Form 20-F
Table of Contents

 

 

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 20-F

 

 

 

REGISTRATION STATEMENT PURSUANT TO SECTION 12(b) OR 12(g) OF THE SECURITIES EXCHANGE ACT OF 1934

OR

 

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2017

OR

 

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

OR

 

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

Date of event requiring this shell company report                     

For the transition period from                      to                     

Commission file number 1-15028

 

 

CHINA UNICOM (HONG KONG) LIMITED

(Exact Name of Registrant as Specified in Its Charter)

 

 

 

N/A

(Translation of Registrant’s Name Into English)

 

Hong Kong

(Jurisdiction of Incorporation or Organization)

75th Floor, The Center

99 Queen’s Road Central

Hong Kong

(Address of Principal Executive Offices)

Yung Shun Loy Jacky

Telephone: +852 2121 3220

Facsimile: +852 2121 3232

75th Floor, The Center

99 Queen’s Road Central

Hong Kong

(Name, Telephone, E-mail and/or Facsimile Number and Address of Company Contact person)

Securities registered or to be registered pursuant to Section 12(b) of the Act:

 

Title of Each Class

 

Name of Each Exchange On Which Registered

Ordinary shares   The New York Stock Exchange, Inc.*

 

* Not for trading, but only in connection with the listing on The New York Stock Exchange, Inc. of American depositary shares, or ADSs, each representing 10 ordinary shares.

Securities registered or to be registered pursuant to Section 12(g) of the Act:

None

(Title of class)

Securities for which there is a reporting obligation pursuant to Section 15(d) of the Act:

None

(Title of Class)

 

 

Indicate the number of outstanding shares of each of the issuer’s classes of capital or common stock as of the close of the period covered by the annual report.

As of December 31, 2017, 30,598,124,345 ordinary shares were issued and outstanding.

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes  ☒    No  ☐

If this report is an annual or transition report, indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.    Yes  ☐    No  ☒

Note – Checking the box above will not relieve any registrant required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 from their obligations under those Sections.

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  ☒    No  ☐

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 (§232.405 of this chapter) of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ☒    No  ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” and “emerging growth company” in Rule 12b-2 of the Exchange Act

Large accelerated filer  ☒             Accelerated filer  ☐             Non-accelerated filer   ☐        Emerging growth company   ☐

If an emerging growth company that prepares its financial statements in accordance with U.S. GAAP, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards† provided pursuant to Section 13(a) of the Exchange Act.  ☐

 

The term “new or revised financial accounting standard” refers to any update issued by the Financial Accounting Standards Board to its Accounting Standards Codification after April 5, 2012.

Indicate by check mark which basis of accounting the registrant has used to prepare the financial statements included in this filing.

 

U.S. GAAP  ☐

    

International Financial Reporting Standards as issued

by the International Accounting Standards Board  ☒

   Other  ☐

If “Other” has been checked in response to the previous question, indicate by check mark which financial statement item the registrant has elected to follow.

Item 17  ☐    Item 18  ☐

If this is an annual report, indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ☐    No  ☒

(APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY PROCEEDINGS DURING THE PAST FIVE YEARS)

Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Sections 12, 13 or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court.    Yes  ☐    No  ☐

 

 

 


Table of Contents

TABLE OF CONTENTS

 

     Page  

NOTE REGARDING FORWARD-LOOKING STATEMENTS

     2  

CERTAIN DEFINITIONS AND INTERPRETATIONS

     3  

PART I

     1  

Item 1. Identity of Directors, Senior Management and Advisers

     1  

Item 2. Offer Statistics and Expected Timetable

     1  

Item 3. Key Information

     1  

Item 4. Information on the Company

     20  

Item 4A. Unresolved Staff Comments

     46  

Item 5. Operating and Financial Review and Prospects

     46  

Item 6. Directors, Senior Management and Employees

     66  

Item 7. Major Shareholders and Related Party Transactions

     73  

Item 8. Financial Information

     81  

Item 9. The Offer and Listing

     82  

Item 10. Additional Information

     83  

Item 11. Quantitative and Qualitative Disclosures about Market Risks

     94  

Item 12. Description of Securities Other than Equity Securities

     97  

PART II

     99  

Item 13. Defaults, Dividend Arrearages and Delinquencies

     99  

Item  14. Material Modifications to the Rights of Security Holders and Use of Proceeds

     99  

Item 15. Controls and Procedures

     99  

Item 16A. Audit Committee Financial Expert

     100  

Item 16B. Code of Ethics

     100  

Item 16C. Principal Accountant Fees and Services

     100  

Item 16D. Exemptions from the Listing Standards for Audit Committees

     101  

Item  16E. Purchases of Equity Securities by the Issuer and Affiliated Purchasers

     101  

Item 16F. Change in Registrant’s Certifying Accountant

     101  

Item 16G. Corporate Governance

     101  

Item 16H. Mine Safety Disclosure

     102  

PART III

     103  

Item 17. Financial Statements

     103  

Item 18. Financial Statements

     103  

Item 19. Exhibits

     103  

 

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Note Regarding Forward-Looking Statements

This annual report contains certain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Such forward-looking statements may include, without limitation, statements relating to (i) our plans and strategies and our ability to successfully execute these plans and strategies, including those in connection with our mergers and acquisitions and capital expenditures; (ii) our plans for network expansion, including those in connection with the build-out of our mobile services and network infrastructure; (iii) our competitive position, including our ability to upgrade and expand existing networks and increase network efficiency, to improve existing services and offer new services, to develop new technological applications and to leverage our position as an integrated telecommunications operator and expand into new services and markets; (iv) our future business condition, including our future financial results, cash flows, financing plans and dividends; (v) the future growth of market demand of, and opportunities for, our new and existing products and services; and (vi) future regulatory and other developments in the PRC telecommunications industry.

The words “anticipate”, “believe”, “could”, “estimate”, “intend”, “may”, “seek”, “will” and similar expressions, as they relate to us, are intended to identify certain of these forward-looking statements. We do not intend to update any of these forward-looking statements and are under no obligation to do so.

The forward-looking statements contained in this annual report are, by their nature, subject to significant risks and uncertainties. In addition, these forward-looking statements reflect our current views with respect to future events and are not a guarantee of our future performance. Actual results may differ materially from those expressed or implied in the forward-looking statements as a result of a number of factors, including, without limitation:

 

    our ability to effectively sustain our growth and to achieve or enhance profitability;

 

    changes in the regulatory regime and policies for the PRC telecommunications industry, including without limitation, changes in the regulatory and tariff policies of the State Council of the PRC, or the State Council, the Ministry of Industry and Information Technology, or the MIIT, the State-owned Assets Supervision and Administration Commission, or the SASAC, and other relevant government authorities of the PRC;

 

    changes in the PRC telecommunications industry resulting from the issuance of licenses for telecommunications services by the central government of the PRC;

 

    changes in telecommunications and related technologies and applications based on such technologies, including testing and monetization of future generations of mobile technologies;

 

    the level of demand for telecommunications services, in particular, the fourth generation mobile telecommunications, or 4G, services;

 

    competitive forces from more liberalized markets and our ability to retain market share in the face of competition from existing telecommunications companies and potential new market entrants;

 

    effects of restructuring and integration (if any) in the PRC telecommunications industry and any cooperation among the PRC telecommunications operators;

 

    the availability, terms and deployment of capital and the impact of regulatory and competitive developments on capital outlays;

 

    changes in the assumptions upon which we have prepared our projected financial information and capital expenditure plans;

 

    costs and benefits from our investment in and arrangements with the China Tower Corporation Limited, or the Tower Company (formerly known as China Communications Facilities Services Corporation Limited);

 

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    results and effects of any investigation by the relevant PRC regulatory authorities overseeing State-owned enterprises and their directors, officers and employees; and

 

    changes in the political, economic, legal, tax and social conditions in China, including the PRC Government’s policies and initiatives with respect to foreign exchange policies, foreign investment activities and policies, entry by foreign companies into the Chinese telecommunications market and structural changes in the PRC telecommunications industry.

Please also see “D. Risk Factors” under Item 3.

Certain Definitions and Interpretations

As used in this annual report, references to “we”, “us”, “our”, the “Company”, “our company” and “Unicom” are to China Unicom (Hong Kong) Limited (formerly known as China Unicom Limited). Unless the context otherwise requires, these references include all of our subsidiaries. In respect of any time prior to our incorporation, references to “we”, “us”, “our” and “Unicom” are to the telecommunications businesses in which our predecessors were engaged and which were subsequently assumed by us. All references to “Unicom Group” are to China United Network Communications Group Company Limited (formerly known as China United Telecommunications Corporation), our indirect controlling shareholder. Unless the context otherwise requires, these references include all of Unicom Group’s subsidiaries, including us and our subsidiaries.

All references to “China Netcom” are to China Netcom Group Corporation (Hong Kong) Limited, which merged with us in October 2008, and, as the context may require, its subsidiaries. References to “Netcom Group” mean China Network Communications Group Corporation, which merged with, and was absorbed by, Unicom Group in January 2009 and, as the context may require, its subsidiaries, other than us and our subsidiaries.

As used in this annual report:

 

    references to “China” or “PRC” mean the People’s Republic of China, excluding, for purposes of this annual report, Hong Kong, Macau and Taiwan, and references to the “central government” or the “PRC Government” mean the central government of the PRC. Certain statistical information set forth in this annual report on Form 20-F relating to China is taken or derived from various publicly available government publications that have not been prepared or independently verified by us, and such statistical information may not be consistent with other statistical information from other sources within or outside China;

 

    references to “our fixed-line northern service region” mean the 10 municipalities, provinces and region where we operate fixed-line services in northern China, consisting of Beijing and Tianjin Municipalities, and Hebei, Henan, Shandong, Liaoning, Heilongjiang, Jilin, and Shanxi Provinces, and the Inner Mongolia Autonomous Region;

 

    references to “Hong Kong Stock Exchange” or “HKSE” mean The Stock Exchange of Hong Kong Limited, and references to “NYSE” or “New York Stock Exchange” mean The New York Stock Exchange, Inc.; and

 

    references to “Renminbi” or “RMB” are to the currency of the PRC, references to “U.S. dollars” or “US$” are to the currency of the United States of America, references to “HK dollars” or “HK$” are to the currency of the Hong Kong Special Administrative Region of the PRC and references to “Euro” are to the currency of the eurozone (19 of the 28 member states of the European Union).

 

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Table of Contents

PART I

 

Item 1. Identity of Directors, Senior Management and Advisers

Not Applicable.

 

Item 2. Offer Statistics and Expected Timetable

Not Applicable.

 

Item 3. Key Information

 

A. Selected Financial Data

The following tables present selected historical financial data of our company as of and for the years ended December 31, 2013, 2014, 2015, 2016 and 2017. Except for amounts presented in U.S. dollars, the selected historical consolidated income statement data (other than ADS data) for the years ended December 31, 2015, 2016 and 2017 and the consolidated statement of financial position data as of December 31, 2016 and 2017 set forth below should be read in conjunction with, and are qualified in their entirety by reference to, our audited consolidated financial statements, including the related notes, included elsewhere in this annual report on Form 20-F. The selected historical consolidated income statement data (other than ADS data) for the years ended December 31, 2013 and 2014 and the consolidated statement of financial position data as of December 31, 2013, 2014 and 2015 set forth below should be read in conjunction with and are qualified in their entirety by reference to our audited consolidated financial statements that are included in our previous annual reports on Form 20-F. Our consolidated financial statements as of and for the years ended December 31, 2013, 2014, 2015, 2016 and 2017 have been prepared and presented in accordance with International Financial Reporting Standards, or IFRS, as issued by the International Accounting Standards Board.

In October 2015, we, through our wholly own subsidiaries, China United Network Communications Corporation Limited, or CUCL, and Unicom New Horizon Telecommunications Company Limited, or Unicom New Horizon, completed the disposal of certain of our telecommunications towers and related assets to the Tower Company. See “A. History and Development of the Company — Establishment of the Tower Company and the Disposal of Telecommunications Towers” under Item 4. As we own 28.1% of the share capital of the Tower Company, we recognized at the completion 71.9% of the gains on such disposal, with the remaining amount of such gain amortized over the remaining useful life of the transferred assets.

As our business continues to evolve, we have been engaged in further integration of our mobile services, fixed-line services and other services, including offering more bundled service packages across mobile and fixed-line services. As such, in 2017, we began presenting the breakdown of service revenue on an integrated basis as revenue from voice usage and monthly fees, broadband and mobile data services, data and Internet application services, other value-added services, interconnection fees, leased lines and associated services and other services. The relevant presentation for our service revenue in 2013, 2014, 2015 and 2016 has therefore been reclassified to conform with current year’s presentation.

 

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     As of or for the year ended December 31,  
     2013     2014     2015     2016     2017     2017  
     RMB     RMB     RMB     RMB     RMB     US$(1)  
     (in millions, except for per share data)  

Consolidated Income Statement Data:

            

Revenue

            

Total service revenue(2)

     237,519       243,242       232,976       238,033       249,015       38,273  

Voice usage and monthly fees

     86,324       76,486       57,030       47,500       39,154       6,018  

Broadband and mobile data services

     81,913       95,679       105,634       118,209       137,133       21,077  

Data and Internet application services

     9,835       10,195       12,936       17,782       20,074       3,085  

Other value-added services

     29,111       31,314       27,411       24,187       22,793       3,503  

Interconnection fees

     17,781       16,376       15,514       14,748       14,233       2,188  

Leased lines and associated services

     10,482       11,078       11,484       11,618       12,519       1,924  

Other services

     2,073       2,114       2,967       3,989       3,109       478  

Sales of telecommunications products(2)

     57,519       41,439       44,073       36,164       25,814       3,967  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total revenue

     295,038       284,681       277,049       274,197       274,829       42,240  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total costs, expenses and others

     (281,324     (268,750     (263,014     (273,413     (272,236     (41,842
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income before income tax

     13,714       15,931       14,035       784       2,593       398  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income tax expenses

     (3,306     (3,876     (3,473     (154     (743     (114
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income

     10,408       12,055       10,562       630       1,850       284  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Earnings per share for income attributable to equity shareholders during the year

            

-Basic earnings per share(3)

     0.44       0.51       0.44       0.03       0.07       0.01  

-Diluted earnings per share(3)

     0.43       0.49       0.44       0.03       0.07       0.01  

-Basic earnings per ADS(4)

     4.40       5.05       4.41       0.26       0.74       0.11  

-Diluted earnings per ADS(4)

     4.31       4.95       4.41       0.26       0.74       0.11  

-Number of shares outstanding for basic earnings per share(3)

     23,658       23,852       23,947       23,947       24,567       24,567  

-Number of shares outstanding for diluted earnings per share(3)

     24,656       24,795       23,947       23,947       24,567       24,567  

-Number of ADS outstanding for basic earnings per ADS(4)

     2,366       2,385       2,395       2,395       2,457       2,457  

-Number of ADS outstanding for diluted earnings per ADS(4)

     2,466       2,480       2,395       2,395       2,457       2,457  

 

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     As of or for the year ended December 31,  
     2013      2014      2015      2016      2017      2017  
     RMB      RMB      RMB      RMB      RMB      US$(1)  
     (in millions, except for per share data)  

Consolidated Statement of Financial Position Data:

                 

Cash and cash equivalents and short-term bank deposits and restricted deposits

     21,560        25,364        21,957        25,387        38,362        5,896  

Property, plant and equipment

     431,625        438,321        454,631        451,115        416,596        64,030  

Interest in associates

     —          3,037        31,997        32,248        33,233        5,108  

Inventories and consumables

     5,536        4,378        3,946        2,431        2,239        344  

Accounts receivable

     14,842        14,671        14,957        13,622        13,964        2,146  

Prepayments and other current assets

     9,664        10,029        10,864        14,023        13,801        2,121  

Financial assets at fair value through other comprehensive income

     6,497        5,902        4,852        4,326        4,286        659  

Total assets

     529,171        545,072        610,346        614,154        571,983        87,913  

Accounts payable and accrued liabilities

     102,212        120,371        167,396        143,224        125,260        19,252  

Short-term bank loans

     94,422        91,503        83,852        76,994        22,500        3,458  

Commercial papers

     35,000        9,979        19,945        35,958        8,991        1,382  

Current portion of long-term bank loans

     48        45        84        161        410        63  

Current portion of other obligations

     2,672        2,698        2,797        3,141        2,987        459  

Current portion of corporate bonds

     —          —          —          2,000        —          —    

Current portion of promissory notes

     —          —          2,499        18,976        17,960        2,761  

Long-term bank loans

     481        420        1,748        4,495        3,473        534  

Promissory notes

     —          21,460        36,928        17,906        —          —    

Corporate bonds

     2,000        2,000        2,000        17,970        17,981        2,764  

Taxes payable

     2,634        1,466        3,163        732        1,121        172  

Total liabilities

     310,272        317,531        379,130        386,472        267,636        41,136  

Equity attributable to equity shareholders of the Company

     218,899        227,541        231,216        227,407        304,050        46,731  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Share capital(5)

     2,328        179,101        179,102        179,102        254,056        39,048  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Non-controlling interests

     —          —          —          275        297        46  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total equity

     218,899        227,541        231,216        227,682        304,347        46,777  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

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     As of or for the year ended December 31,  
     2013     2014     2015     2016     2017     2017  
     RMB     RMB     RMB     RMB     RMB     US$(1)  
     (in millions, except for per share data)  

Other Financial Data:

            

Net cash inflow from operating activities

     78,482       88,094       84,301       74,593       85,054       13,072  

Net cash outflow from investing activities

     (77,110     (75,319     (91,354     (95,749     (47,336     (7,275

Net cash inflow/(outflow) from financing activities

     1,926       (8,973     3,427       22,877       (28,414     (4,367

Net increase/(decrease) in cash and cash equivalents

     3,298       3,802       (3,626     1,721       9,304       1,430  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Dividend declared per share

     0.16       0.20       0.17       —         0.052       0.008  

 

(1)  The translation of RMB into U.S. dollars has been made at the rate of RMB6.5063 to US$1.00, representing the exchange rate as set forth in the H.10 statistical release of the Federal Reserve Board on December 29, 2017. The translations are solely for the convenience of the reader.
(2)  Revenue from sales of products associated with the ICT business, which was previously recorded as part of the fixed-line service revenue, has been reclassified as revenue from sales of telecommunications products to better reflect the commercial nature of the transactions. The related figures for the years ended December 31, 2013, 2014, 2015 and 2016 have been reclassified on the same basis.
(3)  See Note 14 to our consolidated financial statements included elsewhere in this annual report on Form 20-F on how basic and diluted earnings per share are calculated under IFRS.
(4)  Earnings per ADS is calculated by multiplying earnings per share by 10, which is the number of shares represented by each ADS.
(5)  The significant increase in our share capital in 2014 is primarily caused by the conversion of the amounts standing to the credit of the share premium account and the capital redemption reserve into our share capital due to the implementation of the no-par value regime under the Hong Kong Companies Ordinance (Cap. 622), which became effective on March 3, 2014. See Note 28 to our consolidated financial statements included elsewhere in our annual report on Form 20-F for the fiscal year ended December 31, 2015.

Exchange Rate Information

We publish our consolidated financial statements in Renminbi. Solely for the convenience of the reader, this annual report on Form 20-F contains translations of certain Renminbi and Hong Kong dollar amounts into U.S. dollars at specific rates. The exchange rate refers to the exchange rate as set forth in the H.10 statistical release of the Federal Reserve Board, or the daily exchange rate. Unless otherwise indicated, conversions of Renminbi or Hong Kong dollars into U.S. dollars in this annual report are based on the exchange rate on December 29, 2017 (RMB6.5063 to US$1.00 and HK$7.8128 to US$1.00). These translations should not be construed as representations that the Renminbi or Hong Kong dollar amounts could actually be converted into U.S. dollars at such rates or at all.

The daily exchange rates were RMB6.2725 = US$1.00 and HK$7.8499 = US$1.00, respectively, on April 13, 2018. The following table sets forth the high and low daily exchange rates between Renminbi and U.S. dollars and between Hong Kong dollars and U.S. dollars for each month during the previous six months:

Exchange Rate

 

     RMB per US$1.00      HK$ per US$1.00  
     High      Low      High      Low  

October 2017

     6.6533        6.5712        7.8106        7.7996  

November 2017

     6.6385        6.5967        7.8118        7.7955  

December 2017

     6.6210        6.5063        7.8228        7.8050  

January 2018

     6.5263        6.2841        7.8230        7.8161  

February 2018

     6.3741        6.2649        7.8267        7.8183  

March 2018

     6.3565        6.2685        7.8486        7.8275  

April 2018 (up to April 13, 2018)

     6.3045        6.2655        7.8499        7.8482  

 

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The following table sets forth the average exchange rates between Renminbi and U.S. dollars and between Hong Kong dollars and U.S. dollars for each of 2013, 2014, 2015, 2016 and 2017, calculated by averaging the daily exchange rate on the last day of each month during the relevant years.

Average Exchange Rate

 

     RMB per US$1.00      HK$ per US$1.00  

2013

     6.1412        7.7565  

2014

     6.1704        7.7554  

2015

     6.2869        7.7519  

2016

     6.6549        7.7618  

2017

     6.7350        7.7950  

 

B. Capitalization and Indebtedness

Not Applicable.

 

C. Reasons for the Offer and Use of Proceeds

Not Applicable.

 

D. Risk Factors

Risks Relating to Our Business

We face intense competition from other telecommunications operators, including China Mobile and China Telecom, and other companies that provide telecommunications or related services, which may materially and adversely affect our financial condition, results of operations and growth prospects.

The telecommunications industry in China has been evolving. We, along with China Mobile Communications Corporation, or China Mobile, and China Telecommunications Corporation, or China Telecom, are the three full-service telecommunications service providers that operate both fixed-line and mobile telecommunications networks in China. See “A. History and Development of the Company — Restructurings of the Telecommunications Industry” under Item 4. We face intense competition in virtually all aspects of our services, including mobile services, fixed-line voice services, broadband services and data communications services, from China Mobile and China Telecom and expect that this competition will further intensify. In particular, we compete with China Mobile and China Telecom in mobile services. For fixed-line services, we are a leading fixed-line operator in northern China, while China Telecom has a dominant market position in southern China and the MIIT granted to China Mobile the approval for China Mobile to authorize China Mobile Limited to operate the fixed-line telecommunications business in December 2013. In addition, the PRC Government from time to time introduces new policies that may intensify competition among the three telecommunications operators, such as the policies that allow mobile subscribers to switch to the networks of another telecommunications operator with their existing numbers in certain areas in China and the removal by the State Council of the MIIT’s approval requirement on the tariff standard of telecommunications services.

 

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We also face increasing competition from other service providers, such as cable television companies and Internet service providers, which compete against our broadband access, voice and messaging services and other services by offering telecommunications or related services. Such competition may further intensify due to recent policies of the PRC Government. In the recent years, the PRC Government has been implementing policies regarding the convergence of television broadcast, telecommunications and Internet access networks, and has introduced a series of policies that encourage privately-owned enterprises to enter the telecommunications industry. For example, in May 2016, the MIIT granted to China Radio and Television Network Co. Ltd. the approval to operate fixed-line broadband business, which has since then intensified and may continue to intensify the competition in this sector, and could have a material adverse effect on our business. In addition, in May 2013, the MIIT issued the pilot program for mobile telecommunications resale business that permit privately-owned enterprises to purchase mobile services from telecommunications operators and provide mobile services to end-customers after repackaging and rebranding. The initial trial period of the pilot program ended on December 31, 2015, but the telecommunications resale business will continue to be governed by the rules of the pilot program before the MIIT issues any further rules. Since December 2013, the MIIT has approved 42 companies to operate such business. See “Business Overview — Mobile Telecommunications Resale Business” under Item 4.

Intensive competition from China Mobile and China Telecom, as well as other companies that provide telecommunications or related services, could lead to slower subscriber growth, lower usage or traffic volume of our telecommunications services, continued price pressure, higher customer acquisition and retention costs and higher labor costs, which may materially and adversely affect our financial condition, results of operations and growth prospects.

Our net income and ARPU of mobile billing subscribers fluctuated in recent years and may decline in the future.

Our net income decreased by 94.0% from RMB10.56 billion in 2015 to RMB0.63 billion in 2016. The significant decrease in 2016 was primarily because (i) we had a one-off net gain in an amount of RMB9.25 billion (before tax) on disposal of telecommunications towers and related assets to the Tower Company in 2015, (ii) our network, operation and support expenses increased by RMB8.86 billion, or 20.9%, from 2015 to 2016, and (iii) our selling and marketing expenses increased by RMB2.68 billion, or 8.4%, from 2015 to 2016. The significant decrease was partially offset by the increase in our total service revenue by RMB5.06 billion, or 2.2%, from 2015 to 2016. See “Operating and Financial Review and Prospects — Operating Results — Year Ended December 31, 2016 Compared to Year Ended December 31, 2015” under Item 5. Some of these factors, such as increases in network, operation and support expenses and selling and marketing expenses may continue in the future, which could continue to have a material adverse effect on our net income in future years. In addition, our average revenue per subscriber per month, or ARPU, of mobile billing subscribers decreased by 3.1% from 2014 to 2015. Although our net income increased by 193.7% from RMB0.63 billion in 2016 to RMB1.85 billion in 2017, and our ARPU of mobile billing subscribers increased by 3.5% from RMB46.4 in 2016 to RMB48.0 in 2017, we cannot guarantee that we will be able to maintain or enhance our profit or increase ARPU of mobile billing subscribers in the future, and failure to do so could have a material adverse effect on our financial condition and results of operations.

The successful development of our mobile services is subject to market demand, consumer acceptance, technological challenges, competition on service fees, terminal subsidies and other marketing expenses, and other uncertainties, and expected benefits from investments in our mobile networks.

Our principal telecommunications services are mobile services, of which 4G services are a critical part. We commercially launched our 4G services in March 2014. We will continue to make investments in our 4G networks in the future, to expand our network coverage and improve our network quality. We may experience various difficulties in the development of our 4G services and other mobile services, including software, network, handset and other technical issues. We cannot assure you that we will be able to do so in a timely fashion or that we will not encounter other difficulties. Moreover, with respect to our mobile business, in particular our 4G services, we cannot assure you that:

 

    we will be able to gain access to sufficient resources at commercially reasonable terms and conditions for expansion of our mobile networks;

 

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    our mobile services will be more popular among potential subscribers than those of our competitors; and

 

    our mobile services will generate an acceptable or commercially viable rate of return.

Any failure or delay in expanding and upgrading our mobile networks, any increase in the associated costs (including the costs and expenses that may be incurred as a result of the changes of our marketing and sales policies) could hinder the recovery of our significant capital investment in mobile services, respectively, which could in turn have a material adverse effect on our financial condition, results of operations and growth prospects. For example, from 2016 to 2017, our network, operation and support expenses increased by RMB3.34 billion, or 6.5%, and, as a percentage of total revenue, increased from 18.7% to 19.8%, primarily due to the increase in operating lease and other service charges payable to the Tower Company with respect to the telecommunications towers and related assets we lease from the Tower Company. If such expenses continue to increase without corresponding increase in the relevant service revenue, our profitability would be adversely affected.

Our business relies on the lease arrangements with the Tower Company as to telecommunications towers and related assets, and we may not be able to achieve the expected benefits from the establishment of the Tower Company and such lease arrangements.

In July 2014, we, China Mobile and China Telecom, the three major telecommunications operators in China, jointly established the Tower Company, which engages primarily in the construction, maintenance and operation of telecommunications towers and other ancillary facilities in China, as well as the provision of maintenance services of base station equipment. In October 2015, the Tower Company acquired all telecommunications towers and related assets from us, China Mobile and China Telecom. In July 2016 and January 2018, we, through our wholly owned subsidiary, CUCL, and the Tower Company entered into a commercial pricing agreement, or the Pricing Agreement, and the supplementary agreement to such Pricing Agreement, or the Supplementary Agreement, respectively, in relation to the leasing of the telecommunications towers and related assets acquired and newly constructed by the Tower Company. See “A. History and Development of the Company — Establishment of the Tower Company and the Disposal of Telecommunications Towers” under Item 4.

The main purpose for us to participate in the establishment of the Tower Company and lease telecommunications towers and related assets from the Tower Company is to enhance our telecommunications network coverage and capacity, realize long-term investment returns through the equity investment in the Tower Company and reduce capital expenditure as we ceased to construct telecommunications towers on our own. However, there is no assurance that these benefits will be achieved in the near future, or at all. Our network, operation and support expenses increased by RMB8.86 billion, or 20.9%, from RMB42.31 billion in 2015 to RMB51.17 billion in 2016, and further increased by RMB3.34 billion, or 6.5%, to RMB54.51 billion in 2017. As a percentage of total revenue, such expenses increased from 15.3% in 2015 to 18.7% in 2016, and further increased to 19.8% in 2017. The increase was largely as a result of the increase in operating lease and other service charges payable to the Tower Company, which may be larger than the depreciation and amortization expenses and maintenance costs we would have incurred if we own and operate our own telecommunications towers and related assets. In addition, the Pricing Agreement, as supplemented and amended from time to time, provides for a pricing adjustment mechanism, which could result in a significant adjustment of the fees charged to us by the Tower Company in the future if there is any significant fluctuation in steel price, inflation and condition of the real estate market. Furthermore, since it is expected that, in principle, none of us, China Mobile or China Telecom will construct any telecommunications towers in the future, our business will rely on the lease arrangements with the Tower Company. Although we could renegotiate with the Tower Company on the lease fees based on the then current economic condition and benefit-cost analysis upon the expiry of the initial five-year lease term, we cannot assure you that such negotiation would result in the terms of the new lease commercially favorable to us. Moreover, as we do not control the Tower Company, the Tower Company may not act in the best interest of us. As such, we cannot assure you that our investment in the Tower Company, our sale of telecommunications towers and related assets and our lease of such assets from the Tower Company will achieve the anticipated results in the near future as expected, or at all.

 

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Further, during 2016 and 2017, the SEC issued comment letters relating to the Company’s previously filed annual reports on Form 20-F for the fiscal years ended December 31, 2015 and 2016. The comment letters inquired mainly about the background, execution process, and accounting treatment in relation to the Company’s disposal and lease of telecommunications towers and related assets with the Tower Company. The Company responded to these comment letters and was notified by the SEC in its letter dated October 20, 2017 that it has completed its review of such previously filed annual reports of the Company. The SEC did not in its October 2017 letter require us to make any amendment to those previously filed annual reports. However, there is no assurance that the SEC will not issue comment letters on our disclosure relating to these and future transactions with the Tower Company.

The industry trends of mobile service substitution and mobile service migration from older generations to new generations may continue to have a material adverse effect on our older generations mobile services and fixed-line voice services, which may adversely affect our financial condition, results of operations and growth prospects.

As the technology of mobile services evolves, the trend of mobile service migration from older generations to new generations would generally have an adverse effect on our older generations’ services, including a growth slowdown or a decrease in the number of subscribers and usage. In particular, our 2G services and 3G services, have been adversely affected by the trend of migration to 4G services, which resulted in a decrease in our subscribers and revenue from our non-4G mobile services in 2017. Although such trend of migration would increase our 4G service subscribers and revenue, we cannot guarantee that such increase can always fully offset the negative impact. Likewise, we, consistent with the industry trend, have experienced a decline in our fixed-line voice services for years, which is expected to continue due to the trend of mobile service substitution for fixed-line services.

Furthermore, our voice services have also been adversely affected by the trend of mobile service migration from voice services to non-voice services. In particular, primarily due to the increasing popularity of Over-the-Top services and products, such as instant messaging application, voice-over-Internet-protocol, or VoIP, services, and video-chat software, we have experienced the trend of our mobile subscribers substituting voice services for non-voice services, such as mobile data services, which, among other factors, resulted in a decline in our revenue from voice services. Although increasing popularity of Over-the-Top services and products, among other factors, has contributed to the increase in the usage of mobile data and, thus, has a positive effect on our revenue from non-voice services, it may not be able to fully offset the negative impact on our voice services.

We have been taking various measures to attract our older generations mobile service subscribers to migrate to our 4G networks and those of our voice services to migrate to our non-voice services. Such measures include improvement of our products and services, acceleration of the construction and enhancement of coverage of our 4G networks, offering bundled services that integrate fixed-line and mobile services as well as strengthening our data traffic operation capability to encourage data usage. If these efforts are not successful, our financial condition, results of operations and growth prospects could be adversely affected.

Competition from foreign-invested operators may further increase the competition for employees, exacerbate price competition and increase our operating expenses, thereby adversely affecting our financial condition, results of operations and growth prospects.

As a result of China’s accession to the World Trade Organization, or WTO, in December 2001 and the adoption of the Regulations on the Administration of Foreign-Invested Telecommunications Enterprises in January 2002, which implement China’s commitments to the WTO, the PRC Government has agreed to gradually liberalize the various segments and regions of the telecommunications market in China to foreign investors. Currently, foreign investors are permitted to own up to 49% of joint ventures that offer basic telecommunications services without any geographic restrictions in China and up to 50% of joint ventures that offer value-added telecommunications services without any geographic restrictions in China. More foreign-invested operators may enter China’s telecommunications market as a result of this liberalization. They may have greater financial, managerial and technical resources and more expertise in network management and sales and marketing than we do.

Increased competition from foreign-invested operators into the PRC telecommunications market may further increase the competition for skilled and experienced employees, exacerbate price competition and increase our customer acquisition costs and other operating expenses, and thereby adversely affect our financial condition, results of operations and growth prospects.

 

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Failure to respond to technological and industry developments in a timely and effective manner or failure to continually optimize, expand and upgrade our networks and infrastructure could materially and adversely affect our competitive position and hinder our growth.

The telecommunications industry in China and elsewhere in the world has been experiencing rapid and significant changes in the diversity and sophistication of the technologies and services offered. Such changes may render our existing services or technologies inadequate or obsolete. We cannot assure you that we will be able to respond to technological and industry developments in a timely and cost-effective manner, or at all. Our inability to respond successfully to technological or industry developments may adversely affect our financial condition, results of operations and growth prospects. Furthermore, if the new technologies adopted by us do not perform as expected, or if we are unable to effectively deliver new services based on these technologies in a commercially viable manner, our revenue growth may decline and our competitive position may be adversely affected.

For example, the fifth generation mobile telecommunications, or 5G, technology and services are key components of our business strategy to compete in the mobile services market of China. In connection with 5G technology and services, we have been engaged in formulating technical standards, testing technology and network as well as planning towards commercialization. However, the successful development of 5G technology and services may be adversely affected by factors that are beyond our control, such as the timing of obtaining 5G license and the frequency bands allocated to 5G services. In addition, there is no assurance that we will be able to roll out 5G services in a timely and cost-effective manner, or at all. Failure to respond to these uncertainties could disadvantage us from competing successfully in the mobile services market of China, and materially and adversely affect our revenue growth.

In addition, the growth of our business depends on whether we are able to continue to optimize the capacity, expand the coverage and improve the quality of, and upgrade our existing networks and infrastructure in a timely and effective manner. Our ability to expand and upgrade our networks and infrastructure is subject to a number of uncertainties, including our ability to achieve the following on a timely basis and on acceptable terms:

 

    manage technology migration in an effective manner, including effectively promoting the evolution of our network towards software-defined networking and network function virtualization, or SDN and NFV;

 

    obtain adequate financing;

 

    obtain relevant government licenses, permits and approvals;

 

    obtain adequate network equipment and software;

 

    retain experienced management and technical personnel;

 

    obtain sufficient spectrum frequencies, network numbers and other telecommunications resources controlled by the PRC Government;

 

    gain access to the sites for network construction or upgrade; and

 

    enter into interconnection and other arrangements with other operators.

If we are not able to timely and effectively overcome the uncertainties and difficulties we may encounter in expanding and upgrading our networks and infrastructure, our competitive position, financial condition, results of operations and growth prospects may be materially and adversely affected.

 

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Because we rely on arrangements with other telecommunications operators, changes to the terms or availability of these arrangements may result in disruptions to our services and operations and may result in customer dissatisfaction and materially and adversely affect our financial condition, results of operations and growth prospects.

Our ability to provide telecommunications services depends upon arrangements with other telecommunications operators. In particular, interconnection is necessary to complete all calls between our subscribers and subscribers of other telecommunications operators. We, either through ourselves or through Unicom Group, have established interconnection and transmission line leasing arrangements with other telecommunications operators, including our parent company, as required to conduct our current business. Any disruption to our interconnection with the networks of those operators or other international telecommunications operators with which we interconnect may affect our operations, service quality and customer satisfaction, thus adversely affecting our business. Furthermore, we are generally not entitled to collect indirect or consequential damages resulting from disruptions in the networks with which we are interconnected. Any disruption in existing interconnection arrangements and leased line arrangements or any significant change of their terms, as a result of natural events or accidents or for regulatory, technical, competitive or other reasons, may lead to temporary service interruptions and increased costs that can seriously jeopardize our operations and adversely affect our financial condition, results of operations and growth prospects. Difficulties in executing alternative arrangements with other operators on a timely basis and on acceptable terms, including the inability to promptly establish additional interconnection links or increase interconnection bandwidths as required, could also materially and adversely affect our financial condition, results of operations and growth prospects.

Interruptions to our networks and operating systems or to those with which we interconnect, including those caused by natural disaster and service maintenance and upgrades, may disrupt our services and operations and may result in customer dissatisfaction and materially and adversely affect our financial condition, results of operations and growth prospects.

Our network infrastructure and the networks with which we interconnect are vulnerable to potential damages or interruptions from floods, wind, storms, fires, power loss, severed cables, acts of terrorism and similar events. The occurrence of a natural disaster or other unanticipated problems at our facilities or any other failure of our networks or systems, or the networks to which we are interconnected, may result in consequential interruptions in services across our telecommunications infrastructure. In 2017, certain areas of China suffered from natural disasters including typhoons, floods, mountain torrents, mudslides and landslides, and these natural disasters caused extensive damage to our network equipment, including our base stations and optical fiber networks, in the affected areas. As a result, we experienced service stoppage and other disruptions in our operations in those areas and also sustained economic losses. Any future natural disasters may, among other things, significantly disrupt our ability to adequately staff our business, and may generally disrupt our services and operations. Moreover, our networks and systems and the networks with which we interconnect also require regular maintenance and upgrades. Such maintenance and upgrades may cause service disruptions. Network or system failures, as well as abrupt high traffic volumes, may also affect the quality of our services and cause temporary service interruptions. Any such future occurrence may result in customer dissatisfaction and materially and adversely affect our financial condition, results of operations and growth prospects.

If we are unable to fund our capital expenditure and debt service requirements, our financial condition, results of operations and growth prospects will be materially and adversely affected.

