China Telecom Corp Ltd
Annual Report 2002

Plain-text annual report

CONTENTS COMPANY PROFILE AND CORPORATE INFORMATION CHAIRMAN’S STATEMENT BUSINESS REVIEW MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONS AND RESULTS OF OPERATIONS REPORT OF THE DIRECTORS REPORT OF THE SUPERVISORY COMMITTEE CONNECTED TRANSACTIONS DIRECTORS, SUPERVISORS AND SENIOR MANAGEMENT NOTICE OF ANNUAL GENERAL MEETING REPORT OF THE INTERNATIONAL AUDITORS CONSOLIDATED BALANCE SHEET BALANCE SHEET CONSOLIDATED STATEMENT OF INCOME CONSOLIDATED STATEMENT OF SHAREHOLDERS’ EQUITY 2 5 9 21 33 43 44 51 57 62 64 66 67 68 CONSOLIDATED STATEMENT OF CASH FLOW 69 NOTES TO THE FINANCIAL STATEMENTS 71 SUPPLEMENTARY INFORMATION FOR ADS HOLDERS 110 FINANCIAL SUMMARY 115 CHINA TELECOM ANNUAL REPORT 2002 COMPANY PROFILE AND CORPORATE INFORMATION China Telecom Corporation Limited is a joint stock limited company established pursuant to the PRC Company Law by China Telecommunications Corporation as its sole promoter on 10 September 2002. We are the leading provider of wireline telecommunications services in Shanghai Municipality, Guangdong Province, Jiangsu Province and Zhejiang Province in China. Our scope of business includes the following: (1) operating a variety of domestic wireline telecommunications networks and facilities (including wireless local loops); (2) operating voice, data, image, multimedia and other information services mainly based on the wireline networks; (3) conducting accounts settlement relating to international telecommunications services in accordance with state regulations; and (4) dealing with system information consulting, telecommunications equipment design together with manufacture, implementation and sales. integration, technological development, technical services, Our H shares and American Depositary Shares (“ADS”) were listed on the Stock Exchange of Hong Kong and the New York Stock Exchange on 15 November 2002 and 14 November 2002 respectively. Chinese registered name: 中 Œ „ q信 股 份 有 限 公 司 English name: China Telecom Corporation Limited Authorised representative: Zhou Deqiang Company secretary: International auditors: Legal advisers: Li Ping KPMG Jingtian & Gongcheng Freshfields Bruckhaus Deringer Sullivan & Cromwell LLP Registered address: 31 Jinrong Avenue, Xicheng District, Beijing, PRC, 100032 Telephone: Facsimle: (8610) 6642 8166 (8610) 6601 0728 CHINA TELECOM ANNUAL REPORT 2002 2 COMPANY PROFILE AND CORPORATE INFORMATION Website: www.chinatelecom-h.com H share registrar: ADS depositary: Listings: H shares: ADSs: Computershare Hong Kong Investor Services Limited 1712–1716, 17th Floor Hopewell Centre 183 Queen’s Road East, Wanchai Hong Kong Bank of New York 101 Barclay Street New York, NY 10286 The United States of America The Stock Exchange of Hong Kong Limited stock code: 728 New York Stock Exchange, Inc. stock code: CHA CHINA TELECOM ANNUAL REPORT 2002 3 CHAIRMAN’S STATEMENT [divider] CHINA TELECOM ANNUAL REPORT 2002 4 CHAIRMAN’S STATEMENT We firmly believe in the maximisation of shareholder value as our operating principle. We seek to develop a business model that is market-oriented, and return-driven. We strive to take advantage of organic and external growth opportunities to leverage our strength and continuously create value for our shareholders. customer-centered, strategies based on We fine-tune our marketing strategy according to market conditions. We adopt different marketing specific customer segments. This has enabled us to in wireline voice achieve stable growth services and high growth in broadband and Internet services. We have enhanced revenue driven by traffic volume growth and also actively developed new value-added services. As a result, we have successfully maintained a commanding market position. through centralised We continue to take measures to improve cost control and profitability. We have upgraded our overall budget planning and control cash, capabilities investment, and equipment procurement management. consistently implemented operating expense controls, operations especially and network in maintenance, and have reduced capital expenditures, thereby improving profitability. have We • • • Dear shareholders, In 2002 China Telecom Corporation Limited successfully completed its corporate restructuring and went on to complete its global initial public offering. The Company has seized this opportunity to advance closer to its goal of being a world-class telecommunications company and has turned in a strong performance for the year, surpassing its its promises to goals for 2002 and realising shareholders. REVIEW OF 2002 Revenue for the year grew by 10.1% to RMB75,496 million and net income increased to RMB16,864 million with a net profit margin of 22.3%, while operating expenses of RMB54,118 million, 7.3% up from 2001, increased at a rate lower than that of revenue. We have expanded our wireline subscriber base by 17.3%, adding 8.38 million access lines in service, bringing our total to 56.86 million. We more than doubled the size of our broadband business, signing up approximately 0.98 million new customers to reach a year-end subscriber base of 1.38 million. Profitability was enhanced with basic earnings per share of RMB0.24. Our strong performance is largely the result of the effective execution of our business strategies, continued improvement of our internal management innovation, and systems, encouragement of steadfast work ethic. This has led the Company into a new era of development along with a new corporate image. CHINA TELECOM ANNUAL REPORT 2002 5 CHAIRMAN’S STATEMENT • • • • continuing management We are reform initiatives. We have re-positioned our local branches as Basic Business Units and carried out a critical overhaul of their business operations. We have established an internal Service Level Agreement mechanism between front-end marketing units and back-end network support units. A Key Performance Indicator system has been established to improve performance evaluation. We have upgraded technology infrastructure (CTG — MBOSS). All of these efforts are designed to improve our operating efficiency, market responsiveness and service quality, so as to strengthen our core competitiveness. information our We continue to capitalise on our network advantages. Our network is characterised by reliability, extensive coverage and high its further capacity. While structure, we have upgraded network intelligence. As a result, we are able to create new value-added products and services for our customers and are well-positioned to migrate seamlessly the next generation of technology. optimising to We have taken innovative measures in the management of human resources. We have established a compensation system linked with value creation and growth in profitability. We have also set up a dual-track promotion system for employee career development. Together these new approaches have greatly stimulated the enthusiasm and creativeness of our employees, creating a strong basis for our new corporate culture. with committee, supervisory corporate governance norms. We have established a corporate governance structure consisting of shareholders’ meetings, board of and directors, corporate management clear-cut responsibilities. Under the board of directors, we have established audit and remuneration committees in which independent directors play key roles. Further, we are continuing our efforts to improve information disclosure to transparent, efficient and smooth ensure communications between management and investors. We have adopted OECD corporate governance standards. In accordance with relevant laws and regulations, we have adopted OECD In 2002, we successfully completed our initial public offering, the world’s largest telecom IPO for the year. Our shares have been listed on the Stock Exchange of Hong Kong and the New York Stock CHINA TELECOM ANNUAL REPORT 2002 6 Exchange since November 2002. We take pride in the fact that Fortune magazine named us as one of the “most admired companies” for the year 2002. possible when they are commercially viable, so as to better serve our communities. CHAIRMAN’S STATEMENT OUTLOOK FOR 2003 industrial development, We believe China’s economy will continue to record strong and healthy growth in 2003 with the goal of further improving the people’s living standards. The government’s strategic focus is on the development of information technology. Under the slogan of “let technology drive let industrial development drive technology”, a nationwide promotional campaign will help stimulate demand for telecommunications services. With low penetration rates across most of China for wireline services, we see a huge potential for growth. Data communications and information technology solutions have shown strong demand among the popularisation of the Internet, the communication of knowledge and information will drive the fast growth of our broadband services. Various information applications will stimulate high- capacity, value-added services of all kinds. We intend to take full advantage of the unique opportunity presented by China’s large and growing market to create as much value as possible for our shareholders. segments. With customer all Over time, we believe the regulatory environment will become more transparent and mature. Tariff policy for wireline telecommunication services is in the basically stable. Regulations benefit us provision of new services that will enjoy strong demand and high margins. We are actively seeking to become a telecommunications operator. full service of and reform restructuring The China’s telecommunications sector continues to provide us with both opportunities and challenges. We welcome orderly competition as well as cooperation with others in the years to come in the best interest of our shareholders. As a responsible carrier, we seek to provide as many telecom services as We have the unique right, but not the obligation, to grow through acquisitions of high-quality assets from our parent company and see this type of opportunity as an important means of expanding our operations. If we seek to carry out such an acquisition, however, it will be based on market conditions and commercial considerations and will be subject to minority shareholders’ approval. We are excited by our future prospects. We will continue to improve capital expenditures and operating expense control so as to enhance our profitability. We are building China Telecom on the values of innovation, integrity, cooperation, value creation based on a carefully executed strategy. We have a commitment to you, our shareholders and customers, this Information Age. the very best of to share DIVIDEND POLICY At the forthcoming annual general meeting, the board of directors will propose a dividend of HK$0.065 per share on an annual basis. Actual dividend payment for the year 2002 will be pro- rated based on the period from the date of listing to 31 December 2002. Finally, I would like to take this opportunity to express my sincere thanks to all of our constituents — our board members, supervisors, shareholders, employees and customers, for your great support this year. Zhou Deqiang Chairman and Chief Executive Officer Beijing, PRC 24 April 2003 CHINA TELECOM ANNUAL REPORT 2002 7 [Divider] BUSINESS REVIEW 1 1 M \ 3 0 0 2 / 4 0 / 3 2 \ ) m o c e l e T a n i h C ( \ 2 - 1 9 7 8 \ c a M CHINA TELECOM ANNUAL REPORT 2002 8 BUSINESS REVIEW our total to 56.86 million. We grew our broadband subscriber base by 247.4%, signing up 0.98 million new customers to attain a year-end subscriber base of 1.38 million. We built up demand momentum for value-added wireline the successful market debuts of V-net, information telephone, 17901 direct dial VoIP, 4008 quasi toll- free and wireline prepaid services. services through further consolidated our market In 2002, we leadership position with the full implementation of our market segmentation plan and of our growth strategies geared toward wireline voice, broadband and Internet, and value-added services. satisfaction through We enhanced customer differentiated product provisioning, and the establishment of four clearly positioned servicing and distribution channels, consisting of our key account managers, community managers, rural contract personnel and “1000” service hotline. Customer complaints filed with the Ministry of Information Industry against us declined 87% in 2002, falling to one of the lowest levels in the industry. We pushed ahead with our internal restructuring and business re-engineering initiatives aimed at instilling greater market responsiveness, more effective cost control, higher efficiency and competitiveness into our operations. reflected China’s regulatory environment has become more transparent, and the competition more orderly. The structural adjustment in wireline tariffs has been financial fully company’s the in performance of 2002. Tariff policy regarding wireline telecom services is basically stable. In the mean time, the Ministry of Information Industry will increase regulatory scrutiny, and actively facilitate orderly competition in the market. CHINA TELECOM ANNUAL REPORT 2002 9 OVERVIEW We are the leading provider of wireline telephone, data, Internet and leased line services in Shanghai Municipality, Guangdong Province, Jiangsu Province and Zhejiang Province. As is consistent with our first, service philosophy of placing “customer foremost”, we seek to develop a business model is market-oriented, customer-centered and that an outstanding return-driven. We performance in 2002. achieved In 2002, our revenue grew by 10.1% to RMB75,496 million and net income increased to RMB16,864 million with a net profit margin of 22.3%. We have expanded our wireline subscriber base by 17.3%, adding 8.38 million access lines in service, bringing BUSINESS REVIEW The following table illustrates some major indicators of our business development in the last 3 years: Local wireline access lines in service (in thousands) Penetration rate of wireline service (%) Local voice usage (pulses in billions) Domestic long distance usage (minutes in millions) International, Hong Kong, Macau and Taiwan long distance usage (minutes in millions) DDN ports (in thousands) [in 64K equivalents] FR ports (in thousands) [in 128K equivalents] ATM ports (in thousands) [in 2M equivalents] Broadband subscribers (in thousands) Dial-up subscribers (in thousands) Dial-up usage (minutes in billions) 2M digital circuits leased (lines in thousands) Penetration rate of caller ID display 2000 2001 2002 39,822 18.3% 156.6 48,478 22.1% 158.8 56,859 25.7% 174.1 26,967 30,630 33,624 1,417 103.1 11.2 1.3 10 5,171 22.2 65.1 1,406 158.6 20.4 7.8 397 9,627 45.5 84.3 1,325 207.7 24.3 10.8 1,379 11,623 40.2 94.4 Change 2002 over 2001 17.3% 3.6 pp 9.6% 9.8% -5.8% 31.0% 19.1% 38.5% 247.4% 20.7% -11.6% 12.0% (% of lines in service) — 27.9% 41.9% 14.0 pp CHINA TELECOM ANNUAL REPORT 2002 10 Business Line Review Local voice business sustained rapid growth Generating 47.5% of total revenue, local wireline voice service is the pillar of our business and the focus of our development. We enjoy a dominant market position in local services with a subscriber market share of over 99%. Both our subscriber base and traffic volume maintained high growth rates in 2002. BUSINESS REVIEW Local Wireline Subscribers 15% 5% 6% 2002 74% Residential Enterprise Public Telephones Wireless Local Access Total Local Wireline Subscribers (numbers in millions) Subscriber base swiftly expanded % 9 . 5 R : 1 G A C 48.5 56.9 39.8 39.8 2000 2001 2002 Local Wireline Subscribers 14% 4% 3% 2001 79% Residential Enterprise Public Telephones Wireless Local Access for and business foundation We continued to rapidly expand our wireline subscriber base in 2002. Adding 8.38 million new access lines in service, we grew our subscriber base by 17.3% to a total of 56.86 million access lines in service at year-end. Such strong wireline subscriber the growth provides a solid sustained development of our local voice, long distance, Internet and data, and other services. Meanwhile, we also improved the structure of our subscriber base. Through strict emphasis on profitability and high-end subscribers, we grew our high-ARPU telephone subscribers by 21.3% and 58.5%, respectively. Collectively, these valuable customers accounted for 20.3% of our total subscribers at year-end, as compared to 18.5% for 2001. Accelerating wireless local access subscription was driven by strong market demand. Being a natural extension of and supplement to our wireline services, wireless local access played a positive role in boosting local call volume and revenue growth, and in stemming competitive substitution. The year-end wireline penetration rate of 25.7% in our service regions was still significantly lower than the existing rates in mature markets, the great market indicating potential over which we preside. public CHINA TELECOM ANNUAL REPORT 2002 11 BUSINESS REVIEW Local telephone usage made steady headway Local Wireline Usage (minutes in billions) Total local usage, including voice and dial-up, grew 6.7% in 2002, totaling 226.6 billion pulses at year- end. This growth was largely attributable to a 9.6% growth in voice calls driven by expansion in our subscriber base, enhancement of our distribution channels and marketing initiatives focused on usage revenue. The upgrade made by some of our subscribers from dial-up Internet access services to broadband services led to a decrease in total dial- up usage. Local Wireline Usage (pulses in billions) : 1 2 . 0 % C A G R ( 1 ) 54 24 157 159 53 174 2000 2001 2002 Voice Call Dial-up Internet Access(2) (1): 2000-2002CAGR of total usage (2): including dial-up usage by our subscribers and users of other dial-up service providers : 1 8 . 4 % C A G R ( 1 ) 24 118 54 118 53 146 2000 2000 2001 2001 2002 2002 Voice Call Dial-up Internet Access(2) (1): 2000-2002CAGR of total usage (2): including dial-up usage by our subscribers and users of other dial-up service providers Broadband and data business emerged as a major driver of revenue growth Internet and data business experienced Our explosive growth in 2002. Revenue grew 53.4% from 2001 to RMB5,564 million, constituting 7.4% of total revenue. We magnified our broadband subscriber base by 247.4% from year-end 2001 to serve 1.38 million total broadband users. ADSL subscribers accounted for 81.4% of our total broadband subscribers, numbering 1.12 million at year-end 2002. Broadband: Explosive growth Over the past year, we successfully leveraged our enormous existing subscriber base and dominant control over the “last mile” access network to make broadband access a strategic focus. Strong growth in demand enabled us to position our broadband services as premium products. Meanwhile, we increased our brand name recognition through a series of campaigns large-scale promotional throughout 2002, the most notable of which was the market momentum-pumping “Ultimate Broadband Tour”. Supporting operational efforts, CHINA TELECOM ANNUAL REPORT 2002 12 further advances in technology have consistently brought down equipment costs, improving the economics of our broadband business. Broadband access is increasingly becoming a high growth, high margin business that contributes significantly to our revenue growth. We expect to quadruple our broadband subscriber base by the end of 2005. Cooperating with service providers, we have introduced V-net, a new business model aimed at promoting broadband penetration and usage. The interaction between access and applications made possible by V-net will open up a new range of services to our end-users, including on-line gaming, Video-On-Demand, on-line financial services, and distance education, while equipping service providers with easy access to end user payments, and to IDC, bandwidth and customer care services. V-net will effectively promote the rapid proliferation of broadband applications and stimulate growth in our subscriber base and revenue. Dial-up Internet access subscribers exceeded 10 million in 2002, an increase of 20.7% from 2001. A well-established and growing narrow-band business acts as a sort of incubator, nurturing demand for our broadband business. Broadband Subscribers (numbers in thousands) 14 243 1,123 CAGR(1):1080% 8 88 301 2001 2002 LAN Other ADSL:6 LAN: 4 2000 ADSL (1): 2000-2002 CAGR of total broadband subscribers BUSINESS REVIEW Managed data: high growth in usage line remarkable development in our We achieved managed data business over the past year. The bandwidth volume of our Digital Data Network (DDN), Frame Relay (FR) and Asynchronous Transfer Mode (ATM) services grew by 31.0%, 19.1% and 38.5%, respectively. We continued to focus on this business strategically, and have been committed to providing large enterprise customers with tailored services and total solutions that deliver real value. As we have become increasingly recognised as one of China’s preferred providers of managed data services, our subscriber base has expanded without interruption and most of our existing subscribers have upgraded their bandwidth and increased their usage. Managed Data-ATM (numbers in thousands) 10.8 % 6 8 1 (1): R G A C 7.8 5.3 1.4 0.7 1.3 ATM Subscribers 2000 ATM (in 2M Equivalent) 2001 2002 (1): CAGR of ATM (in 2M equivalant) CHINA TELECOM ANNUAL REPORT 2002 13 BUSINESS REVIEW Managed Data-FR (numbers in thousands) 47 Domestic long distance market share (1) 90% 70% 69% 72% 64% 60% 68% 55% 45% 67% 54% 44% 2000 2001 PSTN 2002 1H VoIP 2002 Total (1): in terms of total usage IDD market share (1) 99% 98% 95% 90% 84% 72% 71% 69% 66% 61% 59% 57% 2000 2001 PSTN 2002 1H VoIP 2002 Total (1): in terms of total usage 21 15 CAGR(1):47 % 20 24 11 FR Subscribers 2000 FR (in 128k Equivalent) 2001 2002 (1): CAGR of FR (in 128k equivalant) Managed Data-DDN (numbers in thousands) 157 155 136 208 42% CAGR(1): 159 103 DDN Subscribers DDN (in 64k Equivalent) 2001 2000 2002 (1): CAGR of DDN (in 64k equivalant) Risk in long distance voice business moderated Domestic and international, Hong Kong, Macau and Taiwan long distance services accounted for 23.3% of our total revenue in 2002, falling 3 percentage points from 2001. Due to the shift to a fully competitive market, tariff levels are set to a large extent on a competitive basis. Our long distance business therefore faces markedly reduced risk on the tariff front. CHINA TELECOM ANNUAL REPORT 2002 14 Domestic long distance: Traffic growth steady (minutes in millions) 2000 2001 2002 PSTN VoIP TOTAL 24,780 2,187 26,967 19,133 11,497 30,630 15,915 17,709 33,624 for telephone long distance Domestic services accounted for 19.0% of our total revenue in 2002. Our strategy this business, which we successfully enacted in 2002, has involved the discretionary use of VoIP as a competitive tool to maximise revenue. While the tariff premium for PSTN services remained constant, we fine-tuned the percentage of market-priced VoIP in total long distance traffic to respond to competitive pressures and best achieve our revenue target. In 2002, VoIP services contributed 52.7% of total long distance usage. As a result of the increase in usage of our market-priced VoIP services, we believe that tariff- related risks facing domestic long distance are markedly reduced. Results for the second half of 2002 were even more encouraging. Revenue rose 1.0% over the first half of the year, and our market share in terms of traffic volume was maintained above 50%. International, Hong Kong, Macau and Taiwan long distance: slight decline in traffic long distance telephone Revenue from international, Hong Kong, Macau and Taiwan services contributed 4.3% of our total revenue in 2002. At year-end 2002 we held a market share of 59.2% in terms of traffic volume. Total traffic declined by 5.8% from the previous year to 1.33 billion minutes. The opening of international gateways by other telecom operators in our service regions diverted a BUSINESS REVIEW the international portion of traffic previously transmitted by us. Also, competition translated into higher VoIP usage. that was intensified Value added services exhibited exceptional growth the added signify services resources including caller striking Value combination of limited incremental investment and attractive returns. We leveraged our network and to promote value-added customer services, ID display, call-up information services and information telephone. By the end of 2002, our caller ID display service had 23.84 million subscribers with a penetration rate of 41.9%, up from a penetration rate of 27.9% in 2001. We partnered with government agencies, news media and businesses to provide diversified call-up information services and call center out-sourcing to our customers, which also greatly boosted our voice traffic. In addition, we attempted to combine information services with e-commerce applications. Utilising our existing telephone billing and collection systems as a payment platform, we provided wireline telephone subscribers with such new services as telephone lottery and telephone stock trading. We also introduced 17901 direct dial VoIP, 4008 quasi toll- free and wireline pre-paid services. Interconnection and leased line businesses Interconnection and leased line services accounted for 9.9% of our total revenue in 2002. For local interconnection, we charge a termination fee of RMB0.06 per minute for inbound traffic, but, by regulation, we are exempt from any interconnection payment to mobile operators. Inbound local calls grew 10.8% in 2002. Long distance interconnection was influenced by a for outbound traffic local CHINA TELECOM ANNUAL REPORT 2002 15 investments. For example, we intend to capture potential traffic generated by people on the move full-function public phone by deploying more outlets in competitive areas, and increasing the number of IN-based public phone terminals in highly populated locations, such as schools and hospitals. Intensify development in broadband services. We intend to quadruple our broadband subscriber base over the next three years by continuing to leverage our rich copper wire access resources and making reasonable incremental investments. Given strong market demand, we intend to maintain broadband’s premium product positioning and to continue to promote the proliferation of broadband application services. Mitigate long distance business risks and maintain traffic growth. Our strategy for long distance services is centered on revenue stability, which we can achieve by offering flexible pricing packages, promoting the use of prepaid cards and continuing our defensive strategy for VoIP service. We will not promote lower tariffed VoIP services to a particular customer segment unless there is a competing VoIP product. This strategy has worked well in preventing competitive substitution and achieving steady growth in domestic and international, Hong Kong, Macau and Taiwan long distance traffic. intend to Emphasise business innovation. We further capitalise on existing resources through exploring new earnings models and promoting the development of value added services. Major efforts will also be made to create new revenue streams by selling new products to our huge subscriber base, as we did in 2002 with new services like 17901 direct dial VoIP, 4008 quasi toll-free and wireline prepaid services. We believe these efforts will help enhance our market leadership position. BUSINESS REVIEW significant structural change in traffic pattern in 2002. The traffic routing deregulation enacted in 2002 stimulated long distance operators, including ourselves, to carry on their own networks the long distance traffic generated by their own subscribers. The net impact of this change on us was limited, as we experienced reductions on both the revenue and the expense sides of the equation. financial The total amount of local and long distance 2 Mbit digital leased circuits grew 12.0% in 2002. Our marketing efforts focused on providing global one- stop shopping and total solution packages to enterprise government, customers. We are capable of providing consulting, service provisioning, trouble-shooting, billing and collection, and technical support, all at one single point of contact. We have established an excellent brand image among our major customers through our outstanding SLA service provision. large and Business Strategies Continue to expand our wireline subscriber base in a profitable manner. We intend to continue to expand our subscriber base, focusing on high- return regions and high-value segments, through re-allocation of existing the resources combined with appropriate additional integration and CHINA TELECOM ANNUAL REPORT 2002 16 customer to customer Boost satisfaction: Distributing differentiated products and tailored services via four channels. We will continue to implement our three-pronged general strategy of delivering individually tailored total solutions and global one large enterprise stop shopping services stickiness, increase to customers providing specialised services to small- and medium-sized enterprise customers to boost profit growth, and affording standardised services to residential customers to reduce operating costs. We will