##### Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549



FORM 20-F



| ̈ | REGISTRATION STATEMENT PURSUANT TO SECTION 12(B) OR 12(G) OF THE SECURITIES EXCHANGE ACT OF 1934
|- | ------------------------------------------------------------------------------------------------



or

|x | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934
|- | ------------------------------------------------------------------------------------

| | For the fiscal year ended August 31, 2005
| | -----------------------------------------



or

| ̈ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934
|- | ----------------------------------------------------------------------------------------

| | For the transition period from __________ or __________
| | -------------------------------------------------------



or

| ̈ | SHELL COMPANY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934
|- | -------------------------------------------------------------------------------------------



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)



Level 39

Tower 1, Metroplaza, No. 223
Hing Fong Road

Kwai Chung, New Territories

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

common stock as of August 31, 2005:
614,125,404



---



Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.

Yes ̈No  x



If this report is an annual or transition report, indicate by check mark if the registrant is not required to file reports pursuant to section 13 or 15(d) of the Securities Exchange Act of 1934.

Yes ̈No  x



If this report is an annual report, indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes ̈No  x



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

Yes  x    No ̈



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

Item 17 ̈Item
18  x



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##### Table of Contents

CONTENTS



|                                                                                      |  |    
|------------------------------------------------------------------------------------- |  | ---
|CURRENCY TRANSLATION                                                                  |  | 1  
|FORWARD-LOOKING STATEMENTS                                                            |  | 1  
|PART I                                                                                |  | 2  
|ITEM 1. IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS                         |  | 2  
|ITEM 2. OFFER STATISTICS AND EXPECTED TIMETABLE                                       |  | 2  
|ITEM 3. KEY INFORMATION                                                               |  | 2  
|ITEM 4. INFORMATION ON THE COMPANY                                                    |  | 24 
|ITEM 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS                                  |  | 62 
|ITEM 6. DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES                                    |  | 86 
|ITEM 7. MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS                             |  | 95 
|ITEM 8. FINANCIAL INFORMATION                                                         |  | 97 
|ITEM 9. THE OFFER AND LISTING                                                         |  | 102
|ITEM 10. ADDITIONAL INFORMATION                                                       |  | 104
|ITEM 11. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK                   |  | 111
|ITEM 12. DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES                       |  | 112
|PART II                                                                               |  | 113
|ITEM 13. DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES                              |  | 113
|ITEM 14. MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF PROCEEDS |  | 113
|ITEM 15. CONTROLS AND PROCEDURES                                                      |  | 113
|ITEM 16.                                                                              |  | 113
|ITEM 16A. AUDIT COMMITTEE FINANCIAL EXPERT                                            |  | 113
|ITEM 16B. CODE OF ETHICS                                                              |  | 113
|ITEM 16C. PRINCIPAL ACCOUNTANT FEES AND SERVICES                                      |  | 114
|ITEM 16D. EXEMPTIONS FROM THE LISTING STANDARDS FOR AUDIT COMMITTEES                  |  | 115
|ITEM 16E. PURCHASE OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED PURCHASERS       |  | 115
|PART III                                                                              |  | 116
|ITEM 17. FINANCIAL STATEMENTS                                                         |  | 116
|ITEM 18. FINANCIAL STATEMENTS                                                         |  | 116
|ITEM 19. EXHIBITS                                                                     |  | 116



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##### Table of Contents

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$7.7718, which was the noon
buying rate in The City of New York for cable transfers in Hong Kong dollars as certified for customs purposes by the Federal Reserve Bank of New York on August 31, 2005. On January 24, 2006 the noon buying rate was US$1.00=HK$7.7554. You
should not construe these translations as representations that the Hong Kong dollar amounts actually represent such U.S. dollar amounts or could have been or could be converted into U.S. dollars at the rates indicated or at any other rates.



FORWARD-LOOKING STATEMENTS



This
annual report contains forward-looking statements that are, by their nature, subject to significant risks and uncertainties. These include statements with respect to City Telecom (H.K.) Limited (City Telecom or the Company)
and our plans, strategies and beliefs and other statements that are not historical facts. These statements can be identified by the use of forward-looking terminology such as may, will, expect,
anticipate, intend, estimate, continue, plan, predict, project or other similar words. The statements are based on managements assumptions and beliefs in light
of the information currently available to us.



These
assumptions involve risks and uncertainties which may cause the actual results, performance or achievements to be materially different from any future results, performance or achievements expressed or implied by such forward looking statements.
Potential risks and uncertainties include, without limitation:



| |  |  | technology changes;
| | - |  | -------------------



| |  |  | changes in the regulatory environment in which we operate, or changes in the rules and policies that government regulators apply to our businesses;
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | increased competition in the local or international telecommunications, Internet access or pay-television (pay-TV) markets;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------



| |  |  | the benefits we expect to receive from our continuing capital expenditure on our Metro Ethernet network;
| | - |  | --------------------------------------------------------------------------------------------------------



| |  |  | our ability to maintain growth and successfully introduce new products and services; and
| | - |  | ----------------------------------------------------------------------------------------



| |  |  | the continued development and stability of the technological infrastructure we use to provide our telecommunications, Internet access and pay-TV using Internet Protocol, which we
refer to as IP-TV, services.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



When considering
such forward-looking statements, you should keep in mind the factors described in Item 3 Key InformationRisk Factors and other cautionary statements appearing in Item 5 Operating and Financial Review and
Prospects of this annual report. Such risk factors and statements describe circumstances that could cause actual results to differ materially from those contained in any forward-looking statement.



***********



1



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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, 2001, 2002, 2003, 2004 and 2005. The selected financial information should be read in
conjunction with, and is qualified in its entirety by reference to, the financial statements included elsewhere in this annual report, the accompanying notes thereto and Item 5 Operating and Financial Review and Prospects.



|                                               |  |                                              |   |  |           |   |  |           |   |  |           |   |  |           |   |  |          |  
|---------------------------------------------- |  | -------------------------------------------- | - |  | --------- | - |  | --------- | - |  | --------- | - |  | --------- | - |  | -------- | -
|                                               |  | As of and for the year ended August 31,      |  
|                                               |  | 2001                                         |   |  | 2002      |   |  | 2003      |   |  | 2004      |   |  | 2005      |   |  | 2005     |  
|                                               |  | HK$                                          |   |  | HK$       |   |  | HK$       |   |  | HK$       |   |  | HK$       |   |  | US$      |  
|                                               |  | (Amounts in thousands except per share data) |  
|Consolidated Statement of Income Data:         |  |                                              |   |  |           |   |  |           |   |  |           |   |  |           |   |  |          |  
|Hong Kong GAAP                                 |  |                                              |   |  |           |   |  |           |   |  |           |   |  |           |   |  |          |  
|Revenues:                                      |  |                                              |   |  |           |   |  |           |   |  |           |   |  |           |   |  |          |  
|Fixed telecommunications network services(8)   |  | 154,262                                      |   |  | 241,219   |   |  | 423,107   |   |  | 541,902   |   |  | 629,464   |   |  | 80,993   |  
|International telecommunications               |  | 861,338                                      |   |  | 908,981   |   |  | 875,802   |   |  | 627,978   |   |  | 532,595   |   |  | 68,529   |  
|Content and e-commerce                         |  | 1,034                                        |   |  |          |   |  |          |   |  |          |   |  |          |   |  |         |  
|                                               |  |                                              |   |  |           |   |  |           |   |  |           |   |  |           |   |  |          |  
|Total Operating Revenue                        |  | 1,016,634                                    |   |  | 1,150,200 |   |  | 1,298,909 |   |  | 1,169,880 |   |  | 1,162,059 |   |  | 149,522  |  
|                                               |  |                                              |   |  |           |   |  |           |   |  |           |   |  |           |   |  |          |  
|Network Costs:                                 |  |                                              |   |  |           |   |  |           |   |  |           |   |  |           |   |  |          |  
|Fixed telecommunications network services      |  | (69,085                                      | ) |  | (50,808   | ) |  | (76,845   | ) |  | (122,476  | ) |  | (118,383  | ) |  | (15,232  | )
|International telecommunications               |  | (514,182                                     | ) |  | (407,155  | ) |  | (245,908  | ) |  | (208,932  | ) |  | (221,019  | ) |  | (28,439  | )
|Content and e-commence                         |  | (1,085                                       | ) |  |          |   |  |          |   |  |          |   |  |          |   |  |         |  
|                                               |  |                                              |   |  |           |   |  |           |   |  |           |   |  |           |   |  |          |  
|Total Network Costs                            |  | (584,352                                     | ) |  | (457,963  | ) |  | (322,753  | ) |  | (331,408  | ) |  | (339,402  | ) |  | (43,671  | )
|Other Operating Expenses                       |  | (415,135                                     | ) |  | (602,644  | ) |  | (704,796  | ) |  | (793,125  | ) |  | (951,066  | ) |  | (122,374 | )
|Income/(loss) from operations                  |  | 17,147                                       |   |  | 89,593    |   |  | 271,360   |   |  | 45,347    |   |  | (128,409  | ) |  | (16,523  | )
|Interest income/(expense), net                 |  | 30,896                                       |   |  | 7,366     |   |  | 2,562     |   |  | 3,578     |   |  | (40,884   | ) |  | (5,260   | )
|Other income, net                              |  | 10,935                                       |   |  | 502       |   |  | 1,678     |   |  | 2,668     |   |  | 6,037     |   |  | 777      |  
|Income taxes (charge)/credit                   |  | (17,533                                      | ) |  | (15,190   | ) |  | (17,857   | ) |  | (2,043    | ) |  | 6,725     |   |  | 865      |  
|Income/(loss) after taxation                   |  | 41,445                                       |   |  | 82,271    |   |  | 257,743   |   |  | 49,550    |   |  | (156,531  | ) |  | (20,141  | )
|Minority interest                              |  | 13,724                                       |   |  | 8,234     |   |  |          |   |  |          |   |  |          |   |  |         |  
|Net income/(loss)                              |  | 55,169                                       |   |  | 90,505    |   |  | 257,743   |   |  | 49,550    |   |  | (156,531  | ) |  | (20,141  | )
|Net income/(loss) per share (cents)            |  | 11.2                                         |   |  | 18.3      |   |  | 46.6      |   |  | 8.1       |   |  | (25.5     | ) |  | (3.3     | )
|Diluted net income/(loss) per share (cents)(1) |  | 11.2                                         |   |  | 16.0      |   |  | 41.9      |   |  | 8.1       |   |  | (25.5     | ) |  | (3.3     | )
|Dividends declared per share (cents)           |  | 1.0                                          |   |  |          |   |  | 5.0       |   |  | 9.0       |   |  |          |   |  |         |  
|Diluted weighted average number of shares(2)   |  | 494,449                                      |   |  | 565,889   |   |  | 615,102   |   |  | 614,365   |   |  | 613,525   |   |  | 613,525  |  
|Weighted average number of shares              |  | 490,679                                      |   |  | 495,181   |   |  | 552,600   |   |  | 610,095   |   |  | 613,525   |   |  | 613,525  |  



2



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##### Table of Contents

|                                                                          |  |                                              |   |  |            |   |  |            |   |  |            |   |  |            |   |  |          |  
|------------------------------------------------------------------------- |  | -------------------------------------------- | - |  | ---------- | - |  | ---------- | - |  | ---------- | - |  | ---------- | - |  | -------- | -
|                                                                          |  | As of and for the year ended August 31,      |  
|                                                                          |  | 2001                                         |   |  | 2002       |   |  | 2003       |   |  | 2004       |   |  | 2005       |   |  | 2005     |  
|                                                                          |  | HK$                                          |   |  | HK$        |   |  | HK$        |   |  | HK$        |   |  | HK$        |   |  | US$      |  
|                                                                          |  | (Amounts in thousands except per share data) |  
|U.S. GAAP                                                                 |  |                                              |   |  |            |   |  |            |   |  |            |   |  |            |   |  |          |  
|Total operating revenue(8)                                                |  | 1,006,328                                    |   |  | 1,141,814  |   |  | 1,291,119  |   |  | 1,169,880  |   |  | 1,162,059  |   |  | 149,522  |  
|Total operating costs                                                     |  | (978,843                                     | ) |  | (1,073,283 | ) |  | (1,015,900 | ) |  | (1,123,198 | ) |  | (1,289,014 | ) |  | (165,858 | )
|Net income/(loss) from continuing operations                              |  | 65,389                                       |   |  | 69,317     |   |  | 264,151    |   |  | 51,565     |   |  | (149,148   | ) |  | (19,191  | )
|Net income/(loss) from continuing operations per share (cents)            |  | 13.3                                         |   |  | 14.0       |   |  | 47.8       |   |  | 8.5        |   |  | (24.3      | ) |  | (3.1     | )
|Net income/(loss) from discontinued operations                            |  | (11,423                                      | ) |  | (352       | ) |  | 83         |   |  |           |   |  |           |   |  |         |  
|Loss arising from disposal of discontinued operations                     |  |                                             |   |  |           |   |  | (2,695     | ) |  |           |   |  |           |   |  |         |  
|Net loss from discontinued operations per share (cents)                   |  | (2.3                                         | ) |  | (0.1       | ) |  | (0.5       | ) |  |           |   |  |           |   |  |         |  
|Diluted net income/(loss) from continuing operations per share (cents)(3) |  | 13.2                                         |   |  | 12.3       |   |  | 42.9       |   |  | 8.4        |   |  | (24.3      | ) |  | (3.1     | )
|Diluted net loss from discontinued operations per share (cents)(4)        |  | (2.3                                         | ) |  | (0.1       | ) |  | (0.4       | ) |  |           |   |  |           |   |  |         |  
|Dividends declared per share (cents)                                      |  | 1.0                                          |   |  |           |   |  | 5.0        |   |  | 9.0        |   |  |           |   |  |         |  
|Weighted average number of shares                                         |  | 490,679                                      |   |  | 495,181    |   |  | 552,600    |   |  | 610,095    |   |  | 613,525    |   |  | 613,525  |  
|Diluted weighted average number of shares(2)                              |  | 494,449                                      |   |  | 565,889    |   |  | 615,102    |   |  | 614,365    |   |  | 613,525    |   |  | 613,525  |  



|                                 |  |                                         |   |  |           |   |  |           |   |  |           |   |  |            |   |  |          |  
|-------------------------------- |  | --------------------------------------- | - |  | --------- | - |  | --------- | - |  | --------- | - |  | ---------- | - |  | -------- | -
|                                 |  | As of and for the year ended August 31, |  
|                                 |  | 2001                                    |   |  | 2002      |   |  | 2003      |   |  | 2004      |   |  | 2005       |   |  | 2005     |  
|                                 |  | HK$                                     |   |  | HK$       |   |  | HK$       |   |  | HK$       |   |  | HK$        |   |  | US$      |  
|                                 |  | (Amounts in thousands)                  |  
|Consolidated Balance Sheet Data: |  |                                         |   |  |           |   |  |           |   |  |           |   |  |            |   |  |          |  
|Hong Kong GAAP                   |  |                                         |   |  |           |   |  |           |   |  |           |   |  |            |   |  |          |  
|Total assets                     |  | 1,144,618                               |   |  | 1,327,285 |   |  | 1,548,534 |   |  | 1,683,408 |   |  | 2,347,428  |   |  | 302,044  |  
|Debt                             |  |                                        |   |  |          |   |  | (18,174   | ) |  | (119,170  | ) |  | (945,348   | ) |  | (121,638 | )
|Finance lease obligation         |  | (7,384                                  | ) |  | (2,949    | ) |  |          |   |  |          |   |  | (3,135     | ) |  | (403     | )
|Other liabilities                |  | (326,092                                | ) |  | (419,348  | ) |  | (351,185  | ) |  | (388,540  | ) |  | (378,491   | ) |  | (48,701  | )
|                                 |  |                                         |   |  |           |   |  |           |   |  |           |   |  |            |   |  |          |  
|Total liabilities                |  | (333,476                                | ) |  | (422,297  | ) |  | (369,359  | ) |  | (507,710  | ) |  | (1,326,974 | ) |  | (170,742 | )
|                                 |  |                                         |   |  |           |   |  |           |   |  |           |   |  |            |   |  |          |  
|Net assets                       |  | 811,142                                 |   |  | 904,988   |   |  | 1,179,175 |   |  | 1,175,698 |   |  | 1,020,454  |   |  | 131,302  |  
|Minority interest                |  | (10,407                                 | ) |  |          |   |  |          |   |  |          |   |  |           |   |  |         |  
|                                 |  |                                         |   |  |           |   |  |           |   |  |           |   |  |            |   |  |          |  
|Net assets employed              |  | 800,735                                 |   |  | 904,988   |   |  | 1,179,175 |   |  | 1,175,698 |   |  | 1,020,454  |   |  | 131,302  |  
|                                 |  |                                         |   |  |           |   |  |           |   |  |           |   |  |            |   |  |          |  
|Share capital                    |  | 49,107                                  |   |  | 50,086    |   |  | 60,496    |   |  | 61,057    |   |  | 61,412     |   |  | 7,902    |  
|Share premium                    |  | 569,180                                 |   |  | 572,656   |   |  | 615,886   |   |  | 617,986   |   |  | 619,408    |   |  | 79,699   |  
|Reserves                         |  | 182,448                                 |   |  | 282,246   |   |  | 502,793   |   |  | 496,655   |   |  | 339,634    |   |  | 43,701   |  
|                                 |  |                                         |   |  |           |   |  |           |   |  |           |   |  |            |   |  |          |  
|Total shareholders equity       |  | 800,735                                 |   |  | 904,988   |   |  | 1,179,175 |   |  | 1,175,698 |   |  | 1,020,454  |   |  | 131,302  |  
|                                 |  |                                         |   |  |           |   |  |           |   |  |           |   |  |            |   |  |          |  



3



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##### Table of Contents

|                              |  |                                         |   |  |           |   |  |           |   |  |           |   |  |            |   |  |          |  
|----------------------------- |  | --------------------------------------- | - |  | --------- | - |  | --------- | - |  | --------- | - |  | ---------- | - |  | -------- | -
|                              |  | As of and for the year ended August 31, |  
|                              |  | 2001                                    |   |  | 2002      |   |  | 2003      |   |  | 2004      |   |  | 2005       |   |  | 2005     |  
|                              |  | HK$                                     |   |  | HK$       |   |  | HK$       |   |  | HK$       |   |  | HK$        |   |  | US$      |  
|                              |  | (Amounts in thousands)                  |  
|U.S. GAAP                     |  |                                         |   |  |           |   |  |           |   |  |           |   |  |            |   |  |          |  
|Total assets                  |  | 1,146,994                               |   |  | 1,329,707 |   |  | 1,552,021 |   |  | 1,688,640 |   |  | 2,359,654  |   |  | 303,617  |  
|Total liabilities             |  | (333,476                                | ) |  | (422,297  | ) |  | (369,359  | ) |  | (507,710  | ) |  | (1,326,974 | ) |  | (170,742 | )
|                              |  |                                         |   |  |           |   |  |           |   |  |           |   |  |            |   |  |          |  
|Net assets                    |  | 813,518                                 |   |  | 907,410   |   |  | 1,182,662 |   |  | 1,180,930 |   |  | 1,032,680  |   |  | 132,875  |  
|Minority interest             |  | (10,407                                 | ) |  |          |   |  |          |   |  |          |   |  |           |   |  |         |  
|                              |  |                                         |   |  |           |   |  |           |   |  |           |   |  |            |   |  |          |  
|Total assets less liabilities |  | 803,111                                 |   |  | 907,410   |   |  | 1,182,662 |   |  | 1,180,930 |   |  | 1,032,680  |   |  | 132,875  |  
|                              |  |                                         |   |  |           |   |  |           |   |  |           |   |  |            |   |  |          |  
|Share capital                 |  | 49,107                                  |   |  | 50,086    |   |  | 60,496    |   |  | 61,057    |   |  | 61,412     |   |  | 7,902    |  
|Share premium                 |  | 578,799                                 |   |  | 603,861   |   |  | 644,360   |   |  | 646,190   |   |  | 647,223    |   |  | 83,278   |  
|Reserves                      |  | 175,205                                 |   |  | 253,463   |   |  | 477,806   |   |  | 473,683   |   |  | 324,045    |   |  | 41,695   |  
|                              |  |                                         |   |  |           |   |  |           |   |  |           |   |  |            |   |  |          |  
|Total shareholders equity    |  | 803,111                                 |   |  | 907,410   |   |  | 1,182,662 |   |  | 1,180,930 |   |  | 1,032,680  |   |  | 132,875  |  
|                              |  |                                         |   |  |           |   |  |           |   |  |           |   |  |            |   |  |          |  



|                                                    |  |                                         |   |  |          |   |  |          |   |  |          |   |  |          |   |  |         |  
|--------------------------------------------------- |  | --------------------------------------- | - |  | -------- | - |  | -------- | - |  | -------- | - |  | -------- | - |  | ------- | -
|                                                    |  | As of and for the year ended August 31, |  
|                                                    |  | 2001                                    |   |  | 2002     |   |  | 2003     |   |  | 2004     |   |  | 2005     |   |  | 2005    |  
|                                                    |  | HK$                                     |   |  | HK$      |   |  | HK$      |   |  | HK$      |   |  | HK$      |   |  | US$     |  
|                                                    |  | (Amounts in thousands)                  |  
|Other Financial Data:                               |  |                                         |   |  |          |   |  |          |   |  |          |   |  |          |   |  |         |  
|EBITDA(5)                                           |  | 124,653                                 |   |  | 227,684  |   |  | 449,058  |   |  | 245,032  |   |  | 115,342  |   |  | 14,841  |  
|Net cash provided by (used in) operating activities |  | 38,751                                  |   |  | 288,444  |   |  | 414,500  |   |  | 203,763  |   |  | (15,444  | ) |  | (1,987  | )
|Net cash used in investing activities               |  | (48,769                                 | ) |  | (475,212 | ) |  | (309,634 | ) |  | (406,244 | ) |  | (464,590 | ) |  | (59,779 | )
|Net cash provided by (used in) financing activities |  | 13,880                                  |   |  | 9,109    |   |  | (10,274  | ) |  | 47,221   |   |  | 792,193  |   |  | 101,932 |  
|Capital expenditures                                |  | 166,037                                 |   |  | 579,066  |   |  | 250,209  |   |  | 410,046  |   |  | 419,126  |   |  | 53,929  |  



As a measure of our
operating performance or liquidity, we believe that the most directly comparable measure to EBITDA is net cash provided by (used in) operating activities. The following table reconciles our net cash provided by (used in) operating activities under
Hong Kong GAAP to our definition of EBITDA on a consolidated basis for each of fiscal 2001, 2002, 2003, 2004 and 2005.



|                                                         |  |                                         |   |  |          |   |  |          |   |  |          |   |  |          |   |  |         |  
|-------------------------------------------------------- |  | --------------------------------------- | - |  | -------- | - |  | -------- | - |  | -------- | - |  | -------- | - |  | ------- | -
|                                                         |  | As of and for the year ended August 31, |  
|                                                         |  | 2001                                    |   |  | 2002     |   |  | 2003     |   |  | 2004     |   |  | 2005     |   |  | 2005    |  
|                                                         |  | HK$                                     |   |  | HK$      |   |  | HK$      |   |  | HK$      |   |  | HK$      |   |  | US$     |  
|                                                         |  | (Amounts in thousands)                  |  
|EBITDA                                                   |  | 124,653                                 |   |  | 227,684  |   |  | 449,058  |   |  | 245,032  |   |  | 115,342  |   |  | 14,841  |  
|Depreciation and amortization                            |  | (82,847                                 | ) |  | (129,355 | ) |  | (176,020 | ) |  | (197,017 | ) |  | (237,714 | ) |  | (30,587 | )
|Interest income/(expense), net                           |  | 30,896                                  |   |  | 7,366    |   |  | 2,562    |   |  | 3,578    |   |  | (40,884  | ) |  | (5,260  | )
|Income taxes (charge)/credit                             |  | (17,533                                 | ) |  | (15,190  | ) |  | (17,857  | ) |  | (2,043   | ) |  | 6,725    |   |  | 865     |  
|                                                         |  |                                         |   |  |          |   |  |          |   |  |          |   |  |          |   |  |         |  
|Net income/(loss)                                        |  | 55,169                                  |   |  | 90,505   |   |  | 257,743  |   |  | 49,550   |   |  | (156,531 | ) |  | (20,141 | )
|Depreciation and amortization                            |  | 82,847                                  |   |  | 129,355  |   |  | 176,020  |   |  | 197,017  |   |  | 237,714  |   |  | 30,586  |  
|Amortization of deferred expenditure                     |  |                                        |   |  |         |   |  |         |   |  | 1,828    |   |  | 12,927   |   |  | 1,663   |  
|Income taxes (charge)/credit                             |  | 17,533                                  |   |  | 15,190   |   |  | 17,857   |   |  | 2,043    |   |  | (6,725   | ) |  | (865    | )
|Interest income                                          |  | (35,438                                 | ) |  | (10,870  | ) |  | (3,163   | ) |  | (3,753   | ) |  | (13,578  | ) |  | (1,747  | )
|Interest element of finance lease                        |  |                                        |   |  |         |   |  |         |   |  |         |   |  | 23       |   |  | 3       |  
|Interest on 10-year senior notes                         |  |                                        |   |  |         |   |  |         |   |  |         |   |  | 52,372   |   |  | 6,739   |  
|Amortization of incidental issuance costs                |  |                                        |   |  |         |   |  |         |   |  |         |   |  | 1,693    |   |  | 218     |  
|Minority interest                                        |  | (13,724                                 | ) |  | (8,234   | ) |  |         |   |  |         |   |  |         |   |  |        |  
|Loss/(gain) on disposal of fixed assets                  |  | 3,512                                   |   |  | 2,414    |   |  | 427      |   |  | (34      | ) |  | (134     | ) |  | (17     | )
|Unrealized losses/(gain) on other investments            |  |                                        |   |  |         |   |  |         |   |  | 1,696    |   |  | (300     | ) |  | (39     | )
|Loss on disposal of a subsidiary                         |  |                                        |   |  |         |   |  | 2,695    |   |  |         |   |  |         |   |  |        |  
|Taxation refund/(paid)                                   |  |                                        |   |  | (4,452   | ) |  | (19,861  | ) |  | (24,819  | ) |  | (1,393   | ) |  | (179    | )
|Change in long term receivable                           |  |                                        |   |  |         |   |  |         |   |  | (6,206   | ) |  | (6,893   | ) |  | (887    | )
|Change in term deposits                                  |  |                                        |   |  |         |   |  |         |   |  |         |   |  | (92,850  | ) |  | (11,947 | )
|Change in working capital, net                           |  | (71,148                                 | ) |  | 74,536   |   |  | (17,218  | ) |  | (13,559  | ) |  | (41,769  | ) |  | (5,374  | )
|                                                         |  |                                         |   |  |          |   |  |          |   |  |          |   |  |          |   |  |         |  
|Net cash flow (used in) provided by operating activities |  | 38,751                                  |   |  | 288,444  |   |  | 414,500  |   |  | 203,763  |   |  | (15,444  | ) |  | (1,987  | )
|                                                         |  |                                         |   |  |          |   |  |          |   |  |          |   |  |          |   |  |         |  



4



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##### Table of Contents

|                                                         |  |                                         |  |           |  |           |  |           |  |          
|-------------------------------------------------------- |  | --------------------------------------- |  | --------- |  | --------- |  | --------- |  | ---------
|                                                         |  | As of and for the year ended August 31,
|                                                         |  | 2001                                    |  | 2002      |  | 2003      |  | 2004      |  | 2005     
|Operating Data:                                          |  |                                         |  |           |  |           |  |           |  |          
|Fixed Telecommunications Network Services Subscriptions: |  |                                         |  |           |  |           |  |           |  |          
|Broadband Internet Access                                |  | 17,700                                  |  | 130,000   |  | 172,000   |  | 197,000   |  | 229,000  
|Local VOIP(6)                                            |  |                                        |  | 21,000    |  | 140,000   |  | 237,000   |  | 293,000  
|IP-TV                                                    |  |                                        |  |          |  |          |  | 31,000    |  | 109,000  
|Total                                                    |  | 17,700                                  |  | 151,000   |  | 312,000   |  | 465,000   |  | 631,000  
|                                                         |  |                                         |  |           |  |           |  |           |  |          
|Registered International Telecommunications Accounts(7)  |  | 982,455                                 |  | 1,147,689 |  | 1,589,188 |  | 1,916,235 |  | 2,054,036
|IDD Outgoing Minutes (in thousands)                      |  | 580,000                                 |  | 916,000   |  | 888,000   |  | 1,007,000 |  | 947,100  

---

|(1) | Diluted net income/(loss) per share is computed by dividing the net income/(loss) by the
diluted weighted average number of ordinary shares during the year.
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------



|(2) | Diluted weighted average number of shares is the weighted average number of ordinary shares
outstanding during the year, plus the weighted average number of additional ordinary shares which would have been outstanding assuming all the outstanding share options and share warrants have been exercised at the beginning of the year or on the
date of issue, whichever is earlier.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(3) | Diluted net income/(loss) from continuing operations per share is computed by dividing the
net income/(loss) from continuing operations by the diluted weighted average number of ordinary shares during the year.
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(4) | Diluted net loss from discontinued operations per share is computed by dividing the net loss
from discontinued operations by the diluted weighted average number of ordinary shares during the year.
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(5) | EBITDA for any period means, without duplication, net income/(loss) for such period, plus the
following to the extent deducted in calculating such net income/(loss): interest expense, income taxes, depreciation and amortization expense (excluding any such non cash charge to the extent it represents an accrual of or reserve for cash charges
in any future period or amortization of a prepaid cash expense that was paid in a prior period not included in the calculation), less interest income. EBITDA is not a measure of performance under Hong Kong GAAP or U.S. GAAP. We believe that EBITDA
is an additional measure utilized by investors in determining a borrowers ability to meet debt service requirements. However, EBITDA does not represent, and should not be used as a substitute for, net earnings or cash flows from operations as
determined in accordance with Hong Kong GAAP or U.S. GAAP, and EBITDA is not necessarily an indication of whether cash flow will be sufficient to fund our cash requirements. In addition, our definition of EBITDA may differ from that of other
companies.
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(6) | Includes Hong Kong based subscriptions only.
|--- | --------------------------------------------



|(7) | Registered accounts refer to international telecommunications customers that have a valid
account. Account holders may or may not be active users of our services.
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(8) | As described more fully in Note 31 to the consolidated financial statements, revenue from telecommunications network services for 2005 included mobile
interconnection charges which were different from what was previously reported by the Company under accounting standards generally accepted in Hong Kong. Further, other operating expenses include provision for doubtful accounts which were different
from what was previously reported by the Company under accounting standards generally accepted in Hong Kong.
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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.



5



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##### Table of Contents

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-End
|                                        |  | HK$        |  | HK$    |  | HK$    |  | HK$       
|2001                                    |  | 7.7996     |  | 7.8004 |  | 7.7970 |  | 7.7980    
|2002                                    |  | 7.7996     |  | 7.8095 |  | 7.7970 |  | 7.7988    
|2003                                    |  | 7.7864     |  | 7.8001 |  | 7.7085 |  | 7.7640    
|2004                                    |  | 7.7891     |  | 7.8010 |  | 7.7632 |  | 7.7723    
|2005                                    |  | 7.7775     |  | 7.7999 |  | 7.7514 |  | 7.7718    
|August 2005                             |  | 7.7709     |  | 7.7734 |  | 7.7684 |  | 7.7718    
|September 2005                          |  | 7.7618     |  | 7.7693 |  | 7.7567 |  | 7.7567    
|October 2005                            |  | 7.7559     |  | 7.7587 |  | 7.7519 |  | 7.7519    
|November 2005                           |  | 7.7538     |  | 7.7570 |  | 7.7514 |  | 7.7546    
|December 2005                           |  | 7.7531     |  | 7.7548 |  | 7.7516 |  | 7.7533    
|January 2006 (through January 24, 2006) |  | 7.7528     |  | 7.7554 |  | 7.7506 |  | 7.7554    

---

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



Source: Federal Reserve Bank of New
York.





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##### Table of Contents

Risk Factors



You should carefully consider the risks described below and other information contained in this annual report before
making an investment decision. The risks and uncertainties described below are not the only ones we face. Additional risks and uncertainties not presently known to us, or that we currently deem immaterial, may also impair our business operations. We
cannot assure you that any of the events discussed in the risk factors below will not occur. If they do, our business, financial condition or results of operations could be materially adversely affected.



Risks Relating to Our Business and Operations



We experienced a decline in total revenues and a net loss in fiscal
2005 mainly due to a decline in revenues and profits from our international telecommunications services business and continued start-up losses from our IP-TV operations. We cannot assure you that we will be able to prevent total revenues and profits
from continuing to decline.



Our total revenues
decreased marginally by 0.7% from HK$1,169.9 million in fiscal 2004 to HK$1,162.1 million in fiscal 2005 due to a significant decrease in revenues from our international telecommunications services. The 15.2% decline in our international
telecommunications services revenues from HK$628.0 million in fiscal 2004 to HK$532.6 million in fiscal 2005 offset our 16.2% increase in fixed telecommunications network services revenues from HK$541.9 million in fiscal 2004 to HK$629.5 million in
fiscal 2005. In addition, for the first time in our operating history we suffered a net loss from operations. Income from operations decreased from a profit of HK$45.3 million in fiscal 2004 to a loss of HK$128.4 million in fiscal 2005 mainly due to
lower revenues in our international telecommunications services and substantial early-stage costs incurred for our IP-TV services.



The decline in international telecommunications revenues was due to a decrease in the total number of minutes carried as well as a decrease in average
tariff rates. With the drop in average tariff rates, we expect that the profit margins in our international telecommunications services will continue to be under pressure. To maintain our market share, we must continue to offer our subscribers
international telecommunications services that are competitive with the prices offered by other international telecommunications service providers.



Our fixed telecommunications network services revenues increased in fiscal 2005 primarily due to 35.7% growth in our subscription base to approximately
631,000 users as of August 31, 2005. However, our fixed telecommunications network services suffered a loss from operations due to a provision for mobile interconnection charges, substantial acquisition and marketing costs, and early stage
development costs for our IP-TV business. For more information on our provision for mobile interconnection charges, see We recognized revenues for mobile interconnection charges in fiscal 2002 to fiscal 2005 that have not yet been paid
to us. In fiscal 2005, we made a partial provision for the revenues charged in fiscal 2002 to fiscal 2004 and are awaiting the outcome of the determination by the Telecommunications Authority on the level of mobile interconnection charges that
mobile operators are required to pay us below in this annual report. In fiscal 2005, we focused on obtaining new fixed telecommunications network services subscriptions through various promotions including free trials of our IP-TV services for
periods from six to twelve months. We may not be able to generate revenues from these new subscriptions in the future and as a result we may not be able to prevent our total revenues and profits from continuing to decline.



We have substantially less financial and human resources to apply to
the development of our business than some of our main competitors.



The telecommunications and pay-TV markets in Hong Kong are highly competitive. Our main competitors for Internet access, local telephony, pay-TV and international telecommunications services are PCCW-HKT Telephone
Limited, or PCCW-HKT, Hutchison Global Communications Limited, or HGC, New World Telecommunciations Company Limited, or New World, Wharf T&T Limited, or Wharf T&T, and i-Cable Communications Limited, or i-Cable. PCCW-HKT (then Hong Kong
Telephone Company Limited) held a monopoly on local telephony services until 1995 when the Hong Kong government began to introduce competition to this market. In addition, i-Cable (through its subsidiary Hong Kong Cable Television Limited) was the
first company to offer pay-TV services in Hong Kong beginning in 1993 and held an effective monopoly until 2003 when we and PCCW-HKT (through its subsidiary PCCW-IMS Limited) began to offer pay-TV services.



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##### Table of Contents

As a result of their longer operating histories, and because some of our competitors are subsidiaries of
large business conglomerates, they may have advantages over us in the provision of telecommunications services, including:



| |  |  | greater financial, technical, marketing and other resources;
| | - |  | ------------------------------------------------------------



| |  |  | greater existing infrastructure;
| | - |  | --------------------------------



| |  |  | greater name recognition; and
| | - |  | -----------------------------



| |  |  | larger customer bases.
| | - |  | ----------------------



In addition, certain areas of the fixed telecommunications network services business are very capital intensive. Our competitors may be able to devote
more human and financial resources to research and development, network improvement and marketing than we can. Since our inception, the growth of our market share has depended primarily on our ability to react more quickly to changes in new
technology and consumer trends, offer more competitively priced services, and provide better customer support than our competitors. We cannot assure you that we will continue to be successful at executing this strategy. If these competitors devote
substantial human and financial resources to their businesses, it could hurt our ability to remain competitive in the quality and range of services that we provide and we may lose customers to these competitors. This may limit the growth of our
customer base, reduce our revenues and adversely affect our profits.



Our growth and profitability could be affected by an increasing number of local and foreign entrants in the international and local telecommunications and Internet access markets.



The Hong Kong government has adopted policies and regulations over the past
decade to liberalize the telecommunications industry in Hong Kong, including issuing new wireless and wire-line fixed telecommunications network services licenses, which we refer to as FTNS Licenses. We expect the Hong Kong government to continue to
take actions of these types over the next several years. Further, in contrast to its previous requirements when issuing network licenses, new licensees are no longer required to give any commitment relating to network rollout or investment. There
are currently nine other fixed telecommunications network operators in Hong Kong in addition to ourselves who are licensed to provide local wireline-based fixed line services. These operators are PCCW-HKT, HGC, New World, Wharf T&T, Towngas
Telecommunications Fixed Network Limited, Hong Kong Cable Television Limited, CM Tel (HK) Limited, TraxComm Limited and HKC Network Limited. In addition, as of December 3, 2005, 224 public non-exclusive telecommunications service licenses,
which we refer to as PNETS Licenses, for the provision of external telecommunications service had been issued to various operators in Hong Kong. Some of these licensees are subsidiaries of major foreign telecommunications providers.



The Telecommunications Authority is also currently in the process of
developing a new Fixed-Mobile Convergence, or FMC, licensing regime which may supersede the existing distinctions between fixed-line and mobile operator licensing. This regulatory change, together with the development of new technologies, may
further accelerate the convergence of fixed and mobile telecommunications services resulting in more structural competition between fixed-line and mobile telecommunications operators. PCCW, the parent of PCCW-HKT and one of our main competitors,
purchased a controlling stake in SUNDAY, a mobile telecommunications operator in Hong Kong, in June 2005, which may improve their competitive position.



Increasing liberalization of the telecommunications market in Hong Kong may further attract new local and foreign entrants to the market and broaden the
variety of telecommunications services supplied by existing service providers, thereby heightening the level of competition in the industry. Increased competition could result in price reductions, reduced gross margins or loss of market share, any
of which could adversely affect our future growth and profitability.



8



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##### Table of Contents

The markets in which we compete may become more competitive should there be significant mergers and
acquisitions in the Hong Kong telecommunications market.



Some of our competitors with greater financial resources may attempt to grow their customer base and product offerings through acquisitions. If these competitors make significant acquisitions, they may have increased capacity and may be
better positioned to increase their market share by decreasing prices. Additionally, as a result of such acquisitions, these competitors may be able to provide a broader array of services. If we are unable to grow our business through our continued
expansion or by pursuing our own acquisitions, we may have difficulties competing successfully against these competitors.



On January 20, 2005, PCCW Limited (PCCW) announced it had formed a strategic business alliance with China Network Communications Group
Corporation, or China Netcom, one of Chinas major telecommunications companies. Under this alliance, China Netcom paid approximately US$1.0 billion in cash for newly issued PCCW shares, resulting in it holding 20% of PCCWs share capital.
This transaction may have many effects on the telecommunications market in Hong Kong, which are difficult to predict. In particular, it could result in increased competition for us and other Hong Kong telecommunications companies if PCCW is able to
combine its size and market position with the increased capital provided by China Netcom to decrease prices. Furthermore, such a transaction might allow PCCW to invest more capital and human resources in its telecommunications network services that
directly compete with our services.



In June 2005, PCCW
acquired a controlling stake in SUNDAY, a mobile telecommunications operator in Hong Kong. This acquisition strengthens PCCWs ability to compete by enabling it to offer integrated fixed and mobile telecommunications services. Going forward, we
expect PCCW to offer integrated quad-play services that includes fixed voice, mobile voice, Internet access and IP-TV.



The development of our Metro Ethernet network requires significant capital expenditures. These capital expenditures may vary materially from those
currently planned and may impose a burden on our financing and operating activities.



Our business is capital intensive, and our capital expenditures may not have the positive effect on our business and revenues that we expect. We have made, and will continue to make, capital investments in the
expansion and upgrade of our Metro Ethernet network and the development of our telecommunications services. We incurred total capital expenditures of approximately HK$419 million in fiscal 2005, of which HK$408 million was on our Metro Ethernet
infrastructure. We expect to incur total capital expenditures of approximately HK$400 million in fiscal 2006, the large majority of which will be spent on the continued expansion and upgrade of our Metro Ethernet network.



While we intend to fund such expenditures by using our currently available
cash as well as cash flow from operations and the net proceeds from our January 2005 offering of 8.75% senior notes due 2015, which we refer to in this annual report as the 8.75% notes, we may not have adequate capital to fund these expenditures. In
addition, if we spend our existing capital faster than anticipated or our capital requirements vary materially from those currently planned, we may require additional financing sooner than we anticipate, in which case we may need to seek to raise
additional capital through debt or equity financing or other means. Any such additional debt or equity financing may not be available, and debt financing, if available, may involve restrictions on our financing and operating activities. If we are
unable to obtain additional financing as needed, we may be required to reduce the scope of our operations or anticipated expansion and business development.



We may not realize the benefits we expect from our investments, which may adversely impact our business.



We have made significant investments in our network infrastructure to
provide the services we offer. The launch of new and commercially viable products and services is important to the success of our business. Commercial acceptance by consumers of the new services we offer may not occur at the rate or level expected,
and we may not be able to successfully adapt the new services effectively and economically to meet consumers demand, which would limit the return from our investments. We cannot assure you that services enabled by upgrading and expanding our
Metro Ethernet network will be accepted by the public to the extent required to generate an acceptable rate of return. In addition, we face the risk of unforeseen complications in the deployment of these new services, and we cannot assure you that
our estimate of the necessary capital expenditure to offer such services will not be exceeded. For example, the useful life of the equipment that we employ in buildings and for our fiber-based backbone may be shorter than expected requiring further
capital expenditures. New technology developments such as Worldwide Interoperability for Microwave Access, or WIMAX, and third generation mobile standards, or 3G, etc. may result in substitution of our existing portfolio of services. We may be
unable to develop and/or deploy new services according to expected schedules, and these services may not achieve commercial acceptance or be cost effective. The failure of any of our services to achieve commercial acceptance could result in
additional capital expenditures or a reduction in profitability to the extent that we are required under the applicable accounting standards to recognize a charge for the impairment of assets. Any such charge could materially and adversely affect
our financial condition and the results of our operations.



9



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##### Table of Contents

We rely on third parties to deliver a significant portion of our international telecommunications
traffic and fixed telecommunications network services. Our transmission costs could increase as a result of changes in our relationships with them.



Where we do not currently have our own infrastructure in place, we depend on our contractual relationships with, and the network infrastructure of, other
local network operators and overseas telecommunications carriers in providing international telecommunications and fixed telecommunications network services to our customers. Some of these third parties are our competitors in our international
telecommunications or fixed telecommunications network services, or both. In fiscal 2005, payments to our top five overseas carriers and local network operators accounted for approximately 14% of our total gross operating costs. The terms and
conditions of these local and international arrangements could be subject to changes or modification upon renewal of the relevant agreements. If the terms and conditions upon renewal are less favorable or the arrangements are not renewed, the costs
associated with providing our services in locations where our own infrastructure is not in place could increase significantly.



Because most of the services we provide through our Metro Ethernet network are still at an early stage of implementation, evaluation of our business
and our prospects is difficult.



Because of the short
operating history of most of our fixed telecommunications network services, especially our IP-TV services, our historical financial data may not provide a meaningful basis for you to evaluate us and our prospects. These services are still at an
early stage of implementation, and the revenue, potential income and cash flows from these new businesses are unproven. Accordingly, evaluation of our businesses and our prospects is difficult, and we cannot give you any assurance that we will
succeed in these businesses.



We are involved in several
legal proceedings that, if decided unfavorably to us, could adversely affect our profitability.



We are currently involved in several legal proceedings in Hong Kong. If these proceedings are resolved in a manner adverse to us, our business and
profitability may be harmed. The most significant proceedings are:



| |  |  | A case brought in July 1998 in which PCCW-HKT (then Cable & Wireless HKT) alleges that certain of our business practices breached our agreements with PCCW-HKT and
unlawfully interfered with their telecommunications business.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | A case brought in April 1999 in which the plaintiff alleges that one of our wholly owned subsidiaries wrongfully terminated a telecommunications service agreement between them
leaving unpaid obligations to the plaintiff of approximately US$3.6 million.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



In each of the proceedings mentioned above, we are vigorously defending against the claims. However, we cannot predict the way that an arbitrator or a court of law will view the facts in dispute nor can we predict how
any such arbitrator or court would interpret substantive points of law; therefore, we cannot predict the outcome of these proceedings.



10



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##### Table of Contents

In addition, on November 14, 2005, seven music recording producers (Plaintiffs) jointly
filed an originating summons with the Court of First Instance of Hong Kong against Hong Kong Broadband Network Limited (HKBN), our wholly-owned subsidiary, HGC, PCCW and i CABLE seeking an order from the court that would require HKBN and
the other defendants to disclose the identity of customers to whom certain identified Internet Protocol addresses were assigned (the Customers). The Plaintiffs alleged that these customers have infringed the copyright subsisting in their
sound recordings. The Plaintiffs summons was first heard on January 9, 2006 and was continued on January 16, 2006. After considering the submissions made by the parties, the court handed down the judgment on January 26, 2006
ordering HKBN and the other defendants to disclose the identity of the Customers to the Plaintiffs. In view of this judgment, we anticipate that other copyright owners may pursue similar claims against HKBN, which we expect to increase HKBNs
legal and administrative costs in handling such claims and complying with such court orders.



We are in the process of instituting changes to our internal controls and management systems in order to satisfy the requirements of Section 404 of the Sarbanes Oxley Act of 2002. Our failure to timely and
successfully institute these changes and to maintain the adequacy of our internal controls could subject us to regulatory actions and may adversely affect our stock price and our ability to raise additional capital.



We are in the process of instituting changes to our internal controls and
management systems to satisfy the requirements of Section 404 of the Sarbanes Oxley Act of 2002, which will require us to perform an evaluation of our internal controls over financial reporting, and beginning with our Form 20-F for the fiscal
year ending August 31, 2007, file annual management assessments of their effectiveness with the SEC that include a certification of our internal controls by our chairman and chief financial officer. Additionally, our independent auditors are
required to attest to managements assertion and also come to its own conclusion about the effectiveness of our internal controls over financial reporting.



In order for us to meet these requirements, we will need to design procedures to document various controls and relevant testing procedures under
requirements stipulated by the Public Company Accounting Oversight Board in the United States.



We have assigned an internal audit manager to oversee this compliance process, who reports to both our audit committee and senior management on a periodic basis. In addition, we have hired external consultants to
perform a high-level internal control gap analysis, but we have not retained the continuous services of these consultants in the later phases of this compliance process.



For fiscal 2007, our independent auditors will be required to attest to our evaluation of internal controls over financial
reporting. Unless we successfully design and implement changes to our internal controls and management systems, or if we fail to maintain the adequacy of these controls as such standards are modified or amended from time to time, we may not be able
to comply with Section 404 of the Sarbanes Oxley Act of 2002. As a result, our independent auditors may not be able to attest to managements assertion or may come to a different conclusion about the effectiveness of our internal control
over financial reporting. This could subject us to regulatory scrutiny and result in a loss of public confidence in our management, which could, among other things, adversely affect our stock price and our ability to raise additional capital.



We recognized revenues for mobile interconnection
charges in fiscal 2002 to fiscal 2005 that have not yet been paid to us. In fiscal 2005, we made a partial provision for the revenues charged in fiscal 2002 to fiscal 2004 and are awaiting the outcome of the determination by the Telecommunications
Authority on the level of mobile interconnection charges that mobile operators are required to pay us



HKBN, as a FTNS licensee, provides interconnection services to enable delivery of telecommunications service to customers of different telecommunications
carriers, including mobile operators. Since the FTNS license was granted by the Telecommunications Authority and interconnection services have been provided by HKBN, we have been recognizing interconnection services billed to mobile operators as
revenue (mobile interconnection charges). For the years ended August 31, 2004 and 2005, we recorded as revenue mobile interconnection charges of HK$38,376,000 and HK$24,703,000, respectively. As of August 31, 2004 and 2005, we had
mobile interconnection charges receivable, net of provision for doubtful accounts, of HK$44,617,000 and HK$49,821,000, respectively. As of August 31, 2005, a majority of the mobile operators had not made any payments to us since 2002 when we
started to bill and recognize revenue for the mobile interconnection services.



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We determined the charges using the available rates under the existing calculation model (fully
distributed cost model) for interconnection services between fixed and mobile operators, which are based on historical cost data of PCCW-HKT. In May 2004, the Telecommunications Authority confirmed to HKBN that mobile operators should pay
interconnection charges to fixed network operators in accordance with the existing charging principles under the relevant Telecommunications Authority statements. In August 2004, the Telecommunications Authority agreed to make a determination under
section 36A of the Telecommunications Ordinance to decide the level of mobile and fixed interconnection charges payable by one of the mobile operators to HKBN, and the effective date of the determined interconnection charges. According to the
Revised Telecommunications Authority statement on Procedures for Making Determinations on the Terms and Conditions of Interconnection dated September 27, 2001, the time frame within which determination of Complex Cases
should be made is approximately six and a half months. As of August 31, 2005, more than six and a half months had passed since the Telecommunications Authority agreed to make a determination, but no determination had been made.



The amounts recorded as accounts receivable, after considering provision for
doubtful accounts, in our consolidated balance sheet at August 31, 2005 reflects our best estimate of the collectibility of mobile interconnection charges. We will continue to evaluate the situation and monitor the progress of the TAs
determination and update our analysis as appropriate. However, until the TA makes its determination, and all appeals, if any, by mobile operators are exhausted, we cannot be sure of the amount of revenue we will earn from providing interconnection
services to mobile operators. If the TAs determination is less than the rate at which we have recognized mobile interconnection charges, we will be required to reduce our revenues for the affected periods.



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We cannot predict the outcome of the Telecommunications Authoritys determination. If the mobile
interconnection charges that we recognized in fiscal 2004 and fiscal 2005 are at rates higher than the rates determined by the Telecommunications Authority, we will be required to reverse part of the recognition of revenue or make a provision for
bad debt, which will adversely affect our operating results. Further, if the mobile operators involved are successful in an appeal of the Telecommunications Authoritys determination, we may not be able to collect any amounts that have been
recognized as revenue from the mobile operators.



Our
fixed telecommunications network business has incurred losses since inception and we expect it to incur future losses.



For fiscal 2003, 2004 and 2005, we incurred operating losses of approximately HK$62.7 million, and HK$109.7 million and HK$214.2 million, respectively,
from our fixed telecommunications network service operations. We expect our fixed telecommunications network service business will continue to incur operating losses as we expend substantial resources on developing and marketing broadband Internet
access, local VOIP, IP-TV and corporate data services. We cannot assure you that we will achieve and sustain profitability in our fixed telecommunications network operations.



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



We began to produce, market and offer IP-TV services via our Metro Ethernet
network in August 2003. Our IP-TV service currently consists of a 24-hour news channel and other education and recreation channels (including childrens programming) that we produce, and channels whose content we purchase from other
content-providers. As we are still at an early stage of development, the business model, marketing plans, strategy, and the content we will provide are still evolving. As a result, we cannot provide any assurance that we will be able to successfully
build market share in the pay-TV business or that such business will become profitable. Further, the money that we invest in providing such service could have an adverse effect on our operating results and profitability. In fiscal 2005 we focused on
obtaining new subscribers through various promotions including providing our IP-TV services free of charge for periods of six to twelve months. We may be unable to convert these subscribers into paying subscribers, which will adversely affect our
revenues and results of operations.



Our programming
costs may increase in the future, which could reduce our margins if we are unable to pass that increase on to our IP-TV subscribers.



Revenue growth for our IP-TV services depend on our ability to produce or obtain programming that is both affordable and appealing to our subscribers. We
produce or supplement a small amount of the programming on our channels and obtain programming from third parties for the remainder. The cost of some of our purchased programming may increase in the future as competition in the pay-TV and television
services market intensifies. Such increases could potentially affect our subscriber growth more than our competitors as our sales efforts are focused on our offering a lower-priced pay-TV service. Our inability to pass on programming cost increases
to our subscribers could reduce our revenues, cash flow and operating margins. Additionally, if we are unable to purchase programming that appeals to our targeted customer base, we may not be able to add new subscribers or increase our market share.



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Our growth and expansion may strain our ability to manage our operations, increase our costs of
operation and adversely affect the quality of our services.



We have pursued and continue to pursue a strategy of aggressive growth in our fixed telecommunications network services business. As part of this strategy, we continue to expand and invest in the Metro Ethernet network infrastructure we use
to deliver broadband Internet access, local VOIP, IP-TV and corporate data services. The deployment of these projects has resulted and will result in significant demands on our systems and controls and may place a strain on our administrative,
operational and financial resources. Our ability to manage future growth will depend upon our ability to:



| |  |  | 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 contain costs and maintain effective quality controls; and
| | - |  | ------------------------------------------------------------------------------------------------------



| |  |  | offer competitive prices to customers.
| | - |  | --------------------------------------



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



The Office of the Telecommunications Authority has made changes to the manner in which it regulates PCCW-HKTs tariffs for residential and
business direct exchange line telephone services, which may result in more competition in our markets.



The Office of the Telecommunications Authority, or OFTA, issued a new fixed carrier license to PCCW-HKT on January 14, 2005. Under this new license,
PCCW-HKT is no longer required to obtain prior approval from the Telecommunications Authority before adjusting its tariffs on residential and business direct exchange line telephone services, including moves to offer discounts and other benefits in
response to price competition. Since the issue of this new license, PCCW-HKT has reported success in winning-back fixed line market share for the first time since market liberalization in 1995. Such increased competition may adversely affect our
revenues and profitability.



We depend on certain key
personnel, and our business and growth prospects may be disrupted by the loss of their services.



Our future success is dependent upon the continued service of our key executives and employees. We also rely extensively on the services of our executive
officers, including Wong Wai Kay, Ricky, our chairman, and Cheung Chi Kin, Paul, our managing director. While we have employment agreements with members of our senior management staff, we cannot assure you that we will be able to retain these
executives and employees. If one or more of our key personnel were unable or unwilling to continue in their present positions, or if they joined a competitor or formed a competing company, we may not be able to replace them easily, our business may
be significantly disrupted and our financial condition and results of operations may be materially and adversely affected. Furthermore, since our industry is characterized by high demand and increased competition for talent, we may need to offer
higher compensation and other benefits in order to attract and retain key personnel in the future. We cannot assure you that we will be able to attract and retain the key personnel that we will need to achieve our business objectives.



Universal Services Contributions are reviewed and adjusted periodically
by the Telecommunications Authority, which may result in our either receiving a refund from, or being required to make whole any shortfall in payments to, PCCW-HKT. These adjustments may affect our financial results.



PCCW-HKT has a universal service obligation to provide basic telephone
service to any individual or entity that requests it. To compensate PCCW-HKT for the expenses of this obligation, all incoming and outgoing international calls in Hong Kong are charged a per minute fee payable to PCCW-HKT. The Telecommunications
Authority periodically adjusts the amount of this fee, which is commonly referred to as the USC. In the past we have received large USC refunds, but the amounts of these refunds have declined in the past few years. We cannot predict whether we will
continue to receive refunds or whether the Telecommunications Authority may determine in the future that we have underpaid the USC and require us to make whole the shortfall, if any, in payments to PCCW-HKT. Such adjustments to the USC may affect
our financial results.



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Expansion of our Metro Ethernet network into certain buildings and residences may be limited by
physical limitations or our ability to obtain access permits.



Expanding our Metro Ethernet network coverage requires us to install fiber-to-the-building, as well as install Category 5e copper wiring within residential and commercial buildings to reach the subscribers premises, which we refer to
as in-building-wiring. PCCW-HKT has already installed in-building-wiring in virtually all buildings, and we along with other fixed telecommunications network service providers may encounter a bottleneck when installing our own in-building-wiring
because many buildings have limited physical space for additional in-building wiring. In addition, owners of certain single-owner commercial buildings may grant rights of access to our competitors while barring us from installing our own
in-building-wiring. Furthermore, certain developers may have affiliations with our competitors and may attempt to delay our wiring installations. These constraints may hinder the expansion of our Metro Ethernet network and reduce our ability to add
new subscribers.



Internet security concerns could limit
our ability to develop revenues from Internet access services.



We intend to continue developing our broadband Internet access, local VOIP, IP-TV and corporate data services. Computer viruses, break-ins and other inappropriate or unauthorized uses of our Metro Ethernet network could affect the provision
of our full suite of Internet Protocol, or IP, services. Computer viruses, break-ins or other problems could have the following effects on our fixed telecommunications network services business:



| |  |  | it could result in interruption, delays or cessation in services to our customers;
| | - |  | ----------------------------------------------------------------------------------



| |  |  | it could jeopardize the security of confidential information stored in the computer system of our customers; and
| | - |  | ----------------------------------------------------------------------------------------------------------------



| |  |  | it could result in costly litigation.
| | - |  | -------------------------------------



We may incur significant costs to protect us against the threat of security breaches or to alleviate problems caused by such breaches. In addition,
alleviating these problems may cause interruptions, delays or cessation in service to our users, which could cause them to stop using our service or assert claims against us.



Other fixed telecommunications network operators may be able to limit the transmission of our global off-network local
VOIP traffic carried over their broadband network, which may limit our ability to offer this service



Our global off-network local VOIP service is dependent on the broadband Internet connections provided by other fixed telecommunications network operators
around the world. These operators may be able to limit the transmission of our off-network local VOIP traffic carried over their broadband networks, which may limit our ability to offer this service.



We may be liable for information disseminated over our Internet
services network which could increase our costs or cause us to discontinue certain services.



We may be required to spend substantial resources or discontinue certain services, which could have a material adverse effect on our business, operating
results and financial condition, as a result of liability under Hong Kong law for dissemination of information. Hong Kong law relating to liability of Internet service providers for information carried on or disseminated through their networks is
new and untested. The imposition of potential liability upon Internet service providers, such as liability for defamatory speech or copyright infringement, for materials carried on or disseminated over a network may cause us to adopt measures that
may reduce our exposure to such liability.



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Illegal viewing activities may affect our IP-TV subscriber growth and subscription revenue.



Our IP-TV business is dependent upon subscription
revenue. We are aware that some viewers in Hong Kong use unauthorized pay-TV decoders to receive pay-TV service illegally. Manufacturers or vendors of unauthorized pay-TV decoders may overcome our digital encryption methods and if we fail to deploy
appropriate and timely countermeasures in response to such activities, illegal viewing activities may occur. Such illegal viewing activities will adversely affect the growth of our IP-TV subscriber base and our subscription revenue.



We face risks associated with potential acquisitions, investments,
strategic partnerships or other ventures, including whether we can identify opportunities, complete the transactions and integrate the other parties into our business.



From time to time we have had discussions with companies regarding our acquiring, investing in or partnering with their
businesses, products, services or technologies, and we regularly engage in such discussions in the ordinary course of our business. We may not be able to identify suitable acquisition, investment or strategic partnership candidates, which may place
us at a disadvantage if our competitors are able to grow their market share through acquisitions. If we do identify suitable candidates, we may not be able to complete those transactions on commercially acceptable terms or at all. If we acquire
another company, we could have difficulty in integrating that companys personnel, products, operations and technology. In addition, the key personnel of the acquired company may decide not to work for us. These difficulties could disrupt our
ongoing business, distract our management and employees and increase our expenses.



Risks Relating to Our Technological Infrastructure



Slow system performance over our wireless and leased wireline connections could cause us to lose Internet customers to our competitors.



Our systems performance may slow down at certain peak times, especially with respect to the transmission of multimedia content over our wireless
and leased wireline connections. Our ability to increase our handling capacity, and increase the networks performance, will depend upon:



| |  |  | the successful build out of our own fiber-based backbone, and
| | - |  | -------------------------------------------------------------



| |  |  | our ability to secure leased lines from other network operators where we do not have our own infrastructure in place.
| | - |  | ---------------------------------------------------------------------------------------------------------------------



We cannot be sure that we will be able to replace our wireless and leased
wireline connections with our fiber-based backbone and increase the performance of our Internet access system. If we do not, our customers may subscribe to other Internet access services provided by our competitors.



We will be limited in our ability to continue to expand our
international telecommunications business unless we obtain additional network capacity.



Our international telecommunications network has limited capacity. Our ability to continue to increase traffic volume depends on our ability to expand the
network on a timely basis and add new subscriptions, which in turn is subject to:



| |  |  | the expansion and development of our own international telecommunications facilities;
| | - |  | -------------------------------------------------------------------------------------



| |  |  | the availability of leased lines from third party carriers at favorable rates; and
| | - |  | ----------------------------------------------------------------------------------



| |  |  | the possible termination or cancellation of our existing contracts.
| | - |  | -------------------------------------------------------------------



If we fail to increase the capacity of our international telecommunications network, our ability to increase our telecommunications minutes, market share
and revenues will be limited.



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If we are unable to stay ahead of technology trends and evolving industry standards, our services
may become obsolete.



Telecommunications businesses
are characterized by rapidly changing technology and industry standards, evolving subscriber needs and the introduction of new services. The continuously changing nature of these services, and their increasingly shorter life cycles require us to
continually improve our performance, services and network in order to compete successfully with the services offered by our competitors. Further, new technology or trends in the telecommunications industry could have an adverse effect on the
services we currently offer. For example, the replacement of traditional fixed line home telephones with mobile telephones and/or VOIP services may lead to a decline in our International telecommunications services revenues. Further, technology
substitution from global VOIP providers such as Skype, whom offer free PC-to-PC based international calls, is also becoming more prevalent. Changing our services in response to market demand may require the adoption of new technologies that could
render many of the technologies that we are currently implementing less competitive or obsolete. In addition, our new products and services may contain design flaws or other defects that could have a material adverse effect on our business,
operating results or financial condition. To respond successfully to technological advances and emerging industry standards, we may require substantial capital expenditure and access to related or enabling technologies in order to integrate the new
technology with our existing technology. We may not be successful in modifying our network infrastructure in a timely and cost-effective manner in response to these changes, which will affect our ability to continue to offer the products and
services demanded by our customers.



We are vulnerable to
natural disasters, and other disruptive regional events, which could cause damage to our network and result in lost revenue and perhaps lost customers.



Our network is vulnerable to damage or cessation of operations from fire, earthquakes, severe storms, power loss, telecommunications failures, network
software flaws, vandalism, transmission cable cuts and other catastrophic events. We may experience failures or shutdowns relating to individual points of presence or even catastrophic failure of our entire network. Any failure of our network, our
servers, or any link in the delivery chain, whether from operational disruption, natural disaster or otherwise, resulting in an interruption in our operations, could have a material adverse effect on our business, financial condition and results of
operations.



The loss of key suppliers or their failure
to deliver equipment on a timely basis could negatively impact our business prospects.



We rely on Cisco Systems Inc. and other suppliers to provide equipment, underground cables and other key components in building our Metro Ethernet network
infrastructure, and on Nortel Networks Limited for our VOIP equipment. In order for new subscribers to be able to access our IP-TV services, we must install an IP set-top-box in their homes. We must have an adequate supply of such equipment on hand
to respond to new customer subscriptions in a timely manner. We purchase all of our IP set-top boxes and other equipment from our suppliers on a purchase order basis and have no long-term contracts. If our suppliers are unable to supply us with
these products in a timely manner or the costs of these products increase due to unforeseen causes, this could negatively impact our operating results, especially if we are unable to add new subscribers or pass these costs on to our customers. In
addition, if Cisco Systems, Inc. is unable or is delayed in providing us with the hardware required for building our fiber-based backbone infrastructure, this could negatively impact our operating results.



Our reliance on third parties to provide maintenance and repairs for
our Metro Ethernet network could adversely affect our operating results if their services are not timely or do not meet our standards.



We depend on Cisco Systems, Inc. and other third parties for ongoing support and assistance with respect to maintenance and repairs. We are also dependent
on certain Hong Kong rail transport providers to maintain and provide us with access to their infrastructure to support the proper functioning of our equipment and fiber-based backbone. If these third parties fail to provide us the equipment we
require, or fail to respond or are untimely in their response to our maintenance and repair needs, our customers may experience interruptions or variations in the quality of our fixed telecommunications network services, which may adversely affect
our operating results and our ability to retain or add new customers.



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Environmental factors in Hong Kong could impact our delivery of fixed telecommunications network
services using wireless technology and increase our operating costs.



Wireless transmission of information is subject to environmental influences, which could impact our delivery of fixed telecommunications network services using this technology. In particular:



| |  |  | Wireless technology requires an unobstructed line of sight between two linked antennas. Hong Kong is characterized by large variations in elevation and numerous tall buildings.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Weather conditions, such as heavy rainfall, can adversely impact the transmission quality of wireless signals and necessitate shorter distances between antennas to maintain desired
transmission quality. Hong Kongs weather patterns often result in heavy rainfall during certain periods of the year.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Each of these factors may cause us to either accelerate our plans to install self-owned fiber-based backbone or lease capacity on the wireline-based
backbone of other fixed network operators, which may increase our operating costs.



Risks Relating to the Regulatory, Political and Economic Environment



Regulatory reforms and currently contemplated regulatory initiatives in the telecommunications industry may adversely affect us.



The Hong Kong telecommunications industry is undergoing continuous regulatory reform. In July 2004, Section 7P of the
Telecommunications Ordinance came into force. This provision specifically regulates merger and acquisition activities in the Hong Kong telecommunications industry. Section 7P of the Telecommunications Ordinance gives the Telecommunications
Authority the power to review mergers and acquisitions concerning carrier licensees and to take appropriate actions when it determines that the transaction would, or is likely to, substantially lessen competition in a telecommunications market
without any outweighing public benefits. The Telecommunications Authority also has the right to impose conditions upon or oppose or unwind mergers and acquisitions. This regulation may have an adverse effect on our ability to grow our business
through mergers and acquisitions.



Following the conclusion of
a public consultation on the regulation of Internet Protocol telephony Services, the Telecommunications Authority issued a statement on June 20, 2005, setting out his views and decisions on the regulatory and licensing framework for the
provision of VOIP services. Some of the regulatory issues that were addressed included creation of a licensing framework, conformance to the existing system of assigning telephone numbers, imposition of interconnection charges and establishing
guidelines with respect to the quality of services. As we currently offer Class 1 VOIP services, this new framework will subject us to further regulations that may affect our operations.



Our revenues may be adversely affected by regulatory and commercial
increases in tariffs mandated by the Chinese government and other international carriers.



Chinas Ministry of Information Industry, or the MII, and the State Development Planning Commission jointly set tariffs for all domestic and
international long distance services in China using public switched telephone networks, leased lines and data services. Certain tariffs payable by us to our carrier partners are based, among other things, on the tariffs determined by these agencies
with respect to the calls our subscribers make to persons in China. In fiscal 2005, approximately 73% of our international call traffic volume was to China. We cannot predict the timing, likelihood or magnitude of any tariff adjustments that may be
imposed by the MII, the State Development Planning Commission or other international carriers; nor can we predict the extent or potential impact upon our business of any future tariff increases. Such increases may lead to a decrease in traffic,
reduce our revenues and adversely affect our business and results of operations. In addition, if we are unable to pass the increased network costs onto our customers, it would have an adverse effect on our profit margins for international
telecommunications services.



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The Communications and Technology Branch has issued a letter stating that we are exempt from
obtaining a broadcasting license to provide our IP-TV services. However, should we be required to obtain a broadcasting license for our IP-TV services and we are unable to do so, we may be forced to terminate our IP-TV service.



Unlike our competitors, who hold domestic pay-television program service
licenses, we provide our IP-TV services over our Metro Ethernet network under HKBNs FTNS License. The Hong Kong government has indicated that because our IP-TV services are carried over the Internet, we are exempt under the Broadcasting
Ordinance from the requirement to obtain a domestic pay-television program service license. However, the governments Communications and Technology Branch has informed us that the government is considering a review of the broadcasting
regulatory regime and may introduce changes to the existing regulatory framework, including the existing exemption in the Broadcasting Ordinance. Therefore, we cannot predict whether the government may require us to obtain a pay-television program
service license in the future. Nevertheless, we applied to the Communications Technology Branch for a domestic pay-television program service license in October 2005 to enable us to have the flexibility of providing pay-TV services via means other
than our Metro Ethernet network, such as via satellite. If such license requires us to pay significant fees or imposes restrictions on our current operations, the revenues from our IP-TV business may be adversely affected or, if we are unable to
obtain a pay-television program service license, we may be forced to terminate our IP-TV services.



We require licenses from the Telecommunications Authority to provide our services. If one of these licenses is revoked or not renewed, we would be
unable to deliver the services authorized by that license.



We require licenses from the Telecommunications Authority to provide our international telecommunications and fixed telecommunications network services. Our PNETS License is subject to the Telecommunications Authoritys annual renewal
and HKBNs FTNS License awarded in 2000 is initially granted for a term of 15 years, which may be renewed for such further period not exceeding 15 years at the discretion of the Telecommunications Authority. The Telecommunications
Authoritys failure to renew or its revocation of any of these licenses for any reason would prohibit us from continuing to offer the services authorized by that license, which would have a significant adverse impact on our revenues and
profitability. In addition, future changes in Hong Kongs telecommunications regulations or policies that would require us to obtain additional licenses could have an adverse impact on our operations.



There may be political risks associated with doing business in Hong
Kong.



A significant part of our facilities and
operations are currently located in Hong Kong. Hong Kong is a Special Administrative Region of the Peoples Republic of China, with its own executive, judicial and legislative branches. Hong Kong enjoys a high degree of autonomy from China
under the principle of 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 business and ability to raise capital.



We have approximately 50% of our staff located in Guangzhou, China and changes in Chinese labor or business laws may significantly affect our
operations and our ability to service our Hong Kong based customers.



Our call center in Guangzhou employs over 1,900 persons and is an important resource for us. We are therefore subject, to a significant degree, to the laws and regulations that govern foreign companies with operations
in China. The Chinese legal system is based on written statutes. Prior court decisions may be noted for reference but have limited precedential value. Since 1979, the Chinese government has promulgated laws and regulations dealing with economic
matters such as foreign investment, corporate organization and governance, labor, commerce, taxation and trade. However, because these laws and regulations are relatively new and because of the limited volume of published cases and their non-binding
nature, interpretation and enforcement of these laws and regulations involve significant uncertainty. In addition, as the Chinese legal system develops, changes in such laws and regulations, their interpretation or their enforcement may lead to
additional restrictions on our business.



