defined
in the Listing Rules) is required to be approved by the non-grantee independent
non-executive directors of City Telecom. If City Telecom proposes 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 the New Scheme and any other share option scheme(s) of City
Telecom (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 earlier termination by City
Telecom, the New 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;
| | --- |  | ----------------------------------------

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| | (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 City Telecom (or its 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 City
Telecom (or its 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 a voluntary winding-up of City Telecom;
| | ---- |  | --------------------------------------------------------------------------------------------------------



| | (v) |  | subject to (iv) above, the date of commencement of such
winding-up;
| | --- |  | -------------------------------------------------------------------



| | (vi) |  | the date on which any compromise or arrangement between City
Telecom and its members or creditors in connection with a scheme for
the reconstruction of City Telecom or its 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 City Telecom 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;
| | ----- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (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 City Telecom cancels 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, 2004, the board of directors had adopted nine
resolutions pursuant to the 1997 Scheme and none pursuant to the New Scheme.
The total number of options granted in these resolutions as of January 31, 2004
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.

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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, 2004 by all persons who are known to City
Telecom to own beneficially 5% or more of our ordinary shares.

Percentages ofShares Beneficially
    
    Shares BeneficiallyTitle of Class
    
    Identity of Person or Group
    
    Owned
    
    Owned(%)(1)Ordinary Shares
    
    Top Group International Limited
    
    
    318,516,999
    
    
    
    52.17Ordinary Shares
    
    Wong Wai Kay, Ricky
    
    
    332,636,999
    (2)
    
    
    54.48Ordinary Shares
    
    Cheung Chi Kin, Paul
    
    
    329,024,999
    (3)
    
    
    53.89Ordinary Shares
    
    Leung Ka Pak
    
    
    318,516,999
    (4)
    
    
    52.17Ordinary Shares
    
    Yau Ming Yan, Andrew
    
    
    318,516,999
    (4)
    
    
    52.17Ordinary Shares
    
    EK Investment Management Limited
    
    
    67,246,000
    
    
    
    11.01


Top Group International Limited (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 the chairman and managing director of City Telecom. Top Groups corporate
secretary is Ms. Sio Veng Kuan, Corinna, our finance director.

EK Investment Management Limited is not affiliated with City Telecom or
its officers or directors.

All shareholders own ordinary shares and enjoy the same voting rights with
respect to each share.

As of January 31, 2004, there were nine registered holders of 2,327,548 of
our American depositary shares in the United States, consisting of
approximately 7.62% of our outstanding shares.

City Telecom is not directly or indirectly owned or controlled by another
person, corporation or foreign government.

City Telecom is not aware of any arrangement, which may at a subsequent
date result in a change of control of City Telecom.



---

|(1) |  | Percentage ownership is based on 610,539,693 shares issued as of January 31,
2004.                                                                                                                                                                                                                                                                  
|--- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   
|(2) |  | Of the 332,636,999 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 and his
spouse, 1,524,000 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.                                                                                                                                                                                                                                   

71



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Related Party Transactions

During the period September 1, 2002 to January 31, 2004, 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 (the Agreement) with Takua
Corporation (Takua) for the sale of the entire issued share capital of City
Telecom (Japan) Co., Ltd. (City Telecom Japan) for an aggregate price of
JPY30,000,000 (approximately HK$1,950,000), which is to be paid by Takua in
thirty monthly instalments. 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 the Agreement for no additional
consideration.

As of January 31, 2004, we had received approximately HK$416,000 from
Takua.

Contracts with Our Directors and Senior Management

All of our directors and senior management have service agreements with
us. 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. Details concerning all of these arrangements are disclosed in Item
6 Directors, Senior Management and Employees above.

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ITEM 8. FINANCIAL INFORMATION

Consolidated Statements and Other Financial Information

See pages F-1  F-57 following Item 19.

Legal Proceedings

We are currently involved in three material legal proceedings. They are
described below:

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 Cable & Wireless 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
Cable & Wireless HKT. As a result, we do not believe that the resolution of
this case will impair our ability to lease transmission circuits from Cable &
Wireless HKT or significantly alter the commercial terms on which these
transmission circuits are leased. Cable & Wireless 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 Cable &Wireless 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 Development Limited (Jade Com), a Hong Kong company, alleged in
a claim filed in January 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$3,600,000 under the agreement. We filed a defense in May 1999 asserting
that Jade Com had breached a condition of the agreement that they obtain 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
telecommunication 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.

New World Telephone Limited (New World), a Hong Kong Company, filed a
claim in the High Court of Hong Kong against us in mid June 1999. New Worlds
claim alleged that a total of approximately HK$96,400,000 was owed to it by
City Telecom pursuant to two agreements:



| |  |  | a Carrier Service Agreement dated January 11, 1996, as amended; and
| | - |  | -------------------------------------------------------------------



| |  |  | a Telecommunications Service Agreement dated March 25, 1999.
| | - |  | ------------------------------------------------------------

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The two agreements provided for interconnection of our circuits with those
of New World and the related payment of telecommunications delivery fees and
interconnection fees. In late June 1999, New World dropped its claim related
to the Telecommunications Service Agreement. Accordingly, the claim was
reduced by approximately HK$28,800,000 to approximately HK$67,600,000. Within
this HK$67,600,000, New World alleges that approximately HK$48,700,000 is
payable by us as a result of our use of its international telecommunications
services and approximately HK$18,900,000 is payable in respect of delivery fees
alleged to have been mistakenly paid by New World to us in respect of calls
subject to a special arrangement between New World and Cable & Wireless HKT.
Under this arrangement, Cable & Wireless HKT is required to pay New World
delivery fees. The Carrier Service Agreement requires New World, upon receipt
of statements relating to delivery fees from Cable & Wireless HKT, to pay to us
delivery fees, which are related to those calls that generate delivery fees to
New World under its arrangement with Cable & Wireless HKT. New World claimed
that Cable & Wireless HKT had failed to remit to them these fees as reflected
in the statements. New World therefore alleges that we should repay the
HK$18,900,000 in delivery fees previously paid to us.

We filed a defense in August 1999. In the defense, we asserted that we
are entitled to the disputed HK$18,900,000 in delivery fees under the Carrier
Service Agreement, regardless of the dispute between Cable & Wireless HKT and
New World. We also believe we are not liable to pay the HK$48,700,000 in
interconnection fees because we are entitled to set off these fees against the
delivery fees payable by New World to us under the Carrier Service Agreement.
The proceedings have reached the stage of discovery of documents. We cannot
accurately predict the expected date of resolution of this case and we have not
made any reserve for this litigation.

In October 1999, New World filed a new claim under the Telecommunications
Service Agreement against us in the High Court of Hong Kong. The new claim
asserts damages of approximately HK$28,800,000 relating to interconnection fees
alleged to be payable by us. In late October 1999, we filed a defense to this
claim on the basis that we have fully paid to New World all outstanding
balances due under both the Telecommunications Service Agreement and the
Carrier Service Agreement. In late November 1999, New World responded to our
defense. The proceedings have reached the stage of discovery of documents. We
cannot accurately predict the expected date of resolution of this case and 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:

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| | (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.

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

Except as have been disclosed in this annual report, there have been no
significant changes since August 31, 2003, which is the date of the annual
financial statements in this annual report.

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ITEM 9. THE OFFER AND LISTING

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.

The price of our ordinary shares on the SEHK as of its close of trading on
January 30, 2004 was HK$2.825 per share. The table below shows the high and
low closing prices of the shares on the SEHK since listing.

PriceHigh
    
    Low(In HK$)1997August 4 to September
    
    
    1.750
    
    
    
    1.350October to December
    
    
    1.520
    
    
    
    0.9001998January to March
    
    
    1.170
    
    
    
    0.620April to June
    
    
    1.100
    
    
    
    0.400July to September
    
    
    0.490
    
    
    
    0.175October to December
    
    
    0.590
    
    
    
    0.2231999January to March
    
    
    0.580
    
    
    
    0.440April to June
    
    
    3.100
    
    
    
    0.465July to September
    
    
    5.650
    
    
    
    1.350October to December
    
    
    8.950
    
    
    
    5.1502000January to March
    
    
    8.000
    
    
    
    2.750April to June
    
    
    3.500
    
    
    
    1.330July to September
    
    
    1.480
    
    
    
    0.720October to December
    
    
    0.790
    
    
    
    0.5402001January to March
    
    
    0.720
    
    
    
    0.520April to June
    
    
    0.890
    
    
    
    0.435July to September
    
    
    0.660
    
    
    
    0.420October to December
    
    
    0.800
    
    
    
    0.4652002January to March
    
    
    1.310
    
    
    
    0.740April to June
    
    
    1.690
    
    
    
    1.050July to September
    
    
    1.610
    
    
    
    1.280October to December
    
    
    1.640
    
    
    
    1.300


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PriceHigh
    
    Low(In HK$)2003January
    
    
    1.490
    
    
    
    1.320February
    
    
    1.490
    
    
    
    1.370March
    
    
    1.470
    
    
    
    1.410April
    
    
    1.640
    
    
    
    1.420May
    
    
    2.150
    
    
    
    1.640June
    
    
    2.100
    
    
    
    1.920July
    
    
    2.975
    
    
    
    2.050August
    
    
    2.625
    
    
    
    2.375September
    
    
    2.875
    
    
    
    2.550October
    
    
    3.350
    
    
    
    2.675November
    
    
    3.375
    
    
    
    3.125December
    
    
    3.175
    
    
    
    2.7502004January (through January 31)
    
    
    2.975
    
    
    
    2.750


The price of our American depositary shares on Nasdaq as of its close of
trading on January 30, 2004 was US$7.21 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$)1999November 3 to December
    
    
    21.875
    
    
    
    14.4382000January to March
    
    
    20.500
    
    
    
    8.156April to June
    
    
    8.313
    
    
    
    3.625July to September
    
    
    3.688
    
    
    
    1.750October to December
    
    
    2.063
    
    
    
    1.1252001January to March
    
    
    1.781
    
    
    
    1.375April to June
    
    
    2.400
    
    
    
    1.150July to September
    
    
    1.650
    
    
    
    1.030October to December
    
    
    2.050
    
    
    
    1.0902002January to March
    
    
    4.350
    
    
    
    2.600April to June
    
    
    3.420
    
    
    
    2.870July to September
    
    
    4.090
    
    
    
    3.110October to December
    
    
    3.940
    
    
    
    3.1002003January
    
    
    3.700
    
    
    
    3.080February
    
    
    3.660
    
    
    
    3.340March
    
    
    3.570
    
    
    
    3.420April
    
    
    3.890
    
    
    
    3.510May
    
    
    6.000
    
    
    
    3.810June
    
    
    5.990
    
    
    
    4.781July
    
    
    7.940
    
    
    
    5.400August
    
    
    7.000
    
    
    
    5.900September
    
    
    7.180
    
    
    
    6.270October
    
    
    8.950
    
    
    
    6.820November
    
    
    9.550
    
    
    
    8.021December
    
    
    8.130
    
    
    
    7.0302004January (through January 31)
    
    
    7.720
    
    
    
    7.150


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The price of our warrants on the SEHK as of its close of trading on
January 30, 2004 was HK$2.450 per warrant. The table below shows the high and
low closing prices of the warrants on SEHK since listing.

PriceHigh
    
    Low(In HK$)2001November 2 to December 31
    
    
    0.410
    
    
    
    0.1802002January to March
    
    
    0.890
    
    
    
    0.365April to June
    
    
    1.220
    
    
    
    0.700July to September
    
    
    1.170
    
    
    
    0.850October to December
    
    
    1.180
    
    
    
    0.9002003January
    
    
    1.010
    
    
    
    0.980February
    
    
    1.040
    
    
    
    0.960March
    
    
    1.040
    
    
    
    0.950April
    
    
    1.170
    
    
    
    0.960May
    
    
    1.650
    
    
    
    1.210June
    
    
    1.650
    
    
    
    1.650July
    
    
    2.350
    
    
    
    1.650August
    
    
    2.150
    
    
    
    1.920September
    
    
    2.300
    
    
    
    2.000October
    
    
    2.700
    
    
    
    2.275November
    
    
    2.825
    
    
    
    2.700December
    
    
    2.800
    
    
    
    2.6502004January (through January 31)
    
    
    2.650
    
    
    
    2.450


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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 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 were filed
with the U.S. Securities and Exchange Commission as an exhibit to the
registration statement on Form F-1 (Registration No. 333-11012) under the
Securities Act in connection with a global offering of American depositary
shares in November 1999.