We transferred our then-owned telecommunications towers and related assets to the Tower Company in October 2015, and since then have ceased to construct, maintain or operate telecommunications towers and we expect that our capital expenditure will decrease significantly as a result. However, we continue to have capital expenditure requirements for our mobile networks, broadband and data networks, telecommunications infrastructure and transmission networks, and debt service requirements necessary to implement our business strategies. We incurred capital expenditure of RMB42.13 billion in 2017. To the extent that these capital expenditures exceed our cash resources, we will be required to seek additional debt or equity financing. We cannot assure you that we will be able to obtain future financing on a timely basis and/or on acceptable terms. Even if we obtain such financing, our financing cost may increase significantly as a result of additional financing or higher interest rate. See “Liquidity and Capital Resources” under Item 5. Our failure to do so may adversely affect our financial condition, results of operations and growth prospects. Our ability to obtain acceptable financing at any time may depend on a number of factors, including, among others:

 

    our financial condition and results of operations;

 

    our creditworthiness and relationship with lenders;

 

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    changes in credit policies, other government or banking policies that may affect credit markets in China;

 

    conditions of the economy and the telecommunications industry in China;

 

    conditions in relevant financial markets in China and elsewhere in the world; and

 

    our ability to obtain any required government approvals for our financings.

Adjustments in our charges for telecommunications services and products may have a material adverse effect on our financial condition and results of operations.

From time to time, we adjust our charges for telecommunications services and products by taking into account various factors, including the market conditions and policies of the PRC Government, and such adjustments may have a material adverse effect on our revenue and profitability. For example, in May 2015, the PRC government introduced a policy of increasing network speed and reducing tariffs. Since May 2015, in order to expand our customer base as well as to comply with the relevant policies, we have, in addition to continuing increasing our network speed, offered discounts to our tariff plans. In October 2015, we launched a mobile data carry-over programs, which allow subscribers of our data plans with pre-determined monthly data limit to carry over their unused data to the following month with no extra charge. Furthermore, in light of the governmental policy of achieving coordinated development of Beijing Municipality, Tianjin Municipality and Hebei Province issued in April 2015 by the PRC Government, we cancelled the long-distance and roaming tariffs for voice services within the tariff zones of Beijing Municipality, Tianjin Municipality and Hebei Province so that our customers are only charged with local usage tariff for our voice services provided within the tariff zones. In March 2017, we announced that we plan to substantially reduce Internet private line access tariff for small and medium enterprises customers and international long-distance call tariff. Additionally, in response to the PRC Government’s “speed upgrade and tariff reduction” policy, we ceased charging mobile handset subscribers domestic long-distance and roaming fee since September 2017, which, among other factors, contributed to the decrease in our voice usage and monthly fees by 17.6% from RMB47.50 billion in 2016 to RMB39.15 billion in 2017. Moreover, in the Government Work Report made in the 13th National People’s Congress of the People’s Republic of China on March 5, 2018, the State Council published certain guidance relating to this policy. See “B. Business Overview — Regulatory and Related Matters — Tariff Setting” under Item 4. To the extent we adjust our tariff in response to the guidance to further implement the “speed upgrade and tariff reduction” policy, our results of operations would be adversely affected.

Additionally, we also engage in the pilot program for mobile telecommunications resale business, in which privately-owned enterprises purchase mobile services from China Mobile, China Telecom or us at wholesale price and resell to end-customers after repackaging and rebranding. In January 2016, the MIIT issued the Guidance on the Wholesale Price Adjustments of Mobile Telecommunications Resale Business (关于移动通信转售业务批发价格调整的指导意见), pursuant to which the MIIT required that the wholesale price for resale of mobile telecommunications services should be lower than the per unit price (or package price) for similar businesses of the mobile networks operators. Pursuant to such guidance, we have adjusted our wholesale price for resale of mobile telecommunications services from time to time, which had and may continue to have an adverse effect on our revenue and profitability from such services.

These adjustments in our charges for telecommunications services and products that have been or will be made by us have resulted in or will have an adverse effect on our operating revenue and profitability. Any future governmental policies in China or market conditions that require us to further reduce our charges for telecommunications services and products could materially and adversely affect our financial condition and results of operations.

We face risks associated with our Internet-related services.

We have been proactively exploring and developing certain innovative and Internet-related services, including mobile Internet, digital services and big data services. We face a number of risks in providing these services.

 

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Our network and systems and those of our suppliers, vendors and other service providers may be vulnerable to cyber-attacks, such as unauthorized access, computer viruses and other disruptive problems. As a telecommunications operator, we are considered a critical information infrastructure operator under the relevant PRC law and therefore are subject to the regulations designed to protect critical information infrastructure. For example, under the Cybersecurity Law of the PRC, or the Cybersecurity Law, we are required to perform a security assessment when transferring personal information and important data overseas if such personal information and important data are collected from the operation in China. We also devote significant resources to network security, data security and other security measures to protect our systems and data. To ensure the adequacy and effectiveness of our cybersecurity policies and procedures, we review and assess these policies and procedures regularly, and we review and assess the security and integrity of the components of our network annually or bi-annually, depending on how critical such components are. However, we cannot assure you that the security measures, policies and procedures we have implemented will not be circumvented or otherwise can fully protect the integrity of our network, including our mobile network. The inability to operate our networks and systems or those of our suppliers, vendors and other service providers as a result of cyber-attacks, even for a limited period of time, may result in significant expenses to us and/or a loss of market share to other telecommunications operators. Unauthorized access could jeopardize the security of confidential information stored in our customers’ computer systems and mobile phone systems and may subject us to litigation, liabilities for information loss and/or reputational damage. Eliminating computer viruses and other security problems may also require interruptions, delays or suspension of our services, reduce our customer satisfaction and cause us to incur costs.

As of April 13, 2018, we have not been subject to any material cyber-attacks or incidents, individually or in the aggregate, that had or would expected to have a material adverse effect on our business and operations, nor had we been involved in any legal proceedings or regulatory investigations related thereto. However, there is no assurance that we will not experience them in the future. Additionally, as it is currently difficult to maintain sufficient insurance coverage relating to cybersecurity risks and incidents at commercially reasonable rates and terms, if we fall victim to any material cyber-attacks or involve in any legal proceedings or regulatory investigations relating to cybersecurity incidents, we may be subject to significant financial losses and legal liabilities, which could materially and adversely affect our results of operations, financial condition, prospects and reputation.

Furthermore, personal privacy, information security, and data protection are increasingly significant issues in China. The regulatory framework governing the collection, processing, storage and use of business information and personal data is rapidly evolving. For example, the Cybersecurity Law came into force on June 1, 2017, which sets forth the general framework regulating network products, equipment and services, as well as the operation and maintenance of information networks, the protection of personal data, and the supervision and administration of cybersecurity in China. The new regulatory requirements could increase our cost of compliance and associated risk. Any failure or perceived failure to comply with applicable privacy, security, or data protection laws or regulations may adversely affect our business.

In addition, because we provide connections to the Internet and host websites for customers and develop Internet content and applications, we may be perceived as being associated with the content carried over our network or displayed on websites that we host. We cannot and do not screen all of such content and may face litigations due to a perceived association with such content. These types of litigations have been brought against other providers of online services in the past. Regardless of the merits of the litigations, they can be costly to defend, divert management resources and attention, and may damage our reputation.

We are exposed to reputational and legal risks associated with telecommunications fraud carried out on our network.

Telecommunications fraud, in which a person defrauds another by means of telecommunications technologies including SMS, telephone, and Internet, exposes us to reputational and legal risks. If telecommunications fraud is committed on our network, we may be held liable for our failure to fully comply with PRC regulatory requirements to prevent telecommunications fraud. In September 2016, the Supreme People’s Court, the Supreme People’s Procuratorate, the Ministry of Public Security, the MIIT, the People’s Bank of China and the China Banking Regulatory Commission jointly issued the Notice on the Prevention and Combating of Telecommunications Network Fraud, and, in November 2016, the MIIT issued the Practice Opinions on Further Prevention and Combating Telecommunications Information Fraud, both of which require telecommunications operators to strictly require customers to register under their real names when applying for telecommunications services, which requires us to fully and promptly comply with the requirements on real-name registration. We have implemented various measures to strengthen our management and control over sales and distribution channels, including carrying out the real-name registration system for our customers in accordance with the requirements of government authorities. However, telecommunications fraud may still result in claims being brought against us and may damage our reputation and could have an adverse effect on our business and results of operations.

 

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Our ultimate controlling shareholder, Unicom Group, can exert influence on us and cause us to make decisions that may not always be in the best interests of us or our other shareholders and may fail to provide services and facilities that we rely on to operate our business.

Unicom Group indirectly controlled an aggregate of approximately 79.9% of our issued share capital as of April 13, 2018 and all of our four executive directors also concurrently served as directors or executive officers of Unicom Group as of the same date. As our ultimate controlling shareholder, subject to our articles of association and applicable laws and regulations, Unicom Group is effectively able to control our management, policies and business by controlling the composition of our board of directors and, in turn, indirectly controlling the selection of our senior management, determining the timing and amount of our dividend payments, approving significant corporate transactions, including mergers and acquisitions, and approving our annual budgets. The interests of Unicom Group as our ultimate controlling shareholder may conflict with our interests or the interests of our other shareholders. As a result, Unicom Group may cause us to enter into transactions or take (or fail to take) other actions or make decisions that may not be in our or our other shareholders’ best interests.

In addition, our operations depend on a number of services and facilities provided by Unicom Group. For example, Unicom Group provides us with international gateway services, interconnection services, sales agency and collection services and provision of premises. See “B. Related Party Transactions” under Item 7. The interests of Unicom Group as provider of these services and facilities may conflict with our interests. Failure by Unicom Group to fulfill its obligations under any of these arrangements may have a material adverse effect on our business operations. We currently have limited alternative sources of supply for these services and facilities and, as a result, may have limited ability to negotiate with Unicom Group regarding the terms for providing these services and facilities. Changes in the availability, pricing or quality of these services or facilities may have a material adverse effect on our business and profitability.

The previous internal reorganization of Unicom Group for the A Share offering created a two-step voting mechanism that requires the approval of the minority shareholders of both our Company and China United Network Communications Limited (formerly known as China United Telecommunications Corporation Limited), or the A Share Company, for significant related party transactions between us and Unicom Group.

In October 2002, Unicom Group completed an internal reorganization of its shareholding in our company and the initial public offering in China of its then newly established subsidiary, the A Share Company. As part of this restructuring, a portion of Unicom Group’s indirect shareholding in our company was transferred to the A Share Company, whose business is limited to indirectly holding the equity interest of our company without any other direct business operations. A voting mechanism was established to allow public shareholders of the A Share Company to indirectly participate in our shareholders’ meetings and a two-step voting mechanism was established for the approval of related party transactions. As a result, any significant related party transaction between us or our subsidiaries and Unicom Group or its other subsidiaries will require the separate approval of the independent minority shareholders of both our company and the A Share Company. Related party transactions approved by our independent minority shareholders nevertheless cannot proceed if they are not approved by the independent minority shareholders of the A Share Company. This adds another necessary step of approval process for those transactions. See “A. History and Development of the Company — Two-Step Voting Arrangements” under Item 4.

 

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The benefits that we expect to enjoy relating to the mixed ownership reform of our ultimate controlling shareholder, Unicom Group, are subject to substantial uncertainty.

As part of the PRC government’s efforts to reform state-owned enterprises and increase their competitiveness, our ultimate controlling shareholder, Unicom Group, participate in a pilot program on mixed ownership reform of state-owned enterprises, and implemented a plan to diversify its shareholders’ base, or the Mixed Ownership Reform Plan, by bringing in certain strategic investors, including certain large Internet companies, into the A Share Company, our controlling shareholder. See “A. History and Development of the Company – Our Relationship with Unicom Group” and “A. History and Development of the Company — The Mixed Ownership Reform” under Item 4. The main purpose of the Mixed Ownership Reform Plan is to improve the corporate governance, incentive system and management efficiency of the A Share Company, and create synergies through cooperation with strategic investors. However, as there is substantial uncertainty with respect to our cooperation with strategic investors and the improvement in our incentive system, we cannot assure you that these benefits will be achieved as expected.

Investor confidence and the market prices of our shares and ADSs may be materially and adversely impacted if we are or our independent registered public accounting firm is unable to conclude that our internal control over financial reporting is effective in future years as required by Section 404 of the Sarbanes-Oxley Act of 2002.

We are a public company in the United States that is subject to the Sarbanes-Oxley Act of 2002. Pursuant to the requirements of Section 404 of the Sarbanes-Oxley Act of 2002, we include in this annual report a report of management on our internal control over financial reporting and an attestation report of our independent registered public accounting firm on the effectiveness of our internal control over financial reporting.

Our management conducted an assessment of the effectiveness of our internal control over financial reporting and concluded that our internal control over financial reporting as of December 31, 2017 was effective. The effectiveness of our internal control over financial reporting as of December 31, 2017 has been audited by our independent registered public accounting firm, as stated in its report. However, we cannot assure you that, in the future, our management will continue to conclude that our internal control over financial reporting is effective. Even if our management concludes that our internal control over financial reporting is effective for future periods, our independent registered public accounting firm may disagree. If our independent registered public accounting firm is not satisfied with our internal control over financial reporting or the level at which our controls are documented, designed, operated, reviewed or evaluated, or if the independent registered public accounting firm interprets the relevant requirements, rules or regulations differently from us, then it may issue an adverse opinion. Any of these possible outcomes in the future could result in an adverse reaction in the financial marketplace due to a loss of investor confidence in the reliability of our consolidated financial statements, which could materially and adversely affect the market prices of our shares and ADSs.

Moreover, internal control over financial reporting may not prevent or detect misstatements because of its inherent limitations, including the possibility of human error, the circumvention or overriding of controls, or fraud. Therefore, even effective internal control over financial reporting can provide only reasonable assurance with respect to the preparation and fair presentation of financial statements. If we fail to maintain the adequacy of our internal control over financial reporting, including through a failure to implement required new or improved controls, or if we experience difficulties in their implementation, our business and operating results could be harmed, we could fail to meet our reporting obligations and there could be a material adverse effect on the market prices of our shares and ADSs.

Certain misconduct or alleged misconduct by our executive officers or employees may adversely impact the Company, including potentially by damaging our reputation, creating litigation risk, and adversely impacting the trading price of our ordinary shares and ADSs.

We are aware that certain management personnel of the Company and/or our subsidiaries engaged in or are alleged to have engaged in unlawful conduct, including acceptance of bribes. In response to management misconduct, we have taken and will continue to take various measures, including enhancing our employees’ compliance awareness and taking steps to confirm that our risk management and internal control procedures are robust. However, we cannot be certain that these measures will effectively detect or prevent future employee misconduct. If these measures prove ineffective in detecting or preventing future employee misconduct, among other things our reputation could be harmed, our operations could be disrupted and the trading price of our ordinary shares and ADSs could be adversely impacted.

 

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Our success depends on the continued services of our senior management team and other qualified employees.

Our continued success and growth depends on our ability to identify, hire, train and retain suitably skilled and qualified employees, including management personnel, with relevant professional skills. The services of our directors and members of senior management are essential to our success and future growth. If there is a loss of a significant number of our directors and senior management, and we are unable to find suitable replacements in a timely manner, our business could be materially and adversely affected. As we have to compete for a limited supply of qualified employees, such as managerial, sales, administration, research and development and operating personnel with adequate skills and experience, in China, we may not be able to successfully attract, assimilate or retain all of the personnel we need. We may also need to offer superior compensation and other benefits to attract and retain key personnel and therefore cannot assure you that we will have the resources to fully achieve our staffing need. In addition, if any director or any member of our senior management team or any of our other key personnel were to join a competitor or carry on a competing business, we may lose customers and key professionals and staff members. Due to the intense competition for management and other personnel and qualified employees in the telecommunications industry in mainland China, any failure to recruit and retain the necessary management personnel and other qualified employee could have a material adverse effect on our business and prospects.

Risks Relating to the Telecommunications Industry in China

Government regulation of the telecommunications industry in China may affect our ability to respond to market conditions or competition, and may have a material adverse effect on our financial condition, results of operations and growth prospects.

As a telecommunications operator in China, we are subject to regulation by, and under the supervision of, the MIIT, which is the primary regulator of the telecommunications industry in China. The MIIT is responsible for formulating policies and regulations for the telecommunications industry, granting telecommunications licenses, allocating frequency spectrum and numbers, formulating interconnection and settlement arrangements between telecommunications operators, and enforcing industry regulations. Other PRC Governmental authorities also regulate capital investment and foreign investment in the telecommunications industry. See “B. Business Overview — Regulatory and Related Matters” under Item 4. The regulatory framework within which we operate may constrain our ability to implement our business strategies and limit our ability to respond to market conditions or to changes in our cost structure. Moreover, we operate our businesses pursuant to approvals granted by the State Council and under licenses granted by the MIIT. If these approvals or licenses were revoked or suspended, our business and operations would be materially and adversely affected. In addition, we are subject to various regulatory requirements as to a wide range of matters relating to our business operations, including service quality and real-name registration for telecommunications service subscribers and other actions, and failure to comply with such requirements may subject us to mandatory penalties or other punitive measures, any of which could have a material adverse effect on our financial condition, results of operations and growth prospects. Furthermore, we cannot assure you that we will not experience any adverse effect on our business during the course of our compliance with regulatory requirements in the PRC telecommunications industry. Similarly, the PRC regulators may promulgate and implement new regulations, rules and policies on the telecommunications industry from time to time, and we cannot guarantee that any such new regulations, rules or policies will not have a material adverse effect on our financial condition, results of operations and growth prospects.

Potential changes in laws, regulations and policies relating to the PRC telecommunications industry or any future industry restructuring may materially and adversely affect our financial condition, results of operations and growth prospects.

The PRC Government continues to regulate many aspects of the telecommunications industry in China. Potential changes in laws, regulations and policies and their implementation could lead to significant changes in the overall industry environment and may have a material adverse effect on our financial condition, results of operations and growth prospects. The PRC Government has been adjusting and improving its regulatory oversight of the telecommunications industry, including further deregulating telecommunications tariffs.

 

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For example, in December 2016, the amended Regulations of People’s Republic of China on the Management of Radio Operation came into effect, which provides that permission for using certain radio frequency bands may be obtained through bidding processes or auctions. As such, competition for radio frequencies could become more intensive in the future, and as a result we may not be able to obtain all desirable radio frequencies at commercially acceptable terms, or at all, which may have a material adverse effect on our results of operations and growth prospects.

Relevant departments of the PRC government, under the direction of the State Council, are currently preparing a telecommunications law to provide a uniform regulatory framework for the telecommunications industry in China. As of the date of this annual report, the telecommunications law has not yet been officially promulgated by the PRC Government. The promulgation of the telecommunications law and other new telecommunications regulations or rules, or future changes thereto, such as enforcement of existing regulations and policies, may materially and adversely affect our financial condition, results of operations and growth prospects.

Issues may also arise regarding the interpretation and enforcement of China’s WTO commitments regarding telecommunications services. Any future regulatory changes, such as those relating to the issuance of additional telecommunications licenses, mobile telecommunications resale business, interconnection and settlement arrangements, changes in technical and service standards, universal service obligations, spectrum allocation and number allocation and portability, may have a material adverse effect on our business and operations.

The PRC telecommunications industry has experienced certain restructuring in recent years and may be subject to further restructuring. Such further industry restructuring may materially affect the operations of all telecommunications operators in China, including us. Accordingly, we cannot predict the scope and effect of any further restructuring on our financial condition, results of operations and growth prospects.

The PRC Government may require us, along with other telecommunications service providers in China, to provide universal services with specified obligations, and we may not be compensated adequately for providing such services.

Under the Telecommunications Regulations promulgated by the State Council, telecommunications service providers in China are required to fulfill universal service obligations in accordance with relevant regulations to be promulgated by the PRC Government authorities, and the MIIT has the authority to delineate the scope of universal service obligations. The MIIT, together with the finance department and pricing authorities of the State Council, are also responsible for formulating administrative rules relating to the establishment of a universal service fund and compensation schemes for universal services. For instance, in December 2015, the Ministry of Finance, or MOF, and the MIIT jointly issued the rules regarding the pilot program for universal services to be implemented certain cities across the PRC. Since then, the MIIT has designated additional cities and villages as participants of the pilot program for universal services in public notice from time to time. Pursuant to the pilot program for universal services, we undertook broadband construction projects in 16,134 villages from 2016 to 2017, out of which broadband construction projects in 3,557 villages were undertaken in 2017. See “B. Business Overview — Regulatory and Related Matters — Universal Services” under Item  4.

We cannot predict whether the PRC Government will specifically require us to undertake universal service obligations in the future. To the extent we are required to do so, it is currently uncertain whether we will be adequately or timely compensated by the PRC Government or by the universal service fund. We cannot assure you that we will be able to realize an adequate return on investments for expanding networks to, and providing telecommunications services in, less economically developed areas due to potentially higher capital expenditure requirements, lower usage by customers and lack of flexibility in setting our tariffs. We also cannot predict whether we will be required to make a contribution to the universal service fund. Any of these events may adversely affect our financial condition and results of operations.

Actual or perceived health risks associated with the use of mobile devices could impair our ability to retain and attract customers of our mobile services, reduce mobile service usage or result in litigation.

Concerns have been expressed in some countries that the electromagnetic signals emitted by wireless telephone handsets and base stations may pose health risks at exposure levels below existing guideline levels, and interfere with the operation of electronic equipment. In addition, mobile operators have been subject to lawsuits alleging various health consequences as a result of mobile handset usage or proximity to base stations or seeking protective or remedial measures. While we are not aware that such health risks have been substantiated, there can be no assurance that the actual, or perceived, risks associated with the transmission of electromagnetic signals will not impair our ability to retain customers and attract new customers, reduce mobile service usage or result in litigation.

 

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Risks Relating to Doing Business in China

Our operations may be materially and adversely affected by changes in China’s economic, political and social conditions.

Substantially all of our business operations are conducted in China and substantially all of our revenue is derived from our operations in China. Accordingly, our business, financial condition, results of operations and prospects may be adversely affected by changes in China’s economic, political and social conditions. The PRC economy differs from the economies of most developed countries in many respects, including with respect to the extent of government involvement, level of development, growth rate, and control of foreign exchange and allocation of resources. While the PRC economy has experienced significant growth in the past three decades, growth has been uneven across different regions and among various economic sectors. The PRC Government has implemented various measures to encourage economic development and guide the allocation of resources. Some of these measures benefit the overall PRC economy, but may also have an adverse effect on us. For example, our financial condition and results of operations may be materially and adversely affected by government control over outbound investments.

The PRC economy has experienced a slowdown for the past few years. The GDP growth rate of China decreased from 11.4% in 2007 to 6.9% in 2017. It is uncertain whether China’s economic growth will return to the previous level of growth or it will encounter deterioration. In light of the slowdown of China’s economic growth, our subscribers’ usage of our services may decrease and we may experience increased difficulties in retaining existing subscribers or acquiring new subscribers, which could materially and adversely affect our business, as well as our financial condition and results of operations.

If the PRC Government revises the current regulations that allow a foreign-invested enterprise to pay foreign exchange in current account transactions, our operating subsidiary’s ability to satisfy its foreign exchange obligations and to pay dividends to us in foreign currencies may be restricted.

The ability of our major operating subsidiary, CUCL, to satisfy its foreign exchange obligations and to pay dividends to us depends on existing and future foreign exchange regulations in China. The Renminbi is currently convertible by foreign-invested enterprises in China to settle transactions under the current account, which include trade- and service-related foreign exchange transactions and payments of dividends. The Renminbi currently cannot be freely converted without regulatory approval for transactions under the capital account, which includes outbound foreign investment and payments on foreign loans. CUCL, which holds substantially all of our assets and through which we conduct substantially all of our business, is a foreign-invested enterprise in China. However, there is no assurance that in the future the relevant PRC government authorities will not impose any limitation on the ability of foreign-invested enterprises to purchase foreign exchange to satisfy their foreign exchange obligations or to pay dividends. In that event, CUCL’s ability to satisfy its foreign exchange obligations and to pay dividends to us in foreign currencies may be restricted and the interests of our shareholders may, in turn, be affected.

Fluctuations in the value of the Renminbi could adversely affect the prices of our shares and ADSs as well as our profitability.

Substantially all of our revenue and costs and expenses are denominated in Renminbi, while a portion of our borrowings, equipment purchases and other capital expenditures are denominated in foreign currencies. On July 21, 2005, the PRC Government changed its decade-old policy to permit Renminbi to fluctuate within a narrow and managed band against a basket of certain foreign currencies determined by the People’s Bank of China, or the PBOC. On May 19, 2007, the PBOC announced a policy to further expand the maximum daily floating range of RMB trading prices against the U.S. dollar in the inter-bank spot foreign exchange market. With the increased floating range of the Renminbi’s value against foreign currencies, the Renminbi may appreciate or depreciate significantly in value against the U.S. dollar or other foreign currencies in the long term, depending on the fluctuation of the basket of currencies against which it is currently valued, or it may be permitted to enter into a full float. Increased fluctuations of the Renminbi could adversely affect the value in foreign currency terms of cash flow generated from our operations or any dividends payable on our shares and ADSs, and therefore the price of our shares and ADSs. Any future Renminbi devaluations could also increase our equipment importation costs or lead to significant fluctuations in the exposure of our foreign-currency-denominated liabilities, thereby adversely affecting our profitability.

 

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Uncertainties in the PRC legal system could limit the legal protections available to us and to foreign investors and materially and adversely affect our financial condition, results of operations and growth prospects.

Our wholly owned operating subsidiary, CUCL, is organized under the laws of PRC and is generally subject to laws and regulations applicable to foreign-invested enterprises in China. The Chinese legal system is a civil law system based on written statutes. Unlike common law systems, it is a system in which decided legal cases may be cited for reference but have limited precedential value. Since 1979, the PRC Government has promulgated laws and regulations dealing with economic matters such as foreign investment, corporate organization and governance, commerce, property, taxation and trade. However, because these laws and regulations are relatively new, and because of the relatively limited volume of published cases and their non-binding nature, interpretation and/or enforcement of these laws and regulations involves uncertainties, which may limit the remedies available to you as an investor and to us in the event of any claims or disputes with third parties. In addition, any litigation in China may be protracted and result in costs and diversion of resources and management attention. Therefore, the protection provided by the PRC legal system may not be the same as the legal protection available to investors in the United States or elsewhere. Furthermore, various uncertainties involved in the rulemaking, interpretation and enforcement process of the laws, regulations and rules in China that are related to our business operations, in particular, those in respect of telecommunications and enterprise income tax, may also materially and adversely affect our financial condition, results of operations and growth prospects.

You may experience difficulties in effecting service of legal process and enforcing foreign court judgments against us and our management in China.

Most of our current operations are conducted in China and most of our assets are located in China. In addition, four out of nine of our current directors and all of our current executive officers reside within China, and substantially all of the assets of these persons are located within China. As a result, it may not be possible to effect service of process within the United States or elsewhere outside China upon these directors or executive officers, including with respect to matters arising under U.S. federal securities laws or applicable state securities laws. Moreover, our PRC counsel has advised us that China does not have treaties with the United States or many other countries providing for the reciprocal recognition and enforcement of court judgments. Our Hong Kong counsel has also advised us that Hong Kong has no arrangement for the reciprocal enforcement of judgments with the United States. As a result, recognition and enforcement in China of judgments of a court of the United States or any other jurisdiction, including judgments against us or our directors, executive officers, underwriters or experts, may be difficult or impossible.

Natural disasters and health hazards in China may severely disrupt our business and operations and may severely restrict the level of economic activities in affected areas, which in turn may have a material adverse effect on our financial condition and results of operations.

Natural disasters such as earthquakes, snowstorms and floods may result in significant and extensive damage to our base stations and network equipment. Moreover, certain countries and regions, including China, have encountered incidents of bird flu, or avian flu, as well as severe acute respiratory syndrome, or SARS, and the outbreak of influenza A (H1N1) in the past. In 2017, certain areas of China suffered from natural disasters including typhoons, floods, mountain torrents, mudslides and landslides, and these natural disasters caused extensive damage to our network equipment, including our base stations and optical fiber networks, in the affected areas. We are unable to predict the effect, if any, that any other future natural disasters and health hazards may have on our business. Any future natural disasters and health hazards may, among other things, significantly disrupt our ability to adequately staff our business, and may generally disrupt our operations. Furthermore, natural disasters and health hazards may severely restrict the level of economic activities in affected areas, which may in turn materially and adversely affect our business and prospects. As a result, any natural disasters or health hazards in China may have a material adverse effect on our financial condition and results of operations.

 

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Our investors do not have the benefit to rely on the Public Company Accounting Oversight Board inspection of our independent registered public accounting firm.

As a company registered with the U.S. Securities and Exchange Commission, or the SEC, and traded publicly in the United States, our independent registered public accounting firm is required by the laws of the United States to be registered with the Public Company Accounting Oversight Board, or the PCAOB, and undergo regular inspections by the PCAOB to assess its compliance with the laws of the United States and professional standards. The PCAOB, however, is currently unable to inspect a registered public accounting firm’s audit work relating to a company’s operations in China where the documentation of such audit work is located in China. Accordingly, our independent registered public accounting firm’s audit of our operations in China is not subject to the PCAOB inspection.

The PCAOB has conducted inspections of independent registered public accounting firms outside of China and has at times identified deficiencies in the audit procedures and quality control procedures of those accounting firms. Such deficiencies may be addressed in those accounting firms’ future inspection process to improve their audit quality. Due to the lack of PCAOB inspections of audit work undertaken in China, our investors do not have the benefit of the regular evaluation by PCAOB of the audit works, audit procedures and quality control procedures of our independent registered public accounting firm.

Proceedings instituted by the SEC against certain China-based accounting firms, including our independent registered public accounting firm, could result in financial statements being determined to not be in compliance with the requirements of the Securities Exchange Act of 1934, as amended, or the Exchange Act.

On January 22, 2014, Judge Cameron Elliot, an SEC administrative law judge, issued an initial decision suspending the Chinese member firms of the “Big Four” accounting firms, including our independent registered public accounting firm, from, among other things, practicing before the SEC for six months. In February 2014, the initial decision was appealed. While under appeal and in February 2015, the Chinese member firms of “Big Four” accounting firms reached a settlement with the SEC. As part of the settlement, each of the Chinese member firms of “Big Four” accounting firms agreed to settlement terms that include a censure; undertakings to make a payment to the SEC; procedures and undertakings as to future requests for documents by the SEC; and possible additional proceedings and remedies should those undertakings not be adhered to.

If the settlement terms are not adhered to, Chinese member firms of “Big Four” accounting firms may be suspended from practicing before the SEC which could in turn delay the timely filing of our financial statements with the SEC. In addition, it could be difficult for us to timely identify and engage another registered public accounting firm to audit and issue an opinion on our financial statements. A delinquency in our filings with the SEC may result in NYSE initiating delisting procedures, which could adversely harm our reputation and have other material adverse effects on our overall growth and prospect.

Risk Relating to our ADSs

Holders of our ADSs will not have the same voting rights as the holders of our shares and may not receive voting materials in time to be able to exercise their right to vote.

Except as described in this annual report and in the deposit agreement, holders of our ADSs will not be able to exercise voting rights attaching to the shares represented by our ADSs on an individual basis. Holders of our ADSs will receive proxy materials with respect to matters to be voted on at a meeting of shareholders through the depositary and may only exercise voting rights by appointing the depositary or its nominee as their representative to exercise the voting rights attaching to the shares represented by the ADSs. Consequently, if the materials to be forwarded to holders of ADSs by the depositary are delayed or if the depositary sets deadlines by which holders of ADSs must give their instructions regarding how to vote that fall too soon after mailing of the proxy materials, the holders of our ADSs may not receive voting materials in time to instruct the depositary to vote. Thus, it is possible that such holders, or persons who hold their ADSs through brokers, dealers or other third parties, may not have the opportunity to exercise a right to vote.

 

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Item 4. Information on the Company

 

A. History and Development of the Company

We were incorporated under the laws of Hong Kong on February 8, 2000 under the predecessor of the Companies Ordinance as a company limited by shares under the name “China Unicom Limited”. In connection with the telecommunications industry restructuring initiated by the MIIT, the National Development and Reform Commission, or the NDRC, and the MOF, in 2008 as discussed below, we merged with China Netcom and changed our name to “China Unicom (Hong Kong) Limited” with effect from October 15, 2008. Following our merger with China Netcom, we became an operator providing a full range of telecommunications services, including mobile and fixed-line services, in China.

Our registered office and principal executive offices are located at 75th Floor, The Center, 99 Queen’s Road Central, Hong Kong (telephone number: 852-2126-2018).

Restructurings of the Telecommunications Industry

In May 2008, the MIIT, the NDRC and the MOF issued a joint announcement relating to the further reform of the PRC telecommunications industry. According to the joint announcement, the principal objectives of such further reform included, among others: (i) supporting the formation of three telecommunications service providers of comparable scale and standing, each with nationwide network resources, full-service capabilities and competitive strength, in order to help optimize the allocation of telecommunications resources and foster market competition; (ii) promoting homegrown innovation by telecommunications service providers; and (iii) enhancing the service capabilities and quality of, and the regulatory framework governing, the telecommunications industry. To achieve these objectives, the three ministries encouraged the following restructuring transactions: (a) the acquisition by China Telecom of the CDMA network (including both assets and subscriber base) then owned by Unicom Group; (b) the merger between China Unicom and China Netcom; (c) the transfer of the basic telecommunications service business operated by China Satellite into China Telecom; and (d) the consolidation of China Tietong into China Mobile. The detailed implementation plans relating to these restructuring transactions were subsequently formulated by the relevant parties and, as a result, China Mobile, China Telecom and we became the current three major telecommunications operators in China, each providing a full range of telecommunications services nationwide.

Sale of CDMA Business, Merger with China Netcom and Related Transactions

Disposal of CDMA Business and Related Transactions

In October 2008, we, through CUCL, disposed of our CDMA business and certain other assets to China Telecom, which included (i) the entire CDMA business owned and operated by CUCL, together with the assets of CUCL that are relevant to the CDMA operations and the rights and liabilities of CUCL relating to its CDMA subscribers, (ii) the entire equity interest in China Unicom (Macau) Company Limited, our wholly owned subsidiary, and (iii) all of the 99.5% equity interest in Unicom Huasheng Telecommunications Technology Company Limited, a limited liability company incorporated under the laws of the PRC, held by CUCL. The consideration for the disposal was RMB43.8 billion in cash. In addition, in connection with the disposal, Unicom Group and Unicom New Horizon also disposed of their CDMA network to China Telecom at a consideration of RMB66.2 billion in October 2008.

Merger with China Netcom and Related Transactions

On October 15, 2008, following the approval of the merger by our shareholders and the shareholders of China Netcom at shareholders’ meetings held on September 16, 2008 and September 17, 2008, respectively, and the satisfaction of all other conditions, the merger between China Unicom and China Netcom by way of a scheme of arrangement of China Netcom. As a result, China Netcom became our wholly owned subsidiary and the listings of China Netcom’s ordinary shares and ADSs on the HKSE and the NYSE, respectively, were withdrawn, and our name changed from “China Unicom Limited” to “China Unicom (Hong Kong) Limited” on October 15, 2008. Our stock trading code on the HKSE and our ticker symbol on the NYSE remain unchanged.

 

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China Netcom was incorporated in Hong Kong on October 22, 1999, under the predecessor of the Companies Ordinance as a company limited by shares under the name Target Strong Limited. The company changed its name to China Netcom (Hong Kong) Corporation Limited on December 9, 1999, to China Netcom Corporation (Hong Kong) Limited on August 4, 2000, and to China Netcom Group Corporation (Hong Kong) Limited on July 23, 2004 (the last name change in anticipation of its IPO in 2004).

As part of our integration with China Netcom, our wholly owned subsidiary, CUCL, merged with China Netcom (Group) Company Limited, or CNC China, a wholly owned subsidiary of China Netcom, in January 2009, and upon that merger becoming effective, CUCL assumed all the rights and obligations of CNC China, and all the assets, liabilities and business of CNC China were vested in CUCL. In addition, in January 2009, Unicom Group, our parent company, merged with and absorbed Netcom Group, the parent company of China Netcom. Upon completion of the merger between Unicom Group and Netcom Group, Unicom Group assumed all the rights and obligations of Netcom Group, and all the assets, liabilities and business of Netcom Group have vested in Unicom Group.

Our Relationship with Unicom Group

Our ultimate controlling shareholder is Unicom Group, a company incorporated under the laws of the PRC and majority-owned by the PRC Government. Unicom Group was established in accordance with the State Council’s approval to introduce orderly competition in the telecommunications industry in 1994.

Unicom Group transferred certain of its telecommunications assets, rights and liabilities to CUCL (which became our wholly owned subsidiary in China) in April 2000 in preparation for our initial public offering, or IPO. In June 2000, we successfully completed our IPO. Our ordinary shares are listed on the HKSE and our ADSs, each representing 10 of our ordinary shares, are listed on the NYSE.

Unicom Group holds the licenses required for our telecommunications businesses and we derive our rights to operate our businesses from our status as a subsidiary of Unicom Group. Unicom Group undertook to hold and maintain all licenses received from the MIIT in connection with our businesses solely for our benefit during the term of such licenses and at no cost to us. In addition, Unicom Group undertook to take all actions necessary to obtain and maintain for our benefit such governmental licenses or approvals as we shall require to continue to operate our businesses. Unicom Group also agreed not to engage in any business which competes with our businesses other than the then-existing competing businesses of Unicom Group and to grant us a right of first refusal in relation to any government authorization, license or permit, or other business opportunity to develop any new telecommunications technology, product or service. Finally, Unicom Group also gave us an undertaking not to seek an overseas listing for any of its businesses or the businesses of its subsidiaries in which we have engaged or may engage in the future, except through us.

Set forth below is our shareholding structure as of April 13, 2018.

 

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LOGO

 

(1)  The shares of the A Share Company held by strategic investors represented the shares acquired by the strategic investors introduced by the mixed ownership reform from non-public share issuance and transfer of existing shares.

Two-Step Voting Arrangements

As a result of a series of internal restructurings of Unicom Group’s shareholding in us following our IPO, China Unicom (BVI) Limited, or Unicom BVI, became our direct controlling shareholder, which in turn is directly controlled by the A Share Company and indirectly controlled by the Unicom Group. The A Share Company’s business is limited to indirectly holding the equity interest in Unicom without any other direct business operations. The A Share Company was listed on the Shanghai Stock Exchange in 2002. In order to allow public shareholders of the A Share Company to indirectly participate in our shareholders’ meeting, a voting mechanism was designed in accordance with the articles of association of Unicom BVI and the A Share Company. Under this voting mechanism, before Unicom BVI votes on certain proposals at our shareholders’ meeting, the A Share Company must first convene a shareholders’ meeting to consider the same proposals in order to direct Unicom BVI to vote the shares in our company indirectly held by the A Share Company through Unicom BVI. Unicom Group can similarly direct the voting in respect of its direct equity interest in Unicom BVI.

The voting mechanism described above, however, will not apply to the approval process for any related party transaction between us or our subsidiaries and Unicom Group or its subsidiaries, on which Unicom BVI will not be permitted to vote under the Rules Governing the Listing of Securities on HKSE, or the HKSE Listing Rules. Those related party transactions would require the separate approvals of the public shareholders of each of our company and the A Share Company. We and the A Share Company therefore created the two-step voting arrangements, pursuant to which each related party transaction between us or our subsidiaries and Unicom Group or its subsidiaries will consist of an initial agreement and a further agreement. The initial agreement would be entered into by Unicom Group or its subsidiaries (excluding the A Share Company and its subsidiaries) on the one hand and the A Share Company or Unicom BVI on the other hand. The initial agreement would contain the following terms:

 

    the closing of the initial agreement would be subject to (i) the successful transfer of all rights and obligations of the A Share Company or Unicom BVI under the initial agreement to us or our subsidiaries, and (ii) the approval of the further agreement by our independent shareholders; and

 

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    Unicom Group or its subsidiaries (excluding the A Share Company and its subsidiaries) would agree and acknowledge that all rights and obligations under the initial agreement can be transferred to us or our subsidiaries without any further consent requirements.

