As filed with the Securities and Exchange Commission on June 25, 2004
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C.
FORM 20-F
ANNUAL REPORT PURSUANT TO
SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2003
Commission file number 1-14926
KT Corporation
(Exact name of Registrant as specified in its charter)
The Republic of Korea
(Jurisdiction of incorporation or organization)
206 Jungja-dong
Bundang-ku, Sungnam
Gyunggi-do
463-711 Korea
(Address of principal executive offices)
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
American Depositary Shares, each
representing one-half of one share
of Common Stock
Common Stock, par value
Won 5,000 per share
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.
$150,000,000 7 1/2% Notes due 2006
$200,000,000 7 5/8% Notes due 2007
$1,210,050,000 0.25% Convertible Notes due 2007
$500,000,000 4.30% Bonds due 2005
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.
210,758,426 shares of Common Stock, par value Won 5,000 per share
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. x Yes ¨ No
Indicate by check mark which financial statement item the registrant has elected to follow. ¨ Item 17 x Item 18
(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
PART I
ITEM 1.
IDENTITY OF DIRECTORS, SENIOR MANAGERS AND ADVISORS
Item 1.A.
Directors and Senior Management
Item 1.B.
Advisers
Item 1.C.
Auditors
ITEM 2.
OFFER STATISTICS AND EXPECTED TIMETABLE
ITEM 3.
KEY INFORMATION
Item 3.A.
Selected Financial Data
Item 3.B.
Capitalization and Indebtedness
Item 3.C.
Reasons for Offer and Use of Proceeds
Item 3.D.
Risk Factors
ITEM 4.
INFORMATION ON THE COMPANY
Item 4.A.
History and Development of the Company
Item 4.B.
Business Overview
Item 4.C.
Organizational Structure
Item 4.D.
Property, Plants and Equipment
ITEM 5.
OPERATING AND FINANCIAL REVIEW AND PROSPECTS
Item 5.A.
Operating Results
Item 5.B.
Liquidity and Capital Resources
Item 5.C.
Research and Development, Patents, Licenses, Etc.
Item 5.D.
Trend Information
Item 5.E.
Off-balance Sheet Arrangements
Item 5.F.
Tabular Disclosure of Contractual Obligations
ITEM 6.
DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES
Item 6.A.
Item 6.B.
Compensation
Item 6.C.
Board Practices
Item 6.D.
Employees
Item 6.E.
Share Ownership
ITEM 7.
MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS
Item 7.A.
Major Shareholders
Item 7.B.
Related Party Transactions
Item 7.C.
Interests of Experts and Counsel
ITEM 8.
FINANCIAL INFORMATION
Item 8.A.
Consolidated Statements and Other Financial Information
Item 8.B.
Significant Changes
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ITEM 9.
THE OFFER AND LISTING
Item 9.A.
Offer and Listing Details
Item 9.B.
Plan of Distribution
Item 9.C.
Markets
Item 9.D.
Selling Shareholders
Item 9.E.
Dilution
Item 9.F.
Expenses of the Issuer
ITEM 10.
ADDITIONAL INFORMATION
Item 10.A.
Share Capital
Item 10.B.
Memorandum and Articles of Association
Item 10.C.
Material Contracts
Item 10.D.
Exchange Controls
Item 10.E.
Taxation
Item 10.F.
Dividends and Paying Agents
Item 10.G.
Statements by Experts
Item 10.H.
Documents on Display
ITEM 11.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
ITEM 12.
DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES
PART II
ITEM 13.
DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES
ITEM 14.
MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF PROCEEDS
ITEM 15.
CONTROLS AND PROCEDURES
ITEM 16.A.
AUDIT COMMITTEE FINANCIAL EXPERT
ITEM 16.B.
CODE OF ETHICS
ITEM 16.C.
PRINCIPAL ACCOUNTANT FEES AND SERVICES
ITEM 16.D.
EXEMPTIONS FROM THE LISTING STANDARDS FOR AUDIT COMMITTEES
ITEM 16.E.
PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED PURCHASERS
PART III
ITEM 17.
FINANCIAL STATEMENTS
ITEM 18.
ITEM 19.
EXHIBITS
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GLOSSARY
All references to “Korea” or the “Republic” contained in this annual report mean the Republic of Korea. All references to the “Government” mean the government of the Republic of Korea. All references to “we”, “us” or the “Company” mean KT Corporation and, as the context may require, its subsidiaries.
Any discrepancies in any table between totals and the sums of the amounts listed are due to rounding.
All references to “Won” or “(Won)” in this annual report are to the currency of the Republic and all references to “Dollars”, “$”, “US$” or “U.S. dollars” are to the currency of the United States of America.
Unless otherwise indicated, translations of Won amounts into Dollars in this annual report were made at the noon buying rate in The City of New York for cable transfers in Won per US$1.00 as certified for customs purposes by the Federal Reserve Bank of New York. Unless otherwise stated, the translations of Won into Dollars were made at the noon buying rate in effect on December 31, 2003, which was Won 1,192.0 to US$1.00.
Item 1. Identity of Directors, Senior Managers and Advisors
Item 1.A. Directors and Senior Management
Not applicable.
Item 1.B. Advisers
Item 1.C. Auditors
Item 2. Offer Statistics and Expected Timetable
Item 3. Key Information
Item 3.A. Selected Financial Data
You should read the selected consolidated financial data below in conjunction with the Consolidated Financial Statements as of December 31, 2002 and 2003 and for each of the years in the three-year period ended December 31, 2003 and the report of independent registered public accounting firm on these statements included herein. The selected consolidated financial data for the five years ended December 31, 2003 are derived from our audited consolidated financial statements.
Our Consolidated Financial Statements are prepared in accordance with Korean GAAP, which differ in certain significant respects from accounting principles generally accepted in the United States of America (“U.S. GAAP”). See Note 34 to the Consolidated Financial Statements for a description of the nature and the effects of such differences.
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Income Statement Data
Korean GAAP(1):
Operating revenues
Operating expenses
Operating income
Donations and contribution payments(2)
Gain on disposition of available-for-sale securities(3)
Income taxes(4)
Net earnings
Basic earnings per share(5)
Diluted earnings per share(6)
Dividends per share(7)
U.S. GAAP(8):
Basic earnings per share before cumulative effect of accounting change(5)
Diluted earnings per share before cumulative effect of accounting change(6)
Balance Sheet Data
Working capital(9)
Net property, plants and equipment
Total assets
Long-term debt(10)
Refundable deposits for telephone installation(11)
Total stockholders’ equity
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Operating Data
Lines installed (thousands)(12)
Lines in service (thousands)(12)
Lines in service per 100 inhabitants(13)
Lines in service per employee(12)(14)
PCS subscribers (thousands)(15)
Broadband Internet subscribers (thousands)
Other Financial Data
Net cash provided by operating activities
Net cash used in investing activities
Net cash provided by (used in) financing activities
Other data in accordance with U.S. GAAP-transitional disclosures of SFAS No. 142(16)
Add back: goodwill amortization
Add back: goodwill amortization related to equity investee
Adjusted net earnings
Basic earnings per share
Adjusted basic earnings per share
Basic earnings per share before cumulative effect of accounting change
Adjusted basic earnings per share before cumulative effect of accounting change
During 1999 and 2000, we changed, among others, our method of depreciation for certain property, plants and equipment, accounting for certain foreign currency translation gains and losses, accounting for
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interconnection charges, accounting for prior period adjustments, accounting for deferred charges, accounting for income taxes, accounting for losses on the sale of PCS handsets and accounting for consolidation. Effective January 1, 2003, we adopted Statements of Korea Accounting Standards (“SKAS”) No. 2 through No. 9. In accordance with these standards, the cumulative effects on prior years were adjusted to the beginning balance of retained earnings. In addition, certain accounts of the prior year consolidated financial statements were reclassified to conform to the current year’s presentation. See Note 2(a) to the Consolidated Financial Statements.
Includes subscribers of KT Freetel and resale subscribers of KT Corporation and as of December 31, 2000, subscribers of KT M.com. In June and October 2000, we acquired a 47.9% interest in KT M.com. KT M.com merged into KT Freetel on May 1, 2001. We currently hold a 48.1% effective interest in KT Freetel. As of December 31, 2001, KT Freetel had approximately 8.4 million subscribers and KT Corporation had approximately 1.1 million resale subscribers. As of December 31, 2002, KT Freetel had approximately 8.9 million subscribers and KT Corporation had approximately 1.4 million resale subscribers. As of
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December 31, 2003, KT Freetel had approximately 8.9 million subscribers and KT Corporation had approximately 1.6 million resale subscribers.
Exchange Rate Information
The following table sets out information concerning the noon buying rate for the periods and dates indicated.
Period
At End
ofPeriod
Average
Rate(1)
1999
2000
2001
2002
2003
November
December
2004 (through June 24)
January
February
March
April
May
June (through June 24)
We have translated the Won amounts into Dollars in this annual report solely for your convenience. We make no representation that the Won or Dollar amounts contained in this annual report could have been or could be converted into Dollar or Won, as the case may be, at any particular rate or at all.
Item 3.B. Capitalization and Indebtedness
Item 3.C. Reasons for Offer and Use of Proceeds
Item 3.D. Risk Factors
You should carefully consider the following factors.
Increased competition in Korea has had and may continue to have an adverse effect on our results of operations and financial condition.
The telecommunications sector in Korea is rapidly evolving. We face increasing competition from new entrants to the telecommunications market. We expect the number and the identity of service providers in the
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market to continue to change. Future business combinations and alliances in the telecommunications industry may create significant new competitors. In addition, advances in technology as well as changes in the regulatory environment are also occurring. Any significant changes in the competitive landscape of the telecommunications sector and our inability to adapt to such changes could have a material adverse effect on our business, financial condition and results of operations.
Fixed-line Telephone Services
Before December 1991, we were the sole provider of local, domestic long-distance and international long-distance telephone services in Korea. DACOM Corporation became the second provider of international long-distance service in December 1991 and of domestic long-distance service in January 1996. Onse Telecom Corp. also began offering international long-distance service in October 1997 and domestic long-distance service in December 1999. In April 1999, Hanaro Telecom, Inc. became the second provider of local telephone service in Korea and obtained licenses in January 2003 to offer international long-distance service and domestic long-distance service and will expect to offer these services in July 2004. In addition, SK Telink obtained a license in June 2003 to offer international long-distance service and began offering this service in November 2003. Starting in 1998, specific service providers, such as Internet phone service providers, voice resellers and call-back service providers, also began offering international long-distance service in Korea. Demand for international long-distance services offered by specific service providers has grown rapidly since the launch of their services.
The entry of these and other potential competitors into the local, domestic long-distance and international long-distance telephone service markets has had and may continue to have a material adverse effect on our revenues and profitability from these businesses. We cannot give assurance that we will be able to maintain our share of these businesses at or above current levels. Many of our competitors offer lower rates than we do for similar services. For example, although Hanaro’s and our local usage charges are the same at Won 39 per pulse (generally three minutes), Hanaro’s customers pay a non-refundable telephone installation charge of up to Won 30,000, while our customers pay Won 60,000, and Hanaro’s customers pay a basic monthly charge of up to Won 4,500, while our customers pay up to Won 5,200, depending on location. In addition, the Ministry of Information and Communication announced in October 2002 that it would allow local fixed-line telephone service subscribers to choose a competing local telephone service provider while retaining the same phone number. Local number portability has been implemented in certain regions starting in June 30, 2003 and will be implemented in Pusan in July 2004 and in Seoul in August 2004. As of April 30, 2004, 42,678 of our subscribers switched to Hanaro, which represents 0.2% of our total subscribers, and 209 of Hanaro’s subscribers switched to us. Local number portability may allow Hanaro to compete more effectively for our existing customers and may have a material adverse effect on our number of subscribers and on our results of operations.
Mobile Telecommunications Services
KT Freetel, our consolidated subsidiary in which we currently own a 48.1% effective interest, provides PCS service, a type of mobile telecommunications service based on Code Division Multiple Access (“CDMA”) technology utilizing the 1,800 MHz frequency, in Korea. Competitors in the mobile telecommunications service industry are cellular service provider SK Telecom and PCS service provider LG Telecom. KT Freetel (including 2.1 million resale subscribers of KT Corporation) had a market share of 32.4% as of April 30, 2004 based on the total number of mobile service subscribers in Korea, making KT Freetel the second largest mobile telecommunications service provider. SK Telecom had a market share of 52.0% as of April 30, 2004.
In January 2003, the Ministry of Information and Communication announced its plan to implement mobile number portability, which would allow mobile telephone service subscribers to switch their mobile service provider while retaining the same mobile phone number. Subscribers who switch service providers may return to the original service provider without paying any penalty within 14 days of the switch. Mobile number portability has been allowed to subscribers of SK Telecom starting in January 2004 and will be allowed to subscribers of KT Freetel and LG Telecom starting July 2004 and January 2005, respectively. Following the implementation of
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mobile number portability, 553,275 of SK Telecom’s subscribers switched to KT Freetel from January 1, 2004 to April 30, 2004. We expect some of KT Freetel’s current subscribers to switch to SK Telecom and LG Telecom when KT Freetel’s subscribers are able to transfer their existing mobile numbers starting July 1, 2004. The Ministry of Information and Communication also announced that starting in January 2004, all new subscribers of mobile services and existing subscribers who elect to receive a new mobile number would be given the uniform mobile code of “010” as the first three digits of their mobile numbers without regard to the mobile service provider. The Ministry of Information and Communication is planning to implement the uniform mobile code to all mobile numbers by 2007. Mobile number portability and uniform mobile code may allow SK Telecom and LG Telecom to compete more effectively for KT Freetel’s existing and future customers and may have a material adverse effect on the number of subscribers of KT Freetel and on our results of operations.
On June 15, 2004, the Ministry of Information and Communication announced a temporary restriction on mobile service providers from obtaining new subscribers and us from obtaining new resale subscribers as penalties for providing illegal handset subsidies. The restriction will apply to LG Telecom from June 21, 2004 to July 20, 2004, KT Freetel from July 21, 2004 to August 19, 2004, KT Corporation from July 21, 2004 to August 9, 2004 and SK Telecom from August 20, 2004 to September 28, 2004. The temporary ban may have a material adverse effect on our results of operations.
On March 6, 2003, KT ICOM, a company created by a consortium of companies including KT Corporation and KT Freetel to offer W-CDMA-based IMT-2000 services, merged into KT Freetel in a stock-for-stock transaction. IMT-2000 is a third-generation, high-capacity wireless communications technology, which when implemented, is expected to allow operators to provide to their customers significantly more bandwidth capacity. Although we expect that our competitors will face similar challenges that we expect to face in implementing third-generation technology, we cannot assure you that KT Freetel will be able to successfully compete with other third generation service providers. KT Freetel’s inability to compete effectively with third-generation service providers could have a material adverse effect on its financial condition and results of operations. See “—Implementation of IMT-2000 technology poses significant challenges and risks to us”.
Broadband and Internet-Related Services
The Korean broadband Internet access service market has experienced significant growth over the last four years since Korea Thrunet first introduced its Hybrid Fiber Coaxial (or HFC) based service in July 1998. Hanaro Telecom entered the broadband market in April 1999 offering both HFC and Asymmetric Digital Subscriber Line (or ADSL) services. We began offering broadband Internet access service in June 1999. Dreamline and DACOM followed and introduced their services in late 1999 and early 2000, and numerous cable television operators have also begun HFC-based services. As a result of having to compete with a number of competitors and the maturing of the Internet access service market, we currently encounter and we expect to encounter pressure to increase marketing expenses in the future. We had a market share of 50.6% as of April 30, 2004 based on the number of subscribers in Korea. Our inability to compete effectively with our competitors could have a material adverse effect on our business.
The market for Internet-related services in Korea is very competitive. We anticipate that competition will continue to intensify as the usage and popularity of the Internet grows and as new domestic and international competitors enter the Internet industry in Korea. The substantial growth and potential size of the Internet industry in Korea have drawn many competitors and as a result may lead to increasing price competition to provide Internet-related services. Recently, cable television providers began offering HFC-based broadband Internet access services at rates lower than ours. Increased competition in the Internet industry could have a material adverse effect on the number of subscribers of our broadband Internet access service and on our results of operations.
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WTO Agreement
Under the multilateral agreement on basic telecommunications services among the members of the World Trade Organization effective November 1997 (the “WTO Agreement”), the Government of Korea has agreed to gradually reduce the restrictions on foreign and individual shareholdings in KT Corporation and other network service providers in Korea. The relevant Korean law was amended to give effect to the provisions of the WTO Agreement. See “Item 4. Information on the Company—Item 4.B. Business Overview—Regulation—Foreign Investment”. While the WTO Agreement enables us to seek foreign investors and strategic partners and to more easily take advantage of opportunities for investments in overseas telecommunications projects, it may also benefit our competitors and further intensify competition in the domestic market.
Implementation of the IMT-2000 technology poses challenges and risks to us.
We acquired the right to purchase one of three licenses to provide IMT-2000 services on December 15, 2000, as a member of a consortium of companies including KT Corporation and KT Freetel. In March 2001, KT ICOM, a company created by the consortium to offer IMT-2000 services, paid half of the Won 1.3 trillion license fee payable to the Ministry of Information and Communication. KT ICOM subsequently merged into KT Freetel on March 6, 2003 in a stock-for-stock transaction. KT Freetel will pay the remaining Won 650 billion over a period of five years starting in 2007 as follows: Won 90 billion in 2007, Won 110 billion in 2008, Won 130 billion in 2009, Won 150 billion in 2010 and Won 170 billion in 2011. The Ministry of Information and Communication also charges interest rates of three-year Government bonds minus 0.75% on these amounts until they are paid, which are currently accruing.
As a condition to the merger, KT Freetel was required to offer its IMT-2000 services with limited coverage by the end of 2003. Accordingly, KT Freetel began test service of its IMT-2000 services in metropolitan Seoul and parts of Gyunggi Province in December 2003. Although KT Freetel is planning to offer IMT-2000 services in 45 cities by December 2005, KT Freetel and its competitors may delay the nationwide roll-out of third-generation services if there are unfavorable market conditions and weak service demand. Several telecommunications service providers in Europe have already announced delays in the roll-out of their third-generation services as a result of technological difficulties and unfavorable market conditions. In the event consumer demand for IMT-2000 services does not meet our expectations, we may attempt to renegotiate the terms of the license with the Government. However, there can be no assurance that the Government will agree to adjust the license fee already paid by KT ICOM as well as future license fee payments to be made by KT Freetel.
IMT-2000 presents risks and challenges to our business, any or all of which if realized or not addressed may have a material adverse effect on our financial condition and results of operations. Specifically, IMT-2000 is a new and developing technology. New content, solutions and network must be developed for IMT-2000. We expect KT Freetel to leverage its existing PCS network and 2.5-generation technology to minimize its capital expenditures and other costs related to developing IMT-2000 services. However, we believe KT Freetel will still require significant amounts of research and development and capital expenditures to build out its IMT-2000 network. No assurance can be given that the content, solutions and network will be developed in a timely and efficient manner by us or third parties, or if developed will gain market acceptance such that KT Freetel will be able to derive revenues from IMT-2000 services to justify the Won 1.3 trillion license fee, capital expenditures and other investments required for such service.
Disputes with our labor union may disrupt our business operations.
Our strategy of restructuring to improve our efficiency and profitability by disposing of non-core businesses and reducing our employee base have met with opposition from our labor union. In May 2001, certain members of our labor union held protests in our headquarters opposing our strategy of restructuring unprofitable businesses, including 114 phone directory services, and the layoffs resulting from such strategy. In 2002 and 2003, we did not have any significant labor disputes and unrests. However, there can be no assurance that we will not experience in the future labor disputes and unrests, including expanded protests and strikes, which could disrupt our business operations and have an adverse effect on our financial condition and results of operation.
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We also negotiate wage agreements with our labor union on an annual basis. Our latest round of negotiation was in August 2003. Although we have been able to reach wage agreements with our labor union in recent years, there can be no assurance that we will not experience in the future labor disputes and unrests resulting from disagreement in our annual wage negotiation with the labor union.
The Korean telecommunications industry has been subject to the Government’s regulation and change in Government policy relating to the industry could have a material adverse effect on our operations and financial condition.
The Government, primarily through the Ministry of Information and Communication, has authority to regulate the telecommunications industry. The Ministry of Information and Communication’s policy is to promote competition in the Korean telecommunications markets through measures designed to prevent the dominant service provider in any such market from exercising its market power in such a way as to prevent the emergence and development of viable competitors. The Ministry of Information and Communication, in consultation with the Ministry of Finance and Economy, approves local service rates charged by us and mobile service rates charged by SK Telecom. Under current Government regulations, if a network service provider has the largest market share for a specified type of service and its revenue from that service for the previous year exceeds a specific revenue amount set by the Ministry of Information and Communication, it must obtain prior approval from the Ministry of Information and Communication for the rates and the general terms for that service. Each year the Ministry of Information and Communication designates service providers the rates and the general terms of which must be approved by the Ministry of Information and Communication. In the past five years, the Ministry of Information and Communication has so designated us for local telephone service and SK Telecom for mobile service. The inability to freely set our local telephone service rates may hurt the profit from that business and impede our ability to compete effectively against our competitors. See “Item 4. Information on the Company—Item 4.B. Business Overview—Regulation—Rates”. The form of our standard agreement for providing local network service and each agreement for interconnection with other service providers are also subject to approval by the Ministry of Information and Communication. The Ministry of Information and Communication currently does not regulate our domestic long-distance, international long-distance, broadband Internet access and mobile service rates.
Starting April 2002, we are required to lease to other companies our fixed-lines that connect subscribers to our network. This policy, which is called local loop unbundling, is intended to prevent excessive investment in local loops. This policy requires us to lease to other companies from time to time the portion of our fixed lines that represent our excess capacity at rates that will be determined by the Ministry of Information and Communication based on our cost, and taking into consideration an appropriate rate of return, to enable our competitors to provide fixed-line voice and broadband services. Local loop unbundling may have a material adverse effect on our number of subscribers and on our results of operations.
In October 2002, the Ministry of Information and Communication announced that it would allow local fixed-line telephone service subscribers to choose a competing local telephone service provider while retaining the same phone number, followed by another plan in January 2003 to implement mobile number portability, which would allow mobile telephone service subscribers to switch their mobile service provider while retaining the same mobile phone number. The Ministry of Information and Communication also announced that starting in January 2004, all new subscribers of mobile services and existing subscribers who elect to receive a new mobile number would be given the uniform mobile code of “010” as the first three digits of their mobile numbers without regard to the mobile service provider. The Ministry of Information and Communication is planning to implement the uniform mobile code to all mobile numbers by 2007. See “—Increased competition in Korea has had and may continue to have an adverse effect on our results of operations and financial condition”.
Government policies and regulations relating to the above as well as other regulations involving the telecommunications industry (including regulation imposed on us as a dominant service provider) may change, which could have a material adverse effect on our operations and financial condition. See “Item 4. Information on the Company—Item 4.B. Business Overview—Regulation” and “Item 4. Information on the Company—Item 4.B. Business Overview—Relationship with the Government”.
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We are subject to various regulations under the Monopoly Regulation and Fair Trade Act.
Monopoly Regulation and Fair Trade Act provides for various regulations and restrictions on large business groups enforced by the Fair Trade Commission. Previously, we were not regulated as a large business group under the Monopoly Regulation and Fair Trade Act due to the Government’s ownership (including Government invested enterprises and The Korea Development Bank) of greater than 30% of our issued shares. The Fair Trade Commission initially designated us as a large business group under the Monopoly Regulation and Fair Trade Act on April 1, 2002, which subjects us to regulations limiting, among other things, the gross amount of investments, cross guarantees of debt and cross shareholdings by members of a business group.
If economic conditions in Korea deteriorate, our current business and future growth could be materially and adversely affected.
We are incorporated in Korea, and substantially all of our operations and assets are located in Korea. As a result, we are subject to political, economic, legal and regulatory risks specific to Korea.
From 1997 to 1999, Korea experienced a significant financial and economic downturn, from which it is widely believed the country has recovered to a large extent. Although the Korean economy began to recover since 1999, the pace of the recovery has since slowed and has been volatile. The economic indicators in 2001, 2002 and 2003 have shown mixed signs of recovery and uncertainty, and future recovery or growth of the economy is subject to many factors beyond our control. Events related to terrorist attacks in the United States on September 11, 2001, recent developments in the Middle East, including the war in Iraq, higher oil prices, the general weakness of the global economy and the outbreak of severe acute respiratory syndrome, or SARS, in Asia and other parts of the world have increased the uncertainty of world economic prospects in general and continue to have an adverse effect on the Korean economy. Any future deterioration of the Korean and global economy could adversely affect our financial condition and results of operations.
Other developments that could hurt Korea’s economy in the future include:
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Increased tensions with North Korea could have an adverse effect on us or the price of our securities.
Relations between Korea and North Korea have been tense over most of Korea’s history. The level of tension between the two Koreas has fluctuated and may increase or change abruptly as a result of current and future events, including ongoing contacts at the highest levels of the governments of Korea and North Korea and increasing hostility between North Korea and the United States. In December 2002, North Korea removed the seals and surveillance equipment from its Yongbyon nuclear power plant and evicted inspectors from the United Nations International Atomic Energy Agency, and has reportedly resumed activity at its Yongbyon power plant. In January 2003, North Korea announced its intention to withdraw from the Nuclear Non-Proliferation Treaty, demanding that the United States sign a non-aggression pact as a condition to North Korea dismantling its nuclear program. In August 2003, representatives of Korea, the United States, North Korea, China, Japan and Russia held multilateral talks in an effort to resolve issues relating to North Korea’s nuclear weapons program. While the talks concluded without resolution, participants in the August meeting indicated that further negotiations may take place in the future and, in February 2004, six party talks resumed in Beijing, China. Any further increase in tensions, resulting for example from a break-down in contacts or an outbreak in military hostilities, could hurt our business, results of operations and financial condition and could lead to a decline in the market value of our securities.
Depreciation of the value of the Won against the Dollar and other major foreign currencies may have a material adverse effect on the results of our operations and on the prices of our securities.
Substantially all of our revenues are denominated in Won. Depreciation of the Won may materially affect the results of our operations because, among other things, it causes an increase in the amount of Won required by us to make interest and principal payments on our foreign-currency-denominated debt, the costs of equipment that we purchase from overseas sources, net settlement payments to foreign carriers and administrations and certain payments related to our derivative instruments entered into for foreign exchange risk hedging purposes. In addition, we may be required to pay cash in Dollars the aggregate market value of our common shares deliverable upon conversion of convertible notes issued in January 2002 if conversion by a foreigner results in the violation of the 49% foreign ownership limitation under the Telecommunications Business Law and such conversion becomes effectively prohibited. Of the Won 11,244 billion total long-term debt (including current portion) outstanding as of December 31, 2003, Won 3,089 billion was denominated in foreign currencies with interest rates ranging from 0.25% to 7.63%. See “Item 5. Operating and Financial Review and Prospects—Item 5.B. Liquidity and Capital Resources”.
Fluctuations in the exchange rate between the Won and the Dollar will affect the Dollar equivalent of the Won price of the shares of our common stock on the Korea Stock Exchange. These fluctuations also will affect the amounts a holder of ADSs will receive from the depositary bank in respect of:
See “Item 3. Key Information—Item 3.A. Selected Financial Data—Exchange Rate Information”.
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If an investor surrenders his ADSs to withdraw the underlying shares, he may not be allowed to deposit the shares again to obtain ADSs.
Korean law currently limits foreign ownership of the ADSs and our shares. In addition, under our deposit agreement, the depositary bank cannot accept deposits of shares and deliver ADSs representing those shares unless (1) we have consented to such deposit or (2) Korean counsel has advised the depositary bank that the consent required under (1) is no longer required under Korean laws and regulations. Under current Korean laws and regulations, the depositary bank is required to obtain our prior consent for the number of shares to be deposited in any given proposed deposit which exceeds the difference between (1) the aggregate number of shares deposited by us or with our consent for the issuance of ADSs (including deposits in connection with the initial and all subsequent offerings of ADSs and stock dividends or other distributions related to these ADSs) and (2) the number of shares on deposit with the depositary bank at the time of such proposed deposit. The depositary bank has informed us that, at a time it considers to be appropriate, the depositary bank plans to start accepting deposits of shares without our consent and deliver ADSs representing those shares up to the amount allowed under current Korean laws and regulations. Until such time, however, the depositary bank will continue to obtain our consent for such deposits of shares and delivery of ADSs, which we may not provide. Consequently, if an investor surrenders his ADSs to withdraw the underlying shares, he may not be allowed to deposit the shares again to obtain ADSs. See “Item 10. Additional Information—Item 10.D. Exchange Controls”.
Limitations on foreign ownership may have an adverse effect on the conversion of our convertible notes.
The Telecommunications Business Law limits the aggregate foreign ownership of our shares with voting rights to 49% of our total issued shares with voting rights. Such 49% foreign ownership limitation under the Telecommunications Business Law may have an adverse effect on the conversion of our convertible notes issued in January 2002. See “Item 10. Additional Information—Item 10.B. Memorandum and Articles of Association—Limitation on Shareholding”. If conversion by a foreigner results in the violation of the 49% foreign ownership limitation under the Telecommunications Business Law, such conversion may be effectively prohibited. In such an event, we will be required under the terms of the convertible notes to pay cash in U.S. Dollars the aggregate market value of our common shares deliverable upon conversion of convertible notes to the relevant holder to satisfy the conversion right. As of December 31, 2003, 45.5% of our common shares were owned by foreign investors.
A foreign investor may not be able to exercise voting rights with respect to common shares exceeding the number of common shares held by our largest domestic shareholder.
Under the Foreign Investment Promotion Act, a foreign shareholder who holds 5% or more of our total shares is prohibited from becoming our largest shareholder. In addition, under the Telecommunications Business Law, the Ministry of Information and Communication may, if it deems it necessary to preserve substantial public interests, prohibit a foreign shareholder from being our largest shareholder. In the event that the number of common shares held by a foreign shareholder exceeds the number of common shares held by our largest domestic shareholder, the Telecommunications Business Law restricts such foreign shareholder from exercising his or her voting rights with respect to common shares exceeding such threshold. The Ministry of Information and Communication may also order us or the foreign shareholder to take corrective measures in respect of the excess shares within a specified period of six months or less.
Holders of ADSs will not be able to exercise dissenter’s rights unless they have withdrawn the underlying common stock and become our direct shareholders.
In some limited circumstances, including the transfer of the whole or any significant part of our business and our merger or consolidation with another company, dissenting shareholders have the right to require us to purchase their shares under Korean law. A holder of ADSs will not be able to exercise dissenter’s rights unless he has withdrawn the underlying common stock and become our direct shareholder. See “Item 10. Additional Information—Item 10.B. Memorandum and Articles of Association”.
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An investor may not be able to exercise preemptive rights for additional shares and may suffer dilution of his equity interest in us.
The Commercial Code of Korea and our articles of incorporation require us, with some exceptions, to offer shareholders the right to subscribe for new shares in proportion to their existing ownership percentage whenever new shares are issued. If we offer any rights to subscribe for additional shares of our common stock or any rights of any other nature, the depositary bank, after consultation with us, may make the rights available to an ADS holder or use reasonable efforts to dispose of the rights on behalf of the ADS holder and make the net proceeds available to the ADS holder. The depositary bank, however, is not required to make available to an ADS holder any rights to purchase any additional shares unless it deems that doing so is lawful and feasible and:
We are under no obligation to file any registration statement. If a registration statement is required for an ADS holder to exercise preemptive rights but is not filed by us, the ADS holder will not be able to exercise his preemptive rights for additional shares. As a result, the ADS holder may suffer dilution of his equity interest in us.
You may not be able to find trading markets for your Bonds.
The bonds are securities with no established trading market. We cannot provide any assurance as to the liquidity of, or the trading markets for, these bonds.
Forward-looking statements may prove to be inaccurate.
This annual report contains “forward-looking statements” that are based on our current expectations, assumptions, estimates and projections about our company and our industry. The forward-looking statements are subject to various risks and uncertainties. Generally, these forward-looking statements can be identified by the use of forward-looking terminology such as “anticipate”, “believe”, “estimate”, “expect”, “intend”, “project”, “should”, and similar expressions. Those statements include, among other things, the discussions of our business strategy and expectations concerning our market position, future operations, margins, profitability, liquidity and capital resources. We caution you that reliance on any forward-looking statement involves risks and uncertainties, and that although we believe that the assumptions on which our forward-looking statements are based are reasonable, any of those assumptions could prove to be inaccurate, and, as a result, the forward-looking statements based on those assumptions could be incorrect. The uncertainties in this regard include, but are not limited to, those identified in the risk factors discussed above. In light of these and other uncertainties, you should not conclude that we will necessarily achieve any plans and objectives or projected financial results referred to in any of the forward-looking statements. We do not undertake to release the results of any revisions of these forward-looking statements to reflect future events or circumstances.
Item 4. Information on the Company
Item 4.A. History and Development of the Company
In 1981, the Government established us under the Korea Telecom Act to operate the telecommunications services business that it previously directly operated. The Korea Telecom Act was repealed and we became a corporation with limited liability under the Commercial Code in 1997. Until 1993, the Government owned all of the issued shares of our common stock. From 1993 through May 2002 the Government disposed of all of its equity interest in us. We amended our legal name from Korea Telecom Corp. to KT Corporation in March 2002.
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Before December 1991, we were the sole provider of local, domestic long-distance and international long-distance telephone services in Korea. The Government began to introduce competition in the telecommunications services market in the early 1990’s. As a result, including ourselves, there are currently four international long- distance carriers, three domestic long-distance carriers and two local telephone service providers in Korea. In addition, the Government has also awarded licenses to several new service providers to enhance the competition in other telecommunications business areas such as mobile telephone services and data network services. See “Item 4.B. Business Overview—Competition”.
Item 4.B. Business Overview
We are the leading telecommunications service provider in Korea and one of the largest and most advanced in Asia. As an integrated telecommunications service provider, our principal services include:
We own substantially all of the domestic public exchanges, the nationwide network of local telephone lines, the principal public long-distance telephone transmission facilities and the principal data communications network in Korea, as well as two satellites. In addition, through KT Freetel, we operate a nationwide PCS network.
Historically, we have derived a substantial majority of our revenues from fixed-line telephone services. However, as our traditional businesses have matured and new technologies have become available, we have successfully leveraged our nationwide network, strong brand name and established customer base in Korea to pursue new growth opportunities. These growth businesses include business and data communications (including broadband Internet access service) and mobile telecommunications services. As a result, revenues from these businesses have grown rapidly in recent years and now account for a majority of our total revenues, having risen from 41.5% of our total revenues in 2001 to 47.4% in 2003.
We are focusing on building upon our strong position in each of our principal lines of business:
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For the year ended December 31, 2003, under Korean GAAP our consolidated operating revenues were Won 16,068 billion (US$13,480 million), our consolidated net earnings were Won 822 billion (US$689 million) and our basic earnings per share was Won 3,802 (US$3.19). As of December 31, 2003, our total stockholders’ equity was Won 8,397 billion (US$7,044 million).
The Telecommunications Industry in Korea
The Korean telecommunications industry is one of the most developed in Asia in terms of the growth of the mobile, Internet and data services markets. As of December 31, 2003, the fixed-line penetration rate, which is calculated by dividing the number of lines in service by the population of Korea, was 47.7%, and the mobile penetration rate, which is calculated by dividing the number of mobile subscribers by the population of Korea, was 70.1%. According to the Ministry of Information and Communication from the end of 1997 to the end of 2003, the number of mobile subscribers increased from approximately 6.8 million to approximately 33.6 million, and the number of Internet subscribers increased from approximately 3.1 million at the end of 1998 to approximately 28.6 million at the end of June 2003. The Ministry of Information and Communication estimates that from the end of 1999 to December 31, 2003, broadband Internet access subscribers increased from approximately 290,000 to approximately 11.2 million.
The Ministry of Information and Communication has the primary responsibility for regulating the telecommunications industry in Korea. See “Item 4.B. Business Overview—Regulation”.
Internet Access Market
Korea is one of the largest and fastest growing Internet markets in the Asia/Pacific region. According to the Ministry of Information and Communication, the number of Internet users in Korea has grown from 3.1 million as of December 31, 1998 to 28.6 million at the end of June 2003.