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You may have difficulty enforcing judgments against us or our management.



City Telecom is incorporated in Hong Kong. All of our directors and
executive officers and some of the experts named in this annual report live outside the United States, principally in Hong Kong. Also, all or most of City Telecoms assets are located outside the United States. As a result, you may not be able
to:



| |  |  | effect service of process upon these persons within the United States, or
| | - |  | -------------------------------------------------------------------------



| |  |  | enforce, against us or these persons within the United States, court judgments obtained in United States courts, including judgments relating to the federal securities laws of the
United States.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



There is also doubt as to whether
courts in Hong Kong will enforce judgments of United States courts based only upon the civil liability provisions of the federal securities laws of the United States, or the securities laws of any state of the United States.



The state of Hong Kongs economy may affect our profitability.



As we are principally engaged in the provision of
broadband Internet access, local VOIP, IP-TV, corporate data and international telecommunications services in Hong Kong, our financial position and the results of our operations will be affected by the conditions of the telecommunications, Internet
access and pay-TV markets in Hong Kong, which may in turn be influenced by the general state of the Hong Kong economy, changes in the Hong Kong regulatory environment, and changes in demand and usage habits of Hong Kong consumers. We have limited
control over any of these factors. The Hong Kong economy has experienced considerable volatility during the late 1990s and from 2000 to 2003, and there can be no assurance that it will not continue to do so in the future. This could adversely affect
our business operations.



Fluctuations of the Hong Kong
dollar may increase our operating costs.



A major
portion of our operating costs is interconnection charges paid to overseas carriers for the delivery of our international calls. Substantially all of these interconnection charges are denominated in U.S. dollars or other currencies other than Hong
Kong dollars. In addition, the equipment and hardware we purchase for the expansion of our Metro Ethernet network constitutes a large portion of our capital expenditure and is also denominated in U.S. dollars. Finally, payment of interest, principal
and any other amounts due under the 8.75% notes issued in January 2005 will be made in U.S. dollars. However, our revenues are predominantly denominated in Hong Kong dollars. Any depreciation of the Hong Kong dollar, against the U.S. dollar or other
currencies, would increase our operating costs, including our debt servicing costs, make our capital expenditure plans more expensive, and adversely affect our profitability.



In addition, the expenses that we incur in relation to our call center located in Guangzhou, China are denominated
exclusively in Renminbi, the official currency of the Peoples Republic of China. These include the salaries that we pay to our personnel as well as various operating expenses that we incur to maintain our operations. As a result, we are
exposed to a certain amount of foreign exchange risk based on fluctuations between the Hong Kong dollar and the Renminbi. The value of the Renminbi is subject to changes in Chinas governmental policies and to international economic and
political developments. Since January 1, 1994, the PRC government has used a unitary managed floating rate system. Under this system, the Peoples Bank of China, or PBOC, publishes a daily base exchange rate with reference primarily to the
supply and demand of Renminbi against U.S. dollar and other foreign currencies in the market during the previous day. Authorized banks and financial institutions are allowed to quote buy and sell rates for Renminbi within a specified band around the
central banks daily exchange rate. On July 21, 2005, the PBOC announced an adjustment of the exchange rate of the U.S. dollar to Renminbi from 1:8.27 to 1:8.11 and modified the system by which the exchange rates are determined.



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This adjustment has resulted in an approximately 2.0% appreciation of the Renminbi against the U.S.
dollar and of the Renminbi against the Hong Kong dollar. While the international reaction to the Renminbi revaluation has generally been positive, there remains significant international pressure on the Chinese government to adopt an even more
flexible currency policy, which could result in a further and more significant appreciation of the Renminbi against the U.S. dollar and Hong Kong dollar. If the Renminbi appreciates further against the Hong Kong dollar, the amount of Hong Kong
dollars we would be required to spend to maintain our call center would increase.



Fluctuations of the Hong Kong Dollar could adversely affect the value of the American depositary shares.



Our outstanding shares are listed on The Stock Exchange of Hong Kong (the SEHK), on which shares are quoted and traded in Hong Kong dollars.
Cash dividends, if any, in respect of the shares represented by the American depositary shares will be paid to the depositary in Hong Kong dollars and then converted by the depositary into U.S. dollars, subject to certain conditions. Any
depreciation of the Hong Kong dollar against the U.S. dollar would, among other things, adversely affect (i) the amounts a registered holder or beneficial owner of American depositary shares will receive from the depositary in respect of
dividends, (ii) the U.S. dollar value of the proceeds which a holder would receive upon sale of the shares in Hong Kong and (iii) the secondary market price of the American depositary shares.



Risks Relating to our Securities



Our share price has been and may continue to be volatile.



The trading price of our shares has been, and is
likely to continue to be, extremely volatile. Since our offering of our American depositary shares on November 4, 1999, the closing price of our ordinary shares on the SEHK has ranged from HK$0.420 to HK$8.950. Our share price and the price of
our American depositary shares could be subject to wide fluctuations in response to a variety of factors, including, among others:



| |  |  | actual or anticipated variations in our operating results;
| | - |  | ----------------------------------------------------------



| |  |  | announcements of new services or pricing options by us or our competitors;
| | - |  | --------------------------------------------------------------------------



| |  |  | changes in financial estimates by securities analysts;
| | - |  | ------------------------------------------------------



| |  |  | conditions or trends in the Internet and telecommunications industries;
| | - |  | -----------------------------------------------------------------------



| |  |  | changes in the market valuations of companies that provide Internet and telecommunications services; and
| | - |  | --------------------------------------------------------------------------------------------------------



| |  |  | rumors of and announcements by us or our competitors of significant acquisitions, strategic partnerships, joint ventures or capital commitments.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------



As of January 17, 2006, we had 614,125,404 shares issued and
outstanding. All of the outstanding shares are freely tradable in our primary trading market, the SEHK, and can be traded in the United States in the form of American depositary shares in compliance with the holding period, volume, and manner of
sale restrictions under Rule 144 under the Securities Act of 1933, as amended (if applicable). It is possible that we may issue additional shares in connection with our financing activities, acquisition activities or otherwise. Any shares that we
issue will be freely tradable on the SEHK, and, depending on the circumstances of their issuance, may also be freely tradable in the U.S. public market.



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Risks Related to our Indebtedness



In January 2005, we issued 8.75% notes that contain covenants limiting our financial and operating flexibility.



Covenants under the 8.75% notes that we issued in
January 2005 restrict our ability to, among other things:



| |  |  | pay dividends, make distributions, redeem capital stock and make certain other restricted payments or investments;
| | - |  | ------------------------------------------------------------------------------------------------------------------



| |  |  | incur additional indebtedness or issue certain equity interests;
| | - |  | ----------------------------------------------------------------



| |  |  | merge, consolidate or sell all or substantially all of our assets;
| | - |  | ------------------------------------------------------------------



| |  |  | issue or sell capital stock of some of our subsidiaries;
| | - |  | --------------------------------------------------------



| |  |  | sell or exchange assets or enter into new businesses;
| | - |  | -----------------------------------------------------



| |  |  | create any restrictions on the payment of dividends, the making of distributions, the making of loans and the transfer of assets;
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------



| |  |  | create liens on assets;
| | - |  | -----------------------



| |  |  | enter into sale and lease back transactions; and
| | - |  | ------------------------------------------------



| |  |  | enter into certain transactions with affiliates or related persons.
| | - |  | -------------------------------------------------------------------



All of these limitations are subject to exceptions and qualifications specified in the indenture governing the 8.75% notes.



These restrictive covenants could limit our ability to pursue our growth
plan, restrict our flexibility in planning for, or reacting to, changes in our business and industry and increase our vulnerability to general adverse economic and industry conditions. We may enter into additional Financing arrangements in the
future, which could further restrict our flexibility.



In
fiscal 2006, Standard & Poors and Moodys Investors Services downgraded our credit rating from B to BB- and from B2 to Ba3, respectively, which may limit our ability to obtain future
financing or make such financing more costly.



As a
result of, among other factors, our operating loss in fiscal 2005, Standard & Poors and Moodys Investors Services downgraded our credit rating during 2005, from B to BB- and from B2 to
Ba3, respectively. These downgrades may limit our ability to obtain future financing or make such financing more costly.



We will require a significant amount of cash to service our debt.



Our ability to fund operating and capital expenditures and to service debt will depend significantly on our ability to
generate cash from operations. In fiscal 2005, we incurred net cash outflow from operating activities of HK$15.4 million. We will need to turn around our operations in order to generate sufficient cash flows to meet our future debt service
requirements. However, we cannot assure you that we will be able to do so.



Our ability to generate cash is subject to general economic, financial, competitive, industry, legal and other factors and conditions, many of which are outside our control. In particular, our operations are subject
to price and demand volatility in the telecommunications industry. If we cannot service our debt, we may be required to (among other things) reduce capital expenditures, sell assets, or raise equity. We may not be successful in taking these actions,
which could cause us to default on our obligations. Further, our ability to take many of these steps may be subject to approval by future creditors in addition to holders of the 8.75% notes.



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Our indebtedness could adversely affect our financial condition and prevent us from fulfilling our
obligations under the 8.75% notes.



Upon the issuance
of the 8.75% notes, we incurred US$125.0 million amount of indebtedness. In addition, the indenture governing the 8.75% notes does not prohibit us or our subsidiaries from incurring substantially more debt, including secured credit facility debt and
other debt as long as we meet certain debt incurrence ratios (other than CTI Guangzhou Customer Services Co. Limited (CTI Guangzhou) and, subsequently, any other future subsidiary prohibited by applicable law, regulation or order from
issuing a guarantee of the 8.75% notes, which are restricted from incurring certain indebtedness as specified in the indenture governing the 8.75% notes.) The 8.75% notes and guarantees are effectively subordinated to all of our existing and future
secured debt to the extent of the value of the assets securing such indebtedness and are effectively subordinated to all existing and future debt and other liabilities of non-guarantor subsidiaries, including trade payables. If new debt is added to
our consolidated debt level, the related risks that we now face could intensify.



Covenants in the agreements governing debt we may incur in the future may materially restrict our operations, including our ability to incur debt, pay dividends, make certain investments and payments, and encumber or
dispose of assets. In addition, financial covenants contained in agreements relating to our future debt, including those under a credit agreement, could lead to a default in the event our results of operations do not meet our plans. A default under
one debt instrument may also trigger cross-defaults under our other debt instruments. An event of default under any debt instrument, if not cured or waived, could have a material adverse effect on us. Any new debt that we incur in the future could
have important consequences to holders of the 8.75% notes. For example, it could:



| |  |  | make it more difficult for us to satisfy our obligations with respect to the 8.75% notes;
| | - |  | -----------------------------------------------------------------------------------------



| |  |  | increase our vulnerability to general adverse economic and industry conditions;
| | - |  | -------------------------------------------------------------------------------



| |  |  | limit our ability to fund future working capital, capital expenditures, research and development and other general corporate requirements;
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | require us to dedicate a substantial portion of our cash flows from operations to service payments on our debt;
| | - |  | ---------------------------------------------------------------------------------------------------------------



| |  |  | limit our flexibility to react to changes in our business and the industry in which we operate;
| | - |  | -----------------------------------------------------------------------------------------------



| |  |  | place us at a competitive disadvantage to any of our competitors that have less debt;
| | - |  | -------------------------------------------------------------------------------------



| |  |  | require us to meet additional financial covenants; and
| | - |  | ------------------------------------------------------



| |  |  | limit, along with other restrictive covenants, among other things, our ability to borrow additional funds.
| | - |  | ----------------------------------------------------------------------------------------------------------



We cannot assure you that our business will generate cash in an amount
sufficient to enable us to service our debt, including the 8.75% notes, or to fund our other liquidity needs. In addition, we may need to refinance all or a portion of our debt, including the 8.75% notes, on or before maturity. We cannot assure you
that we will be able to refinance any of our debt on commercially reasonable terms or at all.



We may not have the ability to raise the funds necessary to finance the change of control offer required by the indenture governing the 8.75% notes.



If we undergo a change of control, we must offer to buy back the 8.75% notes
for a price equal to 101% of the principal amount of the 8.75% notes, plus accrued and unpaid interest, additional amounts, if any, and registration default damages, if any. Any new financing arrangement that we may enter into in the future may
require repayment upon a change of control and further prohibit us from repurchasing the 8.75% notes until we first repay the new debt in full. If a change of control occurs, we cannot assure you that we will have sufficient funds to satisfy these
other debt obligations and repurchase the 8.75% notes.



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##### Table of Contents

ITEM 4. INFORMATION ON THE COMPANY



History and Development of the Company



City Telecom (H.K.) Ltd. was incorporated in Hong Kong on May 19, 1992 under the Companies Ordinance (Chapter 32 of the laws of Hong Kong) (the Companies Ordinance). Our registered office is located at Level 39, Tower 1,
Metroplaza, No. 223 Hing Fong Road, Kwai Chung, New Territories, Hong Kong, telephone (852) 3145-6888. Our agent for U.S. federal securities laws purposes is CT Corporation System, 111 Eighth Avenue, New York, NY 10011.



City Telecom provides international telecommunications and, through HKBN,
international telecommunications, Internet access, local telephony, pay-TV and other fixed telecommunications network services in Hong Kong. We believe that one of the cornerstones of our success has been our ability to quickly expand our service
offerings when changes in regulation or technology have provided us with an opportunity to do so. Some of the key events in our history and development have been:



| |  |  | In November 2005, we announced cooperation with China Telecom Hong Kong Limited to provide Pan-China Internet Protocol Virtual Private Network services to corporate customers.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | In October 2005, HKBN became the first service provider in the world to achieve the Cisco Powered Network Metro Ethernet QoS Certified status.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | In October 2005, HKBN launched our 2b Broadband Phone Service, providing VOIP services to local and overseas users via a software-based broadband phone.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | In September 2005, HKBN was conferred as the winner of the Global Entrepolis@Singapore Award 2005, which was presented by the Asian Wall Street Journal in association the Economic
Development Board of Singapore. This award recognizes innovation in the application of technology to a strong business model with commercial potential to be an industry or market leader.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | In May 2005, HKBN formally named its IP-TV arm as HKBN Digital TV, and re-positioned the service to offer additional movie and drama channels.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | In April 2005, HKBN officially launched our bb1,000 fiber-to-the-home 1Gbps residential broadband service.
| | - |  | ------------------------------------------------------------------------------------------------------------



| |  |  | In January 2005, we completed the issuance of US$125 million of 8.75% senior notes due 2015.
| | - |  | --------------------------------------------------------------------------------------------



| |  |  | In November 2004, HKBN launched our bb100 Internet access service with symmetric 100 Mbps access for the residential mass market using self-owned fiber-to-the-building
and standard Category-5e in-building copper wiring.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | In August 2004, HKBN launched our off-network BB Phone services, which allows subscribers to use our local VOIP services using the broadband network of other operators.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | In July 2004, HKBN launched our corporate data services.
| | - |  | --------------------------------------------------------



| |  |  | In August 2003, HKBN launched our IP-TV service, which delivers video content to a television set via an IP set-top-box.
| | - |  | ------------------------------------------------------------------------------------------------------------------------



| |  |  | In July 2003, we sold the entire issued share capital of City Telecom (Japan) Co., Ltd. to Takua Corporation; City Telecom (Japan) Co., Ltd. (now known as City Call Co., Ltd.)
ceased to be related to our group of companies.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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##### Table of Contents

| |  |  | In July 2002, we established a customer service call center in Guangzhou, China to provide customer acquisition and back office customer support services.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------



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



| |  |  | In May 2002, we started operation of our APCN 2 and Japan-U.S. undersea cables for international calls and broadband Internet access.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------



| |  |  | In April 2002, HKBN was notified of our license upgrade from a wireless to a wireline-based FTNS License and we began upgrading our backbone to a self-owned fiber-based backbone. In
that same month HKBN launched our fixed line on-network local VOIP services in Hong Kong.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | In March 2002, the Telecommunications Authority granted us a cable-based external FTNS License.
| | - |  | -----------------------------------------------------------------------------------------------



| |  |  | In May 2001, the Telecommunications Authority granted us a satellite-based fixed carrier license.
| | - |  | -------------------------------------------------------------------------------------------------



| |  |  | In March 2000, HKBN launched our broadband Internet access services and wireless network in Hong Kong.
| | - |  | ------------------------------------------------------------------------------------------------------



| |  |  | In February 2000, HKBN obtained a wireless FTNS License from the Telecommunications Authority.
| | - |  | ----------------------------------------------------------------------------------------------



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



| |  |  | In January 1999, we became the first Hong Kong company to obtain a PNETS License covering the provision of international telecommunications services using international simple
resale and launched a new direct calling service for our international telecommunications operations with the access number 1666, supported by the international simple resale arrangement.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | In November 1998, OFTA announced that PCCW-HKT would lose its monopoly over voice transmission using international simple resale effective in January 1999.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | In February 1998, PCCW-HKT lost its monopoly over facsimile transmission using international simple resale. We launched our fax services using international simple resale in the
same month. We launched our first Internet related service, CTIm@il, which provides email services, in March 1998. We launched our Internet business, named CTInets, in June 1998.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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



| |  |  | In January 1997, we launched our fourth international telecommunications service, the IDD 300 Calling Service. In March of that year, to target our prospective and existing
corporate subscribers, we established INC as a special business unit dedicated to providing high-quality, competitively priced international telecommunications services to corporations in Hong Kong. In June 1997, we obtained a PNETS License from the
Telecommunications Authority for the provision of virtual private network services, catering to the needs of multinational corporations.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | In January 1994, we introduced a second international telecommunications service, marketed under the name 003 International Guaranteed Fax Service, using the store-and-forward
transmission technology. In September 1994, we launched a third international telecommunications service, called GlobaLink International Calling Card Service.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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



| |  |  | In September 1992, we began to provide international telecommunications service using the toll-free transit communication technology, later marketed under the name 888 International
Calling Card Service.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------





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##### Table of Contents

Business Overview



We are an innovative provider of residential and corporate fixed telecommunications network and international
telecommunications services in Hong Kong. Using our self-owned Metro Ethernet network, we deliver fixed telecommunications network services to the residential mass and small-to-medium enterprise market segments, at attractive prices while
simultaneously offering a bandwidth advantage over comparable offerings by our competitors. Our integrated suite of services includes the following:



| |  |  | high-speed broadband Internet access services that provide our customers with symmetric upstream and downstream access speeds with options for 10 Mbps, 100 Mbps and 1,000 Mbps;
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | fixed line local telephony through our voice-over-Internet-Protocol technology;
| | - |  | -------------------------------------------------------------------------------



| |  |  | pay television, where we deliver more than 81 channels including self-produced news, childrens programming, international drama and movies and local interest programming using
our IP platform; and
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | corporate data services, which includes provision of dedicated bandwidth to corporate customers.
| | - |  | ------------------------------------------------------------------------------------------------



As of August 31, 2005 we had a total of approximately 631,000 fixed telecommunications network services subscriptions,
consisting of approximately 229,000 broadband Internet access, 293,000 local VOIP and 109,000 IP-TV services subscriptions.



In addition to providing fixed telecommunications network services, we believe that we are one of the largest providers of international
telecommunications services in Hong Kong. We offer a variety of international telecommunications services and products including direct dial services, international calling cards and mobile call forwarding services. Our total international
telecommunications services customer database comprises approximately 2.1 million registered accounts with an average of 500,000 customers that are billed on a monthly basis. Our international telecommunications business contributed 45.8% to
our total revenues in fiscal 2005 as compared to 53.7% in fiscal 2004.



Our self-owned network is one of the worlds largest Metro Ethernet networks and is cited as a global reference case by our two primary vendors, Cisco Systems, Inc. and Nortel Networks Limited. Our Metro Ethernet network conforms to
industry standards for 10/100/1,000 Mbps Internet access speeds, and covers 1.2 million home passes, which represents coverage of approximately 60% of Hong Kongs population. The coverage of our network is concentrated in Hong Kongs
most densely populated areas and reaches approximately 3,300 residential buildings with an average of approximately 360 residences per building, and approximately 700 commercial buildings, making us one of the largest residential fixed
telecommunications network operators in Hong Kong.



In most
other markets, Metro Ethernet technology is primarily used in commercial buildings in metropolitan areas, as the technology is most cost effective in dense user populations where a provider can service a large number of users in a single building or
cluster of buildings. We have deployed Metro Ethernet technology in densely populated residential areas in Hong Kong, where most of our customers live in high-rise apartment buildings with multiple apartments on each floor. As a result, we have
contained the cost of deploying of our core network to approximately US$130 per home pass. Our strategy is to sell multiple fixed telecommunications network services using our Metro Ethernet network. All of our fixed telecommunications network
services are offered through our single IP platform, unlike our competitors who use multiple platforms to provide comparable services. In addition, unlike most other new entrants, we operate an end-to-end network that extends from our IP
network hub sites and our switching centers in Hong Kong to our subscribers premises.



Hong Kong has one of the most developed telecommunications markets in the world with one of the worlds highest penetration rates for local telephony and broadband Internet access services. As of September, 2005,
the penetration rates of residential fixed line local telephony and residential broadband Internet access were 94% and 72% of Hong Kong households, respectively. Since 1995, when the Hong Kong government began to liberalize Hong Kongs
telecommunications industry, PCCW-HKT (the incumbent carrier and largest fixed telecommunications network telecommunications operator in Hong Kong) began to lose its 100% market share and as of June 2005 retained a 67% market share with respect to
fixed line local telephony services. However, during 2005, PCCW-HKT began winning back fixed-line customers through an aggressive pricing and marketing strategy.



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In contrast, Hong Kongs pay-TV penetration rate is low compared to other developed countries in the
region and globally. While i-Cable is the established incumbent and has been offering pay-TV services since October 1993, it had penetrated only 32% of Hong Kongs households as of June 30, 2005. We believe that this and the fact that Hong
Kong is primarily served by free-to-air television stations will enable us to increase penetration of our IP-TV services. In addition, Chinese-language programs broadcast by free-to-air television stations in Hong Kong attract approximately 85% of
primetime viewership. We produce and obtain programming that targets Hong Kongs largely Chinese-speaking mass market, which we believe differentiates us from our competitors. We launched our IP-TV services in August 2003 and the other
competitors in the pay-TV market are also relative newcomers, with PCCW-HKT launching its services in September 2003 and Galaxy Satellite Broadcasting Limited launching its services in February 2004.



On January 20, 2005 we successfully completed a US$125 million offering
of 8.75% notes in an underwritten private placement transaction. Our net proceeds from the transaction were approximately US$121 million after deduction of expenses and commissions. We used the net proceeds, in part, to repay in full an existing
loan facility in the outstanding amount of HK$196.7 million, and intend to use the remaining net proceeds for capital expenditures, including costs incurred in expanding and upgrading our Metro Ethernet network in Hong Kong, and for additional
working capital and general corporate purposes. On March 18, 2005 we filed a registration statement with the U.S. Securities and Exchange Commission and subsequently completed an exchange of the 8.75% notes for notes with identical terms that
are freely tradeable.



Competitive Strengths:



We believe that our demonstrated success is primarily due to our ability to
capitalize on the following key strengths:



| |  |  | Focus on the Residential Mass and Small-To-Medium Enterprise Market Segments. We focus on offering high-bandwidth services to the residential mass and small-to-medium
enterprise market segments, which we believe have significant growth potential. We price our services attractively and at the same time offer bandwidth advantages over comparable service offerings by our competitors. Our IP-TV services focus on the
residential mass market by providing Chinese-language content that targets the Chinese-speaking population of Hong Kong, which we believe to be largely under served. Our focus on the residential mass and small-to-medium enterprise market segments
has enabled us to quickly grow our subscription base and we believe this will help us to up-sell our services.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Leading-Edge Metro Ethernet Network. Our network deploys Ethernet technology provided by Cisco Systems, Inc. We believe our Metro Ethernet network gives us an inherent cost
and performance advantage over our competitors. Our IP platform is highly scalable, enabling us to offer broadband Internet access, local VOIP, IP-TV and corporate data services over a single network while still leaving us with capacity to offer
more services in the future. It is also capable of providing up to 1,000 Mbps symmetric broadband Internet access. Our bb100 100 Mbps broadband service promotions during 2005 highlighted the bandwidth advantage of our Metro Ethernet
network over xDSL or cable modem services. Ethernet technology is off-the-shelf and has long been deployed for large enterprises, but we believe we are one of the first to deploy this technology for the residential market on a mass
scale.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | First Mover Advantage and High Barriers to Entry. Our first mover advantage and the inherent characteristics of the Hong Kong telecommunications infrastructure, which present
a natural barrier to entry, make it difficult for our competitors to replicate our business model. Metro Ethernet technology is not appropriate for our competitors who intend to offer a full coverage network that includes remote and difficult to
reach areas of Hong Kong. Attempting to deploy Metro Ethernet technology in such locations would significantly increase costs and completion time of such a network. While other telecommunications operators may lay their own fiber-to-the-building, we
believe they would encounter significant in-building bottlenecks when attempting to complete an end-to-end network. This is because the majority of Hong Kongs residential properties have limited space for in-building wiring leading to
subscribers residences, making it difficult for new entrants to replicate our end-to-end network build.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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##### Table of Contents

| |  |  | Innovative and Highly Committed Management Team. Since our inception in 1992, our management team has built a strong track record as an industry innovator and has
successfully led us in competing against larger and better resourced operators. Our management team has consistently demonstrated its ability to quickly capitalize on developments in the Hong Kong regulatory environment that allow us to expand our
service offerings and grow our market share. Our senior management team owns approximately 56% of the company and does not have any material outside business interests. Our managements ownership interest represents a long-term commitment and
significant performance incentive.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Strong Brand and Targeted Marketing Strategy. We have an established brand name that is identified with high quality and competitively priced telecommunications services in
Hong Kong. In order to further promote our brand recognition and to reach a wider subscription base, we have established a network of promoters, sales agents and telemarketers that personally contact potential and existing customers. In addition, we
proactively market our services through a mix of promotions and advertising. We have an established call center in Guangzhou, China with over 1,900 customer service personnel, which provides us with a highly cost efficient resource for processing
and servicing customers. In December 2005, we opened a 14,000 square foot dedicated training center in Guangzhou to enhance the quality of our customer service through improved staff training.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Business Strategy



Our overall strategy is to grow market share, increase our network coverage and introduce new services through our IP
platform. Key components of this strategy include:



| |  |  | Increase Penetration within Existing Network Coverage. We intend to continuously increase the penetration within our existing network coverage and grow our market share
through targeted sales and marketing efforts. During fiscal 2005 we added approximately 166,000 subscriptions for our fixed telecommunications network services to expand our total subscription base to approximately 631,000 as of August 31,
2005.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Expand and Upgrade our Network Coverage. Our self-owned Metro Ethernet network currently covers 1.2 million home passes, representing approximately 60% of Hong
Kongs population. With this network foundation in place we will focus our efforts in the next several years on expanding our network coverage to 1.8 million home passes, representing approximately 80% of Hong Kongs population. After
establishing a strong base in the mass market, we plan to broaden our customer base into the remaining market segments. In fiscal 2005, we upgraded the existing wireless and leased wireline based backbone in our network infrastructure with our own
fiber based backbone, and currently have approximately 85% of our home passes serviced by self-owned fiber based backbone.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Offer High-Value Services at Competitive Prices. We focus on providing high bandwidth services at attractive prices for the residential mass and small-to-medium enterprise
market segments. In November 2004 we launched our leading-edge bb100 broadband Internet access service with symmetric 100 Mbps upstream and downstream bandwidth at prices affordable for residential customers. Our bb100
service is 16 times faster for downstream transmission and 155 times faster for upstream transmission than the bandwidth offered by the most popular asymmetric digital subscriber line broadband Internet access service in Hong Kong. Similarly, our
IP-TV service includes over 81 channels with a large selection of Chinese-language channels targeted at Hong Kongs predominantly Chinese-speaking population at competitive prices.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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##### Table of Contents

| |  |  | Up-sell Multiple Services. We employ customized and targeted sales and marketing efforts to up-sell multiple services to each subscriber. The scalability of our network
allows us to sell additional services to our existing customers, for example adding local VOIP or IP-TV services to our current broadband Internet subscribers, with minimal additional network and operating costs. As a result, each new service we
sell to our existing subscription base contributes significantly to our profitability. If we successfully up-sell additional services to our existing subscriber base, this will result in higher revenues per subscriber, lower our average customer
acquisition costs and help to decrease subscriber churn.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Introduce New Services on our Single IP Platform. The single IP platform of our Metro Ethernet network provides us with a structural advantage over our competitors and
enables us to offer multiple services at low incremental costs. We are committed to continuing to introduce innovative and high bandwidth services in the future. For example, in fiscal 2005, we began offering our near-video-on-demand IP-TV service
which enables our subscribers to view individual episodes of a television series whenever they choose rather than at pre-set screening times.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Proactively migrate IDD to 2b services. In October 2005, we launched our global 2b broadband phone service, which provides VOIP to local and overseas users via a
software-based broadband phone. To counter the decline in international telecommunications services revenues, we are proactively migrating our legacy international telecommunications services and customers to our 2b broadband phone
services. This service is primarily targeted at the overseas Chinese community, which we believe will enable us achieve higher margins and access a wider addressable market compared to the local Hong Kong market for international telecommunications
services.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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, 
|                                             |  | 2003                   |  | 2004      |  | 2005     
|                                             |  | HK$                    |  | HK$       |  | HK$      
|Revenue                                      |  | (Amounts in thousands)
|Fixed telecommunications network services(1) |  | 423,107                |  | 541,902   |  | 629,464  
|International telecommunications services    |  | 875,802                |  | 627,978   |  | 532,595  
|                                             |  |                        |  |           |  |          
|Total operating revenue                      |  | 1,298,909              |  | 1,169,880 |  | 1,162,059
|                                             |  |                        |  |           |  |          

---

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



Fixed Telecommunications Network Services



Metro Ethernet Network Infrastructure



Our Metro Ethernet network is formed by using our own fiber-based backbone,
wireless technology or leased wireline-based backbone to connect our in-building Ethernet infrastructures to our IP hub sites and switching centers in Hong Kong. Our Ethernet infrastructure is a system of Category-5e copper wiring that connects our
subscribers premises to our local area network, or LAN, switches within a residential or commercial building. In fiscal 2005, we reduced our reliance on wireless and leased wireline based backbone from other network operators by expanding our
self-owned fiber-based backbone. This action increased our network capacity and improved the quality of our service. We currently service approximately 85% of our home-passes with our self-owned fiber-based backbone.



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We began replacing the existing wireless and leased wireline-based backbone and installing our own
fiber-based backbone in April 2002 when we received confirmation of our wireless FTNS License upgrade to a wireline-based FTNS License. When we began these replacements, we initially selected locations with the highest population density because our
fiber-based backbone increased our capacity to handle the high traffic volume in such locations. We intend to continue making investments in our own fiber-based backbone in locations where we deem the economic returns sufficiently high to make
replacement of the wireless and leased wireline-based backbone cost-effective. Until we complete construction of our own fiber-based backbone, we will continue to rely on our wireless technology and leased capacity on wireline-based networks from
other fixed network operators in certain select locations.



The
high capacity of our fiber-based backbone has enabled us to offer a suite of services on a single IP network platform. These services include our broadband Internet access, local VOIP, IP-TV and corporate data services. We made capital expenditures
for our fixed telecommunications network infrastructure of approximately HK$392.9 million in fiscal 2004 and HK$408 million in fiscal 2005. In fiscal 2006, we plan to further make total capital expenditures of HK$400 million to continue increasing
the capacity of our existing coverage and extending the reach of our Metro Ethernet network. The service area of our Metro Ethernet network currently includes approximately 1.2 million home passes, representing approximately 60% of Hong
Kongs population. We plan to extend our Metro Ethernet network coverage, over the next several years, to 1.8 million home passes, covering approximately 80% of Hong Kongs population. As we expand the reach and coverage of our Metro
Ethernet network, we plan to continue introducing new services.



The first step in expanding the reach of our fixed telecommunications network infrastructure is to select buildings that we believe will provide sufficient economic returns to justify our investment based on several factors, including
population density, proximity of the building to our existing fiber loop and our projected ability to sell services. We then perform a site visit to analyze the feasibility of installing our Ethernet technology. Once we are satisfied with the
prospects of a particular building, we must obtain access rights from the buildings management, which may take several weeks or months. After receiving access rights, we employ a combination of our full-time staff and contractors to begin
installation of our in-building Ethernet. The length of time required for the installation process depends on the size and structural features of the building and can be completed in as little as three weeks or take several months. As we install our
in-building Ethernet we simultaneously connect the building to our fiber-based backbone. All the buildings that we reach through our expansion efforts will be served by our self-owned infrastructure.



The following table shows the growth of our fixed telecommunications network
subscriptions over the past five years:



|                                                         |  |                  |  |         |  |         |  |         |  |        
|-------------------------------------------------------- |  | ---------------- |  | ------- |  | ------- |  | ------- |  | -------
|                                                         |  | As of August 31,
|                                                         |  | 2001             |  | 2002    |  | 2003    |  | 2004    |  | 2005   
|Fixed Telecommunications Network Services Subscriptions: |  |                  |  |         |  |         |  |         |  |        
|Broadband Internet Access                                |  | 17,700           |  | 130,000 |  | 172,000 |  | 197,000 |  | 229,000
|Local VOIP(1)                                            |  |                 |  | 21,000  |  | 140,000 |  | 237,000 |  | 293,000
|IP-TV                                                    |  |                 |  |        |  |        |  | 31,000  |  | 109,000
|                                                         |  |                  |  |         |  |         |  |         |  |        
|Total                                                    |  | 17,700           |  | 151,000 |  | 312,000 |  | 465,000 |  | 631,000
|                                                         |  |                  |  |         |  |         |  |         |  |        

---

|(1) | Includes Hong Kong based subscriptions only.
|--- | --------------------------------------------



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Internet Access



HKBN began offering our broadband Internet services in March 2000 after it received a wireless FTNS License from the
Telecommunications Authority to provide fixed telecommunications network services in Hong Kong using wireless technologies such as local multi-point distribution systems. Our goal is to build on our position as a leading provider of broadband
Internet services in Hong Kong and increase the revenues we generate from Hong Kongs Internet access market. Our subscription base for broadband Internet access has increased each year since we introduced this service and has expanded to
approximately 229,000 broadband Internet access subscriptions as of August 31, 2005. We use this subscription base to up-sell our other fixed telecommunications network services. In addition to broadband Internet access services, we also
currently provide 56k dial-up Internet access and corporate Internet access via resale of PCCWs Megalink/Mega-access. However, we are focusing exclusively on growing our subscription base for our high bandwidth broadband Internet access
services and are making no further investments in dial-up or Megalink/Mega-access services.



We currently offer broadband Internet access to our residential and corporate customers at access speeds of up to 1,000 Mbps, but the majority of our customers currently have access speeds of up to 10 and 100 Mbps. We
currently offer bb10, our basic symmetric 10 Mbps broadband Internet access service plan to residential customers with unlimited Internet access for a monthly fee ranging from HK$110 to HK$148. Further, in November 2004 we began offering
bb100 and in April 2005, we launched our bb1,000 services that respectively provide symmetric 100 Mbps and 1,000 Mbps broadband Internet access for monthly fees ranging from HK$150 to HK$200 for bb100 and HK$1,350
for bb1,000. All of our broadband Internet access packages offer a free e-mail service and a variety of value added services, such as bbDrive, an on-line virtual hard drive with up to 10Gb of storage, bbGuard, an
anti-spam and anti-virus package, and bbWatch, a full-screen IP-TV service that is viewed on a personal computer. 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 1,000 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$200 to HK$6,000.



Competition



There have been many new entrants to the Internet access business, but our main competitors are PCCW-HKT (through its subsidiary PCCW-IMS Limited),
i-Cable and HGC. PCCW-HKT has been offering broadband Internet access services since May 1998 and uses asymmetric digital subscriber line technology, or ADSL, over its telephone network to provide asymmetric Internet access typically at speeds up to
6 Mbps downstream and 640 Kbps upstream. i-Cable began providing broadband Internet access services in March 2000 using its hybrid fiber coaxial network that provides symmetric typical access speeds up to 8 Mbps shared by a cluster of buildings. HGC
predominantly uses VDSL technology and typically provides symmetric access speeds up to 10 Mbps.



Our basic broadband Internet access service provides symmetric access speeds up to 1,000 Mbps. We believe that there is no other fixed telecommunications
network service provider in Hong Kong with an existing infrastructure that could offer broadband Internet access at speeds comparable to our high-speed offerings to the residential mass market at cost-effective prices. However, our largest
competitors have been in operation longer and may have greater market presence, brand recognition and more financial, technical and personnel resources. In addition, they may have greater network coverage in terms of homes passed.



We had approximately 229,000 broadband Internet access subscriptions as of
August 31, 2005, which represents a market share of approximately 14% with respect to the total number of broadband Internet access subscribers in Hong Kong.



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Local VOIP



In April 2002, we began offering our on-network local VOIP services in Hong Kong. To provide local telephony service, we
install IP-based voice switching equipment in locations already covered by our Metro Ethernet network. Voice signals are transmitted by the VOIP switches into the Ethernet network installed in the subscribers building. The capital cost of
installing VOIP switches is small because the scalability of our Metro Ethernet network allows us to provide new services over existing infrastructure with only minimal additional equipment. In addition, we now install such voice switching equipment
together with our new installations of broadband equipment in some buildings.



The quality of our local VOIP service is indistinguishable from traditional fixed line local telephony services and customers are able to use their existing telephone equipment. In addition, fixed line telephony
subscribers switching to our local VOIP services are able to retain their existing local telephone number via fixed line number portability.



As of August 31, 2005, we had 293,000 local VOIP subscriptions. We currently charge from HK$48 to HK$128 per month for our local VOIP services
depending on the service plan, and we offer a full range of value added services, including call waiting, caller display and conference call services.



In August 2004, we also began offering hardware-based off-network local VOIP services, which we refer to as bb Phone services. bb
Phone allows subscribers to use our local VOIP services via the broadband network of other operators. In October 2005, we launched our global software-based VOIP services branded as 2b, which provides a global Hong Kong-telephone
number service. This service is primarily targeted at the overseas Chinese community, which we believe will enable us to access a wider addressable market compared to the Hong Kong market for international telecommunications services. For HK$48 per
month, 2b provides broadband users around the world with a standard Hong Kong 8-digit fixed line number to make and receive unlimited calls within Hong Kong and to other 2b users around the world.



Competition



PCCW-HKT, the incumbent and largest fixed telecommunications network operator in Hong Kong, announced that it had a market
share of approximately 67% with respect to local telephony services as of June 30, 2005. As the incumbent operator, PCCW-HKT is required to allow interconnection to its fixed telecommunications network to other licensed fixed telecommunications
network operators. The remainder of the market is shared among ourselves and three other alternative carriers HGC, New World and Wharf T&T. The principal basis of competition for local telephony is price and brand name recognition. PCCW-HKT has
the highest brand name recognition, but we and the other operators are contending by offering competitively priced local telephony services that provide comparable quality to PCCW-HKT. As of August 31, 2005, we had approximately 293,000 local
VOIP subscriptions. Our market share with respect to local residential telephony services amounts to approximately 13.9% as of August 31, 2005.



There have been a number of developments that could result in changes to the competitive environment with respect to fixed line local telephony services
in Hong Kong. On January 20, 2005, PCCW announced it had formed a strategic business alliance with China Netcom, one of Chinas major telecommunications companies. Under this alliance, China Netcom paid approximately US$1.0 billion in cash
for newly issued PCCW shares, resulting in its holding 20% of PCCWs share capital. This transaction may result in increased competition for us and other Hong Kong telecommunications companies if PCCW is able to combine its size and market
position with the increased capital provided by China Netcom to decrease prices.



In June 2005, PCCW acquired a controlling stake in SUNDAY, a mobile telecommunications operator. This acquisition strengthens PCCWs ability to compete by enabling it to offer integrated fixed and mobile
telecommunications services. Going forward, we expect PCCW to offer integrated quad-play services that includes fixed voice, mobile voice, Internet access and IP-TV.



Under a new fixed carrier license issued to PCCW-HKT on January 14, 2005, PCCW-HKT is no longer required to obtain
prior approval from the Telecommunications Authority before adjusting its tariffs on residential and business direct exchange line telephone services, including moves to offer discounts and other benefits in response to price competition. We
anticipate this development will increase pricing competition further in an already competitive market. The competitive environment under which we currently operate may also be affected by the ongoing changes in the regulatory framework in Hong Kong
including the phasing out of Type II interconnections at Point A by June 2008. However, in December, 2005, PCCW-HKT entered into a six-year commercial Type II interconnection arrangements with HGC and Wharf T&T. These arrangements, together with
PCCWs agreement with New World entered into in 2004, will allow the practice or Type II interconnection resale to continue beyond the regulatory phase-out.



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IP-TV



In August 2003 we introduced our IP-TV service that provides DVD quality video delivered via our Metro Ethernet network to
an IP set-top-box connected to the subscribers television set. This monthly subscription-based pay television service offers more than 81 channels consisting of a self-produced 24-hour news channel and education and recreation channels
(including childrens programming), and channels whose content is obtained from other content-providers. Our news production team consists of a staff of 100 employees and produces an average of 40-50 news stories per day for our 24-hour news
cycle.



Because of the scalability of our Metro Ethernet
network infrastructure, the current cost of adding IP-TV services to an existing broadband Internet access or local VOIP subscriber is small. Since the launch of our IP-TV services in August 2003 we have progressively upgraded the content offerings
and valued added components of the service. During 2005, we introduced an 8 channel movie and drama package, added J-League Soccer coverage from Japan, plus three Drama Buffet near-video-on-demand channels that empowers viewers to select
and watch drama series by the episode of their choice. All of these enhancements are included in our basic package price of between HK$68 to HK$148 per month, which is significantly cheaper than similar bundles from our competitors. During fiscal
2005, we added 78,000 IP-TV subscriptions to reach 109,000 subscriptions as of August 31, 2005. However, the majority of these new subscriptions are on free-trial plans for periods from six to twelve months. While it is our objective to convert
these free-trial users to paying subscribers, we may not be able to achieve this on sufficient scale to be profitable.



Competition



Our three main competitors in the pay-TV business are i-Cable, PCCW-HKT and Galaxy Satellite Broadcasting Limited. The pay-TV services of i-Cable and
PCCW-HKT include a significant amount of English language content such as English Premier League Football, HBO, Cinemax, ESPN and others. PCCW-HKT, in particular, has signed long-term exclusive content contracts with HBO, ESPN, and Star among
others. We target a different market than these competitors by offering predominantly Chinese language content, and pricing our IP-TV service attractively to the residential mass market.



Television Broadcasts Limited and Asia Television Limited, commonly known as TVB and ATV, respectively, are indirect
competitors to our pay-TV services in the Hong Kong television market. TVB and ATV account for a substantial proportion of Hong Kongs television viewership and we market our services as supplemental to theirs. TVB and ATV are supported by
advertising revenues and, therefore, must design their programming to attract the widest possible audience. In contrast, we and the other pay-TV operators rely on monthly subscription fees for most of our revenues. Other competitors include
satellite TV operators, such as Star TV, as well as potential competition from direct-to-home broadcasters and broadcasters using digital terrestrial delivery methods.



Corporate Data Services



Our corporate data services includes E-1 and T-1 backbone connections and leased bandwidth capacity over our Metro Ethernet
network for mobile and other telecommunications carriers, as well as connectivity for companies with multiple office locations within Hong Kong. We believe that the combination of our low cost base provided by our Metro Ethernet network and our
extensive geographic coverage, positions us well to be competitive in this market. In November 2005, we announced cooperation with China Telecom Hong Kong Limited to provide Pan-China Internet Protocol Virtual Private Network services to corporate
customers. This joint service, allows corporations with multiple office locations throughout Hong Kong and China, to conveniently work with a single service provider to address their Pan-China corporate telecommunications needs. Our corporate data
services are not yet contributing material revenues to our operating results as we are still at an early stage of promoting these services.



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International Telecommunications Service



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



The primary
international telecommunications services that we currently offer our customers are the following:



|                                |  |                                                                                                         
|------------------------------- |  | --------------------------------------------------------------------------------------------------------
|Service                         |  | Description                                                                                             
|                                | 
|IDD 1666                        |  | Provides subscribers with international direct dial using the access number 1666 in Hong Kong.          
|                                | 
|IDD 0030                        |  | Provides subscribers with international direct dial using the access number 0030 in Hong Kong.          
|                                | 
|Mobile Call Forwarding Services |  | Allows call forwarding of Hong Kong mobile numbers so that subscribers can receive calls while overseas.



We offer our
international telecommunications service under the IDD 1666 and IDD 0030 brand names. These two brands provide us with flexibility in our marketing strategies. We charge our IDD 1666 and IDD 0030 users a per minute tariff rate that varies according
to the destination of the call and calling prefixes, while IDD 0030 users are also provided discounts depending on the time of day or day of the week when the call is placed.



We actively promote our international telecommunications services to build our brand name awareness as one of Hong
Kongs leading telecommunications companies. In fiscal 2004 and 2005, in order to maintain our market share, we made the decision to price our international telecommunications services at competitive levels with other market players to compete
with their aggressive pricing strategies.



During fiscal 2005,
we experienced a reduction in total traffic volume of 5.9% from 1,007.0 million minutes in fiscal 2004 to 947.1 million minutes in fiscal 2005. Competition during the year was intense as some of our integrated competitors offered free or
very low cost international direct dial minutes as a customer incentive to gain local fixed line and mobile market share. Further, technology substitution from global VOIP providers such as Skype, which offers free PC-to-PC based international
calls, is also becoming more prevalent. We are proactively migrating our legacy international telecommunications services to our 2b services, which we believe will enable us to achieve higher margins and access a wider addressable
market.



International Telecommunications Network



Our international telecommunications network
infrastructure is a system of switches, self-owned and leased backbone capacity, interconnection arrangements and undersea cables that connect the subscribers telephone call to its destination.



In March 2002, we received our license to provide undersea cable-based fixed
telecommunications network services. This license allows us to purchase and operate our own undersea cables. In 2000, we entered into contracts with two large consortia of international telecommunications companies to acquire undersea cable
capacity. Through the first contract, we invested in the Japan-U.S. undersea cable, which was completed in August 2001. Pursuant to the second contract, we agreed to jointly construct and maintain the Asia-Pacific Cable Network 2 undersea cable as
an international transmission facility. Construction of the APCN 2 cable was completed, and commercial operation began, in May 2002. We spent a total of HK$120 million on these two projects. We believe the utilization of these undersea cables
provides capacity for significant future growth of our international and fixed-network telecommunication services.



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Having our own undersea cables and our fiber-based backbone has enabled us to better control
international transmission quality, reduced the costs associated with international transmission and reduced our reliance on third party infrastructure. Our international telecommunications network currently has a monthly handling capacity of
approximately 150 million minutes. We believe that the continuing improvement of our international telecommunications network is important in supporting the growth in our subscription base and the expansion of our range of services.



International Simple Resale



Our international simple resale license, which became effective in January
1999, has significantly changed the way that we provide our international telecommunications services. To connect an international call, we must transmit the signal between our switching systems and switching systems in the country to which the call
is directed. Switching systems are the electronic systems that direct the telecommunications transmission to the selected international transmission circuit, take the signal from the international transmission circuit in the destination country and
direct it to the local network for delivery to its destination.



Since receiving our PNETS License for the provision of external telecommunications service, we have acquired exclusive use of several leased international transmission circuits for direct transmission of international calls between our
switching systems and switching systems in the destination countries under an international simple resale arrangement. Exclusive use of leased transmission circuits to transmit calls between switching systems has enhanced the quality of our
international calls, reduced our reliance on third party infrastructure and lowered transmission costs of our services.



Interconnection Arrangements



We have entered into interconnection arrangements with other local fixed network operators in Hong Kong and overseas carriers to transmit calls between
Hong Kong and overseas destinations for our off-network customers. In choosing the local fixed network operators and overseas carriers with whom we cooperate, we take into account a number of factors including the level of termination charges and
transmission efficiency and quality. We evaluate the performance of parties with whom we have interconnection arrangements periodically. We believe that we will not have difficulty in finding alternative overseas carriers if performance standards
are not being met or a change is otherwise necessary. We have not experienced any disruption in the provision of our services as a result of a change of arrangements with overseas carriers or local fixed network operators.



We pay a fixed monthly fee to local fixed network operators for connection
between our switches and their networks and a variable access fee payable on a per-minute basis when accessing their network. For customers using our own network, no interconnection fee is charged. We negotiate the termination charges we pay with
the overseas carriers, and the termination charges vary from one overseas carrier to another. All of the interconnection and termination charges we pay to local fixed network operators and overseas carriers, respectively, are made on an open account
basis with credit terms ranging from 15 to 30 days. The interconnection charges we pay to local fixed network operators are denominated in Hong Kong dollars and substantially all the interconnection charges we pay to overseas carriers are
denominated in U.S. dollars.



International
Telecommunications Switching Systems



We own three
international telecommunications switching systems in Hong Kong and two in Canada, comprising one in each of Vancouver and Toronto.



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Our three international telecommunications switching systems in Hong Kong handle telephone calls
originating and terminating in Hong Kong. Our telecommunications network mainly consists of Nortel Networks Limited switching equipment and compression units supplied by Cisco Systems, Inc. and ECI Telecom Ltd. These systems are programmed to
automatically choose the optimal routing for each transmission. Optimal routing is a function of a variety of factors, such as country or territory of origination and destination, communication quality, efficiency and costs, and the capacity of the
various communication methods available.



Furthermore, since
our three international telecommunications switching systems in Hong Kong operate independently of each other, if one systems breaks down, all transmissions are immediately diverted to another switching system. We have never experienced a period
where all systems experienced a failure at the same time since we commenced operations in 1992.



Competition



PCCW-HKT, HGC, New World, and Wharf T&T are our main competitors in the international telecommunications business. As in previous years, we
experienced fierce price competition in Hong Kong during fiscal 2005. This competition drove down the average tariff rates per minutes and we expect this price competition to continue in fiscal 2006. In order to maintain our market share and high
traffic volume, we have significantly reduced some of our international telecommunications rates and introduce new marketing and promotional offers from time to time. We also employ two brand names, IDD 1666 and IDD 0030, to provide us with
flexibility in our marketing strategies. However, to offset these price reductions, we have taken steps to reduce our cost base, such as using our relatively large traffic volume to negotiate lower prices from our international partners,
establishing a call center in Guangzhou to provide customer service and back office support services, and developing our own international telecommunications infrastructure.



CTImall and INCmall



To take advantage of the regular contact that we have with our existing customers through our various sales and customer service channels, we offer our
customers the opportunity to purchase a selection of consumer goods from us including audio-visual products, household appliances, computer and accessories, skincare, watches, cooking utensils and other housewares. We use our large customer base and
the potential for high sales volumes to negotiate discounted prices on electrical goods with distributors, and offer these electrical goods to our customers at attractive prices. We proactively market CTImall to our residential customer base via
direct mail accompanying our bills, our web site, as well as direct calling. During fiscal 2005 we introduced INCmall, which operates on the same premise as CTImall, but is targeted at our corporate customer base.



Maintenance and Monitoring



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



| |  | a year round, 24-hour, 7 days a week network operation center for real-time service monitoring and maintenance that is supported by over 130 operational and field staff;
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | individual self-reporting mechanisms and centralized performance monitoring systems for our switches and equipment;
| | - | -------------------------------------------------------------------------------------------------------------------



| |  | an emergency self-reporting system that automatically contacts designated personnel via mobile phones; and
| | - | ----------------------------------------------------------------------------------------------------------



| |  | back-up systems for our switches, critical software and hardware components.
| | - | ----------------------------------------------------------------------------



Once a network fault is detected by our control room, we will either remotely rectify the situation or dispatch field staff to that location should
physical interaction be required. After the situation has been resolved, we will continue to monitor network performance as well as track customer service feedback until we are assured of the fault being fully rectified.



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Research and Development Activities



We commit considerable resources to our research and development department in order to continuously improve our services
and improve our market position. As of August 31, 2005, our research and development department in Hong Kong consisted of 48 staff members experienced in systems design, engineering, telecommunications and computer programming. Our research and
development department is primarily responsible for assessing and adapting the technology that we employ in upgrading and expanding our Metro Ethernet network. To identify and develop new market opportunities, the research and development department
assesses new services offered by telecommunications and Internet companies in the United States and elsewhere and works closely with our marketing department. Our research and development expenditures were approximately HK$2.6 million, HK$6.0
million and HK$11.0 million for fiscal 2003, 2004 and 2005, respectively.



Sales and Marketing



Our primary marketing
goal is to further our brand name as one of Hong Kongs leading telecommunications companies, and to build HKBNs brand name as a leading broadband Internet access, local VOIP, IP-TV and corporate data services company. We consider brand
identity to be a key factor in building our revenue base. We believe that we have been successful in building a strong corporate image in Hong Kong as a direct result of the efforts we have made, and intend to continue our efforts to advertise and
promote City Telecom and HKBN. We advertise our products and services through our on-the-street marketing force, door-to-door marketing team, telemarketing and direct mailing, as well as through Chinese language television, radio, print
media and on the Internet.



We have developed an extensive
sales network in Hong Kong. Our senior marketing personnel closely oversee our sales network to ensure that a consistent image is presented by all of the sales representatives we use to promote City Telecom and HKBN. We provide commission based
incentives to our residential sales force that sell our international and fixed telecommunications network services, which consists of agents responsible for on-the-street and door-to-door sales, as well as to our full-time telemarketing staff.



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 greatly benefited from utilizing on-the-street and door-to-door sales agents who meet Hong Kong residents
in recreational and residential areas to promote our services.



We have established a sales division responsible for coordinating our corporate marketing and sales efforts. We believe our dedicated corporate and small-to-medium enterprise sales force is one of the largest sales forces targeted at
corporate users of telecommunications and Internet services in Hong Kong. In addition, our dedicated corporate staff designs marketing and sales promotions specifically tailored to address the concerns of business users. This division also organizes
seminars for current and prospective customers to promote new products and services and to raise awareness of our various corporate offerings.



Customer Service



We believe that providing excellent customer service and support is essential to building and retaining a large and loyal subscriber base. We therefore
have committed considerable personnel and financial resources to establishing a reliable and accessible customer service system.



Our customer service department provides integrated support to our international and fixed telecommunications network services subscribers. We provide a
hotline to handle complaints, subscription applications and queries relating to account balances, pricing, billing, service and technical information. Complaints and in-depth queries from subscribers that cannot be immediately remedied or answered
are forwarded to a customer care team, which is responsible for answering such complaints and queries. We also have a dedicated customer service team to provide service to our corporate subscribers, which includes access to a highly skilled
technical team that may go to the customer site for trouble shooting and repairs.



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In July 2002, we established a customer service call center in Guangzhou, and centralized most of our
customer service functions and back office support services at that location. This enables us to lower our operating costs while continuing to increase our customer service capabilities. We have been expanding our Guangzhou customer service facility
since its establishment, which now has approximately 1,900 employees as of August 31, 2005.



In December 2005, we opened a 14,000 square foot dedicated training center in Guangzhou to enhance the quality of our customer service through improved
staff training. We also opened a new 3,500 square foot customer service center in Mongkok, a popular shopping district in Hong Kong, in December 2005.



Billing and Collection



Our account collection department is responsible for securing prompt payment from subscribers. Invoices are issued on a monthly or quarterly basis and
payments are usually due within 15 days of the issue date of the invoice for residential subscribers and 21 days for corporate subscribers. All payments from our subscribers are denominated in Hong Kong dollars and are made by way of cash, check,
credit card, payment by telephone service, automatic transfer from subscribers bank accounts or through Internet banking. As a result of our tight credit control policy, our bad debts represented approximately 1.4%, 1.0% and 3.1% of our
revenue for each of fiscal 2003, 2004 and 2005, respectively. The increase in bad debts by 2.1% of our revenues in fiscal 2005 as compared to fiscal 2004 was mainly due to the provision for mobile interconnection charges receivables in the aggregate
amount of HK$19.5 million in fiscal 2005. For more information on our provision for mobile interconnection charges, see Item 5. Operating and Financial Review and ProspectusOur Revenues Fixed Telecommunications
Network Services in this annual report.



When an account
becomes past due, we send a reminder notice together with the next months invoice to the customers, usually within 15 days after the due date. The notice states the overdue amount and informs the customer that we charge a late payment fee of
1.5% per month on the outstanding overdue amount. For residential subscribers, we have the right to charge the outstanding overdue amount to the subscribers pre-registered credit card account or, if applicable, deduct the outstanding
overdue amount from the subscribers application deposit. Open accounts are maintained for most of the corporate subscribers without pre-registered credit card accounts or deposits.



For residential and corporate subscribers, if an overdue IDD account is not settled within 90 days and 60 days after the due
date, respectively, we terminate the subscribers account. For local VOIP, broadband Internet access and IP-TV services, we generally allow a 90 day period before suspending the account, due to the minimal incremental cost to us of providing
such services. If payment is still not settled after we suspend the account, we determine what recovery actions to take, which may include court proceedings and/or the use of collection agencies.



Environmental Matters



Since our date of incorporation, we have not violated any environmental laws, ordinances or regulations, and believe that
all of our operations comply fully with applicable environmental laws.



Intellectual Property Rights



We have
registered our trademarks with the Trademarks Registry of the Intellectual Property Department in Hong Kong. We have no other material intellectual property.



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Hong Kong Regulatory Overview



The following is a brief summary of the Hong Kong laws and regulations that currently materially affect the
telecommunications, including the Internet, and the broadcasting industries in Hong Kong. This section does not purport to be a comprehensive summary of all present and proposed regulations and legislation relating to these industries. For example,
the regulatory principles relating to the pricing of telecommunications services provided in Hong Kong are relatively complex and are the subject of regular review by the regulator and as such are not covered in great detail here.



Telecommunications Industry



History



Local Fixed Telecommunications Network Services



Prior to July 1995, PCCW-HKT Telephone Limited (then known as Hong Kong
Telephone Company Limited) was the exclusive provider of local fixed wireline telecommunications network services in Hong Kong under an exclusive franchise granted to it under the now repealed Telephone Ordinance (Cap 269). In 1995, the Hong Kong
government introduced limited competition in the local fixed telecommunications network services market. Three new FTNS Licenses (see below for a more detailed description of FTNS Licenses) were issued by the Telecommunications Authority to each of
Hutchison Global Communications Limited (then known as Hutchison Communications Limited) (HGC), Wharf T&T Limited (then known as New T & T Hong Kong Limited or Wharf New T & T Limited ) (Wharf T & T), and New
World Telecommunications Limited (then known as New World Telephone Limited) (New World) on June 30, 1995, June 27, 1995 and June 20, 1995, respectively, which allowed them to provide and operate local fixed wireline
networks. PCCW-HKT was granted a FTNS License on June 29, 1995 in order for it to continue to operate its local fixed wireline network. The Hong Kong government also agreed to a three-year moratorium on the granting of any further FTNS
Licenses.



Following a review conducted by the Hong Kong
government regarding its policy in the fixed telecommunications industry in 1998, on May 5, 1999, it announced its decisions:



| |  |  | to extend the moratorium on granting additional wireline-based local FTNS Licenses until December 31, 2002, subject to the satisfactory binding commitments by each of HGC,
Wharf T&T and New World to roll-out additional local network infrastructure and services; and
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | to invite applications for FTNS Licenses in respect of non-wireline based local networks periodically, the first of such invitation to be made in 1999.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------



To implement the above decisions, five local wireless-based FTNS Licenses
were issued by the Telecommunications Authority in 2000, including one which was issued to HKBN, for the provision of local fixed telecommunications services using non-wireline based networks (commonly referred to as wireless local loop).



At the same time, Hong Kong Cable Television Limited, or
HKCTV, was also granted a FTNS License to offer telecommunications services over its hybrid fiber coaxial cable network, subject to it making binding commitments on the continued roll-out of its cable network and the surrender, on an agreed
schedule, of microwave multipoint distribution system frequencies allocated to it.



In anticipation of the full liberalization of the local fixed telecommunications network market as from January 1, 2003, the Telecommunications Authority published a statement on January 11, 2002 outlining
certain key implementation details, including:



| |  |  | there would be no rollout or capital expenditure commitments required from licensees that are licensed to operate from January 1, 2003, local fixed networks and/or external
facilities;
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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| |  |  | in order to maintain equal treatment between new and existing operators in respect of performance commitments, all performance commitments of existing local and external fixed
telecommunications network services operators that are due on or after January 1, 2003 as initially committed to in the licenses granted would be waived;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | the Telecommunications Authority would not grant any fixed carrier licenses (for details of this license, see description below) to operate local fixed networks to applicants who
intend to rely primarily on interconnection with, and access to, the infrastructure of other fixed telecommunications network services or fixed carrier licensees to roll out their networks or provide their services;
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | newly licensed local wireline-based fixed network operators may apply, on a case-by-case basis and subject to certain conditions, for rights of access to buildings and road opening
under section 14(1) of the Ordinance for purposes of installing telecommunications lines; and
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | existing local wireless network operators, including HKBN, would be entitled to apply for the extension of the scope of services under their existing licenses to operate local fixed
networks and other forms of fixed telecommunications network services.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Following the publication of the statement, HKBN applied to the Telecommunications Authority for modification of the scope of its local wireless FTNS License. HKBNs FTNS License was modified on April 16,
2002 to include the operation of local fixed wireline network services as from January 1, 2003. In addition, HKBNs performance commitments due on or after January 1, 2003 set forth in its FTNS License were waived.



International Telecommunications Facilities and Services



Prior to March 1998, Hong Kong Telecom International Limited, or HKTI,
was the exclusive provider of all external telecommunications circuits and certain external telecommunications services in Hong Kong. The license granted to HKTI in 1981 was due to expire on September 30, 2006.



In May 1993, the Telecommunications Authority began liberalizing certain
external telecommunications services which were not within the scope of HKTIs exclusive license, and issued PNETS Licenses (see below for a more detailed description of such license) which allowed licensees to provide customers with access to
HKTIs external telecommunications services using a transmission method commonly known as call-back.



Following the issuance of a statement by the Telecommunications Authority in April 1996 further clarifying the extent of the exclusivities of HKTIs
license, the Telecommunications Authority began issuing PNETS Licenses for the provision of international virtual private network services.



In January 1998, the Hong Kong government issued a policy statement stating that the provision of the services remaining within the HKTI License, on an
exclusive basis, was not in Hong Kongs best interest. On March 31, 1998, HKTI surrendered its exclusive license under the terms of a framework agreement entered into with the Hong Kong government on January 20, 1998. In the January
1998 policy statement, the government stated that the liberalization of the external telecommunications services and facilities would take place on a two step basis, the first step being liberalization of services and the second being the
liberalization of facilities. Accordingly, the external telecommunications services were liberalized as from January 1, 1999 and the provision of external facilities was liberalized on January 1, 2000. Subsequently, in a 2002 statement of
the Telecommunications Authority relating to the implementation of the full liberalization of local fixed telecommunications network services market, the Telecommunications Authority stated that it would issue licenses for operation from
January 1, 2003 of external facilities based on submarine or land cables to those who may directly invest in cable capacity or acquire the capacity through the purchase of Indefeasible Rights of Use, or IRU, of cables, thus further
liberalizing the external telecommunications market.



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In early 1998, PCCW-HKTs FTNS License was transferred to a group comprised of subsidiary companies
providing international and local telecommunications services and the scope of PCCW-HKTs services to be provided under the FTNS License was in this way expanded to cover the provision of external telecommunications services and facilities. The
FTNS Licenses of the three other local fixed network operators, HGC, New World and Wharf T&T, were also amended allowing them to provide external telecommunications services from January 1, 1999 and all forms of external facilities (cable
and satellite based) from January 1, 2000.



The
Telecommunications Authority began issuing PNETS Licenses in late 1998 for the provision of external telecommunications services using international leased circuits provided by licensed operators as from January 1, 1999. External FTNS Licenses
began to be granted to licensees to operate, as from January 1, 2000, non-cable based external telecommunications facilities (i.e. satellite or other wireless facilities) and/or external telecommunications facilities based on new undersea or
land cables. Furthermore, the Telecommunications Authority stated that it would issue licenses for the operation of external telecommunications facilities to IRU owners as from January 1, 2003.



The Telecommunications Authority granted CTI International Limited, our
wholly owned subsidiary, a satellite-based fixed carrier license in May 2001. This license was modified by the Telecommunications Authority in March 2002 to grant us additional rights to operate a cable-based external fixed telecommunications
network. HKBNs local wireline-based FTNS License was modified on May 22, 2003 to allow for the operation of external fixed telecommunications network services in exchange for the surrender of our cable-based external fixed carrier
license.



Regulatory Environment



The main legislation in Hong Kong which regulates the telecommunications
industry is the Telecommunications Ordinance (Cap 106), and related subsidiary legislation, notably the Telecommunications Regulations (Cap 106A), and the Telecommunications (Carrier Licences) Regulation (Cap 106V). The Telecommunications Ordinance
underwent significant changes in 2000 following a policy review of the telecommunications industry conducted by the Hong Kong government in 1998.



The Telecommunications Authority, an individual appointed by the Chief Executive pursuant to the Telecommunications Ordinance, is the main regulator of
the telecommunications industry in Hong Kong. The Telecommunications Authoritys general responsibilities include: the issuing of non-exclusive licenses; the determination of terms of interconnection; promotion of fair competition in the
telecommunications sector; management of the frequency spectrum; development of technical standards and customer equipment testing; protection of consumer interests; and the control and administration of the Hong Kong numbering plans (including
allocation of numbers or codes).



It should be noted that the
Hong Kong government listed in its 2005 Policy Agenda (January 2006) as one of the policy initiatives of the Communications and Technology branch of the Commerce, Industry and Technology Bureau, to merge the Telecommunications Authority and the
Broadcasting Authority into a single regulator.



Licensing



General Licensing
Requirements



Section 8(1) of the Telecommunications
Ordinance provides, amongst other things, that a telecommunications license is required if a person in Hong Kong establishes or maintains any means of telecommunication. Contravention of Section 8 constitutes an offence. Currently, companies
offering telecommunications services without establishing or maintaining any means of telecommunications (pure resellers) are not yet subject to the licensing regime. The Telecommunications Authority is currently reviewing and considering the
submissions made to him during a public consultation proposing to bring into force provisions (which were introduced in the Telecommunications Ordinance in 2000) to regulate certain resale activities. For a more detailed discussion refer to the
section entitled  Recent Regulatory Developments in the Telecommunications Industry below in this annual report.



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The Telecommunications Regulations and the Carrier Licenses Regulation set forth the licenses which the
Telecommunications Authority may issue pursuant to the Telecommunications Ordinance.



Generally, a licensee is required to be a company registered under the Companies Ordinance (Cap. 32) and this requirement is satisfied either by the incorporation of a Hong Kong company (which can be wholly owned by a
foreign company) or by the registration of a foreign company under the Companies Ordinance. Currently, there is no foreign ownership restriction on the holder of a telecommunications license under the current regulatory regime.



Non-compliance with the Telecommunications Ordinance, any subsidiary
legislation made pursuant to it, any of the license conditions or any direction issued by the Telecommunications Authority by a telecommunications licensee, could result in the revocation or suspension of the relevant license. The Telecommunications
Ordinance contains a set of provisions setting forth the procedural steps which the Telecommunications Authority must adhere to prior to revoking or suspending any telecommunications licenses. In addition, the Chief Executive in Council has the
authority to revoke a telecommunications license at any time if it is in the public interest to do so.



Fixed Telecommunications Network Services License



As noted above, the Telecommunications Ordinance was substantially amended in 2000. Prior to the enactment of the amendments in 2000, FTNS Licenses were
issued for the operation of fixed telecommunications networks in Hong Kong. After the enactment of the amendments in 2000, which was primarily designed to streamline the licensing regime, FTNS Licenses became a part of the general category of
fixed carrier licenses.



An FTNS License authorizes
the licensee, among other things:



| |  |  | to provide a public fixed telecommunication network service, covering internal services or external services, or both; and
| | - |  | --------------------------------------------------------------------------------------------------------------------------



| |  |  | to establish and maintain a fixed telecommunications network, which may be wireline-based or wireless-based, or a combination of both.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------



HKBN currently holds an FTNS License issued to it by the Telecommunications
Authority in February 2000 initially for the operation of a local fixed wireless network. This FTNS License has since been amended twice and presently, HKBN is authorized to operate both local fixed telecommunications networks (wireline and wireless
based) and external telecommunications facilities.



An FTNS
License contains a set of General Conditions, which are prescribed in the Telecommunications Regulations and a set of Special Conditions usually tailored-made by the Telecommunications Authority to address issues specific to the license holder,
including its universal service contribution obligation.



The
Telecommunications Regulations provide that an FTNS License is valid for a period of 15 years, and is renewable for a further period not exceeding 15 year at the Telecommunications Authoritys discretion.



The amount of license fee payable by a holder of a FTNS License is set out in
the Telecommunications Regulations and comprises (i) a fixed annual amount of HK$1.0 million; (ii) a variable amount calculated on the basis of the number of customer connections (which is currently set at HK$700 for each 100 customer
connections); and (iii) a variable fee calculated by reference to the radio spectrum assigned and used by the license holder.



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Fixed Carrier License



The Telecommunications Ordinance was amended by the Telecommunications (Amendment) Ordinance 2000, or the Amendment
Ordinance. With the exception of a few provisions, the amendments set out in the Amendment Ordinance became fully operational as from April 1, 2001. The Amendment Ordinance creates two new categories of licenses: carrier licenses and class
licenses.



A carrier license is defined widely in
the Amendment Ordinance and covers a number of existing network-related licenses, including FTNS Licenses.



The Telecommunications Authority no longer grants FTNS Licenses to operators which wish to operate fixed networks, but instead grants fixed carrier
licenses. The Telecommunications Authority is pursuing a gradual program of replacing expired or surrendered FTNS Licenses under the old regime with fixed carrier licenses, but existing FTNS Licenses remain valid.



The conditions of a fixed carrier license, as set forth in the Carrier
Licences Regulation, are essentially the same as the corresponding FTNS License conditions, except that certain of the General Conditions in a FTNS License have become Special Conditions (in order to make the General Conditions consistent for both
fixed and mobile carriers).



Under the Carrier Licences
Regulation, the period of validity of a fixed carrier license is 15 years from the date of issuance, which may be renewed for a further period of up to 15 years. The current fixed annual license fee payable is HK$1.0 million. The variable amounts
payable are calculated on the same basis as those payable under the FTNS Licenses.



Public Non-Exclusive Telecommunications Services License



A PNETS License is used by the Telecommunications Authority to cover the provision of a number of different telecommunication services where the service
provider provides the service to the public using the network of a licensed carrier or by establishing or maintaining transmission facilities within the boundary of a building or property. In practice, the PNETS License is also used as a
sweep-up license category, where a license is required by virtue of the Telecommunication Ordinance but none of the existing categories are applicable to the means of telecommunications or telecommunications service for which the license
is required.