The initial agreement will constitute a related party transaction of the A Share Company and, if certain thresholds are met, will require the approval of the public or independent shareholders of the A Share Company under the rules of the Shanghai Stock Exchange. The further agreement would be entered into by the A Share Company or Unicom BVI, on the one hand, and us or our subsidiaries, on the other hand, and will provide for the transfer of all rights and obligations of the A Share Company or Unicom BVI under the initial agreement to us or our subsidiaries. The further agreement will constitute a related party transaction of our company and, if certain thresholds are met, will require the approval of our public or independent shareholders under the HKSE Listing Rules. We expect, to the extent the nature of a particular related party transaction allows, the two-step voting arrangements to apply as described above. However, when we or our subsidiaries are the providers, rather than recipients, of certain services, the two-step voting arrangements will need to be adjusted so that the process as described above is effectively reversed, such that the initial agreement is entered into by us or our subsidiaries rather than Unicom Group or its subsidiaries (excluding the A Share Company and its subsidiaries) with the A Share Company or Unicom BVI. Accordingly, Unicom Group or its subsidiaries (excluding the A Share Company and its subsidiaries), rather than us or our subsidiaries, will be a party to the further agreement. The arrangements (including the conditions) will apply correspondingly. This two-step structure will be applied in all related party transactions between us or our subsidiaries and Unicom Group or its subsidiaries and will effectively require the separate approvals of the public or independent shareholders of each of Unicom and the A Share Company for such related party transactions.

Establishment of the Tower Company and the Disposal of Telecommunications Towers

In July 2014, we, through our wholly owned subsidiary, CUCL, a subsidiary of China Mobile and a subsidiary of China Telecom jointly established the Tower Company. We subscribed for 3.01 billion shares of the Tower Company at RMB1.00 per share, representing 30.1% of the registered capital of the Tower Company, and the remaining 40.0% and 29.9% of the registered capital of the Tower Company were subscribed for by China Mobile and China Telecom, respectively, at the same price. The Tower Company primarily engages in the construction, maintenance and operation of telecommunications towers. It will also be engaged in the construction, maintenance and operation of ancillary facilities including base station control rooms, power supplies, air conditioning and interior distribution systems, as well as the provision of maintenance services of base station equipment.

In October 2015, we, through our wholly owned subsidiaries, CUCL and Unicom New Horizon, entered into a transfer agreement with (i) China Mobile Communication Company Limited, a subsidiary of China Mobile, and its 31 subsidiaries, (ii) China Telecom Corporation Limited, a subsidiary of China Telecom, (iii) China Reform Holdings Corporation Limited, a wholly State-owned company, and (iv) the Tower Company, pursuant to which we, China Mobile and China Telecom sold certain telecommunications towers and related assets to the Tower Company, the Tower Company would issue and allot shares in the Tower Company and/or pay certain cash as consideration for such transfers, and China Reform Holdings Corporation Limited agreed to subscribe for new shares in the Tower Company in cash. As of April 13, 2017, we, through CUCL, owned approximately 28.1% equity interest in the Tower Company, while China Mobile, China Telecom and China Reform Holdings Corporation Limited owned approximately 38.0%, 27.9% and 6.0% equity interest in the Tower Company, respectively.

In July 2016, we, through our wholly owned subsidiary, CUCL, and the Tower Company entered into the Pricing Agreement under which we lease telecommunications towers and related assets from the Tower Company for an initial term of five years. In January 2018, pursuant to the Pricing Agreement and after arm-length negotiations and discussions, we, through our wholly owned subsidiary, CUCL and the Tower Company entered into the Supplementary Agreement, which adjusted certain terms and provisions in the Pricing Agreement and annex thereto in relation to the leasing of the tower products. See “B. Related Party Transactions” under Item 7 for major items of the Pricing Agreement and the Supplementary Agreement, including pricing for the lease.

 

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Establishment of China Unicom Finance Company Limited

On December 6, 2013, CUCL and Unicom Group entered into a capital contribution agreement regarding the establishment of China Unicom Finance Company Limited, or the Finance Company. Pursuant to the capital contribution agreement, CUCL and Unicom Group invested RMB2,730 million and RMB270 million, representing 91% and 9% of the total registered capital of the Finance Company, respectively. The Finance Company was established as a cash management platform of Unicom Group, its subsidiaries and other associated entities, purporting to improve the efficiency of cash flow allocation, lower finance cost and enhance financial risk management, see “B. Related Party Transactions — Establishment of the Finance Company and Provision of Financial Services” under Item  7.

The Mixed Ownership Reform

As part of the PRC government’s efforts to reform state-owned enterprises and increase their competitiveness, our ultimate controlling shareholder, Unicom Group, participated in a pilot program on mixed ownership reform of state-owned enterprises, and implemented a plan to diversify the shareholders’ base of A Share Company, our controlling shareholder, by bringing in certain strategic investors, including certain large Internet companies in China. In October 2017, the A Share Company made a non-public share issuance of 9,037,354,292 ordinary shares to the strategic investors, raising capital of RMB61,725.13 million. Subsequently in November 2017, the Unicom Group transferred 1,899,764,201 of its ordinary shares of the A Share Company to China Structural Reform Fund Corporation Limited for a total consideration of RMB12,975.39 million. In April 2018, the A Share Company made an issuance of 793,861,000 restrictive ordinary shares to its employees pursuant to its restrictive incentive shares scheme, or the employee restrictive incentive shares, which bear selling restrictions within 60 months, at the price of RMB3.79 per share. The total number of the employee restrictive incentive shares represented 2.6% of the A Share Company’s outstanding shares immediately after the completion of such issuance. Upon completion of these transactions, the shareholding of the Unicom Group in the A Share Company decreased to 36.7%, and the strategic investors, including China Structural Reform Fund Corporation Limited, held 35.2% of outstanding ordinary shares of the A Share Company in total.

Furthermore, as part of the Mixed Ownership Reform Plan, the A Share Company appointed representatives from the certain strategic investors to serve as directors. In February 2018, senior executive officers of Baidu, Tencent, Alibaba, JD.com and China Life Insurance were appointed as directors of the A Share Company. A more diversified board of directors is expected to improve the corporate governance of the A Shares Company, which is part of the main purpose of the Mixed Ownership Reform Plan. However, as there is substantial uncertainty with respect to our cooperation with strategic investors and the improvement in our incentive system, we cannot assure you that these benefits will be achieved as expected. See “D. Risk Factors — The benefits that we expect to enjoy relating to the mixed ownership reform of our ultimate controlling shareholder, Unicom Group, are subject to substantial uncertainty” under Item  3.

In connection with the Mixed Ownership Reform Plan, the A Share Company and Unicom Group, mainly using the funds from the mixed Ownership Reform Plan to make capital contributions into Unicom BVI, our direct controlling shareholder. Upon completion of such capital contribution, Unicom BVI entered into the Share Subscription Agreement with us on August 22, 2017, pursuant to which Unicom BVI agreed to subscribe for a maximum of 6,651,043,262 newly issued shares of us, or the Subscription Shares, at the subscription price of HK$13.24 per share, or the Subscription. In November 2017, after all conditions precedent to the subscription have been satisfied, we have completed the allotment and issuance of the Subscription Shares, as a result of which an aggregate of 6,651,043,262 new shares have been issued for cash consideration of HK$13.24 per share to Unicom BVI and the gross proceeds of the Subscription amounted to approximately HK$88,059.81 million. See “B. Related Party Transactions — The Share Subscription by Unicom BVI in Relation to the Mixed Ownership Reform Plan” under Item 7 for information concerning the Subscription. We intend to use the proceeds from the Subscription to upgrade our 4G network capabilities, develop technology and launch trial programs in relation to 5G network, develop innovative businesses and repay bank loans.

 

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Capital Expenditures and Divestitures

See “Liquidity and Capital Resources — Capital Expenditures” under Item 5 for information concerning our principal capital expenditures for the previous three years and those planned for 2018. We currently do not have any significant divestiture in progress.

 

B. Business Overview

General

We are an integrated telecommunications operator in China providing a wide range of telecommunications services and telecommunications products to our customers worldwide. Our telecommunications services include mobile voice, data and value-added, fixed-line voice and value-added, fixed-line broadband, data communications and other telecommunications services. We, China Mobile and China Telecom are the three major telecommunications operators in China.

In 2017, our total revenue was RMB274.83 billion, of which our total service revenue increased by 4.6% from RMB238.03 billion in 2016 to RMB249.02 billion in 2017 and our total sales of telecommunications products decreased by 28.6% from RMB36.16 billion in 2016 to RMB25.81 billion in 2017. The number of mobile billing subscribers increased by 7.7% from 263.82 million in 2016 to 284.16 million in 2017, of which our 4G subscribers increased by 67.3% from 104.55 million to 174.88 million.

Telecommunications Services

Our telecommunications services primarily include mobile services, fixed-line services, bundled services and data and Internet application services. We charge voice usage and monthly fees for our mobile voice services and fixed-line voice service. Our service revenue from voice usage and monthly fees decreased by 16.7% from RMB57.03 billion in 2015 to RMB47.50 billion in 2016, and further decreased by 17.6% to RMB39.15 billion in 2017. As a percentage of total revenue, such service revenue decreased from 20.6% in 2015 to 17.3% in 2016, and further decreased to 14.2% in 2017. Our service revenue from other telecommunications services, including mobile non-voice services, fixed-line broadband access services, data communication services, data and Internet application services, fixed-line value-added services, fixed-line other services and bundling services, increased by 8.3% from RMB175.95 billion in 2015 to RMB190.53 billion in 2016, and further increased by 10.1% to RMB209.86 billion in 2017. As a percentage of total revenue, such service revenue increased from 63.5% in 2015 to 69.5% in 2016, and further increased to 76.4% in 2017.

Mobile Services

Our mobile services consist of GSM, 3G and 4G services. In recent years, we have focused on 4G services. Our 4G services adopt two major variants of 4G LTE technologies, being the Time Division LTE technology, or TD-LTE, and the Frequency-Division LTE technology, or LTE-FDD. Our mobile services primarily consist of mobile voice services and mobile non-voice services. Our mobile voice services enable our subscribers to make and receive phone calls, including local calls, domestic long-distance calls, international long-distance calls, intra-provincial roaming, inter-provincial roaming and international roaming, with a mobile handset at any point within the coverage area of our mobile telecommunications networks. Our mobile non-voice services primarily include mobile data, mobile reading, mobile music, “WO App Store”, SMS, “Cool Ringtone” (a personalized ring-back tone service) and other wireless information services.

 

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The following table sets forth selected historical information for our mobile operations and our subscriber base for the periods indicated.

 

     As of or for
the year ended December 31,
 
     2015     2016     2017  

Number of mobile billing subscribers (in thousands)(1)

     252,317       263,822       284,163  

Estimated market share of mobile billing subscribers(1)(2)

     19.8     19.9     20.0

Mobile billing subscribers ARPU (in RMB)(1)(3)

     46.3       46.4       48.0  

Number of 4G subscribers (in thousands)(1)

     44,156       104,551       174,876  

4G subscribers ARPU (in RMB) (1)(4)

     N.A. (6)      76.4       63.4  

4G subscribers DOU (in megabytes)(1)(5)

     N.A. (6)      1,521       4,522  

 

(1) Mobile billing subscribers are referred generally to subscribers who have revenue contribution in the December of the relevant years. 4G subscribers are referred generally to subscribers who possess 4G handsets, use our 4G networks and have revenue contribution in the December of the relevant years. Since January 2016, we have been reviewing and analyzing our mobile billing subscribers data and 4G subscribers data as we believe such data provides more meaningful information to measure our performance in accordance with our operating strategy. The number of mobile billing subscribers and 4G subscribers as of December 31, 2015 has been generated for our management’s review of the trend of performance.
(2) Market share in a given area is determined by dividing the number of our mobile billing subscribers in the area by the total number of our mobile billing subscribers and mobile subscribers of our major competitors in the area. The number of mobile subscribers of our major competitors is publicly disclosed by the mobile operators.
(3) We calculate mobile billing subscribers ARPU by dividing the annual average revenue per mobile billing subscriber by 12. Annual average revenue per mobile billing subscriber is calculated by dividing the amount of revenue from mobile services for the relevant year by the average number of mobile billing subscribers for the year, which is the average of the 12 monthly average mobile billing subscribers during the year. For a particular month, monthly average mobile billing subscribers is the average of the number of mobile billing subscribers as of the end of the preceding month and the end of that month.
(4) We calculate 4G subscribers ARPU by dividing the annual average revenue per 4G subscriber by 12. Annual average revenue per 4G subscriber is calculated by dividing the amount of revenue from 4G services for the relevant year by the average number of 4G subscribers for the year, which is the average of the 12 monthly average 4G subscribers during the year. For a particular month, monthly average 4G subscribers is the average of the number of 4G subscribers as of the end of the preceding month and the end of that month.
(5) We calculate average data usage per 4G user per month, or 4G subscribers DOU, by dividing the annual average data usage per 4G subscriber by 12. Annual data usage per 4G subscriber is calculated by dividing the total data usage under our 4G services for the relevant year by the average number of 4G subscribers for the year, which is the average of the 12 monthly average 4G subscribers during the year. For a particular month, monthly average 4G subscribers is the average of the number of 4G subscribers as of the end of the preceding month and the end of that month.
(6) Since the development of our 4G services was in a relatively preliminary stage in 2015, we considered it not cost-effective to generate accurate data relating to our 4G services.

Mobile Billing Subscribers

Our total number of mobile billing subscribers increased by 7.7% from 263.82 million as of December 31, 2016 to 284.16 million as of December 31, 2017. Mobile billing subscribers are referred generally to subscribers who have revenue contribution in the December of the relevant years. The increase in the total number of mobile billing subscribers was primarily due to the substantial increase in the number of our 4G subscribers. The ARPU of our mobile billing subscribers increased from RMB46.4 in 2016 to RMB48.0 in 2017. The increase in our ARPU was mainly due to the proportion of 4G subscribers to total mobile billing subscribers increased by 21.9 percentage points year-on-year to 61.5%, partially offset by the negative effect of implementation of the PRC Government’s policy of increasing network speed and reducing tariffs.

 

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4G Subscribers

The total number of our 4G subscribers increased from 104.55 million as of December 31, 2016 to 174.88 million as of December 31, 2017. 4G subscribers are referred generally to subscribers who possess 4G handsets, use our 4G networks and have revenue contribution in the December of the relevant years. The increase in our total number of 4G subscribers was primarily due to (i) our marketing initiatives to effectively reach customers through new marketing channels, for example, we offer data promotion or other packages to users of Internet companies by cooperating with such Internet Companies under 2I2C model, and we offer group service packages to the employees of enterprises, governments and other organizations by cooperating with them under 2B2C model, and (ii) our offering of innovative products tailored to customers’ potential demand, such as our “Ice-cream Package” that targets high-end customers by offering unlimited domestic usage of mobile data and mobile voice under certain prescribed terms.

Fixed-Line Services

We are a leading fixed-line broadband and communications operator in northern China. We offer a wide range of fixed-line services nationwide in China, including (i) fixed-line broadband access services, (ii) data communications services, (iii) fixed-line voice services, (iv) fixed-line voice value-added services, and (v) fixed-line other services.

Fixed-Line Broadband Access Services

Fixed-line broadband access services are one of our emphases as part of our strategy to focus on high growth services and also the foundation for the development of our mobile network and services. The growth in fixed-line broadband access services has been driven by the increasing affordability and rising use of personal computers and other Internet access devices, gradual recognition by businesses of the importance of information and the proliferation of content and applications, such as online games and video-on-demand. We are a leading provider of fixed-line broadband access services in our fixed-line northern service region and we seek to maintain this leading position by capitalizing on our extensive fixed-line network, large customer base, experienced sales force, established brand and strategy of multi-service bundling.

In 2017, we focused on “Mass Connection, High-bandwidth, Big Integration and Big Video” and launched “Fiber Broadband+”, a new broadband service brand, and continued to upgrade our fiber-optic transmission network and improved access speed. We also promoted sub-division and contract out (“mini CEO’s initiative”), in order to stimulate front-line vibrancy and thus promoting business development. As of December 31, 2017, our fixed-line broadband subscribers increased by 1.7% to 76.54 million, of which subscribers with 100Mbps-and-above bandwidth accounted for 39% of all fixed-line broadband subscribers, representing an increase of 31 percentage points from the end of 2016. Our fixed-line broadband access ARPU decreased by 6.3% from RMB49.4 in 2016 to RMB46.3 in 2017 primarily due to intensifying competition, in particular, competition as a result of our competitor’s aggressive marketing strategies involving low tariff and bundle sales of products. As of December 31, 2015, 2016 and 2017, we had approximately 72,330,000, 75,236,000 and 76,539,000 fixed-line broadband subscribers, respectively.

Data Communications Services

We are a leading provider of data communications services in our fixed-line northern service region. We offer data products, such as those based on digital data networks, or DDN, frame relay, asynchronous transfer mode, or ATM, and Internet protocol-virtual private network, or IP-VPN. We also offer leased line products, including domestic and international leased circuits. Our customers for these services include government entities, large financial institutions and other domestic and multinational businesses, Internet service providers and other telecommunications operators. In 2017, we continued to offer full-scale data communications services to international operators and domestic and international corporate customers. We have also improved our capabilities to offer cross-border data communications and integrated information services.

Fixed-Line Voice Services

Our fixed-line voice services primarily consist of local voice, domestic long-distance, international long-distance and interconnection services. In 2017, as domestic mobile operators launched service packages at competitive pricing, we lowered our mobile roaming tariffs. Also, the migration of voice usage from fixed-line to mobile continued. The number of our fixed-line local access subscribers was 73.86 million, 66.65 million and 60.00 million as of December 31, 2015, 2016 and 2017, respectively. The decrease in recent years was primarily due to a decrease in the number of our fixed-line telephone service subscribers.

 

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Fixed-Line Voice Value-Added Services

We offer a wide range of voice value-added services on our fixed-line network. Our fixed-line voice value-added services generate additional usage on our network and increase our ARPU for fixed-line services. Our main fixed-line voice value-added services include “Personalized Ring” and caller-identification services. “Personalized Ring” services enable our fixed-line subscribers to personalize the ring-back tone for incoming calls.

Fixed-Line Other Services

Our fixed-line other services primarily include installation of fixed-line equipment services, Internet hosting services, telecommunications equipment and real property leasing services and other services.

Bundled Services

We offer bundled services that integrate mobiles services and fixed-line services in one service package. Such service packages generally include 4G services, fixed-line broadband access services, fixed-line voice services and certain other value-added services. Under our bundled service brands, such as “WO Family” and “Ice-cream Package Bundled”, we offer different combination of mobile services and fixed-line services to attract customers with different demands. Our offering of bundled services, among other things, contributes to the increase in our 4G subscribers and fixed-line broadband subscribers.

Data and Internet Application Services

We offer data and Internet application services, such as Internet data center, or IDC, cloud computing, big data, Internet-of-things, information technology services and other innovative services. In 2017, we actively leveraged our advantages in network and informatization, which led to substantial growth in our IDC and cloud computing services. As of December 31, 2017, we had approximately 349 IDC nationwide, 138,000 racks supporting our IDC services, and 81T IDC bandwidth, and, additionally, the resource pool of our “WO” platform consists of 38 public resource pool and 41 private cloud resource pool, with storage capacity of 22.7PB, Internet capacity of 1050G and computing capacity of 812,000 cores. In 2016 and 2017, revenue from data and Internet application services was RMB17.78 billion and RMB20.07 billion, respectively.

Sales of Telecommunications Products

Our sales of telecommunications products primarily comprise sales of mobile handsets, fixed-line terminals and accessories. Revenue from our sales of telecommunications products decreased by 17.9% from RMB44.07 billion in 2015 to RMB36.16 billion in 2016, and further decreased by 28.6% to RMB25.81 billion in 2017, which accounted for 15.9%, 13.2% and 9.4% of our total revenue in 2015, 2016 and 2017, respectively.

Interconnection and Roaming Arrangements

Interconnection

Interconnection refers to the arrangements that permit the connection of our telecommunications networks with other networks. Our mobile and fixed-line networks interconnect with Unicom Group’s networks. Under current arrangements, settlement between Unicom Group and us is based on an internal settlement standard that takes into account either the internal costs of the relevant networks or the government standard applicable between third-party operators, whichever is the more favorable to us.

We charge interconnection fees for terminating or transiting calls that originate from other domestic telecommunications operators’ networks and pay interconnection fees to other operators for calls originating from our networks that are terminated on their networks. We earn and pay such fees in respect of mobile calls, local and domestic and international long-distance calls and Internet services. We are required to pay the interconnection fees regardless of our ability or inability to collect the tariff from our subscribers. Interconnection charges are accrued on a monthly basis based on the actual call volume and applicable tariff rates.

All interconnection and settlement arrangements among domestic telecommunications operators in China are governed by the Telecommunications Regulations and the rules on interconnection arrangements and settlement promulgated by the MIIT. Some of the agreements pursuant to which we interconnect with other domestic operators were entered into by Unicom Group. We have entered into an agreement with Unicom Group pursuant to which we have agreed with Unicom Group that the costs and benefits arising under these agreements, as they relate to our operations, will be incurred to our account.

 

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For additional information about our domestic and international interconnection arrangements, see “B. Business Overview — Regulatory and Related Matters” under Item 4 and “B. Related Party Transactions” under Item  7.

Roaming

We provide roaming services, which allow our subscribers to access our mobile services while they are physically outside of their registered service area or in the coverage areas of other mobile networks in other countries and regions with which we have roaming arrangements. As of March 31, 2018, we had roaming arrangements for (i) GSM international voice and SMS services with 607 operators in 252 countries and regions, (ii) GPRS international inbound data services with 533 operators in 214 countries and regions and for GPRS international outbound data services with 484 operators in 219 countries and regions, (iii) 3G services with 434 WCDMA operators in 174 countries and regions, and (iv) 4G international inbound data services with 226 operators in 121 countries and regions and for 4G international outbound data services with 214 operators in 138 countries and regions.

A mobile subscriber using roaming services is charged at our roaming usage rate for both incoming and outgoing calls, plus applicable long-distance tariffs. Starting from September 1, 2017, we have ceased charging mobile handset subscribers for domestic long-distance tariffs and roaming fee. With respect to international roaming, we settle roaming charges with international operators in accordance with roaming agreements between Unicom Group and each of the international operators.

Networks

We operate an advanced network system to support our integrated operations. The backbone of the system is a nationwide fiber-optic transmission network, which serves as the common platform for our mobile, fixed-line voice, broadband and data services. We generally utilize a centralized network planning and equipment selection process, which ensures uniform nationwide design and network compatibility. After our merger with China Netcom in October 2008, we have actively integrated our network resources to improve our network quality and capacity.

Mobile Networks

Our mobile network generally consists of:

 

    base station sites, which are physical locations, each equipped with a base station that houses transmitters, receivers and other equipment used to communicate through radio channels with subscribers’ mobile handsets within the range of a cell;

 

    base station controllers, which connect to, and control, the base stations;

 

    mobile switching centers, which control the base station controllers and the routing of telephone calls; and

 

    a transmission network, which links the mobile switching centers, base station controllers, base stations and the public switched telephone network.

We have deployed GSM, WCDMA and LTE mobile networks. Our GSM mobile network mainly operates at 900 MHz, 1800 MHz and 2100MHz frequency bands for FDD network and 2300-2320 MHz and 2655-2675 MHz frequency bands for TDD network. In 2016, Unicom Group was granted the approval to refarm all frequency bands for FDD network to deploy LTE network. Unicom Group currently owns 2x61 MHz of spectrum in the frequency bands for FDD network, of which Unicom Group has deployed UMTS network and GSM network using 2x6 MHz of spectrum in the 900 MHz frequency band, LTE network and GSM network using 2x30 MHz of spectrum in 1800 MHz and LTE network and UMTS network using 2x25 MHz of spectrum in 2100 MHz frequency band. In addition, Unicom Group has achieved converged network of TD-LTE network and FDD-LTE network by deploying TDD-LTE network using 2300-2320 MHz of spectrum which is limited to indoor network and 2655-2675 MHz of spectrum.

 

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Unicom Group authorized our wholly owned subsidiary, CUCL, to operate the 4G services. We have devoted significant resources in developing and improving our 4G networks to enhance our customer experience and continued to expand our network coverage. As of December 31, 2017, our 4G network base stations reached 852,000 with an increase of 116,000 base stations compared to December 31, 2016, and our other mobile service base stations reached 1,336,000.

Fixed-Line Networks

We operate fixed-line networks which provide extensive coverage in China. These networks are technologically advanced and conducive to the introduction of the next generation fixed-line network and mobile technologies. These networks support a wide range of end-to-end fixed-line telecommunications services and enable customized products to be delivered to meet a variety of telecommunications needs in “real-time”.

Our fixed-line networks consist of fixed-line telephone networks, broadband Internet and data networks, transmission networks, value-added service platforms, IT support systems and related infrastructures. Our transmission networks consist primarily of fiber-optic based networks, which cover our major service regions, supplemented by satellite transmission and digital microwave links.

We have integrated our resources to optimize and improve the transport capabilities of our IP networks and improved our long-distance soft-switch network capability. In addition, by adding seven national Internet backbone nodes, we further increased our Internet bandwidth, and our broadband network capacity was substantially enhanced. By the end of 2017, the number of fixed-line broadband access ports increased from 189.00 million to 200.0 million, up by 5.8% from the end of 2016, of which the number of access ports with FTTX accounted for 98.8% of total broadband access ports. Our international Internet outbound bandwidth reached 2.46T, our submarine cable capacity reached 16.2T, and our international land cable capacity reached 10.6T.

Marketing, Sales and Distribution

Our marketing strategy is to establish our image as a full-service telecommunications service provider and utilize our comprehensive service platform and nationwide sales and distribution network. We implemented our marketing and sales strategy by cooperating with Internet companies under 2I2C model as well as by cooperating with strategic investors brought in pursuant to the Mixed Ownership Reform Plan. We sought to enhance our brand value and brand recognition by providing quality services, such as high-speed broadband access services, bundled services as well as video-based services, and distribute our services through a variety of distribution channels, consisting of (i) self-owned channels, including proprietary sales outlets and direct sales forces targeting retail and corporate customers, (ii) social channels, including cooperative sales outlets, exclusive sales outlets and agency sales outlets, and (iii) online channels, including self-owned and third-party channels online e-stores. In 2017, we have actively engaged in Online-to-Offline operations that integrate our online channels and offline channels, including the self-owned channels and the social channels. We also increased the operation efficiency of our offline channels by disengaging certain sales outlets and stores with low efficiency and low contribution, optimizing the location of sales outlets and stores and controlling the number of sales outlets and stores. Moreover, we continued offering innovative products. For example, we offer data promotion or other packages to users of Internet companies under 2I2C model, we offer group service package to the employees of enterprises, governments and other organizations under 2B2C model, and we offer “Ice-cream Package” that includes unlimited domestic usage of mobile data and mobile voice under certain prescribed terms to target high-end customers. In recent years, we have conducted and organized events that help build our image as premium network provider, to further enhance “WO” brand value and value of our corporate brand, “China Unicom”.

Customer Services

We provide customer services through our nationwide sales outlets, hotline number “10010”, online sales outlets, SMSs, handset online stores, self-service service platforms, official micro-blog, WeChat and other channels. Our customer services typically include inquiries, service initiation and termination, and response to reports of mechanical malfunction as well as customer complaints and suggestions. We provide customer services to our customers travelling outside of China via a dedicated international roaming service hotline number “18618610010” 24 hours per day, seven days per week. We implement relevant procedures to ensure that our customer services are provided in a timely manner. For instance, to the extent that we are unable to address certain of our customer’s inquiries via our customer hotline, we will make commitments to our customers that we will provide response to their inquiries within a specified timeframe.

 

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We proactively develop and improve our Internet-based customer services. We also continue to improve our customer service system and operations, customer retention and customer service quality. We launch various initiatives to enhance our customer experience by customer service follow-up calls and regular greetings to customers.

We are dedicated to improve customers’ perception of our services. We have adopted an NPS (net promoter score) evaluation system to provide all-rounded monitoring of each of our operating segments and levels, so that we can further understand the need of our clients, adjust to cater to our clients’ needs and improve our professionalism in all respects. In addition, we sought to improve customers’ perception of our services by focusing on the key issues that affect our customer perception and business support. Pursuant to such initiative, we collected such key issues on a rolling basis, set up improvement goals in a quantitative manner and allocate the responsibility for improvement to appropriate personnel. This issue-oriented initiative drove our internal department to further optimize our work process, which resulted in a significant improvement in our customer perception and business support.

Information Systems

We have established multiple information technology support systems in our headquarters as well as in each province, autonomous region and municipality and comprehensive information systems in each province, autonomous region and municipality to support our business and management. For business support, we have established core systems composed of a customer relationship management system, a comprehensive billing and accounting system and an e-commerce system to support our business operations. We also upgraded our IT framework and established an API opening platform, to facilitate cooperation with our business partners. In addition, we enhanced our independent research capability. For example, we independently developed 37% of our core business support system. Furthermore, we have established integrated systems, such as integrated business support system for corporate group customers, integrated channels management system, integrated account settlement system and integrated partnership management system to achieve integrated and centralized management of our businesses and enhance our sales and service capabilities through electronic channels. For our management support, we focused on the construction and optimization of a comprehensive enterprise resource planning system to optimize our work process and resource allocations, improve our customer perception and enhance our operational efficiency, which supported our mini CEO initiative. For our internal data service capabilities, we have established an integrated data analysis system, launched the construction of a large data platform and compiled all data relating to our operation and business support, to support our appraisal management and operational analysis with data. For the application of new technologies, we have launched the construction of our centralized private “cloud” and tried to enhance the performance of the systems with new technologies to lower the overall cost of information technology.

Research and Development

We focus on technology innovation in coordination with our various business departments in order to provide technical support for our business development. Our research and development activities are focused primarily on fixed-line and mobile technologies and their further development, cloud computing, big data, Internet of things, intelligent channels, SDN and NFV, network and information safety, data center, next generation Internet technologies and businesses, operational planning and development of value-added services. In addition, part of our research and development requirements is fulfilled by our ultimate controlling shareholder, Unicom Group, in return for a service fee. See “B. Related Party Transactions” under Item 7 below. In addition, we participate in the national research project on 5G, closely follow the development of 5G technology and standards, and proactively carry out 5G technology related researches and experiments. We also participated in certain international organizations for telecommunications operators, such as the 3rd Generation Partnership Project and the International Telecommunication Union, in which we organized and led a number of research and development projects for formulating 5G technical standards. We have also initiated research and development program on the migration of advanced 4G services with higher network speed as compared to 4G services, or the 4.5G services, to the 5G services. For example, we initiated research and development programs for application of 5G technology in innovative fields, such as high-dissolution videos, augmented reality and virtual reality, Internet of cars and drones. And, we would begin the field test and monetization of 5G services when market conditions are favorable.

 

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Competition

As a result of the telecommunications industry restructuring in 2008, the Chinese telecommunications market now has three key providers of basic telecommunications services — China Telecom, China Mobile and us — in addition to thousands of value-added service providers and other companies that provide telecommunications or related services. We compete with China Mobile and China Telecom in virtually all aspects of our services, including mobile services, fixed-line voice services, broadband services and data communications services. In May 2016, the MIIT granted to China Radio and Television Network Co. Ltd. the approval to operate fixed-line broadband business. We may also compete with China Radio and Television Network Co. Ltd. in fixed-line broadband business. As Unicom Group, China Mobile and China Telecom were granted the license to operate TD-LTE mobile services by the PRC Government in December 2013, Unicom Group and China Telecom were granted the license to operate LTE-FDD mobile services in February 2015 and China Mobile was granted the license to operate LTE-FDD mobile services in April 2018, we face intensive competition in the 4G services. In addition, the PRC Government recently published a series of regulations to encourage privately-owned enterprises to enter PRC telecommunications industry, including the pilot program to permit companies engaged in the resale of mobile communications services to acquire mobile communications services from China Mobile, China Telecom or us and repackaging and rebranding such services for resale to end-users. The initial trial period of the pilot program ended on December 31, 2015, but the telecommunications resale business will continue to be governed by the rules of the pilot program before the MIIT issues any further rules. The MIIT also issued the price guidance for such resale business requiring that the wholesale price for resale of mobile telecommunications services should be lower than the per unit price (or package price) for similar businesses of the mobile networks operators, and we may face competition from these privately-owned enterprises. We also face increasing competition from other service providers, such as cable television companies and Internet service providers, which compete against our broadband access, voice and messaging services and other services by offering telecommunications or related services. See “D. Risk Factors — Risks Relating to Our Business — We face intense competition from other telecommunications operators, including China Mobile and China Telecom, and other companies that provide telecommunications or related services, which may materially and adversely affect our financial condition, results of operations and growth prospects” and “D. Risk Factors — Risks Relating to Our Business — Competition from foreign-invested operators may further increase the competition for employees, exacerbate price competition and increase our operating expenses, thereby adversely affecting our financial condition, results of operations and growth prospects” under Item 3, respectively.

The Tower Company

See “D. Risk Factors — Our business relies on the lease arrangements with the Tower Company as to telecommunications towers and related assets, and we may not be able to achieve the expected benefits from the establishment of the Tower Company and such lease arrangements” under Item 3 and “A. History and Development of the Company — Establishment of the Tower Company and the Disposal of Telecommunications Towers” under Item 4 for information regarding the Tower Company and arrangement regarding telecommunications towers and related assets.

Strategic Alliances with Telefónica

We entered into and maintained a strategic alliance with Telefónica, S.A., or Telefónica, since January 2009. Telefónica and we agreed to share business experience and strengthen cooperation in the areas of mobile communications, broadband applications, international business, marketing and sales and telecommunications services to corporate clients, to strengthen the business of each party and achieve synergies by cooperation. Additionally, we and Telefónica made mutual investment in each other, and held ordinary shares of the other party. Subsequently, Telefónica completed a series of sales of ordinary shares in the capital of our company. Also, since September 2015, Wang Xiaochu, our Executive Director, Chairman and Chief Executive Officer, has served as a director on the board of directors of Telefónica as our designated representative. As of the date of this annual report, Telefónica held less than 5% ordinary shares in the capital of our company. In December 2015, we and Telefónica established a joint venture company, Smart Steps Digital Technology Co., Ltd., or Smart Steps, to engage in big data application services in China.

 

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Strategic Cooperation with China Telecom

In January 2016, we entered into a strategic cooperation agreement with China Telecom in relation to resource-sharing and joint investments. Under the strategic cooperation, we agreed to share certain telecommunications facilities such as mobile networks and transmission networks with each other, jointly carry out certain network maintenance services and certain marketing initiatives, as well as seek and explore opportunities in joint investments in innovative and emerging business areas. Our strategic cooperation is expected to enhance our service qualities and operating efficiency, and thus improving our customer experience and contributing to our market recognition.

Trademarks

We conduct our businesses under the Unicom name and logo. Unicom Group is the registered proprietor in China of the “Unicom” trademark in English and the trademark bearing the Unicom logo. Unicom Group is also the registered proprietor of the trademark of the word “Unicom” in Chinese (“联通”). Unicom Group has granted us the right to use these trademarks on a royalty-free basis with periodic renewals, and licensed us any trademark that it registers in China in the future which incorporates the word Unicom.

Risk Management and Internal Control

We employ risk management and internal control systems to monitor and facilitate the accomplishment of the our business objectives, safeguard the our assets against loss and misappropriation, respond to natural disasters and other disruptive events, such as cyber-attacks, maintain proper accounting records for the provision of reliable financial information, ensure the our compliance with applicable laws, rules and regulations. Our board of directors is responsible for overseeing the risk management and internal control systems, and reviews the effectiveness of the risk management and internal control systems on an annual basis. However, our risk management and internal control systems are designed to manage rather than eliminate the risk of failure to achieve business objectives, and can only provide reasonable and not absolute assurance against material misstatement or loss.

In addition, we also maintain insurance with respect to our facilities, equipment and inventories, which covers, subject to some limitations, various risks, including fire, typhoons, earthquakes and other risks generally up to the respective policy limit for their replacement values and lost profits due to business interruption. However, there is no assurance that insurance will fully cover any losses and our emergency response plans will be effective in preventing or reducing losses in the future. See “D. Risk Factors — Interruptions to our networks and operating systems or to those with which we interconnect, including those caused by natural disaster and service maintenance and upgrades, may disrupt our services and operations and may result in customer dissatisfaction and materially and adversely affect our financial condition, results of operations and growth prospects” under Item  3.

Regulatory and Related Matters

The telecommunications industry in China is subject to a high degree of government regulation. The primary regulatory authority of the Chinese telecommunications industry is the MIIT, established in 2008 as a new ministry under the PRC State Council and the successor of the former Ministry of Information Industry. The NDRC, the Ministry of Commerce and other governmental authorities also maintain regulatory responsibilities over certain aspects of the Chinese telecommunications industry.

The MIIT, under the supervision of the State Council, is responsible for, among other things:

 

    formulating and enforcing industry policies and regulations, as well as technical standards;

 

    granting telecommunications service licenses;

 

    supervising the operations and quality of services of telecommunications service providers;

 

    allocating and administering telecommunications resources such as spectrum and number resources;

 

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    formulating interconnection and settlement policies between telecommunications networks; and

 

    maintaining fair and orderly market competition among service providers.

The MIIT has established a Telecommunications Administration in each province, autonomous region and municipality in China to oversee the implementation of the MIIT’s policies and regulations and exercising regulatory authority delegated by the MIIT within that province, autonomous region or municipality.

Relevant departments of the PRC government, under the direction of the State Council, are in the process of drafting a telecommunications law that, once adopted by the National People’s Congress of the PRC, will become the basic telecommunications statute and provide the principal legal framework for telecommunications regulations in China. It is currently uncertain when the law will be adopted and become effective. See “D. Risk Factors — Risks Relating to the Telecommunications Industry in China — Potential changes in laws, regulations and policies relating to the PRC telecommunications industry or any future industry restructuring may materially and adversely affect our financial condition, results of operations and growth prospects” under Item 3.