Recognizing the potential of the Internet, the Government has taken major steps to accelerate Internet awareness among Korean consumers and businesses. In March 1999, the Government announced the blueprint for managing the country’s transformation into an information society, which reaffirms the Government’s commitment to focus its resources on the following tasks:
New technologies have been developed in recent years that enable high speed Internet access at speeds of up to 100 Mbps. These technologies include satellite, terrestrial wireless and fiber optic-based solutions. However, the principal technologies used in the provision of high speed Internet access are ADSL with speed of up to 8 Mbps and HFC with speed of up to 10 Mbps. ADSL offers an access solution over existing telephone lines using a specialized modem while HFC service involves the use of two-way cable networks. These two technologies are more widely used than the other available technologies because of their relative reliability, ease of provisioning and cost effectiveness. In case of Korea, we believe that ADSL enjoys an advantage over HFC because two-way cable networks are much less widespread than the local telephone network. While ADSL technology was commercially introduced after HFC technology, it has surpassed HFC to become the prevalent access platform in Korea. In July 2002, VDSL technology with speeds of up to 20 Mbps became commercialized and the broadband Internet service providers introduced wireless LAN service with speed of up to 11 Mbps, which is designed to integrate fixed-line and wireless services by offering high speed wireless Internet access to laptops or PDAs in
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hot-spot zones and at home. Starting December 2003, we began installing infrastructure that enables us to offer VDSL service with speeds of up to 50 Mbps, although we have not yet commercialized such service. With advancement of broadband technology, the Korean broadband Internet access market has experienced significant growth over the past five years. The Ministry of Information and Communication estimates that total broadband Internet subscribers in Korea reached 11.2 million as of December 31, 2003.
Mobile Telecommunications Service Market
The Korean cellular market was formally established in 1984 when SK Telecom, formerly Korea Mobile Telecom, became the first mobile telephone operator in Korea. SK Telecom remained the only cellular operator in Korea throughout the 1980s and the early 1990s. Competition was later introduced to the market when Shinsegi Telecomm began service in 1994. In order to encourage further market growth and competition, the Ministry of Information and Communication awarded three PCS licenses in June 1996. Our mobile subsidiary, KT Freetel, was awarded a license alongside LG Telecom and Hansol M.com. Commercial PCS service was launched in October 1997.
Since the introduction of three new operators in 1997, the Korean mobile market has undergone consolidation and significant growth. Following SK Telecom’s purchase of a controlling stake in Shinsegi, we acquired a 47.9% interest in Hansol M.com in 2000 and renamed the company KT M.com. KT M.com merged into KT Freetel on May 1, 2001 and Shinsegi merged into SK Telecom in January 2002. According to the Ministry of Information and Communication, the total number of mobile subscribers increased from 3.2 million at the end of 1996 to 33.6 million as of December 31, 2003. Mobile penetration has also increased from 7.0% to 70.1% during the same period. With such significant penetration, Korea is among one of the most penetrated mobile markets in the region at the end of 2003.
Korea’s highly developed mobile market also extends into an advanced mobile data market. Mobile Internet service in Korea has grown rapidly since its introduction in 2001. All the mobile operators have developed extensive mobile data and Internet service portals. Korean operators have also invested in networks compatible with EV-DO handsets which allow subscribers to enjoy 2.5 generation high speed wireless data services which KT Freetel began offering in May 2001.
On December 15, 2000, the Ministry of Information and Communication awarded two W-CDMA licenses to provide IMT-2000 service. One license was awarded to SK IMT Co., Ltd., an SK Telecom-led consortium, and the other to KT ICOM, a consortium of companies including KT Corporation and KT Freetel. On August 26, 2001, the Ministry of Information and Communication awarded one additional IMT-2000 license based on CDMA-2000 technology to a LG Telecom-led consortium. KT ICOM merged into KT Freetel on March 6, 2003 and SK IMT Co., Ltd. merged into SK Telecom on May 1, 2003. KT Freetel began offering its test service of IMT-2000 services in metropolitan Seoul and parts of Gyunggi Province in December 2003.
Competitive Strengths
We are the only fully integrated telecommunications service provider in Korea
We are the largest and only fully integrated telecommunications service provider in Korea. We are a leader in broadband Internet access and data communications services, mobile services and Korea’s dominant provider of local, domestic long-distance and international long-distance telephone services. In addition, we own substantially all of the domestic public exchanges, the nationwide network of local telephone lines, the principal public long-distance telephone transmission facilities and the principal data communications network in Korea, as well as two satellites. We also operate a nationwide PCS network through KT Freetel and a satellite broadcasting network through Korea Digital Satellite Broadcasting Company.
As a result, we possess the requisite capabilities to offer convergence services that interconnect the different services in our current portfolio of products and service offerings. For example, in February 2002, we launched
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our wireless LAN service under the brand name “NESPOT”, which is designed to integrate fixed-line and wireless services by offering high speed wireless Internet access to laptops or PDAs in hot-spot zones and at home. We extended this service further in February 2003 through the launch of “NESPOT Swing” which allows users with PDA phones to connect to the Internet even outside the NESPOT hotspots through KT Freetel’s PDA-only wireless data service. We also launched “Home N” service in May 2004 and plan to offer the “DU:” service in the second half of 2004, both of which are services that converge the different products and services that we currently offer. For additional information of Home N and DU:, see “—Business Strategy—Focus on high-growth, high-margin businesses”.
We have a large customer base, dominant market position and strong brand recognition
We have a large customer base. As of April 30, 2004, we had approximately 21.5 million fixed-line telephone service subscribers and 5.8 million broadband service subscribers, and KT Freetel had 11.5 million mobile subscribers (including 2.1 million resale subscribers of KT Corporation). We also have a dominant market position in each of our fixed-line telecommunications service markets, as shown in the following table:
Service
Local(1)
Domestic long distance(2)
International long distance(2)
We also believe that KT Corporation and KT Freetel enjoy wide brand recognition for telecommunications services in Korea with a reputation for quality and reliability.
We are one of the world’s largest broadband Internet access providers
By leveraging our nationwide advanced digital and fiber-optic network, we have become the largest provider of broadband services in Korea. As part of our strategy to focus on higher growth businesses and in order to meet increased demand, we have invested approximately Won 1.9 trillion over the past three years in broadband equipment and network. We achieved market leadership in June 2000 and we have 5.8 million subscribers and a broadband market share in Korea of 50.6% in terms of subscribers as of April 30, 2004.
We have achieved critical mass in the mobile telecommunications service market
We believe we are well-positioned to take advantage of the attractive growth potential in the mobile service market, which we expect will grow with the increasing demand for mobile data communications services and the implementation of nationwide IMT-2000 services. SK Telecom, as the dominant service provider with the largest market share, is subject to approval from the Ministry of Information and Communication for the rates and the general terms of its service. KT Freetel is not subject to such restrictions. KT Freetel had a total of approximately 11.5 million subscribers (including 2.1 million resale subscribers of KT Corporation) as of April 30, 2004, representing 32.4% of the mobile service market.
We have a proven track record of improving our efficiency and profitability
We have successfully executed our plans to improve our efficiency and profitability in recent years. We have closed unprofitable businesses and divested numerous non-core investments over the past several years to enhance overall profitability. In addition, we have streamlined our workforce to increase efficiency. Under our voluntary early retirement programs, we reduced our workforce by 1,389 employees in 2001 and 166 employees in 2002. In September 2003, we offered another round of voluntary early retirement program to our employees,
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which resulted in a reduction of 5,497 employees for the period ended December 31, 2003. We had a total of 38,167 employees as of December 31, 2003 compared to 45,114 employees as of December 31, 2001. We have also been successful in containing increases in employee costs through agreements on wages and retirement programs with the union.
Business Strategy
We believe the telecommunications market in Korea will continue to expand due to Korea’s growing economy, consumers’ willingness to adopt new technologies, relatively high income and a relatively large middle class. Also, Korea has one of the highest fixed-line, mobile and broadband Internet penetration rates in Asia. Use of the Internet has also risen dramatically, commensurate with Korea’s economic growth and development.
We believe that telecommunications services will evolve at an accelerated pace over the coming years, driven by technological advancement and the general improvement of the Korean economy. We also believe that the convergence of communications technologies will provide a competitive advantage to incumbent telecommunications service providers with existing infrastructure, which are able to design and construct sophisticated and nationwide networks capable of serving as a common platform for a broad range of services and enhance value for our customers.
Our slogan, “The Value Networking Company”, reflects our vision to become a global leading company by maximizing shareholder value, pursuing corporate growth through customized services, maintaining our leading position as an integrated telecommunications service provider in all of the market segments we serve and expanding our leadership position in high-growth markets, such as mobile, broadband Internet and data communications services.
Consistent with our strategic objectives, we have developed the following business strategies.
Focus on high-growth, high-margin businesses
We plan to focus our resources on services that have potential for significant growth and high margins. In line with our strategy to place greater emphasis on businesses that have potential for significant growth and higher margins, we plan to increase the proportion of capital expenditures in these areas. We are devoting a substantial part of our resources toward the construction of infrastructure for Internet access and Internet-related services and mobile telecommunications services, and the portion of our planned capital expenditures devoted to these services is approximately 50% in 2004.
Broadband Internet Access and Business and Data Communications. We plan to use our advanced digital network to provide high quality transmission and value added services with competitive pricing. We have the advantage that approximately 98% of potential subscribers are located within a four kilometer radius of our existing telephone offices to receive ADSL service over existing lines, allowing us to provide connection at a lower cost than our competitors. In addition, we launched in July 2002 our VDSL services, which currently allow broadband Internet access speed of up to 20 Mbps. In addition, starting December 2003, we began installing infrastructure that enables us to offer VDSL service with speeds of up to 50 Mbps, although we have not yet commercialized such service. Through continued emphasis on improving the technology and our broadband Internet access services, we plan to remain as the dominant player in this market segment. We will continue to seek to expand our customer base and promote broadband services for high speed Internet access.
In addition, we launched in February 2002 our wireless LAN service called NESPOT, which is designed to integrate fixed-line and wireless services by offering high speed wireless Internet access to laptops and PDAs in hot-spot zones and at home. NESPOT service provides our subscribers wireless access to high speed Internet in hot-spot zones and Megapass service in fixed-line environments. We extended the NESPOT service in February 2003 through the launch of NESPOT Swing, which allows users with PDA phones to connect to the Internet even outside the NESPOT hotspots through KT Freetel’s wireless data service specifically designed for PDAs. As the
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fixed-line broadband Internet access market becomes mature, we believe that our NESPOT and NESPOT Swing service will play an increasingly important role in expanding our customer base for high speed Internet access.
In May 2004, we began offering Home N, a home networking service available to our broadband subscribers for additional installation and monthly fees. The service currently allows subscribers to connect multiple computers in their homes, order videos on demand, monitor homes remotely through security cameras mounted on computers that can be accessed through mobile phones, and receive enhanced traffic, weather and stock market information through a computer or a television set. Additionally, as home appliances compatible with our Home N service develop, we expect our subscribers to be able to remotely control these appliances through their mobile phones. We will continue to develop and introduce value adding services to capture the growth potential that this new technology offers.
Internet-Related Services. Our Internet-related services focus on providing infrastructure and solutions for business enterprises. We expect to continue to build out our Internet data centers to meet the demand resulting from the rapid increase in the use of the Internet and data traffic. We already have twelve Internet data centers, providing a full range of co-location, server hosting and web hosting services. We also anticipate that demand for commercial transactions over the Internet will continue to increase in the future. We launched bizmeka.com to develop and commercialize business-to-business (or B2B) solutions targeting approximately 3.0 million small- and medium-sized business enterprises in Korea. In addition, we launched in June 2003 a smart card business under the “1’ts” brand name, which provides multi-functional services utilizing embedded computer chips that calculate and record information. We expect our smart card to have a variety of functions, including those of credit cards, electronic online wallets and transportation fare passes. We are working with leading banks and credit card companies in Korea to build the necessary infrastructure and increase subscribers to our new service. We plan to continue to expand our Internet-related value added services.
Mobile. We are focusing our resources on the expansion of the type of services offered, as well as growing and consolidating the mobile business. KT Freetel began offering in May 2001 2.5 generation high speed wireless data services which allow voice, data and video transmission to EV-DO handsets. KT Freetel also began test service of its IMT-2000 services in metropolitan Seoul and parts of Gyunggi Province in December 2003, and KT Freetel plans to offer services in 45 cities by December 2005, subject to market conditions and service demand. IMT-2000 is a third generation high capacity wireless Internet and video multimedia communication technology which allows an operator to provide to its subscribers significantly more bandwidth capacity compared to 2.5 generation technology.
In the second half of 2004, we plan to offer DU:, a service which enables specially designed handsets to act as cordless phones within the transmission range of a user’s base transmitter, and to act as mobile phones outside such areas. When used as a cordless phone within the designated area, DU: applies fixed-line telephone services fee. In addition, the handsets can receive data transmissions without being charged for airtime usage within the designated area if the homes or businesses subscribe to one of our fixed-line broadband services. The handsets can also be used as walkie-talkies and to exchange data between DU: phones within short distance. We will continue to develop and introduce additional services to capture the significant growth potential that new technology offers.
Leverage dominant market positions to maximize profitability
We will continue to seek ways to capitalize on our position as the leading telecommunications services provider in Korea with dominant positions in local, domestic long-distance and international long-distance telephone services and leading positions in broadband Internet access and business data communications services, as well as mobile communications services.
The breadth of our network and our ownership of the so called “last one mile” infrastructure, which is comprised of the connection between the local telephone service provider’s switching centers to the end-users’ buildings or homes, provides us with low-cost access to existing and potential customers and creates a platform
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for expanding our services. For example, we have been able to greatly expand our broadband Internet access customer base by utilizing such existing infrastructure. Also, we believe that we can capitalize on our large and well-established customer base, as well as our well-known brand name, to cross-sell our service offerings and expand into other service areas in a cost-efficient manner.
We believe that the above factors will also enable us to achieve lower customer acquisition costs than our competitors, allowing us to more efficiently roll out new services.
Promote synergies within the KT Corporation group
We plan to actively promote synergies within the KT Corporation group to take advantage of economies of scale in various areas and to prepare for increasing demand for mobile data communications and integrated fixed-line and wireless telecommunications services. We also plan to use our extensive customer relationships and market knowledge to expand our revenue bases by bundling and cross-selling our products and services. For example:
See “Item 4.B. Business Overview—Competitive Strengths—We have achieved critical mass in the mobile telecommunications service market”.
Continue to improve operational efficiencies
We will continue to seek to improve our operational efficiencies in order to enhance customer service, increase profitability and maximize shareholder value. For example, in March 2003, we began implementing six sigma initiatives for us and all of our subsidiaries. The objectives of the initiatives, which are designed to reduce the number of defects in processing lines, are to introduce greater efficiency in manufacturing productivity and cost and employee performance while increasing customer satisfaction. We will continue to seek new opportunities to implement our company-wide process innovation and instill six-sigma programs as part of our corporate culture. In addition, we are investing in information technology and management information systems, thereby improving management efficiency, internal communications, and customer relations functions, and disposing of, discontinuing or merging non-core businesses or subsidiaries.
In May 2003, we also reorganized our operational structure from focusing on localized telephone offices responsible for multi-tasking to having individual offices specialized in one of four areas. Each office will focus on either sales, network operation and maintenance, customer relations or regional support. Accordingly, we currently reorganized our offices into 31 sales offices, 31 network operation and maintenance offices, 38 district offices and 11 regional business groups. We believe that this new operational structure will promote specialization and enhance customer satisfaction.
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Focus on maximizing customer satisfaction and promoting quality innovation
Quality of service is critical in attracting and retaining customers and enhancing our long-term profitability. We have a nationwide network of customer service centers which we believe allows us to provide comprehensive customer service functions. We strive to continually enhance customer satisfaction and loyalty by providing higher quality customer service. For example, we are implementing several programs to maximize customer satisfaction, including the expansion of services offered by our on-line customer center dedicated to respond to the special needs and demands of our customers. In June 2003, we began implementing our first round of six-sigma innovation program and will seek new opportunities to implement our company-wide quality innovation and promote cost-effectiveness and new market growth.
Our Services
Our Telephone Network and Fixed-line Telephone Services
We utilize our extensive nationwide telephone network to provide fixed-line telephone services, which consist of local, domestic long-distance and international long-distance services. Our telephone network includes exchanges, long-distance transmission equipment and fiber optic and copper cables. The following table gives some basic measures of the development of our telephone system:
Lines installed (thousands)(1)
Lines in service (thousands)(1)
Lines in service per 100 inhabitants(2)
Percentage of lines connected to digital exchanges
Lines in service per employee(3)
Fiber optic cable (kilometers)
Number of public telephones installed (thousands)
Domestic long-distance call minutes (millions)(4)
Local call pulses (millions)(5)
In recent years, we have increased the proportion of our lines that are connected to exchanges capable of handling digital signal technology. A principal limitation of the older analog technology is that applications other than voice communications, such as the transmission of text and computer data, require either separate networks or conversion equipment. Digital systems permit a range of voice, text and data applications to be transmitted simultaneously on the same network. All lines installed since 1992 have been connected to digital exchanges and we completed connection of all installed lines to digital exchanges on June 9, 2003.
Our domestic long-distance cable network is entirely made up of fiber optic cable and can carry both voice and data transmissions. Compared to conventional materials such as coaxial cable, fiber optic cable provides significantly greater transmission capacity with less signal fading, thus requiring less frequent amplification.
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International Long-Distance Service. The following table shows the number of minutes of international long-distance calls recorded by us in each specified category for each year in the five-year period ended December 31, 2003:
Incoming international long-distance calls
Outgoing international long-distance calls
Total
United States (32%) Japan (20%) and China (14%) accounted for the greatest percentage of our international long-distance call traffic measured in minutes in 2003. The agreed settlement rate is applied to the call minutes to determine the applicable net settlement payment. Overall, we have been a net payer of settlement payments since 1996, and the volume of our outgoing calls exceeded the volume of our incoming calls for the first time in 1997. We receive the largest net settlement payment from U.S. carriers. Because the volume of incoming calls from the United States is larger than that of outgoing calls to the United States, amounts payable by the U.S. carriers to us in respect of calls billed by U.S. carriers have historically exceeded amounts payable by us to U.S. carriers in respect of calls billed by us. On the other hand, because the volume of outgoing calls to China exceeds that of incoming calls from China, we make the largest net settlement payment to international long-distance service providers in China.
To compete with our competitors in the international long-distance services market, we have implemented special discount calling plans and advertising campaigns directed at high-volume corporate users and we are also promoting our international leased-lines business.
We also provide Internet phone service for international long-distance calls. Despite the inconvenience of having to dial many numbers to access the Internet phone service, the volume of international long-distance calls made on Internet phone services, measured in terms of call minutes, has significantly increased since Internet phone service was first introduced in Korea in March 1998. Our Internet phone service also competes with international long-distance services provided by voice resellers.
Interconnection
Under the Telecommunications Business Law, we are required to permit other service providers to interconnect to our fixed-line network. Currently, the principal users of this interconnection capacity include DACOM and Onse (offering international and domestic long-distance services), SK Telecom (transmitting calls to and from its cellular network) and the two PCS service providers (transmitting calls to and from their PCS networks). We expect that an increasing number of new service providers will commence operations and require interconnection services in the future. Accordingly, we expect that interconnection revenues and payments will remain important for our results of operations. In recent years, revenues from a landline user for a call initiated by a landline user to a mobile service subscriber (land-to-mobile interconnection) have become a significant portion of our results of operations, accounting for 12.9% of our operating revenues in 2003. We recognize as land-to-mobile interconnection revenue the entire amount of the usage charge collected from the landline user and recognize as an expense the amount of interconnection charge paid to the mobile service provider.
Business and Data Communications
Our business and data communication services include:
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Broadband Internet Access Service. Responding to the increasing demand for data communications and other value-added services by our customers, we are investing extensively in our data communications infrastructure and are focusing on providing advanced services such as broadband Internet access service and wireless LAN service. Leveraging on our nationwide network of more than 24.0 million installed lines and 122,243 kilometers of fiber optic cable network as of April 30, 2004, we have achieved a leading market position in the broadband Internet access market in Korea. We believe we currently have a competitive advantage over other broadband Internet access service providers because, unlike our competitors, we, as the dominant local telephone service provider, do not have to install new lines or cables in order to provide broadband Internet access service.
Under the “Megapass” brand name, we offer ADSL and VDSL services with data transmission speed of up to 8 Mbps and 20 Mbps, respectively. In addition, we offer a fiber-optic cable-based service under the “Megapass Ntopia” brand name. For those regions where we are not able to provide Internet access service using fixed lines, we offer satellite-based Internet access service and broadband wireless local loop (or BWLL) service. We had 5.8 million broadband Internet subscribers as of April 30, 2004, of which 5.4 million subscribed to the ADSL or VDSL services (approximately 93%) and 0.4 million subscribed to the Ntopia service (approximately 7%).
ADSL is a modem technology that converts existing copper twisted-pair telephone lines into access paths for multimedia and high-speed data communications. While ADSL technology was commercially introduced after HFC-based technology, it has surpassed HFC to become the prevalent access platform in Korea. VDSL with enhanced speeds of up to 20 Mbps became commercialized in July 2002. According to the Ministry of Information and Communication, there were 6.4 million ADSL and VDSL subscribers and 3.8 million HFC subscribers in Korea as of December 31, 2003, representing 57.6% and 34.3% of the broadband market, respectively.
An ADSL or VDSL circuit connects a modem on each end of a twisted-pair telephone line. For ADSL, the high-speed downstream rate reaches up to 8.0 Mbps, while for VDSL, the high-speed downstream rate can reach up to 100.0 Mbps. The asymmetric design optimizes the bandwidth by maximizing the downstream speed for downloading information from the Internet. In essence, ADSL and VDSL transform the existing public information network from one limited to voice, text and low-resolution graphics to a powerful system capable of bringing multimedia to subscriber premises without new cabling. The traditional telephone service channel is split off from the digital information channels by filters, thus guaranteeing uninterrupted telephone service even in the event that ADSL or VDSL connection fails.
Downstream rates depend on a number of factors. For a constant wire gauge, the data rate decreases as the length of the copper wire increases. Generally, if the separation between the telephone office and the subscriber is greater than four kilometers, line attenuation is so severe that broadband speeds can no longer be achieved. Approximately 98% of our subscribers for basic local telephone service are located within a four kilometer radius of our telephone offices, making our ADSL or VDSL service available to most of the Korean population.
Our Ntopia service connects fiber-optic cables to apartment complexes and buildings with LAN capabilities. This technology allows data transmission speed up to 2.5 Mbps. Because this service is UTP cable-based, a subscriber is automatically connected to the Internet whenever his or her personal computer is in operation. We began offering our Ntopia service in September 2001.
On February 1, 2002, we launched a wireless LAN service called NESPOT, which is designed to integrate fixed-line and wireless services by offering high speed wireless Internet access to laptops and PDAs. NESPOT service provides our subscribers wireless access to high speed Internet in hot-spot zones and Megapass service in fixed-line environments. We extended the NESPOT service in 2003 through the launch of NESPOT Swing, which allows users with PDA phones to connect to the Internet even outside the NESPOT hotspots through KT Freetel’s wireless data service specifically designed for PDAs. We had approximately 360 thousand subscribers of NESPOT and 11,500 hot-spot zones nationwide for wireless connection as of April 30, 2004. NESPOT allows users to access the Internet at up to 11.0 Mbps in hot-spot zones.
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Leased-line Service. Leased-line service involves offering exclusive lines that allow point-to-point connection for voice and data traffic between two or more geographically separate points. As of December 31, 2001, 2002 and 2003, we leased 593,567 lines, 598,872 lines and 454,281 lines to domestic businesses. We also had 110 international leased lines on December 31, 2003.
Internet-Related Services. Our Internet-related services focus on providing infrastructure and solutions for business enterprises. We operate Internet data centers and provide website hosting services to numerous companies which need servers, routers and leased lines for Internet access. Internet data centers are facilities used to house, protect and maintain network server computers that store and deliver Internet and other network content, such as web pages, applications and data. We currently operate twelve centers located throughout Korea.
Our Internet data centers are professionally designed to international standards, and are equipped with temperature control systems, regulated and reliable power supplies, fire detection and suppression equipment, security monitoring and high-bandwidth connections to the Internet. Internet data centers allow corporations or Internet service providers to outsource their application and server hardware management. Services offered include shared application hosting, dedicated hosting, co-location and managed hosting. Shared application hosting is the storage and delivery of applications over the Internet via a shared server. Dedicated hosting is application hosting on a dedicated server. Co-location is the installation of the customer’s network equipment at the Internet data centers. Managed hosting refers to additional premium hosting services for which customers are charged separately, such as network availability monitoring, remote power supply, bandwidth utilization monitoring and data backup and recovery.
We anticipate that demand for commercial transactions over the Internet will continue to increase in the future. To prepare for the increased demand, we launched a service called bizmeka.com to develop and commercialize business-to-business solutions targeting approximately 3.0 million small- and medium-sized business enterprises in Korea. Bizmeka.com is an applied application service provider which provides industry-specific business solutions, including customer database management and electronic data interchange. We had approximately 49,000 subscribers as of April 30, 2004. We also established the buynjoy.com on-line shopping mall which offers a variety of products and services from participating on-line retailers, as well as purchase aggregation services and auction services. We spun-off buynjoy.com in June 2002. Our hanmir.com portal site features a search engine and website directory, telephone directory, news articles, financial information and other contents. In December 2003, we transferred buynjoy.com on-line shopping mall and hanmir.com portal site to KTH, our 65.9%-owned subsidiary. We also operate Korea’s largest clearinghouse for medical claims using electronic data interchange and on-line medical prescription and hospital application hosting services.
Miscellaneous. We launched in June 2003 a smart card business under the “1’ts” brand name, which provides multi-functional services utilizing embedded computer chips that calculate and record information. We expect our smart card to have a variety of functions, including those of credit cards, electronic online wallets and transportation fare passes. We plan on working with leading banks and credit card companies in Korea to build the necessary infrastructure and increase subscribers to our new service.
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PCS Service
PCS service is a digital wireless telephone system that uses light handsets with long battery life to communicate via low-power antennae. PCS telephones have the capacity to receive and send data as well as voice transmission. KT Freetel, one of our consolidated subsidiaries in which we currently own a 48.1% effective interest, obtained one of the three licenses to provide nationwide PCS service in June 1996. KT Freetel began offering PCS service in all major population centers in Korea in October 1997 and currently covers substantially all of the Korean population. PCS service is currently offered at rates that are lower than rates for cellular services. KT Freetel’s PCS service uses CDMA technology and utilizes 20 MHz of bandwidth in the 1800 MHz frequency. KT Freetel launched its 2.5 generation high speed wireless data services in May 2001 which currently have a population coverage of 85%. Subscribers who have EV-DO-compatible handsets are able to enjoy high speed multimedia services including voice, data and video transmission.
On December 15, 2000, we acquired the right to purchase one of three licenses to provide W-CDMA-based IMT-2000 services, as a member of a consortium of companies including KT Corporation and KT Freetel. IMT-2000 is a third-generation, high-capacity wireless Internet and video multimedia communications technology which allows an operator to provide to its subscribers significant more bandwidth capacity. In June 2002, KT ICOM, a company created by our consortium to offer IMT-2000 services, launched a pilot version of IMT-2000 services in cities in Korea which sponsored FIFA Worldcup games. KT ICOM subsequently merged into KT Freetel on March 6, 2003 in a stock-for-stock transaction. KT Freetel began offering its test service of IMT-2000 services in metropolitan Seoul and parts of Gyunggi Province in December 2003, and KT Freetel plans to offer service in 45 cities by December 2005, subject to market conditions and service demand.
We entered into air-time reselling arrangements with KT Freetel in July 1999, through which we use our extensive marketing network and strong brand name to attract subscribers who can utilize the PCS networks of KT Freetel. We bill directly to our resale subscribers for their usage of KT Freetel’s PCS networks and collect all fees and charges relating to such usage, including initial subscription fees, monthly access fees and usage charges for outgoing calls, wireless data communications and value-added monthly services. We had approximately 2.1 million resale subscribers who utilized KT Freetel’s network as of April 30, 2004.
Mobile telecommunications service has grown rapidly in Korea in recent years. The table below gives the subscription and penetration information of the mobile telecommunications industry for the periods indicated:
Total Korean Population(1)
Mobile Subscribers(2)
PCS(2)
Cellular(2)
Mobile Subscriber Growth Rate
Mobile Penetration(3)
KT Freetel competes not only with another PCS service provider, LG Telecom, which began its service at around the same time, but also with SK Telecom, a cellular service provider that has a longer operating history. As of April 30, 2004, KT Freetel had approximately 11.5 million subscribers (including 2.1 million resale subscribers of KT Corporation), which was second largest among the three mobile service providers. As of that date, in terms of number of subscribers, we estimate that KT Freetel had a market share of 32.4% of the mobile service market. In recent months, KT Freetel’s subscribers increased as a result of the implementation of the
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mobile phone number portability of SK Telecom’s subscribers starting January 1, 2004. From January 1, 2004 to April 30, 2004, 553,275 of SK Telecom’s subscribers switched to KT Freetel. We expect some of KT Freetel’s current subscribers to switch to SK Telecom or LG Telecom when KT Freetel’s subscribers are able to transfer their existing mobile numbers starting July 1, 2004.
In 2003, KT Freetel had an average monthly churn rate of 2.0%. The churn rate is calculated by dividing the number of customers who discontinue their subscription by the total number of customers. Monthly churn rate calculations include customers who receive a new phone number after upgrading to a new phone.
The following table shows selected information concerning the usage of KT Freetel’s network during the periods indicated and the number of KT Freetel’s subscribers as of the end of such periods:
Outgoing Minutes (in thousands)
Average Monthly Outgoing Minutes Per Subscriber(1)
Average Monthly Revenue per Subscriber(2)
Number of Subscribers (in thousands)(3)
KT Freetel markets its services through two channels: (1) exclusive dealers and (2) the marketing network of KT Corporation pursuant to air-time reselling arrangements with us. The primary distribution channels of KT Freetel are its 1,464 independent exclusive dealers located throughout Korea. In addition to assisting new subscribers to activate PCS service and purchase handsets, authorized dealers are connected to the database of KT Freetel and are able to assist customers with account information. Although most of these dealers sell exclusively products and services of KT Freetel, sub-dealers hired by exclusive dealers may sell products and services offered by other mobile telecommunications service providers. Authorized dealers are entitled to a commission of Won 22,000 for each new subscriber registered, as well as ongoing commissions for the first five years based primarily on the subscriber’s monthly access fee, usage charges and length of subscription. Ongoing commissions range from 5.5% to 8.0% of monthly fees paid by the subscriber depending on the subscriber’s monthly usage charges, and from 0.3% to 0.9% of monthly fees depending on the subscriber’s length of subscription. In addition, dealers are entitled to bonuses ranging from 0.1% to 1.0% of monthly fees based on subscriber satisfaction surveys conducted by KT Freetel.
The handsets sold by KT Freetel to the dealers cannot be returned to KT Freetel unless they are defective. If a handset is defective, it may be exchanged for a new one within three days from the date of purchase.
KT Freetel does not require its subscribers to make facility deposits or take out facility insurance policies with the Korea Guarantee Insurance Company, unless a subscriber purchased his or her handset through the installment payment plan. In such a situation, facility insurance is required and the subscriber usually pays a one-time insurance fee ranging from Won 10,000 to Won 20,000. KT Freetel conducts the screening process for new subscribers with great caution. A potential subscriber must meet all internal credit criteria before receiving PCS service. The procedure includes checking the history of non-payment and credit information from banks and
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credit agencies such as the National Information and Credit Evaluation Corporation. Applicants who do not meet the minimum criteria can only subscribe to the PCS service by using a pre-paid card.
Other Services
We provide various services that extend beyond basic telephone service and data communications service, including:
These services accounted for 4.3% of our operating revenues for 2003.
System and Network Integration Services. We offer a wide range of system and network integration services to our clients. Our range of services includes consulting services that provide solutions to specific system or network issues in designing, building and maintaining communications networks which satisfy the individual needs of our clients. Typically, it takes between six months to one year to complete a project.
From our system and network integration services, we derived revenues of approximately Won 199 billion in 2001, Won 258 billion in 2002 and Won 115 billion in 2003.
Satellite Communications Services. In 1996, we launched Koreasat II, a telecommunications satellite with 15 transponders. Koreasat II became fully operational in July 1996. We use a total of 12 transponders to provide our telecommunications services and three transponders to television broadcasting companies. Koreasat II is due to reach the end of its operational life in 2006.
We launched Koreasat III in September 1999 to replace Koreasat I. Koreasat III carries 33 transponders, of which 27 are used for telecommunications and the remaining 6 for broadcasting purposes. Among the 27 transponders reserved for telecommunications, 12 are used to replace the telecommunications operations of an older satellite that has been phased out, while 12 are used for business and data transmission services. The remaining three transponders are used for ultra-high-speed communications pilot projects for sparsely populated areas. The six broadcast transponders for Koreasat III are used to replace the operations of the older satellite. All broadcast transponders are currently utilized by Korea Digital Satellite Broadcasting Inc., and broadcasting has become the main use of our satellites. The expected useful life of Koreasat III is approximately 15 years.
We are planning to launch Koreasat V in May 2006 to replace Koreasat II. Koreasat V will be a telecommunication satellite with 24 transponders and an expected useful life of approximately 15 years.
From our satellite communications services, we derived revenues of approximately Won 101 billion in 2001, Won 124 billion in 2002 and Won 120 billion in 2003.
KTH. KTH is a consolidated subsidiary in which we own a 65.9% interest, and its services include providing on-line content subscription services under the “Hitel” brand name and developing on-line contents for hanmir.com portal site and our Megapass and NESPOT services. In December 2003, we also transferred hanmir.com portal site to KTH. Hitel subscribers can access a variety of content from various third-party content providers, including news articles and information on business, entertainment, sports and other areas. Hitel subscribers also incur local telephone charges when they access the Hitel service using a dial-up modem. KTH’s communication services include e-mail services, instant messenger services, web storage services and exchanges of electronic files.
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Revenues and Rates
The table below shows the percentage of our revenues derived from each category of services for each of the years from 2001 through 2003.
Fixed-line telephone services:
Local services
Non-refundable service installation fees
Domestic long-distance service
International long-distance service
Land-to-mobile interconnection
Business and data communications services:
Broadband Internet access service
Leased-line service
Internet-related services(1)
Miscellaneous
PCS service
Sales of goods(2)
Other services(3)
Total operating revenues
Local Telephone Service. Our revenues from local telephone service consist primarily of:
All calls are currently measured by call pulses. Each pulse is determined by the duration of the call and the time of the day at which the call is made. For instance, during regular service hours, a call pulse is triggered at the beginning of each local telephone call and every three minutes thereafter.
The rates we charge for local calls are currently subject to approval by the Ministry of Information and Communication after consultation with the Ministry of Finance and Economy. The rates are the same for residential and commercial customers.
Before September 1998, in addition to a non-refundable installation fee of Won 8,000 and a monthly basic charge, a customer was required to pay at the time of a telephone installation a non-interest-bearing refundable deposit. The deposit ranged from Won 122,000 to Won 242,000 depending on the size of the local calling area in which the phone was installed. In September 1998, with the approval of the Ministry of Information and
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Communication, we implemented an alternative telephone installation charge system that allowed our customers to choose between the pre-existing service plan and a second service plan. The charges under each plan were as follows:
Rates from September 1998 to April 14, 2001
Pre-existing Plan
Second Plan
Between Won 122,000 to Won 242,000, depending on location
Won 8,000
Won 100,000
Basic Monthly Charge
Between Won 1,500 to Won 2,500, depending on location
Between Won 2,000 to Won 4,000, depending on location
Through April 14, 2001, approximately 7.1 million existing customers switched to or enrolled under the second plan. To each of these customers, we refunded between Won 30,000 and Won 150,000 of their telephone installation deposits while keeping Won 92,000, reflecting the Won 100,000 non-refundable telephone installation fee under the second plan minus the Won 8,000 non-refundable installation fee paid under the pre-existing plan.
Starting on April 15, 2001, with the approval of the Ministry of Information and Communication, we implemented a new telephone installation charge system. The changes are as follows:
Rates Starting April 15, 2001
New Plan
Won 60,000 (including value added tax)
Between Won 2,500 to
Won 3,700, depending on location
Between Won 3,000 to Won 5,200, depending on location
All new customers subscribing to our local service on or after April 15, 2001 must choose the new plan. Our existing customers who are enrolled in the pre-existing plan are still allowed to switch to the new plan and receive their installation deposit back (less Won 52,000, reflecting the Won 60,000 non-refundable installation fee paid under the new plan minus the Won 8,000 non-refundable installation fee paid under the pre-existing plan). Our existing customers who switched to or enrolled under the second plan cannot switch to the new plan.
From April 15, 2001 to December 31, 2003, approximately 11.8 million customers either chose to switch to the new plan or subscribed to our local service. The total refund amount (excluding the non-refundable telephone installation fees retained by us) to customers choosing to switch to the new plan in 2003 amounted to Won 166 billion. As of December 31, 2003, there were 5.5 million subscribers who are enrolled under the pre-existing plan and eligible to switch to the new plan and receive their installation deposit back (less Won 52,000 as described above).
Starting May 1, 2002, we increased our charge for local directory assistance service from Won 80 per call to Won 100.
On April 15, 2001, with the approval of the Ministry of Information and Communication, we lowered the usage charges from Won 45 per pulse (generally three minutes) to Won 39 per pulse while increasing the basic monthly charge as described above.