The Telecommunications Authority has issued
various PNETS Licenses over the years, including:



| |  |  | those for the provision of external telecommunications services, or PNETS ETS License, over external leased circuits provided by a holder of a FTNS License or other external
switched telecommunications services lawfully operated in Hong Kong; and
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | those for the provision of international value-added network services, or PNETS IVANS License, and/or telecommunications services (including Internet access services) accessed by
customers via public switched telecommunications networks provided by licensed network operators or leased circuits operated or authorized under the Telecommunications Ordinance.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



A PNETS License has a validity period of 12 months, renewable at the
discretion of the Telecommunications Authority on an annual basis upon the payment of a prescribed annual fee, which is currently set at HK$750. Where radio communications apparatus is used, there is an additional variable component calculated by
reference to the number of base stations and mobile stations involved.



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During the mid 1990s, we were initially issued with three PNETS Licenses including a license to provide
calling card services, or a CCS License, a license to provide international simple resale services for facsimile and data services, or an ISR License, and a license to provide virtual private network services, or a VPN License. We also hold a PNETS
IVANS License which allows us to act as an Internet Service Provider. In November 1998, we were issued a PNETS ETS License, replacing the CCS, ISR and VPN Licenses. The PNETS ETS License allows us to continue providing CCS, ISR and VPN services
along with a number of other international telecommunications services. We were also allowed, under the terms of the PNETS ETS License, to commence the provision of external telecommunications services from January 1, 1999 over the external
facilities of the then HKTI and, from January 1, 2000, over the external telecommunications facilities of other licensed external facilities providers.



Under the terms of the PNETS ETS and PNETS IVANS Licenses, we and IDD 1600 Company Limited, or IDD 1600, our wholly owned subsidiary, are required to
comply with certain license conditions relating to technical and reporting matters.



Services-Based Operator License



Following publication of the statement of the Telecommunications Authority entitled Regulation of Internet Protocol (IP) Telephony on June 20, 2005, the Telecommunications Authority issued a consultation paper entitled
Consultation Paper on the Creation of a New License for Services-Based Operators for the Provision of IP Telephony Services on August 22, 2005, or the SBO License Consultation. In the SBO License Consultation, the Telecommunications
Authority proposes to create a Services-Based Operator License, or SBO License, to regulate service-based operators that provide voice telephony services over an IP platform. Having considered the submissions made by interested parties in the SBO
License Consultation, the Telecommunications Authority issued a Statement on January 6, 2006 setting out the scope of services to be covered by the SBO License, the interconnection charging arrangements for the delivery of local
telecommunications traffic to and from SBO licensees, the SBO License Conditions, the direction to be issued under Special Condition 17 of the SBO License; the validity period of the SBO License and the fee structure of the SBO License.



The scope of services permitted by the SBO License are all internal
and external telecommunications services, other than telecommunications services the subject of [a number of licenses issued under the Ordinance specified in the Scope of the Service] which includes international value-added network services
and external telecommunications services accessible to customers of mobile networks, but excludes internal voice telephony services provided to mobile customers. The special conditions of the SBO License puts into effect, in part, the new VOIP
regulatory framework as it relates to service based operations.



The SBO License is valid for one year and may be renewed for a period of one year at a time subject to the discretion of the Telecommunications Authority. The fee is HK$90,000 where Class 1 Services are provided and HK$25,000 where Class 1
Services are not provided. In addition, the SBO licensee is required to pay an additional annual fee of HK$7.00 for each subscriber number allocated to the licensee and for each number ported to the licensees system.



Class License and Unified Carrier License



Currently, there are three Class Licenses within the telecommunications
regulatory framework, one relating to the operation of in-building telecommunications systems, the second relating to the provision of public wireless local area network services and the third one relating to the operation of Citizen Band Radio by
the public for recreational and other communications purposes.



Further, with the advent of new technologies, such as Broadband Wireless Access, or BWA, the Telecommunications Authority recognizes that fixed and mobile services will converge enabling voice, data and multimedia applications to be
provided over common core networks, delivered through a range of wireline and wireless customer access networks and which will be accessible from common end-user devices irrespective of whether the users are at fixed locations or on the move. As it
will become more difficult to classify a service as a fixed or mobile, the Telecommunications Authority is now examining whether the existing separate licensing frameworks for fixed and mobile services remains sustainable and
whether the licensing framework ought to operate on a converged basis under a Unified License.



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Under the proposed unified carrier licensing framework, a licensee may be allowed to provide
(i) fixed services; (ii) mobile services; or (iii) both fixed and mobile services, depending on the scope of services proposed by the licensees in their license applications.



It is proposed that once the unified licensing framework is in place, the
existing fixed carrier license and mobile carrier license would no longer be issued to new entrants or to existing licensees whose licenses are due for renewal. Existing fixed or mobile carriers would, however, be permitted to continue to operate
under their existing licenses until their expiration.



The
Telecommunications Authority is also currently considering the submissions made in response to a public consultation on the introduction of a further class license to regulate the resale of certain telecommunications services. See the section
entitled Recent Regulatory Developments in the Telecommunications Industry below for more detail.



Interconnection



Interconnection between telecommunications networks and services are regulated under the Telecommunications Ordinance and the relevant license conditions.
Hong Kongs current policy on interconnection, including the applicable charging principles and methodology, is set forth in a series of statements issued by the Telecommunications Authority which were substantially revised in 2002 and further
revised in July 2004 following the Chief Executives decision to withdraw mandatory Type II interconnection at the local telephone exchange level by June 2008. For a more detailed discussion, refer to the section entitled  Recent
Regulatory Developments in the Telecommunications Industry below in this annual report.



The Telecommunications Authority divides interconnection into two main types: The first type is Type I Interconnection, which is interconnection between network gateways, such as tandem exchanges, local
exchanges or dedicated interconnection gateways, which allows end users on different networks to communicate with each other. The second type is Type II Interconnection, which is a connection to a fixed carriers network
at points of the customer access network level (more often referred to as local access or local loop unbundling) allowing the end customer requesting the interconnection to use the customer access network of the fixed carrier to obtain fixed
telecommunications services. The Telecommunications Authority is empowered to determine the terms and conditions of both types of interconnections (including the applicable charges) and a set of guidelines was issued in 1995 (and amended in 2001)
setting forth the procedures that the Telecommunications Authority will follow in making such a determination.



Type II Interconnection



Following two rounds of consultation on the review of the Hong Kong governments policy on Type II interconnection, the Communications and Technology
Branch, or CTB, announced in July 2004 that the mandatory Type II interconnection policy applicable to telephone exchanges for individual buildings (often referred to as Point A in statements issued by the Telecommunications Authority)
will be fully withdrawn by June 30, 2008. The mandatory Type II interconnection policy was drawn up in 1995 and is applicable to licensees issued with a FTNS License by the Telecommunications Authority as of June 1995, i.e. PCCW-HKT, HGC, Wharf
T&T and New World. Under this policy, each of these four FTNS License holders has the right to request (and the obligation to provide) interconnection with the other relevant FTNS Licensees at any point in the copper-wire local loops of the
licensee providing interconnection. In practice, it is PCCW-HKT which is required to meet the mandatory obligation given the extensive coverage of its copper-wire local loops.



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In the interim, the mandatory Type II interconnection policy will be withdrawn on a building-by-building
basis. Buildings that are served by at least two self-built customer access networks will no longer be subject to the mandatory Type II Interconnection policy following a two-year transitional period. There will be, in addition, a grandfather period
of one year following the expiry of the transitional period to protect regulated interconnection terms (including charges) for lines connected before and during the transitional period. After the grandfather period, interconnections of the local
loops will be subject to commercial negotiations between the carriers.



The Telecommunications Authority further clarified in a statement entitled Review of Type II Interconnection Policy dated July 6, 2004 that mandatory Type II interconnection policy continues to apply to the following:



| | (i) | buildings meeting the essential facilities criterion that justifies mandatory interconnection in the consumer interest; and
| | --- | -----------------------------------------------------------------------------------------------------------------------------



| | (ii) | interconnection at the street level (often referred to as Point B) and at the in-building level (often referred to as Point C).
| | ---- | -----------------------------------------------------------------------------------------------------------------------------------



It should be noted that the Type II interconnection policy only applies to
copper-based local loops. It does not apply to fiber-based local loops as the Hong Kong government wishes to encourage network operators to upgrade their networks from copper-based to fiber-based.



The maintenance of the mandatory Type II interconnection at the in-building
level means that network operators which roll-out their own copper-based in-building systems, such as HKCTV and HKBN, will continue to be required to permit other operators to access their respective local loop facilities.



The Telecommunications Authority also issued a statement in July 2004
detailing the implementation steps for the new policy.



Competition Provisions



Regulation
of Anti-Competitive Conducts



Although Hong Kong has never
had a general competition code, historically, holders of FTNS Licenses were prohibited from engaging in anti-competitive conduct by certain competition-related license conditions contained in the FTNS Licenses issued by the Telecommunications
Authority. The Telecommunications Authority issued in June 1995 a set of guidelines on how the Telecommunications Authority would interpret the competition-related provisions in FTNS Licenses, which we refer to in this annual report as the 1995
Competition Guidelines.



When the Telecommunications Ordinance
was amended in 2000, a set of competition-related provisions, which are modeled on the competition-related license conditions contained in the FTNS License, were introduced into the Telecommunications Ordinance. These statutory provisions provide
that a licensee is prohibited from engaging in any anti-competitive conduct, abusing its dominant position in a telecommunications market, or engaging in any discriminatory conduct.



The Telecommunications Authority continues to apply the 1995 Competition Guidelines in the application and enforcement of
competition provisions contained in the Telecommunications Ordinance and the FTNS Licenses. However, given that the competition provisions contained in the Telecommunications Ordinance are applicable to all licensees, not just holders of FTNS
Licenses, the Telecommunications Authority commenced a consultation in February 2004 on the issuance of a new set of competition guidelines to replace the 1995 Competition Guidelines.



The Telecommunications Ordinance provides an appeal mechanism by the establishment of a Telecommunications (Competition
Provisions) Appeal Board. A person or a licensee aggrieved by a decision made by the Telecommunications Authority relating to the competition provisions may appeal to the Board. Additionally, a third party suffering loss or damage from breach of
such competition provisions may bring an action for damages or seek other appropriate remedies against the offending licensee.



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Control on Mergers and Acquisitions



In addition to the competition provisions mentioned above, the Telecommunications Ordinance also contains a set of new
provisions which aim to control certain merger and acquisition activities within the telecommunications industry that have an anti-competitive effect. The provisions were introduced by the Telecommunications (Amendment) Ordinance 2003, which we
refer to in this annual report as the 2003 Amendment. The 2003 Amendment came into force on July 9, 2004 after Telecommunications Authority finalized the Guidelines on Mergers and Acquisitions, which we refer to in this annual report as the
M&A Guidelines.



This new regulatory regime on mergers and
acquisitions only applies to carrier licensees, which includes HKBN as a holder of a FTNS License, which, as discussed above, is regarded as a carrier license for the purpose of the Telecommunications Ordinance.



Under the 2003 Amendment, if the Telecommunications Authority determines that
the relevant merger and acquisition activity (defined as a change in the ownership or control over a carrier licensee under the 2003 Amendment) has, or is likely to have, the effect of substantially lessening competition in a
telecommunications market, the Telecommunications Authority is empowered to direct a carrier licensee to take such actions, such as the complete or partial divestiture of the relevant parties interests in the merged entity, as the
Telecommunications Authority considers necessary, to eliminate or avoid any anti-competitive effect. However, the Telecommunications Authority may not issue such a direction if he takes the view that the public benefit of the merger and acquisition
outweighs any detriment caused by a reduction in competition.



The 2003 Amendment provides that a change in relation to a carrier licensee occurs when:



| |  |  | a person, either alone or with any associated person, becomes the beneficial owner or voting controller of more than 15% of the voting shares in the carrier licensee
(This provision does not apply if the person, either alone or with any associated person, is not or does not concurrently become the beneficial owner or voting controller of more than 5% of the voting shares in another carrier licensee
and does not have or acquire the power to ensure that the affairs of such other carrier licensee are conducted in accordance with the wishes of such person); or
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | a person, either alone or with any associated person, becomes the beneficial owner or voting controller of more than 30% of the voting shares in a carrier licensee; or
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | a person, either alone or with any associated person, becomes the beneficial owner or voting controller of more than 50% of the voting shares in a carrier licensee, or
acquires the power (including by the acquisition of voting shares), by virtue of any powers conferred by the memorandum or articles of association or other instrument regulating the licensee or any other corporation or otherwise, to ensure that the
affairs of the licensee are conducted in accordance with the wishes of that person.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



An associated person is widely defined in the Telecommunications Ordinance and includes, where the licensee is a corporation, a corporation
over which the licensee has control, a corporation which has control over the licensee or a corporation which is under the same control as is the licensee. It also includes a person who controls the licensee and a relative and/or partner of that
person (in the case of a natural person) or a director or principal officer of the corporation.



Although the 2003 Amendment essentially creates an ex post regime whereby regulatory control will be exercised by the Telecommunications Authority after a
merger and acquisition has been completed, the 2003 Amendment also provides that a carrier licensee (or any interested party, such as the acquirer) may seek the prior consent of the Telecommunications Authority on a voluntary basis to any proposed
merger or acquisition falling within the definition of change. In this way, a carrier licensee will have the opportunity to consider whether to seek prior consent, taking into account the consequences of being potentially required by the
Telecommunications Authority to unwind the transaction, after its completion, if the transaction is found to have an anti-competitive effect.



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In addition, the Telecommunications Authority states in the M&A Guidelines that carrier licensees or
interested parties are welcome to have informal preliminary discussions with the Telecommunications Authority concerning any proposed merger or acquisition. The view expressed by the Telecommunications Authority in any such informal discussion is,
however, non-binding.



The 2003 Amendment and the M&A
Guidelines further outline the competition analytical framework which the Telecommunications Authority will adopt and the matters which he will take into consideration in assessing if the merger or acquisition in question will or is likely to raise
any competition concern in the relevant telecommunications market.



Any decision made or direction issued by the Telecommunications Authority under the mergers and acquisition provision is subject to appeal to the Telecommunications (Competition Provisions) Appeal Board.



Consumer Protection



The Telecommunications Ordinance also contains a statutory provision that is
primarily aimed at protecting consumers. This provision prohibits a licensee from engaging in any misleading or deceptive conduct.



The Telecommunications Authority issued the Guidelines in relation to Misleading or Deceptive Conduct in the Hong Kong Telecommunications
Markets in May 2003, which provide practical guidance on the application and enforcement of the relevant provision in the Telecommunications Ordinance.



The Telecommunications Authority has taken an active role in enforcing this prohibition and has developed voluntary codes to assist in this respect. For
instance, in November 2004, the Telecommunications Authority issued a Code of Practice for the Service Contracts for the Provision of Public Telecommunications Services which sets out guidelines on the preparation of service contracts.
The code states that important terms of a service contract (e.g. a compensation clause for early termination by the customer) should be presented in a prominent place and should be highlighted in the contract. The code is applicable to all service
providers (except mobile network operators which are subject to a separate code of practice) including holders of FTNS Licenses, such as HKBN, and holders of PNETS ETS Licenses and IVANS Licenses, such as ourselves and IDD 1600. Although the
guidelines are voluntary in nature, the Telecommunications Authority has indicated that the extent of a licensees compliance with the guidelines will be taken into account in assessing if a licensee has complied with the statutory provision
mentioned above.



In addition, on June 17, 2002, the
Telecommunications Authority in conjunction with the Hong Kong Consumer Council, the Independent Commission Against Corruption, and the Office of the Privacy Commissioner of Personal Data issued a voluntary Code of Practice on the Protection
of Customer Information for Fixed and Mobile Service Operators. The code applies to fixed and mobile operators and its objective is to set out best practices for such operators for the protection of customer information (e.g. telephone
numbers, residential addresses and details of call history) in light of the existing sanctions under Hong Kong legislation preventing unauthorized disclosure of protected information to third parties.



Apart from the Telecommunications Ordinance, like any companies carrying on
business in Hong Kong, telecommunications operators are required to comply with applicable Hong Kong consumer protection laws, for example, the Sale of Goods Ordinance (Cap 26), Control of Exemption Ordinance (Cap 71), Supply of Services (Implied
Terms) Ordinance (Cap 457), and the Unconscionable Contracts Ordinance (Cap 458).



Regulation of Pricing



Currently, the pricing of both fixed telecommunications network services and public non-exclusive external telecommunications services in Hong Kong is regulated by license conditions. However, the regulatory frameworks of each type of
services are different.



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All PNETS Licenses contain license conditions requiring the licensees to publish their tariffs and to
charge no more than the published tariffs. In other words, the Telecommunications Authority imposes a maximum ceiling on the prices that holders of PNETS Licenses may charge for their services.



Similarly, holders of FTNS Licenses are prohibited by license conditions from
charging more than their published tariffs for their services. Additionally, the FTNS License conditions prohibit licensees from offering discounts to their published tariffs and require the licensees to seek approval from the Telecommunications
Authority in connection with (i) any revision of published tariffs, (ii) tariffs for any new services or products or (iii) tariffs for any trial services. However, the Telecommunications Authority may grant a waiver of the application
of any or all of these restrictions in relation to a relevant telecommunications market if, in the opinion of the Telecommunications Authority, the licensee is not dominant in such market. This is known as an ex ante regime.



HKBN has been granted a waiver from all the tariff revision prohibitions
contained in its FTNS License and is able to provide discounts and revise its tariffs in all the fixed telecommunications network services markets.



While it is beyond the scope of this annual report to provide a full account of waivers granted, it is important to note that prior to January 14,
2005 PCCW-HKT was the only holder of a FTNS License that was not granted a waiver and was bound by ex ante regulation of its prices in the fixed telephony markets. On January 14, 2005 OFTA issued a new fixed carrier license to PCCW-HKT which
only required PCCW-HKT to notify the Telecommunications Authority of its actual prices at least one day before they become effective. For a more detailed discussion, see the section entitled  Recent Regulatory Developments in the
Telecommunications Industry below in this annual report.



Universal Service Contribution and Local Access Charge



Under the current regulatory regime, as stated in two statements published by the Telecommunications Authority in January 1998 and July 2000, PCCW-HKT has a universal service obligation to provide basic telephone
service to any individual or entity that requests it. To compensate PCCW-HKT for the expenses of this obligation, certain licensees are required to contribute to such cost, which is referred to as the universal service contribution, or USC. Holders
of FTNS Licenses and PNETS ETS Licenses including ourselves, HKBN, and IDD 1600 are required to pay USC.



The level of USC is determined by the Telecommunications Authority and is adjusted periodically. The average rate has declined over the past several
years. The Telecommunications Authority published a statement on November 11, 2005 confirming that the level of provisional USC on or after July 1, 2005 for traffic over Category A Routes is approximately HK$0.3 cents per minute after a
USC adjustment of HK$1.3 cents per minute. The confirmed USC for the period January 1, 2003 to December 31, 2003 for Category A Routes, is HK$0.3 cents per minute after a revised USC adjustment of HK$1.3 cents per minute. For routes that
are to be provided through Reach Networks Hong Kong Limiteds international gateways/facilities (Category B Routes), the actual use is HK$1.6 cents per minute for July 1, 2003 to December 31, 2003. However, after August 2003, all
routes have been classified as Category A Routes and as such, it is no longer necessary for the Telecommunications Authority to set a provisional USC for Category B Routes. However, with the implementation of the new IP Telephony regulatory
framework it is expected that the current USC regime will be reviewed.



Additionally, providers of external telecommunications services, such as holders of PNETS ETS Licenses, including ourselves and IDD 1600, are required to pay a local access charge, or LAC, to the local network operators whose network
facilities holders of PNETS ETS Licenses use to transmit calls to and from their customers sites. The level of the LAC is calculated on a per-minute basis. Although theoretically the operators holding PNETS ETS Licenses may negotiate the level
of LAC with the relevant network operator (whose LAC is not regulated), as at the date of this annual report the bench-mark used by operators is the LAC set by the Telecommunications Authority for PCCW-HKT, whose LAC is determined by the
Telecommunications Authority.



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In February 2004, the Telecommunications Authority completed a review of the principles and costing
methodology of the LAC, subsequent to which the Authority issued a determination on May 4, 2004 revising the LAC for PCCW. The new LAC was intended to be effective from June 1, 2004. However, PCCW successfully applied for a judicial review
of the determination objecting to the principle that only its access charge, and not those of other FTNS operators, is determined by the Telecommunications Authority.



As a result, the determination of May 4, 2004 cannot be implemented and the LAC rates, extant, continue to apply.
Nonetheless the Telecommunications Authority recognizes that market circumstances have been changing and commenced a public consultation entitled Regulation of Local Access Charge on May 20, 2005 by which the Telecommunications
Authority seeks views from interested parties on the future regulation of LACs. The Telecommunications Authority asks whether he should:



| |  | initiate steps to make LAC determinations for all fixed-line operators; or
| | - | --------------------------------------------------------------------------



| |  | make a fresh LAC determination for PCCW (or other local fixed-line operator) on an individual basis if there are legitimate grounds to justify such an action; or
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | make no intervention and allow the parties to the interconnection negotiate and agree on the applicable LAC.
| | - | ------------------------------------------------------------------------------------------------------------



The consultation closed on June 17, 2005 and the Telecommunications
Authority is currently considering the submissions.



Recent Regulatory Developments in the Telecommunications Industry



In recent years, the Telecommunications Authority has introduced various measures to implement the Hong Kong governments policy to liberalize the Hong Kong telecommunications market. The most important changes
have included the full liberalization of the local and external fixed telecommunications network services market and the introduction of a formal competition regulatory framework, as discussed above.



As part of this ongoing process, the Telecommunications Authority and the
Hong Kong government are looking to introduce new measures to address issues relating to the new telecommunications marketplace in Hong Kong.



Currently, the most important regulatory developments include the following:



Revision of Regulatory Regimes for Fixed-Mobile Convergence, or FMC



Currently, fixed and mobile services are two distinct classes of services,
provided by separate operators, through separate networks, and with separate charging mechanisms. With the advent of new technologies, the Telecommunications Authority is of the view that fixed and mobile services will converge. As such, the
Telecommunications Authority issued a Consultation Paper dated September 21, 2005 entitled Revision of Regulatory Regimes for Fixed-Mobile Convergence, or the FMC Consultation Paper, to examine whether the current regulatory regime
will continue to facilitate technological applications, infrastructure investment, market development and enhancement of consumer benefits in the environment of FMC. The issues covered in the FMC Consultation are:



| | (i) | Licensing regime;
| | --- | -----------------



| | (ii) | Certain rights and obligations which are currently applied differentially to the fixed and mobile carriers;
| | ---- | -----------------------------------------------------------------------------------------------------------



| | (iii) | Interconnection charging arrangement between fixed and mobile services;
| | ----- | -----------------------------------------------------------------------



| | (iv) | Local access charge arrangement;
| | ---- | --------------------------------



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| | (v) | Fixed/mobile number portability; and
| | --- | ------------------------------------



| | (vi) | Numbering plan.
| | ---- | ---------------



In particular, the Telecommunications Authority seeks views on whether there is any need for a unified licensing framework and when a detailed formulation
of the unified licensing framework should be commenced. The Telecommunications Authority also seeks views on whether, after the unified licensing framework is implemented, the conversion of the existing fixed or mobile licenses should be voluntary.



The Telecommunications Authority proposes that the unified
carrier license shall be valid for 15 years.



Where an existing
fixed or mobile carrier licensee wishes to convert its license to a unified carrier license. The Telecommunication Authority proposes the following:



| |  | If the existing fixed or mobile carrier licensee surrenders its license to the Telecommunications Authority in return for a unified carrier license under which the scope of service
is equivalent to the existing license, the period of validity of the converted unified carrier license shall expire at the expiration of the period of validity of the existing license. The license conditions of the draft unified carrier license
would be imposed on the licensee and any relevant conditions under the existing fixed (or mobile) carrier license would also be transplanted to the unified carrier license.
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | If the existing fixed or mobile carrier licensee surrenders its license to the Telecommunications Authority in return for a unified carrier license under which the scope of service
is to be expanded, there will be two options available.
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Under Option (a), the licensee will submit proposals on the new services (but not on the existing services). In such a case, the Telecommunications Authority considers it inappropriate to grant a unified carrier license with a validity
period of 15 years to the licensee because it would virtually extend the validity period of the existing carrier license beyond 15 years. Accordingly, the period of validity of the converted unified carrier license shall expire at the expiration of
the period of validity of the existing license. The license conditions of the draft unified carrier license would be imposed on the licensee. In addition, any relevant conditions under the existing fixed (or mobile) carrier license would also be
transplanted to the unified carrier license.



Under Option
(b), the licensee makes a new application for the unified carrier license and submits proposals on both the fixed and mobile services. If the Telecommunications Authority is satisfied that the applications in respect of both the existing and new
services meet the licensing criteria, a unified carrier license will be granted. The validity period of the unified carrier license for the operation of both services should be 15 years from the license issue date. The license conditions of the
draft unified license would be imposed on the licensee but the Telecommunications Authority will not transplant any license rights under the existing fixed (or mobile) carrier license to the unified carrier license if these license rights are no
longer present in a fixed (or mobile) carrier license that the Telecommunications Authority will issue as a new license today. However, it should be noted that the license obligations under the existing fixed (or mobile) carrier license will
be transplanted to the unified carrier license if the Telecommunications Authority is of the view that these license obligations remain relevant to the licensee.



The Telecommunications Authority is minded to keep both Option (a) and Option (b) open and let the interested
parties make their own commercial decision and judgment but the Telecommunications Authority seeks views on whether Option (a), Option (b), or both Options be made available for determining the expiry date of the unified carrier license.



In terms of the rights and obligations under the unified carrier license,
the Telecommunications Authority expresses views and consults on the following:



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| |  | the Telecommunications Authority indicated that he does not intend to set any limitation on the number of unified carrier licenses to be issued.
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------



| |  | whether a unified licensee should make performance commitments.
| | - | ---------------------------------------------------------------



| |  | whether the existing right of access into a building under section 14(1) of the Ordinance should be granted to a unified carrier only if the installation of telecommunications lines
or equipment inside that building is prerequisite for the provision of services by the unified carrier to the residents and occupants of that building, should continue and be maintained.
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | whether unified carriers should be subject to the Telecommunications Authoritys approval on the road opening works on a case-by-case basis and the coordination mechanism set
out in the Road Ordinance Guidelines.
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | whether all unified carriers should comply with the requirement of any-to-any connectivity.
| | - | -------------------------------------------------------------------------------------------



| |  | whether unified carriers should facilitate operator number portability, mobile number portability and fixed/mobile portability.
| | - | -------------------------------------------------------------------------------------------------------------------------------



| |  | whether the status quo on the obligation to provide directory enquiry services should be maintained in the new unified regime in which a unified carrier will not be obliged to
provide directory enquiry services to customers of 2G and 3G mobile services and the directory information of these customers should not be included in any directory databases; whether converged services with limited mobility should be treated like
fixed services in the requirements for the provision of directory services, and whether it is appropriate to continue to require fixed carriers to provide White Pages.
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | the Telecommunications Authority indicated that he is of the preliminary view that the unified carrier license to be issued should adopt the ex post regulatory regime and
that all existing tariff publication requirement should be imposed on all unified carriers and that the Telecommunications Authority may give a direction to waive some of the requirements if he considers it appropriate.
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



On the issue of licensing fees, the Telecommunications Authority proposes to
maintain the $1 million annual fee if the unified license is authorized to provide local services. However, if the unified licensees provide external services only, the annual fee should be HK$200,000. A unified rate of HK$8 per connection might be
set for the subscriber-based fee component. In setting this fee, the relevant consideration is to recover the administrative costs of OFTA in administering the license. It is also proposed that a fee of HK$3 per number be levied based on the
quantity of numbers allocated to the licensee. No changes are proposed for the formulae for calculating the spectrum management fee and base station fee. The FMC Consultation closed on November 21, 2005. The Telecommunications Authority is
currently considering the submissions.



Review Of Regulation
Of Internet Protocol Telephony



Although the
Telecommunications Authority takes the view that IP telephony may be provided under existing licenses, given the specific nature and the technology associated with such service, the Telecommunications Authority issued a consultation paper on
October 4, 2004 to canvass the views of the public with regard to the appropriate regulatory framework for the provision of such service. After considering the submissions of the interested parties, the Telecommunications Authority published a
statement on June 20, 2005 on his findings. In summary, the Telecommunications Authority states the following:



| |  | The Telecommunications Authority will introduce a regulatory regime to allow services-based operators, or SBOs, to enter the market to operate local voice telephony services over an
IP platform.
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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| |  | The Telecommunications Authority will adopt a two-class licensing approach for IP telephony services: class 1 refers to those services that have all the attributes of the
conventional telephone services and are required to fulfill the licensing conditions of the FTNS/FC licenses and class 2 are those services that do not have all the attributes of the conventional telephone services and are only subject to minimal
licensing conditions the main purpose of which is to protect consumer interest and safeguarding fair competition.
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | The Telecommunications Authority will permit provision of IP Telephony services by an operator as an application on the Internet which is assessed through a broadband connection
provided by another operator without any mandatory requirement of having a prior commercial agreement between the IP Telephony provider and the broadband provider. However, these providers are required to highlight the fact that it has no control
over the transmission of the traffic and that services are provided on a best efforts basis.
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | For IP telephony services launched and marketed as class 1 services, customers will be assigned the same 8-digit numbers in the same numbering ranges currently assigned to the users
of the conventional telephone services. In other words, class 1 customers will share the existing prefix 2 and 3 number blocks. For class 2 services, the Telecommunications Authority intends to impose a restriction on the use
of numbers with prefix 2 or 3 but a new range of 8-digit numbers with prefix 57 or 58 will be allocated to users of class 2 telephony services.
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | The number portability obligation will only apply to class 1 services but not to class 2 services.
| | - | --------------------------------------------------------------------------------------------------



| |  | Both class 1 and class 2 services are required to fulfill the any-to-any connectivity principle whenever the numbers under the Hong Kong numbering plan are used for call
routing regardless of the length of the numbers in terms of the number of digits.
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | IP telephony service providers using numbers under the Hong Kong numbering plan are required to provide calling line identification irrespective of whether it is providing class 1
or class 2 services.
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | SBOs of Class 1 and Class 2 Services are required to enter into commercial agreements with one of the FTNS/FC licensees for hosting a connection. The SBOs will not be involved with
the LAC and USC charging mechanisms because under the agreements, the hosting FTNS/FC licensees would be responsible for the payment of the relevant charges to others while the SBOs pay to the hosting FTNS/FC licensee in return.
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | The provision of directory enquiry services and printed directory to customers free of charge will be mandatory for class 1 service providers but voluntary for class 2 service
providers.
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Class 1 service providers are required to provide customers with free access to emergency services and class 2 service providers are required to provide their customers with free
access to emergency services if the customers are assigned numbers from the Hong Kong Numbering Plan. For other types of class 2 services, the provision of free access to emergency services is optional. Those providing access to emergency services
are required to set up a database for maintaining the most up to date information on the location of customers and such database should identify telephone numbers that are potentially nomadic. The service providers are also required to provide a
mechanism whereby the customers can update their location information and remind customers to do so whenever they relocate their IP telephony equipment.
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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| |  | Class 1 service providers are required to provide backup power supply to the network equipment. Where the implementation of the IP Telephony Service requires the installation of a
modem, IAD or other equipment requiring power supply directly from the customer premises concerned, both class 1 and 2 service providers are not required to provide the backup power supply to the network equipment for the IP telephony services.
Class 1 and class 2 service providers are encouraged to label the equipment in order to alert customers that service will be suspended during power failure.
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Both class 1 and class 2 service providers are prohibited from offering their services to life-line users unless they provide backup power supply to the IP phone, IAD,
modem and network equipment.
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Class 1 providers are required to prepare a customer charter setting out minimum standards of service and are required to meet the same quality of standards applicable to
conventional telephone services in the FTNS/FC License.
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Service providers will be required to clearly communicate and educate and customers of the capabilities and limitation of the services before signing service agreements with them.
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



In addition to the above, the Telecommunications Authority will
conduct further consultations on numbering issues related to class 2 services, existing USO/USC regimes, the methodology of calculating LAC and the charging regime for LAC, and whether minimum quality of standard specifications should be prescribed
for class 1 services.



Introduction Of A New Class License
To Regulate Certain Resale Activities



Currently,
telecommunications service providers which provide telecommunications services without establishing or maintaining a means of telecommunications (or pure resellers of telecommunications services) are not subject to the licensing regime outlined
above. However, the Hong Kong government introduced provisions in the Amendment Ordinance in 2000, which provide that a person who, in the course of business, offers a telecommunications service is required to obtain a license. These provisions are
not yet in operation.



The Telecommunications Authority issued
a consultation paper on October 15, 2004 proposing partially to bring into force the provisions referred to above in order to regulate the following two types of resale by the creation of a new class license:



| | (i) | the resale of telecommunications services on a prepaid basis (e.g. the resale of calling cards); and
| | --- | ----------------------------------------------------------------------------------------------------



| | (ii) | the resale of telecommunications services by an associated corporation of a carrier or a telecommunications licensee in a dominant position.
| | ---- | --------------------------------------------------------------------------------------------------------------------------------------------



The consultation period ended on December 14, 2004. As at the date of
this annual report, the submissions received by the Telecommunications Authority are still under review.



Introduction of an Ex post Price Control Regime



The Telecommunications Authority issued a consultation paper on October 8, 2004 regarding its proposal to move from ex ante to ex post regulation of
the tariffs of PCCW-HKT in response to two applications by PCCW-HKT to be declared non-dominant in the markets for residential and business direct exchange line telephone services.



On January 14, 2005, OFTA issued a new fixed carrier license to PCCW-HKT
(to replace its then existing FTNS License) that effectively allows PCCW-HKT to provide discounts to customers in these markets and lifts the requirement that PCCW-HKT obtain prior approval from the Telecommunications Authority before adjusting its
tariffs.



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The two applications made by PCCW-HKT for declaration of non-dominance in business and residential direct
exchange line services have become redundant upon the surrender of its then FTNS license for the new fixed carrier license on January 14, 2005. Under its new fixed carrier license, PCCW-HKT is now only bound by the competition related
regulations prohibiting the abuse of a dominant position in a relevant market or markets (including, for example, a prohibition against predatory pricing) if, and only if, PCCW-HKT is found to be dominant in the relevant market(s). For a
more detailed discussion please refer to the section entitled  Competition Provisions above in this annual report.



Broadband Wireless Access



The Telecommunications Authority issued two consultation papers on December 20, 2004 and August 31, 2005 to consult the public on the licensing
framework for the deployment of Broadband Wireless Access, or BWA.



In the first consultation, the Telecommunications Authority deals with technical issues such as the allocation of a suitable spectrum to BWA, the sharing of spectrum with other services, interference issues, and bandwidth allocation in the
initial phase. The Telecommunications Authority also solicits views on whether he should mandate the technology used in the delivery of BWA services and whether the concerned equipment manufacturers might give rise to competition concerns.



In terms of licensing issues, the Telecommunications Authority
has indicated that he will allow BWA to be offered initially as a wireless extension of the conventional wireline based fixed network service and that the BWA spectrum should be reserved for carriers with an intention to establish fixed networks. In
order to differentiate between BWA services from a full mobile service the Telecommunications Authority proposes that in the initial phase, the service offered through BWA be restricted to limited mobility that excludes cell handoff
capacity.



The first consultation ended on March 14, 2005.
Having considered the submissions received from interested parties, the Telecommunications Authority published the second consultation paper in which he proposes a regulatory framework for the deployment of BWA technologies.



In the second consultation, the Telecommunications Authority dealt with
issues such as the scope of permitted services, the number of licenses, the validity period of the license and the numbering arrangement for services using the BWA spectrum. In order to manage the introduction of BWA technologies, the
Telecommunications Authority proposed the introduction of a new Unified Carrier License.



The Telecommunications Authority proposes, in the second consultation, that any interested party including existing fixed/mobile carriers and new entrants, may bid for the BWA spectrum and, if successful, will be
licensed under the unified carrier license which will permit the licensee to provide fixed telecommunications service using the BWA spectrum from the commencement of the license and to provide both fixed and mobile telecommunications service
commencing from January 1, 2008.



The second consultation
closed on November 21, 2005. The Telecommunications Authority is currently considering the submissions.



Television Broadcasting Industry



History



Until
the end of 1990, Hong Kong had only two television broadcasters, Television Broadcasts Limited, or TVB, and Asia Television Limited, or ATV, that operated under licenses granted by the then Governor in Council under the Television Ordinance.



In December 1990, a satellite television uplink and
downlink license was granted to Hutchvision Hong Kong Limited (now Starvision Hong Kong Limited, or Star TV), by the Telecommunications Authority for the provision of satellite television services. The market was further opened up by the grant
to HKCTV (then known as Wharf Cable Limited) of a broadcasting license for the provision of subscription television services in 1993. To protect the heavy investment involved in the provision of subscription television services, the Hong Kong
government agreed to grant exclusivity to HKCTV for three years.



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In March 1993, PCCW-HKT was permitted to conduct a commercial trial of video-on-demand services, which we
refer to in this annual report as VOD. The VOD trial service provided by PCCW-HKT led to HKCTV taking legal action against both the Hong Kong government and PCCW-HKT alleging breach of its exclusive license. However, it was held that VOD should not
be classified as a broadcasting service for the purpose of the then Television Ordinance (now repealed, see below) but as a point-to-point telecommunications service which PCCW-HKT would be entitled to provide under its telecommunications concession
granted under the Telephone Ordinance.



Following a
comprehensive review of the pay-TV industry in 1996, the Television Ordinance was amended in 1997 and a new category of license  programme service license  was created to bring the VOD services into the television regulatory
regime. In 1998, a program service license was granted to PCCW VOD Limited, or PCCW-VOD.



In September 1998, the CTB (then the Information Technology and Broadcasting Bureau) published a consultation paper entitled 1998 Review of Television Policy. A number of important decisions were made
following the review including that the moratorium on pay-TV would be lifted and the market for pay-TV would be opened for free competition from 1998.



Simultaneously, the CTB proposed new legislation implementing the policy decisions reached by the Hong Kong government in 1998 and intended to replace the
Television Ordinance. The proposed legislation would establish a new regulatory regime under which the broadcasting service and the operation of the underlying telecommunications systems (for the transmission of the broadcasting service) would be
regulated separately, with the broadcasting service itself being subject to the new legislation and the operation of the underlying telecommunications systems subject to the telecommunications regulatory regime.



At present, Hong Kong has two licensed domestic terrestrial broadcasters, TVB
and ATV, providing free-to-air broadcasting services. In addition, there are also three licensed domestic pay-TV broadcasters, namely HKCTV, PCCW-VOD and Galaxy Satellite Broadcasting Limited. HKBN provides TV services over the Internet under its
FTNS License, while Star TV continues to provide its services through satellite means under its satellite television uplink and downlink license.



Regulatory Environment



The main legislation in Hong Kong which regulates the television broadcasting industry is the Broadcasting Ordinance (Cap. 562) and the Broadcasting
(License Fees) Regulations (Cap. 562A). The Broadcasting Ordinance was enacted in 2000 and repealed the Television Ordinance in its entirety.



The Broadcasting Authority, a statutory board established under the Broadcasting Authority Ordinance (Cap. 391), is the main regulator of the television
broadcasting industry in Hong Kong.



Licensing



The Broadcasting Ordinance provides that it is an
offence to provide a broadcasting service without a license. Broadcasting service is further divided into four categories:



| |  | domestic free television program service;
| | - | -----------------------------------------



| |  | domestic pay television program service;
| | - | ----------------------------------------



| |  | non-domestic television program service; and
| | - | --------------------------------------------



| |  | other licensable television program service.
| | - | --------------------------------------------



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Television programme service is broadly defined to mean the provision of television programs
for transmission by telecommunications that are readily accessible to the general public in or outside Hong Kong or to persons in 2 or more specified premises simultaneously or on demand, whether on a point-to-point or a point-to-multipoint basis.



The Broadcasting Ordinance importantly exempts certain
categories of television program services from the current licensing regime, including television program services provided on the service commonly known as the Internet. The Broadcasting Ordinance itself does not contain a definition of
Internet. The Secretary for Commerce, Industry and Technology has indicated that on the condition that HKBN continues to provide its service on the platform currently deployed by HKBN, the Government does not dispute that HKBNs
service is provided on the Internet and is thus exempt. On this basis, HKBN has not obtained a pay-television broadcasting license and provides IP-TV services under its FTNS License. Nevertheless, we applied for a domestic pay-TV program
service license in October 2005 to enable us to have the flexibility of providing pay-TV services via means other than our Metro Ethernet network, such as via satellite.



The exemption reflects the policy decision reached by the Hong Kong government in its 1998 television policy review. The
policy statement issued by the CTB in December 1998 states that any new multimedia service, including Internet originated in Hong Kong, which offers television-type program services on a commercial basis and competes with television program services
operating in Hong Kong should require a television program service license but that Web TV should continue to be regulated as an Internet service until it is caught by the foregoing description.



The commercial television broadcasting licenses granted to TVB and ATV under
the Television Ordinance are deemed to be domestic free television program service licenses. The Telecommunications Authority also issued to each of TVB and ATV a fixed carrier license in December 2003 in relation to the operation of the underlying
fixed telecommunications network.



The subscription television
broadcasting license issued to HKCTV and the program service license granted to PCCW-VOD under the Television Ordinance are deemed to be domestic pay television program service licenses. PCCW-VOD applied to the Hong Kong government for the surrender
of its original program service license and requested the Chief Executive in Council to issue to it a domestic pay television program service license. Such a license was granted to PCCW-VOD in 2003.



The validity period of a broadcasting license varies and will be determined
by the Chief Executive in Council but it is unlikely that a license with a validity period exceeding 12 years would be approved.



The license fee payable by a broadcasting licensee is set forth in the Broadcasting (License Fee) Regulation. The license fee comprises a number of
components, which include a fixed annual amount (e.g. for a domestic pay television program service license, the amount is currently set at around HK$1.4 million) and a variable component (e.g. for a domestic pay television program service license,
HK$4 for each subscriber).



Cross Media Ownership
Restrictions



As with other television regulatory
regimes, there are detailed cross-media ownership restrictions in the Broadcasting Ordinance. The restrictions are only applicable to domestic free and domestic pay television program service licenses.



The Broadcasting Ordinance essentially provides that a company which is
either a disqualified person or has a disqualified person exercising control over it will not be eligible to be granted a broadcasting license unless it discloses the disqualification in its license application.



Disqualified person as defined under Sections 4, 5, 6 and 7 of
Schedule 1 of the Broadcasting Ordinance includes, for example,



| |  | a company which is an existing domestic free or domestic pay television program licensee;
| | - | -----------------------------------------------------------------------------------------



| |  | an advertising agent;
| | - | ---------------------



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| |  | a sound broadcasting licensee; or
| | - | ---------------------------------



| |  | a proprietor of newspaper printed or produced in Hong Kong.
| | - | -----------------------------------------------------------



A disqualified person who has complied with the disclosure requirement (and is otherwise in compliance with Section 8 of the Broadcasting Ordinance)
may apply for a broadcasting license pursuant to Section 10 of the Broadcasting Ordinance. The Broadcasting Ordinance provides that the Chief Executive in Council may grant a broadcasting license to a company, including a disqualified person or
to a company which has a disqualified person exercising control, over it or to a disqualified person in which another disqualified person exercises control subject to such conditions as the Chief Executive in Council sees fit.



Foreign Ownership Restrictions



In addition to the cross-media ownership restrictions outlined above, the
Broadcasting Ordinance also imposes restrictions on foreign ownership of a holder of a domestic free television program service license. The restrictions do not prohibit the ownership of any voting shares in a domestic free television program
service licensee but rather take the form of prohibiting the exercise of any voting rights attached to such voting shares.



Competition Provisions



The Broadcasting Ordinance also contain competition provisions which are aimed at:



| |  | prohibiting a licensee from engaging in anti-competitive conduct which is conduct that has the purpose or effect of preventing, distorting or substantially restricting
competition in a television program service market;
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | prohibiting a licensee who is in a dominant position from abusing its position.
| | - | -------------------------------------------------------------------------------



Certain trade practices however are exempted from the prohibition on anti-competitive conduct
provision and these include restrictions imposed on the inclusion in a television program service of a television program produced wholly or substantially by the licensee of the service.



The Broadcasting Ordinance provides that a breach of any of the competition statutory provision may lead to the relevant
contractual provisions in an agreement being regarded as void.



The Broadcasting Authority to this end issued two guidelines in 2001: the Competition Investigation Procedures and Guidelines to the Application of the Competition Provisions of the Broadcasting Ordinance and Guidelines to
the Application of the Competition Provisions of the Broadcasting Ordinance. These guidelines outline the enforcement procedures and the competition analytical framework which the Broadcasting Authority intends to adopt in order to implement
the competition provisions.



The Broadcasting Authority
recently concluded the investigation of a number of competition complaints relating to certain sports broadcasting rights involving HKCTV, ATV and TVB.



Unlike the regulatory regime for the telecommunications industry, there is no equivalent of a specialized competition appeal board for the television
broadcasting industry. A licensee aggrieved by a decision made by the Broadcasting Authority however may lodge an appeal to the Chief Executive in Council.



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Program Standards and Advertising Standards



A broadcasting licensee is required to comply with the program standards and the advertising standards published by the
Broadcasting Authority. The program standards and the advertising standards were revised recently in June 2003 and August 2004, respectively.





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Organizational Structure



The following chart sets forth our principal subsidiaries as of January 17, 2006:



LOGO

---

|(1) | The other immediate subsidiary of City Telecom (H.K.) Limited is Golden Trinity Holdings Limited, which has Warwick Gold Enterprises Limited and Attitude Holdings
Limited as its immediate subsidiaries.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(2) | The company has only registered its Chinese name. The English name is an unregistered translation.
|--- | --------------------------------------------------------------------------------------------------



|(3) | The other immediate subsidiaries of Automedia Holdings Limited are Global Courier Company Limited (formerly known as iStore.com Limited), CTI International Limited,
BBTV Company Limited, City Telecom (U.S.A.) Inc., City Telecom (Vancouver) Inc. and City Telecom (Toronto) Inc.
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(4) | The other subsidiary of City Telecom (Canada) Inc. is 963673 Ontario Ltd.
|--- | -------------------------------------------------------------------------



|(5) | The immediate subsidiaries of Hong Kong Broadband Network Limited are Excel Billion Profits Limited, Hong Kong Television Network Limited, Hong Kong Broadband
Television Company Limited and Hong Kong Broadband Phone Limited and Hong Kong Broadband Digital TV Limited (formerly known as TeachOnNet.com Limited).
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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The jurisdiction of incorporation and our ownership percentage of each these subsidiaries as of
January 17, 2006 were as follows:



|                                                                                  |  |                              |  |                                               |  |         
|--------------------------------------------------------------------------------- |  | ---------------------------- |  | --------------------------------------------- |  | --------
|                                                                                  |  |                              |  | Percentage of interestheld by City Telecom(%)
|Name                                                                              |  | Jurisdiction ofIncorporation |  | Direct                                        |  | Indirect
|963673 Ontario Limited                                                            |  | Canada                       |  |                                               |  | 100     
|Attitude Holdings Limited                                                         |  | British Virgin Islands       |  |                                               |  | 100     
|Automedia Holdings Limited                                                        |  | British Virgin Islands       |  | 100                                           |  |         
|BBTV Company Limited                                                              |  | Hong Kong                    |  |                                               |  | 100     
|City Telecom (B.C.) Inc.                                                          |  | Canada                       |  |                                               |  | 100     
|City Telecom (Canada) Inc.                                                        |  | Canada                       |  |                                               |  | 100     
|City Telecom (Toronto) Inc.                                                       |  | Canada                       |  |                                               |  | 100     
|City Telecom (U.S.A.) Inc.                                                        |  | United States                |  |                                               |  | 100     
|City Telecom (Vancouver) Inc.                                                     |  | Canada                       |  |                                               |  | 100     
|City Telecom Inc.                                                                 |  | Canada                       |  |                                               |  | 100     
|City Telecom International Limited                                                |  | British Virgin Islands       |  | 100                                           |  |         
|Credibility Holdings Limited                                                      |  | British Virgin Islands       |  | 100                                           |  |         
|CTI Guangzhou Customer Services Co. Limited(1)                                    |  | China                        |  | 100                                           |  |         
|CTI International Limited                                                         |  | Hong Kong                    |  |                                               |  | 100     
|CTI Marketing Company Limited                                                     |  | Hong Kong                    |  |                                               |  | 100     
|Excel Billion Profits Limited                                                     |  | Hong Kong                    |  |                                               |  | 100     
|Golden Trinity Holdings Limited                                                   |  | British Virgin Islands       |  | 100                                           |  |         
|Global Courier Company Limited (formerly known as iStore.com Limited)             |  | Hong Kong                    |  |                                               |  | 100     
|Hong Kong Broadband Digital TV Limited (formerly known as TeachOnNet.com Limited) |  | Hong Kong                    |  |                                               |  | 100     
|Hong Kong Broadband Network Limited                                               |  | Hong Kong                    |  |                                               |  | 100     
|Hong Kong Broadband Phone Limited                                                 |  | Hong Kong                    |  |                                               |  | 100     
|Hong Kong Broadband Television Company Limited                                    |  | Hong Kong                    |  |                                               |  | 100     
|Hong Kong Television Network Limited                                              |  | Hong Kong                    |  |                                               |  | 100     
|IDD1600 Company Limited                                                           |  | Hong Kong                    |  |                                               |  | 100     
|Warwick Gold Enterprises Limited                                                  |  | Hong Kong                    |  |                                               |  | 100     

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



Property, Plants and Equipment



For the provision of fixed telecommunications network
services, we own, or control through long-term leases, equipment consisting of in-building wiring, switching, transmission and receiving equipment and connecting lines comprised of fiber-based backbone, wireless and leased wire-line backbone and
other support structures, conduits and similar items that comprise our Metro Ethernet network. The majority of the fiber-based backbone connecting our services to other telecommunications operators and power sources are under public road, highways
and streets. HKBN, our wholly owned subsidiary, owns two offices with an aggregate of 147,000 square feet and two switching centers comprised of six switching systems in Hong Kong.



For the provision of international telecommunications services, we own three switching systems in Hong Kong and two in
Canada (one each in Vancouver and Toronto). We have invested and have rights to dedicated capacity in two undersea cables, the Japan-U.S. cable and the APCN 2 cable, for use as international transmission facilities, both of which were completed and
have been operational since May 2002.



In addition, we lease
property in Hong Kong for four retail shops and for a 3,500 square foot customer service center in Mongkok.



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ITEM 5.    
OPERATING AND FINANCIAL REVIEW AND PROSPECTS



You should read the following discussion together with the rest of this annual report, including the financial statements and related notes included elsewhere in this annual report. The results
discussed below are not necessarily indicative of the results to be expected in any future periods.



Overview



We are an innovative provider of residential and corporate fixed telecommunications network and international telecommunications services in Hong Kong. We
offer our customers an integrated suite of broadband Internet access, local VOIP, IP-TV and corporate data services through our self-owned Metro Ethernet network. As of August 31, 2005 we had a total of approximately 631,000 fixed
telecommunications network services subscriptions, consisting of approximately 229,000 broadband Internet access, 293,000 local VOIP and 109,000 IP-TV services subscriptions. In addition to providing fixed telecommunications network services, we
believe that we are one of the largest providers of international telecommunications services in Hong Kong. We offer a variety of international telecommunications services and products including direct dial services, international calling cards and
mobile call forwarding services. Our total international telecommunications services customer database comprises approximately 2.1 million registered accounts with an average of 500,000 customers that are billed on a monthly basis.



Our self-owned network is one of the worlds largest Metro Ethernet
networks and is cited as a global reference case by our primary vendors, Cisco Systems, Inc. and Nortel Networks Limited. Our Metro Ethernet network has a current coverage of 1.2 million home passes, which represents approximately 60% of Hong
Kongs population. The coverage of our network is concentrated in Hong Kongs most densely populated areas and reaches 3,300 residential buildings with approximately 360 residences per building and approximately 700 commercial buildings
making us one of the largest residential fixed telecommunications network operators in Hong Kong. In most other markets, Metro Ethernet is primarily used in commercial buildings in metropolitan areas, as the technology is most cost effective in
dense user populations where a provider can service a large number of users in a single building or cluster of buildings. We have applied this technology to densely populated residential areas in Hong Kong where most of our customers live in
high-rise apartment buildings with multiple apartments per floor. This has enabled us to contain our core network costs to approximately US$130 per home pass. Our Metro Ethernet network conforms to industry standards for 10/100/1,000 Mbps Internet
access speeds. All of our fixed telecommunications network services are based on the single Internet Protocol, or IP, platform of our Metro Ethernet network, unlike our competitors who use multiple platforms to provide their services. In addition,
unlike other new entrant operators, we operate an end-to-end network that transmits data between our subscribers premises, our IP network hub sites and our switching centers in Hong Kong.



We were incorporated in May 1992 and we began offering international
telecommunications services in September 1992. From that date, we focused on increasing our subscription base and amount of international traffic, and on building the CTI brand name as a low cost provider of international telecommunications
services. In January 1999, we became the first Hong Kong company to obtain a public non-exclusive telecommunications services license, which we refer to in this annual report as a PNETS License, covering the provision of international
telecommunications services using international simple resale, which had a significant positive impact on our international telecommunications revenues. We incorporated HKBN in Hong Kong in August 1999 and launched our broadband Internet access
services in March 2000. In addition, we began providing local VOIP services in April



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2002, IP-TV services in August 2003, and corporate data services in July 2004 using our Metro Ethernet network.



Because of the various changes to our business over the past five years, our
ability to forecast our revenues with any degree of accuracy is somewhat limited. In addition, our planned capital expenditures and our marketing and sales expenditures may not necessarily lead to increased revenues. Our total revenues decreased by
0.7% from HK$1,169.9 million in fiscal 2004 to HK$1,162.1 million in fiscal 2005 due to a significant decrease in revenues from our international telecommunications services. The 15.2% decline in our international telecommunications services
revenues from HK$ 628.0 million in fiscal 2004 to HK$532.6 million in fiscal 2005 offset our 16.2% increase in fixed telecommunications network services revenues from HK$541.9 million in fiscal 2004 to HK$629.5 million in fiscal 2005. In
addition, for the first time in our operating history we suffered a net loss from operations. Income from operations decreased from a profit of HK$45.3 million in fiscal 2004 to a loss of HK$128.4 million in fiscal 2005 mainly due to lower revenues
in our international telecommunications services and substantial early-stage costs incurred for our IP-TV services.



In fiscal 2005, our international telecommunications business experienced a decrease in the total number of minutes carried as well as a decrease in
average tariff rates resulting in a decrease in revenue and a net loss from operations. If average tariff rates continue to fall, we expect that the profit margins in the international telecommunications services will continue to decrease. To
maintain our market share, we must continue to offer our subscribers telecommunications services that are competitive with the prices offered by other market players. We therefore must continue to lower our costs of providing these services if we
are to maintain our profitability in this business. We cannot be sure that we will be able to reduce our operating costs and if we fail to do so, our profits may be adversely affected. We cannot assure you that we will be able to prevent our
international telecommunications total revenues and profits from continuing to decline.



Our fixed telecommunications network services revenues increased in fiscal 2005 primarily due to 35.7% growth in our subscription base to approximately 631,000 users as of August 31, 2005. However, our fixed
telecommunications network services suffered a loss from operations due to a provision for mobile interconnection charges, substantial acquisition and marketing costs, and early stage development costs for our IP-TV business. For more information on
our provision for mobile interconnection charges, see Our Revenues Fixed Telecommunications Network Services below in this annual report. In fiscal 2005, we focused on obtaining new fixed telecommunications network services
subscriptions through various promotions including free trials of our IP-TV services for periods from six to twelve months. We may not be able to generate sufficient revenues from these new subscriptions in the future to justify their acquisition
costs and as a result we may not be able to prevent our total revenues and profits from continuing to decline.



Operating Environment



Our fixed telecommunications network operations



The wireless-based FTNS License that HKBN obtained from the Telecommunications Authority in February 2000 provided HKBN with the authority to begin
installation of the wireless network that we use to provide broadband Internet access services. To enable HKBN to provide fixed telecommunications network services using wire-line technology in addition to wireless technology, our FTNS License was
amended in April 2002 to include provision of local fixed wireline network services. This amendment allowed us to develop our own fiber-based backbone to replace our existing wireless and leased wireline-based backbone. We currently have
approximately 85% of our Metro Ethernet home passes serviced by our self-owned fiber-based backbone. To maximize our return on investment, we have focused on



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building our Metro Ethernet network in Hong Kongs most densely populated areas to achieve cost savings and provide additional bandwidth capacity for
further growth. After our initial capital expenditure, we expect our operating costs to decline and our service quality to improve because we will rely less on backbone transmission facilities owned by third parties and thereby decrease the leasing
fees that we pay.



Having our own fiber-based backbone allows
us to offer broadband Internet access, local VOIP, IP-TV and corporate data services over a single IP platform without being subject to network limitations of other fixed telecommunications network operators. During fiscal 2005, we devoted
considerable resources to marketing our broadband Internet access, local VOIP and IP-TV services. As a result, our revenues from fixed telecommunications network services grew by 16.2% from HK$541.9 million in fiscal 2004 to HK$629.5 million in
fiscal 2005.



Our international telecommunications
operations



From September 1992 until December 1998, we
relied on the circuits of local fixed line network operators and other overseas carriers to transmit our international calls. This type of international telecommunications service is commonly referred to as callback. A change in Hong
Kong telecommunications regulations that took effect in January 1999 allowed us to obtain a license to use international simple resale to transmit international calls. In 2001 we obtained a satellite based External FTNS License, and then upgraded to
a full External FTNS License in 2002. We have since acquired the exclusive use of several leased international transmission circuits for direct transmission of international calls between our switches in Hong Kong and switches in other countries.
The license upgrades have had a positive effect on our international telecommunications revenues and profits. Additionally, in part due to use of our self-owned capacity on undersea cables, the quality of the service we provide has improved and our
transmission costs have decreased.



Our total international
telecommunications services customer database comprises approximately 2.1 million registered accounts with an average of 500,000 customers that are billed on a monthly basis. During fiscal 2005, we experienced a reduction in total traffic
volume of 5.9% from 1,007.0 million minutes for fiscal 2004 to 947.1 million minutes for fiscal 2005. Competition during the year was intense as some of our integrated competitors offered free or very low cost international direct dial
minutes as a customer incentive to gain local fixed line and mobile market share. Further, technology substitution from global VOIP providers such as Skype, whom offer free PC-to-PC based international calls, is also becoming more prevalent. As a
consequence of reduced minutes and lower revenues per minute, our total international telecommunications revenues decreased by 15.2% from HK$628.0 million in fiscal 2004 to HK$532.6 million in fiscal 2005.



Our Revenues



Fixed Telecommunications Network Services. We charge our
customers a monthly service charge for each of the fixed telecommunications network services that we provide, and the scalability of our network allows us to sell additional services to our existing customers, for example adding local VOIP or IP-TV
services to our current broadband Internet subscribers, with minimal additional network and operating costs. As a result, each new service we add to our existing subscription base contributes significantly to our profitability. We have not generally
sold our fixed telecommunications network services bundled together at discounted rates. Instead, we have focused on increasing our subscription base by offering a single service to new subscribers at an attractive entry price. After the customer
has begun to use our service, we then try to up-sell additional services to the customer.



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In addition to the monthly service charges generated by our fixed telecommunications network business, we
also receive interconnection charges from other telecommunications operators in Hong Kong that use our network to deliver their customers telecommunications traffic. These charges include:



| |  | Local access charges, which we earn when other carriers international telecommunications traffic is carried over our network;
| | - | ------------------------------------------------------------------------------------------------------------------------------



| |  | Local interconnection charges, which are per-call and per-minute charges for other fixed line carriers calls that are terminated on our network; and
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Mobile interconnection charges, which we charge to mobile telecommunications operators that deliver incoming and outgoing traffic over our network. In fiscal 2005, we recognized
revenue from mobile interconnection charges of HK$24.7 million. However, the mobile operators to whom we provide mobile interconnection services have not paid us the mobile interconnection charges that we have billed. The TA is currently considering
the rate at which we are entitled to receive mobile interconnection charges, and as a result, we might not receive all of the revenue that we have recognized for providing mobile interconnection services. Please see Risk Factors  We
recognized revenues for mobile interconnection charges in fiscal 2002 to fiscal 2005 that have not yet been paid to us. In fiscal 2005, we made a partial provision for the revenues charged in fiscal 2002 to fiscal 2004 and are awaiting the outcome
of the determination by the Telecommunications Authority on the level of mobile interconnection charges that mobile operators are required to pay us.
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



In late November 2005, we entered into an agreement with a mobile operator to pay HKBN an interim mobile interconnection
charge based on PCCW-HKTs published fully distributed cost model of HK$0.0436 per occupancy minute until the TA determines the rate. Further, in December 2005, the Telecommunications Authority indicated a preliminary target timetable for
making a determination by the end of April 2006. Although this is the Telecommunications Authoritys preliminary timetable for its determination, our management believes that this has lessened the timing uncertainty of the collectibility of the
mobile interconnection charges which concerned us in November 2005. However, management believes that the heightened competition in the telecommunications market in the past twelve months has increased the likelihood of appeals by either the mobile
party in question or mobile parties subsequently impacted by the determination.



We cannot predict the outcome of the TAs determination. If the mobile interconnection charges that we recognized in fiscal 2004 and fiscal 2005 are at rates higher than the rates determined by the TA, we will be
required to reverse part of the recognition of revenue or make a provision for bad debt, which will adversely affect our operating results. Further, if the mobile operators involved are successful in an appeal of the TAs determination, we may
not be able to collect any amounts that have been recognized as revenue from the mobile operators.



International telecommunications.Substantially all of our international telecommunication revenues are generated by the per minute fees
that we charge our IDD customers. For each of our 1666 and 0030 calling plans, these charges vary according to the destination of the call. For our 0030 calling plan, we also provide certain discounts that depend on the time of day or day of the
week at which the call is placed.



In addition to our per
minute charges, we also record as international telecommunications revenues the sale of household and office appliances and other products to existing residential and corporate customers through our telemarketers, direct mail and on our website.
Revenue from this activity accounted for approximately 5.7% of our international telecommunications revenues in fiscal 2005.



Our Expenses



Fixed Telecommunications Network Services. Since 2001, we have invested significant resources in the development and expansion of our Metro
Ethernet network. The scalability of this network allows us to provide multiple services and increase our revenues per subscription with only small incremental increases to our network costs.



Network Costs. Our fixed telecommunications network costs primarily
consist of four components:



| |  |  | Backbone expenses. To provide broadband Internet access, local VOIP and IP-TV services in areas where we have not yet installed our own fiber-based backbone,
we incur leased wireline backbone charges, which we currently pay to other local fixed telecommunications network operators, with respect to the fixed lines that carry the data between the subscribers premises, our IP network hub sites and our
two switching centers in Hong Kong. However, as we continue to upgrade and expand our
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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| | fiber-based backbone, our reliance on leased transmission capacity has declined significantly.
| | ----------------------------------------------------------------------------------------------



| |  |  | Program fees for IP-TV. We incur costs for self-produced programs and pay fees to third-parties for their content that is offered in our IP-TV service.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Local interconnection charges. We pay fees to local fixed network operators to transmit information that originates on our network and is terminated outside our network over
their fixed lines.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | International leased lines. We pay fees to international bandwidth providers in connection with the leased lines that carry the data from our switching centers to overseas
destinations.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Other Operating Expenses.We have incurred significant operating costs related to our efforts to promote our broadband Internet access, local VOIP, IP-TV and corporate data services. As a result, our sales and marketing costs in subscription acquisition activities have
been relatively high. During fiscal 2005, we spent approximately 35% of our fixed telecommunications network services revenues on sales and marketing activities. We expect that we will be required to continue to invest significant financial and
human resources in our sales and marketing efforts as we strive to build our subscription base, particularly as we work towards enhancing our brand value.



Other operating expenses related to our fixed telecommunications network services include salaries and related costs, office, general and administrative
costs and depreciation and amortization. Our salaries and related costs include those employees working on our various service offerings and on the upgrade and expansion of our Metro Ethernet network.



International telecommunications. The expenses we incur for our
international telecommunications business consists of costs related to transmission, or network costs, and operating expenses. Our network costs currently comprise five components:



| |  |  | Termination charges. When our subscribers calls arrive at the destination countries, they are transferred to a local network services operator who delivers the calls to
their final destination. 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 five components that comprise our international telecommunications network expenses,
termination charges represent the largest component.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Local Access Charges. We pay to the network carriers whose local loop facilities we use to transmit calls to and from our customers sites a local access charge, or LAC.
Our LACs are calculated on a per-minute basis. LACs have been a significant component of our cost of service for our IDD business, although we do not incur LAC charges for IDD calls made by our customers that are also subscribers to our local VOIP
service as we do not require the use of other carriers facilities for such calls.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Charges for our international leased lines. We lease international transmission circuits from other international carriers between Hong Kong and a number of
countries. We use these circuits to carry our international traffic to and from such countries. We make fixed monthly lease payments to these international carriers in
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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| | connection with these circuits. In fiscal 2005, we continued to benefit from our plan to reduce our reliance on transmission facilities owned by third
parties and lower our network costs. Specifically, we capitalized on the two contracts that we had entered into with large consortia of international telecommunications companies to acquire undersea cable capacity. Through the first contract, we
invested in the Japan-U.S. undersea cable, which was completed in August 2001. Pursuant to the second contract, we agreed to jointly construct and maintain the APCN 2 undersea cable as an international transmission facility, which commenced
operation in May 2002. We spent a total of HK$120 million on these projects. We believe the utilization of these undersea cables provides sufficient international capacity for significant growth of our international call and broadband Internet
services.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Universal Services Contribution. PCCW-HKT has a universal service obligation to provide basic telephone service to any individual or entity that requests it. To compensate
PCCW-HKT for the expenses of this obligation, all incoming and outgoing international calls in Hong Kong are charged a per-minute fee payable to PCCW-HKT. The Telecommunications Authority periodically adjusts the amount of this fee, which is
commonly referred to as the USC, and our average rate has declined over the past several years. The provisional USC was approximately HK$0.3 cents per minute as of August 31, 2005 and 2004. We have historically paid PCCW-HKT USC fees according
to the provisional USC rate stipulated by the Telecommunications Authority, which were greater than the actual USC fees that the Telecommunications Authority has subsequently determined that we owe. As a result, we have deducted from our cost of
services a USC fee refund from PCCW-HKT in each of fiscal 2003, 2004 and 2005. However, we cannot predict whether we will continue to receive refunds or whether the Telecommunications Authority may determine in the future that we have underpaid the
USC and require us to make whole the shortfall, if any, in payments to PCCW-HKT.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | CTImall and INCmall cost of goods. These costs include the cost of goods purchased for sale to our residential and corporate customers through CTImall and INCmall,
respectively.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Other Operating Expenses.
In addition to network costs, we generally incur significant sales and marketing expenses in connection with our international telecommunications business. Sales and marketing expenses consist of advertising costs, promotional and public relations
expenses and the salaries and other expenses relating to our commission-based sales personnel. Other operating costs include maintenance costs associated with our network equipment, salaries and other related expenses, office expenses and
depreciation and amortization charges.



Inflation



We do not believe that inflation has had a material
effect on our business, financial condition or results of operations. If our costs were to become subject to significant inflationary pressures, we may not be able to fully offset such higher costs through price increases. Our inability or failure
to do so could adversely affect our business, financial conditions and results of operations.



Seasonality



Our
operations are not generally subject to significant seasonal fluctuations. Our international telecommunications revenues typically experience a slight decrease during the second fiscal quarter of each year (December through February) in connection
with the



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Chinese New Year holiday. We do not believe that seasonality has had a material effect on our business, financial condition or results of operations.



Operating Results



In addition to our operations in Hong Kong, we also provide international
telecommunications and Internet access services in Canada. We own all of the share capital of two telecommunications companies in Canada, City Telecom Inc. and City Telecom (B.C.) Inc., through a wholly owned subsidiary. We acquired our interests in
these companies in December 1998 as part of our efforts to increase our market share of the telecommunications traffic between Canada and Hong Kong.



Our consolidated financial statements reflect the consolidated results of operations and financial position of these subsidiary companies from the date of
their acquisition by us. However, as of August 31, 2005, none of these subsidiary companies located outside of Hong Kong has made a material contribution to our revenues or results of operations, and in fiscal 2005, they contributed
approximately 2.0% to our revenues.