Cybersecurity

We are subject to the Cybersecurity Law, which came into effect on June 1, 2017. The Cybersecurity Law sets forth the general framework regulating network products, equipment, and services, as well as the operation and maintenance of information networks, protection of personal information, and supervision and administration of cybersecurity in Mainland China. According to the Cybersecurity Law, the Cyberspace Administration of China, or the CAC, has a central role in planning, coordination, supervision, and management of network security measures while the MIIT, the national public safety bureau, and other relevant authorities are in charge of network security protection, supervision and management within the scope of their respective responsibilities. Pursuant to the Cybersecurity Law, we are required to perform a security assessment when transferring personal information and important data overseas if such personal information and important data are collected from the operation in China. Such requirements, among other things, could increase our compliance costs. While several related regulations, including the Measures for the Security Review of Network Products and Services (Provisional) and the Internet News Information Service Management Regulations, published by the CAC came into effect on the same day as the Cybersecurity Law, the implementation of the Cybersecurity Law is still at an early stage. The PRC government may amend the relevant regulations or promulgate new regulations to clarify and further implement the Cybersecurity Law. Although we expect that the Cybersecurity Law will have a positive effect on the overall development of the telecommunications industry and enhance information protection in Mainland China, we currently cannot predict the scope of any specific requirements that may be imposed on us and their implications for our operations under the Cybersecurity Law and relevant regulations.

In addition, the Measures for the Security Review of Network Products and Services (Provisional) became effective on June 1, 2017. According to Measures for the Security Review of Network Products and Services (Provisional), the procurement of network products and services must go through a cybersecurity review if such procurement is made for network and information systems that involve national security concern. Relevant government authorities responsible for the protection of critical information infrastructure facilities will decide on whether such procurement of network products and services would threat national security. Since we are one of the leading telecommunications service providers in China, our products and service may be supplied to network and information systems that involve national security concern. As such, we may be requested to provide information for such cybersecurity review. Since the implementation of the Measures for the Security Review of Network Products and Services (Provisional) is still at an early stage, we currently cannot estimate their impact on and implications for our operation.

We have employed risk management and internal control systems to safeguard us against cyber-attacks and to comply with laws and regulations related to cybersecurity. As of April 13, 2018, we have not been subject to any material cyber-attacks or incidents, individually or in the aggregate, that had or would expected to have a material adverse effect on our business and operations, nor had we been involved in any legal proceedings or regulatory investigations related thereto. However, as the regulatory landscape of cybersecurity is subject to substantial uncertainty, we cannot assure you that we will always be in compliance with laws and regulations related to cybersecurity or we will not be held liable for cyber-attacks that committed against us. See “D. Risk Factors — We face risks associated with our Internet-related services” under Item  3.

 

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Anti-Unfair Competition Law

On January 1, 2018, the amended Anti-Unfair Competition Law of the People’s Republic of China came into effect. It revised and expanded the scope of unfair competitive acts which include, among others, a network operator’s interference with and destruction of products or services provided by other operators. It also strengthened the protection of trade secrets and enhanced supervision over and penalties on unfair competitive acts. Given that the implementation of the amended Anti-Unfair Competition Law of the People’s Republic of China is at an early stage and there is uncertainty with respect to its interpretations and enforcement, we are unable to determine its impact on our business.

Telecommunications Regulations

On September 25, 2000, the State Council promulgated the Telecommunications Regulations of the People’s Republic of China, which came into effect on the same date. All telecommunications activities and related activities within China are subject to the Telecommunications Regulations, which were amended in accordance with the Decision of the State Council on Amending Certain Administrative Regulations on February 6, 2016.

According to the PRC Government, its administration and regulation of the Chinese telecommunications industry is based on the principles of the separation of governmental regulation from enterprise management, the elimination of monopolistic behavior, the encouragement of competition and the promotion of the development of the Chinese telecommunications industry, while also taking into account the principles of openness, equality and fairness. The Telecommunications Regulations regulate all major aspects of the telecommunications industry, including licensing, interconnection, tariffs, resources, services, security, facility construction and access to networks.

Licensing

The PRC Government licenses telecommunications businesses in accordance with their classification. Telecommunications businesses are currently classified into two broad categories of basic services and value-added services. An appendix to the Telecommunications Regulations divides each of the two categories into further sub-categories. On December 28, 2015, the MIIT promulgated the Telecommunications Service Catalogue (2015 edition), or the 2015 Catalogue, which took effect on March 1, 2016. According to the 2015 Catalogue:

 

    basic telecommunications services are classified into Category I basic telecommunications services and Category II basic telecommunications services.

 

    Category I basic telecommunications services include fixed-line telecommunications services (including fixed-line local, domestic long-distance and international long-distance telecommunications services and services related to maintaining international telecommunications facilities), cellular mobile telecommunications services (including 2G digital cellular mobile telecommunications services, 3G digital cellular mobile telecommunications services and LTE/4G digital cellular mobile telecommunications services), Category I satellite telecommunications services (including satellite mobile telecommunications and satellite fixed-line telecommunications services), Category I data communications services (including Internet international data telecommunications, Internet domestic long-distance data telecommunications, Internet local data telecommunications and International data communications services) and IP telephone services (including domestic and international IP telephone services).

 

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    Category II basic telecommunications services include trunking telecommunications services (including digital trunking telecommunications services), wireless paging services, Category II satellite telecommunications services (including lease and sales of satellite transponders and very-small-aperture-terminal, or VSAT, telecommunications services), Category II data telecommunications services (including fixed-line domestic data transmission services), services related to network access facilities (including services related to wireless network access facilities and cable network access facilities, and network services from customer premises), services related to maintaining domestic telecommunications facilities and network hosting services.

 

    value-added telecommunications services are classified into Category I value-added telecommunications services and Category II value-added telecommunications services.

 

    Category I value-added telecommunications services include IDC, CDN, domestic Internet virtual private network and Internet access services.

 

    Category II value-added telecommunications services include on-line data processing and interchange, domestic multi-party telecommunications, store-and-forward, call center (including domestic and offshore call centers), information and coding and protocol conversion (including domain name system) services.

On March 1, 2009, the MIIT promulgated the Measures on the Administration of Telecommunications Business Licenses, which took effect on April 10, 2009 and superseded the previous measures promulgated by the former Ministry of Information Industry on December 26, 2001.

The measures govern the application for, approval of and regulation of telecommunications business licenses in China. The operation of any basic telecommunications business is subject to the MIIT’s approval and grant of License for Operation of Basic Telecommunications Businesses. The operation of any value-added business in two or more provinces, autonomous regions or municipalities is subject to the MIIT’s approval and grant of License for Inter-Provincial Operation of Value-Added Telecommunications Businesses. The operation of value-added businesses within a single province, autonomous region or municipality is subject to the approval of the telecommunications authority of the relevant province, autonomous region or municipality in China and the grant of the License for Operation of Value-Added Telecommunications Businesses. The measures, among other things, lowered the minimum amount of registered capital required for an applicant to enter the basic telecommunications business in China.

After the PRC’s accession to the WTO, on December 11, 2001, the State Council promulgated the Administrative Regulations on Telecommunications Companies with Foreign Investments, which took effect on January 1, 2002, and were amended in accordance with the Decision of the State Council on Amending Certain Administrative Regulations on February 6, 2016. Those commitments include the gradual reduction of restrictions on foreign ownership in telecommunications enterprises in China and the step-by-step opening-up of the Chinese telecommunications market to foreign enterprises. In recent years, China gradually lifted restrictions for foreign investors in telecommunications enterprises in China and fulfilled its commitment to open up the Chinese telecommunications market. However, the following restrictions on investments in mobile, value-added telecommunications and fixed-line services remain:

 

    for fixed-line services, there is no longer any geographic restriction and foreign ownership may be no more than 49%;

 

    for mobile voice and data services, there is no longer any geographic restriction and foreign ownership may be no more than 49%; and

 

    for value-added telecommunications services, there is no longer any geographic restriction and foreign ownership may be no more than 50%.

 

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Spectrum and Network Number Resources

The MIIT is responsible for the management of the wireless radio frequency spectrum and the allocation of frequencies within the spectrum. The frequency assigned to a telecommunications operator may not be leased or transferred without the MIIT’s approval. In June 2017, the NDRC and the MOF jointly announced new frequency usage fees: (i) for the nationwide frequency bands, an annual rate of RMB16 million per MHz is charged for frequency bands below 960MHz, an annual rate of RMB14 million per MHz is charged for frequency bands between 960MHz and 2,300MHz, and an annual rate of RMB8 million per MHz is charged for frequency bands above 2,300MHz; (ii) for the frequency bands used in each province, an annual rate of RMB1.6 million per MHz is charged for frequency bands below 960MHz, an annual rate of RMB1.4 million per MHz is charged for frequency bands between 960MHz and 2,300MHz, and an annual rate of RMB0.8 million per MHz is charged for frequency bands above 2,300MHz; (iii) for the frequency bands used in each city, an annual rate of RMB160,000 per MHz is charged for frequency bands below 960MHz, an annual rate of RMB140,000 per MHz is charged for frequency bands between 960MHz and 2,300MHz, and an annual rate of RMB80,000 per MHz is charged for frequency bands above 2,300MHz.

The MIIT is also responsible for the administration of China’s telecommunications network number resources. The telecommunications network number resources are owned by the State, which shall charge fees for the use of such resources. Application for the use of number resources by any telecommunications operator is subject to the approval of the MIIT or the relevant provincial telecommunications authority and the payment of certain usage fees. The measures also provide for the procedures for the application, usage and record-keeping for the telecommunications operators’ use of number resources.

Tariff Setting

Prior to January 2014, the levels and categories of telecommunications tariffs were subject to regulation by various government authorities, including the MIIT, the NDRC, and, at the local level, the relevant provincial Telecommunications Administration Bureaus and price regulatory authorities.

In January 2014, the State Council announced the removal of the MIIT’s approval requirement on the tariff standard of telecommunications services. In addition, pursuant to the amendments to the Telecommunications Regulations dated August 15, 2014, the telecommunications tariffs shall be set by the telecommunications operators based on costs and market conditions.

In May 2015, the PRC government introduced the PRC Government’s policy of increasing network speed and reducing tariff. In response to such policy, we have since then offered discounts to our tariff plans. In addition, in October 2015, we launched our mobile data carry-over programs, which allow subscribers of our data plans with pre-determined monthly data limit to carry over their unused data to the following month with no extra charge. Furthermore, in light of the national policy of achieving coordinated development of Beijing Municipality, Tianjin Municipality and Hebei Province issued in April 2015 by the PRC Government, we cancelled the long-distance and roaming tariffs for voice services within the tariff zones of Beijing Municipality, Tianjin Municipality and Hebei Province so that our customers are only charged with local usage tariff for our voice services provided within the tariff zones. On March 6, 2017, we announced that we plan to substantially reduce Internet private line access tariff for small and medium enterprises customers and international long-distance call tariff. In addition, in September 2017, we ceased charging mobile handset subscribers domestic long-distance and roaming fee. In March 2018, the PRC Government published certain guidance relating to network speed upgrade and tariff reduction in the Government Work Report made in the 13th National People’s Congress of the People’s Republic of China, and set specific goals, including but not limited to (i) stepping up network speed upgrade and tariff reduction measures, (ii) achieving full coverage of high-speed broadband in cities and towns, (iii) expanding the coverage of free Internet access in public venues, (iv) substantially reducing the tariffs of household broadband, corporate broadband and private line services, and (v) cancelling data “roaming” fee while mobile data tariff shall decrease by at least 30% in the year of 2018. As we may have to devote substantial resources, incur significant expenses and make strategic decisions on or adjustment of operation strategies in order to meet with these requirements, our compliance with the “speed upgrade and tariff reduction” policy may have an adverse effect on our financial condition, results of operations and growth prospects.

 

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Mobile Services

Generally, the categories of tariffs we charge our mobile subscribers include, among others, basic monthly fees and local usage charges, roaming charges, long-distance-call charges and charges for value-added services.

Intensifying competition in our mobile service areas has resulted in tariff discounts and service promotions offered by us and our main competitors from time to time, which may reduce the effective tariffs. These discounts and promotions have taken many forms, including promotional tariff rates, free call minutes, reduced roaming charges, off-peak discounts or discounts for high-usage subscribers and package service plans with fixed monthly fees.

We have introduced a number of package service plans. Under these plans, subscribers typically pay a fixed monthly fee for a specified number of call minutes. The plans vary at the levels of fixed monthly fee, number of specified call minutes and tariff rates for call minutes in excess of the specified call minutes. The terms of these plans also vary depending on the local markets.

Fixed-Line Voice Services

For our local voice services, we charge an installation and testing fee that varies depending on whether the subscriber is a residential or a business customer, a fixed monthly fee, local call usage fees based on call duration and fees for certain value-added services. For our domestic long-distance services, our revenue consist of charges based on the duration, time of day and day of the week a call is placed. For our international, Hong Kong, Macau and Taiwan long distance wireline services, we charge usage fees based on call duration and call destination.

Data Services

Our data services consist of DDN services and frame relay services. We charge monthly fees for DDN services and frame relay services, which vary based on bandwidth and whether it is intra-district, inter-district or long-distance.

Leased Line Services

We charge monthly fees for subscribers to our leased line services based on guidance tariffs set by the PRC Government, which vary based on bandwidth and whether the leased line is local or long-distance. Leased line tariffs have generally decreased in recent years.

Interconnection Arrangements

In October 2003, the former Ministry of Information Industry issued Measures on Settlement of Interconnection between Public Telecommunications Networks and Sharing of Relaying Fees, which superseded the Measures on the Settlement of Call Charges between Telecommunications Networks issued by the former Ministry of Information Industry in 2001. These regulations contain specific provisions regarding, among other things, revenue-sharing methods and settlement mechanisms and interconnection agreements among telecommunications service providers. Since November 2005, the former Ministry of Information Industry (or the MIIT after March 2008) has issued a number of administrative measures to adjust the settlement arrangement standards with respect to interconnection fees for certain network interconnections between telecommunications operators. In accordance with various administrative measures, Unicom Group or we, as the case may be, have entered into agreements on interconnection with other telecommunications operators, including China Telecom and China Mobile.

 

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The following table sets forth selected interconnection revenue-sharing and settlement arrangements for local calls:

 

Operator from Whose Network Calls

Are Originated

  

Operator at Whose Network Calls Are
Terminated

  

Current Main Settlement

Arrangement

Mobile operator    Local fixed-line operator   

(1) Mobile operator collects the usage fees from its subscribers;

 

(2) Mobile operator pays RMB0.06 per minute to local fixed-line operator. For calls originated from “157” or “188” prefix phone numbers (TD users) during the period from January 1, 2010 to December 31, 2010, mobile operator (China Mobile) pays RMB0.012 per minute to fixed-line operator. From January 1, 2011, for calls originated from “157” or “188” prefix phone numbers (TD users), mobile operator (China Mobile) continues to pay RMB0.012 per minute to fixed-line operator.

Local fixed-line operator    Mobile operator   

(1) Local fixed-line operator collects the usage charge from its subscribers;

 

(2) No revenue-sharing or settlement prior to June 1, 2010. Local fixed-line operator pays RMB0.001 per minute to mobile operator after June 1, 2010.

Mobile operator A    Mobile operator B   

(1) Mobile operator A collects the cellular usage charge from its subscribers;

 

(2) Mobile operator A pays RMB0.06 per minute to mobile operator B. For calls originated from a mobile user of China Telecom or Unicom to a mobile user of China Mobile (not including “157” or “188” prefix phone numbers (TD users)) during the period from January 1, 2014, Mobile operator A (China Telecom or Unicom) pays RMB0.04 per minute to mobile operator B (China Mobile). For calls originated from “157” or “188” prefix phone numbers (TD users) during the period from January 1, 2010, mobile operator A (China Mobile) pays RMB0.012 per minute to mobile operator B (China Telecom or Unicom).

Local fixed-line operator A    Local fixed-line operator B   

(1) Operator A collects the usage fees from its subscribers;

 

(2) In the case of intra-district calls, operator A pays operator B 50% of the intra-district usage fees;

 

(3) (i) In the case of local inter-district calls from operator A using operator B’s local inter-district trunk circuit, operator A collects the usage charge from its subscribers and pays RMB0.06 per minute to operator B; (ii) In the case of local inter-district calls from operator A not using operator B’s local inter-district trunk circuit, operator A collects the usage charge from its subscribers and pays operator B 50% of the intra-district usage fees.

 

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The following table sets forth selected current major main interconnection revenue-sharing and settlement arrangements for domestic long-distance calls:

 

Operator at Whose Network Calls

Are Originated

 

Operator at Whose Network Calls Are
Terminated

 

Current Main Settlement

Arrangement

Local fixed-line or mobile operator A (through the long-distance network of operator A)   Local fixed-line or mobile operator B   For calls originated from a mobile user of China Telecom or Unicom to a mobile user of China Mobile (not including “157” or “188” prefix phone numbers (TD users)) during the period from January 1, 2014, Mobile operator A (China Telecom or Unicom) pays RMB0.04 per minute to mobile operator B (China Mobile). Other than the above, operator A pays RMB0.06 per minute to operator B.
Fixed-line or mobile operator A   Domestic long-distance calls made without using the carrier identity code of operator B (through the long-distance network of operator B)  

(1) Operator A collects the tariff from the subscribers;

 

(2) If Operator A is a fixed-line operator, operator A retains RMB0.06 per minute; if operator A is a mobile operator, operator A retains local usage fee and RMB0.06 per minute; and

 

(3) Operator A pays operator B the rest of the domestic long-distance tariff.

Note: Domestic long-distance calls shall be charged at the domestic long-distance call tariff of operator B.

Local fixed-line or mobile operator A   Domestic long-distance calls made by using the carrier identity code of operator B (through the long-distance network of operator B)  

(1) Operator B collects the tariff from the subscribers; and

 

(2) Operator B pays operator A RMB0.06 per minute.

 

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The following table sets forth selected current main interconnection revenue-sharing and settlement arrangements for public switched telephone network international long-distance calls, including calls originated from and terminated in Hong Kong, Macau and Taiwan:

 

Operator at Whose Network Calls

Are Originated

  

Operator at Whose Network Calls Are
Terminated

  

Current Main Settlement

Arrangement

Local fixed-line or mobile

operator A

   International long-distance calls (including to Hong Kong, Macau and Taiwan) made without using the carrier identity code of operator B and directed by operator A from the originating network to operator B.   

(1) Operator A collects the tariff from the subscribers;

 

(2) If operator A is a fixed-line operator, operator A retains no more than RMB0.54 per minute with the remaining paid to operator B; and

 

(3) If operator A is a mobile operator, operator A retains local usage fees and no more than RMB0.54 per minute with the remaining paid to operator B.

Note: International long-distance calls shall be charged at the international long-distance call tariff of operator B.

Local fixed-line or mobile

operator A

   International long-distance calls made by using the carrier identity code of operator B and through the domestic and international long-distance networks of operator B.   

(1) Operator B collects the tariff from the subscribers; and

 

(2) Operator B pays operator A RMB0.06 per minute.

The following table sets forth selected current main interconnection revenue-sharing and settlement arrangements for VoIP long-distance calls:

 

Operator from Whose Network Calls

Are Originated

  

Operator at Whose Network Calls Are
Terminated

  

Current Main Settlement

Arrangement

Fixed-line or mobile operator A    Fixed-line or mobile operator B through the VoIP network of operator C   

(1) Operator A collects local usage fees;

 

(2) Operator C collects the VoIP long-distance usage fees from its subscribers;

 

(3) Operator C pays RMB0.06 per minute to operator B on the terminating end;

 

(4) No settlement between operator C and operator A on the originating end.

 

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The following table sets forth selected current main interconnection revenue-sharing and settlement arrangements for SMS:

 

Network from Which

SMS Originated

  

Network at Which
SMS Terminated

  

Current Main Settlement
Arrangement

Fixed-line or mobile operator A    Fixed-line or mobile operator B   

(1) Operator A collects the tariff from its subscribers;

 

(2) Operator A pays RMB0.01 (RMB0.03 during the period from January 1, 2010 to December 31, 2013; RMB0.05 prior to January 1, 2010) per SMS to Operator B

The following table sets forth selected current main interconnection revenue-sharing and settlement arrangements for MMS:

 

Network from Which

MMS Originated

  

Network at Which
MMS Terminated

  

Current Main Settlement
Arrangement

Mobile operator A    Mobile operator B   

(1) Operator A collects the tariff from its subscribers;

 

(2) Operator A pays RMB0.05 (RMB0.10 during the period from January 1, 2010 to December 31, 2013; RMB0.15 prior to January 1, 2010) per MMS to Operator B

Technical Standards

The MIIT is responsible for promulgating the technical standards for China’s telecommunications industry and establishing the technical requirements and testing parameters for telecommunications equipment (including network and end-user equipment). The MIIT is also responsible for designating qualified institutes to test telecommunications equipment, which would grant network access licenses (or product standard certificates) for the equipment that has successfully passed the relevant tests. Only telecommunications equipment for which a network access license (or a product standard certificate) has been granted may be sold and used in China.

Most of the standards used in the Chinese telecommunications industry are generally based on the standards issued by nine international organizations for telecommunications standards, including International Telecommunications Union, 3rd Generation Partnership Project, Groupe Speciale Mobile Association and Global Certification Forum, and six open source platforms including Open Network Operating System and OpenDaylight, with more specific requirements made in light of China’s particular telecommunications industry. On the basis of the technical standards used in China’s telecommunications industry, we may formulate our own technical standards based on our own needs and issue additional requirements for telecommunications equipment in order to meet our operational needs. All telecommunications equipment purchased by China’s telecommunications operators must have been granted a network access license issued by the MIIT and must meet the standards set forth by the relevant operators.

Quality of Services

Under the Telecommunications Regulations, the MIIT and the relevant provincial telecommunications administrations are responsible for supervising and monitoring the quality of services provided by telecommunications operators in China. Under the Telecommunications Regulations, customers of telecommunications operators have the right to submit their complaints to the MIIT and the relevant provincial telecommunications administrations or other relevant government authorities. In addition, the MIIT, together with other governmental authorities, has taken measures to prompt telecommunications operators to screen indecent contents carried through their networks.

 

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Universal Services

Telecommunications service providers in China are required to fulfill universal service obligations in accordance with relevant regulations to be promulgated by the PRC Government, and the MIIT has the authority to delineate the scope of its universal service obligations. The MIIT may also select universal service providers through a tendering process. The MIIT, together with the finance and pricing authorities, is also responsible for formulating administrative rules relating to the establishment of a universal service fund and compensation schemes for universal services. Under the Telecommunications Regulations, all PRC telecommunications operators shall provide universal services, and we expect to perform our duties thereunder accordingly. In December 2015, the MOF and the MIIT jointly issued the rules regarding the pilot program for universal services to be implemented in certain cities across the PRC. Since then, the MIIT has designated additional cities and villages as participants of the pilot program for universal services in public notice from time to time. Pursuant to the pilot program for universal services, we undertook broadband construction projects in 16,134 villages from 2016 to 2017, out of which broadband construction projects in 3,557 villages were undertaken in 2017.

The MIIT has required major Chinese telecommunications service providers, including Unicom Group and former Netcom Group, to participate in a project to provide telecommunications services in tens of thousands of remote villages in certain designated provinces in China as transitional measures prior to the formalization of a universal service obligation framework. In participating in this project, Unicom Group has undertaken the universal service obligation to extend telecommunications service coverage to all administrative-level villages primarily through its fixed-line and mobile broadband networks. Currently, with our assistance, Unicom Group is further extending telecommunications service coverage to natural villages in remote areas in China as designated by the MIIT. We have been assisting Unicom Group in providing mobile telecommunications services to these remote villages and are responsible for the operation and maintenance of the relevant network facilities in our service areas. See “D. Risk Factors — Risks Relating to the Telecommunications Industry in China — The PRC Government may require us, along with other telecommunications service providers in China, to provide universal services with specified obligations, and we may not be compensated adequately for providing such services” under Item 3.

Sharing of Telecommunications Infrastructure.

In May 2017, the MIIT and the SASAC jointly issued the 2017 Implementation Opinions on Promoting the Joint Construction and Sharing of Telecommunications Infrastructure, or the Opinions. The Opinions require that the supporting facilities for base stations, such as the telecommunications towers, and the indoor distribution systems for public transportation and buildings, shall generally be planned, constructed and delivered by the Tower Company, except that certain facilities may be constructed by a telecommunications operator if serving only such operators’ demand. The Opinions also set forth the sharing requirements in the construction of FTTH infrastructure. In newly-built residential areas, commercial areas and campus, FTTH construction must strictly observe the applicable national and local standards. Telecommunication operators are prohibited from entering into any exclusivity arrangement with real estate developers or property management companies. In the upgrading of FTTH for existing residential areas, commercial areas and campus, telecommunication operators and relevant stakeholders must cooperate with each other to comply with the joint construction and sharing requirements. Moreover, with respect to transmission facilities, sharing and joint construction of transmission poles and pipeline is mandatory whenever conditions so allow. It is expected that the sharing of telecommunications infrastructure would enable us to expand our service coverage at lower cost, and thus enhance our service quality and operating efficiency.

Convergence Policy of Telecom, Broadcasting and Internet Networks

In January 2010, the PRC Government announced its decision to accelerate the advancement of convergence of television broadcast, telecommunications and Internet access networks to realize interconnection and resource-sharing among the three networks and further develop the provision of voice, data, television and other services. In 2015, the PRC Government promulgated the Notice on Issuance of the Plan to Promote Convergence of Telecom, Broadcasting and Internet Networks by the General Office of the State Council, and started to fully implement such policy across-the-board. The PRC Government may amend relevant policies or promulgate new regulations corresponding to the implementation of the three-network convergence policy in the future.

 

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Mobile Telecommunications Resale Business

In May 2013, the MIIT issued the pilot program for mobile telecommunications resale business that permit privately-owned enterprises to purchase mobile services from telecommunications operators and provide mobile services to end-customers after repackaging and rebranding. Although the initial trial period of the pilot program ended on December 31, 2015, the mobile services leasing and repackaging will continue to be governed by the rules of the pilot program until the MIIT issues any further rule. On January 6, 2016, the MIIT issued the Guidance on the Wholesale Price Adjustments of Mobile Telecommunications Resale Business (关于移动通信转售业务批发价格调整的指导意见), pursuant to which the MIIT required that the wholesale price for resale of mobile telecommunications services should be lower than the per unit price (or package price) for similar businesses of the mobile networks operators. We have been promoting the sustainable development of the resale business through cooperation to achieve win-win results. As of December 31, 2017, 31 companies purchased mobile services covering approximately 45 million end customers from us, accounting for approximately 73% of the total market share as of the same date in terms of the number of end customers.

VAT Applicable to the Telecommunications Services

The PRC Government implemented value-added tax, or VAT, to replace business tax relating to the telecommunications services in China on June 1, 2014. Effective as of May 1, 2016, VAT became applicable to all the other industries in China. Furthermore, as of May 1, 2018, the rate of VAT applicable to our basic telecommunications services would be reduced from 11% to 10%, and the rate of VAT applicable to our sales of telecommunications products would be reduced from 17% to 16%.

Output VAT is excluded from operating revenue while input VAT, which is incurred as a result of our receipt of services and purchases of telecommunications equipment and materials, is excluded from operating expenses or the original cost of equipment purchased and can be netted against the output VAT, arriving at the net amount of VAT recoverable or payable. Such net amount of VAT is recorded in the line item of prepayments and other current assets and taxes payable, respectively, on the face of consolidated statements of financial position. As a result of application of VAT to all other industries in China, more of capital expenditures and operating expenses became entitled to input VAT credits, which offset our VAT output tax obligations. As the implementation of VAT to replace business tax was expanded to other industries nationwide in 2016, we were able to reduce operating costs by claiming input VAT credits. In addition, we have claimed input VAT credits on our capital expenditures for purchasing certain assets, which resulted in a lower depreciation.

Others

As a company with substantially all of our operations in China, we, along with our ultimate controlling shareholder, Unicom Group, are subject to various regulations of the PRC Government in addition to those regulating telecommunications industry. PRC regulatory authorities, such as the State Bureau of Taxation, National Audit Office and SAIC, exercise extensive oversight over various aspects of our businesses and conduct various regular inspections, examinations and/or audits on us and Unicom Group. As required by the relevant PRC laws and regulations, Unicom Group, as one of the key State-owned enterprises under the direct supervision of the SASAC, is also subject to routine audits by the National Audit Office, or the NAO as well as other PRC regulatory authorities.

In addition, the SASAC has an indirect influence over us as our ultimate controlling shareholder, Unicom Group, is under the direct supervision of the SASAC. In particular, the SASAC may designate certain nominees and request Unicom Group to propose the appointment of such nominees as our directors and senior management. The SASAC may also request Unicom Group to remove our directors and senior management in accordance with relevant procedures provided by applicable law and our articles of association.

Disclosure of Iranian Activities under Section 13(r) of the Securities Exchange Act of 1934

Section 219 of the Iran Threat Reduction and Syria Human Rights Act of 2012 added Section 13(r) to the Exchange Act of 1934, as amended. Section 13(r) requires an issuer to disclose in its annual or quarterly reports, as applicable, whether it or any of its affiliates knowingly engaged in certain activities, transactions or dealings relating to Iran or with designated natural persons or entities involved in terrorism or the proliferation of weapons of mass destruction. Disclosure is required even where the activities, transactions or dealings are conducted outside the U.S. by non-U.S. affiliates in compliance with applicable law, and whether or not the activities are sanctionable under U.S. law.

 

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As of the date of this report, we are not aware of any activity, transaction or dealing by us or any of our affiliates in 2017 that requires disclosure in this under Section 13(r) of the Exchange Act of 1934, as amended, except as set forth below.

Our ultimate controlling shareholder, Unicom Group, is a party to the international roaming agreements with Mobile Company of Iran, or MCI, and MTN Irancell, or MTN, respectively. We have been informed by Unicom Group that, in 2017, the estimated gross revenue Unicom Group generated from such inbound international roaming traffic with MCI and MTN was approximately RMB367,534 and RMB6,003, respectively, and the estimated total amount paid by Unicom Group to MCI and MTN for the outbound international roaming traffic was approximately RMB64,290 and approximately RMB356,908, respectively. Unicom Group does not customarily allocate net profit on a country-by-country or activity-by-activity basis, and therefore it is not possible to determine accurately the precise net profits attributable to such transactions with MCI and MTN. Unicom Group estimates that the net profits attributable to the transactions with MCI and MTN were negligible relevant to its overall net profits. We understand that Unicom Group intends to continue these activities in the future.

 

C. Organizational Structure

We are incorporated in Hong Kong and as of April 13, 2018, we were (i) 53.5% owned by Unicom BVI, which was 17.9% owned by Unicom Group and 82.1% owned by the A Share Company, which in turn was 36.7% owned by Unicom Group, (ii) 26.4% owned by Unicom Group BVI, which in turn was 100% owned by Unicom Group, and (iii) 20.1% owned by public shareholders. See “— A. History and Development of the Company” above. Set forth below are details of our significant subsidiaries.

 

Name of Subsidiary

   Place of Incorporation    Ownership Interest  

China United Network Communications Corporation Limited

   China      100

Unicom Vsens Telecommunications Company Limited

   China      100

Unicom New Horizon Telecommunications Company Limited

   China      100

China Unicom (Hong Kong) Operations Limited

   Hong Kong      100

China Unicom (Americas) Operations Limited

   United States      100

China Unicom (Singapore) Operations Pte. Ltd.

   Singapore      100

China Unicom (Europe) Operations Limited

   United Kingdom      100

China Unicom (Japan) Operations Corporation

   Japan      100

China Unicom (MYA) Operations Company Limited

   The Republic of the Union of
Myanmar
     100

China Unicom (Australia) Operations Pty Limited

   Australia      100

China Unicom Global Limited

   Hong Kong      100

China Unicom (Russia) Operations Limited Liability Company

   Russia      100

China Unicom (Brazil) Telecommunications Company Limited

   Brazil      100

China Unicom Finance Company Limited

   China      91

China Unicom Big Data Company Limited

   China      100

China Unicom (Guangdong Branch) Internet Industry Limited

   China      100

China Unicom (Zhejiang) Industry Internet Company Limited

   China      100

China Unicom (ShanDong) Industrial Internet Company Limited

   China      100

 

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D. Properties

Our principal executive offices are located in Hong Kong. We also maintain executive offices in Beijing. We own and lease a large number of offices, retail outlets, equipment rooms and base stations throughout China. In some cases, we have not entered into formal lease agreements with the lessors or the lessors may not possess requisite title certificates. We believe that it is unlikely that we would be denied our right to use a large number of these properties at any given time.

 

Item 4A. Unresolved Staff Comments

Not Applicable.

 

Item 5. Operating and Financial Review and Prospects

You should read the following discussion and analysis in conjunction with the selected financial data set forth in Item 3 and our consolidated financial statements, together with the related notes, included elsewhere in this annual report on Form 20-F.

Overview

We are an integrated telecommunications operator in China providing voice usage, broadband and mobile data services, data and Internet application services, other value-added services, leased lines and associated services and telecommunications products to our customers. In recent years, we have continued to extend the coverage of all of our services nationwide. We, China Mobile and China Telecom are the three major telecommunications operators in China.

The table below sets forth revenue from our major services and their respective percentage of our total revenue in 2015, 2016 and 2017.

 

     For the Year Ended December 31,  
     2015      2016      2017  
     RMB in
millions
     % of
Total
     RMB in
millions
     % of
Total
     RMB in
millions
     % of
Total
 

Total revenue

     277,049        100.0        274,197        100.0        274,829        100.0  

Total service revenue(1)

     232,976        84.1        238,033        86.8        249,015        90.6  

Voice usage and monthly fees

     57,030        20.6        47,500        17.3        39,154        14.2  

Broadband and mobile data services

     105,634        38.1        118,209        43.1        137,133        49.9  

Data and Internet application services

     12,936        4.7        17,782        6.5        20,074        7.3  

Other value-added services

     27,411        9.9        24,187        8.8        22,793        8.3  

Interconnection fees

     15,514        5.6        14,748        5.4        14,233        5.2  

 

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     For the Year Ended December 31,  
     2015      2016      2017  
     RMB in
millions
     % of
Total
     RMB in
millions
     % of
Total
     RMB in
millions
     % of
Total
 

Leased lines and associated services

     11,484        4.1        11,618        4.2        12,519        4.6  

Other services

     2,967        1.1        3,989        1.5        3,109        1.1  

Sales of telecommunications products(2)

     44,073        15.9        36,164        13.2        25,814        9.4  

 

(1)  As our business continues to evolve, we have been engaged in further integration of our mobile services, fixed-line services and other services, including offering more bundled service packages across mobile and fixed-line services. As such, in 2017, we began presenting the breakdown of service revenue as revenue from voice usage and monthly fees, broadband and mobile data services, data and Internet application services, other value-added services, interconnection fees, leased lines and associated services and other services. The relevant presentation for our service revenue in 2015 and 2016 has therefore been reclassified to conform with current year’s presentation.
(2)  Revenue from sales of products associated with the ICT business, which was previously recorded as part of the fixed-line service revenue, has been reclassified as revenue from sales of telecommunications products to better reflect the commercial nature of the transactions. The related figures for the years ended December 31, 2015 and 2016 have been reclassified on the same basis.

Our service revenue primarily consists of the following:

 

    revenue from voice usage and monthly fees for our mobile and fixed-line voice services, which are recognized when we render the services to our customers;

 

    revenue from broadband and mobile data services, which are recognized when the services are provided to customers;

 

    revenue from data and Internet application services mainly representing revenue from the provision of data storage and application, information communications technology and other Internet-related service, which are recognized when services are rendered;

 

    revenue from other value-added services revenue mainly representing revenue from the provision of short message, cool ringtone, “Personalized Ring”, caller number display and secretarial services, which are recognized when services are rendered;

 

    revenue from interconnection fees representing revenue received or receivable from other domestic and foreign telecommunications operators for the use of the Group’s telecommunications network, which are recognized when service is rendered;

 

    revenue from leased lines and associated services representing income from offering lines and customer-end equipment to customers for usage and related services, which are recognized on a straight-line basis over the lease and service period;

 

    revenue from other services representing revenue from broadband installation services, subscriber points reward program, real property leasing services and certain other miscellaneous services; and

 

    revenue from sales of telecommunications products mainly representing revenue from sale of mobile handsets, fixed-line terminals and accessories, which are recognized when title has been passed to the buyers.

 

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The following table sets forth our major costs and expenses items and income before income tax, both in terms of amount and as a percentage of total revenue in 2015, 2016 and 2017.

 

     For the Year Ended December 31,  
     2015     2016     2017  
     RMB in
millions
    % of Total     RMB in
millions
    % of Total     RMB in
millions
    % of Total  

Total revenue

     277,049       100.0       274,197       100.0       274,829       100.0  

Costs, expenses and others

     263,014       94.9       273,413       99.7       272,236       99.1  

Interconnection charges

     13,093       4.7       12,739       4.6       12,617       4.6  

Depreciation and amortization

     76,738       27.7       76,805       28.0       77,492       28.2  

Network, operation and support expenses

     42,308       15.3       51,167       18.7       54,507       19.8  

Employee benefit expenses

     35,140       12.7       36,907       13.5       42,471       15.5  

Selling and marketing

     31,965       11.5       34,646       12.6       34,086       12.4  

General, administrative and other expenses(1)

     20,962       7.6       19,939       7.3       23,080       8.4  

Cost of telecommunications products sold(1)

     46,079       16.6       39,301       14.3       26,643       9.7  

Finance costs, net of interest income

     6,496       2.3       3,857       1.4       4,087       1.5  

Other income-net

     (9,767     (3.5     (1,948     (0.7     (2,747     (1.0

 

(1)  Revenue from sales of products associated with the ICT business, which was previously recorded as part of the fixed-line service revenue, has been reclassified as revenue from sales of telecommunications products to better reflect the commercial nature of the transactions. Correspondingly, certain cost of sales of products associated with the ICT business, which was previously recorded as part of the general, administrative and other expenses, has been reclassified as part of the cost of telecommunications product sold. The related figures for the years ended December 31, 2015 and 2016 have been reclassified on the same basis.

Our major costs and expenses include the following:

 

    interconnection expenses, representing amounts paid to other operators for calls from our networks to their networks and for calls made by our subscribers roaming in their networks;

 

    depreciation and amortization expenses, mainly relating to our property, plant and equipment and other assets;

 

    network, operation and support expenses, primarily including repairs and maintenance, power and water charges, operating lease charges for network, premises, equipment and facilities, operating lease and other service charges to Tower Company and others;

 

    employee benefit expenses, primarily including salaries and wages, contributions to defined contribution pension schemes, contributions to medical insurance, contributions to housing fund and other benefits;

 

    selling and marketing expenses, primarily including commission and other service expenses, advertising and promotion expenses, Internet access terminal maintenance expenses and customer retention costs;

 

    general, administrative and other expenses, primarily including impairment losses for doubtful debts and write-down of inventories, auditors’ remuneration, property management fee, office and administrative expenses, transportation expense, miscellaneous taxes and fees, service technical support expenses, repairs and maintenance expenses, loss on disposal of property, plant and equipment and others;

 

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    cost of telecommunications products sold, primarily including costs of handsets and other telecommunication products and others; and

 

    finance costs, net of interest income, primarily including interest expenses, net of interest income.

Critical Accounting Policies

The preparation of our financial statements and this annual report on Form 20-F requires us to make estimates and judgments that affect the reported and disclosed amounts of assets and liabilities, including contingent assets and liabilities, as of the relevant dates and revenue and expenses for the relevant periods. We have identified below the areas involving a higher degree of judgment or complexity, or areas where assumptions are significant to the accounting policies and estimates, as critical to our business operations and an understanding of our results of operations and financial position. The impact and any associated risks related to these policies on our business operations are discussed throughout this Item 5 where such policies affect our reported and expected financial results. For a discussion of the application of these and other accounting policies, see Note 2 and Note 4 to our consolidated financial statements included elsewhere in this annual report on Form 20-F. There can be no assurance that actual results will not differ from those estimates and assumptions.