continue to allocate more personnel to “front- end” operations where these experienced workers, equipped with adequate training, will enhance our direct customer service capability. Since the compensation of “front-end” employees can be more closely linked to revenue, we will be able to convert formerly fixed costs into variable costs. Network development and IT systems Network development BUSINESS REVIEW smooth service on the user end. We are the first telecom operator in China to achieve this, ensuring superior service for our large enterprise customers. Our broadband access network was a key focus of our network development in 2002. While ADSL was our mainstream technology, we offered even higher bandwidth products such as VDSL. We also developed WLAN presence in high mobility business areas in major cities, including hotels, airports, cafes and office buildings. For example, at the end of 2002, we obtained authorisation to deploy WLAN in 206 hot spots in Shanghai. Throughout, utilisation of existing resources has been a major focus. We managed to improve network efficiency and increase utilisation through deployment resource optimisation. At the end of 2002, the utilisation of local and long distance switches rose 5.0 and 3.2 percentage points, respectively, as compared with 2001. re-allocation and Our wireline network boasts unparalleled coverage and scale in our service regions. At the end of 2002, our fiber-optic network had a total cable length of 250,000 kilometers. Local and long distance switching capacity totaled 74.76 million lines and 1.67 million ports, respectively. The bandwidth of our international gateway totaled 8.12 Gbps. We continued to utilise existing network resources, including our Intelligent Network platform, to roll out value-added and new services. The year 2002 witnessed the market debut of such new services as MPLS-VPN, 17901 direct dial VoIP and 4008 quasi toll-free services. IT systems our employed Our network infrastructure is 100% digitalised, high speed, reliable and multi-dimensional in terms of servicing capability. SDH+DWDM technology is transmission in broadly infrastructure, and Gigabit routers are widely deployed in our broadband Internet network. Strong reliability and high quality characterised our network operations in 2002, as demonstrated by our connection rate of over 96%. Our broad implementation of advanced technology has allowed us fiber optic capacity deployment on a real-time basis while maintaining to optimise As a consistent corporate focus, we have always sought to improve operational and management efficiency through establishing strong IT systems. Our IT systems (CTG-MBOSS) include the Business Support System (BSS), Operation Support System (OSS) and Management Support System (MSS). IT design heralds the Implementation of our technological and organisational restructuring of our the Enterprise Application technology has allowed for smooth interconnection between all IT systems. Adoption of Integration (EAI) CHINA TELECOM ANNUAL REPORT 2002 17 BUSINESS REVIEW the The planned company. major systems, enabling full information sharing within future development of our IT system is expected to further enhance market improve customer service, significantly raise operation and management our competitiveness. responsiveness and strengthen levels and Organisational restructuring and business re- engineering Determined to maintain market leadership and improve our competitiveness, we continued to implement internal restructuring and business re- engineering measures aimed at further gearing our company toward a “market-oriented, customer- centered and return-driven” business model. Market-oriented, stream-lined operational structure In 2002 we launched an organisational restructuring that involved all levels of our operations, from the headquarters to the provincial subsidiaries and local branches. A new “front-end-back-end” structure has been established at each level to enhance market responsiveness. The front-end is composed of “customer interface units” with related marketing functions, while at the back-end, all network resources have been consolidated to provide the front-end with service provisioning, quality control, billing and operation support services. An internal Service Level Agreement (SLA) system has been set up between the front-end and the back-end to ensure more concerted and high quality end-to-end service delivery. Illustration of the New Organizational Structure Back End Front End Network process re- engineering Large enterprises Network Network operations & maintenance IT SLA Product management Business subscribers Network Construction Public subscribers Account managers Community managers Rural contract agents "1000" Hotline End users CHINA TELECOM ANNUAL REPORT 2002 18 Business process re-engineering Drawing from international best practices and from our own experiences with a number of pilot programs, we are in the process of implementing business process re-engineering in all 47 of our Basic Business Units, or local network operations. Our efforts are centered on large corporate account resource utilisation, capital service, network expenditure and performance evaluation. We implemented the Key Account Management Process, which is based upon dedicated account managers with industry specific training. We are also working to control costs and enhance operational efficiency with the Network Resource Allocation Process. As part of this effort, we have implemented a computerised order processing system that creates an updated information link running throughout our entire internal service provisioning chain. This system allows us to fill customer orders more quickly, and to monitor the provisioning process in a systematic manner. Efforts to improve capital expenditure control and investment returns are centered on the Recurring Capital Expenditure Process, which utilises an investment priority system that ranks investment needs according to return prospects. Finally, we have established a KPI-linked compensation system to motivate our work force. Our dedicated efforts to put these processes into effect have instilled in our for in employees a belief shareholders, our have competitiveness. strengthened creating value and BUSINESS REVIEW Human resource development and the re-shaping of our corporate culture Over the past year, we have adopted a series of measures resource to enhance our human capabilities and re-shape the corporate culture of implemented a new China Telecom. We have evaluation system based on clearly defined Key Performance Indicators that links compensation to In addition, performance evaluation competition has been introduced in the designation and resignation of job posts. Both measures have helped establish a human resource management system that provides adequate motivation to our employees. We are excited to witness our energised team shaping new corporate values of innovation, execution, integrity and value creation. results. CHINA TELECOM ANNUAL REPORT 2002 19 MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONS AND RESULTS OF OPERATIONS [Divider] CHINA TELECOM ANNUAL REPORT 2002 20 MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONS AND RESULTS OF OPERATIONS in our increased by 7.3% Our total operating revenue in 2002 grew 10.1% in 2001 to RMB75,496 million. Our over that to operating expenses RMB54,118 million in 2002. Surpassing the profit forecast set out initial public offering prospectus by RMB367 million, we attained a net income of RMB16,864 million for the year and our basic earnings per share was RMB0.24. Our EBITDA(1) was RMB42,260 million in 2002, representing an EBITDA margin (defined as EBITDA divided by total operating revenue) of 56.0%. Our cash flows from operating activities increased by 13.3% to RMB37,102 million in 2002. (1) associates, depreciation interests. As Our EBITDA represents profit before net finance (costs)/income, investment income, share of profit and from taxation, the and minority amortisation telecommunications business is a capital-intensive industry, capital expenditures, the level of gearing and finance costs may have a significant impact on the net profit of companies with similar operating results. Therefore, we believe EBITDA may be helpful in analysing the operating results of a telecommunications service provider like us. Although EBITDA is widely used in the global telecommunications industry as a benchmark to reflect operating performance, financing capability and is not regarded as a it measure of operating performance and liquidity under generally accepted accounting principles. It also does not represent cash flows from operating activities. In addition, our EBITDA may not be comparable to similar indicators provided by other companies. liquidity, You should read the following discussion and analysis in conjunction with our audited financial statements and the accompanying notes included elsewhere in this annual report. Overview We made substantial achievements in the fiscal year of 2002, in terms of steady revenue growth, effective control of operating expenses, significantly improved profitability and strong growth of cash generated from operations. We also significantly reduced our capital expenditures in 2002. As a result, we managed to achieve our internal financial targets. Our strong financial position has set a solid foundation for future developments. CHINA TELECOM ANNUAL REPORT 2002 21 MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONS AND RESULTS OF OPERATIONS The table below sets forth our total operating revenue, operating expenses, operating income, net income and cash flows from operating activities in terms of amount and as a percentage of our total operating revenue for 2001 and 2002: Year Ended 31 December 2001 Percentage of Operating Revenue 2002 Percentage of Operating Revenue Amount (RMB in millions, except percentage data) 100.0% 73.6% 26.4% 10.0% 75,496 54,118 21,378 16,864 100.0% 71.7% 28.3% 22.3% — 37,102 — Amount 68,546 50,448 18,098 6,883 32,761 services usage and priced VoIP increased competition, the rate of decline decelerated from that of 2001. Fuelled by the surge in broadband subscribers and continued growth in managed data services, our total revenue from Internet and managed data services increased by 53.4% from that of 2001 to account for 7.4% of our total operating revenue in 2002. Revenue from leased line services, interconnection and other services also maintained positive growth. Operating revenue Operating expenses Operating income Net income Cash flows from operating activities Operating Revenue Our total operating revenue grew by RMB6,950 million, or 10.1%, from RMB68,546 million in 2001 to RMB75,496 million in 2002. Driven by the continued expansion of our wireline telephone subscriber base and a higher proportion of high-end subscribers, revenue from our local telephone services grew 12.1%. Although revenue from our long distance telephone services decreased by 2.3% due to an increase in the proportion of lower CHINA TELECOM ANNUAL REPORT 2002 22 MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONS AND RESULTS OF OPERATIONS The following table sets forth a breakdown of our operating revenue in terms of amount and as a percentage of our total operating revenue for 2001 and 2002: Year Ended 31 December 2001 Percentage of Operating Revenue Amount 2002 Percentage of Operating Revenue Amount (RMB in millions, except percentage data) 780 10,186 21,004 31,970 14,676 3,392 3,814 6,290 60,142 2,150 1,477 3,627 2,862 1,915 1.1% 14.9% 30.6% 46.6% 21.4% 4.9% 5.6% 9.2% 87.7% 3.1% 2.2% 5.3% 4.2% 2.8% 995 12,460 22,392 35,847 14,365 3,285 4,363 6,018 63,878 3,775 1,789 5,564 3,095 2,959 1.3% 16.5% 29.7% 47.5% 19.0% 4.3% 5.8% 8.0% 84.6% 5.0% 2.4% 7.4% 4.1% 3.9% Wireline telephone services(1) Local: Installation fees Monthly fees Local usage fees Sub-total Domestic long distance(2) International, Hong Kong, Macau and Taiwan long distance(2) Interconnections Upfront connection fees Sub-total Data and Internet services: Internet Managed data Sub-total Leased line services Other services(3) Toal operating revenue 68,546 100.0% 75,496 100.0% (1) Includes revenue from our registered subscribers, public telephones and prepaid calling cards services. (2) Includes revenue from our VoIP long distance services. (3) Includes primarily revenue from the provision of value-added telecommunications services and the sale and maintenance of certain customer-end equipment. CHINA TELECOM ANNUAL REPORT 2002 23 MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONS AND RESULTS OF OPERATIONS Local Telephone Services Long Distance Telephone Services Revenue from long distance telephone services decreased by 2.3%, from RMB18,068 million in 2001 to RMB17,650 million in 2002, primarily due to a higher proportion of the lower priced VoIP services to total long distance telephone usage. The rate at which revenue decreased, however, was lower than that of 2001. • • in 2001 Domestic Long Distance Services. Domestic long distance revenue decreased by 2.1%, from RMB14,676 million to RMB14,365 million in 2002. While total usage of our domestic long distance services increased, it was insufficient to offset the adverse impact of a higher proportion of the substantially lower priced VoIP services to the total usage. Total usage of domestic long distance services (including calls originated subscribers) from wireline increased by 9.8%, from 30.63 billion minutes in 2001 to 33.62 billion minutes in 2002. Usage of our VoIP domestic long distance services increased as a percentage of the total usage of domestic long distance services, from 37.5% in 2001 to 52.7% in 2002. and mobile international International Long Distance Services. Revenue from long distance services decreased by 3.2%, from RMB3,392 million in in 2002. This 2001 to RMB3,285 million revenue decrease was primarily due to increased Total usage of international long distance services (including calls originated from wireline and mobile subscribers) decreased by 5.8%, from 1.41 billion minutes in 2001 to 1.33 billion minutes in 2002. competition. telephone in 2002. The position of our local telephone services as the largest revenue source of our wireline services was further enhanced as local revenue grew by 12.1%, from RMB31,970 million in 2001 to RMB35,847 services Local million contributed 47.5% of our total operating revenue for 2002, which rose 0.9 percentage points from 46.6% in 2001. The increase in local revenue primarily resulted from increases in revenue from monthly fees and local usage fees driven by subscriber growth. The number of our access lines in service increased by 8.38 million, or 17.3%, from 48.48 million at 31 December 2001 to 56.86 million at 31 December 2002. • the expected customer Installation Fees. Installation fees received from customers are deferred and amortised relationship over the period of 10 years. Revenue amortised amount of upfront installation fees increased by 27.6%, from RMB780 million in 2001 to RMB995 million in 2002. The increase was primarily due to the rapid increase in the number of our access lines in service in recent years. from • Monthly Fees. Monthly fee revenue increased by 22.3%, from RMB10,186 million in 2001 to RMB12,460 million in 2002, primarily due to a 19.3% increase in the average number of our access lines in service, from 44.15 million in 2001 to 52.67 million in 2002. • Local Usage Fees. Revenue from local usage increased by 6.6%, from RMB21,004 million in 2001 to RMB22,392 million in 2002. The increase was primarily due to an increase in local telephone usage volume (including dial- up usage), which increased by 6.7%, from 212.4 billion pulses in 2001 to 226.6 billion pulses in 2002. CHINA TELECOM ANNUAL REPORT 2002 24 MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONS AND RESULTS OF OPERATIONS Internet and Managed Data Services substantial in China. Demand for our services Our service regions are among the most prosperous areas Internet and managed data from business and residential subscribers continued to increase, and subscriber base particularly, our broadband experienced Altogether, Internet and managed data service revenue grew 53.4%, from RMB3,627 million in 2001 to RMB5,564 million in 2002, and accounted for 7.4% of our total operating revenue in 2002. We expect such revenue will continue to increase as our subscriber base and usage of our Internet and managed data services continue to grow. growth. • Internet Services. Internet access services revenue increased by 75.6%, or RMB1,625 million, from RMB2,150 million in 2001 to RMB3,775 million in 2002. While usage of dial- up Internet services decreased, strong growth in broadband subscription was the key driver of revenue. Our broadband subscribers (primarily ADSL and LAN subscribers) increased by 982,000, or 247.4%, to 1,379,000 at the end of 2002. Broadband service has emerged as a major contributor to our revenue growth. the boost Internet in • Managed Data Services. Driven primarily by growth in the usage of our services, revenue increased by from managed data services 21.1%, from RMB1,477 million in 2001 to RMB1,789 million in 2002. The total leased bandwidth of our DDN services was 207,700 x 64Kbps at 31 December 2002, representing an increase of 31.0% from that at 31 December 2001. The total leased bandwidth of our ATM services was 10,800 x 2Mbps at 31 December 2002, representing an increase of 38.5% from that at 31 December 2001, and the total leased bandwidth of our frame relay services was 24,300 x 128Kbps at 31 December 2002, representing an increase of 19.1% from that at 31 December 2001. Leased Line, Interconnection and Other Services • • increased by 8.1%, Leased Line Services. Revenue from leased line services from RMB2,862 million in 2001 to RMB3,095 million in 2002. This increase was fuelled by a 12.0% increase in bandwidth of digital circuits leased, which amounted to 94,400 x 2Mbps at the end of 2002. Interconnection Services. Revenue from interconnection fees increased by 14.4%, from RMB3,814 million in 2001 to RMB4,363 million in 2002. This increase primarily reflected the settlement revenue we began to receive from international China Telecom Group and operators interconnection under agreement with China Telecom Group and our arrangement with China Telecom Group for apportionment of international settlement with effect from 1 January 2002, which amounted to RMB1,954 million in 2002. This increase was in by partially interconnection revenue from other operators of RMB1,405 million. decrease offset our a • Other Services. Revenue from other services increased by 54.5%, from RMB1,915 million in 2001 to RMB2,959 million in 2002, primarily due to the rapid growth in our value-added telephone services and revenue from the sale and rental of customer-end equipment. The contribution of total operating revenue increased from 2.8% in 2001 to 3.9% in 2002. these services to CHINA TELECOM ANNUAL REPORT 2002 25 MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONS AND RESULTS OF OPERATIONS Upfront Connection Fees Upfront connection fees represent the upfront fees received initial activation of wireline services, amortised over the expected customer the for relationship period of 10 years. Effective from 1 July 2001, we ceased charging upfront connection fees to new subscribers. Consequently, the amortised amount decreased by 4.3%, from RMB6,290 million in 2001 to RMB6,018 million in 2002. The table below sets forth the amortisation of our upfront connection fees for each of the years from 2003 to 2011 based on a 10-year estimated amortisation period: 2003 2004 2005 Year Ended 31 December 2007 2008 2006 2009 2010 2011 (RMB in millions) 5,535 4,784 3,842 2,815 1,886 1,158 646 274 53 and experienced Our operating expenses increased by 7.3%, from RMB50,448 million in 2001 to RMB54,118 million in interconnection 2002. While personnel increases, expenses depreciation and amortisation expenses grew moderately. Moreover, we maintained the level of selling, general and administrative expenses and reduced network operations and significantly support expenses. significant Amortisation of upfront connection fees Operating Expenses In 2002, we took the initiative to centralise our financial and budget management, equipment procurement, billing, network resource allocation and network maintenance to improve the efficiency of our resource utilisation, to rationalise our cost structure and to keep operating expenses under control. CHINA TELECOM ANNUAL REPORT 2002 26 MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONS AND RESULTS OF OPERATIONS The following table breaks down our operating expenses in terms of amount and as a percentage of our total operating revenue for 2001 and 2002: Depreciation and amortisation Network operations and support(1) Selling, general and administrative(1) Personnel Interconnection charges and other expenses Amount 19,451 16,477 6,986 6,207 1,327 Year Ended 31 December 2001 Percentage of Operating Revenue 2002 Percentage of Operating Revenue Amount (RMB in millions, except percentage data) 28.4% 24.0% 10.2% 9.1% 1.9% 20,882 14,724 6,960 8,915 2,637 27.7% 19.5% 9.2% 11.8% 3.5% 71.7% Total operating expenses 50,448 73.6% 54,118 (1) Does not include personnel expenses. in increases Depreciation and Amortisation. Our depreciation and amortisation expenses increased by 7.4%, from RMB19,451 million in 2001 to RMB20,882 million in capital to 2002, mainly due expenditures in recent years. In 2002, we tightened control over capital expenditures. As a result, the rate at which depreciation and amortisation expenses increased was lower than the 11.9% increase in 2001 compared to 2000 and the amount of depreciation and amortisation expenses as a percentage of total operating revenue dropped by 0.7 percentage points as compared with 2001. to Network Operations and Support. In 2002, we further resource centralised network maintenance and allocation improve efficiency and network utilisation, thereby trimming our network operations and support expenses (excluding related personnel expenses) by 10.6%, from RMB16,477 million in 2001 to RMB14,724 million in 2002. This decrease was mainly due to a 22.4% decrease in our maintenance in 2001 to expenses, RMB7,937 million in 2002. from RMB10,225 million Selling, General and Administrative Expenses. Despite the continued expansion of our customer base, our selling, general and administrative expenses (excluding related personnel expenses) dropped slightly to RMB6,960 million in 2002 from RMB6,986 million in 2001. This reflected our improved operating efficiency and the benefits of economies of scale. Selling and marketing expenses decreased by 1.8%, from RMB3,074 million in 2001 to RMB3,019 million in 2002. General and administrative expenses increased by 0.7%, from RMB3,912 million in 2001 to RMB3,941 million in 2002. Personnel Expenses. Our personnel expenses increased by 43.6%, from RMB6,207 million in 2001 to RMB8,915 million in 2002. This increase was primarily due to the enhancement of our merit- based compensation system to retain and motivate competent our compensation in line with that of market level. We believe such a system helps improve our corporate competitiveness. personnel, bring and to CHINA TELECOM ANNUAL REPORT 2002 27 MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONS AND RESULTS OF OPERATIONS Income Tax to tax rate was primarily due Our statutory income tax rate is 33%. In 2002, our income tax expense was RMB3,855 million, representing an effective tax rate of 18.5%. The difference between the statutory tax rate and our the effective preferential income tax rate of 15% applied to some of our subsidiaries located in special economic zones in China and the exclusion of the upfront connection fees and part of the usage fees from taxable revenue. See note 24 to the audited financial statements included elsewhere in this annual report for further details in respect of the reconciliation of our effective tax rate to the statutory tax rate. Net Income In 2002, we surpassed the profit forecast set out in our initial public offering prospectus. Driven by steady revenue growth, coupled with the effective control over operating expenses, our net income reached RMB16,864 million. Capital Expenditures Our capital expenditures decreased by 27.8%, from RMB40,028 million in 2001 to RMB28,919 million in 2002. Interconnection Charges and Other Expenses. Interconnection and other expenses increased by 98.7%, from RMB1,327 million in 2001 to RMB2,637 million in 2002. This increase was primarily due to the settlement expenses we began to pay to China Telecom Group and international operators under our interconnection agreement with China Telecom Group and our arrangement with China Telecom Group for apportionment of international settlement with effect from 1 January 2002, which amounted to increase was RMB2,160 million in 2002. This in domestic partially offset by a decrease interconnection to other operators of RMB842 million. expenses payable Net Finance Costs/(Income) in net foreign Caused primarily by a change exchange differences, we had net finance costs of RMB632 million in 2002 as opposed to net finance income of RMB293 million in 2001. We experienced a net foreign exchange loss of RMB221 million in 2002, as compared to a net foreign exchange gain of RMB430 million in 2001. In addition, while our in 2002 decreased by gross RMB94 million from 2001 as a result of the repayment of bank loans, net interest expense increased from RMB383 million in 2001 to RMB551 million in 2002. This increase was primarily due to a reduction in the amount of capitalised interest of RMB262 million following a decrease in our capital expenditures. interest expense CHINA TELECOM ANNUAL REPORT 2002 28 MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONS AND RESULTS OF OPERATIONS The table below sets forth our historical and planned capital expenditures for the years indicated. Actual capital expenditures for the years after 31 December 2002 may differ from the amounts indicated below. Year Ended 31 December 2000 2001 2002 2003 (Planned) 2004 (Planned) (RMB in millions) Total capital expenditures 34,310 40,028 28,919 25,000 23,500 The advanced and expansive network infrastructure we built in recent years, together with the improved utilisation of these resources, allowed us the flexibility to substantially decrease our capital expenditure in 2002. to We further rationalised the allocation of our capital expenditures in 2002. We continued to allocate a majority of our capital expenditures the development of access infrastructure in order to meet subscriber growth needs and to strengthen our position as the owner of the “last mile”. Internet and data networks were another major area of capital expenditure as we capitalised on the surging demand for broadband, managed data and Internet services. In addition, we increased expenditures for our Business Support System (BSS), Operation Support System (OSS) and Management Support System (MSS) as part of our effort to improve customer service quality, operating efficiency and information disclosure. We expect to fund our capital expenditure needs through a combination of cash generated from operating activities, short-term and long-term bank loans and other debt and equity financing. We believe we will have sufficient resources to meet our capital expenditure the foreseeable future. requirements for Liquidity and Capital Resources Cash Flows We experienced a net cash inflow of RMB12,541 million in 2002 as opposed to a net cash outflow of RMB9,979 million in 2001. We raised RMB10,659 million from the initial public offering of our shares in international capital markets in the fourth quarter of 2002. Furthermore, our net cash flow benefited from an increase in cash flows from operating activities and a substantial reduction in capital expenditures. The table below summarises our cash flows for 2001 and 2002. Year Ended 31 December 2001 2002 (RMB in millions) 32,761 (35,399) 37,102 (29,095) Cash flows from operating activities Net cash used in investing activities Net cash (used in)/ from financing activities (7,341) 4,534 (Decrease)/increase in cash and cash equivalents (9,979) 12,541 CHINA TELECOM ANNUAL REPORT 2002 29 MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONS AND RESULTS OF OPERATIONS Working Capital Our working capital (defined as total current assets minus total current liabilities) was a deficit of RMB31,125 million at 31 December 2002 and a deficit of RMB43,316 million at 31 December 2001. The reduction in working capital deficit in 2002 was primarily the net proceeds of RMB10,659 million we received from the initial public offering of our shares. In addition, from 31 December 2001 to 31 December 2002, our net accounts receivable increased by RMB353 million, and our accounts payable decreased by RMB520 million. result of the Our cash and cash equivalents were RMB16,423 million at 31 December 2002, of which 70.2%, 23.4% and 6.4% were denominated in Renminbi, US dollars and Hong Kong dollars, respectively. Indebtedness Our indebtedness