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



|                                            |  |                       |   |  |            |   |  |            |   |  |          |  
|------------------------------------------- |  | --------------------- | - |  | ---------- | - |  | ---------- | - |  | -------- | -
|                                            |  | Year Ended August 31, |  
|                                            |  | 2003                  |   |  | 2004       |   |  | 2005       |   |  | 2005     |  
|                                            |  | HK$                   |   |  | HK$        |   |  | HK$        |   |  | US$      |  
|                                            |  | (In thousands)        |  
|Hong Kong GAAP                              |  |                       |  
|Revenues                                    |  |                       |  
|Fixed telecommunications network services   |  | 423,107               |   |  | 541,902    |   |  | 629,464    |   |  | 80,993   |  
|International telecommunications            |  | 875,802               |   |  | 627,978    |   |  | 532,595    |   |  | 68,529   |  
|                                            |  |                       |   |  |            |   |  |            |   |  |          |  
|                                            |  | 1,298,909             |   |  | 1,169,880  |   |  | 1,162,059  |   |  | 149,522  |  
|                                            |  |                       |   |  |            |   |  |            |   |  |          |  
|Operating Expenses:                         |  |                       |   |  |            |   |  |            |   |  |          |  
|Network costs                               |  |                       |   |  |            |   |  |            |   |  |          |  
|Fixed telecommunications network services   |  | (76,845               | ) |  | (122,476   | ) |  | (118,383   | ) |  | (15,232  | )
|International telecommunications            |  | (245,908              | ) |  | (208,932   | ) |  | (221,019   | ) |  | (28,439  | )
|                                            |  |                       |   |  |            |   |  |            |   |  |          |  
|Total network costs                         |  | (322,753              | ) |  | (331,408   | ) |  | (339,402   | ) |  | (43,671  | )
|                                            |  |                       |   |  |            |   |  |            |   |  |          |  
|Other operating expenses                    |  |                       |   |  |            |   |  |            |   |  |          |  
|Salaries and related costs                  |  | (220,350              | ) |  | (226,650   | ) |  | (252,987   | ) |  | (32,552  | )
|Sales and marketing expenses                |  | (182,471              | ) |  | (228,169   | ) |  | (267,423   | ) |  | (34,409  | )
|Office, general and administrative expenses |  | (108,270              | ) |  | (129,787   | ) |  | (157,497   | ) |  | (20,265  | )
|Depreciation and amortization               |  | (176,020              | ) |  | (197,017   | ) |  | (237,714   | ) |  | (30,587  | )
|Provision for doubtful accounts receivable  |  | (17,685               | ) |  | (11,502    | ) |  | (35,445    | ) |  | (4,561   | )
|                                            |  |                       |   |  |            |   |  |            |   |  |          |  
|Total other operating expenses              |  | (704,796              | ) |  | (793,125   | ) |  | (951,066   | ) |  | (122,374 | )
|                                            |  |                       |   |  |            |   |  |            |   |  |          |  
|Total Operating Expenses                    |  | (1,027,549            | ) |  | (1,124,533 | ) |  | (1,290,468 | ) |  | (166,045 | )
|                                            |  |                       |   |  |            |   |  |            |   |  |          |  
|Income/(loss) from operations               |  | 271,360               |   |  | 45,347     |   |  | (128,409   | ) |  | (16,523  | )
|Interest income                             |  | 3,163                 |   |  | 3,753      |   |  | 13,578     |   |  | 1,747    |  
|Interest expense                            |  | (601                  | ) |  | (175       | ) |  | (54,462    | ) |  | (7,007   | )
|Other income, net                           |  | 1,678                 |   |  | 2,668      |   |  | 6,037      |   |  | 777      |  
|                                            |  |                       |   |  |            |   |  |            |   |  |          |  
|Income/(loss) before taxation               |  | 275,600               |   |  | 51,593     |   |  | (163,256   | ) |  | (21,006  | )
|Income taxes (charge)/credit                |  | (17,857               | ) |  | (2,043     | ) |  | 6,725      |   |  | 865      |  
|                                            |  |                       |   |  |            |   |  |            |   |  |          |  
|Income/(loss) after taxation                |  | 257,743               |   |  | 49,550     |   |  | (156,531   | ) |  | (20,141  | )
|Minority interest                           |  |                      |   |  |           |   |  |           |   |  |         |  
|                                            |  |                       |   |  |            |   |  |            |   |  |          |  
|Net income/(loss)                           |  | 257,743               |   |  | 49,550     |   |  | (156,531   | ) |  | (20,141  | )
|                                            |  |                       |   |  |            |   |  |            |   |  |          |  



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Year Ended August 31, 2005 Compared to Year Ended August 31, 2004



Revenues. Our total revenues decreased by 0.7% from HK$1,169.9
million in fiscal 2004 to HK$1,162.1 million in fiscal 2005, due to a significant decrease in revenues from our international telecommunications services. The 15.2% decline in our international telecommunications services revenues from HK$628.0
million in fiscal 2004 to HK$532.6 million in fiscal 2005 offset our 16.2% increase in FTNS revenues from HK$541.9 million in fiscal 2004 to HK$629.5 million in fiscal 2005.



Our fixed telecommunications network services continued to record significant revenue growth and increased their
contribution to our total revenues, accounting for 54.2% of total revenues in fiscal 2005, compared to 46.3% and 32.6% in fiscal 2004 and fiscal 2003, respectively. Revenues increased from HK$541.9 million in fiscal 2004 to HK$629.5 million in
fiscal 2005, representing 16.2% growth. During the year we grew our FTNS subscription base by 166,000, or 35.7% year-on-year, to 631,000 as of August 31, 2005.



With respect to voice services, we grew our VOIP subscription base by 56,000, or 23.6% year-on-year, to 293,000
subscriptions.



With respect to broadband services, we grew our
subscription base by 32,000, or 16.2% year-on-year, to 229,000 subscriptions. During fiscal 2005, we focused on differentiating our services by emphasizing our high bandwidth with the commercial launch of our bb100 and bb1000
supported by the Liu Xiang advertising campaign. Furthermore, we introduced value-added services such as bbDrive (an on-line virtual hard drive with up to 10 Gbps storage, bbGuard (an anti-spam and anti-virus package) and
bbWatch (a full screen IP-TV experience via the PC).



With respect to IP-TV services, we grew our subscription base by 78,000, or 251.6% year-on-year, to 109,000 subscriptions, although the majority of the new subscriptions were from our free trial promotions for periods of six to twelve
months.



Our international telecommunications business revenues
decreased by 15.2% from HK$628.0 million in fiscal 2004 to HK$532.6 million in fiscal 2005 due to the combined effects of lower volumes and lower revenues per minute. Competition during the year was intense as some of our integrated competitors
offered international direct dial minutes free or at very low cost as a marketing incentive to gain local fixed line and mobile market share. Further, technology substitution from global VOIP providers such as Skype, which offer free PC-to-PC based
international calls, is also becoming more prevalent.



Network costs. Network costs increased by 2.4% from HK$331.4 million in fiscal 2004 to HK$339.4 million in fiscal 2005. Our fixed telecommunications network costs declined by 3.3% from HK$122.5 million in fiscal 2004 to
HK$118.4 million in fiscal 2005. The decline was mainly due to reduction in our backbone expenses as our network became more self-reliant as we continue to roll out self-owned fiber based backbone. International telecommunications network costs
increased by 5.8% from HK$208.9 million in fiscal 2004 to HK$221.0 million in fiscal 2005, which was principally due to an increase in sales volume for products offered through CTImall and INCmall.



Other operating expenses. Our other operating expenses,
excluding network costs, increased by 19.9% from HK$793.1 million during fiscal 2004 to HK$951.1 million during fiscal 2005. Other operating expenses of our fixed telecommunications network services increased by 37.0% from HK$530.9 million in fiscal
2004 to HK$727.2 million in fiscal 2005 due to the increased scale of our fixed network operations with the addition of 166,000



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subscriptions during fiscal 2005 to 631,000 subscriptions as of August 31, 2005. Other operating expenses associated with our international
telecommunications services declined by 14.6% from HK$262.2 million in fiscal 2004 to HK$223.9 million in fiscal 2005.



Salaries and related costs. Salaries and related costs increased by 11.6% from HK$226.7 million during fiscal 2004 to HK$253.0 million during
fiscal 2005. Salaries and related costs associated with our fixed telecommunications network services increased by 25.9% from HK$132.1 million in fiscal 2004 to HK$166.4 million in fiscal 2005. Most of the additional staff hired during fiscal 2005
were home equipment installation employees necessitated by the growth of our customer base for broadband Internet access, local VOIP and IP-TV services. Our total number of permanent full time employees increased from 3,583 as of August 31,
2004 to 3,896 as of August 31 2005. We also provided our employees with several types of training programs in fiscal 2005 in order to develop and enhance their productivity. Furthermore we remain committed to research and development efforts.
During fiscal 2005, we spent HK$11.0 million for research and development, compared to HK$6.0 million during fiscal 2004.



Salaries and related costs associated with our international telecommunications services decreased 8.4% from HK$94.5 million in fiscal 2004 to HK$86.6
million in fiscal 2005, as we pushed through staff efficiencies and also reallocated staff from international telecommunications services to fixed telecommunications network services



Sales and marketing expenses. Our sales and marketing expenses increased by 17.2% from HK$228.2 million during fiscal
2004 to HK$267.4 million during fiscal 2005. Sales and marketing expenses related to our fixed telecommunications network services increased by 34.0% from HK$155.9 million to HK$208.9 million due to several acquisition marketing programs that we
utilized to grow our subscription base. We also increased the number of sales and marketing personnel in marketing and servicing our various service offerings and launched a large scale branding campaign for our broadband Internet access and IP-TV
services. This investment in sales and marketing was important to the continued expansion of our customer base for fixed telecommunications network services, which we believe will increase our revenues in the future. We focused our marketing
activities on direct customer sales, including door-to-door sales, on-the-street promoters and telemarketing. A large component of our marketing expenses is attributable to sales commissions that directly related to our increased fixed
telecommunications network services revenues. Additionally, during fiscal 2005 we introduced our Liu Xiang series of television, radio and print branding promotions. Liu Xiang is the first Chinese man to win an Olympic gold medal in a
track and field event, having secured this honor in the 110 meter hurdles at the 2004 Olympic Games. Finally, we account for salaries of our sales and marketing personnel in this item, and our sales and marketing expense increased as we added
personnel to our sales and marketing team during fiscal 2005. We expect our sales and marketing expenses to remain high as we continue to market our services to expand our customer base.



Sales and marketing expense associated with our international telecommunications services fell by 19.1% from HK$72.3 million
in fiscal 2004 to HK$58.5 million in fiscal 2005 as part of our strategy to focus our resources on higher growth segments of our service portfolio.



Office, general and administrative expenses. Office, general and administrative expenses increased by 21.3% from HK$129.8 million in fiscal 2004 to
HK$157.5 million in fiscal 2005. Office, general and administration expenses associated with our fixed telecommunications network services increased by 59.7% from HK$66.8 million to HK$106.7 million due mainly to our expanded office and warehouse
space and higher equipment maintenance costs. Office, general and administration expenses associated with our international telecommunications



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services expense declined by 19.4% from HK$63.0 million in fiscal 2004 to HK$50.9 million in line with the reduced scale of operations.



Depreciation and amortization. Depreciation and amortization expenses
increased by 20.7% from HK$197.0 million in fiscal 2004 to HK$237.7 million in fiscal 2005. Depreciation and amortization associated with our fixed telecommunications services increased by 26.7% from HK$168.0 million in fiscal 2004 to HK$212.8
million in fiscal 2005 due to the heavy capital expenditures that we incurred for the upgrade and expansion of our Metro Ethernet. Depreciation and amortization associated with our international telecommunications services decreased 14.1% from
HK$29.0 million in fiscal 2004 to HK$24.9 million in fiscal 2005 as our mature international telecommunications services network no longer requires heavy capital expenditure.



Provision for doubtful accounts receivable. Overall, our provision for doubtful accounts receivable increased by
207.8% from HK$11.5 million in fiscal 2004 to HK$35.4 million in fiscal 2005, which included a provision of HK$19.5 million for mobile interconnection charge receivables from prior years. For more information regarding our provision for mobile
interconnection charges, see Our RevenuesFixed Telecommunications Network Services above in this annual report.



Loss from operations. We suffered loss from operations of HK$128.4 million in fiscal 2005, compared to profit from operations of HK$45.3
million in fiscal 2004. The loss from operations is due to reduced international telecommunications business profitability, provisions for prior year mobile interconnection charges, high acquisition and marketing costs for new fixed
telecommunications network services subscriptions and early-stage operations of IP-TV services.



Interest income and expense. Our interest income was HK$13.6 million in fiscal 2005 compared to HK$3.8 million in fiscal 2004. We derive
interest income from our deposit of surplus capital in interest-bearing accounts at commercial banks. The substantial increase in fiscal 2005 interest income is due to the temporary surplus cash from our US$125 million 8.75% senior notes issued in
January 2005. Our interest expense increased to HK$54.5 million in fiscal 2005 compared to HK$0.2 million in fiscal 2004, predominantly due to the interest expense of our 8.75% notes issued in January 2005. We also capitalized our borrowing costs of
HK$2.0 million of the funding for our network rollout.



Other income, net. Our other income, net consists of the roaming charges we receive from overseas carriers that deliver traffic over our network, exchange gains and losses, small penalties we have received from time to time
from contractors that we employ, and management and other fees we receive from other fixed line operators in the ordinary course of our business. Other income, net of expenses was HK$6.0 million in fiscal 2005 compared to HK$2.7 million in fiscal
2004.



Income tax (charge)/credit. We receive
income tax credit of HK$6.7 million for fiscal 2005 compared to income tax expense of HK$2.0 million during fiscal 2004. Income tax is based on our estimated assessable profit during each period, and our income tax credit in fiscal 2005 was mainly
due to the recognition of deferred tax assets on current years unrecognized tax losses from our fixed telecommunications network services business that offset the taxes associated with profit generated from our international telecommunications
services in fiscal 2005.



Net loss. For the
foregoing reasons, we incurred a net loss of HK$156.5 million in fiscal 2005 compared to a net income of HK$49.6 million in fiscal 2004.



Year Ended August 31, 2004 Compared to Year Ended August 31, 2003



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Revenue. In fiscal 2004, our total revenues dropped by 9.9% from HK$1,298.9 million in
fiscal 2003 to HK$1,169.9 million in fiscal 2004, due to a significant decrease in revenue from our international telecommunications services, which was partially offset by the continued growth in revenues of our fixed telecommunications network
services.



Our fixed telecommunications network services
continued to record significant growth in revenues and increased their contribution to our total revenues, accounting for 46.3% of total revenues in fiscal 2004, compared to 32.6% and 21.0% in fiscal 2003 and fiscal 2002, respectively. Revenues
increased from HK$423.1 million in fiscal 2003 to HK$541.9 million in fiscal 2004, representing 28.1% growth. While our number of broadband subscriptions increased from 172,000 as of August 31, 2003 to 197,000 as of August 31, 2004, our
revenues from our Internet access services declined by 9.5% from HK$330.5 million in fiscal 2003 to HK$299.2 million in fiscal 2004. The decline was mainly due to the phasing-out of our resale of Megalink/Mega-access services, and loss of customers
to whom we previously provided dial-up Internet services to alternative broadband Internet access providers, which more than offset our increase in broadband Internet access revenues.



Our local VOIP services recorded significant growth as a result of our strong marketing efforts and strong brand
recognition, which resulted in an increase in local VOIP subscriptions from 140,000 as of August 31, 2003 to 237,000 as of August 31, 2004. In fiscal 2004, our local VOIP services revenues increased 156.8% from HK$92.6 million in fiscal
2003 to HK$237.7 million in fiscal 2004.



Our IP-TV services,
launched in August 2003, generated HK$5.0 million in revenues in fiscal 2004, and we had acquired 31,000 IP-TV subscriptions as of August 31, 2004.



Our corporate data services were launched in July 2004 and therefore did not contribute significantly to our revenues in fiscal 2004.



Our international telecommunications business experienced a decrease of 36.8%
in our average prices per minute in fiscal 2004 compared to fiscal 2003. A principal reason for this decline was that in fiscal 2003, we increased our rates for outbound calls to China in response to an increase in the termination rates payable by
us to our carrier partners for incoming telecommunications traffic into China due to the imposition by Chinas MII of these rate increases. As approximately 65% of our outgoing calls in fiscal 2003 were to China, this increase had a significant
effect on our average prices per minute. When our carrier partners subsequently reduced their termination charges, we were able to reduce our per minute charges as compared to fiscal 2003.



In addition, in order to maintain our international telecommunications market
share in fiscal 2004, we made the decision to price our international telecommunications services competitively with other market players despite their aggressive pricing strategies. While we experienced an increase in total traffic volume of 13.4%
from 888.0 million minutes to 1,007.0 million minutes, our international telecommunications services revenues decreased 28.3% from HK$875.8 million in fiscal 2003 to HK$628.0 million in fiscal 2004.



Network costs. Network costs increased by 2.7% from HK$322.8 million in
fiscal 2003 to HK$331.4 million in fiscal 2004. While network costs with respect to our international telecommunications services decreased, network costs for our fixed telecommunications network services increased significantly.



Accompanying the continued expansion of our Metro Ethernet network and
service offerings, the network costs for our fixed telecommunications network services increased by 59.5% from HK$76.8 million in fiscal 2003 to HK$122.5 million in fiscal 2004 while



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representing 37.0% of the total network costs. The network costs for our fixed telecommunications network services represented 23.8% of our total network
costs in fiscal 2003. Our percentage increase in costs was greater than our increase in revenues partly as a result of start-up costs of HK$19.2 million we incurred in connection with our IP-TV services, which generated HK$5.0 million in revenues
during fiscal 2004. We account for the salaries of the production personnel that we employ for our IP-TV operations in our network costs, and we added several production personnel during fiscal 2004. Network costs associated with our local VOIP
services increased as our subscriptions increased, and accounted for HK$64.6 million of our total network costs in fiscal 2004. This increase also contributed to our network costs increasing at a greater rate than our revenues, as our gross margins
for local VOIP services are less than gross margins in broadband Internet access business.



Network costs for our international telecommunications operations decreased by 15.0% from HK$245.9 million in fiscal 2003 to HK$208.9 million in fiscal 2004. Excluding the USC refund, our international
telecommunications costs decreased 27.1% to HK$240.6 million in fiscal 2004, compared to HK$330.0 million in fiscal 2003, despite our increase in traffic volume. This was principally due to our efforts to leverage our significant volume of traffic
to negotiate more attractive pricing with service providers whom we rely on for international transmission. These savings were partially offset by a decline in the amount of USC refund received from PCCW-HKT, from HK$84.1 million in fiscal 2003 to a
refund of HK$31.7 million in fiscal 2004.



We have historically
paid higher aggregate USC fees to PCCW-HKT based on provisional rates stipulated by the Telecommunications Authority than the rates subsequently determined by the Telecommunications Authority to be due, and therefore have received a USC refund in
each year since fiscal 2002.



Other operating
expenses. Our other operating expenses increased by 12.5% from HK$704.8 million in fiscal 2003 to HK$793.1 million in fiscal 2004. Other operating expenses incurred for fixed telecommunications network services increased by 29.0% from
HK$411.6 million in fiscal 2003 to HK$530.9 million in fiscal 2004 as we incurred significant operating costs related to our efforts to promote our broadband Internet access, local VOIP, IP-TV and corporate data services. Other operating expenses
incurred for international telecommunications services declined by 10.5% from HK$293.2 million in fiscal 2003 to HK$262.2 million in fiscal 2004.



Salaries and related costs. Salaries and related costs increased slightly by 2.9% from HK$220.4 million in fiscal 2003 to HK$226.7 million
in fiscal 2004. Salaries and related costs related fixed telecommunications network services increased by 23.7% from HK$106.8 million in fiscal 2003 to HK$132.1 million in fiscal 2004. A large component of this increase was attributable to the
expansion of our fixed telecommunications network operations. Most of the additional staff hired during fiscal 2004 were customer service and home equipment installation employees necessitated by the growth of our customer base for local VOIP and
IP-TV services.



Salaries and related costs for international
telecommunications services decreased 16.7% from HK$113.5 million in fiscal 2003 to HK$94.5 million in fiscal 2004, as we pushed through staff efficiencies and also reallocated staff from international telecommunications services to fixed
telecommunications network services.



Sales and marketing
expenses.Our sales and marketing expenses increased by 25.0% from HK$182.5 million in fiscal 2003 to HK$228.2 million in fiscal 2004. Sales and marketing expenses associated with fixed telecommunications network services increased by
51.1% from HK$103.2 million to HK$155.9 million due to several acquisition marketing programs that we utilized to grow our subscription base. We focused our marketing activities on direct customer sales, including door-to-door sales,
on-the-street promoters and telemarketing. Most of the increased marketing expenses were attributable to sales commissions that directly related to our increased fixed telecommunications network services revenues. Additionally, we
incurred sales and marketing expenses in connection with our free appliances promotion in fiscal 2004. Under this program, new subscribers received a household appliance upon signing a contract with HKBN for a term of 24 to 36 months,
during which period we recover the cost of the appliance. Finally, we accounted for salaries of our sales and marketing personnel in this item, and our sales and marketing expense increased as we added personnel to our sales and marketing team
during fiscal 2004.



Sales and marketing expenses associated
with international telecommunications services fell by 8.8% from HK$79.3 million in fiscal 2003 to HK$72.3 million in fiscal 2004 as part of our strategy to focus our resources on higher growth segments of our service portfolio.



Office, general and administration expenses. Office, general and
administrative expenses, excluding depreciation and amortization, increased by 19.9% from HK$108.3 million in fiscal 2003 to HK$129.8 million in fiscal 2004. Office, general and administration expenses associated with our fixed telecommunications
network services increased by 30.2% from HK$51.3 million in fiscal 2003 to HK$66.8 million in fiscal 2004 due mainly to our expanded office and warehouse space. Office, general and administration expenses associated with international
telecommunications services increased by 10.5% from HK$57.0 million in fiscal 2003 to HK$63.0 million in fiscal 2004.



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Depreciation and amortization.Depreciation and amortization expenses increased by 11.9%
from HK$176.0 million in fiscal 2003 to HK$197.0 million in fiscal 2004. Depreciation and amortization associated with our fixed telecommunications network services increased by 18.6% from HK$141.7 million in fiscal 2003 to HK$168.0 million in
fiscal 2004. This increase was driven by the continued expansion of our Metro Ethernet network. Depreciation and amortization expenses associated with international telecommunications services decreased 15.5% from HK$34.3 million in fiscal 2003 to
HK$29.0 million in fiscal 2004 as a result of reduced capital expenditure and from the full depreciation of certain of the assets used in this business.



Provision for doubtful accounts receivable. We record provision for doubtful accounts receivable based on the aggregate amount of our overdue
accounts. We increased our number of collection personnel, and strengthened our overdue account collection procedures during fiscal 2004, and were successful at reducing the amount of our overdue accounts. As a result, our provision for doubtful
accounts receivable decreased by 35.0% from HK$17.7 million in fiscal 2003 to HK$11.5 million in fiscal 2004.



Income from operations. Operating profit was HK$45.3 million in fiscal 2004, compared to HK$271.4 million in fiscal 2003, representing a
decrease of 83.3%. Operating profit from international telecommunications operations decreased by 53.4%, from HK$336.7 million in fiscal 2003 to HK$156.8 million in fiscal 2004. The decrease was largely attributable to the large decrease in average
tariff rates per call, which more than offset our increase in international call traffic. Operating losses from our fixed telecommunications network services increased significantly, from a loss of HK$65.3 million in fiscal 2003 to a loss of
HK$111.5 million in fiscal 2004, as we incurred significant sales and marketing expenses related to these services, and incurred start-up costs associated with our IP-TV and corporate data businesses.



Interest income and expense. Our interest income was HK$3.8
million in fiscal 2004 compared to HK$3.2 million in fiscal 2003. We derive interest income from our deposit of surplus capital in interest-bearing accounts at commercial banks. The increase in interest income was due to an increase in interest
rates. Our interest expense was HK$0.2 million in fiscal 2004 compared to HK$0.6 million in fiscal 2003. We also capitalized our borrowing costs of HK$3.1 million of the funding for our network rollout in fiscal 2004.



Other income, net. Our other income, net consists of roaming
charges we receive from overseas carriers that deliver traffic over our network, exchange gains and losses, small penalties we have received from time to time from contractors that we employ, and management and other fees we receive from other fixed
line operators in the ordinary course of our business. Other income and expense was HK$2.7 million in fiscal 2004 compared to HK$4.4 million in fiscal 2003.



Income tax charge. Income tax expense was HK$2.0 million in fiscal 2004 compared to HK$17.8 million in fiscal 2003. Income tax is based on
our estimated assessable profit during each period, and our income tax expense decreased in fiscal 2004 as a result of the decrease in our assessable profit compared to fiscal 2003. Our effective tax rate decreased from 6.5% in fiscal 2003 to 4.0%
in fiscal 2004 as a result of the recognition of deferred tax assets on prior years unrecognized tax losses brought forward from our fixed telecommunications network services business that offset the taxes associated with profit generated from
our international telecommunications services in fiscal 2004.



Net income. For the foregoing reasons, our net income decreased by 80.8% from HK$257.7 million in fiscal 2003 to HK$49.6 million in fiscal 2004.



Liquidity and Capital Resources



On January 20, 2005 we successfully completed a US$125 million offering of 8.75% senior notes due 2015. This offering
was an underwritten transaction and our net proceeds were approximately US$121.0 million after deduction of expenses and commissions. We used the net proceeds, in part, to repay in full an existing loan facility in the outstanding amount of HK$196.7
million, and will use the remaining net proceeds for capital expenditures, including costs incurred in expanding and upgrading our Metro Ethernet network in Hong Kong, and for additional working capital and general corporate purposes.



A principal source of our liquidity historically has been cash flow from
operations. In addition, we have undertaken several transactions that have provided us with working capital, including:



| |  |  | In August 1997, we completed our initial public offering of 100,000,000 new shares and listing on The Stock Exchange of Hong Kong. We received net proceeds of HK$159.8 million from
this offering.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | In November 1999, we completed a global offering of 80,000,000 new shares and our American depositary shares were listed on The Nasdaq Stock Market. We received net proceeds of
approximately HK$411.6 million from this offering.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | In March 2000, KDDI Corporation, a telecommunications company in Japan, purchased 15.0% of the share capital of HKBN, now a wholly owned subsidiary of the Company, for HK$225.0
million.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | In December 2003, we drew down HK$100.0 million of a HK$200.0 million loan facility made available by The Hongkong and Shanghai Banking Corporation Limited, or HSBC, as of October
9, 2002. We drew down a further HK$40.0 million in September 2004, and the remaining HK$60.0 million in December 2004 for a total amount of HK$200.0 million. All outstanding amounts under this facility were fully repaid as of January 24, 2005
with part of the proceeds of the 8.75% notes offering that was completed on January 20, 2005 and the operating cash of HK$3.3 million.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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| |  |  | In January 2005, we issued US$125.0 million of our 8.75% senior notes due 2015. We received net proceeds of approximately US$121.0 million from this offering.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------



The following table summarizes our cash flows
for each of fiscal 2003, 2004 and 2005:



|                                                    |  |                       |   |  |          |   |  |          |   |  |         |  
|--------------------------------------------------- |  | --------------------- | - |  | -------- | - |  | -------- | - |  | ------- | -
|                                                    |  | Year Ended August 31, |  
|                                                    |  | 2003                  |   |  | 2004     |   |  | 2005     |   |  | 2005    |  
|                                                    |  | HK$                   |   |  | HK$      |   |  | HK$      |   |  | US$     |  
|                                                    |  | (In thousands)        |  
|Net cash flow from (used in) operating activities   |  | 414,500               |   |  | 203,763  |   |  | (15,444  | ) |  | (1,987  | )
|Net cash used in investing activities               |  | (309,634              | ) |  | (406,244 | ) |  | (464,590 | ) |  | (59,779 | )
|Net cash (used in) provided by financing activities |  | (10,274               | ) |  | 47,221   |   |  | 792,193  |   |  | 101,932 |  
|                                                    |  |                       |   |  |          |   |  |          |   |  |         |  
|(Decrease)/increase in cash and cash equivalents    |  | 94,592                |   |  | (155,260 | ) |  | 312,159  |   |  | 40,166  |  
|Effect of foreign exchange rate changes             |  | (1,135                | ) |  | (253     | ) |  | (915     | ) |  | (118    | )
|                                                    |  |                       |   |  |          |   |  |          |   |  |         |  
|Cash and cash equivalents (closing balance)         |  | 383,860               |   |  | 228,347  |   |  | 539,591  |   |  | 69,429  |  
|                                                    |  |                       |   |  |          |   |  |          |   |  |         |  



Operating
Activities



Our net cash flow from operating
activities for fiscal 2005, 2004 and 2003 was an outflow of HK$15.4 million, and an inflow of HK$203.8 million and HK$414.5 million, respectively. The principal source of cash flow from operating activities in each of these fiscal years was the cash
flow we generate from our fixed telecommunications network services and international telecommunications businesses.



In fiscal 2005, we incurred a net cash outflow in our operating activities that amounted to HK$15.4 million. The reduced operational cash flow was
principally due to the significant cash we spent in sales and marketing expenses in offering incentives to acquire new subscriptions and the expanding scale for retaining our growing existing subscription base. Since such expenses were incurred
before cash receipts from customers, it significantly reduced our operational cash flow. Moreover, increases in payment of staff costs due to the expansion of our fixed telecommunications network services operations and increases in home equipment
installation necessitated by the growth of our customer base also reduced our cash flow from operations. Cash from operating activities also decreased due to increased cash going to early stage operations of our IP-TV service. Further, an increase
in term deposits of HK$92.9 million reduced our cash inflow from operations accordingly.



Net cash provided by operating activities amounted to HK$203.8 million during fiscal 2004, which represented a substantial decrease compared with fiscal 2003, principally as a result of the significant cash we
continued to invest in our Metro Ethernet network. Cash from operating activities also decreased due to increased costs we incurred in promoting our new services, as well as decreased profitability of our international telecommunications business.
In fiscal 2004, we recorded an increase in trade and other payables of HK$31.0 million that comprised amounts owed to our supplier of household appliances that we offered to new subscribers under our free appliance program. We also recorded an
increase in deferred service income of HK$29.3 million in fiscal 2004 associated with our free appliance program, as we billed new subscribers credit cards a fee equivalent to 18 months of service charges upon their signing a 24 to 36 month
contract with us. Net cash provided by operating activities in fiscal 2004 was offset by an increase in trade and other receivables of HK$50.4 million. The principal component of this receivable consisted of an increase in income of HK$38.7 million
in connection with mobile interconnection charges that we believe are due to us by Hong Kong mobile telecommunications operators based on their use of our Metro Ethernet network to transmit mobile telecommunications traffic. We also recorded an
increase in prepayments of HK$8.3 million in fiscal 2004 in connection with our use of the fiber ring owned and operated by the KCRC. Finally, our cash flows from operations were reduced by Hong Kong profits taxes paid of HK$24.0 million.



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Net cash provided by operating activities amounted to HK$414.5 million in fiscal 2003, a significant
increase versus fiscal 2002 that resulted from increased profitability of each of our business lines. Income before taxation of HK$275.6 million was offset by a decrease in trade and other payables of HK$28.7 million that resulted from our lower
levels of capital expenditures in fiscal 2003 as compared to fiscal 2002. In addition, we paid Hong Kong profits tax of HK$18.1 million in fiscal 2003.



Investing Activities



Net cash used in investing activities was HK$464.6 million, HK$406.2 million and HK$309.6 million during fiscal 2005, 2004 and 2003, respectively.
Throughout each of the three fiscal years, investing activities consisted primarily of purchases of fixed assets for the development of our Metro Ethernet network. In addition, we used smaller amounts of cash for investing in the upgrade of our
fixed assets, and also made investments in upgrading our international telecommunications facilities.



Financing Activities



Net cash provided by financing activities was HK$792.2 million in fiscal 2005, which mainly consisted of our net proceeds of US$121.0 million from our
8.75% notes issued in the amount of HK$943.7 million plus a bank loan draw down of HK$100.0 million offset by our repayment of a bank loan in the amount of HK$200.0 million and interest payments for the 8.75% notes in the aggregate amount of HK$52.4
million.



Net cash provided by financing activities was HK$47.2
million in fiscal 2004, which consisted of our draw down of HK$100.0 million on our loan facility with HSBC, offset by our payment of HK$54.9 million in dividends during fiscal 2004.



In fiscal 2003, net cash used in financing activities was HK$10.3 million. This principally consisted of our repayment of a
shareholder loan to KDDI of HK$22.5 million when we purchased KDDIs remaining interest in HKBN, and dividends we paid in fiscal 2003 of HK$30.2 million. Net cash used in financing activities in fiscal 2003 was offset by our issues of HK$45.4
million of shares during the year in connection with the exercise of share options that we had granted to our employees and exercise of outstanding warrants in prior years.



Indebtedness



In December 2003, we drew down HK$100.0 million of a HK$200.0 million loan facility made available by HSBC as of October 9, 2002. We drew down a
further HK$40.0 million in September 2004, and the remaining HK$60.0 million in December 2004. The loan facility accrues interest at the Hong Kong Interbank Offer Rate plus 1.5%, and repayment is required to be made in 60 equal installments
beginning in January 2005. We have entered into an interest rate swap arrangement to hedge against interest rate risk for up to HK$100.0 million of the total amount drawn under the facility. All outstanding amounts under this facility were fully
repaid as of January 24, 2005 with the proceeds of the 8.75% notes offering described below.



We also have a banking facility provided by Citibank for the equivalent of HK$19.2 million in Japanese Yen, which is secured by a pledge over bank
deposits. Interest under the facility accrues at the cost of funds in Japan plus 0.8%. This banking facility was subsequently fully repaid on March 24, 2005, and the related pledge over bank deposits was released accordingly.



On January 20, 2005, we issued US$125.0 million of our 8.75% notes. We
received net proceeds of approximately US$121.0 million from this offering.



Capital expenditures and working capital



In order to continue the development of our Metro Ethernet network and maintain the operations of our international telecommunications business, we plan to make total capital expenditures of approximately HK$400
million in fiscal 2006. Our required capital expenditures, other than with respect to our network expansion, will be influenced to a significant degree by the rate of growth in the subscription base for our services, the expansion of our network
coverage and any changes to our business plan.



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As of August 31, 2005, we had cash and cash equivalents of HK$539.6 million compared to HK$228.3
million (net of short term loans) at the end of fiscal 2004. As of August 31, 2005, we had capital commitments contracted but not provided for relating to the purchase of telecommunications, computer and office equipment of HK$178.8 million. In
addition, we had commitments under non-cancelable operating leases relating to land, buildings, telecommunications facilities and computer equipment of HK$80.5 million, of which HK$43.7 million is due in fiscal 2006. We also had commitments on
program fees of HK$19.3 million, of which HK$13.0 million is due in fiscal 2006. As of August 31, 2005 we had total utilized banking facilities of HK$13.3 million.



The following table sets forth information regarding our aggregate payment obligations in future years of the contractual
obligations and commercial commitments that we had as of August 31, 2005.



|                              |  |                        |  |                 |  |          |  |          |  |                 
|----------------------------- |  | ---------------------- |  | --------------- |  | -------- |  | -------- |  | ----------------
|                              |  | Payments due by period
|Contractual Obligations       |  | Total                  |  | Lessthan 1 year |  | 1-3years |  | 3-5years |  | Morethan 5 years
|                              |  | (Thousands of HK$)    
|Capital expenditure           |  | 178,793                |  | 178,793         |  |         |  |         |  |                
|Operating leases              |  | 80,515                 |  | 43,654          |  | 27,852   |  | 1,898    |  | 7,111           
|Short-term and long-term debt |  | 948,483                |  | 1,194           |  | 1,941    |  |         |  | 945,348         
|Programming fees (IP-TV)      |  | 19,314                 |  | 13,055          |  | 6,259    |  |         |  |                
|                              |  |                        |  |                 |  |          |  |          |  |                 
|Total                         |  | 1,227,105              |  | 236,696         |  | 36,052   |  | 1,898    |  | 952,459         
|                              |  |                        |  |                 |  |          |  |          |  |                 



Our working capital as
of August 31, 2005 was HK$565.0 million, which we believe is sufficient for our current requirements. Further, we believe that our current cash and cash equivalents and cash flow from operations will be sufficient to meet our anticipated cash
needs, including for working capital, capital expenditure, repayment of our indebtedness and various contractual obligations, for at least the next 12 months. However, if our customer demand changes significantly due to rapid technological changes,
if we are not able to successfully compete with local and foreign entrants into the market, or if we fail to maintain or obtain the necessary license renewals from the Telecommunications Authority, this could have a significant adverse impact on our
cash flows from operations, which could effect our ability to make planned capital expenditures as well as meet scheduled payments on the 8.75% notes, our various operating and capital leases and amounts due under banking facilities.



Research and development, patents and licenses



We commit considerable resources to our research and development department
in order to continuously improve our services and improve our market position. As of August 31, 2005, our research and development team consisted of 48 staff members experienced in systems design, engineering, telecommunications and computer
programming. Our research and development department is primarily responsible for assessing and adapting the technology that we employ in upgrading and expanding our Metro Ethernet network. To identify and develop new market opportunities, the
research and development team assesses new services offered by telecommunications and Internet companies in the United States and elsewhere and works closely with our marketing department. Our research and development expenditures were approximately
HK$2.6 million, HK$6.0 million and HK$11.0 million for fiscal 2003, 2004 and 2005, respectively.



Trend information



During fiscal 2005, our international telecommunications business experienced a decrease of 9.8% in our average tariffs per minute combined with a 6.0% decline in volume from 1,007.0 million minutes to
947.1 million minutes, resulting in a 15.2% reduction in international telecommunications revenues to HK$532.6 million in fiscal 2005 from HK$628.0 million in fiscal 2004. The principal reason for this decline was the fierce competition, as our
key competitors introduced highly aggressive price cuts. Rather than directly competing on price, our strategy is to proactively migrate our international telecommunications customers to our global 2b VOIP service which we believe will
enable us to obtain higher margins and provide us with access to a wider addressable market.



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Our revenues from our fixed telecommunications network services grew by 16.2% to HK$629.5 million in
fiscal 2005, trailing subscription base growth of 35.7% to 631,000 subscriptions as of August 31, 2005. The short fall in revenues versus subscription growth was primarily due to our strategy to gain new IP-TV subscriptions through offering
free-trial periods of between six to twelve months. While we intend to convert these trial subscriptions from a free to paid basis, we may not be able to successfully achieve this transition on a scale that will be profitable.



Off-Balance Sheet Arrangements



Other than as described below in  Critical Accounting
Policies and Note 28-Off-balance sheet items of the Notes to the Consolidated Financial Statements, we have not entered into any off-balance-sheet arrangements with any entities or individuals.



Tabular disclosure of contractual obligations.



See Liquidity and Capital Resources above in this Item 5.



Critical Accounting Policies



Introduction



Our consolidated financial statements have been prepared in accordance with
accounting principles generally accepted in Hong Kong. Our significant accounting policies are more fully described in note 2 to our financial statements. The preparation of our financial statements requires management to make estimates and
judgments that affect the reported amounts of assets, liabilities, revenues and expenses and the disclosure of contingent assets and liabilities. We continually evaluate our estimates and judgments including those related to fixed assets, bad debts,
deferred taxes, USC charges and certain revenue items. We base our estimates and judgments on historical experience and on various other assumptions we believe to be reasonable under the circumstances. This forms the basis for making judgments about
the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates as facts, circumstances and conditions change.



Our accounting policies have been developed over many years as the
telecommunications industry and Generally Accepted Accounting Principles or GAAP have evolved. As our financial statements are prepared under Hong Kong GAAP, our accounting policies are necessarily compliant with all aspects of Hong Kong GAAP. Hong
Kong GAAP is based on a substance over form conceptual framework that requires us to look through the legal interpretation of an arrangement or transaction to its underlying purpose and to reflect it in our financial statements on that
basis.



In developing accounting policies, in addition to Hong
Kong GAAP requirements, we also consider telecommunications industry practice in other countries. Where there is no conflict with Hong Kong GAAP we also align our accounting policies with U.S. GAAP. In all material respects our accounting policies
are applied consistently across City Telecom. The critical accounting policies discussed below generally apply to all segments of City Telecom.



The following are the most significant accounting estimates and judgments we apply in producing our consolidated financial statements.



Useful lives of fixed assets



We estimate the useful lives of fixed assets in order to determine the
amount of depreciation expense to be recorded. The useful lives are estimated at the time the asset is acquired based on historical experience, the expected usage, wear and tear of the assets, as well as technical obsolescence arising from changes
in the market demands or service output of the assets. Changes in technology or industry conditions may cause the estimated period of use or the value of these assets to change. We perform periodic reviews to confirm the appropriateness of estimated
economic useful lives for each class of fixed assets. For the three years ended August 31, 2005, no changes of assets useful lives have occurred.



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Impairment of fixed assets



Under Hong Kong GAAP and U.S. GAAP, if a triggering event occurs indicating that the carrying amount of an asset may not be
recoverable, a new assessment of the carrying amount of that asset is required. Triggering events include significant adverse changes in the market value of an asset, changes in the business or regulatory environment, or certain legal events. The
interpretation of such events requires judgment from the management with respect to whether such an event has occurred and whether the management feels that reassessment of the carrying value of the asset is required. If an event occurs that could
affect the carrying value of the asset and the management does not identify it as a triggering event and identify the asset as impaired, future operations could be adversely affected if this asset is subsequently written off or sold for less than
its carrying value due to sudden downturns in the business environment.



Upon the occurrence of triggering events, the carrying amounts of fixed assets are reviewed to assess whether their recoverable amounts have declined below their carrying amounts. The recoverable amount is the present value of estimated net
future cash flows which we expect to recover from the future use of the asset, plus the assets residual value on disposal. Where the recoverable amount of fixed and other long-lived assets is less than their carrying value, an impairment loss
is recognized to write the assets down to their recoverable amount, which is based on the fair value or discounted estimated cash flows.



Under U.S. GAAP the impairment testing is done on the basis of undiscounted cash flows as opposed to discounted cash flows under Hong Kong GAAP.



Estimation of cash flows arising from future use of the asset
requires careful analysis regarding what we expect to recover from its future use. This includes consideration of our target market share and customer base, market competition, future changes to our cost structure and technological change. In
addition, the residual value of the asset on disposal requires judgment, as the estimated fair value of the asset at the time of disposal could change in response to market conditions and changes in expected use of the asset prior to disposal.
Changes in the estimate of cash flows arising from expected future use of the asset or its residual value on disposal  based on changes in market conditions, changes in the use of assets, managements plan, foreseeable technological changes or
otherwise  could significantly change the calculation of the fair value or recoverable amount of the asset and the resulting impairment loss. This in turn could significantly affect the results of our operations.



For the three fiscal years ended August 31, 2005, no impairment loss was
recognized based on the estimated recoverable amount of our long-lived assets.



Accounts Receivable



Under Hong Kong GAAP and U.S. GAAP, provision is made against accounts receivable to the extent they are considered to be doubtful. This provision requires judgment regarding the collectibility of certain receivables both as they are
incurred and as they age. We determine bad debt provisions based on past experience of recovery of old receivables, the aging of the accounts receivable balance and historical write-off experience. Certain receivables may be initially identified as
collectible, yet subsequently become uncollectible and result in a subsequent write-off of the related receivable to the statement of operations. Changes in the collectibility of accounts receivable for which provisions are not made could affect our
future results of operations.



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Changes in the provision for doubtful debts consist of:



|                                 |  |                       |   |  |         |   |  |         |  
|-------------------------------- |  | --------------------- | - |  | ------- | - |  | ------- | -
|                                 |  | Year ended August 31, |  
|                                 |  | 2003                  |   |  | 2004    |   |  | 2005    |  
|                                 |  | (Thousands of HK$)    |  
|Balance at beginning of the year |  | 17,139                |   |  | 22,916  |   |  | 22,959  |  
|Additions charged to expense(1)  |  | 17,685                |   |  | 11,502  |   |  | 35,445  |  
|Write-off                        |  | (11,908               | ) |  | (11,459 | ) |  | (10,088 | )
|                                 |  |                       |   |  |         |   |  |         |  
|Balance at the end of the year   |  | 22,916                |   |  | 22,959  |   |  | 48,316  |  
|                                 |  |                       |   |  |         |   |  |         |  

---

|(1) | Provision for doubtful debts as at August 31, 2005 includes provision for mobile
interconnection charges receivables of HK$19.5 million (Further details has been included in note 31 of the consolidated financial statements included in this annual report).
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Deferred Taxation



Under Hong Kong GAAP, deferred taxation is provided in full, using the
liability method, on temporary differences arising between the tax bases of assets and liability and their carrying amounts in the financial statements. Deferred tax assets are recognized to the extent that it is probable that future taxable profit
will be available against which the temporary differences can be utilized. Deferred taxation is provided on temporary differences arising on investments in subsidiaries except where the timing of the reversal of the temporary difference can be
controlled and it is probable that the temporary difference will not reverse in the foreseeable future. In determining whether a liability or asset is expected to be payable or recoverable in the foreseeable future, we estimate the availability of
future taxable profit and assess the effect of our capital expenditures and other plans, such as the existing network capacity, technological changes, future market trends and projected fixed network coverage.



Under U.S. GAAP, deferred tax assets and liabilities are determined based on
the temporary differences between the financial reporting basis and tax basis of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse. Future tax benefits in respect of tax loss carry
forwards are also required to be recognized in full. We must establish a valuation allowance for such assets if we determine it is more likely than not that we will not be able to utilize such benefits in the future.



The recording of certain deferred tax assets requires judgment regarding the
results of future operations, including the assumption that there will be sufficient future operations to allow us to utilize the related deferred tax asset. Any changes in the estimate of future operations could change the recognition of such
assets, which could significantly affect the results of our operations.



A change in judgement regarding the likelihood of the generation of future taxable income necessary to realize deferred tax assets could result in a change in the valuation allowance on deferred tax assets which would impact our results
under both Hong Kong GAAP and U.S. GAAP.



Carrying value
of investments and goodwill



We assess the carrying
value of our investments in subsidiaries, including acquired goodwill, for impairment on an annual basis based on their recoverable amount. Our assessments generally include methodology of discounted cash flow analysis, and review of comparable
entities. This methodology sometimes relies on factors such as forecasts of future performance and long-term growth rates of the investee, and selection of discount rate. If these forecasts and assumptions prove to be incorrect or circumstances
change, we may be required to write down our investments.



Based on our most recent assessment of recoverable amount we believe that as at August 31, 2005 our goodwill is recoverable at the amounts at which they are stated in our financial statements.



USC charges



Our management makes their best estimates for charges of the USC payable to
PCCW-HKT in order to fund the costs of network development incurred by PCCW-HKT in remote areas in Hong Kong (the Development). Such estimated costs are included as part of our costs of rendering services. The estimate is made based on
the provisional rates announced by the Telecommunications Authority and is effective up to the date of the release of our financial statements. The Telecommunications Authority periodically reviews the actual costs incurred by PCCW-HKT in the
Development and adjusts the amounts owed to PCCW-HKT, or to be refunded by it, to the respective USC contributing parties, including our company (the Rate Revisions). Accordingly, the estimate made by our management is subject to changes
based on the Rate Revisions identified during a financial year and up to the date prior to the release of our financial statements. We adjust such differences as an addition to, or reduction of, the corresponding costs of services in that particular
reporting period.



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Any sum received in advance from PCCW-HKT as an estimated refund of USC on a provisional basis, which is
subject to the final confirmation and determination of the Telecommunications Authority, is recorded in other payables and accrued charges in our balance sheet.



Revenue Recognition



Revenue for the provision of telecommunications services is recognized when an arrangement exists, service is rendered, fee is fixed or determinable and
collectibility is probable. Revenue received in advance is deferred and amortized based on actual usage by customers or the stated period of time in the subscriber agreement. Network interconnection charges are recorded as revenue based on usage of
the fixed telecommunications network of the Company by mobile and other fixed telecommunications network operators. The determination of the rates at which revenue is recognized involved significant estimates by management. Significant changes in
management estimates may result in material revenue adjustments.



Hong Kong Broadband Network Limited (HKBN), a wholly-owned subsidiary of the Company, as a Fixed Telecommunications Network Services (FTNS) licensee, provides interconnection services to enable delivery of
telecommunications service to customers of different operators. Since the FTNS license was granted by the TA and interconnection services have been provided, the Company has been recognising interconnection services billed to mobile operators as
revenue (mobile interconnection charges). For the years ended August 31, 2003, 2004 and 2005, the Company recorded mobile interconnection charges of HK$6,090,000, HK$38,676,000 and HK$24,703,000, respectively. As of August 31, 2005,
substantially all of the mobile operators had not made any payments to the Company since 2002 when the Company started to bill for the mobile interconnection services.



The charges were determined using the available rates under the existing calculation model (fully distributed cost model)
for interconnection services between fixed and mobile operators, which are based on historical cost data of PCCW-HKT. In May 2004, TA confirmed to HKBN that mobile operators should pay interconnection charges to fixed network operators in accordance
with the existing charging principles under the relevant TA statements. In August 2004, TA agreed to make a determination (the Determination) under section 36A of the Telecommunications Ordinance to cover the level of mobile and fixed
interconnection charges payable by one of the mobile operators to HKBN; and the effective date of the determined interconnection charges.



We report revenue related to mobile interconnection charges at amounts we believe to be realizable after consideration of the uncertainty regarding the
timing and amount of the ultimate collection of amounts due. Amounts reported for the year ended August 31, 2005 reflect a discount from the amount billed which is determined based on our assessment of the range of likely outcomes from the
determination process. Actual amounts realized could be different from our estimate.



Legal contingencies



We are currently involved in certain legal proceedings. The assessment of the ultimate outcome of those proceedings is derived from consultation with outside counsel, as well as an assessment of litigation and settlement strategies. A
future event or change in the facts and circumstances may require us to make accruals with would be charged to our income statement in the future.



U.S. GAAP Reconciliation



Our financial statements are prepared in accordance with Hong Kong GAAP, which differs in certain material respects from U.S. GAAP. The following tables
provide a comparison of our net income and shareholders equity in accordance with Hong Kong GAAP and U.S. GAAP



|                                                                                         |  |                       |   |  |           |   |  |           |   |  |         |  
|---------------------------------------------------------------------------------------- |  | --------------------- | - |  | --------- | - |  | --------- | - |  | ------- | -
|                                                                                         |  | Year Ended August 31, |  
|                                                                                         |  | 2003                  |   |  | 2004      |   |  | 2005      |   |  | 2005    |  
|                                                                                         |  | HK$                   |   |  | HK$       |   |  | HK$       |   |  | US$     |  
|                                                                                         |  | (in thousands)        |  
|Net income/(loss)                                                                        |  |                       |   |  |           |   |  |           |   |  |         |  
|Hong Kong GAAP                                                                           |  | 257,743               |   |  | 49,550    |   |  | (156,531  | ) |  | (20,141 | )
|U.S. GAAP adjustments:                                                                   |  |                       |   |  |           |   |  |           |   |  |         |  
|Compensation benefit cost associated with share options                                  |  | 2,731                 |   |  | 270       |   |  | 389       |   |  | 50      |  
|Amortization of goodwill (acquired prior to June 30, 2001)                               |  |                      |   |  |          |   |  |          |   |  |        |  
|Reversal of amortization of goodwill under Hong Kong GAAP (acquired after June 30, 2001) |  | 1,065                 |   |  | 1,065     |   |  | 1,065     |   |  | 137     |  
|Fair value of interest rate swap                                                         |  |                      |   |  | 680       |   |  | 1,890     |   |  | 243     |  
|Fair value of forward foreign exchange contracts                                         |  |                      |   |  |          |   |  | 4,039     |   |  | 520     |  
|Tax effects of U.S. GAAP adjustments                                                     |  |                      |   |  |          |   |  |          |   |  |        |  
|                                                                                         |  |                       |   |  |           |   |  |           |   |  |         |  
|Net income/(loss) under U.S. GAAP                                                        |  | 261,539               |   |  | 51,565    |   |  | (149,148  | ) |  | (19,191 | )
|                                                                                         |  |                       |   |  |           |   |  |           |   |  |         |  
|Shareholders Equity                                                                     |  |                       |   |  |           |   |  |           |   |  |         |  
|Hong Kong GAAP                                                                           |  | 1,179,175             |   |  | 1,175,698 |   |  | 1,020,454 |   |  | 131,302 |  
|U.S. GAAP adjustments:                                                                   |  |                       |   |  |           |   |  |           |   |  |         |  
|Goodwill                                                                                 |  | 5,092                 |   |  | 5,092     |   |  | 5,092     |   |  | 655     |  
|Accumulated amortization of goodwill under U.S. GAAP                                     |  | (3,735                | ) |  | (3,735    | ) |  | (3,735    | ) |  | (481    | )
|Reversal of amortization of goodwill under Hong Kong GAAP                                |  | 2,130                 |   |  | 3,195     |   |  | 4,260     |   |  | 548     |  
|Fair value of interest rate swap                                                         |  |                      |   |  | 680       |   |  | 2,570     |   |  | 331     |  
|Fair value of forward foreign exchange contracts                                         |  |                      |   |  |          |   |  | 4,039     |   |  | 520     |  
|Tax effects of U.S. GAAP adjustments                                                     |  |                      |   |  |          |   |  |          |   |  |        |  
|                                                                                         |  |                       |   |  |           |   |  |           |   |  |         |  
|Total shareholders equity under U.S. GAAP                                               |  | 1,182,662             |   |  | 1,180,930 |   |  | 1,032,680 |   |  | 132,875 |  
|                                                                                         |  |                       |   |  |           |   |  |           |   |  |         |  



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Under Hong Kong GAAP, no compensation cost is required to be recognized in respect of the grant of stock
options to employees and executive directors. Under U.S. GAAP, compensation expense is required to be measured either in accordance with the intrinsic value method prescribed by APB Opinion No. 25 Accounting for Stock Issued to
Employees or the fair value method prescribed by Statement of Financial Accounting Standards (SFAS) No. 123 Accounting for Stock-based Compensation. We apply the intrinsic value method prescribed by APB Opinion
No. 25 and disclose in our consolidated financial statements the pro forma effect that use of the fair value method would have on our net income and earnings per share. The compensation cost for stock options under U.S. GAAP represents the cost
of amortizing the compensation expense given to employees over the vesting period of the options. Because the exercise price of certain options granted can decrease during the vesting period, such options are considered variable options under APB
Opinion No. 25 and compensation expense is based on our share price at the balance sheet date. The charge for compensation expense for fiscal 2005 primarily relates to such variable options.



Goodwill and accumulated amortization comprises goodwill arising on the
acquisition in 1999 of 963673 Ontario Limited group of companies and the goodwill arising on the deemed acquisition of additional interest in one of our wholly owned subsidiaries, HKBN, through subscription of Rights Issue and from acquiring
remaining interest from the minority shareholder in 2002.



Under Hong Kong GAAP, the Company charged the goodwill arising from the acquisition of 963673 Ontario Limited group of companies against available reserves. However, in accordance with the change in accounting standards in Hong Kong,
goodwill on acquisitions occurring on or after September 1, 2001 is shown separately on the consolidated balance sheet and is amortized using the straight-line method over its estimated useful life. As a result of that, the goodwill arising for
HKBN is recorded as an asset on the balance sheet and amortized over its estimated useful life, which in this case is five years. For the goodwill arising for the 963673 Ontario Limited group of companies, the Company has taken advantage of the
transitional provisions of the new accounting standard and goodwill previously written off against reserves has not been restated. Where an indication of impairment exists, the carrying amount of goodwill, including goodwill previously written off
against reserves, is assessed and written down immediately to its recoverable amount with the charges being recorded in the Companys statement of operations.



Under U.S. GAAP, goodwill recorded on the acquisition of a business prior to June 30, 2001 was capitalized and
amortized to the statement of operations over its expected useful life of five years. In June 2001, FASB issued the SFAS No. 142 Goodwill and other Intangible Assets effective for fiscal years beginning after December 15, 2001.
In connection with the adoption of this standard in fiscal 2003 under U.S. GAAP, we ceased amortizing goodwill recognized on business combinations initiated prior to June 30, 2001 and performed a transitional goodwill impairment assessment.
Goodwill recognized on business combinations initiated after June 30, 2001, is not amortized under SFAS No. 142 and is required to be tested annually for impairment in accordance with the provisions of SFAS No. 142. We have performed
the impairment tests on the goodwill recorded prior to and after June 30, 2001 at the fiscal year end and no impairment loss was identified from the process for fiscal 2005.



Under Hong Kong GAAP, where a non-speculative forward contract is used as a hedge of a net monetary asset or liability the
gain or loss on the contract is credited or charged to the statement of operations and the discount or premium is either amortized over the period of the contract or credited or charged to the statement of operations. Where a non-speculative forward
contract is used as a hedge of a firm commitment no gain or loss is recognized during the commitment period. At the end of that period any gain or loss will be added to, or deducted from, the amount of the relevant transaction. The discount or
premium is either amortized over the period of the contract or deferred with the gain or loss. Where a forward contract is speculative the gain or loss is credited or charged to the statement of operations. As a result, the Company does not
recognize the interest rate swap or forward foreign exchange contracts at fair value and does not account for the gains or losses relating to the fair value changes in these derivatives. Interest income or expenses arising from the interest rate
swap contracts are netted of against the related interest income or expenses applicable to the on-balance sheet items.



Under U.S. GAAP, the Company accounted for its derivatives under SFAS No. 133 Accounting for Derivative Instruments and Hedge Activities,
as amended by SFAS No. 138 Accounting for Certain Derivative Instruments and Certain Hedging Activities, which requires all derivative instruments be recognized on the balance sheet at fair value.



Since the Company did not have any derivatives that qualify as hedges, the
gain or loss on change in fair value of these derivative instruments are recognized currently in earnings.



Recent Accounting Pronouncements



Hong Kong GAAP



In March 2004, the Hong Kong Institute of Certified Public Accountants (HKICPA) issued the Hong Kong Accounting Standards (HKAS) and HKAS Interpretation (HKAS Interpretation) that were converged with
equivalent International Accounting Standards and Standing Interpretations Committee Interpretations issued by the International Accounting Standards Board (IASB), most of which were revised recently as a result of the IASBs
improvements project.



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The HKAS and HKAS Interpretation will become effective for accounting periods beginning on or after
January 1, 2005 and are required to be adopted by us for the year ending August 31, 2006. As a consequence, all existing Statement of Standard Accounting Practices (SSAP) and the related interpretations issued by the HKICPA,
for which there are equivalent International Accounting Standards and Standing Interpretations Committee Interpretations will be renamed as HKAS and HKAS Interpretations, or otherwise, will be superseded at that time.



The Company did not early adopt these new Hong Kong Financial Reporting
Standards (HKFRSs) in the financial statements for fiscal 2005. The Company has made a preliminary assessment of the impact of these new HKFRSs and has concluded that the adoption of HKFRS 2 Share-based Payment,
HKFRS 3 Business Combinations and HKAS 39 Financial Instruments: Recognition and Measurement will have an impact on the Companys financial statements as described below:



|(i) | HKFRS 2 Share-based Payment
|--- | -----------------------------



With effect from September 1, 2005, HKFRS 2 requires that the Company recognize the fair value of share options granted to employees as an expense in
the consolidated statements of operations, or as an asset, if the cost qualifies for recognition as an asset under the Companys accounting policies. A corresponding increase is recognized in a capital reserve within equity. HKFRS 2 requires
that the fair value of the share options is measured at the date of grant. Where the employees are required to meet vesting conditions before they become entitled to the options, the fair value of the options granted should be recognized over the
vesting period.



Under the transitional provisions of HKFRS 2,
the Company can choose not to apply this treatment to share-based payments which were granted on or before November 7, 2002 or which were granted after November 7, 2002 but already vested before September 1, 2005.



If this revised accounting standard been adopted for fiscal 2005, the other
operating expenses and the capital reserve of the Company would increase due to the recognition of share-based compensation expense. Management has assessed and considered the impact of the adoption of this new policy on the Companys
profit/(loss) attributable to shareholders and net assets as not significant.



|(ii) | HKFRS 3 Business Combination
|---- | ------------------------------



With effect from September 1, 2005, HKFRS 3 requires goodwill to be recorded at cost less any accumulated impairment losses. Positive goodwill
under HKFRS 3 is no longer amortized but requires an annual test for impairment, including in the year of its initial recognition, as well as when there are indications of impairment. Impairment losses are recognized when the carrying amount of the
cash generating unit to which the goodwill has been allocated exceeds its recoverable amounts.



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In accordance with HKFRS 3, if the fair value of the net assets acquired in a business combination
exceeds the consideration paid (i.e. an amount arises which would have been known as negative goodwill), the excess is recognized immediately in the consolidated statements of operations as it arises.



In accordance with the transitional arrangements under HKFRS 3, goodwill
which had previously been taken directly to reserves (i.e. goodwill which arose before January 1, 2001) will not be recognized in the consolidated statements of operations on disposal or impairment of the acquired business, or under any other
circumstances.



This new policy is to be applied prospectively
from September 1, 2005 in accordance with the transitional arrangements under HKFRS 3. This will result in a change to the Companys current accounting policies from September 1, 2005 onwards on the amortization of goodwill. The new
policy in respect of negative goodwill would have no impact on the consolidated financial statements of the Company.



If this revised accounting standard been adopted for fiscal 2005, the other operating expenses would decrease and the goodwill balance would increase
because of the cessation of the amortization of the goodwill balance.



Management has assessed and considered the impact on of the adoption of this new policy on the Companys consolidated profit/(loss) attributable to shareholders and consolidated net assets as not significant.



|(iii) | HKAS 39 Financial Instruments: Recognition and Measurement
|----- | ------------------------------------------------------------



With effect from September 1, 2005, HKAS 39 requires the following:



All non-trading investments are classified as available-for-sale securities and carried at fair value. Changes in fair value
are recognized in equity, unless there is objective evidence that an individual investment has been impaired. If there is objective evidence that an individual investment has been impaired, any amount held in fair value reserve in respect of the
investment is transferred to the statements of operations for the period in which the impairment is identified. Any subsequent increase in the fair value of available-for-sale securities is recognized directly in equity.



Based on managements evaluation, the adoption of this new policy would
not be significant on the financial statements of the Company.



All derivative financial instruments entered into by the Company are stated at fair value. The accounting for changes in fair value depends on whether the derivative instrument qualifies as a hedge. Gains and losses on a derivative
instrument designated and qualifying as a fair value hedge as well as the offsetting loss or gain on the hedged item attributable to the hedged risk shall be recognized currently in the statements of operations. The effective portion of the gain or
loss on a derivative instrument designated and qualifying as a cash flow hedge shall be reported in equity and reclassified into earnings in the same period or periods during which the hedged forecasted transaction impact earnings. Any ineffective
portion of the changes in fair value of the derivatives is recognized in the statements of operations.



Management expects that the adoption of this new policy would result in an increase or decrease in the net asset or the other revenues of the Company
depending on the change in fair value of the financial instruments. If this new policy been adopted in fiscal 2005, the other revenues and the net asset of the Company would increase due to the recognition of the gain in increase in fair value of
the interest rate swap and foreign forward exchange contracts.



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Convertible notes issued are split into their liability and equity components at initial recognition by
recognizing the liability component at its fair value and attributing to the equity component the difference between the proceeds from the issue and the fair value of the liability component. The liability component is subsequently carried at
amortized cost. The equity component is recognized in the capital reserve until the note is either converted (in which case it is transferred to share premium) or the note is redeemed (in which case it is released directly to retained profits). This
new policy in respect of convertible notes would have no impact on the financial statements because the Company did not issue any convertible notes as defined under HKAS 32 Financial instruments: Disclosure and Presentation.



The Company is continuing its assessment of the impact of other new HKFRSs
and other significant changes may be identified as a result.



The Company considers that there is no significant impact on the adoption of HKFRS 4 and HKFRS 5 on our financial statements presented in accordance with Hong Kong GAAP.



U.S. GAAP



In December 2004, the FASB issued SFAS No. 123 (revised 2004) (SFAS No. 123(R)) Share-Based Payment. SFAS
No. 123(R) replaces SFAS No. 123 Accounting for Stock-Based Compensation and supersedes APB Opinion No. 25 Accounting for Stock Issued to Employees and its related implementation guidance. SFAS No. 123(R)
requires the company to measure the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award and recognize in the financial statements. That cost will be recognized over the
period during which an employee is required to provide service in exchange for the award. No compensation cost is recognized for equity instruments for which employees do not render the requisite service. For public entities that do not file as
small business issuers, SFAS No. 123(R) is effective for all awards granted after June 15, 2005, and to awards modified, repurchased, or cancelled after that date. For the Company, SFAS No. 123(R) is effective for the accounting
period from September 1, 2005. The Company is currently assessing the impact of this statement on its consolidated financial statements and has not yet completed that assessment.



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ITEM 6.    DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES



Directors and Senior Management



Our board of directors consists of seven directors, three of whom are independent non-executive directors and one of whom is a non-executive director.
Three are executive directors, namely, Mr. Wong Wai Kay, Ricky, Mr. Cheung Chi Kin, Paul, and Mr. Lai Ni Quiaque. The non-executive director is Mr. Cheng Mo Chi, Moses. The three independent non-executive directors are
Mr. Lee Hon Ying, John, Dr. Chan Kin Man and Mr. Peh Jefferson Tun Lu.



The following table sets forth certain information concerning our directors and senior management as of January 17, 2006.



|                         |  |     |  |                                                                          |  |                       
|------------------------ |  | --- |  | ------------------------------------------------------------------------ |  | ----------------------
|Name                     |  | Age |  | Position                                                                 |  | DateJoined CityTelecom
|Board of Directors:      |  |     |  |                                                                          |  |                       
|WONG Wai Kay, Ricky      |  | 44  |  | Chairman                                                                 |  | 1992                  
|CHEUNG Chi Kin, Paul     |  | 48  |  | Managing Director                                                        |  | 1992                  
|LAI Ni Quiaque           |  | 36  |  | Chief Financial Officer                                                  |  | 2004                  
|CHENG Mo Chi, Moses      |  | 55  |  | Non-Executive Director                                                   |  | 1997                  
|LEE Hon Ying, John       |  | 59  |  | Non-Executive Director                                                   |  | 1997                  
|CHAN Kin Man             |  | 46  |  | Non-Executive Director                                                   |  | 1997                  
|PEH Tun Lu, Jefferson    |  | 46  |  | Non-Executive Director                                                   |  | 2004                  
|                         |  |     | 
|Senior Management:       |  |     |  |                                                                          |  |                       
|CHONG Kin Chun, John     |  | 43  |  | Director, Corporate Division                                             |  | 1996                  
|FUNG So Mui, Fion        |  | 42  |  | Director, Business Development                                           |  | 1993                  
|LEUNG Yau Man, Haily     |  | 37  |  | Senior Vice-President, Digital-TV Services                               |  | 2003                  
|LO Sui Lun               |  | 41  |  | Director, Network Development                                            |  | 1998                  
|TO Wai Bing              |  | 43  |  | Director, International Business, Carrier Business and Carrier Relations |  | 1998                  
|YEUNG Chu Kwong, William |  | 45  |  | Chief Operating Officer                                                  |  | 2005                  



Executive Directors



Mr. WONG Wai Kay, Ricky, aged 44, 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 20 years experience in the telecommunications and
computer industries. Mr. Wong has worked at a major U.S.-listed computer company as a marketing representative and was responsible for the marketing and the distribution of computer products in Hong Kong from 1985 to 1989. He was also a
co-founder and director of a company principally engaged in the import and distribution of computer systems in Canada prior to co-founding City Telecom. Mr. Wong is a first cousin of Mr. Cheung Chi Kin, Paul, our managing director.



Mr. CHEUNG Chi Kin, Paul, aged 48, 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 25 years experience in the telecommunications and computer industries. Mr. Cheung has worked in companies engaged in application software development and computer consultancy prior to
co-founding City Telecom. Mr. Cheung is a first cousin of Mr. Wong Wai Kay, Ricky, our chairman.



Mr. LAI Ni Quiaque, aged 36, is our chief financial officer. Mr. Lai joined City Telecom in May 2004 and is responsible for our financial
operations. Mr. Lai has 13 years experience in telecommunications industry research and finance. Prior to joining City Telecom, Mr. Lai was the Director and Head of Asia Telecom Research for Credit Suisse First Boston, having spent
eight years with the firm. Before that, Mr. Lai held positions with Hongkong Telecom and Kleinwort Benson Securities (Asia). Mr. Lai holds a Bachelor of Commerce degree from the University of Western Australia and is a qualified member of
the Australian Society of CPAs.



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Non-executive Director



Mr. CHENG Mo Chi, Moses, aged 55, was re-designated as a non-executive director of City Telecom with effect from September 30, 2004. He was
appointed as an independent non-executive director of the Company since June 17, 1997 and a member of the Audit Committee since its establishment on March 22, 1999. He is the senior partner of P.C. Woo & Co., a firm of solicitors
and notaries in Hong Kong, the Founder Chairman of the Hong Kong Institute of Directors of which he is now the Honorary President and Chairman Emeritus, the Chairman of the Council and Court of the Hong Kong Baptist University and the Football
Betting and Lotteries Commission. Mr. Cheng was appointed a member of the Legislative Council of Hong Kong from 1991 to 1995.



Independent Non-executive Directors



Mr. LEE Hon Ying, John, aged 59, 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 a member of
each of the Institution of Electronic and Radio Engineers, the United Kingdom and the Hong Kong Institution of Engineers and the Hong Kong Computer Society. He received a masters degree in information systems from The Hong Kong Polytechnic
University in 1992. In addition, he is the Territory Vice-President of the Society of St. Vincent de Paul of Asia and Oceania, which is an international charity body. He is the Chairperson of the Catholic Diocese of Hong Kong Diocesan for Hospital
Pastoral Care. Mr. Lee has been a director of City Telecom since June 1997.



Dr. CHAN Kin Man, aged 46, is an associate professor of the Department of Sociology of The Chinese University of Hong Kong, specializing in the state-society relations in China and Hong Kong. He received a
Bachelor of Social Science degree from The Chinese University of Hong Kong in 1983 and a doctor of philosophy degree from Yale University in the U.S. in 1995. Dr. Chan has been a director of City Telecom since June 1997.



Mr. PEH Tun Lu, Jefferson, aged 46, is a Certified Public Accountant of
the Hong Kong Institute of Certified Public Accountants and a Certified Practicing Accountant of CPA Australia. Mr. Peh holds a Masters degree in business from the University of Technology, Sydney. He has over 23 years of experience in
finance, accounting and management with listed and private companies in Hong Kong and Australia. Mr. Peh has been a director of City Telecom since September 2004.



Senior Management



Mr. CHONG Kin Chun, John, aged 43, is the director of our corporate division. He is responsible for sales, marketing and development of our
international telecommunications services and fixed telecommunications network services for our business and corporate customers. Mr. Chong joined City Telecom in February 1996 and was appointed as an executive director in June 1997. He holds a
bachelors degree in arts from the University of Hong Kong. Mr. Chong worked as a general manager overseeing product management and the sales force of a listed telecommunications products company in Hong Kong from 1987 to 1996.



Ms. FUNG So Mui, Fion, aged 42, is the director of business
development. She holds a bachelors degree in business administration from the University of Wisconsin, Madison in the United States. Ms. Fung is currently in charge of our business planning and development. Prior to that she was
responsible for the development of our fixed telecommunications network businesses, the expansion of network coverage in Hong Kong, regulatory affairs and other business development operations of City Telecom. Ms. Fung worked as a research
manager in a foreign-based executive recruitment firm in Hong Kong from 1986 to 1989. She joined City Telecom in October 1993 and was appointed as an executive director in June 1997.



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Ms. LEUNG Yau Man, Haily, aged 37, is the senior vice-president of Digital-TV services.
Ms. Leung joined City Telecom in April 2003 with the title of director and is responsible for the overall planning and development of City Telecoms Digital-TV business. She graduated from The University of Hong Kong and holds a
Bachelors of Arts degree. Prior to joining City Telecom, Ms. Leung has worked in various large corporations including a television broadcaster, a mobile company and a telecommunications company.



Mr. LO Sui Lun, aged 41, is the director of network development. He is
responsible for the engineering and development of our fixed telecommunications network. He joined City Telecom in September 1998 and was promoted to the title of director in 1999. Prior to joining City Telecom, Mr. Lo worked for PCCW-HKT
(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. TO Wai Bing, aged 43, is our director in charge of international business, carrier business and carrier relations. She joined City Telecom in
September 1998 and was appointed an executive director in October 2000. She is responsible for setting up business relationships with international carriers to build reliable, high quality and cost effective international telecommunications and IP
platforms. She also manages China business development. Ms. To is also in charge of the carrier business to develop wholesale services in Hong Kong. Under the scope of carrier relations, she is responsible for liaising with local fixed and
mobile operators for interconnection issues. Ms. To worked at Cable & Wirless 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.