Significant Accounting Policies

Revenue Recognition

Revenue comprises the fair value of the consideration received or receivable for the services and sales of goods or telecommunications products in the ordinary course of our business activities.

We recognize revenue when the amount of revenue can be reliably measured, it is probable that future economic benefits will flow to the entity and specific criteria have been met for each of our activities as described below. We base our estimates on historical results, taking into consideration the type of customer, the type of transaction and the specifics of each arrangement.

Sales of services and goods

 

    Voice usage and monthly fees are recognized when the services are rendered;

 

    Revenue from the provision of broadband and mobile data services are recognized when the services are provided to customers;

 

    Data and Internet application service revenue, which mainly represent revenue from the provision of data storage and application, information communications technology and other Internet-related service, are recognized when services are rendered;

 

    Other value-added services revenue, which mainly represents revenue from the provision of services such as short message, cool ringtone, “Personalized Ring”, caller number display and secretarial services, are recognized when services are rendered;

 

    Interconnection fees represent revenue received or receivables from other domestic and foreign telecommunications operators for the use of our telecommunications network, are recognized when the services are rendered;

 

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    Revenue from leased lines and associated services, which mainly represents income from offering lines and customer-end equipment to customers for usage and related services are recognized on a straight-line basis over the respective lease and service period;

 

    Standalone sales of telecommunications products, which mainly represent handsets and accessories, are recognized when titles have been passed to the buyers; and

 

    Preferential packages to the customers which include the bundled sale of mobile handsets and provision of services. The total contract consideration of such preferential packages is allocated to service revenue and sales of handsets based on their relative fair values. Revenue relating to the sale of the handset is recognized when the title is passed to the customer whereas service revenue is recognized based upon the actual usage of the telecommunications services. The cost of the mobile handset is expensed immediately to the statement of income upon revenue recognition.

Dividend income

Dividend income is recognized when the right to receive payment is established.

Deferred Revenue, Advances from Customers and Subscriber Points Reward Program

Deferred revenue

Deferred revenue mainly represents upfront non-refundable fees, including installation fees of fixed-line services, which are deferred and recognized over the expected customer service period. Deferred revenue expected to be recognized in one year or less is classified as current liabilities. If not, they are presented as non-current liabilities.

Advances from customers

Advances from customers are mainly amounts paid by customers for prepaid cards, other calling cards and prepaid service fees, which cover future telecommunications services. Advances from customers are stated at the amount of proceeds received less the amount already recognized as revenue upon the rendering of services.

Subscriber points reward program

The fair value of providing telecommunications services and the subscriber points reward is allocated based on their relative fair values. The allocated portion of fair value for the subscriber points reward is recorded as deferred revenue when the rewards are granted and recognized as revenue when the points are redeemed or expired.

Critical Accounting Estimates and Judgments

Depreciation on Property, Plant and Equipment

Depreciation on our property, plant and equipment is calculated using the straight-line method to allocate cost up to residual values over the estimated useful lives of the assets. We review the useful lives and residual values periodically to ensure that the method and rates of depreciation are consistent with the expected pattern of realization of economic benefits from property, plant and equipment. We estimate the useful lives of property, plant and equipment based on historical experience, taking into account anticipated technological changes. If there are significant changes from previously estimated useful lives, the amount of depreciation expenses may change.

Impairment of Non-Financial Assets

We test whether non-financial assets have suffered from any impairment, in accordance with the accounting policy stated in Note 2.12 to the audited consolidated financial statements contained elsewhere in this annual report on Form 20-F. The recoverable amount of an asset is the higher of its fair value less costs to sell and its value in use. Management estimates value in use based on estimated discounted pre-tax future cash flows of the cash generating unit at the lowest level to which the asset belongs. If there is any significant change in management’s assumptions, including discount rates or growth rates in the future cash flow projection, the estimated recoverable amounts of the non-financial assets and our results would be significantly affected. Such impairment losses are recognized in the statement of income. Accordingly, there will be an impact to the future results if there is a significant change in the recoverable amounts of the non-financial assets.

 

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No significant impairment loss on property, plant and equipment was recognized for the years ended December 31, 2015, 2016 and 2017.

Allowance for Doubtful Debts

Management estimates an allowance for doubtful debts resulting from the inability of the customers to make the required payments. Management bases its estimates on the aging of the accounts receivable balance, customer credit-worthiness, and historical write-off experience. If the financial condition of the customers were to deteriorate, additional allowance may be required.

Income Tax and Deferred Taxation

We estimate our income tax provision and deferred taxation in accordance with the prevailing tax rules and regulations, taking into account any special approvals obtained from relevant tax authorities and any preferential tax treatment to which we are entitled in each location or jurisdiction in which we operate. There are many transactions and calculations for which the ultimate tax determination is uncertain during the ordinary course of business. We recognize liabilities for anticipated tax audit issues based on estimates of whether additional taxes will be due. Where the final tax outcome of these matters is different from the amounts that were initially recorded, such differences will impact the income tax and deferred tax provisions in the period in which such determination is made.

For temporary differences which give rise to deferred tax assets, we have assessed the likelihood that the deferred tax assets could be recovered. Major deferred tax assets relate to deductible tax losses, unrecognized revaluation surplus on prepayments for the leasehold land determined under PRC regulations, accruals of expenses not yet deductible for tax purpose, and allowance for doubtful debts. Due to the effects of these temporary differences on income tax, we have recorded net deferred tax assets amounting to approximately RMB5,973 million as of December 31, 2017. Deferred tax assets are recognized based on our estimates and assumptions that they will be recovered from taxable income arising from continuing operations in the foreseeable future.

We believe we have recorded adequate current tax provision and deferred taxes based on the prevailing tax rules and regulations and our current best estimates and assumptions. In the event that future tax rules and regulations or related circumstances change, adjustments to current and deferred taxation may be necessary which would impact our results or financial position.

Determining the Type of Lease

We analyze the substance of the leases to determine whether the arrangements should be classified as operating leases or finance leases in accordance with the requirements of the prevailing accounting standards. We base our judgment on the lease agreements and related arrangements to assess whether substantially all the risks and rewards incidental to ownership of the leased assets has been transferred.

Recently Issued International Financial Reporting Standards

The IASB has issued a number of amendments to IFRSs that are first effective for the current accounting period commencing January 1, 2016 or are available for early adoption. See Note 2.2(c) to our consolidated financial statements included elsewhere in this annual report on Form 20-F.

Up to the date of issue of our 2017 financial statements, the following amendments, new standards and interpretations have been issued but not yet effective for the annual accounting period ended December 31, 2017 and have not been adopted by us in our 2017 financial statements:

 

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     Effective for
accounting periods
beginning on or after

IFRS 9 (2014) “Financial instruments”

   1 January 2018

IFRS 15 “Revenue from contracts with customers”

   1 January 2018

Amendments to IFRS 2, Share-based payment “Classification and measurement of share-based payment transactions”

   1 January 2018

Amendments to IFRS 40, Investment property “Transfer of investment property”

   1 January 2018

IFRIC 22, “Foreign currency transaction and advance consideration”

   1 January 2018

Annual Improvements to IFRSs 2014-2016 Cycle

   January 1, 2019

IFRS 16 “Leases”

   January 1, 2019

IFRIC 23, “Uncertainty over income tax treatments”

   January 1, 2019

Operating Results

Year Ended December 31, 2017 Compared to Year Ended December 31, 2016

Revenue

In 2017, we continued to actively develop full-service operation with a focus on 4G services and fixed-line broadband services. Total revenue in 2017 was RMB274.83 billion, representing an increase of 0.2% from RMB274.20 billion in 2016. The increase in our total revenue was primarily due to the increase of RMB10.98 billion, or 4.6%, in our total service revenue from RMB238.03 billion in 2016 to RMB249.02 billion in 2017, partially offset by the decrease of RMB10.35 billion, or 28.6%, in sales of telecommunications products from RMB36.16 billion in 2016 to RMB25.81 billion in 2017. The service revenue represented 86.8% and 90.6% of our total revenue in 2016 and 2017, respectively. The growth in our service revenue was primarily due to an increase of RMB18.92 billion, or 16.0% in our revenue from broadband and mobile data services from RMB118.21 billion in 2016 to RMB137.13 billion in 2017, which was partially offset by decrease of RMB8.35 billion, or 17.6% in our revenue from voice usage and monthly fees from RMB47.50 billion in 2016 to RMB39.15 billion in 2017.

The table below sets forth the composition of our revenue for the years ended December 31, 2016 and 2017, respectively.

 

     For the Year Ended December 31,  
     2016      2017  
     RMB in millions      % of Total      RMB in millions      % of Total  

Total revenue

     274,197        100.0        274,829        100.0  

Total service revenue(1)(2)

     238,033        86.8        249,015        90.6  

Voice usage and monthly fees

     47,500        17.3        39,154        14.2  

Broadband and mobile data services

     118,209        43.1        137,133        49.9  

Data and Internet application services

     17,782        6.5        20,074        7.3  

Other value-added services

     24,187        8.8        22,793        8.3  

Interconnection fees

     14,748        5.4        14,233        5.2  

Leased lines and associated services

     11,618        4.2        12,519        4.6  

Other services

     3,989        1.5        3,109        1.1  

Sales of telecommunications products(2)

     36,164        13.2        25,814        9.4  

 

(1)  As our business continues to evolve, we have been engaged in further integration of our mobile services, fixed-line services and other services, including offering more bundled service packages across mobile and fixed-line services. As such, in 2017, we began presenting the breakdown of service revenue as revenue from voice usage and monthly fees, broadband and mobile data services, data and Internet application services, other value-added services, interconnection fees, leased lines and associated services and other services. The relevant presentation for our service revenue in 2016 has therefore been reclassified to conform with current year’s presentation.

 

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(2)  Revenue from sales of products associated with the ICT business, which was previously recorded as part of the fixed-line service revenue, has been reclassified as revenue from sales of telecommunications products to better reflect the commercial nature of the transactions. The related figures for the year ended December 31, 2016 has been reclassified on the same basis.

Voice Usage and Monthly Fees. Voice usage include local usage fees charged for local voice calls and VoIP long-distance calls, and long-distance usage fees for domestic and international long-distance calls originated by our mobile and fixed-line subscribers, users of our pre-paid phone cards and certain other customers. Monthly fees represent the fixed amount of service charges to our customers for using our mobile and fixed-line voice services.

Our service revenue from voice usage and monthly fees was RMB39.15 billion in 2017, representing a decrease of 17.6% from RMB47.50 billion in 2016. The decrease in our revenue from voice usage and monthly fees was primarily as a result of (i) the intensifying competition among the major PRC telecommunications operators, (ii) the implementation of the PRC Government’s “speed upgrade and tariff reduction” policy, as well as our cancelling of mobile handset subscribers domestic long-distance and roaming fee in September 2017, and (iii) the continuing decline in the number of fixed-line local access subscribers and revenue due to the continuing effect of mobile substitution, as such decline was not fully offset by the corresponding increase in revenue from mobile voice usage. We expect the above factors to have a continuing effect on our usage fees and monthly fees in the foreseeable future. As a percentage of total revenue, revenue from our voice usage and monthly fees decreased from 17.3% in 2016 to 14.2% in 2017.

Broadband and Mobile Data Services. Our service revenue from broadband and mobile data services consist primarily of revenue from our fixed-line broadband and mobile data services. Due to our proactive promotion of integrated broadband and mobile data services, our service revenue from broadband and mobile data services amounted to RMB137.13 billion in 2017, representing an increase of 16.0% from RMB118.21 billion in 2016. The increase was partially offset by the implementation of the PRC Government’s “speed upgrade and tariff reduction” policy. As a percentage of total revenue, service revenue from our broadband and mobile data services increased from 43.1% in 2016 to 49.9% in 2017.

Data and Internet Application Services. Our service revenue from data and Internet application services primarily include revenue from data storage and application, information communications technology and other Internet-related services. Our service revenue from data and Internet application services increased by 12.9% from RMB17.78 billion in 2016 to RMB20.07 billion in 2017. The increase in our service revenue from data and Internet application services was primarily as a result of our cooperation with Internet companies under 2I2C model to offer their users data promotion and other packages, and our focus on providing content-based services to our customers. As a percentage of total revenue, service revenue from our data and Internet application services increased from 6.5% in 2016 to 7.3% in 2017.

Other value-added Services. Our service revenue from other value-added services primarily include revenue from SMSs, Cool Ringtone, “Personalized Ring”, call number display and secretarial services to subscribers. Our service revenue from other value-added services decreased by 5.8% from RMB24.19 billion in 2016 to RMB22.79 billion in 2017. The decrease in our service revenue from other value-added services was primarily as a result of a declining trend of customers using ringtone or certain other voice service related services. As a percentage of total revenue, service revenue from other value-added services decreased from 8.8% in 2016 to 8.3% in 2017.

Interconnection Fees. Interconnection fees primarily include revenue received or receivable from other domestic and foreign telecommunications operators for the use of our telecommunications network Our service revenue from interconnection fees decreased by 3.5% from RMB14.75 billion in 2016 to RMB14.23 billion in 2017. The decrease in our service revenue from interconnection fees was primarily as a result of the decrease in the volume of the interconnection voice calls primarily due to a substitution trend that mobile subscribers use certain value-added telecommunications applications or services in lieu of voice calls for communication purposes. As a percentage of total revenue, revenue from interconnection fees slightly decreased from 5.4% in 2016 to 5.2% in 2017.

 

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Leased Lines and Associated Services. Our service revenue from leased lines and associated services primarily include income from offering lines and customer-end equipment to customers for usage and related services. Our service revenue from leased lines and associated services increased by 7.8% from RMB11.62 billion in 2016 to RMB12.52 billion in 2017. The increase in our service revenue from leased lines and associated services was primarily driven by the increasing demand by enterprises and government for our lines and other network elements leasing services. As a percentage of total revenue, revenue from leased lines and associated services increased from 4.2% in 2016 to 4.6% in 2017.

Other Services. Our service revenue from other services primarily include broadband installation services, subscriber points reward program and certain other miscellaneous services. Service revenue from other services decreased by 22.1% from RMB3.99 billion in 2016 to RMB3.11 billion in 2017, mainly due to the increase in our subscriber points and the usage of subscriber points. As a percentage of total revenue, service revenue from other services decreased from 1.5% in 2016 to 1.1% in 2017.

Sales of Telecommunications Products. Our sales of telecommunications products decreased by 28.6% from RMB36.16 billion in 2016 to RMB25.81 billion in 2017, mainly due to the decrease in the sales amount of our mobile handsets as we changed our sales and marketing model from attracting customers mainly via sales of telecommunications products and providing handset subsidies to attracting customers mainly by our mobile data service packages. We expect such adjustment in our sales and marketing model to have a continuing effect on our revenue from sales of telecommunications products in the foreseeable future. As a percentage of total revenue, our sales of telecommunications products decreased from 13.2% in 2016 to 9.4% in 2017.

Costs, Expenses and Others

Total costs, expenses and others in 2017 were RMB272.24 billion, representing a decrease of 0.4% from RMB273.41 billion in 2016. The decrease in total costs, expenses and others was primarily due to a 32.2% decrease in cost of telecommunications products sold as a result of the decrease in our sales of telecommunications products, which was partially offset by increase in network, operation and support expenses, employee benefit expenses and general, administrative and other expenses, partially offset by the increase in our general, administrative and other expenses, employee benefit expenses and network, operation and support expenses.

The table below sets forth the major items of costs, expenses and others and their respective percentage of the total revenue in 2016 and 2017:

 

     For the Year Ended December 31,  
     2016      2017  
     RMB in millions      % of Total      RMB in millions      % of Total  

Total revenue

     274,197        100.0        274,829        100.0  

Costs, expenses and others

     273,413        99.7        272,236        99.1  

Interconnection charges

     12,739        4.6        12,617        4.6  

Depreciation and amortization

     76,805        28.0        77,492        28.2  

Network, operation and support expenses

     51,167        18.7        54,507        19.8  

Employee benefit expenses

     36,907        13.5        42,471        15.5  

Selling and marketing expenses

     34,646        12.6        34,086        12.4  

General, administrative and other expenses(1)

     19,939        7.3        23,080        8.4  

Cost of telecommunications products sold(1)

     39,301        14.3        26,643        9.7  

Finance costs, net of interest income

     3,857        1.4        4,087        1.5  

Other income-net

     (1,948      (0.7      (2,747      (1.0

 

(1)  Revenue from sales of products associated with the ICT business, which was previously recorded as part of the service revenue, has been reclassified as revenue from sales of telecommunications products to reflect the commercial nature of the transaction. Correspondingly, certain cost of sales of products associated with the ICT business, which was previously recorded as part of the general, administrative and other expenses, has been reclassified as part of the cost of telecommunications products sold. The related costs for the year ended December 31, 2016 has been reclassified on the same basis.

 

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Interconnection Charges. Interconnection charges were RMB12.62 billion in 2017, down by 1.0% from RMB12.74 billion in 2016, primarily due to the decrease in volume of the interconnection voice calls. Interconnection charges as a percentage of total revenue remained stable in 2017 as compared with 2016.

Depreciation and Amortization. Our depreciation and amortization expenses were RMB77.49 billion in 2017, up by 0.9% from RMB76.81 billion in 2016 mainly due to the increase in our property, plant and equipment. As a percentage of total revenue, our depreciation and amortization expenses slightly increased from 28.0% in 2016 to 28.2% in 2017.

Network, Operation and Support Expenses. We incurred network, operation and support expenses of RMB54.51 billion in 2017, up by 6.5% from RMB51.17 billion in 2016, primarily due to the increase in the operating lease and other service charges of telecommunications towers and related assets payable to the Tower Company, and the increase in our other spending to maintain network quality and customer experience. Network, operation and support expenses, as a percentage of total revenue, increased from 18.7% in 2016 to 19.8% in 2017.

Employee Benefit Expenses. Our employee benefit expenses increased by 15.1% from RMB36.91 billion in 2016 to RMB42.47 billion in 2017, mainly due to the increase in compensation for our front-line staff, and, as a percentage of total revenue, increased from 13.5% in 2016 to 15.5% in 2017.

Selling and Marketing Expenses. Our selling and marketing expenses were RMB34.09 billion in 2017, down by 1.6% from RMB34.65 billion in 2016, primarily due to the decrease in the service fees we paid to traditional marketing channels as we cooperated with Internet companies under 2I2C model to offer their users data promotion and other packages, and we disengaged certain sales outlets and stores with low efficiency and low contribution, and as a percentage of total revenue, slightly decreased from 12.6% in 2016 to 12.4% in 2017.

General, Administrative and Other Expenses. Our general, administrative and other expenses were RMB23.08 billion in 2017 and accounted for 8.4% of total revenue, up by 15.8% from RMB19.94 billion in 2016, primarily because we had a net loss in an amount of RMB3.49 billion on disposal of property, plant and equipment in 2017. As a percentage of total revenue, general, administrative and other expenses increased from 7.3% in 2016 to 8.4% in 2017.

Cost of Telecommunications Products Sold. In 2017, the cost of telecommunications products sold amounted to RMB26.64 billion, down by 32.2% from RMB39.30 billion in 2016, generally in line with the decrease in the sales of telecommunications products in 2017 as we reduced handset subsidies to our customers mainly due to the decrease in our sales of telecommunications products. As a percentage of total revenue, cost of telecommunication products sold decreased from 14.3% in 2016 to 9.7% in 2017.

Finance Costs, Net of Interest Income. Our finance costs, net of interest income, increased by 6.0% from RMB3.86 billion in 2016 to RMB4.09 billion in 2017, which was primarily due to the increase in our payment of interest on bank loans repayable within five years, partially offset by the decrease in our payment of interest on corporate bonds, promissory notes and commercial papers repayable within five years as we made full repayments for certain of such debt and our loss of foreign exchange settlement mainly as a result of appreciation in exchange rate of Renminbi against U.S. dollars. As a percentage of total revenue, finance cost, net of interest income, slightly increased from 1.4% in 2016 to 1.5% in 2017.

Other Income-Net. In 2017, other income-net was RMB2.75 billion in 2017, representing an increase by 41.0% from RMB1.95 billion in 2016, primarily as a result of increase in our share of net profit of associates and our share of net profit of the Tower Company. As a percentage of total revenue, other income-net increased from 0.7% in 2016 to 1.0% in 2017.

 

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Income Before Income Tax

In 2017, our income before income tax was RMB2.59 billion, representing a significant increase from RMB0.78 billion in 2016, primarily driven by (i) a 16.0% increase in our service revenue from broadband and mobile data services, (ii) a 32.2% decrease in our cost of telecommunications products sold, and (iii) a 12.9% increase in our service revenue from data and Internet application services. This was partially offset by (i) the 28.6% decrease in our revenue from sales of telecommunications products, (ii) the 17.6% decrease in our service revenue from voice usage and monthly fees, (iii) the 6.5% increase in our network, operation and support expenses, (iv) the 15.1% increase in our employees benefit expenses and (v) the 15.8% increase in our general, administrative and other expenses.

Income Tax

Our income tax was RMB0.74 billion in 2017, up by 382.5% from RMB0.15 billion in 2016, primarily due to the increase in our income before income tax. Our effective tax rate in 2017 was 28.6%, up by 9.0 percentage points from 19.6% in 2016, primarily because (i) certain expenses paid by CUCL in 2017 were not tax deductible, and (ii) we did not recognize certain unused tax losses in 2017 as deferred tax assets.

Net Income for the Year

As a result of the foregoing, our net income was RMB1.85 billion in 2017, representing a significant increase from RMB0.63 billion in 2016 primarily due to the increase in our income before income tax. Our basic earnings per share was RMB0.07 in 2017, compared to RMB0.03 in 2016.

Year Ended December 31, 2016 Compared to Year Ended December 31, 2015

Revenue

In 2016, we continued to actively develop full-service operation with a focus on 4G services and fixed-line broadband services. Total revenue in 2016 was RMB274.20 billion, representing a decrease of 1.0% from RMB277.05 billion in 2015. The decrease in our total revenue was primarily due to the decrease of RMB7.91 billion, or 17.9%, in our revenue from sales of telecommunications products from RMB44.07 billion in 2015 to RMB36.16 billion in 2016, which was partially offset by the increase in total service revenue of RMB5.06 billion, or 2.2%, from RMB232.98 billion in 2015 to RMB238.03 billion in 2016. Our service revenue represents 84.1% and 86.8% of our total revenue in 2015 and 2016, respectively. The growth in our service revenue was primarily drive by an increase in our revenue from broadband and mobile data services and data and Internet application services, which was partially offset by decrease in our service revenue from voice usage and monthly fees and other value-added services.

The table below sets forth the composition of our total revenue and each revenue item’s respective share of total revenue for the years ended December 31, 2015 and 2016.

 

     2015      2016  
     RMB in millions      % of Total      RMB in millions      % of Total  

Total revenue

     277,049        100.0        274,197        100.0  

Total service revenue(1)(2)

     232,976        84.1        238,033        86.8  

Voice usage and monthly fees

     57,030        20.6        47,500        17.3  

Broadband and mobile data services

     105,634        38.1        118,209        43.1  

Data and Internet application services

     12,936        4.7        17,782        6.5  

Other value-added services

     27,411        9.9        24,187        8.8  

Interconnection fees

     15,514        5.6        14,748        5.4  

Leased lines and associated services

     11,484        4.1        11,618        4.2  

Other services

     2,967        1.1        3,989        1.5  

Sales of telecommunications products(2)

     44,073        15.9        36,164        13.2  

 

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(1)  As our business continues to evolve, we have been engaged in further integration of our mobile services, fixed-line services and other services, including offering more bundled service packages across mobile and fixed-line services. As such, in 2017, we began presenting the breakdown of service revenue as revenue from voice usage and monthly fees, broadband and mobile data services, data and Internet application services, other value-added services, interconnection fees, leased lines and associated services and other services. The relevant presentation for our service revenue in 2015 and 2016 has therefore been reclassified to conform with current year’s presentation.
(2)  Revenue from sales of products associated with the ICT business, which was previously recorded as part of the fixed-line service revenue, has been reclassified as revenue from sales of telecommunications products to better reflect the commercial nature of the transactions. The related figures for the years ended December 31, 2015 and 2016 have been reclassified on the same basis.

Voice Usage and Monthly Fees. Voice usage include local usage fees charged for local voice calls and VoIP long-distance calls, and long-distance usage fees for domestic and international long-distance calls originated by our mobile and fixed-line subscribers, users of our pre-paid phone cards and certain other customers. Monthly fees represent the fixed amount of service charges to our customers for using our mobile and fixed-line voice services.

Our service revenue from voice usage and monthly fees were RMB47.50 billion in 2016, representing a decrease of 16.7% from RMB57.03 billion in 2015. The decrease in our revenue from voice usage and monthly fees was primarily as a result of (i) the intensifying competition among the major PRC telecommunications operators and (ii) the implementation of the PRC Government’s “speed upgrade and tariff reduction” policy. As a percentage of total revenue, revenue from our voice usage and monthly fees decreased from 20.6% in 2015 to 17.3% in 2016. We expect the above factors to have a continuing effect on our usage fees and monthly fees in the foreseeable future.

Broadband and Mobile Data Services. Our service revenue from broadband and mobile data services consist primarily of revenue from our fixed-line broadband and mobile data services. Due to our proactive promotion of 4G data services, our service revenue from broadband and mobile data services was RMB118.21 billion in 2016, representing an increase of 11.9% from RMB105.63 billion in 2015. The increase was partially offset by the implementation of the PRC Government’s “speed upgrade and tariff reduction” policy and our unused mobile data carry over policy. As a percentage of total service revenue, service revenue from our broadband and mobile data services increased from 38.1% in 2015 to 43.1% in 2016.

Data and Internet Application Services. Our service revenue from data and Internet application services primarily include revenue from data storage and application, information communications technology and other Internet-related services. Our service revenue from data and Internet application services increased by 37.5% from RMB12.94 billion in 2015 to RMB17.78 billion in 2016. The increase in our service revenue from data and Internet application services was primarily driven by the increasing demand for our data storage and application, information communications technology and other Internet-related services. As a percentage of total revenue, service revenue from our data and Internet application services increased from 4.7% in 2015 to 6.5% in 2016.

Other value-added Services. Our service revenue from other value-added services primarily include revenue from SMSs, Cool Ringtone, “Personalized Ring”, call number display and secretarial services to subscribers. Our service revenue from other value-added services decreased by 11.8% from RMB27.41 billion in 2015 to RMB24.19 billion in 2016. The decrease in our service revenue from other value-added services was primarily as a result of the decrease in subscribers of Cool Ringtone, “Personalized Ring” and other voice value-added services. As a percentage of total revenue, service revenue from our other value-added services decreased from 9.9% in 2015 to 8.8% in 2016.

 

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Interconnection Fees. Interconnection fees primarily include revenue received or receivable from other domestic and foreign telecommunications operators for the use of the Group’s telecommunications network Our service revenue from interconnection fees decreased by 4.9% from RMB15.51 billion in 2015 to RMB14.75 billion in 2016. The decrease in our service revenue from interconnection fees was primarily as a result of a substitution trend that mobile subscribers use certain value-added telecommunications applications or services in lieu of voice calls for communication purposes. As a percentage of total revenue, service revenue from our interconnection fees decreased from 5.6% in 2015 to 5.4% in 2016.

Leased Lines and Associated Services. Our service revenue from leased lines and associated services primarily include income from offering lines and customer-end equipment to customers for usage and related services. Our service revenue from leased lines and associated services increased by 1.2% from RMB11.48 billion in 2015 to RMB11.62 billion in 2016. The increase in our service revenue from leased lines and associated services was primarily driven by the increasing demand by enterprises and government for our lines and other network elements leasing services. As a percentage of total revenue, service revenue from our leased lines and associated services increased from 4.1% in 2015 to 4.2% in 2016.

Other Services. Our service revenue from other services primarily include broadband installation services, subscriber points reward program and certain other miscellaneous services. Service revenue from other services increased by 34.4% from RMB2.97 billion in 2015 to RMB3.99 billion in 2016, mainly due to the increase in our mobile telecommunications resale business. As a percentage of total revenue, service revenue from our other services increased from 1.1% in 2015 to 1.5% in 2016.

Sales of Telecommunications Products. Our sales of telecommunications products decreased by 17.9% from RMB44.07 billion in 2015 to RMB36.16 billion in 2016, mainly due to the decrease in the sales amount of our mobile handsets as we reduced handset subsidies to our customers. We expect the above factors to have a continuing effect on our revenue from sales of telecommunications products in the foreseeable future. As a percentage of total revenue, our sales of telecommunications products decreased from 15.9% in 2015 to 13.2% in 2016.

Costs, Expenses and Others

Total costs, expenses and others in 2016 were RMB273.41 billion, representing an increase of 4.0% from RMB263.01 billion in 2015. The implementation of VAT in the PRC telecommunications industry reduced our costs and expenses to the extent we are entitled to claim certain input VAT credits for the purchase of goods and services. In addition, we receive a benefit of claiming input VAT credits on our capital expenditures for purchasing certain assets, which resulted in a lower depreciation. However, certain costs and expenses, such as employee benefit expenses are not subject to VAT and therefore do not qualify for input VAT credits.

The table below sets forth the major items of costs, expenses and others and their respective percentage of the total revenue in 2015 and 2016:

 

     For the Year Ended December 31,  
     2015      2016  
     RMB in millions      % of Total      RMB in millions      % of Total  

Total revenue

     277,049        100.0        274,197        100.0  

Costs, expenses and others

     263,014        94.9        273,413        99.7  

Interconnection charges

     13,093        4.7        12,739        4.6  

Depreciation and amortization

     76,738        27.7        76,805        28.0  

Network, operation and support expenses

     42,308        15.3        51,167        18.7  

Employee benefit expenses

     35,140        12.7        36,907        13.5  

Selling and marketing expenses

     31,965        11.5        34,646        12.6  

General, administrative and other expenses(1)

     20,962        7.6        19,939        7.3  

Cost of telecommunications products sold(1)

     46,079        16.6        39,301        14.3  

Finance costs, net of interest income

     6,496        2.3        3,857        1.4  

Other income-net

     (9,767      (3.5      (1,948      (0.7

 

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(1)  Revenue from sales of products associated with the ICT business, which was previously recorded as part of the fixed-line service revenue, has been reclassified as revenue from sales of telecommunications products to better reflect the commercial nature of the transactions. Correspondingly, we certain cost of sales of products associated with the ICT business, which was previously recorded as part of the general, administrative and other expenses, has been reclassified as part of the cost of telecommunications products sold. The related costs for the years ended December 31, 2015 and 2016 have been reclassified on the same basis.

Interconnection Charges. Interconnection charges were RMB12.74 billion in 2016, down by 2.7% from RMB13.09 billion in 2015, primarily due to the decrease in volume of the interconnection voice calls. Interconnection charges as a percentage of total revenue decreased from 4.7% in 2015 to 4.6% in 2016.

Depreciation and Amortization. Our depreciation and amortization expenses were RMB76.81 billion in 2016, remaining stable compared with 2015. As a percentage of total revenue, our depreciation and amortization expenses slightly increased from 27.7% in 2015 to 28.0% in 2016. In 2016, our depreciation and amortization expenses decreased as a result of our transfer of telecommunications towers and related assets to the Tower Company, which was largely offset by the increase in depreciation and amortization expenses of other assets.

Network, Operation and Support Expenses. We incurred network, operation and support expenses of RMB51.17 billion in 2016, up by 20.9% from RMB42.31 billion in 2015, primarily due to the increase in the operating lease and other service charges of telecommunications towers and related assets payable to the Tower Company, which results from our transfer of telecommunications towers and related assets to the Tower Company, and the expansion of our network scale. In general, the implementation of VAT in the PRC telecommunications industry reduces our network, operation and support expenses to the extent we are entitled to the input VAT credits. Network, operation and support expenses, as a percentage of total revenue, increased from 15.3% in 2015 to 18.7% in 2016. With the expansion of our network, we had an increased demand of leased lines and the related telecommunications line leasing fees in 2016 was RMB7.43 billion, representing a substantial increase from RMB3.35 billion in 2015.

Employee Benefit Expenses. Our employee benefit expenses increased by 5.0% from RMB35.14 billion in 2015 to RMB36.91 billion in 2016, mainly due to the increases in salaries and wages as well as contributions to defined contribution pension schemes, medical insurance and housing benefits, and as a percentage of total revenue, increased from 12.7% in 2015 to 13.5% in 2016.

Selling and Marketing Expenses. Our selling and marketing expenses were RMB34.65 billion in 2016, up by 8.4% from RMB31.97 billion in 2015, primarily due to our strengthened selling and marketing efforts to accelerate business development, strive for revenue growth and enhance customer quality, and as a percentage of total revenue, increased from 11.5% in 2015 to 12.6% in 2016.

General, Administrative and Other Expenses. Our general, administrative and other expenses were RMB19.94 billion in 2016 and accounted for 7.3% of total revenue, down by 4.9% from RMB20.96 billion in 2015, primarily due to the decrease in our loss on asset disposal related to fiber-optic network upgrade. As a percentage of total revenue, general, administrative and other expenses decreased from 7.6% in 2015 to 7.3% in 2016.

Cost of Telecommunications Products Sold. In 2016, the cost of telecommunications products sold amounted to RMB39.30 billion, down by 14.7% from RMB46.08 billion in 2015, primarily due to the decrease in sales of telecommunications terminal products in 2016. As a percentage of total revenue, cost of telecommunications products sold decreased from 16.6% in 2015 to 14.3% in 2016.

 

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Finance Costs, Net of Interest Income. Our finance costs, net of interest income, decreased by 40.6% from RMB6.50 billion in 2015 to RMB3.86 billion in 2016, which was primarily because we had losses of foreign exchange settlement as a result of fluctuations in exchange rate of Renminbi against the other currencies in 2015 and we made full repayment of our outstanding U.S. dollar-denominated convertible bonds when due on October 18, 2015, which reduced our exposure to losses relating to foreign currency denominated liabilities. As a percentage of total revenue, finance cost, net of interest income, decreased from 2.3% in 2015 to 1.4% in 2016.

Other Income-Net. In 2016, other income-net was RMB1.95 billion, representing a significant decrease from 2015, primarily as a result of the one-off effect of the net gain in an amount of RMB9.25 billion (before tax) on disposal of telecommunications towers to the Tower Company in 2015. As a percentage of total revenue, other income-net decreased from 3.5% in 2015 to 0.7% in 2016.

Income Before Income Tax

In 2016, our income before income tax was RMB0.78 billion, down by 94.4% from RMB14.04 billion in 2015, primarily because (i) we had a one-off net gain in an amount of RMB9.25 billion (before tax) on disposal of telecommunications towers and related assets to the Tower Company in 2015, (ii) our network, operation and support expenses increased by RMB8.86 billion, or 20.9%, and (iii) our selling and marketing expenses increased by RMB2.68 billion, or 8.4%. The significant decrease was partially offset by the increase in our total service revenue by RMB5.06 billion, or 2.2%.

Income Tax

Our income tax was RMB0.15 billion in 2016, down by 95.7% from RMB3.47 billion in 2015, largely due to the decrease in our income before income tax. Our effective tax rate in 2016 was 19.6%, down by 5.1 percentage points from 24.7% in 2015, primarily because in 2016 we used certain tax losses that were not previously recognized as deferred tax assets.

Net Income for the Year

As a result of the foregoing, our net income was RMB0.63 billion in 2016, down by 94.0% from RMB10.56 billion in 2015, primarily due to the significant decrease in our income before income tax. Our basic earnings per share was RMB0.03 in 2016, down by 93.2% from RMB0.44 in 2015.

Liquidity and Capital Resources

Working Capital and Cash Flows

As of December 31, 2017, we had RMB32.84 billion of cash and cash equivalents, as compared with RMB23.63 billion as of December 31, 2016 and RMB21.76 billion as of December 31, 2015. As of December 31, 2017, we had RMB5.53 billion of short-term bank deposits and restricted deposits, as compared with RMB1.75 billion as of December 31, 2016 and RMB0.20 billion as of December 31, 2015. As of December 31, 2017, we had a working capital deficit (current liabilities less current assets) of RMB165.90 billion, representing a decrease by 36.3% from the working capital deficit of RMB260.44 billion as of December 31, 2016. The decrease in working capital deficit in 2017 primarily resulted from the decreases in short-term bank loans, commercial papers and accounts payable and accrued liabilities of RMB54.49 billion, RMB26.97 billion and RMB17.96 billion, respectively.

In recent years, although the PRC Government introduced measures to avoid overheating of the economy, including tightening bank lending policies, we, due to our enterprise nature and our good credit records with PRC banks, generally have not experienced and do not expect to experience in the foreseeable future significant difficulties in obtaining bank financing in China. As of December 31, 2017, we had RMB307.40 billion revolving banking facilities and registered quota of corporate bonds, of which RMB271.50 billion was unutilized. There is no term of the facilities that materially restricts our ability to draw down the unutilized banking facilities. In addition, we believe we have the ability to raise funds from short-, medium- and long-term perspectives and maintain reasonable financing costs through appropriate financing portfolio. Therefore, we believe that we will be able to fund our anticipated capital and liquidity needs with our access to debt and equity financing, in particular bank financing in China, and net cash inflows from our operations.

 

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The following table sets forth cash inflows and outflows in 2015, 2016 and 2017.

 

     For the Year Ended December 31,  
     2015      2016      2017  
     (RMB in millions)  

Net cash inflow from operating activities

     84,301        74,593        85,054  

Net cash outflow from investing activities

     (91,354      (95,749      (47,336

Net cash inflow/(outflow) from financing activities

     3,427        22,877        (28,414
  

 

 

    

 

 

    

 

 

 

Net (decrease)/increase in cash and cash equivalents

     (3,626      1,721        9,304  
  

 

 

    

 

 

    

 

 

 

Our net cash inflow from operating activities decreased by 11.5% from RMB84.30 billion in 2015 to RMB74.59 billion in 2016, primarily due to our payment of operating lease and other service charges of telecommunications towers and related assets to the Tower Company. Our net cash inflow from operating activities increased by 14.0% from RMB74.59 billion in 2016 to RMB85.05 billion in 2017, primarily due to the increase in the cash generated from operations mainly as a result of the decrease in our mobile handset subsidies in connection with our adjustments in the sales and marketing strategies while we achieved a moderate increase in our revenue in 2017.

Our net cash outflow from investing activities increased by 4.8% from RMB91.35 billion in 2015 to RMB95.75 billion in 2016, mainly due to the increase in our investment in 4G services and project payment upon completion of construction in 2016. Our net cash outflow from investing activities decreased by 50.6% from RMB95.75 billion in 2016 to RMB47.34 billion in 2017, primarily due to the decrease in our purchase of property, plant and equipment and the increase in the proceeds we received as a result of the disposal of telecommunications and related tower assets to the Tower Company as a result of the settlement of the remaining consideration.