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 has a material interest. This prohibition shall not apply to the
following:



| | (a) |  | the giving to the director of any guarantee, indemnity or
security in respect of money lent or obligations undertaken by the
director for the benefit of City Telecom or any of its subsidiaries;
| | --- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (b) |  | the giving to a third party of any guarantee, indemnity or
security in respect of a debt or a obligation of City Telecom or any
of its subsidiaries for which the director has assumed responsibility
in whole or in part under a guarantee or indemnity or by the giving of
security;
| | --- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (c) |  | where City Telecom or any of its subsidiaries is offering
securities in which offer the director is or may be entitled to
participate as a holder of securities or in the underwriting or
sub-underwriting of which the director is to participate;
| | --- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (d) |  | any contract in which the director is interested by virtue of his
interest in shares or debentures or other securities of City Telecom
or by reason of any other interest in or through City Telecom;
| | --- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (e) |  | any contract concerning any other company (not being a company in
which the director owns five percent or more) in which the director is
interested directly or indirectly;
| | --- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (f) |  | any contract concerning the adoption, modification or operation
of a pension fund or retirement, death or disability benefits scheme
which relates both to directors and employees of City Telecom or of
any of its subsidiaries and does not provide in respect of any
director any privilege or advantage not accorded to the employees to
which the fund or scheme relates;
| | --- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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| | (g) |  | any contract for the benefit of employees of City Telecom or of
any of its subsidiaries under which the director benefits in a similar
manner to the employees and which does not accord to any director any
privilege not accorded to the employees to whom the contract relates;
and
| | --- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (h) |  | any contract for the purchase or maintenance for any director of
insurance against any liability.
| | --- |  | -------------------------------------------------------------------------------------------------

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
| | --- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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| | (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.

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 10% or more of the shares which carry 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

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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.

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

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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:



| | (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

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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.

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 18.5%. The
maximum tax payable is, however, limited to tax at the standard rate of 15% 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

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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$2.50 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.

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$2.50 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

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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.

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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.




ITEM 12. DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES

Not applicable.

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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.]




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 it
files or submits under the U.S. Securities Exchange Act of 1934, as amended, is
recorded, processed, summarized and reported within the time periods specified
in Securities and Exchange Commission 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 City Telecoms management,
including the 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]

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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-57 following Item 19.




ITEM 19. EXHIBITS



| | (a) |  | See pages F-1 to F-57 following this item.
| | --- |  | ------------------------------------------



| | (b) |  | Exhibit 31  Section 302 Certifications of each of the Chairman and
Finance Director.
| | --- |  | -------------------------------------------------------------------------------------



| | (c) |  | Exhibit 32  Section 906 Certification of Chairman and Finance
Director.
| | --- |  | ------------------------------------------------------------------------

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Report of Independent Accountants 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, 2002 and 2003 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, 2001, 2002 and 2003, 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 auditing standards generally
accepted in the United States of America and Hong Kong. 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, 2002 and 2003, and the results of its operations and cash flows for
each of the three years ended August 31, 2001, 2002 and 2003, 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. The application of the latter would have affected
the determination of consolidated net income for each of the three years ended
August 31, 2001, 2002 and 2003 and the determination of consolidated
shareholders equity and consolidated financial position at August 31, 2002 and
2003 to the extent summarised in Note 29 to the consolidated financial
statements. PricewaterhouseCoopers
Certified Public Accountants Hong Kong, November 24, 2003 except for Note 30, which is as of February 19, 2004. F-1




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|                                                           |                                                                                       |  |  |  |  |  |  | 
|---------------------------------------------------------- | ------------------------------------------------------------------------------------- |  |  |  |  |  |  | 
|CURRENCY TRANSLATION                                      
|FORWARD-LOOKING STATEMENTS                                
|PART I                                                    
|                                                           | ITEM 1. IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS                        
|                                                           | ITEM 2. OFFER STATISTICS AND EXPECTED TIMETABLE                                      
|                                                           | ITEM 3. KEY INFORMATION                                                              
|                                                           | ITEM 4. INFORMATION ON THE COMPANY                                                   
|                                                           | ITEM 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS                                 
|                                                           | ITEM 6. DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES                                   
|                                                           | ITEM 7. MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS                            
|                                                           | ITEM 8. FINANCIAL INFORMATION                                                        
|                                                           | ITEM 9. THE OFFER AND LISTING                                                        
|                                                           | ITEM 10. ADDITIONAL INFORMATION                                                      
|                                                           | ITEM 11. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK                  
|                                                           | ITEM 12. DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES                      
|PART II                                                   
|                                                           | ITEM 13. DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES                             
|                                                           | ITEM 14. MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF PROCEEDS
|                                                           | ITEM 15. CONTROLS AND PROCEDURES                                                     
|                                                           | ITEM 16. [RESERVED]                                                                  
|PART III                                                  
|                                                           | ITEM 17. FINANCIAL STATEMENTS                                                        
|                                                           | ITEM 18. FINANCIAL STATEMENTS                                                        
|                                                           | ITEM 19. EXHIBITS                                                                    
|Report of Independent Accountants                         
|CONSOLIDATED STATEMENTS OF INCOME                         
|CONSOLIDATED BALANCE SHEETS                               
|CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
|ONSOLIDATED STATEMENTS OF CASH FLOWS                      
|NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS            
|SIGNATURE                                                 
|Ex-31 Certifications Pursuant to Section 302              
|Ex-32 Certifications Pursuant to Section 906              



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CITY TELECOM (H.K.) LIMITED AND ITS SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME
(Amounts in thousands except per share data) Year ended August 31,2001
    
    2002
    
    2003Note
    
    HK$
    
    HK$
    
    HK$Revenue from provision of telecommunication
and other services, net
    
    
    
    
    
    
    1,016,634
    
    
    
    1,150,200
    
    
    
    1,298,909Cost of services provided
    
    
    3
    
    
    
    (584,352
    )
    
    
    (457,963
    )
    
    
    (322,753
    )Gross profit
    
    
    
    
    
    
    432,282
    
    
    
    692,237
    
    
    
    976,156Operating expensesSalaries and related costs
    
    
    
    
    
    
    (149,237
    )
    
    
    (196,158
    )
    
    
    (220,350
    )Sales and marketing expenses
    
    
    
    
    
    
    (86,574
    )
    
    
    (168,441
    )
    
    
    (182,471
    )General and administrative expenses
    
    
    
    
    
    
    (169,661
    )
    
    
    (227,768
    )
    
    
    (284,290
    )Provision for doubtful accounts receivable
    
    
    
    
    
    
    (9,663
    )
    
    
    (10,277
    )
    
    
    (17,685
    )Income from operations
    
    
    
    
    
    
    17,147
    
    
    
    89,593
    
    
    
    271,360Bank interest income
    
    
    
    
    
    
    35,438
    
    
    
    10,870
    
    
    
    3,163Interest expense
    
    
    
    
    
    
    (4,542
    )
    
    
    (3,504
    )
    
    
    (601
    )Loss on disposal of a subsidiary
    
    
    4
    
    
    
    
    
    
    
    
    
    
    
    (2,695
    )Other income, net
    
    
    
    
    
    
    10,935
    
    
    
    502
    
    
    
    4,373Income before taxation
    
    
    5
    
    
    
    58,978
    
    
    
    97,461
    
    
    
    275,600Income tax charge
    
    
    6
    
    
    
    (18,775
    )
    
    
    (14,566
    )
    
    
    (17,778
    )Income after taxation
    
    
    
    
    
    
    40,203
    
    
    
    82,895
    
    
    
    257,822Minority interests
    
    
    
    
    
    
    13,724
    
    
    
    8,234
    
    
    
    Net income
    
    
    
    
    
    
    53,927
    
    
    
    91,129
    
    
    
    257,822Earnings per shareBasic
    
    
    7
    
    
    11.0 cents
    
    18.4 cents
    
    46.7 centsDiluted
    
    
    7
    
    
    10.9 cents
    
    16.1 cents
    
    41.9 cents
 The accompanying notes are an integral part of these consolidated financial statements. F-2




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##### Table of Contents






CITY TELECOM (H.K.) LIMITED AND ITS SUBSIDIARIES CONSOLIDATED BALANCE SHEETS
(Amounts in thousands except number of shares and per share amounts) August 31,2002
    
    2003Note
    
    HK$
    
    HK$ASSETSCurrent assetsCash and bank balances
    
    
    20
    
    
    
    309,583
    
    
    
    402,034Pledged bank deposits
    
    
    16
    
    
    
    5,000
    
    
    
    29,608Trade receivables, net
    
    
    8
    (a)
    
    
    108,058
    
    
    
    94,080Other receivables, deposits and prepayments
    
    
    8
    (b)
    
    
    27,287
    
    
    
    34,714Total current assets
    
    
    
    
    
    
    449,928
    
    
    
    560,436Goodwill
    
    
    9
    
    
    
    4,261
    
    
    
    3,196Fixed assets, net
    
    
    10
    
    
    
    873,096
    
    
    
    945,952Other investments
    
    
    17
    
    
    
    
    
    
    
    23,370Long term bank deposit
    
    
    18
    
    
    
    
    
    
    
    15,580Total assets
    
    
    
    
    
    
    1,327,285
    
    
    
    1,548,534LIABILITIES AND SHAREHOLDERS EQUITYCurrent liabilitiesLoan from a former minority shareholder
    
    
    14
    
    
    
    22,500
    
    
    
    Trade payables
    
    
    
    
    
    
    126,280
    
    
    
    113,384Deposits received
    
    
    
    
    
    
    18,189
    
    
    
    19,908Deferred service income
    
    
    
    
    
    
    5,167
    
    
    
    10,172Other payables and accrued charges
    
    
    11
    
    
    
    182,858
    
    
    
    164,552Obligations under finance leases
    
    
    12
    
    
    
    2,949
    
    
    
    Income taxes payable
    
    
    
    
    
    
    24,979
    
    
    
    22,895Bank overdrafts  unsecured
    
    
    20
    
    
    
    19,180
    
    
    
    Short-term bank loan  secured
    
    
    20
    
    
    
    
    
    
    
    18,174Total current liabilities
    
    
    
    
    
    
    402,102
    
    
    
    349,085Long-term liabilitiesDeferred taxation
    
    
    13
    
    
    
    15,000
    
    
    
    15,000Total liabilities
    
    
    
    
    
    
    417,102
    
    
    
    364,085Commitments and contingencies
    
    
    15Shareholders equityOrdinary shares, par value $0.1 per share 2,000,000,000 shares authorised at
August 31, 2002 and August 31, 2003 500,863,202 shares issued and
outstanding at August 31, 2002,
604,959,787 shares issued and outstanding
at August 31, 2003
    
    
    19
    
    
    
    50,086
    
    
    
    60,496Share premium
    
    
    
    
    
    
    572,656
    
    
    
    615,886Retained profits
    
    
    
    
    
    
    278,390
    
    
    
    505,978Exchange reserve
    
    
    
    
    
    
    (38
    )
    
    
    1,231Warrant reserve
    
    
    
    
    
    
    9,089
    
    
    
    858Total shareholders equity
    
    
    
    
    
    
    910,183
    
    
    
    1,184,449Total liabilities and shareholders equity
    
    
    
    
    
    
    1,327,285
    
    
    
    1,548,534
 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 STATEMENTS OF CHANGES IN SHAREHOLDERS EQUITY
(Amounts in thousands, except number of shares) Ordinary sharesNumber of
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Totalshares
    
    Amount
    
    Share
    
    Warrant
    
    Exchange
    
    Retained
    
    shareholdersNote
    
    outstanding
    
    outstanding
    
    premium
    
    reserve
    
    reserve
    
    profits
    
    equityHK$
    
    HK$
    
    HK$
    
    HK$
    
    HK$
    
    HK$Balance at August 31, 2001
    
    
    
    
    
    
    491,074,000
    
    
    
    49,107
    
    
    
    569,180
    
    
    
    
    
    
    
    (242
    )
    
    
    187,261
    
    
    
    805,306Issue of warrants
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    10,815
    
    
    
    
    
    
    
    
    
    
    
    10,815Expenses in connection with issue of new warrants
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,058
    )
    
    
    
    
    
    
    
    
    
    
    (1,058
    )Shares issued upon exercise of warrants
    
    
    
    
    
    
    6,729,202
    
    
    
    673
    
    
    
    2,686
    
    
    
    (668
    )
    
    
    
    
    
    
    
    
    
    
    2,691Shares issued upon exercise of share options
    
    
    
    
    
    
    3,060,000
    
    
    
    306
    
    
    
    790
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,096Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    91,129
    
    
    
    91,129Exchange adjustment on translation of the
accounts of overseas subsidiaries
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    204
    
    
    
    
    
    
    
    204Balance at August 31, 2002
    
    
    
    
    
    
    500,863,202
    
    
    
    50,086
    
    
    
    572,656
    
    
    
    9,089
    
    
    
    (38
    )
    
    
    278,390
    
    
    
    910,183Balance at August 31, 2002
    
    
    
    
    
    
    500,863,202
    
    
    
    50,086
    
    
    
    572,656
    
    
    
    9,089
    
    
    
    (38
    )
    
    
    278,390
    
    
    
    910,1832003 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
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    257,822
    
    
    
    257,822Exchange 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
    
    
    
    505,978
    
    
    
    1,184,449
 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 CASH FLOWS
(Amounts in thousands) Year ended August 31,2001
    
    2002
    
    2003HK$
    
    HK$
    
    HK$Cash flows from operating activitiesIncome before taxation
    
    
    58,978
    
    
    
    97,461
    
    
    
    275,600Amortization of goodwill
    
    
    
    
    
    
    1,065
    
    
    
    1,065Depreciation of purchased fixed assets
    
    
    77,187
    
    
    
    124,563
    
    
    
    173,619Depreciation of fixed assets held under
finance leases
    
    
    5,660
    
    
    
    3,727
    
    
    
    1,336Interest income
    
    
    (35,438
    )
    
    
    (10,870
    )
    
    
    (3,163
    )Interest expense
    
    
    3,854
    
    
    
    3,279
    
    
    
    559Interest element of finance leases
    
    
    688
    
    
    
