Hong Kong Television Network Ltd 20-F 2008
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
For the fiscal year ended August 31, 2007
For the transition period from or
Commission file number: 333-11012
City Telecom (H.K.) Limited
(Exact name of registrant as Specified in its Charter)
Hong Kong Special Administrative Region,
The Peoples Republic of China
(Jurisdiction of Incorporation or Organization)
Tower 1, Metroplaza, No. 223 Hing Fong Road
Kwai Chung, New Territories
(Address of Principal Executive Offices)
Securities registered or to be registered pursuant to Section 12(b) of the Act:
Securities registered or to be registered pursuant to Section 12(g) of the Act:
American Depositary Shares, representing 20 Ordinary Shares, par value HK$0.10 per share
Securities for which there is a reporting obligation pursuant to Section 15(d) of the Act:
Indicate the number of outstanding shares of each of the issuers classes of capital
common stock as of August 31, 2007: 616,503,404
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
Yes ¨ No x
If this report is an annual or transition report, indicate by check mark if the registrant is not required to file reports pursuant to section 13 or 15(d) of the Securities Exchange Act of 1934.
Yes ¨ No x
If this report is an annual report, indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes ¨ No x
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes x No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of accelerated filer or large accelerated filer in Rule 12b-2 of the Exchange Act (Circle one):
Large accelerated filer ¨ Accelerated Filer ¨ Non-accelerated filer x
Indicate by check mark which financial statement item the registrant has selected to follow.
Item 17 ¨ Item 18 x
We publish our financial statements in Hong Kong dollars. In this annual report, references to Hong Kong dollars or HK$ 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$7.7968, 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, 2007. On January 23, 2008 the noon buying rate was US$1.00=HK$7.8075. 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.
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 managements 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:
When considering such forward-looking statements, you should keep in mind the factors described in Item 3 Key InformationRisk 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.
ITEM 3. KEY INFORMATION
City Telecoms 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, 2003, 2004, 2005, 2006 and 2007. 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 a measure of our operating performance or liquidity, we believe that the most directly comparable measure to EBITDA is net cash provided by operating activities. The following table reconciles our net cash provided by operating activities under HKFRSs to our definition of EBITDA on a consolidated basis for each of fiscal 2003, 2004, 2005, 2006 and 2007.
Our reassessment had the following effects on our consolidated statement of operations for the years ended August 31, 2005 and 2006:
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 Authoritys (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 HKMAs ability to back the official rate with foreign reserves.
Exchange rates between the Hong Kong dollar and other currencies are influenced by the rate between the U.S. dollar and the Hong Kong dollar.
The following table sets forth the average, high, low and period-end noon buying rate between the Hong Kong dollar and the U.S. dollar (in Hong Kong dollars per U.S. dollar) for the periods indicated:
Source: Federal Reserve Bank of New York.
B. Capitalization and indebtedness
C. Reasons for the offer and use of proceeds
D. 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 cannot assure you that we will be able to maintain an increase in total revenues and operating results
In fiscal 2007, our total revenues increased to HK$1,141.3 million from HK$1,134.9 million in fiscal 2006, and we recorded a net profit of HK$28.9 million versus a net loss of HK$142.1 million in fiscal 2006. The profit in fiscal 2007 was mainly due to our focus on increasing the average revenue per user from our fixed telecommunications network business and also from enhancing operating efficiency over the last 18 months. Moreover, the shift in the revenue composition from our international telecommunications services to our fixed telecommunications network business also represents a transition to a higher margin business model. However, we cannot assure you that we will be able to maintain the profits and business growth.
Revenues from our international telecommunications business decreased by 22.4% primarily due to a decrease in the total number of minutes by 16.4% and the intentional drop out of low profit margin subscribers. With the drop in average tariff rates and a reduced operating scale, we expect profit margins from our international telecommunications services will continue to be under pressure and less revenue will be generated in future.
Revenues from our fixed telecommunications network business increased by 14.0% in fiscal 2007, primarily due to an increase in our average revenue per user and an increase in our subscription base of 10.7%. This increase was mainly driven by the growing demand for high bandwidth broadband Internet access service. However, we cannot assure you that our fixed telecommunications network service business will continue to be profitable as we will continue to expand substantial resources in developing and marketing broadband Internet access, local VOIP, IP-TV and corporate data services.
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. Some of our main competitors for Internet access, local telephony, pay-TV and international telecommunications services have longer operating histories and others are subsidiaries of large business conglomerates. Consequently, our competitors may have resource advantages over us including as follows:
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.
Our growth and profitability could be affected by an increasing number of local and foreign entrants in the international and local telecommunications, Internet access and television broadcasting markets.
The Hong Kong government continues to liberalize access into 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 open the telecommunications market in the next several years. Some of these changes may impact our Company:
As of January 4, 2008, 253 public non-exclusive telecommunications service licenses, which we refer to as PNETS Licenses, for the provision of external telecommunications services had been issued in Hong Kong. Some of these licenses are held by subsidiaries of major foreign telecommunications providers, which have competitive advantage due to their global presence and size.
On December 31, 2007, TVB and ATV launched digital terrestrial television, which will expand the publics access to free channels in both standard and high definition. This improvement in the quality of free television may result in a reduction in the number of subscribers for pay-television services. If the number of subscribers to our pay-television service declines, it could adversely affect our results of operations.
Increasing liberalization of the telecommunications market in Hong Kong may continue to attract new local and foreign entrants to the market, which may broaden the variety of telecommunications services supplied by existing service providers, thereby heightening the overall level of competition in our industry. Increased competition could result in price reductions, reduced gross margins or loss of market share, any of which could adversely affect our future growth and profitability.
The development of our Next Generation 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 self-owned Next Generation Network, and the development of our telecommunications services. We incurred total capital expenditures of approximately HK$132.3 million in fiscal 2007. For the three fiscal years ending August 31, 2010, we expect to incur a total capital expenditure of approximately HK$850 million, the large majority of which will be spent on the continued expansion and upgrade of our network.
While we intend to fund such expenditures by using our currently available cash as well as cash flow from operations, we may not have adequate capital to fund our projected capital expenditures. Future, additional debt or equity financing may not be available, and debt financing, if available, may involve restrictions on our investing, financing and operating activities.
We may not realize the commercial 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 compete in 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 could limit the return from our investments. Specifically, we cannot assure you that services enabled by upgrading and expanding our Next Generation Network will be accepted by the public to the extent required to generate an acceptable rate of return. Furthermore, we cannot assure you that our estimate of the necessary capital expenditure to offer such services will not be exceeded. 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.
Although we have expressed our interest in Singapores Next Generation National Broadband Network project, we cannot assure you that we will be capable of participating in the project and, if we will, that this project will be successful.
We are exploring the possibility of bidding for Singapores Next Generation National Broadband Network project. See Business OverviewDevelopments in Fiscal Year 2007. To participate in this project, we may be required to structure the transactions to comply with certain restrictive covenants under the 8.75% notes that we issued in January 2005. No assurance can be given that we will be able to successfully structure the transactions. We may also require financing, which might include the issuance of equity securities and issuance of debt instruments, among other alternatives. Raising additional funds by issuing common stock or other types of equity securities would dilute our existing stockholders.
If we elect to submit a bid for the project, we cannot assure you that our bid will be accepted or, if accepted, that the awarded contract will generate sufficient revenues to result in profitability. Because the Infocomm Development Authority of Singapore (IDA) requires a bid on this project in advance of the completion of the relevant design, we are subject to the risks of unforeseen software development or other technological difficulties and/or cost overruns.
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.
The United States Securities and Exchange Commission, or the SEC, as required by Section 404 of the Sarbanes-Oxley Act of 2002, adopted rules requiring every public company to include a management report on such companys internal controls over financial reporting in its annual report, which contains managements assessment of the effectiveness of the companys internal controls over financial reporting. In addition, an independent registered public accounting firm must attest to and report on the effectiveness of the companys internal controls over financial reporting. As a non-accelerated filer, we are required to file managements first report on internal controls over financial reporting for the fiscal year ending August 31, 2008 and our first auditors attestation report on the effectiveness of our internal controls over financial reporting for the fiscal year ending August 31, 2009.
We are in the process of instituting changes to our internal controls and management systems to comply with the requirements. Among others, we are designing 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 our Audit Committee, Chairman and other senior management on a periodic basis. In addition, we hired external consultants to perform a high-level internal control gap analysis and we would hire external consultants for advisory services whenever necessary.
Notwithstanding our efforts, our management may conclude that our internal controls over our financial reporting are not effective. Moreover, even if our management concludes that our internal controls over financial reporting are effective, our independent registered public accounting firm may conclude that our internal control over financial reporting is not effective.
If we do not 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. This could subject us to regulatory scrutiny and penalties that may result in a loss of public confidence in our management, which could, among other things, adversely affect our customer and vendor confidence, stock price, our ability to raise additional capital and operate our business as projected.
Our growth and expansion may impact 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 Next Generation 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 impact our administrative, operational and financial resources. Our ability to manage our future growth will depend upon our ability to:
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.
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 rely extensively on the services of our executive officers, including Wong Wai Kay, Ricky, our Chairman, and Cheung Chi Kin, Paul, our Chief Executive Officer. 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, or if they shifted their focus away from Hong Kong operations, 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, as 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.
Expansion of our Next Generation Network into certain buildings and residences may be limited by physical limitations or our ability to obtain access permits.
Expanding our Next Generation Network coverage requires us to install fiber-to-the-home, or fiber-to-the-building, as well as install Category 5e copper wiring within residential and commercial buildings to reach the subscribers premises, which we refer to as in-building-wiring. One of our competitors 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 Next Generation Network from current 1.4 million home passes coverage to our three-year target of 2.0 million home passes. Failure to expand our network coverage will limit our growth opportunities and reduce our ability to benefit from economics of scale.
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 Next Generation 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:
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. While we continue to strengthen our network security, there is no assurance that computer viruses and other harmful attacks could not affect our business.
Risks Relating to Our Technological Infrastructure
We will be limited in our ability to continue to expand our internet access business unless we obtain additional network capacity.
Our internet access network has limited capacity. Our ability to continue to increase internet service depends on our ability to expand the network bandwidth on a timely basis, which in turn is subject to:
If we fail to increase the capacity of our international bandwidth, our ability to increase our internet access business market share and revenues will be limited.
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. Hong Kongs weather patterns often result in heavy rainfall during certain periods of the year. Any sustained 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 our key suppliers Cisco Systems Inc., Nortel Networks Limited and other suppliers to provide equipment, underground cables and other necessary components in building our Next Generation Network infrastructure, and for our VOIP equipment. In order for new subscribers 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 installation 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 acquire new subscribers or effectively appropriate our costs on to our customers. In addition, if Cisco Systems, Inc. or Nortel is unable or is delayed in providing us with the hardware required for building our fiber-based backbone infrastructure or VOIP equipment, this could negatively impact our operating results.
Our reliance on third parties to provide maintenance and repairs for our Next Generation 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.
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, some of which 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.
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. Our business and results of operations may be adversely affected by changes in the telecommunications regulations, especially in the following areas:
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 Authoritys annual renewal and HKBNs 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 Authoritys 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 Kongs telecommunications regulations or policies that would require us to obtain additional licenses could have an adverse impact on our operations.
Our revenues may be adversely affected by increases in tariffs in China.
In China, the 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 set by these agencies with respect to the calls our subscribers make to persons in China. In fiscal 2007, approximately 75% 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 and the State Development Planning Commission 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 effectively manage the increased network costs, it would have an adverse effect on our profit margins for international telecommunications services.
We have approximately 47% 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 1,200 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. As the Chinese legal system develops, changes in such laws and regulations, their interpretation or their enforcement may lead to restrictions on our ability to hire and retain our employees in China which could impact our ability to provide service to our Hong Kong based customers.
Currency fluctuations of the Hong Kong dollar, our functional currency, may increase our operating costs and long term liability.
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 Next Generation 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 are made in U.S. dollars. However, our revenues are predominantly denominated in Hong Kong dollars. Since October 17, 1983, the Hong Kong dollar has been linked to the U.S. dollar at the rate of HK$7.80 per US$1.00. We cannot assure you the link will be maintained.
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 Peoples 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 Renminbi is presently pegged to a basket of currencies, and there remains significant international pressure on the PRC government to further liberalize its currency policy. This could result in a further and more significant appreciation in the value of the Renminbi against the Hong Kong dollar, which would increase the cost of operating our call center.
Any depreciation of the Hong Kong dollar against the U.S. dollar, Renminbi 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.
Risks Relating to our Securities
We cannot assure you that we will be able to generate sufficient cash from operations to fund our operations.
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 2007, we were able to generate cash from operations of HK$384.0 million. However, we cannot assure you that we will be able to sustain our operations in order to generate sufficient cash flows to meet our future debt service requirements.