Mr. YEUNG Chu Kwong, William, aged 45, is our Chief Operating Officer. Mr. Yeung joined City Telecom in October 2005 and is responsible for
heading our customer engagement department to oversee customer relationship management. He holds a Bachelor of Arts degree from Hong Kong Baptist University, a Master of Business Administration degree from University of Strathclyde, UK and a Master
of Science degree in electronic commerce and Internet computering from The University of Hong Kong. Mr. Yeung has more than 13 years experience in the telecommunications industry. Prior to joining City Telecom, Mr. Yeung was the
Director of Customers Division at Smartone-Vodafone, the General Manager of Personal Communications and Retail Division at Tricom Telecom Limited, and has been an Inspector of Police in the Hong Kong Police Force.



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 fiscal 2005 was approximately HK$20.2 million. We paid approximately HK$1.7 million as our contribution to the pension schemes of the
directors in the year ended August 31, 2005. In addition we paid our fiscal non-executive directors fees in the aggregate amount of approximately HK$487,000 during fiscal 2005.



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 and approval by the Remuneration Committee (as defined below). Additionally, our senior management and employees are entitled to receive an annual discretionary bonus based on their individual performance and
our financial performance during the year in question.



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The total number of ordinary shares representing outstanding options granted under the 2002 Scheme (as
defined under  Share Option Schemes below) as of January 17, 2006 was 36,520,000. On October 21, 2004, we granted to our directors and senior managers under our 2002 Scheme options to subscribe for 14,670,000 ordinary
shares. On October 21, 2004, the board of directors also proposed to grant options to subscribe for 8,000,000 ordinary shares to each of Mr. Wong Wai Kay, Ricky and Mr. Cheung Chi Kin, Paul. The proposed grants of option were approved
by shareholders at our annual general meeting held on December 29, 2004. On October 3, 2005, the board of directors granted options to subscribe for 1,000,000 ordinary shares to Mr. Yeung Chu Kwong, William. The total number of
ordinary shares representing outstanding options under the 1997 Scheme (as defined under  Share Option Schemes below) as of January 17, 2006 was 528,000.



Except as discussed herein, no other payments have been paid or are payable, in respect of fiscal 2005, by us or any of our
subsidiaries to our directors and senior management.



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 fiscal 2005 was approximately HK$10.1 million.



For fiscal 2005, the aggregate amount accrued by us to provide pension
retirement or similar benefits for our directors, senior management and other employees was approximately HK$27.4 million.



Board Practices



Service Contracts



We have entered into service contracts with two of our executive directors, Wong Wai Kay, Ricky, and Cheung Chi Kin, Paul. The service agreements with
Mr. Wong and Mr. Cheung had an initial term that ended on June 30, 2000. These service agreements are automatically renewed annually after the initial term until termination with prior notice. After the initial term, the agreements
with Mr. Wong and Mr. Cheung can be terminated by either party with six months notice. We will also enter into a service contract with Mr. Lai Ni Quiaque as the Chief Financial Officer upon approval by the Remuneration
Committee. These service contracts include non-competition clauses under which our executive directors agree not to compete with us in accordance with the terms and conditions therein. None of the agreements provide for any benefits or compensation
upon termination of employment.



Audit Committee



Our board of directors established an Audit Committee to ensure the
impartial supervision of our accounting and business operations. The Audit Committee is comprised of three independent non-executive directors, namely, Mr. Lee Hon Ying, John (the Chairman of the Audit Committee), Dr. Chan Kin Man and
Mr. Peh Tun Lu, Jefferson Mr. Peh was appointed to the Audit Committee on September 1, 2004 and is a financial expert within the meaning of, and as required by the U.S. Sarbanes-Oxley Act of 2002.



The Audit Committee is governed by our audit committee charter, which was
adopted by our board of directors at a meeting held in August 2004. It is responsible for overseeing the accounting and financial reporting process of the Group and the audits of the Groups financial statements on behalf of the Board of
Directors.



Additionally, the Audit Committee is responsible
for the appointment, compensation, retention and oversight of the work of City Telecom s independent auditors (including resolution of disagreements between management and the auditors regarding financial reporting) for the purpose of
preparing or issuing an audit report or performing other audit, review or attest services for City Telecom.



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The Audit Committee shall meet at least twice a year. The Audit Committee shall have the resources and
authority appropriate to discharge its responsibilities as required by law, including the authority to engage independent counsel and other advisors as the Audit Committee deems necessary to carry out its duties.



Remuneration Committee



Our board of directors established a remuneration committee in August, 2001 to ensure the supervision of the remuneration
packages we pay to our executive directors. The remuneration committee is comprised of 6 members with three independent non-executive directors, Mr. Lee Hon Ying, John, Mr. Peh Tun Lu, Jefferson, Dr. Chan Kin Man, the non-executive
director, Mr. Cheng Mo Chi, Moses, our finance director and our director of human resources. The remuneration committees main duties are set out as follows:-



| | (a) | to make recommendations to the Board on City Telecoms policy and structure for all remuneration of directors and senior management and on the establishment of a formal and
transparent procedure for development policy on such remuneration;
| | --- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (b) | to have the delegated responsibility to determine the specific remuneration packages of all executive directors and senior management, including benefits in kind, pension rights,
short and long term incentives and compensation payments, including any compensation payable for loss or termination of their office or appointment, and make recommendations to the Board of the remuneration of Non-executive Directors;
| | --- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (c) | to review and approve performance-based remuneration by reference to corporate goals and objectives resolved by the Board from time to time;
| | --- | --------------------------------------------------------------------------------------------------------------------------------------------



| | (d) | to review and approve the compensation payable to executive directors and senior management in connection with any loss or termination of their office or appointment to ensure that
such compensation is determined in accordance with relevant contractual terms and that such compensation is otherwise fair and not excessive for City Telecom;
| | --- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (e) | to review and approve compensation arrangements relating to dismissal or removal of directors for misconduct to ensure that such arrangements are determined in accordance with
relevant contractual terms and that any compensation payment is otherwise reasonable and appropriate; and
| | --- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (f) | to ensure that no director or any of his associates is involved in deciding his own remuneration.
| | --- | -------------------------------------------------------------------------------------------------



Employees



The following chart sets forth the number of our employees by functional area as of August 31, 2005.



|                                       |  |          
|-------------------------------------- |  | ---------
|                                       |  | Employees
|Information technology and engineering |  | 685      
|Sales and marketing                    |  | 1,764    
|Customer service                       |  | 977      
|General administration and others      |  | 470      
|                                       |  |          
|Total                                  |  | 3,896    
|                                       |  |          



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The following chart sets forth the number of our employees by geographical region as of August 31,
2005.



|          |  |          
|--------- |  | ---------
|          |  | Employees
|Hong Kong |  | 1,927    
|Guangzhou |  | 1,940    
|Canada    |  | 29       
|          |  |          
|Total     |  | 3,896    
|          |  |          



As of August 31,
2003, 2004 and 2005, we had 2,753, 3,583 and 3,896 employees, respectively. In connection with the transfer of our calling center operations to Guangzhou, China, we have hired over 1,900 customer service representatives and back office employees to
staff that facility. We also substantially increased the number of our sales and marketing and back office during fiscal 2005. As a result, our total number of employees increased. We have not experienced any work slowdowns or stoppages and we
consider our relations with our employees to be good.



Share Ownership



The following chart
sets forth the share ownership of our directors and senior management as of January 17, 2006.



|                |  |                             |  |                                         |  |                                                |  |              
|--------------- |  | --------------------------- |  | --------------------------------------- |  | ---------------------------------------------- |  | -------------
|Title of Class  |  | Identity of Person or Group |  | Number of Shares Beneficially Owned(13) |  | Percentage of Shares Beneficially Owned (%)(3) |  | Share Options
|Ordinary Shares |  | Wong Wai Kay, Ricky         |  | 334,754,999(1)                          |  | 54.51                                          |  | 8,000,000(4) 
|Ordinary Shares |  | Cheung Chi Kin, Paul        |  | 329,024,999(2)                          |  | 53.58                                          |  | 8,000,000(5) 
|Ordinary Shares |  | Lai Ni Quiaque              |  | 8,560,000                               |  | 1.39                                           |  | 6,000,000(6) 
|Ordinary Shares |  | Chong Kin Chun, John        |  | 1,574,000                               |  | Less than 1.0                                  |  | 2,000,000(7) 
|Ordinary Shares |  | Fung So Mui, Fion           |  | 1,964,000                               |  | Less than 1.0                                  |  | 500,000(8)   
|Ordinary Shares |  | To Wai Bing                 |  | 398,000                                 |  | Less than 1.0                                  |  | 2,000,000(9) 
|Ordinary Shares |  | Lo Sui Lun                  |  | 700,000                                 |  | Less than 1.0                                  |  | 500,000(10)  
|Ordinary Shares |  | Leung Yau Man, Haily        |  |                                        |  |                                               |  | 300,000(11)  
|Ordinary Shares |  | Yeung Chu Kwong, William    |  |                                        |  |                                               |  | 1,000,000(12)

---

|(1) | Of the 334,754,999 shares, 318,516,999 shares are beneficially owned through
Mr. Wongs approximately 35% interest in Top Group International Limited, or Top Group, 1,346,000 shares are held by Bullion Holdings Limited, which is wholly owned by Mr. Wong, 3,098,000 shares are owned jointly by Mr. Wong and
his spouse, and 11,794,000 shares are owned personally by him.
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(2) | Of the 329,024,999 shares, 318,516,999 shares are beneficially owned through
Mr. Cheungs approximately 35% interest in Top Group and 10,508,000 shares are owned personally by Mr. Cheung.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(3) | Percentage ownership is based on 614,125,404 shares issued and outstanding as of
January 17, 2006.
|--- | --------------------------------------------------------------------------------------------------



|(4) | Options to subscribe for 8,000,000 shares were granted to Mr. Wong for a purchase price
of HK$1.0, at an exercise price of HK$1.54 per share and exercisable on or before October 20, 2014 in the following manner: (i) 4,000,000 on or after January 5, 2005, (ii) 2,000,000 on or after January 1, 2006 and
(iii) 2,000,000 on or after January 1, 2007. The grant of option was proposed on October 21, 2004 and approved by shareholders at our annual general meeting held on December 29, 2004.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(5) | Options to subscribe for 8,000,000 shares were granted to Mr. Cheung for a purchase
price of HK$1.0, at an exercise price of HK$1.54 per share and exercisable on or before October 20, 2014 in the following manner: (i) 4,000,000 on or after January 5, 2005, (ii) 2,000,000 on or after January 1, 2006 and
(iii) 2,000,000 on or after January 1, 2007. The grant of option was proposed on October 21, 2004 and approved by shareholders at our annual general meeting held on December 29, 2004.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(6) | Options to subscribe for 6,000,000 shares were granted to Mr. Lai on June 3, 2004
for a purchase price of HK$1.0, at an exercise price of HK$1.47 per share and exercisable on or before June 2, 2014 in the following manner: (i) 5,000,000 on or after May 1, 2005, and (ii) 1,000,000 on or after May 1, 2006.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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|(7) | Options to subscribe for 2,000,000 shares were granted to Mr. Chong on October 21,
2004 for a purchase price of HK$1.0, at an exercise price of HK$1.54 per share and exercisable on or before October 20, 2014 in the following manner: (i) 1,000,000 on or after January 1, 2005, (ii) 500,000 on or after
January 1, 2006, and (iii) 500,000 on or after January 1, 2007.
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(8) | Options to subscribe for 500,000 shares were granted to Ms. Fung on October 21,
2004 for a purchase price of HK$1.0, at an exercise price of HK$1.54 per share and exercisable on or before October 20, 2014 in the following manner: (i) 200,000 on or after January 1, 2005, (ii) 200,000 on or after
January 1, 2006, and (iii) 100,000 on or after January 1, 2007.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(9) | Options to subscribe for 2,000,000 shares were granted to Ms. To on October 21,
2004 for a purchase price of HK$1.0, at an exercise price of HK$1.54 per share and exercisable on or before October 20, 2014 in the following manner: (i) 1,000,000 on or after January 1, 2005, (ii) 500,000 on or after
January 1, 2006, and (iii) 500,000 on or after January 1, 2007.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(10) | Options to subscribe for 500,000 shares were granted to Mr. Lo on October 21, 2004
for a purchase price of HK$1.0, at an exercise price of HK$1.54 per share and exercisable on or before October 20, 2014 in the following manner: (i) 200,000 on or after January 1, 2005, (ii) 200,000 on or after January 1,
2006, and (iii) 100,000 on or after January 1, 2007.
|---- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(11) | Options to subscribe for 300,000 shares were granted to Ms. Leung on October 21,
2004 for a purchase price of HK$1.0, at an exercise price of HK$1.54 per share and exercisable on or before October 20, 2014 in the following manner: (i) 120,000 on or after January 1, 2005, (ii) 100,000 on or after
January 1, 2006, and (iii) 80,000 on or after January 1, 2007.
|---- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(12) | Options to subscribe for 1,000,000 shares were granted to Mr. Yeung on October 3,
2005 for a purchase price of HK$1.0, at an exercise price of HK$0.81 per share and exercisable on or after October 1, 2006 but before October 2, 2015.
|---- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(13) | Beneficial ownership is determined in accordance with the rules of the SEC.
|---- | ---------------------------------------------------------------------------



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



Share
Option Schemes



We adopted a second share option scheme,
which we refer to as the 2002 Scheme, on December 23, 2002 and terminated the share option scheme adopted and in effect since July 12, 1997, which we refer to as the 1997 Scheme. The provisions of the 1997 Scheme remain in force to the
extent necessary to give effect to the exercise of any option granted pursuant to the 1997 Scheme. Such options continue to be valid and exercisable in accordance with the 1997 Scheme. Under the terms of the 2002 Scheme, our board of directors or
the Board, may, in its discretion from time to time, and subject to such conditions as the Board may determine, within ten years beginning on December 23, 2002, grant employees, including executive, non-executive and independent non-executive
directors, of City Telecom or any of its subsidiaries and any suppliers and professional advisers of City Telecom or any of its subsidiaries options to subscribe for our ordinary shares.



The maximum number of ordinary shares which may be issued upon exercise of all options to be granted under our 2002 Scheme
and any of our other share option scheme(s) must not exceed 10% of the ordinary shares in issue as of the date of approval or adoption of the scheme by the shareholders which was December 23, 2002 for the 2002 Scheme. Ordinary shares which
would have been issuable pursuant to options which have lapsed in accordance with the terms of such share option schemes will not be counted for the purpose of the 10% limit. Such limit may be refreshed upon approval by shareholders and compliance
with all requirements under the Rules Governing the Listing of Securities on The Stock Exchange of Hong Kong Limited, which we refer to as the Listing Rules. Pursuant thereto, such limit was refreshed with the approval of our shareholders in our
annual general meeting held on December 29, 2004 up to a maximum limit equal to 10% of our total number of issued shares as at December 29, 2004. Notwithstanding the foregoing, the number of ordinary shares which may be issued upon
exercise of all outstanding options granted and yet to be exercised under our 2002 Scheme and any of our other share option scheme(s) at any time shall not exceed 30% of the total number of ordinary shares in issue from time to time.



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The total number of ordinary shares issued and which may be issued upon exercise in full of the options
granted under our 2002 Scheme and any of our other share option scheme(s) (including exercised, cancelled and outstanding options) to each eligible participant in any 12 month period up to and including the date of grant shall not exceed 1% of the
outstanding ordinary shares as at the date of grant. Any further grant of options in excess of this 1% limit must be approved by shareholders.



The subscription price for an ordinary share payable by a participant upon the exercise of any option granted under the 2002 Scheme will be determined by
the Board in its absolute discretion, except that such price will not be less than the highest of (a) the closing price of the ordinary shares as stated in The Stock Exchange of Hong Kong Limiteds daily quotations sheet on the date of
grant, which must be a business day; (b) the average of the closing prices of the ordinary shares as stated in The Stock Exchange of Hong Kong Limiteds daily quotations sheets for the five business days immediately preceding the date of
grant; and (c) the nominal value of an ordinary share.



Any grant of options to any of our directors, chief executives or substantial shareholders or any of their respective associates (as defined in the Listing Rules) is required to be approved by our non-grantee independent non-executive
directors. If we propose to grant options to a substantial shareholder or any of its independent non-executive directors, or their respective associates, which will result in the number of ordinary shares issued and to be issued upon exercise of
options granted and to be granted under our 2002 Scheme and any of our other share option scheme(s) (including options exercised, cancelled and outstanding) to such person in the 12 month period up to and including the date of such grant
(a) representing in aggregate over 0.1% of the outstanding ordinary shares; and (b) having an aggregate value in excess of HK$5 million, based on the closing price of the ordinary shares at the date of each grant, such further grant of
options will be subject to approval by shareholders and all requirements under the Listing Rules.



A grant of options may not be made after a price sensitive event has occurred or a price sensitive matter has been the subject of a decision until such
price sensitive information, including annual and interim results, has been made public.



The period during which an option may be exercised will be determined by the Board in its absolute discretion, except that no option may be exercised later than ten years from the date of grant. No option may be
granted more than ten years after December 23, 2002. Subject to our earlier termination, the 2002 Scheme shall be valid and effective for a period of ten years after the date of adoption, that is, until December 23, 2012. In addition and
to the extent not already exercised, an option will automatically lapse and not be exercisable upon the occurrence of any of the following events:



| | (i) | the expiry date relevant to that option;
| | --- | ----------------------------------------



| | (ii) | one month following the date a grantee ceases to be an eligible participant for any reason other than death or termination of his relationship with us (or the relevant subsidiary,
as the case may be) on any of the grounds specified in (vii) below;
| | ---- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (iii) | 12 months, or such longer period as the Board may determine, following the death of a grantee whose relationship with us (or the relevant subsidiary, as the case may be) would not
have been terminated on any of the grounds specified in (vii) below;
| | ----- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (iv) | 21 days following the date an effective resolution is passed for our voluntary winding-up;
| | ---- | ------------------------------------------------------------------------------------------



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



| | (vi) | the date on which any compromise or arrangement between us and our members or creditors in connection with a scheme for our reconstruction or our amalgamation with any other company
or companies becomes effective;
| | ---- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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| | (vii) | the date on which the grantee ceases to be an eligible participant by reason of the termination of his or her relationship with us or the relevant subsidiary on any one or more of
the grounds of serious misconduct or breach, bankruptcy, insolvency, composition with his or her creditors or conviction of any criminal offense involving his or her integrity or honesty or, in the case of a grantee-employee and if so determined by
the Board, on any other common law, statutory or contractual ground on which an employer would be entitled to terminate such grantees employment;
| | ----- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (viii) | 14 days following the date a general offer (which has been made to shareholders by way of take-over offer, share repurchase offer or scheme of arrangement or otherwise in like
manner) becomes, or is declared unconstitutional; and
| | ------ | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (ix) | the date on which we cancel the options by reason that the grantee in any way sells, transfers, charges, mortgages, encumbers or creates any interest in favor of any third party
over or in relation to any of his or her options or attempt to do so.
| | ---- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Through January 17, 2006, the Board had adopted nine resolutions pursuant to the 1997 Scheme and three resolutions pursuant to the 2002 Scheme. The total number of options granted in the resolutions pursuant to
the 1997 Scheme as of January 17, 2006 is 80,490,000, of which 35,946,000 have been exercised, 528,000 are outstanding and 44,016,000 have lapsed, been forfeited or cancelled. The number of options granted in the resolutions pursuant to the
2002 Scheme as of January 17, 2006 is 37,670,000 of which none have been exercised, 36,520,000 are outstanding and 1,150,000 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 17, 2006 by all persons who are known to us to own beneficially 5% or more of our ordinary shares.



|                |  |                                  |  |                      |     |  |                                               
|--------------- |  | -------------------------------- |  | -------------------- | --- |  | ----------------------------------------------
|Title of Class  |  | Identity of Person or Group      |  | BeneficiallyOwned(6) |     |  | Percentages of Shares Beneficially Owned(%)(1)
|Ordinary Shares |  | Wong Wai Kay, Ricky              |  | 334,754,999          | (2) |  | 54.51                                         
|Ordinary Shares |  | Cheung Chi Kin, Paul             |  | 329,024,999          | (3) |  | 53.58                                         
|Ordinary Shares |  | Top Group International Limited  |  | 318,516,999          |     |  | 51.87                                         
|Ordinary Shares |  | Leung Ka Pak                     |  | 318,516,999          | (4) |  | 51.87                                         
|Ordinary Shares |  | Yau Ming Yan, Andrew             |  | 318,516,999          | (4) |  | 51.87                                         
|Ordinary Shares |  | EK Investment Management Limited |  | 67,900,000           | (5) |  | 11.06                                         

---

|(1) | Percentage ownership is based on 614,125,404 shares issued as of January 17, 2006.
|--- | ----------------------------------------------------------------------------------



|(2) | Of the 334,754,999 shares, 318,516,999 shares are beneficially owned through
Mr. Wongs approximately 35% interest in Top Group, 1,346,000 shares are held by Bullion Holdings Limited, which is wholly owned by Mr. Wong, 3,098,000 shares are owned jointly by Mr. Wong and his spouse, and 11,794,000 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 approximately 35% 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% and
Mr. Yaus 9.8% interest in Top Group International Limited.
|--- | -------------------------------------------------------------------------------------------------------------------------------------



|(5) | The 67,900,000 shares owned by EK Investment Management Limited is the number of shares as
notified to us by EK Investment Management Limited as of August 15, 2005.
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(6) | Beneficial ownership is determined in accordance with the rules of the SEC.
|--- | ---------------------------------------------------------------------------



Top Group International Limited is a holding
company incorporated in British Virgin Islands with no active operations. Top Group has two directors, Mr. Wong Wai Kay, Ricky and Mr. Cheung Chi Kin, Paul, who are our chairman and managing director. Mr. Leung Ka Pak and Mr. Yau
Ming Yan, Andrew are the two other shareholders of Top Group.



Mr. Leung Ka Pak was an executive director and the president of our subsidiaries in Canada other than City Telecom (Canada) Inc. until October 2005 when he resigned. Mr. Yau Ming Yan, Andrew, is an executive director and the
president of our subsidiaries in Canada other than City Telecom (Canada) Inc.



EK Investment Management Limited is not affiliated with us or our officers or directors.



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



As of January 17, 2006, there were fifteen registered holders of
2,112,131 of our American depositary shares in the United States, consisting of approximately 6.88% of our outstanding shares.



Except as disclosed above, we are not directly or indirectly owned or controlled by any other person, corporation or foreign government.



We are not aware of any arrangement the operation of which may at a
subsequent date result in a change of control of City Telecom.



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Related Party Transactions



As of January 17, 2006, we were party to the following related party transactions.



Sale of City Telecom (Japan) Co., Ltd.



On July 15, 2003, Automedia Holdings Limited, a wholly-owned subsidiary
of the Company, entered into a conditional agreement with Takua Corporation, or Takua, for the sale of the entire issued share capital of City Telecom (Japan) Co., Ltd., or City Telecom Japan, for an aggregate price of JPY30.0 million (approximately
HK$2.0 million), which is to be paid by Takua in thirty monthly installments. Prior to the entering into the Agreement, City Telecom Japan was our wholly-owned subsidiary. Takua is wholly-owned by Mr. Masaaki Asai, who is a brother of
Mr. Tatsushi Asai, a director of City Telecom Japan. Mr. Tatsushi Asai also acts as a guarantor for the due and punctual performance of Takuas obligations under this agreement for no additional consideration.



As of August 31, 2005, we had received approximately HK$0.5 million from
Takua.



Contracts with Our Directors and Senior
Management



All of our directors and senior management
have service agreements with us except for our recently appointed Chief Financial Officer who will enter into a service contract after approval from the Remuneration Committee. 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. See Item 6
Directors and Senior Management of this annual report for details concerning these arrangements.



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ITEM 8.    
FINANCIAL INFORMATION



Consolidated Statements and Other Financial Information



See pages F-1  F-52 following Item 19.



Legal and Regulatory Proceedings



The claim
filed against us in 2004 by PCCW-HKT and PCCW-IMS, in which PCCW-HKT and PCCW-IMS sought a judicial review on the decision on the Telecommunications Authorities claiming that HKBN was acting outside the scope of its FTNS License in providing local
VOIP services accessible over the broadband connections provided by other operators, was settled in September 2005. By order of the Court dated September 6, 2005, PCCW-IMS and PCCW-HKT withdrew the entire proceedings against the
Telecommunications Authorities and HKBN. PCCW-IMS and PCCWHKT were ordered to pay the costs of the proceedings to HKBN, to be taxed if not agreed. The substantive hearing which had been fixed for November 28, 2005 was vacated.



We are currently involved in four material legal or regulatory
proceedings. They are described below:



Peoples
Telecom. In March 2004, we asked the Telecommunications Authority to make a determination on the level of charges to be paid by China Resources Peoples Telephone Company Limited, or Peoples Telecom, for direct interconnection between
its mobile network and our Metro Ethernet network and the effective date of such charges under the Telecommunications Ordinance. In May 2004, the Telecommunications Authority confirmed to Peoples Telecom and HKBN that mobile operators should
pay interconnection charges to fixed network operators, including ourselves, in accordance with the existing charging principles provided by the Telecommunications Authority. In August 2004, the Telecommunications Authority agreed to make a
determination regarding the level and effective date of interconnection charges payable to us by Peoples Telecom. These proceedings are still in progress and the Telecommunications Authority is considering the submissions, information and
comments submitted by both parties. The Telecommunications Authority has not yet reached any conclusion, but has informed the parties in writing that the preliminary analysis and determination will be made by the end of February 2006 and April 2006,
respectively.



WHARF T & T LIMITED.On
June 10, 2005, we requested the Telecommunications Authority to make determination on the terms and conditions for the establishment of the self-built points of interconnections between us and Wharf T & T Limited pursuant to
Section 36A of the Telecommunications Ordinance. Having considered the representations made by both parties and the factors setout in Section36A (10), the Telecommunications Authority is of the view that it is not likely that the parties could
reach an agreement on the establishment of the self-built points of interconnections without its intervention. In the circumstance, the Telecommunications Authority decided to accept our request for determination on November 2, 2005. The scope
of determination would cover the issues relating to (i) the number of interconnection points; (ii) the location of interconnection points; (iii) the negotiation timetable on implementation; (iv) actual implementation timeline of
the self-built points of interconnection; and (v) any other terms and conditions as the Telecommunications Authority considered fit in order to implement the interconnection. Both parties had submitted their respective submissions to the
Telecommunications Authority in December 2005 and January 2006. These proceedings are still in progress and the Telecommunications Authority is still considering the submissions, information and comments submitted by both parties. The
Telecommunications Authority has not yet reached any conclusion.



PCCW-HKT. PCCW-HKT (then Cable & Wireless HKT), a Hong Kong company, brought an action against us on July 10, 1998 in the High Court of Hong Kong, alleging breach of agreements relating to the supply and
operation of telecommunications services and unlawful interference with trade. This claim was subsequently amended on September 1, 1998 and further amended on October 5, 2005, in which PCCW-HKT has quantified their damages to the sum of
HK$78,275,000 or such other sums as may be assessed. The PCCW-HKT claim relates specifically to its alleged monetary loss between the months of July and October in 1997 resulting from the manner in which we used its telecommunications transmission
lines. The main issue raised by Cable & Wireless HKT in this case is whether we are liable for monetary damages to PCCW-HKT. As a result, we do not believe that the resolution of this case will impair our ability to lease transmission
circuits from PCCW-HKT or significantly alter the commercial terms on which these transmission circuits are leased. PCCW-HKT has yet to stipulate the exact amount of their monetary loss during that period as a result of our alleged misuse.



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We filed a defense and a counterclaim on October 7, 1998 alleging anti-competitive practices on the
part of PCCW-HKT. We subsequently amended our counterclaim on November 18, 1998. We had engaged Senior Counsel to provide a detailed opinion on the merits and evidence in this action and we are in the course of reviewing the case and
considering whether to amend the defense and whether any further action is required. On September 22, 2005, the court ordered directions for the future course of the action. It was ordered that the parties shall file and exchange their
respective experts reports by April 29, 2006. The case is currently in the stage of exchange of witness statements of the parties. We cannot accurately predict the expected date of resolution of this case and we have not made any reserve
for this case.



Jade Com. Jade Com Development
Limited, or Jade Com, a Hong Kong company, alleged in a claim filed in April 13, 1999 in the High Court of Hong Kong that we, as a principal of one of our wholly owned subsidiaries, wrongfully terminated a telecommunications service agreement
entered into on November 26, 1997. Jade Com claimed damages for breach of contract and misrepresentation, but did not state the specific amount of its claim. If the agreement had not been terminated, we would have had a remaining commitment of
approximately US$3.6 million under the agreement. We filed a defense in May 24, 1999 asserting that we were not the principal of the wholly owned subsidiary which entered the agreement and alternatively, Jade Com had breached a condition of the
agreement that they possess all the legal approvals and licenses necessary for the provision of their services. Specifically, our defense asserts that Jade Com did not have certain regulatory approvals required for the provision of the international
telecommunications services that formed the basis of the agreement. As such, we asserted in our defense that our wholly owned subsidiary was entitled to terminate the agreement. In February 2001, the parties consented to adjourn the case
indefinitely with liberty to restore. Accordingly, we have not made any reserve for this litigation.



Dividends



Unless the
relevant provisions of the Companies Ordinance require otherwise, we may by ordinary resolution (being a resolution passed by a majority of our shareholders who attend and vote at a meeting of shareholders) from time to time declare dividends, but
no dividend shall exceed the amount recommended by our board of directors. Our Articles contain provisions on apportioning dividends where shares are not or were not fully paid for during the period covered by the dividend.



Unless the relevant provisions of the Companies Ordinance require otherwise,
our board of directors may pay such interim dividends as appears to them to be justified by our financial position and pay any dividend payable at a fixed rate at intervals decided upon by our board of directors, whatever our financial position, if
the board of directors feels that this payment is justified.



In respect of any dividend proposed to be paid or declared by our board of directors or by us in a general meeting, our board of directors may further propose and announce prior to or at the same time as the payment or declaration of such
dividend either that:



| | (a) | such dividend be made in whole or in part in the form of an allotment of shares to the shareholders, credited as being fully paid. However, all the shareholders entitled to receive
these new shares will also be entitled to choose to receive the dividend (or a part of it) in cash and not shares; or
| | --- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (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.
| | --- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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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.



No dividends were declared in fiscal 2005.



US$125 million 8.75% Senior Notes due 2015



On January 20, 2005, we successfully completed a US$125 million
offering of 8.75% senior notes due 2015. This offering was an underwritten transaction and our estimated net proceeds were approximately US$121.0 million after deduction of expenses and commissions. We used the net proceeds, in part, to repay in
full an existing loan facility in the outstanding amount of HK$196.7 million, and will use the remaining net proceeds for capital expenditures, including costs incurred in expanding and upgrading our Metro Ethernet network in Hong Kong, and for
additional working capital and general corporate purposes.



The
following paragraphs provide a brief summary of the material terms of the 8.75% notes:



|Issuer | City Telecom (H.K.) Limited
|------ | ---------------------------



|Guarantees | The 8.75% notes will be irrevocably and unconditionally guaranteed, subject to release as specified in the indenture governing the 8.75% notes as
to the payment of all principal, and interest, additional amounts, if any, and registration default damages, if any, jointly and severally, on a senior unsecured basis by all of our existing and future subsidiaries (other than, as of the issue date
of the 8.75% notes, CTI Guangzhou and, subsequently, any other subsidiary prohibited by applicable law, regulation or order from issuing a guarantee of the 8.75% notes). If we cannot make payments on the 8.75% notes when they are due, the guarantors
must make them instead. The guarantees may be released without the consent of the holders of the 8.75% notes in accordance with the terms of the Indenture.
|---------- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|Notes Offered | US$125,000,000 of 8.75% senior notes due 2015.
|------------- | ----------------------------------------------



|Maturity Date | February 1, 2015.
|------------- | -----------------



|Issue Price | 100%.
|----------- | -----



|Interest Rate and Payment Dates | Interest on the 8.75% notes will be payable at the rate of 8.75% per annum, payable every six months in arrears on February 1 and
August 1 of each year, beginning August 1, 2005.
|------------------------------- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|Ranking of the 8.75% Notes | The 8.75% notes and the guarantees will be our unsecured senior debt obligations and those of the guarantors. The 8.75% notes and the guarantees
will:
|-------------------------- | ------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | be effectively subordinated to all of our existing and future secured debt, including any new credit agreement, to the extent of the value of the assets securing such debt;
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | be effectively subordinated to all existing and future debt and other liabilities of any non-guarantor subsidiary, including trade payables;
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | rank pari passu with all our current and future unsubordinated unsecured debt and those of the guarantors; and
| | - |  | --------------------------------------------------------------------------------------------------------------



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| |  |  | be senior in right of payment to all the guarantors and our subordinated debt.
| | - |  | -------------------------------------------------------------------------------



| | As of the issue date of the 8.75% notes, CTI Guangzhou will be the only non-guarantor subsidiary and it has no outstanding third-party
indebtedness. The Limitation of Indebtedness covenant in the indenture governing the 8.75% notes will restrict any non-guarantor subsidiary from incurring any indebtedness.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | The indenture governing the 8.75% notes will permit us, subject to specified limitations, to incur additional debt, some or all of which may be
senior debt and some of which may be secured debt.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|Optional Redemption | We may redeem the 8.75% notes, in whole or in part, on or after February 1, 2010, at the redemption prices set forth in the indenture
governing the 8.75% notes. In addition, prior to February 1, 2008, we may redeem up to a maximum of 35% of the original aggregate principal amount of the 8.75% notes with the proceeds from one or more specified public or private offerings of
our common stock at a redemption price equal to 108.75% of the principal amount of the 8.75% notes. In all cases of optional redemption, we will pay principal at the redemption price specified plus accrued and unpaid interest, additional amounts, if
any, and registration default damages, if any, thereon to, but not including, the date of redemption.
|------------------- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|Optional Tax Redemption | We may redeem all, but not part, of the 8.75% notes if there are specified changes in tax laws, at a redemption price equal to 100% of the
principal amount of the 8.75% notes, plus accrued and unpaid interest to the date of redemption.
|----------------------- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|Change of Control | Upon the occurrence of change of control events, unless we have exercised our right to redeem all of the 8.75% notes by way of optional redemption
or optional tax redemption, noteholders may require us to repurchase all or a portion of their 8.75% notes at 101% of the principal amount, plus accrued and unpaid interest, additional amounts, if any, and registration default damages, if any, to,
but not including the repurchase date.
|----------------- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|Covenants | The indenture governing the 8.75% notes will contain covenants that will limit, among other things, our ability and the ability of certain of our
existing and future subsidiaries to:
|--------- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | pay dividends, make distributions, redeem capital stock and make certain other restricted payments or investments;
| | - |  | ------------------------------------------------------------------------------------------------------------------



| |  |  | incur additional indebtedness or issue certain equity interests;
| | - |  | ----------------------------------------------------------------



| |  |  | merge, consolidate or sell all or substantially all of our assets;
| | - |  | ------------------------------------------------------------------



| |  |  | issue or sell capital stock of some of our subsidiaries;
| | - |  | --------------------------------------------------------



| |  |  | sell or exchange assets or enter into new businesses;
| | - |  | -----------------------------------------------------



| |  |  | create any restrictions on the payment of dividends, the making of distributions, the making of loans and the transfer of assets;
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------



| |  |  | create liens on assets;
| | - |  | -----------------------



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| |  enter into certain transactions with affiliates or related persons; and
| | -------------------------------------------------------------------------



| |  enter into sale and lease back transactions.
| | ----------------------------------------------



| | All of these limitations are subject to certain exceptions and qualifications set forth in the indenture governing the 8.75% notes.
| | -----------------------------------------------------------------------------------------------------------------------------------



|Registration Rights | Under a registration rights agreement that we executed in connection with the offering of our 8.75% notes, we have agreed to:
|------------------- | -----------------------------------------------------------------------------------------------------------------------------



| |  |  | file a registration statement within 60 days after the issue date of the 8.75% notes with respect to an offer to exchange the 8.75% notes for a new issue of notes registered under
the Securities Act, which will have terms substantially identical in all material respects to the 8.75% notes;
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | use our reasonable efforts to cause the registration statement to be declared effective under the Securities Act within 180 days after the issue date of the 8.75% notes and to keep
the exchange offer open for not less than 30 days (or longer, if required by applicable law); and
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | file a shelf registration statement for the resale of the 8.75% notes, if we cannot effect an exchange offer within the required time period and in several other specified
circumstances.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | If we fail to satisfy our registration obligations under the registration rights agreement, we will be required to pay registration default
damages to the holders of the 8.75% notes.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|Transfer Restrictions | The 8.75% notes have not been registered under the Securities Act and are subject to certain restrictions on transfer. The 8.75% notes are
eligible to trade in the Portal Market and are listed and quoted on the SGX-ST.
|--------------------- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|Further Notes | We may from time to time, without notice to or the consent of the holders of the 8.75% notes, issue further notes, which will form a single series
with the 8.75% notes.
|------------- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Trustee, Registrar, Principal

|Paying Agent and Transfer Agent | Deutsche Bank Trust Company Americas.
|------------------------------- | -------------------------------------



|Governing Law | The 8.75% notes and the indenture will be governed by, and shall be construed in accordance with, the laws of the State of New York.
|------------- | ------------------------------------------------------------------------------------------------------------------------------------



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ITEM 9.    THE OFFER AND LISTING



Offer and Listing Details



Our ordinary shares of common stock were listed under the number 1137 on the Stock Exchange of Hong Kong Limited (the SEHK) on August 4, 1997. Our American depositary shares, each representing 20 ordinary
shares, were listed under the symbol CTEL on the Nasdaq on November 3, 1999. Our 8.75% notes were listed under the ISIN codes of US178677AA87 and USY16599AA30 on the Singapore Exchange Securities Trading Limited (SGX-ST)
on January 24, 2005. The 8.75% notes were subsequently exchanged for registered notes with ISIN code US178677AB60 pursuant to a registration statement under the U.S. Securities Act of 1933 on June 24, 2005.



The price of our ordinary shares on the SEHK as of its close of trading on
January 17, 2006 was HK$0.60 per share. The table below shows the high and low closing prices of the shares on the SEHK since listing.



|                                   |  |          |  |      
|---------------------------------- |  | -------- |  | -----
|                                   |  | Price   
|                                   |  | High     |  | Low  
|                                   |  | (In HK$)
|2001                               |  | 0.890    |  | 0.420
|2002                               |  | 1.690    |  | 0.740
|2003                               |  | 3.375    |  | 1.320
|2004                               |  | 2.975    |  | 1.310
|2005                               |  | 1.530    |  | 0.550
|                                   |  |         
|2004                               |  |          |  |      
|January to March                   |  | 2.975    |  | 2.400
|April to June                      |  | 2.525    |  | 1.310
|July to September                  |  | 1.930    |  | 1.390
|October to December                |  | 1.690    |  | 1.460
|                                   |  |         
|2005                               |  |          |  |      
|January to March                   |  | 1.530    |  | 1.300
|April to June                      |  | 1.280    |  | 0.790
|July to September                  |  | 0.930    |  | 0.780
|October to December                |  | 0.920    |  | 0.550
|                                   |  |         
|2005                               |  |          |  |      
|July                               |  | 0.930    |  | 0.850
|August                             |  | 0.900    |  | 0.820
|September                          |  | 0.860    |  | 0.780
|October                            |  | 0.920    |  | 0.760
|November                           |  | 0.870    |  | 0.640
|December                           |  | 0.700    |  | 0.550
|                                   |  |         
|2006                               |  |          |  |      
|January through (January 17, 2006) |  | 0.610    |  | 0.570



The price of our
American depositary shares on Nasdaq as of its close of trading on January 17, 2006 was US$1.59 per American depositary share. The table below shows the high and low closing prices of the American depositary shares on Nasdaq since listing.



|     |  |          |  |      
|---- |  | -------- |  | -----
|     |  | Price   
|     |  | High     |  | Low  
|     |  | (In US$)
|2000 |  | 20.500   |  | 1.125
|2001 |  | 2.400    |  | 1.030
|2002 |  | 4.350    |  | 2.600



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|                                   |  |          |  |      
|---------------------------------- |  | -------- |  | -----
|                                   |  | Price   
|                                   |  | High     |  | Low  
|                                   |  | (In US$)
|2003                               |  | 9.550    |  | 3.080
|2004                               |  | 7.720    |  | 3.320
|2005                               |  | 3.980    |  | 1.370
|                                   |  |         
|2004                               |  |          |  |      
|January to March                   |  | 7.720    |  | 5.900
|April to June                      |  | 6.570    |  | 3.320
|July to September                  |  | 4.960    |  | 3.410
|October to December                |  | 4.600    |  | 3.710
|                                   |  |         
|2005                               |  |          |  |      
|January to March                   |  | 3.980    |  | 3.190
|April to June                      |  | 3.160    |  | 1.970
|July to September                  |  | 2.320    |  | 1.900
|October to December                |  | 2.440    |  | 1.370
|                                   |  |         
|2005                               |  |          |  |      
|July                               |  | 2.300    |  | 2.100
|August                             |  | 2.320    |  | 2.060
|September                          |  | 2.140    |  | 1.900
|October                            |  | 2.440    |  | 1.910
|November                           |  | 2.080    |  | 1.640
|December                           |  | 1.700    |  | 1.370
|                                   |  |         
|2006                               |  |          |  |      
|January through (January 17, 2006) |  | 1.590    |  | 1.440



Markets



Our ordinary shares of common stock were listed under
the number 1137 on the SEHK on August 4, 1997. Our American depositary shares, each representing 20 ordinary shares, were listed under the symbol CTEL on the Nasdaq on November 3, 1999. Our 8.75% notes were listed
under the ISIN codes of US178677AA87 and USY16599AA30 on the SGX-ST on January 24, 2005. The 8.75% notes were subsequently exchanged for registered notes with ISIN code US178677AB60 pursuant to a registration statement under the U.S. Securities
Act of 1933 on June 24, 2005.



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ITEM 10. ADDITIONAL INFORMATION



Memorandum and Articles of Association



Described below is a summary of certain provisions of our Memorandum and Articles of Association (the Articles), as amended on December 29, 2004 and December 29, 2005 and currently in effect, and, where relevant, the
Companies Ordinance (Chapter 32 of the laws of Hong Kong) (the Companies Ordinance). As this is a summary, it does not contain all the information that may be important to you. You should therefore read our complete Articles if you would
like additional information, which are filed with the U.S. Securities and Exchange Commission as exhibit 1 to this annual report.



General



We were incorporated in Hong Kong on May 19, 1992 under the Companies Ordinance. Article 3 states that City Telecoms objects are to carry on the business of telecommunications services in addition to
various other related and unrelated business activities.



Directors
Interests



A director shall not vote on, or be counted in
the quorum in relation to, any resolution of the board of directors in respect of any contract in which the director or any of his associate(s) (within the meaning of the Listing Rules) has a material interest. This prohibition shall not apply to
the following:



| | (a) | the giving of any security or indemnity to him or his associates(s) in respect of money lent or obligations incurred or undertaken by him or any of them at the request of or for the
benefit of the Company or any of its subsidiaries;
| | --- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (b) | the giving of any security or indemnity to a third party in respect of a debt or obligation of the Company or any of its subsidiaries for which he or his associate(s) has
himself/themselves assumed responsibility in whole or in part and whether alone or jointly under a guarantee or indemnity or by the giving of security;
| | --- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (c) | any proposal concerning an offer of shares, debentures or other securities of or by the Company or any other company which the Company may promote or be interested in for
subscription or purchase in which offer he or his associate(s) is/are or is/are to be interested as a participant in the underwriting or sub-underwriting thereof;
| | --- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (d) | any proposal concerning any other company in which he or his associate(s) is/are interested only, whether directly or indirectly, as an officer, executive or shareholder or in which
he or his associate(s) is/are beneficially interested in shares of that company, provided that he and any of his associate(s) are not in aggregate beneficially interested in five per cent. or more of the issued shares of any class of such company
(or of any third company through which his interest or that of his associate(s) is derived) or of the voting rights;
| | --- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (e) | any proposal or arrangement concerning the benefit of employees of the Company or its subsidiaries, including the adoption, modification or operation of any employees share
scheme or any share incentive or share option scheme under which the director or his associate(s) may benefit;
| | --- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (f) | any proposal or arrangement concerning the benefit of employees of the Company or its subsidiaries, including the adoption, modification or operation of a pension fund or
retirement, death or disability benefits scheme which relates both to directors (or his associate(s)) and employees of the Company or any of its subsidiaries and does not provide in respect of any director or his associate(s), as such any privilege
or advantage not generally accorded to the class of persons to which such scheme or fund relates; and
| | --- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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| | (g) | any contract or arrangement in which he or his associate(s) is/are interested in the same manner as other holders of shares or debentures or other securities of the Company by
virtue only of his/their interest in shares or debentures or other securities of the Company.
| | --- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Additionally, there is no shareholding qualification required to be a director.



Dividends



Unless the relevant provisions of the Companies Ordinance require otherwise, we may by ordinary resolution (being a resolution passed by a majority of our
shareholders who attend and vote at a meeting of shareholders) from time to time declare dividends, but no dividend shall exceed the amount recommended by our board of directors. Our Articles contain provisions on apportioning dividends where shares
are not or were not fully paid for during the period covered by the dividend.



Unless the relevant provisions of the Companies Ordinance require otherwise, our board of directors may pay such interim dividends as appears to them to be justified by our financial position and pay any dividend
payable at a fixed rate at intervals decided upon by our board of directors, whatever our financial position, if the board of directors feels that this payment is justified.



In respect of any dividend proposed to be paid or declared by our board of directors or by us in a general meeting, our
board of directors may further propose and announce prior to or at the same time as the payment or declaration of such dividend either that:



| | (a) | such dividend be made in whole or in part in the form of an allotment of shares to the shareholders, credited as being fully paid. However, all the shareholders entitled to receive
these new shares will also be entitled to choose to receive the dividend (or a part of it) in cash and not shares; or
| | --- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (b) | the shareholders entitled to such dividend are entitled to elect to receive an allotment of shares, credited as fully paid instead of the whole or that part of the cash dividend as
the board of directors may decide upon.
| | --- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Any
general meeting declaring a dividend may, upon the recommendation of our board of directors, by ordinary resolution, direct that the dividend shall be met, wholly or partly, by the distribution of our assets.



Any dividend not claimed by a shareholder after a period of six years from
the date when it was first due to be paid shall be forfeited and shall revert to us. The payment by our board of directors of any unclaimed dividend, interest or other sum payable on or in respect of a share into a separate account shall not make us
responsible as a trustee for such sums.



Liquidation



If City Telecom commences liquidation, the liquidator may, with the sanction
of a special resolution of City Telecom and any other sanction required by the Companies Ordinance:



| | (a) | divide among the shareholders the whole or any part of the assets of City Telecom and set such value as the liquidator deems fair upon any property to be divided and determine how
the division shall be carried out between the shareholders; or
| | --- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (b) | vest the whole or any part of such assets in trustees upon such trusts for the benefit of the contributories as the liquidator shall think fit,
| | --- | -----------------------------------------------------------------------------------------------------------------------------------------------



but no shareholder shall be compelled to accept any shares or other assets
upon which there is any liability.



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Annual and Extraordinary General Meeting of Shareholders



The Companies Ordinance requires our board of directors to hold an annual
general meeting of our shareholders once every calendar year and not more than 15 months after our previous annual general meeting. The annual general meeting and any other general meeting of our shareholders held for the passing of a special
resolution (being a resolution passed by a majority of not less than 75% of those shareholders who attend and vote at a meeting of shareholders) should be convened by not less than 21 clear days notice in writing. The notice shall specify the
place, date and time of meeting and the general nature of the business to be transacted. An annual general meeting may be called by less than 21 days notice if it is agreed to by all shareholders entitled to attend and vote at the meeting. The
business of the annual general meeting will include:



| | (a) | the declaration and sanctioning of dividends;
| | --- | ---------------------------------------------



| | (b) | the consideration and adoption of the financial statements and balance sheet and the report of the directors and other documents required to be attached to the financial statements;
| | --- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (c) | the appointment of directors in place of those retiring (by rotation or otherwise);
| | --- | -----------------------------------------------------------------------------------



| | (d) | the appointment of auditors; and
| | --- | --------------------------------



| | (e) | the fixing of, or the determining of the method of fixing, the remuneration of the directors and of the auditors.
| | --- | -----------------------------------------------------------------------------------------------------------------



Our board of directors may convene an extraordinary general meeting (which is
any general meeting of the shareholders other than the yearly annual general meeting) whenever it thinks fit and must do so upon the request in writing of shareholders holding not less than one-twentieth of our paid-up capital carrying the right to
vote at the general meeting. All extraordinary general meetings (other than those convened for the passing of a special resolution referred to above) should be convened by not less than 14 clear days notice in writing. Extraordinary general
meetings may be called by less than 14 days notice by a majority in number of the shareholders having the right to attend and vote at the meeting, being a majority together holding not less than 95% in nominal value of the shares giving that
right.



Except as otherwise provided by our Articles, two
shareholders present in person or by proxy and entitled to vote shall be a quorum for all purposes. No business shall be transacted at any general meeting unless a quorum is present when the meeting proceeds to business, but the absence of a quorum
shall not preclude the choice or appointment of a chairman which shall not be treated as part of the business of the meeting.



Nasdaqs marketplace rules, which apply to all companies listed on the Nasdaq Stock Market, state in Rule 4350(f) that the minimum quorum for any
meeting of holders of a companys common stock is 33 1/3% of the outstanding shares. Consistent with practice of companies incorporated in Hong Kong, our articles of association only require a quorum of two Members (as such term is
defined our articles of association) for any general meeting of our shareholders. As a result, we requested, and Nasdaq granted to us, an exemption from compliance with the Rule 4350(f) requirement.



Restrictions on Ownership of Shares



There are no restrictions, either pursuant to our Articles, or pursuant to
the laws of Hong Kong, on the rights of non-residents of Hong Kong or foreign persons to hold or exercise voting rights with respect to our ordinary shares.



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.



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Unless any shares have special terms as to voting, on a show of hands every member who is present in
person at a general meeting, shall have one vote and on a poll every member who is present in person or by proxy shall have one vote for every share of which he is the holder. Our Articles set out the circumstances in which a poll can be demanded.



Any shareholder that is a recognized clearing house within the
meaning of the Securities and Futures Ordinance of Hong Kong may authorize such person or persons as it thinks fit to act as its representative (or representatives) at any general meeting or at any separate meeting of any class of shareholders (if
relevant). However, if more than one person is authorized, the authorization must specify the number and class of shares in respect of which each person is in fact authorized. The authorized person will be entitled to exercise the same power on
behalf of the recognized clearing house as that clearing house (or its nominees) could exercise if it were an individual shareholder.



Issue of Shares



Under the Companies Ordinance, our board of directors may, without the prior approval of the shareholders, offer to issue new shares to existing
shareholders in proportion to their current shareholdings. Our board of directors may not issue new shares in any other way without the prior approval of the shareholders in a general meeting. Any such approval given in a general meeting shall
continue in force until the earlier of: (1) the conclusion of next years annual general meeting; or (2) the expiration of the period within which the next annual general meeting is required by law to be held; or (3) when revoked
or varied by an ordinary resolution of the shareholders in a general meeting. If such approval is given, our unissued shares shall be at the disposal of our board of directors, which may offer, allot, grant options over or otherwise dispose of them
to such persons, at such times and for such consideration and upon such terms and conditions as the directors may decide.



Unless specifically restricted by our Articles, any shareholder may transfer all or any of his shares by an instrument of transfer in the usual or common
form or in such other form as our board of directors may accept and may approve. Such transfer may be signed by hand or, if the buyer or seller is a clearing house or its nominee(s), signed by hand or by a machine imprinted signature or by such
other manner as our board of directors may approve from time to time.



The instrument of transfer of a share shall be signed by or on behalf of both the buyer and the seller of that share provided that our board of directors may dispense with the signing of the instrument of transfer by the buyer in any case
which it thinks fit in its discretion to do so. Except as provided in the paragraph above, our board of directors may also decide, either generally or in any particular case, upon request by either the buyer or seller of shares to accept
mechanically signed transfers. The seller shall be deemed to remain the holder of the share until the name of the buyer is entered into our register in respect of that share. All instruments of transfer, when registered, may be retained by us.
Nothing in our Articles shall prevent our board of directors from recognizing a renunciation of the allotment or provisional allotment of any share by the person to whom the shares were to be allotted in favor of some other person.



Our board of directors may in its absolute discretion and without giving any
reason, decline to register any transfer of any share which is not a fully paid share.



Our board of directors may also decline to register any transfer unless:



| | (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;
| | --- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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| | (c) | the instrument of transfer is in respect of only one class of share;
| | --- | --------------------------------------------------------------------



| | (d) | in the case of a transfer of a share to be registered in more than one name (i.e. there are joint holders), the number of joint holders to whom the share is to be transferred does
not exceed four; and
| | --- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (e) | the shares concerned are free of any lien in favor of us.
| | --- | ---------------------------------------------------------



If our board of directors declines to register a transfer of any share, it shall, within two months after the date on which the instrument of transfer was
lodged, send to the purchaser notice of the refusal.



Shareholders



In accordance with the Companies Ordinance and our
Articles, only persons who are registered in our register of members are recognized by us as shareholders and absolute owners of the shares. The register of members may be closed by our board of directors at such times and for such periods as it may
from time to time decide, but the register shall not be closed in any year for more than 30 days (excluding Sundays and public holidays).



Material Contracts



Other than such contracts as are described in our disclosure in Item 7 Major Shareholders and Related Party Transactions  Related Party
Transactions, we have not entered into any material contracts, outside the ordinary course of our business within the two years preceding the date of this annual report.



Exchange Controls



The Basic Law of Hong Kong provides that the Hong Kong dollar will remain the legal tender in Hong Kong after July 1, 1997. The Basic Law also
provides that no foreign exchange control policies will be applied in Hong Kong and that the Hong Kong dollar will be freely convertible. During the Asia regional economic crisis in 1998, however, the Hong Kong Government intervened on several
occasions in the foreign exchange market by purchasing the Hong Kong dollar and selling the U.S. dollar to support the value of the Hong Kong dollar.



There are no restrictions, either pursuant to our Articles, or pursuant to the laws of Hong Kong, on the rights of non-residents of Hong Kong or foreign
persons to hold or exercise voting rights with respect to our ordinary shares, or export or import capital.



Hong Kong Taxation



The following provides a general outline of the material tax considerations that may be relevant to a decision to own or dispose of the American depositary shares or shares but does not purport to deal with the tax
consequences applicable to all categories of investors. Prospective investors should consult their own professional advisers on the Hong Kong and overall tax implications of investing, holding or disposing the American depositary shares or shares
under the laws of the countries in which they are liable to taxation. The discussion below is applicable to both U.S. and non-U.S. citizens as an investor.



Tax on dividends



No tax is payable in Hong Kong by withholding or otherwise in respect of dividends paid by City Telecom.



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Profits tax



No tax is imposed in Hong Kong in respect of gains from the sale of property, including shares and American depositary
shares, unless all the following three factors are present:



| | (i) | such gain is derived from or arising in Hong Kong;
| | --- | --------------------------------------------------



| | (ii) | such gain is attributable to a trade, profession or business carried on in Hong Kong; and
| | ---- | -----------------------------------------------------------------------------------------



| | (iii) | the property in question such as shares and American depositary shares was not a capital asset of that trade, profession or business.
| | ----- | -------------------------------------------------------------------------------------------------------------------------------------



Taxable gains will be subject to Hong Kong profits tax which is currently
imposed on corporations at a rate of 17.5%. A persons income from employment, less allowable deductions, charitable donations and personal allowances, is chargeable to salaries tax at progressive rates ranging from 2% to 20%. The maximum tax
payable is, however, limited to tax at the standard rate of 16% on the persons income from employment less allowable deductions and charitable donations, but without a deduction for personal allowances.



Gains from sales of shares effected on the Hong Kong Stock Exchange will be
considered to be derived from or arising in Hong Kong. Liability to Hong Kong profits tax in respect of such gains would arise if the Shares were not held as capital assets and the gains are attributable to a business, trade or profession carried
out in Hong Kong.



Gains from sales of American depositary
shares will be considered to be derived from or arising in Hong Kong if the relevant purchase or sales contracts are negotiated and concluded in Hong Kong, and such gains will be subject to Hong Kong profits tax in the case of those persons dealing
or trading in the American depositary shares as part of their business being carried out in Hong Kong. In any case of an exchange of any American depositary receipts evidencing American depositary shares for certificates representing shares, any
gain on subsequent disposition of such shares will be the difference between the initial price of American depositary shares and the market value of such shares at the date of disposition.



Stamp duty



A sale or purchase of shares is subject to Hong Kong stamp duty if the
transfer of such shares is required to be registered in Hong Kong. The shares will be registered in City Telecoms Hong Kong branch register of members and, therefore, will constitute Hong Kong stock for the purposes of Hong Kong
stamp duty. For such purposes any person who effects a sale or purchase of Hong Kong stock such as the shares registered on City Telecoms Hong Kong register of members, whether as principal or agent, is required to execute a contract note
evidencing such sale or purchase and to have that note stamped. Contract notes attract stamp duty, payable by the seller and the purchaser in equal shares, at the rate of HK$1.00 per HK$1,000 or part thereof by reference to the value of the
consideration paid or the market value of the shares on the Hong Kong Stock Exchange or otherwise on the date the contract note is executed, whichever is greater. If, in the case of a sale or purchase of the shares by a person who is not resident in
Hong Kong, the stamp duty on either or both of the contract notes is not paid, the transferee will be liable to pay stamp duty on the instrument of transfer in an amount equal to the unpaid duty. If the stamp duty is not paid on or before the due
date, a penalty of up to ten times the duty payable may be imposed. In addition, a fixed duty of HK$5.00 is currently payable on any instrument of transfer of shares.



Upon the exchange of any American depositary receipts evidencing American depositary shares for certificates representing
shares, or exchange of shares for American depositary receipts evidencing American depositary shares, stamp duty aggregating HK$1.00 per HK$1,000 or part thereof is payable in addition to the depositarys charges, if any. Investors are not
liable for stamp duty on the issuance of the American depositary shares upon the initial deposit of shares issued directly to the depositary or for the account of the depositary. No Hong Kong stamp duty is payable upon the transfer of American
depositary receipts evidencing American depositary shares if such American depositary receipts are not maintained on a register in Hong Kong.



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Estate duty



The shares, being registered on City Telecoms register of members in Hong Kong, are property in relation to which Hong
Kong estate duty will be chargeable on the death of the owner of such shares regardless of the place of the owners residence, citizenship or domicile, unless there is an applicable exemption under the Estate Duty Ordinance (Chapter 111 of the
Laws of Hong Kong).



Tax treaty



There is currently no reciprocal tax treaty between Hong Kong and the U.S.
regarding withholding.



Documents on Display



We filed with Securities and Exchange Commission in
Washington, D.C. a registration statement on Form F-1 (Registration No. 333-11012) under the Securities Act in connection with our global offering of American depositary shares in November 1999. The registration statement contains exhibits and
schedules. For further information with respect to City Telecom and the American depositary shares, please refer to the registration statement and to the exhibits and schedules filed with the registration statement. In addition, whenever a reference
is made in this annual report to a contract or other document of City Telecom, you should be aware that such reference is not necessarily complete and that you should refer to the exhibits and schedules that are a part of the registration statement
for a copy of the contract or other document.



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ITEM 11.    QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK



Our functional currency is the Hong Kong dollar, the currency in which the majority of our revenue and related accounts receivable and expenses are
denominated. Certain of the expenses of our telecommunications business are payable in other currencies, primarily the U.S. dollar. Since the exchange rate between the Hong Kong and the U.S. dollar was fixed before we commenced business, our
operations have not been significantly affected by exchange rate fluctuations. Therefore, we do not use derivative financial instruments to manage our exchange rate exposures.



In the normal course of business, we also face risks that are either non-financial or non-quantifiable. Such risks
principally include country risk, credit risk and legal risk and we do not use derivative financial instruments to hedge such risks.



We are exposed to market risk from changes in currency exchange rates and interest rates.



Foreign Currency Risk



The functional currency of our operations, and our financial statement reporting currency, is the Hong Kong dollar. Our
monetary assets and liabilities are primarily denominated in Hong Kong dollars, substantially all our net sales are denominated and received in Hong Kong dollars, and our labor and administrative costs are incurred primarily in Hong Kong dollars.
However, we have certain current and long-term bank deposits, other investments and short-term bank loans which are primarily denominated in U.S. dollars.



As of August 31, 2005, we had the following significant foreign currencies denominated account balances:



|                                |  |                      
|------------------------------- |  | ---------------------
|                                |  | As of August 31, 2005
|                                |  | (Thousands of HK$)   
|Cash and bank balances:         |  |                      
|Denominated in U.S. dollars     |  | 310,675              
|Denominated in Chinese renminbi |  | 23,281               
|Denominated in Canadian dollars |  | 2,317                
|Long-term bank deposits:        |  |                      
|Denominated in U.S. dollars     |  | 15,540               
|Other investments:              |  |                      
|Denominated in U.S. dollars     |  | 25,906               



Further, our principal
long-term debt obligations are the US$125.0 million 8.75% senior notes issued in January 2005, which are denominated in U.S. dollars.



As the exchange rate of the Hong Kong dollar to the U.S. dollar has remained close to the current pegged rate of HK$7.80=$1.00 since 1983, we have not
experienced significant foreign exchange gains or losses associated with that currency. The Hong Kong government could, however, change the pegged rate or abandon the peg altogether. Depreciation of the Hong Kong dollar against the U.S. dollar would
generally increase our U.S. dollar expenses, and increase the amount of Hong Kong dollar revenue that we would be required to earn to meet our payment obligations under the 8.75% notes or exchange notes.



We also incur expenses denominated in Renminbi, the official currency of the
Peoples Republic of China, in connection with our Guangzhou call centre. These include the salaries that we pay to our personnel as various operating expenses that we incur to maintain our operations. As a result, we are exposed to a certain
amount of foreign exchange risk based on fluctuations between the Hong Kong dollar and the Renminbi. If the Renminbi appreciates against the Hong Kong dollar, the amount of Hong Kong dollars we would be required to spend to maintain our call center
would increase. Therefore, in order to limit our foreign currency risk exposure on Renminbi, we have entered into certain forward foreign exchange contracts during fiscal 2005. No recognition of such instrument is required under Hong Kong GAAP.
Under U.S. GAAP reporting, such forward foreign exchange contracts must be recorded at fair value, which we determined to be approximately HK$4,039,000 as of August 31, 2005.



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Interest Rate Risk



Prior to our repayment in full of our floating interest rate loan facility with HSBC, we were exposed to interest rate
risks. In connection with this facility, we entered into an interest rate swap agreement to hedge the impact of fluctuations in interest rates, under which we make a monthly interest payment at a fixed rate of 2.675% per annum on a notional
amount of HK$100.0 million (which is reduced by the principal repayment schedule during the loan period), and will receive monthly interest payments calculated at HIBOR during the period from March 2004 to December 2009 or until the facility is
repaid and we terminate the swap agreement. No recognition of such instrument is required under Hong Kong GAAP. Under U.S. GAAP reporting, such interest rate swap instrument must be recorded at fair value, which we determined to be approximately
HK$2,570,000 as of August 31, 2005. The interest rate swap agreement is still valid following the full repayment of our loan facility with HSBC.



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.



Use of Proceeds



We have used all of the net proceeds of approximately HK$411.6 million from a global offering of 80,000,000 new shares in November 1999 on the upgrade and
expansion of our fixed telecommunications network.



ITEM 15.    CONTROLS AND PROCEDURES



We maintain a set of disclosure controls and procedures designed to ensure that information required to be disclosed by City Telecom in reports that we file or submit under the U.S. Securities Exchange Act of 1934, as
amended, is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commissions rules and forms. Within the 90-day period prior to the filing of this report, an evaluation was carried out
under the supervision and with the participation of our management, including our Chief Executive Officer (CEO) and Chief Financial Officer (CFO), of the effectiveness of our disclosure controls and procedures. Based on that
evaluation, the CEO and CFO have concluded that our disclosure controls and procedures are effective.



Subsequent to the date of their evaluation, there have been no significant changes in our internal controls or in other factors that could significantly
affect these controls.



ITEM 16.



ITEM 16A.    AUDIT COMMITTEE FINANCIAL EXPERT



Our board of directors established an Audit Committee to ensure the impartial supervision of our accounting and business operations. The Audit Committee
is comprised of three independent, non-executive directors, namely, Mr. Lee Hon Ying, John, Dr. Chan Kin Man and Mr. Peh Tun Lu Jefferson. Mr. Peh was appointed to the Audit Committee on September 1, 2004 and is a
financial expert within the meaning of, and as required by the U.S. Sarbanes-Oxley Act of 2002.



ITEM 16B.    CODE OF ETHICS



All of our employees, officers and directors are bound by our code of business ethics and conduct. We adopted our code of ethics in 1995 and modified it following the passage of, and to comply with, the U.S. Sarbanes
Oxley Act of 2002. We have never granted a waiver for non-compliance with the policies and procedures set forth in the code of ethics for any employee of our company or any of our subsidiaries. Copies of our code of ethics are available free of
charge upon request made to our corporate secretary.



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ITEM 16C.    PRINCIPAL ACCOUNTANT FEES AND SERVICES



During the year, PricewaterhouseCoopers, or PwC, tendered its resignation with effect from May 13, 2005. KPMG was appointed as our auditors to fill
the casual vacancy caused by the resignation of PwC until the conclusion of the annual general meeting held on December 29, 2005. A resolution was passed in the annual general meeting to reappoint KPMG as our auditor. The fees for the
professional services rendered by PwC and KPMG, in fiscal 2004 and fiscal 2005, are set forth in the table below.



|                      |  |              
|--------------------- |  | -------------
|Nature of the service |  | 2005         
|                      |  | (HK$ million)
|Audit fees            |  | 1.3          
|Audit-related fees    |  | 0.1          
|Tax fees              |  |             
|All other fees        |  | 0.1          
|                      |  |              
|Total                 |  | 1.5          
|                      |  |              



For fiscal 2004, PwC
was our principal accountant and the fees for the professional services rendered by PwC are set forth in the table below.



|                      |  |               |  |              
|--------------------- |  | ------------- |  | -------------
|Nature of the service |  | 2004          |  | 2005         
|                      |  | (HK$ million) |  | (HK$ million)
|Audit fees            |  | 0.8           |  | 0.3          
|Audit-related fees    |  | 0.3           |  | 0.2          
|Tax fees              |  | 0.2           |  | 0.1          
|All other fees        |  |              |  |             
|                      |  |               |  |              
|Total                 |  | 1.3           |  | 0.6          
|                      |  |               |  |              



Audit Fees



Audit fees are the aggregate fees billed by our independent auditors for the
annual financial statement audit, subsidiary audits and other procedures required to be performed for the auditors to form an opinion on our consolidated financial statements. Other procedures include information systems and procedural reviews and
testing performed in order to understand and rely on the internal control systems and consultations relating to the audit and interim review. Audit services will also include the attestation engagement for the independent auditors report on
managements report on internal controls for financial reporting in fiscal 2005 and thereafter.



Audit-Related Fees



Audit-related fees are the aggregate fees billed by our independent auditors for accounting and advisory services fees and generally include support for the interpretation and implementation of new accounting and reporting standards and
acquisition accounting. It also includes the review of the Statement on Details of Contribution of the Occupational Retirement Scheme, and the audit and review of reports for compliance with telecommunications regulations and debt obligations.



Tax Fees



Tax Fees are the aggregate fees billed by our independent auditors for tax compliance, tax planning and tax consultation
services on domestic and international taxation matters.



114



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##### Table of Contents

All Other Fees



All other fees are the aggregate fees billed by our independent auditors for financial due diligence services relating to potential business acquisitions
and dispositions.



Pre-approval Polices



The engagement of PwC and KPMG and the services provided pursuant to such
engagement were approved by our audit committee in accordance with paragraph (c)(7)(i) of Rule 2-01 of Regulation S-X. The fees for all such services have been pre-approved by our audit committee. Our audit committee has satisfied itself
that the provision of the above-stated non-audit services has not impaired the independence of PwC and KPMG.



ITEM 16D.    EXEMPTIONS FROM THE LISTING STANDARDS FOR AUDIT COMMITTEES



Not Applicable.



ITEM 16E.    PURCHASE OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED PURCHASERS



The following table sets forth information relating to the repurchase of our shares by way of a general mandate granted to our directors, which we refer
to as the Mandate. The maximum aggregate nominal amount of shares that may be purchased pursuant to a Mandate corresponds to 10% of the aggregate nominal amount of our issued share capital at the date the Mandate was granted. In fiscal 2005, no
shares were purchased under any of the Mandates then in force.



|                        |  |                                 |  |                             |  |                                                                      |  |                                                                |    
|----------------------- |  | ------------------------------- |  | --------------------------- |  | -------------------------------------------------------------------- |  | -------------------------------------------------------------- | ---
|Period                  |  | Total Number ofShares Purchased |  | Average PricePaid per Share |  | Total Number ofShares Purchased asPart of PubliclyAnnounced Mandates |  | Maximum Number ofShares that May BePurchased Under theMandates |    
|September 1 to 30, 2004 |  | 0                               |  | N/A                         |  | 0                                                                    |  | 61,051,969                                                     | (1)
|October 1 to 31, 2004   |  | 0                               |  | N/A                         |  | 0                                                                    |  | 61,051,969                                                     | (1)
|November 1 to 30, 2004  |  | 0                               |  | N/A                         |  | 0                                                                    |  | 61,051,969                                                     | (1)
|December 1 to 29, 2004  |  | 0                               |  | N/A                         |  | 0                                                                    |  | 61,051,969                                                     | (1)
|December 30 to 31, 2004 |  | 0                               |  | N/A                         |  | 0                                                                    |  | 61,407,340                                                     | (2)
|January 1 to 31, 2005   |  | 0                               |  | N/A                         |  | 0                                                                    |  | 61,407,340                                                     | (2)
|February 1 to 29, 2005  |  | 0                               |  | N/A                         |  | 0                                                                    |  | 61,407,340                                                     | (2)
|March 1 to 31, 2005     |  | 0                               |  | N/A                         |  | 0                                                                    |  | 61,407,340                                                     | (2)
|April 1 to 30, 2005     |  | 0                               |  | N/A                         |  | 0                                                                    |  | 61,407,340                                                     | (2)
|May 1 to 31, 2005       |  | 0                               |  | N/A                         |  | 0                                                                    |  | 61,407,340                                                     | (2)
|June 1 to 30, 2005      |  | 0                               |  | N/A                         |  | 0                                                                    |  | 61,407,340                                                     | (2)
|July 1 to 31, 2005      |  | 0                               |  | N/A                         |  | 0                                                                    |  | 61,407,340                                                     | (2)
|August 1 to 31, 2005    |  | 0                               |  | N/A                         |  | 0                                                                    |  | 61,407,340                                                     | (2)
|Total                   |  | 0                               |  | N/A                         |  | 0                                                                    |  | 61,407,340                                                     | (2)

---

|(1) | The relevant Mandate was granted at our annual general meeting on December 23, 2003.
|--- | ------------------------------------------------------------------------------------

|(2) | The relevant Mandate was granted at our annual general meeting on December 29, 2004 and
replaced the Mandate granted on December 23, 2003.
|--- | ------------------------------------------------------------------------------------------------------------------------------------------



115



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##### Table of Contents

PART III



ITEM 17.    FINANCIAL STATEMENTS



City Telecom has selected to provide the financial statements and related information specified in Item 18 in lieu of Item 17.