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Domestic Long-distance Telephone Service. Our revenues from domestic long-distance service consist of charges for calls placed, charged for the duration, time of day and day of the week a call is placed, and the distance covered by the call. Since January 1998, we have been setting our own rates for domestic long-distance service with no need to obtain Ministry of Information and Communication approval.
The following table summarizes our local usage charges and domestic long-distance rates as of each date on which rates were revised since our establishment in 1981.
Local Usage Charges (per pulse)(2)
Regular service
Public telephone
Domestic Long-Distance Service (per three minutes)(3)
Up to 30 km
Up to 100 km
100 km or longer
From September 10, 2002 to December 9, 2002, with the approval from the Ministry of Information and Communication, we also offered an optional flat rate plan for our fixed-line telephone service subscribers who had been our customers since August 1, 2001. Under the optional plan, a subscriber who elected to pay the monthly average of local and domestic long-distance usage amounts previously paid by such subscriber from August 1, 2001 to July 31, 2002 plus an extra charge of Won 1,000 to Won 5,000 each month (depending on average usage amount) is able to make unlimited minutes of local and domestic long-distance calls for up to 12 months from the election date. We obtained an approval from the Ministry of Information and Communication to extend the optional flat rate plan for another 12 months for those subscribers who had previously elected to participate. The plan is not renewable at the expiration of the 24-month period unless we obtain another approval from the Ministry of Information and Communication.
The revenues from domestic calls placed from public telephones, which are included in local and domestic long-distance service revenues, as appropriate, were Won 114 billion in 2001, Won 93 billion in 2002 and Won 84 billion in 2003.
International Long-distance Service. Our revenues from international long-distance service consist of:
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We bill outgoing calls made by customers in Korea (and calls made to Korea from foreign countries under our home country direct-dial service) in accordance with our international long-distance rate schedule for the country called. These rates vary depending on the time of day at which a call is placed. We bill outgoing international calls on the basis of one-second increments. Since January 1998, we have been setting our own rates for international long-distance service without the need to obtain Ministry of Information and Communication approval.
We bill outgoing calls (and calls made from Korea through a home country direct-dial service) to the relevant foreign carrier or administration at the applicable settlement rate specified under the agreement with the foreign entity. We have entered into over 240 bilateral agreements with foreign carriers and administrations. We negotiate the settlement rates under these agreements with each foreign carrier, subject to Ministry of Information and Communication approval. It is the practice among international carriers for the carrier in the country in which the call is billed to collect payments due in respect of the use of overseas networks. Although we record the gross amounts due to and from us in our consolidated financial statements, we make settlements with most carriers quarterly on a net basis.
The net settlement payment rate between U.S. carriers and us was reduced from US$0.355 per minute in 1999 to US$0.255 per minute in 2000 and US$0.190 per minute in 2001, 2002, 2003 and 2004. The reduction in the net settlement payment rates between KT Corporation and U.S. carriers will adversely affect our revenues from international long-distance service unless the reduction in rates can be offset by volume increases.
Effective January 1, 1999, the settlement rate applicable to Japan was reduced from Special Drawing Rights 0.315 per minute to Special Drawing Rights 0.20 per minute. The rate was further reduced to Special Drawing Rights 0.19 per minute effective October 1, 1999. Special Drawing Rights 1.00 was equivalent to US$1.44 on December 31, 2003.
Starting March 10, 2003, we changed the rate structure for our international long-distance telephone service to compete more effectively in the international long-distance market, as well as in the Internet phone service market. We lowered our international long-distance rates applicable to most countries while decreasing the discounted hours during weekdays from 12 hours to 6 hours and on Saturdays from 16 hours to 6 hours and the discount rates applicable during these hours from 30% to 10%. Our normal rates for international long-distance calls to the United States, Japan and China decreased by 60%, 18% and 22%, respectively. DACOM and Onse also made comparable changes to their international long-distance rates.
We provide other telecommunications service providers, including mobile operators and other fixed-line operators, interconnection to our fixed-line network.
Land-to-mobile Interconnection. In December 1997, the Ministry of Information and Communication issued an order setting the interconnection charge calculation method applicable to interconnections with SK Telecom as well as all other mobile service providers. Commencing in 1998, for a call initiated by a landline user to a mobile service subscriber, we collect from the landline user the land-to-mobile usage charge and remit to the mobile service provider a land-to-mobile interconnection charge.
For 2000, our payments to cellular and PCS service providers were calculated by taking the actual costs of carrying a call (“Imputed Costs”) of SK Telecom in 1998 and adjusting for several factors including the call
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volume of mobile service providers. For 2001, our payments to mobile service providers were calculated by reducing the 2000 per-minute amount applicable to cellular service providers by 7.76% and the 2000 per-minute amount applicable to PCS service providers by 10.75%. On December 12, 2002, the Ministry of Information and Communication issued an order revising the land-to-mobile interconnection charge calculation method applicable beginning January 2002. In addition to taking the actual Imputed Costs of SK Telecom in 2000, the Ministry of Information and Communication took into consideration several factors including the call volume of each mobile service provider in determining interconnection charges we pay per minute to SK Telecom, KT Freetel and LG Telecom. Starting in 2004, the Ministry of Information and Communication announced that it will determine the land-to-mobile interconnection charge by calculating the long-run incremental cost of mobile service providers, taking into consideration technology development and future expected costs. We can give no assurance, however, that the method of calculating the payments will be implemented as planned.
The following table shows the interconnection charges we paid per minute (exclusive of value-added taxes) to cellular and PCS operators for landline to mobile calls in 2001, 2002 and 2003 and which KT Corporation will pay in 2004 under the revised calculation method. The Ministry of Information and Communication is expected to announce the new rates for 2004 in mid-2004.
SK Telecom
KT Freetel(1)
LG Telecom
The following table shows the usage charge per ten seconds collected from a landline user for a call initiated by a landline user to a mobile service subscriber.
Weekday
Weekend
Evening (1)
The charges above have been agreed among the parties involved and confirmed by the Ministry of Information and Communication. In order to compensate for the lack of corresponding decrease in the base usage charge per ten seconds in 2001 and the first four months of 2002 which remained at Won 19.0, we agreed with the Ministry of Information and Communication to offer to landline users ten minutes of free calls per month from May 2002 to December 2002 for calls initiated by a landline user to a mobile service subscriber. In addition, in order to compensate for the lack of corresponding decrease in the base usage charge per ten seconds in the first half of 2003, we agreed with the Ministry of Information and Communication to offer to landline users six minutes of free calls per month from July 2003 to December 2003 for calls initiated by a landline user to a mobile service subscriber. The amounts for 2004 are expected to be confirmed by the Ministry of Information and Communication in mid-2004 after consultation with other government agencies.
We recognize as land-to-mobile interconnection revenue the entire amount of the usage charge collected from the landline user and recognize as expense the amount of interconnection charge paid to the mobile service provider.
Land-to-land Interconnection. We entered into interconnection agreements with DACOM, Onse and Hanaro in February 2001. The DACOM interconnection agreement provides that for a domestic or international long-distance call initiated by a DACOM subscriber, DACOM bills the customer its normal rate for the call and remits
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to us an interconnection charge based on our Imputed Costs. We entered into an interconnection agreement with Onse on the same terms as the DACOM interconnection agreement. We also entered into an interconnection agreement with Hanaro which provides that for a domestic call initiated by a Hanaro subscriber, Hanaro bills the customer its normal rate for the call and remits to us an interconnection charge based on our Imputed Costs.
On March 30, 2002, the Government issued an order to require us to provide domestic long distance interconnection services to our competitors without charging for local access network charge, effective retroactively starting January 2001. Additional exemptions will adversely affect our revenues from domestic long distance interconnection business.
Mobile-to-land Interconnection. Commencing in 1998, for a call initiated by a mobile service subscriber to a landline user, the mobile service provider collects from its subscriber the mobile-to-land usage charge and remits to us a mobile-to-land interconnection charge based on our Imputed Costs. For 2002 and 2003, payments are calculated by taking our actual Imputed Costs in 2000 and adjusting for call volume. Mobile-to-land interconnection charges we received from mobile service providers were Won 16.2 or Won 20.3 per minute in 2002 and Won 14.9 or Won 19.0 per minute in 2003, depending on location of interconnection. The Ministry of Information and Communication is expected to announce the new rates for 2004 in the fourth quarter of 2004. Starting in 2004, the Ministry of Information and Communication plans to determine the mobile-to-land interconnection charge by calculating our long-run incremental cost, taking into consideration technology development and future expected costs.
Business and Data Communications Services
Broadband Internet Access Service. We offer broadband Internet access service that uses existing telephone lines to provide both voice and data transmission. Our broadband Internet access service revenues accounted for 54.6% of our business and data communications revenues in 2003. The substantial increase in our broadband Internet revenues was primarily due to the increase in our broadband Internet access subscribers from approximately 12,000 as of December 31, 1999 to 5.8 million as of April 30, 2004. We charge customers of broadband Internet services on a monthly fixed-cost basis with no additional time charges. In addition, we charge customers a one time installation fee per site of Won 30,000. The following table summarizes our charges for different broadband Internet services:
Megapass Special II
Megapass Special I
Megapass Premium
Megapass Ntopia
Megapass Lite
The following table is a comparison of standard rate plans of our competitors:
Hana FOS V Dream II (VDSL)
Hana FOS V Dream I (VDSL)
Hana FOS V Pro (ADSL)
Hana FOS V Pro (Cable)
Thrunet VDSL Special
Thrunet VDSL Premium
Thrunet Cable Internet Premium
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In addition, the entry of cable television providers that offer HFC-based broadband Internet access services at rates lower than ours has increased competition in the broadband Internet access service market. They typically charge initial installation fee of Won 30,000 and monthly access fee of Won 17,000 to Won 25,000 per month.
Leased-line Service. We charge customers of domestic leased-lines on a monthly fixed-cost basis based on the distance of the line, the capacity of the line measured in bits per second (“bps”), the type of line provided and whether the service site is local or long-distance. In addition, we charge customers a one-time installation fee per site ranging from Won 56,000 to Won 1,940,000, depending on the capacity of the line. As part of our effort to maximize revenues through rebalancing our rate structure, effective September 15, 2002, we increased our rates for local leased lines with capacity of up to 1,544 Kbps by 5.0% to 15.0%, depending on speed, and our rates for long-distance leased lines with distances of up to 100 kilometers by 8.0% to 10.0%, depending on distance.
PCS Services and Handset Sales
Our revenues from PCS service and PCS handset sales are generated through our consolidated subsidiary KT Freetel and our PCS resale service. We derive revenues principally from:
KT Freetel may set these fees and charges, including any promotional rates, without the need to obtain Ministry of Information and Communication approval. Like all Korean mobile service providers, KT Freetel does not charge its customers for incoming calls. Instead, KT Freetel receives interconnection charges from us for calls initiated from our fixed-line network to its PCS network (which are eliminated in consolidation) and charges from other mobile service operators for calls initiated by their subscribers. Rates for PCS services are lower than rates for cellular services.
The following table is a comparison of the standard rate plan of KT Freetel with the standard rate plans of its competitors as of April 30, 2004:
SK Telecom(1)
Although KT Freetel provides various rate plans, approximately 25% of its subscribers are currently enrolled in the standard rate plan. KT Freetel’s other rate plans include those that offer a specified number of free airtime minutes per month in return for a higher monthly access fee and those that are geared toward business customers. Our competitors also offer similar plans.
In order to promote its PCS services, KT Freetel acquires PCS handsets in bulk for resale to its subscribers. Sales of PCS handsets by KT Freetel amounted to Won 1,032 billion in 2001, Won 1,112 billion in 2002 and Won 875 billion in 2003. KT Freetel and its competitors offered handsets to subscribers at prices that were substantially below the prices at which they purchased the handsets from manufacturers until June 1, 2000 when the Government banned such subsidies.
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Investments
We invested Won 60.3 billion in March 2001 for an 18.2% interest in Korea Digital Satellite Broadcasting Co., Ltd., a new affiliate created to offer satellite broadcasting services, and invested an additional Won 82.4 billion in December 2003. KT Corporation currently holds a 27.4% interest, KT Freetel (our 48.1%-owned consolidated subsidiary) holds a 2.4% interest and KT Networks Corporation (our wholly-owned consolidated subsidiary) holds an additional 0.1% interest. We formed a consortium with 51 other companies in June 2000 and obtained the license for satellite broadcasting on December 19, 2000. Other members of the consortium include major television broadcasting companies in Korea, conglomerates, newspaper companies and other media companies as well as manufacturers of equipment for satellite broadcasting. Korea Digital Satellite Broadcasting Company started its broadcasting services called SkyLife in March 2002 and had approximately 1.3 million subscribers as of April 30, 2004. Our satellites are used to provide these services.
From time to time, we may also consider investment opportunities involving acquisitions and strategic relationships. We may acquire controlling interests in companies that we believe possess growth opportunities. We may also make selective minority investments in companies with which we want to form strategic alliances.
Competition
Under the Telecommunications Basic Law and the Telecommunications Business Law, telecommunications service providers in Korea are currently classified into network service providers, value-added service providers and specific service providers. See “Item 4.B. Business Overview—Regulation”.
Network Service Providers
All network service providers in Korea are permitted to set the rates for international or domestic long-distance services on their own without Ministry of Information and Communication approval. Many of our competitors have set their rates lower than ours. Currently, we can compete freely with other providers on the basis of rates in all services except for local rates which require advance Ministry of Information and Communication approval. See “Item 4.B. Business Overview —Regulation”. In all service areas, we also compete by endeavoring to provide superior customer service and superior technical quality, taking advantage of our broad customer base and our ability to provide integrated telecommunication services.
We and SK Telecom qualify as market-dominating business entities in the respective markets under the Monopoly Regulation and Fair Trade Act. Under this Act, a market-dominating business entity may not engage in any act of abuse, such as unreasonably interfering with business activities of other business entities, hindering unfairly the entry of newcomers or substantially restricting competition to the detriment of the interests of consumers. The Ministry of Information and Communication has also issued guidelines on fair competition of the telecommunications companies under the Telecommunications Business Law. If any telecommunications service provider breaches the guidelines, the Ministry of Information and Communication may take necessary corrective measures against it after a hearing at which the service provider may defend its action.
Local. The only company licensed to compete with us in the local telecommunications business is Hanaro, whose major shareholders include American International Group Inc. and Newbridge Capital, LLC, and began providing local telephone service in four major cities in 1999. According to statistics published by the Ministry of Information and Communication, as of December 31, 2003, Hanaro had 4.4% of the market for local service in terms of number of subscribers. Although the local usage charge of both Hanaro and us is the same at Won 39 per pulse (generally three minutes), Hanaro’s non-refundable telephone installation charge and basic monthly charge are lower than ours. Hanaro’s customers pay non-refundable telephone installation charge of up to Won 30,000 and pay basic monthly charge of up to Won 4,500, while our customers pay an installation charge of Won 60,000 and basic monthly charge of up to Won 5,200, depending on location.
The Ministry of Information and Communication implemented local number portability in certain regions starting on June 30, 2003 and plans to implement it in Pusan in July 2004 and in Seoul in August 2004, which allows our existing customers to choose a competing local telephone service provider without changing his or her
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telephone number. This implementation may allow Hanaro to compete more effectively for our existing customers. As of April 30, 2004, 42,678 of our subscribers have switched to Hanaro and 209 subscribers of Hanaro have switched to us.
Domestic Long-Distance. Three companies, DACOM, Onse and Hanaro, are licensed to compete with us in the domestic long-distance market. DACOM began offering domestic long-distance service in January 1996. Currently, DACOM’s rates for domestic long-distance service are approximately 2.8% lower on average than ours. Onse began providing domestic long-distance service in December 1999. Onse’s domestic long-distance rates are up to 4.1% lower than ours depending on the calling area. Onse filed for court receivership in April 2003. Hanaro obtained its domestic long-distance licenses in January 2003, and we expect Hanaro to begin offering this service in July 2004.
The following table shows the market share, in terms of revenue, of us, DACOM and Onse in the domestic long-distance market in terms of revenues estimated by us for the years indicated:
International Long-Distance. Four companies, DACOM, Onse, Hanaro and SK Telink, are licensed to compete with us in the international long-distance market. Since its entry into the market for international long-distance service in December 1991, DACOM has obtained a significant share of Korea’s international long-distance business. In 2003, DACOM had 24.0% of the international long-distance market in terms of revenue. Currently, we estimate that DACOM’s rates are at an average discount of 0.6% to ours.
Onse became the third carrier in Korea to provide international long-distance service and commenced service in October 1997. We estimate that Onse’s international rates are currently at an average discount of 4.1% to ours. SK Telink obtained another international-long distance license in June 2003 and began offering this service in November 2003. In addition, Hanaro obtained an international-long distance license in January 2003 and we expect Hanaro to begin offering this service in July 2004.
The following table shows market share, in terms of revenue, of us, DACOM and Onse in the international long-distance market as estimated by us for the years indicated:
Market Share (%)
DACOM
Onse
In addition, the entry of other telecommunications services providers, such as Internet phone service providers and voice resellers, that can offer telecommunications services at rates lower than ours has increased competition in the international long-distance market and adversely affected our revenues and profitability from international long-distance services. See “Item 4.B. Business Overview—Specific Service Providers”.
Business and Data Communications. The Korean broadband Internet access service market has experienced significant growth over the last four years since Korea Thrunet first introduced its HFC-based service in July 1998. Hanaro Telecom entered the broadband market in April 1999 offering both HFC and ADSL services. We entered the market with our ADSL services in June 1999. Dreamline and DACOM followed and introduced their services in late 1999 and early 2000. In addition, the entry of cable television providers that offer HFC-based broadband Internet access services at rates lower than ours has increased competition in the broadband Internet access service market. We expect competition from these service providers to intensify in the future.
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The following table presents the number of subscribers and the market shares in terms of subscribers as of April 30, 2004 as announced by the Ministry of Information and Communication:
Hanaro
Korea Thrunet
Others
DACOM had a monopoly on business and data communications services (except for leased-line service) until July 1990, when we were permitted by the Ministry of Information and Communication to compete in this area. We had a monopoly in domestic leased-line service until January 1994, when DACOM was also authorized to provide the same service. We estimate that for the year ended December 31, 2003, we had a market share of 72.3% in domestic leased-line services, Powercomm had a market share of 10.2% and DACOM had a market share of 6.3%.
Mobile Telecommunications.Competition in the mobile telecommunications industry in Korea is intense among cellular service provider SK Telecom and PCS service providers KT Freetel and LG Telecom. As of April 30, 2004, in terms of number of subscribers, we estimate that KT Freetel (including 2.1 million resale subscribers of KT Corporation) had a market share 32.4% of the mobile service market. SK Telecom acquired control of Shinsegi in a series of transactions ending in April 2000, and Shinsegi merged into SK Telecom in January 2002. As of April 30, 2004, SK Telecom had a market share of approximately 52.0% based on the total number of mobile subscribers in Korea.
In January 2003, the Ministry of Information and Communication announced its plan to implement mobile number portability, which would allow mobile telephone service subscribers to switch their mobile service provider while retaining the same mobile phone number. Subscribers who switch service providers must purchase a new handset and may return to the original service provider without paying any penalty within 14 days of the switch. Mobile number portability has been allowed to subscribers of SK Telecom starting in January 2004 and will be allowed to subscribers of KT Freetel and LG Telecom starting July 2004 and January 2005, respectively. Following the implementation of mobile number portability, 553,275 of SK Telecom’s subscribers switched to KT Freetel from January 1, 2004 to April 30, 2004. We expect some of KT Freetel’s current subscribers to switch to SK Telecom and LG Telecom when KT Freetel’s subscribers are able to transfer their existing mobile numbers starting July 1, 2004.
The Ministry of Information and Communication also announced that starting in January 2004, all new subscribers of mobile services and existing subscribers who elect to receive a new mobile number would be given the uniform mobile code of “010” as the first three digits of their mobile numbers without regard to the mobile service provider. The Ministry of Information and Communication is planning to implement the uniform mobile code to all mobile numbers by 2007.
The cellular services provided by SK Telecom and the PCS services provided by the PCS service providers have had a material adverse effect on KT Corporation in terms of the number of subscribers to KT Corporation’s fixed-line telephone services and our revenues from fixed-line telecommunications services. We expect this situation to continue. See “Item 5. Operating and Financial Review and Prospects”.
Value-Added Service Providers
Value-added service providers may commence operations following filing of a report to the Ministry of Information and Communication. The scope of business of a value-added service provider includes specific value-added telecommunications activities (other than services reserved for network service providers), such as data communications using telecommunications facilities leased from network service providers.
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Specific Service Providers
Specific service providers, such as Internet phone service providers and voice resellers, started operations in Korea in 1998. We began providing Internet phone service for international long-distance calls in May 1998. Our Internet phone service also competes with international long-distance services provided by voice resellers who have also seen sharp increases in demand for their services.
Foreign Competition
Under the multilateral agreement on basic telecommunications services among the members of the WTO, effective November 27, 1997, the Government of Korea agreed to gradually reduce the restrictions on foreign and individual shareholdings in KT Corporation and other network service providers in Korea. Currently, the Telecommunications Business Law limits aggregate ownership of shares with voting rights in network service providers (including us) by foreign shareholders to 49% of issued shares with voting rights. In addition, the Foreign Investment Promotion Act regulations prohibit a foreign shareholder from being our largest shareholder if such shareholder holds 5% or more of our shares. See “Item 4.B. Business Overview—Regulation—Foreign Investment”. While the WTO Agreement enables us to seek foreign investors and strategic partners and to more easily take advantage of opportunities for investments in overseas telecommunications projects, it may also benefit our competitors and further intensify competition in the domestic market.
Regulation
Under the Telecommunications Basic Law and the Telecommunications Business Law, telecommunications service providers are currently classified into three categories:
Under the Telecommunications Basic Law and the Telecommunications Business Law, the Ministry of Information and Communication has comprehensive regulatory authority over the telecommunications industry and all network service providers. The Ministry of Information and Communication’s policy is to promote competition in the Korean telecommunications markets through measures designed to prevent the dominant service provider in any such market from exercising its market power in such a way as to prevent the emergence and development of viable competitors. A network service provider must be licensed by the Ministry of Information and Communication. Our license as a network service provider permits us to engage in a wide range of telecommunications services.
Rates
Under current regulations implementing the Telecommunications Business Law, a network service provider may set its rates at its discretion, although it must report to the Ministry of Information and Communication the rates and the general terms and conditions for each type of network service provided by it. There is, however, one exception to this general rule: if a network service provider has the largest market share for a specified type of service and its revenue from that service for the previous year exceeds a specific revenue amount set by the
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Ministry of Information and Communication, it must obtain prior approval from the Ministry of Information and Communication for the rates and the general terms for that service. Each year the Ministry of Information and Communication designates the service providers and the types of services for which the rates and the general terms must be approved by the Ministry of Information and Communication. In 2003, the Ministry of Information and Communication designated us for local telephone service and SK Telecom for cellular service. The Ministry of Information and Communication, in consultation with the Ministry of Finance and Economy, is required to approve the rates proposed by a network service provider if (1) the proposed rates are appropriate, fair and reasonable and (2) the calculation method for the rates are appropriate and transparent.
In January 2001, the Ministry of Information and Communication announced its intention to adopt a price range system for local service rates, under which local service providers (including us) may set the rates for their service at their own discretion within a range determined by the Ministry of Information and Communication. However, it remains uncertain when such price range system for local service rates will be implemented. Although no system has been implemented yet, we expect that this price range system would allow local service providers to increase their rates each year by a percentage no higher than the percentage increase in the consumer price index minus an amount that would be subject to periodic review. This system would give us greater flexibility in setting our local rates in response to market conditions, but we cannot give any assurance that the system will be adopted as contemplated or at all.
Other Activities
A network service provider, such as us, must obtain the permission of the Ministry of Information and Communication in order to:
A telephone service provider may provide some network services using the equipment it currently has by submitting a report to the Ministry of Information and Communication. The Ministry of Information and Communication can revoke our licenses or order the suspension of any of our businesses if we do not comply with the regulations of the Ministry of Information and Communication under the Telecommunications Business Law.
The Ministry of Information and Communication’s responsibilities also include:
The Ministry of Information and Communication may also recommend to network service providers that they invest a percentage of their total annual revenues in research and development or that they contribute to telecommunications research institutes in Korea. In addition, since January 2000, all network service providers (other than regional paging service providers) are obligated to contribute toward the supply of “universal”
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telecommunications services in Korea. Telecommunications service providers designated as “universal service providers” by the Ministry of Information and Communication are required to provide universal telecommunications services such as local services, local public telephone services, telecommunications services for remote islands and wireless communication services for ships. We have been designated as a universal service provider. The costs and losses recognized by universal service providers in connection with providing these universal telecommunications services will be shared on an annual basis by all network service providers (other than regional paging service providers), including us, on a pro rata basis based on their respective net annual revenue calculated pursuant to a formula set by the Ministry of Information and Communication.
Due to the amendment of the Telecommunication Business Law, effective April 9, 2001, a network service provider must permit other network service providers to co-use wirelines connecting the switching equipment to end-users, upon the request of such other telecommunication service providers. In addition, a network service provider may permit other network service providers to co-use its wireless communication systems upon the request of any of such other network service providers. The compensation method for the co-use must be determined by the Ministry of Information and Communication and be settled, by fair and proper methods.
In addition, starting April 2002, we are required to lease to other companies our fixed-lines that connect subscribers to our network. This system, which is called local loop unbundling, is intended to prevent excessive investment in local loops. This system requires us to lease the portion of our copper lines that represent our excess capacity to other companies upon their request at rates that are determined by the Ministry of Information and Communication based on our cost, and taking into consideration an appropriate rate of return, to enable them to provide voice and broadband services.
Korea Communications Commission
In accordance with the Telecommunications Basic Law, the Korea Communications Commission was established within the Ministry of Information and Communication to:
The Korea Communications Commission is composed of up to nine commissioners appointed by the President of the Republic. The Ministry of Information and Communication has established a working bureau in the Korea Communications Commission to support the work of the Korea Communications Commission and intends to make the Korea Communications Commission more independent. We expect that the Korea Communications Commission will become more active in investigating and settling the above mentioned matters.
Foreign Investment
The Telecommunications Business Law restricts the ownership and control of network service providers by foreign shareholders. Foreigners, foreign governments and “foreign invested companies” may not own more than 49% of the issued shares with voting rights of a network service provider, including us, and a foreign shareholder may not become our largest shareholder. For purposes of the Telecommunications Business Law, the term “foreign invested company” means a company in which foreigners and foreign governments hold 15% or more shares with voting rights in the aggregate and a foreigner or a foreign government is the largest shareholder, provided, however, that such company will not be counted as a foreign shareholder for the purposes of the above-referenced 49% limit if it holds less than 1% of our total issued and outstanding Shares with voting rights. As of December 31, 2003, 45.5% of our common shares were owned by foreign investors. There is no restriction on foreign ownership for specific service providers and value-added service providers. In the event that a network
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service provider violates the shareholding restrictions, its shareholders cannot exercise voting rights for their shares in excess of such limitation, and the Ministry of Information and Communication may require corrective measures be taken to comply with the ownership restrictions.
Individual Shareholding Limit
In January 1999, the Government amended the Privatization Law and raised the ceiling on individual shareholdings from 7% to 15%. Accordingly, our articles of incorporation had provided for an individual shareholding limit of 15%. However, with the completion of the disposition of the Government’s ownership interest in us in May 2002, the Privatization Law ceased to apply to us after the general shareholders’ meeting held in August 2002 and such ceiling on individual shareholding specified in the articles of incorporation has been eliminated. See “Item 10. Additional Information—Item 10.B. Memorandum and Articles of Incorporation—Limitation on Shareholding”.
Relationship with the Government
Government as Shareholder
Before 1993, the Government owned all of our shares. Since 1993, the Government has gradually reduced its ownership and completed the disposition of its ownership interest in us in May 2002.
Government as Regulator
Under Korean law, the Government, primarily through the Ministry of Information and Communication, has authority to regulate all aspects of our activities. Currently, our telecommunications rates for local telephone service are subject to Ministry of Information and Communication’s approval. See “Item 4.B. Business Overview—Regulation”. The form of our standard agreement for providing local network service and each of our agreements for interconnection with other service providers are also subject to the Ministry of Information and Communication’s approval. In addition, we are required to furnish reports relating to our business and affairs to the Ministry of Information and Communication and from time to time consult with Ministry of Information and Communication officials on these matters. See “Item 4.B. Business Overview—Regulation”.
Government as Customer
The Government purchases services from us on an arm’s-length basis. The rates charged to the Government for our services are the same as those charged to the public.
Contributions to Government
We make contributions to the Ministry of Information and Communication, primarily to its Information and Telecommunication Improvement Fund. Our contributions amounted to Won 97 billion in 2001, Won 69 billion in 2002 and Won 63 billion in 2003. See Note 30 to the Consolidated Financial Statements.
Since 1988, the Government has sold shares of a number of Government-owned companies to promote the efficiency of these companies. Examples include the privatization of POSCO completed in 2000 and the partial privatization of Korea Electric Power Corporation in 1989, 1999 and 2000. In keeping with its privatization plans, the Government has gradually reduced its ownership interest in us since 1993 and completed the disposition of all of its equity interest in us in May 2002.
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The following table shows the dates, the number of shares sold in each series of share sales by the Government:
November 9, 1993(1)
April 19, 1994
November 10, 1994(2)
October 14, 1996
November 12, 1996(3)
November 29, 1996
December 12, 1996(4)
May 28, 1999
February 20, 2001
July 2, 2001
January 4, 2002(5)
May 23 and 24, 2002(6)
Under the Korea Telecom Act and the Government-Invested Enterprises Management Basic Act the Government had a greater control over our business and affairs. Effective October 1, 1997, the Korea Telecom Act was repealed and the Government-Invested Enterprises Management Basic Act became inapplicable to us. As a result, we became a corporation (chusik hoesa) under the Commercial Code, and our corporate organization and shareholders’ rights were governed by the Privatization Law and the Commercial Code. Among other things, we began to exercise greater autonomy in setting our annual budget and making investments within the telecommunications industry, and our directors, who used to be appointed by the Government under the Korea Telecom Act, are now elected by our shareholders. See “Item 6. Directors, Senior Management and Employees”. With the completion of disposition of the Government’s ownership interest in us in May 2002, the Privatization Law ceased to apply to us after the general shareholders’ meeting in August 2002.
Customers and Customer Billing
We charge residential subscribers and business subscribers the same rates for services provided. We bill all of our customers on a monthly basis. Our customers may make payment at either payment points such as local post offices, banks or our service offices, through a direct-debit service that automatically deducts the monthly payment from a subscriber’s designated bank account, or through a direct-charge service that automatically charges the monthly payment to a subscriber’s designated credit card account. In Seoul, approximately half of our subscribers pay through the direct-debit service. Subscribers who incur charges in an amount greater than the amount deposited at initial installation receive a notice of payment from us and if such charges are not paid after the notice, we cease to provide outgoing service to such subscribers after a period of time determined by, among other things, their credit history. If charges are still not paid after outgoing service is cut off, we cease all services
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to such subscribers after a period of time determined by the head of our relevant regional office. After service is ceased, we transfer the account to a collection agency and the overdue charges that are not collected by the collection agency are written off.
To support business subscribers and meet their increasing demand for data communications services, we have initiated an on-site service system. Under this system, business subscribers have access to an account manager who has the capability to market new products and services tailored to the needs of the business subscribers and provide systems management consulting and technical assistance.
Insurance
We carry insurance against loss or damage to all significant buildings and automobiles. Except for our insurance coverage of our two satellites, we do not carry insurance covering losses to outside plant or to equipment because we believe the cost of such insurance is excessive and the risk of material loss or damage is insignificant. We do not have any provisions or reserves against such loss or damage.
We provide co-location and a variety of value-added services including web- and server-hosting and application-hosting services to a number of corporations whose business largely depends on critical data operated on our servers or on their servers located at our data centers. Any disruptions, interruptions, physical or electronic data loss, delays or slow down in communication connections could expose us to potential liabilities for losses relating to the disrupted businesses of our customers relying on our services.
Item 4.C. Organizational Structure
These matters are discussed under Item 4.B. where relevant.
Item 4.D. Property, Plants and Equipment
Our principal fixed asset is our integrated telecommunications network that consists of exchanges and transmission equipment, access lines, backbone network, and PCS network of KT Freetel. In addition, we own buildings and real estate.
Our fixed-line equipment vendors include well-known international and local suppliers such as Samsung Electronics, Cisco, LG Electronics and Lucent Technologies. Our major mobile equipment suppliers are Samsung Electronics, LG Electronics and Lucent Technologies.
Exchanges and Transmission Equipment
Exchanges include local exchanges and “toll” exchanges that connect local exchanges to long-distance transmission facilities.
All of our exchanges are fully automatic. We completed replacement of all electromechanical analog exchanges with digital exchanges on June 9, 2003 in order to provide higher speed and larger volume services. We had 25.2 million lines connected to local exchanges and 2.1 million lines connected to toll exchanges as of December 31, 2003.
Access Lines
As of December 31, 2003, we had 25.2 million access lines installed, which allow us to reach virtually all homes and businesses in Korea. As part of our broadband deployment strategy, we have upgraded many of our access lines by equipping them with broadband capability using ADSL and VDSL technology. As of December 31, 2003, we had approximately 5.6 million broadband lines that enable us to deliver high-speed Internet access and multimedia content to our customers.
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Domestic Backbone
Our domestic fiber network consisted of 128,478 kilometers of fiber as of December 31, 2003. Our network is based on a synchronous digital hierarchy (SDH) architecture, which allows for instantaneous re-routing and reduced failure in the event of a fiber cut. In addition, SDH offers better reliability and performance for optical fiber transmission at a lower operating cost. In certain parts of our SDH network we have installed dense wavelength division multiplexing (DWDM) equipment. DWDM technology allows the combination of data from multiple signals on an optical fiber by carrying each signal on a separate wavelength, and hence substantially improving bandwidth efficiency.
Our extensive domestic long-distance network is supplemented by our fully digital domestic microwave network, which consists of 56 relay sites and 6 satellite earth stations.
International Long-Distance Network
Our international long-distance network infrastructure consists of both submarine cables and satellite transmission systems, which link our national network directly to 109 telecommunications service providers in 77 international destinations.
International calls are routed between Korea and international destinations through our four international switching centers, two of which are located in Seoul, while the other two are located in Daejun and Pusan. Each center had four international gateway switches with a combined simultaneous call capacity of 52,050 as of December 31, 2003.
In order to supplement the capacity of our cable and microwave networks and enhance our domestic long-distance and broadcasting services, we operate two telecommunications satellites, Koreasat II and III, launched in 1996 and 1999, respectively. The two satellites are due to reach the end of their normal operational lives in 2007 and 2015, respectively. We are planning to launch Koreasat V in May 2006 to replace Koreasat II. Koreasat V will be a telecommunication satellite with 24 transponders and an expected useful life of approximately 15 years. See “Item 4.B. Business Overview—Other Telecommunications Services”.
Personal Communication Services (PCS) Networks
Our PCS network architecture includes the following components:
The following table lists selected information regarding PCS networks of KT Freetel as of December 31, 2003.
Mobile switching centers
Base station controllers
Base transceiver stations
Indoor and outdoor repeaters
Total capacity (millions)
Population coverage of 2.0 generation network
Population coverage of 2.5 generation network
Population coverage of 3.0 generation (IMT-2000) network
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Through our consolidated subsidiary KT Freetel, we have 20 MHz of bandwidth in the 1,800 MHz spectrum to provide PCS services based on CDMA wireless network standards. We also have another 20 MHz of bandwidth in the 2,000 MHz spectrum to provide IMT-2000 services based on W-CDMA wireless network standards. We have also installed an intelligent network on our mobile network infrastructure to enable us to provide a wide range of advanced call features and value-added services.
We have been upgrading our digital networks to provide 2.5 generation multimedia services. Toward this effort, we have installed 2,557 IS-95C base transceiver stations as of December 31, 2003. Starting in February 2002, we have also installed 2,132 EV-DO base transceiver stations as of December 31, 2003, and we expect to install an additional 607 EV-DO base transceiver stations in 2004. We launched our 2.5 generation services in May 2001 and currently have population coverage of 84%. We launched test service of our 3.0 generation service (IMT-2000) in December 2003 in metropolitan Seoul and parts of Gyunggi Province, and KT Freetel is planning to offer IMT-2000 service in 45 cities by December 2005, subject to market conditions and service demand.
International Submarine Cable Networks
International long-distance traffic is handled by telecommunications satellites and submarine cables. Because of the high cost of laying a submarine cable, the usual practice is for multiple carriers to jointly commission a new cable and share the costs and the capacity.
We own interests in several international fiber optic submarine cable networks, including:
We have also invested in 19 other international fiber optic submarine cables around the world.
Item 5. Operating and Financial Review and Prospects
Overview
We are an integrated provider of telecommunications services. Our principal services include fixed-line telephone services, interconnection services to other telecommunications companies, business and data communications services including broadband Internet access service and leased-line service, and mobile telecommunications services through our consolidated subsidiaries. The principal factors affecting our revenues from these services have been our rates for, and the volume of usage of, these services, as well as the number of subscribers.