Our ability to generate cash from operations is subject to general economic, financial, 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 finance our operations and capital expenditure using cash generated from operations, we may be required to (among other things) incur additional debt, reduce capital expenditures, sell assets, or raise equity. We may not be successful in taking these actions. 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 issued in January 2005.
The 8.75% notes that we issued in January 2005 contain covenants that limit our financial and operating flexibility.
Covenants under the 8.75% notes that we issued in January 2005 restrict our ability to, among other things:
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.
ITEM 4. INFORMATION ON THE COMPANY
A. History and Development of the Company
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 Hong Kong Broadband Network Limited (HKBN) in Hong Kong in August 1999 and launched our broadband Internet access services in March 2000. In addition, we began providing local VOIP services in April 2002, IP-TV services in August 2003, and corporate data services in July 2004 using our Next Generation Network.
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 include:
B. Business Overview
We are a provider of residential and corporate fixed telecommunications network and international telecommunications services in Hong Kong. Using our self-owned Next Generation Network, we deliver fixed telecommunications network services to the residential mass market and small-to-medium corporate and enterprise market segments, at competitive prices while simultaneously offering a larger bandwidth over comparable offerings by our competitors. Our integrated suite of services includes the following:
As of August 31, 2007, we had a total of approximately 683,000 fixed telecommunications network services subscriptions, consisting of 247,000 broadband Internet access, 308,000 local VOIP and 128,000 IP-TV services subscriptions.
In addition to providing fixed telecommunications network services, we also offer international telecommunications services in Hong Kong and Canada. 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 2.3 million registered accounts. Our international telecommunications business contributed 28.4% to our total revenues in fiscal 2007 as compared to 36.9% in fiscal 2006.
On February 9, 2007, we signed a Memorandum of Understanding with MobileOne Limited to work together to participate in Singapores Next Generation National Broadband Network project (NGN). The Project relates to the provision of ultra-high speed national connectivity in Singapore at competitive prices by 2015.
Since then we have submitted our indication of interest in response to an invitation by the IDA to participate in the Pre-Qualification Exercise and Competitve Dialogue for the NGN project.
On December 11, 2007, the IDA released the terms of Request-For-Proposal (RFP) for the Network Company. Under this RFP, a company will be selected to design, build and operate the passive infrastructure layer of the project. The deployment of active electronics will be done by an operating company which will also be the entity that offers wholesale broadband access to downstream retail service providers.
Under the terms of the RFP, the Singapore Government is prepared to provide a grant of up to Singapore dollar 750 million for the project and will evaluate proposals based on four key criteria:
It is expect that the IDA will award the winning bid in the third quarter of 2008.
We are now exploring the viability of this project and are in the process of assessing if we will submit the bid. For uncertainties relating to our participation in this project, see Risks Relating to Our Business and Operations Although we have expressed our interest in Singapores Next Generation National Broadband Network project, we cannot assure you that we will be capable of participating in the project, and, if we will, that the project will be successful.
A significant majority of our revenues are derived from business conducted in Hong Kong. A breakdown of revenues by category of activity is as follows:
We will continue our business strategy to grow market share, increase our network coverage and introduce new services through our IP platform. We believe that our success will continue to depend on our ability to capitalize on our focus on the residential mass and small to medium corporate and enterprise market segments, our leading-edge Next Generation Network, and our first mover advantage in an industry with high barriers to entry.
Our operations are not generally subject to significant seasonal fluctuations. Our international telecommunications business typically experience a slight decrease in revenue during the second fiscal quarter of each year (December through February) in connection with the Christmas holiday and Chinese New Year holiday. We do not believe that seasonality has had a material effect on our business, financial condition or results of operations.
Our self-owned network is one of the worlds largest Next Generation Networks and is cited as a global reference case by our two primary vendors, Cisco Systems, Inc. and Nortel Networks Limited. Our Next Generation Network conforms to the industry standards for 10/100/1000 Mbps Internet access speeds, and covers 1.4 million home passes, which represents coverage of approximately 60% of Hong Kongs population. The coverage of our network is concentrated in Hong Kongs most densely populated areas.
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. Our strategy is to sell multiple fixed telecommunications network services using our Next Generation 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.
In November 2007, we have collaborated with one of the largest network solution providers for the deployment of the GPON in Hong Kong to deliver advanced triple play services to our subscribers and enlarge our FTTH network coverage in Hong Kong.
Our Competitive Strengths
We believe that our demonstrated success is primarily due to our ability to capitalize on the following key strengths:
Fixed Telecommunications Network Services
Next Generation Network Infrastructure
Our Next Generation 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.
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 incurred capital expenditures for our fixed telecommunications network infrastructure of approximately HK$309.1 million in fiscal 2006 and HK$132.3 million in fiscal 2007. In fiscal 2008 to fiscal 2010, we plan to further incur total capital expenditures of HK$850.0 million to continue increasing the capacity of our existing network coverage and extending the reach of our Next Generation Network. The service area of our Next Generation Network currently includes approximately 1.4 million home passes, representing approximately 60% of Hong Kongs population. We plan to extend our Next Generation Network coverage, over the next three years, to 2.0 million home passes, covering approximately 90% of Hong Kongs population. As we expand the reach and coverage of our Next Generation 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 buildings 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 profile of our fixed telecommunications network subscriptions over the past three years:
HKBN offers our broadband Internet access services in Hong Kong over our Next Generation Network. We use our broadband subscription base to up-sell our other fixed telecommunications network services such as local VOIP and IP-TV. In addition to broadband Internet access services, we maintain on a limited scale for the 56k dial-up Internet access and corporate Internet access via resale of another carriers service. 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 resale 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 between 25 Mbps and 100 Mbps. We currently offer broadband service for bb25, bb50, bb100, bb200 and bb1000 at monthly fees ranging from HK$208 to HK$1,688 for unlimited service. Moreover, we also offer FTTH broadband service for 100 Mbps, 200 Mbps and 1000 Mbps at monthly fees ranging from HK$378 to HK$1,688 for unlimited service. Currently, 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$150 to HK$17,000.
There have been many new entrants to the Internet access business, but our main competitors are PCCW-HKT (through its current 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. In November 2007, PCCW-HKT announced the provision of 100 Mbps and 1000 Mbps fiber direct broadband Internet access service to two-thirds of Hong Kongs households. 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 main 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 247,000 broadband Internet access subscriptions as of August 31, 2007, which represented a market share of approximately 13% with respect to the total number of broadband Internet access subscribers in Hong Kong.
We offer 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 Next Generation Network. Voice signals are transmitted by the VOIP switches into the Ethernet network installed in the subscribers building. The capital cost of installing VOIP switches is small
because the scalability of our Next Generation 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.
We currently charge from HK$58 to HK$99 per month for our local VOIP services depending on the service plan, and we offer a full range of value added services, including call waiting, caller display and conference call services.
We also offer 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$168 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. Moreover, we offer a full range of value added services, including call waiting, voice mail and conference call features.
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, 2007. 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, 2007, we had 308,000 local VOIP subscriptions. Our market share with respect to local residential telephony services amounts to approximately 14% as of August 31, 2007.
In August 2003 we introduced our IP-TV service that provides DVD quality video delivered via our Next Generation Network to an IP set-top-box connected to the subscribers television set. In May 2007, we renamed our IP-TV service as bbTV. This monthly subscription-based pay television service offers 83 channels consisting of a self-produced 24-hour news channel and education and recreation channels (including childrens programming), and channels whose content is obtained from other content-providers. Our news production team consists of a staff of 78 employees and produces an average of 70-80 news stories per day for our 24-hour news cycle.
Because of the scalability of our Next Generation 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 adjusted our content offerings and valued added components of the services. We consider our IP-TV to be an incremental component of our broadband and VOIP service offerings, rather than a large standalone business. As of August 31, 2007, we had 128,000 subscriptions representing approximately 8% of the total Pay-TV subscription base in Hong Kong.
Our two main competitors in the pay-TV business are i-Cable and PCCW-HKT. 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 English Premier League Football, 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 Kongs 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.
On December 31, 2007, TVB and ATV launched digital terrestrial television (DTT) to bring viewers a wide array of free programme choices, better reception and to open up new creativity platforms for television production. New free channels on standard definition television and high definition television were launched on December 31, 2007. TVB and ATV have pledged to speed up the construction of the six transmission stations to advance the target of providing coverage to 75% of the population of Hong Kong by August 2008. As DTT signals are broadcasted on new frequency channels, building management offices of each building may need to upgrade their communal aerial broadcast distribution systems for reception and distribution of DTT programmes. Viewers are also required to maintain a digital set-top-box, or buy an integrated digital television set with a built-in decoder for receiving DTT programmes. The launch of DTT by TVB and ATV may decrease the demand for pay television service.
International Telecommunications Services
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:
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 users of services are also provided discounts depending on the time of day or day of the week when the call is placed.
In fiscal 2006, we experienced a reduction in total traffic volume of 16.8% to 788 million minutes and in fiscal 2007, a further reduction in total traffic volume of 16.4% to 659 million minutes. The continuing reduction in traffic volume was mainly due to intense competition 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 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 subscribers 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 telecommunications services.
Having our own undersea cables and our fiber-based backbone has enabled us to better control international transmission quality, reduced the costs associated with international transmission and reduced our reliance on third party infrastructure. Our international telecommunications network currently has a monthly handling capacity of approximately 150 million minutes. We believe that the continuing improvement of our international telecommunications network is important in supporting the growth in our subscription base and the expansion of our range of services.
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 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.
Our three international telecommunications switching systems in Hong Kong handle telephone calls originating or 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 system 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.
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 2007. This competition drove down the average tariff rates per minute and we expect this price competition to continue in fiscal 2008. 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.
Sales and Marketing
We advertise our products and services through our on-the-street marketing kiosks, 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.
We have 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.
Maintenance and Monitoring
To ensure reliability of our fixed telecommunications network, we continue to maintain our monitoring system which involves:
Once a network fault is detected by our control room, we will either remotely rectify the situation or dispatch field staff to that location should physical interaction be required. After the situation has been resolved, we will continue to monitor network performance as well as track customer service feedback until we are assured of the fault being fully rectified.
Research and Development Activities
We commit considerable resources to our research and development department in order to continuously improve our services and improve our market position. As of August 31, 2007, our research and development department in Hong Kong consisted of approximately 30 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 Next Generation 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$11.0 million, HK$9.6 million and HK$5.0 million for fiscal 2005, 2006 and 2007, respectively.
We believe that providing excellent customer service and support is essential to building and retaining a large and loyal subscriber base. We therefore have committed considerable personnel and financial resources to establishing a reliable and accessible customer service system.
Our customer service department provides integrated support to our international and fixed telecommunications network services subscribers. We provide a hotline to handle complaints, subscription applications and queries relating to account balances, pricing, billing, service and technical information. Complaints and in-depth queries from subscribers that cannot be immediately remedied or answered are forwarded to a customer care team, which is responsible for answering such complaints and queries. We also have a dedicated customer service team to provide service to our corporate subscribers, which includes access to a highly skilled technical team that may go to the customer site for trouble shooting and repairs.
In February 2007, to further enhance customer experiences, we established a Special Duty Unit (SDU) customer care system whereby residential broadband customers are assigned a designated personal customer care executive for service account matters.
Our centralized customer service call center is located in Guangzhou which provides 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. As of August 31, 2007, our Guangzhou customer service facility had 1,264 employees.
Billing and Collection
Our credit and control team is responsible for securing prompt payment from subscribers. Invoices are issued on a monthly or quarterly basis with a specified payment due date. Variety of payment methods are used for payment collection including cash, check, credit card, payment by telephone service, automatic transfer from subscribers bank accounts or through Internet banking. Our bad
debts expense represented approximately 3.1%,1.5% and 0.6% of our revenue for each of fiscal 2005, 2006 and 2007, respectively. Bad debts expense for fiscal 2005 was higher compared to fiscal 2006 and 2007 due to the recognition of a provision of HK$19.5 million for mobile interconnection charges in 2005. The lower bad debt expenses in fiscal 2007 was due to the reversal of HK$9.4 million of a previously recognized provision for doubtful accounts as a result of the issuance of the Final Determination for the mobile interconnection charges. For more information regarding our provision for mobile interconnection charges, see Our Revenues Fixed Telecommunications Network Services above in this annual report.
We maintain tight collection procedures including periodic reminder notices, late payment fee of 1.5% per month on outstanding overdue amount, right to charge the outstanding overdue amount to the subscribers pre-registered credit card account or, if applicable, deduct the outstanding overdue amount from the subscribers application deposit. Moreover, we generally suspend an account if the outstanding overdue amount is not settled within our prescribed period. If payment is still not settled after we suspend the account, further recovery actions including court proceedings and/or the use of collection agencies will be taken.
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.