ITEM 18.    FINANCIAL STATEMENTS



See pages F-1 to F-52 following Item 19.





ITEM 19.    EXHIBITS



| | (a) | See pages F-1 to F-52 following this item.
| | --- | ------------------------------------------

| | (b) | Exhibit 1  the Articles.
| | --- | -------------------------

| | (c) | Exhibit 31  Section 302 Certifications of each of the Chairman and Chief Financial Officer.
| | --- | --------------------------------------------------------------------------------------------

| | (d) | Exhibit 32  Section 906 Certification of Chairman and Chief Financial Officer.
| | --- | -------------------------------------------------------------------------------



116



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##### Table of Contents

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS



|                                                           |  |       
|---------------------------------------------------------- |  | ------
|Audited Consolidated Financial Statements                  |  |       
|                                                           | 
|Reports of Independent Registered Public Accounting Firms  |  | F-2, 3
|                                                           | 
|Consolidated Statements of Operations                      |  | F-4   
|                                                           | 
|Consolidated Balance Sheets                                |  | F-5   
|                                                           | 
|Consolidated Statements of Changes in Shareholders Equity |  | F-6   
|                                                           | 
|Consolidated Statements of Cash Flows                      |  | F-7   
|                                                           | 
|Notes to the Consolidated Financial Statements             |  | F-10  



F-1



---

##### Table of Contents

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM



The Board of Directors and Shareholders

City Telecom (H.K.) Limited



We have audited the accompanying consolidated balance sheet of City Telecom (H.K.) Limited and its subsidiaries
(collectively referred to as the Company) as of August 31, 2005, and the related consolidated statements of operations, shareholders equity, and cash flows for the year ended August 31, 2005. These consolidated financial statements
are the responsibility of the Companys management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.



We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States).
Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the 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 audit
provides a reasonable basis for our opinion.



In our opinion,
the consolidated financial statements referred to above present fairly, in all material respects, the financial position of City Telecom (H.K.) Limited and its subsidiaries as of August 31, 2005, and the results of their operations and their cash
flows for the year ended August 31, 2005, in conformity with accounting principles generally accepted in Hong Kong.



As described in Note 31 to the consolidated financial statements, certain amounts previously reported in the Hong Kong statutory financial statements for
the year ended August 31, 2005, have been revised.



Accounting
principles generally accepted in Hong Kong vary in certain significant respects from accounting principles generally accepted in the United States of America. Information relating to the nature and effect of such differences is presented in Note 30
to the consolidated financial statements.



/s/ KPMG



HONG KONG, CHINA

January 27, 2006



F-2



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##### Table of Contents

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM



To the Board of Directors and Shareholders of

City Telecom (H.K.) Limited



We have audited the accompanying consolidated balance sheet of City Telecom (H.K.) Limited and its subsidiaries (hereafter collectively referred to as the
Company) as of August 31, 2004 and the related consolidated statements of operations, of cash flows and of changes in shareholders equity for each of the two years in the period ended August 31, 2004, all expressed in
Hong Kong Dollars. These financial statements are the responsibility of the Companys management. Our responsibility is to express an opinion on these financial statements based on our audits.



We conducted our audits in accordance with the standards of the Public
Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free from material misstatement. An audit includes examining, on
a test basis, evidence supporting amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis for our opinion.



In our opinion, the consolidated financial statements audited by us present fairly, in all material respects, the financial position of the company at August 31, 2004, and the results of its operations and cash
flows for each of the two years in the period ended August 31, 2004, in conformity with accounting principles generally accepted in Hong Kong.



Accounting principles generally accepted in Hong Kong vary in certain significant respects from accounting principles generally accepted in the United
States of America. Information relating to the nature and effect of such differences is presented in Note 30 to the consolidated financial statements.



/s/ PricewaterhouseCoopers



HONG KONG, CHINA

November 23, 2004, except for Note 32, which is as of January 20, 2005



F-3



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##### Table of Contents

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



CONSOLIDATED STATEMENTS OF OPERATIONS



|                                                                    |  |      |  |                                              |   |  |           |   |  |              |  
|------------------------------------------------------------------- |  | ---- |  | -------------------------------------------- | - |  | --------- | - |  | ------------ | -
|                                                                    |  |      |  | Year ended August 31,                        |  
|                                                                    |  | Note |  | 2003                                         |   |  | 2004      |   |  | 2005         |  
|                                                                    |  |      |  | HK$                                          |   |  | HK$       |   |  | HK$          |  
|                                                                    |  |      |  | (Amounts in thousands except per share data) |  
|Revenue from provision of telecommunication and other services, net |  |      |  | 1,298,909                                    |   |  | 1,169,880 |   |  | 1,162,059    |  
|Network costs                                                       |  | 3    |  | (322,753                                     | ) |  | (331,408  | ) |  | (339,402     | )
|Operating expenses                                                  |  |      |  |                                              |   |  |           |   |  |              |  
|Salaries and related costs                                          |  |      |  | (220,350                                     | ) |  | (226,650  | ) |  | (252,987     | )
|Sales and marketing expenses                                        |  |      |  | (182,471                                     | ) |  | (228,169  | ) |  | (267,423     | )
|General and administrative expenses                                 |  |      |  | (284,290                                     | ) |  | (326,804  | ) |  | (395,211     | )
|Provision for doubtful accounts receivable                          |  |      |  | (17,685                                      | ) |  | (11,502   | ) |  | (35,445      | )
|                                                                    |  |      |  |                                              |   |  |           |   |  |              |  
|(Loss)/income from operations                                       |  |      |  | 271,360                                      |   |  | 45,347    |   |  | (128,409     | )
|Bank interest income                                                |  |      |  | 3,163                                        |   |  | 3,753     |   |  | 13,578       |  
|Interest expense                                                    |  |      |  | (601                                         | ) |  | (175      | ) |  | (54,462      | )
|Loss on disposal of a subsidiary                                    |  | 4    |  | (2,695                                       | ) |  |          |   |  |             |  
|Other income, net                                                   |  |      |  | 4,373                                        |   |  | 2,668     |   |  | 6,037        |  
|                                                                    |  |      |  |                                              |   |  |           |   |  |              |  
|(Loss)/income before taxation                                       |  | 5    |  | 275,600                                      |   |  | 51,593    |   |  | (163,256     | )
|Income tax credit/(expense)                                         |  | 6    |  | (17,857                                      | ) |  | (2,043    | ) |  | 6,725        |  
|                                                                    |  |      |  |                                              |   |  |           |   |  |              |  
|Net (loss)/income                                                   |  |      |  | 257,743                                      |   |  | 49,550    |   |  | (156,531     | )
|                                                                    |  |      |  |                                              |   |  |           |   |  |              |  
|(Loss)/earnings per share                                           |  |      |  |                                              |   |  |           |   |  |              |  
|Basic                                                               |  | 7    |  | 46.6 cents                                   |   |  | 8.1 cents |   |  | (25.5) cents |  
|                                                                    |  |      |  |                                              |   |  |           |   |  |              |  
|Diluted                                                             |  | 7    |  | 41.9 cents                                   |   |  | 8.1 cents |   |  | (25.5) cents |  
|                                                                    |  |      |  |                                              |   |  |           |   |  |              |  



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 BALANCE SHEETS



|                                                                                                                                                                                                                                                 |  |         |     |  |                                                                    |  |               
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------ |  | ------- | --- |  | ------------------------------------------------------------------ |  | --------------
|                                                                                                                                                                                                                                                 |  |         |     |  | August 31,                                                        
|                                                                                                                                                                                                                                                 |  | Note(s) |     |  | 2004                                                               |  | 2005          
|                                                                                                                                                                                                                                                 |  |         |     |  | HK$                                                                |  | HK$           
|                                                                                                                                                                                                                                                 |  |         |     |  | (Amounts in thousandsexcept number of sharesand per share amounts)
|ASSETS                                                                                                                                                                                                                                           |  |         |     |  |                                                                    |  |               
|Current assets                                                                                                                                                                                                                                   |  |         |     |  |                                                                    |  |               
|Cash and bank balances                                                                                                                                                                                                                           |  | 20      |     |  | 247,517                                                            |  | 539,591       
|Term deposits                                                                                                                                                                                                                                    |  |         |     |  |                                                                   |  | 92,850        
|Pledged bank deposits                                                                                                                                                                                                                            |  | 16      |     |  | 26,805                                                             |  | 90,447        
|Trade receivables, net                                                                                                                                                                                                                           |  | 8       | (a) |  | 134,849                                                            |  | 130,010       
|Other receivables, deposits and prepayments Inventories Tax recoverable                                                                                                                                                                          |  | 8       | (b) |  | 44,029                                                           |  | 78,7581,957535
|                                                                                                                                                                                                                                                 |  |         |     |  |                                                                    |  |               
|Total current assets                                                                                                                                                                                                                             |  |         |     |  | 453,200                                                            |  | 934,148       
|Goodwill                                                                                                                                                                                                                                         |  | 9       |     |  | 2,131                                                              |  | 1,066         
|Fixed assets, net                                                                                                                                                                                                                                |  | 10      |     |  | 1,158,875                                                          |  | 1,336,543     
|Other investments                                                                                                                                                                                                                                |  | 17      |     |  | 25,604                                                             |  | 25,901        
|Long term bank deposit                                                                                                                                                                                                                           |  | 18      |     |  | 15,600                                                             |  | 15,540        
|Long term receivables and prepayment                                                                                                                                                                                                             |  |         |     |  | 6,206                                                              |  | 13,099        
|Deferred tax assets                                                                                                                                                                                                                              |  | 12      |     |  | 229                                                                |  |              
|Deferred expenditure                                                                                                                                                                                                                             |  | 13      |     |  | 21,563                                                             |  | 21,131        
|                                                                                                                                                                                                                                                 |  |         |     |  |                                                                    |  |               
|Total assets                                                                                                                                                                                                                                     |  |         |     |  | 1,683,408                                                          |  | 2,347,428     
|                                                                                                                                                                                                                                                 |  |         |     |  |                                                                    |  |               
|LIABILITIES AND SHAREHOLDERS EQUITY                                                                                                                                                                                                             |  |         |     |  |                                                                    |  |               
|Current liabilities                                                                                                                                                                                                                              |  |         |     |  |                                                                    |  |               
|Trade payables                                                                                                                                                                                                                                   |  |         |     |  | 122,459                                                            |  | 90,762        
|Deposits received                                                                                                                                                                                                                                |  |         |     |  | 17,983                                                             |  | 15,510        
|Current portion of deferred services income                                                                                                                                                                                                      |  |         |     |  | 35,288                                                             |  | 36,744        
|Other payables and accrued expenses                                                                                                                                                                                                              |  | 11      |     |  | 188,605                                                            |  | 223,208       
|Income taxes payable Current portion of obligation under finance lease                                                                                                                                                                           |  | 14      |     |  | 1,173                                                             |  | 1,7281,194    
|Short-term bank loan                                                                                                                                                                                                                             |  | 20,22   |     |  | 19,170                                                             |  |              
|Current portion of long-term bank loan                                                                                                                                                                                                           |  | 14      |     |  | 13,333                                                             |  |              
|                                                                                                                                                                                                                                                 |  |         |     |  |                                                                    |  |               
|Total current liabilities                                                                                                                                                                                                                        |  |         |     |  | 398,011                                                            |  | 369,146       
|Long-term liabilities                                                                                                                                                                                                                            |  |         |     |  |                                                                    |  |               
|Deferred taxation                                                                                                                                                                                                                                |  | 12      |     |  | 18,891                                                             |  | 10,539        
|Long-term portion of deferred services income                                                                                                                                                                                                    |  |         |     |  | 4,141                                                              |  |              
|Long-term debt and other liabilities                                                                                                                                                                                                             |  | 14      |     |  | 86,667                                                             |  | 947,289       
|                                                                                                                                                                                                                                                 |  |         |     |  |                                                                    |  |               
|Total liabilities                                                                                                                                                                                                                                |  |         |     |  | 507,710                                                            |  | 1,326,974     
|Commitments and contingencies                                                                                                                                                                                                                    |  | 15      |     |  |                                                                    |  |               
|Shareholders equity                                                                                                                                                                                                                             |  |         |     |  |                                                                    |  |               
|Ordinary shares, par value $0.10 per share  2,000,000,000 shares authorized at August 31, 2004 and August 31, 2005  610,573,361 shares issued and outstanding at August 31, 2004, 614,125,404 shares issued and outstanding at August 31,
2005 |  | 19      |     |  | 61,057                                                             |  | 61,412        
|Share premium                                                                                                                                                                                                                                    |  |         |     |  | 617,986                                                            |  | 619,408       
|Retained profits                                                                                                                                                                                                                                 |  |         |     |  | 495,307                                                            |  | 338,794       
|Translation reserve                                                                                                                                                                                                                              |  |         |     |  | 983                                                                |  | 840           
|Warrant reserve                                                                                                                                                                                                                                  |  |         |     |  | 365                                                                |  |              
|                                                                                                                                                                                                                                                 |  |         |     |  |                                                                    |  |               
|Total shareholders equity                                                                                                                                                                                                                       |  |         |     |  | 1,175,698                                                          |  | 1,020,454     
|                                                                                                                                                                                                                                                 |  |         |     |  |                                                                    |  |               
|Total liabilities and shareholders equity                                                                                                                                                                                                       |  |         |     |  | 1,683,408                                                          |  | 2,347,428     
|                                                                                                                                                                                                                                                 |  |         |     |  |                                                                    |  |               

---



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 CHANGES IN SHAREHOLDERS EQUITY



|                                                                            |  |                                                 |  |                            |  |                   |  |              |  |                |   |  |                    |   |  |                 |   |  |                          |  
|--------------------------------------------------------------------------- |  | ----------------------------------------------- |  | -------------------------- |  | ----------------- |  | ------------ |  | -------------- | - |  | ------------------ | - |  | --------------- | - |  | ------------------------ | -
|                                                                            |  |                                                 |  | Ordinary shares            |  |                   |  |              |  |                |   |  |                    |   |  |                
|                                                                            |  | Note                                            |  | Number ofsharesoutstanding |  | AmountOutstanding |  | Sharepremium |  | Warrantreserve |   |  | Translationreserve |   |  | Retainedprofits |   |  | Totalshareholdersequity |  
|                                                                            |  |                                                 |  |                            |  | HK$               |  | HK$          |  | HK$            |   |  | HK$                |   |  | HK$             |   |  | HK$                      |  
|                                                                            |  | (Amounts in thousands, except number of shares) | 
|Balance at August 31, 2003                                                  |  |                                                 |  | 604,959,787                |  | 60,496            |  | 615,886      |  | 858            |   |  | 1,231              |   |  | 505,978         |   |  | 1,184,449                |  
|Changes in accounting policy  provision for net deferred tax liabilities   |  |                                                 |  |                           |  |                  |  |             |  |               |   |  |                   |   |  | (5,274          | ) |  | (5,274                   | )
|                                                                            |  |                                                 |  |                            |  |                   |  |              |  |                |   |  |                    |   |  |                 |   |  |                          |  
|Balance at August 31, 2003                                                  |  |                                                 |  | 604,959,787                |  | 60,496            |  | 615,886      |  | 858            |   |  | 1,231              |   |  | 500,704         |   |  | 1,179,175                |  
|2003 final dividends declared and paid                                      |  | 21                                              |  |                           |  |                  |  |             |  |               |   |  |                   |   |  | (45,789         | ) |  | (45,789                  | )
|2004 interim dividends declared and paid                                    |  | 21                                              |  |                           |  |                  |  |             |  |               |   |  |                   |   |  | (9,158          | ) |  | (9,158                   | )
|Shares issued upon exercise of warrants                                     |  |                                                 |  | 4,973,574                  |  | 497               |  | 1,985        |  | (493           | ) |  |                   |   |  |                |   |  | 1,989                    |  
|Shares issued upon exercise of share options                                |  |                                                 |  | 640,000                    |  | 64                |  | 115          |  |               |   |  |                   |   |  |                |   |  | 179                      |  
|Net income                                                                  |  |                                                 |  |                           |  |                  |  |             |  |               |   |  |                   |   |  | 49,550          |   |  | 49,550                   |  
|Exchange adjustment on translation of the accounts of overseas subsidiaries |  |                                                 |  |                           |  |                  |  |             |  |               |   |  | (248               | ) |  |                |   |  | (248                     | )
|                                                                            |  |                                                 |  |                            |  |                   |  |              |  |                |   |  |                    |   |  |                 |   |  |                          |  
|Balance at August 31, 2004                                                  |  |                                                 |  | 610,573,361                |  | 61,057            |  | 617,986      |  | 365            |   |  | 983                |   |  | 495,307         |   |  | 1,175,698                |  
|Realization of outstanding warrant reserve upon warrant expiration          |  |                                                 |  |                           |  |                  |  |             |  | (18            | ) |  |                   |   |  | 18              |   |  |                         |  
|Shares issued upon exercise of warrants                                     |  |                                                 |  | 3,500,043                  |  | 350               |  | 1,397        |  | (347           | ) |  |                   |   |  |                |   |  | 1,400                    |  
|Shares issued upon exercise of share options                                |  |                                                 |  | 52,000                     |  | 5                 |  | 25           |  |               |   |  |                   |   |  |                |   |  | 30                       |  
|Net loss                                                                    |  |                                                 |  |                           |  |                  |  |             |  |               |   |  |                   |   |  | (156,531        | ) |  | (156,531                 | )
|Exchange adjustment on translation of the accounts of overseas subsidiaries |  |                                                 |  |                           |  |                  |  |             |  |               |   |  | (143               | ) |  |                |   |  | (143                     | )
|                                                                            |  |                                                 |  |                            |  |                   |  |              |  |                |   |  |                    |   |  |                 |   |  |                          |  
|Balance at August 31, 2005                                                  |  |                                                 |  | 614,125,404                |  | 61,412            |  | 619,408      |  |               |   |  | 840                |   |  | 338,794         |   |  | 1,020,454                |  
|                                                                            |  |                                                 |  |                            |  |                   |  |              |  |                |   |  |                    |   |  |                 |   |  |                          |  



The accompanying notes
are an integral part of these consolidated financial statements.



F-6



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##### Table of Contents

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



CONSOLIDATED STATEMENTS OF CASH FLOWS



|                                                                                          |  |                        |   |  |          |   |  |          |  
|----------------------------------------------------------------------------------------- |  | ---------------------- | - |  | -------- | - |  | -------- | -
|                                                                                          |  | Year ended August 31,  |  
|                                                                                          |  | 2003                   |   |  | 2004     |   |  | 2005     |  
|                                                                                          |  | HK$                    |   |  | HK$      |   |  | HK$      |  
|                                                                                          |  | (Amounts in thousands) |  
|Cash flows from operating activities                                                      |  |                        |   |  |          |   |  |          |  
|(Loss)/income before taxation                                                             |  | 275,600                |   |  | 51,593   |   |  | (163,256 | )
|Adjustments to reconcile                                                                  |  |                        |   |  |          |   |  |          |  
|(Loss)/income before taxation to net cash (used in)/provided from operating activities:   |  |                        |   |  |          |   |  |          |  
|Amortization of goodwill                                                                  |  | 1,065                  |   |  | 1,065    |   |  | 1,065    |  
|Depreciation of purchased fixed assets                                                    |  | 173,619                |   |  | 195,952  |   |  | 236,269  |  
|Depreciation of fixed assets held under finance leases                                    |  | 1,336                  |   |  |         |   |  | 380      |  
|Amortization of deferred expenditure                                                      |  |                       |   |  | 1,828    |   |  | 12,927   |  
|Interest income                                                                           |  | (3,163                 | ) |  | (3,753   | ) |  | (13,578  | )
|Interest expense                                                                          |  | 559                    |   |  | 175      |   |  | 374      |  
|Interest element of finance leases                                                        |  | 42                     |   |  |         |   |  | 23       |  
|(Gain)/loss on disposal of fixed assets                                                   |  | 427                    |   |  | (34      | ) |  | (134     | )
|Unrealized (gain)/losses on other investments                                             |  |                       |   |  | 1,696    |   |  | (300     | )
|Amortization of incidental issuance cost                                                  |  |                       |   |  |         |   |  | 1,693    |  
|Interest on 10-year senior notes                                                          |  |                       |   |  |         |   |  | 52,372   |  
|Loss on disposal of a subsidiary                                                          |  | 2,695                  |   |  |         |   |  |         |  
|Increase in long term receivable and prepayment                                           |  |                       |   |  | (6,206   | ) |  | (6,893   | )
|Changes in operating assets and liabilities:                                              |  |                        |   |  |          |   |  |          |  
|Increase in term deposits                                                                 |  |                       |   |  |         |   |  | (92,850  | )
|(Increase)/decrease in trade receivables, other receivables, deposits and prepayments     |  | 6,455                  |   |  | (50,382  | ) |  | (29,890  | )
|Increase in inventories                                                                   |  |                       |   |  |         |   |  | (1,957   | )
|Increase in deferred expenditure                                                          |  |                       |   |  | (23,391  | ) |  | (12,495  | )
|Increase/(decrease) in trade payables, other payables, accrued charges, deposits received |  | (28,678                | ) |  | 30,957   |   |  | 5,258    |  
|(Decrease)/increase in deferred service income                                            |  | 5,005                  |   |  | 29,257   |   |  | (2,685   | )
|                                                                                          |  |                        |   |  |          |   |  |          |  
|Net cash (outflow)/inflow generated from operations                                       |  | 434,962                |   |  | 228,757  |   |  | (13,677  | )
|                                                                                          |  |                        |   |  |          |   |  |          |  
|Interest paid                                                                             |  | (559                   | ) |  | (175     | ) |  | (374     | )
|Interest element of finance leases                                                        |  | (42                    | ) |  |         |   |  | (23      | )
|Hong Kong profits tax paid                                                                |  | (18,107                | ) |  | (24,011  | ) |  | (805     | )
|Overseas tax paid                                                                         |  | (1,754                 | ) |  | (808     | ) |  | (588     | )
|                                                                                          |  |                        |   |  |          |   |  |          |  
|Net cash (outflow)/inflow from operating activities                                       |  | 414,500                |   |  | 203,763  |   |  | (15,467  | )
|                                                                                          |  |                        |   |  |          |   |  |          |  
|Investing activities                                                                      |  |                        |   |  |          |   |  |          |  
|(Increase)/decrease in pledged bank deposits                                              |  | (24,608                | ) |  | 2,803    |   |  | (63,642  | )
|Increase in long term bank deposits                                                       |  | (15,580                | ) |  |         |   |  |         |  
|Purchases of fixed assets                                                                 |  | (250,209               | ) |  | (410,046 | ) |  | (415,494 | )
|Interest received                                                                         |  | 3,163                  |   |  | 3,753    |   |  | 13,578   |  
|Purchase of other investments                                                             |  | (23,370                | ) |  | (3,900   | ) |  |         |  
|Proceeds from disposal of fixed assets                                                    |  | 1,552                  |   |  | 1,146    |   |  | 968      |  
|Disposal of a subsidiary, net of cash disposed (Note (1) below)                           |  | (582                   | ) |  |         |   |  |         |  
|                                                                                          |  |                        |   |  |          |   |  |          |  
|Net cash outflow from investing activities                                                |  | (309,634               | ) |  | (406,244 | ) |  | (464,590 | )
|                                                                                          |  |                        |   |  |          |   |  |          |  
|Net cash (outflow)/inflow before financing activities                                     |  | 104,866                |   |  | (202,481 | ) |  | (480,057 | )
|                                                                                          |  |                        |   |  |          |   |  |          |  



(Continued)



The accompanying notes are an integral part of these
consolidated financial statements.



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##### Table of Contents

|                                                                     |  |                        |   |  |          |   |  |          |  
|-------------------------------------------------------------------- |  | ---------------------- | - |  | -------- | - |  | -------- | -
|                                                                     |  | Year ended August 31,  |  
|                                                                     |  | 2003                   |   |  | 2004     |   |  | 2005     |  
|                                                                     |  | HK$                    |   |  | HK$      |   |  | HK$      |  
|                                                                     |  | (Amounts in thousands) |  
|Financing activities                                                 |  |                        |   |  |          |   |  |          |  
|Issue of new shares                                                  |  | 45,409                 |   |  | 2,168    |   |  | 1,430    |  
|Net proceeds of senior notes issue                                   |  |                       |   |  |         |   |  | 943,655  |  
|Interest paid for senior notes                                       |  |                       |   |  |         |   |  | (52,372  | )
|Bank loan drawn down                                                 |  |                       |   |  | 100,000  |   |  | 100,000  |  
|Repayment of bank loan                                               |  |                       |   |  |         |   |  | (200,000 | )
|Repayment of loan to a former minority shareholder                   |  | (22,500                | ) |  |         |   |  |         |  
|Repayment of capital element of finance leases                       |  | (2,949                 | ) |  |         |   |  | (497     | )
|Dividend paid                                                        |  | (30,234                | ) |  | (54,947  | ) |  |         |  
|                                                                     |  |                        |   |  |          |   |  |          |  
|Net cash inflow/(outflow) from financing activities                  |  | (10,274                | ) |  | 47,221   |   |  | 792,216  |  
|                                                                     |  |                        |   |  |          |   |  |          |  
|Increase/(decrease) in cash and cash equivalents                     |  | 94,592                 |   |  | (155,260 | ) |  | 312,159  |  
|Cash and cash equivalents at the beginning of year                   |  | 290,403                |   |  | 383,860  |   |  | 228,347  |  
|Effect of foreign exchange rate changes on cash and cash equivalents |  | (1,135                 | ) |  | (253     | ) |  | (915     | )
|                                                                     |  |                        |   |  |          |   |  |          |  
|Cash and cash equivalents at the end of year (Note 20)               |  | 383,860                |   |  | 228,347  |   |  | 539,591  |  
|                                                                     |  |                        |   |  |          |   |  |          |  



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##### Table of Contents

Note(1):



Disposal of a subsidiary



|                                                                     |  |                        |   |  |      |  |     
|-------------------------------------------------------------------- |  | ---------------------- | - |  | ---- |  | ----
|                                                                     |  | Year ended August 31, 
|                                                                     |  | 2003                   |   |  | 2004 |  | 2005
|                                                                     |  | HK$                    |   |  | HK$  |  | HK$ 
|                                                                     |  | (Amounts in thousands)
|Fixed assets                                                         |  | 1,354                  |   |  |     |  |    
|Trade receivable, other receivables, deposits and prepayments        |  | 1,914                  |   |  |     |  |    
|Cash and bank balances                                               |  | 714                    |   |  |     |  |    
|Trade payable, other payables, accrued charges and deposits received |  | (805                   | ) |  |     |  |    
|Income taxes payable                                                 |  | (1                     | ) |  |     |  |    
|                                                                     |  |                        |   |  |      |  |     
|Net assets disposed of                                               |  | 3,176                  |   |  |     |  |    
|Translation reserve transferred to statements of operations          |  | 1,469                  |   |  |     |  |    
|Net loss on disposal                                                 |  | (2,695                 | ) |  |     |  |    
|                                                                     |  |                        |   |  |      |  |     
|Sale proceeds                                                        |  | 1,950                  |   |  |     |  |    
|Less: Cash and cash equivalents of the subsidiary disposed           |  | (714                   | ) |  |     |  |    
|Sale proceeds receivable                                             |  | (1,818                 | ) |  |     |  |    
|                                                                     |  |                        |   |  |      |  |     
|Net cash outflow in respect of the disposal of a subsidiary          |  | (582                   | ) |  |     |  |    
|                                                                     |  |                        |   |  |      |  |     

---

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 30(e).



The accompanying notes are an integral part of these consolidated financial statements.



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##### Table of Contents

1 Description of business and basis of presentation



City Telecom (H.K.) Limited was incorporated in Hong Kong on May 19, 1992 under the Hong Kong Companies Ordinance. The Company and its subsidiaries (collectively referred to as the Company) are
engaged in the provision of international telecommunications services and fixed telecommunications network services to customers in Hong Kong and Canada.



As of August 31, 2005 the Company had the following principal direct and indirect subsidiaries:



|                                                                                         |  |                                                           |  |                               |  |                   |  |          |  |                                                                                             
|---------------------------------------------------------------------------------------- |  | --------------------------------------------------------- |  | ----------------------------- |  | ----------------- |  | -------- |  | --------------------------------------------------------------------------------------------
|                                                                                         |  |                                                           |  |                               |  | Percentageholding |  |         
|Name                                                                                     |  | Place and date of establishment/operation                 |  | Issued capital                |  | Direct            |  | Indirect |  | Nature of business                                                                          
|963673 Ontario Limited                                                                   |  | Canada November 12, 1991                                  |  | CommonCAD502,000              |  |                  |  | 100      |  | Investment holding in Canada                                                                
|Attitude Holdings Limited                                                                |  | British Virgin Islands November 3, 1997                   |  | Ordinary US$1                 |  |                  |  | 100      |  | Inactive                                                                                    
|Automedia Holdings Limited                                                               |  | British Virgin Islands January 23, 2001                   |  | Ordinary US$1                 |  | 100               |  |         |  | Investment holding in Hong Kong                                                             
|City Telecom (B.C.) Inc.                                                                 |  | Canada February 25, 1992                                  |  | CommonCAD501,000              |  |                  |  | 100      |  | Provision of international telecommunications and dial-up internet access services in Canada
|City Telecom (Canada) Inc.                                                               |  | Canada October 6, 1997                                    |  | CommonCAD100                  |  |                  |  | 100      |  | Maintenance of switching equipment and provision of operational services in Canada          
|City Telecom Inc.                                                                        |  | Canada September 19, 1991                                 |  | CommonCAD1,000                |  |                  |  | 100      |  | Provision of international telecommunications and dial-up internet access services in Canada
|City Telecom International Limited                                                       |  | British Virgin Islands May 8, 1997                        |  | OrdinaryUS$5,294              |  | 100               |  |         |  | Investment holding in Hong Kong                                                             
|City Telecom (USA) Inc.                                                                  |  | USA May 5, 1997                                           |  | Common US$1                   |  |                  |  | 100      |  | Inactive                                                                                    
|Credibility Holdings Limited                                                             |  | British Virgin Islands December 18, 1998                  |  | Ordinary US$1                 |  | 100               |  |         |  | Investment holding in Hong Kong                                                             
|CTI Guangzhou Customer Service Co. Ltd. (translated from the registered name in Chinese) |  | The Peoples Republic of China (the
PRC) April 29, 2002 |  | Paid in capitalofHK$8,000,000 |  | 100               |  |         |  | Provision of administrative support services in the PRC                                     
|CTI International Limited                                                                |  | Hong Kong August 23, 1999                                 |  | OrdinaryHK$10,000,000         |  |                  |  | 100      |  | Inactive                                                                                    
|CTI Marketing Company Limited                                                            |  | Hong Kong August 23, 1999                                 |  | OrdinaryHK$10,000             |  |                  |  | 100      |  | Provision of media marketing services in Hong Kong                                          
|Golden Trinity Holdings Limited                                                          |  | British Virgin Islands June 11, 1997                      |  | Ordinary US$1                 |  | 100               |  |         |  | Investment holding in Hong Kong                                                             



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##### Table of Contents

|                                                                      |  |                                           |  |                    |  |                   |  |          |  |                                                                                                         
|--------------------------------------------------------------------- |  | ----------------------------------------- |  | ------------------ |  | ----------------- |  | -------- |  | --------------------------------------------------------------------------------------------------------
|                                                                      |  |                                           |  |                    |  | Percentageholding |  |         
|Name                                                                  |  | Place and date of establishment/operation |  | Issued capital     |  | Direct            |  | Indirect |  | Nature of business                                                                                      
|Hong Kong Broadband Network Limited                                   |  | Hong Kong August 23, 1999                 |  | OrdinaryHK$383,049 |  |                  |  | 100      |  | Provision of international telecommunications and fixed telecommunications network services in Hong Kong
|IDD1600 Company Limited                                               |  | Hong Kong November 4, 1998                |  | OrdinaryHK$2       |  |                  |  | 100      |  | Provision of international telecommunications services
in Hong Kong                                     
|Global Courier Company Limited (formerly known as iStore.com Limited) |  | Hong Kong September 17, 1999              |  | OrdinaryHK$10,000  |  |                  |  | 100      |  | Inactive                                                                                                



The consolidated
financial statements have been prepared in accordance with generally accepted accounting principles in Hong Kong and comply with accounting standards issued by the Hong Kong Institute of Certified Public Accountants (HKICPA). They have
been prepared under the historical cost convention except that, as disclosed in the accounting policies below, other investments are stated at fair value and senior notes are stated at fair value on the date of inception. These principles differ in
certain significant respects from accounting principles generally accepted in the United States of America (U.S. GAAP), details of which are set out in Note 30.



The consolidated financial statements do not represent the Hong Kong statutory financial statements of the Company as
certain reclassifications and changes in presentation have been made to the consolidated financial statements in order to conform more closely to presentations customary in filings with the Securities and Exchange Commission of the United States of
America (the SEC).



All amounts are expressed in
Hong Kong Dollars, the Companys functional currency. Unless indicated otherwise, amounts in Hong Kong Dollars have been rounded to the nearest thousand.



2 Principal accounting policies



The principal accounting policies adopted in the preparation of these consolidated financial statements are set out below:



(a) Consolidation



The consolidated financial statements include the financial statements of the Company and all its subsidiaries as of
August 31, 2004 and 2005, and the results of operations, cash flows and changes in shareholders equity for the years ended August 31, 2003, 2004 and 2005. All significant inter-company transactions and balances are eliminated on
consolidation.



Subsidiaries are those entities in which the
company, directly or indirectly, controls the composition of the board of directors, controls more than half the voting power or holds more than half of the issued share capital.



The results of subsidiaries acquired or disposed of during the year are included in the consolidated statements of
operations 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 operations.



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##### Table of Contents

Minority interests represent the interests of outside shareholders in the operating results and net
assets of subsidiaries.



(b) Goodwill



Goodwill represents the excess of the cost of an acquisition over the fair
value of the Companys share of the identifiable net assets of the acquired subsidiary at the date of acquisition.



Goodwill on acquisitions that occurred prior to September 1, 2001 was written off against reserves.



Goodwill on acquisitions occurring on or after September 1, 2001 is
separately shown on the consolidated balance sheets and is amortized using the straight-line method over its estimated useful life. Goodwill arising on major strategic acquisitions of the Company to expand its product or geographical market coverage
is amortized over a period of not more than 20 years.



Where an
indication of impairment exists, the carrying amount of goodwill, including goodwill previously written off against reserves, is assessed and written down immediately to its recoverable amount and any write down is accounted for in the consolidated
statements of operations.



(c) Fixed assets



Fixed assets are stated at cost less accumulated depreciation and
accumulated impairment losses.



Leasehold land is depreciated
over the period of the lease while other tangible fixed assets are depreciated at rates sufficient to write off their costs less accumulated impairment losses over their estimated useful lives on a straight-line basis. The principal annual rates are
as follows:



|                                                  |  |       
|------------------------------------------------- |  | ------
|                                                  |  | %     
|Leasehold land                                    |  | 2     
|Leasehold buildings                               |  | 2     
|Furniture, fixtures and fittings                  |  | 25    
|Telecommunications, computer and office equipment |  | 7 - 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 operations. 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 in the statements of operations to reduce the assets
to its recoverable amount. No impairment losses were recognized in each of the years in the three-year period ended August 31.



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 operations.



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##### Table of Contents

(d) Assets held under leases



(i) Finance leases



Leases that substantially transfer to the Company all the risks and rewards of ownership of assets are accounted for as finance leases. Finance leases are
capitalized at the inception of the leases at the lower of fair value of the leased assets or the present value of the minimum lease payments. Each lease payment is allocated between capital and finance charges so as to achieve a constant rate on
the capital balances outstanding. The corresponding rental obligations, net of finance charges, are included in short-term or long-term liabilities. The finance charges are charged to the consolidated statements of operations over the lease periods.



Assets held under finance leases are depreciated over the
shorter of lease periods or their estimated useful lives.



At
each balance sheet date, both internal and external sources of information are considered to assess whether there is any indication that finance leased 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 asset to its recoverable amount. Such impairment losses are recognized in the consolidated statements of operations.



(ii) Operating leases



Leases where substantially all the risk and rewards of ownership of assets
remain with the leasing company are accounted for as operating leases. Payments made under operating leases net of any incentives received from the leasing company are charged to the consolidated statements of operations on a straight-line basis
over the lease periods.



(e) Other investments



Other investments are carried at fair value. At each balance sheet date, the
net unrealized gains or losses arising from the changes in fair value of other investments are recognized in the consolidated statements of operations. 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 operations as they arise.



(f) Deferred expenditure



Customer acquisition costs incurred to obtain long term service agreements with customers are deferred and amortized on a straight line basis over the
period of the underlying service subscription agreements executed with the customers. All other related advertising and marketing costs are charged to the consolidated statements of operations as incurred.



(g) Accounts receivable



Provision is made against accounts receivable to the extent that collection of the balance is considered to be doubtful.
Accounts receivable in the consolidated balance sheets are stated net of such provision.



(h) Inventories



Inventories are carried at the lower of cost and net realisable value.



Cost is determined using the first in, first out method (FIFO) and comprises all costs of purchase, costs of conversion and other costs incurred in bringing the inventories to their present location and condition.



Net realisable value is the estimated selling price in the
ordinary course of business less the estimated costs of completion and the estimated costs necessary to make the sale.



When inventories are sold, the carrying amount of those inventories is recognized as an expense in the period in which the related revenue is recognized.
The amount of any write-down of inventories to net realisable value and all losses of inventories are recognized as an expense in the period the write-down or loss occurs. The amount of any reversal of any write-down of inventories, arising from an
increase in net realisable value, is recognized as a reduction in the amount of inventories recognized as an expense in the period in which the reversal occurs.



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As of August 31, 2005, there was no write-down or reversal of a previous write-down made against
inventories due to change in net realisable value.



(i) Deferred taxation



Deferred taxation is provided in full, using the
liability method, on temporary differences arising between the tax bases of assets and liabilities and their carrying amounts in the financial statements. Taxation rates enacted or substantively enacted by the balance sheet date are used to
determine deferred taxation.



Deferred tax assets are
recognized to the extent that it is probable that future taxable profit will be available against which the temporary differences can be utilized.



Deferred taxation is provided on temporary differences arising on investments in subsidiaries except where the timing of the reversal of the temporary
difference can be controlled and it is probable that the temporary difference will not reverse in the foreseeable future.



(j) Senior notes



The senior notes are initially accounted at fair value (which is equivalent to the issuance price) less the amount of incidental issuance costs.



After initial recognition, the senior notes are stated at
amortized cost and any difference between the initial recognized fair value (net of incidental issuance costs) and the redemption or par value is amortized from the date of issue to the date of maturity using the effective interest method.



In the event that the senior notes are redeemed prior to the
maturity date, the difference between the carrying value and the redemption value of the notes is charged immediately to the consolidated statements of operations.



(k) Translation of foreign currencies



Transactions in foreign currencies are translated at exchange rates ruling at the transaction dates. Monetary assets and liabilities expressed in foreign
currencies at the balance sheet date are translated at the rates of exchange ruling at the balance sheet date. Exchange differences arising in these cases are dealt with in the consolidated statements of operations.



The balance sheets of subsidiaries expressed in foreign currencies are
translated at the rates of exchange ruling at the balance sheet date whereas the statements of operations are translated at an average rate for the year. Such exchange differences are dealt with as a movement in translation reserves.



(l) Cash and cash equivalents



Cash and cash equivalents comprise cash at bank and on hand, demand deposits
with banks, and short-term, highly liquid investments that are readily convertible into known amounts of cash and which are subject to an insignificant risk of changes in value, having been within three months of maturity at acquisition.



Cash equivalents, are stated at cost, which approximates fair value
because of the short-term maturity of these investments.



(m) Provisions



Provisions are recognized when the Company has a present
legal or constructive obligation as a result of past events, it is probable that an outflow of resources will be required to settle the obligation, and a reliable estimate of the amount can be made. Where the Company expects a provision to be
reimbursed, the reimbursement is recognized as a separate asset but only when the reimbursement is virtually certain.



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(n) Contingent liabilities and contingent assets



A contingent liability is a possible obligation that arises from past events and whose existence will only be confirmed by
the occurrence or non-occurrence of one or more uncertain future events not wholly within the control of the Company. It can also be a present obligation arising from past events that is not recognized because it is not probable that outflow of
economic resources will be required or the amount of obligation cannot be measured reliably.



A contingent liability is not recognized but is disclosed in the notes to the consolidated financial statements. When a change in the probability of an outflow occurs so that outflow is probable, they will then be
recognized as a provision.



A contingent asset is a possible
asset that arises from past events and whose existence will be confirmed only by the occurrence or non-occurrence of one or more uncertain events not wholly within the control of the Company.



Contingent assets are not recognized but are disclosed in the notes to the
consolidated financial statements when an inflow of economic benefits is probable. When inflow is virtually certain, an asset is recognized.



(o) Revenue recognition



(i) Revenue for the provision of international telecommunications and fixed telecommunications network services is recognized, net of discounts, when an arrangement exists, service is rendered, the fee is fixed or
determinable, and collectibility is probable.



(ii) Amounts received in advance
for the provision of international telecommunications services using calling cards is deferred and included under deferred services income and subsequently recognized as revenue when the calling cards are used by customers or when the calling cards
have expired.



(iii) Amounts received in advance for the provision of fixed
telecommunications network services is deferred and included under deferred services income, and subsequently recognized as revenue on a straight-line basis over the agreed period of time in accordance with the terms of the subscription agreement.



(iv) Revenue from the sales of products is recognized upon the transfer of
risks and rewards of ownership, which generally coincides with the time when the goods are delivered to customers and title has passed.



(v) Interest income is recognized on a time proportion basis, taking into account the principal amounts outstanding and the interest rates applicable.



(p) Employee benefits



(i) Employee leave entitlements



Employee entitlements to annual leave and long service leave are recognized when they accrue to employees. A provision is made for the estimated liability
for annual leave and long-service leave as a result of services rendered by employees up to the balance sheet date.



Employee entitlements to sick leave and maternity or paternity leave are not recognized until the time of leave.



(ii) Profit sharing and bonus plans



Provisions for profit sharing and bonus plans due wholly within twelve months
after balance sheet date are recognized when the Company has a present legal or constructive obligation as a result of services rendered by employees and a reliable estimate of the obligation can be made.



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(iii) Retirement benefit costs



The Company contributes to defined contribution retirement schemes which are available to all employees. Contributions to
the schemes by the Company and employees are calculated as a percentage of employees basic salaries. The retirement benefit scheme cost charged to the consolidated statements of operations 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.



(q) Research and development costs



Research and development costs of new services and enhancements to existing
services are charged to the consolidated statements of operations as incurred.



Total research and development expenses incurred for the years ended August 31, 2003, 2004 and 2005 amounted to HK$2,622,000, HK$5,962,000, and HK$11,023,000 respectively.



(r) Borrowing costs



Borrowing costs that are directly attributable to the acquisition, construction or production of an asset that necessarily
takes a substantial period of time to get ready for its intended use or sale are capitalized as part of the cost of that asset. All other borrowing costs are charged to the consolidated statements of operations in the year in which they are
incurred.



Total borrowing costs capitalized for the year ended
August 31, 2005 was HK$2,047,000 (2004: HK$3,053,000 and 2003: Nil).



(s) Segment reporting



In accordance with the
Companys internal financial reporting, the Company has determined that business segments be presented as the primary reporting format and geographical as the secondary reporting format.



Segment assets consist primarily of goodwill, fixed assets, receivables and
operating cash. Segment liabilities comprise operating liabilities and exclude items such as taxation and certain corporate borrowings. Capital expenditure comprises additions to fixed assets.



In respect of geographical segment reporting, sales are reported based on the
country in which the customer is located. Total assets and capital expenditure are reported based on where the assets are located.



(t) Barter transactions



When goods or services are exchanged or swapped for goods or services which are of a similar nature and value, the exchange is not regarded as a
transaction which generates revenue. When goods are sold or services are rendered in exchange for dissimilar goods or services, the exchange is regarded as a transaction which generates revenue. The revenue is measured at the fair value of the goods
or services received, adjusted by the amount of any cash or cash equivalents transferred. When the fair value of the goods or services received cannot be measured reliably, the revenue is measured at the fair value of the goods or services given up,
adjusted by the amount of any cash or cash equivalents transferred.



F-16



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##### Table of Contents

(u) Use of estimates



The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions
that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the year. Actual results could differ
from these estimates.



3 Network costs



Network costs mainly include interconnection charges paid to local and
overseas carriers, leased line rentals, program fees and production costs for the IP-TV service, and do not include depreciation charge which is included in other operating expenses.



The Company estimates the Universal Services Contributions (USC) payable to PCCW-HKT Telephone Limited
(PCCW-HKT) to fund the costs of network development in remote areas in Hong Kong (the Development) and includes such estimated costs as part of the network costs. The Telecommunications Authority (TA) periodically
reviews the actual costs of such development and revises the amounts owed to, or to be refunded by, PCCW-HKT to the USC contributing parties.



Management of the Company makes their best estimates for charges of the USC payable to PCCW-HKT. Such estimated costs are included as part of the
Companys costs of rendering its services. The estimate is made based on the provisional rates announced by the TA which is effective up to the date of the release of the consolidated financial statements of the Company. The TA periodically
reviews the actual costs incurred by PCCW-HKT in the Development and revises the amounts owed to, or to be refunded by, PCCW-HKT to the respective USC contributing parties, including the Company (the Rate Revisions). Accordingly, the
estimate made by the Companys management is subject to changes based on the Rate Revisions identified during a financial year and up to the date prior to the release of the financial statements of the Company. The Company adjusts such
differences as an addition or reduction of the corresponding costs of services in that particular reporting period.



Any sum received in advance from PCCW-HKT as an estimated refund of the USC on a provisional basis, which is subject to the final confirmation and
determination of TA, is recorded in other payables and accrued charges in the Companys consolidated balance sheet.



On November 30, 2002, the TA issued a statement (the November 2002 Statement) that confirmed the actual USC payable by USC contributing
parties for the calendar year 2000. As a result of the release of the November 2002 Statement, in February 2003, the Company received a refund of USC paid for the period from January 1, 2000 to December 31, 2000 of HK$40,586,000 which was
set off against the network costs of the Company for the year ended August 31, 2003.



On March 8, 2003, the Company received in advance a sum of HK$56,489,000 from PCCW-HKT as a provisional refund of the USC paid for the period from January 1, 2001 to June 30, 2002 (the Provisional
Refund). On October 20, 2003, TA issued another statement on the USC and confirmed the contribution level for calendar year 2001. Accordingly, HK$40,276,000 out of the Provisional Refund and an additional refund of approximately
HK$3,000,000 payable by PCCW-HKT to the Company for the calendar year 2001 were set off against the network costs of the Company. In aggregate, the Company had set off against the costs of services of HK$84,119,000 in respect of USC refund for the
year ended August 31, 2003. The remaining HK$16,212,000 of the Provisional Refund received by the Company, being the provisional refund of the USC for the period from January 1, 2002 to June 30, 2002 which was subject to confirmation
of the TA (2002 Provisional Refund) was included in other payables and accrued charges in the Companys balance sheets as at August 31, 2003.



On November 19, 2004, the TA issued a statement on the USC that confirmed the actual contribution level for calendar
year 2002. The 2002 Provisional Refund was confirmed. Additional refund payable by PCCW-HKT to the Company and related adjustments required to be made to the USC for calendar year 2002 were also determined. In aggregate, an amount of HK$31,689,000
was recorded as an off-set against the network costs of the Company for the year ended August 31, 2004.



F-17



---

##### Table of Contents

On November 11, 2005, the TA issued a statement on the USC and confirmed the actual contribution
level for calendar year 2003. In aggregate, an amount of HK$6,448,000 was recorded as a reduction against the network cost of the Company for the year ended August 31, 2005.



The actual contribution level for calendar year 2004 and 2005 is not yet confirmed by the TA.



4 Loss on disposal of a subsidiary



During the year ended August 31, 2003, the Companys operation in
Japan was discontinued following the disposal of its subsidiary operating in Japan to a company wholly-owned by a relative of a director of the subsidiary (the Purchaser). The subsidiary was sold for a consideration of JPY30,000,000
(equivalent to HK$1,950,000) which is to be satisfied by the Purchaser in thirty monthly installments commencing July 15, 2003. The disposal resulted in a loss of HK$2,695,000 which was recognized in the consolidated statements of operations.



As at August 31, 2005, a receivable balance of HK$279,000
was due from the Purchaser, and included in other receivables, deposits and prepayments and is expected to be received within one year.



F-18



---

##### Table of Contents

5 (Loss)/income before taxation



|                                                                |  |                       |  |         |   |  |         |  
|--------------------------------------------------------------- |  | --------------------- |  | ------- | - |  | ------- | -
|                                                                |  | Year ended August 31, | 
|                                                                |  | 2003                  |  | 2004    |   |  | 2005    |  
|                                                                |  | HK$000               |  | HK$000 |   |  | HK$000 |  
|(Loss)/income before taxation is stated after charging:         |  |                       |  |         |   |  |         |  
|Amortization of goodwill                                        |  | 1,065                 |  | 1,065   |   |  | 1,065   |  
|Amortization of deferred expenditure                            |  |                      |  | 1,828   |   |  | 12,927  |  
|Depreciation of purchased fixed assets                          |  | 173,619               |  | 195,952 |   |  | 236,269 |  
|Depreciation of fixed assets held under finance leases          |  | 1,336                 |  |        |   |  | 380     |  
|Operating lease charges in respect of:                          |  |                       |  |         |   |  |         |  
| Land and buildings                                            |  | 6,481                 |  | 8,084   |   |  | 13,081  |  
| Computer equipment                                            |  | 100                   |  | 31      |   |  | 914     |  
|Research and development costs                                  |  | 2,622                 |  | 5,962   |   |  | 11,023  |  
|Retirement benefit costs  defined contribution plans (Note 24) |  | 15,843                |  | 26,287  |   |  | 27,437  |  
|Interest expense comprises:                                     |  |                       |  |         |   |  |         |  
|Interest element of finance leases                              |  | 42                    |  |        |   |  | 23      |  
|Interest on 10-year senior notes                                |  |                      |  |        |   |  | 52,372  |  
|Interest on bank overdrafts                                     |  | 210                   |  | 3,228   |   |  | 2,421   |  
|Interest paid to third parties                                  |  | 349                   |  |        |   |  |        |  
|Amortization of incidental issuance cost                        |  |                      |  |        |   |  | 1,693   |  
|                                                                |  |                       |  |         |   |  |         |  
|                                                                |  | 601                   |  | 3,228   |   |  | 56,509  |  
|Less: amount capitalized as fixed assets                        |  |                       |  |         |   |  |         |  
|Interest capitalized                                            |  |                      |  | (2,553  | ) |  | (2,047  | )
|Other incidental borrowing cost                                 |  |                      |  | (500    | ) |  |        |  
|                                                                |  |                       |  |         |   |  |         |  
|Total borrowing cost capitalized                                |  |                      |  | (3,053  | ) |  | (2,047  | )
|                                                                |  |                       |  |         |   |  |         |  
|Total interest expenses                                         |  | 601                   |  | 175     |   |  | 54,462  |  
|                                                                |  |                       |  |         |   |  |         |  
|Other income comprises:                                        |  |                       |  |         |   |  |         |  
|Exchange gains, net                                             |  | 1,291                 |  | 131     |   |  | 3,300   |  
|Others                                                          |  | 3,082                 |  | 2,537   |   |  | 2,737   |  
|                                                                |  |                       |  |         |   |  |         |  
|                                                                |  | 4,373                 |  | 2,668   |   |  | 6,037   |  
|                                                                |  |                       |  |         |   |  |         |  



6 Income tax credit/(charge)



(Loss) / income before taxation by
geographical location is as follows:



|                              |  |                       |  |         |   |  |          |  
|----------------------------- |  | --------------------- |  | ------- | - |  | -------- | -
|                              |  | Year ended August 31, | 
|                              |  | 2003                  |  | 2004    |   |  | 2005     |  
|                              |  | HK$000               |  | HK$000 |   |  | HK$000  |  
|Hong Kong                     |  | 272,016               |  | 53,200  |   |  | (160,451 | )
|Overseas (loss)/income        |  | 3,584                 |  | (1,607  | ) |  | (2,805   | )
|                              |  |                       |  |         |   |  |          |  
|(Loss)/income before taxation |  | 275,600               |  | 51,593  |   |  | (163,256 | )
|                              |  |                       |  |         |   |  |          |  



Income tax credit/(charge) consist of the following:



|                                      |  |                       |   |  |         |   |  |         |  
|------------------------------------- |  | --------------------- | - |  | ------- | - |  | ------- | -
|                                      |  | Year ended August 31, |  
|                                      |  | 2003                  |   |  | 2004    |   |  | 2005    |  
|                                      |  | HK$000               |   |  | HK$000 |   |  | HK$000 |  
|Hong Kong income tax                  |  |                       |   |  |         |   |  |         |  
|current (note (a))                    |  | (15,300               | ) |  | (1,537  | ) |  | (147    | )
|under provision of tax in prior years |  |                      |   |  | (1,221  | ) |  | (333    | )
|deferred (Note 12)                    |  | (139                  | ) |  | 1,412   |   |  | 8,325   |  
|Overseas taxation                     |  |                       |   |  |         |   |  |         |  
|current (note (b))                    |  | (2,478                | ) |  | (596    | ) |  | (919    | )
|deferred (Note 12)                    |  | 60                    |   |  | (101    | ) |  | (201    | )
|                                      |  |                       |   |  |         |   |  |         |  
|                                      |  | (17,857               | ) |  | (2,043  | ) |  | 6,725   |  
|                                      |  |                       |   |  |         |   |  |         |  

---

|(a) | The Company is subject to tax on an entity basis on income arising in or derived from Hong Kong. The rate of taxation of the Company operating in Hong Kong for the
years ended August 31, 2003, 2004 and 2005 was 17.5%.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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##### Table of Contents

|(b) | Taxation on overseas profits has been calculated on the estimated assessable profit for the year at the rates of taxation prevailing in the countries in which the Company operates.
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



The income taxes attributable to income for the
years ended August 31, 2003, 2004 and 2005 differs from the amount of income taxes determined by applying the applicable income tax rate prevailing in the countries in which the Company operates to pre-tax income as a result of the following
differences:



|                                                                                                 |  |                       |   |  |         |   |  |         |  
|------------------------------------------------------------------------------------------------ |  | --------------------- | - |  | ------- | - |  | ------- | -
|                                                                                                 |  | Year ended August 31, |  
|                                                                                                 |  | 2003                  |   |  | 2004    |   |  | 2005    |  
|                                                                                                 |  | HK$000               |   |  | HK$000 |   |  | HK$000 |  
|Income tax (credit)/charge calculated at the prevailing taxation rate of respective countries    |  | 48,520                |   |  | 9,696   |   |  | (28,433 | )
|Effect of expenses not deductible for income taxes                                               |  | 5,584                 |   |  | 730     |   |  | 1,788   |  
|Effect of income not subject to income taxes                                                     |  | (5,151                | ) |  | (825    | ) |  | (3,963  | )
|Under provision for Hong Kong income tax in prior years                                          |  |                      |   |  | 1,221   |   |  | 333     |  
|Recognition of deferred tax assets on prior years tax losses, net of other temporary difference |  | (36,505               | ) |  | (9,066  | ) |  | (4,981  | )
|Effect of tax loss not recognized                                                                |  | 208                   |   |  | 27      |   |  | 28,464  |  
|Increase in opening net deferred tax liabilities resulting from an increase in tax rate          |  | 1,893                 |   |  |        |   |  |        |  
|Others                                                                                           |  | 3,308                 |   |  | 260     |   |  | 67      |  
|                                                                                                 |  |                       |   |  |         |   |  |         |  
|Income tax (credit)/charges                                                                      |  | 17,857                |   |  | 2,043   |   |  | (6,725  | )
|                                                                                                 |  |                       |   |  |         |   |  |         |  



7 (Loss)/earnings per share



|                                                          |  |                           |  |                           |  |                          
|--------------------------------------------------------- |  | ------------------------- |  | ------------------------- |  | -------------------------
|                                                          |  | Year ended August 31,    
|                                                          |  | 2003                      |  | 2004                      |  | 2005                     
|                                                          |  | HK$000                   |  | HK$000                   |  | HK$000                  
|Net (loss)/income                                         |  | 257,743                   |  | 49,550                    |  | (156,531)                
|                                                          |  |                           |  |                           |  |                          
|                                                          |  | No. of shares in thousand |  | No. of shares in thousand |  | No. of shares in thousand
|Weighted average number of shares in issue                |  | 552,600                   |  | 610,095                   |  | 613,525                  
|Incremental shares from assumed exercise of share options |  | 7,112                     |  | 604                       |  |                         
|Incremental shares from assumed exercise of warrants      |  | 55,390                    |  | 3,666                     |  |                         
|                                                          |  |                           |  |                           |  |                          
|Diluted weighted average number of shares                 |  | 615,102                   |  | 614,365                   |  | 613,525                  
|                                                          |  |                           |  |                           |  |                          
|Basic (loss)/earnings per share                           |  | HK46.6 cents              |  | HK8.1 cents               |  | HK(25.5) cents           
|Diluted (loss)/earnings per share                         |  | HK41.9 cents              |  | HK8.1 cents               |  | HK(25.5) cents           



(Loss)/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 (loss)/income amount. The number of incremental
shares from assumed exercise of share options and warrants has been determined using the treasury stock method.



For the year ended August 31, 2005, the number of shares used in the calculation of diluted loss per share is equal to the number of shares used to
calculate basic loss per share as the incremental effect of share options would be anti-dilutive in a loss-making year.



F-20



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##### Table of Contents

8 Receivables



(a) Trade receivables, net



|                                          |  |            |   |  |         |  
|----------------------------------------- |  | ---------- | - |  | ------- | -
|                                          |  | August 31, |  
|                                          |  | 2004       |   |  | 2005    |  
|                                          |  | HK$000    |   |  | HK$000 |  
|Trade receivables                         |  | 157,808    |   |  | 178,326 |  
|Less: provision for doubtful debts (note) |  | (22,959    | ) |  | (48,316 | )
|                                          |  |            |   |  |         |  
|                                          |  | 134,849    |   |  | 130,010 |  
|                                          |  |            |   |  |         |  



(Note) Provision for doubtful debts as
at August 31, 2005 includes provision for mobile interconnection charges receivables of HK$19,499,000 (note 31)).



Changes in the provision for doubtful debts consist of:



|                                 |  |                       |   |  |         |   |  |         |  
|-------------------------------- |  | --------------------- | - |  | ------- | - |  | ------- | -
|                                 |  | Year ended August 31, |  
|                                 |  | 2003                  |   |  | 2004    |   |  | 2005    |  
|                                 |  | HK$000               |   |  | HK$000 |   |  | HK$000 |  
|Balance at beginning of the year |  | 17,139                |   |  | 22,916  |   |  | 22,959  |  
|Additions charged to expense     |  | 17,685                |   |  | 11,502  |   |  | 35,445  |  
|Write-off                        |  | (11,908               | ) |  | (11,459 | ) |  | (10,088 | )
|                                 |  |                       |   |  |         |   |  |         |  
|Balance at the end of the year   |  | 22,916                |   |  | 22,959  |   |  | 48,316  |  
|                                 |  |                       |   |  |         |   |  |         |  



(b) Other receivables, deposits
and prepayments



|                                                   |  |            |  |            
|-------------------------------------------------- |  | ---------- |  | -----------
|                                                   |  | August 31,
|                                                   |  | 2004       |  | 2005       
|                                                   |  | HK$000    |  | HK$000    
|Deposits for purchase of fixed assets              |  | 7,090      |  | 20,275     
|Deposits for lease of land and building            |  | 2,995      |  | 5,081      
|Interest receivables                               |  |           |  | 1,266      
|Prepayments                                        |  | 17,943     |  | 20,929     
|Receivables from disposal of a subsidiary (Note 4) |  | 780        |  | 279        
|USC refund receivable Unbilled revenue             |  | 9,848     |  | 6,44816,193
|Others                                             |  | 5,373      |  | 8,287      
|                                                   |  |            |  |            
|                                                   |  | 44,029     |  | 78,758     
|                                                   |  |            |  |            



9 Goodwill



|                             |  |            |  |        
|---------------------------- |  | ---------- |  | -------
|                             |  | August 31,
|                             |  | 2004       |  | 2005   
|                             |  | HK$000    |  | HK$000
|Cost                         |  |            |  |        
|At the beginning of the year |  | 5,326      |  | 5,326  
|Accumulated amortization     |  |            |  |        
|At the beginning of the year |  | 2,130      |  | 3,195  
|Charge for the year          |  | 1,065      |  | 1,065  
|                             |  |            |  |        
|At the end of the year       |  | 3,195      |  | 4,260  
|                             |  |            |  |        
|Net book value               |  |            |  |        
|At the end of the year       |  | 2,131      |  | 1,066  
|                             |  |            |  |        



Goodwill was
recognized for the amount of the excess of the purchase price paid over the net book value (which approximates fair value) of the assets acquired, and is amortized on a straight-line basis over a five year period.



F-21



---

##### Table of Contents

10 Fixed assets, net



|                         |  |                            |  |                       |   |  |                                |   |  |                                                 |   |  |               |   |  |           |  
|------------------------ |  | -------------------------- |  | --------------------- | - |  | ------------------------------ | - |  | ----------------------------------------------- | - |  | ------------- | - |  | --------- | -
|                         |  | Leaseholdland andbuildings |  | Leaseholdimprovements |   |  | Furniture,fixturesand fittings |   |  | Telecommunicationscomputers andoffice equipment |   |  | Motorvehicles |   |  | Total     |  
|                         |  | HK$000                    |  | HK$000               |   |  | HK$000                        |   |  | HK$000                                         |   |  | HK$000       |   |  | HK$000   |  
|Cost                     |  |                            |  |                       |   |  |                                |   |  |                                                 |   |  |               |   |  |           |  
|At September 1, 2003     |  | 61,599                     |  | 56,191                |   |  | 10,920                         |   |  | 1,295,630                                       |   |  | 8,892         |   |  | 1,433,232 |  
|Exchange adjustments     |  |                           |  | (76                   | ) |  | (21                            | ) |  | 915                                             |   |  |              |   |  | 818       |  
|Additions                |  | 22,109                     |  | 15,344                |   |  | 2,339                          |   |  | 369,583                                         |   |  | 671           |   |  | 410,046   |  
|Disposals                |  |                           |  | (6,760                | ) |  |                               |   |  | (5,329                                          | ) |  | (1,790        | ) |  | (13,879   | )
|                         |  |                            |  |                       |   |  |                                |   |  |                                                 |   |  |               |   |  |           |  
|At August 31, 2004       |  | 83,708                     |  | 64,699                |   |  | 13,238                         |   |  | 1,660,799                                       |   |  | 7,773         |   |  | 1,830,217 |  
|                         |  |                            |  |                       |   |  |                                |   |  |                                                 |   |  |               |   |  |           |  
|At September 1, 2004     |  | 83,708                     |  | 64,699                |   |  | 13,238                         |   |  | 1,660,799                                       |   |  | 7,773         |   |  | 1,830,217 |  
|Exchange adjustments     |  |                           |  | 244                   |   |  | 133                            |   |  | 2,497                                           |   |  |              |   |  | 2,874     |  
|Additions                |  | 462                        |  | 3,701                 |   |  | 2,122                          |   |  | 411,550                                         |   |  | 1,291         |   |  | 419,126   |  
|Disposals                |  |                           |  | (26                   | ) |  | (1                             | ) |  | (2,875                                          | ) |  | (692          | ) |  | (3,594    | )
|Adjustment (note (a))    |  |                           |  |                      |   |  |                               |   |  | (4,825                                          | ) |  |              |   |  | (4,825    | )
|                         |  |                            |  |                       |   |  |                                |   |  |                                                 |   |  |               |   |  |           |  
|At August 31, 2005       |  | 84,170                     |  | 68,618                |   |  | 15,492                         |   |  | 2,067,146                                       |   |  | 8,372         |   |  | 2,243,798 |  
|                         |  |                            |  |                       |   |  |                                |   |  |                                                 |   |  |               |   |  |           |  
|                         |  |                            |  |                       |   | 
|Accumulated depreciation |  |                            |  |                       |   |  |                                |   |  |                                                 |   |  |               |   |  |           |  
|At September 1, 2003     |  | 3,494                      |  | 21,271                |   |  | 7,507                          |   |  | 449,018                                         |   |  | 5,990         |   |  | 487,280   |  
|Exchange adjustments     |  |                           |  | 22                    |   |  | 15                             |   |  | 840                                             |   |  |              |   |  | 877       |  
|Charge for the year      |  | 1,530                      |  | 7,067                 |   |  | 1,530                          |   |  | 184,389                                         |   |  | 1,436         |   |  | 195,952   |  
|Disposals                |  |                           |  | (6,757                | ) |  |                               |   |  | (4,220                                          | ) |  | (1,790        | ) |  | (12,767   | )
|                         |  |                            |  |                       |   |  |                                |   |  |                                                 |   |  |               |   |  |           |  
|At August 31, 2004       |  | 5,024                      |  | 21,603                |   |  | 9,052                          |   |  | 630,027                                         |   |  | 5,636         |   |  | 671,342   |  
|                         |  |                            |  |                       |   |  |                                |   |  |                                                 |   |  |               |   |  |           |  
|At September 1, 2004     |  | 5,024                      |  | 21,603                |   |  | 9,052                          |   |  | 630,027                                         |   |  | 5,636         |   |  | 671,342   |  
|Exchange adjustments     |  |                           |  | 188                   |   |  | 68                             |   |  | 1,768                                           |   |  |              |   |  | 2,024     |  
|Charge for the year      |  | 1,678                      |  | 8,445                 |   |  | 1,390                          |   |  | 224,444                                         |   |  | 1,346         |   |  | 237,303   |  
|Disposals                |  |                           |  | (11                   | ) |  | (1                             | ) |  | (2,260                                          | ) |  | (488          | ) |  | (2,760    | )
|Adjustment (note (a))    |  |                           |  |                      |   |  |                               |   |  | (654                                            | ) |  |              |   |  | (654      | )
|                         |  |                            |  |                       |   |  |                                |   |  |                                                 |   |  |               |   |  |           |  
|At August 31, 2005       |  | 6,702                      |  | 30,225                |   |  | 10,509                         |   |  | 853,325                                         |   |  | 6,494         |   |  | 907,255   |  
|                         |  |                            |  |                       |   |  |                                |   |  |                                                 |   |  |               |   |  |           |  
|Net book value           |  |                            |  |                       |   |  |                                |   |  |                                                 |   |  |               |   |  |           |  
|At August 31, 2004       |  | 78,684                     |  | 43,096                |   |  | 4,186                          |   |  | 1,030,772                                       |   |  | 2,137         |   |  | 1,158,875 |  
|                         |  |                            |  |                       |   |  |                                |   |  |                                                 |   |  |               |   |  |           |  
|At August 31, 2005       |  | 77,468                     |  | 38,393                |   |  | 4,983                          |   |  | 1,213,821                                       |   |  | 1,878         |   |  | 1,336,543 |  
|                         |  |                            |  |                       |   |  |                                |   |  |                                                 |   |  |               |   |  |           |  



| | (a) | The adjustment of the cost and the depreciation charge for the year ended August 31, 2005 amounting to HK$4,825,000 and HK$654,000 represented the finalization of the estimated
accrued cost of the submarine cable made in prior years.
| | --- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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



|                                 |  |            |  |        
|-------------------------------- |  | ---------- |  | -------
|                                 |  | August 31,
|                                 |  | 2004       |  | 2005   
|                                 |  | HK$000    |  | HK$000
|Leases of between 10 to 50 years |  | 78,684     |  | 77,468 
|                                 |  |            |  |        



| | (c) | 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,
|                         |  | 2004       |  | 2005   
|                         |  | HK$000    |  | HK$000
|Cost                     |  |           |  | 3,631  
|Accumulated depreciation |  |           |  | 380    
|                         |  |            |  |        
|                         |  |           |  | 3,251  
|                         |  |            |  |        



F-22



---

##### Table of Contents

11 Other payables and accrued charges



|                                                          |  |            |  |        
|--------------------------------------------------------- |  | ---------- |  | -------
|                                                          |  | August 31,
|                                                          |  | 2004       |  | 2005   
|                                                          |  | HK$000    |  | HK$000
|Accrual for staff salaries and bonus                      |  | 26,557     |  | 36,034 
|Accrual for premium costs                                 |  | 23,309     |  | 1,752  
|Accrual for vetting charges                               |  | 1,204      |  | 962    
|Accrual for porting charges                               |  | 5,378      |  | 9,429  
|Accrual for international call forwarding service charges |  | 2,501      |  | 3,622  
|Payable for purchase of fixed assets                      |  | 92,383     |  | 116,201
|Payable for advertising and promotional expenses          |  | 14,676     |  | 16,241 
|Payable for USC                                           |  | 905        |  | 428    
|Interest payable on 10-year senior notes                  |  |           |  | 7,109  
|Others                                                    |  | 21,692     |  | 31,430 
|                                                          |  |            |  |        
|                                                          |  | 188,605    |  | 223,208
|                                                          |  |            |  |        



12 Deferred taxation



Deferred taxation is calculated in full on temporary
differences under the liability method using the taxation rates prevailing in respective countries in which the Company operates. The movement of the deferred tax liabilities account is as follows:



|                                                                                                                           |  |            |   |  |         |  
|-------------------------------------------------------------------------------------------------------------------------- |  | ---------- | - |  | ------- | -
|                                                                                                                           |  | August 31, |  
|                                                                                                                           |  | 2004       |   |  | 2005    |  
|                                                                                                                           |  | HK$000    |   |  | HK$000 |  
|At September 1                                                                                                             |  | 20,274     |   |  | 18,662  |  
|Exchange differences                                                                                                       |  | (301       | ) |  | 1       |  
|Deferred taxation credited to statements of operations  relating to the origination and reversal of temporary
differences |  | (1,311     | ) |  | (8,124  | )
|                                                                                                                           |  |            |   |  |         |  
|At August 31                                                                                                               |  | 18,662     |   |  | 10,539  |  
|                                                                                                                           |  |            |   |  |         |  



Prior to 2003, the
Company recognized deferred taxation arising from timing differences attributable to accelerated depreciation at profits tax rate in force in the year in which the temporary differences arose. SSAP 12 (revised) requires the provision of deferred
taxation on temporary differences between the tax bases of assets and liabilities and their carrying amounts in the financial statements using the profits tax rate enacted, or substantially enacted, at the balance sheet date. On adoption of SSAP 12
(revised) retrospectively, opening retained profits at September 1, 2003 have been reduced by HK$5,274,000, which represents the unprovided net deferred tax liabilities as at that dates, as a result of the change in accounting policy. In
addition, the profit for the year ended August 31, 2003 has been reduced by HK$79,000.