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Historically, our revenues were derived principally from fixed-line telephone services which consist of local, domestic long-distance and international long-distance services. In recent years we have been deriving an increasing portion of our operating revenues from business and data communications services (including broadband Internet access and leased-line services), PCS service, land-to-mobile interconnection and other telecommunications services. The principal factors affecting our operating revenues from these services have been our rates for, and the volume of, usage of these services. For information on rates we charge for telephone services, see “Item 4. Information on the Company—Item 4.B. Business Overview—Revenues and Rates”.
The following table shows, for each of the years in the three-year period ended December 31, 2003, our operating revenues, expenses and operating income, and each amount as a percentage of total operating revenues.
Operating revenues:
Local service
Sub-total
Internet-related services
Sales of goods
Others:
System and network integration services
Satellite service
Operating expenses:
Salaries and related costs
Depreciation and amortization
Other operating and maintenance(1)
Total operating expenses
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We have two reportable operating segments—a wireline communications segment and a PCS services segment. Wireline communications include all services provided to fixed-line customers, including local, domestic long-distance and international long-distance telephone service, interconnection service, and business and data communications services, including broadband Internet access service and leased-line service. The revenues for the PCS services segment include sales of PCS handsets. Our operations such as submarine cable construction and group telephone management that are provided by some of our consolidated subsidiaries are included in the “Miscellaneous” segment under Note 2(ag) to the Consolidated Financial Statements. The revenues from the “Miscellaneous” segment are included in “Other” in the above table.
One of the major factors contributing to our historical performance was the growth of the Korean economy, and our future performance will depend at least in part on the Republic’s general economic growth and prospects. For a description of recent developments that have had and may continue to have an adverse effect on our results of operations and financial condition, see “Item 3. Key Information—Item 3.D. Risk Factors—If economic conditions in Korea deteriorate, our current business and future growth could be materially and adversely affected”. A number of other developments have had a material impact on our results of operations, financial condition and capital expenditures. These developments include:
As a result of these changes, our financial results in the past may not be indicative of future results or trends in those results.
Developing IMT-2000 Services
IMT-2000 presents risks and challenges to our business, any or all of which if realized or not addressed may have a material adverse effect on our financial condition and results of operations. Specifically, IMT-2000 is a new and developing technology. New content, solutions and network must be developed for IMT-2000. We expect KT Freetel to leverage its existing PCS network and 2.5-generation technology to minimize its capital expenditures and other costs related to developing IMT-2000 services. However, we believe KT Freetel will still require significant amounts of research and development and capital expenditures to build out its IMT-2000 network. KT Freetel began test service of its IMT-2000 services in metropolitan Seoul and parts of Gyunggi Province in December 2003, and KT Freetel is planning to offer IMT-2000 services in 45 cities by December 2005. KT Freetel and its competitors may, however, delay the nationwide roll-out of third-generation services if there are unfavorable market conditions and weak service demand.
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Stock Swap Transactions with SK Telecom
SK Telecom and we agreed to an equity swap on December 20, 2002, under which each company agreed to sell to the other all of the equity ownership in the other. Accordingly, on December 30, 2002 and January 10, 2003, we exchanged an aggregate of 8,266,923 shares of SK Telecom, or a 9.3% interest in SK Telecom, for an aggregate of 29,808,333 of our shares previously owned by SK Telecom plus Won 335 billion in cash. We recognized a gain on the disposition of the shares of SK Telecom in the amount of Won 908 billion in 2002 and Won 775 billion in 2003. As a result of the stock swap transactions with SK Telecom, we no longer own any interest in SK Telecom.
Employee Reductions and Changes in Severance and Retirement Benefits
In 2001, we reduced our workforce by 1,389 employees under a voluntary early retirement program. The aggregate amount of retirement and severance benefits paid in 2001 was approximately Won 87 billion (including Won 13 billion of normal retirement and severance benefits). In 2002, we implemented another voluntary early retirement program under which a total of 166 employees retired. The aggregate amount of retirement and severance benefits paid in 2002 was approximately Won 19 billion (including Won 3 billion of normal retirement and severance benefits). In 2003, we implemented another voluntary retirement program under which a total of 5,497 employees retired. The aggregate amount of retirement and severance benefits paid in 2003 was approximately Won 942 billion (including Won 111 billion of normal retirement and severance benefits). See “Item 6. Directors, Senior Management and Employees—Item 6.D Employees—The Voluntary Early Retirement Programs” and Note 16 to the Consolidated Financial Statements.
We pay a lump-sum retirement and severance benefit to employees who have been employed by us for more than one year when they leave. In 1999 we changed the method of calculating retirement and severance benefits with the consent of our employees’ labor union in order to reduce retirement and severance expenses. Prior to July 1, 1999, employees received more than one month’s salary and wages for each year of service. Starting July 1, 1999, employees receive only one month’s salary and wages for each year of employment. The amount that would have been payable to our employees using the previous method if they had all retired on June 30, 1999 was Won 2,389 billion. We decided to pay the entire amount, together with applicable interest on such amount, to our employees during 2000 and the first half of 2001 as an interim settlement of their retirement and severance benefits. We paid Won 1,741 billion in 2000 and Won 745 billion in 2001 (including accrued interest). Of these amounts, Won 115 billion in 2000 and Won 1 billion in 2001 were paid from funds previously deposited with insurance companies.
A Change in the Rate Structure for Land-to-mobile Interconnection
On December 12, 2002, the Ministry of Information and Communication issued an order revising the interconnection charge calculation method applicable beginning January 2002. On December 12, 2002, the Ministry of Information and Communication issued another order lowering the base usage charge collected from a landline user for a call initiated by a landline user to a mobile service subscriber. As a result, the base usage charge per ten seconds collected from a landline user for a call initiated by a landline user to a mobile service subscriber on a weekday decreased from Won 19.00 as of April 1, 2000 to Won 14.83 as of July 1, 2003. The interconnection charge we pay per minute (exclusive of value-added taxes) to SK Telecom, KT Freetel and LG Telecom decreased from Won 63.6, Won 65.7 and Won 65.7 in 2001 to Won 45.7, Won 53.5 and Won 59.0 in 2002, respectively. These rates further decreased to Won 41.0, Won 48.0 and Won 52.9 in 2003. We expect these changes in the rate structure to have a negative impact on our land-to-mobile interconnection revenues and profits. Revenues from land-to-mobile interconnection accounted for 12.9% of our operating revenues in 2003, compared to 13.1% in 2002. See “Item 4. Information on the Company—Item 4.B. Business Overview—Revenues and Rates—Interconnection”.
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Changes in the Rate Structure for Local, Domestic Long-distance and International Long-distance Telephone Services
On April 15, 2001, with the approval from the Ministry of Information and Communication, we changed the rate structure for our local telephone service which applies to all our customers. We lowered usage charges from Won 45 per pulse (generally three minutes) to Won 39 per pulse while increasing the basic monthly charge from the previous range of Won 1,500 to Won 4,000 to the new range of Won 2,500 to Won 5,200, depending on location. Such adjustment in the rate structure has had a positive effect on our financial condition by increasing the portion of fixed income and stabilizing our cash flow. In addition, because the growing use of mobile telecommunications services has decreased the usage of our fixed-line telephone services, we believe we are able to maximize our revenues from fixed-line telephone services by adjusting the rate structure so as to increase our basic monthly charges. Revenues from local telephone service were Won 3,026 billion in 2003, compared to Won 2,750 billion in 2001. See “Item 4. Information on the Company—Item 4.B. Business Overview—Revenues and Rates—Fixed-line Telephone Services”.
From September 10, 2002 to December 9, 2002, with the approval from the Ministry of Information and Communication, we also offered an optional flat rate plan for our fixed-line telephone service subscribers who had been our customers since August 1, 2001. Under the optional plan, a subscriber who elected to pay the monthly average of local and domestic long-distance usage amounts previously paid by such subscriber from August 1, 2001 to July 31, 2002 plus an extra charge of Won 1,000 to Won 5,000 each month (depending on average usage amount) is able to make unlimited minutes of local and domestic long-distance calls for up to 12 months from the election date. We obtained an approval from the Ministry of Information and Communication to extend the optional flat rate plan for another 12 months for those subscribers who had previously elected to participate. The plan is not renewable at the expiration of the 24-month period unless we obtain another approval from the Ministry of Information and Communication. Such optional flat rate plan has increased the portion of fixed income and stabilized our cash flow. See “Item 4. Information on the Company—Item 4.B. Business Overview—Revenues and Rates—Domestic Long-distance Telephone Service.”
Starting March 10, 2003, we changed the rate structure for our international long-distance telephone service. We lowered our international long-distance rates applicable to most countries while decreasing the discounted hours during weekdays from 12 hours to 6 hours and on Saturdays from 16 hours to 6 hours and the discount rates applicable during these hours from 30% to 10%. Our normal rates for international long-distance calls to the United States, Japan and China decreased by 60%, 18% and 22%, respectively. We expect such adjustment in the rate structure to have a negative effect on our revenues from international long-distance service. Revenues from international long-distance service accounted for 2.8% of our operating revenues in 2003, compared to 3.2% in 2002. See “Item 4. Information on the Company—Item 4.B. Business Overview—Revenues and Rates—International Long-distance Service.
Changes in the Telephone Installation Charge System
In September 1998, with the approval of the Ministry of Information and Communication, we implemented an alternative telephone installation charge system that allowed our new and existing customers to choose between a pre-existing plan and a second plan for telephone service. Under the pre-existing plan, a customer paid a basic monthly charge and was also required to post a non-interest-bearing refundable telephone installation deposit ranging from Won 122,000 to Won 242,000, depending on the size of the local calling area in which the phone was installed, and a non-refundable installation fee of Won 8,000. The deposit was required to be refunded upon termination of service. Under the second plan, customers paid a Won 100,000 non-refundable installation fee instead of the refundable telephone installation deposit and paid a higher basic monthly charge. When customers switched from the pre-existing plan to the second plan, we refunded the telephone installation deposit (less Won 92,000, reflecting the Won 100,000 non-refundable installation fee under the second plan minus the Won 8,000 non-refundable installation fee paid under the pre-existing plan) to these customers.
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Starting on April 15, 2001, we implemented a new telephone installation charge system as part of our adjustment in the rate structure for local telephone services described above. New customers who did not previously subscribe to our local services no longer have the option to choose the pre-existing plan and must pay a Won 60,000 non-refundable installation fee (including value added tax). Our existing customers who are enrolled in the pre-existing plan may switch to the new plan and receive the telephone installation deposit (less Won 52,000, reflecting the Won 60,000 non-refundable installation fee under the new plan minus the Won 8,000 non-refundable installation fee paid under the pre-existing plan). Our existing customers who enrolled under the second plan cannot switch to the new plan. These telephone installation fees are recognized as revenues. See “Item 4. Information on the Company—Item 4.B. Business Overview—Revenues and Rates—Fixed-line Telephone Services”.
The non-refundable installation fees and higher monthly charges payable by our customers under the revised plans have partially offset the amount of the refunds, but the refunds have increased our reliance on short-term and long-term debt for our working capital and other capital requirements.
A Change in the Telephone Tax System
In December 2000, the Government ruled that Korean fixed-line telecommunications service providers, which include ourselves, are eligible for a refund of the 10% value added tax assessed based on capital and other applicable expenditures incurred on or after September 1, 2001. Prior to that date, the value added tax we paid to Korean tax authorities was non-refundable.
Effective starting September 1, 2001, the National Assembly abolished the telephone excise tax charged to our customers as part of their monthly service charges. However, starting September 1, 2001, we are charging our customers a 10% value added tax.
Taxes we collect from our customers are remitted by us to the Korean tax authorities. We also record revenues in our financial statements net of such taxes. Effective from September 1, 2001, value added tax we collect from our customers can be offset against value added tax refundable to us by the Korean tax authorities. The total amount of value added tax refunded to us by the Korean tax authorities was Won 123 billion in 2002 and Won 60 billion in 2003.
Critical Accounting Policies
The following discussion and analysis is based on our consolidated financial statements, which have been prepared in accordance with Korean GAAP. Korean GAAP varies in certain significant respects from accounting principles generally accepted in the United States of America. We have summarized these differences and their effect on our stockholders’ equity as of December 31, 2002 and 2003 and the results of our operations for each of the years in the three-year period ended December 31, 2003, in Note 34 to the Consolidated Financial Statements.
The preparation of financial statements in conformity with Korean GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and revenues and expenses during the years reported. We based our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying amounts of assets and liabilities that are not readily apparent from other sources. On an on-going basis, management evaluates its estimates. Actual results may differ from those estimates under different assumptions and conditions.
The fundamental objective of financial reporting is to provide useful information that allows a reader to comprehend our business activities. To aid in that understanding, our management has identified “critical accounting policies”. These policies have the potential to have a more significant impact on our financial
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statements, either because of the significance of the financial statement item to which they relate, or because they require judgment and estimation due to the uncertainty involved in measuring, at a specific point in time, events which are continuous in nature.
These critical accounting policies include:
Allowances for doubtful accounts
Allowance for doubtful accounts is our best estimate of the amount of probable credit losses in our existing notes and accounts receivable. We determine the allowance for doubtful notes and accounts receivable based on an analysis of portfolio quality and historical write-off experience. Account balances are charged off against the allowance after all means of collection have been exhausted and the potential for recovery is considered remote.
Changes in the allowances for doubtful accounts for each of the years in the three-year period ended December 31, 2003 are summarized as follows:
Balance at beginning of year
Increase due to the changes of consolidated subsidiaries
Provision
Write-offs
Balance at end of year
If economic or specific industry trends change, we would adjust our allowances for doubtful accounts by recording additional expense or benefit. Our study shows that a 5% decrease or increase in the historical write-off experience would increase or decrease the provision for doubtful accounts by approximately Won 50 billion.
Useful lives of property, plant and equipment
Property, plant and equipment are depreciated based on the useful lives disclosed in Notes 2(h) to the Consolidated Financial Statements. Generally, the useful lives are estimated at the time the asset is acquired and are based on historical experience with similar assets as well as taking into account anticipated technological or other changes. In certain cases and as permitted under Korean GAAP, those useful lives used for accounting purpose are different from the estimated economic lives of the related asset. In addition, the estimated lives of certain other assets, including underground access to cable tunnels, and concrete and steel telephone poles are based on rates established by a ruling by the Korean National Tax Service (which is also applicable under Korean GAAP). If technological changes were to occur more rapidly than anticipated or in a different form than anticipated, the useful lives assigned to these assets may need to be shortened, resulting in the recognition of increased depreciation expense in future periods. A decrease in useful life by one year would result in an increase of depreciation expense of approximately Won 361 billion.
Impairment of long-lived assets including the IMT-2000 frequency usage right
Long-lived assets generally consist of property, plant and equipment and intangible assets. We review long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of
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an asset may not be recoverable. In addition, we evaluate our long-lived assets for impairment each year as part of our annual forecasting process. An impairment loss would be considered when estimated undiscounted future net cash flow expected to result from the use of the asset and its eventual disposition are less than its carrying amount. If such assets are considered to be impaired, the impairment to be recognized is measured as the amount by which the carrying amount of the assets exceeds the fair value of the assets.
Our intangible assets include the IMT-2000 frequency usage right, which has a contractual life of 15 years and will be amortized commencing on the date commercial service is initiated through the end of its contractual life. We started to amortize this frequency usage right on December 1, 2003. Because IMT-2000 presents risks and challenges to our business, any or all of which, if realized or not properly addressed, may have a material adverse effect on our financial condition and results of operations, we review the IMT-2000 frequency usage right for impairment on an annual basis. In connection with our review, we utilize the estimated long-term revenue and cash flow forecasts developed as part of our planning process and assumptions on terminal value. The use of different assumptions within our cash flow model could result in different amounts for the IMT-2000 frequency usage right. The results of our review using the testing method described above did not indicate any need to impair the IMT-2000 frequency usage right for 2003.
Impairment of investment securities
For investments in companies, whether or not publicly held, that are not controlled, but under our significant influence, we utilize the equity method of accounting. Under the equity method of accounting, our initial investment is recorded at cost and is subsequently increased to reflect our share of the investee income and reduced to reflect our share of the investee losses or dividends received. Any excess in our acquisition cost over our share of the investee’s identifiable net assets is generally recorded as goodwill or other intangibles and amortized by the straight-line method over the estimated useful life. The amortization of goodwill is recorded against the equity income (losses) of affiliates.
Under U.S. GAAP, when events or circumstances indicate that the carrying amount of an investment may not be recoverable, we review the investment for other-than-temporary impairment. As part of this review, the investee’s operating results, net asset value and future performance forecasts as well as general market conditions are taken into consideration. If we believe, based on this review, that the market value of our investment may realistically be expected to recover, the loss will continue to be classified as temporary. If economic or specific industry trends worsen beyond our estimates, valuation losses previously determined to be recoverable may need to be charged as a valuation loss in equity income (losses) of affiliates.
Significant management judgment is involved in the evaluation of declines in value of individual investments. The estimates and assumptions used by management to evaluate declines in value can be impacted by many factors, such as the financial condition, earnings capacity and near-term prospects of the company in which we have invested and, for publicly-traded securities, the length of time and the extent to which fair value has been less than cost. The evaluation of these investments is also subject to the overall condition of the economy and its impact on the capital markets.
We currently own 48.1% of KT Freetel, and owned 46.9% as of December 31, 2003. Under Korean GAAP, an entity is required to be consolidated with the holding entity if the holding entity is the largest shareholder of the entity and owns more than 30% of the entity’s equity. Accordingly, we consolidate KT Freetel under Korean GAAP. However, under U.S. GAAP, KT Freetel is accounted for as an investment under the equity method of accounting.
KT Freetel is a publicly held company which trades on the Korea Stock Exchange. Using the testing method described above, in considering whether our investment in KT Freetel is other-than-temporarily impaired, we compare the closing price of the KT Freetel shares compared to our carrying value.
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For the years ended December 31, 2002 and 2003, we recognized an impairment loss amounting to Won 663 billion and Won 790 billion, respectively, relating to KT Freetel under U.S.GAAP, principally due to our conclusion that the decline of the KT Freetel stock price merited such an impairment.
If the quoted market value of KT Freetel continues to decline, we may be required to record additional impairment losses.
Income Taxes
We are required to estimate the amount of tax payable or refundable for the current year and the deferred income tax liabilities and assets for the future tax consequences of events that have been reflected in our financial statements or tax returns. This process requires management to make assessments regarding the timing and probability of the ultimate tax impact. Actual income taxes could vary from these estimates due to future changes in income tax law or unpredicted results from the final determination of each year’s liability by taxing authorities.
We believe that the accounting estimate related to establishing tax valuation allowances is a “critical accounting estimate” because: (1) it requires management to make assessments about the timing of future events, including the probability of expected future taxable income and available tax planning opportunities, and (2) the impact that changes in actual performance versus these estimates could have on the realization of tax benefits as reported in our results of operations could be material. Management’s assumptions require significant judgment because actual performance has fluctuated in the past and may continue to do so.
In 2001, KT M.com merged with and into KT Freetel. As a result of KT M.com’s operating performance in 2001 as well as a change in tax regulations, KT Freetel was able to utilize KT M.com’s loss carryforward in the amount of Won 97 billion in 2001, Won 151 billion in 2002 and Won 136 billion in 2003. However, KT Freetel, having concluded that it is not probable that the tax benefit of the loss carryforward generated by KT M.com could be realized in future years, did not recognize a deferred income tax asset related to KT M.com’s remaining loss carryforwards of Won 290 billion as of December 31, 2003, which will expire through 2005. The utilization of remaining loss carryforwards is dependent on whether or not KT M.com’s operating businesses in KT Freetel would be able to generate a profit in future years.
During 2003, having concluded that it is not probable that we would be able to realize the tax benefit of our equity in losses of affiliates within the near future, mainly from KT Freetel’s goodwill amortization expense, we wrote off the related deferred income tax assets in the amount of Won 134 billion by taking a charge to deferred income tax expense under Korean GAAP. However, under U.S. GAAP, we did not recognize valuation allowance. For an investment in an equity method investee, there is no prescribed time limit with respect to the realization of a deferred tax asset, provided that the tax basis exceeds its book basis under U.S. GAAP.
Item 5.A. Operating Results
Fixed-line Telephone Service Revenues
Local Service Revenues. Local service revenues include basic monthly charges and monthly usage charges from local telephone service and revenues from other value-added services, including local telephone directory assistance, call waiting and caller identification services. In addition, we charge interconnection fees to Hanaro and mobile service providers whenever Hanaro and mobile service providers use our network in providing their local services. Basic monthly charges vary depending on the location of the customer and the telephone installation charge system selected by the customer, and monthly usage charges are based on the number of call pulses. All lines in service are subject to measured service under which call pulses are a function of the number of calls made, each call’s duration and the time of day at which each call is made. Revenues from local calls placed from public telephones are also included in local service revenues. After the implementation of the new rate structure in 2001, revenues from local service increased from Won 2,750 billion in 2001 to Won 3,026 billion in 2003.
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Service revenues from local service vary principally depending on the number of lines in service, the number of new lines placed in service, rates and the volume of calls.
In 2002, we had local service revenues of Won 2,897 billion, representing an increase of 5.3% compared to 2001 local service revenues of Won 2,750 billion. The increase in local service revenues in 2002 was due principally to a change in the rate structure for our local telephone service and, to a lesser extent, to the implementation of our optional flat rate plan in the last quarter of 2002, which had a positive effect on our financial condition by increasing the portion of fixed income and stabilizing our cash flow, and a 2.0% increase in lines in service as of December 31, 2002 compared to December 31, 2001. See “—Overview—Changes in the Rate Structure for Local, Domestic Long-distance and International Long-distance Telephone Services”. These effects more than offset the effect of a 13.3% decrease in the number of local call pulses in 2002 compared to 2001 which were attributable principally to the continued increase in usage of mobile telephone services and the Internet.
In 2003, we had local service revenues of Won 3,026 billion, representing an increase of 4.5% compared to 2002 local service revenues of Won 2,897 billion. The increase in local service revenues in 2003 was due principally to the implementation of our optional flat rate plan, which more than offset a 12.1% decrease in the number of local call pulses in 2003 compared to 2002 attributable principally to the continued increase in usage of mobile telephone services and the Internet.
Non-refundable Service Installation Fee. Prior to April 15, 2001, we recognized as revenue the non-refundable service installation fee paid by customers who had chosen an alternative plan instead of the pre-existing plan. Starting on April 15, 2001, we implemented a new telephone installation charge system, pursuant to which new customers who did not previously subscribe to our local service no longer have the option to choose the pre-existing plan and must pay a Won 60,000 non-refundable installation fee. We also recognize such non-refundable installation fee as revenue. See “Item 4. Information on the Company—Item 4.B. Business Overview—Revenues and Rates—Fixed-line Telephone Services”. We recognized as revenue Won 233 billion in non-refundable service installation fees in 2001, Won 251 billion in 2002 and Won 125 billion in 2003.
Domestic Long-distance Revenues. Service revenues from domestic long-distance service depend on rates, the number of call minutes, and the distance and the time of day each call is made. In addition, we charge interconnection fees to DACOM, Onse, mobile service providers and voice resellers whenever they use our network in providing their domestic long-distance services. Domestic long-distance revenues include revenues from domestic long-distance calls placed from public telephones. Revenues from domestic long-distance service have decreased in recent years and are accounting for a smaller portion of our total operating revenues, decreasing from 6.5% of our total operating revenues in 2001 to 5.8% in 2003.
In 2002, we had domestic long-distance revenues of Won 1,061 billion, representing an increase of 1.4% from 2001 domestic long-distance revenues. The increase in domestic long-distance revenues in 2002 was due principally to the implementation of our optional flat rate plan, which more than offset the effect of a 12.7% decrease in the number of domestic long-distance call minutes in 2002 compared to 2001. The decrease in call minutes was due principally to the substitution effect of increased mobile telephone and Internet usage.
In 2003, we had domestic long-distance revenues of Won 932 billion, representing a decrease of 12.2% from 2002 domestic long-distance revenues. The decrease in domestic long-distance revenues in 2003 was due principally to the implementation of our optional flat rate plan and, to a lesser extent, a 0.7% decrease in the number of domestic long-distance call minutes in 2003 compared to 2002. The decrease in call minutes was due principally to the substitution effect of increased mobile telephone and Internet usage. For more information on the optional flat rate plan, see “Item 4. Information on the Company—Item 4.B. Business Overview—Revenues and Rates—Fixed-line Telephone Services”.
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International Long-Distance Revenues. Service revenues from international long-distance service consist of:
Outgoing calls made by customers in Korea (and by customers from foreign countries under our home country direct service) are billed in accordance with our rate schedule for the country called, which rates vary depending on the time of day when a call is placed. Incoming calls are billed by us to the relevant foreign carrier or administration at the applicable settlement rate specified under the relevant agreement with the foreign entity. International long-distance calls to and from the United States, Japan and China in the aggregate accounted for approximately 66% of our total international long-distance call minutes in 2003. See “Item 4. Information on the Company—Item 4.B. Business Overview—Our Services—Our Telephone Network and Fixed-line Telephone Services—International Long-Distance Service”.
In 2002, we had international long-distance revenues of Won 534 billion, representing a decrease of 0.2% compared to 2001 international long-distance revenues. Our international long-distance revenues remained fairly constant in 2002 as increased competition offset a 4.7% increase in the number of international long-distance call minutes to and from Korea in 2002 compared to 2001.
In 2003, we had international long-distance revenues of Won 451 billion, representing a decrease of 15.5% compared to 2002 international long-distance revenues. Our international long-distance revenues decreased in 2003 due principally to the implementation of our lower rates in March 2003 and a 5.6% decrease in the number of international long-distance call minutes to and from Korea in 2003 compared to 2002.
Land-to-mobile Interconnection Revenues
When a landline user initiates a call to a mobile subscriber, we record the entire amount of the usage charges for these calls in land-to-mobile interconnection revenues and pay an interconnection charge to the relevant mobile service provider. See “Item 4. Information on the Company—Item 4.B. Business Overview—Revenues and Rates—Interconnection”.
In 2002, we had land-to-mobile interconnection revenues of Won 2,152 billion, representing a decrease of 20.2% from 2001 interconnection revenues, primarily due to a 17.7% decrease in the usage charge which are collected by us as land-to-mobile interconnection fees, Won 19.0 per ten seconds in 2001 to Won 15.6 per ten seconds in 2002, as well as increased volume of calls between mobile subscribers which had the effect of lowering call volume from landline users to mobile subscribers.
In 2003, we had land-to-mobile interconnection revenues of Won 2,075 billion, representing a decrease of 3.6% from 2002 interconnection revenues, primarily due to increased volume of calls between mobile subscribers which had the effect of lowering call volume from landline users to mobile subscribers, as well as lower land-to-mobile interconnection rates in 2003 compared to 2002. See “Item 4. Information on the Company—Item 4.B. Business Overview—Revenues and Rates—Interconnection”.
Business and Data Communications Revenues
Traditionally, the largest component of our business and data communications revenues has been our revenues from leased lines, which accounted for 38.7% of our business and data communications revenues in
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2001, 32.4% in 2002 and 26.1% in 2003. However, broadband Internet access service is accounting for an increasing portion of our total operating revenues since we began offering the service in 2000 and in 2002 and 2003 accounted for the largest component of our business and data communications revenues. Broadband Internet access service accounted for 38.7% of our business and data communications revenues in 2001, 48.3% in 2002 and 54.6% in 2003. Internet-related services, which include Internet-related value-added services provided by our Internet data centers, Kornet, bizmeka.com and hanmir.com, accounted for 13.6% of our business and data communications revenues in 2001, 12.9% in 2002 and 14.0% in 2003. Miscellaneous services include packet service, participation in construction of national infrastructure network, integrated services digital network (ISDN) service, electronic document transfer service and modem dial-up service under the brand name 014XY.
In 2002, we had business and data communications revenues of Won 3,252 billion, representing an increase of 12.8% from 2001 business and data communications revenues, primarily due to an increase in our broadband Internet access subscribers from approximately 3.9 million as of December 31, 2001 to approximately 4.9 million as of December 31, 2002.
In 2003, we had business and data communications revenues of Won 3,454 billion, representing an increase of 6.2% from 2002 business and data communications revenues, primarily due to continued increase in our broadband Internet access subscribers from approximately 4.9 million as of December 31, 2002 to approximately 5.6 million as of December 31, 2003.
Broadband Internet Access Service Revenues. Broadband Internet access service revenues increased to Won 1,572 billion in 2002 from Won 1,116 billion in 2001 primarily due to an increase in subscribers and the launch of our wireless LAN service in February 2002.
Broadband Internet access service revenues increased to Won 1,885 billion in 2003 from Won 1,572 billion in 2002 primarily due to continued increase in our broadband Internet access subscribers, as well as subscribers of our wireless LAN service.
Leased-line Service Revenues. Leased-line revenues decreased to Won 1,054 billion in 2002 from Won 1,116 billion in 2001, primarily due to a decrease in revenues from Internet service providers utilizing connections other than through leased-lines.
Leased-line revenues decreased to Won 900 billion in 2003 from Won 1,054 billion in 2002, primarily due to continued decrease in revenues from Internet service providers utilizing connections other than through leased-lines.
Internet-related Service Revenues. Internet-related service revenues increased to Won 418 billion in 2002 from Won 392 billion in 2001, primarily due to increased revenues from our Internet data centers, Kornet, bizmeka.com and a general increase in usage of our other Internet-related value added services.
Internet-related service revenues increased to Won 485 billion in 2003 from Won 418 billion in 2002, primarily due to increased revenues from bizmeka.com and our other Internet-related value added services.
Miscellaneous Revenues. The miscellaneous component of our business and data communications revenues decreased to Won 208 billion in 2002 from Won 260 billion in 2001.
The miscellaneous component of our business and data communications revenues decreased to Won 184 billion in 2003 from Won 208 billion in 2002.
PCS Revenues
KT Freetel, a consolidated subsidiary in which we currently own a 48.1% effective interest, provides PCS service.
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In 2002, PCS service revenues increased by 10.5% to Won 4,127 billion, and revenues from sales of goods increased by 8.8% to Won 1,367 billion, primarily due to a 7.7% increase in the number of subscribers, including the resale subscribers of KT Corporation, to approximately 10.3 million subscribers as of December 31, 2002 compared to 9.6 million as of December 31, 2001. The average monthly revenue per subscriber of KT Freetel decreased slightly to Won 38,694 in 2002 from Won 38,729 in 2001.
In 2003, PCS service revenues increased by 0.9% to Won 4,164 billion primarily due to a 1.1% increase in the number of subscribers, including the resale subscribers of KT Corporation, to approximately 10.4 million subscribers as of December 31, 2003 compared to 10.3 million as of December 31, 2002. Revenues from sales of goods decreased 15.6% to Won 1,154 billion in 2003, primarily due to a decrease in the number of handsets purchased by PCS service subscribers. The average monthly revenue per subscriber of KT Freetel decreased to Won 38,538 in 2003 from Won 38,694 in 2002.
Other Revenues
Revenues from other services consist primarily of revenues from system and network integration consulting services, satellite communications services, domestic and international telegram services and KTH.
Other revenues decreased by 5.4% in 2002 to Won 796 billion primarily due to a decrease in revenues from submarine cable construction and maintenance, which more than offset a 29.6% increase in revenues from system and network integration consulting services and a 22.8% increase in revenues from satellite services in 2002 compared to 2001.
Other revenues decreased by 13.7% in 2003 to Won 687 billion primarily due to a 55.4% decrease in revenues from system and network integration services, which more than offset a 9.2% increase in revenues from miscellaneous services.
Salaries and Related Costs
The principal components of salaries and related costs are salaries and wages, provisions for retirement and severance benefits and employee benefits. Employee benefits include meal subsidies, commuting subsidies and contributions to pension plans. The retirement and severance benefit is a lump-sum amount paid to employees who have been employed by us for more than one year when they leave. We changed the method of calculating the lump-sum amount effective July 1, 1999 with the consent of our employees’ labor union in order to reduce retirement and severance expenses, as discussed in “Item 5. Operating and Financial Review and Prospects—Overview—Employee Reductions and Changes in Severance and Retirement Benefits” above.
In 2002, salaries and related costs were Won 3,089 billion, representing a 4.4% increase from 2001, primarily as a result of a 7.6% increase in salaries and wages which more than offset a 19.6% decrease in provision for retirement and severance benefits, including early retirement payments. The increase in salaries and wages occurred despite a 0.1% decrease in the number of employees as of December 31, 2002 compared to December 31, 2001, and reflected higher incentive bonus.
In 2003, salaries and related costs were Won 3,710 billion, representing a 20.1% increase from 2002, primarily as a result of an increase in provision for retirement and severance benefits resulting from our latest round of voluntary early retirement program. In September 2003, we offered a voluntary early retirement plan to 5,497 of our employees and recognized costs of Won 832 billion related to this plan. See Note 16 to the Consolidated Financial Statements.
Wireline Communications. In 2002, salaries and related costs increased by 4.4% to Won 2,757 billion for the reasons described above. The number of employees as of December 31, 2002 decreased by 0.2% compared to December 31, 2001. In 2003, salaries and related costs increased by 22.8% to Won 3,385 billion, primarily as a result of an increase in provision for retirement and severance benefits of the latest round of voluntary early retirement program.
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PCS Service. In 2002, salaries and related costs increased by 42.3% to Won 195 billion primarily as a result of a 37.2% increase in salaries and wages and a 125.0% increase in provision for retirement and severance benefit. The number of employees at KT Freetel increased by 4.3% to 2,505 as of December 31, 2002 compared to 2,403 as of December 31, 2001. In 2003, salaries and related costs decreased by 1.5% to Won 192 billion primarily as a result of a decrease in the number of employees at KT Freetel by 2.3% to 2,446 as of December 31, 2003 compared to 2,505 as of December 31, 2002.
Depreciation and Amortization
In 2002, depreciation and amortization expense decreased by 5.3% to Won 3,797 billion due primarily to a decrease in capital expenditures on property and equipment in 2002 as a result of more efficient utilization of our facilities.
In 2003, depreciation and amortization expense decreased by 1.1% to Won 3,757 billion due primarily to a decrease in capital expenditures on property and equipment in 2003.
Wireline Communications.Depreciation and amortization expense decreased by 10.6% in 2002 to Won 2,714 billion and 7.3% in 2003 to Won 2,515 billion due primarily to a decrease in capital expenditures on property and equipment in recent years as a result of a more efficient utilization of our facilities.
PCS Service.In 2002, depreciation and amortization expense increased by 17.3% to Won 729 billion due primarily to additional capital expenditures at KT Freetel to enhance and expand its mobile network. In 2003, depreciation and amortization expense increased further by 16.5% to Won 849 billion due primarily to increases in capital expenditures at KT Freetel to enhance and expand its mobile network.
Other Operating and Maintenance Expenses
The largest components of other operating and maintenance expenses are commissions and cost of services, cost of PCS handsets, interconnection payments for landline to mobile calls, and repairs and maintenance costs. The following table shows other operating and maintenance expenses broken down by major components and the percentage changes in these expenses for each of the years in the three-year period ended December 31, 2003:
Commissions and cost of services and settlement payments
Cost of goods sold
Interconnection charge
Repairs and maintenance
Other expenses
Commissions, cost of services and settlement payments consist principally of payments to foreign carriers and administrations for provision of international long-distance service pursuant to service agreements, commissions related to PCS handset sales and system and network integration services and production of prepaid phone cards. In 2002, our commissions, cost of services and settlement payments increased by 3.6% to Won 2,344 billion as a 25.4% increase in commissions related to 114 phone directory services to Won 795 billion more than offset a 5.7% decrease in commissions to PCS sales agents to Won 632 billion and a 13.1% decrease in international settlement payments to Won 174 billion. In 2003, our commissions, cost of services and settlement payments decreased by 9.7% to Won 2,117 billion, primarily as a result of a 28.3% decrease in commissions for system integration service and other miscellaneous services to Won 532 billion, as well as a 10.5% decrease in commissions to PCS sales agents to Won 565 billion.
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The cost of goods sold was Won 1,206 billion in 2001, Won 1,346 billion in 2002 and Won 1,131 billion in 2003.
We recognize as an expense the interconnection payments to mobile service providers for calls from landline users to mobile service subscribers. We paid interconnection charges of Won 1,593 billion in 2001, Won 1,188 billion in 2002 and Won 1,077 billion in 2003. Our payments to cellular service providers were calculated in 2002 and 2003 by taking the actual Imputed Costs in 2000 of SK Telecom and taking into consideration several factors including the call volume of each mobile service provider in determining interconnection charges we pay per minute to SK Telecom, KT Freetel and LG Telecom. See “Item 4. Information on the Company—Item 4.B. Business Overview—Revenues and Rates—Interconnection”.