The following is a brief summary of the Hong Kong laws and regulations that currently materially affect our business. This section does not purport to be a comprehensive summary of all present and proposed regulations and legislation relating to the industries in which we operate.
C. Regulatory Framework
As a provider of broadband Internet access, local VoIP, IP-TV and international telecommunications services in Hong Kong, our operations are subject to the Telecommunications Ordinance and the Broadcasting Ordinance and their respective subsidiary legislation, regulations and codes of practice. The Telecommunications Ordinance provides the legislative and regulatory framework for the provision of telecommunications services and facilities in Hong Kong. The Broadcasting Ordinance governs the content and scope of television programming and the licensing of television broadcasters.
Our primary regulator is the Telecommunications Authority, whose responsibility and functions include regulating and licensing telecommunications network services and regulating the telecommunications markets in Hong Kong, including 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). The Telecommunications Authority is also responsible for the administration of the Telecommunications Ordinance. We are also regulated by the Broadcasting Authority, which administers the Broadcasting Ordinance and makes recommendations to the Chief Executive-in-Council on applications for broadcasting licenses, as well as on the renewal, suspension and revocation of licenses.
It is unlawful to establish or maintain any means of telecommunications, or possess, use or deal with telecommunications apparatus in Hong Kong without a license. The Telecommunications Authority has the authority to grant licenses for all means of telecommunications services and facilities in Hong Kong, including the provision of fixed wireline, public mobile telephone, internet and satellite services. Furthermore, the Telecommunications Authority has the authority to require a licensee to comply with the terms of its license and any applicable legislation or regulations or codes of practice, and to suspend or revoke licenses to enforce the Telecommunications Ordinance or other rules or regulations or codes of practice to protect the public interest.
Currently, there are four 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, the third relating to the operation of Citizen Band Radio by the public for recreational and other communications purposes and the fourth relating to the provision of telecommunications services to the general public without establishment, operation or maintenance of telecommunications equipment.
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 proposing to abolish the distinction between fixed and mobile carrier licenses and establishing a single Unified Carrier License, or UCL which would encompass both fixed and mobile carrier services. The Telecommunications Authority has jointly with the Commerce and Economic Department Bureau issued a consultation paper inviting public submissions on this issue. The Telecommunications Authority is currently expected to make its decision after the consultations close in February 2008.
General Licensing Requirements
Generally, a licensee is required to be a company incorporated in Hong Kong (which can be wholly owned by a foreign company) or a foreign company registered in Hong Kong. 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, at the recommendation of the Telecommunications Authority, to revoke a telecommunications license at any time if it is in the public interest to do so.
Public Non-Exclusive Telecommunications Services License
A PNETS License is used by the Telecommunications Authority to cover the provision of a number of different telecommunications 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 Telecommunications Ordinance but none of the existing categories are applicable to the means of telecommunications or telecommunications service for which the license is required.
A PNETS License has a validity period of 12 months and is 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.
We currently hold a PNETS ETS License, which was issued to us in November 1998. This PNETS ETS License has been subsequently amended twice and presently gives us the right to provide calling card services, international simple resale services for facsimile and data services, virtual private network services and external telecommunications services over the external telecommunications facilities of other licensed external facilities providers. We also hold a PNETS IVANS License, which was issued to us in December 1993. This PNETS IVANS License allows us to act as an Internet Service Provider.
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.
Fixed Telecommunications Network Services License
A FTNS License authorizes the licensee, among other things:
A FTNS License is valid for a period of 15 years and is renewable for a further period not exceeding 15 years at the Telecommunications Authoritys discretion. The amount of license fee payable by a holder of a FTNS License 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.
HKBN, our wholly-owned subsidiary, currently holds a FTNS License, which was issued to it in February 2000 initially for the operation of a local fixed wireless network. This FTNS License has been subsequently amended three times and presently, HKBN is authorized to operate both local fixed telecommunications networks (wireline and wireless based) and external telecommunications facilities.
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 carriers 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 introduced the Type II interconnection policy in 1995 that the fixed carriers have obligation to provide Type II interconnection at regulated terms and conditions. But, in July 2004, the Government decided the policy at the telephone exchange level to be withdrawn before June 30, 2008.
Regulation of Anti-Competitive Conduct
Although Hong Kong has never had a general competition code, historically, holders of FTNS Licenses were prohibited from engaging in anti-competitive conduct, abusing its dominant position in a telecommunications market, or engaging in any discriminatory conduct by certain competition-related license conditions contained in the FTNS Licenses issued by the Telecommunications Authority. In June 2000, the competition provisions of the Telecommunications Ordinance became operational and, as from that time, anti-competitive conduct was prohibited by legislation as well as under the relevant licence conditions.
The Telecommunications Ordinance provides an appeal mechanism by the establishment of a Telecommunications (Competition Provisions) Appeal Board. A person or a licensee aggrieved by a decision made by the Telecommunications Authority relating to the competition provisions may appeal to the Board. Additionally, a third party suffering loss or damage from breach of such competition provisions may bring an action for damages or seek other appropriate remedies against the offending licensee.
Control on Mergers and Acquisitions
If the Telecommunications Authority determines that the relevant merger and acquisition activity has, or is likely to have, the effect of preventing or 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. 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.
The regulatory regime on mergers and acquisitions only applies to carrier licensees, which includes HKBN as a holder of a FTNS License, which is regarded as a carrier license for the purpose of the Telecommunications Ordinance.
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 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 licensees compliance with the guidelines will be taken into account in assessing if a licensee has complied with the statutory provision mentioned above.
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), the Unconscionable Contracts Ordinance (Cap 458) , Personal Data (Privacy) Ordinance (Cap 486), and the Unsolicited Electronic Messages Ordinance (Cap 593).
Regulation of Pricing
Currently, the pricing of both fixed telecommunications network services and public non-exclusive external telecommunications services in Hong Kong is regulated by license conditions. However, the regulatory frameworks of each type of services are different.
All PNETS Licenses contain license conditions requiring the licensees to publish their tariffs and to charge no more than the published tariffs.
Similarly, holders of FTNS Licenses are prohibited by license conditions from charging more than their published tariffs for their services. 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.
Universal Service Contribution and Local Access Charge
Under the current regulatory regime, PCCW-HKT has a universal service obligation to provide good, efficient and continuous basic telecommunications services at reasonable cost on a non-discriminatory basis to all persons in Hong Kong. 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 (USC). Holders of FTNS Licenses and PNETS ETS Licenses, including ourselves, HKBN, and IDD1600 are required to pay USC.
The level of USC is determined by the Telecommunications Authority and is reviewed periodically based on actual cost and revenue and on a customer-by-customer basis. The average rate has declined over the past several years. In accordance with a statement dated December 28, 2007 issued by the Telecommunications Authority, the level for the period from January 1, 2005 to June 30, 2007 is confirmed to be zero cent per minute. In the circumstances, PCCW-HKT must refund to all USC contributing parties HK 0.3 cent per minute already paid before and there will not be any interest payment for the adjustment of those USC. The level of USC from July 1, 2007 onwards is to be determined by the Telecommunications Authority.
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 (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 and its arrangement is based on the statement dated November 25, 1998 issued by the Telecommunications Authority. Recently, based on the conclusion from the statement dated April 27, 2007 issued by the Telecommunications Authority, the Telecommunications Authority will not, for the time being, proceed with the complete deregulation of LAC.
Fixed Mobile Interconnection Charge
Fixed Mobile Interconnection Charge, or FMIC, is an interconnection charge for circuit-switched traffic between a Fixed Network Operator and a Mobile Network Operator. The rate of FMIC is currently set by the Telecommunications Authority. The current level of FMIC charged by the incumbent Fixed Network Operator, PCCW Limited is HK$4.36 cents per occupancy minute, as determined by the Telecommunications Authority in November 2004. In June 2007, the Telecommunications Authority determined the FMIC rates for Hong Kong Broadband Network Limited, or HKBN, our wholly owned subsidiary which is a Fixed Network
Operator, with one of its Mobile Network Operators, China Resources Peoples Telephone Company Limited, or Peoples, at a rate of HK$4.8 cents per occupancy minute from April 1, 2002 to August 31, 2002, HK$4.22 cents per occupancy minute from September 1, 2002 to August 31, 2003 and HK$2.89 cents per occupancy minute from September 1, 2004 to August 31, 2004. However, in its statement published on April 27, 2007, the Telecommunications Authority has indicated that it will de-regulate the existing FMIC arrangement with effect from April 27, 2009. When this occurs the Fixed and Mobile Network Operators would have to adopt a more market driven approach in that parties are expected bilaterally to negotiate a commercially agreed FMIC without the Telecommunications Authoritys intervention.
Television Broadcasting Industry
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 Media Limited 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.
It is unlawful to offer any television programme service in Hong Kong without a license. 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 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, however, 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 HKBNs 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.
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 includes, for example, a company which is an existing domestic free or domestic pay television program licensee; an advertising agent; a sound broadcasting licensee; or a proprietor of newspaper printed or produced in Hong Kong.
Generally, a disqualified person who has complied with the disclosure requirement may apply for a broadcasting license. 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.
The Broadcasting Ordinance also contains competition provisions, which are aimed at prohibiting a licensee from engaging in anti-competitive conduct and a licensee who is in a dominant position from abusing its position. Anti-competitive conduct is defined as conduct that has the purpose or effect of preventing, distorting or substantially restricting competition in a television program service market.
The Broadcasting Ordinance provides that a breach of any of the competition statutory provisions may lead to the relevant contractual provisions in an agreement being regarded as void.
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.
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 latest program standards and the advertising standards were both issued on May 4, 2007.
D. Organizational Structure
The following chart sets forth our principal subsidiaries as of January 21, 2008:
The jurisdiction of incorporation and our ownership percentage of each these subsidiaries as of January 21, 2008 were as follows:
E. Property, Plants and Equipment
For the provision of fixed telecommunications network services, we own, or control through long-term leases, equipment consisting of switching, transmission and power equipment and connecting lines comprised of in-building wiring, fiber-based backbone, wireless and leased wire-line backbone and other support structures, conduits and similar items that comprise our Next Generation Network. The majority of the fiber-based backbone connecting our services 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 two retail shops and for a 3,500 square foot customer service center in Mongkok.
We rely on key supplier Cisco Systems Inc., Nortel Networks Limited and other suppliers to provide equipment, underground cables and other necessary components in building our Next Generation Network infrastructure, and 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 installation 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 acquire new subscribers or effectively appropriate our costs on to our customers.
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.
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.
We are a provider of residential and corporate fixed telecommunications network 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 Next Generation Network. As of August 31, 2007 we had a total of approximately 683,000 fixed telecommunications network services subscriptions. In addition to providing fixed telecommunications network services, we are a provider 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 2.3 million registered accounts.
Our self-owned network is one of the worlds largest Next Generation Networks and is cited as a global reference case by our primary vendors, Cisco Systems, Inc. and Nortel Networks Limited. Our Next Generation Network has a current coverage of 1.4 million home passes, which represents approximately 60% of Hong Kongs population. The coverage of our network is concentrated in Hong Kongs most densely populated areas, which reduces our cost of network deployment per home pass.
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 also offer international telecommunications services to our FTNS customers and to other carriers customers via indirect access. Indirect access allows any pre-registered telecom user in Hong Kong to access our services via our two primary access codes 1666 and 0030. By dialing our access code, our registered customers can access any destination in the World, allowing us to generate a usage charge.
Factors Affecting Our Results of Operations
Fixed Telecommunications Network Services. We charge our customers a monthly service charge for each of the fixed telecommunications network services that we provide, and the scalability of our network allows us to sell additional services to our existing customers, for example adding local VOIP or IP-TV services to our current broadband Internet subscribers, with minimal additional network and operating costs. As a result, each new service we add to our existing subscription base contributes significantly to our profitability. We have not generally sold our fixed telecommunications network services bundled together at discounted rates. Instead, we have focused on increasing our subscription base by offering a single service to new subscribers at an attractive entry price. After the customer has begun to use our service, we then try to up-sell additional services to the customer.
In addition to the monthly service charges generated by our fixed telecommunications network business, we also receive interconnection charges from other telecommunications operators in Hong Kong that use our network to deliver their customers telecommunications traffic.
As a Fixed Telecommunications Network Services, or FTNS, licensee, HKBN, a wholly-owned subsidiary of the Company, is obliged to provide interconnection services to enable delivery of telecommunications service to customers of different operators, including mobile network operators. Unless an agreement cannot be reached, the rate of such interconnection charges are subject to commercial agreement between interconnecting parties. Since the issuance of its FTNS license, HKBN has been charging mobile network operators for its interconnection services 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, the incumbent FTNS operator. We have recognized all such mobile interconnection charges as revenue. As of August 31, 2007, the majority of the mobile interconnection charges billed to mobile network operators had not been collected.