    225
    
    
    
    42Loss on disposal of fixed assets
    
    
    3,512
    
    
    
    2,414
    
    
    
    427Loss on disposal of a subsidiary
    
    
    
    
    
    
    
    
    
    
    2,695Decrease/(increase) in trade receivables,
other receivables, deposits and prepayments
    
    
    39,943
    
    
    
    (15,211
    )
    
    
    6,455(Decrease)/increase in trade payables,
other payables, accrued charges, deposits
received and deferred service income
    
    
    (111,091
    )
    
    
    89,747
    
    
    
    (23,673
    )Net cash inflow generated from operations
    
    
    43,293
    
    
    
    296,400
    
    
    
    434,962Interest paid
    
    
    (3,854
    )
    
    
    (3,279
    )
    
    
    (559
    )Interest element of finance leases
    
    
    (688
    )
    
    
    (225
    )
    
    
    (42
    )Hong Kong profits tax paid
    
    
    
    
    
    
    (4,107
    )
    
    
    (18,107
    )Overseas tax paid
    
    
    
    
    
    
    (345
    )
    
    
    (1,754
    )Net cash inflow from operating activities
    
    
    38,751
    
    
    
    288,444
    
    
    
    414,500Investing activitiesAcquisition of additional interest in a
subsidiary (Note (*) below)
    
    
    
    
    
    
    (7,500
    )
    
    
    Increase/decrease in prepayments for fixed
assets
    
    
    (54,929
    )
    
    
    54,929
    
    
    
    Decrease in bank deposits
    
    
    133,480
    
    
    
    20,000
    
    
    
    (Increase)/decrease in pledged bank deposits
    
    
    2,000
    
    
    
    23,000
    
    
    
    (24,608
    )Increase in long term bank deposits
    
    
    
    
    
    
    
    
    
    
    (15,580
    )Purchases of fixed assets
    
    
    (166,037
    )
    
    
    (579,066
    )
    
    
    (250,209
    )Interest received
    
    
    35,438
    
    
    
    10,870
    
    
    
    3,163Purchase of other investments
    
    
    
    
    
    
    
    
    
    
    (23,370
    )Proceeds from disposal of fixed assets
    
    
    1,279
    
    
    
    2,555
    
    
    
    1,552Disposal of a subsidiary, net of cash
disposed (Note (**) below)
    
    
    
    
    
    
    
    
    
    
    (582
    )Net cash outflow from investing activities
    
    
    (48,769
    )
    
    
    (475,212
    )
    
    
    (309,634
    )Net cash inflow/(outflow) before financing
activities
    
    
    (10,018
    )
    
    
    (186,768
    )
    
    
    104,866
 (Continued) 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 (Continued)
(Amounts in thousands) Year ended August 31,2001
    
    2002
    
    2003HK$
    
    HK$
    
    HK$Financing activitiesIssue of new shares
    
    
    382
    
    
    
    3,787
    
    
    
    45,409Issue of warrants
    
    
    
    
    
    
    10,815
    
    
    
    Expenses in connection with the issue of
warrants
    
    
    
    
    
    
    (1,058
    )
    
    
    Loan from a minority shareholder
    
    
    22,500
    
    
    
    
    
    
    
    Repayment of loan to a former minority
shareholder
    
    
    
    
    
    
    
    
    
    
    (22,500
    )Repayment of capital element of finance leases
    
    
    (4,095
    )
    
    
    (4,435
    )
    
    
    (2,949
    )Dividend paid
    
    
    (4,907
    )
    
    
    
    
    
    
    (30,234
    )Net cash inflow/(outflow) from financing
activities
    
    
    13,880
    
    
    
    9,109
    
    
    
    (10,274
    )Increase/(decrease) in cash and cash equivalents
    
    
    3,862
    
    
    
    (177,659
    )
    
    
    94,592Cash and cash equivalents at the beginning of
year
    
    
    460,628
    
    
    
    467,750
    
    
    
    290,403Effect of foreign exchange rate changes on cash
and cash equivalents
    
    
    3,260
    
    
    
    312
    
    
    
    (1,135
    )Cash and cash equivalents at the end of year (Note 20)
    
    
    467,750
    
    
    
    290,403
    
    
    
    383,860
 Note (*): Acquisition of additional interest in a subsidiary Year ended August 31,2001
    
    2002
    
    2003HK$
    
    HK$
    
    HK$Minority interests acquired
    
    
    
    
    
    
    6,483
    
    
    
    Goodwill on acquisition
    
    
    
    
    
    
    1,017
    
    
    
    
    
    
    
    7,500
    
    
    
    Satisfied by:Cash
    
    
    
    
    
    
    7,500
    
    
    
    
 F-6




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##### Table of Contents



CITY TELECOM (H.K.) LIMITED AND ITS SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
(Amounts in thousands) Note (**): Disposal of a subsidiary Year ended August 31,2001
    
    2002
    
    2003HK$
    
    HK$
    
    HK$Fixed assets
    
    
    
    
    
    
    
    
    
    
    1,354Accounts receivable, other receivables,
deposits and prepayments
    
    
    
    
    
    
    
    
    
    
    1,914Cash and bank balances
    
    
    
    
    
    
    
    
    
    
    714Accounts payable, other payables, accrued
charges, deposits received and deferred
service income
    
    
    
    
    
    
    
    
    
    
    (805
    )Taxation payable
    
    
    
    
    
    
    
    
    
    
    (1
    )Net assets disposed of
    
    
    
    
    
    
    
    
    
    
    3,176Exchange reserve transferred to Statements of
income
    
    
    
    
    
    
    
    
    
    
    1,469Net loss on
disposal
    
    
    
    
    
    
    
    
    
    
    
    (2,695
    )Sale proceeds
    
    
    
    
    
    
    
    
    
    
    
    1,950Less: Cash and cash equivalents of the
disposed subsidiary
    
    
    
    
    
    
    
    
    
    
    
    (714
    )Sale proceeds receivable (Note 4)
    
    
    
    
    
    
    
    
    
    
    (1,818
    )Net cash outflow in respect of the disposal of a
subsidiary
    
    
    
    
    
    
    
    
    
    
    
    (582
    )
 These consolidated statements of cash flows are prepared in accordance with
Hong Kong Statement of Standard Accounting Practice (SSAP) No. 15 (revised)
Cash Flow Statements which differs in certain respects from U.S. Statement
of Financial Accounting Standard No. 95 (SFAS 95) Statement of Cash Flows.
The principal differences are explained in Note 29(d). The accompanying notes are an integral part of these consolidated financial statements. F-7




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##### Table of Contents






CITY TELECOM (H.K.) LIMITED AND ITS SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS  1
    
    Description of business and basis of presentationCity 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 in Hong Kong, Japan and Canada and
fixed telecommunications network services in Hong Kong and Canada.As of August 31, 2003, the Company had the following principal direct and
indirect subsidiaries: Place and date ofestablishment/
    
    Issued
    
    Percentage holding
    
    Nature ofName
    
    operation
    
    capital
    
    Direct
    
    Indirect
    
    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.
    
    USA
May 5, 1997
    
    Common
US$1
    
    
    
    
    
    
    100
    
    
    Inactive
 F-8




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##### Table of Contents



CITY TELECOM (H.K.) LIMITED AND ITS SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS  1
    
    Description of business and basis of presentation (Continued) Place and date of
establishment/
    
    Issued
    
    Percentage holding
    
    Nature ofName
    
    operation
    
    capital
    
    Direct
    
    Indirect
    
    businessCredibility
Holdings Limited
    
    British Virgin
Islands
December 18, 1998
    
    Ordinary
US$1
    
    
    100
    
    
    
    
    
    
    Investment holding
in Hong KongCTI Guangzhou
Customer Service
Co. Ltd.
(translated, but
not the registered
name)
    
    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 KongHong 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 (formerly
known as Seabright
Associates 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
 F-9




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##### Table of Contents



CITY TELECOM (H.K.) LIMITED AND ITS SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS  1
    
    Description of business and basis of presentation (Continued)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 Hong Kong Society of Accountants
(HKGAAP). 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 29.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 policiesThe principal accounting policies adopted in the preparation of these
financial statements are set out below:(a)
    
    ConsolidationThe consolidated financial statements include the financial statements of
the Company and all its subsidiaries as of August 31, 2002 and 2003, and
the results of operations, cash flows and changes in shareholders equity
for the years ended August 31, 2001, 2002 and 2003. All significant
inter-company transactions and balances are eliminated on consolidation.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.Minority interests represent the interests of outside shareholders in the
operating results and net assets of subsidiaries. F-10




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##### Table of Contents



CITY TELECOM (H.K.) LIMITED AND ITS SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS  2
    
    Principal accounting policies (Continued)(b)
    
    GoodwillGoodwill represents the excess of the cost of an acquisition over the
fair value of the Companys share of the 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 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 is accounted for in
the profit and loss account.(c)
    
    Fixed assetsFixed 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
    
    
    2
    %Leasehold buildings
    
    
    2
    %Furniture, fixtures and fittings
    
    
    25
    %Telecommunications, computer and office equipment
    
    
    7% - 25
    %Auto-diallers
    
    
    25
    %Motor 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, 2003.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



CITY TELECOM (H.K.) LIMITED AND ITS SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS  2
    
    Principal accounting policies (Continued)(d)
    
    Assets held under leases  (i)
    
    Finance leasesLeases 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 leasesLeases 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 investmentsOther 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)
    
    Accounts receivableProvision 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.(g)
    
    Deferred taxationDeferred taxation is 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 financial statements to the extent that a liability
or an asset is expected to be payable or recoverable 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 tax 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 HKGAAP. F-12




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##### Table of Contents



CITY TELECOM (H.K.) LIMITED AND ITS SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS  2
    
    Principal accounting policies (Continued)(h)
    
    Translation of foreign currenciesTransactions 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.(i)
    
    Cash and cash equivalentsCash 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.(j)
    
    ProvisionsProvisions 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.(k)
    
    Contingent liabilities and contingent assetsA 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



CITY TELECOM (H.K.) LIMITED AND ITS SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS  2
    
    Principal accounting policies (Continued)(l)
    
    Revenue recognitionRevenue 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 amortized
based on the estimated actual usage by customers. Revenue received in
advance for provision of fixed telecommunications network services is
amortized on a straight line basis over the life 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.(m)
    
    Employee benefits  (i)
    
    Employee leave entitlementsEmployee 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 plansProvisions 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 costsThe 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. F-14




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##### Table of Contents



CITY TELECOM (H.K.) LIMITED AND ITS SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS  2
    
    Principal accounting policies (Continued)(n)
    
    Research and development costsResearch 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, 2001, 2002 and 2003 amounted to HK$2,791,000, HK$2,166,000 and
HK$2,622,000 respectively.(o)
    
    Borrowing costsBorrowing 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.No borrowing costs were capitalized for the three years ended August 31,
2003.(p)
    
    Segment reportingIn 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.(q)
    
    Use of estimatesThe 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. F-15




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##### Table of Contents



3
    
    Cost of services providedManagement of the Company make their best estimates for charges of the
Universal Services Contribution (USC) payable to PCCW-HKT Telephone
Limited (PCCW) in order to fund the costs of network development
incurred by PCCW in remote areas in Hong Kong (the Development).
Such estimated costs are included as part of the costs of rendering
its services of the Company. The estimate is made based on the
provisional rates announced by The Office of the Telecommunications
Authority (the OFTA) and effective up to the date of the release of
the financial statements of the Company. The OFTA periodically
reviews the actual costs incurred by PCCW in the Development and
revises the amounts owed to PCCW or to be refunded by it to the
respective USC contributing parties, including the Company (the Rate
Revisions). Accordingly, the estimate made by 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 as an estimated refund of 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 OFTA issued a statement (the November 2002
Statement) on the USC which confirms the actual USC payable by USC
contributing parties for the calender year 2000. As a result 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 this has been set off against the cost of services of the
Company in the current year.On March 8, 2003, the Company also received in advance a sum of
HK$56,488,570 from PCCW as the estimated refund of the USC paid for the
period from January 1, 2001 to June 30, 2002 on a provisional basis (the
Provisional Refund). On October 20, 2003, OFTA issued another statement
(the October 2003 Statement) on the USC and confirmed the contribution
level for calender year 2001. Accordingly, HK$40,276,440 out of the
Provisional Refund and an additional refund of HK$3,257,071 payable by PCCW
to the Company for the period from January 1, 2001 to December 31, 2001
were set of against costs of services of the Company in the current year.
The Company has therefore set off against costs a total of HK$84,119,117 in
respect of USC Refund in the current year.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, is still subject to confirmation of OFTA.
The amount has been included in other payables and accrued charges in the
Companys consolidated balance sheet as at August 31, 2003. F-16




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##### Table of Contents



CITY TELECOM (H.K.) LIMITED AND ITS SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS  4
    
    Loss on disposal of a subsidiaryIn the current year, 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 paid by the
Purchaser in thirty monthly instalments commencing from 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, 2003, HK$1,818,000 receivable from the Purchaser is
included in other receivables, deposits and prepayments. HK$780,000 and
HK$1,038,000 are expected to be received within one year and after one
year respectively.5
    
    Income before taxation Year ended August 31,2001
    
    2002
    
    2003HK$000
    
    HK$000
    
    HK$000Income before taxation is stated after
charging:Amortization of goodwill
    
    
    