at 31 December 2001 and 2002 was as follows: Short-term debt Current portion of long-term debt Long-term debt, excluding current portion Total debt 2001 2002 (RMB in millions) 18,827 3,621 19,175 2,219 7,101 4,853 29,549 26,247 Our principal source of liquidity is cash flows from operating activities. In 2002, cash flows from operating activities was RMB37,102 million, representing an increase of RMB4,341 million from RMB32,761 million in 2001. This increase was mainly due to an RMB1,603 million increase in cash generated from operations and a RMB2,973 million decrease in income tax paid. Stemming from a substantial decrease in capital expenditures, net cash used in investing activities fell by RMB6,304 million, from RMB35,399 million in 2001 to RMB29,095 million in 2002. Net cash from financing activities was RMB4,534 million in 2002, while net cash used in financing activities was RMB7,341 million in 2001. This change was primarily due to the net proceeds of RMB10,659 million we raised from the initial public offering of our shares in the fourth quarter of 2002. This cash inflow was offset by the substantial amount of bank loans we were able to repay, given the significant increase in cash flows from operating activities and the substantial decrease in our capital expenditures. As a result, net cash flow from bank debt (proceeds from bank debts minus repayments of bank debts) changed from a net cash inflow of RMB4,444 million in 2001 to a net cash outflow of RMB3,529 million in 2002. See our audited financial statements included elsewhere in this annual report for further details of net cash from financing activities. CHINA TELECOM ANNUAL REPORT 2002 30 MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONS AND RESULTS OF OPERATIONS With the benefit of increased cash flows from operating activities and decreased amount of cash used in investing activities, we paid off a significant amount of bank loans. This, together with the proceeds from the initial public offering of our shares, has strengthened our capital structure. Our debt-to-asset ratio (defined as total debt divided by total assets) declined from 15.6% at 31 December 2001 to 12.4% at 31 December 2002. This has provided us with a solid foundation for continuing organic and external growth. In 2002, we further centralised cash management to boost efficiency. Our total debt was reduced by RMB3,302 million to RMB26,247 million at 31 Contractual Obligations December 2002, of which 84.0%, 10.0% and 6.0% were denominated in Renminbi, Japanese Yen and US dollars, respectively. Having established and maintained high credit ratings at major commercial banks in the PRC, we have been able to obtain adequate debt financing on preferable terms. In 2002, we fine-tuned our the dual debt costs and objectives of managing financial risks. The weighted average interest rate of our short-term debt was 4.7% at 31 December 2002, representing an 80 basis points decrease from that at 31 December 2001. financing strategy reducing to achieve financing The following table sets forth our contractual obligations at 31 December 2002: Repayable in Total 2003 2004 2005 2006 Thereafter (RMB in millions) Short-term debt Long-term debt Operating lease commitments Capital commitments Guarantees 19,175 7,072 1,438 4,239 6 19,175 2,219 457 4,239 6 — 1,196 355 — — Total contractual obligations 31,930 26,096 1,551 — 825 114 — — 939 — 268 75 — — 343 — 2,564 437 — — 3,001 We will continue to pursue steady revenue growth, implement prudent financial management policies, control operating expenses, rationalise our cost structure, reduce capital expenditures and enhance the investment return of our capital projects. We are confident in our ability to create higher value for our shareholders. CHINA TELECOM ANNUAL REPORT 2002 31 REPORT OF THE DIRECTORS [Divider] CHINA TELECOM ANNUAL REPORT 2002 32 The directors (the “Directors”) of China Telecom Corporation Limited (the “Company”) are pleased to present their report together with the audited financial statements of the Company and its subsidiaries (the “Group”) prepared in accordance with International Financial Reporting Standards for the year ended 31 December 2002. PRINCIPAL ACTIVITIES the leading provider of wireline We are Shanghai telecommunications Municipality, Guangdong Province, Jiangsu Province and Zhejiang Province in China. Our scope of business includes the following: services in (1) operating a variety of domestic wireline telecommunications networks and facilities (including wireless local loops); (2) operating voice, data, image, multimedia and other information services mainly based on the wireline networks; (3) conducting accounts settlement relating to international telecommunications services in accordance with state regulations; and REPORT OF THE DIRECTORS (4) dealing with system integration, technological development, technical services, information telecommunications equipment consulting, design manufacture, implementation and sales. together with CORPORATE GOVERNANCE We have made efforts to optimise our corporate internal governance management the transparency of information disclosure. structure, practises, regulate improve and Our shareholders’ meetings, the Board of Directors and its respective committees, the Supervisory Committee and the management team check and balance the powers of each other and discharge their functions in a regulated matter. in order We conduct our business in strict compliance with to be our Articles of Association accountable to all our shareholders. All directors have performed their duties conscientiously and diligently. Our Board of Directors consists of two independent non-executive directors who are experienced in terms of corporate management and reputable in the community. The independent non- executive directors have provided a check and balance to decisions made by the Board of Directors and thus effectively guarded the interest of minority shareholders. two committees have We have established an audit committee and a in 2002 and 2003 remuneration committee two respectively. The independent non-executive directors and one employee respresentative. The audit committee is primarily responsible for the accuracy of the financial information and is required to opine on the fairness and reasonableness of the connected CHINA TELECOM ANNUAL REPORT 2002 33 REPORT OF THE DIRECTORS remuneration committee is transactions. The primarily responsible for the determination of remuneration packages for managerial officers and to ensure the fairness of the remuneration policy with the purpose of incentivising the employees. Being a H share company, we have complied with the PRC laws to establish a Supervisory Committee. The Supervisory Committee has supervised the legality and regularity of the Company’s financial affairs, the performance of our Directors and senior management. investors’ We aim to improve our corporate transparency in order to strengthen the confidence of investors. The Company has established various departments to focus on secretarial matters of the Board of relationship. These Directors and departments are primarily responsible for the development of a communication channel with the investors disclosure. Simultaneously, pursuant to the relevant laws and information internal control and regulations, disclosure systems have been strengthened in order to enhance corporate transparency. information and DIRECTORS AND SENIOR MANAGEMENT OF THE COMPANY The following table sets forth certain information concerning the Directors and senior management of the Company. Name Age Position in the Company Date of Appointment Chairman of the Board of Directors and Chief Executive Officer 10 September 2002 Executive Director and President 10 September 2002 Executive Director, Executive Vice President and Chief Financial Officer 10 September 2002 Executive Director and Executive Vice President 10 September 2002 Executive Director and Executive Vice President 10 September 2002 Executive Director, Executive Vice President and Company Secretary 10 September 2002 Executive Director and Executive Vice President 10 September 2002 Executive Director Executive Director 10 September 2002 10 September 2002 Independent Non-executive Director 10 September 2002 Independent Non-executive Director 10 September 2002 Chairman and President of Jiangsu Telecom Corporation Limited 19 October 2002 Zhou Deqiang Chang Xiaobing Wu Andi Zhang Jiping Huang Wenlin Li Ping Wei Leping Cheng Xiyuan Feng Xiong Zhang Youcai Vincent Lo Hong Sui Sun Jiuming 61 46 48 47 49 49 57 59 57 62 55 56 CHINA TELECOM ANNUAL REPORT 2002 34 REPORT OF THE DIRECTORS Name Wang Jirong Wang Qi Age 49 48 Position in the Company Date of Appointment Chairman and President of Zhejiang Telecom Corporation Limited 10 October 2002 Controller of China Telecom Corporation Limited 10 September 2002 The executive Directors of the Company also hold executive positions with China Telecommunications Corporation. SUPERVISORS The following table sets forth certain information concerning the Supervisors of the Company: Name Age Position in the Company Date of Appointment Zhang Xiuqin Tan Ming1 Zhu Lihao Xie Songguang Li Jing 56 49 62 54 37 Chairperson of Supervisory Committee 10 September 2002 Supervisor Independent Supervisor Supervisor Supervisor 10 September 2002 10 September 2002 10 September 2002 10 September 2002 1 Mr. Tan Ming resigned from his position as Supervisor effective on 1 April 2003, and has been replaced by Mr. Wang Huanhui. DIRECTORS’ INTEREST IN AND RIGHT TO ACQUIRE SHARES As at 31 December 2002, none of the Directors of the Company had any interest in any shares or debentures of the Company or any associated corporation (as defined in the Securities (Disclosure of Interest) Ordinance of Hong Kong (the “SDIO”)) as recorded in the register required to be kept under section 29 of the SDIO, or as otherwise notified to the Company and the HKSE pursuant to the Model Code for Securities Transactions by Directors of Listed Companies or, in the case of Supervisors, which would be required to be notified as above if they had been Directors. As at 31 December 2002, the Company has not granted its Directors, or their respective spouses or children below the age of 18 any rights to subscribe for its equity securities. DIRECTORS’ SERVICE CONTRACTS INTEREST IN CONTRACTS AND Each of the existing Directors entered into a service contract with the Company for a term of three years. Save as the service contracts mentioned above, for the year ended 31 December 2002, the Directors did not have any material interests, whether directly or indirectly, in any contracts of significance entered into by the Company, any of its holding companies or subsidiaries or subsidiaries of the Company’s holding company. CHINA TELECOM ANNUAL REPORT 2002 35 REPORT OF THE DIRECTORS EMOLUMENTS OF SUPERVISORS THE DIRECTORS AND Please refer to note 25 of the audited financial statements for details of the emoluments of the Directors and Supervisors of the Company. SHARE CAPITAL a and share registered businesses Corporation Telecommunications The Company was incorporated on 10 September 2002 with capital of 68,317,270,803 ordinary domestic shares with a par value of RMB1.00 each. Such shares were issued to in China for the transfer of the wireline consideration telecommunications related operations in Shanghai Municipality, Guangdong Province, Jiangsu Province and Zhejiang Province to the Company. As part of a reform plan approved by the State Council with respect to the administration services, China of Telecommunications transferred 5,719,768,087 shares, 975,047,636 shares and 2,177,711,698 shares to Guangdong Rising Assets Management Co., Ltd., Jiangsu Guoxin Investment Group Co., Ltd. and Zhejiang Financial Development Company, respectively. telecommunications Corporation rural controlling shareholder, Pursuant to the global offering of the Company’s H shares conducted in 2002 (the “Global Offering”), issued 6,868,767,600 H shares the Company (including H shares underlying American Depositary Shares (“ADSs”)) in November 2002 and a further 428,148,100 H shares in December 2002. The China Company’s Telecommunications Corporation, and each of Guangdong Rising Assets Management Co., Ltd., Jiangsu Guoxin Investment Group Co., Ltd. and Zhejiang Financial Development Company, sold 598,327,900 H shares, 57,571,100 H shares, 9,814,100 H shares and 21,919,300 H shares, in November 2002 and a further respectively, 37,295,300 H shares, 3,588,600 H shares, 611,700 H shares and 1,366,300 H shares, respectively, in December 2002. After the completion of the Global Offering, 8,027,410,000 H shares were held by the public, representing approximately 10.62% of the issued share capital of the Company. The Company’s H shares and ADSs were listed on The Stock Exchange of Hong Kong Limited (the “HKSE”) and the New York Stock Exchange (the “NYSE”) on 15 November 2002 and 14 November 2002, respectively. CHINA TELECOM ANNUAL REPORT 2002 36 The share capital of the Company in issue as fully paid or credited as fully paid as at 31 December 2002 was 75,614,186,503 shares with a par value of RMB1.00 each. As at 31 December 2002 the share capital of the Company comprised: REPORT OF THE DIRECTORS Shares Domestic shares (total): Domestic shares held by: China Telecommunications Corporation Guangdong Rising Assets Management Co., Ltd. Jiangsu Guoxin Investment Group Co., Ltd. Zhejiang Financial Development Company H shares (including H shares underlying ADSs) Total RESULTS Results of the Group for the year ended 31 December 2002 and the financial position of the Company and the Group as at that date are set out in the audited financial statements on pages 64 to 109 in this annual report. DIVIDEND the year, representing a The directors propose to declare a final dividend for the year ended 31 December 2002 on the basis of HK$0.065 per share, pro-rated based on the number of days the Company’s shares have been listed during total of approximately RMB672 million. The dividend proposal shall be submitted for consideration at the annual general meeting to be held on 20 June 2003. Dividends will be denominated and declared in Renminbi. Dividends on domestic shares will be paid in Renminbi and dividends on H shares will be paid in Hong Kong dollars. The exchange rate for dividends to be paid in Hong Kong dollars will be the mean of the average rate of Hong Kong dollars Number of shares as at 31 December 2002 67,586,776,503 58,809,120,182 5,658,608,387 964,621,836 2,154,426,098 8,027,410,000 75,614,186,503 Percentage of the total number of shares in issue as at 31 December 2002 (%) 89.38 77.78 7.48 1.27 2.85 10.62 100.00 to Renminbi as announced by the People’s Bank of China for the week prior to the date of declaration of dividends. PURCHASE, SALE AND REDEMPTION OF SHARES Except for the issue of shares in connection with the Global Offering, the Company has not purchased, sold or redeemed any securities of the Company during the reporting period. SUMMARY OF FINANCIAL INFORMATION Please refer to pages 115 to 116 in this annual report for a summary of the operating results and financial condition of the Group for each of the years in the four year period ended 31 December 2002. BANK LOANS AND OTHER BORROWINGS Please refer to note 13 of the audited financial statements for details of bank loans and other borrowings of the Group. CHINA TELECOM ANNUAL REPORT 2002 37 REPORT OF THE DIRECTORS CAPITALISED INTEREST Please refer to note 23 of the audited financial statements for details of the Group’s capitalised interest for the year ended 31 December 2002. FIXED ASSETS Please refer to note 3 of the audited financial statements for movements in the fixed assets of the Group for the year ended 31 December 2002. TRUST DEPOSITS AND OVERDUE FIXED DEPOSITS Please also refer to note 19 of the audited financial statements for details of the movements in the reserves of the Company and of the Group for the year ended 31 December 2002. DONATIONS For the year ended 31 December 2002, the Group made charitable and other donations totaling RMB23 million. SUBSIDIARIES AND ASSOCIATED COMPANIES As at 31 December 2002, the Group did not have any trust deposits or any overdue fixed deposits with financial institutions or any other units. Please refer to notes 5 and 6 of the audited financial statements for details of the Company’s subsidiaries and the Group’s interests in associated companies as at 31 December 2002. RESERVES CHANGES IN SHAREHOLDERS’ EQUITY Please refer to page 68 of this annual report for the consolidated statement of shareholders’ equity. RETIREMENT BENEFITS Please refer to note 33 of the audited financial statements for details of the retirement benefits of the Group. and accounting Pursuant to Article 147 of the Company’s articles of association (the “Articles of Assocation”), where the financial statements prepared in accordance with PRC regulations standards materially differ from those prepared in accordance with either international accounting standards, or those of the place outside the PRC where the Company’s shares are listed, the distributable profit for the relevant accounting period shall be deemed to be the lesser of the amounts shown in those respective statements. Distributable reserves of the Company as at 31 December 2002, calculated based on the above and prior to the proposed final dividend for 2002, amounted to approximately RMB6,497 million. financial In addition to the allocation to the statutory reserve funds, the Directors propose to allocate RMB6,497 million to a discretionary surplus reserve. The allocation proposal for consideration at the annual general meeting to be held on 20 June 2003. submitted shall be CHINA TELECOM ANNUAL REPORT 2002 38 PRE-EMPTIVE RIGHTS There are no provisions for pre-emptive rights in the Articles of Association requiring the Company to offer new shares to the existing shareholders in proportion to their shareholdings. USE OF PROCEEDS The net proceeds from the Global Offering, after deduction of fees and expenses, amounted to RMB10,659 million. As at 31 December 2002, these proceeds have been deposited in interest-bearing accounts as short-term deposits and will be used for the expansion and upgrading of the Company’s telecommunications network the improvement of the Company’s business operation the development of supporting systems and telecommunications applications and technologies infrastructure, CONNECTED TRANSACTIONS REPORT OF THE DIRECTORS from as originally proposed in the Company’s prospectus. The remaining amount will be used to fund potential Telecommunications China acquisitions Corporation and its subsidiaries (“China Telecom Group”) the telecommunications in China that are industry consistent with our business strategies and for general corporate purposes. investments strategic and in MAJOR CUSTOMERS AND SUPPLIERS For the year ended 31 December 2002, sales to the five largest customers represented an amount not exceeding 30% of the operating revenue of the Group. the For the year ended 31 December 2002, purchases from suppliers represented an amount not exceeding 30% of the total purchases of the Group. largest equipment five During the year ended 31 December 2002, the Group had the following connected transactions expenditures: Transaction Amount Annual limit (in RMB millions) (in RMB millions) Payment of costs associated with the provision of management services (part of centralised services) Payment of costs associated with international telecommunications facilities (part of centralised services) Payment of interconnection fees to China Telecommunications Corporation Payment of interconnection fees to the Company by China Telecommunications Corporation Leasing of optic fibers from China Telecommunications Corporation Provision of engineering services by China Telecom Group Leasing of properties from China Telecom Group 69 414 687 302 102 3,243 266 N/A1 N/A1 N/A1 N/A1 N/A1 4,392 N/A1 CHINA TELECOM ANNUAL REPORT 2002 39 REPORT OF THE DIRECTORS Transaction Leasing of properties by the Group to China Telecom Group Provision of third party property sub-leasing by China Telecom Group Provision of IT services by China Telecom Group Provision of equipment procurement services by China Telecom Group Provision of community services by China Telecom Group Provision of ancillary telecommunications services by China Telecom Group Provision of special communications services to China Telecom Group Amount Annual limit (in RMB millions) (in RMB millions) 3 321 151 782 1,291 1,219 28 N/A1 N/A1 N/A1 N/A1 2,639 1,510 N/A1 1 2 Since these transactions are all on normal commercial terms in which the total consideration of each transaction is not expected to exceed 3 percent of the book value of the net tangible assets of the Company as at 31 December 2002 and therefore Rule 14.25(1) of the Listing Rules shall apply. Since no waivers have been applied for, no specific annual limits have been set. Following the transfer of China Telephony Directory Company in September 2002 from China Telecom Group to China Netcom Group, which is not a connected party, the Company has subsquently adjusted the amount incurred under the equipment procurement agreements. For further details of the connected transactions please refer to pages 44 to 50 of this annual report. The independent non-executive Directors have confirmed that all connected transactions in the year ended 31 December 2002 to which the Group was a party: 1. had been entered into, and the agreements governing those transactions were entered into, by the Group in the ordinary and usual course of business; (ii) where there was no available comparison to judge whether they are on normal less commercial terms, on terms no favourable than those available to or from independent third parties; and 3. had been entered into on terms that are fair and reasonable so far as the independent shareholders of the Company are concerned. independent non-executive Directors have The further confirmed that: 2. had been entered into either: (i) on normal commercial terms; or 1. the aggregate annual value of the Group’s expenditure for engineering services has not exceeded the limit of RMB4,392 million; CHINA TELECOM ANNUAL REPORT 2002 40 2. 3. the aggregate annual value of the Group’s expenditure for community services has not exceeded the limit of RMB2,639 million; and the aggregate annual value of ancillary telecommunications services has not exceeded the limit of RMB1,510 million. The auditors of the Group have reviewed the the connected Directors that the transactions: transactions and confirmed to 1. 2. 3. 4. have received the approval of the Directors of the Company; have been entered into in accordance with the pricing policies as stated in the relevant agreements, where applicable; have been entered into in accordance with the terms of the agreements governing such transactions; and for services engineering and the aggregate annual value of the Group’s services, expenditure community ancillary telecommunications services, respectively, has not exceeded the limits of RMB4,392 million, RMB2,639 million and RMB1,510 million, respectively. REPORT OF THE DIRECTORS EMPLOYEES As at 31 December 2002, the Group had 102,647 employees illustrated as follows: Number of employees Percentage Management, finance and administration Sales and marketing Operations and maintenance Others 18,200 27,263 52,581 4,603 17.7 26.6 51.2 4.5 Total 102,647 100.0 As at 31 December 2002, the Group also had 39,714 temporary employees. incentive combined The Company has implemented a short-term and remuneration long-term scheme: the primary components of an employee’s remuneration include basic salary, bonus based on performance, compensation based on seniority and share appreciation rights (share appreciation rights are exclusively for senior management and senior technological experts). In addition, the Company importance of employee also emphasises the training and uses various means of training to improve the quality and capability of its employees. COMPLIANCE WITH CODE OF BEST PRACTICE Throughout the period commencing from the date of the listing of the Company’s H shares on The Stock Exchange of Hong Kong Limited on 15 November 2002 through to 31 December 2002, the Company was in compliance with the Code of Best Practice as set out in the Listing Rules. CHINA TELECOM ANNUAL REPORT 2002 41 REPORT OF THE DIRECTORS SUBSTANTIAL INTERESTS IN THE SHARE CAPITAL OF THE COMPANY The Company has been notified of the following interests in the Company’s issued shares as at 31 December 2002 amounting to 10% or more of the ordinary shares in issue: Ordinary shares held Percentage of Total Issued Shares China Telecommunications Corporation 58,809,120,182 77.78% interests Apart from the foregoing, no person or corporation had any in the share capital of the Company as recorded in the register required to be kept under section 16(1) of the SDIO as having an interest in 10% or more of the issued share capital of the Company. MATERIAL LEGAL PROCEEDINGS As at 31 December 2002, as far as the Directors are aware of, the Group was not involved in any material litigation or arbitration and no material litigation claims were pending or threatened or made against the Group. AUDITORS KPMG Huazhen and KPMG were appointed as the domestic and international auditors of the Company respectively for the year ended 31 December 2002. KPMG has audited the accompanying financial statements which have been prepared in accordance with International Financial Reporting Standards. The Company has retained KPMG Huazhen and KPMG since the date of its listing. A resolution for the reappointment of KPMG Huazhen and KPMG as the domestic and international auditors of the Company for the year ending 31 December 2003 will be proposed at the annual general meeting of the Company to be held on 20 June 2003. By Order of the Board Zhou Deqiang Chairman Beijing, PRC 24 April 2003 CHINA TELECOM ANNUAL REPORT 2002 42 REPORT OF THE SUPERVISORY COMMITTEE To shareholders: During the period covered by this report, all the members of the Supervisory Committee acted in accordance with the relevant provisions of the Company Law of the People’s Republic of China and the Company’s Articles of the Association, adhered to the principle of honesty and trustworthiness, and conscientiously performed their supervisory duties, so as to safeguard the rights and interests of the shareholders. The Supervisory Committee has held two meetings its establishment. Ms Zhang Xiuqin was since elected the Chairperson of the first Supervisory Committee of the Company at its first meeting on 6 September 2002. The second meeting was held on 1 April 2003 to consider and to examine the audited financial statements of the Company prepared for the year 2002 and to further consider the dividend distribution proposal and the draft auditors’ report prepared by KPMG. The Supervisory Committee believes the audited financial statements of the Company for the year 2002 truly, accurately and objectively reflect the results of financial condition and Company’s the dividend further believes It operations. distribution proposal takes into account the interests of shareholders and long-term development, and the accounting and financial administration comply with the relevant provisions of the Accounting Standards for Enterprises and Accounting System for Enterprises promulgated by the Ministry of Finance of the People’s Republic of China. the Company’s in compliance with The Supervisory Committee believes that, in 2002, the Company operated its Articles of Association, the Company Law of the People’s Republic of China and other relevant PRC laws and regulations regulations as well as promulgated by domestic and overseas securities commissions. All members of the board of directors and the senior management adhere to the principle of diligence, honesty and trustworthiness, worked diligently and made valuable contributions to the development of the Company. As far as the Supervisory Committee is aware of, no member of the board of directors or any senior management has violated any law or regulation of the PRC or the Articles of Association of the Company, nor has any of them been involved in any activity damaging the interests of the Company during the performance of their duties. the new financial year, In the Supervisory Committee will continue to work diligently to safeguard the interests of the shareholders. By Order of the Supervisory Committee Zhang Xiuqin Chairperson of the Supervisory Committee Beijing, PRC 1 April 2003 CHINA TELECOM ANNUAL REPORT 2002 43 CONNECTED TRANSACTIONS World Bank Loan by China In 1994, the Ministry of Finance obtained a loan from the World Bank (the “World Bank Loan”), of series of novations, China which, after a Telecommunications Corporation became the borrower. A portion of the World Bank Loan was advanced Telecommunications Corporation to the Company for general corporate use. The Company also bears the cost of servicing that portion of the World Bank Loan. As at 31 December 2002, the outstanding amount of the World Bank