In May 2004, the Telecommunications Authority confirmed that mobile network operators are obliged to pay interconnection charges to HKBN in accordance with the charging principles promulgated by the Telecommunications Authority. Certain mobile network operators, however, disputed the basis of our calculation. In August 2004, to resolve our dispute with one mobile network operator, we asked the Telecommunications Authority to make a determination on the level of interconnection charges payable by such mobile network operator to HKBN and the effective date of the determined interconnection charges.
In November 2005, HKBN entered into contractual agreements with two other mobile network operators, who agreed to pay to HKBN on interim mobile interconnection charges at a rate based on PCCW-HKTs published fully distributed cost model of HK$0.0436 per occupancy minute until the Telecommunications Authority issued its final ruling.
In March 2006, the Telecommunications Authority, or TA, made a confidential preliminary analysis (the 2006 PA) on the Determination with respect to the rates of mobile interconnection charges payable by mobile operators under dispute and the timing of the Determination. The final level of mobile interconnection charges was then subject to the Determination to be issued by TA. As a result of the foregoing, in fiscal 2006, we recognized mobile interconnection charges of HK$46.7 million, which included mobile interconnection charges for fiscal 2005 previously not recognized due to the uncertainties existing at that time and charges for fiscal 2006, both of which were measured based on the 2006 PA.
In March 2007, the TA issued a revised confidential preliminary analysis (the 2007 PA) which superseded the 2006 PA. The 2007 PA set out the rates of mobile interconnection charges, which are different from those rates stated in the 2006 PA. In June 2007, the TA issued a final determination (the Final Determination) which set out the rates of mobile interconnection charges payable by the mobile operator under dispute, which approximate the rates stated in the 2007 PA.
Based on the Final Determination, we recorded mobile interconnection charges of HK$40.9 million in fiscal 2007 which include charges for the current fiscal year and additional charges for fiscal 2005 and 2006 previously measured based on the 2006 PA. We have also reversed a portion of the provision for doubtful accounts for mobile interconnection charges receivables of HK$9.4 million based on the amount we expected to collect for billings outstanding through August 31, 2007.
Our total international telecommunications services customer database comprises approximately 2.3 million registered accounts. During fiscal 2007, we experienced a reduction in total traffic volume of 16.4% to 659 million minutes. 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 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 22.4% to HK$324.5 million in fiscal 2007.
Substantially all of our international telecommunications revenues are generated by the per minute tariff rate 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 and we also provide certain discounts that depend on the time of day or day of the week at which the call is placed.
Network Costs. Network costs vary according to either our network capacity or our traffic volume. Such costs mainly include leased line rentals, program fees and production costs for the IP-TV service and costs of inventories sold, local interconnection charges payable to other local fixed network operators and interconnection charges payable to international bandwidth providers and do not include depreciation charge which is included in general and administration expenses.
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. 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 include salaries and related costs, office, general and administrative costs and depreciation and amortization. Salaries and related costs include those employees working on our various service offerings and on maintaining and operating our Next Generation Network.
Critical Accounting Policies
Our consolidated financial statements have been prepared in accordance with HKFRSs. Accounting principles generally accepted in Hong Kong 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 29 to our consolidated financial statements. Our significant accounting policies are more fully described in note 2 to our consolidated financial statements. The preparation of our financial statements in conformity with HKFRSs 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, provision for doubtful accounts, deferred taxes, USC charges and certain revenue items. We base our estimates and judgments on historical experience and on various other factors 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. The estimates and underlying assumptions are reviewed on an ongoing basis. Revisions to accounting estimates are recognized in the period in which the estimate is revised if the revision affects only that period or in the period of the revision and future periods if the revision affects both current and future periods.
Our accounting policies have been developed over many years as the telecommunications industry and generally accepted accounting principles have evolved. As our financial statements are prepared under HKFRSs, our accounting policies are necessarily compliant with all aspects of HKFRSs. HKFRSs 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 HKFRSs requirements, we also consider telecommunications industry practice in other countries. Where there is no conflict with HKFRSs 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 started providing broadband Internet access service in 2000 and substantially completed the construction of the fibre backbone network in fiscal 2005. With only a short history of operating the broadband business, we assessed the estimated useful lives of our network assets based on our knowledge and expected usage at that time. As we have gained more experience and knowledge of the broadband business, our expected usage of the assets and the impact of certain new telecommunication technologies indicated that we should re-evaluate the estimated useful lives of our network assets.
During the second half of fiscal 2007, we reviewed the estimated useful lives of fixed assets based on technology considerations, actual business experience, consultation with internal experts and external valuation firm and industry benchmarks. Based on such review, certain classes of network assets are expected to operate beyond their original estimated useful lives and as such the estimated useful lives of the fibre network and related peripherals have been revised from 4-15 years to 6-20 years effective from June 1, 2007.
The change in the estimated useful lives is a change in accounting estimate that is accounted for prospectively from June 1, 2007. As a result of such change, the depreciation expense decreased by HK$15.9 million, and both income before taxation and net income after taxation increased by HK$15.9 million for fiscal 2007. The increase in net income resulted in a HK$2.6 cents increase in both basic earnings per share and diluted earnings per share. This change also increased each of total assets, retained profits and total shareholders equity for fiscal 2007 by HK$15.9 million.
Impairment of fixed assets
Under HKFRSs 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. Under HKFRSs, 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 assets residual value on disposal, discounted at the financial assets original effective interest rate. Where the recoverable amount of fixed and other long-lived assets is less than their carrying value, an impairment loss is recognized to write down the assets to their recoverable amount, which is based on the fair value or discounted estimated cash flows.
Under U.S. GAAP, recoverability of assets is measured by a comparison of the carrying amount of an asset to estimated undiscounted future cash flows, an impairment charge is recognized by the amount by which the carrying amount of the asset exceeds the fair value of the asset which is the amount the asset can be bought and sold in a current transaction between willing parties.
Estimation of cash flows arising from future use of the asset requires careful analysis regarding what we expect to recover from its future use. This includes consideration of our target market share and customer base, market competition, future changes to our cost structure and technological change. In addition, the residual value of the asset on disposal requires judgment, as the estimated fair value of the asset at the time of disposal could change in response to market conditions and changes in expected use of the asset prior to disposal. Changes in the estimate of cash flows arising from expected future use of the asset or its residual value on disposal based on changes in market conditions, changes in the use of assets, management 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, 2007, except for investment property, no impairment loss was recognized based on the estimated recoverable amount of our long-lived assets. The Company has assessed the open market value of the investment property and based on such assessment, the carrying amount has been written down by HK$1.1 million for the year ended August 31, 2006. There was no difference between HKFRSs and U.S. GAAP in the accounting for the impairment in our investment property because the investment property represents the lowest level at which cash flows can be identified that are largely independent of the cash flows of other asset groups and its carrying value before the recognition of an impairment loss was higher than its recoverable amount.
Under HKFRSs 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 consolidated statement of operations. Changes in the collectibility of accounts receivable for which provisions are not made could affect our future results of operations.
Included in the accounts receivable balance (net of provision for doubtful accounts) are receivables for mobile interconnection charges of HK$49.8 million, HK$62.1 million and HK$103.8 million as of August 31, 2005, 2006 and 2007, respectively. The balance represented mobile interconnection charges we billed to the local mobile network operators and the majority of which, however, had not been collected.
Changes in the provision for doubtful accounts consist of:
Under HKFRSs, we recognized deferred tax assets for all deductible temporary differences, and operating loss carry forwards to the extent it is probable that future taxable profits will be available against which the asset can be utilized.
In assessing whether a deferred tax asset is expected to be utilized in the foreseeable future, we consider all available evidence, including projected future taxable profit by taking into consideration of 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, a valuation allowance against deferred tax assets is recorded if we determine it is more likely than not that we will not be able to utilize such benefits in the future.
The recognition of 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 judgment 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 HKFRSs and U.S. GAAP.
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.
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 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 recognized as revenue on a
straight-line basis over 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 on mobile interconnection charges at which revenue is recognized involved significant estimates by management. Significant changes in management estimates may result in material revenue adjustments.
Mobile network operators are obliged to pay interconnection charges to HKBN in accordance with the charging principles promulgated by the Telecommunications Authority. Because certain local mobile network operators disagreed with the level of charges computed by HKBN, the majority of the mobile interconnection charges billed by HKBN had not been collected as of August 31, 2007. We recognize 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. The amount recognized for the fiscal 2004 or before was determined using the available rates under the existing calculation model (fully distributed cost model) for interconnection service between fixed and mobile operators, which are based on historical cost data of PCCW-HKT Telephone Limited. The amount recognized in fiscal year 2005 reflects a discount from the amount billed which is determined based on our assessment of the range of likely outcomes from the determination process. The amount recognized in fiscal year 2006 is based on the preliminary rates from the Telecommunications Authority as we await a final ruling by the Telecommunications Authority on the level of charges payable by one of the operators. The amount recognized in fiscal year 2007 is based on the final determination which set out the rates payable by a mobile operator under dispute. For a discussion of our revenue recognition of mobile interconnection charges, please refer to Our Revenues-Fixed Telecommunications Network Services above in this Item 5 of this annual report and notes 25(c) to our consolidated financial statements. Actual amounts realized could be different from our estimate.
Fair value of share options
In assessing the value of the share options granted, Black-Scholes option pricing model (the Black-Scholes Model) has been used. The Black-Scholes Model is one of the most generally accepted methodologies used to calculate the value of options and the assumptions used in the Black-Scholes Model include expected life of the options, risk-free interest rate, expected volatility, expected dividend yield and the market value of the ordinary shares of the Company.
The Black-Scholes Model, applied for determination of the estimated fair value of the share options granted under the Companys share option scheme was developed for use in estimating the fair value of traded options that are fully transferable and have no vesting restrictions. Such an option pricing model requires input of assumptions, including the expected stock volatility, and expected dividend yield. As the Companys share options have characteristics significantly different from those of traded options, the determination of fair value of the options granted is sensitive to certain assumptions used in the valuation model, in particular the expected volatility.
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 which would be charged to our income statement in the future.
A. 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, 2007, 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 2007, they contributed approximately 1.8% to our revenues.
The following table sets forth, for the years indicated, a summary of our results of operations.
Year Ended August 31, 2007 Compared to Year Ended August 31, 2006
Revenues. Our total revenues increased by 0.6% to HK$1,141.3 million in fiscal 2007. The 22.4% decline in our international telecommunications services revenues to HK$324.5 million in fiscal 2007 offset our 14.0% increase in FTNS revenues to HK$816.8 million in fiscal 2007.
Our fixed telecommunications network services continued to record significant revenue growth and increased their contribution to our total revenues, accounting for 71.6% of total revenues in fiscal 2007, compared to 63.1% and 54.2% in fiscal 2006 and fiscal 2005, respectively. During fiscal 2007, our FTNS subscription base increased 10.7% to 683,000. This return to growth is an indicator that the market has now accepted a premium pricing positioning.
With respect to voice services, our VOIP subscription base rose by 9.6%, to 308,000 subscriptions due to improved branding and crossing selling from our broadband customers.
With respect to broadband services, our subscription base rose by 12.3%, to 247,000 subscriptions. During fiscal 2007, we focused on differentiating our services by emphasizing our ultra high Internet access speeds, which allow us to increase our average revenue per user. By providing stable and high speed broadband services and reliable customer service, we aim to acquire and retain customers with longer subscription period at higher price. This has significantly increased our revenue from our fixed telecommunications network services.
With respect to IP-TV services, our subscription base increased by 10.3% to 128,000 subscriptions, with the majority of the new subscriptions coming from existing broadband and voice customers.
Our international telecommunications business revenues decreased by 22.4% to HK$324.5 million in fiscal 2007 due to the combined effects of lower volumes and lower revenue per minute. Competition during the year was intense as some of our integrated competitors offered international direct dial minutes for free or at very low cost as a marketing incentive to gain local fixed line and mobile market share. Further, technology 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 decreased by 28.6% to HK$214.6 million in fiscal 2007 mainly due to a reduction in international tariff volume and less reliance on third parties backhaul for our FTNS business.
Other operating expenses. Our other operating expenses, excluding network costs, decreased by 9.3% to HK$834.1 million in fiscal 2007.
Salaries and related costs. Salaries and related costs decreased by 16.1% to HK221.1 million in fiscal 2007. During fiscal 2007, we increased our total work force by 4.9% to 2,692 employees due to the expansion of operations in fixed telecommunications network services. The reduction in salaries and related costs was mainly due to the flow over benefits from streamlining the work force in fiscal 2006.
Sales and marketing expenses. Our sales and marketing expenses increased by 6.9% to HK$219.2 million in fiscal 2007 as we increased our sales and marketing efforts in brand building through mass media advertising. We started a strategy of promoting the brand to a wider audience. A series of 1 minute mini programs were shown to educate viewers on the merits of HKBNs high bandwidth Next Generation Network.