Our repair and maintenance expenses increased by 8.8% in 2002 to Won 421 billion and by 7.0% to Won 451 billion in 2003 primarily due to expansion and maintenance of our broadband network.
Provision for doubtful accounts increased by 19.4% in 2002 to Won 194 billion and by 87.2% in 2003 to Won 364 billion primarily due to an increase in unpaid accounts resulting from an increase in the number of consumers in Korea with credit risks in recent years.
Wireline Communications. The largest components of other operating and maintenance expenses are commissions and settlement payments, interconnection payments for landline to mobile calls and repair and maintenance expenses discussed above.
PCS Service. The largest components of other operating and maintenance expenses are commissions (including commissions related to PCS handset sales), sales promotion costs and advertisement costs.
Operating Income
Operating income in 2002 increased by 20.5% to Won 2,381 billion, as the increase in operating revenues more than offset the increase in expenses described above. Our operating margin also increased to 14.5% in 2002.
Operating income in 2003 decreased by 23.4% to Won 1,823 billion as a result of an increase in expenses described above, as well as a decrease in operating revenues. Our operating margin decreased to 11.3% in 2003. In particular, our operating income in 2003 was negatively affected by an increase in provision for retirement and severance benefits resulting from our latest round of voluntary early retirement program.
Wireline Communications. In 2002, operating income increased by 23.4% to Won 1,831 billion, as the increase in operating revenues more than offset the increase in operating expenses described above. Operating margin also increased from 12.8% in 2001 to 15.6% in 2002. In 2003, operating income decreased by 32.1% to Won 1,243 billion due to an increase in operating expenses as described above, as well as a decrease in operating revenues. Operating margin decreased to 10.7% in 2003.
PCS Service. In 2002, operating income increased by 3.2% to Won 789 billion as the increase in operating revenues more than offset the increase in expenses described above. Operating margin decreased from 15.2% in 2001 to 14.7% in 2002. In 2003, operating income decreased by 1.4% to Won 778 billion as a decrease in operating revenues more than offset a decrease in operating expenses. Operating margin increased to 15.3% in 2003.
In 2002, our income tax expense was Won 741 billion and our effective tax rate was 24.7%. In 2003, our income tax expense was Won 524 billion and our effective tax rate was 33.1%. The effective tax rate of 24.7% in 2002 differed from the normal tax rate primarily due to investment tax credit of Won 162 billion in 2002. In
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2003, we recognized investment tax credit of Won 175 billion but also recognized impairment of deferred tax asset of Won 134 million in 2003 resulting from our conclusion that it was not probable for us to be able to realize the tax benefit of our equity in losses of affiliates.
We had investment tax credit carryforward of Won 26 billion outstanding as of December 31, 2003 which are available to reduce our future income taxes through 2008.
Wireline Communications. Income tax expense of the wireline communications segment was Won 652 billion in 2002 and Won 459 billion in 2003, primarily due to a decrease in earnings before income taxes from Won 2,616 billion in 2002 to Won 1,290 billion in 2003.
PCS Services. Income tax expense of the PCS services segment increased from Won 80 billion in 2002 to Won 52 billion in 2003, primarily due to a decrease in earnings before income taxes from Won 612 billion in 2002 to Won 459 billion in 2003.
Net Earnings
Our net earnings increased by 74.9% in 2002 to Won 1,947 billion principally as a result of an 87.5% increase in our net gain on disposition of investment securities to Won 1,177 billion, a 20.5% increase in our operating income discussed above and a net foreign currency translation gain of Won 100 billion in 2002 compared to a net foreign currency translation loss of Won 24 billion in 2001. We recognized net gain on disposition of investment securities of Won 1,177 billion in 2002 principally as a result of our disposition of shares of SK Telecom. On April 11, 2002, we disposed 1,000,000 shares of SK Telecom, or a 1.1% interest in SK Telecom, and recorded a gain on disposition of Won 246 billion. On December 30, 2002, we exchanged 4,457,635 shares of SK Telecom, or a 5.0% interest in SK Telecom, for an aggregate of 15,454,659 of our shares previously owned by SK Telecom plus Won 212 billion in cash. We recognized a gain on disposition of investment securities in the amount of Won 908 billion in this stock swap transaction. We recorded net foreign currency translation gain of Won 100 billion in 2002 primarily as a result of the appreciation of the Won against major currencies, primarily against the Dollar.
Our net earnings decreased by 57.8% in 2003 to Won 822 billion principally as a result of a 23.6% decrease in our operating income discussed above, a 34.3% decrease in our net gain on disposition of investment securities to Won 773 billion, a net foreign currency translation loss of Won 27 billion in 2003 compared to a net foreign currency translation gain of Won 100 billion in 2002, and a 74.9% decrease in contributions received for losses on universal telecommunication services to Won 29 billion. Our net gain on disposition of investment securities decreased in 2003 primarily as a result of an unusually large net gain on disposition of shares of SK Telecom in 2002 which was greater than the net gain on our disposition of additional shares of SK Telecom in 2003. On January 10, 2003, we exchanged an additional 3,809,288 shares of SK Telecom, or a 4.5% interest in SK Telecom, for 14,353,674 of our shares previously owned by SK Telecom plus Won 123 billion in cash. We recognized a gain on disposition of investment securities in the amount of Won 775 billion in this stock swap transaction. We recorded net foreign currency translation loss of Won 27 billion in 2003 primarily as a result of the depreciation of the Won against the Dollar. Contributions received for losses on universal telecommunication services decreased in 2003 as losses resulting from local universal telecommunication services were excluded from contributions starting in 2003. We also recognized additional payment of prior year’s tax of Won 54 billion in 2003 resulting from tax audit by Korea National Tax Service, compared to prior year’s income tax refund of Won 6 billion in 2002. In addition, we recognized impairment loss on available-for-sale securities of Won 44 billion in 2003, primarily as a result of impairment of equity-linked securities resulting from a decrease of the market value of SK Telecom shares. See Note 8(b) to the Consolidated Financial Statements.
Wireline Communications. Net earnings increased by 80.6% in 2002 to Won 1,964 billion and decreased by 57.7% in 2003 to Won 830 billion as a result of the reasons described above.
PCS Service. Net earnings increased by 16.8% in 2002 to Won 531 billion and decreased by 22.6% in 2003 to Won 411 billion as a result of the reasons described above.
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Inflation
We do not consider that inflation in the Republic has had a material impact on our results of operations in recent years. Inflation in the Republic was 4.1% in 2001, 2.7% in 2002 and 3.7% in 2003. See “Item 3. Key Information—Item 3.D. Risk Factors—If economic conditions in Korea deteriorate, our current business and future growth could be materially and adversely affected”.
Item 5.B. Liquidity and Capital Resources
The following table sets forth the summary of our cash flows for the periods indicated:
Cash and cash equivalents at beginning of period
Cash and cash equivalents at end of period
Net increase (decrease) in cash and cash equivalents
Capital Requirements
Historically, uses of cash consisted principally of purchases of property, plant and equipment and other assets and payments of long-term debt. In recent years, we have also used cash for acquisition of treasury shares and payment of retirement and severance benefits for early retirement plans. From time to time, we may also require capital for investments involving acquisitions and strategic relationships.
Net cash used in investing activities was Won 3,916 billion in 2001, Won 4,065 billion in 2002 and Won 1,481 billion in 2003, including additions to property, plants and equipment of Won 3,918 billion in 2001, Won 3,232 billion in 2002 and Won 3,209 billion in 2003. We recorded net acquisition of short-term financial instruments of Won 352 billion in 2001 and Won 126 billion in 2002 and net sale of short-term financial instruments of Won 759 billion in 2003.
In our financing activities, we used cash of Won 2,205 billion in 2001, Won 2,065 billion in 2002 and Won 1,989 billion in 2003 for principal repayment of outstanding long-term debt. Repayment of long-term debt in 2002 included our repurchase and retirement of US$108 million aggregate principal amount of 0.25% convertible notes due 2007 and Won 74 billion aggregate principal amount of 3.00% convertible notes due 2005. Repayment of long-term debt in 2003 consisted of our repurchase and retirement of US$84 million aggregate principal amount of 0.25% convertible notes issued due 2007.
From time to time, we have also required capital needs for acquisition of treasury shares and payment of retirement and severance benefits for early retirement plans. In 2002, we spent Won 3,234 billion to purchase 60,294,575 of our shares from the Government as treasury shares as a part of our privatization plan and an additional Won 167 billion to purchase 3,122,000 of our shares on the Korea Stock Exchange for retirement. In 2003, we spent Won 412 billion to purchase an additional 8,773,600 of our shares on the Korea Stock Exchange for retirement. In 2003, we also spent Won 1,021 billion as payment of retirement and severance benefits, primarily resulting from our latest round of early retirement program in which 5,497 employees elected to retire. See Note 16 to the Consolidated Financial Statements.
Payments of cash dividends amounted to Won 161 billion in 2001, Won 225 billion in 2002 and Won 213 billion in 2003.
We anticipate that capital expenditures, and, to a lesser extent, repayment of outstanding contractual obligations and commitments will represent the most significant use of funds for the next several years. We may also require capital for investments involving acquisitions and strategic relationships, as well as funds to pay cash
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in Dollars the aggregate market values of our common shares deliverable upon conversion of 0.25% convertible notes due 2007 to satisfy their conversion right if such conversion may be effectively prohibited due to their violation of the 49% foreign ownership limitation under the Telecommunications Business Law. As of December 31, 2003, 45.5% of our common shares were owned by foreign investors. See “Item 3. Key Information—Item 3.D. Risk Factors—Limitation on foreign ownership may have an adverse effect on the conversion of our convertible notes”. Holders of the 0.25% convertible notes due 2007 have the option to redeem the notes on January 4, 2005 at 100% of their principal amount of approximately $1,126 million, plus any accrued and unpaid interest to the redemption date. If holders elect to exercise their option, we will be required to spend funds to pay such amounts in Dollars. We may also purchase additional treasury shares on the Korea Stock Exchange from the market.
Our total capital expenditures are estimated to be approximately Won 3,100 billion in 2004 (including approximately Won 950 billion in capital expenditures by KT Freetel). See “—Capital Expenditures”. We compete in the telecommunications sector in Korea which is rapidly evolving. We also face increasing competition from new entrants to the market. We may need to incur additional capital expenditures to keep up with unexpected developments in rapidly evolving telecommunications technology. There can be no assurance that we will be able to secure funds on satisfactory terms from financial institutions or other sources which are sufficient for our unanticipated needs.
Payments of contractual obligations and commitments will also require considerable resources. In our ordinary course of business, we routinely enter into commercial commitments for various aspects of our operations, including repair and maintenance. As of December 31, 2003, we had various contractual obligations and commitments which are more fully disclosed in the notes to our consolidated financial statements.
The following table sets forth selected information regarding our contractual obligations to make future payments as of December 31, 2003.
Contractual obligations(1)
Less than
1 year
1-3
years
4-5
After
5 years
Long-term debt obligations (including current portion of long-term debt)
Capital lease obligations
Other long-term liabilities reflected on our balance sheet
In addition, we have entered into off-balance sheet operating lease agreements for certain machinery and equipment that will require capital resources. See Note 22(k)(i) to the Consolidated Financial Statements. Future lease payments under these operating leases as of December 31, 2003 are as follows:
Fiscal year ending December 31,
Amount of payments
(in millions of Won)
2004
2005
2006
2007
2008
Thereafter
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Capital Resources
We have traditionally met our working capital and other capital requirements principally from cash provided by operations, while raising the remainder of our requirements primarily through debt financing. Until 1997, additional working capital and other requirements had been met primarily by increases in non-interest-bearing refundable deposits for telephone installation, although as a result of a recent decline in these deposits, short-term and long-term debt and equity financings have increasingly become important sources of cash. For a discussion of the reduction of the amount of these deposits, see “Item 5. Operating and Financial Review and Prospects—Overview—Changes in the Telephone Installation Charge System” and “Item 4. Information on the Company—Item 4.B. Business Overview—Revenues and Rates—Fixed-line Telephone Services”.
Our major sources of cash have been net earnings before depreciation and amortization and proceeds of long-term debt and other long-term liabilities, and we expect that these sources will continue to be our principal sources of cash in the future. Net income before depreciation and amortization were Won 5,123 billion in 2001, Won 5,744 billion in 2002 and Won 4,579 billion in 2003, and cash proceeds from long-term debt were Won 3,226 billion in 2001, Won 5,559 billion in 2002 and Won 1,286 billion in 2003. The sources of such proceeds from long-term debt included:
In recent years, KT Freetel has also begun utilizing off-balance financing arrangements to supplement the primary sources of financing discussed above. The off-balance sheet arrangements are as follows:
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We believe that we have sufficient working capital available to us for our current requirements and that we have a variety of alternatives available to us to satisfy our financial requirements to the extent that they are not met by funds generated by operations, including the issuance of debt securities and bank borrowings denominated in Won and various foreign currencies. However, our ability to rely on some of these alternatives could be affected by factors such as the liquidity of the Korean and other financial markets, prevailing interest rates, our credit rating and the Government’s policies regarding Won currency and foreign currency borrowings. Other factors which could materially affect our liquidity in the future include unanticipated increase in capital expenditures and decrease in cash provided by operations resulting from a significant decrease in demand for our services. We may also need to raise additional capital sooner than we expect in order to fund unanticipated investments and acquisitions.
Our total shareholders’ equity decreased from (Won)13,759 billion at December 31, 2001 to (Won)8,397 billion at December 31, 2003, primarily as a result of our acquisition of treasury shares.
Liquidity
We had a working capital (current assets minus current liabilities) deficit of Won 331 billion as of December 31, 2001, surplus of Won 499 billion as of December 31, 2002 and deficit of Won 1,184 billion as of December 31, 2003. The following table sets forth the summary of our significant current assets for the periods indicated:
Cash and cash equivalents
Short-term financial instruments
Current portion of available-for-sale securities
Notes and accounts receivable—trade, net of allowance for doubtful accounts
Accounts receivable—other
Inventories
Our cash, cash equivalents and short-term financial instruments maturing within one year totaled Won 1,864 billion as of December 31, 2001, Won 1,907 billion as of December 31, 2002 and Won 822 billion as of December 31, 2003. Under Korean GAAP, bank deposits and all highly liquid temporary cash instruments within maturities of three months are considered as cash equivalents. Short-term financial instruments primarily consist of time and trust deposits with maturities between four to twelve months. Cash, cash equivalents and short-term financial instruments in 2002 remained at a similar level compared to 2001. The decrease in cash, cash equivalents and short-term financial instruments in 2003 resulted primarily from our net sale of short-term financial instruments of Won 759 billion in 2003 to raise capital for payment of retirement and severance benefits of our latest round of voluntary early retirement program and repayment of short-term borrowing and long-term debt.
The following table sets forth the summary of our significant current liabilities for the periods indicated:
Notes and accounts payable—trade
Short-term borrowings
Current portion of long-term debt
Accounts payable—other
As of December 31, 2003, we had unused credit lines of approximately Won 441 billion out of total available credit lines of Won 443 billion. These credit lines permit drawings at an interest rate of approximately 5.8%. We have not had, and do not believe that we will have, difficulty gaining access to short-term financing sufficient to meet our current requirements. We had issued guarantees in favor of our consolidated companies of Won 70 billion as of December 31, 2003.
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Capital Expenditures
Capital expenditures on property, plants and equipment in 2003 totaled Won 3,209 billion compared to Won 3,232 billion in 2002 and Won 3,918 billion in 2001.
Our current capital expenditure plan (including expenditures on property, plants and equipment and other investments) calls for the expenditure of approximately Won 3,100 billion in 2004 (including approximately Won 950 billion by KT Freetel). The principal components of our capital investment plans are:
We expect that KT Freetel will obtain the necessary capital from financial institutions. There can be no assurance, however, that KT Freetel will be able to secure sufficient funds on satisfactory terms from these or other sources, and KT Freetel’s failure to secure funds for its capital expenditures and ongoing operating costs may have a material adverse effect on its financial condition and results of operations. We are not under any obligation to fund capital expenditures of KT Freetel if these consolidated subsidiaries are unable to obtain necessary capital through operations or from financial institutions.
U.S. GAAP Reconciliation
In 2001, we recorded net earnings of Won 1,006 billion under U.S. GAAP compared to net earnings of Won 1,113 billion under Korean GAAP, primarily because of the application of different depreciation methods and useful lives, the treatment of equity method affiliates and service installation fees. In 2002, we recorded net earnings of Won 1,556 billion under U.S. GAAP compared to net earnings of Won 1,947 billion under Korean GAAP, primarily because of impairment loss relating to equity method, foreign currency translation of convertible notes and deferred tax effects of U.S. GAAP adjustments. In 2003, we recorded net earnings of Won 395 billion under U.S. GAAP compared to net earnings of Won 822 billion under Korean GAAP, primarily because of impairment loss relating to equity method investments.
Stockholders’ equity under U.S. GAAP is lower than under Korean GAAP by Won 2,562 billion and Won 2,506 billion at December 31, 2002 and 2003, respectively, primarily as a result of:
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which more than offset the effect of:
In addition, under U.S. GAAP, certain subsidiaries, including KT Freetel, would be accounted for under the equity method and would not be consolidated.
For further discussion of the principal differences between Korean GAAP and U.S. GAAP as they relate to us, see Note 34 to the Consolidated Financial Statements.
Significant Changes in U.S. GAAP
In December 2003, the Financial Accounting Standards Board (“FASB”) issued revised FASB Interpretation No. 46, “Consolidation of Variable Interest Entities” (FIN 46R), which addresses how a business enterprise should evaluate whether it has a controlling financial interest in an entity through means other than voting rights and accordingly should consolidate the entity. FIN 46R replaces FASB Interpretation No. 46, “Consolidation of Variable Interest Entities”, which was issued in January 2003. We will be required to apply FIN 46R to variable interests in variable interest entities created after December 31, 2003. For variable interests in variable interest entities created before January 1, 2004, the interpretation will be applied beginning on January 1, 2005. For any variable interest entities that must be consolidated under FIN 46R that were created before January 1, 2004, the assets, liabilities and non-controlling interests of variable interest entities initially would be measured at their carrying amounts with any difference between the net amount added to the balance sheet and any previously recognized interest being recognized as the cumulative effect of an accounting change. If determining the carrying amount is not practicable, fair value at the date FIN 46R first applies may be used to measure the assets, liabilities and non-controlling interest of the variable interest entities. We currently do not have any variable interest entities that are within the scope of this interpretation.
FASB Statement No. 150, “Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity”, was issued in May 2003. This statement establishes standards for the classification and measurement of certain financial instruments with characteristics of both liabilities and equity. The statement also includes required disclosures for financial instruments within its scope. For us, the statement was effective for instruments entered into or modified after May 31, 2003 and otherwise will be effective as of January 1, 2004, except for mandatorily redeemable financial instruments. For certain mandatorily redeemable financial instruments, the statement will be effective for us on January 1, 2005. The effective date has been deferred indefinitely for certain other types of mandatorily redeemable financial instruments. We currently do not have any financial instruments that are within the scope of this statement.
In April 2003, the FASB issued Statement of Financial Standards (“SFAS”) No. 149, “Amendment of Statement 133 on Derivative Investments and Hedging Activities”. This standard amends and clarifies the accounting for derivative instruments, including certain derivative instruments embedded in other contracts, and hedging activities under SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities”. This statement is effective prospectively for contracts entered into or modified after December 31, 2003, and for hedging relationships designated after December 31, 2003. SFAS No. 149 will not have an impact upon initial adoption and is not expected to have a material effect on our results of operations, financial position and cash flows.
In May 2003, the FASB’s Emerging Issues Task Force (“EITF”) reached a consensus on Issue 00-21, “Revenue Arrangements with Multiple Deliverables” (“Issue 00-21”). Issue 00-21 provides guidance on how to recognize revenue for arrangements that have multiple deliverables. The guidance in Issue 00-21 was effective for arrangements entered into in fiscal periods beginning after June 15, 2003. We have adopted the consensus reached in Issue 00-21. Adoption did not have a significant impact on our financial condition or results of operations.
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In March 2004, the EITF reached a consensus regarding EITF 03-1, “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments”. The consensus provides guidance for evaluating whether an investment is other-than-temporarily impaired. The EITF 03-1 guidance for determining other-than-temporary impairment will be effective beginning in the second half of 2004. We are currently evaluating the impact that EITF 03-1 may have on our consolidated financial statements.
Item 5.C. Research and Development, Patents, Licenses, Etc.
In order to develop applications of new technology for the Korean telecommunications system, we operate:
At December 31, 2003, these research centers employed a total of 628 researchers and additional 116 employees, of whom 98 had doctoral degrees and 494 had master’s degrees. Total expenditures on research and development (excluding the contributions referred to below) were Won 378 billion in 2001, Won 274 billion in 2002 and Won 306 billion in 2003.
A substantial part of our research and development budget is for contributions to unaffiliated educational foundations and institutes conducting research. Under the Telecommunications Basic Law, the Ministry of Information and Communication may recommend that network service providers contribute a percentage of their total annual revenues to telecommunications research institutes in Korea. Our contributions amounted to Won 97 billion in 2001, Won 69 billion in 2002 and Won 63 billion in 2003. See Note 30 to the Consolidated Financial Statements. Under contracts with the recipients of these contributions, we are entitled to co-ownership of intellectual property developed through the use of the contributions and any of the intellectual property may be licensed to a third party only with our consent. Intellectual property developed by our affiliated research and development centers and unaffiliated educational foundations and institutes is licensed on a commercial basis to domestic manufacturers. As of December 31, 2003, we had approximately 4,581 registered patents and approximately 3,027 patents pending domestically and had approximately 476 registered patents and approximately 181 patents pending internationally.
The recent products and systems developed by us include:
Item 5.D. Trend Information
These matters are discussed under Item 5.A. above where relevant.
Item 5.E. Off-balance Sheet Arrangements
These matters are discussed under Item 5.B. above where relevant.
Item 5.F. Tabular Disclosure of Contractual Obligations
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Item 6. Directors, Senior Management and Employees
Item 6.A. Directors and Senior Management
Directors
Our board of directors has the ultimate responsibility for the administration of our affairs. Our articles of incorporation provide for a board of directors consisting of:
All of our directors are elected at the annual general meeting of shareholders. If the total assets of a company listed on the Korea Stock Exchange as of the end of the preceding year exceeds Won 2,000 billion, which is the case with us, the Securities and Exchange Act requires such company to have at least three outside directors with at least half of its total directors being outside directors. Our articles of incorporation provide that the board of directors consists of up to four standing directors and up to eight outside directors. The term of office for all directors is three years, but the term is extended to the close of the annual general meeting of shareholders convened with respect to the last fiscal year of the term.
Under the Securities and Exchange Act, we must establish a committee to recommend candidates for outside directors within the board of directors, and outside directors must make up not less than half of the total members of the outside director recommendation committee. According to our articles of incorporation, such committee must consist of one standing director and four outside directors. Our outside director candidates recommendation committee recommends outside director candidates for appointment at the general shareholders’ meeting.
One-third of the outside directors must be up for election in any given year. Upon the request of any director, a meeting of the board of directors will be assembled. The chairman of the board of directors is elected from among the outside directors by a resolution of the board of directors. The term of office of the chairman is one year.
Our current directors are as follows:
Name
Position
Standing Directors*
Yong-Kyung Lee
President and Chief Executive Officer
Woo-Sik Kim
Executive Vice President
Sang-Hoon Lee
Hi-Chang Roh
Senior Vice President
Outside Directors*
Sung-Deuk Park
President of The Electronic Times
Chu-Hwan Yim
President, Electronics and Telecommunications Research Institute
Kook-Hyun Moon
Chief Executive Officer of Yuhan-Kimberly Corporation
Stuart B. Solomon
Chief Executive Officer of Metropolitan Life Insurance (Korea)
Jong-Sang Kim
Chief Executive Officer of Seil Tax-Accounting Service
Do-Hwan Kim
Professor, Sejong University
Jeong-Ro Yoon
Professor, Korea Advanced Institute of Science and Technology
Kon-Sik Kim
Professor, Seoul National University
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For the purposes of the Commercial Code, our President is deemed to be the “representative director” who is authorized to perform all judicial and extra-judicial acts relating to our business. Our shareholders elect the President in accordance with the provisions of the Commercial Code and our articles of incorporation. A candidate for President is recommended by a committee formed for that purpose. The president recommendation committee consists of:
Under our articles of incorporation, the president recommendation committee must submit a draft management contract between the company and the candidate covering the management objectives of the company, including management goals during the tenure of the president, to the general meeting of shareholders at the time of recommendation of the candidate to the meeting. When the draft management contract has been approved at the shareholders’ meeting, the company enters into such management contract with the candidate for president. In such case, the chairman of the president recommendation committee, as representative of the company, signs the management contract.
The board of directors may conduct performance review discussions to determine if the new President performed his or her duties under the management contract, or hire a professional evaluation agency for such purpose. If the board of directors determines, based on the results of the performance review, that the new President has failed to achieve the management goals, it may propose to dismiss the president at a shareholders’ meeting.
Senior Management
Our executive officers consist of Senior Executive Vice Presidents, Executive Vice Presidents, Senior Vice Presidents and Vice Presidents. The executive officers other than the standing directors are appointed by the President and may serve up to three years. Our Chief Financial Officer is Jeong-Soo Suh, Vice President of the Financial Management Office.
The current executive officers are as follows:
Name(1)
Title and Responsibilities
Kyun-Chul Park
Executive Vice President, Human Resource Office
Moon-Kee Choi
Executive Vice President, Marketing Planning Group
Jong-Lok Yoon
Executive Vice President, Research & Development Center
Won-Pyo Hong
Senior Vice President(2)
Boo-Kweun Park
Executive Vice President, Quality Management Office
Byoung-Kon Shin
Senior Vice President, Metropolitan North Regional Business Group
Tae-Poong Kang
Vice President, Planning and Management Team
Han-Suk Kim
Senior Vice President, Global Business Center
Soo-Ho Maeng
Vice President, Management Research Laboratory
Dong-Hoon Kim
Vice President, Chollabuk Regional Business Group
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Jeong-Soo Suh
Senior Vice President, Financial Management Office
Kyung-Choon Shin
Vice President, Kangwon Regional Business Group
Yo-Dong Kim
Senior Vice President, Choongnam Regional Business Group
Gwang-Ju Seo
Senior Vice President, Next Generation Telecommunications Center
Myung-Sang Yoon
Senior Vice President, IT Group
Young-Hyun Cho
Senior Vice President, Technology Investigation & Evaluation Center
Deok-Rae Lim
Vice President, SI/NI Business Center
Tae-Soek Roh
Senior Vice President, Customer Service Center
Dong-Hoon Han
Vice President, Internet Telecommunications Team
Sung-Man Kim
Vice President, Network Management and Support Center
Oak-Kie Lee
Vice President, Network Installation Center
Myeng-Gyu Sun
Vice President, Chollanam Regional Business Group
Duek-Kyum Kim
Vice President, Taegu Regional Business Group
Young-Whan Kim
Vice President(2)
Jong-Soo Lee
Vice President, Choongbuk Regional Business Group
Ki-Yeoul Kim
Senior Vice President, Audit Office
Hee-Kyun Park
Vice President, Human Resource Office, Personnel Team
Byung-Woo Lee
Vice President, Public Relations Office, Public Relations Team
Haing Min Kwon
Vice President, Vision and Corporate Strategy Office
In-Sung Jun
Vice President, Business Cooperation Center
Gwi-Tae Oak
Sang-Heon Song
Vice President, Construction Center
Jeong-Tae Park
Vice President, New Business Planning Office
Yu-Yeol Seo
Vice President, Solution Business Center
Sang-Ho Lee
Vice President, Professional Development Center
Sang-Hong Lee
Vice President, Service Development Laboratory
Won-Joong Song
Vice President, Labor Cooperation Management Team
Tae-Il Park
Vice President, Technology Laboratory
Yoon-Hak Bang
Vice President, Applied Systems Laboratory
Hun-Chul Shin
Vice President, Metropolitan West Regional Business Group
Bong-Kee Yang
Vice President, Metropolitan South Regional Business Group
Man-Doo Kim
Vice President, Pusan Regional Business Group
Yeong-Geun Ryou
Vice President, Jeju Regional Business Group
Item 6.B. Compensation
Compensation of Directors and Executive Officers
For the year ended December 31, 2003, the total amount of salaries, bonuses and allowances paid and accrued to all standing directors and executive officers of KT Corporation for services in all capacities was
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approximately Won 7.7 billion. The aggregate amount set aside or accrued by us to provide person and retirement benefits to such persons was Won 0.6 billion in 2003. Outside directors do not receive salaries, fees for attending meetings or retirement and severance benefits, but their actual expenses required for the execution of their duties are reimbursed.
In August 2002, the chairman of the committee for recommending candidates for President entered into an employment agreement on our behalf with our current President. The employment agreement sets certain management targets to be achieved by the President, including a target for the amount of “economic value added” to be achieved in each year. Economic value added is defined as net operating profits after tax minus the cost of capital. Failure to achieve certain thresholds below the targets will allow the board of directors to take actions with respect to the President’s employment, including proposing to the general meeting of shareholders an early termination of his employment. In addition, the head of each of our functional departments, the president of each of our subsidiaries and the heads of each regional head office have entered into employment agreements with the President that provides for similar management targets to be achieved by each of our departments, subsidiaries and regional head offices.
Item 6.C. Board Practices
As of December 31, 2003, none of our standing or outside directors maintained directors’ service contracts with us or with any of our subsidiaries providing for benefits upon termination of employment.
Outside Director Recommendation Committee
The Outside Director Recommendation Committee is comprised of four outside directors, Stuart B. Solomon, Kook-Hyun Moon, Jong-Sang Kim and Do-Hwan Kim, and one standing director, Woo-Sik Kim. The committee’s duties include reviewing the qualifications of potential candidates and proposing nominees to serve as outside directors on our board of directors. The committee members are appointed on an ad hoc basis when recommendations are required in connection with the appointment of new outside directors. The committee members’ terms expire immediately after the adjournment of the ordinary general meeting of shareholders at which the committee’s formal recommendations are made.
Evaluation and Compensation Committee
The Evaluation and Compensation Committee is comprised of five outside directors, Sung-Deuk Park, Chu-Hwan Yim, Do-Hwan Kim, Stuart B. Solomon and Kon-Sik Kim. The committee’s duties include the appointment of an outside management evaluation consulting firm, prior review of the President’s management goals, terms and conditions proposed for inclusion in the employment contract of the President, including, but not limited to, determining whether the President has achieved the management goals, and the determination of compensation of the President and the standing directors. The committee members’ term is for one year, to terminate immediately after the ordinary general meeting of shareholders.
Business Strategy Committee
The Executive and Management Committee is comprised of three standing directors, Yong-Kyung Lee, Sang-Hoon Lee and Hi-Chang Roh, and three outside directors, Kook-Hyun Moon, Jong-Sang Kim and Jeong-Ro Yoon. The committee’s duties include the oversight of medium and long-term business strategies, the annual management plans and budget proposals. The committee members’ term is for one year, to terminate immediately after the ordinary general meeting of shareholders.
Executive Committee
The Executive Committee is comprised of all of the standing directors. The committee’s duties include the establishment and management of branch offices, the acquisition and disposal of real estate having market value
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between Won 10 billion to Won 30 billion, making investments and providing guarantees up to Won 10 billion, the disposal and sale of stocks of our subsidiaries, which stocks have a market value of between Won 10 billion and Won 30 billion, provided that no change of control with respect to such subsidiary occurs as a result of such disposal or sale, the authorization of charitable contributions between Won 100 million to Won 1 billion and the issuance of certain debt securities.
Insider Trading Committee
The Insider Trading Committee is comprised of four outside directors, Chu-Hwan Yim, Sung-Deuk Park, Kook-Hyun Moon and Stuart B. Solomon. This committee reviews internal transactions and ensures compliance with applicable insider trading rules and regulations. The committee members’ term is for one year, to terminate immediately after the ordinary general meeting of shareholders.
Audit Committee
Under the Securities and Exchange Act of Korea, we are required to establish an audit committee within the board of directors comprised of three or more outside directors. Audit Committee members must also meet the applicable independence criteria set forth under the rules and regulations of the Sarbanes-Oxley Act of 2002. The committee is currently comprised of Jong-Sang Kim, Do-Hwan Kim, Jeong-Ro Yoon and Kon-Sik Kim. Members of the committee are elected by our shareholders at the annual shareholder’s meeting. Our internal and external auditors report directly to the committee.
The duties of the committee include:
In addition, in connection with the ordinary general meeting of shareholders, the committee examines the agenda for, and financial statement and other reports to be submitted by, the board of directors at each ordinary general meeting of shareholders.
Differences in Corporate Governance Practices
Pursuant to the rules of the New York Stock Exchange applicable to foreign private issuers like us that are listed on the New York Stock Exchange, we are required to disclose significant differences between the New York Stock Exchange’s corporate governance standards and those that we follow under Korean law and in accordance with our own internal procedures. The following is a summary of such significant differences.
NYSE Corporate Governance Standards
KT Corporation’s Corporate Governance Practice
Director independence
Independent directors must comprise a majority of the board.
The Securities and Exchange Act of Korea requires that our board of directors must comprise no less than a majority of outside directors. Our outside directors must meet the criteria for outside directorship set forth under the Securities and Exchange Act of Korea.
The majority of our board of directors is independent (as defined in accordance with the New York Stock Exchange’s standards), and 8 out of 12 directors are outside directors.
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Nomination/Corporate Governance Committee
Listed companies must have a nomination/corporate governance committee composed entirely of independent directors.
Compensation Committee
Listed companies must have a compensation committee composed entirely of independent directors.
Executive Session
Listed companies must hold meetings solely attended by non-management directors to more effectively check and balance management directors.
Listed companies must have an audit committee that is composed of more than three directors and satisfy the requirements of Rule 10A-3 under the Exchange Act.
Shareholder Approval of Equity Compensation Plan
Listed companies must allow its shareholders to exercise their voting rights with respect to any material revision to the company’s equity compensation plan.
We currently have two equity compensation plans: one providing for the grant of stock options to officers and directors; and an Employee Stock Ownership Program.
All material matters related to the granting stock options are provided in our articles of incorporation, and any amendments to the articles of incorporation are subject to shareholders’ approval. Matters related to the Employee Stock Ownership Program are not subject to shareholders’ approval under Korean law.
Corporate Governance Guidelines
Listed companies must adopt and disclose corporate governance guidelines.
Code of Business Conduct and Ethics
Listed companies must adopt and disclose a code of business conduct and ethics for directors, officers and employees, and promptly disclose any waivers of the code for directors or executive officers.
Item 6.D. Employees
On a consolidated basis, we had 43,068 employees as of December 31, 2003,compared to 48,624 employees as of December 31, 2002 and 48,668 employees as of December 31, 2001. KT Freetel had 2,446 employees as of December 31, 2003.
Our efficiency, as measured by lines in service per employee (excluding employees of our subsidiaries), has improved from 446 as of December 31, 1999 to 580 as of December 31, 2003. This improvement has been achieved through the construction of new lines, the continuing modernization of our facilities and the voluntary early retirement programs described below.
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The Voluntary Early Retirement Programs
In 2001, we implemented a voluntary early retirement program under which a total of 1,389 employees retired. We have agreed with the KT Trade Union that we will not conduct any spin-offs in the future which result in layoffs of our employees. The aggregate amount of retirement and severance benefits paid in connection with the 2001 program was approximately Won 87 billion (including Won 13 billion of normal retirement and severance benefits).
In 2002, we implemented another voluntary retirement program under which a total of 166 employees retired. The aggregate amount of retirement and severance benefits paid in connection with the 2002 program was approximately Won 19 billion (including Won 3 billion of normal retirement and severance benefits).
In 2003, we implemented another voluntary retirement program under which a total of 5,497 employees retired. The aggregate amount of retirement and severance benefits paid in connection with the 2003 program was approximately Won 943 billion (including Won 111 billion of normal retirement and severance benefits).
Labor Relations
Although we consider our current relations with our work force to be good, our strategy of restructuring to improve our efficiency and profitability by disposing of non-core businesses and reducing our employee base have met with opposition from our labor union. In December 2000, certain members of the KT Trade Union carried out work stoppages, demanding changes in Government policies to prevent widespread layoffs and seeking negotiations with management regarding the scope of our restructuring. In May 2001, certain members of our labor union held protests in our headquarters opposing our strategy of restructuring unprofitable businesses, including 114 phone directory services, and the expected layoffs resulting from such strategy.
Under Korean labor law, our employees are permitted to strike. However, because the maintenance of our network is in the public interest, the Government has the authority to mediate and/or arbitrate any strike, as well as any disagreement involving the collective bargaining process. Criminal proceedings may be brought against any party refusing Government mediation or arbitration. The current collective bargaining agreement provides that even in the event of a strike, the minimum number of employees necessary to operate the telecommunications business must continue to work.