Loan owed by the Company was US$46.61 million. The Company has fully repaid such outstanding portion of the World Bank Loan in March 2003. Guarantees the former Shanghai, In 1993 and 1994, Jiangsu and Zhejiang Posts and Guangdong, Telecommunications Administrations entered into various loan agreements with China Import and Export Bank for an aggregate loan amount of the to Japanese yen 38,436 million telecommunications networks, development of including inter-provincial transmission optic fibers. These loans were novated to the four provincial subsidiaries of the Company and were guaranteed by China Telecommunications Corporation. the development of finance CHINA TELECOM ANNUAL REPORT 2002 44 As the Company has assumed the guarantees in place of China Telecommunications Corporation immediately after its listing, such guarantees no longer constitute connected transactions. Terms of Agreements Other Connected Transactions On 10 September 2002, the Company and China into Telecommunications Corporation entered certain connected transactions agreements set out below. The term of the agreements will expire on 31 December 2004, automatically for further periods of three years unless the Company provides three months’ written notification to China Telecommunications Corporation of its intention not to renew the agreements upon expiry of their current term. renewable Trademark Licence Agreement Pursuant to the Trademark Licence Agreement, China Telecommunications Corporation has granted to the Company the right, on a royalty-free basis, to use the trademark bearing the China Telecom logo which is in the process of being registered at the State Trademark Office under the PRC State General Administration for Industry and Commerce, as well as the right to use certain other registered trademarks and trademarks in the process of being registered. Centralised Services Agreement Centralised Services include: • the the provision of management services in relation to certain large enterprise customers China headquarters of Telecommunications Corporation and the operation of business support centre and network management centre; and of • the use of the international telecommunications transmission facilities. The use of the international telecommunications facilities CONNECTED TRANSACTIONS The settlement of any net amount due to or due from the Company is made once a year. The provision of management services relating to certain large enterprise customers of the headquarters of China Telecommunications Corporation, and the operation of the business support centre and the network management centre Under the Centralised Services Agreement, the Group and China Telecommunications Corporation share certain overhead costs and the Group has agreed to provide human resources relating to administrative functions of China Telecom Group. Assets relating to the Centralised Services are used by both the Group and China Telecom Group. The Group has also agreed to provide the necessary human resources responsible for the upkeep and in maintenance with respect to these assets, addition to providing maintenance services in relation to the international transmission facilities. The aggregate costs incurred by the Group and China Telecommunications Corporation the provision of the Centralised Services (which include salaries and benefits of employees of the Group, depreciation properties, equipment maintenance fees and research and development fees) are apportioned pro rata between the Group and Corporation Telecommunications according to the revenues generated by each of the Group and China Telecom Group. China and for of For the year ended 31 December 2002, the Group’s portion of the costs in respect of the provision of such services was RMB69 million. Corporation Telecommunications China has retained the assets associated with international telecommunications facilities, such as international gateways, undersea cables and satellite facilities, and has granted a licence to the Group to use such facilities. The Group has agreed to provide the necessary human resources responsible for the upkeep and maintenance with respect to the international facilities. The telecommunications Group and China Telecommunications Corporation agreed to apportion the costs associated with operating such assets pro rata according to the aggregate volume of the inbound international calls terminated by and outbound international calls originating from, the Group and China Telecom Group, respectively. For the year ended 31 December 2002, the Group’s portion of the costs in respect of the use of international facilities was telecommunications RMB414 million. Interconnection Agreement facilitate interconnection between In order to subscribers within the Group’s service regions and subscribers outside the service regions which are serviced by China Telecom Group, China Telecommunications Corporation and the Company entered settlement agreement (the “Interconnection Agreement”). The Interconnection Agreement does not provide for early termination or non-renewal by China Telecom Group. interconnection into an CHINA TELECOM ANNUAL REPORT 2002 45 For the year ended 31 December 2002, the total amount China the Telecommunications Corporation with respect to optic fibers leasing was RMB102 million. Group paid by to Engineering Agreements The Group and the provincial subsidiaries of China Telecom Group in each of the Group’s service regions (the “Provincial Subsisting Companies”) entered into engineering framework agreements (the “Engineering Framework Agreements”) to govern the tendering for the right to provide the construction, design, equipment Group with installation and testing services and/or to act as general contractors in relation to construction and supervision of engineering projects commissioned by the Group. for engineering The charges payable related services rendered under the Engineering Framework Agreements shall be determined by reference to market rates as reflected by prices obtained through a tendering process. The Group does not accord any priority to any of the Provincial Subsisting Companies to provide such services, and the tender may be awarded to an independent third party. However, if the terms of an offer from a Provincial Subsisting Company are at least as favourable as those offered by another tenderer, it is expected that the Group would award the tender to the relevant Provincial Subsisting Company. For the year ended 31 December 2002, the Group’s expenditure for engineering services was RMB3,243 million. CONNECTED TRANSACTIONS Pursuant to the Interconnection Agreement, the telephone operator terminating a telephone call made to its local network shall be entitled to receive from the operator from which the telephone call originated a fee prescribed by the MII, which is currently RMB0.06 per minute. The formula for settlement is based on the net volume of telephone calls originating from the Group to China Telecom Group or originating from China Telecom Group to the MII prescribed the Group multiplied by settlement fee. The settlement is made between the Group and China Telecom Group on a monthly basis, with the operator who has originated more calls paying the net amount to the operator who has terminated more calls. For the year ended 31 December 2002, the net settlement payment made by the Group to China Telecom Group pursuant to the Interconnection Agreement was RMB385 million. Optic Fibers Leasing Agreement Pursuant to the Optic Fibers Leasing Agreement, the Company agreed to lease the relevant parts of the inter-provincial transmission optic fibers within the Group’s service regions from China Telecom Group. The amount payable by the Group to China Telecommunications Corporation for the leasing of the is inter-provincial transmission optic fibers based on the depreciation charge for the optic to be fibers. responsible for the maintenance of these optic fibers within the Group’s service regions. the Group agreed In addition, CHINA TELECOM ANNUAL REPORT 2002 46 Property Leasing Agreements Mutual leasing of properties Under the Property Leasing Framework Agreements between the Group and the Provincial Subsisting Companies, the Group leases properties from the Provincial Subsisting Companies for use as its business premises, offices, equipment storage facilities and sites for network equipment. Under the Property Leasing Framework Agreements, the the Group also Provincial Subsisting Companies. leases certain properties to The rental charges in respect of each property are based on market rates, with reference to amounts stipulated by local price bureaus. Rental charges are payable monthly in arrears and subject to review every three years. For the year ended 31 December 2002, the Group’s expenditure for the property leasing was RMB266 the Provincial the same period, million. For Subsisting Companies’ expenditure for the property leasing was RMB3 million. CONNECTED TRANSACTIONS Third Party Properties Sub-Leasing Agreements The Provincial Subsisting Companies sub-let to the Group certain properties owned by and leased from independent third parties for use as offices, retail outlets, spare parts storage facilities and sites for network equipment (the “Third Party Properties”). China Telecom Group has agreed to give the Group an indemnity with respect to any claims or costs incurred by the Group in connection with any defect in the titles to any such Third Party Properties. The amounts payable by the Group to the Provincial the Third Party Subsisting Companies under Properties Sub-Leasing Agreements are the same as the amounts payable by China Telecom Group to the relevant third parties. The rental charges for the Third Party Properties are based on market rates negotiated between the Provincial Subsisting Companies and the relevant third party on an arm’s length basis. For the year ended 31 December 2002, the Group’s expenditure in relation to third party properties sub-leasing was RMB321 million. IT Services Agreements The Group entered into framework agreements with the Provincial Subsisting Companies pursuant to which the Provincial Subsisting Companies agreed information to provide the Group with certain technology services such as office automation and software adjustment (the “IT Services Framework Agreements”). CHINA TELECOM ANNUAL REPORT 2002 47 CONNECTED TRANSACTIONS The Provincial Subsisting Companies are entitled to tender for the right to provide the Group with technology services. The charges information payable for such information technology services under the IT Services Framework Agreements shall be determined by reference to market rates as reflected by prices obtained through a tendering process. The Group does not accord any priority to the Provincial Subsisting Companies to provide such services, and the tender may be awarded to an independent third party. However, if the terms of an offer from a Provincial Subsisting Company are at least as favourable as those offered by another tenderer, the Group may award the tender to the relevant Provincial Subsisting Company. For the year ended 31 December 2002, the Group’s expenditure for information technology services was RMB151 million. Equipment Procurement Services Agreements Provincial Pursuant to the equipment procurement framework agreements entered into between the Group and (the Subsisting the “Equipment Procurement Framework Agreements”), the Provincial Subsisting Companies agreed to services, comprehensive procurement provide including the management of tenders, verification of technical specifications and installation services. Companies procuring Pursuant to the Equipment Procurement Framework Agreements, the Group may request that the Provincial Subsisting Companies act as their agents domestic foreign in telecommunications equipment and other domestic non-telecommunications materials. The Group may give priority to the Provincial Subsisting Companies if the terms and conditions of the services provided by them are at least as favourable as those offered by independent third parties. and CHINA TELECOM ANNUAL REPORT 2002 48 Commission charges calculated at the maximum rate of: for these services are (1) 1% of the contract value, in the case of imported telecommunications equipment; or (2) 1.8% of the contract value, in the case of domestic telecommunications equipment and other non-telecommunications materials. domestic For the year ended 31 December 2002, the Group’s expenditure for equipment procurement services was RMB78 million. Community Services Agreements through the Provincial China Telecom Group, Subsisting Companies, provides certain cultural, educational, property management, vehicles, health and medical services, hotel and conference, community and sanitary services to the Group. The arrangements are set out in the community services framework agreements between the Group and the Provincial Subsisting Companies (the “Community Services Framework Agreements”). If the Group cannot, without incurring significant additional costs and expenses, obtain these services from a third party after such termination, the Provincial Subsisting Companies the provision of such services. terminate cannot Although the Community Services Framework Agreements are on a non-exclusive basis, the following conditions are to apply: (1) the Group may give priority to the Provincial Subsisting Companies in using the services, provided that the terms and conditions offered by independent third parties to the Group are no more favourable than those offered by the Provincial Subsisting Companies for the same services; (2) (3) (4) in return, the Provincial Subsisting Companies have undertaken to the Group that the Provincial Subsisting Companies shall not provide services to the Group on terms which are less favourable than those offered by them to third parties; the Provincial Subsisting Companies are only entitled to provide the relevant services to third parties provided that it would not affect the provision of services to the Group under the Framework Agreements; and Community Services if the Provincial Subsisting Companies cannot satisfy the needs of the Group for the services to be provided under the Community Services Framework Agreements or the terms offered by independent third parties are more favourable, the Group may obtain such services from independent third parties. The Community Services Framework Agreements stipulate that the above community services be provided at: (1) the government prescribed price; (2) where there is no government-prescribed price but where there is a government-guided price, the government-guided price applies; (3) where there is neither a government prescribed price nor a government-guided price, the market price applies. The market price is defined as the price at which the same type of services are provided by independent third parties the ordinary course of business; or in CONNECTED TRANSACTIONS (4) where none of the above is applicable, the price is to be agreed between the relevant parties for the provision of the above services, which shall be the reasonable cost incurred in providing the same plus a reasonable marginal profit (for this purpose, “reasonable costs” means the costs confirmed by both parties after negotiations). For the year ended 31 December 2002, the Group’s expenditure for community services was RMB1,291 million. Ancillary Telecommunications Services Agreements The Provincial Subsisting Companies provide certain repair services to the Group, such as the repair of certain telecommunications equipment, the maintenance of the fire prevention equipment and telephone booths and other customers services (the “Ancillary Telecommunications Services”) on a non-exclusive basis. (the “Ancillary Under the framework agreements between the Group and the Provincial Subsisting Companies for the provision of Ancillary Telecommunications Services Telecommunications Services Framework Agreements”), the Provincial Subsisting Companies agreed to provide Ancillary Telecommunications Services the Group. However, if the Group cannot, without incurring significant additional costs and expenses, obtain these services from a third party, the Provincial Subsisting Companies the provision of such services. terminate cannot to Ancillary Agreements Telecommunications Services The Framework same conditions as set out in (1) to (4) in the second paragraph under the heading “Community Services Agreements” above. contain the CHINA TELECOM ANNUAL REPORT 2002 49 CONNECTED TRANSACTIONS Ancillary The Ancillary Telecommunications Services under the Services Framework Agreements are provided in accordance with the same pricing policy as that of the Community Services Framework Agreements. Telecommunications For the year ended 31 December 2002, the Group’s expenditure for Ancillary Telecommunications Services was RMB1,219 million. Special Communications Services Agreements The Provincial Subsisting Companies continue to be for providing emergency network responsible services and network services dedicated to the Chinese government (the “Special Communications Services”). The Provincial Subsisting Companies agreed to lease the infrastructure in connection with the Special Communications Services from the Group at a fee prescribed by the MII. On the other hand, the Group agreed to provide the to maintain and resources necessary human operate the Special Communications Services within the Service Regions in return for China Telecom Group reimbursing the Group its actual costs, including the costs for network operations and support, general and administrative expenses and certain other operating expenses. For the year ended 31 December 2002, the Group was Special RMB28 million Communications Services by China Telecom Group. paid for CHINA TELECOM ANNUAL REPORT 2002 50 DIRECTORS, SUPERVISORS AND SENIOR MANAGEMENT MR. Zhou Deqiang, age 61, is Chairman MR. Chang Xiaobing, age 46, is an MS. Wu Andi, age 48, is an Executive of our Board of Directors and Chief Executive Director and President in Director, Executive Vice President and Executive Officer of our company in charge of marketing development of our the Chief Financial Officer in charge of charge of our overall management. Mr. company. Mr. Chang is a professor level financial management of our company. Zhou is a professor level Senior Senior Engineer. He graduated in 1982 Ms. Wu is a Senior Accountant. She Engineer. He graduated in 1968 from from the Nanjing Institute of Posts and graduated in 1983 from the Beijing Nanjing Institute of Posts and Telecommunications with a B.S. degree Institute of Economics with a B.A. Telecommunications with a major in in telecommunications engineering and degree in finance and trading. From wireline telecommunications. Prior to received an MBA degree from Tsinghua 1996 to 1998, Ms. Wu studied in a post- joining China Telecommunications University in 2001. Prior to joining graduate program in business Corporation in May 2000, Mr. Zhou China Telecommunications Corporation economics management at the Chinese served as a Vice Minister of the MII and in May 2000, Mr. Chang served as a Institute of Social Sciences. Prior to its predecessor ministry, the Ministry of Deputy Director General and Director joining China Telecommunications Posts and Telecommunications, or MPT, General of the Department of Corporation in May 2000, Ms. Wu a Deputy Director General and Director Telecommunications Administration of served as Director General of the General of Anhui Posts and the Ministry of Information Industry, a Department of Economic Adjustment Telecommunications Administration, or Deputy Director General of the and Communication Settlement of the PTA, and a Deputy Chief Engineer of Directorate General of Ministry of Information Industry, and Beijing Long Distance Telephone Telecommunications, or DGT of the director General, deputy Director Bureau. Mr. Zhou is also President of MPT, and a Deputy Director of the General and director of the Department China Telecommunications Corporation. Nanjing Municipal Posts and of Finance of the MPT. Ms. Wu is also a Mr. Zhou has in-depth industry Telecommunications Bureau of Jiangsu Vice President of China knowledge and 34 years of extensive PTA. Mr. Chang is also a Vice President Telecommunications Corporation. Ms. operational and managerial experience of China Telecommunications Wu has 21 years of financial experience in the telecommunications industry in Corporation. Mr. Chang has 21 years of in the telecommunications industry in China. operational and managerial experience China. in the telecommunications industry in China. CHINA TELECOM ANNUAL REPORT 2002 51 DIRECTORS, SUPERVISORS AND SENIOR MANAGEMENT MR. Zhang Jiping, age 47, is an MS. Huang Wenlin, age 49, is an MR. Li Ping, age 49, is an Executive Executive Director and Executive Vice Executive Director and Executive Vice Director, Executive Vice President and President in charge of network President in charge of human resources Company Secretary of our company in construction and operations of our management of our company. Ms. charge of investor relationship company. Mr. Zhang is a professor level Huang is a Senior Economist. She management. Mr. Li is a Senior Senior Engineer. He graduated in 1982 graduated in 1984 from the Beijing Engineer. He graduated in 1976 from from the Beijing Institute of Posts and Institute of Posts and the Beijing Institute of Posts and Telecommunications with a B.Sc. Telecommunications with a Telecommunications with a major in degree in radio telecommunications concentration in engineering radio telecommunications and received engineering. From 1986 to 1988, Mr. management. Prior to joining China an MBA degree from the state Zhang studied in a post-graduate Telecommunications Corporation in May University of New York at Buffalo in program in applied computer 2000, Ms. Huang served as Director of 1989. Prior to joining China engineering at Northeastern Industrial the Domestic Communications Division Telecommunications Corporation in University. Prior to joining China and Director of the Communications August 2000, Mr. Li served as Chairman Telecommunications Corporation in May Organization Division of the DGT of the and the President of China Telecom 2000, Mr. Zhang was a Deputy Director MPT. Ms. Huang is also a Vice President (Hong Kong) International Limited, a General of the DGT of the MPT, and a of China Telecommunications Vice Chairman and Executive Vice Deputy Director General of Liaoning PTA Corporation. Ms. Huang has 28 years of President of China Mobile (Hong Kong) and Director of the Network operational and managerial experience Limited and a Deputy Director General Management Center of the Liaoning in the telecommunications industry in of the DGT and the MPT. Mr. Li is also a PTA. Mr. Zhang is also a Vice President China. Vice President of China of China Telecommunications Corporation. Mr. Zhang has 21 years of operational and managerial experience in the telecommunications industry in China. Telecommunications Corporation. Mr. Li has extensive experience in managing public companies and 27 years of operational and managerial experience in the telecommunications industry in China. CHINA TELECOM ANNUAL REPORT 2002 52 DIRECTORS, SUPERVISORS AND SENIOR MANAGEMENT MR. Wei Leping, age 57, is an Executive MR. Cheng Xiyuan, age 59, is an MR. Feng Xiong, age 57, is an Executive Director and Executive Vice President in Executive Director of our company. Mr. Director of our company. Mr. Feng is a charge of research and development Cheng is a professor level Senior professor level Senior Engineer. He work of our company. Mr. Wei is a Engineer. He graduated from Chongqing graduated from Tsinghua University in professor level Senior Engineer. He Institute of Military 1970 with a major in electronic graduated in 1970 from Tsinghua Telecommunications and Engineering in engineering. He received a master’s University with a major in radio 1968 with a major in degree from Nanjing Institute of Posts engineering and received a M.S. degree telecommunications. Prior to joining and Telecommunications in 1982 with a in communication and information china Telecom Group, Mr. Cheng served major in communications and systems. systems from the Research Institute of as Director General of Shanghai Long Prior to joining China Telecom Group, Post and Telecommunications. Prior to Distance Telephone Bureau, and a Mr. Feng served as a Deputy Chief joining China Telecommunications Deputy Director General, Director Engineer and Chief Engineer of the corporation in April 2001, Mr. Wei General and Chief Engineer of Shanghai Nanjing Municipal Telecommunications served as a Deputy Director of the PTA. Mr. Cheng currently serves as Bureau of Jiangsu PTA, and a Deputy Telecommunications Research Institute General Manager of China Telecom Chief Engineer, Chief Engineer and a of the Ministry of Information Industry, Group Shanghai Corporation and has 34 Deputy Director General of Jiangsu PTA. a Deputy Director of the years of operational and managerial Mr. Feng currently serves as General Telecommunications Science Planning experience in the telecommunications Manager of China Telecom Group and Research Institute of the MPT and a industry in China. Deputy Director and Chief Engineer of the Telecommunications Transmissions Research Center of the MPT. Mr. Wei is also Chief Engineer of China Telecommunications Corporation. Mr. Wei has 25 years of experience in research and development for network technologies in the telecommunications industry in China. Guangdong Corporation and has 21 years of operational and managerial experience in the telecommunications industry in China. CHINA TELECOM ANNUAL REPORT 2002 53 DIRECTORS, SUPERVISORS AND SENIOR MANAGEMENT MR. Zhang Youcai, age 62, is an independent Non-executive Director of our company. Mr. Zhang graduated from Nanjing Industrial Chemistry College in 1965 with a major in inorganic chemistry. He was a former Vice Minister of the Ministry of Finance of China and was responsible for the formulation and implementation of government finance policies. Mr. Zhang has contributed to the improvement and reform of the finance system of China over more than a decade. Prior to serving at the Ministry of Finance, Mr. Zhang served as a Deputy Director of the Planning Commission of Nantong City in Jiangsu Province and a Deputy Mayor and Mayor of Nantong. Mr. Zhang has more than 40 years of experience in the regulation of Chinese state-owned enterprises and finance administration. MR. Vincent Lo Hong Sui, age 55, is an independent Non-executive Director of our company. Mr. Lo is the chairman and chief executive of the Shui On Group which he founded 32 years ago. He is also the founding chairman and current president of the Business and Professionals Federation of Hong Kong, a member of The Tenth National Committee of Chinese People’s Political Consultative Conference, Vice Chairman of the All-China Federation of Industry and Commerce, the president of the Shanghai-Hong Kong Council for the Promotion and Development of Yangtze, court member of the Hong Kong University of Science and Technology, a member of HK-US Business Council-HK Section, a director of The Real Estate Development Association of Hong Kong, an adviser to the Chinese Society of Macroeconomics, an adviser to Peking University China Center for Economic Research, a council member of the China Overseas Friendship Association, a director of Great Eagle Holdings Limited and a non-executive director of Hang Seng Bank Limited and New World China Land Limited. He was awarded the Gold Bauhinia Star in 1998 and appointed Justice of the Peace in 1999 by the Government of the Hong Kong Special Administrative Region. He was made an Honorary Citizen of Shanghai in 1999. In 2001, he was named Businessman of the Year by the DHL/South China Morning Post Hong Kong Business Awards, and most recently he received one of the Hong Kong Institute of Directors’ “2002 Director of the Year” awards. CHINA TELECOM ANNUAL REPORT 2002 54 DIRECTORS, SUPERVISORS AND SENIOR MANAGEMENT MR. Sun Jiuming, age 56, is president MR. Wang Jirong, age 49, is Deputy and Chairman of Board of Directors of Director and President of Zhejiang Jiangsu Telecommunications Corporation Telecommunications Corporation Ltd. Mr. Ltd. Mr. Sun is a Senior Engineer, and he Wang is a professor level Senior graduated from Nanjing Institute of Posts Engineer, and graduated from Nanjing Institute of Posts and Telecommunications and the Australian National University. Mr. Wang was formerly Deputy Director of Suzhou Telecommunications Bureau. He has 33 years of operational and management experience in the telecommunications industry in China. and Telecommunications and the Australian National University in 1982 with a B.Sc. degree in radio telecommunications engineering. Mr Sun was a Deputy Director of the Nanjing Municipal Posts and Telecommunications Bureau, and Director of Nantong Posts Bureau, Director and Deputy Director of Nantong Telecommunications Bureau, and President of Jiangsu Telecommunications Corporation. Mr. Sun has 21 years experience of operational