Office, general and administrative expenses. Office, general and administrative expenses decreased by 21.4% to HK$129.1 million in fiscal 2007 mainly as a result of last years operational efficiency plan and cost savings due to the decentralization of authority to department heads.
Depreciation and amortization. Depreciation and amortization expenses decreased by 6.7% to HK$258.1 million in fiscal 2007 mainly due to changes in the estimated useful lives of certain assets amounting to HK$15.9 million.
During the second half of fiscal 2007, we reviewed the estimated useful lives of fixed assets based on technology considerations, actual business experience, consultation with external valuation firm and industry benchmark. Based on the review, the estimated useful lives of certain classes of network assets have been extended from 4-15 years to 6-20 years effective from June 1, 2007.
The change in the estimated useful lives is a change in accounting estimate that is accounted for prospectively from June 1, 2007. As a result of such change, depreciation expense decreased by HK$15.9 million for the year ended August 31, 2007. Earning per share is also increased by 2.6 cents. This change does not have any effect on the total depreciation charges of those assets during their remaining useful lives.
Provision for doubtful accounts. Overall, our provision for doubtful accounts decreased to HK$6.6 million in fiscal 2007 mainly due to the reversal of previously recognized provisions for mobile interconnection charges receivable. In fiscal 2006, we recorded a provision of HK$20.8 million for mobile interconnection charges receivable accumulated from previous years following our assessment of the collectibility of these charges. In fiscal 2007, we have reversed a portion of this provision by HK$9.4 million based on the rates set by the TA in the final determination issued in June 2007. Our provision for other trade receivables recorded in fiscal 2007 was HK$16.0 million compared to the HK$17.5 million in fiscal 2006. For more information regarding our provisions for mobile interconnection charges, see Our RevenuesFixed Telecommunications Network Services above in this annual report.
Income from operations. We recorded an income from operations of HK$92.6 million in fiscal 2007, compared to a loss from operations of HK$85.5 million in fiscal 2006. The income from operations is due to higher revenue contribution from fixed telecommunications network services and the increase in margin from our international business services as a result of the drop off of low margin customers.
Interest income and expense. Our interest income was HK$22.7 million in fiscal 2007 compared to HK$20.4 million in fiscal 2006. The increase in interest income was due to a strong net cash inflow from our operations and a favorable interest rate environment. We derive interest income from our deposit of surplus capital in interest-bearing accounts at commercial banks. Our interest expense in fiscal 2007 was HK$87.5 million which is comparable to HK$88.6 million in fiscal 2006. Such interest expense was predominantly due to the interest expense of our 8.75% notes issued in January 2005.
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 and management and other fees we received in the ordinary course of our business. Other income, net of expenses was HK$3.1 million in fiscal 2007 compared to HK$4.5 million in fiscal 2006. The other income, net in fiscal 2007 mainly includes and net realized and unrealized gains on investment securities and derivative financial instruments of HK$1.8 million.
Income tax (expense)/credit. We recognized income tax expense of HK$2.0 million for fiscal 2007 compared to an income tax credit of HK$7.2 million in fiscal 2006. Our income tax expense in fiscal 2007 was mainly due to the tax paid by one of our subsidiaries in Guangzhou. Our income tax credits in fiscal 2006 were mainly related to the recognition of deferred tax assets in respect of the tax losses from our fixed telecommunications network services business offset by the income tax expense associated with the profit generated from our international telecommunications services.
Net income. For the foregoing reasons, we had a net income of HK$28.9 million in fiscal 2007 compared to a net loss of HK$142.1 million in fiscal 2006.
Year Ended August 31, 2006 Compared to Year Ended August 31, 2005
Revenues. Our total revenues decreased by 2.3% to HK$1,134.9 million in fiscal 2006 due to a significant decrease in revenues from our international telecommunications services. The 21.5% decline in our international telecommunications services revenues to HK$418.3 million in fiscal 2006 offset our 13.8% increase in FTNS revenues to HK$716.6 million in fiscal 2006.
Our fixed telecommunications network services continued to record significant revenue growth and increased their contribution to our total revenues, accounting for 63.1% of total revenues in fiscal 2006, compared to 54.2% and 46.3% in fiscal 2005 and fiscal 2004, respectively. During fiscal 2006, our FTNS subscription base declined 2.2% to 617,000 as of August 31, 2006 as we placed a priority on revenue yields by increasing revenue per user over subscription growth.
With respect to voice services, our VOIP subscription base fell by 4.1% year-on-year, to 281,000 subscriptions due to intensive competition.
With respect to broadband services, our subscription base fell by 3.9% year-on-year, to 220,000 subscriptions. During fiscal 2006, we focused on differentiating our services by emphasizing our high internet access speeds, which allow us to increase our revenue per user. By providing stable and high speed broadband services and good quality of customer service, we are able to acquire and retain customers with longer subscription period at higher price. This has significantly increased our revenue in fixed telecommunications network services despite a decrease in our subscription base.
With respect to IP-TV services, we grew our subscription base by 6.4% to 116,000 subscriptions, with the majority of the new subscriptions being an upsell to existing broadband and voice customers.
Our international telecommunications business revenues decreased by 21.5% to HK$418.3 million in fiscal 2006 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. As a result, we expect that our international telecommunications business continues to decline in future.
Network costs. Network costs decreased 11.4% to HK$300.6 million in fiscal 2006 mainly due to a reduction in international tariff volume.
Other operating expenses. Our other operating expenses, excluding network costs, decreased by 4.0% to HK$919.8 in fiscal 2006.
Salaries and related costs. Salaries and related costs decreased by 1.0% to HK256.7 million in fiscal 2006. During fiscal 2006, we reduced our total work force by 34.2% to 2,565 employees with the majority of the reductions occurring towards the end of the fiscal year. The reduction in our work force was a result of our efforts to eliminate duplication of operational procedures and to enhance efficiency and improve quality of our work flows. The aggregate amount of severance payments made was not significant, as most of the terminations of employment were voluntary.
Sales and marketing expenses. Our sales and marketing expenses decreased by 23.5% to HK$205.0 million in fiscal 2006 as we switched our sales and marketing efforts from costlier mass media advertising to word-of-mouth efforts. Word-of-mouth results from existing customers sharing their positive service experience with their associates, thereby enhancing our brand value without the need for direct advertising expenditure.
Office, general and administrative expenses. Office, general and administrative expenses increased by 4.3% to HK$164.2 million in fiscal 2006 mainly due to increase in rental expenses as a result of inflationary pressures.
Depreciation and amortization. Depreciation and amortization expenses increased by 16.3% to HK$276.5 million in fiscal 2006 mainly due to expansion of our Next Generation Network.
Provision for doubtful accounts. Overall, our provision for doubtful accounts decreased by 50.8% to HK$17.4 million in fiscal 2006 mainly due to the decrease in provision for mobile interconnection charges receivable. In fiscal 2005, we recorded a provision of HK$19.5 million for mobile interconnection charges receivable accumulated from previous years following our assessment of the collectibility of these charges. In fiscal 2006, we increased such provision by HK$1.3 million to HK$20.8 million based on the preliminary rates from the Telecommunications Authority. Provision for other trade receivables recorded in fiscal 2006 was HK$16.1 million which is comparable to the HK$15.9 million in fiscal 2005. For more information regarding our provision for mobile interconnection charges, see Our RevenuesFixed Telecommunications Network Services above in this annual report.
Loss from operations. We suffered loss from operations of HK$85.5 million in fiscal 2006, compared to loss from operations of HK$135.4 million in fiscal 2005. The loss from operations is due to reduced profitability of our international telecommunications business as a result of intense competition from local telecommunications services companies and global VOIP providers and losses from our FTNS business.
Interest income and expense. Our interest income was HK$20.4 million in fiscal 2006 compared to HK$13.6 million in fiscal 2005. The increase in interest income was due to the full year impact of investment return on proceeds from our 8.75% notes issued in January 2005 and a higher overall interest rate environment. We derive interest income from our deposit of surplus capital in interest-bearing accounts at commercial banks. Our interest expense increased to HK$88.6 million in fiscal 2006 compared to HK$54.5 million in fiscal 2005, predominantly due to the full year impact of interest expense of our 8.75% notes issued in January 2005.
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$4.5 million in fiscal 2006 compared to HK$6.0 million in fiscal 2005. The other income, net in 2006 mainly includes net exchange gains of HK$1.1 million, net realized and unrealized gains on investment securities and derivative financial instruments of HK$0.6 million and penalty received from contractors of HK$0.3 million.
Income tax( expense)/credit. We recognized income tax credit of HK$7.2 million for fiscal 2006 compared to income tax credit of HK$6.7 million in fiscal 2005. Our income tax credits in fiscal 2006 and fiscal 2005 were mainly related to the recognition of deferred tax assets in respect of the tax losses from our fixed telecommunications network services business offset by the income tax expense associated with the profit generated from our international telecommunications services.
Net loss. For the foregoing reasons, we incurred a net loss of HK$142.1 million in fiscal 2006 compared to a net loss of HK$163.5 million in fiscal 2005.
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 contribution to our total revenues. Revenue from FTNS accounted for 54.2% of our 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 20.8% from HK$793.2 million during fiscal 2004 to HK$958.0 million during fiscal 2005.
Salaries and related costs. Salaries and related costs increased by 14.4% from HK$226.7 million during fiscal 2004 to HK$259.4 million during fiscal 2005. 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.
Sales and marketing expenses. Our sales and marketing expenses increased by 17.4% from HK$228.2 million during fiscal 2004 to HK$268.0 million during fiscal 2005. Sales and marketing increased due to several marketing programs that we utilized to grow our FTNS 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. 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.
Office, general and administrative expenses. Office, general and administrative expenses increased by 21.4% from HK$129.8 million in fiscal 2004 to HK$157.5 million in fiscal 2005 due mainly to our expanded office and warehouse space and higher equipment maintenance costs.
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 due to the increased capital expenditures that we incurred for the upgrade and expansion of our Next Generation Network.
Provision for doubtful accounts. Our provision for doubtful accounts increased by 208.2% 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. We recorded a provision of HK$19.5 million for mobile interconnection charges receivable in fiscal 2005 given the uncertainty regarding the timing and amount of the ultimate collection of amounts due. For more information regarding our provision for mobile interconnection charges, see Our RevenuesFixed Telecommunications Network Services above in this annual report. Provision for other trade receivables recorded in fiscal 2005 was HK$15.9 million compared to HK$11.5 million in fiscal 2004. The provision as a percentage of revenue was approximately 1% of our revenue for both years.
Loss from operations. We suffered loss from operations of HK$135.4 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 profitability of our international telecommunications business, provisions for mobile interconnection charges, increased 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 (expense)/credit. We recorded 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 calculated based on our estimated assessable profit during each period, and our income tax credit in fiscal 2005 was mainly related to the recognition of deferred tax assets on current years unrecognized tax losses from our fixed telecommunications network services business that offset by the income tax expense 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$163.5 million in fiscal 2005 compared to a net income of HK$49.5 million in fiscal 2004.
U.S. GAAP Reconciliation
Our financial statements are prepared in accordance with HKFRSs, which differs in certain significant respects from U.S. GAAP. The following tables provide a comparison of our net income/(loss) and shareholders equity in accordance with HKFRSs and U.S. GAAP
Differences between HKFRSs and U.S. GAAP for the periods presented relate primarily to:
Disclosure relating to those differences can be found in note 30 to our consolidated financial statements. In addition, our condensed consolidated statement of operations, changes in shareholders equity and comprehensive (loss)/ income have been included in note 29 to our consolidated financial statements to reflect the impact of the significant differences between HKFRSs and U.S. GAAP.
Recent Accounting Pronouncements
Recently issued and adopted accounting pronouncements under HKFRSs and U.S. GAAP have been included in note 28 to our consolidated financial statements.
B. Liquidity and Capital Resources
As of August 31, 2007, we had a total cash position of HK$634.5 million and outstanding borrowings of HK$953.8 million. Our long term liability consists mainly of our 8.75% senior notes due 2015, which amounted to HK$952.6 million. Our total cash position of HK$634.5 million consisted of HK$532.9 million in cash and bank balances, HK$87.2 million in pledged bank deposits and HK$14.4 million in long term bank deposits.
We expect cash flows generated from operations will continue to be our principal source of liquidity.
The following table summarizes our cash flows for each of fiscal 2005, 2006 and 2007:
Our net cash flow from operating activities for fiscal 2007, 2006 and 2005 was an inflow of HK$384.0 million, HK$184.2 million and HK$77.4 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 2007, we generated a net cash inflow from our operating activities that amounted to HK$384.0 million. The increase in operating cash flow was mainly due to increased revenue from our fixed telecommunications network services and lower network costs as a result of the decrease in our international telecommunications services. Moreover, leveraging on last years operating efficiency plan and decentralizating of authority to individual department heads helped to increase our operating cash flow.