    
    
    
    1,065
    
    
    
    1,065Depreciation of purchased fixed assets
    
    
    77,187
    
    
    
    124,563
    
    
    
    173,619Depreciation of fixed assets held under
finance leases
    
    
    5,660
    
    
    
    3,727
    
    
    
    1,336Exchange losses, net
    
    
    
    
    
    
    508
    
    
    
    Operating lease charges in respect
of:
    
    
    17,908
    
    
    
    11,486
    
    
    
    6,481Land and buildings Computer equipment
    
    
    7,715
    
    
    
    5,141
    
    
    
    100Retirement benefit costs  defined
contribution plans (Note 24)
    
    
    4,082
    
    
    
    11,335
    
    
    
    15,843Interest expense comprises:Interest element of finance leases
    
    
    688
    
    
    
    225
    
    
    
    42Interest on bank overdrafts
    
    
    928
    
    
    
    235
    
    
    
    210Interest paid to third parties
    
    
    1,468
    
    
    
    2,198
    
    
    
    349Interest paid to a minority shareholder
    
    
    1,458
    
    
    
    846
    
    
    
    Total interest expenses
    
    
    4,542
    
    
    
    3,504
    
    
    
    601Other income comprises:Exchange gains, net
    
    
    2,694
    
    
    
    
    
    
    
    1,291Late payment charges
    
    
    1,284
    
    
    
    
    
    
    
    Others
    
    
    6,957
    
    
    
    1,010
    
    
    
    3,08210,935
    
    
    
    1,010
    
    
    
    4,373
 F-17




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##### Table of Contents



CITY TELECOM (H.K.) LIMITED AND ITS SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS  6
    
    Provision for income taxesProvisions for income taxes Year ended August 31,2001
    
    2002
    
    2003HK$000
    
    HK$000
    
    HK$000Hong Kong
    
    
    59,210
    
    
    
    95,396
    
    
    
    272,016Overseas
    
    
    (232
    )
    
    
    2,065
    
    
    
    3,584Income before taxation
    
    
    58,978
    
    
    
    97,461
    
    
    
    275,600
  Income tax (expense)/credit consists of the following: Year ended August 31,2001
    
    2002
    
    2003HK$000
    
    HK$000
    
    HK$000Hong Kong income tax current (note (a))
    
    
    (21,746
    )
    
    
    (18,000
    )
    
    
    (15,300
    ) overprovision in prior years
    
    
    4,200
    
    
    
    10,665
    
    
    
     deferred (Note 13)
    
    
    (1,000
    )
    
    
    (9,515
    )
    
    
    Overseas taxation current (note (b))
    
    
    (229
    )
    
    
    (116
    )
    
    
    (2,478
    ) overprovisions in prior years
    
    
    
    
    
    
    2,400
    
    
    
    (18,775
    )
    
    
    (14,566
    )
    
    
    (17,778
    )
  (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 each of the two years ended August 31, 2001 and 2002 is 16%
and for the year ended August 31, 2003 is 17.5%. In 2003, the Hong Kong
government enacted a change in the profits tax rate from 16% to 17.5% for
the fiscal year 2003/2004. F-18




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##### Table of Contents



CITY TELECOM (H.K.) LIMITED AND ITS SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS  6
    
    Provision for income taxes (Continued)(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 provision for income taxes attributable to income for the years ended
August 31, 2001, 2002 and 2003 differs from the amount of income taxes
determined by applying the applicable Hong Kong statutory income tax rate
to pre-tax income as a result of the following differences: Year ended August 31,2001
    
    2002
    
    2003HK$000
    
    HK$000
    
    HK$000Hong Kong statutory tax rate
    
    
    16
    %
    
    
    16
    %
    
    
    17.5
    %Income tax expense at the Hong Kong
statutory tax rate
    
    
    8,492
    
    
    
    15,594
    
    
    
    48,230Effect of expenses not deductible for
income taxes
    
    
    1,944
    
    
    
    11,094
    
    
    
    2,217Effect of income not subject to
income taxes
    
    
    (5,739
    )
    
    
    (1,467
    )
    
    
    (2,880
    )Overprovision for Hong Kong income
tax in prior years
    
    
    (4,200
    )
    
    
    (10,665
    )
    
    
    Overprovision for Overseas income tax
in prior years
    
    
    
    
    
    
    (2,400
    )
    
    
    Effect of income tax rate
differential between Hong Kong and
other jurisdictions
    
    
    (465
    )
    
    
    (285
    )
    
    
    1,490Effect of tax loss not recognised
    
    
    38,276
    
    
    
    34,721
    
    
    
    (21,700
    )Effect of temporary differences not
provided for
    
    
    (18,277
    )
    
    
    (31,878
    )
    
    
    (10,235
    )Others
    
    
    (1,256
    )
    
    
    (148
    )
    
    
    656Provision for income taxes
    
    
    18,775
    
    
    
    14,566
    
    
    
    17,778
  Income tax expense is affected by temporary differences between income for
tax and book purposes because, under HKGAAP, provision for deferred
taxation is only made for such differences to the extent that a liability
or an asset is expected to be payable or receivable in the foreseeable
future. For purposes of the reconciliation of the Companys financial
statements to U.S.GAAP, deferred taxation has to be provided in full on
such temporary differences, the details of which are set out in Note 29. F-19




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##### Table of Contents



CITY TELECOM (H.K.) LIMITED AND ITS SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS



|7 |  | Earnings per share
|- |  | ------------------

Year ended August 31,2001
    
    2002
    
    2003HK$000
    
    HK$000
    
    HK$000Net income
    
    
    53,927
    
    
    
    91,129
    
    
    
    257,822No. of shares
    
    No. of shares
    
    No. of sharesin thousand
    
    in thousand
    
    in thousandWeighted
average number of shares in issue
    
    
    490,679
    
    
    
    495,181
    
    
    
    552,600Incremental shares from assumed exercise of share options
    
    
    3,770
    
    
    
    11,219
    
    
    
    7,112Incremental shares from assumed exercise of warrants
    
    
    
    
    
    
    59,489
    
    
    
    55,390Diluted weighted average number of shares
    
    
    494,449
    
    
    
    565,889
    
    
    
    615,102Basic earnings per share
    
    HK$11.0 cents
    
    HK$18.4 cents
    
    HK$46.7 centsDiluted earnings per share
    
    HK$10.9 cents
    
    HK$16.1 cents
    
    HK$41.9 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.
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|8   |  | Receivables           
|--- |  | ----------------------
|   
|(a) |  | Trade receivables, net

August 31,2002
    
    2003HK$000
    
    HK$000Trade receivables
    
    
    125,197
    
    
    
    116,996Less: provision for doubtful debts
    
    
    (17,139
    )
    
    
    (22,916
    )108,058
    
    
    
    94,080




| |  | Changes in the provision for doubtful debts consist of:
| |  | -------------------------------------------------------

Year ended August 31,2001
    
    2002
    
    2003HK$000
    
    HK$000
    
    HK$000Balance at beginning of the year
    
    
    11,455
    
    
    
    14,362
    
    
    
    17,139Additions charged to expense
    
    
    9,663
    
    
    
    10,277
    
    
    
    17,685Write-off
    
    
    (6,756
    )
    
    
    (7,500
    )
    
    
    (11,908
    )Balance at the end of the year
    
    
    14,362
    
    
    
    17,139
    
    
    
    22,916


F-20



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##### Table of Contents



CITY TELECOM (H.K.) LIMITED AND ITS SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS



|8   |  | Receivables (Continued)                    
|--- |  | -------------------------------------------
|   
|(b) |  | Other receivables, deposits and prepayments

August 31,2002
    
    2003HK$000
    
    HK$000Deposits for purchase of fixed assets
    
    
    12,520
    
    
    
    8,051Deposits for lease of land and building
    
    
    3,686
    
    
    
    4,121Network connection charges receivables
    
    
    
    
    
    
    11,982Prepayments
    
    
    4,662
    
    
    
    6,475Receivables from disposal of a subsidiary (Note 4)
    
    
    
    
    
    
    1,818Others
    
    
    6,419
    
    
    
    2,26727,287
    
    
    
    34,714




|9 |  | Goodwill
|- |  | --------

August 31,2002
    
    2003HK$000
    
    HK$000CostAt the beginning of the year
    
    
    
    
    
    
    5,326Deemed acquisition of
additional interest in a
subsidiary through subscription
of rights issue (Note (a))
    
    
    4,309
    
    
    
    Acquisition of additional
interest in a subsidiary from a
minority shareholder (Note (b))
    
    
    1,017
    
    
    
    At the end of the year
    
    
    5,326
    
    
    
    5,326Accumulated amortizationAt the beginning of the year
    
    
    
    
    
    
    1,065Charge for the year
    
    
    1,065
    
    
    
    1,065At the end of the year
    
    
    1,065
    
    
    
    2,130Net book valueAt the end of the year
    
    
    4,261
    
    
    
    3,196




| | (a) |  | On January 10, 2002, the Company increased its shareholdings
in a subsidiary, Hong Kong Broadband Network Limited (HKBN), from
85% to 96% through the subscription of shares under a rights issue.
The minority shareholder, KDDI Corporation, did not subscribe under
the rights issue. The subscription price of HK$169,829,400 was
settled in cash.
| | --- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| | (b) |  | On March 13, 2002, the Company purchased the remaining 15,000
ordinary shares in HKBN from KDDI Corporation for cash consideration
of HK$7,500,000. As a result, HKBN became the wholly owned
subsidiary of the Company.                                                                                                                                



| |  | Goodwill was recognized on both transactions 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 years.
| |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F-21



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CITY TELECOM (H.K.) LIMITED AND ITS SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS



|10 |  | Fixed assets, net
|-- |  | -----------------

Furniture,
    
    Tele-Leasehold
    
    Leasehold
    
    fixtures
    
    communicationsland and
    
    improve-
    
    and
    
    computers and
    
    Auto-
    
    Motorbuildings
    
    ments
    
    fittings
    
    office equipment
    
    diallers
    
    vehicles
    
    TotalHK$000
    
    HK$000
    
    HK$000
    
    HK$000
    
    HK$000
    
    HK$000
    
    HK$000CostAt September 1, 2001
    
    
    45,069
    
    
    
    44,351
    
    
    
    8,835
    
    
    
    500,716
    
    
    
    17,190
    
    
    
    5,046
    
    
    
    621,207Exchange adjustments
    
    
    
    
    
    
    (6
    )
    
    
    (11
    )
    
    
    (145
    )
    
    
    (2
    )
    
    
    
    
    
    
    (164
    )Additions
    
    
    13,113
    
    
    
    9,529
    
    
    
    1,034
    
    
    
    552,496
    
    
    
    80
    
    
    
    2,814
    
    
    
    579,066Disposals
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (7,920
    )
    
    
    
    
    
    
    
    
    
    
    (7,920
    )At August 31, 2002
    
    
    58,182
    
    
    
    53,874
    
    
    
    9,858
    
    
    
    1,045,147
    
    
    
    17,268
    
    
    
    7,860
    
    
    
    1,192,189At 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
    
    
    
    1,433,232Accumulated
depreciationAt September 1, 2001
    
    
    1,277
    
    
    
    11,488
    
    
    
    4,860
    
    
    
    158,596
    
    
    
    13,788
    
    
    
    3,802
    
    
    
    193,811Exchange adjustments
    
    
    
    
    
    
    (5
    )
    
    
    (1
    )
    
    
    (51
    )
    
    
    
    
    
    
    
    
    
    
    (57
    )Charge for the year
    
    
    1,031
    
    
    
    5,204
    
    
    
    1,449
    
    
    
    118,052
    
    
    
    1,648
    
    
    
    906
    
    
    
    128,290Disposals
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (2,951
    )
    
    
    
    
    
    
    
    
    
    
    (2,951
    )At August 31, 2002
    
    
    2,308
    
    
    
    16,687
    
    
    
    6,308
    
    
    
    273,646
    
    
    
    15,436
    
    
    
    4,708
    
    
    
    319,093At 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
    
    
    
    487,280Net book valueAt August 31, 2002
    
    
    55,874
    
    
    
    37,187
    
    
    
    3,550
    
    
    
    771,501
    
    
    
    1,832
    
    
    
    3,152
    
    
    
    873,096At August 31, 2003
    
    
    58,105
    
    
    
    34,920
    
    
    
    3,413
    
    
    
    846,074
    
    
    
    538
    
    
    
    2,902
    
    
    
    945,952




|(a) |  | The interests in leasehold land and buildings situated in Hong Kong at
their net book values are analyzed as follows:
|--- |  | ---------------------------------------------------------------------------------------------------------------------

August 31,2002
    
    2003HK$000
    
    HK$000Leases of between 10 to 50 years
    
    
    55,874
    
    
    
    58,105


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CITY TELECOM (H.K.) LIMITED AND ITS SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS



|10  |  | Fixed assets, net (Continued)                                                                                                                                                                                                         
|--- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   
|(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 31,2002
    
    2003HK$000
    
    HK$000Cost
    
    
    23,581
    
    
    
    23,581Accumulated depreciation
    
    
    (19,519
    )
    
    
    (23,581
    )4,062
    
    
    
    




|(c) |  | The net book value of fixed assets pledged as security for a loan from a
former minority shareholder (Note 14) amounted to nil (August 31, 2002:
HK$12,714,000).
|--- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------



|11 |  | Other payables and accrued charges
|-- |  | ----------------------------------