As of December 31, 2003, about 82.6% of all our employees were members of the KT Trade Union. On behalf of its members, the Union negotiates with us a collective bargaining agreement every two years and an annual agreement on wages. Under the Act of the Promotion of Worker’s Participation and Cooperation, our Employee-Employer Cooperation Committees, which are composed of representatives of management and labor for each business unit and regional office, meet quarterly to discuss employee grievances, working conditions and potential employee-initiated improvements in service or management.
Employee Stock Ownership and Benefits
We have an employee stock ownership association, which may purchase on behalf of its members up to 20% of any of our shares offered publicly in Korea. The employee stock ownership association owned 5.76% of our issued shares as of December 31, 2003.
We maintain a retirement and severance plan, as required by Korean labor law. Employees terminating their employment after one year or more of service are entitled to receive a lump-sum payment based upon the length of their service and their wage rates, with adjustments, at the time of termination. We make provision for our obligations under the retirement plan. In addition, we provide a wide range of fringe benefits to our employees, including physical education grants, meal allowances, housing, housing loans, medical examinations and training and resort centers. See “Item 5. Operating and Financial Review and Prospects—Item 5.A Operating Results—Salaries and Related Costs”.
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Employee Training
We operate a central training and learning center in Daejon and three regional training centers in Wonju, Gimhae and Najoo, offering courses in subjects such as management and new technologies. In 2003, our employees participated in such courses at our central and regional training centers, new employees receive training in technology and service, and selected employees receive additional training to enhance their knowledge and leadership skills. We also send selected employees to the Korea Advanced Institute of Science and Technology for training and to universities in Korea and abroad.
Item 6.E. Share Ownership
Common Stock
The persons who are currently our directors held, as a group, 8,826 common shares as of December 31, 2003, the most recent date for which this information is available. This represented less than 0.01% of our outstanding common shares as of December 31, 2003. The table below shows the ownership of our common shares by directors.
Shareholders
Number of
common shares owned(1)
Stock Options
The following table sets forth information regarding the stock options we have granted to our directors and executive officers. With respect to all of the options granted, we may elect either to issue shares of common stock or pay in cash the difference between the exercise and the market price at the date of exercise. All of the stock options listed below relate to our common shares. See Note 28 to the Consolidated Financial Statements.
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Item 7. Major Shareholders and Related Party Transactions
Item 7.A. Major Shareholders
The following table sets forth certain information relating to the shareholders of our common stock as of December 31, 2003.
Employee stock ownership association
National Pension Corporation
Directors as a group
Public
KT Corporation (held in the form of treasury stock)(1)(2)
Total issued shares
Before 1993, the Government owned all of our shares. Since 1993, the Government has gradually reduced its ownership and currently does not own any of our issued shares.
For a discussion of our relationship with the Government, see “Item 4. Information on the Company—Item 4.B. Business overview—Relationship with the Government”. For a discussion of the Government’s dispositions and plans for future dispositions of shares, see “Item 4. Information on the Company—Item 4.C. Organizational Structure”.
Item 7.B. Related Party Transactions
On November 29, 2002 and December 13, 2002, we sold all of our 46.6% interest in KT ICOM to KT Freetel for Won 540 billion in cash and Won 309 billion in 3-month short term notes. We also purchased Won 336 billion of convertible bonds issued by KT Freetel on November 29, 2002. These convertible bonds have a maturity of three years and are convertible into shares of KT Freetel after one year from the issuance date at an exercise price of Won 37,200 per share.
We have issued guarantees of Won 112 billion as of December 31, 2001, Won 81 billion as of December 31, 2002 and Won 70 billion as of December 31, 2003, in favor of our consolidated subsidiaries. We have also engaged in various transactions with our subsidiaries and affiliated companies. See Note 2(a) to the Consolidated Financial Statements.
Item 7.C. Interests of Experts and Counsel
Item 8. Financial Information
Item 8.A. Consolidated Statements and Other Financial Information
See “Item 18—Financial Statements” and pages F-1 through F-73.
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Legal Proceedings
Dispute with the Fair Trade Commission
On February 20, 2001, the Fair Trade Commission issued a cease and desist order prohibiting us from engaging in any activity amounting to an unfair intra-group transaction, claiming that certain of our transactions with our affiliates were in violation of the Fair Trade Laws. The Fair Trade Commission alleged that we had unfairly assisted our affiliates by paying them unreasonably high service fees. We paid a fine of approximately Won 30 billion to the Fair Trade Commission but filed an appeal. On July 9, 2001, the Korean Fair Trade Commission rejected our appeal. We subsequently filed an appeal in the Seoul High Court and intend to continue to seek redress in the courts.
Proceedings by the Ministry of Information and Communication
On June 1, 2000, the Government prohibited wireless service providers from providing subsidies to subscribers for purchase of handsets. Subsequently, the Ministry of Information and Communication has imposed fines on entities deemed to be in violation of such prohibition. From time to time, KT Freetel and we have been subject to such fines. Since March 2003, KT Freetel and we have been assessed fines in the aggregate amounts of Won 18.5 billion and Won 7.0 billion, respectively, including the largest fines to date on February 23, 2004 of Won 7.5 billion and Won 4.1 billion, respectively. KT Freetel and we have paid all of the fines assessed on us. SK Telecom and LG Telecom have also been assessed similar fines in the aggregate amounts of Won 32.7 billion and Won 7.0 billion, respectively.
As penalties for providing illegal handset subsidies, the Ministry of Information and Communication has also imposed temporary restrictions on wireless service providers from obtaining new subscribers and us from obtaining new resale subscribers. On June 15, 2004, the Ministry of Information and Communication announced its latest intention to impose such restrictions, which will apply to LG Telecom from June 21, 2004 to July 20, 2004, KT Freetel from July 21, 2004 to August 19, 2004, KT Corporation from July 21, 2004 to August 9, 2004 and SK Telecom from August 20, 2004 to September 28, 2004.
Retirement Benefits Disputes
In March and June of 2003, we implemented our regular voluntary retirement plan, in which 198 employees chose to participate. Under the plan, employees who elected to participate were provided with a paid leave ranging from 3 to 6 months. Later in 2003, we implemented another voluntary retirement plan, in which we provided participating employees with a different retirement and severance package. On February and March of 2004, 155 former employees filed two lawsuits against us, in an aggregate claim amount of Won 7.2 billion, on the basis that they deserve the same retirement package of the September 18, 2003 plan, alleging that the paid leave they received was inferior to the retirement and severance package offered to the participants of the September 18, 2003 plan. The two lawsuits are pending at the Seoul District Court and Seongnam District Court. We anticipate that the remaining 43 former employees who have not filed lawsuits against us may do so in the near future, and, if such suits are filed, we expect the aggregate amount of their claim to be approximately Won 2 billion.
Dispute in the Philippines
In September 2001 and December 2001, two of three subcontractors of Korea Telecom Philippines, Inc. (“KTPI”), our wholly-owned subsidiary in the Philippines, filed lawsuits seeking damages of approximately US$19 million and US$10 million, respectively, from us in connection with a telecommunication project where KTPI acted as the project manager. PT&T, the project coordinator, defaulted on payments to KTPI and, as a consequence, KTPI was unable to make payments to the three subcontractors. Although their contracts were entered into with KTPI, the plaintiffs brought their claims against us on the basis that KTPI is a small, wholly- owned subsidiary with insufficient assets to pay the claimed amounts and we are the actual party owing payment
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obligations to such sub-contractors. With respect to the claim for US$19 million, which was brought by Korea Communications Engineering, the Seoul District Court held in December 2002 that we should pay US$4.17 million and applicable interest accrued on such amount to the claimant. We accrued US$4.17 million and US$1.1 million of applicable interests as expenses in 2003. The Seoul District Court also ordered that the full amount of the judgment be paid although the judgment was not ultimately concluded, and we filed an application for an order suspending such payment obligation pending our appeal of the judgment. Based on our application, the Seoul District Court reduced our payment obligation to Won 1 billion. We paid such amount but filed an appeal to the Seoul High Court which ruled in our favor. Korea Communications Engineering subsequently appealed the Seoul High Court’s judgment to the Supreme Court of Korea, which appeal is currently pending. The claim for US$10 million was brought by Ssangyong Singapore Pte., Ltd. in the Seoul District Court, but the claim for the entire amount was denied on June 20, 2003. However, Ssangyong Singapore Pte., Ltd. filed an appeal with the Seoul High Court on July 25, 2003. We cannot give assurance that the ultimate outcome of these lawsuits or related future claims will be favorable to us.
Interruption and Slowdown of Internet Services
In April 2003, a suit was filed by 1,587 claimants (including People’s Solidarity for Participatory Democracy, at-home users of the Internet and businesses providing access to the Internet to consumers in their premises) against us and seven other defendants, including five Internet service providers. The claimants have claimed damages in the amount of Won 117 million as a result of interruption and slowdown of Internet services. The interruption and slowdown of Internet services in certain areas was caused by a worm virus that infected MS-SQL server and jammed Internet traffic. We plan to defend against this claim on the basis that it is too onerous to require that we and the other defendants be held liable to protect end-users of Internet services from any and all viruses that may inflict the telecommunications network through which such Internet services are provided, especially in the case of viruses that originate from outside Korea, as was the case in this case. Although we plan to vigorously defend against this claim, we are unable to predict the outcome of this lawsuit or any similar future claims. We further understand that the class of claimants and the amounts claimed in this lawsuit may be increased.
We are a defendant in various court proceedings involving claims for civil damages arising in the ordinary course of our business. While we are unable to predict the ultimate disposition of these claims, in the opinion of our management, the ultimate disposition of these claims will not, taken as a whole, have a material adverse effect on us.
Dividends
The table below sets out the dividends declared on the outstanding common stock to shareholders of record on December 31 of the years indicated. As of December 31, 2003, there were 284,849,400 shares of common stock issued. The dividends set out for each of the years below were paid in the immediately following year.
Year Ended December 31,
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If sufficient profits are available, the Board of Directors may propose annual dividends on the outstanding common stock, which our shareholders must approve by a resolution at the ordinary general meeting of shareholders. This meeting is generally held in March of the following year and if our shareholders at such ordinary general meeting of shareholders approve the annual dividend, we must pay such dividend within one month following the date of such resolution. Typically, we pay such dividends shortly after the meeting. The declaration of annual dividends is subject to the vote of our shareholders, and consequently, there can be no assurance as to the amount of dividends per common stock or that any such dividends will be declared. Interim dividends paid in cash can be declared by a resolution of the board of directors. See “Item 10. Additional Information—Item 10.B. Memorandum and Articles of Association—Dividends” and “Item 12. Description of Securities Other than Equity Securities—Description of American Depositary Shares—Dividends and Distributions”.
The Commercial Code provides that shares of a company of the same class must receive equal treatment. However, major shareholders may consent to receive dividend distributions at a lesser rate than minor shareholders (a “Differential Rate”). Accordingly, it is possible that in any given dividend distribution, the dividend distribution per share may vary depending on whether major shareholders consent to receiving dividends at a Differential Rate. If any shareholder who would otherwise receive the reduced dividend dissents, such shareholder would receive a dividend at the full rate. When a Differential Rate dividend is to be distributed, the resolution declaring the dividend must specify both the full dividend rate for minor shareholders and the reduced rate for the consenting shareholders. Previously, the Government consented to receiving a smaller dividend compared to other shareholders. The Government no longer holds any interest in us.
Any cash dividends relating to the shares held in the form of ADSs will be paid to the depositary bank in Won. The deposit agreement provides that, except in certain circumstances, cash dividends received by the depositary bank will be converted by the depositary bank into Dollars and distributed to the holders of the ADRs, less withholding tax, other governmental charges and the depositary bank’s fees and expenses. See “Item 12. Description of Securities Other than Equity Securities—Description of the American Depositary Shares—Dividends and Distributions”.
Item 8.B. Significant Changes
Item 9. The Offer and Listing
Item 9.A. Offer and Listing Details
Notes
Our 7.50% Notes due 2006 and 7.625% Notes due 2007 are traded in the over-the-counter market. Sales prices for the Notes are not regularly reported on any exchange or other quotation service. Our 0.25% Convertible Notes due 2007 are listed on the Luxembourg Stock Exchange. There is no existing trading market for our 4.30% Bonds due 2005.
Shares and ADSs
The principal trading market for the shares is the Korea Stock Exchange. The ADSs are traded on the New York Stock Exchange under the symbol “KTC”. The ADSs have been admitted to the Official List of the London Stock Exchange. Each ADS represents one-half of one share.
Item 9.B. Plan of Distribution
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Item 9.C. Markets
The Korea Stock Exchange
The Korea Stock Exchange began its operations in 1956. Currently it is the only stock exchange in Korea. It has a single trading floor located in Seoul. The Korea Stock Exchange is a non-profit making organization privately managed by its members, consisting of all Korean securities companies and some Korean branches of foreign securities companies.
As of December 31, 2003, the aggregate market value of equity securities listed on the Korea Stock Exchange was approximately Won 355 trillion. The average daily trading volume of equity securities for 2003 was approximately 542 million shares with an average transaction value of Won 2,217 billion.
The Korea Stock Exchange has the power in some circumstances to suspend trading in the shares of a given company or to de-list a security. The Korea Stock Exchange also restricts share price movements. All listed companies are required to file accounting reports annually and quarterly and to release immediately all information that may affect trading in a security.
The Government has in the past exerted, and continues to exert, substantial influence over many aspects of the private sector business community which can have the intention or effect of depressing or boosting the market. In the past, the Government has informally both encouraged and restricted the declaration and payment of dividends, induced mergers to reduce what it considers excess capacity in a particular industry and induced private companies to offer publicly their securities.
The Korea Stock Exchange publishes the Korea Composite Stock Price Index every thirty seconds, which is an index of all equity securities listed on the Korea Stock Exchange. On January 1, 1983, the method of computing the Korea Composite Stock Price Index was changed from the Dow Jones method to the aggregate value method. In the new method, the market capitalizations of all listed companies are aggregated, subject to certain adjustments, and this aggregate is expressed as a percentage of the aggregate market capitalization of all listed companies as of the base date, January 4, 1980.
Movements in Korea Composite Stock Price Index are set out in the following table together with the associated dividend yields and price earnings ratios.
Year
1979
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
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1994
1995
1996
1997
1998
2004 (through June 23)
Source: The Korea Stock Exchange
Shares are quoted “ex-dividend” on the first trading day of the relevant company’s accounting period; since the calendar year is the accounting period for the majority of listed companies, this may account for the drop in the Korea Composite Stock Price Index between its closing level at the end of one calendar year and its opening level at the beginning of the following calendar year.
With certain exceptions, principally to take account of a share being quoted “ex-dividend” and “ex-rights”, permitted upward and downward movements in share prices of any category of shares on any day are limited under the rules of the Korea Stock Exchange to 15% of the previous day’s closing price of the shares, rounded down as set out below:
Previous Day’s Closing Price (Won)
Less than 5,000.
5,000 to less than 10,000
10,000 to less than 50,000
50,000 to less than 100,000
100,000 to less than 500,000
500,000 or more .
As a consequence, if a particular closing price is the same as the price set by the fluctuation limit, the closing price may not reflect the price at which persons would have been prepared, or would be prepared to continue, if so permitted, to buy and sell shares. Orders are executed on an auction system with priority rules to deal with competing bids and offers.
Due to a recent deregulation of restrictions on brokerage commission rates, the brokerage commission rate on equity securities transactions may be determined by the parties, subject to commission schedules being filed with the Korea Stock Exchange by the securities companies. In addition, a securities transaction tax will generally be imposed on the transfer of shares or certain securities representing rights to subscribe for shares at the rate of 0.15% if such transfer is made through the Korea Stock Exchange. A special agricultural and fishery
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tax of 0.15% of the sales prices will also be imposed on transfer of these shares and securities on the Korea Stock Exchange. See “Item 10. Additional Information—Item 10.A. Taxation—Korean Taxation”.
The number of companies listed on the Korea Stock Exchange, the corresponding total market capitalization at the end of the periods indicated and the average daily trading volume for those periods are set forth in the following table:
Market Capitalization
on the Last Day of Each Period
Average Daily Trading Volume,
Value
The Korean securities markets are principally regulated by the Financial Supervisory Commission of Korea and the Securities and Exchange Act. The Securities and Exchange Act was amended fundamentally numerous times in recent years to broaden the scope and improve the effectiveness of official supervision of the securities markets. As amended, the law imposes restrictions on insider trading and price manipulation, requires specified information to be made available by listed companies to investors and establishes rules regarding margin trading, proxy solicitation, takeover bids, acquisition of treasury shares and reporting requirements for shareholders holding substantial interests.
Further Opening of the Korean Securities Market
A stock index futures market was opened on May 3, 1996 and a stock index option market was opened on July 7, 1997, in each case at the Korea Stock Exchange. Remittance and repatriation of funds in connection with
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investment in stock index futures and options are subject to regulations similar to those that govern remittance and repatriation in the context of foreign investment in Korean stocks.
Starting from May 1, 1996, foreign investors were permitted to invest in warrants representing the right to subscribe for shares of a company listed on the Korea Stock Exchange or registered on the KOSDAQ, subject to certain investment limitations. A foreign investor may not acquire such warrants with respect to shares of a class of a company for which the ceiling on aggregate investment by foreigners has been reached or exceeded.
As of December 30, 1997, foreign investors were permitted to invest in all types of corporate bonds, bonds issued by national or local governments and bonds issued in accordance with certain special laws without being subject to any aggregate or individual investment ceiling. The Financial Supervisory Commission sets forth procedural requirements for such investments. The Government announced on February 8, 1998 its plans for the liberalization of the money market with respect to investment in money market instruments by foreigners in 1998. According to the plan, foreigners have been permitted to invest in money market instruments issued by corporations, including commercial paper, starting February 16, 1998 with no restrictions as to the amount. Starting May 25, 1998, foreigners have been permitted to invest in certificates of deposit and repurchase agreements.
Currently, foreigners are permitted to invest in securities including shares of all Korean companies which are not listed on the Korea Stock Exchange nor registered on the KOSDAQ and in bonds which are not listed.
Protection of Customer’s Interest in Case of Insolvency of Securities Companies
Under Korean law, the relationship between a customer and a securities company in connection with a securities sell or buy order is deemed to be consignment and the securities acquired by a consignment agent (i.e., the securities company) through such sell or buy order are regarded as belonging to the customer in so far as the customer and the consignment agent’s creditors are concerned. Therefore, in the event of a bankruptcy or reorganization procedure involving a securities company, the customer of the securities company is entitled to the proceeds of the securities sold by the securities company.
When a customer places a sell order with a securities company which is not a member of the Korea Stock Exchange and this securities company places a sell order with another securities company which is a member of the Korea Stock Exchange, the customer is still entitled to the proceeds of the securities sold received by the non-member company from the member company regardless of the bankruptcy or reorganization of the non-member company.
Under the Securities and Exchange Act, the Korea Stock Exchange is obliged to indemnify any loss or damage incurred by a counterparty as a result of a breach by its members. If a securities company which is a member of the Korea Stock Exchange breaches its obligation in connection with a buy order, the Korea Stock Exchange is obliged to pay the purchase price on behalf of the breaching member. Therefore, the customer can acquire the securities that have been ordered to be purchased by the breaching member.
When a customer places a buy order with a non-member company and the non-member company places a buy order with a member company, the customer has the legal right to the securities received by the non-member company from the member company because the purchased securities are regarded as belonging to the customer in so far as the customer and the non-member company’s creditors are concerned.
As the cash deposited with a securities company is regarded as belonging to the securities company, which is liable to return the same at the request of its customer, the customer cannot take back deposited cash from the securities company if a bankruptcy or reorganization procedure is instituted against the securities company and, therefore, can suffer from loss or damage as a result. However, the Depositor Protection Act provides that Korea Deposit Insurance Corporation will, upon the request of the investors, pay investors up to Won 50 million in case of the securities company’s bankruptcy, liquidation, cancellation of securities business license or other
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insolvency events. Pursuant to the Securities and Exchange Act, as amended, securities companies are required to deposit the cash received from its customers to the extent the amount not covered by the insurance with the Korea Securities Finance Corporation, a special entity established pursuant to the Securities and Exchange Act.
Set-off or attachment of cash deposits by securities companies is prohibited. The premiums related to this insurance are paid by securities companies.
Market Price Information
Our shares were listed on the Korea Stock Exchange on December 23, 1998. The price of the shares on the Korea Stock Exchange as of the close of trading on June 25, 2004 was Won 40,250 per Share. The table below shows the high and low closing prices and the average daily volume of trading activity on the Korea Stock Exchange for the shares since December 23, 1998.
Average Daily
Trading Volume
First quarter
Second quarter
Third quarter
Fourth quarter
2004 (through June 25)
Second quarter (through June 25)
June (through June 25)
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ADSs
The outstanding ADSs, each of which represents one-half of one share of our common stock, are traded on the New York Stock Exchange and the London Stock Exchange.
The price of the ADSs on the New York Stock Exchange as of the close of trading on June 24, 2004 was $18.02 per ADS. The table below shows the high and low trading prices and the average daily volume of trading activity on the New York Stock Exchange for our ADSs since May 25, 1999.
Daily
Trading
Volume
1999 (from May 25)
Second quarter (from May 25)
Second quarter (through June 24)
Item 9.D. Selling Shareholders
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Item 9.E. Dilution
Item 9.F. Expenses of the Issuer
Item 10. Additional Information
Item 10.A. Share Capital
Currently, our authorized share capital is 1,000,000,000 shares, which consists of shares of common stock, par value Won 5,000 per share (“Common Shares”) and shares of non-voting preferred stock, par value Won 5,000 per share (“Non-Voting Shares”). Common Shares and Non-Voting Shares together are referred to as “Shares”. Under our articles of incorporation, we are authorized to issue Non-Voting Shares up to one-fourth of our total issued capital stock. As of December 31, 2003, 284,849,400 Common Shares were issued, of which 1,259,170 shares were held by the treasury stock fund and an additional 72,831,804 shares were held by us as treasury shares. We have never issued any Non-Voting Shares. All of the issued Common Shares are fully-paid and non-assessable and are in registered form. We issue share certificates in denominations of 1, 5, 10, 50, 100, 500, 1,000 and 10,000 shares.
Item 10.B. Memorandum and Articles of Association
This section provides information relating to our capital stock, including brief summaries of material provisions of our articles of incorporation, the Korean Securities and Exchange Act of 1962 (the “Securities and Exchange Act”), the Commercial Code and related laws of Korea, all as currently in effect. The following summaries are subject to, and are qualified in their entirety by reference to, our articles of incorporation and the applicable provisions of the Securities and Exchange Act and the Commercial Code. We have filed copies of our articles of incorporation and these laws as exhibits to registration statements under the Securities Act or the Securities Exchange Act previously filed by us.
We distribute dividends to our shareholders in proportion to the number of shares owned by each shareholder. No dividends are distributed with respect to shares held by us or our treasury stock fund. The Common Shares represented by the ADSs have the same dividend rights as other outstanding Common Shares.
Holders of Non-Voting Shares are entitled to receive dividends in priority to the holders of Common Shares in an amount of not less than 9% of the par value of the Non-Voting Shares as determined by the board of directors at the time of their issuance, provided that if the dividends on the Common Shares exceed those on the Non-Voting Shares, the Non-Voting Shares will also participate in the distribution of such excess dividend amount in the same proportion as the Common Shares. If the amount available for dividends is less than the aggregate amount of such minimum dividend, the holders of Non-Voting Shares will be entitled to receive such accumulated unpaid dividend in priority to the holders of Common Shares from the dividends payable in respect of the next fiscal year.
We declare dividends annually at the annual general meeting of shareholders which is held within three months after the end of the fiscal year. We pay the annual dividend shortly after the annual general meeting to the shareholders of record as of the end of the preceding fiscal year. We may distribute the annual dividend in cash or in Shares. However, a dividend of Shares must be distributed at par value. If the market price of the Shares is less than their par value, dividends in Shares may not exceed one-half of the annual dividend. We may pay interim dividends in cash once a year to shareholders or registered pledgees who are registered in the registry
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of shareholders as of June 30 of each fiscal year by a resolution of the board of directors. We have no obligation to pay any annual dividend unclaimed for five years from the payment date.
Under the Commercial Code, we may pay our dividend only out of the excess of our net assets, on a non-consolidated basis, over the sum of (1) our stated capital and (2) the total amount of our capital surplus reserve and legal reserve accumulated up to the end of the relevant dividend period. In addition, we may not pay any dividend unless we have set aside as legal reserve an amount equal to at least 10% of the cash portion of the dividend or unless we have accumulated a legal reserve of not less than one-half of our stated capital. Financial Supervisory Commission regulations applicable to companies listed on the Korea Stock Exchange requires us to set aside specified amounts as financial structure improvement reserve until the ratio of our shareholders’ equity to the total assets reaches 30.0%. We may not use legal reserve to pay cash dividends but may transfer amounts from legal reserve to capital stock or use legal reserve to reduce an accumulated deficit. See Note 26 to the Consolidated Financial Statements.
Distribution of Free Shares
In addition to paying dividends in Shares out of our retained or current earnings, we may also distribute to our shareholders an amount transferred from our capital surplus or legal reserve to our stated capital in the form of free shares. We must distribute such free shares to all our shareholders in proportion to their existing shareholdings.
Preemptive Rights and Issuance of Additional Shares
We may issue authorized but unissued shares at times and, unless otherwise provided in the Commercial Code, on terms our board of directors may determine. Subject to the limitation described in “Limitation on Shareholdings” below, all our shareholders are generally entitled to subscribe for any newly issued Shares in proportion to their existing shareholdings. We must offer new Shares on uniform terms to all shareholders who have preemptive rights and are listed on our shareholders’ register as of the relevant record date. Under the Commercial Code, we may vary, without shareholders’ approval, the terms of these preemptive rights for different classes of shares. We must give public notice of the preemptive rights regarding new Shares and their transferability at least two weeks before the relevant record date. Our board of directors may determine how to distribute Shares for which preemptive rights have not been exercised or where fractions of Shares occur.
Under the Commercial Code, the new Shares, convertible bonds or bonds with warrants must be issued to persons other than the existing shareholders solely for the purpose of achieving managerial objectives. Under our articles of incorporation, we may issue new Shares pursuant to a board resolution to persons other than existing shareholders, who in these circumstances will not have preemptive rights, if the new Shares are:
In addition, we may issue convertible bonds or bonds with warrants, each up to an aggregate principal amount of Won 2,000 billion, to persons other than existing shareholders in situations described above.
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Members of our employee stock ownership association, whether or not they are our shareholders, generally have a preemptive right to subscribe for up to 20% of the Shares publicly offered pursuant to the Securities and Exchange Act. This right is exercisable only to the extent that the total number of Shares so acquired and held by members of our employee stock ownership association does not then exceed 20% of the total number of all issued and uncancelled Shares then issued. As of December 31, 2003, approximately 5.76% of the issued Shares were held by members of our employee stock ownership association.
Limitation on Shareholdings
The Telecommunications Business Law permits maximum aggregate foreign shareholding in us to be 49% of our total issued and outstanding Shares with voting rights. For the purposes of the foregoing, a shareholder is a “foreign shareholder” if such shareholder is: (1) a foreign person; (2) a foreign government; or (3) a company (i) in which foreign persons and/or foreign governments hold, in aggregate, 15% or more of such company’s total voting shares, (ii) such company’s largest shareholder is a foreign person or a foreign government, and (iii) such company holds at least 1% of our total issued and outstanding Shares with voting rights. For the avoidance of doubt, all of conditions (i) to (iii) in the foregoing clause (3) must exist for such a company to be counted as a “foreign shareholder” for the purposes of calculating whether the 49% foreign shareholding threshold is reached under the Telecommunications Business Law. In addition, Foreign Investment Promotion Act regulations prohibit a foreign shareholder from being our largest shareholder if such shareholder owns 5% or more of our Shares with voting rights. For the purposes of this restriction, a “foreign shareholder” is defined in the same manner as described above with respect to the foreign shareholding restriction under the Telecommunications Business Law, provided, however, that no exception is made under the Foreign Investment Promotion Act regulations for companies that own less than 1% of our Shares (see clause (3)(iii) above in this paragraph). A foreigner who has acquired the Shares in excess of such ceiling described above may not exercise its voting rights for shares in excess of such limitation, and the Ministry of Information and Communication may require corrective measures to comply with the ownership restrictions.
General Meeting of Shareholders
We hold the annual general meeting of shareholders within three months after the end of each fiscal year. Subject to a board resolution or court approval, we may hold an extraordinary general meeting of shareholders:
Holders of Non-Voting Shares may request a general meeting of shareholders only after the Non-Voting Shares become entitled to vote or are enfranchised, as described under “—Voting Rights” below.
We must give shareholders written notice setting out the date, place and agenda of the meeting at least two weeks before the date of the general meeting of shareholders. However, for holders of less than 1% of the total number of issued and issued Common Shares, we may give notice by placing at least two public notices in at least two daily newspapers at least two weeks in advance of the meeting. Currently, we use The Korea Daily News, Maeil Business Newspaper and The Korea Economic Daily published in Seoul for this purpose. Shareholders not on the shareholders’ register as of the record date are not entitled to receive notice of the general meeting of shareholders or attend or vote at the meeting. Holders of Non-Voting Shares, unless enfranchised, are not entitled to receive notice of general meetings of shareholders, but may attend such meetings.
Our general meetings of shareholders are held at our head office, in Sungnam, or if necessary, may be held anywhere near our head office or in Seoul.
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Voting Rights
Holders of our Common Shares are entitled to one vote for each Common Share, except that voting rights of Common Shares held by us, or by a corporate shareholder that is more than 10% owned by us either directly or indirectly, may not be exercised. The Commercial Code permits cumulative voting, under which voting method each shareholder has multiple voting rights corresponding to the number of directors to be appointed in the voting and may exercise all voting rights cumulatively to elect one director. Our articles of incorporation permit cumulative voting at our shareholders’ meeting. Under the Securities and Exchange Act, any shareholder holding shares equivalent to not less than 1/100 of the total number of shares with voting rights issued may ask us to select and appoint such directors by cumulative voting.
Our shareholders may adopt resolutions at a general meeting by an affirmative majority vote of the voting shares present or represented at the meeting, where the affirmative votes also represent at least one-fourth of our total voting shares then outstanding. However, under the Commercial Code, the following matters require approval by the holders of at least two-thirds of the voting shares present or represented at a meeting, where the affirmative votes also represent at least one-third of our total voting shares then outstanding:
In general, holders of Non-Voting Shares are not entitled to vote on any resolution or receive notice of any general meeting of shareholders. However, in the case of amendments to our articles of incorporation, any merger or consolidation of us, capital reductions or in some other cases which affect the rights or interests of the Non-Voting Shares, approval of the holders of Non-Voting Shares is required. We may obtain such approval by a resolution of holders of at least two-thirds of the Non-Voting Shares present or represented at a class meeting of the holders of Non-Voting Shares, where the affirmative votes also represent at least one-third of our total issued Non-Voting Shares. In addition, if we are unable to pay dividends on Non-Voting Shares as provided in our articles of incorporation, the holders of Non-Voting Shares will become enfranchised and will be entitled to exercise voting rights until those dividends are paid. The holders of enfranchised Non-Voting Shares have the same rights as holders of Common Shares to request, receive notice of, attend and vote at a general meeting of shareholders.
Shareholders may exercise their voting rights by proxy. The proxy must present a document evidencing an appropriate power of attorney prior to the start of the general meeting of shareholders.
Holders of ADRs exercise their voting rights through the depositary bank, an agent of which is the record holder of the underlying Common Shares. Subject to the provisions of the deposit agreement, ADR holders are entitled to instruct the depositary bank how to vote the Common Shares underlying their ADSs. See “Item 12. Description of Securities Other than Equity Securities—Description of American Depositary Shares—Voting Rights”.
Rights of Dissenting Shareholders
In some limited circumstances, including the transfer of the whole or any significant part of our business and our merger or consolidation with another company, dissenting shareholders have the right to require us to purchase their Shares. To exercise this right, shareholders must submit to us a written notice of their intention to
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dissent before the general meeting of shareholders. Within 20 days after the relevant resolution is passed at a meeting, the dissenting shareholders must request us in writing to purchase their Shares. We are obligated to purchase the Shares of dissenting shareholders within one month after the expiration of the 20-day period. The purchase price for the Shares is required to be determined through negotiation between the dissenting shareholders and us. If we cannot agree on a price through negotiation, the purchase price will be the average of (1) the weighted average of the daily Share prices on the Korea Stock Exchange for the two-month period before the date of the adoption of the relevant board resolution, (2) the weighted average of the daily Share price on the Korea Stock Exchange for the one month period before the date of the adoption of the relevant board resolution and (3) the weighted average of the daily Share price on the Korea Stock Exchange for the one week period before the date of the adoption of the relevant board resolution. However, the Financial Supervisory Commission may adjust this price if we or holders of 30% or more of the Shares we are obligated to purchase do not accept the purchase price. Holders of ADSs will not be able to exercise dissenter’s rights unless they have withdrawn the underlying common stock and become our direct shareholders.
Register of Shareholders and Record Dates
Our transfer agent, Kookmin Bank, maintains the register of our shareholders at its office in Seoul, Korea. It registers transfers of Shares on the register of shareholders on presentation of the Share certificates.
The record date for annual dividends is December 31. For the purpose of determining the shareholders entitled to annual dividends, the register of shareholders may be closed for the period from the day after the record date to January 31 of the following year. Further, for the purpose of determining the shareholders entitled to some other rights pertaining to the Shares, we may, on at least two weeks’ public notice, set a record date and/or close the register of shareholders for not more than three months. The trading of Shares and the delivery of share certificates may continue while the register of shareholders is closed.
Annual Report
At least one week before the annual general meeting of shareholders, we must make our annual report and audited non-consolidated financial statements available for inspection at our principal office and at all of our branch offices. In addition, copies of annual reports, the audited non-consolidated financial statements and any resolutions adopted at the general meeting of shareholders will be available to our shareholders.
Under the Securities and Exchange Act, we must file with the Financial Supervisory Commission and the Korea Stock Exchange (1) an annual report within 90 days after the end of our fiscal year and (2) interim reports with respect to the three month period, six month period and nine month period from the beginning of each fiscal year within 45 calendar days following the end of each period. Copies of these reports are or will be available for public inspection at the Financial Supervisory Commission and the Korea Stock Exchange.
Transfer of Shares
Under the Commercial Code, the transfer of Shares is effected by delivery of share certificates. However, to assert shareholders’ rights against us, the transferee must have his name and address registered on our register of shareholders. For this purpose, a shareholder is required to file his name, address and seal with our transfer agent. A non-Korean shareholder may file a specimen signature in place of a seal, unless he is a citizen of a country with a sealing system similar to that of Korea. In addition, a non-resident shareholder must appoint an agent authorized to receive notices on his behalf in Korea and file a mailing address in Korea. The above requirements do not apply to the holders of ADSs.
Under current Korean regulations, Korean securities companies and banks, including licensed branches of non-Korean securities companies and banks, investment management companies, futures trading companies, internationally recognized foreign custodians and the Korea Securities Depository may act as agents and provide
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related services for foreign shareholders. Certain foreign exchange controls and securities regulations apply to the transfer of Shares by non-residents or non-Koreans. See “Item 10. Additional Information—Item 10.D. Exchange Controls”.
Our transfer agent is Kookmin Bank, located at 24-3, Yoido-dong, Youngdungpo-ku, Seoul, Korea.
Acquisition of Shares by Us
We may not acquire our own Shares except in limited circumstances, such as a reduction in capital. In addition, we may acquire Shares through purchases on the Korea Stock Exchange or through a tender offer. We may also acquire interests in our own Shares through agreements with trust companies, securities investment trust companies and securities investment companies. The aggregate purchase price for the Shares may not exceed the total amount available for distribution of dividends at the end of the preceding fiscal year, subject to certain procedural requirements, provided that, in case of acquisition of our own Shares by us for the purpose of cancellation, the aggregate purchase price may not exceed the total amount available for distribution of dividends at the end of the current fiscal year minus certain reserves.
In general, corporate entities in which we own a 50% or more equity interest may not acquire our Shares.
Liquidation Rights
In the event of our liquidation, after payment of all debts, liquidation expenses and taxes, our remaining assets will be distributed among shareholders in proportion to their shareholdings. Holders of Non-Voting Shares have no preference in liquidation.
Item 10.C. Material Contracts
None.
Item 10.D. Exchange Controls
General
The Foreign Exchange Transaction Act and the Presidential Decree and regulations under that Act and Decree (collectively the “Foreign Exchange Transaction Laws”) regulate investment in Korean securities by non-residents and issuance of securities outside Korea by Korean companies. Under the Foreign Exchange Transaction Laws, non-residents may invest in Korean securities only to the extent specifically allowed by these laws or otherwise permitted by the Ministry of Finance and Economy. The Financial Supervisory Commission has also adopted, pursuant to its authority under the Korean Securities and Exchange Act, regulations that restrict investment by foreigners in Korean securities and regulate issuance of securities outside Korea by Korean companies.