In fiscal 2006, we generated a net cash inflow from our operating activities that amounted to HK$184.2 million. The increase in operating cash flow was mainly due to lower network costs as a result of the completion of our fiber backbone network, which reduced our network costs paid to third party network operators. Moreover, by leveraging on the large scale sales and marketing activities in fiscal 2005 which has enhanced brand image and improved customer experience, less sales and marketing expenses were incurred in fiscal 2006, which also helped to increase the operating cash flow.
In fiscal 2005, we generated a net cash inflow in our operating activities that amounted to HK$77.4 million. The reduced operating cash flow when compared with fiscal 2004 was principally due to the significant cash we spent in sales and marketing expenses in offering incentives to acquire new subscriptions and retain our growing subscription base. Since such expenses were incurred before cash receipts from customers, it significantly reduced our operating cash flow. Moreover, increases in 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 spending for early stage operations of our IP-TV service.
In fiscal 2007, net cash generated from investing activities was HK$114.1 million, whereas in fiscal 2006 and 2005, net cash used in investing activities was HK$492.7 million and HK$557.4 million respectively. In 2006 and 2005, investing activities consisted primarily of purchases of fixed assets for the development of our Next Generation Network and upgrading of our international telecommunications facilities of HK$382.2 and HK$415.4 respectively. An increase in term deposits of HK$144.6 million and HK$92.9 million respectively further increased the cash outflow for investing activities in 2006 and 2005 respectively. In fiscal 2007, the net cash generated was mainly due to the receipt in term deposits of HK$237.5 million and lower level in purchase of fixed assets of HK$149.3 million.
Net cash used in financing activities was HK$109.5 million in fiscal 2007 consisting mainly of interest paid on our 8.75% senior notes of HK$85.3 million and interim dividend of HK$24.6 million.
Net cash used in financing activities was HK$86.4 million in fiscal 2006 which mainly consisted of interest paid on our 8.75% senior notes of HK$85.2 million.
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 and a bank loan of HK$100.0 million. The cash inflow was 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.
On January 20, 2005 we issued unsecured 10-year senior fixed rate notes in the aggregate principle amount of US$125 million at par value. The notes mature on February 1, 2015 and bear interest at the fixed rate of 8.75% per annum. Interest on the notes are payable semi-annually in arrears on February 1 and August 1. The notes are irrevocably and unconditionally guaranteed, 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 notes, CTI Guangzhou and, subsequently, any other subsidiary prohibited by applicable law, regulation or order from issuing a guarantee of the notes).
We may redeem all but not less than all of the 8.75% notes in the event we have to pay additional amounts as a result of certain changes in taxation. We may redeem the notes, in whole or in part, on or after February 1, 2010, at the redemption prices set forth in the indenture governing the 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 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 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, thereon to, but not including, the date of redemption.
The indenture governing the 8.75% notes contains covenants that limit, among other things, our ability and the ability of certain of our existing and future subsidiaries to:
The net proceeds of the 8.75% notes 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 bank loan in the outstanding amount of HK$196.7 million. The remaining net proceeds has been and will continue to be used for capital expenditures, including costs incurred in expanding and upgrading our Next Generation Network in Hong Kong, and for additional working capital and general corporate purposes.
As of August 31, 2007, the 8.75% notes were stated at the amortized cost of US$122.1 million (HK$952.6 million), compared with the amortized costs of US$121.9 million (HK$948.0 million) as of August 31, 2006.
As of August 31, 2007, we had available banking facilities of HK$80.2 million of which HK$78.6 million was unutilized.
During December 2007 and January 2008, we have bought back cumulative principal value of 8.75% notes of US$21.9 million by way of market acquisition. The total consideration (including accrued interest) paid was US$22.1 million. The principal value of 8.75% notes remaining in issue after the buy-back is US$103.2 million. The 8.75% notes bought back have been cancelled subsequently in December 2007 and January 2008.
In order to further develop our Next Generation Network and maintain the operations of our international telecommunications business, we plan to make total capital expenditures of approximately HK$850 million over the next three years to increase our home pass from 1.4 million to 1.8 million and to increase our fiber-connected commercial buildings from 600 to 1,800. Our required capital expenditures will be financed by the companys free cash flow in the respective year.
Contractual Obligations and Commercial Commitments
As of August 31, 2007, we had capital commitments contracted but not provided for relating to the purchase of telecommunications, computer and office equipment of HK$54.2 million. In addition, we had commitments under non-cancelable operating leases relating to land, buildings, telecommunications facilities and computer equipment of HK$83.6 million, of which HK$43.6 million is due in fiscal 2008. We also had commitments on program fees of HK$14.0 million, of which HK$10.3 million is due in fiscal 2008. As of August 31, 2007 we utilized HK$1.6 million of the HK$80 million available banking facilities.
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, 2007.
During December 2007 and January 2008, we have bought back and cancelled cumulative principal value of the 8.75% notes of US$21.9 million (equivalent to HK$170.7 million) by way of market acquisition. As a result of the buy-back of the 8.75% notes, our contractual obligations in respect of the short-term and long-term debt (principal and interest payments) has decreased by US$36.3 million (equivalent to HK$283.0 million).
Our working capital as of August 31, 2007 was HK$563.9 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 commitments and amounts due under banking facilities.
C. 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, 2007, our research and development team consisted of approximately 30 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 Next Generation 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$11.0 million, HK$9.6 million and HK$5.0 million for fiscal 2005, 2006 and 2007, respectively.
D. Trend information
During fiscal 2007, our international telecommunications business experienced a 16.4% decline in volume to 659.0 million minutes, which combined with the lower revenue per minute, resulted in a 22.4% reduction in our international telecommunications revenues to HK$324.5 million in fiscal 2007. The principal reason for this decline was the intense competition, as our key competitors introduced highly aggressive price cuts. We expect that such decline will continue in future. Rather than directly competing on price, our strategy is to proactively migrate our international telecommunications customers to our FTNS global 2b VOIP service which we believe will enable us to obtain higher margins and provide us with access to a wider addressable market.
Our revenues from our fixed telecommunications network services grew by 14.0% to HK$816.8 million in fiscal 2007 due to a rise in the subscription base of our fixed telecommunications network services of 10.7% to 683,000 subscriptions as of August 31, 2007. The revenue growth was attributable to our success in raising revenue yields per subscription.
E Off-Balance Sheet Arrangements
Other than as described above in Critical Accounting Policies and note 27 to our Consolidated Financial Statements, we have not entered into any off-balance-sheet arrangements with any entities or individuals.
F. Tabular disclosure of contractual obligations.
See Liquidity and Capital Resources above in this Item 5.
ITEM 6. DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES
A. 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 21, 2008.
Mr. WONG Wai Kay, Ricky, aged 46, is the co-founder and Chairman of City Telecom. He is responsible for our overall strategic planning and management. Mr. Wong holds a bachelors degree in science from The Chinese University of Hong Kong and has over 20 years experience in the telecommunications and computer industries. Mr. Wong had worked at a major US-listed computer company as a marketing representative and was responsible for marketing and distribution of computer products in Hong Kong from 1985 to 1989. He was also a co-founder and director of a company principally engaged in the import and distribution of computer systems in Canada prior to co-founding of City Telecom. Mr. Wong is a first cousin of Mr. Cheung Chi Kin, Paul, our
Chief Executive Officer. Currently, he is a member of Commission on Youth, a member of the Zhejiang Committee, Chinese Peoples Political Consultative Conference, an independent non-executive director of Bossini International Holdings Limited and a member of the Board of Trustees, United College, The Chinese University of Hong Kong.
Mr. CHEUNG Chi Kin, Paul, aged 50, is the co-founder and Chief Executive Officer 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 26 years experience in the telecommunications and computer industries. Mr. Cheung had worked in companies engaged in application software development and computer consultancy prior to co-founding of City Telecom. Mr. Cheung is a first cousin of Mr. Wong Wai Kay, Ricky, our Chairman.
Mr. LAI Ni Quiaque, aged 38, is our Chief Financial Officer, Company Secretary and Head of Staff Engagement. Mr. Lai joined City Telecom in May 2004. Mr. Lai has extensive experience in telecommunications industry research and finance, being highly rated in this field. Prior to joining City Telecom, Mr. Lai was Director and Head of Asia Telecom Research for Credit Suisse , having spent 8 years with the firm. During his tenure with Credit Suisse, he was involved in global fund raisings for a wide range of Asian Telecom carriers such as China Mobile, China Telecom, China Unicom, China Netcom, SK Telecom, PCCW, Telekom Malaysia, etc. 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, is a fellow member of CPA Australia and a member of Hong Kong Institute of Directors. Mr. Lai has been accepted into the Kellogg-HKUST EMBA program commencing in January 2008.
Mr. CHENG Mo Chi, Moses, aged 57, 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. 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 and the Chairman of the Betting and Lotteries Commission. Mr. Cheng was appointed as a member of the Legislative Council of Hong Kong from 1991 to 1995.
Independent Non-Executive Directors
Dr. CHAN Kin Man, aged 48, is an associate professor in the Department of Sociology of The Chinese University of Hong Kong, specializing in state-society relations in Mainland 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. LEE Hon Ying, John, aged 61, is the 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 Engineering and Technology, the United Kingdom and the Hong Kong Institution of Engineers and the Hong Kong Computer Society. He received a masters 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 Commission member of Catholic Diocese of Hong Kong Diocesan for Hospital Pastoral Care. Mr. Lee has been a director of City Telecom since June 1997.
Mr. PEH Tun Lu, Jefferson, aged 48, 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 masters degree in business from the University of Technology, Sydney. He has over 25 years of experience in finance, accounting and management from listed and private companies in Hong Kong and Australia. Mr. Peh has been a director of City Telecom since September 2004.
Mr. CHANG Wing Fu, Stephen, aged 44, is our Chief Technology Officer. Mr Chang joined the Company in July 2006 as Chief Information Officer and has also been the Companys Chief Technology Officer since December 2006. He provides advice and assistance to the Company, to ensure that information and communications technologies are acquired and managed in a manner that is aligned with business strategy, supporting the goals and objectives of the Company and its various business units. Mr Chang graduated from Australia and holds a Masters in Information Systems degree and a Bachelor of Science degree from Monash University. Mr Chang has 19 years of experience in Systems Development, Project Management, Consulting and Information Technology Management. Prior to joining the Company, Mr Chang was the Asia Pacific/Japan Vice-President of Worldwide Support for a U.S. software company. Before that he was the General Manager of Information Technology at SmarTone-Vodafone.
Mr. CHONG Kin Chun, John, aged 45, is the director of the corporate division. He is responsible for sales, marketing and servicing development of the Companys international telecommunications services and fixed telecommunications network services for business and corporate customers. Mr. Chong joined City Telecom in February 1996 and holds a bachelors 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.
Mr. LO Sui Lun, aged 43, is a director of Hong Kong Broadband Network Limited (HKBN). He is now in charge of the Companys participation in the Next Generation National Broadband Network (NGNBN) project in Singapore. That project is to develop a FTTH network for the whole country. Before that, Mr. Lo was in charge of regulatory, carrier business, international business, network operation and network development for HKBN. He joined City Telecom in September 1998. Prior to that, Mr. Lo worked for PCCW (formerly known as Hong Kong Telecom) for 9 years, gaining experience in network planning and undersea cable investment. Mr. Lo holds a bachelors degree in sciences in electronics from The Chinese University of Hong Kong and a masters degree in business administration from the University of Strathclyde, UK.
Ms. TO Wai Bing, aged 45, is our managing director of business development. Ms. To is a member of the management committee of the Company and in charge of the International Business Department and the Carrier Business Department. She is responsible for the control of cost of services, carrier relations, sales of carrier business, exploring and securing business partnerships to strengthen the Companys business operations and development. Before joining the Company, Ms. To had worked for the Hong Kong Telecom Company for 16 years after graduating from Hong Kong Polytechnic University with a Diploma in Electronic Engineering and subsequently a Higher Certificate in Electronic Engineering. Ms. To rejoined the Company in May 2007 after her previous services with the Company from September 1998 to July 2006.
Mr. YEUNG Chu Kwong, William, aged 47, is our Chief Operating Officer. Mr. Yeung joined City Telecom in October 2005 and is responsible to head our Customer Engagement Department to oversee customer relationship management. Mr. Yeung is also responsible to head Network Development Department. 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 Computing from The University of Hong Kong. Mr. Yeung has more than 15 years experience in the telecom industry. Prior to joining City Telecom, Mr. Yeung was the Director of Customers Division in SmarTone-Vodafone, the General Manager of Personal Communications and Retail Division at Tricom Telecom Limited, and was also an Inspector of Police in the Hong Kong Police Force.