Our net cash inflow from financing activities increased significantly from RMB3.43 billion in 2015 to RMB22.88 billion in 2016, primarily due to an increase in the amount of proceeds from commercial papers and corporate bonds we issued in 2016. We had net cash outflow from financing activities of RMB28.41 billion in 2017, as compared to net cash inflow from financing activities of RMB22.88 billion in 2016, primarily due to our repayment of short-term bank loans and promissory notes as they matured, partially offset by the increase in the amount of proceeds we received for issue of new shares to Unicom BVI.

Indebtedness and Capital Structure

The following table sets forth the amount of cash, cash equivalents, assets, short-term and long-term debt and equity as well as debt-to-capitalization and debt-to-equity ratios as of the end of 2015, 2016 and 2017.

 

     As of December 31,  
     2015      2016      2017  
     (RMB in millions, except percentages)  

Cash and cash equivalents and short-term bank deposits and restricted deposits

     21,957        25,387        38,362  

Total assets

     610,346        614,154        571,983  

Short-term debt

     107,998        134,675        52,141  

Short-term bank loans

     83,852        76,994        22,500  

Commercial papers

     19,945        35,958        8,991  

Current portion of long-term bank loans

     84        161        410  

Amounts due to related parties

     —          —          475  

Amounts due to ultimate holding company

     1,344        —          1,344  

Current portion of obligations under finance lease included in other obligations

     274        586        461  

Current portion of promissory notes

     2,499        18,976        17,960  

Current portion of corporate bonds

     —          2,000        —    

 

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     As of December 31,  
     2015     2016     2017  
     (RMB in millions, except percentages)  

Long-term debt

     40,944       40,579       21,685  

Promissory notes

     36,928       17,906       —    

Corporate bonds

     2,000       17,970       17,981  

Non-current portion of long-term bank loans

     1,748       4,495       3,473  

Non-current portion of obligations under finance lease included in other obligations

     268       208       231  

Total Equity

     231,216       227,682       304,347  

Equity attributable to equity shareholders of the Company

     231,216       227,407       304,050  

Non-controlling interests

     —         275       297  

Debt-to-capitalization ratio(1)

     39.2     43.5     19.5

Debt-to-equity ratio(2)

     64.4     77.0     24.3

 

(1)  Debt-to-capitalization ratio = (long-term interest-bearing debt + short-term interest-bearing debt)/(long-term interest-bearing debt + short-term interest-bearing debt + total equity).
(2)  Debt-to-equity ratio = (long-term interest-bearing debt + short-term interest-bearing debt)/(total equity).

Our debt-to-capitalization ratio was 19.5% at the end of 2017, compared to 43.5% at the end of 2016 and 39.2% at the end of 2015. Our debt-to-equity ratio was 24.3% at the end of 2017, compared to 77.0% at the end of 2016 and 64.4% at the end of 2015. The sum of our long-term and short-term interest-bearing debt exceeds the amount of our cash and cash equivalents and short-term bank deposits and restricted deposits by RMB35.46 billion as of December 31, 2017, compared to RMB149.87 billion as of December 31, 2016 and RMB126.99 billion as of December 31, 2015. The increases in our debt-to-capitalization ratio and debt-to-equity ratio from 2015 to 2016 were mainly due to the increase in the amount of our interest-bearing debts and the decrease in equity attributable to equity shareholders. The decreases in our debt-to-capitalization ratio and debt-to-equity ratio from 2016 to 2017 were mainly due to the (i) decrease in the amount outstanding of short-term bank loans, commercial papers and promissory notes as a result of our repayments in 2017 and (2) increase in the equity attributable to equity shareholders of us as we issued 6,651,043,262 new shares to Unicom BVI for cash consideration of RMB74.95 billion. We continue to seek to optimize our capital structure, develop multiple financing sources and reduce overall financing costs. In addition, we seek to increase our capital turnover ratio and control the amount of monetary assets.

Our outstanding short-term and long-term bank loans, denominated in RMB, U.S. dollar and Euro, was RMB26.38 billion at the end of 2017, compared to RMB81.65 billion at the end of 2016 and RMB85.68 billion at the end of 2015. The decrease from 2015 to 2017 was mainly due to our repayment of certain bank loans. As of December 31, 2017, no short-term bank loans or long-term bank loans were guaranteed by Unicom Group.

In order to further rationalize our debt structure and reduce our interest expense, we may continue to finance a portion of our business operations and capital expenditures through issuance of debt securities. Our liquidity in the future will primarily depend on our ability to maintain adequate cash inflow from operations and obtain adequate external financing to meet our debt service obligations and planned capital expenditures. Our operating cash flows could be adversely affected by numerous factors beyond our control, including, but not limited to, decreased demand for our telecommunications services and further intensifying competition. Our ability to obtain external financing also depends on numerous factors, including, but not limited to, our financial condition and creditworthiness as well as our relationship with lenders. See “D. Risk Factors — Risks Relating to Our Business — If we are unable to fund our capital expenditure and debt service requirements, our financial condition, results of operations and growth prospects will be materially and adversely affected” under Item 3.

On June 8, 2007, we issued RMB2 billion 10-year corporate bonds, bearing interest at 4.5% per annum. The corporate bonds are secured by a guarantee issued by Bank of China Limited. The 10-year corporate bonds matured and all the outstanding amounts were repaid in full in June 2017.

 

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On October 18, 2010, Billion Express Investments Limited, a wholly owned subsidiary of our company, issued the 2015 Convertible Bonds in aggregate principal amount of US$1,838,800,000 (at the fixed exchange rate of US$1 equivalent to HK$7.7576), which are guaranteed by our company and are exchangeable into ordinary shares of our company. On October 18, 2015, the 2015 convertible bonds matured and all the outstanding amounts were paid in full.

On April 3, 2014, the Company established a Medium-Term Note Program, or the Program, under which the Company could offer and issue notes of aggregate principal amount of up to RMB10.0 billion. Notes issued under the Program will be denominated in Renminbi and issued to professional investors outside the United States. On April 16, 2014, the Company completed the issue of notes in an aggregate nominal amount of RMB4 billion pursuant to the Program, with a maturity period of three years and at an interest rate of 4.00% per annum. The notes were fully repaid in April 2017.

On April 16, 2014, CUCL completed the issue of the first tranche of promissory note for the year 2014 in an amount of RMB5 billion, with a maturity period of three years and at an interest rate of 5.35% per annum. The first tranche of promissory note was fully repaid in April 2017.

On July 14, 2014, CUCL completed the issue of the second tranche of promissory note for the year 2014 in an amount of RMB5 billion, with a maturity period of three years and at an interest rate of 4.84% per annum. The second tranche of promissory note was fully repaid in July 2017.

On July 15, 2014, CUCL completed the issue of the first tranche of commercial paper for the year 2014 in an amount of RMB10 billion, with a maturity period of 365 days and at an interest rate of 4.60% per annum. The first tranche of commercial paper was fully repaid in July 2015.

On July 24, 2014, the Company completed the issue of notes in an aggregate nominal amount of RMB2.5 billion pursuant to the Program, with a maturity period of two years and at an interest rate of 3.80% per annum. The notes were fully repaid in July 2016.

On November 28, 2014, CUCL completed the issue of the third tranche of promissory note for the year 2014 in an amount of RMB5 billion, with a maturity period of three years and at an interest rate of 4.20% per annum. The third tranche of promissory note was fully repaid in November 2017.

On March 19, 2015, CUCL completed the issue of the first tranche of super and short-term commercial paper for the year 2015 in an amount of RMB10 billion, with a maturity period of 270 days and at an interest rate of 4.40% per annum. The first tranche of super and short-term commercial paper was fully paid in December 2015.

On June 15, 2015, CUCL completed the issue of the first tranche of promissory note for the year 2015 in an amount of RMB4 billion, with a maturity period of three years and at an interest rate of 3.85% per annum.

On June 18, 2015, CUCL completed the issue of the second tranche of promissory note for the year 2015 in an amount of RMB4 billion, with a maturity period of three years and at an interest rate of 3.85% per annum.

On November 20, 2015, CUCL completed the issue of the second tranche of super and short-term commercial paper for the year 2015 in an amount of RMB10 billion, with a maturity period of 270 days and at an interest rate of 3.15% per annum. The second tranche of super and short-term commercial paper was fully repaid in August 2016.

On November 27, 2015, CUCL completed the issue of the first tranche of short-term commercial paper for the year 2015 in an amount of RMB10 billion, with a maturity period of 366 days and at an interest rate of 3.15% per annum. The first tranche of short-term commercial paper was fully repaid in November 2016.

On November 30, 2015, CUCL completed the issue of the third tranche of promissory note for the year 2015 of an amount of RMB3.5 billion, the fourth tranche of promissory note for the year 2015 of an amount of RMB3.5 billion and the fifth tranche of promissory note for the year 2015 of an amount of RMB3 billion, all with a maturity period of three years and at an interest rate of 3.30% per annum.

 

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On April 8, 2016, CUCL completed the issue of first tranche of super short-term commercial papers for the year of 2016 in an amount of RMB12 billion, with a maturity period of 90 days and at an interest rate of 2.47% per annum. The first tranche of super short-term commercial papers was fully repaid in July 2016.

On April 26, 2016, CUCL completed the issue of second tranche of super short-term commercial papers for the year of 2016 in an amount of RMB12 billion, with a maturity period of 90 days and at an interest rate of 2.70% per annum. The second tranche of super short-term commercial papers was fully repaid in July 2016.

On June 3, 2016, CUCL completed the issue of third tranche of super short-term commercial papers for the year of 2016 in an amount of RMB6 billion, with a maturity period of 270 days and at an interest rate of 2.72% per annum. The third tranche of super short-term commercial papers was fully repaid in February 2017.

On June 7, 2016, we issued RMB7 billion three-year corporate bonds and RMB1 billion five-year corporate bond, bearing interest at 3.07% and 3.43% per annum, respectively.

On July 12, 2016, CUCL completed the issue of fourth tranche of super short-term commercial papers for the year of 2016 in an amount of RMB10 billion, with a maturity period of 270 days and at an interest rate of 2.55% per annum. The fourth tranche of super short-term commercial papers was fully repaid in April 2017.

On July 14, 2016, we issued RMB10 billion three-year corporate bonds, bearing interest at 2.95% per annum.

On November 17, 2016, CUCL completed the issue of fifth tranche of super short-term commercial papers for the year of 2016 in an amount of RMB10 billion, with a maturity period of 270 days and at an interest rate of 3.00% per annum. The fifth tranche of super short-term commercial papers was fully repaid in August 2017.

On November 24, 2016, CUCL completed the issue of sixth tranche super short-term commercial papers for the year of 2016 in an amount of RMB5 billion, with a maturity period of 180 days and at an interest rate of 3.00% per annum. The sixth tranche of super short-term commercial papers was fully repaid in May 2017.

On November 24, 2016, CUCL completed the issue of seventh tranche super short-term commercial papers for the year of 2016 in an amount of RMB5 billion, with a maturity period of 180 days and at an interest rate of 3.00% per annum. The seventh tranche of super short-term commercial papers was fully repaid in May 2017.

On April 20, 2017, CUCL completed the issue of first tranche super short-term commercial papers for the year of 2017 in an amount of RMB4 billion, with a maturity period of 90 days and at an interest rate of 3.90% per annum. The first tranche of super short-term commercial papers was fully repaid in July 2017.

On April 26, 2017, CUCL completed the issue of second tranche super short-term commercial papers for the year of 2017 in an amount of RMB4 billion, with a maturity period of 90 days and at an interest rate of 3.95% per annum. The second tranche of super short-term commercial papers was fully repaid in July 2017.

On May 11, 2017, CUCL completed the issue of third tranche super short-term commercial papers for the year of 2017 in an amount of RMB6 billion, with a maturity period of 90 days and at an interest rate of 4.40% per annum. The third tranche of super short-term commercial papers was fully repaid in August 2017.

On July 6, 2017, CUCL completed the issue of fourth tranche super short-term commercial papers for the year of 2017 in an amount of RMB1 billion, with a maturity period of 270 days and at an interest rate of 4.38% per annum.

On July 27, 2017, CUCL completed the issue of fifth tranche super short-term commercial papers for the year of 2017 in an amount of RMB4 billion, with a maturity period of 90 days and at an interest rate of 4.09% per annum. The fifth tranche of super short-term commercial papers was fully repaid in October 2017.

On August 7, 2017, CUCL completed the issue of sixth tranche super short-term commercial papers for the year of 2017 in an amount of RMB4 billion, with a maturity period of 270 days and at an interest rate of 4.26% per annum.

 

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On August 10, 2017, CUCL completed the issue of seventh tranche super short-term commercial papers for the year of 2017 in an amount of RMB4 billion, with a maturity period of 270 days and at an interest rate of 4.23% per annum.

Contractual Obligations and Commercial Commitments

The following table sets forth the amounts of our outstanding contractual cash obligations as of December 31, 2017.

 

     Total      Less than 1
year
     Between 1 and
3 years
     Between 3 and
5 years
     Over 5 years  
     (RMB in millions)  

Long-term bank loans (1)*

     4,752        412        890        883        2,567  

Corporate bonds (2)*

     18,875        544        17,316        1,015        —    

Promissory notes (3)*

     18,440        18,440        —          —          —    

Other obligations*

     3,394        3,006        321        20        47  

Capital commitments (4)

     50,877        43,688        5,279        1,345        565  

Operating leases and other commitments (4)

     49,688        19,131        26,294        3,286        977  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total obligations

     146,026        85,221        50,100        6,549        4,156  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

* Interest included
(1)  See Note 31 “Long-Term Bank Loans” to our consolidated financial statements included elsewhere in this annual report on Form 20-F.
(2)  See Note 33 “Corporate Bonds” to our consolidated financial statements included elsewhere in this annual report on Form 20-F.
(3)  See Note 32 “Promissory Notes” to our consolidated financial statements included elsewhere in this annual report on Form 20-F.
(4)  See Note 42 “Contingencies and Commitments” to our consolidated financial statements included elsewhere in this annual report on Form 20-F.

Trend Information

Please refer to the discussion in sections headed “— Overview” and “— Operating Results” under this Item 5.

Off-Balance-Sheet Arrangements

As of December 31, 2017, we did not have any other off-balance-sheet arrangement.

Capital Expenditures

The following table sets forth our historical capital expenditure requirements for the periods indicated.

 

     For the Year Ended December 31,  
     2015     2016     2017  
     (RMB in
billions)
     As a
Percentage
    (RMB in
billions)
     As a
Percentage
    (RMB in
billions)
     As a
Percentage
 

Mobile services

     61.02        45.6     27.74        38.5     15.92        37.8

Broadband and data services

     33.76        25.2     16.84        23.4     9.02        21.4

Infrastructure and transmission network

     31.16        23.3     19.71        27.3     11.94        28.3

Others (1)

     7.94        5.9     7.82        10.8     5.25        12.5
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total

     133.88        100.0     72.11        100.0     42.13        100.0
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

 

(1) Other expenditures consist of innovation and value-added platform, IT system, fixed-line services and procurement of miscellaneous assets, equipment and spare parts.

 

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Our capital expenditure totaled RMB42.13 billion in 2017, which mainly consisted of investment in mobile services, broadband and data services, and infrastructure and transmission network. In 2017, capital expenditure attributable to mobile services was RMB15.92 billion; capital expenditure attributable to broadband and data services was RMB9.02 billion; capital expenditure attributable to infrastructure and transmission network was RMB11.94 billion.

We expect our capital expenditure in 2018 to be approximately RMB50.00 billion. We expect our capital expenditure in 2018 to include primarily investments in upgrading our 4G services and fixed-line broadband services as well as infrastructure and transmission networks that support the development of our 5G services, 4G services, fixed-line broadband services and Internet of things network.

We expect to fund our capital expenditure needs through a combination of cash generated from operating activities, granted and unused banking facilities and other available financing sources and the proceeds from the Subscription. See “D. Risk Factors — Risks Relating to Our Business — If we are unable to fund our capital expenditure and debt service requirements, our financial condition, results of operations and growth prospects will be materially and adversely affected” under Item 3.

 

Item 6. Directors, Senior Management and Employees

 

A. Directors and Senior Management

The following table sets forth certain information concerning our current directors and executive officers.

 

Name

  

Age

  

Position

Wang Xiaochu

   59    Chairman of the Board of Directors and Chief Executive Officer

Lu Yimin

   54    Executive Director and President

Li Fushen

   55    Executive Director and Chief Financial Officer

Shao Guanglu

   53    Executive Director and Senior Vice President

Cesareo Alierta Izuel

   72    Non-Executive Director

Cheung Wing Lam Linus

   69    Independent Non-Executive Director

Wong Wai Ming

   60    Independent Non-Executive Director

Chung Shui Ming Timpson

   66    Independent Non-Executive Director

Law Fan Chiu Fun Fanny

   65    Independent Non-Executive Director

Mai Yanzhou

   49    Senior Vice President

Liang Baojun

   48    Senior Vice President

 

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Mr. Wang Xiaochu was appointed in September 2015 as an Executive Director, Chairman and Chief Executive Officer of the Company. Mr. Wang, a professor level senior engineer, graduated from Beijing Institute of Posts and Telecommunications in 1989 and received a doctorate degree in business administration from the Hong Kong Polytechnic University in 2005. Mr. Wang served as Deputy Director General and Director General of the Hangzhou Telecommunications Bureau in Zhejiang province; Director General of the Tianjin Posts and Telecommunications Administration; Chairman and Chief Executive Officer of China Mobile (Hong Kong) Limited; Vice President of China Mobile Communications Corporation; an Executive Director, Chairman and Chief Executive Officer of China Telecom Corporation Limited; Chairman and President of China Telecommunications Corporation; and Chairman and a Non-executive Director of China Communications Services Corporation Limited. Mr. Wang has served as a Director of Telefónica (listed on various stock exchanges including Madrid, New York and London) since September 2015. Mr. Wang also serves as the Chairman of Unicom Group, A Share Company and CUCL, respectively. Mr. Wang has extensive experience in management and telecommunications industry.

Mr. Lu Yimin was appointed as an Executive Director of the Company in October 2008 and President of the Company in February 2009. Mr. Lu, a researcher level senior engineer, graduated from Shanghai Jiao Tong University in 1985 and received a master’s degree in public administration from the John F. Kennedy School of Government at Harvard University in 2001. Mr. Lu joined Netcom Group in December 2007, serving as senior management. Mr. Lu has served as a Non-Executive Director of PCCW Limited (“PCCW”, listed on the Hong Kong Stock Exchange with an American Depositary Receipts trading on OTC Markets Group Inc. in the U.S.) since May 2008, the Deputy Chairman of the Board of PCCW, a Non-Executive Director of HKT Limited (HKT Trust and HKT Limited are listed on the Hong Kong Stock Exchange) and HKT Management Limited (the trustee-manager of the HKT Trust) since November 2011. Prior to joining the Netcom Group, Mr. Lu was a member of the Secretary Bureau of the General Office of the Chinese Communist Party Central Committee, served as the Deputy Director and the Director of the Information Processing Office, Secretary at deputy director general level and Secretary at director general level. Mr. Lu also serves as a Vice Chairman and General Manager of Unicom Group, a Director and President of A Share Company, as well as a Director and President of CUCL. Mr. Lu has extensive experience in administration and business management in the government and the telecommunications industry.

Mr. Li Fushen was appointed in March 2011 as an Executive Director and Chief Financial Officer of the Company. Mr. Li graduated from the Jilin Engineering Institute in 1988, and received a master’s degree in management from the Australian National University in 2004. Mr. Li served as Deputy General Manager of the former Jilin Provincial Telecommunications Company and Jilin Communications Company, General Manager of the Finance Department of Netcom Group, the Chief Accountant of Netcom Group, Chief Financial Officer of China Netcom, Executive Director of China Netcom, Joint Company Secretary of China Netcom and Senior Vice President of the Company. In addition, Mr. Li has served as a Non-Executive Director of PCCW Limited (listed on the Hong Kong Stock Exchange with an American Depositary Receipts trading on OTC Markets Group Inc.) since July 2007, a Non-Executive Director of HKT Limited (HKT Trust and HKT Limited are listed on the Hong Kong Stock Exchange) and HKT Management Limited (the trustee-manager of the HKT Trust) since November 2011. Mr. Li is a Vice General Manager and Chief Accountant of Unicom Group, a Director and Senior Vice President of A Share Company, as well as a Director and Senior Vice President of CUCL. Mr. Li has worked in the telecommunications industry for a long period of time and has extensive management experience.

Mr. Shao Guanglu was appointed in March 2017 as an Executive Director of the Company. Mr. Shao was appointed in April 2011 as a Senior Vice President of the Company. Mr. Shao, a professor level senior engineer, graduated from Harbin Institute of Technology in 1985. Mr. Shao received a master’s degree in engineering and a master’s degree in economics from Harbin Institute of Technology in 1988 and 1990 respectively, a master’s degree in management from BI Norwegian Business School in 2002 and a doctor’s degree in management from Nankai University in 2009. Mr. Shao joined Unicom Group in February 1995. Mr. Shao served as Deputy General Manager of Tianjin Branch, Deputy General Manager of Henan Branch, General Manager of Guangxi Branch, as well as General Manager of Human Resource Department of Unicom Group. In addition, Mr. Shao has served as a Non-Executive Director of PCCW (listed on the Hong Kong Stock Exchange with an American Depositary Receipts trading on OTC Markets Group Inc.) since March 2017, and a Non-Executive Director of China Communications Services Corporation Limited (listed on the Hong Kong Stock Exchange) since June 2017. Mr. Shao also serves as a Vice General Manager of Unicom Group, a Senior Vice President of A Share Company as well as a Director and Senior Vice President of CUCL. Mr. Shao has worked in the telecommunications industry for a long period of time and has extensive management experience.

 

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Mr. Cesareo Alierta Izuel was appointed in October 2008 as a Non-Executive Director of the Company. Mr. Alierta is Executive Chairman of Telefónica Foundation and Profuturo Foundation, Director of Telefónica Audiovisual Digital, S.L.U. and Trustee of Caixa d’Estalvis i Pensions de Barcelona Banking Foundation (la Caixa). He is also the Chairman of the Social Board of the UNED (National Long Distance Spanish University) and member of the Columbia Business School Board of Overseers. Between 1970 and 1985, he served as General Manager of the Capital Markets division at Banco Urquijo in Madrid. He was the founder and Chairman of Beta Capital. Since 1991, he has also acted as Chairman of the Spanish Financial Analysts’ Association. He was also a member of the Board of Directors and the Standing Committee of the Madrid Stock Exchange. Between 1996 and 2000, he served as Chairman of Tabacalera, S.A., and subsequently Altadis following the company’s merger with the French group Seita. Between January 1997 and May 2017, he was a member of the Board of Directors of Telefónica (listed on various stock exchanges including Madrid, New York and London). Between July 2000 and April 2016, he served as Executive Chairman of Telefónica. Mr. Alierta served as a Non-Executive Director of China Netcom during the period from December 2007 to November 2008. From April 2008 to December 2013 he was a member of the Board of Directors of Telecom Italia, S.p.A.. Between September 2010 and June 2016, Mr. Alierta served as a member of the Board of Directors of International Consolidated Airlines Group (listed on the stock exchanges of Madrid and London). Between October 2017 and March 2018, Mr. Alierta served as a member of the Board of Directors of Mediobanca, S.p.A. (listed on Milan stock exchange). In September 2005, Mr. Alierta received “The Global Spanish Entrepreneur” award from the Spanish/US Chamber of Commerce. Mr. Alierta holds a degree in law from the University of Zaragoza and received a master’s degree in business administration at the University of Columbia (New York) in 1970.

Mr. Cheung Wing Lam Linus was appointed in May 2004 as an Independent Non-Executive Director of the Company. Mr. Cheung is Independent Non-Executive Directors of HKR International Limited (listed on the Hong Kong Stock Exchange) and Sotheby’s (listed on the New York Stock Exchange). Mr. Cheung was a member of the University of Hong Kong Council, Chairman of the Council of Centennial College, a member of the Board of Governors of Centennial College, Chairman of the University of Hong Kong School of Professional and Continuing Education, Chairman of Asia Television Limited, Deputy Chairman of PCCW Limited, an Independent Non-Executive Director of Taikang Life Insurance Company Limited, as well as President of the Chartered Institute of Marketing (Hong Kong Region). Prior to the merger of Pacific Century Cyberworks Limited and Hong Kong Telecom Limited, Mr. Cheung was the Chief Executive of Hong Kong Telecom Limited and an Executive Director of Cable & Wireless plc in the United Kingdom. Mr. Cheung worked at Cathay Pacific Airways for 23 years, leaving as Deputy Managing Director. He was appointed an Official Justice of the Peace in 1990 and a Non-official Justice of the Peace in 1992. Mr. Cheung received a bachelor’s degree in social sciences and a diploma in management studies from the University of Hong Kong. He is also an Honorary Fellow of the University of Hong Kong and of The Chartered Institute of Marketing in the United Kingdom.

Mr. Wong Wai Ming was appointed in January 2006 as an Independent Non-Executive Director of the Company. Mr. Wong is Executive Vice President and Chief Financial Officer of Lenovo Group Limited (listed on the Hong Kong Stock Exchange and the New York Stock Exchange). Prior to his current executive position at Lenovo Group Limited, Mr. Wong was the Chief Executive Officer and Executive Director of Roly International Holdings Limited. Mr. Wong was previously an investment banker with over 15 years of experience in investment banking business in Greater China and was a member of the Listing Committee of the Hong Kong Stock Exchange. Mr. Wong is a chartered accountant and holds a bachelor’s degree (with Honors) in management science from the Victoria University of Manchester in the United Kingdom.

Mr. Chung Shui Ming Timpson was appointed in October 2008 as an Independent Non-Executive Director of the Company. Mr. Chung is a member of the National Committee of the 13th Chinese People’s Political Consultative Conference. He is also the Pro-Chancellor of the City University of Hong Kong. Besides, Mr. Chung is an Independent Non-Executive Director of Glorious Sun Enterprises Limited, The Miramar Hotel & Investment Co. Limited, China Overseas Grand Oceans Group Limited, China Everbright Limited, China Construction Bank Corporation, Jinmao Hotel and Jinmao (China) Hotel Investments and Management Limited (formerly known as “Jinmao Investments and Jinmao (China) Investments Holdings Limited”) and China Railway Group Limited (all listed on the Hong Kong Stock Exchange). From October 2004 to October 2008, Mr. Chung served as an Independent Non-Executive Director of China Netcom. Formerly, he was the Chairman of China Business of Jardine Fleming Holdings Limited and the Deputy Chief Executive Officer of BOC International Limited. He was also the Director-General of Democratic Alliance for the Betterment and Progress of Hong Kong, the Chairman of the Advisory Committee on Arts Development, the Chairman of the Council of the City University of Hong Kong, the Chairman of the Hong Kong Housing Society, a member of the Executive Council of the Hong Kong Special Administrative Region, the Vice Chairman of the Land Fund Advisory Committee of Hong Kong Special Administrative Region Government, a member of the Managing Board of the Kowloon-Canton Railway Corporation, a member of the Hong Kong Housing Authority, a member of the Disaster Relief Fund Advisory Committee, an Independent Non-Executive Director of Henderson Land Development Company Limited and Nine Dragons Paper (Holdings) Limited, an Independent Director of China Everbright Bank Company Limited and China State Construction Eng. Corp, Ltd. and an Outside Director of China Mobile Communications Corporation. Mr. Chung holds a bachelor of science degree from the University of Hong Kong and a master’s degree in business administration from the Chinese University of Hong Kong. Mr. Chung also received an honorary doctoral degree in Social Science from the City University of Hong Kong in 2010. Mr. Chung is a fellow member of the Hong Kong Institute of Certified Public Accountants.

 

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Mrs. Law Fan Chiu Fun Fanny was appointed in November 2012 as an Independent Non-Executive Director of the Company. Mrs. Law is currently Chairman of the Board of Directors of Hong Kong Science and Technology Parks Corporation, a Member of the Executive Council of the Government of the Hong Kong Special Administrative Region, or HKSAR, the Special Adviser to the China-US Exchange Foundation, a Director of the Fan Family Trust Fund and the Honorary Principal of Ningbo Huizhen Academy. Besides, Mrs. Law is an Independent Non-Executive Director of CLP Holdings Limited and DTXS Silk Road Investment Holdings Company Limited (formerly known as “UDL Holdings Limited”) and Nameson Holdings Limited (all listed on the Hong Kong Stock Exchange), as well as External Director of China Resources (Holdings) Co., Limited. Mrs. Law served as a Deputy of HKSAR to the National People’s Congress of the People’s Republic of China. Prior to her retirement from the civil service in 2007, Mrs. Law was the Commissioner of the Hong Kong Independent Commission Against Corruption. During her 30 years as an Administrative Officer, Mrs. Law has worked in many fields, including medical and health, economic services, housing, land and planning, home affairs, social welfare, civil service, transport and education. Mrs. Law graduated from the University of Hong Kong with an Honours degree in Science, and in 2009 was named an outstanding alumnus of the Science Faculty of the University of Hong Kong. She received a Master degree in Public Administration from Harvard University and was named a Littauer Fellow of Harvard University. She also holds a Master degree in Education from the Chinese University of Hong Kong and is a Fellow of The Hong Kong Institute of Directors.

Mr. Mai Yanzhou was appointed in February 2018 as a Senior Vice President of the Company. Mr. Mai, a professor level senior engineer, graduated from Zhengzhou University in 1991 and received a master’s degree in Electronics and Information Engineering from Beijing University of Posts and Telecommunications in 2002. Mr. Mai served as Deputy General Manager of Guangdong Branch of China Network Communications Group Corporation, Deputy General Manager of Guangdong Branch, General Manager of Fujian Branch, as well as General Manager of Liaoning Branch of Unicom Group. Mr. Mai served as a Delegate to the 12th National People’s Congress. Mr. Mai also serves as Vice General Manager of Unicom Group, Senior Vice President of A Share Company as well as Director and Senior Vice President of CUCL. Mr. Mai has extensive experience in management and telecommunications industry.

Mr. Liang Baojun was appointed in February 2018 as a Senior Vice President of the Company. Mr. Liang, a professor level senior engineer, graduated from Changchun Institute of Posts and Telecommunications in 1991, received a master’s degree in Engineering from Beijing University of Posts and Telecommunications in 1998 and an executive master’s degree of Business Administration from Tsinghua University in 2006. Mr. Liang served as Deputy General Manager of Beijing Branch of China Telecom Corporation Limited, as well as General Manager of Henan Branch, General Manager of Corporate Informatization Department, General Manager of Government and Enterprise Customers Department of China Telecommunications Corporation. Mr. Liang also serves as Vice General Manager of Unicom Group, Senior Vice President of A Share Company as well as Director and Senior Vice President of CUCL. Mr. Liang has extensive experience in management and telecommunications industry.

 

B. Compensation

The aggregate compensation and other benefits paid by us to our directors as a group in 2017 was approximately RMB4.254 million, which included the retirement benefits in the amount of approximately RMB433,000. Each of our executive directors participated in a bonus scheme with us that ties the amount of bonus he or she will receive at the end of a year to our operating results of the year and his or her job performance. As of the date of this annual report, none of our directors hold any outstanding options to purchase shares in our company. See “E. Share Ownership” below for detailed descriptions of our share option scheme.

 

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Name

   Compensation for 2017  
     (RMB in thousands)  

Directors

  

Wang Xiaochu

     707  

Lu Yimin

     707  

Li Fushen

     647  

Shao Guanglu

     506 (1) 

Cesareo Alierta Izuel

     260  

Cheung Wing Lam Linus

     355  

Wong Wai Ming

     363  

Chung Shui Ming Timpson

     372  

Law Fan Chiu Fun Fanny

     337  
  

 

 

 

Total

     4,254  

 

(1) The above compensation was received by Mr. Shao Guanglu from his appointment since March 16, 2017.

 

C. Board Practices

General

Pursuant to our articles of association, at each annual general meeting, one-third of our directors retire from office by rotation. The retiring directors are eligible for re-election. The Board may at any time appoint a new director to fill a vacancy or as an additional director. The Board may also appoint and remove our executive officers. No benefits are payable to our directors or executive officers upon termination of their services with us in accordance with the provisions of their service agreements, except certain statutory compensation.

 

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The following table sets forth certain information concerning our current directors.

 

          Name    Appointment Date   

Re-appointment Date

   Resignation or
Retirement Date

Wang Xiaochu

   September 1, 2015    May 12, 2016    —  

Lu Yimin

   October 15, 2008    May 26, 2009,
May 24, 2011, April 16, 2014, and May 12, 2016
   —  

Li Fushen

   March 30, 2011    May 24, 2011,
May 21, 2013 and May 12, 2016
   —  

Shao Guanglu

   March 16, 2017    May 10, 2017    —  

Cesareo Alierta Izuel

   October 15, 2008    May 26, 2009,
May 24, 2011,
May 21, 2013, May 8, 2015 and May 10, 2017
   —  

Cheung Wing Lam Linus

   May 12, 2004    May 12, 2006,
May 16, 2008, May 12, 2010, May 29, 2012, April 16, 2014 and May 10, 2017
   —  

Wong Wai Ming

   January 19, 2006    May 12, 2006,
May 26, 2009,
May 24, 2011 April 16, 2014 and May 10, 2017
   —  

Chung Shui Ming Timpson

   October 15, 2008    May 26, 2009, May 29, 2012 and May 8, 2015    —  

Law Fan Chiu Fun Fanny

   November 21, 2012    May 21, 2013 and May 12, 2016    —  

Audit Committee

The audit committee reviews and supervises our financial reporting process, risk management and internal controls. The duties of the audit committee include, among others:

 

    as the key representative body for overseeing our relationship with the independent auditor, considering and approving the appointment, resignation and removal of our independent auditor and the auditor’s fees;

 

    reviewing our quarterly, interim and annual financial statements before submission to the board of directors;

 

    coordinating and discussing with the independent auditor with respect to any issues identified and recommendations made during the audits;

 

    reviewing any correspondence from the independent auditor to our management and the responses of our management;

 

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    reviewing the relevant reports concerning our risk management, internal controls and procedures;

 

    discussing our risk management and internal control system with our management to ensure that our management performs its duties to have effective systems in place;

 

    pre-approving the audit and non-audit services to be provided by the external auditor, and determining whether any non-audit services would affect the independence of the auditor;

 

    discussing with our management the schedule and procedures for the rotation of the partner of the auditing firm who will principally be responsible for the audit of our company and the partners who will actively participate in the audit of our company;

 

    supervising the internal audit department, which will directly report to the committee; and

 

    having the right to approve the appointment or removal of the head of internal audit department.

As of April 13, 2018, the members of the audit committee were Mr. Wong Wai Ming (Chairman of the audit committee), Mr. Cheung Wing Lam Linus, Mr. Chung Shui Ming Timpson and Mrs. Law Fan Chiu Fun Fanny, all being independent non-executive directors of our company.

Remuneration Committee

The remuneration committee meets regularly to consider human resources issues, issuance of options and other matters relating to compensation. The primary duties of the remuneration committee include considering and approving the remuneration policies and structure for directors’ and senior management’s remuneration, considering and making recommendations to the Board regarding the remuneration packages of the directors and senior management, and considering and approving our Company’s share option schemes. The remuneration committee also conducts performance review of the Chief Executive Officer and determines the Chief Executive Officer’s year-end bonus pursuant to the performance target contract entered into between the Board and the Chief Executive Officer. The Chief Executive Officer is responsible for the performance review and determination of performance-based year-end bonuses for the other members of our management, which is subject to the review of the remuneration committee. In addition, the remuneration committee consults the Chairman of the Board on the remuneration proposals for other executive directors. As of April 13, 2018, the members of the remuneration committee were Mr. Cheung Wing Lam Linus (Chairman of the remuneration committee), Mr. Wong Wai Ming and Mr. Chung Shui Ming Timpson, all being independent non-executive directors of our company.

Nomination Committee

The nomination committee meets regularly to consider the nomination of our directors and senior management personnel. The primary duties of the nomination committee are to (i) review the structure, size and composition (including skills, knowledge and experience) of the Board at least annually and make recommendations on any proposed changes to the Board to complement our corporate strategy; (ii) identify individuals suitably qualified to become Board members and select or make recommendations to the Board; (iii) formulate and review the policy of diversity of Board members as appropriate; (iv) give due regards to the benefits of diversity on the Board against the criteria set out in the policy of diversity of Board members when performing its duties; (v) assess the independence of independent non-executive directors; (vi) make recommendations to the Board on the appointment or re-appointment of directors and succession planning for directors; and (vii) provide opinion to the Board on candidates nominated by our Chief Executive Officer to become our senior management personnel and on changes to our senior management personnel. As of April 13, 2018, the members of the nomination committee were Mr. Chung Shui Ming Timpson (Chairman of the nomination committee), Mr. Wang Xiaochu, and Mrs. Law Fan Chiu Fun Fanny. Except for Mr. Wang Xiaochu, who is our Chairman and Chief Executive Officer, the other members of the nomination committee are independent non-executive directors of our company.

 

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D. Employees

As of December 31, 2015, 2016 and 2017, we had a total number of 268,887, 270,484 and 267,590 employees, respectively. The employees as of December 31, 2017 are classified by function as follows:

 

By Function

   Number of Employees  

Employees

     252,555  

Management

     22,550  

Marketing

     114,112  

Technology

     80,576  

Support

     30,873  

Others

     4,444  

Temporary employees

     15,035  
  

 

 

 

Total

     267,590  

 

E. Share Ownership

As of April 13, 2018, our directors who own shares in our company are listed as follows:

 

Name

  

Capacity and Nature

   Ordinary
Shares Held
     Percentage of Total
Issued Shares
 

Cheung Wing Lam Linus

   Beneficial Owner (Personal)      200,000        0.0007

Chung Shui Ming Timpson

   Beneficial Owner (Personal)      6,000        0.0000

Apart from those disclosed herein, as of April 13, 2018, our other directors as a group do not own any shares in our company and none of our directors hold any outstanding options for our shares.

Stock Incentive Scheme

We adopted a share option scheme on April 16, 2014. The scheme provides for the grant of options to our employees, including executive directors and non-executive directors. Any grant of options to a “connected person” (as defined in the HKSE Listing Rules) of Unicom requires approval by our independent non-executive directors, excluding any independent non-executive director who is the grantee of the option. The option period commences on any date after the date on which an option is offered, but may not exceed 10 years from the offer date, after which period no further option may be granted under the share option scheme, but the provisions of the share option scheme will remain in full force and effect to the extent necessary to give effect to the exercise of the options granted prior to the expiry or otherwise as may be required in accordance with the provisions of the share option scheme. The subscription price of a share in respect of any particular option granted under this share option scheme will be determined by our board of directors in its discretion at the grant date, which shall be no less than the higher of: (i) the closing price of the shares on the HKSE on the grant date of such option; and (ii) the average closing price of the shares on the HKSE for the five trading days immediately preceding the grant date. As of April 13, 2018, no options had been granted or agreed to be granted by us under the share option scheme.