and management in the telecommunications industry in China. CHINA TELECOM ANNUAL REPORT 2002 55 DIRECTORS, SUPERVISORS AND SENIOR MANAGEMENT MR. Wang Qi, age 48, is the controller of our Company. Mr. Wang is a senior accountant. He studied at Beijing Institute of Posts and Telecommunications and the Australian National University. Mr. Wang has a B.A. degree in international economics and a Masters degree in international management. Prior to joining the Company, Mr. Wang served as a Deputy Director General of Anhui PTA. Mr. Wang also served as a Deputy general Manager of China Telecom Group Anhui Corporation prior to his relocation to the headquarters of China Telecom Group in 2000. Mr. Wang is also Managing Director of the Planning and Finance Department of China Telecommunications Corporation. Mr. Wang has 28 years of managerial and accounting experience in the telecommunications industry in China. MS. Zhang Xiuqin, age 56, is the Chairperson of our Supervisory Committee. Ms. Zhang is a Senior Accountant. Prior to joining China Telecom Group, Ms. Zhang served as a Director of the Systems Division of the Financial Department of the MPT, Director of the Department of Economic Adjustment and Communication Settlement of the MII, Director of the Communication Settlement Centre of the MII and General Manager of the Huaxin Posts and Telecommunication Economic Development Center. Since July 2000, Ms. Zhang has served as Director of the Audit Department of China Telecommunications Corporation. Ms. Zhang has 34 years of operational and managerial experience in the telecommunications industry in China. MR. Wang Huanhui, age 58, has been the Supervisor representing employees from 1 April this year. Mr. Wang is a senior economist, and graduated from Beijing Institute of Posts and Telecommunications in 1969. In August 2000, Mr. Wang was assigned as Director of Supervisors Board of China Telecommunications Corporations. Mr Wang has more than 30 years of operational and management experience in the telecommunications industry in China. MS. Zhu Lihao, age 62, is an independent Supervisor on our Supervisory Committee. Ms. Zhu is a Senior Auditor and is a board member of the Auditors’ Association. She graduated from Beijing Mining College in 1963 with a major in engineering economics. Ms. Zhu served as a Deputy Director General and Director General of the Department of Industry and Communications of the National Audit Office of China, and the Director General of the Department of Foreign Affairs Auditing of the Audit Bureau. Ms. Zhu has 40 years of experience in management and auditing. MR. Xie Songguang, age 54, is a Supervisor on our Supervisory Committee. Mr. Xie is a Senior Engineer. He graduated from Nanjing Institute of Posts and Telecommunications in 1985 with a major in communications. Mr. Xie completed an advanced business program in Hangzhou University in 1998. Prior to joining China Telecom Group, Mr. Xie served as a Deputy Director of the Telecommunications Division, and Director of the Operation and Maintenance Division of Zhejiang PTA. Mr. Xie currently serves as a Deputy General Manager of China Telecom Group Zhejiang Corporation and has 28 years of operational and managerial experience in the telecommunications industry in China. MR. Li Jing, age 37, is a Supervisor on our Supervisory Committee. Mr. Li is an economist. He graduated from the Central Party School in 1995 with a major in economics and management. Prior to joining China Telecom Group, Mr. Li worked at the Audit Division of the Jiangsu PTA, and the audit department and financial department of Suzhou Municipal Posts and Telecommunications Bureau. Mr. Li currently serves as a Deputy Director of the Audit Department of China Telecom Group Jiangsu Corporation and has 18 years of financial and auditing experience in the telecommunications industry in China. CHINA TELECOM ANNUAL REPORT 2002 56 NOTICE OF ANNUAL GENERAL MEETING NOTICE IS HEREBY GIVEN that an Annual General Meeting of China Telecom Corporation Limited (the “Company”) for the year ended 31 December 2002 will be held at 10:00 a.m. on 20 June 2003 at Beijing Nan Yue Yuan Hotel, 186 Zheng Wang Fen, Feng Tai District, Beijing, PRC to consider the following businesses: ORDINARY RESOLUTIONS 6. to consider and approve other matters, if any. And as special business, to consider and, if thought fit, to pass the followings as special resolutions: SPECIAL RESOLUTIONS 7. “THAT: 1. 2. 3. 4. 5. to consider and approve the consolidated financial statements of the Company, the report of the Board of Directors, the report of the Supervisory Committee and the report of the international auditors for the year ended 31 December 2002; to consider and approve the profit distribution proposal and declaration and payment of a final dividend for the year ended 31 December 2002; to consider and approve the appointment of Mr. Shi Wanpeng as an independent non- executive director of the Company; the and consider approve for annual to the Company’s remuneration proposal directors for the year to be ended 31 December 2003. The current salary system of a state- owned enterprise shall be changed into the salary system based on a joint stock company with salary benefits of a joint stock company which include the basic salary, allowance and subsidies, performance based bonus, annuity, insurance benefits and share appreciation rights; to consider and approve the reappointment of KPMG Huazhen as the Company’s domestic auditors and KPMG as the Company’s international auditors for the year ending 31 December 2003 and the authorisation to the directors to fix the remuneration thereof; and (a) (b) (c) subject to paragraph (c) below, the exercise by the directors during the Relevant Period (as hereinafter defined) of all the powers of the Company to allot, issue and deal with additional Shares and to make or grant offers, agreements and options which might require the exercise of such powers be hereby generally and unconditionally approved; in paragraph the directors during (a) shall the approval the authorise Relevant Period to make or grant offers, agreements and options which might require the exercise of such powers after the end of the Relevant Period; the aggregate nominal amount of share capital allotted, issued and dealt with or agreed conditionally or unconditionally to issued and dealt with be allotted, (whether pursuant to an option or otherwise) by the directors pursuant to the approval in paragraph (a), otherwise than pursuant to (i) a Rights Issue (as hereinafter defined) or (ii) any scrip dividend arrangement providing for the allotment of Shares in lieu of the whole or part of a dividend on Shares in accordance with the Articles of Association, the aggregate of (aa) 20% of the aggregate nominal amount of the share capital of the Company in issue at the date of shall not exceed similar or CHINA TELECOM ANNUAL REPORT 2002 57 NOTICE OF ANNUAL GENERAL MEETING passing this Resolution, plus (bb) (if the directors are so authorised by a separate ordinary resolution of the shareholders of the Company) the aggregate nominal amount of share capital of the Company repurchased by the Company subsequent to the passing of this Resolution (up to maximum equivalent to 10% of the aggregate nominal amount of the share capital of the Company in issue at the date of passing this Resolution), and the said limited approval accordingly; and shall be (d) for the purpose of this Resolution: “Relevant Period” means the period from the passing of this Resolution until the earlier of: (i) (ii) the conclusion of the next annual general meeting of the Company; the expiry of the period within which the next annual general meeting of the Company is required by the Articles of Association or the Companies Ordinance to be held; and (iii) the revocation or variation of the authority given to the directors under this Resolution by resolution of the Company’s shareholders in general meetings; and “Rights Issue” means an offer of shares open for a period fixed by the directors to holders of Shares on the register of members on a fixed record date in proportion of their then holdings of such Shares (subject to such exclusion or other arrangements as the directors may CHINA TELECOM ANNUAL REPORT 2002 58 to any deem necessary or expedient in relation fractional entitlements or having to legal or practical regard restrictions or obligations under the laws of, or the requirement of, any recognised regulatory body or any stock exchange in any territory applicable to the Company) and an offer, allotment or issue of shares by way of rights shall be construed accordingly.” 8. “THAT the directors be and are hereby authorised to exercise the powers of the in paragraph (a) of Company referred to Resolution 7 in respect of the share capital of the Company repurchased by the Company referred to in sub-paragraph (bb) of paragraph (c) of such resolution.” After the completion of the global offering of the Company’s shares and pursuant to the Chinese laws and regulations, the following amendments to the Articles of Association shall be made to the provisions relating to the Company’s shareholding structure. 9. “THAT amendments shall be made to the Articles of Association in order to reflect the aggregate number of shares issued by the Company and the details of the amendments are as follows: (a) Article 6 of the Articles of Association shall be restated as follows: In accordance with the provisions of the Company Law, the Special Regulations and the Mandatory Provisions for Articles of Association of Companies to be Listed Overseas (the “Mandatory Provisions”) and other PRC laws and administrative regulations, the Company convened its general meeting on 20 June 2003 to amend the original Articles of Association of the Company (the “Original Articles of Association”) and adopt these Articles of Association (the “Articles of Association” or “these Articles of Association”). (b) Article 20 of the Company’s Articles of Association shall be restated as follows: the the approval of relevant By companies department authorised by the State Council, the Company may issue a total of 75,614,186,503 ordinary shares, of which 68,317,270,803 were issued to the promoter of the Company at the time when the Company was established, representing 90.35% of the entire issued share capital. (c) Article 21 of the Company’s Articles of Association shall be restated as follows: of from the the the Company after All the 7,296,915,700 ordinary shares issued by its the overseas-listed incorporation are foreign-invested shares (H Shares). A total of 730,494,300 shares have been respective reduced shareholdings State-owned shareholders of the Company, namely, China Telecommunications Corporation, Guangdong Rising Assets Management Co., Ltd., Investment Jiangsu Guoxin Group Co., Ltd. and Zhejiang Financial Development Company during the global offering and all the reduced shares have become foreign- the overseas-listed invested shares (H Shares). The total of foreign-invested the shares (H Shares) issued by the Company shall shares, representing 10.62% of the issued share capital of the Company. overseas-listed 8,027,410,000 be NOTICE OF ANNUAL GENERAL MEETING Rising shares Guangdong The share capital structure of the Company is as follows: there are a total shares of 75,614,186,503 ordinary issued, of which 58,809,120,182 shares the promoter, China are held by Telecommunications Corporation, representing 77.78% of the total of the ordinary shares issued by the Company. The other holders of the domestic shares Assets are Management Co., Ltd., holding a total of 5,658,608,387 representing 7.48% of the total of the ordinary shares issued by the Company, Jiangsu Guoxin Investment Group Co., Ltd., holding a total of 964,621,836 shares representing 1.27% of the total of the ordinary shares issued by the Company and Zhejiang Financial Development Company, holding a shares representing 2.85% of the total of the ordinary shares issued by the Company. A total of 8,027,410,000 overseas-listed foreign-invested share are held by foreign- holders invested shares, representing 10.62% of the total of the ordinary shares issued by the Company.” overseas-listed 2,154,426,098 total of of 10. “THAT Article 43 of the Articles of Association shall be amended as follows due to the repeal of the Securities (Clearing Houses) Ordinance on 1 April 2003: transfer of Overseas-Listed Foreign The Invested Shares in the Company listed in Hong Kong shall be carried out in writing on normal or standard instruments of transfer or on a form acceptable to the Board of Directors; and such transfer instrument can be signed only by hand or, if the transferor or transferee is a securities its representative recognised in accordance with institution clearing or CHINA TELECOM ANNUAL REPORT 2002 59 NOTICE OF ANNUAL GENERAL MEETING section 37 of the Securities and Futures Ordinance (Hong Kong Law Chapter 571), in printed signed by hand or signed mechanical form. All the transfer instruments shall be maintained in the legal address of the Company or other place the Board of Director may designate from time to time.” By Order of the Board Li Ping Company Secretary Beijing, PRC 24 April 2003 Notes: (1) Buyers who submit the share transfer application forms to the Company’s share registrar before 4:00 p.m. on 19 May 2003 (Monday) and then registered as shareholders on the register of members of the Company are entitled to attend the annual general meeting. (2) (3) Each shareholder entitled to attend and vote at the annual general meeting may appoint one or more proxies to attend and vote on his behalf at the annual general meeting. A proxy need not be a shareholder. Each shareholder who wishes to appoint one or more proxies should first review the annual report of the Company for the year 2002, which is expected to be despatched to shareholders before 30 April 2003 (Wednesday). To be valid, the form of proxy together with the power of attorney or other authorisation document (if any) signed by the authorised person or notarially certified power of attorney must be delivered to the Secretariat of the board for holders of domestic shares and to the Computershare Hong Kong Ivestor Services Limited for holders of H shares not CHINA TELECOM ANNUAL REPORT 2002 60 less than 24 hours before the designated time for the holding of the annual general meeting. Completion and return of a form of proxy will not preclude a shareholder from attending in person and voting at the annual general meeting if he so wishes. The address of the share registrar for the Company’s H Shares is as follows: Computershare Hong Kong Investor Services Limited Rooms 1712-1716, 17th Floor, Hopewell Centre 183 Queens Road East, Wanchai, Hong Kong (4) A proxy of a shareholder may vote by hand or vote on a poll, but a proxy of a shareholder who has appointed more than one proxy may only vote on a poll. (5) In connection with special resolution 7 set out above, the directors have no plans to issue any new share for the time being. In accordance with section 57B of the Companies Ordinance (Cap. 32) and the Rules Governing the Listing of Securities on the Stock Exchange of Hong Kong Limited, the authorisation given by the shareholders is a general mandate. (6) The registration procedure for attending the annual general meeting: (a) legal shareholder attending the annual general meeting in person or by proxy shall present its identity certification. If the attending shareholder is a corporation, its representative or person authorised by the board or other decision making authority shall present the copy of the relevant resolution of the board or other decision making authority in order to attend the annual general meeting; and NOTICE OF ANNUAL GENERAL MEETING (b) shareholders intending to attend the annual general meeting shall return the attendance slip via hand delivery, mail or fax to the Secretariat on or before 30 May 2003 (Friday). (7) Closure of the register of members: The register of members of the Company will be closed from 20 May 2003 (Tuesday) to 20 June 2003 (Friday) (both days inclusive). (8) The annual general meeting is expected to last for half a day and shareholders (in person or the annual general by proxy) attending meeting shall be responsible for their own transportation and accommodation expenses. (9) The address of the Secretariat of the Board is as follows: 31 Jinrong Street Xicheng District, Beijing 100032 PRC Contact person: Telephone: Fascmile: Li Ping (8610) 6642 8166 (8610) 6601 0728 CHINA TELECOM ANNUAL REPORT 2002 61 REPORT OF THE INTERNATIONAL AUDITORS To the Shareholders of China Telecom Corporation Limited (Incorporated in The People’s Republic of China with limited liability) We have audited the financial statements on pages 64 to 109 which have been prepared in accordance with International Financial Reporting Standards promulgated by the International Accounting Standards Board. RESPECTIVE RESPONSIBILITIES OF DIRECTORS AND AUDITORS The Company’s directors are responsible for the preparation of financial statements which give a true and fair view. In preparing financial statements which give a true and fair view it is fundamental that appropriate accounting policies are selected and applied consistently, that judgements and estimates are made which are prudent and reasonable and that the reasons for any significant departure from applicable accounting standards are stated. It is our responsibility to form an independent opinion, based on our audit, on those financial statements and to report our opinion to you. BASIS OF OPINION We conducted our audit in accordance with Statements of Auditing Standards issued by the Hong Kong Society of Accountants. An audit includes examination, on a test basis, of evidence relevant to the amounts and disclosures in the financial statements. It also includes an assessment of the significant estimates and judgements made by the directors in the preparation of the financial statements, and of whether the accounting policies are appropriate to the Company’s and the Group’s circumstances, consistently applied and adequately disclosed. We planned and performed our audit so as to obtain all the information and explanations which we considered necessary in order to provide us with sufficient evidence to give reasonable assurance as to whether the financial statements are free from material misstatement. In forming our opinion we also evaluated the overall adequacy of the presentation of information in the financial statements. We believe that our audit provides a reasonable basis for our opinion. CHINA TELECOM ANNUAL REPORT 2002 62 REPORT OF THE INTERNATIONAL AUDITORS OPINION In our opinion, the financial statements give a true and fair view of the state of affairs of the Company and of the Group as at 31 December 2002 and of the Group’s profit and cash flows for the year then ended and have been properly prepared in accordance with International Financial Reporting Standards promulgated by the International Accounting Standards Board and the disclosure requirements of the Hong Kong Companies Ordinance. KPMG Certified Public Accountants Hong Kong, China 24 April 2003 CHINA TELECOM ANNUAL REPORT 2002 63 CONSOLIDATED BALANCE SHEET at 31 December 2002 (Amounts in millions) ASSETS Non-current assets Property, plant and equipment, net Construction in progress Lease prepayments Interests in associates Investments Deferred tax assets Other assets Total non-current assets Current assets Inventories Accounts receivable, net Prepayments and other current assets Time deposits with maturity over three months Cash and cash equivalents Total current assets Total assets LIABILITIES AND SHAREHOLDERS’ EQUITY Current liabilities Short-term debt Current portion of long-term debt Accounts payable Accrued expenses and other payables Income tax payable Current portion of finance lease obligations Current portion of deferred revenues Total current liabilities Net current liabilities Total assets less current liabilities Non-current liabilities Long-term debt Finance lease obligations Deferred revenues Deferred tax liabilities Total non-current liabilities Total liabilities Minority interests Balance carried forward Note 2002 RMB 2001 RMB 3 4 6 7 8 17 9 10 11 12 13 13 14 15 16 17 13 16 17 8 149,165 20,319 2,644 429 270 5,118 6,405 138,623 23,274 2,638 417 446 4,059 5,749 184,350 175,206 1,066 5,961 1,736 1,316 16,423 26,502 1,413 5,608 2,752 473 3,882 14,128 210,852 189,334 19,175 2,219 14,399 10,266 3,842 — 7,726 57,627 18,827 3,621 14,919 11,672 212 38 8,155 57,444 (31,125) (43,316) 153,225 131,890 4,853 — 21,612 618 27,083 84,710 1,134 7,101 11 26,353 — 33,465 90,909 940 85,844 91,849 The notes on pages 71 to 109 form part of these financial statements. 64 CONSOLIDATED BALANCE SHEET (CONTINUED) at 31 December 2002 (Amounts in millions) Note 2002 RMB 2001 RMB Balance brought forward 85,844 91,849 Shareholders’ equity Share capital Reserves 18 19 75,614 49,394 — 97,485 Total shareholders’ equity 125,008 97,485 Total liabilities and shareholders’ equity 210,852 189,334 Approved and authorised for issue by the Board of Directors on 24 April 2003. Zhou Deqiang Chairman and Chief Executive Officer Chang Xiaobing Executive Director and President Wu Andi Executive Director, Executive Vice President and Chief Financial Officer The notes on pages 71 to 109 form part of these financial statements. 65 BALANCE SHEET at 31 December 2002 (Amounts in millions) ASSETS Non-current assets Interests in subsidiaries Current assets Prepayments and other current assets Time deposits with maturity over three months Cash and cash equivalents Total current assets Total assets LIABILITIES AND SHAREHOLDERS’ EQUITY Current liabilities Accrued expenses and other payables Income tax payable Total current liabilities Net current assets Total assets less current liabilities Shareholders’ equity Share capital Reserves Total shareholders’ equity Total liabilities and shareholders’ equity Approved and authorised for issue by the Board of Directors on 24 April 2003. Note 2002 RMB 5 11 12 15 18 19 114,866 1,527 1,000 9,570 12,097 126,963 570 1,385 1,955 10,142 125,008 75,614 49,394 125,008 126,963 Zhou Deqiang Chairman and Chief Executive Officer Chang Xiaobing Executive Director and President Wu Andi Executive Director, Executive Vice President and Chief Financial Officer The notes on pages 71 to 109 form part of these financial statements. 66 CONSOLIDATED STATEMENT OF INCOME for the year ended 31 December 2002 (Amounts in millions, except per share data) Operating revenues Operating expenses Depreciation and amortisation Network operations and support Selling, general and administrative Other operating expenses Total operating expenses Operating profit Deficit on revaluation of property, plant and equipment Net finance (costs)/income Investment income Share of profit from associates Note 20 21 22 3 23 2002 RMB 2001 RMB 75,496 68,546 (20,882) (20,131) (10,468) (2,637) (19,451) (20,269) (9,401) (1,327) (54,118) (50,448) 21,378 18,098 — (11,930) (632) 4 35 293 310 22 Profit before taxation and minority interests 20,785 6,793 Taxation 24 (3,855) 69 Profit before minority interests Minority interests Profit attributable to shareholders Basic earnings per share Weighted average number of shares 16,930 6,862 (66) 21 16,864 6,883 0.24 0.10 69,242 68,317 27 29 29 The notes on pages 71 to 109 form part of these financial statements. 67 CONSOLIDATED STATEMENT OF SHAREHOLDERS’ EQUITY for the year ended 31 December 2002 (Amounts in millions) Share capital RMB Capital reserve RMB Share premium RMB Revaluation reserve RMB Surplus reserves RMB Note Statutory common welfare fund RMB Other reserves RMB Retained earnings RMB Total shareholders’ equity RMB Balance as at 1 January 2001 Net profit Contributions from China Telecom Distributions to China Telecom Assets distributed to China Telecom in connection with the Restructuring Revaluation surplus Recognition of deferred tax assets Elimination of net deferred tax liabilities Balance as at 31 December 2001 Capitalisation as share capital upon incorporation of the Company Issue of shares, net of issuing expenses of RMB796 million Net profit Appropriations Revaluation surplus realised Deferred tax on amortisation of land use rights realised Balance as at 31 December 2002 —- — — — — — — — — — — — — — — — — — — — — — — — — — — 1 3 8 8 18, 19 68,317 20,955 — 18 19 7,297 — — — — — — — — — 3,362 — — — — — — — — — 4,154 — — 4,154 — — — — (10) — — — — — — — — — — — — — — — — — — — — 101,619 6,883 — 101,619 6,883 — 3,003 3,003 — (15,835) (15,835) — (11,285) — — (11,285) 4,154 4,059 — — 4,887 4,059 4,887 — 4,059 89,272 97,485 — — (89,272) — — — 8,121 — — — — 1,624 — — — — — — (75) — 16,864 (9,745) 10,659 16,864 — 10 75 — — 75,614 20,955 3,362 4,144 8,121 1,624 3,984 7,204 125,008 The notes on pages 71 to 109 form part of these financial statements. 68 CONSOLIDATED STATEMENT OF CASH FLOW for the year ended 31 December 2002 (Amounts in millions) Cash flows from operating activities Cash flows from investing activities Capital expenditure Purchase of investments Lease prepayments Proceeds from disposal of property, plant and equipment Increase in time deposits with maturity over three months Maturity of time deposits with maturity over three months Note (a) 2002 RMB 2001 RMB 37,102 32,761 (28,169) (50) (74) 41 (1,312) 469 (34,610) (290) (437) 72 (473) 339 Net cash used in investing activities (29,095) (35,399) Cash flows from financing activities Proceeds from initial public offering, net of issuing expenses Capital element of finance lease payments Proceeds from bank debt Repayments of bank debt Cash distributions to minority interests Cash contributions from China Telecom Cash distributions to China Telecom 10,659 (49) 25,749 (29,278) (12) — (2,535) — (305) 21,423 (16,979) — 3,003 (14,483) Net cash from/(used in) financing activities 4,534 (7,341) Net increase/(decrease) in cash and cash equivalents 12,541 (9,979) Cash and cash equivalents at beginning of year 3,882 13,861 Cash and cash equivalents at end of year 16,423 3,882 The notes on pages 71 to 109 form part of these financial statements. 69 CONSOLIDATED STATEMENT OF CASH FLOW (CONTINUED) for the year ended 31 December 2002 (Amounts in millions) (a) Reconciliation of profit before taxation and minority interests to cash flows from operating activities 2002 RMB 2001 RMB Profit before taxation and minority interests 20,785 6,793 Adjustments for: Depreciation and amortisation Deficit on revaluation of property, plant and equipment Provision for doubtful accounts Investment income Share of profit from associates Interest income Interest expense Unrealised foreign exchange losses/(gains) Loss on retirement and disposal of property, plant and equipment (Increase)/decrease in accounts receivable Decrease/(increase) in inventories Decrease/(increase) in prepayments and other current assets Increase in other non-current assets (Decrease)/increase in accounts payable Increase/(decrease) in accrued expenses and other payables Decrease in deferred revenues Cash generated from operations Interest received Interest paid Investment income received Income tax paid 20,882 — 345 (4) (35) (140) 1,321 227 410 (698) 347 1,149 (588) (78) 157 (5,170) 38,910 140 (1,315) 33 (666) 19,451 11,930 186 (310) (22) (246) 1,415 (325) 1,720 1,336 (99) (550) (1,139) 1,231 (373) (3,691) 37,307 246 (1,408) 255 (3,639) Cash flows from operating activities 37,102 32,761 The notes on pages 71 to 109 form part of these financial statements. 