Directors and Senior Managements 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, share-based payment, other allowances and benefits in kind paid by us to our directors (not including our non-executive directors) during fiscal 2007 was approximately HK$19.4 million. We paid approximately HK$1.4 million as our contribution to the pension schemes of the directors during fiscal 2007. In addition we paid our fiscal non-executive directors fees in the aggregate amount of approximately HK$605,000 during fiscal 2007.
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.
As of January 21, 2008, the Company granted share options to various directors and members of our senior management. For details, please refer to Item 6E Share Ownership herein.
Except as discussed herein, no other payments have been paid or are payable, in respect of fiscal 2007, 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 2007 was approximately HK$13.4 million.
For fiscal 2007, the aggregate amount accrued by us to provide pension retirement or similar benefits for our directors, senior management and other employees was approximately HK$23.9 million. (please refer to the second paragraph of this section)
C. Board Practices
We entered into service agreements with our three executive directors, Wong Wai Kay, Ricky, Cheung Chi Kin, Paul and Lai Ni Quiaque respectively. These service agreements include non-competition clauses under which our executive directors agree not to compete with us in accordance with the terms and conditions therein and shall continue to be effective unless and until terminated by either party of the respective service agreements. None of the agreements provide for any benefits or compensation upon termination of employment.
Our board of directors established an Audit Committee in March 1999 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 Company and the audits of the Companys financial statements on behalf of the Board of Directors.
Additionally, the Audit Committee is directly responsible for the appointment, compensation, retention and oversight of the work of City Telecoms 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.
As provided in our audit committee charter, the Audit Committee shall meet in person or telephonically at least twice a year and 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.
The Audit Committee met three times in fiscal 2007. The major works performed by the Committee from September 1, 2006 to August 31, 2007 included:
Our board of directors established a Remuneration Committee in August 2001 to manage our offer of remuneration packages to executive directors. The Remuneration Committee is comprised of six members with three independent non-executive directors,
Mr. Lee Hon Ying, John, Mr. Peh Tun Lu, Jefferson and Dr. Chan Kin Man, the non-executive director, Mr. Cheng Mo Chi, Moses, Mr. Lai Ni Quiaque, our Chief Financial Officer, Company Secretary and Head of Staff Engagement and our director of Talent Management. The Remuneration Committees main duties are set out as follows:-
The following chart sets forth the number of our employees by functional area as of August 31, 2007.
The following chart sets forth the number of our employees by geographical region as of August 31, 2007.
As of August 31, 2005, 2006 and 2007, we had 3,896, 2,565 and 2,692 employees, respectively. In connection with the transfer of our calling center operations to Guangzhou, China, we have hired over 1,200 customer service representatives and back office employees to staff that facility. The slight increase in our total number of employees in fiscal 2007 was mainly due to the expansion in our fixed telecommunications network business.
E. Share Ownership
The following chart sets forth the share ownership of our directors and senior management as of January 21, 2008.
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. Upon termination of the 1997 Scheme, no further options can be granted under the 1997 Scheme. Options granted under the 1997 Scheme that are not exercised have lapsed automatically on July 12, 2007. 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 any employee or executive or officer of the Company or any of its subsidiaries (including executive, non-executive and independent non-executive directors of each of the abovementioned companies) and any suppliers or professional advisers who will or have provided services to the Company and/or its subsidiaries 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 24, 2007 up to a maximum limit equal to 10% of our total number of issued shares as at December 24, 2007. Notwithstanding the foregoing, the number of ordinary shares which may be issued upon exercise of all outstanding options granted and yet to be exercised under our 2002 Scheme and any of our other share option scheme(s) at any time shall not exceed 30% of the total number of ordinary shares in issue from time to time.
The total number of ordinary shares issued and which may be issued upon exercise in full of the options granted under our 2002 Scheme and any of our other share option scheme(s) (including exercised, cancelled and outstanding options) to each eligible participant in any 12 month period up to and including the date of grant shall not exceed 1% of the outstanding ordinary shares as at the date of grant. Any further grant of options in excess of this 1% limit must be approved by shareholders.
The subscription price for an ordinary share payable by a participant upon the exercise of any option granted under the 2002 Scheme will be determined by the Board in its absolute discretion, except that 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 Limiteds 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 Limiteds daily quotations sheets for the 5 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:
As of January 21, 2008, a total number of 72,280,000 options were granted, 12,625,000 options were exercised, 8,020,000 options were lapsed and 51,635,000 options remain outstanding and unexercised. In our annual general meeting held on December 24, 2007, our shareholders approved the refreshment of the 2002 Scheme limit, i.e. 62,704,840 shares representing 10% of the issued share capital of the Company as at December 24, 2007. A total number of 62,704,840 options is available for issue as of January 21, 2008.
ITEM 7. MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS
A. Major Shareholders
The following table sets forth certain information regarding ownership of our ordinary shares as of January 21, 2008 by all persons who are known to us to own beneficially 5% or more of our ordinary shares.
As of January 21, 2008, there were 11 registered holders of 2,586,127 American Depositary Shares in the United States, consisting of 8.25 % of our outstanding shares.
All shareholders own ordinary shares and enjoy the same voting rights with respect to each share.
Top Group International Ltd. 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 chief executive officer respectively. They are two of shareholders of Top Group. Mr. Leung Ka Pak and Mr. Yau Ming Yan, Andrew are the two other shareholders of Top Group.
Mr. Leung Ka Pak was a director and the president of all subsidiaries in Canada other than City Telecom (Canada) Inc.. He resigned as a director and president in October 2005. After Mr. Leung resigned, Mr. Yau Ming Yan, Andrew was a director and the president of all our subsidiaries in Canada other than City Telecom (Canada) Inc.. He resigned as a director and president in July 2006.
EK Investment Management Limited is not affiliated with us or our officers or directors.
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.
B. Related Party Transactions
For the period since the beginning of our preceding three financial years up to the date of this document, we were a party to the following related party transactions.
Contracts with Our Directors and Senior Management
All of our directors and senior management have employment service agreements with us. Certain of our directors and senior management receive housing allowances, pensions and bonuses. In addition, some of our directors are also senior management of City Telecom and these persons may also have the ability to make significant business decisions effecting our operations. See Item 6 Directors and Senior Management of this annual report for details concerning these arrangements.
C. Interests of Experts and Counsel
ITEM 8. FINANCIAL INFORMATION
A. Consolidated Statements and Other Financial Information
See pages F-1 F-90 following Item 19.
Legal and Regulatory Proceedings
We are currently involved in two material legal or regulatory proceedings. They are described below:
Peoples Telecom. In March 2004, our wholly owned subsidiary, Hong Kong Broadband Network Limited (HKBN) requested the Telecommunications Authority to make a determination, pursuant to section 36A of the Telecommunications Ordinance (Cap 106), in respect of the level of fixed-mobile interconnection charge (FMIC) to be paid by China Resources Peoples Telephone Company Limited (Peoples) and the effective date of such charges. This FMIC is paid by a mobile network operator to the interconnecting fixed network operator for telephony traffic both from a fixed line to a mobile phone and from a mobile phone to a fixed line. In May 2004, the Telecommunications Authority confirmed to Peoples and HKBN that mobile operators (in this case Peoples) should pay interconnection charges to fixed network operators (in this case HKBN) in accordance with the existing charging principles stated clearly in the relevant Statements issued by the Telecommunications Authority, particular in Statements No. 5 & 7. In August 2004, the Telecommunications Authority agreed to commence a determination regarding the level and effective date of FMIC payable to HKBN by Peoples. In March 2006, the Telecommunications Authority issued a preliminary analysis and requested comments from HKBN. HKBN submitted its response to the Telecommunications Authority in July 2006 and September 2006 respectively. Finally, in June 2007, the Telecommunications Authority made a determination on the level of FMIC payable by Peoples to HKBN for the period from April 2002 to August 2004.
PCCW case On December 24, 2007, PCCW IMS Limited filed a Writ together with an Endorsement of Claim with the High Court of Hong Kong, alleging a claim against the Company in respect of an advertisement published by the Company on December 19, 2007, seeking damages of no less than HK$1,000,000 and an injunction preventing further publication of the advertisement, based on defamation and malicious falsehood. The Company is now waiting for the detailed Statement of Claim to be filed by PCCW IMS Limited and shall contest this claim accordingly.
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.
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.
For fiscal 2007, an interim dividend was declared and paid of HK4 cents per ordinary share totaling of HK$24,635,000. A final dividend of HK4 cents per ordinary share together with a script alternative was proposed on November 22, 2007, which was subsequently approved by shareholders in the annual general meeting held on December 24, 2007.
B. Significant Changes
ITEM 9. THE OFFER AND LISTING
A. Offer and Listing Details
Our ordinary shares 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 21, 2008 was HK$1.92 per share. The table below shows the high and low closing prices of the shares on the SEHK since listing.
The price of our American depositary shares on Nasdaq as of its close of trading on January 18, 2008 was US$4.70 per American depositary share. The table below shows the high and low closing prices of the American depositary shares on Nasdaq since listing.
B. Plan of distribution
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.
D. Selling shareholders
F. Expenses of the issue
ITEM 10. ADDITIONAL INFORMATION
A. Share Capital
B. Memorandum and Articles of Association
Described below is a summary of certain provisions of our existing Memorandum and Articles of Association (the Articles) and, where relevant, the Companies Ordinance (Chapter 32 of the laws of Hong Kong) (the Companies Ordinance). As this is a summary, it does not contain all the information that may be important to you. You should therefore read our complete Articles if you would like additional information, which were filed with the U.S. Securities and Exchange Commission as an exhibit 1 to the annual report on Form 20-F for fiscal 2005 and is incorporated by reference herein.
City Telecom was incorporated in Hong Kong on May 19, 1992 under the Companies Ordinance. Clause 3 of the Memorandum of Association states that the Company s objects are to carry on the business of telecommunications services in addition to various other related and unrelated business activities.
A director shall not vote on, or be counted in the quorum in relation to, any resolution of our 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:
Additionally, there is no shareholding qualification required to be a director.
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, whenever 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:
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.
If the Company commences liquidation, the liquidator may, with the sanction of a special resolution of the Company and any other sanction required by the Companies Ordinance:
but no shareholder shall be compelled to accept any shares or other assets upon which there is any liability.
Annual and Extraordinary General Meeting of Shareholders
The Companies Ordinance requires our board of directors to hold an annual general meeting of our shareholders once every calendar year and not more than 15 months after our previous annual general meeting. The annual general meeting and any other general meeting of our shareholders held for the passing of a special resolution (being a resolution passed by a majority of not less than 75% of those shareholders who attend and vote at a meeting of shareholders) should be convened by not less than 21 clear days notice in writing. The notice shall specify the place, date and time of meeting and the general nature of the business to be transacted. An annual general meeting may be called by less than 21 clear days notice if it is agreed by all shareholders entitled to attend and vote at the meeting. The business of the annual general meeting will include:
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 clear 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.
The Nasdaq marketplace rules also provide that a foreign private issuer such as the Company may be granted an exemption from such requirements if it follows the practice of its home country.
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.
Any business to be transacted by the shareholders in a general meeting requires the passing of either an ordinary or a special resolution at such meeting. Generally, resolutions of the shareholders are passed by ordinary resolution. However, the Companies Ordinance and our Articles provide that certain matters may only be passed as special resolutions.
Unless any shares have special terms as to voting, on a show of hands every shareholder who is present in person at a general meeting, shall have one vote and on a poll every shareholder 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 of the Company.
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 the next 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, subject to the Listing Rules, 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:
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 buyer notice of the refusal.
In accordance with 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).
C. 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.
D. 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.
The following provides a general outline of the material tax considerations that may be relevant to a decision to own or dispose of our 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, United States 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.
Hong Kong Taxation
Tax on dividends
No tax is payable in Hong Kong by withholding or otherwise in respect of dividends paid by City Telecom.
No tax is imposed in Hong Kong in respect of gains from the sale of our shares and American depositary shares, unless all the following three factors are present:
Taxable gains will be subject to Hong Kong profits tax which is currently imposed on corporations at the rate of 17.5% and on unincorporated businesses or individuals at the rate of 16%.
Gains from sales of our shares, which are 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 our American depositary shares will be considered to be derived from or arising in Hong Kong if the relevant purchase or sales contracts are effected 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 trade, profession or 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.
A sale or purchase of shares is subject to Hong Kong stamp duty which is payable by each of 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 for the sale or purchase 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.
In addition to the depositarys charges, if any, the withdrawal of the shares upon the surrender of American depositary receipts evidencing American depositary shares, and the issuance of American depositary receipts evidencing American depositary shares upon the deposit of the shares, will be subject to Hong Kong stamp duty at the rate described above for sale and purchase transactions, unless the withdrawal or deposit does not result in change in the beneficial ownership of the shares under Hong Kong law. 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 our American depositary shares if such American depositary receipts are not maintained on a register in Hong Kong.