August 31,2002
    
    2003HK$000
    
    HK$000Accrual for staff salaries and bonus
    
    
    25,944
    
    
    
    42,795Accrual for transmission costs
    
    
    7,388
    
    
    
    Accrual for vetting charges
    
    
    
    
    
    
    2,775Accrual for porting charges
    
    
    
    
    
    
    2,001Accrual for international call forwarding service charges
    
    
    
    
    
    
    1,452Payable for additions of fixed assets
    
    
    129,204
    
    
    
    76,341Payable for advertising and promotional expenses
    
    
    3,601
    
    
    
    5,645Payable for site rentals and rates
    
    
    4,008
    
    
    
    Payable for USC
    
    
    
    
    
    
    2,817Provisional refund of USC (Note 3)
    
    
    
    
    
    
    16,212Others
    
    
    12,713
    
    
    
    14,514182,858
    
    
    
    164,552


F-23



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CITY TELECOM (H.K.) LIMITED AND ITS SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS



|12 |  | Obligations under finance leases
|-- |  | --------------------------------

August 31,2002
    
    2003HK$000
    
    HK$000Minimum lease payments:- within one year
    
    
    3,003
    
    
    
    - in the second year
    
    
    
    
    
    
    3,003
    
    
    
    Future finance charges on finance leases
    
    
    (54
    )
    
    
    Present value of finance lease liabilities
    
    
    2,949
    
    
    
    The
present value of finance lease liabilities is as follows- within one year
    
    
    2,949
    
    
    
    - in the second year
    
    
    
    
    
    
    2,949
    
    
    
    




|13 |  | Deferred taxation
|-- |  | -----------------



| |  | The potential deferred tax liabilities/(assets) and the amounts
provided/(recognized) are as follows:
| |  | -----------------------------------------------------------------------------------------------------

August 31, 2002
    
    August 31, 2003Full potential
    
    
    
    
    
    Full potentialliabilities/
    
    Provision
    
    liabilities/
    
    Provision(assets)
    
    made
    
    (assets)
    
    madeHK$000
    
    HK$000
    
    HK$000
    
    HK$000Accelerated
depreciation
allowances
    
    
    84,978
    
    
    
    15,000
    
    
    
    110,925
    
    
    
    15,000Tax losses
    
    
    (127,522
    )
    
    
    
    
    
    
    (105,822
    )
    
    
    (42,544
    )
    
    
    15,000
    
    
    
    5,103
    
    
    
    15,000




| |  | Movements in deferred taxation are as follows:
| |  | ----------------------------------------------

Year ended August 31,2001
    
    2002
    
    2003HK$000
    
    HK$000
    
    HK$000Balance at the beginning of the year
    
    
    4,485
    
    
    
    5,485
    
    
    
    15,000Transfer from consolidated statements of income
(Note 6)
    
    
    1,000
    
    
    
    9,515
    
    
    
    Balance at the end of the year
    
    
    5,485
    
    
    
    15,000
    
    
    
    15,000


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CITY TELECOM (H.K.) LIMITED AND ITS SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS



|14  |  | Loan from a former minority shareholder                                                                                                                                                                                                                                                                        
|--- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   
|    |  | As at August 31, 2002, the balance was a loan from a former minority
shareholder, which was due on or before June 25, 2003, bearing interest
at a fixed rate of 7% per annum.                                                                                                                                  
|   
|    |  | As security for the Companys obligations to the former minority
shareholder, the subsidiary has pledged a property in favour of the
former minority shareholder (Note 10(c)). In November 2002 the Company
repaid the HK$22.5 million loan plus accrued interest and the security
under the loan was released.
|   
|15  |  | Commitments and contingencies                                                                                                                                                                                                                                                                                  
|   
|(a) |  | Capital commitments                                                                                                                                                                                                                                                                                            

August 31,2002
    
    2003HK$000
    
    HK$000Purchases of telecommunications, computer and office equipment-contracted but not provided for
    
    
    139,009
    
    
    
    122,540




|(b) |  | Commitments under operating leases
|--- |  | ----------------------------------



| |  | As of August 31, 2002 and 2003, the Company had future aggregate minimum
lease payments under non-cancelable operating leases as follows:
| |  | -----------------------------------------------------------------------------------------------------------------------------------------

August 31,2002
    
    2003HK$000
    
    HK$000Leases in respect of land and buildings which are
payable:- within one year
    
    
    6,970
    
    
    
    10,229- in the second year
    
    
    1,874
    
    
    
    3,240- in the third year
    
    
    
    
    
    
    288,844
    
    
    
    13,497Leases in respect of telecommunications facilities
and computer equipment which are payable:- within one year
    
    
    8,199
    
    
    
    22,996- in the second year
    
    
    528
    
    
    
    8,324- in the third year
    
    
    
    
    
    
    22- in the fourth year
    
    
    
    
    
    
    228,727
    
    
    
    31,36417,571
    
    
    
    44,861


F-25



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CITY TELECOM (H.K.) LIMITED AND ITS SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS



|15  |  | Commitments and contingencies (Continued)
|--- |  | -----------------------------------------
|   
|(c) |  | Contingent liabilities                   

August 31,2002
    
    2003HK$000
    
    HK$000Bank guarantees provided to suppliers (Note 16(b)(i))
    
    
    
    
    
    
    7,812Bank guarantee in lieu of utility deposits (Note 16(b)(ii))
    
    
    
    
    
    
    3,622
    
    
    
    11,434




|(d) |  | 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 defense which included a
counterclaim 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.                                                             
| | ---- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| | (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.

F-26



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CITY TELECOM (H.K.) LIMITED AND ITS SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS



|15  |  | Commitments and contingencies (Continued)
|--- |  | -----------------------------------------
|   
|(d) |  | Pending litigation (Continued)           



| | (iii) |  | In June 1999, New World Telephone Limited (New
World) commenced proceedings against the Company. The
dispute arose from certain contractual arrangements between
the parties whereby New World provided carrier services to
the Company for the Companys incoming and outgoing
international telephone call traffic through New Worlds
telecommunication network facility and operation system. In
the proceedings, New World alleged, inter alia, that the
Company failed to settle the interconnection fees of the same
amount payable to New World and that New World is entitled to
recover delivery fees allegedly paid by mistake to the
Company. New Worlds claim is approximately HK$96.4 million.
The directors believe that the Company is entitled to set off
the interconnection fees payable to New World against the
delivery fees receivable by the Company. Defences were filed
in August and October 1999 to the same effect. The Company
has instructed its solicitors to defend the case vigorously.
The proceedings have reached the stage of discovery but New
World has not taken any steps in the proceedings since
November 1999. No provision against the claims has been made
in the consolidated financial statements.
| | ----- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|16  |  | Pledge of assets                                                                                                                                                                                                                                                  
|--- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   
|(a) |  | As at August 31, 2002, the Company had deposits of HK$5,000,000 at a bank
as sureties to the Office of the Telecommunications Authority (OFTA) for
the due performance of the terms of the Wireless Fixed Telecommunications
Network Services License (WFTNS).
|   
|    |  | On March 28, 2003, the terms of the licence had all been satisfied by the
Company. The OFTA then issued a certificate of completion and the
pledged deposits were released accordingly.                                                                           
|   
|(b) |  | As at August 31, 2003, the Company had the following pledge of bank
deposits:                                                                                                                                                                                     



| | (i)  |  | bank deposits of HK$7,812,000 (2002: Nil) to secure bank
guarantees of the same amounts issued by the banks to third party
suppliers of the Company to guarantee the due payment for the
products and services procured by the Company from these third party
suppliers (Note 15(c)).
| | ---- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| | (ii) |  | bank deposits of HK$3,622,000 (2002: Nil) to secure bank
guarantee issued by a bank in lieu of utility deposits (Note 15(c)).                                                                                                                                                        



|(c) |  | 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 the further development of the fixed
telecommunications network of Hong Kong Broadband Network Limited
(HKBN), which is a wholly-owned subsidiary of the Company. 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 instalments
beginning in January 2005.
|--- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   
|    |  | The Company must comply with certain covenants under the facility. The
Company has not drawn any amount under this facility as of August 31,
2003.                                                                                                                                                                                                                                                                                                                                                                                    
|   
|(d) |  | As at August 31, 2003, the short-term bank loan was secured by a pledged
bank deposit of HK$18,174,000.                                                                                                                                                                                                                                                                                                                                                                                                                               

F-27



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CITY TELECOM (H.K.) LIMITED AND ITS SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS



|17 |  | Other investments
|-- |  | -----------------

August 312002
    
    2003HK$000
    
    HK$000Debt securities, at fair value unlisted outside Hong Kong
    
    
    
    
    
    
    23,370




|18 |  | Long term bank deposit                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|-- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|  
|   |  | The balance is a ten-year US$2 million (equivalent to HK$15,580,000)
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. The
deposit will be terminated once the cumulative interest reaches the
predetermined accrued interest cap at 13% per annum or the aggregate
interest amount of US$260,000 (equivalent to HK$2,025,000), or otherwise,
will reach maturity on August 22, 2013 when interest will be paid out at
the guaranteed accrued interest rate of 13% per annum or the aggregate
interest amount of US$260,000 (equivalent to HK$2,025,000).
|  
|19 |  | Share capital                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             

Authorised(Ordinary shares of HK$0.10 each)No. of shares
    
    HK$000At
August 31, 2001, August 31,2000 and August 31, 2003
    
    
    2,000,000,000
    
    
    
    200,000


Issued and fully paid (Ordinary shares of HK$0.10 each)August 31, 2002
    
    August 31, 2003No. of shares
    
    HK$000
    
    No. of shares
    
    HK$000At the beginning of the year
    
    
    491,074,000
    
    
    
    49,107
    
    
    
    500,863,202
    
    
    
    50,086Exercise of share options (note
(a) and (b))
    
    
    3,060,000
    
    
    
    306
    
    
    
    21,120,000
    
    
    
    2,112Exercise of warrants (Note (d))
    
    
    6,729,202
    
    
    
    673
    
    
    
    82,976,585
    
    
    
    8,298At the end of the year
    
    
    500,863,202
    
    
    
    50,086
    
    
    
    604,959,787
    
    
    
    60,496




|(a) |  | During the year ended August 31, 2002, 2,120,000 shares were issued at a
price of HK$0.26 per share and 940,000 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 passu with the then
existing shares in issue. 
|--- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   
|(b) |  | 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 passu with the then
existing shares in issue.

F-28



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CITY TELECOM (H.K.) LIMITED AND ITS SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS



|19  |  | Share capital (continued)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|--- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   
|(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, 2002 and 2003 are set out in Note 25.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|   
|(d) |  | The Company effected a warrant issue at a price of HK$0.11 per warrant to
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 HK$39,325,920 in cash, at any time on or before
November 1, 2004, for ordinary shares of the Company at a price of HK$0.40
per share (subject to adjustment). If the warrants are fully exercised,
the Company will be required to issue 98,314,800 additional shares.
During the year ended August 31, 2003, 82,976,585 (2002: 6,729,202)
warrants were exercised for an equivalent number of shares and 8,609,013
(2002: 91,585,598) warrants were outstanding at year end. The shares
issued rank pari passu with the then existing shares in issue.



|20 |  | Cash and cash equivalents
|-- |  | -------------------------

August 31,2002
    
    2003HK$000
    
    HK$000Cash and bank balances
    
    
    101,839
    
    
    
    88,119Bank deposits
    
    
    207,744
    
    
    
    313,915Bank overdrafts  unsecured
    
    
    (19,180
    )
    
    
    Short-term bank loan  secured
    
    
    
    
    
    
    (18,174
    )290,403
    
    
    
    383,860




|21 |  | Dividends
|-- |  | ---------

Year ended August 31,2001
    
    2002
    
    2003HK$000
    
    HK$000
    
    HK$000Interim,
declared and paid, of HK$0.05 (2002: Nil, 2001: HK$0.01) per ordinary share
    
    
    4,907
    
    
    
    
    
    
    
    30,234Final,
proposed, of HK$0.075 (2002 and 2001: Nil) per ordinary share
    
    
    
    
    
    
    
    
    
    
    45,3724,907
    
    
    
    
    
    
    
    75,606




| | Note: | At a board meeting held on November 24, 2003 the
directors proposed a final dividend of HK$0.075 per ordinary
share for the year ended August 31, 2003. This dividend is
not reflected as a dividend payable in the consolidated
financial statements, but will be reflected as an
appropriation of retained earnings for the year ending August
31, 2004.
| | ----- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F-29



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##### Table of Contents



CITY TELECOM (H.K.) LIMITED AND ITS SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS 22
    
    Banking facilitiesThe 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 utilized
    
    Terms as of August 31, 2003August 31,
    
    August 31,
    
    Interest rate
    
    Repayment terms2002
    
    2003
    
    2002
    
    2003HK$000
    
    HK$000
    
    HK$000
    
    HK$000Bank overdrafts/bank
loans
    
    
    55,400
    
    
    
    232,000
    
    
    
    19,180
    
    
    