70 NOTES TO THE FINANCIAL STATEMENTS for the year ended 31 December 2002 1. PRINCIPAL ACTIVITIES, ORGANISATION AND BASIS OF PRESENTATION Principal activities China Telecom Corporation Limited (‘‘the Company’’) and its subsidiaries (hereinafter, collectively referred to as ‘‘the Group’’) are engaged in the provision of wireline telecommunications and related services in Shanghai Municipality, Guangdong Province, Jiangsu Province and Zhejiang Province of the People’s Republic of China (‘‘the PRC’’). The Group offers a comprehensive range of wireline telecommunications services to residential and business customers, including local, domestic long distance and international long distance telephone services, Internet and managed data, leased line, and other related services. The operations of the Group are subject to the supervision and regulation by the PRC government. The Ministry of Information Industry, pursuant to the authority delegated to it by the PRC’s State Council, is responsible for formulating the telecommunications industry policies and regulations, including the regulation and setting of tariff levels for basic telecommunications services, such as local and long distance telephone services, managed data services, leased line and interconnection arrangements. Organisation The Company was incorporated in the PRC on 10 September 2002 as part of the reorganisation (the ‘‘Restructuring’’) of China Telecommunications Corporation (‘‘China Telecom’’ and together with its subsidiaries other than the Company referred to as ‘‘China Telecom Group’’), a state-owned enterprise which is under the supervision and regulation of the Ministry of Information Industry. Pursuant to the Restructuring, China Telecom transferred to the Company the wireline telecommunications business and related operations in Shanghai Municipality, Guangdong Province, Jiangsu Province and Zhejiang Province together with the related assets and liabilities (the ‘‘Predecessor Operations’’) in consideration for 68,317 million ordinary domestic shares of the Company. The shares issued to China Telecom have a par value of RMB1.00 each and represented the entire registered and issued share capital of the Company at that date. As discussed below, certain assets historically associated with the Predecessor Operations were not transferred to the Company but were retained by China Telecom in connection with the Restructuring. China Telecom was initially established in May 2000 to operate the PRC’s nationwide wireline telecommunications network as part of the restructuring of the PRC’s telecommunications industry. In November 2001, pursuant to a further industry restructuring plan approved by the State Council, China Telecom’s wireline telecommunications networks and related operations in 10 northern provinces, municipalities and autonomous regions of the PRC were transferred to China Netcom Group. China Telecom retained the wireline telecommunications networks and related operations of 21 provinces, municipalities and autonomous regions of including the Predecessor Operations. In accordance with this industry restructuring plan, China Telecom and China Netcom Group own 70% and 30%, respectively, of the nationwide inter-provincial optic fibres. the PRC, 71 NOTES TO THE FINANCIAL STATEMENTS for the year ended 31 December 2002 1. PRINCIPAL ACTIVITIES, ORGANISATION AND BASIS OF PRESENTATION (Continued) Basis of presentation Since China Telecom controlled the Predecessor Operations transferred to the Company before the Restructuring and continues to control the Company after the Restructuring, the accompanying financial statements have been prepared as a reorganisation of businesses under common control in a manner similar to a pooling-of-interests. Accordingly, the assets and liabilities transferred to the Company have been recognised at historical amounts. For periods prior to the legal formation of the Company and its subsidiaries, the assets, liabilities, revenue and expenses of the entities comprising the Predecessor Operations were combined in preparing the financial statements. The accompanying consolidated financial statements present the results of the Company and its subsidiaries as if the Group had been in existence throughout the years presented and as if the Predecessor Operations were transferred to the Company from China Telecom as at 1 January 2001. In addition, the consolidated financial statements for the year ended 31 December 2001 include the results related to certain assets historically associated with the Predecessor Operations that were not transferred to the Company and were retained by China Telecom in connection with the Restructuring. The assets retained by China Telecom primarily related to investments in non- telecommunications industries, inter-provincial transmission optic fibres and properties and, as at 31 December 2001, consisted of the following: Current assets, primarily prepayments Property, plant and equipment, net Construction in progress Interests in associates and long-term investments RMB millions 1,128 4,457 686 5,014 11,285 In preparing the consolidated financial statements, the assets and liabilities, revenues and expenses of the Predecessor Operations are reflected in the accompanying consolidated financial statements. In addition, for the year ended 31 December 2001, the consolidated financial statements have been prepared to include certain assets historically associated with the Predecessor Operations that were retained by China Telecom. As a result of the segregation and separate management of these assets by China Telecom beginning 31 December 2001, the assets retained by China Telecom have been reflected as a distribution to China Telecom in the consolidated statement of shareholders’ equity as at 31 December 2001. 72 NOTES TO THE FINANCIAL STATEMENTS for the year ended 31 December 2002 1. PRINCIPAL ACTIVITIES, ORGANISATION AND BASIS OF PRESENTATION (Continued) Basis of presentation (Continued) Management believes that all historical costs of operations have been reflected in the consolidated financial statements for the year ended 31 December 2001. Expenses that were specifically identified including the costs of ancillary, social and supporting services to the Predecessor Operations, provided to the Predecessor Operations by China Telecom and its affiliates, are reflected in the consolidated financial statements. Expenses associated with corporate services provided by China Telecom (consisting primarily of corporate headquarter administrative expenses) were allocated based on revenues to companies within China Telecom, including the Predecessor Operations. The amount of corporate administrative expenses allocated to the Group for the year ended 31 December 2001 was RMB118 million. Management believes that the method of allocation of corporate administrative expenses presents a reasonable basis of estimating what the Group’s expenses would have been on a stand-alone basis for the year ended 31 December 2001. 2. SIGNIFICANT ACCOUNTING POLICIES (a) Basis of preparation The accompanying financial statements have been prepared in accordance with International Financial Reporting Standards (‘‘IFRS’’) promulgated by the International Accounting Standards Board (‘‘IASB’’). IFRS includes International Accounting Standards (‘‘IAS’’) and interpretations. These financial statements also comply with the disclosure requirements of the Hong Kong Companies Ordinance and the applicable disclosure provisions of the Rules Governing the Listing of Securities on the Stock Exchange of Hong Kong Limited. These financial statements are prepared on the historical cost basis as modified by the revaluation of certain property, plant and equipment (Note 3). The preparation of the financial statements in accordance with IFRS requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. The accounting policies described below have been consistently applied by the Group. (b) Basis of consolidation A subsidiary is an enterprise controlled by the Company. Control exists when the Company has the power, directly or indirectly, to govern the financial and operating policies of an enterprise so as to obtain benefits from its activities. 73 NOTES TO THE FINANCIAL STATEMENTS for the year ended 31 December 2002 2. SIGNIFICANT ACCOUNTING POLICIES (Continued) (b) Basis of consolidation (Continued) The financial results of subsidiaries are included in the consolidated financial statements from the date that control commences until the date that control ceases, and the share attributable to minority interests is deducted from or added to profit before minority interests. All significant intercompany balances and transactions and any unrealised gains/losses arising from intercompany transactions are eliminated on consolidation. An associate is a company, not being a subsidiary, in which the Group exercises significant influence over its management. Significant influence is the power to participate in the financial and operating policy decisions of the investee but is not control over those policies. its The consolidated statement of associates for the period. In the consolidated balance sheet, interests in associates are stated at the Group’s attributable share of net assets. income includes the Group’s share of the results of (c) Translation of foreign currencies The functional and reporting currency of the Group is Renminbi (‘‘RMB’’). Foreign currency transactions during the year are translated into RMB at the applicable rates of exchange quoted by the People’s Bank of China (‘‘PBOC rates’’) prevailing on the transaction dates. Foreign currency monetary assets and liabilities are translated into RMB at the applicable PBOC rates at the balance sheet date. Exchange differences, other than those capitalised as construction in progress, are recognised as income or expense in the consolidated statement of income. For the periods presented, no exchange differences were capitalised. (d) Cash and cash equivalents Cash and cash equivalents comprise cash at bank and in hand and time deposits with original maturities of three months or less when purchased. Cash equivalents are stated at cost, which approximates fair value. None of the Group’s cash and cash equivalents is restricted as to withdrawal. (e) Accounts receivable Accounts receivable are stated at cost less allowance for doubtful accounts. An allowance for doubtful accounts is provided based upon the evaluation of the recoverability of these accounts at the balance sheet date. 74 NOTES TO THE FINANCIAL STATEMENTS for the year ended 31 December 2002 2. SIGNIFICANT ACCOUNTING POLICIES (Continued) (f) Inventories Inventories consist of materials and supplies used in maintaining the Group’s wireline telecommunications network and goods for resale. Materials and supplies are valued at cost less a provision for obsolescence. Inventories that are held for resale are stated at the lower of cost and net realisable value. Net realisable value is the estimated selling price in the ordinary course of business less the estimated costs of completion and the estimated costs necessary to make the sale. (g) Property, plant and equipment Property, plant and equipment are initially recorded at cost less accumulated depreciation and impairment losses (Note 2(l)). The cost of an asset comprises its purchase price, any directly attributable costs of bringing the asset to working condition and location for its intended use and the cost of borrowed funds used during the periods of construction. Expenditure incurred after the asset has been put into operation is capitalised only when it increases the future economic benefits embodied in the item of property, plant and equipment. All other expenditure, including the cost of repairs and maintenance, is expensed as it is incurred. the date of Subsequent to the revaluation carried out as at 31 December 2001, which was based on depreciated replacement costs (Note 3), property, plant and equipment are carried at revalued amount, being the fair value at the date of the revaluation, less subsequent accumulated depreciation and impairment losses. When an item of property, plant and equipment is the revaluation is restated revalued, any accumulated depreciation at proportionately with the change in the gross carrying amount of the asset so that the carrying amount of the asset after revaluation equals its revalued amount. The separate classes into which the Company groups assets for the revaluation are buildings and improvements; telecommunications network plant and transmission and switching equipment; and furniture, fixture, motor vehicles and other equipment. When an item of property, plant and equipment is revalued, the entire class of property, plant and equipment to which that asset belongs is revalued simultaneously. When an asset’s carrying amount is increased as a result of a revaluation, the increase is credited directly to shareholders’ equity under the component of revaluation reserve. However, a revaluation increase is recognised as income to the extent that it reverses a revaluation decrease of the same asset previously recognised as an expense. When an asset’s carrying amount is decreased as a result of a revaluation, the decrease is recognised as an expense in the consolidated statement of income. However, a revaluation decrease is charged directly against any related revaluation surplus to the extent that the decrease does not exceed the amount held in the revaluation reserve in respect of that same asset. Revaluations are performed with sufficient regularity such that the carrying amount does not differ materially from that which would be determined using fair value at the balance sheet date. Revaluations are performed annually on items which experience significant and volatile movements in fair value while items which experience insignificant movements in fair value are revalued every three years. 75 NOTES TO THE FINANCIAL STATEMENTS for the year ended 31 December 2002 2. SIGNIFICANT ACCOUNTING POLICIES (Continued) (g) Property, plant and equipment (Continued) Assets acquired under leasing agreements which effectively transfer substantially all the risks and benefits incidental to ownership from the lessor to the lessee are classified as assets under finance leases. Assets under finance leases are initially recorded at amounts equivalent to the present value of the minimum lease payments (computed using the rate of interest implicit in the lease) which approximate the fair value at the inception of the lease. The net present value of the future minimum lease payments is recorded correspondingly as a finance lease obligation. Assets under finance leases are amortised over their estimated useful lives. As at 31 December 2002, none of the Group’s assets were held under finance leases (2001 : RMB48 million). Gains or losses arising from retirement or disposal of property, plant and equipment are determined as the difference between the net disposal proceeds and the carrying amount of the asset and are recognised as income or expense in the consolidated statement of income on the date of disposal. On disposal of a revalued asset, the related revaluation surplus is transferred from the revaluation reserve to retained earnings. Depreciation is provided to write off the cost/revalued amount of each asset over its estimated useful life on a straight-line basis, after taking into account its estimated residual value, as follows: Depreciable life Buildings and improvements Telecommunications network plant, transmission and switching equipment Furniture, fixture, motor vehicles and other equipment 8 to 30 years 6 to 10 years 4 to 10 years (h) Lease prepayments Lease prepayments represent land use rights paid to the PRC’s land bureau. Land use rights are carried at cost and are amortised on a straight-line basis over the respective periods of the rights which range from 20 years to 70 years. (i) Construction in progress Construction in progress represents buildings, telecommunications network plant, transmission and switching equipment and other equipment under construction and pending installation, and is stated at cost less impairment losses (Note 2(l)). Cost comprises direct costs of construction as well as interest charges, and foreign exchange differences on related borrowed funds to the extent that they are regarded as an adjustment to interest charges, during the periods of construction. Capitalisation of these costs ceases and the construction in progress is transferred to property, plant and equipment when the asset is substantially ready for its intended use. 76 NOTES TO THE FINANCIAL STATEMENTS for the year ended 31 December 2002 2. SIGNIFICANT ACCOUNTING POLICIES (Continued) (i) Construction in progress (Continued) No depreciation is provided in respect of construction in progress. (j) Investments in subsidiaries In the Company’s stand-alone balance sheet, investments in subsidiaries are accounted for using the equity method. (k) Investments Investments in non-marketable equity securities are stated at cost less provision for impairment losses (Note 2(l)). A provision is made where, in the opinion of management, the carrying amount of the investments exceeds its recoverable amount. (l) Impairment the Group’s long-lived assets, including property, plant and The carrying amounts of equipment, are reviewed periodically in order to assess whether the recoverable amounts have declined below the carrying amounts. These assets are tested for impairment whenever events or changes in circumstances indicate that their recorded carrying amounts may not be recoverable. When such a decline has occurred, the carrying amount is reduced to the recoverable amount. The recoverable amount is the greater of the net selling price and the value in use. The amount of the reduction is recognised as an expense in the consolidated statement of income. In determining the value in use, expected future cash flows generated by the assets are discounted to their present value. For the periods presented, no impairment losses were recognised in the consolidated statement of income. (m) Revenue recognition The Group’s revenues are principally derived from the provision of local, domestic long distance (‘‘DLD’’) and international long distance (‘‘ILD’’) telephone services which consist of (i) usage charges for telephone services, which vary depending on the day, the time of day, distance and duration of the telephone call, (ii) a monthly telephone service fee, (iii) service activation and installation fees, and (iv) charges for value-added telecommunications services, such as call waiting, call diverting and caller number display. The Group records wireline service revenues over the periods they are earned as follows: (i) Revenues derived from local, DLD and ILD telephone usage are recognised as the services are provided. (ii) Upfront fees received for activation of wireline services and wireline installation charges are deferred and recognised over the expected customer relationship period. The related direct incremental customer acquisition costs are deferred to the extent of the upfront fees and are amortised over the same expected customer relationship period. 77 NOTES TO THE FINANCIAL STATEMENTS for the year ended 31 December 2002 2. SIGNIFICANT ACCOUNTING POLICIES (Continued) (m) Revenue recognition (Continued) (iii) Monthly telephone service fees are recognised in the month during which the telephone services are provided to customers. (iv) Revenues from sale of prepaid calling cards are recognised as the cards are used by customers. (v) Revenues derived from value-added telecommunications services are recognised when the services are provided to customers. Other related wireline telecommunications service revenues are recognised as follows: (i) (ii) Revenues from the provision of Internet and managed data services are recognised when the services are provided to customers. Interconnection fees from domestic and foreign telecommunications operators are recognised when the services are rendered as measured by the minutes of traffic processed. (iii) Lease income from operating leases is recognised over the term of the lease. (iv) Sale of customer-end equipment is recognised on delivery of the equipment to customers and when the significant risks and rewards of ownership and title have been transferred to the customers. (n) Advertising and promotion expense The costs for advertising and promoting the Group’s wireline telecommunications services are expensed as incurred. Advertising and promotion expense, which is included in selling, general and administrative expenses, was RMB1,300 million for the year ended 31 December 2002 (2001 : RMB1,097 million). (o) Net financing costs financing costs comprise interest interest expense on Net borrowings, and foreign exchange gains and losses. Interest income from bank deposits is recognised on a time proportion basis that takes into account the effective yield on the asset. income on bank deposits, Interest costs incurred in connection with borrowings are expensed as incurred, except to the extent that they are capitalised as being directly attributable to the construction of an asset which necessarily takes a substantial period of time to get ready for its intended use. 78 NOTES TO THE FINANCIAL STATEMENTS for the year ended 31 December 2002 2. SIGNIFICANT ACCOUNTING POLICIES (Continued) (p) Research and development expense Research and development expenditure is expensed as incurred. For the year ended 31 December 2002, research and development expense was RMB172 million (2001 : RMB123 million). (q) Employee benefits The Group’s contributions to defined contribution retirement plans administered by the PRC government are recognised as an expense in the consolidated statement of income. Further information is set out in Note 33. (r) Provisions A provision is recognised in the consolidated balance sheet when the Group has a legal or constructive obligation as a result of a past event, and it is probable that an outflow of economic benefits will be required to settle the obligation. (s) Income tax Income tax comprises current and deferred tax. Current tax is calculated on the taxable income for the year by applying the applicable tax rates. Deferred tax is provided using the balance sheet liability method, providing for all temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for taxation purposes. The amount of deferred tax is calculated on the basis of the enacted tax rates that are expected to apply in the period when the asset is realised or the liability is settled. The effect on deferred tax of any changes in tax rates is charged or credited to the consolidated statement of income. A deferred tax asset is recognised only to the extent that it is probable that future taxable income will be available against which the asset can be utilised. Deferred tax assets are reduced to the extent that it is no longer probable that the related tax benefit will be realised. (t) Dividends Dividends are recognised as a liability in the period in which they are declared. (u) Segmental reporting A business segment is a distinguishable component of the Group that is engaged in providing products or services and is subject to risks and rewards that are different from those of other segments. For the periods presented, the Group has one operating segment which is the provision of wireline telecommunications services. All the Group’s operating activities are carried out in the PRC. 79 NOTES TO THE FINANCIAL STATEMENTS for the year ended 31 December 2002 3. PROPERTY, PLANT AND EQUIPMENT, NET The Group: Buildings and improvements RMB millions Telecommunications network plant and equipment RMB millions Furniture, fixture, motor vehicles and other equipment RMB millions Total RMB millions Cost/valuation: Balance at 1 January 2001 Additions Transferred from construction in progress Disposals Revaluation Distributions to China Telecom in connection with the Restructuring 22,944 1,187 4,481 (265) 641 (2,865) 164,450 5,763 30,915 (3,794) (28,016) 9,919 877 1,501 (780) (2,328) 197,313 7,827 36,897 (4,839) (29,703) (2,057) (1,130) (6,052) Balance at 31 December 2001 26,123 167,261 8,059 201,443 Accumulated depreciation: Balance at 1 January 2001 Depreciation charge for the year Written back on disposals Revaluation Distributions to China Telecom in connection with the Restructuring (3,506) (918) 126 1,482 480 (62,612) (17,116) 2,288 18,719 (3,667) (1,417) 480 1,726 (69,785) (19,451) 2,894 21,927 742 373 1,595 Balance at 31 December 2001 (2,336) (57,979) (2,505) (62,820) Net book value at 31 December 2001 23,787 109,282 5,554 138,623 Cost/valuation: Balance at 1 January 2002 Additions Transferred from construction in progress Disposals 26,123 438 4,888 (81) 167,261 1,133 23,530 (1,136) 8,059 356 1,529 (250) 201,443 1,927 29,947 (1,467) Balance at 31 December 2002 31,368 190,788 9,694 231,850 Accumulated depreciation: Balance at 1 January 2002 Depreciation charge for the year Written back on disposals (2,336) (1,188) 25 (57,979) (18,281) 796 (2,505) (1,413) 196 (62,820) (20,882) 1,017 Balance at 31 December 2002 (3,499) (75,464) (3,722) (82,685) Net book value at 31 December 2002 27,869 115,324 5,972 149,165 80 NOTES TO THE FINANCIAL STATEMENTS for the year ended 31 December 2002 3. PROPERTY, PLANT AND EQUIPMENT, NET (Continued) As required by the relevant PRC rules and regulations with respect to the Restructuring, the property, plant and equipment of the Group as at 31 December 2001 were revalued for each asset class by Beijing China Enterprise Appraisal Co., Ltd. (the ‘‘PRC valuers’’), independent valuers registered in the PRC, on a depreciated replacement cost basis. The value of the property, plant and equipment was determined at RMB138,623 million. The tax base of such assets has been adjusted to the revalued amount (Note 8). The surplus on revaluation of certain property, plant and equipment totalling RMB4,154 million was credited to the revaluation reserve while the deficit arising from the revaluation of certain property, plant and equipment totalling RMB11,930 million was recognised as an expense for the year ended 31 December 2001. The reduction in the carrying amount was primarily the result of the-then market decline in the replacement cost of certain network switching equipment. The net deficit on the revaluation of the property, plant and equipment of RMB7,776 million was reflected in the consolidated balance sheet of the Group as at 31 December 2001. The Group’s properties were also revalued separately by Chesterton Petty Limited, independent qualified valuers in Hong Kong, as at 31 December 2001. The value arrived at by these valuers was approximately the same as that arrived at by the PRC valuers. The historical carrying amounts of the Group’s property, plant and equipment as at 31 December 2001 and the revalued amounts of these assets were as follows: Historical carrying amount RMB millions Revaluation surplus RMB millions Revaluation deficit RMB millions Revalued amount RMB millions Buildings and improvements Telecommunications network plant 21,664 2,361 (238) 23,787 and equipment 118,579 1,653 (10,950) 109,282 Furniture, fixture, motor vehicles and other equipment 6,156 140 (742) 5,554 146,399 4,154 (11,930) 138,623 In connection with the initial public offering of the Company’s H shares, the properties of the Group as at 30 June 2002 were valued by Chesterton Petty Limited, independent qualified valuers in Hong Kong, as required by the Rules Governing the Listing of Securities on the Stock Exchange of Hong Kong Limited. The value of the properties other than land use rights was not materially different from the book carrying value as at 30 June 2002 and therefore the consolidated financial statements have not been adjusted. 81 NOTES TO THE FINANCIAL STATEMENTS for the year ended 31 December 2002 4. CONSTRUCTION IN PROGRESS The Group 2002 RMB millions 2001 RMB millions Balance at beginning of year Additions Transferred to property, plant and equipment Distributions to China Telecom in connection with the Restructuring 23,274 26,992 (29,947) — 28,656 32,201 (36,897) (686) Balance at end of year 20,319 23,274 5. INTERESTS IN SUBSIDIARIES Share of net assets The Company 2002 RMB millions 114,866 Details of the Company’s subsidiaries at 31 December 2002 which principally affected the results of operations and the financial position of the Group are as follows: Name of Company Type of legal entity Date of incorporation Registered capital (RMB millions) Direct attributable equity interest Principal activities Guangdong Telecom Company Limited Limited company 10 October 2002 Zhejiang Telecom Limited company Company Limited Jiangsu Telecom Limited company Company Limited Shanghai Telecom Limited company Company Limited 10 October 2002 19 October 2002 11 October 2002 47,513 100% Provision of telecommunications services 22,400 100% Provision of telecommunications services 19,208 100% Provision of telecommunications services 15,984 100% Provision of telecommunications services The above subsidiaries are incorporated in the PRC. 82 6. INTERESTS IN ASSOCIATES NOTES TO THE FINANCIAL STATEMENTS for the year ended 31 December 2002 The Group 2002 RMB millions 2001 RMB millions Share of net assets 429 417 The Group’s interests in associates are accounted for under the equity method and are individually and in aggregate not material to the Group’s financial conditions or results of operations for all periods presented. Details of the Group’s principal associates are as follows: Name of company equity interest Principal activities Attributable Shenzhen Shekou Telecommunications 50.00% Provision of telecommunications services Company Limited Shanghai Information Investment Incorporation 24.00% Provision of information technology consultancy services The above associates are established in the PRC and are not traded on any stock exchange. 7. INVESTMENTS The Group 2002 RMB millions 2001 RMB millions Unlisted equity investments 270 446 Unlisted equity investments mainly represent the Group’s various interests in PRC private enterprises which are mainly engaged in the provision of information technology services and Internet contents. These investments are accounted for at cost, less provision for any impairment. The Group has no investments in marketable securities. 