 

Item 7. Major Shareholders and Related Party Transactions

 

A. Major Shareholders

As of April 13, 2018, our ultimate controlling shareholder, Unicom Group, through its 17.9% direct interest in Unicom BVI, 36.7% direct interest in the A Share Company (which in turn holds 82.1% of Unicom BVI) and 100% direct interest in Unicom Group BVI, indirectly controlled approximately 24.5 billion shares of Unicom, or 79.9% of our total outstanding shares. See “A. History and Development of the Company” under Item 4. Unicom Group’s shares are held by the SASAC and a group of companies, most of which are State-owned enterprises in China. Shares controlled by Unicom Group do not carry voting rights different from our other issued shares.

 

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As of April 13, 2018, most of our shareholders of record were located outside of the United States. In addition, as of April 13, 2018, there were approximately 34,226,200 ADSs outstanding, each representing 10 shares and together representing 1.12% of our total outstanding shares or 5.57% of our total outstanding shares not controlled by our controlling shareholder.

 

B. Related Party Transactions

The Share Subscription by Unicom BVI in Relation to the Mixed Ownership Reform Plan

In connection with the Mixed Ownership Reform Plan of our ultimate controlling shareholder, Unicom Group, we and Unicom BVI entered into the Share Subscription Agreement on August 22, 2017, pursuant to which Unicom BVI agreed to subscribe for a maximum of 6,651,043,262 Subscription Shares, at the subscription price of HK$13.24 per share, or HK$88,059.81 million in total. We completed the allotment and issuance of the Subscription Shares in November 2017. Unicom BVI funded the consideration by using its funds received as a result of capital contribution by its shareholders, including (i) Unicom A Share Company, mainly using the funds from its non-public share issuance to a number of strategic investors in October 2017, and (ii) Unicom Group, mainly using the funds from its disposal of shares in Unicom A Share Company. See “A. History and Development of the Company — The Mixed Ownership Reform” under Item 4 for information concerning the Mixed Ownership Reform.

Establishment of the Finance Company and Provision of Financial Services

On December 6, 2013, CUCL and Unicom Group entered into a capital contribution agreement regarding the establishment of the Finance Company, with a registered capital of RMB3,000 million. Pursuant to the capital contribution agreement, CUCL and Unicom Group invested RMB2,730 million and RMB270 million in the Finance Company, representing 91% and 9% of the total registered capital of the Finance Company, respectively.

The Finance Company was established as a cash management platform of Unicom Group, its subsidiaries and other associated entities, purporting to improve the efficiency of cash flow allocation, lower finance cost and enhance financial risk management, and may carry out all or part of the following businesses: to provide financial advice, credit verification and related consultancy services and agency services, to handle payment and collection of transaction money, to conduct approved insurance agency business, to grant guarantees, to handle entrusted loans, to carry out bill acceptance and discounting businesses, to handle fund transfers and settlement and advise on the relevant settlement options and structures, to accept internal money deposits, to arrange for loans and finance leases, to conduct inter-bank lending and borrowing, and to carry out any other businesses approved by the CBRC.

As of December 31, 2017, amounts due to Unicom Group and its subsidiaries included a balance of deposits received by the Finance Company from Unicom Group and its subsidiaries of RMB2,285 million with interest rates ranging from 0.35% to 2.75% per annum for saving and fixed deposits of different terms. As of December 31, 2017, amounts due to a joint venture included a balance of deposits received by the Finance Company from Smart Steps of RMB12 million with interest rates ranging from 0.42% to 1.48% per annum for saving and fixed deposits of different terms. As of December 31, 2017, amount due from Unicom Group and its subsidiaries included a loan from the Finance Company to Unicom Group of RMB200 million with a maturity period of 1 year and floating interest rate at 90% of the one-year lending rate set by the People’s Bank of China. The Finance Company paid RMB34 million interest expense on such deposits to Unicom Group and its subsidiaries in 2017.

Continuing Related Party Transactions under the 2017-2019 Comprehensive Services Agreement

Under the two-step approach described under “A. History and Development of the Company — Two-Step Voting Arrangements” under Item 4, the continuing transactions between CUCL and Unicom Group under the comprehensive services agreement entered into in 2006 were amended, or the amended comprehensive services agreement, effective upon the completion of our merger with China Netcom, with CNC China added as party to such transactions. In January 2009, CNC China merged into CUCL. Pursuant to the amended comprehensive services agreement, Unicom Group agreed to provide certain services to CUCL and CNC China, being the supply of telephone cards, the provision of equipment procurement services, interconnection arrangements, the mutual provision of premises, the provision of international telecommunications network gateway, the provision of operator-based value-added services, the provision of value-added telecommunications services, the provision of “10010/10011” customer services, the provision of agency services and the provision of engineering design and technical services, until December 31, 2010.

 

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On October 29, 2010, CUCL and Unicom Group entered into the 2010 comprehensive services agreement to renew certain continuing related party transactions for a term of three years commencing on January 1, 2011 and expiring on December 31, 2013.

On October 24, 2013, CUCL and Unicom Group entered into a new comprehensive services agreement, or the 2013 comprehensive services agreement, to renew the relevant continuing related party transactions under the 2010 comprehensive services agreement for a term of three years commencing on January 1, 2014 and expiring on December 31, 2016. On August 21, 2015, CUCL and Unicom Group entered into an amendment agreement of the 2013 comprehensive services agreement to change the transaction caps for the comprehensive support services in 2015 and 2016 from RMB1 billion each to RMB2 billion and RMB3.5 billion, respectively. Other provisions of the original agreement remain the same.

On November 25, 2016, CUCL and Unicom Group entered into the 2017-2019 comprehensive services agreement, to renew the relevant continuing related party transactions under the 2013 comprehensive services agreement for a term of three years commencing on January 1, 2017 and expiring on December 31, 2019, and CUCL and its subsidiaries have also agreed to provide certain services to Unicom Group.

2017-2019 Comprehensive Services Agreement

Details of the continuing related party transactions under the 2017-2019 comprehensive services agreement are summarized below.

 

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Telecommunications Resources Leasing

Unicom Group agrees to lease to CUCL:

 

  (i) certain international telecommunications resources (including international telecommunications channel gateways, international telecommunications service gateways, international submarine cable capacity, international land cables and international satellite facilities); and

 

  (ii) certain other telecommunications facilities required by CUCL for its operations.

The rental charges for the leasing of international telecommunications resources and other telecommunications facilities are based on the annual depreciation charges of such resources and telecommunications facilities provided that such charges would not be higher than market rates. CUCL will be responsible for the on-going maintenance of such international telecommunications resources. CUCL and Unicom Group will determine and agree which party is to provide maintenance service for the telecommunications facilities referred to in paragraph (ii) above. Unless otherwise agreed by CUCL and Unicom Group, such maintenance service charges would be borne by CUCL. If Unicom Group is responsible for maintaining any telecommunications facilities referred to in paragraph (ii) above, CUCL will pay to Unicom Group the relevant maintenance service charges which will be determined with reference to market rates, or where there are no market rates, be agreed between the parties and determined on a cost-plus basis. The net rental charges and service charges due to Unicom Group for the provision of the above telecommunications resources leasing will be settled between CUCL and Unicom Group on a quarterly basis. In 2017, the total charges paid by CUCL to Unicom Group amounted to approximately RMB270 million.

Property Leasing

CUCL and Unicom Group agree to lease to each other properties and ancillary facilities owned by CUCL or Unicom Group (including their respective branch companies and subsidiaries).

The rental charges for the leasing of each other’s properties and ancillary facilities are based on market rates. Where there is no market rate or it is not possible to determine the market rate, the rate will be negotiated and agreed between the two parties. Market rates refer to the rates at which the same or similar type of products or services are provided by independent third parties in the ordinary course of business and under normal commercial terms. Negotiated rates refer to the rates based on the reasonable costs plus the amount of the relevant taxes and reasonable profit margin. The rental charges are payable quarterly in arrears. In 2017, the rental charges paid by CUCL to Unicom Group amounted to approximately RMB1,017 million and the rental charges paid by Unicom Group to CUCL was negligible.

Value-added Telecommunications Services

Unicom Group (or its subsidiaries) agrees to provide the customers of CUCL with various types of value-added telecommunications services.

CUCL will settle the revenue generated from the value-added telecommunications services with the branches of Unicom Group (or its subsidiaries) on the condition that such settlement will be based on the average revenue for independent value-added telecommunications content providers who provide value-added telecommunications content to CUCL in the same region. The revenue will be settled on a monthly basis. In 2017, the total revenue allocated to Unicom Group in relation to value-added services amounted to approximately RMB30 million.

Materials Procurement Services

Unicom Group agrees to provide comprehensive procurement services for imported and domestic telecommunications materials and other domestic non-telecommunications materials to CUCL. Unicom Group also agrees to provide services on management of tenders, verification of technical specifications, installation, consulting and agency services.

In addition, Unicom Group will sell cable, modem and other materials operated by itself to CUCL and will also provide storage and logistics services in relation to the above materials procurement.

 

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Charges for the provision of materials procurement services are calculated at the rate of:

 

  (a) up to 3% of the contract value of those procurement contracts in the case of domestic materials procurement; and

 

  (b) up to 1% of the contract value of those procurement contracts in the case of imported materials procurement.

The charges for the provision of materials operated by Unicom Group, and the pricing and/or charging standard of various materials procurement services, and storage and logistics services commission relevant to the direct material procurement are based on the market rates. Where there is no market rate or it is not possible to determine the market rate, the rate will be negotiated and agreed between the two parties. Market rates refer to the rates at which the same or similar type of assets or services is provided by independent third party in the ordinary course of business and under normal commercial terms. Negotiated rates refer to the rates based on the reasonable costs incurred in providing the services plus the amount of the relevant taxes and reasonable profit margin. The service charges due to Unicom Group will be settled on a monthly basis. In 2017, the total charges paid by CUCL to Unicom Group amounted to approximately RMB60 million.

Engineering Design and Construction Services

Unicom Group agrees to provide engineering design, construction and supervision services and IT services to CUCL. Engineering design services include planning and design, engineering inspection, telecommunications electronic engineering, telecommunications equipment engineering and corporate telecommunications engineering. Construction services include services relating to telecommunications equipment, telecommunications routing, power supplies, telecommunications conduit, and technical support systems. IT services include services relating to office automation, software testing, network upgrading, research and development of new business, and development of support systems.

The charges for the provision of engineering design and construction services are based on market rates. Market rates refer to the rates at which the same or similar type of products or services are provided by independent third parties in the ordinary course of business and under normal commercial terms. In the event the recipient will determine the specific provider of engineering design and construction services through tender, the provider will be no less qualified and equipped than the independent third parties, and will participate in the tender procedure in a similar manner as the independent third parties. Under such circumstances, the pricing will be determined by the final rate according to the tender procedure.

The service charges will be settled between CUCL and Unicom Group as and when the relevant services are provided. In 2017, the total charges paid by CUCL to Unicom Group amounted to approximately RMB2,411 million.

Ancillary Telecommunications Services

Unicom Group agrees to provide ancillary telecommunications services to CUCL. These services include certain telecommunications pre-sale, on-sale and after-sale services such as assembling and repairing of certain client telecommunications equipment, sales agency services, printing and invoice delivery services, maintenance of telephone booths, customers acquisitions and servicing and other customers’ services.

The charges payable for the provision of ancillary telecommunications services are determined by the market rates between the two parties. Where there is no market rate or it is not possible to determine the market rates, the rate will be negotiated and agreed between the two parties. Market rates refer to the rates at which the same or similar type of assets or services are provided by independent third parties under normal commercial terms. Negotiated rates refer to the rates based on the reasonable costs plus the amount of the relevant taxes and reasonable profit margin. The service charges will be settled between CUCL and Unicom Group as and when the relevant services are provided. In 2017, the total charges paid by CUCL to Unicom Group amounted to approximately RMB2,699 million.

 

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Comprehensive Support Services

Unicom Group and CUCL agree to provide comprehensive support services to each other, including dining services, facilities leasing services (excluding those facilities which are provided under the paragraph headed “Provision of Telecommunications Resources Leasing” above), vehicle services, health and medical services, labor services, security services, hotel and conference services, gardening services, decoration and renovation services, sales services, construction agency, equipment maintenance services, market development, technical support services, research and development services, sanitary services, parking services, staff trainings, storage services, advertising services, marketing, property management services, information and communications technology services (including construction and installation services, system integration services, software development, product sales and agent services, operation and maintenance services, and consultation services).

The service charges are determined by the market rates between the two parties. Where there is no market rate or it is not possible to determine the market rate, the rate will be negotiated and agreed between the two parties. Market rates refer to the rates at which the same or similar type of assets or services are provided by independent third parties under normal commercial terms. Negotiated rates refer to the rates based on the reasonable costs plus the amount of the relevant taxes and reasonable profit margin. The service charges will be settled between CUCL and Unicom Group as and when the relevant services are provided. In 2017, the total service charges paid by CUCL to Unicom Group amounted to approximately RMB1,274 million and the total service charges paid by Unicom Group to CUCL was RMB67 million.

Shared Services

Unicom Group and CUCL agree to provide shared services to each other, including, but not limited to, the following:

 

  (a) CUCL will provide headquarter human resources services to Unicom Group;

 

  (b) Unicom Group and CUCL will provide business support center services to each other;

 

  (c) CUCL will provide hosting services related to the services referred to in paragraphs (a) and (b) above to Unicom Group; and

 

  (d) Unicom Group will provide premises to CUCL and other shared services requested by its headquarters.

In relation to the business support center services referred to in paragraph (b) above, CUCL will provide support services, such as billing and settlement services provided by the business support center and operational statistics reports. Unicom Group will provide support services, including telephone card production, development and related services, maintenance and technical support and management services in relation to the telecommunications card operational system.

Unicom Group and CUCL will share the costs related to the shared services proportionately in accordance with their respective total assets value, except that the total assets value of the overseas subsidiaries and the listed company of Unicom Group will be excluded from the total asset value of Unicom Group, and the shared costs proportion will be agreed between Unicom Group and CUCL in accordance with the total assets value set out in the financial statements provided to each other, as adjusted in accordance with their respective total assets value on an annual basis. In 2017, the total service charges paid by CUCL to Unicom Group amounted to approximately RMB83 million and the total service charges paid by Unicom Group to CUCL was negligible.

Financial Services

CUCL or its subsidiaries have agreed to provide financial services to Unicom Group, including deposit services, lending and other credit services, and other financial services. Other financial services include settlement services, acceptance of bills, entrusted loans, credit verification, financial and financing consultation, consultation, agency business, approved insurance agent services, and other businesses approved by China Banking Regulatory Commission.

 

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The key pricing policies are as follows:

 

  (a) Deposit services

The interest rate for Unicom Group’s deposit with CUCL or its subsidiaries will be no more than the maximum interest rate promulgated by the People’s Bank of China for the same type of deposit, the interest rate for the same type of deposit offered to other clients and the applicable interest rate offered by the general commercial banks in PRC for the same type of deposit.

 

  (b) Lending and other credit services

The lending interest rate will follow the interest rate standard promulgated by the People’s Bank of China, and will be no less than the minimum interest rate offered by CUCL and its subsidiaries to other clients for the same type of loan, and the applicable interest rate offered to Unicom Group by the general commercial banks in PRC for the same type of loan.

 

  (c) Other financial services

The fees to be charged by CUCL or its subsidiaries for the provision of the financial services to Unicom Group will comply with the relevant prescribed rates for such services as determined by the People’s Bank of China or the China Banking Regulatory Commission. Where no relevant prescribed rate is applicable, the fee will be determined with reference to market rates of similar financial service charges and agreed between the parties.

The service charges will be settled between CUCL or its subsidiaries and Unicom Group as and when the relevant services are provided. In 2017, the total interest expenses paid by CUCL or its subsidiaries to Unicom Group amounted to approximately RMB34 million, and the total service charges paid by Unicom Group to CUCL or its subsidiaries amounted to approximately RMB8 million.

Transfer of Telecommunications Towers and Related Assets to the Tower Company

In October 2015, we, through our wholly owned subsidiaries, CUCL and Unicom New Horizon, entered into a transfer agreement with (i) China Mobile Communication Company Limited, a subsidiary of China Mobile, and its 31 subsidiaries, (ii) China Telecom Corporation Limited, a subsidiary of China Telecom, (iii) China Reform Holdings Corporation Limited, a wholly State-owned company, and (iv) the Tower Company, pursuant to which we, China Mobile and China Telecom sold certain telecommunications towers and related assets to the Tower Company, and the Tower Company would issue and allot shares in the Tower Company and/or pay certain cash as consideration for such transfers. In January 2016, CUCL and the Tower Company entered into a share subscription agreement to settle the number of share subscribed by CUCL and the amount of consideration paid by the Tower Company.

Arrangement Relating to Telecommunications Towers, Related Assets and Other Services

At the time the transfer of telecommunications towers and related assets was completed, or the Completion Date, CUCL and the Tower Company were in the process of finalizing the terms of lease arrangements. However, to ensure that there would be no interruptions in our operations, we are entitled to continue the use of the telecommunications towers and related assets transferred by us to the Tower Company during the period from the day following the Completion Date until the lease arrangements are finalized. After the lease arrangements are finalized and agreed by us and the Tower Company, we shall pay the leasing fees and relevant service charges incurred during the such period to the Tower Company. In addition, we also subsequently leased certain other telecommunications towers and related assets from the Tower Company that were previously owned by China Mobile or China Telecom, or those newly constructed by the Tower Company.

On July 8, 2016, we, through CUCL, and the Tower Company entered into the Pricing Agreement to finalize the lease arrangements relating to the telecommunications towers and related assets. The Pricing Agreement stipulated specific terms on, among other things, the categories of assets for leasing, pricing basis for the lease fees and service charges, and relevant service period. Based on the actual demand of our operations, we, through the subsidiaries of CUCL, subsequently entered into provincial service agreements and detailed lease confirmation forms and/or orders for specified telecommunications towers with the Tower Company or their subsidiaries. According to these Agreements, we recognized operating lease and other service charges in an amount of RMB16,524 million for the year ended December 31, 2017. In 2017, we also provided certain engineering design and construction services to the Tower Company under the Pricing Agreement and the total service fees were RMB267 million.

 

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On January 31, 2018, pursuant to the Pricing Agreement and after arm-length negotiations and discussions, we, through our wholly owned subsidiary, CUCL, and the Tower Company entered into the Supplementary Agreement, which mainly included amendments to the pricing of tower products as stated in the Annex 1 Product Catalogue and Pricing of the Pricing Agreement. Such amendments shall be effective from January 1, 2018 and acknowledged by the respective provincial companies or municipal companies of the parties by entering a confirmation letter of the telecommunications towers to be leased. The term of the Supplementary Agreement shall be five years, effective from January 1, 2018 and expiring on December 31, 2022. Prior to expiry of the agreement, CUCL and the Tower Company shall negotiate with each other for the pricing thereafter. We are of the view that the signing of the supplementary agreement with the Tower Company will be beneficial for us to lower the tower usage fee in the future.

Loan from Unicom Group BVI

On December 21, 2017, our company borrowed an unsecured loan from Unicom Group BVI in the principal amount of HK$520.00 million, with a term of one year at a floating interest rate of one-year Hong Kong Interbank Offer Rate plus 1.2% per annum. The proceeds from the loan were mainly used to fund our working capital. As of April 13, 2018, the amount outstanding of such loan was approximately HK$524.45 million.

Loan from Smart Steps

On October 24, 2017, CUCL borrowed an unsecured entrusted loan from Smart Steps, a joint venture company in which we own 55% equity interest, in the principal amount of RMB50.00 million, with a term of one year at an interest rate of 3.915% per annum. The proceeds from the loan were mainly used to fund our working capital. As of April 13, 2018, the amount outstanding of such loan was approximately RMB30.08 million.

Certain Agreements Relating to Our Initial Public Offering

The Reorganization Agreement

In relation to the restructuring in connection with our initial public offering, our wholly owned subsidiary, CUCL, entered into a reorganization agreement with Unicom Group, dated April 21, 2000. This agreement includes the following terms:

 

    Unicom Group’s agreement to transfer to CUCL certain assets and liabilities;

 

    mutual warranties and indemnities given by Unicom Group and CUCL in relation to the assets and liabilities transferred to CUCL and in relation to the restructuring;

 

    undertakings by Unicom Group in favor of CUCL, including, among other things:

 

    to hold and maintain all licenses received from the former Ministry of Information Industry in connection with any of our businesses for our benefit, and to allocate spectrum and to provide other resources to us;

 

    subject to applicable Chinese laws and regulations in effect at the relevant time, to take all actions necessary to obtain, maintain, renew and otherwise extend to or for our benefit such governmental or regulatory licenses, consents, permits or other approvals as we shall require to continue to operate our businesses;

 

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    to arrange for us to participate in its international roaming arrangements;

 

    not to engage in any business that competes with our businesses, except for the existing competing businesses of Unicom Group;

 

    to grant us a right of first refusal in relation to any governmental authorization, license or permit, or other business opportunity to develop any new telecommunications technology, product or service;

 

    to ensure that we can continue to use the premises for which title documentation cannot be obtained at this time, for a period of three years following the restructuring;

 

    not to dispose of any of our shares it beneficially owns or to take or permit any other actions, including primary issuances of securities by us or CUCL, which would result in us or CUCL no longer constituting majority-owned subsidiaries of Unicom Group; and

 

    not to seek an overseas listing for any of its businesses or the businesses of its subsidiaries in which we are engaged or may engage in the future except through us;

 

    an option granted by Unicom Group to us to acquire Unicom Group’s interest in any telecommunications interest, such as Unicom Paging, Unicom Xingye and Unicom Group’s CDMA telephony license and business; and

 

    a commitment by Unicom Group that it will provide continuous financial support to us when necessary.

The 2017-2019 comprehensive services agreement provides that the determination of whether we or CUCL would constitute majority-owned subsidiaries of the Unicom Group shall be made in accordance with the PRC Enterprise Accounting Standards, as amended by the MOF from time to time.

Trademark Agreement

Unicom Group is the registered owner of the Unicom trademark in English, the trademark bearing the Unicom logo and the trademark of the word “Unicom” in Chinese (“联通”), which are registered at the PRC State Trademark Bureau. Under a PRC trademark license agreement entered into on May 25, 2000 between Unicom Group and CUCL, CUCL and our affiliates were granted the right to use these trademarks on a royalty-free basis for an initial period of five years, renewable at the option of CUCL. CUCL has elected to renew the trademark license agreement and the trademark license agreement is currently valid. Under the terms of this agreement, we and our affiliates are the exclusive licensees of these trademarks, provided that Unicom Group may also license these trademarks to any of its existing or future subsidiaries. Unicom Group also agreed to license to CUCL any trademark that it registers in China in the future that incorporates the word “Unicom”.

 

C. Interests of Experts and Counsel

Not Applicable.

 

Item 8. Financial Information

See Item 18 “Financial Statements”. Other than as disclosed elsewhere in this annual report, no significant change has occurred since the date of the annual financial statements.

 

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Legal Proceedings

We are not involved in any material litigation, arbitration or administrative proceedings. We are not aware of any pending or threatened litigation, arbitration or administrative proceedings expected to have a material effect on our financial condition and results of operations.

Policy on Dividend Distribution

The objective of our dividend policy is to achieve a long-term, sustainable and steadily increasing dividend, with a view to maximizing our shareholders’ value. The declaration and payment of future dividends will depend upon, among other things, financial condition, business prospects, future earnings, cash flow, liquidity level and cost of capital. We believe such policy will provide our shareholders with a stable return in the long term along with the growth of our company. We may only pay dividends out of our distributable profits.

Taking into consideration our profitability, debt and cash flow level and capital requirements for its future development, our board of directors recommended the payment of a cash dividend of RMB0.052 per share for the year ended December 31, 2017. We did not pay a cash dividend for the year ended December 31, 2016.

 

Item 9. The Offer and Listing

Market Price Information

Our ADSs, each representing 10 ordinary shares, are listed and traded on the NYSE. Our ordinary shares are listed and traded on the HKSE. The NYSE and the HKSE are the principal trading markets for our ADSs and ordinary shares, which are not listed on any other exchanges in or outside the United States.

The high and low closing prices of our ordinary shares on the HKSE and of our ADSs on the NYSE since listing are as follows:

 

     Price per Ordinary Share
(HK$)
   Price per ADS (US$)
     High    Low    High    Low

Annual:

           

2013

   13.34    9.51    17.40    12.21

2014

   14.14    9.17    18.03    11.73

2015

   15.46    9.08    19.80    11.53

2016

   10.24    7.77    13.16    9.98

2017

   12.36    8.76    16.42    11.30

Quarterly:

           

First Quarter, 2016

   10.24    8.00    13.16    10.38

Second Quarter, 2016

   10.06    7.77    13.06    9.98

Third Quarter, 2016

   9.55    7.86    12.36    10.01

Fourth Quarter, 2016

   9.94    8.50    12.78    10.92

First Quarter, 2017

   10.52    8.76    13.52    11.30

Second Quarter, 2017

   11.70    9.98    15.08    12.89

Third Quarter, 2017

   12.36    10.44    16.42    13.47

Fourth Quarter, 2017

   12.18    10.40    15.51    13.36

First Quarter, 2018

   11.80    9.32    15.04    11.88

Monthly:

           

October 2017

   11.40    10.94    14.50    13.97

November 2017

   12.18    11.32    15.51    14.54

December 2017

   11.40    10.40    14.47    13.36

January 2018

   11.72    10.74    15.04    13.84

February 2018

   11.80    9.94    14.93    12.76

March 2018

   10.08    9.32    12.83    11.88

April 2018 (through April 13, 2018)

   10.34    9.72    13.20    12.65

 

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Item 10. Additional Information

 

A. Share Capital

Not Applicable.

 

B. Articles of Association

General

Under our Articles of Association, we have the capacity, rights, powers and privileges of a natural person and, in addition to and without limiting the forgoing, we may do anything which is permitted or required to be done by any enactment or rule of law. The following is a summary of selected provisions of our Articles of Association.

Directors

Material Interests and Voting

A director shall not vote (or be counted in the quorum) on any resolution of our board of directors in respect of any transaction, contract or arrangement or proposal in which he or any of his close associates (and if required by the HKSE Listing Rules, his other associates) (as defined in the HKSE Listing Rules) is materially interested, and if he shall do so, his vote shall not be counted (nor shall he be counted in the quorum for that resolution), but this prohibition does not apply to any transaction, contract, arrangement or other proposal for or concerning:

 

    the giving of any security or indemnity either (i) to the director or any of his close associates (and if required by the HKSE Listing Rules, his other associates) in respect of money lent or obligations incurred or undertaken by him or any of them at the request of or for the benefit of Unicom or any of its subsidiaries or (ii) to a third party in respect of a debt or obligation of Unicom or any of its subsidiaries for which the director or any of his close associates (and if required by the HKSE Listing Rules, his other associates) has assumed responsibility in whole or in part and whether alone or jointly under a guarantee or indemnity or by the giving of security;

 

    an offer of shares or debentures or other securities of or by Unicom (or any other company which Unicom may promote or be interested in) where the director or any of his close associates (and if required by the HKSE Listing Rules, his other associates) is or will be an interested participant in the underwriting or sub-underwriting of the offer;

 

    any transaction, contract or arrangement in which the director or any of his close associates (and if required by the HKSE Listing Rules, his other associates) is interested in the same manner as other holders of shares or debentures or other securities of Unicom by virtue only of his interest in shares or debentures or other securities of Unicom;

 

    any other company in which the director or any of his close associates (and if required by the HKSE Listing Rules, his other associates) is interested only, whether directly or indirectly, as an officer or shareholder or in which the director or any of his close associates (and if required by the HKSE Listing Rules, his other associates) is beneficially interested in shares of that company, provided that he, together with any of his close associates (and if required by the HKSE Listing Rules, his other associates), is not beneficially interested in 5% or more of (i) the issued shares of any class of such company (or of any third company through which such interest is derived), or (ii) the voting rights attached to such issued shares or securities (excluding for the purpose of calculating such 5% interest, any indirect interest of such director or any of his close associates (and if required by the HKSE Listing Rules, his other associates) by virtue of Unicom’s interest in such company); or

 

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    the benefit of employees of Unicom or any of its subsidiaries, including (i) the adoption, modification or operation of a pension fund or retirement, death or disability benefits scheme which relates to directors, their close associates (and if required by the HKSE Listing Rules, their other associates) and employees of Unicom or any of its subsidiaries and does not provide in respect of the director or any of his close associates (and if required by the HKSE Listing Rules, his other associates) any privilege or advantage not generally accorded to the class of persons to which such scheme or fund relates; or (ii) the adoption, modification or operation of any employee share scheme involving the issue or grant of options over shares or other securities by Unicom to, or for the benefit of, the employees of Unicom or its subsidiaries under which the director or any of his close associates (and if required by the HKSE Listing Rules, his other associates) may benefit.

Remuneration and Pensions

The directors of Unicom are entitled to receive by way of remuneration for their services such sum as is from time to time determined by Unicom in a general meeting. The directors are also entitled to have reimbursed all traveling, hotel and other expenses reasonably incurred by them in or about the performance of their duties as directors. The board of directors may grant special remuneration to any director who performs services that, in the opinion of the board, are outside the scope of the ordinary duties of a director.

The board may establish and maintain or procure the establishment and maintenance of any contributory or non-contributory pension or superannuation funds for the benefit of, or give donations, gratuities, pensions, allowances or emoluments to, any persons (i) who are or were at any time in the employment or service of Unicom, or of any company which is a subsidiary of Unicom, or is allied or associated with Unicom or with any such subsidiary company, or (ii) who are or were at any time directors or officers of Unicom or of any such other company above, and have or who have had any salaried employment or had held office in Unicom or such other company, and the wives, widows, families and dependents of any such persons. The board may also establish and subsidize or subscribe to any institutions, associations, clubs or funds calculated to be for the benefit of or to advance the interests and wellbeing of Unicom or of any such other company above or of any such persons above, and may make payments for or towards the insurance of any such persons, and subscribe or guarantee money for charitable or benevolent objects or for any exhibition or for any public, general or useful object. Any director holding any such employment or office is entitled to participate in, and retain for his own benefit, any such donation, gratuity, pension, allowance or emolument.

Borrowing Powers

The directors may exercise all the powers of Unicom to borrow money and to mortgage or charge all or any part of the undertaking, property and assets (present and future) and uncalled capital of Unicom and to issue debentures, debenture stocks, bonds and other securities, whether outright or as collateral security for any debt, liability or obligation of Unicom or of any third party.

Qualification of Directors

A director of Unicom is not required to hold any qualification shares.

Rotation of Directors

At every annual general meeting, one-third of the directors for the time being, or, if the number is not three or a multiple of three, then the number nearest one-third, shall retire from office by rotation, except for any director holding office as chairman or chief executive officer. The directors to retire in every year shall be those who have been in office the longest since their last election. In addition, a director appointed by the board to fill in a casual vacancy or as an addition to the board shall retire at the next following annual general meeting and shall then be eligible for re-election, but shall not be taken into account in determining the number of directors who are to retire by rotation at each annual general meeting. The retiring directors shall be eligible for re-election.

 

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Rights Attached to Ordinary Shares

Voting Rights

Under the Companies Ordinance, any action to be taken by the shareholders at a general meeting requires an affirmative vote by either an ordinary or a special resolution passed at the meeting. An ordinary resolution is one passed by the majority of such shareholders as are entitled to, and do, vote in person or by proxy at a general meeting. A special resolution is one passed by not less than three-quarters of such shareholders as are entitled to, and do, vote in person or by proxy at a general meeting. Most shareholders’ decisions are passed by ordinary resolutions. However, the Companies Ordinance and our Articles of Association stipulate that certain matters may only be passed by special resolutions.

At any general meeting a resolution put to the vote of the meeting shall be decided on a poll is demanded by:

 

    the Chairman of the meeting;

 

    at least five members present in person (or in the case of a member being a corporation, by its duly authorized representative) or by proxy and entitled to vote at the meeting; or

 

    any member or members present in person (or in the case of a member being a corporation, by its duly authorized representative) or by proxy and representing in the aggregate not less than five per cent. of the total voting rights of all members having the right to attend and vote at the meeting;

provided that a resolution put to the vote of the meeting may be decided on a show of hands to the extent permitted by the Listing Rules and other applicable laws, rules and regulations.

Subject to any special rights, privileges or restrictions as to voting for the time being attached to any class or classes of shares, every member who (being an individual) is present in person or by proxy or (being a corporation) is present by a representative duly authorized under Section 606 of the Companies Ordinance at any general meeting shall be entitled, on a show of hands, to one vote only and, on a poll, to one vote for every fully paid-up share of which he is the holder.

On a poll, votes may be given either personally or by proxy and a member entitled to more than one vote need not use all his votes or cast all the votes he uses in the same way.

Issue of Shares

A general meeting resolving upon the creation of any new shares may direct that the same or any of them shall be offered in the first instance to all the holders for the time being of any class of shares in the capital of Unicom, in proportion to the number of shares of such class held by them respectively, or make any other provisions as to the issue and allotment of the new shares, and in default of any such direction, or so far as the same shall not extend, the new shares shall be at the disposal of the Directors, and Article 10 of our Articles of Association shall apply thereto.

Dividends

Subject to the Companies Ordinance and as set out in our Articles of Association, our shareholders at a general meeting may by ordinary resolution declare dividends but no dividend shall be declared in excess of the amount recommended by our board of directors.

 

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In addition to any dividends declared at a general meeting upon the recommendation of the board of directors, our board of directors may, as they deem appropriate, from time to time resolve to pay to our shareholders such interim dividends as appear to our board of directors to be justified by our financial position. Our board of directors may also pay any fixed dividend that is payable on any of our shares on any other dates, whenever our financial position, in the opinion of our board of directors, justifies such payments.

All dividends unclaimed for one year after having become payable may be invested or otherwise made use of by the board for the benefit of Unicom until claimed. All dividends unclaimed for six years after having become payable may be forfeited by the board and will revert to Unicom.

Winding Up

If we are wound up, the surplus assets remaining after payment to all creditors shall be divided among the shareholders in proportion to the capital paid up on the shares held by them, subject to the rights of the holders of any shares that may be issued on special terms or conditions.

If we are wound up, the liquidator may, with the sanction of a special resolution, divide among our shareholders in specie or in kind the whole or any part of our assets or vest any part of our assets in trustees upon such trusts for the benefit of our shareholders or any of them as the resolution shall provide.

Miscellaneous

Shareholders are not entitled to any redemption rights, conversion rights or preemptive rights on the transfer of ordinary shares.

The transfer agent and registrar for the shares is Hong Kong Registrars Limited, 17th Floor, Hopewell Centre, 183 Queen’s Road East, Hong Kong.

Modification of Rights

Whenever the share capital of Unicom is divided into different classes of shares, the special rights attached to any class may, subject to the Company Ordinance, be varied or abrogated either with the consent in writing of the holders of not less than seventy-five percent of the total voting rights of holders of the shares of the class or with the sanction of a special resolution passed at a separate general meeting of the holders of the shares of the class (but not otherwise) and may be so varied or abrogated either whilst Unicom is a going concern or during or in contemplation of a winding up. To every such separate general meeting, all the provisions of our Articles of Association relating to general meetings and to the proceedings thereat shall mutatis mutandis apply, except that the necessary quorum shall be two persons present in person or by proxy together holding at least one-third of the total voting rights of holders of the shares of the class (but so that, if at any adjourned meeting a quorum as above defined is not present, any one holder of shares of the class present in person or proxy shall be a quorum) and that any holder of shares of the class present in person or by proxy may demand a poll and that every such holder shall on a poll have one vote for every share of the class held by him.

Annual General and Extraordinary General Meetings

We must hold in each year a general meeting as our annual general meeting in accordance with Section 610 of the Company Ordinance in addition to any other meetings in that year. The annual general meeting is held at such time and place as may be determined by the board of directors and subject to our Articles of Association. All other general meetings are called extraordinary general meetings. The board of directors may call an extraordinary general meeting at any time or upon request from the members in accordance with the Companies Ordinance.

Under the Companies Ordinance, an annual general meeting can be called by not less than 21 days’ notice in writing, and any other general meeting can be called by not less than 14 days’ notice in writing. The notice must specify the place, date and time of the meeting, and, in the case of special business, the general nature of that business.

 

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Limitations on Rights to Own Securities

There are no limitations on the rights to own securities, including the rights of non-resident or foreign shareholders to hold or exercise voting rights on the securities, imposed by Hong Kong law or by our Articles of Association.

Changes in Capital

We may exercise any powers conferred or permitted by the Companies Ordinance to buy-back our own shares and warrants (including any redeemable share) at any price or to give, directly or indirectly, by means of a loan, guarantee, the provision of security or otherwise, financial assistance for the purpose of or in connection with a buy-back made or to be made by any person of any shares or warrants in Unicom. Buy-backs of our own shares may be made either by way of a general offer to all shareholders in proportion to their shareholdings, by purchasing our shares on a stock exchange or by an off-market contract with individual shareholders. Any such share buy-back or financial assistance must be made or given in accordance with any relevant rules or regulations issued by the HKSE or the Securities and Futures Commission of Hong Kong.

We may, from time to time, on more than one occasion or at a specified time or in specified circumstances alter our share capital in accordance with the Company Ordinance and as the resolution shall prescribe. Subject to the Companies Ordinance, we may from time to time by ordinary resolution:

 

    consolidate all of our shares into smaller number of shares than the existing number;

 

    divide our shares into several classes and attach to them any preferential, deferred, qualified or special rights, privileges or conditions;

 

    cancel any shares that at the date of the passing of the resolution have not been taken or agreed to be taken by any person, or have been forfeited in accordance with our Articles of Association;

 

    sub-divide our shares into larger number of shares than the existing number; and

 

    make provision for the issue and allotment of shares which do not carry any voting rights.

Miscellaneous

We keep our share register with our share registrar, which is Hong Kong Registrars Limited, Shops 1712-1716, 17th Floor, Hopewell Centre, 183 Queen’s Road East, Wanchai, Hong Kong. In addition, we also file certain documents with the Registrar of Companies, Hong Kong, in accordance with the requirements of the Companies Ordinance. Our company number is 703499.

 

C. Material Contracts

In addition to the contracts described in “B. Related Party Transactions” under Item 7 and “A. History and Development of the Company” under Item 4, Unicom Group, we or our subsidiaries have entered into the following contracts that are not in the ordinary course of business within the two years preceding the date of this annual report that are or may be material:

 

    the Pricing Agreement, dated July 8, 2016, between CUCL and the Tower Company in relation to the leasing of the telecommunications towers and related assets;

 

    the Share Subscription Agreement, dated August 22, 2017, between the Company and Unicom BVI to subscribe for shares of the Company; and

 

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    the Supplementary Agreement dated January 31, 2018 between CUCL and the Tower Company to adjust certain terms and provisions in the Pricing Agreement and annex thereto in relation to the leasing of the tower products.