Under the Foreign Exchange Transaction Laws, if the Government deems that certain emergency circumstances, including, but not limited to, the outbreak of natural calamities, wars or grave and sudden changes in domestic or foreign economies, are likely to occur, the Ministry of Finance and Economy may temporarily suspend the transactions where Foreign Exchange Transaction Laws are applicable, or impose an obligation to deposit or sell capital to certain Korean governmental agencies or financial institutions. In addition, if the Government deems that it is confronted or is likely to be confronted with serious difficulty in movement of capital between Korea and abroad which will bring serious obstacles in carrying out its currency policies, exchange rate policies and other macroeconomic policies, the Ministry of Finance and Economy may take measures to require any person who plans to conduct transactions to obtain permission or to require any person who performs transactions to deposit such capital to certain Korean governmental agencies or financial institutions.
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Government Review of Issuance of ADSs
In order for us to issue shares represented by ADSs in an amount exceeding US$30 million, we are required to file a prior report of the issuance with the Ministry of Finance and Economy. No further Korean governmental approval is necessary for the initial offering and issuance of the ADSs.
Under current Korean laws and regulations, the depositary bank is required to obtain our prior consent for the number of shares to be deposited in any given proposed deposit which exceeds the difference between (1) the aggregate number of shares deposited by us or with the consent of us for the issuance of ADSs (including deposits in connection with the initial and all subsequent offerings of ADSs and stock dividends or other distributions related to these ADSs) and (2) the number of shares on deposit with the depositary bank at the time of such proposed deposit. We can give no assurance that we would grant our consent, if our consent is required. Therefore, a holder of ADRs who surrenders ADRs and withdraws shares may not be permitted subsequently to deposit those shares and obtain ADRs.
Reporting Requirements for Holders of Substantial Interests
Any person whose direct or beneficial ownership of shares, whether in the form of shares or ADSs, certificates representing the rights to subscribe for Shares and equity-related debt securities including convertible bonds and bonds with warrants (collectively, the “Equity Securities”) together with the Equity Securities beneficially owned by certain related persons or by any person acting in concert with the person accounts for 5% or more of the total issued Equity Securities is required to report the status of the holdings to the Financial Supervisory Commission and the Korea Stock Exchange within five business days after reaching the 5% ownership interest. In addition, any change in the ownership interest subsequent to the report which equals or exceeds 1% of the total issued Equity Securities is required to be reported to the Financial Supervisory Commission and the Korea Stock Exchange within five business days from the date of the change.
Violation of these reporting requirements may subject a person to criminal sanctions such as fines or imprisonment and may result in a loss of voting rights with respect to the unreported ownership of Equity Securities exceeding 5%. Furthermore, the Financial Supervisory Commission may issue an order to dispose of non-reported Equity Securities.
Restrictions Applicable to ADSs
No Korean governmental approval is necessary for the sale and purchase of ADSs in the secondary market outside Korea or for the withdrawal of shares underlying ADSs and the delivery inside Korea of shares in connection with the withdrawal, provided that a foreigner who intends to acquire the shares must obtain an investment registration card from the Financial Supervisory Service as described below. The acquisition of the shares by a foreigner must be reported by the foreigner or his standing proxy in Korea immediately to the Governor of the Financial Supervisory Service.
Persons who have acquired shares as a result of the withdrawal of shares underlying the ADSs may exercise their preemptive rights for new shares, participate in free distributions and receive dividends on shares without any further governmental approval.
Restrictions Applicable to Shares
As a result of amendments to the Foreign Exchange Transaction Laws and Financial Supervisory Commission regulations (together, the “Investment Rules”) adopted in connection with the stock market opening from January 1992 and after that date, foreigners may invest, with limited exceptions and subject to procedural requirements, in all shares of Korean companies, whether listed on the Korea Stock Exchange or registered on the KOSDAQ, unless prohibited by specific laws. Foreign investors may trade shares listed on the Korea Stock
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Exchange or registered on the KOSDAQ only through the Korea Stock Exchange or the KOSDAQ, except in limited circumstances, including:
For over-the-counter transactions of shares between foreigners outside the Korea Stock Exchange or the KOSDAQ for shares with respect to which the limit on aggregate foreign ownership has been reached or exceeded, a securities company licensed in Korea must act as an intermediary. Odd-lot trading of shares outside the Korea Stock Exchange or the KOSDAQ must involve a licensed securities company in Korea as the other party. Foreign investors are prohibited from engaging in margin transactions through borrowing shares from a securities company with respect to shares which are subject to a foreign ownership limit.
The Investment Rules require a foreign investor who wishes to invest in shares on the Korea Stock Exchange or the KOSDAQ (including Converted Shares) to register its identity with the Financial Supervisory Service prior to making any such investment; however, the registration requirement does not apply to foreign investors who acquire Converted Shares with the intention of selling such Converted Shares within three months from the date of acquisition of the Converted Shares. Upon registration, the Financial Supervisory Service will issue to the foreign investor an investment registration card which must be presented each time the foreign investor opens a brokerage account with a securities company. Foreigners eligible to obtain an investment registration card include foreign nationals who are individuals residing abroad for more than six months, foreign governments, foreign municipal authorities, foreign public institutions, international financial institutions or similar international organizations, corporations incorporated under foreign laws and any person in any additional category designated by decree of the Ministry of Finance and Economy. All Korean offices of a foreign corporation as a group are treated as a separate foreigner from the offices of the corporation outside Korea. However, a foreign corporation or depositary bank issuing depositary receipts may obtain one or more investment registration cards in its name in certain circumstances as described in the relevant regulations.
Upon a foreign investor’s purchase of shares through the Korea Stock Exchange or the KOSDAQ, no separate report by the investor is required because the investment registration card system is designed to control and oversee foreign investment through a computer system. However, a foreign investor’s acquisition or sale of shares outside the Korea Stock Exchange or the KOSDAQ (as discussed above) must be reported by the foreign investor or his standing proxy to the Governor of the Financial Supervisory Service at the time of each such acquisition or sale; provided, however, that a foreign investor must ensure that any acquisition or sale by it of shares outside the Korea Stock Exchange or the KOSDAQ in the case of trades in connection with a tender offer, odd-lot trading of shares or trades of a class of shares for which the aggregate foreign ownership limit has been reached or exceeded, is reported to the Governor of the Financial Supervisory Service by the securities company engaged to facilitate such transaction. A foreign investor must appoint one or more standing proxies from among the Korea Securities Depository, foreign exchange banks, including domestic branches of foreign banks, securities companies, including domestic branches of foreign securities companies, investment trust companies, futures trading companies and internationally recognized custodians which will act as a standing proxy to exercise shareholders’ rights or perform any matters related to the foregoing activities if the foreign investor does not perform these activities himself. However, a foreign investor may be exempted from complying with these standing proxy rules with the approval of the Governor of the Financial Supervisory Service in cases deemed inevitable by reason of conflict between laws of Korea and the home country of the foreign investor.
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Certificates evidencing shares of Korean companies must be kept in custody with an eligible custodian in Korea. Only foreign exchange banks, including domestic branches of foreign banks, securities companies, including domestic branches of foreign securities companies, the Korea Securities Depository, investment trust companies, futures trading companies and internationally recognized custodians are eligible to act as a custodian of shares for a non-resident or foreign investor. A foreign investor must ensure that his custodian deposits its shares with the Korea Securities Depository. However, a foreign investor may be exempted from complying with this deposit requirement with the approval of the Governor of the Financial Supervisory Service in circumstances where compliance with that requirement is made impracticable, including cases where compliance would contravene the laws of the home country of such foreign investor.
Under the Investment Rules, with certain exceptions, foreign investors may acquire shares of a Korean company without being subject to any foreign investment ceiling. As one such exception, designated public corporations are subject to a 40% ceiling on the acquisition of shares by foreigners in the aggregate. Designated public corporations may set a ceiling on the acquisition of shares by a single person within 3% of the total number of shares. Currently, Korea Electric Power Corporation is the only designated public corporation which has set such a ceiling. Furthermore, an investment by a foreign investor of not less than 10% of the issued shares with voting rights of a Korean company is defined as a direct foreign investment under the Foreign Investment Promotion Law, which is, in general, subject to the report to, and acceptance, by the Ministry of Commerce, Industry and Energy. The acquisition of our Shares by a foreign investor is also subject to the restrictions prescribed in the Telecommunications Business Law. The Telecommunications Business Law limits the maximum aggregate foreign shareholdings in us to 49% of the total issued shares with voting rights and Foreign Investment Promotion Act regulations prohibit a foreign shareholder from being our largest shareholder if such shareholder owns 5% or more of our Shares. See “Item 4. Information on the Company—Item 4.B. Business Overview—Regulation—Foreign Investment” and “—Limitation on Shareholdings”. A foreigner who has acquired Shares in excess of such restriction described above may not exercise its voting rights with respect to the Shares exceeding such limitations. As of December 31, 2003, 45.5% of our common shares were owned by foreign investors.
Under the Foreign Exchange Transaction Laws, a foreign investor who intends to acquire shares through a securities company in Korea must designate a foreign exchange bank at which he must open a foreign currency account and a Won account exclusively for stock investments. No approval is required for remittance into Korea and deposit of foreign currency funds in the foreign currency account. Foreign currency funds may be transferred from the foreign currency account at the time required to place a deposit for, or settle the purchase price of, a stock purchase transaction to a Won account opened at a securities company. Funds in the foreign currency account may be remitted abroad without any governmental approval.
Dividends on Shares are paid in Won. No governmental approval is required for foreign investors to receive dividends on, or the Won proceeds of the sale of, any shares to be paid, received and retained in Korea. Dividends paid on, and the Won proceeds of the sale of, any shares held by a non-resident of Korea must be deposited either in a Won account with the investor’s securities company or his Won Account. With respect to the withdrawal of local living expenses, up to US$10,000 in Won equivalent per individual may be withdrawn without governmental approval or filing of any report to governmental authorities. However, if an amount in excess of such threshold is withdrawn in any single withdrawal transaction, such withdrawal must be reported to the Korea Tax Office. Funds in the Won Account may also be used for future investment in shares or for payment of the subscription price of new shares obtained through the exercise of preemptive rights.
The securities companies and investment trust companies were allowed to open foreign currency accounts with foreign exchange banks exclusively for accommodating foreign investors’ stock investments in Korea. Through these accounts, these securities companies and investment trust companies may enter into foreign exchange transactions on a limited basis, such as conversion of foreign currency funds and Won funds, either as a counterparty to or on behalf of foreign investors, without the investors having to open their own accounts with foreign exchange banks.
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Item 10.E. Taxation
The following summary is based upon tax laws of the United States and the Republic of Korea as in effect on the date of this annual report on Form 20-F, and is subject to any change in United States or Korean law that may come into effect after such date. Investors in the convertible notes, bonds, shares of common stock or ADSs are advised to consult their own tax advisers as to the United States, Korean or other tax consequences of the purchase, ownership and disposition of such securities, including the effect of any national, state or local tax laws. In this section, all references to “convertible notes” mean our 0.25% Convertible Notes due 2007 and all references to “bonds” mean our 7.50% Notes due 2006, 7.625% Notes due 2007 and 4.30% Bonds due 2005.
Korean Taxation
The following summary of Korean tax considerations applies to you as long as you are not:
Convertible Notes or Bonds
Tax on Interest
In principle, interest paid to a non-resident by a Korean company is subject to withholding of Korean income or corporation tax unless exempted by relevant laws or tax treaties. However, the Special Tax Treatment Control Law of Korea (the “STTCL”) exempts interest on convertible notes or bonds denominated in a foreign currency (excluding payments to a Korean corporation or resident other than to its overseas permanent establishment) from Korean income and corporation tax. The residence tax referred to below is also therefore eliminated. Therefore, under the STTCL, you may be exempt from any Korean withholding tax on convertible notes or bonds.
Tax on Capital Gains
Korean tax laws currently exclude from Korean taxation gains made by a non-resident without a permanent establishment in Korea from the sale of convertible notes or bonds to non-residents (unless the sale is to the non-resident’s permanent establishment in Korea). In addition, capital gains earned by non-residents in Korea from the transfer of convertible notes or bonds taking place outside of Korea are currently exempt from taxation by virtue of the STTCL, provided that the offering of the convertible notes or bonds is deemed to be an overseas issuance under the STTCL.
In the absence of an applicable treaty or any other special tax laws reducing or eliminating capital gains tax, the applicable rate of tax is the lower of 11.0% of the gross realization proceeds or (subject to the production of satisfactory evidence of the acquisition cost and the transaction cost of the relevant Korean securities) 27.5% of the gain made. There is no provision under relevant Korean law for offsetting gains and losses or otherwise aggregating transactions for the purpose of computing the net gain attributable to sales of Korean securities. If you are a resident of the United States for the purposes of the income tax treaty currently in force between Korea and the United States (“US-Korea Tax Treaty”), you are generally entitled to an exemption from Korean taxation in respect of any capital gain realized on a disposition of convertible notes or bonds, regardless of whether the disposition is to a Korean resident or made within Korea. In order to obtain the benefit of a tax exemption available under applicable tax treaties on or after July 1, 2002, you should submit to the purchaser or the securities company, as applicable, the application for the exemption prior to the time of the payment, together with a certificate of your tax residence issued by a competent authority of your resident country. However, this requirement will not apply to the exemption under Korean tax laws.
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There is no liability for tax on capital gains in respect of the delivery of shares of common stock following the conversion of the convertible notes. The Korean tax authority has interpreted that the acquisition cost of such shares which are subsequently sold is to be calculated as the acquisition cost of the relevant convertible notes.
Inheritance Tax and Gift Tax
Korean inheritance tax is imposed upon (1) all assets (wherever located) of the deceased if at the time of death the deceased was domiciled in Korea and (2) all property located in Korea which passes on death (irrespective of the domicile of the deceased). Gift tax is imposed in similar circumstances to the above. Taxes are currently imposed at the rate of 10% to 50% if the value of the relevant property is above a certain limit and the tax amount varies according to the value of the relevant property and the identity of the parties involved. Under Korean inheritance and gift tax laws, convertible notes or bonds issued by Korean corporations are deemed located in Korea irrespective of where they are physically located or by whom they are owned.
Shares or ADSs
Dividends on Shares of Common Stock or ADSs
Unless an applicable tax treaty provides otherwise, we will deduct Korean withholding tax from dividends paid to you either in cash or shares at a rate of 27.5%. If you are a resident of a country that has entered into a tax treaty with Korea, you may qualify for a reduced rate of Korean withholding tax under such a treaty. For example, if you are a qualified resident of the United States for purposes of the US-Korea Tax Treaty (the “Treaty”) and you are the beneficial owner of a dividend, a reduced withholding tax rate of 16.5% generally will apply. You will not be entitled to claim treaty benefits if you are not the beneficial owner of a dividend.
In order to obtain the benefits of a reduced withholding tax rate under a tax treaty, you must submit to us, prior to the dividend payment date, such evidence of tax residence as may be required by the Korean tax authorities. In the case of ADSs, evidence of tax residence may be submitted to us through the depositary. In addition, on or after July 1, 2002, in order to obtain the benefit of a tax exemption available under applicable tax treaties, you should submit an exemption application prior to the time of the dividend payment, together with a certificate of your tax residence issued by a competent authority of your resident country. Excess taxes withheld generally are not recoverable even if you subsequently produce evidence that you were entitled to have tax withheld at a lower rate.
If we distribute to you free shares representing a transfer of certain capital reserves or asset revaluation reserves into paid-in capital, that distribution may be a deemed dividend subject to Korean tax.
Capital Gains
Capital gain from a sale of shares of common stock will generally be exempt from Korean taxation if you have owned, together with certain related parties, less than 25% of our total issued shares during the year of sale and the five calendar years before the year of sale, and the sale is made through the Korea Stock Exchange. Capital gain earned by a non-Korean holder from a sale of ADSs outside of Korea are exempt from Korean taxation by virtue of the STTCL, provided that the issuance of the ADSs is deemed to be an overseas issuance under the STTCL.
If you are subject to tax on capital gain from a sale of ADSs, or shares of common stock that you acquired as a result of a withdrawal, your gain will be calculated based on your cost of acquiring the ADSs representing the shares of common stock, although there are no specific Korean tax provisions or rulings on this issue. In the absence of the application of a tax treaty that exempts or reduces the rate of tax on capital gain, the amount of Korean tax imposed on such capital gains will be the lesser of 11% of the gross realization proceeds or, subject to the production of satisfactory evidence of the acquisition cost and the transaction costs of the ADSs, 27.5% of the net capital gain.
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If you sell your shares of common stock or ADSs, the purchaser or, in the case of a sale of shares of common stock on the Korea Stock Exchange or through a licensed securities company in Korea, the licensed securities company, is required to withhold Korean tax from the sales price in an amount equal to 11% of the gross realization proceeds and to make payment thereof to the Korean tax authorities, unless you establish your entitlement to an exemption or lower rate of taxation under an applicable tax treaty or produce satisfactory evidence of your acquisition cost and the transaction costs for the shares of common stock or ADSs. In order to obtain the benefit of an exemption of tax pursuant to a tax treaty, you must submit to the purchaser or the securities company (or through the depositary), as the case may be, prior to the first payment, an exemption application, together with a certificate of your tax residence issued by a competent authority of your residence country. This requirement will not apply to exemptions under Korean tax law. Excess taxes withheld are generally not recoverable even if you subsequently produce evidence that you were entitled to have taxes withheld at a lower rate.
Korean inheritance tax is imposed upon (a) all assets (wherever located) of the deceased if at the time of his death he was domiciled in Korea and (b) all property located in Korea which passes on death (irrespective of the domicile of the deceased). Gift tax is imposed in similar circumstances to the above. Taxes are currently imposed at the rate of 10% to 50% if the value of the relevant property is above a certain limit and vary according to the identity of the parties involved.
Under Korean Inheritance and Gift Tax Law, shares issued by a Korean corporation are deemed located in Korea irrespective of where they are physically located or by whom they are owned. It remains unclear whether, for Korean inheritance and gift tax purposes, a non-resident holder of ADSs will be treated as the owner of the shares underlying the ADSs. If such non-resident is treated as the owner of the shares, the heir or donee of such non-resident (or in certain circumstances, the non-resident as the donor) will be subject to Korean inheritance or gift tax at the same rate as described above.
Securities Transaction Tax
If you transfer shares of common stock on the Korea Stock Exchange, you will be subject to securities transaction tax at a rate of 0.15% and an agriculture and fishery special tax at a rate of 0.15%, calculated based on the sales price of the shares. If you transfer shares of common stock and your transfer is not made on the Korea Stock Exchange you will generally be subject to the securities transaction tax at a rate of 0.5% and will generally not be subject to the agriculture and fishery special tax. Transfers of ADSs will not be subject to either the securities transaction tax or the agriculture and fishery special tax.
Although a tax ruling has been issued to the effect that a foreign holder of depositary shares will not be subject to securities transaction tax upon (i) deposit of underlying stock and receipt of depositary shares or upon (ii) the surrender of depositary shares and withdrawal of originally deposited underlying stock, an issue still remains as to whether, in the case where the depositary shares were transferred by one holder to another (which transfer is not subject to securities transaction tax it itself), the surrender of depositary shares and withdrawal of underlying stock by the subsequent (as opposed to the initial) holder of depositary shares will be treated as a taxable event for the purpose of the securities transaction tax. The Korean tax authorities issued another ruling indicating that securities transaction tax would be imposed “when depository shares which were issued upon deposit with an overseas depository of stock issued by a Korean company are later converted into the underlying stock,” except in the circumstances mentioned in the previously discussed ruling issued by the Korean tax authorities. This ruling, however, is silent on certain essential points such as the party responsible for the payment of the tax as well as the amount of tax due in such event. As a result, it remains uncertain under Korean tax law whether the surrender of depositary shares and withdrawal of underlying stock by the holders of depositary other than an initial holder will not trigger the securities transaction tax.
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United States Federal Income Taxation
This summary describes the material U.S. federal income tax consequences to you, if you are a U.S. holder (as defined below), of owning our convertible notes, bonds, shares of common stock or ADSs. This summary applies to you only if you hold convertible notes, bonds, shares of common stock or ADSs as capital assets for tax purposes and, in the case of the convertible notes, only if you purchased such convertible notes in the applicable initial offering at their issue price. This summary does not apply to you if you are a member of a class of holders subject to special rules, such as:
This summary is based on laws, treaties and regulatory interpretations in effect on the date hereof, all of which are subject to change, possibly on a retroactive basis.
Please consult your own tax advisers concerning the U.S. federal, state, local and other national tax consequences of purchasing, owning and disposing of convertible notes, bonds, shares of common stock or ADSs in your particular circumstances.
For purposes of this summary, you are a “U.S. holder” if you are a beneficial owner of a convertible note, bond, warrant, share of common stock or ADS that is:
Convertible Notes
Stated Interest
Payments of stated interest on the convertible notes will generally be subject to U.S. federal income taxation as ordinary income at the time such payments are accrued or received, in accordance with your method of tax accounting.
Premium
If you purchase a convertible note at a cost greater than the convertible note’s remaining redemption amount (i.e., the total of all future payments to be made on the convertible note other than payments of stated interest), you will be considered to have purchased the convertible note at a premium, and you may elect to amortize the
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premium as an offset to interest income, using a constant yield method, over the remaining term of the convertible note. If you make this election, it generally will apply to all debt instruments that you hold at the time of the election, as well as any debt instruments that you subsequently acquire. In addition, you may not revoke the election without the consent of the Internal Revenue Service. If you elect to amortize the premium, you will be required to reduce your tax basis in the convertible note by the amount of the premium amortized during your holding period. Convertible notes purchased at a premium will not be subject to the original issue discount rules described above. If you do not elect to amortize premium, the amount of premium will be included in your tax basis in the convertible note. Therefore, if you do not elect to amortize premium and you hold the convertible note to maturity, you generally will be required to treat the premium as capital loss when the convertible note matures.
Market Discount
If you purchase a convertible note at a price that is lower than the convertible note’s remaining redemption amount, by 0.25% or more of the remaining redemption amount, multiplied by the number of remaining whole years to maturity, the convertible note will be considered to bear “market discount” in your hands. In this case, any gain that you realize on the disposition of the convertible note generally will be treated as ordinary interest income to the extent of the market discount that accrued on the convertible note during your holding period. In addition, you may be required to defer the deduction of a portion of the interest paid on any indebtedness that you incurred or continued to purchase or carry the convertible note. In general, market discount will be treated as accruing ratably over the term of the convertible note, or, at your election, under a constant yield method.
You may elect to include market discount in gross income currently as it accrues (on either a ratable or constant yield basis), in lieu of treating a portion of any gain realized on a sale of the convertible note as ordinary income. If you elect to include market discount on a current basis, the interest deduction deferral rule described above will not apply. If you do make such an election, it will apply to all market discount debt instruments that you acquire on or after the first day of the first taxable year to which the election applies. The election may not be revoked without the consent of the Internal Revenue Service.
Conversion
For U.S. federal income tax purposes, if you elect to convert a convertible note into shares of common stock or ADSs pursuant to the conversion right incorporated in the terms of the convertible note, you generally will realize no gain or loss from the conversion. Your basis in the shares of common stock or ADSs received upon such a conversion generally will be equal to your adjusted basis in the convertible notes so converted, and your holding period for such shares of common stock and ADSs generally will include the period during which you held such convertible notes.
Adjustment of the Conversion Price
The conversion ratio of the convertible notes is subject to adjustment under certain circumstances. Adjustments that have the effect of increasing the proportionate interest of a holder of the convertible notes in our assets or earnings (for example, an adjustment following the distribution of property by us to our shareholders) can give rise to deemed dividend income to those holders; similarly, a failure to adjust the conversion ratio to reflect a stock dividend or other event increasing the proportionate interest of the holders of the outstanding shares of common stock or ADSs can in some circumstances give rise to deemed dividend income to those holders.
Sale, Exchange or other Disposition
Except as described above under “—Conversion,” you will generally recognize gain or loss on a sale, exchange or other disposition of a convertible note (including pursuant to any cash settlement) in an amount equal to the difference between the amount realized on such sale, exchange or other disposition (less any accrued
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stated interest, which will be taxable as ordinary interest income) and your adjusted basis in the convertible note (or, in the case of cash settlement in respect of less than all of the shares of common stock or ADSs into which the convertible notes may be converted, the amount of such basis allocable to the cash settlement amount). Initially, your tax basis in a convertible note generally will equal the cost of the convertible note to you. Your basis will increase by any amounts that you are required to include in income under the rules governing market discount, and will decrease by the amount of any amortized premium and any payments other than stated interest made on the convertible note. Gain or loss that you recognize on a sale, exchange or other disposition of a convertible note generally will be capital gain or loss, and will be long-term capital gain or loss if the convertible note was held for more than one year. Your ability to offset capital losses against ordinary income is limited. Long-term capital gain recognized by an individual U.S. holder generally is subject to taxation at reduced rates.
Foreign Tax Credit Considerations
You should consult your own tax advisers to determine whether you are subject to any special rules that limit your ability to make effective use of foreign tax credits, including the possible adverse impact of failing to take advantage of benefits under the income tax treaty between the United States and Korea. If no such rules apply, you may claim a credit against your U.S. federal income tax liability for Korean taxes withheld from payments of interest or in respect of a conversion of the convertible notes into shares of common stock or ADSs, or you may, at your election, deduct such Korean taxes in computing your taxable income, subject to generally applicable limitations under U.S. tax law.
As discussed above, your conversion of convertible notes into shares of common stock or ADSs generally will not be a taxable event for U.S. federal income tax purposes (and, thus, no U.S. federal income tax will be imposed on any gains realized by you on such a conversion transaction). Consequently, any Korean withholding tax imposed on a conversion of convertible notes into shares of common stock or ADSs would be treated for U.S. federal income tax purposes as being imposed on “general limitation” income. Such treatment may affect your ability to utilize any available foreign tax credit in respect of such Korean tax.
The calculation of foreign tax credits and, if you elect to deduct foreign taxes, the availability of deductions involve the application of complex rules that depend on your particular circumstances. You should consult your own tax advisers regarding the creditability and deductibility of such taxes.
The Bonds
Payments of stated interest on the bonds will generally be subject to U.S. federal income taxation as ordinary income at the time such payments are accrued or received, in accordance with your method of tax accounting.
Original Issue Discount
If you invest in a bond, you generally will be subject to the special tax accounting rules for “original issue discount” obligations provided by the Internal Revenue Code and certain U.S. Treasury regulations. The difference between the issue price and the stated redemption price at maturity of the bonds will be the “original issue discount.” The aggregate “issue price” of the bonds is the total principal amount thereof less the fair market value of the warrants at the time of the issuance. The “stated redemption price at maturity” will include all payments under the bonds other than payments of stated interest. You should be aware that, as described in greater detail below, if you invest in a bond, you generally will be required to include original issue discount in ordinary gross income for U.S. federal income tax purposes as it accrues, although you may not yet have received the cash attributable to that income.
In general, and regardless of whether you use the cash or the accrual method of tax accounting, if you are the holder of a bond, you will be required to include in ordinary gross income the sum of the “daily portions” of
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original issue discount on that bond for all days during the taxable year that you own the bond. The daily portions of original issue discount on a bond are determined by allocating to each day in any accrual period a ratable portion of the original issue discount allocable to that period. Accrual periods may be any length and may vary in length over the term of a bond, so long as no accrual period is longer than one year and each scheduled payment of principal or interest occurs on the first or last day of an accrual period. The amount of original issue discount on a bond allocable to each accrual period is determined by:
(i) multiplying the “adjusted issue price” (as defined below) of the bond at the beginning of the accrual period by a fraction, the numerator of which is the annual yield to maturity (defined below) of the bond and the denominator of which is the number of accrual periods in a year; and
(ii) subtracting from that product the amount payable as stated interest allocable to that accrual period.
The “adjusted issue price” of a bond at the beginning of any accrual period will generally be the sum of its issue price (including any accrued interest) and the amount of original issue discount allocable to all prior accrual periods, reduced by the amount of all payments other than any stated interest payments on the bond in all prior accrual periods. All payments on a bond (other than stated interest) will generally be viewed first as payments of previously accrued original issue discount (to the extent of the previously accrued discount), with payments considered made from the earliest accrual periods first, and then as a payment of principal. The “annual yield to maturity” of a bond is the discount rate (appropriately adjusted to reflect the length of accrual periods) that causes the present value on the issue date of all payments on the bond to equal the issue price. As a result of this “constant yield” method of including original issue discount income, the amounts you will be required to include in your gross income if you invest in a bond generally will be lower in the early years and higher in the later years than amounts that would be includible on a straight-line basis.
You generally may make an irrevocable election to include in income your entire return on a bond (i.e., the excess of all remaining payments to be received on the bond, including payments of stated interest, over the amount you paid for the bond) under the constant yield method described above. If you purchase bonds at a premium or market discount and if you make this election, you will also be deemed to have made the election (discussed below under the “Premium” and “Market Discount”) to amortize premium or to accrue market discount currently on a constant yield basis in respect of all other premium or market discount bonds that you hold.
If you purchase a bond at a cost less than its remaining redemption amount (i.e., the total of all future payments to be made on the bond other than payments of stated interest), you generally will also be required to include in gross income the daily portions of original issue discount, calculated as described above. However, if you acquire a bond at a price greater than its adjusted issue price, you will be entitled to reduce your periodic inclusions of original issue discount to reflect the premium paid over the adjusted issue price.
If you purchase a bond at a cost greater than the bond’s remaining redemption amount, you will be considered to have purchased the bond at a premium, and you may elect to amortize the premium as an offset to interest income, using a constant yield method, over the remaining term of the bond. If you make this election, it generally will apply to all debt instruments that you hold at the time of the election, as well as any debt instruments that you subsequently acquire. In addition, you may not revoke the election without the consent of the Internal Revenue Service. If you elect to amortize the premium, you will be required to reduce your tax basis in the bond by the amount of the premium amortized during your holding period. Bonds purchased at a premium will not be subject to the original issue discount rules described above.
If you do not elect to amortize premium, the amount of premium will be included in your tax basis in the bond. Therefore, if you do not elect to amortize premium and you hold the bond to maturity, you generally will be required to treat the premium as capital loss when the bond matures.
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If you purchase a bond at a price that is lower than the bond’s adjusted issue price, by 0.25% or more of the adjusted issue price, multiplied by the number of remaining whole years to maturity, the bond will be considered to bear “market discount” in your hands. In this case, any gain that you realize on the disposition of the bond generally will be treated as ordinary interest income to the extent of the market discount that accrued on the bond during your holding period. In addition, you may be required to defer the deduction of a portion of the interest paid on any indebtedness that you incurred or continued to purchase or carry the bond. In general, market discount will be treated as accruing ratably over the term of the bond, or, at your election, under a constant yield method.
You may elect to include market discount in gross income currently as it accrues (on either a ratable or constant yield basis), in lieu of treating a portion of any gain realized on a sale of the bond as ordinary income. If you elect to include market discount on a current basis, the interest deduction deferral rule described above will not apply. If you do make such an election, it will apply to all market discount debt instruments that you acquire on or after the first day of the first taxable year to which the election applies. The election may not be revoked without the consent of the Internal Revenue Service.
Sale, Exchange and Retirement of the Bonds
You will generally recognize gain or loss on a sale, exchange or other disposition of a bond in an amount equal to the difference between the amount realized on such sale, exchange or other disposition (less any accrued stated interest, which will be taxable as ordinary interest income) and your adjusted basis in the bond. Initially, your tax basis in a bond generally will equal the cost of the bond to you. Your basis will increase by any amounts that you are required to include in income under the rules governing original issue discount and market discount, and will decrease by the amount of any amortized premium and any payments other than stated interest made on the bond. (The rules for determining these amounts are discussed above.) Except as discussed above with respect to market discount, gain or loss recognized on a sale, exchange or other disposition of a bond generally will be capital gain or loss, and will be long-term capital gain or loss if the bond was held for more than one year. Your ability to offset capital losses against ordinary income is limited. Long-term capital gain recognized by an individual U.S. holder generally is subject to taxation at reduced rates.
You should consult your own tax advisers to determine whether you are subject to any special rules that limit your ability to make effective use of foreign tax credits, including the possible adverse impact of failing to take advantage of benefits under the income tax treaty between the United States and Korea. If no such rules apply, you may claim a credit against your U.S. federal income tax liability for Korean taxes withheld from payments of interest, or you may, at your election, deduct such Korean taxes in computing your taxable income, subject to generally applicable limitations under U.S. tax law.
The Shares of Common Stock and ADSs
In general, if you hold ADSs, you will be treated as the holder of the shares of common stock represented by those ADSs for U.S. federal income tax purposes, and no gain or loss will be recognized if you exchange an ADS for the shares of common stock represented by that ADS.
The gross amount of cash dividends that you receive (prior to deduction of Korean taxes) generally will be subject to U.S. federal income taxation as foreign source dividend income. Dividends paid in Won will be
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included in your income in a U.S. dollar amount calculated by reference to the exchange rate in effect on the date of your (or, in the case of ADSs, the depositary’s) receipt of the dividend, regardless of whether the payment is in fact converted into U.S. dollars. If such a dividend is converted into U.S. dollars on the date of receipt, you generally should not be required to recognize foreign currency gain or loss in respect of the dividend income.
Subject to certain exceptions for short-term and hedged positions, the U.S. dollar amount of dividends received by an individual prior to January 1, 2009 with respect to the ADSs will be subject to taxation at a maximum rate of 15% if the dividends are “qualified dividends.” Dividends paid on the ADSs will be treated as qualified dividends if (i) the ADSs are readily tradeable on an established securities market in the United States and (ii) we were not, in the year prior to the year in which the dividend was paid, and are not, in the year in which the dividend is paid, a passive foreign investment company (“PFIC”), foreign personal holding company (“FPHC”) or foreign investment company (“FIC”). The ADSs are listed on the New York Stock Exchange, and will qualify as readily tradeable on an established securities market in the United States so long as they are so listed. Based on our audited financial statements and relevant market and shareholder data, we believe that we were not treated as a PFIC, FPHC or FIC for U.S. federal income tax purposes with respect to our 2003 taxable year. In addition, based on our audited financial statements and our current expectations regarding the value and nature of our assets, the sources and nature of our income, and relevant market and shareholder data, we do not anticipate becoming a PFIC, FPHC or FIC for our 2004 taxable year. Based on existing guidance, it is not entirely clear whether dividends received with respect to the common shares will be treated as qualified dividends, because the common shares are not themselves listed for trading on a U.S. exchange. In addition, the U.S. Treasury has announced its intention to promulgate rules pursuant to which holders of ADSs or common stock and intermediaries though whom such securities are held will be permitted to rely on certifications from issuers to establish that dividends are treated as qualified dividends. Because such procedures have not yet been issued, it is not clear whether we will be able to comply with them. You should consult your own tax advisers regarding the availability of the reduced dividend tax rate in the light of your own particular circumstances.
Distributions of additional shares in respect of shares of common stock or ADSs that are made as part of a pro-rata distribution to all of our shareholders generally will not be subject to U.S. federal income tax.
Sales and Other Dispositions
For U.S. federal income tax purposes, gain or loss you realize on the sale or other disposition of shares of common stock or ADSs will be capital gain or loss, and will be long-term capital gain or loss if the shares of common stock or ADSs were held for more than one year. Your ability to offset capital losses against ordinary income is limited. Long-term capital gain recognized by an individual U.S. holder generally is subject to taxation at reduced rates.
You should consult your own tax advisers to determine whether you are subject to any special rules that limit your ability to make effective use of foreign tax credits, including the possible adverse impact of failing to take advantage of benefits under the income tax treaty between the United States and Korea. If no such rules apply, you may claim a credit against your U.S. federal income tax liability for Korean taxes withheld from dividends on shares of common stock or ADSs, so long as you have owned the shares of common stock or ADSs (and not entered into specified kinds of hedging transactions) for at least a 16-day period that includes the ex-dividend date. Instead of claiming a credit, you may, at your election, deduct such Korean taxes in computing your taxable income, subject to generally applicable limitations under U.S. tax law. Korean taxes withheld from a distribution of additional shares that is not subject to U.S. tax will be treated for U.S. federal income tax purposes as imposed on “general limitation” income. Such treatment may affect your ability to utilize any available foreign tax credit in respect of such taxes.
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Any Korean securities transaction tax or agriculture and fishery special tax that you pay will not be creditable for foreign tax credit purposes.
The calculation of foreign tax credits and, in the case of a U.S. holder that elects to deduct foreign taxes, the availability of deductions involve the application of complex rules that depend on a U.S. holder’s particular circumstances. You should consult your own tax advisers regarding the creditability or deductibility of such taxes.
U.S. Information Reporting and Backup Withholding Rules
Payments in respect of the convertible notes, bonds, shares of common stock or ADSs that are made within the United States or through certain U.S.-related financial intermediaries are subject to information reporting and may be subject to backup withholding unless the holder (1) is a corporation or other exempt recipient or (2) provides a taxpayer identification number and certifies that no loss of exemption from backup withholding has occurred. Holders that are not U.S. persons generally are not subject to information reporting or backup withholding. However, such a holder may be required to provide a certification of its non-U.S. status in connection with payments received within the United States or through a U.S.-related financial intermediary.