83 NOTES TO THE FINANCIAL STATEMENTS for the year ended 31 December 2002 8. DEFERRED TAX ASSETS AND LIABILITIES Deferred tax assets and deferred tax liabilities are attributable to the items set out below: The Group: Assets 2002 2001 RMB millions RMB millions RMB millions RMB millions RMB millions RMB millions 2001 2001 Liabilities 2002 Net balance 2002 Current Provisions, primarily for accounts receivable Non-current Property, plant and equipment Deferred revenues and installation costs Land use rights 99 — 1,035 3,984 — — — 4,059 — (193) (425) — Deferred tax assets 5,118 4,059 (618) — — — — — 99 (193) 610 3,984 — — — 4,059 4,500 4,059 A valuation allowance on deferred tax assets is recorded if it is more likely than not that some portion or all of the deferred tax assets will not be realised through recovery of taxes previously paid and/or future taxable income. The allowance is subject to ongoing adjustments based on changes in circumstances that affect the Group’s assessment of the realisability of the deferred tax assets. The Group has reviewed its deferred tax assets as at 31 December 2001 and 2002. Based on the level of historical taxable income and projections for future taxable income over the periods which the deferred tax assets are deductible, management believes that it is more likely than not the Group will realise the benefits of these temporary differences. Therefore, no valuation allowances were provided for the years ended 31 December 2001 and 2002 in respect of deferred tax assets arising from temporary differences. 84 NOTES TO THE FINANCIAL STATEMENTS for the year ended 31 December 2002 8. DEFERRED TAX ASSETS AND LIABILITIES (Continued) Movements in temporary differences are as follows: Balance at 1 January 2001 RMB millions Note Recognised in statement of income RMB millions Recognised in shareholders’ equity RMB millions Balance at 31 December 2001 RMB millions Current Provisions, primarily for accounts receivable Non-current Property, plant and equipment Deferred revenues and installation costs Land use rights (i) (i) (i) (ii) 308 (88) (220) — (9,194) 611 — 3,271 205 — 5,923 (816) 4,059 — — 4,059 Net deferred tax (liabilities)/assets (8,275) 3,388 8,946 4,059 Current Provisions, primarily for accounts receivable Non-current Property, plant and equipment Deferred revenues and installation costs Land use rights Net deferred tax assets (Note 24) Balance at 1 January 2002 RMB millions Recognised in statement of income RMB millions Balance at 31 December 2002 RMB millions — 99 99 — — 4,059 4,059 (193) 610 (75) 441 (Note 24) (193) 610 3,984 4,500 Note: (i) (ii) As described in Note 3, in connection with the Restructuring, the Group’s property, plant and equipment were revalued as at 31 December 2001. The tax base of these assets has been adjusted to conform to the respective revalued amount. In addition, in connection with the Restructuring, the tax bases of the Group’s assets and liabilities that gave rise to the temporary differences above have been adjusted to conform to the related financial carrying amounts. As a result, the timing differences that gave rise to the net deferred tax liabilities relating to the items above were eliminated. The reduction in net deferred tax liabilities of RMB4,887 million as at 31 December 2001 was reflected as a credit to shareholders’ equity. In connection with the Restructuring, the Group’s land use rights, which as at 31 December 2001 had a carrying amount of RMB2,638 million, were revalued as required by the relevant PRC rules and regulations. The revalued amount of the land use rights was determined at RMB14,939 million. The tax base of the land use rights has been adjusted to conform to such revalued amount. The land use rights were not revalued for financial reporting purposes and accordingly, a deferred tax asset of RMB4,059 million was created with a corresponding increase in shareholders’ equity. Based upon the level of historical taxable income and projections of future taxable income, management believes that it is more likely than not the Group will realise the benefits of the deferred tax asset. 85 NOTES TO THE FINANCIAL STATEMENTS for the year ended 31 December 2002 9. INVENTORIES Inventories represent: Materials and supplies Goods for resale 10. ACCOUNTS RECEIVABLE, NET Accounts receivable, net, is analysed as follows: Accounts receivable Less: Allowance for doubtful accounts The Group 2002 RMB millions 2001 RMB millions 911 155 1,166 247 1,066 1,413 The Group 2002 RMB millions 2001 RMB millions 6,440 (479) 6,121 (513) 5,961 5,608 Amounts due from the provision of wireline telecommunications services to residential and business customers are due within 30 days from the date of billing. Customers who have accounts overdue by more than 90 days will have their services disconnected. The following table summarises the changes in the allowance for doubtful accounts: The Group 2002 RMB millions 2001 RMB millions 513 345 (379) 479 661 186 (334) 513 At beginning of year Provision for doubtful accounts Accounts receivable written off At end of year 86 NOTES TO THE FINANCIAL STATEMENTS for the year ended 31 December 2002 10. ACCOUNTS RECEIVABLE, NET (Continued) Ageing analysis of accounts receivable from telephone subscribers is as follows: Current, within 1 month 1 to 3 months 4 to 12 months More than 12 months Less: Allowance for doubtful accounts The Group 2002 RMB millions 2001 RMB millions 5,036 352 309 130 5,827 (439) 4,436 709 233 255 5,633 (488) 5,388 5,145 Ageing analysis of accounts receivable from other telecommunications operators and customers is as follows: The Group 2002 RMB millions 2001 RMB millions Current, within 1 month 1 to 3 months 4 to 12 months More than 12 months Less: Allowance for doubtful accounts 363 109 85 56 613 (40) 573 189 137 77 85 488 (25) 463 87 NOTES TO THE FINANCIAL STATEMENTS for the year ended 31 December 2002 11. PREPAYMENTS AND OTHER CURRENT ASSETS Prepayments and other current assets represent: Amounts due from China Telecom Group Amounts due from subsidiaries Prepayments in connection with construction work and equipment purchases Prepaid expenses and deposits Other receivables 12. CASH AND CASH EQUIVALENTS The Group 2002 RMB millions 2001 RMB millions The Company 2002 RMB millions 342 — 376 269 749 970 — 383 247 1,152 34 1,493 — — — 1,736 2,752 1,527 The Group 2002 RMB millions 2001 RMB millions The Company 2002 RMB millions Cash at bank and in hand Time deposits with maturity within three months 11,574 4,849 3,604 278 16,423 3,882 4,815 4,755 9,570 13. SHORT-TERM AND LONG-TERM DEBT Short-term debt comprises: The Group 2002 RMB millions 2001 RMB millions Bank loans 19,175 18,827 Weighted average interest rate of the Group’s short-term debt as at 31 December 2002 was 4.7% (2001 : 5.5%). 88 NOTES TO THE FINANCIAL STATEMENTS for the year ended 31 December 2002 13. SHORT-TERM AND LONG-TERM DEBT (Continued) Long-term debt comprises: Interest rates and final maturity The Group 2002 RMB millions 2001 RMB millions Bank loans Renminbi denominated Interest rates ranging from 4.5% to 8.0% per 2,867 6,005 annum with maturities through 2006 US Dollars denominated Interest rates ranging from 2.0% to 8.3% per 1,582 2,137 annum with maturities through 2021 Japanese Yen denominated Interest rates ranging from 2.5% to 3.5% per 2,623 2,544 annum with maturities through 2022 Other loans Renminbi denominated Interest rate at 2.4% per annum — 36 7,072 10,686 Total long-term debt Less: current portion Non-current portion 7,072 10,722 (2,219) (3,621) 4,853 7,101 As at 31 December 2002, no bank loans were secured. As at 31 December 2001, bank loans of RMB14 million were secured by certain of the Group’s property, plant and equipment. The net book value of the property, plant and equipment pledged as security amounted to RMB4 million as at 31 December 2001. 89 NOTES TO THE FINANCIAL STATEMENTS for the year ended 31 December 2002 13. SHORT-TERM AND LONG-TERM DEBT (Continued) The aggregate maturities of the Group’s long-term debt subsequent to 31 December 2002 are as follows: Within 1 year Between 1 to 2 years Between 2 to 3 years Between 3 to 4 years Between 4 to 5 years Thereafter The Group 2002 RMB millions 2001 RMB millions 2,219 1,196 825 268 219 2,345 3,621 2,795 1,306 325 263 2,412 7,072 10,722 The Group’s short-term and long-term debts do not contain any financial covenants. As at 31 December 2002, the Group had available credit facilities of RMB2,634 million (2001 : RMB Nil) which it can draw upon. 14. ACCOUNTS PAYABLE Accounts payable are analysed as follows: Third parties China Telecom Group The Group 2002 RMB millions 2001 RMB millions 11,505 2,894 12,498 2,421 14,399 14,919 Amounts due to China Telecom Group are repayable in accordance with normal commercial terms. 90 NOTES TO THE FINANCIAL STATEMENTS for the year ended 31 December 2002 14. ACCOUNTS PAYABLE (Continued) Ageing analysis of accounts payable is as follows: Due within 1 month or on demand Due after 1 month but within 3 months Due after 3 months but within 6 months Due after 6 months 15. ACCRUED EXPENSES AND OTHER PAYABLES Accrued expenses and other payables represent: The Group 2002 RMB millions 2001 RMB millions 1,715 2,701 3,329 6,654 2,166 2,010 2,150 8,593 14,399 14,919 The Group 2002 RMB millions 2001 RMB millions The Company 2002 RMB millions Distributions payable to China Telecom Amounts due to China Telecom Group Accrued expenses Customer deposits and receipts in advance — 1,790 7,884 592 2,535 1,673 6,883 581 10,266 11,672 — — 570 — 570 91 NOTES TO THE FINANCIAL STATEMENTS for the year ended 31 December 2002 16. FINANCE LEASE OBLIGATIONS Obligations under finance leases are analysed as follows: Within 1 year Between 1 to 2 years Between 2 to 3 years Less: finance charges related to future periods Present value of minimum lease payments Less: current portion Non-current portion 17. DEFERRED REVENUES The Group 2002 RMB millions 2001 RMB millions — — — — — — — 40 7 4 (2) 49 (38) 11 Deferred revenues represent the unearned portion of upfront connection fees and installation fees received from customers and the unused portion of calling cards. Connection fees and installation fees are amortised over the expected customer relationship period of 10 years. Beginning 1 July 2001, connection fees were no longer collected from new customers. The Group 2002 RMB millions 2001 RMB millions 34,508 38,199 — 1,987 5,235 7,222 (6,018) (995) (5,379) 1,168 2,019 5,580 8,767 (6,290) (780) (5,388) 29,338 34,508 7,726 21,612 29,338 8,155 26,353 34,508 Balance at beginning of year Additions for the year — connection fees — installation fees — calling cards Reduction for the year — amortisation of connection fees — amortisation of installation fees — usage of calling cards Balance at end of year Representing: — Current portion — Non-current portion 92 NOTES TO THE FINANCIAL STATEMENTS for the year ended 31 December 2002 17. DEFERRED REVENUES (Continued) Included in other non-current assets are capitalised direct incremental costs associated with the installation of wireline services. As at 31 December 2002, the unamortised portion of these costs was RMB5,687 million (2001 : RMB5,126 million). 18. SHARE CAPITAL Registered, issued and fully paid 67,586,776,503 ordinary domestic shares of RMB 1.00 each 8,027,410,000 overseas listed H shares of RMB 1.00 each The Group and the Company 2001 RMB millions 2002 RMB millions 67,587 8,027 75,614 — — — The Company was incorporated on 10 September 2002 with a registered capital of 68,317,270,803 ordinary domestic shares with a par value of RMB1.00 each. Such shares were issued to China Telecom in consideration for the assets and liabilities related to the Predecessor Operations transferred to the Company (Note 1). As part of a reform plan approved by the State Council on the administration of rural telecommunication services, China Telecom transferred a portion of its shareholdings in the Company to certain state-owned enterprises (‘‘Other Domestic Shareholders’’) Jiangsu owned and controlled by the provincial governments in each of Guangdong Province, Province and Zhejiang Province. Pursuant to the resolutions passed at an extraordinary general meeting held on 4 November 2002 and approvals from relevant government authorities, the Company was authorised to increase its share capital to a maximum of 76,216 million shares with a par value of RMB1.00 each and offer not more than 7,899 million of such shares to investors outside the PRC. China Telecom and the Other Domestic Shareholders were authorised to offer not more than 791 million shares in aggregate of their shareholdings in the Company to investors outside the PRC. The shares sold by China Telecom and the Other Domestic Shareholders to investors outside the PRC would be converted into H shares. In November 2002, the Company issued 6,868,767,600 H shares with a par value of RMB1.00 each, representing 377,820,000 H shares and 64,909,476 American Depositary Shares (‘‘ADSs’’, each representing 100 H shares), at prices of HK$1.47 per H share and US$18.98 per ADS, respectively, by way of a global initial public offering to Hong Kong and overseas investors. As part of the global initial public offering, 687,632,400 ordinary domestic shares of RMB1.00 each owned by China Telecom and the Other Domestic Shareholders were converted into H shares and sold to Hong Kong and overseas investors. 93 NOTES TO THE FINANCIAL STATEMENTS for the year ended 31 December 2002 18. SHARE CAPITAL (Continued) In December 2002, the Company issued 428,148,100 H shares with a par value of RMB1.00 each, representing 4,281,481 ADSs at US$18.98 per ADS to overseas investors upon exercise of an over- allotment option granted to the underwriters in connection with the global initial public offering. In addition, 42,861,900 ordinary domestic shares of RMB1.00 each owned by China Telecom and the Other Domestic Shareholders were converted into H shares and sold to overseas investors. All ordinary domestic shares and H shares rank pari passu in all material respects. 19. RESERVES The Group Statutory common Capital reserve RMB Share Revaluation Surplus welfare Other Retained premium RMB reserve RMB reserves RMB fund RMB reserves RMB earnings RMB Total RMB millions millions millions millions millions millions millions millions Balance as at 1 January 2001 Net profit Contributions from China Telecom Distributions to China Telecom Assets distributed to China Telecom in connection with the Restructuring (Note 1) Revaluation surplus (Note 3) Recognition of deferred tax assets (Note 8) Elimination of net deferred tax liabilities (Note 8) Balance as at 31 December 2001 Capitalisation as share capital upon incorporation of the — — — — — — — — — Company (Note (i)) 20,955 — — — — — — — — — — Issue of shares, net of issuing expenses of RMB796 million Net profit Appropriations (Notes (ii) and (iii)) Revaluation surplus realised Deferred tax on amortisation of land use rights realised — — — — — 3,362 — — — — — — — — — 4,154 — — 4,154 — — — — (10) — — — — — — — — — — — — — — — — — — — — — — — — — — 101,619 101,619 — — 6,883 6,883 3,003 3,003 — (15,835) (15,835) — (11,285) (11,285) — 4,059 — — 4,154 4,059 — 4,887 4,887 4,059 89,272 97,485 — (89,272) (68,317) — — 3,362 — 16,864 16,864 8,121 1,624 — — — — — — (75) (9,745) 10 75 — — — Balance as at 31 December 2002 20,955 3,362 4,144 8,121 1,624 3,984 7,204 49,394 94 19. RESERVES (Continued) NOTES TO THE FINANCIAL STATEMENTS for the year ended 31 December 2002 Statutory common The Company Capital reserve RMB Share premium RMB Revaluation reserve RMB Surplus reserves RMB welfare fund RMB Other reserves RMB Retained earnings RMB Total RMB millions millions millions millions millions millions millions millions Capitalisation as share capital upon incorporation of the Company (Note (i)) 20,955 — 4,154 Issue of shares, net of issuing expenses of RMB796 million Net profit Appropriations (Notes (ii) and (iii)) Revaluation surplus realised Deferred tax on amortisation of land use rights realised — — — — — 3,362 — — — — — — — (10) — — — — — — — 4,059 — 29,168 — — 3,362 — 16,864 16,864 8,121 1,624 — — — — — — (75) (9,745) 10 75 — — — Balance as at 31 December 2002 20,955 3,362 4,144 8,121 1,624 3,984 7,204 49,394 Note: (i) The amount of RMB68,317 million represents the par value of shares issued to China Telecom upon incorporation of the Company. (ii) According to the Company’s Articles of Association, the Company is required to transfer 10% of its net profit, as determined in accordance with the PRC accounting rules and regulations, to a statutory surplus reserve until such reserve balance reaches 50% of the registered capital. The transfer to this reserve must be made before distribution of any dividend to shareholders. For the year ended 31 December 2002, the Company transferred RMB1,624 million, being 10% of the year’s net profit determined in accordance with PRC accounting rules and regulations, to this reserve. According to the Company’s Articles of Association, the Directors authorised, subject to shareholders’ approval, the transfer of RMB6,497 million, being 40% of the year’s net profit determined in accordance with PRC accounting rules and regulations, to a discretionary surplus reserve. The surplus reserves are non-distributable other than liquidation and can be used to make good of previous years’ losses, if any, and may be utilised for business expansion or converted into share capital by issuing new shares to existing shareholders in proportion to their shareholdings or by increasing the par value of the shares currently held by them, provided that the remaining reserve balance after such issue is not less than 25% of the registered capital. (iii) According to the Company’s Articles of Association, the Company is required to transfer 5% to 10% of its net profit, as determined in accordance with the PRC accounting rules and regulations, to a statutory common welfare fund. This fund can only be utilised on capital items for the collective benefits of the Company’s employees such as construction of dormitories, canteen and other staff welfare facilities. This fund is non-distributable other than on liquidation. The transfer to this fund must be made before distribution of any dividend to shareholders. For the year ended 31 December 2002, the Directors authorised, subject to shareholders’ approval, the transfer of RMB1,624 million, being 10% of the year’s net profit determined in accordance with the PRC accounting rules and regulations, to this fund. 95 NOTES TO THE FINANCIAL STATEMENTS for the year ended 31 December 2002 19. RESERVES (Continued) (iv) According to the Company’s Articles of Association, the amount of retained earnings available for distribution to shareholders of the Company is the lower of the amount determined in accordance with the PRC accounting rules and regulations and the amount determined in accordance with IFRS. At 31 December 2002, the amount of retained earnings available for distribution was RMB6,497 million, being the amount determined in accordance with the PRC accounting rules and regulations. Final dividend of RMB672 million in respect of the financial year 2002 proposed after the balance sheet date has not been recognised as a liability at the balance sheet date (Note 28). 20. OPERATING REVENUES Operating revenues represent revenues from the provision of wireline telecommunications services, net of PRC business tax and government levies, where applicable, in all periods presented. The components of the Group’s operating revenues are as follows: Upfront connection fees Upfront installation fees Monthly fees Local usage fees DLD ILD Internet Managed data Interconnections Leased line Others Note: Note (i) (ii) (iii) (iv) (iv) (iv) (v) (vi) (vii) (viii) (ix) The Group 2002 RMB millions 2001 RMB millions 6,018 995 12,460 22,392 14,365 3,285 3,775 1,789 4,363 3,095 2,959 6,290 780 10,186 21,004 14,676 3,392 2,150 1,477 3,814 2,862 1,915 75,496 68,546 (i) Represent the amortised amount of the upfront fees received for initial activation of wireline services. (ii) Represent the amortised amount of the upfront fees received for installation of wireline services. (iii) Represent amounts charged to customers each month for their use of the Group’s telephone services. (iv) Represent usage fees charged to customers for the provision of telephone services. (v) Represent amounts charged to customers for the provision of Internet access services. (vi) Represent amounts charged to customers for the provision of managed data transmission services. 96 NOTES TO THE FINANCIAL STATEMENTS for the year ended 31 December 2002 20. OPERATING REVENUES (Continued) (vii) Represent amounts charged to domestic and foreign telecommunications operators for delivery of calls connecting to the Group’s wireline telecommunications networks. (viii) Represent lease income from other domestic telecommunications operators and business customers for the usage of the Group’s wireline telecommunications networks and is measured by the number of lines leased and the agreed upon rate per line leased. The lease arrangements are primarily on a year to year basis. (ix) Represent primarily revenues from provision of value-added telecommunications services to customers, sale and repairs and maintenance of customer-end equipment. 21. OTHER OPERATING EXPENSES Other operating expenses consist of: Interconnection charges Donations Others Note: Note (i) The Group 2002 RMB millions 2001 RMB millions 2,608 23 6 1,290 26 11 2,637 1,327 (i) Interconnection charges represent amounts incurred for the use of other telecommunications operators’ networks for facilitating the completion of calls that originate from the Group’s wireline telecommunications networks. 22. TOTAL OPERATING EXPENSES Total operating expenses for the year ended 31 December 2002 include personnel expenses of RMB8,915 million (2001 : RMB6,207 million) and auditors’ remuneration of RMB19 million (2001 : RMB Nil). 97 NOTES TO THE FINANCIAL STATEMENTS for the year ended 31 December 2002 23. NET FINANCE COSTS/(INCOME) Net finance costs/(income) comprise: Interest expense incurred Less: Interest expense capitalised* Net interest expense Interest income Foreign exchange losses Foreign exchange gains The Group 2002 RMB millions 2001 RMB millions 1,321 (770) 1,415 (1,032) 551 (140) 228 (7) 632 383 (246) 3 (433) (293) * Interest expense was capitalised in construction in progress at the following rates per annum 4.4% to 5.6% 5.1% to 5.8% 24. TAXATION Taxation in the consolidated statement of income comprises: Provision for PRC income tax Deferred taxation (Note 8) The Group 2002 RMB millions 2001 RMB millions 4,296 (441) 3,319 (3,388) 3,855 (69) 98 NOTES TO THE FINANCIAL STATEMENTS for the year ended 31 December 2002 24. TAXATION (Continued) A reconciliation of the expected tax with the actual tax expense/(benefit) is as follows: The Group 2002 RMB millions 2001 RMB millions Note Profit before taxation and minority interests 20,785 6,793 Expected PRC income tax expense at statutory tax rate of 33% Differential tax rate on subsidiaries’ income Non-deductible expenses Non-taxable income (i) (i) (ii) Income tax Note: 6,859 (708) 542 (2,838) 2,242 (506) 436 (2,241) 3,855 (69) (i) The provision for PRC current income tax is based on a statutory rate of 33% of the assessable income of the Group as determined in accordance with the relevant income tax rules and regulations of the PRC, except for certain subsidiaries of the Company which are taxed at a preferential rate of 15%. (ii) Amounts primarily represent connection fees and certain usage fees on phone calls received from customers which are not subject to income tax. 25. DIRECTORS’ AND SUPERVISORS’ REMUNERATION The following table sets out the remuneration received or receivable by the Company’s directors and supervisors during the periods presented: Fees Salaries, allowances and benefits in kind Retirement benefits 2002 RMB thousand 2001 RMB thousand 127 3,148 211 — 1,602 145 3,486 1,747 99 NOTES TO THE FINANCIAL STATEMENTS for the year ended 31 December 2002 25. DIRECTORS’ AND SUPERVISORS’ REMUNERATION (Continued) Included in the directors’ and supervisors’ remuneration were fees of RMB127,000 (2001 : RMB Nil) paid or payable to the independent non-executive directors and independent supervisors for the year ended 31 December 2002. The number of directors and supervisors whose remuneration falls within the following band is set out below: HK$ equivalent Nil–1,000,000 2002 Number 2001 Number 16 12 None of the directors and supervisors received any fees, bonuses, inducements, or compensation for loss of office, or waived any emoluments during the periods presented. 26. INDIVIDUALS WITH HIGHEST EMOLUMENTS Of the five highest paid individuals of the Group during the periods presented, one is a director of the Company and his remuneration has been included in Note 25 above. The following table sets out the emoluments of the Group’s remaining four highest paid employees who were not directors or supervisors of the Company during the periods presented: Salaries, allowances and benefits in kind Retirement benefits 2002 RMB thousand 2001 RMB thousand 1,614 110 991 108 1,724 1,099 The number of these employees whose emoluments fall within the following band is set out below: HK$ equivalent Nil–1,000,000 2002 Number 2001 Number 4 4 None of these employees received any inducements or compensation for loss of office, or waived any emoluments during the periods presented. 100 NOTES TO THE FINANCIAL STATEMENTS for the year ended 31 December 2002 27. PROFIT ATTRIBUTABLE TO SHAREHOLDERS The profit attributable to shareholders includes a profit of RMB16,864 million which has been dealt with in the stand-alone financial statements of the Company. 28. DIVIDENDS Pursuant to a resolution passed at the Directors’ meeting on 24 April 2003, a final dividend of RMB0.00888 per share totalling RMB672 million was proposed for shareholders’ approval at the Annual General Meeting. The dividend has not been provided for in the financial statements for the year ended 31 December 2002. 29. BASIC EARNINGS PER SHARE The calculation of basic earnings per share is based on the net profit of RMB16,864 million (2001 : RMB6,883 million) and the weighted average number of shares in issue during the year of 69,241,674,942 (2001 : 68,317,270,803), as if the 68,317,270,803 shares issued and outstanding upon the legal formation of the Company on 10 September 2002 had been outstanding for all periods presented. The weighted average number of shares for the year ended 31 December 2002 also reflects the issuance of 7,296,915,700 shares in 2002 in connection with the Company’s global initial public offering (Note 18). The amount of diluted earnings per share is not presented as there were no dilutive potential ordinary shares in existence for both years. 30. COMMITMENTS AND CONTINGENCIES Operating lease commitments The Group leases business premises through non-cancellable operating leases. These operating leases do not contain provisions for contingent lease rentals. None of the rental agreements contain escalation provisions that may require higher future rental payments nor impose restrictions on dividends, additional debt and/or further leasing. 101 NOTES TO THE FINANCIAL STATEMENTS for the year ended 31 December 2002 30. COMMITMENTS AND CONTINGENCIES (Continued) Operating lease commitments (Continued) As at 31 December 2002, future minimum lease payments under non-cancellable operating leases having initial or remaining lease terms of more than one year, which include the new lease agreements with China Telecom Group (Note 32), were as follows: Within 1 year Between 1 to 2 years Between 2 to 3 years Between 3 to 4 years Between 4 to 5 years Thereafter The Group 2002 RMB millions 2001 RMB millions 457 355 114 75 70 367 334 154 111 73 52 316 Total minimum lease payments 1,438 1,040 Total rental expense in respect of operating leases charged to the consolidated statement of income for the year ended 31 December 2002 was RMB807 million (2001 : RMB523 million). Capital commitments As at 31 December 2002, the Group had capital commitments as follows: The Group 2002 RMB millions 2001 RMB millions 800 3,439 755 2,742 4,239 3,497 1,359 3,640 1,398 5,831 4,999 7,229 Authorised and contracted for Properties Telecommunications network plant and equipment Authorised but not contracted for Properties Telecommunications network plant and equipment 102 NOTES TO THE FINANCIAL STATEMENTS for the year ended 31 December 2002 30. COMMITMENTS AND CONTINGENCIES (Continued) Contingent liabilities (a) The Company has been advised by its PRC lawyers that, except for liabilities constituting or arising out of or relating to the business transferred to the Company in the Restructuring, no other liabilities were assumed by the Company, and the Company is not jointly and severally liable for other debts and obligations incurred by China Telecom Group prior to the Restructuring. (b) As at 31 December 2002, the undiscounted maximum amount of potential future payments under guarantees given to banks in respect of banking facilities granted to the parties below were as follows: China Telecom Group and the Group’s investees Subsidiaries The Group 2002 RMB millions 2001 RMB millions The Company 2002 RMB millions 6 — 6 150 — 150 — 2,869 2,869 The Group monitors the conditions that are subject to the guarantees to identify whether it is probable that a loss has occurred, and recognise any such losses under guarantees when those losses can be estimated. At 31 December 2001 and 2002, it was not probable that the Group would be required to make payments under these guarantees. Thus no liability was accrued for losses related to the Group’s obligations under these guarantee arrangements. Legal contingencies The Group is a defendant in certain lawsuits as well as the named party in other proceedings arising in the ordinary course of business. While the outcomes of such contingencies, lawsuits or other proceedings cannot be determined at present, management believes that any resulting liabilities will not have a material adverse effect on the financial position or operating results of the Group. 