    18,174
    
    
    Prime + 1% or
HIBOR + 1.5% or
commercial
best lending rate
    
    Repayable on demand
 The prime rate and HIBOR rate were 5.00% and 1.16% respectively, as of
August 31, 2003. The prime rate is determined by the individual banks
and is subject to revision from time to time.The utilized banking facilities as of August 31, 2002 and 2003 were
denominated in Japanese Yen. The weighted average interest rates of
short-term borrowings of the Company were 1.03% and 0.85% as of August
31, 2002 and 2003, respectively.23
    
    Related party transactionsSignificant related party transactions, which were carried out in
the normal course of the Companys business are as follows:
 Year ended August 31,2001
    
    2002
    
    2003HK$000
    
    HK$000
    
    HK$000Calling
charges payable to KDDI Corporation (Note (a))
    
    
    34,106
    
    
    
    13,161
    
    
    
    Interest
expenses payable to KDDI Corporation (Note (b))
    
    
    1,458
    
    
    
    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 (Note 14). 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. F-30




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##### Table of Contents



CITY TELECOM (H.K.) LIMITED AND ITS SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS 24
    
    Provident fund arrangementsThe 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
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.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 31,2001
    
    2002
    
    2003HK$000
    
    HK$000
    
    HK$000Gross contributions
    
    
    7,616
    
    
    
    11,965
    
    
    
    16,340Less: forfeited contributions utilized
to offset the Companys contributions
during the year
    
    
    (3,534
    )
    
    
    (630
    )
    
    
    (497
    )Net contributions charged to the
consolidated statements of income
    
    
    4,082
    
    
    
    11,335
    
    
    
    15,843
 At August 31, 2003, no forfeited contribution is available to
offset future contributions by the Company to the schemes
(2002:HK$21,000; 2001: HK$31,000).
 F-31




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##### Table of Contents



CITY TELECOM (H.K.) LIMITED AND ITS SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS 25
    
    Share option schemeOn 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, 2003 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 23, 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. No New Share Options have been granted subsequent to the adoption
of the 2002 Share Option Scheme.Under HKGAAP, 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 29(a)(i).
 F-32




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##### Table of Contents



CITY TELECOM (H.K.) LIMITED AND ITS SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS 25
    
    Share option scheme (Continued)Details of Share Options granted pursuant to the 1997 Share Option
Scheme and outstanding at August 31, 2001, 2002 and 2003, which
will lapse not later than July 11, 2007, are as follows:
 September 19,
    
    September 3,
    
    September 10,
    
    June 2,
    
    October 20,1997
    
    1998
    
    1999
    
    2000
    
    2000Date of grant
    
    (Note a)
    
    (Note b)
    
    (Note c)
    
    (Note d)
    
    (Note e)Exercise price per
Share (HK$)
    
    
    1.20/1.5
    
    
    
    0.26
    
    
    
    2.10
    
    
    
    1.50
    
    
    
    0.58Average market
price per Share
(HK$) for five
trading days
preceding the date
of grant
    
    
    1.50
    
    
    
    0.26
    
    
    
    2.10
    
    
    
    1.50
    
    
    
    0.58Outstanding at
August 31, 2000
    
    
    1,500,000
    
    
    
    4,480,000
    
    
    
    60,000
    
    
    
    21,008,000
    
    
    
    Granted
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    22,408,000Exercised
    
    
    
    
    
    
    (1,470,000
    )
    
    
    
    
    
    
    
    
    
    
    Cancelled
    
    
    (1,500,000
    )
    
    
    
    
    
    
    
    
    
    
    (20,908,000
    )
    
    
    Lapsed upon
resignation of
employees
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (100,000
    )
    
    
    (22,000
    )Outstanding at
August 31, 2001
    
    
    
    
    
    
    3,010,000
    
    
    
    60,000
    
    
    
    
    
    
    
    22,386,000Exercised
    
    
    
    
    
    
    (2,120,000
    )
    
    
    
    
    
    
    
    
    
    
    (940,000
    )Cancelled
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (16,000
    )Lapsed upon
resignation of
employees
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (20,000
    )Outstanding at
August 31, 2002
    
    
    
    
    
    
    890,000
    
    
    
    60,000
    
    
    
    
    
    
    
    21,410,000Exercised
    
    
    
    
    
    
    (100,000
    )
    
    
    
    
    
    
    
    
    
    
    (21,020,000
    )Outstanding at
August 31, 2003
    
    
    
    
    
    
    790,000
    
    
    
    60,000
    
    
    
    
    
    
    
    390,000
 (a)
    
    On September 19, 1997, each of the three executive directors of the
Company was granted options to subscribe for 1,000,000 shares with an
exercise period commencing from September 19, 1998. The exercise price
of 500,000 Share Options granted to each of the directors was fixed at
HK$1.20 per share at the date of grant. These options cannot be
exercised prior to September 19, 2000. The exercise price of the
remaining 500,000 Share Options is HK$1.50 per share if exercised prior
to September 19, 2000 and HK$1.20 per share if exercised thereafter. Of
these 500,000 Share Options, 200,000 Share Options became exercisable on
September 19, 1998 and the remaining 300,000
Share Options became exercisable on September 19, 1999. The outstanding
Share Options were cancelled pursuant to a board resolution passed on
October 20, 2000.
 F-33




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##### Table of Contents



CITY TELECOM (H.K.) LIMITED AND ITS SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS 25
    
    Share option scheme (Continued)(b)
    
    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.(c)
    
    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.(d)
    
    Share Options to subscribe for 748,000 shares, 20,000,000 shares,
100,000 shares and 260,000 shares at a subscription price of HK$8.00,
HK$8.20, HK$6.00 and HK$4.40 per share respectively were granted to the
employees including executive directors of the Company on December 8,
1999, December 14, 1999, February 12, 2000 and March 6, 2000
respectively. Share Options to subscribe for 78,000 shares were
cancelled upon the resignation of employees while the remaining Share
Options to subscribe for 21,030,000 shares were cancelled pursuant to a
board resolution passed on June 2, 2000. On June 2, 2000, employees
including executive directors were granted options to subscribe for
21,030,000 shares at a price of HK$1.50 per share. Share Options to
subscribe for 122,000 shares were cancelled upon the resignation of
employees while the remaining Share Options to subscribe for 20,908,000
shares were cancelled pursuant to a board resolution passed on October
20, 2000.(e)
    
    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.
 F-34




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##### Table of Contents



CITY TELECOM (H.K.) LIMITED AND ITS SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS 25
    
    Share option scheme (Continued)(f)
    
    The Share Options outstanding in respect of the 1997 Share Option Scheme
as of August 31, 2001, 2002 and 2003 is summarized as follows:
 Number of Share
    
    Average exercise
    
    Weighted averageOptions
    
    price
    
    market price atOutstanding
    
    per Share
    
    the date of grant(thousands)
    
    HK$000
    
    HK$000Balance at August 31, 2000
    
    
    27,048
    
    
    
    1.28
    
    
    
    1.30Grant at exercise price
equal to market price on
the date of grant
    
    
    22,408
    
    
    
    0.58
    
    
    
    0.58Exercised during the year
    
    
    (1,470
    )
    
    
    0.26
    
    
    
    0.26Lapsed upon resignation
of employees during the
year
    
    
    (122
    )
    
    
    1.33
    
    
    
    1.33Cancelled during the year
    
    
    (22,408
    )
    
    
    1.48
    
    
    
    1.50Balance 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
    
    
    
    0.45
 (g)
    
    The following table summarizes the information about share options
outstanding at August 31, 2003:
 Number
    
    
    
    
    
    Exercisableoutstanding at
    
    
    
    
    
    shares atExercise price at
    
    August 31,
    
    
    
    
    
    August 31,Date of grant
    
    August 31, 2003
    
    2003
    
    Remaining life
    
    2003(thousands)
    
    (years)
    (thousands)September 3, 1998
    
    
    0.26
    
    
    
    790
    
    
    
    4.0
    
    
    
    790September 10, 1999
    
    
    2.10
    
    
    
    60
    
    
    
    4.0
    
    
    
    60October 20, 2000
    
    
    0.58
    
    
    
    390
    
    
    
    4.0
    
    
    
    3901,240
    
    
    
    4.0
    
    
    
    1,240
 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.
 F-35




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##### Table of Contents



CITY TELECOM (H.K.) LIMITED AND ITS SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS 26
    
    Turnover, revenues and segmental informationDuring the year ended August 31, 2001, the Company had derived its
revenue principally from provision of international telecommunications
services and fixed telecommunications network services to customers,
and provision of internet advertising services.Since September 2001, the Company has discontinued the provisions of
internet advertising services. Revenues recognized during the year are
as follows:
 2001
    
    2002
    
    2003HK$000
    
    HK$000
    
    HK$000Turnover
International telecommunications services
    
    
    861,338
    
    
    
    908,981
    
    
    
    875,802Fixed telecommunications network services
    
    
    154,262
    
    
    
    241,219
    
    
    
    423,107Internet advertising services
    
    
    1,034
    
    
    
    
    
    
    
    1,016,634
    
    
    
    1,150,200
    
    
    
    1,298,909Other revenuesInterest income
    
    
    35,438
    
    
    
    10,870
    
    
    
    3,163Other income
    
    
    10,935
    
    
    
    1,010
    
    
    
    4,37346,373
    
    
    
    11,880
    
    
    
    7,536Total revenues
    
    
    1,063,007
    
    
    
    1,162,080
    
    
    
    1,306,445
 (a)
    
    Primary reporting format  business segmentsThe Company is organized on a worldwide basis into three business
segments:
  
    
    International telecommunications  provision of international
long distance calls services
    
    Fixed telecommunications network  provision of dial up and
broadband internet access services and local telephony services
    
    Internet advertising  provision of internet advertising
services The Companys internet advertising services were discontinued since September 2001 (Note 26(c)).The Companys inter-segment transactions mainly consist of provision of leased lines
services. The Company believes that the terms were similar as to those available from third
parties. For the year ended August 31, 2002, the Company changed its method of measuring
segment results to include an allocation of bank interest income to each segment. This has
resulted in an improvement to segment results. Prior year amounts have been reclassified
to include the allocation of interest income by segment.For the year ended August 31, 2003, the Company changed its method of measuring segment
results to include amortization charges related to the goodwill arising from acquisition of the
remaining interest in a subsidiary to fixed telecommunications network services segment. The
related goodwill has also been included in the segment assets of fixed telecommunications
network services segment. Prior year amounts have been reclassified to include the amortization
charges and related goodwill to fixed telecommunications network services segment.
 F-36




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##### Table of Contents



CITY TELECOM (H.K.) LIMITED AND ITS SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS 26
    
    Turnover, revenues and segmental information (Continued)(a)
    
    Business segments (Continued)
 2001International
    
    Fixed
    
    Internettelecommunications
    
    telecommunications
    
    advertisingservices
    
    network services
    
    services
    
    Elimination
    
    CompanyHK$000
    
    HK$000
    
    HK$000
    
    HK$000
    
    HK$000TurnoverExternal sales
    
    
    861,338
    
    
    
    154,262
    
    
    
    1,034
    
    
    
    
    
    
    
    1,016,634Inter-segment sales
    
    
    5,400
    
    
    
    
    
    
    
    
    
    
    
    (5,400
    )
    
    
    866,738
    
    
    
    154,262
    
    
    
    1,034
    
    
    
    (5,400
    )
    
    
    1,016,634Segment results
    
    
    146,611
    
    
    
    (72,123
    )
    
    
    (10,968
    )
    
    
    
    
    
    
    63,520Interest expense
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (4,542
    )Income before taxation
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    58,978Segment assets
    
    
    645,948
    
    
    
    497,209
    
    
    
    1,461
    
    
    
    
    
    
    
    1,144,618Segment liabilities
    
    
    187,566
    
    
    
    62,166
    
    
    
    399
    
    
    
    
    
    
    
    250,131Unallocated liabilities
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    78,774Total liabilities
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    328,905Capital expenditure
    
    
    19,940
    
    
    
    145,922
    
    
    
    175
    
    
    
    
    
    
    
    166,037Depreciation
    
    
    37,238
    
    
    
    45,416
    
    
    
    193
    
    
    
    
    
    
    
    82,847Amortization charge
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
 F-37




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##### Table of Contents



CITY TELECOM (H.K.) LIMITED AND ITS SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS 26
    
    Turnover, revenues and segmental information (Continued)(a)
    
    Business segments (Continued)
 2002International
    
    Fixedtelecommunications
    
    telecommunicationsservices
    
    network services
    
    Elimination
    
    CompanyHK$000
    
    HK$000
    
    HK$000
    
    HK$000TurnoverExternal 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
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    59,159Total liabilities
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    417,102Capital expenditure
    
    
    138,521
    
    
    
    440,545
    
    
    
    
    
    
    
    579,066Depreciation
    
    
    32,951
    
    
    
    95,339
    
    
    
    
    
    
    
    128,290Amortization charge
    
    
    
    
    
    
    1,065
    
    
    
    
    
    
    
    1,065
 F-38




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CITY TELECOM (H.K.) LIMITED AND ITS SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS 26
    
    Turnover, revenues and segmental
information (Continued)(a)
    
    Business segments (Continued)
 2003International
    
    Fixedtelecommunications
    
    telecommunicationsservices
    
    network services
    
    Elimination
    
    CompanyHK$000
    
    HK$000
    
    HK$000
    
    HK$000TurnoverExternal 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
    
    
    340,523
    
    
    
    (61,627
    )
    
    
    
    
    
    
    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
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    56,069Total liabilities
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    364,085Capital expenditure
    
    
    20,749
    
    
    
    229,460
    
    
    
    
    
    
    
    250,209Depreciation
    
    
    36,043
    
    
    
    138,912
    
    
    
    
    
    
    
    174,955Amortization charge
    
    
    
    
    
    
    1,065
    
    
    
    
    
    
    
    1,065
 F-39




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CITY TELECOM (H.K.) LIMITED AND ITS SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS  26
    
    Turnover, revenues and segmental information (Continued)(b)
    
    Geographical segmentsAlthough the Companys three business segments are managed on a worldwide
basis, they operate in three main geographical areas:  
    
    Hong Kong  international telecommunications and fixed
telecommunications network services.
    