As of August 31, 2005, the Company had accumulated tax losses amounting to HK$1,011,475,000 (2004: HK$735,059,000) 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$177,827,000 (2004: HK$129,222,000).



Deferred income tax assets are recognized for tax loss carry forwards to the extent that the related tax benefit through the utilization of tax losses
against the future taxable profits is probable. The Company has unrecognized tax losses of HK$165,861,000 at August 31, 2005 (2004: HK$40,573,000) to carry forward against future taxable income, these tax losses will expire in the following
periods:



|                  |  |            |  |        
|----------------- |  | ---------- |  | -------
|                  |  | August 31,
|                  |  | 2004       |  | 2005   
|                  |  | HK$000    |  | HK$000
|After 5 years     |  | 133        |  | 934    
|From 2 to 5 years |  | 2,597      |  | 2,862  
|No expiry date    |  | 37,843     |  | 162,065
|                  |  |            |  |        
|                  |  | 40,573     |  | 165,861
|                  |  |            |  |        



F-23



---

##### Table of Contents

The movement in deferred tax assets and liabilities (prior to offsetting of balances within the same
taxation jurisdiction) during the year is as follows:



|                                    |  |                                   |   |        |         |       |         |  |         |  |         |   |  |        
|----------------------------------- |  | --------------------------------- | - | ------ | ------- | ----- | ------- |  | ------- |  | ------- | - |  | -------
|                                    |  | Accelerateddepreciationallowances |   | Others |         | Total
|Deferred tax liabilities            |  | 2004                              |   |        | 2005    |       | 2004    |  | 2005    |  | 2004    |   |  | 2005   
|                                    |  | HK$000                           |   |        | HK$000 |       | HK$000 |  | HK$000 |  | HK$000 |   |  | HK$000
|At September 1                      |  | 110,925                           |   |        | 140,202 |       |        |  | 49      |  | 110,925 |   |  | 140,251
|Charged to statements of operations |  | 29,590                            |   |        | 18,267  |       | 49      |  | 35      |  | 29,639  |   |  | 18,302 
|Exchange differences                |  | (313                              | ) |        | 8       |       |        |  | 1       |  | (313    | ) |  | 9      
|                                    |  |                                   |   |        |         |       |         |  |         |  |         |   |  |        
|At August 31                        |  | 140,202                           |   |        | 158,477 |       | 49      |  | 85      |  | 140,251 |   |  | 158,562
|                                    |  |                                   |   |        |         |       |         |  |         |  |         |   |  |        



|                                     |  |            |   |  |          |  
|------------------------------------ |  | ---------- | - |  | -------- | -
|                                     |  | Tax Losses |  
|Deferred tax assets                  |  | 2004       |   |  | 2005     |  
|                                     |  | HK$000    |   |  | HK$000  |  
|At September 1                       |  | (90,651    | ) |  | (121,589 | )
|Credited to statements of operations |  | (30,950    | ) |  | (26,426  | )
|Exchange differences                 |  | 12         |   |  | (8       | )
|                                     |  |            |   |  |          |  
|Balance at August 31                 |  | (121,589   | ) |  | (148,023 | )
|                                     |  |            |   |  |          |  



Deferred income tax
assets and liabilities are offset when there is a legally enforceable right to set off current tax assets against current tax liabilities and when the deferred income taxes relate to the same fiscal authority. The following amounts, determined after
appropriate offsetting, are shown in the consolidated balance sheet:



|                         |  |            |   |  |        
|------------------------ |  | ---------- | - |  | -------
|                         |  | August 31,
|                         |  | 2004       |   |  | 2005   
|                         |  | HK$000    |   |  | HK$000
|Deferred tax assets      |  | (229       | ) |  |       
|Deferred tax liabilities |  | 18,891     |   |  | 10,539 
|                         |  |            |   |  |        
|                         |  | 18,662     |   |  | 10,539 
|                         |  |            |   |  |        



13 Deferred expenditure



|                                                |  |            |   |  |         |  
|----------------------------------------------- |  | ---------- | - |  | ------- | -
|                                                |  | August 31, |  
|                                                |  | 2004       |   |  | 2005    |  
|                                                |  | HK$000    |   |  | HK$000 |  
|Balance at September 1                          |  |           |   |  | 21,563  |  
|Additions during the year                       |  | 23,391     |   |  | 12,495  |  
|Less: Amortization charge for the year (Note 5) |  | (1,828     | ) |  | (12,927 | )
|                                                |  |            |   |  |         |  
|Balance at August 31                            |  | 21,563     |   |  | 21,131  |  
|                                                |  |            |   |  |         |  



Deferred expenditure
represents costs incurred in acquiring subscribers of the fixed line phone services, which is treated as customer acquisition costs and are amortized over the expected subscription period of the services.



F-24



---

##### Table of Contents

14 Long-term debt and other liabilities



The Companys long-term debt and other liabilities were repayable as follows:



|                                                        |  |            |   |  |         |  
|------------------------------------------------------- |  | ---------- | - |  | ------- | -
|                                                        |  | August 31, |  
|                                                        |  | 2004       |   |  | 2005    |  
|                                                        |  | HK$000    |   |  | HK$000 |  
|Long-term bank loan-secured                             |  |            |   |  |         |  
|Within one year                                         |  | 13,333     |   |  |        |  
|In the second year                                      |  | 20,000     |   |  |        |  
|In the third to fifth year                              |  | 60,000     |   |  |        |  
|After the fifth year                                    |  | 6,667      |   |  |        |  
|                                                        |  |            |   |  |         |  
|                                                        |  | 100,000    |   |  |        |  
|Less: Current portion of long-term bank loan  secured  |  | (13,333    | ) |  |        |  
|                                                        |  |            |   |  |         |  
|                                                        |  | 86,667     |   |  |        |  
|                                                        |  |            |   |  |         |  
|8.75% senior notes due 2015                             |  |            |   |  |         |  
|After the fifth year                                    |  |           |   |  | 945,348 |  
|                                                        |  |            |   |  |         |  
|Obligation under finance lease                          |  |            |   |  |         |  
|Within one year                                         |  |           |   |  | 1,194   |  
|In the second year                                      |  |           |   |  | 1,218   |  
|In the third year                                       |  |           |   |  | 723     |  
|                                                        |  |            |   |  |         |  
|                                                        |  |           |   |  | 3,135   |  
|Less: Current portion of obligation under finance lease |  |           |   |  | (1,194  | )
|                                                        |  |            |   |  |         |  
|                                                        |  |           |   |  | 1,941   |  
|                                                        |  |            |   |  |         |  
|                                                        |  | 86,667     |   |  | 947,289 |  
|                                                        |  |            |   |  |         |  



(a) On January 3, 2005, the
Company has repaid approximately HK$3.3 million of the outstanding long-term bank loan. On January 20, 2005, the Company completed a US$125 million notes offering of 8.75% senior notes due 2015 with net proceeds of approximately US$121 million
after deduction of expenses and commissions (note (b)). The Company used the net proceeds, in part, to repay in full the then outstanding loan facility in the amount of HK$196.7 million on January 24, 2005.



In connection with the above draw-down of the loan facility, the Company
entered into an interest rate swap agreement with a bank, under which, the Company makes a monthly interest payment at a fixed rate of 2.675% per annum on a notional amount of HK$100 million (which is reduced by the principal repayment schedule
during the loan period), as at the effective date of the interest rate swap agreement, and receives monthly interest payments calculated at Hong Kong Interbank borrowing rate (HIBOR) during the period from March 2004 to December 2009. The interest
rate swap agreement remains outstanding as at August 31, 2005.



(b) On
January 20, 2005, the Company issued unsecured 10-year senior fixed rates notes (the 10-year senior notes) with a principle amount of US$125 million at an issue price equal to 100 per cent of the principal amount. The 10-year
senior notes mature on February 1, 2015 and bear interest at the fixed rate of 8.75% per annum and such interest is payable semi-annually on February 1 and August 1 of each year, commencing August 1, 2005.



The 10-year senior notes are unconditionally and irrevocably guaranteed on a
joint and several basis by the Companys subsidiaries (other than CTI Guangzhou Customer Services Co. Limited) as subsidiary guarantors.



The 10-year senior notes were issued as an underwritten transaction and the net proceeds were approximately US$121 million after deduction of
expenses and commissions. The Company used the net proceeds, in part, to repay in full an existing loan facility in the outstanding amount of HK$196.7 million (note (a)), and intends to use the remaining net proceeds for capital expenditures,
including expanding and upgrading the Companys Metro Ethernet network in Hong Kong, and for additional working capital and general corporate purposes.



F-25



---

##### Table of Contents

15 Commitments and contingencies



(a) Capital commitments



|                                                                                               |  |            |  |        
|---------------------------------------------------------------------------------------------- |  | ---------- |  | -------
|                                                                                               |  | August 31,
|                                                                                               |  | 2004       |  | 2005   
|                                                                                               |  | HK$000    |  | HK$000
|Purchases of telecommunications, computer and office equipment contracted but not provided for |  | 213,310    |  | 178,793
|                                                                                               |  |            |  |        



(b) Commitments under operating
leases



(i) As of August 31, 2005, the Company
had future aggregate minimum lease income receivable under non-cancelable operating leases as follows:



|                                                                                             |  |            |  |        
|-------------------------------------------------------------------------------------------- |  | ---------- |  | -------
|                                                                                             |  | August 31,
|                                                                                             |  | 2004       |  | 2005   
|                                                                                             |  | HK$000    |  | HK$000
|Leases in respect of telecommunications facilities and computer equipment which are payable: |  |            |  |        
|within one year                                                                              |  |           |  | 934    
|in the second year                                                                           |  |           |  | 583    
|                                                                                             |  |            |  |        
|                                                                                             |  |           |  | 1,517  
|                                                                                             |  |            |  |        



(ii) As of
August 31, 2004 and 2005, the Company had future aggregate minimum lease payments under non-cancelable operating leases as follows:



|                                                                                             |  |            |  |        
|-------------------------------------------------------------------------------------------- |  | ---------- |  | -------
|                                                                                             |  | August 31,
|                                                                                             |  | 2004       |  | 2005   
|                                                                                             |  | HK$000    |  | HK$000
|Leases in respect of land and buildings which are payable:                                   |  |            |  |        
|within one year                                                                              |  | 10,419     |  | 17,759 
|in the second year                                                                           |  | 4,369      |  | 14,977 
|in the third year                                                                            |  | 2,688      |  | 7,348  
|in the forth year                                                                            |  | 446        |  | 298    
|in the fifth year                                                                            |  | 462        |  |       
|                                                                                             |  |            |  |        
|                                                                                             |  | 18,384     |  | 40,382 
|                                                                                             |  |            |  |        
|Leases in respect of telecommunications facilities and computer equipment which are payable: |  |            |  |        
|within one year                                                                              |  | 36,479     |  | 25,895 
|in the second year                                                                           |  | 5,697      |  | 4,727  
|in the third year                                                                            |  | 823        |  | 800    
|in the fourth year                                                                           |  | 800        |  | 800    
|in the fifth year                                                                            |  | 800        |  | 800    
|within sixth year to twelve years                                                            |  | 7,800      |  | 7,111  
|                                                                                             |  |            |  |        
|                                                                                             |  | 52,399     |  | 40,133 
|                                                                                             |  |            |  |        
|                                                                                             |  | 70,783     |  | 80,515 
|                                                                                             |  |            |  |        



F-26



---

##### Table of Contents

(c) Program fee commitments



The Company entered into agreements with program content providers for granting the program rights to deliver certain
program contents in the Companys IP-TV services. Minimum amounts of program fees are committed to be paid by the Company which are analyzed as follows:



|                                                            |  |            |  |        
|----------------------------------------------------------- |  | ---------- |  | -------
|                                                            |  | August 31,
|                                                            |  | 2004       |  | 2005   
|                                                            |  | HK$000    |  | HK$000
|Program fee in respect of program rights which are payable: |  |            |  |        
|within one year                                             |  | 15,542     |  | 13,055 
|in the second year                                          |  | 12,873     |  | 5,682  
|in the third year                                           |  | 5,996      |  | 577    
|                                                            |  |            |  |        
|                                                            |  | 34,411     |  | 19,314 
|                                                            |  |            |  |        



(d) Contingent liabilities



|                                                                        |  |            |  |        
|----------------------------------------------------------------------- |  | ---------- |  | -------
|                                                                        |  | August 31,
|                                                                        |  | 2004       |  | 2005   
|                                                                        |  | HK$000    |  | HK$000
|Bank guarantees provided to suppliers (Note 16(a)(i) and (ii))          |  | 6,295      |  | 6,200  
|Bank guarantee in lieu of payment of utility deposits (Note 16(a)(iii)) |  | 3,622      |  | 3,772  
|                                                                        |  |            |  |        
|                                                                        |  | 9,917      |  | 9,972  
|                                                                        |  |            |  |        



(e) Pending litigation



(i) In July 1998, Cable & Wireless HKT, a
Hong Kong company, commenced proceedings against the Company and served a statement of claim which alleged that the Company has breached the terms of a contract it had with Cable & Wireless HKT and committed an economic tort. The Company
denied these allegations in a comprehensive defense which included a counterclaim lodged against the plaintiffs seeking damages for anti-competitive practices conducted by Cable & Wireless HKT in Hong Kong. Neither the claim amount made by
Cable & Wireless HKT nor the counterclaim amount made by the Company has been quantified. The directors believe that the allegations against the Company are without merit and intend to defend the litigation vigorously. The case is currently
in its discovery phase and no provision against the claims has been made in the consolidated financial statements as the directors do not consider the liability to be probable.



(ii) In January 1999, Jade Com Development Limited (Jade Com) commenced proceedings against the Company and two
directors of the Company, alleging 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 whereby Jade
Com did not 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, accordingly, no provision has been made in
the consolidated financial statements with respect to the litigation.



(f) Business risk



The Company relies
on third parties to deliver a significant portion of its international telecommunications traffic and fixed telecommunications network services. Where the Company does not currently have its own infrastructure in place, it depends on contractual
relationships with, and the network infrastructure of, other local network operators and overseas telecommunications carriers in providing international telecommunications and fixed telecommunications network services to its customers.



16 Pledge of assets



(a) As at August 31, 2005, the Company had pledged bank deposits of US$9,900,000 (equivalent to HK$76,923,000), RMB4,705,000
(equivalent to HK$4,524,000) and HK$9,000,000 as security of the following significant banking facilities:



(i) bank facility of US$9,000,000 (equivalent to HK$69,930,000) granted by the bank for issuance of bank guarantees to third party suppliers, letters of
credit, short term loan, overdraft, foreign exchange and interest rate hedging arrangements (as of August 31, 2005, bank guarantee of HK$1,900,000 and letters of credit of HK$11,350,000 were issued against this bank facility);



F-27



---

##### Table of Contents

(ii) bank guarantees of HK$4,300,000 issued by the bank to third party suppliers of the Company and one
of its subsidiaries for payment of certain products and services procured by the Company from these third party suppliers;



(iii) bank guarantees of HK$3,772,000 issued by the bank to certain utility vendors of the Company in lieu of payment of utility deposits; and



(iv) outstanding forward foreign exchange contracts of RMB155,632,000.



As at August 31, 2004, the Company had pledged bank deposits of
US$800,000 (equivalent to HK$6,240,000) and HK$1,395,000, and a charge over an investment with market value of US$468,000 (equivalent to HK$3,650,000), as security for:



(i) bank guarantees of HK$6,295,000 issued by the banks to third party suppliers of the Company for payment of certain
products and services procured by the Company from these third party suppliers; and



(ii) bank guarantees of HK$3,622,000 issued by the bank to certain utility vendors in lieu of payment of utility deposits.



During the year ended August 31, 2005, the charge over an investment with market value of US$468,000 (equivalent to HK$3,650,000) has been released.



(b) On October 9, 2002, the Company entered into a HK$200,000,000 long-term loan
facility (the 2002 facility) with The Hongkong and Shanghai Banking Corporation Limited (HSBC) to provide funding for further development of the fixed telecommunications network of a wholly-owned subsidiary of the Company.
According to the agreement, all amounts under the 2002 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. As at August 31, 2004, the
amount drawn down and outstanding was HK$100,000,000. The Company drew down a further HK$40,000,000 in September 2004 and the remaining HK$60,000,000 in December 2004.



On July 27, 2004, the Company entered into an additional HK$200,000,000 long-term loan facility (the 2004
facility) with HSBC to provide funding for the same purpose. All amounts under the facility were required to be drawn by December 31, 2006. The principal balance drawn down is to be repaid in 60 equal monthly instalments beginning in
January 2007. The Company has not drawn any amount under the facility during the year ended August 31, 2005.



On January 3, 2005, approximately HK$3.3 million of the 2002 facility was repaid. On January 20, 2005, the Group completed a US$125 million
notes offering of 8.75% senior notes due 2015, with net proceeds of approximately US$121 million after deduction of expenses and commissions. The Group used the net proceeds, in part, to repay in full the outstanding bank loan in the amount of
HK$196.7 million on January 24, 2005.



Both the 2002 and
2004 facilities were cancelled upon the request of the Company in January 2005 and the fixed and floating charge over all assets of the Company for these facilities has been released accordingly.



(c) As at August 31, 2004, the short-term bank loan was secured by a bank deposit of
HK$19,170,000. The short-term bank loan was subsequently fully repaid on March 24, 2005, and the related pledged bank deposit was released accordingly.



F-28



---

##### Table of Contents

17 Other investments



|                                                |  |            |  |        
|----------------------------------------------- |  | ---------- |  | -------
|                                                |  | August 31,
|                                                |  | 2004       |  | 2005   
|                                                |  | HK$000    |  | HK$000
|Debt securities, at fair value                  |  |            |  |        
|Unlisted outside Hong Kong Secured (Note 16(a)) |  | 3,650      |  |       
|Unsecured                                       |  | 21,954     |  | 25,901 
|                                                |  |            |  |        
|                                                |  | 25,604     |  | 25,901 
|                                                |  |            |  |        



The Company maintains
an investment portfolio of HK$25,901,000 and HK$25,604,000 classified as debt securities as of August 31, 2005 and 2004, respectively. These investments represent primarily money market funds subject to price volatility.



Net realized investment gains and net changes in unrealized gains (losses) on
investments for the years ended August 31, 2005, 2004 and 2003 are summarized as follows:

|                                                                                     |  |            |  |         |   |  |         |  
|------------------------------------------------------------------------------------ |  | ---------- |  | ------- | - |  | ------- | -
|                                                                                     |  | August 31, | 
|                                                                                     |  | 2003       |  | 2004    |   |  | 2005    |  
|                                                                                     |  | HK$000    |  | HK$000 |   |  | HK$000 |  
|Net realized investment gains                                                        |  |           |  |        |   |  |        |  
|Net changes in unrealized gains (losses) on investment                               |  |           |  | (1,696  | ) |  | 300     |  
|Exchange                                                                             |  |            |  | 30      |   |  | (3      | )
|Net realized investment gains and changes in unrealized gains (losses) on investment |  |           |  | (1,696  | ) |  | 300     |  



Following is a summary
of the disposition and purchases of investment securities for the year ended August 31, 2005, 2004 and 2003:



|                       |  |         |       |                |        |                 |  |        
|---------------------- |  | ------- | ----- | -------------- | ------ | --------------- |  | -------
|                       |  | Amount  |       | Gross realized |        | Netrealizedgain
|                       |  |         | Gains |                | Losses |                
|                       |  | HK$000 |       | HK$000        |        | HK$000         |  | HK$000
|Sales:                 |  |         |       |                |        |                 |  |        
|2005 - debt securities |  |        |       |               |        |                |  |       
|2004 - debt securities |  |        |       |               |        |                |  |       
|2003 - debt securities |  |        |       |               |        |                |  |       
|Purchases:             |  |         |       |                |        |                 |  |        
|2005 - debt securities |  |        |       |               |        |                |  |       
|2004 - debt securities |  | 3,900   |       |               |        |                |  |       
|2003 - debt securities |  | 23,370  |       |               |        |                |  |       



18 Long term bank deposit



The balance is a ten-year US$2,000,000 (2004:
US$2,000,000) (equivalent to HK$15,540,000) deposit placed with a bank in which the Company receives a floating rate deposit interest. The deposit has a 10-year term maturing on August 22, 2013. An interest rate of 10% per annum has been
guaranteed for the first year from the inception date on August 22, 2003. The deposit will be terminated once the cumulative interest reaches the predetermined accrued interest cap at 13% of the principal amount or an aggregate sum of
US$260,000 (equivalent to HK$2,020,000).



19 Share capital



|                                       |  |                                            |  |        
|-------------------------------------- |  | ------------------------------------------ |  | -------
|                                       |  | Authorized Ordinary shares of HK$0.10 each
|                                       |  | No. of shares                              |  | HK$000
|At August 31, 2004 and August 31, 2005 |  | 2,000,000,000                              |  | 200,000
|                                       |  |                                            |  |        



|                                     |  |                                                         |  |                 |  |               |  |        
|------------------------------------ |  | ------------------------------------------------------- |  | --------------- |  | ------------- |  | -------
|                                     |  | Issued and fully paid (Ordinary shares of HK$0.10 each)
|                                     |  | August 31, 2004                                         |  | August 31, 2005
|                                     |  | No. of shares                                           |  | HK$000         |  | No. of shares |  | HK$000
|At the beginning of the year         |  | 604,959,787                                             |  | 60,496          |  | 610,573,361   |  | 61,057 
|Exercise of share options (note (a)) |  | 640,000                                                 |  | 64              |  | 52,000        |  | 5      
|Exercise of warrants (note (b))      |  | 4,973,574                                               |  | 497             |  | 3,500,043     |  | 350    
|                                     |  |                                                         |  |                 |  |               |  |        
|At the end of the year               |  | 610,573,361                                             |  | 61,057          |  | 614,125,404   |  | 61,412 
|                                     |  |                                                         |  |                 |  |               |  |        



(a) During the year ended
August 31, 2005, 52,000 ordinary shares (2004: 600,000 ordinary shares and 40,000 ordinary shares) were issued at a price of HK$0.58 per ordinary share (2004: HK$0.26 per ordinary share and HK$0.58 per ordinary share, respectively), to share
option holders who had exercised their subscription rights. These issued shares rank pari passu with the then existing ordinary shares in issue.



(b) The Company effected a warrant issue at a price of HK$0.11 per warrant to certain qualifying shareholders (shareholders domiciled in Hong Kong) for cash during the
year ended August 31, 2002. One warrant was offered for every five existing ordinary shares held on the date of record. The warrants entitled the holders to subscribe for ordinary shares of the Company (on a one to one basis) at an exercised
price of HK$0.40 per share (subject to adjustment) at any time on or before November 1, 2004. If the warrants are fully exercised, the Company will receive cash, totalling HK$39,325,920, and issue 98,314,800 additional ordinary shares. During
the year, 3,500,043 (2004: 4,973,574) warrants were exercised for an equivalent number of ordinary shares at a price of HK$0.40 per share. The shares so issued rank pari passu with the then existing ordinary shares in issue. The remaining
outstanding warrants of 135,396 expired on November 1, 2004. There was 3,635,439 warrants outstanding as at August 31, 2004.



(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,
2004 and 2005 are set out in Note 25.



F-29



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##### Table of Contents

20 Cash and cash equivalents



|                               |  |            |   |  |        
|------------------------------ |  | ---------- | - |  | -------
|                               |  | August 31,
|                               |  | 2004       |   |  | 2005   
|                               |  | HK$000    |   |  | HK$000
|Cash and bank balances         |  | 107,517    |   |  | 100,903
|Bank deposits                  |  | 140,000    |   |  | 438,688
|Short-term bank loan  secured |  | (19,170    | ) |  |       
|                               |  |            |   |  |        
|                               |  | 228,347    |   |  | 539,591
|                               |  |            |   |  |        



21 Dividends



|                                                                                         |  |                       |  |         |  |        
|---------------------------------------------------------------------------------------- |  | --------------------- |  | ------- |  | -------
|                                                                                         |  | Year ended August 31,
|                                                                                         |  | 2003                  |  | 2004    |  | 2005   
|                                                                                         |  | HK$000               |  | HK$000 |  | HK$000
|Interim, declared and paid, of HK$Nil (2004: HK$0.015, 2003: HK$0.05) per ordinary share |  | 30,234                |  | 9,158   |  |       
|Final, dividend paid, of HK$Nil (2004: HK$Nil, 2003: HK$0.075) per ordinary share        |  |                      |  | 45,789  |  |       
|                                                                                         |  |                       |  |         |  |        
|                                                                                         |  | 30,234                |  | 54,947  |  |       
|                                                                                         |  |                       |  |         |  |        



22 Banking facilities



The Companys banking facilities as of each balance
sheet date, denominated in Hong Kong dollars and Japanese Yen, can be analysed as follows:



|                            |  |                  |  |                 |  |                             |  |         |  |                                       
|--------------------------- |  | ---------------- |  | --------------- |  | --------------------------- |  | ------- |  | --------------------------------------
|                            |  | Amount available |  | Amount utilized |  |                            
|                            |  | August 31,       |  | August 31,      |  | Terms as of August 31, 2005
|                            |  | 2004             |  | 2005            |  | 2004                        |  | 2005    |  | Interest rate                         
|                            |  | HK$000          |  | HK$000         |  | HK$000                     |  | HK$000 |  |                                       
|Bank overdrafts/ bank loans |  | 432,000          |  | 78,930          |  | 119,170                     |  | 13,250  |  | HIBOR or Cost ofFunds + 0.8% per annum
|                            |  |                  |  |                 |  |                             |  |         |  |                                       



As of August 31,
2005, the Company did not utilize any banking facilities which are interest bearing.



F-30



---

##### Table of Contents

The utilized banking facilities as of August 31, 2004 and 2005 were denominated in Hong Kong Dollar
and Japanese Yen. The currency denomination of the utilized banking facilities for the borrowings was as follows:



|                              |  |         |  |        
|----------------------------- |  | ------- |  | -------
|                              |  | 2004    |  | 2005   
|                              |  | HK$000 |  | HK$000
|Hong Kong Dollars  secured   |  | 100,000 |  |       
|Japanese Yen  secured        |  | 19,170  |  |       
|Hong Kong Dollars  unsecured |  |        |  | 13,250 
|                              |  |         |  |        
|Total                         |  | 119,170 |  | 13,250 
|                              |  |         |  |        



The weighted average
interest rate of short-term borrowings of the Company was 0.85% as of August 31, 2005.



The Company has entered into an interest rate swap arrangement for the HK$100,000,000 long-term loan with a bank. Under the arrangement, the Company will pay a fixed rate interest of 2.675% per annum on the
notional amount of HK$100,000,000 on a monthly basis commencing from March 2004 to December 2009 and receiving a floating interest at HIBOR rate. The purpose of this arrangement is to hedge the interest payments on the loan drawn down as describe in
Note 14 to a fixed rate of 4.175%.



23 Related party transactions



Significant related party transactions, which were
carried out in the normal course of the Companys business are as follows:



|                                  |  |                       |  |         |  |        
|--------------------------------- |  | --------------------- |  | ------- |  | -------
|                                  |  | Year ended August 31,
|                                  |  | 2003                  |  | 2004    |  | 2005   
|                                  |  | HK$000               |  | HK$000 |  | HK$000
|Disposal of a subsidiary (Note 4) |  | 1,950                 |  |        |  |       
|                                  |  |                       |  |         |  |        



24 Provident fund arrangements



The Company contributes to a defined contribution
retirement scheme, an Occupational Retirement Scheme (the ORSO Scheme), which is available to some of its employees. Under the ORSO Scheme, the employees are required to contribute 5% of their monthly salaries, while the Companys
contributions are calculated at 10% and 5% of the monthly salaries of senior management staff and all other staff, respectively. The employees are entitled to 100% of the employers contributions after 10 years of completed service, or at a
reduced scale after completion of 3 to 9 years of service. Contributions to the ORSO Scheme are reduced by contributions forfeited by those employees who leave the ORSO Scheme prior to vesting fully in the Companys contributions.



A mandatory provident fund scheme (the MPF Scheme) has been
established under the Hong Kong Mandatory Provident Fund Scheme Ordinance in December 2000, the then existing employees of the Company in Hong Kong could elect to join the MPF Scheme, while all new employees joining the Company in Hong Kong from
then onwards are required to join the MPF Scheme. Both the Company and the employees are required to contribute 5% of each individuals relevant income with a maximum amount of HK$1,000 per month as a mandatory contribution. Employers
mandatory contributions are 100% vested in the employees as soon as they are paid to the MPF Scheme. Employees may also elect to contribute more than the minimum as a voluntary contribution.



The retirement schemes for staff of the Company in other countries follow the
local statutory requirements of the respective countries.



F-31



---

##### Table of Contents

The aggregate employers contributions, net of forfeited contributions, which have been dealt with
in the consolidated statements of operations during the year are as follows:



|                                                                                             |  |                       |   |  |         |   |  |         |  
|-------------------------------------------------------------------------------------------- |  | --------------------- | - |  | ------- | - |  | ------- | -
|                                                                                             |  | Year Ended August 31, |  
|                                                                                             |  | 2003                  |   |  | 2004    |   |  | 2005    |  
|                                                                                             |  | HK$000               |   |  | HK$000 |   |  | HK$000 |  
|Gross contributions                                                                          |  | 16,340                |   |  | 26,922  |   |  | 27,789  |  
|Less: forfeited contributions utilized to offset the Companys contributions during the year |  | (497                  | ) |  | (635    | ) |  | (352    | )
|                                                                                             |  |                       |   |  |         |   |  |         |  
|Net contributions charged to the consolidated statements of operations                       |  | 15,843                |   |  | 26,287  |   |  | 27,437  |  
|                                                                                             |  |                       |   |  |         |   |  |         |  



At August 31,
2005, there is no forfeited contribution available to offset future contributions by the Company to the schemes (2004: HK$12,000; 2003: HK$Nil).



25 Share option scheme



On July 12, 1997, a share option scheme (the 1997 Share Option Scheme) was approved by the shareholders of the Company under which its
directors may, at their discretion, invite employees of the Company including any executive directors of the Company to take up options (the Share Options) to subscribe for shares in the Company subject to the terms and conditions
stipulated therein. Share options granted under the 1997 Share Option Scheme will lapse no later than July 11, 2007.



At an extraordinary general meeting held on December 23, 2002, a new share option scheme (the 2002 Share Option Scheme) was approved by
the shareholders of the Company and the 1997 Share Option Scheme was terminated on the same date. No further share option could be granted under the 1997 Share Option Scheme after the date of its termination, but all share options outstanding in
respect of the 1997 Share Option Scheme as of August 31, 2005 shall continue to be exercisable in accordance with the terms of the 1997 Share Option Scheme.



Under the 2002 Share Option Scheme, directors may grant options to employees (including executive, non-executive and
independent non-executive directors), suppliers and professional advisers (the New Share Options) to subscribe for Shares in the Company. The maximum number of options authorized under the 2002 Share Option Scheme may not, when
aggregated with any shares subject to any other executive and employee share option scheme, exceed 10% of the Companys issued share capital on the date of adoption. The exercise price of a New Share Option will be determined by the
Companys board of directors at a price not less than the highest of (a) the par value of a share; (b) the average closing price of the Companys shares for five trading days preceding the grant date; and (c) the closing
price of the Companys shares on the date of grant. The 2002 Share Option Scheme is valid and effective for a ten year period up to December 22, 2012 subject to earlier termination by the Company in general meeting or the board of
directors. The period during which a New Share Option may be exercised will be determined by the board of directors at its discretion, save that no option may be exercised after more than ten years from the date of grant. During the year ended
August 31, 2005, options were granted under the 2002 Share Option Scheme to an eligible participant for the subscription of 30,670,000 shares of the Company at an exercise price of HK$1.54 each.



Under Hong Kong GAAP, no compensation cost to staff is required to be
recognized in respect of the grant of share options. Proceeds from issue of shares upon the exercise of share options are credited to share capital and share premium account respectively and there is no effect on the results of the Company in
connection with any share option schemes. Details of compensation cost for share options which is required to be recognized under U.S. GAAP are disclosed in Note 30(a)(i).



Details of Share Options granted pursuant to the 1997 Share Option Scheme and 2002 Share Option Scheme, and outstanding at
August 31, 2002, 2003, 2004 and 2005, which will lapse not later than July 11, 2007 and December 22, 2012, respectively, are as follows:



F-32



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##### Table of Contents

|                                              |  |                           |   |  |                            |  |                          |   |  |                      |  |                          |  |                        
|--------------------------------------------- |  | ------------------------- | - |  | -------------------------- |  | ------------------------ | - |  | -------------------- |  | ------------------------ |  | -----------------------
|Date of grant                                 |  | September 3,1998 (Note a) |   |  | September 10,1999 (Note b) |  | October 20,2000 (Note c) |   |  | June 3, 2004(Note d) |  | October 21,2004 (Note e) |  | January 5,2005 (Note f)
|Exercise price per Share (HK$)                |  | 0.26                      |   |  | 2.10                       |  | 0.58                     |   |  | 1.47                 |  | 1.54                     |  | 1.54                   
|Market price per Share (HK$) at date of Grant |  | 0.26                      |   |  | 2.10                       |  | 0.58                     |   |  | 1.43                 |  | 1.49                     |  | 1.48                   
|                                              |  |                           |   |  |                            |  |                          |   |  |                      |  |                          |  |                        
|Outstanding at August 31, 2001                |  | 3,010,000                 |   |  | 60,000                     |  | 22,386,000               |   |  |                     |  |                         |  |                       
|Exercised                                     |  | (2,120,000                | ) |  |                           |  | (940,000                 | ) |  |                     |  |                         |  |                       
|Cancelled                                     |  |                          |   |  |                           |  | (16,000                  | ) |  |                     |  |                         |  |                       
|Lapsed upon resignation of employees          |  |                          |   |  |                           |  | (20,000                  | ) |  |                     |  |                         |  |                       
|                                              |  |                           |   |  |                            |  |                          |   |  |                      |  |                          |  |                        
|Outstanding at August 31, 2002                |  | 890,000                   |   |  | 60,000                     |  | 21,410,000               |   |  |                     |  |                         |  |                       
|Exercised                                     |  | (100,000                  | ) |  |                           |  | (21,020,000              | ) |  |                     |  |                         |  |                       
|                                              |  |                           |   |  |                            |  |                          |   |  |                      |  |                          |  |                        
|Outstanding at August 31, 2003                |  | 790,000                   |   |  | 60,000                     |  | 390,000                  |   |  |                     |  |                         |  |                       
|Granted                                       |  |                          |   |  |                           |  |                         |   |  | 6,000,000            |  |                         |  |                       
|Exercised                                     |  | (600,000                  | ) |  |                           |  | (40,000                  | ) |  |                     |  |                         |  |                       
|                                              |  |                           |   |  |                            |  |                          |   |  |                      |  |                          |  |                        
|Outstanding at August 31, 2004                |  | 190,000                   |   |  | 60,000                     |  | 350,000                  |   |  | 6,000,000            |  |                         |  |                       
|Granted                                       |  |                          |   |  |                           |  |                         |   |  |                     |  | 14,670,000               |  | 16,000,000             
|Exercised                                     |  |                          |   |  |                           |  | (52,000                  | ) |  |                     |  |                         |  |                       
|                                              |  |                           |   |  |                            |  |                          |   |  |                      |  |                          |  |                        
|Outstanding at August 31, 2005                |  | 190,000                   |   |  | 60,000                     |  | 298,000                  |   |  | 6,000,000            |  | 14,670,000               |  | 16,000,000             
|                                              |  |                           |   |  |                            |  |                          |   |  |                      |  |                          |  |                        

---

| | (a) | On September 3, 1998, employees including executive directors were granted options to subscribe for 12,270,000 shares at a price of HK$0.26 per share. These share options are
immediately exercisable.
| | --- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (b) | On September 10, 1999, employees were granted options to subscribe for 674,000 shares at a price of HK$2.10 per share. These share options are immediately exercisable.
| | --- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (c) | On October 20, 2000, employees including executive directors were granted options to subscribe for 22,408,000 shares at a price of HK$0.58 per share. These share options are
immediately exercisable.
| | --- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (d) | On June 3, 2004, an employee was granted options to subscribe for 6,000,000 shares at a price of HK$1.47 per share. The vesting period for those shares is May 1, 2005 to
May 1, 2006.
| | --- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (e) | On October 21, 2004, employees including executive directors were granted options to subscribe for 14,670,000 shares at a price of HK$1.54 per share. The vesting period for
those shares is October 21, 2004 to December 31, 2005.
| | --- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (f) | On January 5, 2005 executive directors were granted options to subscribe for 16,000,000 shares at a price of HK$1.54 per share. The vesting period for those shares is
January 5, 2005 to December 31, 2006.
| | --- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (g) | The Share Options outstanding in respect of the 1997 Share Option Scheme and 2002 Share Options Scheme as of August 31, 2002, 2003 2004 and 2005 is summarized as follows:
| | --- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|                                                     |  |                                  |   |  |                               |  |                                                
|---------------------------------------------------- |  | -------------------------------- | - |  | ----------------------------- |  | -----------------------------------------------
|                                                     |  | Number ofShareOptionsOutstanding |   |  | Averageexerciseprice perShare |  | Weightedaverage marketprice at thedate of grant
|                                                     |  | (Thousands)                      |   |  | HK$000                       |  | HK$000                                        
|Balance at August 31, 2001                           |  | 25,456                           |   |  | 0.55                          |  | 0.55                                           
|Exercised during the year                            |  | (3,060                           | ) |  | 0.36                          |  | 0.36                                           
|Cancelled during the year                            |  | (16                              | ) |  | 0.58                          |  | 0.58                                           
|Lapsed upon resignation of employees during the year |  | (20                              | ) |  | 0.58                          |  | 0.58                                           
|                                                     |  |                                  |   |  |                               |  |                                                
|Balance at August 31, 2002                           |  | 22,360                           |   |  | 0.57                          |  | 0.57                                           
|Exercised during the year                            |  | (21,120                          | ) |  | 0.58                          |  | 0.58                                           
|                                                     |  |                                  |   |  |                               |  |                                                
|Balance at August 31, 2003                           |  | 1,240                            |   |  | 0.45                          |  | 0.45                                           
|Granted during the year                              |  | 6,000                            |   |  | 1.47                          |  | 1.43                                           
|Exercised during the year                            |  | (640                             | ) |  | 0.28                          |  | 0.28                                           
|                                                     |  |                                  |   |  |                               |  |                                                
|Balance at August 31, 2004                           |  | 6,600                            |   |  | 1.39                          |  | 1.36                                           
|Granted during the year                              |  | 30,670                           |   |  | 1.54                          |  | 1.48                                           
|Exercised during the year                            |  | (52                              | ) |  | 0.58                          |  | 0.58                                           
|                                                     |  |                                  |   |  |                               |  |                                                
|Balance at August 31, 2005                           |  | 37,218                           |   |  | 1.51                          |  | 1.46                                           
|                                                     |  |                                  |   |  |                               |  |                                                



F-33



---

##### Table of Contents

(h) The following table summarizes the information about share options outstanding at August 31, 2005:



|                   |  |                                 |  |                                     |  |               |  |                                    
|------------------ |  | ------------------------------- |  | ----------------------------------- |  | ------------- |  | -----------------------------------
|Date of grant      |  | Exercise priceat August 31,2005 |  | Numberoutstanding atAugust 31, 2005 |  | Remaininglife |  | Exercisableshares atAugust 31, 2005
|                   |  |                                 |  | (Thousands)                         |  | (Years)       |  | (Thousands)                        
|September 3, 1998  |  | 0.26                            |  | 190                                 |  | 2.0           |  | 190                                
|September 10, 1999 |  | 2.10                            |  | 60                                  |  | 2.0           |  | 60                                 
|October 20, 2000   |  | 0.58                            |  | 298                                 |  | 2.0           |  | 298                                
|June 3, 2004       |  | 1.47                            |  | 6,000                               |  | 9.0           |  | 5,000                              
|October 21, 2004   |  | 1.54                            |  | 14,670                              |  | 10.0          |  | 7,400                              
|January 5, 2005    |  | 1.54                            |  | 16,000                              |  | 10.0          |  | 8,000                              
|                   |  |                                 |  |                                     |  |               |  |                                    
|                   |  |                                 |  | 37,218                              |  |               |  | 20,948                             
|                   |  |                                 |  |                                     |  |               |  |                                    



The share options
granted on 3 September 1998, 10 September 1999 and 20 October 2000 were made under a share option scheme approved by the shareholders of the Company on 12 July 1997 (the 1997 Share Option Scheme) and are immediately
exercisable.



The share options granted on 3 June 2004,
21 October 2004 and 5 January 2005 were made under the 2002 Share Option Scheme and they have a vesting period of approximately two years from the respective dates of grant.



During the year ended 31 August 2005, options were granted under the 2002 Share Option Scheme to eligible participants
for the subscription of 30,670,000 shares of the Company at an exercise price of HK$1.54 each.



Each option entitles the holder to subscribe for one ordinary share of HK$0.10 each in the Company at a predetermined exercise price.



26 Turnover, revenues and segmental information



The Companys reportable segments are strategic business units that offer different type of telecommunication services.
Each of these business units are operated and managed under the direction of management.



Revenue recognized during the year is as follows:



|                                          |  |                       |  |           |  |          
|----------------------------------------- |  | --------------------- |  | --------- |  | ---------
|                                          |  | Year ended August 31,
|                                          |  | 2003                  |  | 2004      |  | 2005     
|                                          |  | HK$000               |  | HK$000   |  | HK$000  
|Turnover                                  |  |                       |  |           |  |          
|International telecommunications services |  | 875,802               |  | 627,978   |  | 532,595  
|Fixed telecommunications network services |  | 423,107               |  | 541,902   |  | 629,464  
|                                          |  |                       |  |           |  |          
|                                          |  | 1,298,909             |  | 1,169,880 |  | 1,162,059
|Other revenues                            |  |                       |  |           |  |          
|Interest income                           |  | 3,163                 |  | 3,753     |  | 13,578   
|Other income                              |  | 4,373                 |  | 2,668     |  | 6,037    
|                                          |  |                       |  |           |  |          
|                                          |  | 7,536                 |  | 6,421     |  | 19,615   
|Total revenues                            |  | 1,306,445             |  | 1,176,301 |  | 1,181,674
|                                          |  |                       |  |           |  |          



F-34



---

##### Table of Contents

(a) Primary reporting format  business segments



The Company is organized on a worldwide basis into two business segments:



| |  | International telecommunications  provision of international long distance calls services.
| | - | -------------------------------------------------------------------------------------------



| |  | Fixed telecommunications network  provision of dial up and broadband Internet access services, local voice-over-IP services and IP-TV services.
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------



The Companys inter-segment transactions mainly consist of provision of
leased lines services. The Company believes that the terms were similar to those available from third parties.



Segment results are income / (loss) from operations excluding interest expense, interest income and gains and losses from the disposal of subsidiaries,
but includes other income, net. All segment measures are based on accounting policies that are consistent with those used in the preparation of the consolidated financial statements.



|                                 |  |                                         |  |                                         |   |  |             |   |  |           |  
|-------------------------------- |  | --------------------------------------- |  | --------------------------------------- | - |  | ----------- | - |  | --------- | -
|                                 |  | Year ended August 31, 2003              | 
|                                 |  | Internationaltelecommunicationsservices |  | Fixedtelecommunicationsnetwork services |   |  | Elimination |   |  | Company   |  
|                                 |  | HK$000                                 |  | HK$000                                 |   |  | HK$000     |   |  | HK$000   |  
|Turnover                         |  |                                         |  |                                         |   |  |             |   |  |           |  
|External sales                   |  | 875,802                                 |  | 423,107                                 |   |  |            |   |  | 1,298,909 |  
|Inter-segment sales              |  | 15,302                                  |  | 26,449                                  |   |  | (41,751     | ) |  |          |  
|                                 |  |                                         |  |                                         |   |  |             |   |  |           |  
|                                 |  | 891,104                                 |  | 449,556                                 |   |  | (41,751     | ) |  | 1,298,909 |  
|                                 |  |                                         |  |                                         |   |  |             |   |  |           |  
|Segment results                  |  | 339,028                                 |  | (63,295                                 | ) |  |             |   |  | 275,733   |  
|                                 |  |                                         |  |                                         |   |  |             |   |  |           |  
|Loss on disposal of a subsidiary |  |                                         |  |                                         |   |  |             |   |  | (2,695    | )
|Interest income                  |  | 2,560                                   |  | 603                                     |   |  |            |   |  | 3,163     |  
|Interest expense                 |  |                                         |  |                                         |   |  |             |   |  | (601      | )
|                                 |  |                                         |  |                                         |   |  |             |   |  |           |  
|Income before taxation           |  |                                         |  |                                         |   |  |             |   |  | 275,600   |  
|                                 |  |                                         |  |                                         |   |  |             |   |  |           |  
|Segment assets                   |  | 674,066                                 |  | 874,468                                 |   |  |            |   |  | 1,548,534 |  
|                                 |  |                                         |  |                                         |   |  |             |   |  |           |  
|Segment liabilities              |  | 157,524                                 |  | 150,492                                 |   |  |            |   |  | 308,016   |  
|Unallocated liabilities          |  |                                         |  |                                         |   |  |            |   |  | 61,343    |  
|                                 |  |                                         |  |                                         |   |  |             |   |  |           |  
|Total liabilities                |  |                                         |  |                                         |   |  |             |   |  | 369,359   |  
|                                 |  |                                         |  |                                         |   |  |             |   |  |           |  
|Capital expenditure              |  | 20,749                                  |  | 229,460                                 |   |  |            |   |  | 250,209   |  
|Depreciation                     |  | 36,043                                  |  | 138,912                                 |   |  |            |   |  | 174,955   |  
|Goodwill amortization charge     |  |                                        |  | 1,065                                   |   |  |            |   |  | 1,065     |  



|                             |  |                                         |  |                                         |   |  |             |   |  |           |  
|---------------------------- |  | --------------------------------------- |  | --------------------------------------- | - |  | ----------- | - |  | --------- | -
|                             |  | Year ended August 31, 2004              | 
|                             |  | Internationaltelecommunicationsservices |  | Fixedtelecommunicationsnetwork services |   |  | Elimination |   |  | Company   |  
|                             |  | HK$000                                 |  | HK$000                                 |   |  | HK$000     |   |  | HK$000   |  
|Turnover                     |  |                                         |  |                                         |   |  |             |   |  |           |  
|External sales               |  | 627,978                                 |  | 541,902                                 |   |  |            |   |  | 1,169,880 |  
|Inter-segment sales          |  | 5,682                                   |  | 30,183                                  |   |  | (35,865     | ) |  |          |  
|                             |  |                                         |  |                                         |   |  |             |   |  |           |  
|                             |  | 633,660                                 |  | 572,085                                 |   |  | (35,865     | ) |  | 1,169,880 |  
|                             |  |                                         |  |                                         |   |  |             |   |  |           |  
|Segment results              |  | 157,829                                 |  | (109,814                                | ) |  |             |   |  | 48,015    |  
|                             |  |                                         |  |                                         |   |  |             |   |  |           |  
|Interest income              |  | 3,634                                   |  | 119                                     |   |  |            |   |  | 3,753     |  
|                             |  |                                         |  |                                         |   |  |             |   |  |           |  
|Interest expense             |  |                                         |  |                                         |   |  |             |   |  | (175      | )
|                             |  |                                         |  |                                         |   |  |             |   |  |           |  
|Income before taxation       |  |                                         |  |                                         |   |  |             |   |  | 51,593    |  
|                             |  |                                         |  |                                         |   |  |             |   |  |           |  
|Segment assets               |  | 532,161                                 |  | 1,151,018                               |   |  |            |   |  | 1,683,179 |  
|Unallocated assets           |  |                                         |  |                                         |   |  |             |   |  | 229       |  
|                             |  |                                         |  |                                         |   |  |             |   |  |           |  
|Total assets                 |  |                                         |  |                                         |   |  |             |   |  | 1,683,408 |  
|                             |  |                                         |  |                                         |   |  |             |   |  |           |  
|Segment liabilities          |  | 128,304                                 |  | 340,172                                 |   |  |            |   |  | 468,476   |  
|Unallocated liabilities      |  |                                         |  |                                         |   |  |             |   |  | 39,234    |  
|                             |  |                                         |  |                                         |   |  |             |   |  |           |  
|Total liabilities            |  |                                         |  |                                         |   |  |             |   |  | 507,710   |  
|                             |  |                                         |  |                                         |   |  |             |   |  |           |  
|Capital expenditure          |  | 17,164                                  |  | 392,882                                 |   |  |            |   |  | 410,046   |  
|Depreciation                 |  | 29,023                                  |  | 166,929                                 |   |  |            |   |  | 195,952   |  
|Goodwill amortization charge |  |                                        |  | 1,065                                   |   |  |            |   |  | 1,065     |  



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##### Table of Contents

|                             |  |                                         |  |                                         |   |  |             |   |  |           |  
|---------------------------- |  | --------------------------------------- |  | --------------------------------------- | - |  | ----------- | - |  | --------- | -
|                             |  | Year ended August 31, 2005              | 
|                             |  | Internationaltelecommunicationsservices |  | Fixedtelecommunicationsnetwork services |   |  | Elimination |   |  | Company   |  
|                             |  | HK$000                                 |  | HK$000                                 |   |  | HK$000     |   |  | HK$000   |  
|Turnover                     |  |                                         |  |                                         |   |  |             |   |  |           |  
|External sales               |  | 532,595                                 |  | 629,464                                 |   |  |            |   |  | 1,162,059 |  
|Inter-segment sales          |  | 4,108                                   |  | 33,188                                  |   |  | (37,296     | ) |  |          |  
|                             |  |                                         |  |                                         |   |  |             |   |  |           |  
|                             |  | 536,703                                 |  | 662,652                                 |   |  | (37,296     | ) |  | 1,162,059 |  
|                             |  |                                         |  |                                         |   |  |             |   |  |           |  
|Segment results              |  | 92,119                                  |  | (214,491                                | ) |  |             |   |  | (122,372  | )
|                             |  |                                         |  |                                         |   |  |             |   |  |           |  
|Interest income              |  | 13,240                                  |  | 338                                     |   |  |            |   |  | 13,578    |  
|Interest expense             |  |                                         |  |                                         |   |  |             |   |  | (54,462   | )
|                             |  |                                         |  |                                         |   |  |             |   |  |           |  
|Loss before taxation         |  |                                         |  |                                         |   |  |             |   |  | (163,256  | )
|                             |  |                                         |  |                                         |   |  |             |   |  |           |  
|Segment assets               |  | 942,304                                 |  | 1,404,589                               |   |  |            |   |  | 2,346,893 |  
|Unallocated assets           |  |                                         |  |                                         |   |  |             |   |  | 535       |  
|                             |  |                                         |  |                                         |   |  |             |   |  |           |  
|Total assets                 |  |                                         |  |                                         |   |  |             |   |  | 2,347,428 |  
|                             |  |                                         |  |                                         |   |  |             |   |  |           |  
|Segment liabilities          |  | 130,011                                 |  | 721,748                                 |   |  |            |   |  | 851,759   |  
|Unallocated liabilities      |  |                                         |  |                                         |   |  |             |   |  | 475,215   |  
|                             |  |                                         |  |                                         |   |  |             |   |  |           |  
|Total liabilities            |  |                                         |  |                                         |   |  |             |   |  | 1,326,974 |  
|                             |  |                                         |  |                                         |   |  |             |   |  |           |  
|Capital expenditure          |  | 11,582                                  |  | 407,544                                 |   |  |            |   |  | 419,126   |  
|Depreciation                 |  | 24,928                                  |  | 211,721                                 |   |  |            |   |  | 236,649   |  
|Goodwill amortization charge |  |                                        |  | 1,065                                   |   |  |            |   |  | 1,065     |  



(b) Geographical
segments



Although the Companys two business segments are
managed on a worldwide basis, they operate in two main geographical areas:



| |  | Hong Kong  international telecommunications and fixed telecommunications network services.
| | - | -------------------------------------------------------------------------------------------



| |  | Canada  international telecommunications and fixed telecommunications network services.
| | - | ----------------------------------------------------------------------------------------



In presenting information on the basis of geographical segments, turnover and segment results are based on the geographical
location of customers. Total assets and capital expenditure are based on the geographical location of the assets.



There were no sales between the geographical segments.



|                                 |  |              |  |                    |   |  |                  |  |                        |  |                     
|-------------------------------- |  | ------------ |  | ------------------ | - |  | ---------------- |  | ---------------------- |  | --------------------
|                                 |  | Turnover2003 |  | Segmentresults2003 |   |  | Total assets2003 |  | Capitalexpenditure2003 |  | Fixedassets,net 2003
|                                 |  | HK$000      |  | HK$000            |   |  | HK$000          |  | HK$000                |  | HK$000             
|Hong Kong                        |  | 1,263,160    |  | 275,126            |   |  | 1,539,212        |  | 250,093                |  | 940,403             
|Canada                           |  | 27,959       |  | 3,501              |   |  | 9,322            |  | 116                    |  | 5,549               
|Japan                            |  | 7,790        |  | 269                |   |  |                  |  |                        |  |                     
|                                 |  |              |  |                    |   |  |                  |  |                        |  |                     
|                                 |  | 1,298,909    |  | 278,896            |   |  | 1,548,534        |  | 250,209                |  | 945,952             
|                                 |  |              |  |                    |   |  |                  |  |                        |  |                     
|Loss on disposal of a subsidiary |  |              |  | (2,695             | ) |  |                  |  |                        |  |                     
|                                 |  |              |  |                    |   |  |                  |  |                        |  |                     
|Operating profit                 |  |              |  | 276,201            |   |  |                  |  |                        |  |                     
|                                 |  |              |  |                    |   |  |                  |  |                        |  |                     



|                   |  |              |  |                    |   |  |                  |  |                        |  |                     
|------------------ |  | ------------ |  | ------------------ | - |  | ---------------- |  | ---------------------- |  | --------------------
|                   |  | Turnover2004 |  | Segmentresults2004 |   |  | Total assets2004 |  | Capitalexpenditure2004 |  | Fixedassets, net2004
|                   |  | HK$000      |  | HK$000            |   |  | HK$000          |  | HK$000                |  | HK$000             
|Hong Kong          |  | 1,145,102    |  | 53,375             |   |  | 1,675,546        |  | 409,866                |  | 1,154,036           
|Canada             |  | 24,778       |  | (1,607             | ) |  | 7,633            |  | 180                    |  | 4,839               
|                   |  |              |  |                    |   |  |                  |  |                        |  |                     
|                   |  | 1,169,880    |  | 51,768             |   |  | 1,683,179        |  | 410,046                |  | 1,158,875           
|                   |  |              |  |                    |   |  |                  |  |                        |  |                     
|Unallocated assets |  |              |  |                    |   |  | 229              |  |                        |  |                     
|                   |  |              |  |                    |   |  |                  |  |                        |  |                     
|                   |  |              |  |                    |   |  | 1,683,408        |  |                        |  |                     
|                   |  |              |  |                    |   |  |                  |  |                        |  |                     



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##### Table of Contents

|                   |  |              |  |                    |   |  |                  |  |                        |  |                     
|------------------ |  | ------------ |  | ------------------ | - |  | ---------------- |  | ---------------------- |  | --------------------
|                   |  | Turnover2005 |  | Segmentresults2005 |   |  | Total assets2005 |  | Capitalexpenditure2005 |  | Fixedassets, net2005
|                   |  | HK$000      |  | HK$000            |   |  | HK$000          |  | HK$000                |  | HK$000             
|Hong Kong          |  | 1,138,821    |  | (105,989           | ) |  | 2,337,793        |  | 418,981                |  | 1,332,172           
|Canada             |  | 23,238       |  | (2,805             | ) |  | 9,100            |  | 145                    |  | 4,371               
|                   |  |              |  |                    |   |  |                  |  |                        |  |                     
|                   |  | 1,162,059    |  | (108,794           | ) |  | 2,346,893        |  | 419,126                |  | 1,336,543           
|                   |  |              |  |                    |   |  |                  |  |                        |  |                     
|Unallocated assets |  |              |  |                    |   |  | 535              |  |                        |  |                     
|                   |  |              |  |                    |   |  |                  |  |                        |  |                     
|                   |  |              |  |                    |   |  | 2,347,428        |  |                        |  |                     
|                   |  |              |  |                    |   |  |                  |  |                        |  |                     



(c) During the year ended
August 31, 2003, the Companys operation in Japan was discontinued following the disposal of its subsidiary operating in Japan (Note 4). The contribution to turnover and the operating results in respect of the discontinued Japanese segment
are disclosed in (b) above and are included in the international telecommunications services reporting segment.



(d) Included in segment results are mobile interconnection charges for which the company has not received payment as of year end. Revenue recognised for the year ended 31
August 2003, 2004 and 2005 was HK$6,090,000, HK$38,676,000 and HK$24,703,000, respectively.



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27 Financial instruments



(a) Fair value



The Companys financial instruments primarily comprise cash and cash equivalents, short-term loans, bank overdrafts, loan from a minority
shareholder/former minority shareholder and other investments and long term debt.



The fair values of the cash and cash equivalents, short-term loans and bank overdrafts as of August 31, 2004 and 2005 approximate their carrying values because of the short maturity of instruments.



The fair value of other investments as of August 31, 2004 and 2005 based
on the market prices approximates the carrying value.



The fair
value of the long term debt and long term bank deposit as of August 31, 2004 and 2005 approximate their carrying values.



All other financial instruments included among current assets and liabilities are stated at cost which approximates their fair values.



(b) Concentration of credit risk



Financial instruments which potentially subject the Company to concentration
of credit risk consist principally of cash and cash equivalents, trade receivables and deposits, prepayments and other receivables.



Cash and cash equivalents  substantially all the Companys cash and bank balances are placed with a number of international banks in Hong Kong
to which the Company believes its exposure to risk is limited.



Trade receivables  these mainly represent service fee receivables from the Companys customers in Hong Kong and Canada.



Deposits, prepayments and other receivables  these are spread among numerous third parties.



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28 Off balance sheet items



|(a) | Barter transaction
|--- | ------------------



During the year ended August 31, 2004, HKBN entered into two sets of agreements with a third party (the Contract Party 1). Pursuant to
one agreement (First Agreement), the Contract Party 1 agreed to sell to HKBN a set of un-activated telecommunications facility (the Facility) at a cash consideration of approximately HK$42.4 million (the Facility
Considerations). The full amount of the Facility Considerations was paid by HKBN during the year ended August 31, 2004. In conjunction with the First Agreement, HKBN also entered into an operations and maintenance agreement with the
Contract Party 1 for the provision of ongoing operations and maintenance services for the Facility at a fee of approximately HK$1 million per annum, commencing September 1, 2007 onward.



Another agreement (Second Agreement) was entered into on the same
date by both contract parties whereby HKBN undertakes to provide certain telecommunication services to the Contract Party 1 (the Services) with fees computed based on unit service charges specified in the Second Agreement. The Contract
Party 1 is required to pay to HKBN a guarantee minimum service fee of approximately HK$42.4 million over a period of three years, commencing September 1, 2004. A prepayment of the service charges of HK$36.5 million (the Prepaid
Charges) was paid by the Contract Party 1 to HKBN during the year ended August 31, 2004.



The Directors of the Company made an assessment of the fair values of the items under exchange and have drawn a conclusion that no fair values could be
assigned to them. Accordingly, the Facility was not recognized as an asset and no revenue or deferred revenue was recognized in the consolidated financial statements of the Company as at and for the year ended August 31, 2004 and 2005. The
difference between the amounts paid for the Facility Considerations and the Prepaid Charges received, amounting to approximately HK$5.9 million, was recorded as a long-term receivable balance in the balance sheet as at August 31, 2004 and 2005.
The balance will be paid by the Contract Party 1 prior to the end of the service period on September 1, 2007.



During the year ended August 31, 2005, HKBN entered into two agreements with a third party (the Contract Party 2). Pursuant to the
agreements,



(i) HKBN and the Contract Party 2 agreed to make
available certain telecommunications services (the Services Component) to each other on a barter basis at no consideration for a period of ten years, commencing January 1, 2005.

(ii) HKBN agreed to provide network capacity to the Contract Party 2 for a service term of fifteen years from the respective activation of the relevant
network capacity, and, in exchange, the Contract Party 2 agreed to provide HKBN the right to use telecommunications facilities for a term of fifteen years from the respective activation of the relevant facilities (the Capacity
Component). The transaction was entered into on a barter basis with no consideration being exchanged.



The directors of the Company made an assessment and determined that since the Services Component (for (i) above) and Capacity Component (for
(ii) above) involves exchange of services are of a similar nature and value, the exchange is not regarded as a transaction which generates revenue. Accordingly, both components were not recognized as an asset or an expense and no revenue or
deferred revenue was recognized in the consolidated financial statements of the Company as at and for the year ended August 31, 2005.



|(b) | Financial Instruments
|--- | ---------------------



The Company manages its exposure to financial risks using a variety of techniques and instruments.



(i) Interest rate swap



As at August 31, 2005, the Company had an outstanding interest rate swap contract with notional principle amount of
HK$86,666,667 (2004: HK$100,000,000). Under this arrangement, the Company will pay a fixed rate interest of 2.675% per annum on the notional amount on a monthly basis, and receiving a floating interest rate at HIBOR rate.



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##### Table of Contents

The purpose of the arrangement was to hedge the interest payments on the long-term bank loan which bears
a floating interest rate as described in note 14. The said loan was fully repaid by January 24, 2005 but the interest rate swap contract remains valid. The maturity date of the contract will be on December 1, 2009.



(ii) Forward foreign exchange contracts



As at August 31, 2005, the Company had outstanding forward foreign
exchange contracts of RMB155,632,000 and US$13,421,000 (2004: Nil) that mature at various dates over the following one year. The purpose of the arrangement is to manage the Companys exposure to foreign currencies fluctuations.



Under Hong Kong GAAP, there are specific accounting standards governing the
accounting for non-speculative forward contract which is used as a hedge, however, under U.S. GAAP, it requires all financial instruments and derivatives be recognized on the balance sheet at fair value and the accounting for changes in fair value
depends on whether the derivative instrument is designated and qualifies as a hedging relationship. For purposes of the reconciliation of the Companys financial statements to U.S. GAAP, the interest rate swap and forward foreign exchange
contracts have been accounted for at fair value on the balance sheet, the details of which are set out in Note 30(a)(v).



29 New effective standards/recent accounting pronouncements



(i) Hong Kong GAAP



The HKICPA has issued a number of new and revised Hong Kong Financial Reporting Standards and Hong Kong Accounting Standards (HKAS)
(collectively, new HKFRSs) which are effective for accounting periods beginning on or after January 1, 2005. The Company has not early adopted these new HKFRSs in the financial statements for the year ended August 31, 2005. The
Company has made a preliminary assessment of the impact of these new HKFRSs and has concluded that the adoption of HKFRS 2 Share-based Payment, HKFRS 3 Business Combinations and HKAS 39 Financial Instruments:
Recognition and Measurement will have an impact on the Companys financial statements as described below:



(i) HKFRS 2 Share-based Payment



With effect from September 1, 2005, HKFRS 2 requires that the Company recognizes the fair value of share options granted to employees as an expense
in the consolidated statements of operations, or as an asset, if the cost qualifies for recognition as an asset under the Companys accounting policies. A corresponding increase is recognized in a capital reserve within equity. HKFRS 2 requires
that the fair value of the share options is measured at the date of grant. Where the employees are required to meet vesting conditions before they become entitled to the options, the fair value of the options granted should be recognized over the
vesting period.



Under the transitional provisions of HKFRS 2,
the Company can choose not to apply this treatment to share-based payments which were granted on or before November 7, 2002 or which were granted after November 7, 2002 but already vested before September 1, 2005.



Had this revised accounting standard been adopted for the year ended
August 31, 2005, the other operating expenses and the capital reserve of the Company would increase due to the recognition of share-based compensation expense. Management has assessed and considered the impact of the adoption of this new policy
on the Companys profit/(loss) attributable to shareholders and net assets not significant.



(ii) HKFRS 3 Business Combination



With effect from September 1, 2005, HKFRS 3 requires goodwill to be recorded at cost less any accumulated impairment losses. Positive goodwill under HKFRS 3 is no longer amortized but requires annual test for
impairment, including in the year of its initial recognition, as well as when there are indications of impairment. Impairment losses are recognized when the carrying amount of the cash generating unit to which the goodwill has been allocated exceeds
its recoverable amounts.



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##### Table of Contents

In accordance with HKFRS 3, if the fair value of the net assets acquired in a business combination
exceeds the consideration paid (i.e. an amount arises which would have been known as negative goodwill), the excess is recognized immediately in the consolidated statements of operations as it arises.



In accordance with the transitional arrangements under HKFRS 3, goodwill
which had previously been taken directly to reserves (i.e. goodwill which arose before 1 January 2001) will not be recognized in the consolidated statements of operations on disposal or impairment of the acquired business, or under any other
circumstances.



This new policy is to be applied prospectively
from September 1, 2005 in accordance with the transitional arrangements under HKFRS 3. This will result in a change to the Companys current accounting policies from September 1, 2005 onwards on the amortization of goodwill. The new
policy in respect of negative goodwill would have no impact on the consolidated financial statements of the Company.



Had this revised accounting standard been adopted for the year ended August 31, 2005, the other operating expenses would decrease and the goodwill
balance would increase because of the cessation of the amortization of the goodwill balance.



Management has assessed and considered the impact on of the adoption of this new policy on the Companys consolidated profit/(loss) attributable to shareholders and consolidated net assets not significant.



(iii) HKAS 39 Financial Instruments:
Recognition and Measurement



With effect from
September 1, 2005, HKAS 39 requires the following:



All
non-trading investments are classified as available-for-sale securities and carried at fair value. Changes in fair value are recognized in equity, unless there is objective evidence that an individual investment has been impaired. If there is
objective evidence that an individual investment has been impaired, any amount held in fair value reserve in respect of the investment is transferred to the statements of operations for the period in which the impairment is identified. Any
subsequent increase in the fair value of available-for-sale securities is recognized directly in equity.



Based on managements evaluation, the adoption of this new policy would not be significant on the financial statements of the Company.



All derivative financial instruments entered into by the Company are stated
at fair value. The accounting for changes in fair value depends on whether the derivative instrument qualifies as a hedge. Gains and losses on a derivative instrument designated and qualifying as a fair value hedge as well as the offsetting loss or
gain on the hedged item attributable to the hedged risk shall be recognized currently in the statements of operations. The effective portion of the gain or loss on a derivative instrument designated and qualifying as a cash flow hedge shall be
reported in equity and reclassified into earnings in the same period or periods during which the hedged forecasted transaction impact earnings. Any ineffective portion of the changes in fair value of the derivatives is recognized in the statements
of operations.



Management expects that the adoption of this
new policy would result in an increase or decrease in the net asset or the other revenues of the Company depending on the change in fair value of the financial instruments. Had this new policy been adopted in the year ended August 31, 2005, the
other revenues and the net asset of the Company would increase due to the recognition of the gain in increase in fair value of the interest rate swap and foreign forward exchange contracts.



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Convertible notes issued are split into their liability and equity components at initial recognition by
recognizing the liability component at its fair value and attributing to the equity component the difference between the proceeds from the issue and the fair value of the liability component. The liability component is subsequently carried at
amortized cost. The equity component is recognized in the capital reserve until the note is either converted (in which case it is transferred to share premium) or the note is redeemed (in which case it is released directly to retained profits). This
new policy in respect of convertible notes would have no impact on the financial statements because the Company did not issue any convertible notes as defined under HKAS 32 Financial instruments: Disclosure and Presentation.



The Company is continuing its assessment of the impact of other new HKFRSs
and other significant changes may be identified as a result.



(ii) U.S.
GAAP



The United States Financial Accounting Standards
Board (FASB) has issued certain pronouncements which are effective or will be effective with respect to the fiscal years presented in the consolidated financial statements: 



In December 2004, the FASB issued SFAS No. 123 (revised 2004)
(SFAS No. 123(R)) Share-Based Payment. SFAS No. 123(R) replaces SFAS No. 123 Accounting for Stock-Based Compensation and supersedes APB Opinion No. 25 Accounting for Stock Issued to
Employees and its related implementation guidance. SFAS No. 123(R) requires the company to measure the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award and
recognize in the financial statements. That cost will be recognized over the period during which an employee is required to provide service in exchange for the award. No compensation cost is recognized for equity instruments for which employees do
not render the requisite service. For public entities that do not file as small business issuers, SFAS No. 123(R) is effective for all awards granted after June 15, 2005, and to awards modified, repurchased, or cancelled after that date.
For the Company, SFAS No. 123(R) is effective for the accounting period from September 1, 2005. The Company is currently assessing the impact of this statement on its consolidated financial statements and has not yet completed that
assessment.



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##### Table of Contents

30 Summary of differences between Hong Kong GAAP and U.S. GAAP



The Companys financial statements are prepared in accordance with
generally accepted accounting principles applicable in Hong Kong (HK GAAP), which differ in certain significant respects from accounting principles generally accepted in the United States (U.S. GAAP). Differences between HK
GAAP and U.S. GAAP which have significant effects on the consolidated net (loss)/income, total shareholders equity and statement of cash flows of the Company are set out below.