103 NOTES TO THE FINANCIAL STATEMENTS for the year ended 31 December 2002 31. CONCENTRATION OF RISKS Credit and concentration risks The carrying amounts of cash and cash equivalents, time deposits, accounts receivable and other receivables represent the Group’s maximum exposure to credit risk in relation to financial assets. The majority of the Group’s accounts receivable relate to provision of telecommunications services to residential and corporate customers operating in various industries. The Group performs ongoing credit evaluations of its customers’ financial condition and generally does not require collateral on accounts receivable. The Group maintains an allowance for doubtful accounts and actual losses have been within management’s expectations. The Group has a diversified base of customers. No single customer contributed more than 10% of revenues for the periods presented. The Group does not have concentrations of available sources of labour, services, franchises, licenses or other rights that could, if suddenly eliminated, severely impact its operations. The Group invests its cash with several large state-owned financial institutions in the PRC and international financial institutions. Business and economic risks The Group conducts its principal operations in the PRC and accordingly is subject to special considerations and significant risks not typically associated with investments in equity securities of United States and Western European companies. These include risks associated with, among others, the political, economic, legal environment and social uncertainties in the PRC, influence of the Ministry of Information Industry over certain aspects of the Group’s operations and competition in the telecommunications industry. In addition, the ability to negotiate and implement specific business development projects in a timely and favourable manner may be impacted by political considerations unrelated to or beyond the control of the Group. Although the PRC government has been pursuing economic reform policies for the past two decades, no assurance can be given that the PRC government will continue to pursue such policies or that such policies may not be significantly altered. There is also no guarantee that the PRC government’s pursuit of economic reforms will be consistent or effective and as a result, changes in the rate or method of taxation, reduction in tariff protection and other import restrictions, and changes in State policies and regulations affecting the telecommunications industry may have a negative impact on the Group’s operating results and financial condition. 104 NOTES TO THE FINANCIAL STATEMENTS for the year ended 31 December 2002 31. CONCENTRATION OF RISKS (Continued) Currency risk Substantially all of the revenue-generating operations of the Group are transacted in RMB, which is not fully convertible into foreign currencies. On 1 January 1994, the PRC government abolished the dual rate system and introduced a single rate of exchange as quoted by the People’s Bank of China. However, the unification of the exchange rate does not imply convertibility of RMB into United States dollars or other foreign currencies. All foreign exchange transactions must take place either through the People’s Bank of China or other institutions authorised to buy and sell foreign exchange or at a foreign currency payments by the People’s Bank of China or other swap center. Approval of institutions requires submitting a payment application form together with suppliers’ invoices, shipping documents and signed contracts. Interest rate risk The interest rates and terms of repayment of the Group’s debts are disclosed in Note 13. 32. RELATED PARTY TRANSACTIONS Companies are considered to be related if one company has the ability, directly or indirectly, to control the other company or exercise significant influence over the other company in making financial and operating decisions. Companies are also considered to be related if they are subject to common control or common significant influence. The Group conducts business with enterprises directly or indirectly owned or controlled by the PRC government (‘‘state-owned enterprises’’). Furthermore, the PRC government itself represents a significant customer of the Group both directly through its numerous authorities and indirectly through its numerous affiliates and other organisations. The Group considers that the provision of wireline telecommunications services to the PRC government authorities and affiliates and other state-owned enterprises are activities in the ordinary course of business in the PRC and has not disclosed such services as related party transactions. The Group is part of a larger group of companies under China Telecom and has significant transactions and relationships with members of China Telecom. Because of these relationships, it is possible that the terms of these transactions are not the same as those that would result from transactions among wholly unrelated parties. Under IFRS, state-owned enterprises, other than China Telecom and its affiliates, are not disclosed as related parties. Related parties refer to enterprises over which China Telecom is able to exercise control or significant influence. 105 NOTES TO THE FINANCIAL STATEMENTS for the year ended 31 December 2002 32. RELATED PARTY TRANSACTIONS (Continued) The principal related party transactions with China Telecom Group, which were carried out in the ordinary course of business, are as follows: Purchases of telecommunications equipment and materials Construction, engineering and information technology services Provision of community services Provision of ancillary services Operating lease expenses Centralised service expenses Interconnection revenues Interconnection charges Note: 2002 RMB millions 2001 RMB millions Note (i) (ii) (iii) (iv) (v) (vi) (vii) (vii) 78 3,394 1,291 1,219 368 483 302 687 2,331 2,884 742 613 94 — — — (i) Represent purchases of telecommunications equipment and materials from China Telecom Group. (ii) Represent provision of network construction, engineering and information technology services to the Group by China Telecom Group. (iii) Represent amounts paid and payable by the Group to China Telecom Group in respect of cultural, educational, hygiene and other community services. (iv) Represent amounts paid and payable by the Group to China Telecom Group in respect of ancillary services such as repairs and maintenance of telecommunications equipment and facilities and certain customer services. (v) Represent amounts paid and payable to China Telecom Group for operating leases in respect of business premises and inter-provincial transmission optic fibres. (vi) Represent net amount charged by China Telecom to the Group for costs associated with common corporate services and international telecommunications facilities. (vii) Represent amounts charged from/to China Telecom for interconnection of domestic long distance telephone calls. The directors of the Company are of the opinion that the above transactions with related parties were conducted in the ordinary course of business and on normal commercial terms or in accordance with the agreements governing such transactions, and this has been confirmed by the independent non- executive directors. 106 32. RELATED PARTY TRANSACTIONS (Continued) NOTES TO THE FINANCIAL STATEMENTS for the year ended 31 December 2002 In connection with the Restructuring, the Group and China Telecom Group entered into a number of agreements effective on 1 January 2002 with an initial term expiring on 31 December 2004. The terms of the principal agreements are summarised as follows: (1) (2) (3) (4) (5) (6) The Company has entered into an agreement with China Telecom pursuant to which expenses associated with common corporate services and international telecommunications facilities will be allocated between the Group and China Telecom based on revenues or volume of traffic as appropriate. The Company has entered into an agreement with China Telecom for interconnection of domestic long distance telephone calls. Pursuant to the interconnection agreement, the telephony operator terminating a telephone call made to its local network shall be entitled to receive a fee prescribed by the Ministry of Information Industry from the operator from which the telephone call is originated. The Company has entered into an optic fibre leasing agreement with China Telecom pursuant to which the Company will lease the inter-provincial transmission optic fibres in Shanghai Municipality, Guangdong Province, Jiangsu Province and Zhejiang Province from China Telecom. The lease payment will be based on the depreciation charge of the optic fibres. The Group has entered into agreements with China Telecom Group pursuant to which China Telecom Group will provide the Group with construction, design, equipment installation, testing and engineering project management services. the Group has entered into information technology service agreements with China Telecom Group pursuant to which China Telecom Group will provide the Group with certain information technology services including office automation and software modification. The amounts to be charged for these services will be determined by reference to market rates as reflected in prices obtained through a tender. In addition, The Group has entered into property leasing agreements with China Telecom Group pursuant to which the Group will lease certain business premises and storage facilities from China Telecom Group. The rental charges will be based on market rates, with reference to amounts stipulated by local price bureaus. The Group has entered into agreements with China Telecom Group pursuant to which China Telecom Group will provide the Group with the procurement of equipment and materials. The amount to be charged for this service will be based on a percentage not exceeding 1.8% of the contract value of the equipment and materials purchased. 107 NOTES TO THE FINANCIAL STATEMENTS for the year ended 31 December 2002 32. RELATED PARTY TRANSACTIONS (Continued) (7) The Group has entered into community services agreements for cultural, educational, hygiene and other community services with China Telecom Group. In addition, the Group has entered into ancillary services agreements with China Telecom Group. The ancillary services to be provided by China Telecom Group will include repairs and maintenance of telecommunications equipment and facilities and certain customer services. Pursuant to these agreements, China Telecom Group will charge the Group for these services in accordance with the following terms: . . . . government prescribed price; where there is no government prescribed price but where there is a government guided price, the government guided price will apply; where there is neither a government prescribed price nor a government guided price, the market price will apply; where none of the above is available, the price is to be agreed between the relevant parties, which shall be based on the cost incurred in providing the services plus a reasonable profit margin. Pursuant to the Restructuring, China Telecom has agreed to hold and maintain, for the Group’s benefit, all licenses received from the Ministry of Information Industry in connection with the Predecessor Operations transferred to the Group. The licenses maintained by China Telecom were granted by the Ministry of Information Industry at zero or nominal cost. To the extent that China Telecom incurs a cost to maintain or obtain licenses in the future, the Company will reimburse China Telecom for the expenses it incurs. 33. EMPLOYEE BENEFITS PLAN As stipulated by the regulations of the PRC, the Group participates in various defined contribution retirement plans organised by municipal and provincial governments for its employees. The Group is required to make contributions to the retirement plans at rates ranging from 18% to 20% of the salaries, bonuses and certain allowances of the employees. A member of the plan is entitled to a pension equal to a fixed proportion of the salary prevailing at the member’s retirement date. The Group has no other material obligation for the payment of pension benefits associated with these plans beyond the annual contributions described above. The Group’s contributions for the year ended 31 December 2002 were RMB999 million (2001 : RMB849 million). 108 34. FAIR VALUES OF FINANCIAL INSTRUMENTS NOTES TO THE FINANCIAL STATEMENTS for the year ended 31 December 2002 Financial assets of the Group include cash and cash equivalents, time deposits, investments, accounts receivable, amounts due from China Telecom Group, advances and other receivables. Financial liabilities of the Group include debts, accounts payable, amounts due to China Telecom Group, accrued expenses and other payables. The Group does not hold nor issue financial instruments for trading purposes. The following disclosure of the estimated fair value of financial instruments is made in accordance with the requirements of IAS 32 and IAS 39. Fair value estimates, methods and assumptions, set forth below for the Group’s financial instruments, are made to comply with the requirements of IAS 32 and IAS 39, and should be read in conjunction with the Group’s consolidated financial statements and related notes. The estimated fair value amounts have been determined by the Group using market information and valuation methodologies considered appropriate. However, considerable judgement is required to interpret market data to develop the estimates of fair values. Accordingly, the estimates presented herein are not necessarily indicative of the amounts the Group could realise in a current market exchange. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts. The following summarises the major methods and assumptions used in estimating the fair values of the Group’s financial instruments. Long-term debt: The fair values of long-term indebtedness are estimated by discounting future cash flows using current market interest rates offered to the Group for debt with substantially the same characteristics and maturities. As at 31 December 2002 and 2001, the carrying amounts and fair values of the Group’s long-term debt were as follows: 2002 2001 Carrying amount RMB millions Fair value RMB millions Carrying amount RMB millions Fair value RMB millions Long-term debt 7,072 7,368 10,722 11,160 The Group’s long term investments are unlisted equity interests and there are no quoted market prices for such interests in the PRC. Accordingly, a reasonable estimate of their fair values could not be made without incurring excessive costs. The fair values of all other financial instruments approximate their carrying amounts due to the short-term maturity of these instruments. 35. ULTIMATE HOLDING COMPANY The directors consider the ultimate holding company of the Group at 31 December 2002 to be China Telecommunications Corporation, a state-owned enterprise established in the PRC. 109 SUPPLEMENTARY INFORMATION FOR ADS HOLDERS The Group’s accounting policies conform with IFRS which differ in certain significant respects from US GAAP. Differences which have a significant effect on net profit and shareholders’ equity are set out below. (a) Revaluation of property, plant and equipment In connection with the Restructuring, the property, plant and equipment of the Group were revalued as at 31 December 2001 (see Note 3 on the financial statements). The net revaluation deficit has been reflected in the consolidated financial statements as at 31 December 2001. Such revaluation resulted in an increase directly to shareholders’ equity of RMB4,154 million with respect to the increase in carrying amount of certain property, plant and equipment above their historical cost bases, and a charge to income of RMB11,930 million with respect to the reduction in carrying amount of certain property, plant and equipment below their historical cost bases. Under US GAAP, property, plant and equipment are stated at their historical cost less accumulated depreciation unless an impairment loss has been recorded. An impairment loss on property, plant and equipment is recorded under US GAAP if the carrying amount of such asset exceeds its future undiscounted cash flows resulting from the use of the asset and its eventual disposition. The future undiscounted cash flows of the Group’s property, plant and equipment, whose carrying amount was reduced in connection with the Restructuring, exceed the historical cost carrying amount of such property, plant and equipment and, therefore, impairment of such assets is not appropriate under US GAAP. Accordingly, the revaluation reserve recorded directly to shareholders’ equity and the charge to income recorded under IFRS as a result of the Restructuring are reversed for US GAAP purposes. However, as a result of the tax deductibility of the net revaluation deficit, a deferred tax liability related to the net revaluation deficit is created under US GAAP with a corresponding decrease in shareholders’ equity. (b) Disposal of revalued property, plant and equipment Under IFRS, on disposal of a revalued asset, the related revaluation surplus is transferred from the revaluation reserve to retained earnings. Under US GAAP, the gain and loss on disposal of an asset is determined with reference to the asset’s historical carrying amount and included in current earnings. (c) Related party transactions Under IFRS, transactions with state-controlled enterprises other than China Telecom and its affiliates are not required to be disclosed as related party transactions. Furthermore, government departments and agencies are deemed not to be related parties to the extent that such transactions are in the normal course of business. Therefore, related party transactions as disclosed in Note 32 on the financial statements only refer to transactions with China Telecom Group. CHINA TELECOM ANNUAL REPORT 2002 110 SUPPLEMENTARY INFORMATION FOR ADS HOLDERS (CONTINUED) Under US GAAP, there are no similar exemptions. The Group’s principal transactions with state- controlled telecommunications operators in the PRC were as follows: Interconnection revenues Interconnection charges Leased line revenues 2002 RMB millions 2001 RMB millions 2,409 448 2,727 3,814 1,290 2,839 The amounts set out above represent the historical costs incurred by the related parties in carrying out such transactions. (d) Recently issued accounting standards SFAS No. 143 In June 2001, the FASB issued SFAS No. 143, “Accounting for Asset Retirement Obligations”. SFAS No. 143 requires the Group to record the fair value of an asset retirement obligation as a liability in the period in which it incurs a legal obligation associated with the retirement of tangible long-lived assets that result from the acquisition, construction, development and/or normal use of the assets. The Group is also required to record a corresponding asset which is depreciated over the life of the asset. Subsequent to the initial measurement of the asset retirement obligation, the obligation will be adjusted at the end of each period to reflect the passage of time and changes in the estimated future cash flows underlying the obligation. The Group is required to adopt SFAS No. 143 on 1 January 2003. The Group does not expect the adoption of SFAS No. 143 will have a material impact on its consolidated financial statements. SFAS No. 145 In April 2002, the FASB issued SFAS No. 145, which rescinds SFAS No. 4, “Reporting Gains and Losses from Extinguishment of Debt”, and an amendment of that Statement, SFAS No. 64, “Extinguishments of Debt Made to Satisfy Sinking-Fund Requirements”. SFAS No. 145 also rescinds SFAS No. 44, “Accounting for Intangible Assets of Motor Carriers”. SFAS No. 145 amends SFAS No. 13, “Accounting for Leases”, to eliminate an inconsistency between the required accounting for sale-leaseback transactions and the required accounting for certain lease modifications that have economic effects that are similar to sale-leaseback transactions. SFAS No. 145 also amends other existing authoritative pronouncements to make various technical corrections, clarify meanings, or describe their applicability under changed conditions. CHINA TELECOM ANNUAL REPORT 2002 111 SUPPLEMENTARY INFORMATION FOR ADS HOLDERS (CONTINUED) The provisions of SFAS No. 145 related to the rescission of SFAS No. 4 shall be applied in fiscal years beginning after 15 May 2002. The provisions in paragraphs 8 and 9(c) of SFAS No. 145 related to Statement 13 shall be effective for transactions occurring after 15 May 2002. All other provisions of SFAS No. 145 shall be effective for financial statements issued on or after 15 May 2002. The Group does not expect the adoption of SFAS No. 145 will have a material impact on its consolidated financial statements. SFAS No. 146 In July 2002, the FASB issued SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities” which applies to costs associated with an exit activity (including restructuring) or with a disposal of long-lived assets. SFAS No. 146 requires an entity to record a liability for cost associated with an exit or disposal activity when that liability is incurred and can be measured at fair value. Commitment to an exit plan or a plan of disposal expresses only management’s intended future actions and does not meet the requirement for recognising a liability and the related expense. An entity is required to disclose information about its exit and disposal activities, the related costs, and changes in those costs in the notes to the interim and annual financial statements that include the period in which an exit or disposal activity is initiated and in any subsequent period until the activity is completed. The Group is required to adopt SFAS No. 146 on 1 January 2003. The provisions of SFAS No. 146 are required to be applied prospectively after the adoption date to newly exit or disposal activities. Therefore, management cannot determine the potential effect that the adoption of SFAS No. 146 will have on the Group’s consolidated financial statements. FIN No. 45 Including Indirect Guarantees of In November 2002, the FASB issued Interpretation No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Indebtedness to Others, an interpretation of FASB Statements No. 5, 57 and 107 and a rescission of FASB Interpretation No. 34". This Interpretation elaborates on the disclosures to be made by a guarantor in its interim and annual financial statements about its obligations under guarantees issued. The Interpretation also clarifies that a guarantor is required to recognise, at inception of a guarantee, a liability for the fair value of the obligation undertaken. The initial recognition and measurement provisions of the Interpretation are applicable to guarantees issued or modified after 31 December 2002. The disclosure requirements are effective for financial statements of interim and annual periods ending after 31 December 2002. The Group does not expect the application of this Interpretation will have a material effect on its consolidated financial statements. FIN No. 46 In January 2003, the FASB issued Interpretation No. 46, “Consolidation of Variable Interest Entities, an interpretation of ARB No. 51”. This Interpretation addresses the consolidation by business enterprises of variable interest entities as defined in the Interpretation. The Interpretation applies immediately to variable interests in variable interest entities created after 31 January 2003, and to variable interests CHINA TELECOM ANNUAL REPORT 2002 112 SUPPLEMENTARY INFORMATION FOR ADS HOLDERS (CONTINUED) in variable interest entities obtained after 31 January 2003. The Interpretation requires certain disclosures in financial statements issued after 31 January 2003 if it is reasonably possible that the Group will consolidate or disclose information about variable interest entities when the Interpretation becomes effective. The Group does not expect the application of this Interpretation will have a material impact on its consolidated financial statements. Reconciliation of net profit and shareholders’ equity under IFRS to US GAAP The effect on net profit of significant differences between IFRS and US GAAP for the year ended 31 December 2002 is as follows: (Note) 2002 US$ millions 2002 RMB millions 2001 RMB millions 2,037 16,864 6,883 Net profit under IFRS US GAAP adjustments: Reversal of deficit on revaluation of property, plant and equipment, net of minority interests — — 11,838 Depreciation on revalued property, plant and equipment Disposal of revalued property, plant and equipment Deferred tax effect of US GAAP adjustments (186) (1,542) — (7) 64 (55) 527 — (3,936) Net profit under US GAAP 1,908 15,794 14,785 Basic earnings per share under US GAAP Basic earnings per ADS* under US GAAP 0.03 2.76 0.23 0.22 22.81 21.64 * Basic earnings per ADS is calculated on the basis that one ADS is equivalent to 100 shares. CHINA TELECOM ANNUAL REPORT 2002 113 SUPPLEMENTARY INFORMATION FOR ADS HOLDERS (CONTINUED) The effect on shareholders’ equity of significant differences between IFRS and US GAAP as at 31 December 2002 is as follows: Shareholders’ equity under IFRS US GAAP adjustments: Revaluation of property, plant and equipment, net of minority interests Deferred tax effect of US GAAP adjustment (Note) 2002 US$ millions 2002 RMB millions 2001 RMB millions 15,098 125,008 97,485 735 (246) 6,087 (2,039) 7,684 (2,566) Shareholders’ equity under US GAAP 15,587 129,056 102,603 Note: Solely for the convenience of the reader, the amounts for 2002 have been translated into United States dollars at the noon buying rate in New York City on 31 December 2002 for cable transfers in RMB as certified for custom purposes by the Federal Reserve Bank of New York of US$1.00=RMB8.2800. No representation is made that the RMB amounts could have been, or could be, converted into United States dollars at that rate or at any other certain rate on 31 December 2002, or at any other date. CHINA TELECOM ANNUAL REPORT 2002 114 FINANCIAL SUMMARY (Amounts in millions, except per share data) 2002 RMB Year ended 31 December 2000 RMB 2001 RMB 6,018 995 12,460 22,392 14,365 3,285 3,775 1,789 4,363 3,095 2,959 6,290 780 10,186 21,004 14,676 3,392 2,150 1,477 3,814 2,862 1,915 6,322 583 7,763 20,503 17,190 5,177 1,144 1,750 4,869 4,268 1,452 1999 RMB 5,923 442 6,829 18,371 15,220 6,043 435 1,429 4,779 4,549 1,271 Results Upfront connection fees Upfront installation fees Monthly fees Local usage fees DLD ILD Internet Managed data Interconnections Leased line Others Operating revenues 75,496 68,546 71,021 65,291 Depreciation and amortisation Network operations and support Selling, general and administratrive Other operating expenses (20,882) (20,131) (10,468) (2,637) (19,451) (20,269) (9,401) (1,327) (17,386) (19,004) (9,743) (1,264) (14,903) (15,584) (7,553) (889) Operating expenses (54,118) (50,448) (47,397) (38,929) Operating profit Deficit on revaluation of property, plant and equipment Net finance (costs)/income Investment income Share of profit from associates Profit before taxation Taxation Profit before minority interests Minority interests 21,378 18,098 23,624 26,362 — (632) 4 35 20,785 (3,855) 16,930 (66) (11,930) 293 310 22 6,793 69 6,862 21 — 298 177 45 24,144 (4,857) 19,287 (68) — (516) 95 20 25,961 (5,459) 20,502 (93) Profit attributable to shareholders 16,864 6,883 19,219 20,409 Basic earnings per share 0.24 0.10 0.28 0.30 115 FINANCIAL SUMMARY (Amounts in millions) Financial condition Property, plant and equipment, net Construction in progress Other non-current assets Cash and bank deposits Other current assets 2002 RMB As at 31 December 2001 RMB 2000 RMB 149,165 20,319 14,866 17,739 8,763 138,623 23,274 13,309 4,355 9,773 127,528 28,656 14,516 14,200 12,501 1999 RMB 116,461 26,313 11,158 15,640 12,795 Total assets 210,852 189,334 197,401 182,367 Current liabilities Non-current liabilities 57,627 27,083 57,444 33,465 43,799 51,033 36,443 54,508 Total liabilities 84,710 90,909 94,832 90,951 Minority interests 1,134 940 950 866 Shareholders’ equity 125,008 97,485 101,619 90,550 Total liabilities and shareholders’ equity 210,852 189,334 197,401 182,367 Note: The above summary present the results of the Company and its subsidiaries as if the Group had been in existence throughout the years presented and as if the Predecessor Operations were transferred to the Company from China Telecommunications Corporation as at 1 January 1999. 116 

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