    Japan  international telecommunications.
    
    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
    
    
    
    
    
    CapitalTurnover
    
    results
    
    Total assets
    
    expenditure2001
    
    2001
    
    2001
    
    2001HK$000
    
    HK$000
    
    HK$000
    
    HK$000Hong Kong
    
    
    971,584
    
    
    
    63,660
    
    
    
    1,130,157
    
    
    
    166,004Japan
    
    
    9,272
    
    
    
    (122
    )
    
    
    4,794
    
    
    
    7Canada
    
    
    35,778
    
    
    
    (18
    )
    
    
    9,667
    
    
    
    261,016,634
    
    
    
    63,520
    
    
    
    1,144,618
    
    
    
    166,037
 Segment
    
    
    
    
    
    CapitalTurnover
    
    results
    
    Total assets
    
    expenditure2002
    
    2002
    
    2002
    
    2002HK$000
    
    HK$000
    
    HK$000
    
    HK$000Hong Kong
    
    
    1,107,987
    
    
    
    98,687
    
    
    
    1,304,789
    
    
    
    578,979Japan
    
    
    8,386
    
    
    
    (135
    )
    
    
    4,397
    
    
    
    45Canada
    
    
    33,827
    
    
    
    2,413
    
    
    
    18,099
    
    
    
    421,150,200
    
    
    
    100,965
    
    
    
    1,327,285
    
    
    
    579,066
 F-40




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CITY TELECOM (H.K.) LIMITED AND ITS SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS  26
    
    Turnover, revenues and segmental information (Continued)(b)
    
    Geographical segments (Continued) Segment
    
    
    
    
    
    CapitalTurnover
    
    results
    
    Total assets
    
    expenditure2003
    
    2003
    
    2003
    
    2003HK$000
    
    HK$000
    
    HK$000
    
    HK$000Hong Kong
    
    
    1,263,160
    
    
    
    275,126
    
    
    
    1,539,212
    
    
    
    250,093Japan
    
    
    7,790
    
    
    
    269
    
    
    
    
    
    
    
    Canada
    
    
    27,959
    
    
    
    3,501
    
    
    
    9,322
    
    
    
    1161,298,909
    
    
    
    278,896
    
    
    
    1,548,534
    
    
    
    250,209Loss on disposal of
a subsidiary
    
    
    
    
    
    
    (2,695
    )Operating profit
    
    
    
    
    
    
    276,201
  (c)
    
    Since September 2001, the Companys internet advertising operation has
been discontinued. The revenue and operating loss relating to the
internet advertising segment are disclosed above and are included in the
Hong Kong reporting segment. The contribution to turnover and the loss
from ordinary activities in respect of the discontinued operation, up to
the date of discontinuance, are as follows: 2001
    
    2002
    
    2003HK$000
    
    HK$000
    
    HK$000Sales
    
    
    1,034
    
    
    
    
    
    
    
    Loss from ordinary activities
    
    
    10,968
    
    
    
    
    
    
    
    
  (d)
    
    In the current year, 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. F-41




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CITY TELECOM (H.K.) LIMITED AND ITS SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS  27
    
    Financial instruments(a)
    
    Fair valueThe 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.The fair values of the cash and cash equivalents, short-term loans and
bank overdrafts as of August 31, 2002 and 2003 approximate their carrying
values because of the short maturity of instruments. The estimated fair
value of the loan from a minority shareholder as of August 31, 2002 based
on the then current rates offered in the market for debts with the same
maturities approximates the carrying value.The fair value of other investments as of August 31, 2003 based on the
market prices approximates the carrying value.All other financial instruments included among current assets and
liabilities are stated at cost which approximates their fair values.(b)
    
    Concentration of credit riskFinancial 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, Japan and Canada.Deposits, prepayments and other receivables  these are spread among
numerous third parties.28
    
    New effective standards/recent accounting pronouncementsThe 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: F-42




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CITY TELECOM (H.K.) LIMITED AND ITS SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS  28
    
    New effective standards/recent accounting pronouncements (Continued)(a)
    
    In November 2002, the FASB issued FASB interpretation No. (FIN) 45,
Guarantors Accounting and Disclosure Requirements for Guarantees,
Including Indirect Guarantees of Indebtedness of Others. FIN 45 requires
that an entity issuing a guarantee (including those embedded in a purchase
or sales agreement) must recognize, at the inception of the guarantee, a
liability equal to the fair value of the guarantee. The recording of this
liability is not dependent on the probability that the payments will be
required. The offset to the liability will depend on the circumstances
under which the guarantee was issued, but could include: cash/accounts
receivable if it is a standalone transaction, net proceed in a sales
transaction, or expense if no compensation is received. FIN 45 also
requires detailed information to be disclosed about each guarantee or
group of guarantees even if the likelihood of making a payment is remote.
The recognition and measurement provisions of this interpretation are
applicable on a prospective basis to guarantees issued or modified after
December 31, 2002. The disclosure requirements of this interpretation are
effective for financial statements of periods ending after December 15,
2002.The Company has evaluated the requirements of the above statement and
believes that the Company had no transactions that should be disclosed
or accounted for in accordance with this new standard.(b)
    
    In December 2002, the FASB issued the Statement of Financial Accounting
Standard (SFAS) No. 148 Accounting for Stock-Based Compensation 
Transition and disclosure  an amendment of FAS 123. SFAS 148 amends
FASB Statement No. 123 Accounting for Stock-based Compensation (SFAS
123) to provide alternative methods of transition for an entity that
voluntarily changes to the fair value based method of accounting for
stock-based employee compensation. It also amends the disclosure
provisions of SFAS 123 to require prominent disclosure about the effects
on reported net income of an entitys accounting policy decisions with
respect to stock-based employee compensation. Finally, SFAS 148 amends
APB Opinion No. 28 Interim Financial Reporting to require disclosure
about those effects in interim financial information. SFAS 148 is
effective for financial statements for fiscal years ending and for interim
periods beginning after December 15, 2002.As of August 31, 2003, the Company had no immediate plans to change to
the fair value based method of accounting for stock-based employee
compensation, and are therefore not affected by the transition provision
of SFAS 148.(a)
    
    In April 2003, the FASB issued SFAS No. 149, Amendment of Statement 133
on Derivative Instruments and Hedging Activities. This statement amends
and clarifies the accounting for derivative instruments, including certain
derivative instruments embedded in other contracts, and hedging activities
under SFAS No. 133, Accounting for Derivative Instruments and Hedging
Activities. This statement clarifies when a contract with an initial net
investment meets the characteristic of a derivative and when a derivative
contains a financing component. This statement also amends the definition
of an underlying to conform to the language contained in FIN 45. This
statement is effective for contracts entered into or modified after June
30, 2003, and for hedging relationships designated after June 30, 2003.The Company has evaluated the requirements of the above statement and
believes that the adoption of this new standard would not have a material
impact on its financial position or on its results of operations. F-43




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CITY TELECOM (H.K.) LIMITED AND ITS SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS  28
    
    New effective standards/recent accounting pronouncements (Continued)(d)
    
    In May 2003, the FASB issued SFAS No. 150, Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and
Equity. The new statement requires that certain financial instruments
that, under the previous guidance, could be accounted for as equity by
issuers, be classified as liabilities in statements of financial position.
SFAS No. 150 affects the issuers accounting for three types of freestanding financial instruments.
One type is mandatorily redeemable shares, which the issuing company is obligated to buy back in exchange for
cash or other assets. A second type, which includes put options and
forward purchase contracts, involves instruments that do or may require
the issuer to buy back some of its shares in exchange for cash or other
assets. The third type of instruments that are liabilities under this
statement is obligations that can be settled with shares, the monetary
value of which is fixed, tied solely or predominantly to a variable such
as a market index, or varies inversely with the value of the issuers shares. SFAS No. 150 does not apply to features embedded in a financial
instrument that is not a derivative in its entirety. In addition to its
requirements for the classification and measurement of financial instruments in its scope, SFAS No. 150 also requires disclosures about
alternative ways of settling the instruments and the capital structure of
entities, all of whose shares are mandatorily redeemable. Most of the
guidance in SFAS No. 150 is effective for all financial instruments
entered into or modified after May 31, 2003, and otherwise is effective at
the beginning of the first interim period beginning after June 15, 2003.The Company has evaluated the requirements of the above statement and
believes that the Company had no transactions that should be disclosed or
accounted for in accordance with this new standard.Recently issued pronouncementsIn November 2002, the Emerging Issue Task Force (EITF) reached
a consensus on EITF 00-21, Revenue Arrangements with Multiple
Deliverables, related to the timing of revenue recognition for
arrangements in which goods or services or both are delivered
separately in a bundled sales arrangement. The EITF requires that
when the deliverables included in this type of arrangement met
certain criteria they should be accounted for separately as separate
units of accounting. This may result in a difference in the timing
of revenue recognition but will not result in a change in the total
amount of revenue recognized in a bundled sales arrangement. The
allocation of revenue to the separate deliverables is based on the
relative fair value of each item. If the fair value is not
available for the delivered items then the residual method must be
used. The residual method requires that the amount allocated to the
undelivered items in the arrangement is their full fair value. This
would result in the discount, if any, being allocated to the
delivered items. This consensus is effective prospectively for
arrangements entered into in financial periods beginning after June
15, 2003.The Company has evaluated the requirements of the above statement
and believes that the adoption of this new standard would not have a
material impact on its financial position or on its results of
operations. F-44




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##### Table of Contents



CITY TELECOM (H.K.) LIMITED AND ITS SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS  29
    
    Summary of differences between HKGAAP and U.S.GAAP  The Companys consolidated financial statements are prepared in
accordance with HKGAAP, which differ in certain significant respects from
U.S.GAAP. Differences between HKGAAP 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 31,2001
    
    2002
    
    2003Note
    
    HK$000
    
    HK$000
    
    HK$000Net incomeAs stated under HKGAAP
    
    
    
    
    
    
    53,927
    
    
    
    91,129
    
    
    
    257,822U.S.GAAP
adjustments:
Compensation benefit cost
associated with share
options
    
    
    (i
    )
    
    
    (184
    )
    
    
    (21,586
    )
    
    
    2,731Amortization of goodwill
(acquired prior to June
30, 2001)
    
    (ii)
    
    
    (1,019
    )
    
    
    (1,019
    )
    
    
    Reversal of amortization
of goodwill (acquired
after June 30, 2001)
    
    (ii)
    
    
    
    
    
    
    1,065
    
    
    
    1,065Deferred tax on
accelerated depreciation
    
    (iii)
    
    
    1,242
    
    
    
    (624
    )
    
    
    (79
    )Net income under U.S.GAAP
    
    
    
    
    
    
    53,966
    
    
    
    68,965
    
    
    
    261,539Profit from continuing
operations (less taxation 2003: HK$17,778,000, 2002: HK$14,562,000, 2001: HK$18,770,000)
    
    
    
    
    
    
    65,389
    
    
    
    69,317
    
    
    
    264,151Profit/(loss) from
discontinued operations
(less taxation 2003: HK$Nil, 2002: HK$4,000,
2001: HK$5,000)
    
    
    (v
    )
    
    
    (11,423
    )
    
    
    (352
    )
    
    
    83Loss arising from disposal
of discontinued operations
    
    
    (v
    )
    
    
    
    
    
    
    
    
    
    
    (2,695
    )Net income under U.S.GAAP
    
    
    
    
    
    
    53,966
    
    
    
    68,965
    
    
    
    261,539
 Year ended August 31,Note
    
    2001
    
    2002
    
    2003Earnings/(loss) per share
under U.S.GAAPBasic:Continuing operations
    
    
    
    
    
    13.3 cents
    
    14.0 cents
    
    47.8 centsDiscontinued operations
    
    
    (v
    )
    
    (2.3) cents
    
    (0.1) cents
    
    (0.5) centsTotal
    
    (iv)
    
    11.0 cents
    
    13.9 cents
    
    47.3 centsDiluted:Continuing operations
    
    
    
    
    
    13.2 cents
    
    12.3 cents
    
    42.9 centsDiscontinued operations
    
    
    (v
    )
    
    (2.3) cents
    
    (0.1) cents
    
    (0.4) centsTotal
    
    (iv)
    
    10.9 cents
    
    12.2 cents
    
    42.5 cents
 F-45




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CITY TELECOM (H.K.) LIMITED AND ITS SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS  29
    
    Summary of differences between HKGAAP and U.S.GAAP (Continued) Year ended August 31,2001
    
    2002
    
    2003Note
    
    HK$000
    
    HK$000
    
    HK$000Total shareholders equityAs stated under HKGAAP
    
    
    
    
    
    
    805,306
    
    
    
    910,183
    
    
    