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##### Table of Contents

(a) Net (loss)/income and total shareholders equity



|                                                                                    |  |      |    |  |                       |   |  |         |  |            |  
|----------------------------------------------------------------------------------- |  | ---- | -- |  | --------------------- | - |  | ------- |  | ---------- | -
|                                                                                    |  |      |    |  | Year ended August 31, |  
|                                                                                    |  | Note |    |  | 2003                  |   |  | 2004    |  | 2005       |  
|                                                                                    |  |      |    |  | HK$000               |   |  | HK$000 |  | HK$000    |  
|Net (loss)/income As stated under Hong Kong GAAP                                    |  |      |    |  | 257,743               |   |  | 49,550  |  | (156,531   | )
|U.S. GAAP adjustments:                                                             |  |      |    |  |                       |   |  |         |  |            |  
|Compensation benefit cost associated with share options                             |  | (i   | )  |  | 2,731                 |   |  | 270     |  | 389        |  
|Reversal of amortization of goodwill (acquired after June 30, 2001)                 |  | (ii  | )  |  | 1,065                 |   |  | 1,065   |  | 1,065      |  
|Fair value of interest rate swap Fair value of foreign forward exchange contracts   |  | (v(v | )) |  |                     |   |  | 680    |  | 1,8904,039 |  
|Tax effects of U.S. GAAP adjustments                                                |  |      |    |  |                      |   |  |        |  |           |  
|                                                                                    |  |      |    |  |                       |   |  |         |  |            |  
|Net (loss)/income under U.S. GAAP                                                   |  |      |    |  | 261,539               |   |  | 51,565  |  | (149,148   | )
|                                                                                    |  |      |    |  |                       |   |  |         |  |            |  
|(Loss)/profit from continuing operations add/(less) taxation:                       |  |      |    |  |                       |   |  |         |  |            |  
|2005: HK$6,725,000, 2004: HK$(2,043,000) and 2003: HK$(17,857,000):                 |  |      |    |  | 264,151               |   |  | 51,565  |  | (149,148   | )
|Profit from discontinued operations (less taxation 2005: Nil, 2004: Nil, 2003: Nil) |  | (iv  | )  |  | 83                    |   |  |        |  |           |  
|Loss arising from disposal of discontinued operations                               |  | (iv  | )  |  | (2,695                | ) |  |        |  |           |  
|                                                                                    |  |      |    |  |                       |   |  |         |  |            |  
|Net (loss)/income under U.S. GAAP                                                   |  |      |    |  | 261,539               |   |  | 51,565  |  | (149,148   | )
|                                                                                    |  |      |    |  |                       |   |  |         |  |            |  



|                                          |  |      |   |  |                       |  |           |  |             
|----------------------------------------- |  | ---- | - |  | --------------------- |  | --------- |  | ------------
|                                          |  |      |   |  | Year ended August 31,
|                                          |  | Note |   |  | 2003                  |  | 2004      |  | 2005        
|                                          |  |      |   |  | HK$                   |  | HK$       |  | HK$         
|(Loss)/earnings per share under U.S. GAAP |  |      |   |  |                       |  |           |  |             
|Basic:                                    |  |      |   |  |                       |  |           |  |             
|Continuing operations                     |  |      |   |  | 47.8 cents            |  | 8.5 cents |  | (24.3) cents
|Discontinued operations                   |  |      |   |  | (0.5) cents           |  |          |  |            
|                                          |  |      |   |  |                       |  |           |  |             
|Total                                     |  | (iii | ) |  | 47.3 cents            |  | 8.5 cents |  | (24.3) cents
|                                          |  |      |   |  |                       |  |           |  |             
|Diluted:                                  |  |      |   |  |                       |  |           |  |             
|Continuing operations                     |  |      |   |  | 42.9 cents            |  | 8.4 cents |  | (24.3) cents
|Discontinued operations                   |  | (iv  | ) |  | (0.4) cents           |  |          |  |            
|                                          |  |      |   |  |                       |  |           |  |             
|Total                                     |  | (iii | ) |  | 42.5 cents            |  | 8.4 cents |  | (24.3) cents
|                                          |  |      |   |  |                       |  |           |  |             



For the year ended August 31,
2005, the number of shares used in the calculation of diluted loss per share is equal to the number of shares for basic loss per share as the incremental effect of share options would be anti-dilutive in a loss-making year.



|                                                          |  |      |   |  |            |   |  |           |   |  |           |  
|--------------------------------------------------------- |  | ---- | - |  | ---------- | - |  | --------- | - |  | --------- | -
|                                                          |  |      |   |  | August 31, |  
|                                                          |  | Note |   |  | 2003       |   |  | 2004      |   |  | 2005      |  
|                                                          |  |      |   |  | HK$000    |   |  | HK$000   |   |  | HK$000   |  
|Total shareholders equity As stated under Hong Kong GAAP |  |      |   |  | 1,179,175  |   |  | 1,175,698 |   |  | 1,020,454 |  
|U.S. GAAP adjustments:                                    |  |      |   |  |            |   |  |           |   |  |           |  
|Goodwill                                                  |  | (ii  | ) |  | 5,092      |   |  | 5,092     |   |  | 5,092     |  
|Accumulated amortization of goodwill                      |  | (ii  | ) |  | (3,735     | ) |  | (3,735    | ) |  | (3,735    | )
|Reversal of amortization of goodwill                      |  | (ii  | ) |  | 2,130      |   |  | 3,195     |   |  | 4,260     |  
|Fair value of interest rate swap                          |  | (v   | ) |  |           |   |  | 680       |   |  | 2,570     |  
|Fair value of forward foreign exchange contracts          |  |      |   |  |           |   |  |          |   |  | 4,039     |  
|Tax effects of U.S. GAAP adjustments                      |  |      |   |  |           |   |  |          |   |  |          |  
|                                                          |  |      |   |  |            |   |  |           |   |  |           |  
|Total shareholders equity under U.S. GAAP                |  |      |   |  | 1,182,662  |   |  | 1,180,930 |   |  | 1,032,680 |  
|                                                          |  |      |   |  |            |   |  |           |   |  |           |  



(i) Compensation cost for share
options



Accounting Principles Board Opinion No. 25,
Accounting for Stock Issued to Employees (APB 25) and related interpretations have been applied in the computation of the compensation cost for share options granted to the Companys employees.



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##### Table of Contents

Under HK GAAP, no staff compensation cost for 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 at the time of exercise of the options and there is no effect on the results of the Company in
connection with any share option schemes.



On
September 19, 1997, the Company issued 1,500,000 options to certain executive directors of the Company at an exercise price fixed at HK$1.20. 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 operations 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, the 1,500,000 options have been accounted for as variable
options since that date in accordance with Financial Accounting Standards Board (FASB) Interpretation No. 44, Accounting for Certain Transactions Involving Stock Compensation, an interpretation of APB25. Compensation
expense is recognized based on the difference between the exercise price of HK$0.58 and the Companys share price at the date on which they are exercised or at each balance sheet date if they are still outstanding.



Pursuant to a board resolution passed on October 20, 2000, 20,908,000
out of 21,030,000 options granted to certain employees including three executive directors on June 2, 2000 at an exercise price of HK$1.50 were cancelled. On the same date, 20,908,000 new options were issued to the same employees including
three executive directors at an exercise price fixed at HK$0.58. Because of this repricing arrangement, these options have been accounted for as variable options and compensation expense is recognized based on the difference between the exercise
price of each balance sheet date if they are still outstanding and the Companys Share price at the date on which they are exercised. Such compensation expense is being amortized to the statements of operations over the vesting period of the
options. All options were fully vested as of August 31, 2003, 2004 and 2005. A charge was recorded in the years ended August 31, 2003, 2004 and 2005 in calculating the final cost amount associated with options that were exercised during
the year.



During the year ended August 31, 2004, the
Company issued 6,000,000 options to an employee at an exercise price fixed at HK$1.47 on June 3, 2004. The difference of HK$0.04 per Share between the exercise price of HK$1.47 and the market value of the Shares on June 3, 2004 of HK$1.43
was being amortized to the statements of operations over the vesting period from May 1, 2005 to May 1, 2006.



Although the Company accounts for share options using the intrinsic value method in APB 25, pro forma information regarding net income and earnings per
share is required by SFAS No. 123 Accounting for Stock-Based Compensation, and has been determined as if the Company had accounted for its employee share options under the fair value method outlined in SFAS 123. The weighted average
fair value of options granted during the years ended August 31, 2000 and 2001 were HK$3.84 and HK$0.51, respectively. No options were granted in fiscal 2002 and 2003 and therefore no assumptions were required as new calculations were not
performed in fiscal 2002 and 2003. During the year ended August 31, 2004, 6,000,000 share options were granted and its fair value was HK$0.7. During the year ended August 31, 2005, 30,670,000 share options were granted and the weighted
average fair value of the share options were HK$0.82. The fair value for these options was estimated at the date of grant using the Black-Scholes Option Valuation model with the following weighted-average assumptions for the relevant years:



|                                                                       |  |                       |   |  |         |   |  |         |  
|---------------------------------------------------------------------- |  | --------------------- | - |  | ------- | - |  | ------- | -
|                                                                       |  | Year ended August 31, |  
|Weighted average                                                       |  | 2001                  |   |  | 2004    |   |  | 2005    |  
|Risk-free interest rates                                               |  | 6.6                   | % |  | 3.78    | % |  | 2.7     | %
|Dividend yield                                                         |  | 0                     | % |  | 1.02    | % |  | 1.01    | %
|Volatility factor of the expected market price of the Companys shares |  | 102.0                 | % |  | 59.04   | % |  | 70.66   | %
|Expected life of the options                                           |  | 5.4 years             |   |  | 5 years |   |  | 5 years |  



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##### Table of Contents

For the purpose of pro forma disclosure, the estimated fair value of the options is amortized to expense
over the options vesting period. The Companys pro forma information for the years ended August 31, 2003, 2004 and 2005 is set out as follows:



|                                                                                                                    |  |                       |   |  |             |   |  |                |  
|------------------------------------------------------------------------------------------------------------------- |  | --------------------- | - |  | ----------- | - |  | -------------- | -
|                                                                                                                    |  | Year ended August 31, |  
|                                                                                                                    |  | 2003                  |   |  | 2004        |   |  | 2005           |  
|                                                                                                                    |  | HK$000               |   |  | HK$000     |   |  | HK$000        |  
|Net (loss)/income                                                                                                   |  |                       |   |  |             |   |  |                |  
|As reported                                                                                                         |  | 261,539               |   |  | 51,565      |   |  | (149,148       | )
|Less: total stock-based employee compensation expense determined under intrinsic value method for all awards        |  | (2,731                | ) |  | (270        | ) |  | (389           | )
|Less: total stock-based employee compensation expense determined under fair value method for all awards, net of tax |  |                      |   |  | (1,904      | ) |  | (20,547        | )
|                                                                                                                    |  |                       |   |  |             |   |  |                |  
|                                                                                                                    |  | 258,808               |   |  | 49,391      |   |  | (170,084       | )
|                                                                                                                    |  |                       |   |  |             |   |  |                |  
|Basic (loss)/earnings per share                                                                                     |  |                       |   |  |             |   |  |                |  
|As reported                                                                                                         |  | HK47.3 cents          |   |  | HK8.5 cents |   |  | HK(24.3) cents |  
|Pro forma                                                                                                           |  | HK46.8 cents          |   |  | HK8.1 cents |   |  | HK(27.7) cents |  
|Diluted (loss)/earnings per share As reported                                                                       |  | HK42.5 cents          |   |  | HK8.4 cents |   |  | HK(24.3) cents |  
|Pro forma                                                                                                           |  | HK42.1 cents          |   |  | HK8.0 cents |   |  | HK(27.7) cents |  



(ii) Goodwill



Prior to September 1, 2001, under HK GAAP the Company charged goodwill
on acquisition of a business, which represents the excess of the cost of investment over the fair value ascribed to the identifiable net underlying assets acquired, against available reserves. In accordance with the change in accounting standards of
Hong Kong GAAP, goodwill on acquisitions occurring on or after September 1, 2001 is shown separately on the consolidated balance sheet and is amortized using the straight-line method over its estimated useful life (see Note 2(b) of the notes to
the consolidated financial statements). Goodwill 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 HKICPA 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
operations.



Under U.S. GAAP, goodwill recognized on the
acquisition of a business prior to June 30, 2001 was amortized to the consolidated statements of operations over its estimated useful life, but not to exceed 40 years. In June 2001, the FASB issued SFAS 142 Goodwill and Other Intangible
Assets effective for fiscal years beginning after December 15, 2001. In connection with the adoption of this standard in fiscal 2003 under U.S. GAAP, the Company ceased amortizing goodwill recognized on business combinations initiated
prior to June 30, 2001 and performed a transitional goodwill impairment assessment. Goodwill recognized on business combinations initiated after June 30, 2001, is not amortized under SFAS No. 142 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. No impairment loss was identified from the process for year ended August 31, 2005.



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##### Table of Contents

(iii) (Loss)/earnings per share



|                                                                                       |  |                       |  |             |  |                |  
|-------------------------------------------------------------------------------------- |  | --------------------- |  | ----------- |  | -------------- | -
|                                                                                       |  | Year ended August 31, | 
|                                                                                       |  | 2003                  |  | 2004        |  | 2005           |  
|                                                                                       |  | HK$000               |  | HK$000     |  | HK$000        |  
|Net (loss)/income under U.S. GAAP                                                      |  | 261,539               |  | 51,565      |  | (149,148       | )
|Basic weighted average common shares issued and outstanding (in 000s)                 |  | 552,600               |  | 610,095     |  | 613,525        |  
|Incremental shares from assumed exercise of share options (in 000s)                   |  | 7,112                 |  | 604         |  |               |  
|Incremental shares from assumed exercise of warrants (in 000s)                        |  | 55,390                |  | 3,666       |  |               |  
|                                                                                       |  |                       |  |             |  |                |  
|Diluted weighted average common and potential shares issued and outstanding (in 000s) |  | 615,102               |  | 614,365     |  | 613,525        |  
|                                                                                       |  |                       |  |             |  |                |  
|(Loss)/earnings per share under U.S. GAAPBasic                                         |  | HK47.3 cents          |  | HK8.5 cents |  | HK(24.3) cents |  
|                                                                                       |  |                       |  |             |  |                |  
|Diluted                                                                                |  | HK42.5 cents          |  | HK8.4 cents |  | HK(24.3) cents |  
|                                                                                       |  |                       |  |             |  |                |  



Basic (loss)/earnings
per share is calculated based on the weighted average number of ordinary shares issued and outstanding. Diluted (loss)/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, 2003, and 2004, 60,000 options to purchase shares of the Company, were outstanding but have not been
included in the calculation of diluted earnings per share as the effect of exercise would have been anti-dilutive.



At August 31, 2005, the number of shares used in the calculation of diluted loss per share is equal to the basic weighted average common shares
issued and outstanding as the incremental effect of outstanding share options would be anti-dilutive in a loss making year.



(iv) Discontinued operations



The discontinued operations of the Company for year ended August 31, 2003 included the operating profit of approximately HK$83,000 of the subsidiary
operating in Japan. Under HK GAAP, presentation of continuing and discontinued operations is not required to be disclosed on the face of the consolidated statements of operations, while under U.S. GAAP, profit or loss from discontinued operations
would be shown on a separate line in the consolidated statements of operations below income from continuing operations.



(v) Derivative Instruments



Derivative instruments, which include interest rate swap arrangement and forward foreign exchange contracts, are entered into for the purpose of managing
interest rates fluctuations and foreign currency exposures. In connection with the drawdown of the long-term bank loan of HK$100 million in fiscal year 2004, the Company entered into an interest rate swap agreement to hedge the impact of
fluctuations in interest rates. As disclosed in Note 14, the interest rate swap agreement remained outstanding after the full repayment of the long-term bank loan during fiscal year 2005. The Company also enters into a number of forward foreign
exchange contracts to manage its foreign currency risk relating to the payment of services and goods for a subsidiary located in the PRC.



Under HK GAAP, where a non-speculative forward contract is used as a hedge of a net monetary asset or liability the gain or loss on the contract is
credited or charged to the statements of operations and the discount or premium is either amortized over the period of the contract or credited or charged to the statements of operations. Where a non-speculative forward contract is used as a hedge
of a firm commitment no gain or loss is recognized during the commitment period. At the end of that period any gain or loss will be added to, or deducted from, the amount of the relevant transaction. The discount or premium is either amortized over
the period of the contract or deferred with the gain or loss. Where a forward contract is speculative the gain or loss is credited or charged to the statements of operations. As a result, the Company does not recognise the interest rate swap or
forward foreign exchange contracts at fair value and does not account for the gains or losses relating to the fair value changes in these derivatives. Interest income or expenses arising from the interest rate swap contracts are netted of against
the related interest income or expenses applicable to the on-balance sheet items.



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Under U.S. GAAP, the Company accounted for its derivatives under SFAS No. 133 Accounting for
Derivative Instruments and Hedge Activities, as amended by SFAS No. 138 Accounting for Certain Derivative Instruments and Certain Hedging Activities, which requires all derivative instruments be recognized on the balance sheet
at fair value. The accounting for changes in fair value depends on whether the derivative instrument qualifies as a hedge. Gains or losses on a derivative instrument designated and qualifying as a fair value hedge as well as the offsetting loss or
gain on the hedged item attributable to the hedged risk shall be recognized currently in statements of operations. The effective portion of the gain or loss on a derivative instrument designated and qualifying as a cash flow hedge shall be reported
as a component of other comprehensive income and reclassified into earnings in the same period or periods during which the hedged forecasted transaction impacts earnings. The ineffective portion of gain or loss on the derivative instrument, if any,
shall be recognized currently in earnings. For derivative that does not qualify as a hedge, the gain or loss reflecting changes in fair value is recognized in earnings.



As of August 31, 2005, the Company did not have any derivatives that qualify as hedges.



(b) Statements of (loss)/ income under U.S. GAAP



Under Hong Kong GAAP, depreciation charges of network assets are included in
general and administrative expenses under other operating expenses.



Under U.S. GAAP, however, depreciation charges of networks assets which are directly related to the generation of revenue are included in network costs. As a result, under U.S. GAAP, the consolidated statements of operations, including the
U.S. GAAP adjustments as set out in note 30(a), would be reported as follows:



|                                                                    |  |                       |   |  |           |   |  |           |  
|------------------------------------------------------------------- |  | --------------------- | - |  | --------- | - |  | --------- | -
|                                                                    |  | Year ended August 31, |  
|                                                                    |  | 2003                  |   |  | 2004      |   |  | 2005      |  
|                                                                    |  | HK$000               |   |  | HK$000   |   |  | HK$000   |  
|Revenue from provision of telecommunication and other services, net |  | 1,291,119             |   |  | 1,169,880 |   |  | 1,162,059 |  
|Network costs                                                       |  | (469,238              | ) |  | (499,519  | ) |  | (550,029  | )
|                                                                    |  |                       |   |  |           |   |  |           |  
|Operating expenses:                                                 |  |                       |   |  |           |   |  |           |  
|Salaries and related costs                                          |  | (215,541              | ) |  | (226,380  | ) |  | (252,598  | )
|Sales and marketing expenses                                        |  | (182,471              | ) |  | (228,169  | ) |  | (267,423  | )
|General and administrative expenses                                 |  | (130,965              | ) |  | (157,628  | ) |  | (183,519  | )
|Provision for doubtful accounts receivable                          |  | (17,685               | ) |  | (11,502   | ) |  | (35,445   | )
|                                                                    |  |                       |   |  |           |   |  |           |  
|(Loss)/income from operations                                       |  | 275,219               |   |  | 46,682    |   |  | (126,955  | )
|Bank interest income                                                |  | 3,163                 |   |  | 3,753     |   |  | 13,578    |  
|Interest expense                                                    |  | (415                  | ) |  | (175      | ) |  | (54,462   | )
|Other income, net                                                   |  | 4,041                 |   |  | 3,348     |   |  | 11,966    |  
|                                                                    |  |                       |   |  |           |   |  |           |  
|(Loss)/income before taxation                                       |  | 282,008               |   |  | 53,608    |   |  | (155,873  | )
|Income tax charges/(credit)                                         |  | (17,857               | ) |  | (2,043    | ) |  | 6,725     |  
|                                                                    |  |                       |   |  |           |   |  |           |  
|(Loss)/income after taxation                                        |  | 264,151               |   |  | 51,565    |   |  | (149,148  | )
|Minority interests                                                  |  |                      |   |  |          |   |  |          |  
|                                                                    |  |                       |   |  |           |   |  |           |  
|(Loss)/income from continuing operations                            |  | 264,151               |   |  | 51,565    |   |  | (149,148  | )
|Net income from discontinued operation                              |  | 83                    |   |  |          |   |  |          |  
|Loss arising from disposal of a subsidiary                          |  | (2,695                | ) |  |          |   |  |          |  
|                                                                    |  |                       |   |  |           |   |  |           |  
|Net (loss)/income                                                   |  | 261,539               |   |  | 51,565    |   |  | (149,148  | )
|                                                                    |  |                       |   |  |           |   |  |           |  



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##### Table of Contents

(c) Comprehensive (loss)/income



The comprehensive (loss)/income of the Company, disclosed in accordance with SFAS No. 130 Reporting Comprehensive
Income, is set out as follows:



|                                         |  |                       |   |  |         |   |  |          |  
|---------------------------------------- |  | --------------------- | - |  | ------- | - |  | -------- | -
|                                         |  | Year ended August 31, |  
|                                         |  | 2003                  |   |  | 2004    |   |  | 2005     |  
|                                         |  | HK$000               |   |  | HK$000 |   |  | HK$000  |  
|Net (loss)/income under U.S. GAAP        |  | 261,539               |   |  | 51,565  |   |  | (149,148 | )
|Foreign currency translation adjustments |  | (200                  | ) |  | (248    | ) |  | (143     | )
|                                         |  |                       |   |  |         |   |  |          |  
|Comprehensive (loss)/income              |  | 261,339               |   |  | 51,317  |   |  | (149,291 | )
|                                         |  |                       |   |  |         |   |  |          |  



No deferred tax assets
were recognized because the Company expects that the reported amount of the investment in subsidiaries can be recovered tax-free under HK tax laws.



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##### Table of Contents

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



NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS  (Continued)



(d) Statement of changes in shareholders equity under U.S.
GAAP



|                                                                   |  |                            |  |                   |  |              |  |                          |   |  |                |   |  |                    |   |  |                 |   |  |                          |  
|------------------------------------------------------------------ |  | -------------------------- |  | ----------------- |  | ------------ |  | ------------------------ | - |  | -------------- | - |  | ------------------ | - |  | --------------- | - |  | ------------------------ | -
|                                                                   |  | Ordinary shares            |  |                   |  |              |  |                          |   |  |                |   |  |                    |   |  |                
|                                                                   |  | Number ofsharesoutstanding |  | Amountoutstanding |  | Sharepremium |  | Additionalpaid incapital |   |  | Warrantreserve |   |  | Translationreserve |   |  | Retainedprofits |   |  | Totalshareholdersequity |  
|                                                                   |  |                            |  | HK$000           |  | HK$000      |  | HK$000                  |   |  | HK$000        |   |  | HK$000            |   |  | HK$000         |   |  | HK$000                  |  
|Balance at August 31, 2002                                         |  | 500,863,202                |  | 50,086            |  | 572,656      |  | 31,205                   |   |  | 9,089          |   |  | (38                | ) |  | 244,412         |   |  | 907,410                  |  
|Shares issued upon exercise of share options                       |  | 21,120,000                 |  | 2,112             |  | 10,106       |  |                         |   |  |               |   |  |                   |   |  |                |   |  | 12,218                   |  
|Compensation cost for outstanding share options                    |  |                           |  |                  |  |             |  | (2,731                   | ) |  |               |   |  |                   |   |  |                |   |  | (2,731                   | )
|Shares issued upon exercise of warrants                            |  | 82,976,585                 |  | 8,298             |  | 33,124       |  |                         |   |  | (8,231         | ) |  |                   |   |  |                |   |  | 33,191                   |  
|Exchange reserve realized upon disposal of a subsidiary            |  |                           |  |                  |  |             |  |                         |   |  |               |   |  | 1,469              |   |  |                |   |  | 1,469                    |  
|2003 Interim dividend declared and paid (Note 21)                  |  |                           |  |                  |  |             |  |                         |   |  |               |   |  |                   |   |  | (30,234         | ) |  | (30,234                  | )
|Net income                                                         |  |                           |  |                  |  |             |  |                         |   |  |               |   |  |                   |   |  | 261,539         |   |  | 261,539                  |  
|Foreign currency translation adjustments                           |  |                           |  |                  |  |             |  |                         |   |  |               |   |  | (200               | ) |  |                |   |  | (200                     | )
|Comprehensive income                                               |  |                           |  |                  |  |             |  |                         |   |  |               |   |  |                   |   |  |                |   |  | 261,339                  |  
|                                                                   |  |                            |  |                   |  |              |  |                          |   |  |                |   |  |                    |   |  |                 |   |  |                          |  
|Balance at August 31, 2003                                         |  | 604,959,787                |  | 60,496            |  | 615,886      |  | 28,474                   |   |  | 858            |   |  | 1,231              |   |  | 475,717         |   |  | 1,182,662                |  
|Shares issued upon exercise of share options                       |  | 640,000                    |  | 64                |  | 115          |  |                         |   |  |               |   |  |                   |   |  |                |   |  | 179                      |  
|Compensation cost for outstanding share options                    |  |                           |  |                  |  |             |  | (270                     | ) |  |               |   |  |                   |   |  |                |   |  | (270                     | )
|Shares issued upon exercise of warrants                            |  | 4,973,574                  |  | 497               |  | 1,985        |  |                         |   |  | (493           | ) |  |                   |   |  |                |   |  | 1,989                    |  
|2003 final dividend declared and paid (Note 21)                    |  |                           |  |                  |  |             |  |                         |   |  |               |   |  |                   |   |  | (45,789         | ) |  | (45,789                  | )
|2004 interim dividend declared and paid (Note 21)                  |  |                           |  |                  |  |             |  |                         |   |  |               |   |  |                   |   |  | (9,158          | ) |  | (9,158                   | )
|Net income                                                         |  |                           |  |                  |  |             |  |                         |   |  |               |   |  |                   |   |  | 51,565          |   |  | 51,565                   |  
|Foreign currency translation adjustments                           |  |                           |  |                  |  |             |  |                         |   |  |               |   |  | (248               | ) |  |                |   |  | (248                     | )
|Comprehensive income                                               |  |                           |  |                  |  |             |  |                         |   |  |               |   |  |                   |   |  |                |   |  | 51,317                   |  
|                                                                   |  |                            |  |                   |  |              |  |                          |   |  |                |   |  |                    |   |  |                 |   |  |                          |  
|Balance at August 31, 2004                                         |  | 610,573,361                |  | 61,057            |  | 617,986      |  | 28,204                   |   |  | 365            |   |  | 983                |   |  | 472,335         |   |  | 1,180,930                |  
|Shares issued upon exercise of share options                       |  | 52,000                     |  | 5                 |  | 25           |  |                         |   |  |               |   |  |                   |   |  |                |   |  | 30                       |  
|Compensation cost for outstanding share options                    |  |                           |  |                  |  |             |  | (389                     | ) |  |               |   |  |                   |   |  |                |   |  | (389                     | )
|Realization of outstanding warrant reserve upon warrant expiration |  |                           |  |                  |  |             |  |                         |   |  | (18            | ) |  |                   |   |  | 18              |   |  |                         |  
|Shares issued upon exercise of warrants                            |  | 3,500,043                  |  | 350               |  | 1,397        |  |                         |   |  | (347           | ) |  |                   |   |  |                |   |  | 1,400                    |  
|Net loss                                                           |  |                           |  |                  |  |             |  |                         |   |  |               |   |  |                   |   |  | (149,148        | ) |  | (149,148                 | )
|Foreign currency translation adjustments                           |  |                           |  |                  |  |             |  |                         |   |  |               |   |  | (143               | ) |  |                |   |  | (143                     | )
|Comprehensive loss                                                 |  |                            |  |                   |  |              |  |                          |   |  |                |   |  |                   |   |  |                 |   |  | (149,291                 | )
|                                                                   |  |                            |  |                   |  |              |  |                          |   |  |                |   |  |                    |   |  |                 |   |  |                          |  
|Balance at August 31, 2005                                         |  | 614,125,404                |  | 61,412            |  | 619,408      |  | 27,815                   |   |  |               |   |  | 840                |   |  | 323,205         |   |  | 1,032,680                |  
|                                                                   |  |                            |  |                   |  |              |  |                          |   |  |                |   |  |                    |   |  |                 |   |  |                          |  



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(e) Statement of cash flows



Under Hong Kong GAAP, in adopting SSAP 15 (revised), only three categories of activities are reported: operating activities;
investing activities and financing activities, which is similar to U.S. GAAP. However, the difference is that cash flows from interest income would be included in investing activities under Hong Kong GAAP but it would be included in operating
activities under U.S. GAAP. Further, under Hong Kong GAAP, cash and cash equivalents include bank loans and overdrafts repayable within three months from the date of the advance, such items would not be considered as cash and cash equivalents under
U.S. GAAP and would be included in financing activities under U.S. GAAP. Moreover, cash paid for term deposits would be included in investing activities under U.S. GAAP.



Under U.S. GAAP, the following amounts would be reported:



|                                                      |  |                       |   |  |          |   |  |          |  
|----------------------------------------------------- |  | --------------------- | - |  | -------- | - |  | -------- | -
|                                                      |  | Year ended August 31, |  
|                                                      |  | 2003                  |   |  | 2004     |   |  | 2005     |  
|                                                      |  | HK$000               |   |  | HK$000  |   |  | HK$000  |  
|Net cash provided from operating activities           |  | 417,663               |   |  | 207,516  |   |  | 90,984   |  
|Net cash used in investing activities                 |  | (312,797              | ) |  | (409,997 | ) |  | (571,018 | )
|Net cash provided from/(used in) financing activities |  | (11,280               | ) |  | 48,217   |   |  | 773,023  |  
|                                                      |  |                       |   |  |          |   |  |          |  
|Increase/(decrease) in cash and cash equivalents      |  | 93,586                |   |  | (154,264 | ) |  | 292,989  |  
|Cash and cash equivalents at the beginning of year    |  | 309,583               |   |  | 402,034  |   |  | 247,517  |  
|Effect of foreign exchange rate changes               |  | (1,135                | ) |  | (253     | ) |  | (915     | )
|                                                      |  |                       |   |  |          |   |  |          |  
|Cash and cash equivalents at the end of year          |  | 402,034               |   |  | 247,517  |   |  | 539,591  |  
|                                                      |  |                       |   |  |          |   |  |          |  



(f) Deferred taxes



Until August 31, 2003, under Hong Kong GAAP,
deferred taxation is accounted for at the current taxation rate with respect to timing differences between profit as computed for taxation purposes and profit as stated in the account to the extent that a liability or an asset is expected to be
payable or receivable in the foreseeable future. In determining whether a liability is expected to be payable in the foreseeable future the Company assesses the effect of its capital expenditures and other plans. If these plans indicate that
sufficient accelerated depreciation allowances will be available to offset the effect of the reversal of timing differences, a deferred tax liability is not established for such timing differences, in accordance with the requirements of Hong Kong
GAAP.



With effect from September 1, 2004, in order to
comply with SSAP 12 (revised) issued by the HKICPA, the Company adopted a new accounting policy for deferred tax as follow:



Deferred taxation is provided in full, using the liability method, on temporary differences arising between the tax bases of assets and liabilities and
their carrying amounts in the financial statements.



Deferred
tax assets are recognized to the extent that it is probable that future taxable profit will be available against which the temporary differences can be utilized.



The new accounting policy has been adopted retrospectively.



Under U.S. GAAP, the Company is required to recognize deferred tax assets and liabilities for the expected future tax
consequences of all events that have been included in the account or tax returns. Under this method, deferred tax assets and liabilities are determined based on the temporary differences between the financial reporting basis and tax basis of assets
and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse. Future tax benefits in respect of tax losses carry forward are also required to be recognized in full. A valuation allowance is required
to be established for such assets if it is more likely than not that the Company will not be able to utilize such benefits in the future.



As a result of the adoption of SSAP 12 (revised), there are no longer any differences arising from the recognition of deferred tax under Hong Kong GAAP
and U.S. GAAP, other than that all deferred tax assets recognized and reduced by a valuation allowance if it is more likely than not that the Company will not be able to utilize such benefits in the future.



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As of August 31, 2005, the Company had accumulated tax losses amounting to HK$1,011,475,000 (2004:
HK$735,059,000) 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 losses of the Hong Kong subsidiaries can be carried forward indefinitely while the tax losses of subsidiaries in the Mainland China and
overseas expire within periods ranging from 2 to 20 years. These tax losses will expire in the following periods:



|                  |  |                       |  |          
|----------------- |  | --------------------- |  | ---------
|                  |  | Year ended August 31,
|                  |  | 2004                  |  | 2005     
|                  |  | HK$000               |  | HK$000  
|After 5 years     |  | 264                   |  | 1,132    
|From 2 to 5 years |  | 2,597                 |  | 2,862    
|No expiry date    |  | 732,198               |  | 1,007,481
|                  |  |                       |  |          
|                  |  | 735,059               |  | 1,011,475
|                  |  |                       |  |          



The tax effect on the
accumulated tax losses amounted to HK$177,827,000 (2004: HK$129,222,000). Realization of deferred tax assets associated with tax loss carry forwards is dependent upon generating sufficient taxable income. As of August 31, 2005, a valuation
allowance of HK$29,804,000 (2004: HK$7,633,000) had been provided for against the remaining deferred tax assets related to the tax losses carried forward since management believes it is more likely than not that insufficient taxable income will be
generated in the foreseeable future to utilize the tax loss carry forwards.



Changes in the valuation allowance consist of:



|                                             |  |                       |   |  |         |   |  |        
|-------------------------------------------- |  | --------------------- | - |  | ------- | - |  | -------
|                                             |  | Year ended August 31,
|                                             |  | 2003                  |   |  | 2004    |   |  | 2005   
|                                             |  | HK$000               |   |  | HK$000 |   |  | HK$000
|Balance at beginning of the year             |  | 62,739                |   |  | 15,171  |   |  | 7,633  
|Additions/(reduction) to income tax expenses |  | (47,568               | ) |  | (7,538  | ) |  | 22,171 
|                                             |  |                       |   |  |         |   |  |        
|Balance at end of the year                   |  | 15,171                |   |  | 7,633   |   |  | 29,804 
|                                             |  |                       |   |  |         |   |  |        



(g) Other investments



Under Hong Kong GAAP, other investments of the
Company 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 operations.



Under U.S. GAAP, the Company adopted SFAS No. 133 Accounting for
Derivative Instruments and Hedging Activities, as amended by SFAS No. 138 Accounting for Certain Derivative Instruments and Certain Hedging Activities for other investments during the year. SFAS No. 133, as amended,
establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities. It requires that all derivatives be recorded on the balance sheet at fair
value. Additionally, it requires that an embedded derivative instrument to be separated from the host contract and accounted for as a derivative instrument if all the following criteria are met: the economic characteristics of the embedded
derivative are not clearly and closely related to the economic characteristics of the host contract; the hybrid instrument is not re-measured at fair value with changes in fair value reported in earnings and a separate derivative with the same terms
as the embedded derivative would meet the definition of a derivative instrument under SFAS No. 133. If an embedded derivative instrument is separated from its host contract, the host contract shall be accounted for based on U.S. GAAP applicable
of that type that do not contain embedded derivative instruments. However, if an embedded derivative instrument cannot be reliably identified and measured separately from the host contract, the entire contract shall be measured at fair value with
gain or loss recognized in the statements of operations, but it may not be designated as hedging instrument.



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As the embedded derivative of the other investments held by the Company as of August 31, 2005 cannot
be reliably identified and measured separately from the host contract, the entire contract has been measured at fair value under U.S. GAAP. There is no reconciling difference between Hong Kong GAAP and U.S. GAAP in this respect. Unrealized loss has
been recognized in the statements of operations for the year ended August 31, 2005.



Note 31. Adjusting Events After the Balance Sheet Date



Hong Kong Broadband Network Limited (HKBN), a wholly-owned subsidiary of the Company, as a Fixed Telecommunications Network Services (FTNS) licensee, provides interconnection services to enable
delivery of telecommunications service to customers of different operators. Since the FTNS license was granted by the TA and interconnection services have been provided, the Company has been recognising interconnection services billed to mobile
operators as revenue (mobile interconnection charges). For the years ended August 31, 2003, 2004 and 2005, the Company recorded mobile interconnection charges of HK$6,090,000, HK$38,676,000 and HK$24,703,000, respectively. As of August
31, 2004 and 2005, the Company had mobile interconnection charges receivable, net of provision for doubtful accounts, of HK$44,617,000 and HK$49,821,000, respectively. As of August 31, 2005, substantially all of the mobile operators had not made any
payments to the Company since 2002 when the Company started to bill for the mobile interconnection services. In late November 2005, the Company entered a contractual agreement with a mobile operator to pay HKBN interim mobile interconnection charges
at a rate based on PCCW-HKTs published fully distributed cost model of HK$0.0436 per occupancy minute.



The charges were determined using the available rates under the existing calculation model (fully distributed cost model) for interconnection services
between fixed and mobile operators, which are based on historical cost data of PCCW-HKT. In May 2004, TA confirmed to HKBN that mobile operators should pay interconnection charges to fixed network operators in accordance with the existing charging
principles under the relevant TA statements. In August 2004, TA agreed to make a determination (the Determination) under section 36A of the Telecommunications Ordinance to cover the level of mobile and fixed interconnection charges
payable by one of the mobile operators to HKBN; and the effective date of the determined interconnection charges. In addition, in December 2005, the Telecommunications Authority indicated that it would make a determination of the mobile
interconnection charges by the end of April 2006.



The
Determination is still in progress with no determination made. Therefore, the Company performed an assessment as at August 31, 2005 on the timing and the recoverability of these charges and determined that it was not able to provide a reasonable
estimate on the timing of the completion of the determination process. Accordingly, at the time the Company finalized its Hong Kong statutory financial statements in November 2005, the Company concluded that it would discontinue the recognition of
revenue for mobile interconnection charges billed to several mobile for the year ended August 31, 2005, and provide a full provision against existing mobile interconnection charges receivable as at August 31, 2005.



Subsequent to the issuance in November 2005 of the Companys Hong Kong
statutory financial statements for the year ended August 31, 2005, management re-assessed its previous conclusions regarding revenue recognition for mobile interconnection charges for the year ended August 31, 2005 and the amount it expected to
collect for billings outstanding through that date. As a result of the re-assessment, management determined that revenue related to mobile interconnection charges for the year ended August 31, 2005 should be recognized, and that the allowance for
doubtful accounts should also be adjusted to the estimated amount expected to be realized. Consequently, the Company recorded adjustments to increase revenue recognized from mobile interconnection charges from HK$ nil to HK$24,703,000 for the year
ended August 31, 2005, reduced the allowance for doubtful accounts for mobile interconnection charges receivable carried over from August 31, 2004 from HK$44,617,000 to HK$19,499,000, and increased the mobile interconnection charges receivable from
HK$ nil to HK$49,821,000. This had the impact of increasing trade accounts receivable, net, total current assets, total assets, retained profits and total shareholders equity each by HK$ 49,821,000 on the Companys consolidated balance
sheet at August 31, 2005 from amounts previously reported. These adjustments also had the following effects on the Companys consolidated statement of operations for the year ended August 31, 2005 (amounts in thousands except per share data):



|                                                                    |  |                       |   |  |             |  |              |  
|------------------------------------------------------------------- |  | --------------------- | - |  | ----------- |  | ------------ | -
|Statement of Operations Data                                        |  | As previouslyreported |   |  | Adjustments |  | As revised   |  
|                                                                    |  | HK$ 000               |   |  | HK$ 000     |  | HK$ 000      |  
|Revenue from provision of telecommunication and other services, net |  | 1,137,356             |   |  | 24,703      |  | 1,162,059    |  
|Provision for doubtful accounts receivable                          |  | (60,563               | ) |  | 25,118      |  | (35,445      | )
|Loss from operations                                                |  | (1,112,378            | ) |  | 49,821      |  | (951,066     | )
|Net loss after tax                                                  |  | (206,352              | ) |  | 49,821      |  | (156,531     | )
|Loss per share - Basic and Diluted                                  |  | (33.6) cents          |   |  | 8.1 cents   |  | (25.5) cents |  



32 Supplemental Guarantors
Consolidated Financial Information



The senior notes
mentioned above in Note 14(b) are irrevocably and unconditionally guaranteed, jointly and severally, on a senior unsecured basis by all of the subsidiaries of City Telecom (H.K.) Limited (collectively defined as Guarantor Subsidiaries),
except CTI Guangzhou Customer Services Co. Ltd. in the PRC (Non-guarantor Subsidiary).



The condensed consolidated financial information is presented below and should be read in connection with the consolidated financial statements of City
Telecom (H.K.) Limited prepared under HK GAAP. Separate financial statements of the Guarantor Subsidiaries are not presented because the Guarantor Subsidiaries are wholly-owned and will fully and unconditionally guarantee to the Notes on a joint and
several basis. Reconciliations to U.S. GAAP are not presented because the majority of the reconciling items relate to City Telecom (H.K.) Limited and Guarantor Subsidiaries and such reconciling items are already disclosed and explained in Note 30.



The following condensed consolidated financial information
presents the condensed consolidated balance sheets as of August 31, 2005 and 2004 and the related condensed consolidated statements of operations and statements of cash flows for the years ended August 31 2005, 2004 and 2003 of
(a) City Telecom (H.K.) Limited, the parent; (b) the Guarantor Subsidiaries on a combined basis; (c) the Non-guarantor Subsidiary; (d) eliminating entries; and (e) the total consolidated amounts.



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##### Table of Contents

Condensed Consolidated Balance Sheet as of August 31, 2005



|                                                               |  |                          |  |                       |   |  |                         |  |                    |   |  |                  
|-------------------------------------------------------------- |  | ------------------------ |  | --------------------- | - |  | ----------------------- |  | ------------------ | - |  | -----------------
|                                                               |  | CityTelecom(H.K.)Limited |  | GuarantorSubsidiaries |   |  | Non-GuarantorSubsidiary |  | EliminatingEntries |   |  | ConsolidatedTotal
|                                                               |  | HK$000                  |  | HK$000               |   |  | HK$000                 |  | HK$000            |   |  | HK$000          
|Current assets                                                 |  |                          |  |                       |   |  |                         |  |                    |   |  |                  
|Cash and bank balances                                         |  | 461,001                  |  | 55,309                |   |  | 23,281                  |  |                    |   |  | 539,591          
|Term deposit                                                   |  | 92,850                   |  |                      |   |  |                        |  |                    |   |  | 92,850           
|Pledged bank deposits                                          |  | 85,923                   |  | 4,524                 |   |  |                        |  |                    |   |  | 90,447           
|Trade receivables, net                                         |  | 15,253                   |  | 114,757               |   |  |                        |  |                    |   |  | 130,010          
|Other receivables, deposits and prepayments                    |  | 8,395                    |  | 67,171                |   |  | 6,896                   |  | (3,704             | ) |  | 78,758           
|Inventories                                                    |  | 1,581                    |  | 385                   |   |  |                        |  | (9                 | ) |  | 1,957            
|Tax recoverable                                                |  |                         |  | 535                   |   |  |                        |  |                    |   |  | 535              
|                                                               |  |                          |  |                       |   |  |                         |  |                    |   |  |                  
|Total current assets                                           |  | 665,003                  |  | 242,681               |   |  | 30,177                  |  |                    |   |  | 934,148          
|Fixed assets, net                                              |  | 133,328                  |  | 1,185,970             |   |  | 17,245                  |  |                    |   |  | 1,336,543        
|Investments in subsidiaries(1)                                 |  | 1,277,479                |  | 250,113               |   |  |                        |  | (1,527,592         | ) |  |                 
|Long-term bank deposits                                        |  | 15,540                   |  |                      |   |  |                        |  |                    |   |  | 15,540           
|Other long-term assets                                         |  | 22,315                   |  | 63,115                |   |  |                        |  | (24,233            | ) |  | 61,197           
|                                                               |  |                          |  |                       |   |  |                         |  |                    |   |  |                  
|Total assets                                                   |  | 2,113,665                |  | 1,741,879             |   |  | 47,422                  |  |                    |   |  | 2,347,428        
|                                                               |  |                          |  |                       |   |  |                         |  |                    |   |  |                  
|Current liabilities                                            |  |                          |  |                       |   |  |                         |  |                    |   |  |                  
|Amounts due to subsidiaries/fellow subsidiaries                |  | 10,830                   |  | 1,146,698             |   |  | 23,662                  |  | (1,181,190         | ) |  |                 
|Trade payables                                                 |  | 58,728                   |  | 32,034                |   |  |                        |  |                    |   |  | 90,762           
|Deposits received                                              |  | 8,770                    |  | 6,740                 |   |  |                        |  |                    |   |  | 15,510           
|Current portion of deferred service income                     |  | 11,254                   |  | 29,195                |   |  |                        |  | (3,705             | ) |  | 36,744           
|Other payables and accrued charges                             |  | 22,343                   |  | 185,678               |   |  | 14,992                  |  | 195                |   |  | 223,208          
|Income tax payable                                             |  | 1,481                    |  | 17                    |   |  | 230                     |  |                    |   |  | 1,728            
|Current portion of obligation under finance leases             |  |                         |  | 1,194                 |   |  |                        |  |                    |   |  | 1,194            
|                                                               |  |                          |  |                       |   |  |                         |  |                    |   |  |                  
|Total current liabilities                                      |  | 113,406                  |  | 1,401,556             |   |  | 38,884                  |  |                    |   |  | 369,146          
|Long-term liabilities                                          |  | 980,645                  |  | 2,404                 |   |  | 84                      |  | (25,305            | ) |  | 957,828          
|                                                               |  |                          |  |                       |   |  |                         |  |                    |   |  |                  
|Total liabilities                                              |  | 1,094,051                |  | 1,403,960             |   |  | 38,968                  |  |                    |   |  | 1,326,974        
|Commitments and contingencies                                  |  |                          |  |                       |   |  |                         |  |                    |   |  |                  
|Shareholders equity                                           |  |                          |  |                       |   |  |                         |  |                    |   |  |                  
|Ordinary shares, par value $0.1 per share                      |  |                          |  |                       |   |  |                         |  |                    |   |  |                  
| 2,000,000,000 shares authorized at August 31, 2005           |  |                          |  |                       |   |  |                         |  |                    |   |  |                  
| 614,125,404 shares issued and outstanding at August 31, 2005 |  | 61,412                   |  | 15,485                |   |  | 8,131                   |  | (23,616            | ) |  | 61,412           
|Share premium                                                  |  | 619,408                  |  | 470,836               |   |  |                        |  | (470,836           | ) |  | 619,408          
|Retained profits/(accumulated losses)                          |  | 338,794                  |  | (148,502              | ) |  | 226                     |  | 148,276            |   |  | 338,794          
|Other reserves                                                 |  |                         |  | 100                   |   |  | 97                      |  | 643                |   |  | 840              
|Total shareholders equity                                     |  | 1,019,614                |  | 337,919               |   |  | 8,454                   |  |                    |   |  | 1,020,454        
|                                                               |  |                          |  |                       |   |  |                         |  |                    |   |  |                  
|Total liabilities and shareholders equity                     |  | 2,113,665                |  | 1,741,879             |   |  | 47,422                  |  |                    |   |  | 2,347,428        
|                                                               |  |                          |  |                       |   |  |                         |  |                    |   |  |                  

---

|(1) | The investment in subsidiaries amounts at City Telecom (H.K.) Limited level have included the share of net assets of its subsidiaries using the equity method of accounting.
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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##### Table of Contents

Condensed Consolidated Balance Sheet as of August 31, 2004



|                                                               |  |                          |  |                       |   |  |                         |   |  |                    |   |  |                  
|-------------------------------------------------------------- |  | ------------------------ |  | --------------------- | - |  | ----------------------- | - |  | ------------------ | - |  | -----------------
|                                                               |  | CityTelecom(H.K.)Limited |  | GuarantorSubsidiaries |   |  | Non-GuarantorSubsidiary |   |  | EliminatingEntries |   |  | ConsolidatedTotal
|                                                               |  | HK$000                  |  | HK$000               |   |  | HK$000                 |   |  | HK$000            |   |  | HK$000          
|Current assets                                                 |  |                          |  |                       |   |  |                         |   |  |                    |   |  |                  
|Cash and bank balances                                         |  | 199,643                  |  | 41,691                |   |  | 6,183                   |   |  |                    |   |  | 247,517          
|Pledged bank deposits                                          |  | 20,565                   |  | 6,240                 |   |  |                        |   |  |                    |   |  | 26,805           
|Trade receivables, net                                         |  | 24,275                   |  | 110,574               |   |  |                        |   |  |                    |   |  | 134,849          
|Other receivables, deposits and prepayments                    |  | 13,060                   |  | 59,865                |   |  | 1,967                   |   |  | (30,863            | ) |  | 44,029           
|                                                               |  |                          |  |                       |   |  |                         |   |  |                    |   |  |                  
|Total current assets                                           |  | 257,543                  |  | 218,370               |   |  | 8,150                   |   |  |                    |   |  | 453,200          
|Fixed assets, net                                              |  | 157,407                  |  | 983,872               |   |  | 17,596                  |   |  |                    |   |  | 1,158,875        
|Investments in subsidiaries(1)                                 |  | 909,126                  |  | 269,029               |   |  |                        |   |  | (1,178,155         | ) |  |                 
|Long-term bank deposits                                        |  | 15,600                   |  |                      |   |  |                        |   |  |                    |   |  | 15,600           
|Other long-term assets                                         |  | 22,310                   |  | 31,292                |   |  |                        |   |  | 2,131              |   |  | 55,733           
|                                                               |  |                          |  |                       |   |  |                         |   |  |                    |   |  |                  
|Total assets                                                   |  | 1,361,986                |  | 1,502,563             |   |  | 25,746                  |   |  |                    |   |  | 1,683,408        
|                                                               |  |                          |  |                       |   |  |                         |   |  |                    |   |  |                  
|Current liabilities                                            |  |                          |  |                       |   |  |                         |   |  |                    |   |  |                  
|Amounts due to subsidiaries/fellow subsidiaries                |  | 10,000                   |  | 683,771               |   |  | 9,591                   |   |  | (703,362           | ) |  |                 
|Trade payables                                                 |  | 72,577                   |  | 49,882                |   |  |                        |   |  |                    |   |  | 122,459          
|Deposits received                                              |  | 11,093                   |  | 6,890                 |   |  |                        |   |  |                    |   |  | 17,983           
|Current portion of deferred service income                     |  | 29,222                   |  | 35,076                |   |  |                        |   |  | (29,010            | ) |  | 35,288           
|Other payables and accrued charges                             |  | 24,113                   |  | 157,173               |   |  | 8,890                   |   |  | (1,571             | ) |  | 188,605          
|Income tax payable/(recoverable)                               |  | 1,271                    |  | (98                   | ) |  |                        |   |  |                    |   |  | 1,173            
|Short-term bank loansecured                                   |  | 19,170                   |  |                      |   |  |                        |   |  |                    |   |  | 19,170           
|Current portion of long-term bank loansecured                 |  |                         |  | 13,333                |   |  |                        |   |  |                    |   |  | 13,333           
|                                                               |  |                          |  |                       |   |  |                         |   |  |                    |   |  |                  
|Total current liabilities                                      |  | 167,446                  |  | 946,027               |   |  | 18,481                  |   |  |                    |   |  | 398,011          
|Long-term liabilities                                          |  |                          |  |                       |   |  |                         |   |  |                    |   |  |                  
|Long-term bank loansecured                                    |  |                         |  | 86,667                |   |  |                        |   |  |                    |   |  | 86,667           
|Other long-term liabilities                                    |  | 18,842                   |  | 4,141                 |   |  | 49                      |   |  |                    |   |  | 23,032           
|                                                               |  |                          |  |                       |   |  |                         |   |  |                    |   |  |                  
|Total liabilities                                              |  | 186,288                  |  | 1,036,835             |   |  | 18,530                  |   |  |                    |   |  | 507,710          
|Commitments and contingencies                                  |  |                          |  |                       |   |  |                         |   |  |                    |   |  |                  
|Shareholders equity                                           |  |                          |  |                       |   |  |                         |   |  |                    |   |  |                  
|Ordinary shares, par value $0.1 per share                      |  |                          |  |                       |   |  |                         |   |  |                    |   |  |                  
| 2,000,000,000 shares authorized at August 31, 2004           |  |                          |  |                       |   |  |                         |   |  |                    |   |  |                  
| 610,573,361 shares issued and outstanding at August 31, 2004 |  | 61,057                   |  | 15,486                |   |  | 8,131                   |   |  | (23,617            | ) |  | 61,057           
|Share premium                                                  |  | 617,986                  |  | 470,836               |   |  |                        |   |  | (470,836           | ) |  | 617,986          
|Retained profits/(accumulated losses)                          |  | 495,307                  |  | (20,637               | ) |  | (852                    | ) |  | 21,489             |   |  | 495,307          
|Other reserves                                                 |  | 1,348                    |  | 43                    |   |  | (63                     | ) |  | 20                 |   |  | 1,348            
|                                                               |  |                          |  |                       |   |  |                         |   |  |                    |   |  |                  
|Total shareholders equity                                     |  | 1,175,698                |  | 465,728               |   |  | 7,216                   |   |  |                    |   |  | 1,175,698        
|                                                               |  |                          |  |                       |   |  |                         |   |  |                    |   |  |                  
|Total liabilities and shareholders equity                     |  | 1,361,986                |  | 1,502,563             |   |  | 25,746                  |   |  |                    |   |  | 1,683,408        
|                                                               |  |                          |  |                       |   |  |                         |   |  |                    |   |  |                  

---

|(1) | The investment in subsidiaries amounts at City Telecom (H.K.) Limited level have included the
share of net assets of its subsidiaries using the equity method of accounting.
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------



F-55



---

##### Table of Contents

Condensed Consolidated Statements of operations for the year ended August 31, 2005



|                                                                    |  |                          |   |  |                       |   |  |                         |   |  |                    |   |  |                   |  
|------------------------------------------------------------------- |  | ------------------------ | - |  | --------------------- | - |  | ----------------------- | - |  | ------------------ | - |  | ----------------- | -
|                                                                    |  | CityTelecom(H.K.)Limited |   |  | GuarantorSubsidiaries |   |  | Non-GuarantorSubsidiary |   |  | EliminatingEntries |   |  | ConsolidatedTotal |  
|                                                                    |  | HK$000                  |   |  | HK$000               |   |  | HK$000                 |   |  | HK$000            |   |  | HK$000           |  
|Revenue from provision of telecommunication and other services, net |  | 227,045                  |   |  | 1,104,389             |   |  | 122,054                 |   |  | (291,429           | ) |  | 1,162,059         |  
|Network costs                                                       |  | (111,836                 | ) |  | (271,203              | ) |  |                        |   |  | 43,637             |   |  | (339,402          | )
|Operating expenses:                                                 |  |                          |   |  |                       |   |  |                         |   |  |                    |   |  |                   |  
|Salaries and related costs                                          |  | (48,421                  | ) |  | (220,678              | ) |  | (94,120                 | ) |  | 110,232            |   |  | (252,987          | )
|Sales and marketing expenses                                        |  | (25,506                  | ) |  | (416,168              | ) |  |                        |   |  | 174,251            |   |  | (267,423          | )
|General and administrative expenses                                 |  | (65,552                  | ) |  | (316,284              | ) |  | (26,132                 | ) |  | 12,757             |   |  | (395,211          | )
|Provision for doubtful accounts receivable                          |  | (1,814                   | ) |  | (33,631               | ) |  |                         |   |  |                    |   |  | (35,445           | )
|                                                                    |  |                          |   |  |                       |   |  |                         |   |  |                    |   |  |                   |  
|(Loss)/income from operations                                       |  | (26,084                  | ) |  | (153,575              | ) |  | 1,802                   |   |  |                    |   |  | (128,409          | )
|Bank interest income                                                |  | 13,061                   |   |  | 403                   |   |  | 114                     |   |  |                    |   |  | 13,578            |  
|Interest expenses                                                   |  | (54,167                  | ) |  | (17,354               | ) |  |                        |   |  | 17,059             |   |  | (54,462           | )
|Other income, net                                                   |  | 25,617                   |   |  | 43,515                |   |  | 99                      |   |  | (63,194            | ) |  | 6,037             |  
|Share of net losses from subsidiaries(2)                            |  | (123,475                 | ) |  |                      |   |  |                         |   |  | 123,475            |   |  |                  |  
|                                                                    |  |                          |   |  |                       |   |  |                         |   |  |                    |   |  |                   |  
|(Loss)/income before taxation                                       |  | (165,048                 | ) |  | (127,011              | ) |  | 2,015                   |   |  |                    |   |  | (163,256          | )
|Income tax charges/(credit)                                         |  | 8,517                    |   |  | (854                  | ) |  | (938                    | ) |  |                    |   |  | 6,725             |  
|                                                                    |  |                          |   |  |                       |   |  |                         |   |  |                    |   |  |                   |  
|(Loss)/income after taxation                                        |  | (156,531                 | ) |  | (127,865              | ) |  | 1,077                   |   |  |                    |   |  | (156,531          | )
|Minority interests                                                  |  |                         |   |  |                      |   |  |                        |   |  |                    |   |  |                  |  
|                                                                    |  |                          |   |  |                       |   |  |                         |   |  |                    |   |  |                   |  
|Net (loss)/income                                                   |  | (156,531                 | ) |  | (127,865              | ) |  | 1,077                   |   |  |                    |   |  | (156,531          | )

---

|(2) | The net (loss)/income amounts at City Telecom (H.K.) Limited level have included the share of
net (losses)/ income of its subsidiaries using the equity method of accounting.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------



F-56



---

##### Table of Contents

Condensed Consolidated Statements of operations for the year ended August 31, 2004



|                                                                    |  |                            |   |  |                       |   |  |                         |   |  |                    |   |  |                   |  
|------------------------------------------------------------------- |  | -------------------------- | - |  | --------------------- | - |  | ----------------------- | - |  | ------------------ | - |  | ----------------- | -
|                                                                    |  | City Telecom(H.K.) Limited |   |  | GuarantorSubsidiaries |   |  | Non-GuarantorSubsidiary |   |  | EliminatingEntries |   |  | ConsolidatedTotal |  
|                                                                    |  | HK$000                    |   |  | HK$000               |   |  | HK$000                 |   |  | HK$000            |   |  | HK$000           |  
|Revenue from provision of telecommunication and other services, net |  | 260,675                    |   |  | 1,081,591             |   |  | 113,953                 |   |  | (286,339           | ) |  | 1,169,880         |  
|Network costs                                                       |  | (90,520                    | ) |  | (282,282              | ) |  |                        |   |  | 41,394             |   |  | (331,408          | )
|Operating expenses                                                  |  |                            |   |  |                       |   |  |                         |   |  |                    |   |  |                   |  
|Salaries and related costs                                          |  | (49,367                    | ) |  | (191,751              | ) |  | (86,544                 | ) |  | 101,012            |   |  | (226,650          | )
|Sales and marketing expenses                                        |  | (53,251                    | ) |  | (351,518              | ) |  |                        |   |  | 176,600            |   |  | (228,169          | )
|General and administrative expenses                                 |  | (71,124                    | ) |  | (240,874              | ) |  | (23,342                 | ) |  | 8,536              |   |  | (326,804          | )
|Provision for doubtful accounts receivable                          |  | (1,683                     | ) |  | (9,819                | ) |  |                        |   |  |                    |   |  | (11,502           | )
|                                                                    |  |                            |   |  |                       |   |  |                         |   |  |                    |   |  |                   |  
|(Loss)/income from operations                                       |  | (5,270                     | ) |  | 5,347                 |   |  | 4,067                   |   |  |                    |   |  | 45,347            |  
|Bank interest income                                                |  | 3,580                      |   |  | 135                   |   |  | 38                      |   |  |                    |   |  | 3,753             |  
|Interest expenses                                                   |  | (175                       | ) |  |                      |   |  |                        |   |  |                    |   |  | (175              | )
|Other income, net                                                   |  | 3,516                      |   |  | 41,038                |   |  | 17                      |   |  | (41,903            | ) |  | 2,668             |  
|Share of income from subsidiaries(2)                                |  | 49,309                     |   |  |                      |   |  |                        |   |  | (49,309            | ) |  |                  |  
|                                                                    |  |                            |   |  |                       |   |  |                         |   |  |                    |   |  |                   |  
|Income before taxation                                              |  | 50,960                     |   |  | 46,520                |   |  | 4,122                   |   |  |                    |   |  | 51,593            |  
|Income tax charges                                                  |  | (1,410                     | ) |  | (464                  | ) |  | (169                    | ) |  |                    |   |  | (2,043            | )
|                                                                    |  |                            |   |  |                       |   |  |                         |   |  |                    |   |  |                   |  
|Net income                                                          |  | 49,550                     |   |  | 46,056                |   |  | 3,953                   |   |  |                    |   |  | 49,550            |  
|                                                                    |  |                            |   |  |                       |   |  |                         |   |  |                    |   |  |                   |  

---

|(2) | The net income amounts at City Telecom (H.K.) Limited level have included the share of net
income/(losses) of its subsidiaries using the equity method of accounting.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------



Condensed Consolidated Statements of operations for the year ended August 31, 2003



|                                                                    |  |                            |   |  |                       |   |  |                         |   |  |                    |   |  |                   |  
|------------------------------------------------------------------- |  | -------------------------- | - |  | --------------------- | - |  | ----------------------- | - |  | ------------------ | - |  | ----------------- | -
|                                                                    |  | City Telecom(H.K.) Limited |   |  | GuarantorSubsidiaries |   |  | Non-GuarantorSubsidiary |   |  | EliminatingEntries |   |  | ConsolidatedTotal |  
|                                                                    |  | HK$000                    |   |  | HK$000               |   |  | HK$000                 |   |  | HK$000            |   |  | HK$000           |  
|Revenue from provision of telecommunication and other services, net |  | 351,866                    |   |  | 1,090,195             |   |  | 37,921                  |   |  | (181,073           | ) |  | 1,298,909         |  
|Network costs                                                       |  | (69,307                    | ) |  | (295,553              | ) |  |                        |   |  | 42,107             |   |  | (322,753          | )
|Operating expenses                                                  |  |                            |   |  |                       |   |  |                         |   |  |                    |   |  |                   |  
|Salaries and related costs                                          |  | (78,009                    | ) |  | (148,726              | ) |  | (29,104                 | ) |  | 35,489             |   |  | (220,350          | )
|Sales and marketing expenses                                        |  | (46,939                    | ) |  | (263,878              | ) |  |                        |   |  | 128,346            |   |  | (182,471          | )
|General and administrative expenses                                 |  | (102,259                   | ) |  | (202,566              | ) |  | (11,159                 | ) |  | 31,694             |   |  | (284,290          | )
|Provision for doubtful accounts receivable                          |  | (5,139                     | ) |  | (12,546               | ) |  |                        |   |  |                   |   |  | (17,685           | )
|                                                                    |  |                            |   |  |                       |   |  |                         |   |  |                    |   |  |                   |  
|Income/(loss) from operations                                       |  | 50,213                     |   |  | 166,926               |   |  | (2,342                  | ) |  |                    |   |  | 271,360           |  
|Bank interest income                                                |  | 2,480                      |   |  | 670                   |   |  | 13                      |   |  |                    |   |  | 3,163             |  
|Interest expenses                                                   |  | (414                       | ) |  | (324                  | ) |  |                        |   |  | 137                |   |  | (601              | )
|Loss on disposal of a subsidiary                                    |  |                           |   |  | (2,695                | ) |  |                        |   |  |                    |   |  | (2,695            | )
|Other income, net                                                   |  | 2,657                      |   |  | 58,976                |   |  | (92                     | ) |  | (57,168            | ) |  | 4,373             |  
|Share of income from subsidiaries(2)                                |  | 218,602                    |   |  |                      |   |  |                        |   |  | (218,602           | ) |  |                  |  
|                                                                    |  |                            |   |  |                       |   |  |                         |   |  |                    |   |  |                   |  
|Income before taxation                                              |  | 273,538                    |   |  | 223,553               |   |  | (2,421                  | ) |  |                    |   |  | 275,600           |  
|Income tax charges                                                  |  | (15,795                    | ) |  | 397                   |   |  | (2,459                  | ) |  |                    |   |  | (17,857           | )
|                                                                    |  |                            |   |  |                       |   |  |                         |   |  |                    |   |  |                   |  
|Net income/(loss)                                                   |  | 257,743                    |   |  | 223,950               |   |  | (4,880                  | ) |  |                    |   |  | 257,743           |  
|                                                                    |  |                            |   |  |                       |   |  |                         |   |  |                    |   |  |                   |  

---

|(2) | The net income amounts at City Telecom (H.K.) Limited level have included the share of net
income/(losses) of its subsidiaries using the equity method of accounting.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------



F-57



---

##### Table of Contents

Condensed Consolidated Statement of Cash Flow for the Year Ended August 31, 2005



|                                                    |  |                          |   |  |                       |   |  |                           |   |  |                    |   |  |                   |  
|--------------------------------------------------- |  | ------------------------ | - |  | --------------------- | - |  | ------------------------- | - |  | ------------------ | - |  | ----------------- | -
|                                                    |  | City Telecom(HK) Limited |   |  | GuarantorSubsidiaries |   |  | Non-guarantorSubsidiaries |   |  | EliminatingEntries |   |  | ConsolidatedTotal |  
|                                                    |  | HK$000                  |   |  | HK$000               |   |  | HK$000                   |   |  | HK$000            |   |  | HK$000           |  
|Net cash (used in)/provided by operating activities |  | (75,334                  | ) |  | 42,676                |   |  | 23,094                    |   |  | (5,880             | ) |  | (15,444           | )
|Net cash used in investing activities               |  | (536,911                 | ) |  | (404,293              | ) |  | (5,786                    | ) |  | 482,400            |   |  | (464,590          | )
|Net cash provided by financing activities           |  | 892,713                  |   |  | 381,880               |   |  |                          |   |  | (482,400           | ) |  | 792,193           |  
|                                                    |  |                          |   |  |                       |   |  |                           |   |  |                    |   |  |                   |  
|Net increase in cash and cash equivalents           |  | 280,468                  |   |  | 20,263                |   |  | 17,308                    |   |  |                    |   |  | 312,159           |  
|Cash and cash equivalents at beginning of year      |  | 180,473                  |   |  | 41,691                |   |  | 6,183                     |   |  |                    |   |  | 228,347           |  
|Effects of foreign exchange rates changes           |  | 60                       |   |  | (405                  | ) |  | (210                      | ) |  | (360               | ) |  | (915              | )
|                                                    |  |                          |   |  |                       |   |  |                           |   |  |                    |   |  |                   |  
|Cash and cash equivalents at end of years           |  | 461,001                  |   |  | 61,549                |   |  | 23,281                    |   |  |                    |   |  | 539,591           |  
|                                                    |  |                          |   |  |                       |   |  |                           |   |  |                    |   |  |                   |  



Condensed Consolidated Statement of
Cash Flow for the Year Ended August 31, 2004



|                                                     |  |                          |   |  |                       |   |  |                         |   |  |                    |   |  |                   |  
|---------------------------------------------------- |  | ------------------------ | - |  | --------------------- | - |  | ----------------------- | - |  | ------------------ | - |  | ----------------- | -
|                                                     |  | City Telecom(HK) Limited |   |  | GuarantorSubsidiaries |   |  | Non-GuarantorSubsidiary |   |  | EliminatingEntries |   |  | ConsolidatedTotal |  
|                                                     |  | HK$000                  |   |  | HK$000               |   |  | HK$000                 |   |  | HK$000            |   |  | HK$000           |  
|Net cash (used in)/provided by operating activities  |  | (47,586                  | ) |  | 237,247               |   |  | 13,476                  |   |  | 626                |   |  | 203,763           |  
|Net cash used in investing activities                |  | (71,625                  | ) |  | (374,577              | ) |  | (9,622                  | ) |  | 49,580             |   |  | (406,244          | )
|Net cash (used in)/provided by financing activities  |  | (52,779                  | ) |  | 150,000               |   |  |                        |   |  | (50,000            | ) |  | 47,221            |  
|                                                     |  |                          |   |  |                       |   |  |                         |   |  |                    |   |  |                   |  
|Net (decrease)/increase in cash and cash equivalents |  | (171,990                 | ) |  | 12,670                |   |  | 3,854                   |   |  |                    |   |  | (155,260          | )
|Cash and cash equivalents at beginning of year       |  | 352,512                  |   |  | 29,317                |   |  | 2,031                   |   |  |                    |   |  | 383,860           |  
|Effects of foreign exchange rates changes            |  | (49                      | ) |  | (296                  | ) |  | 298                     |   |  | (206               | ) |  | (253              | )
|                                                     |  |                          |   |  |                       |   |  |                         |   |  |                    |   |  |                   |  
|Cash and cash equivalents at end of year             |  | 180,473                  |   |  | 41,691                |   |  | 6,183                   |   |  |                    |   |  | 228,347           |  
|                                                     |  |                          |   |  |                       |   |  |                         |   |  |                    |   |  |                   |  



Condensed Consolidated Statement of
Cash Flow for the Year Ended August 31, 2003



|                                                     |  |                          |   |  |                       |   |  |                         |   |  |                    |   |  |                   |  
|---------------------------------------------------- |  | ------------------------ | - |  | --------------------- | - |  | ----------------------- | - |  | ------------------ | - |  | ----------------- | -
|                                                     |  | City Telecom(HK) Limited |   |  | GuarantorSubsidiaries |   |  | Non-guarantorSubsidiary |   |  | EliminatingEntries |   |  | ConsolidatedTotal |  
|                                                     |  | HK$000                  |   |  | HK$000               |   |  | HK$000                 |   |  | HK$000            |   |  | HK$000           |  
|Net cash provided by operating activities            |  | 119,634                  |   |  | 290,376               |   |  | 4,940                   |   |  | (450               | ) |  | 414,500           |  
|Net cash used in investing activities                |  | (5,877                   | ) |  | (250,118              | ) |  | (10,718                 | ) |  | (42,921            | ) |  | (309,634          | )
|Net cash (used in)/provided by financing activities  |  | (10,274                  | ) |  | (50,564               | ) |  | 7,082                   |   |  | 43,482             |   |  | (10,274           | )
|                                                     |  |                          |   |  |                       |   |  |                         |   |  |                    |   |  |                   |  
|Net (decrease)/increase in cash and cash equivalents |  | 103,483                  |   |  | (10,306               | ) |  | 1,304                   |   |  |                    |   |  | 94,592            |  
|Cash and cash equivalents at beginning of year       |  | 249,029                  |   |  | 40,363                |   |  | 1,011                   |   |  |                    |   |  | 290,403           |  
|Effects of foreign exchange rates changes            |  |                         |   |  | (740                  | ) |  | (284                    | ) |  | (111               | ) |  | (1,135            | )
|                                                     |  |                          |   |  |                       |   |  |                         |   |  |                    |   |  |                   |  
|Cash and cash equivalents at end of year             |  | 352,512                  |   |  | 29,317                |   |  | 2,031                   |   |  |                    |   |  | 383,860           |  
|                                                     |  |                          |   |  |                       |   |  |                         |   |  |                    |   |  |                   |  



F-58



---

##### 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/ Lai Ni QuiaqueName: Lai Ni QuiaqueTitle: Chief Financial Officer




Date: January 27, 2006