 

D. Exchange Controls

The ability of our operating subsidiary, CUCL, to satisfy its foreign exchange obligations and to pay dividends to us depends on existing and future exchange control regulations in China. Under the current relevant regulations, Renminbi is convertible under the current account, which includes trade- and service-related foreign exchange transactions, but is not convertible under the capital account, which includes foreign direct investment. CUCL, our wholly owned subsidiary that holds substantially all of our assets, is a foreign investment enterprise. The foreign investment enterprise status will allow it to purchase foreign exchange at designated foreign exchange banks for settlement of current account transactions without the approval of the State Administration for Foreign Exchange of the PRC, or the SAFE. These current account transactions include payment of dividends by foreign investment enterprises. However, the relevant PRC Government authorities may in the future limit or eliminate the authorizations for a foreign investment enterprise to retain its foreign exchange to satisfy its foreign exchange obligations or to pay dividends in the future. Furthermore, certain foreign exchange transactions of CUCL under the capital account still require approvals from the SAFE. This requirement affects our subsidiary’s ability to obtain foreign exchange through equity financing, including by means of capital contributions from us.

Under existing Hong Kong law, (i) there are no foreign exchange controls or other laws that restrict the import or export of capital and that would affect the availability of cash and cash equivalents for our use, (ii) there are no foreign exchange controls or other laws, decrees or regulations that affect the remittance of interest, dividends or other payments on our outstanding debt and equity securities to U.S. residents and (iii) there are no limitations on the rights of non-resident or foreign owners to hold our debt or equity securities.

 

E. Taxation

The taxation of income and capital gains of holders of ordinary shares or ADSs is subject to the laws and practices of the PRC, Hong Kong and jurisdictions in which holders of ordinary shares or ADSs are resident or otherwise subject to tax. The following summary of certain relevant taxation provisions is based on current law and practice, is subject to change and does not constitute legal or tax advice. The discussion does not deal with all possible tax consequences relating to an investment in the ordinary shares or ADSs. In particular, the discussion does not address the tax consequences under state, local and other laws, such as non-PRC, non-Hong Kong and non-U.S. federal laws. The discussion is based upon laws and relevant interpretations in effect as of the date of this annual report.

People’s Republic of China

This section describes certain PRC tax consequences of the ownership and disposition of our ordinary shares or ADSs. This section does not address all possible PRC tax considerations that may be relevant to an investment in our ordinary shares or ADSs in light of an investor’s specific circumstances, and is based on PRC tax laws and relevant interpretations as in effect as of the date of this annual report on Form 20-F, which are subject to change, possibly with retroactive effect. Accordingly, each prospective investor should consult its own tax advisor regarding the PRC and other tax consequences of an investment in our ordinary shares or ADSs applicable under its particular circumstances.

Taxation of Dividends

Under the PRC Enterprise Income Tax, or the EIT Law and its implementing rules that became effective on January 1, 2008, a non-resident enterprise is generally subject to PRC enterprise income tax with respect to PRC-sourced income, including dividends received from an enterprise that is domiciled in China. The PRC enterprise income tax with respect to such dividends is currently required to be withheld at the rate of 10%, unless there is an applicable tax treaty between China and the jurisdiction in which such non-resident enterprise resides that reduces or exempts the tax.

 

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On April 22, 2009, the SAT issued the Notice Regarding the Determination of Tax Residence Status of Chinese-Controlled Offshore-Incorporated Enterprises on the Basis of De Facto Management Bodies, or the 2009 Notice, which was retroactively effective as of January 1, 2008. Pursuant to the 2009 Notice, an enterprise incorporated under the laws of a foreign country (or region) but controlled by a PRC enterprise or enterprise group may be determined to be a PRC resident enterprise with its de facto management bodies located within China for PRC tax purposes if certain criteria specified under the 2009 Notice are met. Under the 2009 Notice, dividends paid by such an off-shore incorporated enterprise are deemed to be PRC-sourced income and subject to PRC enterprise income tax. On November 11, 2010, we were notified by the PRC tax authorities that we are determined to be a PRC resident enterprise since January 1, 2008 for PRC tax purposes. Accordingly, we are required to withhold the 10% EIT when we distribute dividends to our non-resident enterprise shareholders.

Accordingly, we will withhold the 10% EIT when we distribute our final dividend for the fiscal year ended December 31, 2017 in respect of the non-resident enterprise shareholders for PRC tax purposes whose names appear on our register of members as of the record date for such dividends, and who are not individuals, unless such non-individual shareholders are able to provide documents from the relevant PRC tax authorities confirming that we are not required to withhold the 10% EIT in respect of the dividends that such shareholders are entitled to, on the basis that dividend income between two PRC resident enterprises is exempted from enterprise income tax, subject to certain conditions, under the EIT Law. In addition, certain investors hold our shares or ADSs through custodians, nominees, corporate trustees or other intermediaries and the names of these investors do not appear on our register of members. Payments of dividends to such investors are also subject to the 10% EIT withholding. These investors should enquire about the relevant procedures with the relevant custodians, nominees, trustees or other intermediaries if they wish to change the identities of the shareholders on our register of members.

Taxation of Capital Gains

Under the PRC EIT Law and its implementing rules, a non-resident enterprise is generally subject to PRC enterprise income tax with respect to PRC-sourced income, but there remain substantial uncertainties as to their interpretation and application by the relevant PRC tax authorities. We intend to comply with any interpretation or notice in relation to the taxation of capital gains issued by the PRC tax authorities in the future.

Additional PRC Tax Considerations

Stamp duty. Under the Provisional Regulations of the PRC Concerning Stamp Duty (as amended by the Decision of the State Council to Abolish and Amend Certain Administrative Regulations on January 8, 2011) and its implementing rules, both of which became effective on October 1, 1988, PRC stamp duty should not apply to acquisitions or dispositions of our ordinary shares or ADSs outside of China as the PRC stamp duty is imposed only on documents executed or received within China that are legally binding in China and protected under PRC law.

Estate tax. China does not currently levy estate tax.

Hong Kong

Taxation of Dividends

Under the current practices of the Hong Kong Inland Revenue Department, no tax is payable in Hong Kong in connection with dividends paid by us, either by withholding or otherwise, unless such dividends are attributable to a trade, profession or business carried on in Hong Kong.

Profits

No tax is imposed in Hong Kong in respect of capital gains from the sale of shares and ADSs. Trading gains from the sale of shares or ADSs by persons carrying on a trade, profession or business in Hong Kong where such gains are derived from or arise in Hong Kong from such trade, profession or business will be chargeable to Hong Kong income tax rates of 16.5% on corporations and 15.0% on individuals, unless such gains are chargeable under the respective half-rates of 8.25% and 7.5% that may apply for the first HK$2 million of assessable profits for years of assessment beginning on or after April 1, 2018. Gains from sales of shares effected on the HKSE will be considered by the Hong Kong Inland Revenue Department to be derived from or arise in Hong Kong. Liability for Hong Kong profits tax would thus arise in respect of trading gains from sales of shares or ADSs realized by persons carrying on a business of trading or dealing in securities in Hong Kong.

 

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Stamp Duty

Hong Kong stamp duty, currently charged at the rate of 0.1% of the higher of the consideration for or the value of the shares, will be payable by the purchaser on every purchase and by the seller on every sale of shares. In addition, a fixed duty of HK$5 is currently payable on any instrument of transfer of shares. If one of the parties to the sale is a non-resident of Hong Kong and does not pay the required stamp duty, the duty not paid will be assessed on the instrument of transfer (if any) and the transferee will be liable for payment of such duty.

The withdrawal of shares upon the surrender of American Depository Receipts, or ADRs, and the issuance of ADRs upon the deposit of shares, will also attract stamp duty at the rate described above unless such withdrawal or deposit does not result in a change in the beneficial ownership of the shares under Hong Kong law, in which case only a fixed duty of HK$5 is payable on the transfer. The issuance of the ADRs upon the deposit of shares issued directly to The Bank of New York, as depositary of the ADSs, or for the account of The Bank of New York does not attract stamp duty. No Hong Kong stamp duty is payable upon the transfer of ADSs outside Hong Kong.

Estate Duty

Currently no Hong Kong estate duty is payable.

United States

United States Federal Income Taxation

This section describes the material United States federal income tax consequences to a U.S. holder (as defined below) of owning shares or ADSs. It applies to you only if you hold your shares or ADSs as capital assets for tax purposes. This section does not apply to you if you are a member of a special class of holders subject to special rules, including:

 

    a dealer in securities or currencies,

 

    a trader in securities that elects to use a mark-to-market method of accounting for your securities holdings,

 

    a tax-exempt organization,

 

    an insurance company,

 

    a person liable for alternative minimum tax,

 

    a person that actually or constructively owns 10% or more of the combined voting power of our voting stock or of the total value of our stock,

 

    a person that holds shares or ADSs that are a hedge or as part of a straddle or a conversion transaction,

 

    a person that purchases or sells shares or ADSs as part of a wash sale for tax purposes, or

 

    a person whose functional currency is not the U.S. dollar.

 

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This section is based on the Internal Revenue Code of 1986, as amended, or the Code, its legislative history, existing and proposed regulations, published rulings and court decisions, all as currently in effect, as well as on the agreement between the United States and the People’s Republic of China for the avoidance of double taxation, or the U.S.-PRC Treaty. These laws are subject to change, possibly on a retroactive basis. In addition, this section is based in part upon the representations of the Depositary and the assumption that each obligation in the deposit agreement and any related agreement will be performed in accordance with its terms.

You are a U.S. holder if you are a beneficial owner of shares or ADSs and you are:

 

    a citizen or resident of the United States,

 

    a corporation organized under the laws of the United States, any States thereof, or the District of Columbia,

 

    an estate whose income is subject to United States federal income tax regardless of its source, or

 

    a trust if a United States court can exercise primary supervision over the trust’s administration and one or more United States persons are authorized to control all substantial decisions of the trust.

If a partnership holds the shares or ADSs, the United States federal income tax treatment of a partner will generally depend on the status of the partner and the tax treatment of the partnership. A partner in a partnership holding the shares or ADSs should consult its tax advisor with regard to the United States federal income tax treatment of its investment in the shares or ADSs.

You should consult your own tax advisor regarding the United States federal, state and local tax consequences of owning and disposing of shares and ADSs in your particular circumstances.

This discussion addresses only United States federal income taxation.

In general, taking into account the earlier assumptions, for United States federal income tax purposes, if you hold ADRs evidencing ADSs, you will be treated as the owner of the shares represented by those ADRs. Exchanges of shares for ADRs, and ADRs for shares, generally will not be subject to United States federal income tax.

Taxation of Dividends

Under the United States federal income tax laws, and subject to the passive foreign investment company rules discussed below, if you are a U.S. holder, the gross amount of any dividend we pay out of our current or accumulated earnings and profits (as determined for United States federal income tax purposes) is subject to United States federal taxation. If you are a non-corporate U.S. holder, dividends that constitute qualified dividend income will be taxable to you at the preferential rates applicable to long-term capital gains, provided that you hold the shares or ADSs for more than 60 days during the 121-day period beginning 60 days before the ex-dividend date and meet other holding period requirements. Dividends that are paid with respect to ADSs that are readily tradable on an established securities market in the United States are qualified dividend income. Under this rule, we expect that the dividends we pay with respect to the ADSs will be qualified dividend income. In addition, dividends paid by a non-U.S. corporation that is eligible for the benefits of a comprehensive income tax treaty with the United States will be qualified dividend income. Because our shares are not readily tradable on an established securities market in the United States and because we are uncertain as to whether we are eligible for the benefits of the U.S.-PRC Treaty, it is unclear whether dividends paid with respect to our shares will also be qualified dividend income.

 

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The dividend is taxable to you when you, in the case of shares, or the Depositary, in the case of ADSs, receive the dividend, actually or constructively. The dividend will not be eligible for the dividends-received deduction generally allowed to United States corporations in respect of dividends received from other United States corporations. The amount of the dividend distribution that you must include in your income as a U.S. holder will be the U.S. dollar value of the Hong Kong Dollar payments made, determined at the spot Hong Kong/U.S. dollar rate on the date the dividend distribution is includible in your income, regardless of whether the payment is in fact converted into U.S. dollars. Generally, any gain or loss resulting from currency exchange fluctuations during the period from the date you include the dividend payment in income to the date you convert the payment into U.S. dollars will be treated as ordinary income or loss and will not be eligible for the special tax rate applicable to qualified dividend income. The gain or loss generally will be income or loss from sources within the United States for foreign tax credit limitation purposes. Distributions in excess of current and accumulated earnings and profits, as determined for United States federal income tax purposes, will be treated as a non-taxable return of capital to the extent of your basis in the shares or ADSs and thereafter as capital gain.

Special rules apply in determining the foreign tax credit limitation with respect to dividends that are subject to the preferential tax rates. Dividends will generally be income from sources outside the United States and will generally be “passive” income for purposes of computing the foreign tax credit allowable to you. If you are subject to PRC withholding tax (as discussed in “People’s Republic of China — Taxation of Dividends” above), you must include any such tax withheld from the dividend payment in your gross income, even though you do not in fact receive it. The PRC tax withheld and paid over to the PRC will be creditable against your United States federal income tax liability. To the extent a refund of the tax withheld is available under PRC law, or to the extent you could have avoided the withholding tax by complying with any certification, identification requirement or by completing any forms, the amount of tax withheld that is refundable or that could have been avoided will not be eligible for credit against your United States federal income tax liability.

Taxation of Capital Gains

Subject to the passive foreign investment company rules discussed below, if you are a U.S. holder and you sell or otherwise dispose of your shares or ADSs, you will recognize capital gain or loss for United States federal income tax purposes equal to the difference between the U.S. dollar value of the amount that you realize and your tax basis, determined in U.S. dollars, in your shares or ADSs. Capital gain of a non-corporate U.S. holder is generally taxed at preferential rates where the property is held for more than one year. Subject to the paragraph immediately below regarding gain subject to PRC tax, the gain or loss will generally be income or loss from sources within the United States for foreign tax credit limitation purposes. Your ability to deduct capital losses is subject to limitations. Any Hong Kong stamp duty that you pay will not be a creditable tax for United States federal income tax purposes, but you may be able to deduct such stamp duty subject to limitations under the Code.

It is not clear if PRC tax will be imposed on any gain from the disposition of your shares or ADSs (as discussed above in “People’s Republic of China — Taxation of Capital Gains”). Under the U.S.-PRC Treaty, if PRC tax were to be imposed on any gain from the disposition of your shares or ADSs, then such gain will be treated as PRC source income if you are eligible for the benefits of the U.S.-PRC Treaty. U.S. holders should consult their tax advisors regarding the possibility of PRC tax being imposed on gain from the disposition of their shares or ADSs, the tax consequences if a PRC tax were to be imposed on such dispositions, and the availability of the foreign tax credit under their particular circumstances.

Passive Foreign Investment Company Rules. We believe that we should not be treated as a passive foreign investment company, or PFIC, for United States federal income tax purposes, but this conclusion is a factual determination that is made annually and thus may be subject to change.

In general, if you are a U.S. holder, we will be a PFIC with respect to you if for any taxable year in which you held our ADSs or shares:

 

    at least 75% of our gross income for the taxable year is passive income; or

 

    at least 50% of the value, determined on the basis of a quarterly average, of our assets is attributable to assets that produce or are held for the production of passive income.

Passive income generally includes dividends, interest, royalties, rents (other than certain rents and royalties derived in the active conduct of a trade or business), annuities and gains from assets that produce passive income. If a foreign corporation owns, directly or indirectly, at least 25% by value of the stock of another corporation, the foreign corporation is treated for purposes of the PFIC tests as owning its proportionate share of the assets of the other corporation, and as receiving directly its proportionate share of the other corporation’s income.

 

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If we are treated as a PFIC and you are a U.S. holder that does not make a mark-to-market election, as described below, you will be subject to special rules with respect to:

 

    any gain you realize on the sale or other disposition of your shares or ADSs; and

 

    any excess distribution that we make to you (generally, any distributions to you during a single taxable year that are greater than 125% of the average annual distributions received by you in respect of the shares or ADSs during the three preceding taxable years or, if shorter, your holding period for the shares or ADSs).

Under these rules:

 

    the gain or excess distribution will be allocated ratably over your holding period for the shares or ADSs;

 

    the amount allocated to the taxable year in which you realized the gain or excess distribution will be taxed as ordinary income;

 

    the amount allocated to each prior year, with certain exceptions, will be taxed at the highest tax rate in effect for that year; and

 

    the interest charge generally applicable to underpayments of tax will be imposed in respect of the tax attributable to each such year.

Special rules apply for calculating the amount of the foreign tax credit with respect to excess distributions by a PFIC.

If we are a PFIC and you own ADSs then you can make a mark-to-market election with respect of the ADSs. If we are a PFIC and you own shares then you can make a mark-to-market election if the shares are treated as marketable stock under the applicable regulations. If you make this election, you will not be subject to the PFIC rules described above. Instead, in general, you will include as ordinary income each year the excess, if any, of the fair market value of your shares or ADSs at the end of the taxable year over your adjusted basis in your shares or ADSs. You will also be allowed to take an ordinary loss in respect of the excess, if any, of the adjusted basis of your shares or ADSs over their fair market value at the end of the taxable year (but only to the extent of the net amount of previously included income as a result of the mark-to-market election). Your basis in the shares or ADSs will be adjusted to reflect any such income or loss amounts. Your gain, if any, recognized upon the sale of your shares or ADSs will be taxed as ordinary income.

In addition, notwithstanding any election you make with regard to the shares or ADSs, dividends that you receive from us will not constitute qualified dividend income to you if we are a PFIC either in the taxable year of the distribution or the preceding taxable year. Moreover, subject to the following sentence, your shares or ADSs will be treated as stock in a PFIC if we were a PFIC at any time during your holding period in your shares or ADSs, even if we are not currently a PFIC. The rule in the preceding sentence will not apply, however, if you had a mark-to-market election in effect with respect to your shares or ADSs in the final year in which we are a PFIC or if you made a special “purging election” with respect to your shares or ADSs. Dividends that you receive that do not constitute qualified dividend income are not eligible for taxation at the preferential rates applicable to qualified dividend income. Instead, you must include the gross amount of any such dividend paid by us out of our accumulated earnings and profits (as determined for United States federal income tax purposes) in your gross income, and it will be subject to tax at rates applicable to ordinary income.

If you own shares or ADSs during any year that we are a PFIC with respect to you, you may be required to file Internal Revenue Service Form 8621.

 

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F. Dividends and Paying Agents

Not Applicable.

 

G. Statement by Experts

Not Applicable.

 

H. Documents on Display

You can read and copy documents referred to in this annual report that have been filed with the U.S. Securities and Exchange Commission at the SEC’s public reference room located at 100 Fifth Street, N.E., Room 1580, Washington, D.C. 20549. Please call the SEC at 1-800-SEC-0330 for further information on the public reference rooms and their copy charges. The SEC also maintains a web site at http://www.sec.gov that contains reports, proxy statements and other information regarding registrants that are filed electronically with the SEC.

The SEC allows us to “incorporate by reference” the information we file with the SEC. This means that we can disclose important information to you by referring you to another document filed separately with the SEC. The information incorporated by reference is considered to be part of this annual report on Form 20-F.

 

I. Subsidiary Information

Not Applicable.

 

Item 11. Quantitative and Qualitative Disclosures about Market Risks

Our exposure to financial market risks relates primarily to changes in interest rates and currency exchange rates.

Interest Rate Risk

The People’s Bank of China has the sole authority in China to establish the official interest rates for Renminbi-denominated loans. Financial institutions in China set their effective interest rates within the range established by the People’s Bank of China. Interest rates and payment methods in China on loans denominated in foreign currencies are set by the financial institutions based on interest rate changes in the international financial market, cost of funds, risk levels and other factors. The fair value of our borrowings is approximately the same as the carrying value. These bank loans, denominated in Renminbi, are mainly borrowed from domestic banks at interest rates that vary in accordance with the standard guidance interest rates announced by relevant PRC Government authorities.

We are subject to risks arising from interest-bearing borrowings, including bank loans, commercial papers, promissory notes, corporate bonds and related party loans. The majority of our interest-bearing borrowings are loans from banks in China, the majority of which bear fixed interest rates. A rise in interest rates will increase the cost of new borrowings and interest expenses of outstanding floating rate debt. Accordingly, fluctuations in interest rates can lead to significant fluctuations in the fair value of these instruments, and, therefore, could have a material adverse effect on our financial position. To mitigate our exposure to interest rate risks in connection with our borrowings denominated in foreign currencies, we may enter into designed interest rate swap agreements from time to time in the future.

The following table provides information, by maturity date, regarding our interest rate-sensitive financial instruments, including short-term and long-term debt obligations, as well as the expected maturity profile of such instruments as of December 31, 2017.

 

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     Expected Maturity     As of
December 31,
2017
 
     2018     2019     2020     2021     2022     Thereafter     Total     Fair Value  
     (RMB equivalent in millions, except interest rates)  

Liabilities:

  

RMB-denominated loans

                

Fixed rate

     24,246       371       345       365       377       1,713       27,417       27,190  

Average rate(1)

     4.40     1.13     1.13     1.13     1.13     1.13     1.68     —    

U.S. dollar-denominated loans

                

Fixed rate

     25       29       32       24       18       150       278       232  

Average rate

     0.22     0.19     0.15     0.10     0.05     0.00     0.12     —    

Euro-denominated loans

                

Fixed rate

     23       23       12       1       1       12       72       74  

Average rate

     2.03     1.92     1.60     1.23     1.23     1.37     1.56     —    

HK dollar-denominated loans

                

Fixed rate

     435       —         —         —         —         —         435       435  

Average rate

     2.73     —         —         —         —         —         2.73     —    

RMB-denominated commercial papers

                

Fixed rate

     8,991       —         —         —         —         —         8,991       8,991  

Average rate

     4.26     —         —         —         —         —         4.26     —    

RMB-denominated corporate bonds

                

Fixed rate

     —         16,983       —         998       —         —         17,981       17,712  

Average rate

     —         3.00     —         3.43     —         —         3.02     —    

RMB-denominated promissory notes

                

Variable rate

     17,960       —         —         —         —         —         17,960       17,960  

Average rate

     3.54     —         —         —         —         —         3.54     —    

 

(1) The average interest rates for variable rate loans are calculated based on the rates reported as of December 31, 2017.

 

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For the year ended December 31, 2017, if there were 50 basis points increase/decrease in interest rates on the floating rate borrowings and short-term fixed rate borrowings while all other variables were held constant, the effect on profit after tax would have been approximately RMB125 million (2016: approximately RMB424 million; 2015: approximately RMB395 million).

Exchange Rate Risk

We conduct our business primarily in Renminbi, which is also our functional and reporting currency. The Renminbi is not a fully convertible currency. From 1994 to July 20, 2005, the official exchange rate for the conversion of Renminbi to U.S. dollars was generally stable. On July 21, 2005, the PRC Government introduced a managed floating exchange rate system to allow the value of the Renminbi to fluctuate within a regulated band based on market supply and demand and by reference to a basket of currencies. On the same day, the value of the Renminbi appreciated by 2% against the U.S. dollar. The PRC Government has since made and in the future may make further adjustments to the exchange rate system. Fluctuations in exchange rates may adversely affect the value, translated or converted into United States dollars or Hong Kong dollars (which are pegged to the U.S. dollar), of our net assets, earnings and any declared dividends. For a detailed description of the unitary managed floating rate system used by the PRC Government to set foreign exchange rates, see “A. Selected Financial Data — Exchange Rate Information” under Item  3.

We are exposed to foreign currency risk primarily because we receive some of our revenue from our international operations and pay-related expenses in foreign currencies. As a result, our foreign currency exposure relates to our foreign currency-denominated debt and, to a limited extent, cash and cash equivalents denominated in foreign currencies.

The following table provides information regarding our foreign currency-sensitive financial instruments, which consist of cash and cash equivalents, short-term bank deposits and restricted deposits, short-term and long-term debt obligations and capital commitments as of December 31, 2017 and the expected maturity profile of these debt obligations and capital commitments.

 

     Expected Maturity      As of
December 31,
2017
 
     2018      2019      2020      2021      2022      Thereafter      Total      Fair Value  
     (RMB equivalent in millions)  

Assets:

                       

Cash and cash equivalents:

                       

U.S. dollars

     980        —          —          —          —          —          980        980  

HK dollars

     425        —          —          —          —          —          425        425  

Japanese yen

     1        —          —          —          —          —          1        1  

Euro dollars

     95        —          —          —          —          —          95        95  

GBP

     10        —          —          —          —          —          10        10  

SGD

     1        —          —          —          —          —          1        1  

Short-term bank deposits and restricted deposits

                       

U.S. dollars

     —          —          —          —          —          —          —          —    

HK dollars

     —          —          —          —          —          —          —          —    

Liabilities:

                       

U.S. dollar-denominated loans

     25        29        32        24        18        150        278        232  

Euro-denominated loans

     23        23        12        1        1        12        72        74  

HK dollar-denominated loans

     435        —          —          —          —          —          435        435  

Off-balance-sheet commitments:

                       

Capital commitments authorized and contracted for in U.S. dollars

     —          —          —          —          —          —          —          —    

 

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If the RMB had strengthened/weakened by 10% against the foreign currencies, relative to December 31, 2017, primarily with respect to U.S. dollars, HK dollars and Euro, while all other variables are held constant, the effect on profit after tax would be approximately RMB138 million (2016: approximately RMB216 million; 2015: approximately RMB120 million) for cash and cash equivalents, borrowings and obligations under finance lease included in other obligations denominated in foreign currencies.

Risk Relating to Financial Assets at Fair Value through Other Comprehensive Income

The investments we hold are classified in the consolidated statement of financial position as financial assets at fair value through other comprehensive income. These investments are subject to equity price risk, which results primarily from changes in the level or volatility of underlying equity prices. One of our significant investments is denominated in Euro and the fair value of such investment is also subject to risks associated with fluctuations of foreign exchange rate between Euro and Renminbi (our functional currency). If either (i) the share price of our invested equity securities (in Euro) had increased/decreased by 10% or (ii) the exchange rate between Euro and Renminbi had changed by 10%, in each case, relative to December 31, 2017, while the other variable is held constant, we would have recorded additional change in fair value of approximately RMB407 million in our investment revaluation reserve. As of April 13, 2018, the change in the foreign exchange rate between Euro and Renminbi and, to a lesser extent, the change of the underlying equity price denominated in Euro resulted in a depreciation of the fair value of our relevant investment by approximately 0.24% from December 31, 2017. If Euro-related uncertainty remains, we may be subject to further gain/loss in the fair value of our investments denominated in Euro and our financial condition may be materially and adversely affected.

 

Item 12. Description of Securities Other than Equity Securities

The Bank of New York Mellon, as the depositary of our ADSs, collects its fees for delivery and surrender of ADSs directly from investors depositing shares or surrendering ADSs for the purpose of withdrawal. The depositary collects fees for making distributions to investors by deducting those fees from the amounts distributed or by selling a portion of distributable property to pay the fees. The depositary may generally refuse to provide fee-attracting services until its fees for those services are paid.

 

ADR holders must pay:    For:

•  US$5.00 (or less) per 100 ADRs (or portion thereof)

  

•   Each issuance of an ADR, including as a result of a distribution of shares or rights or other property

  

•   Each cancellation of an ADR, including if the deposit agreement terminates

  

•   Each distribution of securities, other than shares or ADRs, treating the securities as if they were shares for purpose of calculating fees

•  US$0.02 (or less) per ADR

  

•   Any cash distribution (not including cash dividend distribution)

•  Registration or transfer fees

  

•   Transfer and registration of shares on the share register of our transfer agent and the registrar in Hong Kong from an ADR holder’s name to the name of the depositary or its agent when the ADR holder deposits or withdraws shares

•  Expenses of the depositary

  

•   Conversion of Hong Kong dollars to U.S. dollars

  

•   Cable, telex and facsimile transmission expenses

•  Taxes and other governmental charges the depositary or the custodian has to pay on any ADR or share underlying an ADR, for example, stock transfer taxes, stamp duty or withholding taxes

  

•   As necessary

 

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From January 1, 2017 to December 31, 2017, we received from The Bank of New York Mellon a total of US$143,751.26, net of withholding tax, reimbursement for the expenses we incurred, including but not limited to, annual stock exchange listing fee, investor relations reimbursement, non-standard out-of-pocket maintenance costs for the ADR, charges incurred in connection with services provided for by third-party vendors, charges and out-of-pocket expenses for the servicing of non-registered holders. The Bank of New York Mellon also waived certain costs of US$130,605.21 in connection with the administration of the ADR program, investor relationship programs (including investor relationship intelligence services) and other services provided to our registered shareholders. In addition, The Bank of New York Mellon has agreed to reimburse us annually for our expenses incurred in connection with administration and maintenance of the depositary receipt facility in the future. The amount of such reimbursements is subject to certain limits and conditions.

 

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PART II

 

Item 13. Defaults, Dividend Arrearages and Delinquencies

None.

 

Item 14. Material Modifications to the Rights of Security Holders and Use of Proceeds

None.

 

Item 15. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

Our Chief Executive Officer and Chief Financial Officer, after evaluating the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(e) of the Exchange Act of 1934, as amended) as of December 31, 2017, the end of the period covered by this annual report, have concluded that, as of such date, our disclosure controls and procedures were effective.

Management’s Annual Report on Internal Control Over Financial Reporting

Our management is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Rule 13a-15(f) of the Exchange Act of 1934, as amended) for the Company. Our internal control over financial reporting is a process designed under the supervision of our chief executive officer and chief financial officer to provide reasonable assurance regarding the reliability of financial reporting and the preparation of our financial statements for external reporting purposes in accordance with applicable generally accepted accounting principles. Our internal control over financial reporting includes policies and procedures that pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect transactions and dispositions of assets; provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with applicable generally accepted accounting principles, and that receipts and expenditures are being made only in accordance with authorizations of our management and our directors; and provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our assets that could have a material effect on our financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect all misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

As of December 31, 2017, our management conducted an assessment of the effectiveness of our internal control over financial reporting, based on the framework established in Internal Control — Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission, or COSO. Based on this assessment, our management has concluded that our Company’s internal control over financial reporting as of December 31, 2017 was effective.

The effectiveness of our internal control over financial reporting as of December 31, 2017, has been audited by our independent registered public accounting firm, as stated in its report.

Changes in Internal Control Over Financial Reporting

There were no changes in our internal control over financial reporting that occurred during the period covered by this annual report that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

We are fully aware of the importance of maintaining and improving our controls and procedures in relation to internal control over financial reporting. Our management, with the oversight of our audit committee and board of directors, is committed to having proper internal control over financial reporting.

 

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Item 16A. Audit Committee Financial Expert

Our board of directors has determined that Mr. Wong Wai Ming is an audit committee financial expert in accordance with the terms of Item 16.A of Form 20-F. Mr. Wong satisfies the “independence” requirements of Section 303A of the NYSE Manual. For Mr. Wong’s biographical information, see “A. Directors and Senior Management” under Item 6.

 

Item 16B. Code of Ethics

In 2003, we adopted a code of ethics that applies to our chief executive officer, chief financial officer, president, vice-presidents, controller and other senior officers, a copy of which was filed as Exhibit 11.1 to our annual report on Form 20-F for the fiscal year ended December 31, 2003. In February 2006, we adopted another code of ethics that applies to our employees generally, a copy of which was filed as Exhibit 11.2 to our annual report on Form 20-F for the fiscal year ended December 31, 2005. Copies of our Code of Ethics for Senior Officers and Code of Ethics for Employees may also be downloaded from our website at http://www.chinaunicom.com.hk. Information on that website is not a part of this annual report on Form 20-F.

 

Item 16C. Principal Accountant Fees and Services

KPMG, an independent registered public accounting firm, served as our principal accountant for the fiscal year ended December 31, 2015. KPMG Huazhen LLP, an independent registered public accounting firm, served as our principal accountant for the fiscal years ended December 31, 2016 and 2017. The following table sets forth the aggregate audit fees, audit-related fees, tax fees and other fees our principal accountant billed for audit services, audit-related services, tax services and other services for each of the fiscal years 2016 and 2017:

 

     For the Year Ended
December 31,
 
     2016      2017  
     (in RMB thousands)  

Audit services

     68,943        74,277  

Audit-related services

     10,296        8,084  

Tax services

     88        301  

Other

     —          1,160  
  

 

 

    

 

 

 

Total

     79,327        83,822  
  

 

 

    

 

 

 

 

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Audit services include the audit work that needs to be performed each year in order to issue an opinion on the consolidated financial statements of the Company and its subsidiaries. Audit services in 2016 and 2017 also include audit work in connection with the audit of the Company’s internal control over financial reporting, pursuant to Section 404 of the Sarbanes-Oxley Act of 2002. They also include performing agreed-upon procedures on quarterly financial statements and reviews of interim financial statements and audit services provided to overseas subsidiaries.

Audit-related services include other assurance and related services that can be reasonably provided by our principal accountant. In 2017, the provisions of audit-related services mainly include performing limited procedures on the XBRL-tagged data related to this Form 20-F for the fiscal year ended December 31 2017, and accounting and reporting consulting service.

Tax services in 2016 and 2017 are tax compliance services.

Other services in 2017 relate to certain permitted advisory services provided to our subsidiary on its clearing and settlement process.

Audit Committee’s Pre-approval Policies and Procedures

The audit committee of our board of directors is responsible for, among other things, the oversight of the external auditor subject to the requirements of the Companies Ordinance and our Articles of Association. The audit committee has adopted a policy regarding pre-approval of audit and permissible non-audit services to be provided by our independent accountants. Under the policy, proposed services either (i) may be pre-approved by the audit committee without consideration of specific case-by-case services; or (ii) require the specific pre-approval of the audit committee. General approval applies to services of a recurring and predictable nature. These types of services, once approved by the audit committee, will not require further approval in the future. Specific pre-approval applies to all other services, which must be approved by the audit committee on a case-by-case basis after an application, including proposed budget and scope of services to be provided by our independent auditors, is submitted to the audit committee.

Our audit committee pre-approved all audit and non-audit services performed by our principal accountant for the years ended December 31, 2016 and 2017.

 

Item 16D. Exemptions from the Listing Standards for Audit Committees

Not Applicable.

 

Item 16E. Purchases of Equity Securities by the Issuer and Affiliated Purchasers

Not Applicable.

 

Item 16F. Change in Registrant’s Certifying Accountant

Not Applicable.

 

Item 16G. Corporate Governance

As a company listed on both the HKSE and the NYSE, we are subject to applicable Hong Kong laws and regulations, including the HKSE Listing Rules, and the Companies Ordinance, as well as applicable U.S. federal securities laws, including the Exchange Act and the Sarbanes-Oxley Act of 2002. In addition, we are subject to the listing standards of the NYSE to the extent they apply to non-U.S. issuers. As a non-U.S. issuer, we are not required to comply with all of the corporate governance listing standards of the NYSE.

The following is a summary of the significant differences between our corporate governance practices and those required to be followed by U.S. companies under the listing standards of the NYSE.

 

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Section 303A.01 of the NYSE Listed Company Manual provides that listed companies must have a majority of independent directors on its board of directors. As a listed company in Hong Kong, we are subject to the requirement under the HKSE Listing Rules that at least three members of our board of directors, who constitute at least one-third of the board of directors, be independent as determined under the HKSE Listing Rules. The standards for establishing independence under the HKSE Listing Rules differ from those set forth in the NYSE Listed Company Manual. We currently have four independent directors out of a total of nine directors.

Section 303A.03 of the NYSE Listed Company Manual provides that listed companies must schedule regular executive sessions in which non-management directors meet without management participation. Under the applicable Hong Kong law, our board of directors is required to meet regularly and at least four times a year, involving active participation by a majority of the directors and affording all directors an opportunity to include matters on the agenda. In addition, when a board meeting considers a matter in which a substantial shareholder or a director has a conflict of interest, the independent directors with no material interest in such matter must be present. Furthermore, it has been our practice to organize exclusive meetings for our independent non-executive directors at least annually.

Section 303A.04 of the NYSE Listed Company Manual provides that (i) a listed company must have a nominating/corporate governance committee that consists entirely of independent directors and (ii) the nominating/corporate governance committee of a listed company must have a written charter that addresses the committee’s purpose and responsibilities, which shall include, among others, the development and recommendation of corporate governance guidelines to the board of directors. The HKSE Listing Rules also contain a code provision that the listed companies should establish a nomination committee which consists of a majority of independent non-executive directors. We established a nomination committee in August 2011 with a written charter that specifies its duties and authorities. In addition, our board of directors is directly in charge of developing our corporate governance guidelines.

Section 303A.05 of the NYSE Listed Company Manual provides that (i) a listed company must have a compensation committee that consists entirely of independent directors and (ii) the compensation committee of a listed company must have a written charter that addresses the committee’s purpose and responsibilities. The HKSE Listing Rules also contain a code provision that the listed companies should establish a remuneration committee which consists of a majority of independent non-executive directors. The Company has established a remuneration committee with a written charter that specifies its duties and authorities.

Section 303A.07 of the NYSE Listed Company Manual also provides that if an audit committee member simultaneously serves on the audit committee of more than three public companies, and the listed company does not limit the number of audit committees on which its audit committee members serve to three or less, then, the board of directors of the listed company must (i) determine that such simultaneous service would not impair the ability of such member to effectively serve on the audit committee of the listed company and (ii) disclose such determination. We are not required, under applicable Hong Kong laws, to make such determination.

Section 303A.10 of the NYSE Listed Company Manual provides that listed companies must adopt and disclose a code of business conduct and ethics for directors, officers and employees. While we are not required to adopt any similar code under the HKSE Listing Rules, we, as required under the Sarbanes-Oxley Act, have adopted a code of ethics that is applicable to our chief executive officer, president, vice presidents, chief financial officer, principal accounting officer and general managers and deputy general managers of each of our departments, provincial branches and local branches or persons performing similar functions. We have also adopted a code of ethics that is applicable to all of our employees.

Section 303A.12(a) of the New York Stock Exchange Listed Company Manual provides that each listed company’s chief executive officer must certify to the New York Stock Exchange each year that he or she is not aware of any violation by the company of New York Stock Exchange corporate governance listing standards. Our Chief Executive Officer is not required, under the applicable Hong Kong law, to make similar certifications.

 

Item 16H. Mine Safety Disclosure

Not Applicable.

 

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PART III

 

Item 17. Financial Statements

We have elected to provide the financial statements and related information specified in Item 18 in lieu of Item 17.

 

Item 18. Financial Statements

See “Index to Consolidated Financial Statements” for a list of all financial statements filed as part of this annual report.

 

Item 19. Exhibits

 

Exhibit

Number

  

Description of Exhibit

  1.1    Articles of Association of Unicom, dated January 27, 2000.(1)(P)
  1.2    Amended Articles of Association of Unicom (as amended on September  16, 2008).(12)
  1.3    Amended Articles of Association of Unicom (as amended on May 24, 2011).(14)
  1.4    Amended Articles of Association of Unicom (as amended on May 8, 2015).(18)
  2.1    Deposit Agreement, among Unicom, The Bank of New York, as Depositary, and Owners and Beneficial Owners of American Depositary Receipts issued thereunder, including the form of American Depositary Receipt.(2)(P)
  2.2    Form of specimen certificate for the shares.(1)(P)
  4.1    Reorganization Agreement between Unicom Group and CUCL, dated April 21, 2000 (together with English translation).(1)(P)
  4.2    Equity Transfer Agreement among Unicom Group, Unicom HK, Unicom BVI and Unicom, dated April 21, 2000.(1)(P)
  4.3    Trademark Licens