    1,184,449U.S.GAAP adjustments:Goodwill
    
    (ii)
    
    
    5,092
    
    
    
    5,092
    
    
    
    5,092Accumulated amortization of
goodwill
    
    (ii)
    
    
    (2,716
    )
    
    
    (3,735
    )
    
    
    (3,735
    )Reversal of amortization of
goodwill
    
    (ii)
    
    
    
    
    
    
    1,065
    
    
    
    2,130Deferred tax liabilities, net
    
    (iii)
    
    
    (4,571
    )
    
    
    (5,195
    )
    
    
    (5,274
    )Total shareholders equity
under U.S.GAAP
    
    
    
    
    
    
    803,111
    
    
    
    907,410
    
    
    
    1,182,662
  (i)
    
    Compensation cost for share optionsAPB 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 HKGAAP, 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.As explained in Note 25(a), 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. F-46




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CITY TELECOM (H.K.) LIMITED AND ITS SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS  29
    
    Summary of differences between HKGAAP and U.S.GAAP (Continued)(a)
    
    Net income and total shareholders equity (Continued)  (i)
    
    Compensation cost for share options (Continued)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 amortized to the profit and loss account over the
vesting period of the options. All options were fully vested as
of August 31, 2003. A benefit was recorded in 2003 in calculating
the final cost amount associated with options that were exercised
during the year.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. 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 endedAugust 31,Weighted average
    
    2001Risk-free interest rates
    
    
    6.6
    %Dividend yield
    
    
    0
    %Volatility factor of the expected market
price of the Companys shares
    
    
    102.0
    %Expected life of the options
    
    5.4 years
 F-47




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##### Table of Contents



CITY TELECOM (H.K.) LIMITED AND ITS SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS  29
    
    Summary of differences between HKGAAP and U.S.GAAP (Continued)(a)
    
    Net income and total shareholders equity (Continued)  (i)
    
    Compensation cost for share options (Continued)For the purpose of pro forma disclosure, the estimated fair value
of the options is amortized to expense over the options vesting
period. Options were fully vested as of August 31, 2002. The
Companys pro forma information for the years ended August 31,
2001, 2002 and 2003 is set out as follows: Year ended August 31,2001
    
    2002
    
    2003HK$000
    
    HK$000
    
    HK$000Net incomeAs reported
    
    
    53,966
    
    
    
    68,965
    
    
    
    261,539Add: total stock-based
employee compensation
expense determined under
intrinsic value method
for all awards
    
    
    184
    
    
    
    21,586
    
    
    
    (2,731
    )Less: total stock-based
employee compensation
expense determined under
fair value method for
all awards, net of tax
    
    
    (40,095
    )
    
    
    (18,219
    )
    
    
    Pro forma
    
    
    14,055
    
    
    
    72,332
    
    
    
    258,808Basic earnings per shareAs reported
    
    HK$11.0 cents
    
    HK$13.9 cents
    
    HK$47.3 centsPro forma
    
    HK$2.9 cents
    
    HK$14.6 cents
    
    HK$46.8 centsDiluted earnings per
shareAs reported
    
    HK$10.9 cents
    
    HK$12.2 cents
    
    HK$42.5 centsPro forma
    
    HK$2.8 cents
    
    HK$12.8 cents
    
    HK$42.1 cents
 F-48




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##### Table of Contents



29
    
    Summary of differences between HKGAAP and U.S.GAAP (Continued)  (ii)
    
    GoodwillPrior to September 1, 2001, under HKGAAP 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 HKGAAP,
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 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 recognised 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 fiscal 2003. F-49




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CITY TELECOM (H.K.) LIMITED AND ITS SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS  29
    
    Summary of differences between HKGAAP and U.S.GAAP (Continued)(a)
    
    Net income and total shareholders equity (Continued)  (iii)
    
    Deferred taxesUnder HKGAAP, 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 financial
statements 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 tax
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
HKGAAP.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 financial statements 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.In addition, the U.S.GAAP reconciliations include adjustments to
reflect the SFAS 109 tax impact of the U.S.GAAP differences.Details of deferred income taxes provided under U.S.GAAP are disclosed
in Note 29(e). F-50




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##### Table of Contents



CITY TELECOM (H.K.) LIMITED AND ITS SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS  29
    
    Summary of differences between HKGAAP and U.S.GAAP (Continued)(a)
    
    Net income and total shareholders equity (Continued)  (iv)
    
    Earnings per share Year ended August 31,2001
    
    2002
    
    2003HK$000
    
    HK$000
    
    HK$000Net income under U.S.GAAP
    
    
    53,966
    
    
    
    68,965
    
    
    
    261,539Basic weighted average common
shares issued and outstanding
(in 000s)
    
    
    490,679
    
    
    
    495,181
    
    
    
    552,600Incremental shares from assumed
exercise of share options (in
000s)
    
    
    3,770
    
    
    
    11,219
    
    
    
    7,112Incremental shares from
assumed exercise of warrants
(in 000s)
    
    
    
    
    
    
    59,489
    
    
    
    55,390Diluted weighted average
common and potential shares
issued and outstanding (in
000s)
    
    
    494,449
    
    
    
    565,889
    
    
    
    615,102Earnings per share under
U.S.GAAPBasic
    
    11.0 cents
    
    13.9 cents
    
    47.3 centsDiluted
    
    10.9 cents
    
    12.2 cents
    
    42.5 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, 2001, 2002 and 2003, 126,000, 60,000 and 60,000 options
to purchase shares of the Company, respectively, 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. F-51




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##### Table of Contents



CITY TELECOM (H.K.) LIMITED AND ITS SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS  29
    
    Summary of differences between HKGAAP and U.S.GAAP (Continued)(a)
    
    Net income and total shareholders equity (Continued)  (v)
    
    Discontinued operationsThe discontinued operations of the Company for fiscal years 2001,
2002 and 2003 included the operating loss of approximately
HK$455,000, operating loss of approximately HK$352,000 and
operating profit of approximately HK$83,000 respectively of the
subsidiary operating in Japan. The discontinued operations of the
Company for fiscal 2001 also included the operating loss of
approximately HK$10,968,000 of its internet advertising segment.
Under HKGAAP, 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.  (b)
    
    Comprehensive incomeThe comprehensive income of the Company, disclosed in accordance with
SFAS No. 130 Reporting Comprehensive Income, is set out as follows: Year ended August 31,2001
    
    2002
    
    2003HK$000
    
    HK$000
    
    HK$000Net income under U.S.GAAP
    
    
    53,966
    
    
    
    68,965
    
    
    
    261,539Foreign currency translation adjustments
    
    
    2,480
    
    
    
    204
    
    
    
    (200
    )Comprehensive income
    
    
    56,446
    
    
    
    69,169
    
    
    
    261,339
 F-52




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##### Table of Contents



CITY TELECOM (H.K.) LIMITED AND ITS SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS  29
    
    Summary of differences between HKGAAP and U.S. GAAP (Continued)(c)
    
    Statement of changes in shareholders equity under U.S. GAAP Ordinary sharesAdditional
    
    
    
    
    
    
    
    
    
    
    
    
    
    TotalNumber of
    
    Amount
    
    Share
    
    paid in
    
    Warrant
    
    Exchange
    
    Retained
    
    shareholdersshares
    
    outstanding
    
    premium
    
    capital
    
    reserve
    
    reserve
    
    profits
    
    equityoutstanding
    
    HK$000
    
    HK$000
    
    HK$000
    
    HK$000
    
    HK$000
    
    HK$000
    
    HK$000Balance at August 31, 2000
    
    
    489,604,000
    
    
    
    48,960
    
    
    
    568,945
    
    
    
    9,435
    
    
    
    
    
    
    
    (2,722
    )
    
    
    126,388
    
    
    
    751,006Shares issued upon exercise of share options
    
    
    1,470,000
    
    
    
    147
    
    
    
    235
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    382Compensation cost for outstanding share options
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    184
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    184Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    53,966
    
    
    
    53,966Foreign currency translation adjustments
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,480
    
    
    
    
    
    
    
    2,480Comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    56,4462000 Interim dividend paid (Note 21)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (4,907
    )
    
    
    (4,907
    )Balance 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
    
    
    
    1,182,662
 F-53




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##### Table of Contents



CITY TELECOM (H.K.) LIMITED AND ITS SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS 29
    
    Summary of differences between HKGAAP and U.S.GAAP (Continued)(d)
    
    Statement of cash flowsThe Company adopted SSAP 15 (revised) Cash flow statement during the
year and resulted in presentational changes in consolidated statements of
cash flows under HKGAAP. Under HKGAAP, cash flows were previously
presented separately for operating activities; returns on investments and
servicing of finance; taxation; investing activities and financing
activities. 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 HKGAAP but it would be included in operating
activities under U.S.GAAP. Further, under HKGAAP, cash and cash
equivalents include bank loans and overdrafts repayable within three
months from the date of the advance but these would be included in
financing activities under U.S.GAAP.Under U.S.GAAP, the following amounts would be reported:
 Year ended August 31,2001
    
    2002
    
    2003HK$000
    
    HK$000
    
    HK$000Net cash provided from operating activities
    
    
    74,189
    
    
    
    321,814
    
    
    
    417,663Net cash used in investing activities
    
    
    (84,207
    )
    
    
    (486,082
    )
    
    
    (312,797
    )Net cash used in financing activities
    
    
    (26,799
    )
    
    
    (20,620
    )
    
    
    (11,280
    )Increase/(decrease) in cash and cash equivalents
    
    
    (36,817
    )
    
    
    (184,888
    )
    
    
    93,586Cash and cash equivalents at the beginning of year
    
    
    527,716
    
    
    
    494,159
    
    
    
    309,583Effect of foreign exchange rate changes
    
    
    3,260
    
    
    
    312
    
    
    
    (1,135
    )Cash and cash equivalents at the end of year
    
    
    494,159
    
    
    
    309,583
    
    
    
    402,034
 (e)
    
    Deferred taxesUnder U.S.GAAP, deferred tax liabilities and assets comprise the
following:
 August 31,2002
    
    2003HK$000
    
    HK$000Deferred tax liabilitiesAccelerated depreciation
    
    
    (84,978
    )
    
    
    (110,925
    )(84,978
    )
    
    
    (110,925
    )Deferred tax assetsTax loss carry forwards
    
    
    127,522
    
    
    
    105,822Valuation allowance
    
    
    (62,739
    )
    
    
    (15,171
    )64,783
    
    
    
    90,651(20,195
    )
    
    
    (20,274
    )
 F-54




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##### Table of Contents



CITY TELECOM (H.K.) LIMITED AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS 29
    
    Summary of differences between HKGAAP and U.S.GAAP (Continued)(e)
    
    Deferred taxes (Continued)As of August 31, 2003, the Company had accumulated tax losses amounting
to HK$598,583,000 (2002: HK$754,899,000) 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$105,822,000 (2002: 127,522,000).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 5 to 20 years.
Realisation of deferred tax assets associated with tax loss carry
forwards is dependent upon generating sufficient taxable income. At
August 31, 2003, a valuation allowance of HK$15,171,000 (2002: HK$62,739,000) had been provided for a 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 31,2001
    
    2002
    
    2003HK$000
    
    HK$000
    
    HK$000Balance at beginning of the year
    
    
    32,227
    
    
    
    49,049
    
    
    
    62,739Additions/(reduction) to income tax
expenses
    
    
    17,182
    
    
    
    13,690
    
    
    
    (47,568
    )Balance at end of the year
    
    
    49,409
    
    
    
    62,739
    
    
    
    15,171
 F-55




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##### Table of Contents



CITY TELECOM (H.K.) LIMITED AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS 29
    
    Summary of differences between HKGAAP and U.S.GAAP (Continued)(f)
    
    Other investmentsUnder HKGAAP, 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 recognised in the statements of
income, but it may not be designated as hedging instrument.As a result of the embedded derivative of the other investments held by
the Company as of August 31,2003 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 HKGAAP and U.S.GAAP in this respect. No gain or loss
has been recognised in the statements of income for the year ended August
31, 2003.
 F-56




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##### Table of Contents



30
    
    Post balance sheet events (unaudited)(a)
    
    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 the further development of HKBNs fixed
telecommunications network. All amounts should be drawn by December 31,
2004. The facility provides that interest will be charged at a rate of
1.5% over the one, two, three or six month Hong Kong Interbank Money
Market Offer Rate payable at the end of each month and that it is to be
repaid in 60 equal monthly installments beginning in January 2005.The Company must comply with certain covenants under the facility,
including (i) maintaining its listing on the SEHK; (ii) maintaining its
shareholding in HKBN at no less than 51%; (iii) maintaining certain
financial ratios, and various information delivery requirements to HSBC.As of August 31, 2003, the Company has not drawn any amount under this
facility. Subsequent to the year end, on December 31, 2003, the Company
has drawn down HK$100,000,000 under this facility.(b)
    
    On January 19, 2004, 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 in note (a) above to a fixed rate
of 4.175%.
 F-57




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##### Table of Contents






SIGNATURE The registrant hereby certifies that it meets all of the requirements for
filing on Form 20-F and that it has duly caused and authorized the undersigned
to sign this annual report on its behalf. CITY TELECOM (H.K.) LIMITEDBy:
    /s/ CORINNA SIOName:
    Corinna SioTitle:
    Finance Director Date: February 26,2004