There is currently no reciprocal tax treaty between Hong Kong and the U.S. regarding withholding.
United States Taxation
Certain U.S. Federal Income Tax Considerations
The following is a summary of certain United States federal income tax considerations that are anticipated to be material to the purchase, ownership, and disposition of our shares or American depositary shares by U.S. Holders, as defined below. This summary is based on the U.S. Internal Revenue Code of 1986, as amended (the Code), its legislative history, existing and proposed U.S. Treasury regulations, published rulings and court decisions, all as in effect on the date hereof. These laws are all subject to change or different interpretation, possibly on a retroactive basis. This summary does not discuss all aspects of United States federal income taxation which may be important to particular investors in light of their individual investment circumstances, such as investors subject to special tax rules including: partnerships, financial institutions, insurance companies, broker-dealers, tax-exempt organizations, and, except as described below, non-U.S. Holders, or to persons that will hold our shares or American depositary shares as part of a straddle, hedge, conversion, or constructive sale transaction for United States federal income tax purposes or that have a functional currency other than the United States dollar, all of whom may be subject to tax rules that differ significantly from those summarized below. In addition, this summary does not discuss any foreign, state, or local tax considerations. This summary assumes that investors will hold our shares or American depositary shares as capital assets (generally, property held for investment) under the United States Internal Revenue Code.
Each prospective investor is urged to consult its own tax advisor regarding the United States federal, state, local, and foreign income and other tax considerations of the purchase, ownership, and disposition of our shares or American depositary shares.
For purposes of this summary, a U.S. Holder is a beneficial owner of shares or American depositary shares that is for United States federal income tax purposes:
A beneficial owner of our shares or American depositary shares that is not a U.S. Holder is referred to herein as a Non-U.S. Holder.
A foreign corporation will be treated as a passive foreign investment company or PFIC, for United States federal income tax purposes, if 75% or more of its gross income consists of certain types of passive income or 50% or more of its assets are passive for any year. Based on our current and projected income, assets, and activities, we presently believe that we are not a PFIC in the current year and do not anticipate becoming a PFIC in the future. This is, however, a factual determination made on an annual basis. Because the classification of certain of our assets for United States federal income tax purposes is uncertain, the PFIC rules are subject to administrative interpretation, and the relevant facts may change in the future, however, no assurance can be given that we are not or will not be treated as a PFIC. The discussion below under U.S. Holders-Dividends and U.S. Holders-Sale or Other Disposition of Shares or American depositary shares, assumes that we will not be subject to treatment as a PFIC for United States federal income tax purposes. If we were currently or were to become a PFIC, U.S. Holders would be subject to special rules and a variety of potentially adverse tax consequences under the Code. See PFIC Considerations below.
For United States federal income tax purposes, a U.S. Holder of an American depositary share will be treated as the owner of the proportionate interest of the shares held by the depositary that is represented by an American depositary share and evidenced by such
American depositary share. Accordingly, no gain or loss will be recognized upon the exchange of an American depositary share for the holders proportionate interest in the shares. A U.S. Holders tax basis in the withdrawn shares will be the same as the tax basis in the American depositary share surrendered therefore, and the holding period in the withdrawn shares will include the period during which the holder held the surrendered American depositary share.
Dividends. Any cash distributions paid by us out of our earnings and profits, as determined under United States federal income tax principles, will be subject to tax as ordinary dividend income and will be includible in the gross income of a U.S. Holder upon actual or constructive receipt. Cash distributions paid by us in excess of our earnings and profits will be treated first as a tax-free return of capital to the extent of the U.S. Holders adjusted tax basis in our shares or American depositary shares, and thereafter as gain from the sale or exchange of a capital asset. Dividends paid in Hong Kong dollars will be includible in income in a United States dollar amount based on the United States dollar to Hong Kong dollar exchange rate prevailing at the time of receipt of such dividends by the depositary, in the case of American depositary shares, or by the U.S. Holder, in the case of shares held directly by such U.S. Holder. U.S. Holders should consult their own tax advisors regarding the United States federal income tax treatment of any foreign currency gain or loss recognized on the subsequent conversion of Hong Kong dollars received as dividends to United States dollars. Dividends received on shares or American depositary shares will not be eligible for the dividends received deduction allowed to corporations.
Under current law, qualified dividend income received by an individual after December 31, 2002 and before January 1, 2011 is subject to United States federal income tax rates lower than those applicable to ordinary income. The top federal income tax rate on such qualifying dividends received by an individual is 15%, or 5% for those individuals whose incomes fall in the 10- or 15- percent brackets. Based upon our existing and anticipated future operations and current assets, we believe that we are a qualified foreign corporation and that our dividends paid to U.S. Holders who are individuals will be eligible to be treated as qualified dividend income, provided that such Holders satisfy applicable holding period requirements with respect to the American depositary shares and other application requirements. Dividends paid by foreign corporations that are classified as PFICs are not qualified dividend income. See PFIC Considerations below.
Dividends received on shares or American depositary shares generally will be treated, for United States federal income tax purposes, as income from non-U.S. sources. Such non-U.S. source income generally will be passive income or financial services income for taxable years beginning on or before December 31, 2006, and as passive category income, or in certain cases general category income, for taxable years beginning after December 31, 2006, which is treated separately from other types of income for purposes of computing the foreign tax credit. A U.S. Holder may be eligible, subject to a number of complex limitations, to claim a foreign tax credit in respect of any foreign withholding taxes imposed on dividends received on shares or American depositary shares. U.S. Holders who do not elect to claim a foreign tax credit for federal income tax withheld may instead claim a deduction, for United States federal income tax purposes, in respect of such withholdings, but only for a year in which the U.S. Holder elects to do so for all creditable foreign income taxes.
In addition, the United States Treasury has expressed concerns that parties to whom depositary shares are pre-released may be taking actions that are inconsistent with the claiming of foreign tax credits by the holders of American depositary shares. Accordingly, the analysis of the creditability of foreign withholding taxes could be affected by future actions that may be taken by the United States Treasury.
Sale or Other Disposition of Shares or American depositary shares. A U.S. Holder will recognize capital gain or loss upon the sale or other disposition of shares or American depositary shares in an amount equal to the difference between the amount realized upon the disposition and the U.S. Holders adjusted tax basis in such shares or American depositary shares, as each is determined in U.S. dollars. Any such capital gain or loss will be long-term if the shares or American depositary shares have been held for more than one year and will generally be United States source gain or loss. The claim of a deduction in respect of a capital loss, for United States federal income tax purposes, may be subject to limitations. If a U.S. Holder receives Hong Kong dollars for any such disposition, such U.S. Holder should consult its own tax advisor regarding the United States federal income tax treatment of any foreign currency gain or loss recognized on the subsequent conversion of the Hong Kong dollars to United States dollars.
If we were to be classified as a PFIC for any taxable year, a U.S. Holder would be subject to special rules generally intended to reduce or eliminate any benefits from the deferral of United States federal income tax that a U.S. Holder could derive from investing in a foreign company that does not distribute all of its earnings on a current basis. In such event, a U.S. Holder of the shares or American depositary shares may be subject to tax at ordinary income tax rates on (i) any gain recognized on the sales of the shares or American depositary shares and (ii) any excess distribution paid on the shares or American depositary shares (generally, a distribution in excess of 125% of the average annual distributions paid by us in the three preceding taxable years). In addition, a U.S. Holder may be subject to an interest charge on such gain or excess distribution. Prospective investors are urged to consult their own tax advisors regarding the potential tax consequences to them if we are or do become a PFIC, as well as certain elections that may be available to them to mitigate such consequences.
An investment in shares or American depositary shares by a Non-U.S. Holder will not give rise to any United States federal income tax consequences unless:
Backup Withholding and Information Reporting
In general, information reporting requirements will apply to dividends on or the proceeds received on the sale, exchange or redemption of shares or American depositary shares paid within the United States (and, in certain cases, outside the United States) to U.S. Holders other than certain exempt recipients, such as corporations, and backup withholding tax at the rate of 28% may apply to such amounts if the U.S. Holder fails to provide an accurate taxpayer identification number (or otherwise establishes, in the manner provided by law, an exemption from backup withholding) or to report dividends required to be shown on the U.S. Holders United States Federal income tax returns.
Backup withholding is not an additional income tax, and the amount of any backup withholding from a payment to a U.S. Holder will be allowed as credit against the U.S. Holders United States Federal income tax liability provided that the appropriate returns are filed.
A non-U.S. Holder generally may eliminate the requirement for information reporting and backup withholding by providing certification of its foreign status to the payor, under penalties of perjury, on IRS Form W-8BEN.
F. Dividends and paying agents
G. Statement by experts
H. 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.
I. Subsidiary Information
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 is pegged, 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 other risks such as 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, 2007, we had the following significant foreign currencies denominated account balances:
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.
We also incur expenses denominated in Renminbi, the official currency of the Peoples 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 the Renminbi, we maintain Renminbi cash balance that approximates three months operating cash flow.
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.
In prior years, no recognition of such instrument is required under HKFRS. However, with effect from September 1, 2005, such interest rate swap instrument must be recorded at fair value, which we determined to be approximately HK$1.8 million as of August 31, 2006 and HK$1.0 million as of August 31, 2007. Under U.S. GAAP reporting, such interest rate swap instrument is and has been recorded at fair value. As of August 31, 2007, the interest rate swap agreement remains outstanding following the full repayment of our loan facility with HSBC. On January 24, 2008, the interest rate swap agreement has been unwound.
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 Commissions rules and forms. With the passing of the U.S. Sarbanes-Oxley Act of 2002, we have adopted additional measures to strengthen the internal controls within City Telecom, including the following:
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 and Chief Financial Officer, of the effectiveness of our disclosure controls and procedures. Based on that evaluation, our Chief Executive Officer and Chief Financial Officer 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 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 and modified it following the passage of, and to comply with, the U.S. Sarbanes Oxley Act of 2002. Copies of our code of ethics are available for viewing on our website at www.ctigroup.com.hk and free of charge upon request made to our company secretary. We have not made any amendment to our code of ethics since our most recently completed fiscal year. 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.
ITEM 16C. PRINCIPAL ACCOUNTANT FEES AND SERVICES
With effect from May 13, 2005, PricewaterhouseCoopers, or PwC, tendered its resignation. KPMG was appointed as our independent auditor 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 KPMG in fiscal 2006 and in fiscal 2007, are set forth in the table below.
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.
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.
All Other Fees
All other fees are the aggregate fees for agreed upon procedures performed in respect of our internal control procedures over financial reporting.
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 KPMG.
ITEM 16E. PURCHASE OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED PURCHASERS
By way of a general mandate granted to our directors, 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 2007, no shares were purchased under the mandate then in force.
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.
See pages F-1 to F-88 following Item 19.
ITEM 19. EXHIBITS
Index to Consolidated Financial Statements
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 sheets of City Telecom (H.K.) Limited and its subsidiaries (collectively referred to as the Group) as of August 31, 2006 and 2007, and the related consolidated statements of operations, changes in shareholders equity, and cash flows for each of the years in the three-year period ended August 31, 2007. These consolidated financial statements are the responsibility of the Groups management. Our responsibility is to express an opinion on these consolidated 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 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 audits provide 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, 2006 and 2007, and the results of their operations and their cash flows for each of the years in the three-year period ended August 31, 2007, in conformity with Hong Kong Financial Reporting Standards.
Hong Kong Financial Reporting Standards 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 29 to the consolidated financial statements.
Hong Kong, China
November 22, 2007, except as to note 30 which is as of January 22, 2008
Consolidated financial statements for the year ended August 31, 2007
City Telecom (H.K.) Limited and its subsidiaries
Consolidated statements of operations
(Amounts in thousands except per share data)
The accompany notes are an integral part of these consolidated financial statements.
Consolidated financial statements for the year ended August 31, 2007
City Telecom (H.K.) Limited and its subsidiaries
Consolidated balance sheets
(Amounts in thousands except number of shares and per share amounts)
City Telecom (H.K.) Limited
Consolidated financial statements for the year ended August 31, 2007
City Telecom (H.K.) Limited and its subsidiaries
Consolidated balance sheets (continued)
(Amounts in thousands except number of shares and per share amounts)
The accompany notes are an integral part of these consolidated financial statements.
Consolidated financial statements for the year ended August 31, 2007
City Telecom (H.K.) Limited and its subsidiaries
Consolidated statements of changes in shareholders equity
(Amounts in thousands)
The accompany notes are an integral part of these consolidated financial statements.
Consolidated financial statements for the year ended August 31, 2007
City Telecom (H.K.) Limited and its subsidiaries
Consolidated statements of cash flows
(Amounts in thousands)
City Telecom (H.K.) Limited
Consolidated financial statements for the year ended August 31, 2007
City Telecom (H.K.) Limited and its subsidiaries
Consolidated statements of cash flows (continued)
(Amounts in thousands)