Item 10.F. Dividends and Paying Agents
See “Item 8. Financial Information—Consolidated Statements and Other Financial Information—Dividends” for information concerning our dividend policies and our payment of dividends. See “Item 10. Additional Information—Item 10.B. Memorandum and Articles of Association—Dividends” for a discussion of the process by which dividends are paid on our common shares. See “Item 12. Description of Securities Other than Equity Securities—Description of American Depositary Shares—Dividends and Distributions” for a discussion of the process by which dividends are paid on our ADSs. The paying agent for payment of our dividends on ADSs in the United States is Citibank, N.A.
Item 10.G. Statements by Experts
The financial statements as of December 31, 2002 and 2003 and for the three years ended December 31, 2003 included in this annual report have been audited by KPMG Samjong Accounting Corp., independent registered public accounting firm, as stated in their report appearing herein and are included in reliance upon the report of such firm given upon their authority as experts in accounting and auditing. KPMG Samjong Accounting Corp. is the Korean member firm of KPMG. KPMG refers to the network of member firms of KPMG International, each of which is a separate and independent legal entity. KPMG Samjong Accounting Corp.’s address is Star Towers, 10th Floor, Kangnam-ku Yuksam-dong 773, Seoul (135-984), Korea.
Item 10.H. Documents on Display
We are subject to the information requirements of the U.S. Securities Exchange Act of 1934, as amended, and, in accordance therewith, are required to file reports, including annual reports on Form 20-F, and other information with the U.S. Securities and Exchange Commission. These materials, including this annual report and the exhibits thereto, may be inspected and copied at the Commission’s public reference rooms in Washington, D.C., New York, New York and Chicago, Illinois. Please call the Commission at 1-800-SEC-0330 for further information on the public reference rooms. We are required to make filings with the Commission by electronic means, which will be available to the public over the Internet at the Commission’s web site at http://www.sec.gov.
Item 11. Quantitative and Qualitative Disclosures About Market Risk
We are exposed to foreign exchange rate and interest rate risks primarily associated with underlying liabilities, and to equity price risk as a result of our investment in equity-linked securities. Following evaluation
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of these positions, we selectively enter into derivative financial instruments to manage the related risk exposures. These contracts are entered into with major financial institutions, thereby minimizing the risk of credit loss. The activities of our finance division are subject to policies approved by senior management. These policies address the use of derivative financial instruments, including the approval of counterparties, setting of limits and investment of excess liquidity. Our general policy is to hold or issue derivative financial instruments only for hedging purposes.
Exchange Rate Risk
Substantially all of our cash flow is denominated in Won. We are exposed to foreign exchange risk related to foreign currency denominated liabilities and anticipated foreign exchange payments. Anticipated foreign exchange payments, mostly in Dollars, relate primarily to payments of foreign currency denominated debt, net settlements paid to foreign telecommunication carriers and payments for equipment purchased from foreign suppliers.
We entered into two currency swap contracts for principal and interest denominated in Won in place of principal and interest of long-term debt denominated in dollars in June 2003. Details of currency swap contracts outstanding as of December 31, 2003 are as follows:
Bank
Receiving
interest rate
Paying
J.P. Morgan
Under these currency swap contracts, we recognized a valuation loss of (Won)2.4 billion in 2003.
In October 2003, we also entered into five interest currency swap contracts with financial institutions for principal and the variable rate of interest denominated in Won in place of principal and the fixed rate of interest of long-term debt denominated in Dollars. The principal amounts in Won will be adjusted according to the foreign exchange rate of the terminal date within certain ranges. Details of interest currency swap contracts outstanding as of December 31, 2003 are as follows:
Amount
(billions)
Fixed Receivinginterest rate
(1 year)
Variable paying
(6 months)
Citibank
UBS Bank
Deutsche bank
Shinhan bank
Under these interest currency swap contracts, we recognized a valuation gain of (Won)5.1 billion in 2003.
Interest Rate Risk
We are also subject to market risk exposure arising from changing interest rates. A reduction of interest rates increases the fair value of our debt portfolio, which is primarily of a fixed interest nature. We use, to a limited extent, interest rate swap contracts, interest rate swaption contracts and interest currency swap contracts to reduce interest rate volatility on some of our debt and manage our interest expense by achieving a balanced mixture of floating and fixed rate debt.
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During 2003, we entered into various interest rate swap contracts with financial institutions for variable rates of interest in place of fixed rates of interest. Details of interest rate swap contracts outstanding as of December 31, 2003 are as follows:
Fixed amount(millions ofDollars andbillions
of Won)
Shinhan Bank
Under the above interest rate swap contracts, we recognized a net valuation loss of (Won)13.4 billion in 2003. In addition, we settled two contracts before the terminal date and recognized a transaction gain of (Won)8.2 billion in 2003.
In 2002, we also entered into one interest rate swaption contract with Citibank for variable rates of interest in place of fixed rates of interest. Details of interest rate swaption contract outstanding as of December 31, 2003 are as follows:
Under the above interest swaption contract, we recognized a valuation gain of (Won)2.4 billion in 2003.
In addition, we entered into five interest currency swap contracts with financial institutions for principal and the variable rate of interest denominated in Won in place of principal and the fixed rate of interest of long-term debt denominated in U.S. dollars in October 2003, as discussed above in “—Exchange Rate Risk”.
See note 22 to the Consolidated Financial Statements.
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The following table summarizes the carrying amounts, fair values, principal cash flows by maturity date and weighted average interest rates of our short-term and long-term liabilities as of December 31, 2003 which are sensitive to exchange rates and/or interest rates. The information is presented in Won, which is our reporting currency.
Fair
Local currency:
Fixed rate
Average weighted rate(1)
Variable rate
Foreign currency, principally Dollars:
Subtotal
Item 12. Description of Securities Other than Equity Securities
Description of American Depositary Shares
Citibank, N.A. is the depositary bank for our outstanding American Depositary Shares and has agreed to continue to act as the depositary bank for this offering of American Depositary Shares. Citibank’s depositary offices are located at 111 Wall Street, New York, New York 10005. American Depositary Shares are frequently referred to as “ADSs” and represent ownership interests in securities that are on deposit with the depositary bank. ADSs are normally represented by certificates that are commonly known as “American Depositary Receipts” or “ADRs”. The depositary bank typically appoints a custodian to safekeep the securities on deposit. In this case, the custodian is Korea Securities Depository located at 33 Yoido-dong, Youngdeungpo-ku, Seoul 150-010, Korea.
We have appointed Citibank as depositary bank pursuant to a deposit agreement. A copy of the deposit agreement is on file with the SEC under cover of a Registration Statement on Form F-6. You may obtain a copy of the deposit agreement from the SEC’s Public Reference Room at 450 Fifth Street, N.W., Washington, D.C. 20549. Please refer to Registration Number 333-13578 when retrieving such copy.
We are providing you with a summary description of the material terms of the ADSs and of your material rights as an owner of ADSs. Please remember that summaries by their nature lack the precision of the information summarized and that a holder’s rights and obligations as an owner of ADSs will be determined by reference to the terms of the deposit agreement and not by this summary. We urge you to review the deposit agreement in its entirety.
Each ADS represents one-half of one share of common stock on deposit with the custodian. An ADS will also represent any other property received by the depositary bank or the custodian on behalf of the owner of the ADS but that has not been distributed to the owners of ADSs because of legal restrictions or practical considerations.
If you become an owner of ADSs, you will become a party to the deposit agreement and therefore will be bound to its terms and to the terms of the ADR that represents your ADSs. The deposit agreement and the ADRs
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specify our rights and obligations as well as your rights and obligations as owner of ADSs and those of the depositary bank. As an ADS holder you appoint the depositary bank to act on your behalf in certain circumstances. The deposit agreement and the ADRs are governed by New York law. However, our obligations to the holders of common stock will continue to be governed by the laws of Korea which may be different from the laws in the United States.
As an owner of ADSs, you may hold your ADSs either by means of an ADR registered in your name or through a brokerage or safekeeping account. If you decide to hold your ADSs through your brokerage or safekeeping account, you must rely on the procedures of your broker or bank to assert your rights as ADS owner. Please consult with your broker or bank to determine what those procedures are. This summary description assumes you have opted to own the ADSs directly by means of an ADR registered in your name and, as such, we will refer to you as the “holder”. When we refer to “you”, we assume the reader owns ADSs and will own ADSs at the relevant time.
Dividends and Distributions
As a holder, you generally have the right to receive the distributions we make on the securities deposited with the custodian bank. Your receipt of these distributions may be limited, however, by practical considerations and legal limitations. Holders will receive such distributions under the terms of the deposit agreement in proportion to the number of ADSs held as of a specified record date.
Distributions of Cash
Whenever we make a cash distribution for the securities on deposit with the custodian, we will notify the depositary bank. Upon receipt of such notice the depositary bank will arrange for the funds to be converted into U.S. dollars and for the distribution of the U.S. dollars to the holders, subject to Korean laws and regulations.
The conversion into U.S. dollars will take place only if practicable and if the U.S. dollars are transferable to the United States. The amounts distributed to holders will be net of the fees, expenses, taxes and governmental charges payable by holders under the terms of the deposit agreement. The depositary bank will apply the same method for distributing the proceeds of the sale of any property (such as undistributed rights) held by the custodian in respect of securities on deposit.
The distribution of cash will be made net of fees, expenses, taxes and governmental charges payable by holders under the terms of the deposit agreement.
Distributions of Shares
Whenever we make a free distribution of common stock for the securities on deposit with the custodian, we will notify the depositary bank and deposit the applicable number of common stock with the custodian. Upon receipt of notice of such deposit, the depositary bank will either distribute to holders new ADSs representing the common stock deposited or modify the ADS to common stock ratio, in which case each ADS you hold will represent rights and interests in the additional common stock so deposited. Only whole new ADSs will be distributed. Fractional entitlements will be sold and the proceeds of such sale will be distributed as in the case of a cash distribution.
The distribution of new ADSs or the modification of the ADS-to-share ratio upon a distribution of common stock will be made net of the fees, expenses, taxes and governmental charges payable by holders under the terms of the deposit agreement. In order to pay such taxes or governmental charges, the depositary bank may sell all or a portion of the new common stock so distributed.
No such distribution of new ADSs will be made if it would violate a law (such as the U.S. securities laws) or if it is not, in our opinion or that of the depositary bank, operationally practicable. If the depositary bank does not
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distribute new ADSs as described above, it will use its best efforts to sell the common stock received and will distribute the proceeds of the sale as in the case of a distribution of cash.
Distributions of Rights
Whenever we intend to distribute rights to purchase additional common stock, we will give prior notice to the depositary bank and the depositary bank will determine whether it is lawful and reasonably practicable to distribute rights to purchase additional ADSs to holders.
The depositary bank will establish procedures to distribute rights to purchase additional ADSs to holders and to enable such holders to exercise such rights if it is lawful and reasonably practicable to make the rights available to holders of ADSs, and if we provide all of the documentation contemplated in the deposit agreement such as opinions to address the lawfulness of the transaction. You may have to pay fees, expenses, taxes and other governmental charges to subscribe for the new ADSs upon the exercise of your rights. The depositary bank is not obligated to establish procedures to facilitate the distribution and exercise by holders of rights to purchase new common stock directly rather than new ADSs.
The depositary bank will not distribute the rights to you if:
The depositary bank will sell the rights that are not exercised or not distributed if such sale is, in our opinion, lawful and reasonably practicable. The proceeds of such sale will be distributed to holders as in the case of a cash distribution. If the depositary bank is unable to sell the rights, it will allow the rights to lapse.
Other Distributions
Whenever we intend to distribute property other than cash, common stock or rights to purchase additional common stock, we will notify the depositary bank in advance and will indicate whether we wish such distribution to be made to you. If so, the depositary bank will determine whether such distribution to holders is lawful and reasonably practicable.
If it is reasonably practicable to distribute such property to you and if we provide all of the documentation contemplated in the deposit agreement, the depositary bank will distribute the property to the holders in a manner it deems practicable.
The distribution will be made net of fees, expenses, taxes and governmental charges payable by holders under the terms of the deposit agreement. In order to pay such taxes and governmental charges, the depositary bank may sell all or a portion of the property received.
The depositary bank will not distribute the property to you and will sell the property if:
The proceeds of such a sale will be distributed to holders as in the case of a cash distribution.
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If a distribution consists of a dividend in, or a free distribution of, our non-voting preferred stock, we will enter into a non-voting shares deposit agreement with the depositary bank. If you are an owner of ADSs, you will become a party to the non-voting shares deposit agreement and will receive depositary shares representing the non-voting preferred stock in proportion to your holding of ADSs. However, if the depositary bank determines that such a distribution of our non-voting preferred stock is not feasible, it may adopt, after consultation with us, another method of effecting such a distribution which it deems to be equitable and practicable. If we issue rights with respect to our non-voting preferred stock, the securities issuable upon the exercise of such rights will be depositary shares representing our non-voting preferred stock issued pursuant to a non-voting shares deposit agreement.
We will not be obligated to list depositary shares representing our non-voting preferred stock on any exchange.
Changes Affecting Common Stock
The common stock held on deposit for your ADSs may change from time to time. For example, there may be a change in nominal or par value, a split-up, cancellation, consolidation or reclassification of such common stock or a recapitalization, reorganization, merger, consolidation or sale of assets.
If any such change were to occur, your ADSs would, to the extent permitted by law, represent the right to receive the property received or exchanged in respect of the common stock held on deposit. The depositary bank may (with our approval) or will (if we request) deliver new ADSs to you or call for the exchange of your existing ADSs for new ADSs in such circumstances. If the depositary bank may not lawfully distribute such property to you, the depositary bank may sell such property and distribute the net proceeds to you as in the case of a cash distribution.
Issuance of ADSs upon Deposit of Common Stock
The depositary bank may create ADSs on your behalf if you or your broker deposits common stock with the custodian. The depositary bank will deliver these ADSs to the person you indicate only after you pay any applicable issuance fees and any charges and taxes payable for the transfer of the common stock to the custodian. Your ability to deposit common stock and receive ADSs may be limited by U.S. and Korean legal considerations applicable at the time of deposit. The depositary bank cannot accept deposits of shares and deliver ADSs representing those shares unless (1) we have consented to such deposit or (2) Korean counsel has advised the depositary bank that the consent required under (1) is no longer required under Korean laws and regulations. Under current Korean laws and regulations, the depositary bank is required to obtain our prior consent for the number of shares to be deposited in any given proposed deposit which exceeds the difference between (1) the aggregate number of shares deposited by us or with the consent of us for the issuance of ADSs (including deposits in connection with the initial and all subsequent offerings of ADSs and stock dividends or other distributions related to these ADSs) and (2) the number of shares on deposit with the depositary bank at the time of such proposed deposit. The depositary bank has informed us that, at a time it considers to be appropriate, the depositary bank plans to start accepting deposits of shares without our consent and deliver ADSs representing those shares up to the amount allowed under current Korean laws and regulations. Until such time, however, the depositary bank will continue to obtain our consent for such deposits of shares and delivery of ADSs, which we may not provide.
The issuance of ADSs may be delayed until the depositary bank or the custodian receives confirmation that all required approvals have been given and that the common stock has been duly transferred to the custodian. The depositary bank will only issue ADSs in whole numbers.
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When you make a deposit of common stock, you will be responsible for transferring good and valid title to the depositary bank. As such, you will be deemed to represent and warrant that:
If any of the representations or warranties are incorrect in any way, we and the depositary bank may, at your cost and expense, take any and all actions necessary to correct the consequences of the misrepresentations.
Withdrawal of Shares Upon Cancellation of ADSs
As a holder, you will be entitled to present your ADSs to the depositary bank for cancellation and then receive the corresponding number of underlying shares of common stock at the custodian’s offices. In order to withdraw the common stock represented by your ADSs, you will be required to pay to the depositary bank the fees for cancellation of ADSs and any charges and taxes payable upon the transfer of the common stock being withdrawn. You assume the risk for delivery of all funds and securities upon withdrawal. Once cancelled, the ADSs will not have any rights under the deposit agreement.
If you hold an ADR registered in your name, the depositary bank may ask you to provide proof of identity and genuineness of any signature and such other documents as the depositary bank may deem appropriate before it will cancel your ADSs. The withdrawal of the common stock represented by your ADSs may be delayed until the depositary bank receives satisfactory evidence of compliance with all applicable laws and regulations. Please keep in mind that the depositary bank will only accept ADSs for cancellation that represent a whole number of securities on deposit.
You will have the right to withdraw the securities represented by your ADSs at any time except for:
The deposit agreement may not be modified to impair your right to withdraw the securities represented by your ADSs except to comply with mandatory provisions of law.
An investor who wants to withdraw the shares from the depositary facility created under the deposit agreement must register its identity with the Financial Supervisory Service of Korea before the acquisition of the shares if such registration has not been made unless such investor intends to sell the shares within three months of obtaining them. See “Item 10. Additional Information—Item 10.D. Exchange controls—Restrictions Applicable to ADSs”.
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As a holder, you generally have the right under the deposit agreement to instruct the depositary bank to exercise the voting rights for the common stock represented by your ADSs. The voting rights of holders of common stock are described in this annual report under the heading, “Additional Information—Articles of Incorporation—Voting Rights”.
At our request, the depositary bank will distribute to you any notice of shareholders’ meetings received from us together with information explaining how to instruct the depositary bank to exercise the voting rights of the securities represented by ADSs.
If the depositary bank timely receives voting instructions from a holder of ADSs, it will endeavor to vote the securities represented by the holder’s ADSs in accordance with such voting instructions.
Please note that the ability of the depositary bank to carry out voting instructions may be limited by practical and legal limitations and the terms of the securities on deposit. We may not be able to notify the depositary bank sufficiently in advance of the scheduled date of a shareholders’ meeting and cannot assure you that you will receive voting materials in time to enable you to return voting instructions to the depositary bank in a timely manner. Securities for which no voting instructions have been received will not be voted, and the depositary bank and the custodian will not exercise any discretion as to voting under any circumstances.
Fees and Charges
As an ADS holder, you will be required to pay the following service fees to the depositary bank:
Issuance of ADSs
Cancellation of ADSs
Distributions (other than cash or stock dividends); Sale or exercise of rights; or other corporate action involving distributions to shareholders (including any distribution in the form of common stock, non-voting preferred stock or delivery of ADSs upon exercise of rights)
The depositary bank has agreed to waive the fees that would have been payable in connection with the issuance of ADSs in offerings of ADSs by us. In addition, the depositary bank has agreed to waive the fees that may be payable by the Government in connection with this offering.
As an ADS holder you will also be responsible for paying the following fees and expenses incurred by the depositary bank and taxes and governmental charges:
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We have agreed to pay certain other charges and expenses of the depositary bank. Please note that the fees and charges you may be required to pay may vary over time and may be changed by us and by the depositary bank. You will receive prior notice of such changes.
Amendments and Termination
We may agree with the depositary bank to modify the deposit agreement at any time without your consent. We undertake to give holders 30 days’ prior notice of any modifications that would materially prejudice any of their substantial rights under the deposit agreement.
You will be bound by the modifications to the deposit agreement if you continue to hold your ADSs after the modifications to the deposit agreement become effective. The deposit agreement cannot be amended to prevent you from withdrawing the common stock represented by your ADSs (except as permitted by law).
We have the right to direct the depositary bank to terminate the deposit agreement. Similarly, the depositary bank may in certain circumstances on its own initiative terminate the deposit agreement. In either case, the depositary bank must give notice to the holders at least 30 days before termination.
If any ADSs remain outstanding after termination, the following will occur under the deposit agreement:
Books of Depositary
The depositary bank will maintain ADS holder records at its depositary office. You may inspect such records at such office during regular business hours but solely for the purpose of communicating with other holders in the interest of business matters relating to the ADSs and the deposit agreement.
The depositary bank will maintain in New York facilities to record and process the issuance, cancellation, combination, split-up and transfer of ADRs. These facilities may be closed from time to time, to the extent not prohibited by law.
Limitations on Obligations and Liabilities
The deposit agreement limits our obligations and the depositary bank’s obligations to you. Please note the following:
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Pre-Release Transactions
The depositary bank may, in certain circumstances, issue ADSs before receiving a deposit of common stock and deliver shares of common stock before receipt and cancellation of ADSs. These transactions are commonly referred to as “pre-release transactions”. The deposit agreement limits the aggregate size of pre-release transactions and imposes a number of conditions on such transactions (i.e., the need to receive collateral, the type of collateral required, the representations required from brokers, etc.). The depositary bank may retain the compensation received from the pre-release transactions.
Taxes
You will be responsible for the taxes and other governmental charges payable on the ADSs and the securities represented by the ADSs. We, the depositary bank and the custodian may deduct from any distribution the taxes and governmental charges payable by holders and may sell any and all property on deposit to pay the taxes and governmental charges payable by holders. You will be liable for any deficiency if the sale proceeds do not cover the taxes that are due.
The depositary bank may refuse to issue ADSs, to deliver, transfer, split and combine ADRs or to release securities on deposit until all taxes and charges are paid by the applicable holder. The depositary bank and the custodian may take reasonable administrative actions to obtain tax refunds and reduced tax withholding for any distributions on your behalf. However, you may be required to provide to the depositary bank and to the custodian proof of taxpayer status and residence and such other information as the depositary bank and the custodian may require to fulfill legal obligations. In certain circumstances, you will be required to indemnify us, the depositary bank and the custodian for any claims with respect to taxes based on any tax benefit obtained for you.
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Foreign Currency Conversion
The depositary bank will arrange for the conversion of all foreign currency received into U.S. dollars if such conversion is practical, and it will distribute the U.S. dollars in accordance with the terms of the deposit agreement. You may have to pay fees and expenses incurred in converting foreign currency, such as fees and expenses incurred in complying with currency exchange controls and other governmental requirements.
If the conversion of foreign currency is not practical or lawful, or if any required approvals are denied or not obtainable at a reasonable cost or within a reasonable period, the depositary bank may take the following actions in its discretion:
The Custodian
The depositary bank has agreed with the custodian that the custodian will receive and hold the deposited securities for the account of the depositary bank in accordance with the deposit agreement. If the custodian resigns or is discharged from its duties under the deposit agreement, the depositary bank will promptly appoint a successor custodian that is organized under the laws of Korea. The resigning or discharged custodian will deliver the deposited securities and related records to the custodian designated by the depositary bank. The depositary bank may also appoint an additional custodian for any deposited securities. The depositary bank will immediately give you and us written notice of any such changes. If the depositary bank resigns or is discharged from its duties under the deposit agreement, the custodian will, unless otherwise instructed by the depositary bank, continue to act as custodian and will be subject to the direction of the successor depositary.
Governing Law
The deposit agreement is governed by the laws of the State of New York. We and the depositary bank have agreed that the federal or state courts in The City of New York shall have jurisdiction to hear and determine any suit, action or proceeding and to settle any dispute between us that may arise out of or in connection with the deposit agreement. We also submitted to the jurisdiction of such courts and we have appointed an agent for service of process in The City of New York.
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Item 13. Defaults, Dividend Arrearages and Delinquencies
Item 14. Material Modifications to the Rights of Security Holders and Use of Proceeds
Item 15. Controls and Procedures
As of December 31, 2003, we carried out an evaluation under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures. There are inherent limitations to the effectiveness of any system of disclosure controls and procedures, including the possibility of human error and the circumvention or overriding of the controls and procedures. Accordingly, even effective disclosure controls and procedures can only provide reasonable assurance of achieving their control objectives. Based upon and as of the date of our evaluation, our Chief Executive Officer and Chief Financial Officer concluded that the disclosure controls and procedures as of December 31, 2003 were effective to provide reasonable assurance that information required to be disclosed in the reports we file and submit under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported as and when required.
There has been no change in our internal control over financial reporting during 2003 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
Item 16.A. Audit Committee Financial Expert
At our annual general meeting of shareholders in March 2004, our shareholders elected the following four members of the Audit Committee: Jong-Sang Kim, Do-Hwan Kim, Jeong-Ro Yoon and Kon-Sik Kim. In addition, they determined and designated that Jong-Sang Kim is an “audit committee financial expert” within the meaning of this Item 16A. The board of directors have approved this newly elected Audit Committee, and reaffirmed the determination by our shareholders that Jong-Sang Kim is an audit committee financial expert and further determined that he is independent within the meaning of applicable SEC rules and the listing standards of the New York Stock Exchange.
Item 16.B. Code of Ethics
We have adopted a code of ethics, as defined in Item 16B of Form 20-F under the Securities Exchange Act of 1934, as amended. Our code of ethics applies to our Chief Executive Officer, Chief Financial Officer and persons performing similar functions, as well as to our directors, other officers and employees. Our code of ethics is available on our web site at www.kt.co.kr. If we amend the provisions of our code of ethics that apply to our Chief Executive Officer, Chief Financial Officer and persons performing similar functions, or if we grant any waiver of such provisions, we will disclose such amendment or waiver on our web site.
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Item 16.C. Principal Accountant Fees and Services
Audit and Non-Audit Fees
The following table sets forth the fees billed to us by our independent auditors, KPMG Samjong Accounting Corp., during the fiscal years ended December 31, 2002 and 2003:
Year ended
December 31,
Audit fees
Audit-related fees
Tax fees
Other fees
Total fees
Audit fees in the above table are the aggregate fees billed by KPMG Samjong Accounting Corp. in connection with the audit of our annual financial statements and the review of our interim financial statements.
Audit-related fees in the above table are the aggregate fees billed by KPMG Samjong Accounting Corp. for advisory services relating to analyses of multiple accounting issues.
Tax fees in the above table are fees billed by KPMG Samjong Accounting Corp. for the preparation of our income tax return and tax advice.
Other fees in the above table are fees billed by KPMG Samjong Accounting Corp. primarily related to best practice recommendations for our finance resource management system.
Audit Committee Pre-Approval Policies and Procedures
Our audit committee has not established pre-approval policies and procedures for the engagement of our independent auditors for services. Our audit committee expressly approves on a case-by-case basis any engagement of our independent auditors for audit and non-audit services provided to our subsidiaries or us.
Item 16.D. Exemptions from the Listing Standards for Audit Committees
Item 16.E. Purchases of Equity Securities by the Issuer and Affiliated Purchasers
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Item 17. Financial Statements
Item 18. Financial Statements
AUDITED CONSOLIDATED ANNUAL FINANCIAL STATEMENTS OF KT CORPORATION
Report of Independent Registered Public Accounting Firm of KPMG Samjong Accounting Corp.
Consolidated Balance Sheets as of December 31, 2002 and 2003
Consolidated Statements of Earnings and Retained Earnings for the Years Ended December 31, 2001, 2002 and 2003
Consolidated Statements of Cash Flows for the Years Ended December 31, 2001, 2002 and 2003
Notes to Consolidated Financial Statements
AUDITED CONSOLIDATED ANNUAL FINANCIAL STATEMENTS OF KT FREETEL CO., LTD.*
Report of Independent Public Accountants of Anjin Deloitte LLC for the Years Ended December 31, 2003 and 2002
Consolidated Balance Sheets as of December 31, 2003 and 2002
Consolidated Statements of Income for the Years Ended December 31, 2003 and 2002
Consolidated Statements of Shareholders’ Equity for the Years Ended December 31, 2003 and 2002
Consolidated Statements of Cash Flows for the Years Ended December 31, 2003 and 2002
Notes to Consolidated Financial Statements for Years Ended December 31, 2003 and 2002
AUDITED CONSOLIDATED ANNUAL FINANCIAL STATEMENTS OF KT FREETEL CO., LTD.
Report of Independent Public Accountants of Anjin Deloitte LLC for the Years Ended December 31, 2002 and 2001
Consolidated Balance Sheets as of December 31, 2002 and 2001
Consolidated Statements of Income for the Years Ended December 31, 2002 and 2001
Consolidated Statements of Shareholders’ Equity for the Years Ended December 31, 2002 and 2001
Consolidated Statements of Cash Flows for the Years Ended December 31, 2002 and 2001
Notes to Consolidated Financial Statements for Years Ended December 31, 2002 and 2001
AUDITED FINANCIAL STATEMENTS OF KT ICOM CO., LTD.
Reports of Independent Public Accountants of Samil Accounting Corporation for the period from March 16, 2001 to December 31, 2001 and for the year ended December 31, 2002.**
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Item 19. Exhibits
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Report of Independent Registered Public Accounting Firm
The Board of Directors and Stockholders
KT Corporation:
We have audited the accompanying consolidated balance sheets of KT Corporation and subsidiaries (the “Company”) as of December 31, 2002 and 2003, and the related consolidated statements of earnings and retained earnings and cash flows for each of the years in the three-year period ended December 31, 2003, all expressed in Korean Won. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We did not audit the financial statements of (1) KT Freetel Co., Ltd. (“KTF”), a 40.3% and 46.9% owned subsidiary at December 31, 2002 and 2003, respectively, as of and for each of the years in the three-year period ended December 31, 2003, and (2) KTICOM Co., Ltd. (“KTICOM”), a 87.3% owned (all owned by KTF) subsidiary at December 31, 2002, for the period from March 16, 2001 (date of inception) to December 31, 2001 and for the year ended December 31, 2002, which was merged into KTF on March 6, 2003. The financial statements of KTF and KTICOM, which are included in the consolidated financial statements of the Company, reflect total combined assets constituting 30.1% and 29.1% as of December 31, 2002 and 2003, respectively, and total revenues constituting 27.8%, 29.3% and 28.1% for the years ended December 31, 2001, 2002 and 2003, respectively, of the related consolidated totals. Those financial statements were audited by other auditors whose reports have been furnished to us, and our report, insofar as it relates to the amounts included for KTF and KTICOM, is based solely on the reports of the other auditors.
We conducted our audits in accordance with the Auditing Standards as established by the Financial Supervisory Commission of the Republic of Korea, and the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits and the reports of the other auditors provide a reasonable basis for our opinion.
In our opinion, based on our audits and the reports of the other auditors, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2002 and 2003, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2003 in accordance with the Financial Accounting Standards, as established by the Financial Supervisory Commission of the Republic of Korea.
The accompanying consolidated financial statements as of and for the year ended December 31, 2003 have been translated into United States dollars solely for the convenience of the reader and have been translated on the basis set forth in note 3 to the consolidated financial statements.
As discussed in note 2(a) to the consolidated financial statements, effective on January 1, 2003, the Company adopted Statements of Korea Accounting Standards No. 2 through No. 9. In accordance with these standards, the cumulative effects on prior years were recorded as an adjustment to the beginning balance of retained earnings and minority interest at January 1, 2003. In addition, certain accounts of prior year’s financial statements were reclassified to conform to the current year’s presentation.
Accounting principles generally accepted in the Republic of Korea vary in certain significant respects from accounting principles generally accepted in the United States of America. Information relating to the nature and effect of such differences is presented Note 34 to the consolidated financial statements.
KPMG Samjong Accounting Corp.
Seoul, Korea
February 13, 2004
F-1
KT CORPORATION AND SUBSIDIARIES
Consolidated Balance Sheets
December 31, 2002 and 2003
(In millions of won and U.S. dollars)
(note 3)
Assets
Current assets:
Cash and cash equivalents (notes 4 and 5)
Short-term financial instruments (note 5)
Current portion of investment securities (note 8):
Trading securities
Available-for-sale securities
Held-to-maturity securities
Notes and accounts receivable—trade, less allowance for doubtful accounts of (Won)430,066 in 2002 and (Won)646,273 in 2003 (note 2)
Inventories (note 6)
Other current assets (note 7)
Total current assets
Investment securities:
Available-for-sale securities (note 8)
Held-to-maturity securities (note 8)
Equity securities of affiliates (note 9)
Total investment securities
Property, plant and equipment (note 10):
Land
Buildings and structures
Machinery and equipment
Vehicles
Tools, furniture and fixtures
Construction in progress
Less accumulated depreciation
Net property, plant and equipment
Other assets (notes 5, 11 and 25)
See accompanying notes to consolidated financial statements.
F-2
Consolidated Balance Sheets—Continued
(In millions of won and U.S. dollars, except share data)
Liabilities and Stockholders’ Equity
Current liabilities:
Short-term borrowings (note 12)
Current portion of long-term debt (note 14)
Advance receipts from customers
Accrued expenses
Withholdings
Income taxes payable
Other current liabilities (note 13)
Total current liabilities
Long-term debt, excluding current portion (note 14)
Refundable deposits for telephone installation (note 15)
Retirement and severance benefits, net of cumulative transfers to National Pension Fund and deposit for severance benefit insurance (note 16)
Long-term accounts payable—other (note 2(l))
Other long-term liabilities (note 17)
Total liabilities
Stockholders’ equity (note 18):
Common stock of (Won)5,000 par value:
Authorized—1,000,000,000 shares Issued—309,077,659 shares in 2002 and 284,849,400 shares in 2003
Capital surplus (note 19)
Retained earnings (deficit):
Appropriated (note 20)
Unappropriated (deficit)
Capital adjustments:
Foreign-based operations translation adjustment
Unrealized gains (losses) on available-for-sale securities (note 8)
Unrealized losses on equity securities of affiliates (note 9)
Stock options (note 28)
Treasury stock (note 21)
Loss on retirement of treasury stock
Minority interest in consolidated subsidiaries
Commitments and contingencies (note 22)
F-3
Consolidated Statements of Earnings and Retained Earnings
Years ended December 31, 2001, 2002 and 2003
(In millions of won and U.S. dollars, except earnings per share)
Operating revenues (note 23)
Operating expenses (note 24)
Other income (expense):
Interest income
Interest expense
Equity in losses of affiliates, net (note 9)
Foreign currency translation gain (loss), net
Loss on disposition of property, plant and equipment, net
Gain on disposition of available-for-sale securities, net (note 8)
Impairment loss on available-for-sale securities (note 8)
Contributions received for losses on universal telecommunications services (note 31)
Prior year’s income tax refund (additional payment)
Contribution payments for research and development and donations (notes 22 and 30)
Other, net
Earnings before income taxes and minority interest
Income taxes (note 25)
Earnings before minority interest
Minority interest in earnings of consolidated subsidiaries, net
Retained earnings at beginning of year
Cumulative effect of accounting change (note 2)
Retirement of treasury stock (notes 18 and 21)
Dividends (notes 2 and 26)
Retained earnings at end of year
Basic earnings per share of common stock in Won and U.S. dollars (note 27)
Diluted earnings per share of common stock in Won and U.S. dollars (note 27)
F-4
Consolidated Statements of Cash Flows
(In millions of won and US dollars)
Cash flows from operating activities:
Adjustments to reconcile net earnings to net cash provided by operating activities:
Depreciation
Amortization
Provision for doubtful accounts
Provision for retirement and severance benefits
Equity in losses of affiliates
Loss on disposition of property, plant and equipment
Loss (gain) on foreign currency translation, net
Gain on disposition of available-for-sale securities, net
Impairment loss on available-for-sale securities
Deferred income tax expense
Minority interest in earnings of consolidated subsidiaries
Changes in assets and liabilities:
Increase in notes and accounts receivable—trade
Increase in accounts receivable—other
Increase in inventories
Decrease (increase) in other current assets
Decrease (increase) in long-term account receivable—trade
Increase (decrease) in notes and accounts payable— trade
Increase (decrease) in advance receipts from customers
Increase (decrease) in income taxes payable
Increase (decrease) in withholdings
Increase (decrease) in accrued expenses
Payment of retirement and severance
Increase in severance benefits insurance deposit
Increase (decrease) in accounts payable—other
F-5
Consolidated Statements of Cash Flows—Continued
Cash flows from investing activities:
Purchases of property, plant and equipment
Proceeds from sale of property, plant and equipment
Decrease in accounts receivable—other (notes 2 and 8)
Decrease (increase) in other assets
Decrease (increase) in short-term financial instruments
Purchase of available-for-sale securities
Purchase of held-to-maturity securities
Purchase of equity securities of affiliates
Proceeds from sale of available-for-sale securities
Proceeds from maturity on held-to-maturity securities
Cash flows from financing activities:
Payment of dividends
Proceeds from sale of accounts receivable
Repayment of short-term borrowings, net
Repayment of long-term debt
Proceeds from issuance of long-term debt
Proceeds from refundable deposits for telephone installation
Repayment of refundable deposits for telephone installation
Increase (decrease) in other long-term liabilities
Purchase of subsidiaries’ own shares of treasury stock
Increase in minority interest
Acquisition of treasury stock
Proceeds from sale of treasury stock
Acquisition of additional equity interest in consolidated subsidiaries
Net increase (decrease) in cash and cash equivalents from change of subsidiaries in consolidated financial statements
Cash and cash equivalents at beginning of year
Cash and cash equivalents at end of year
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(1) Business
KT Corporation (“KT”) commenced operations on January 1, 1982 through the segregation of specified operations from the Korean Ministry of Information and Communication (the “MIC”) for the purpose of contributing to the convenience in national life and improvement of public welfare through rational management of the public telecommunications business and improvement of telecommunications technology under the Korea Telecom Act.
Upon the repeal of the Korea Telecom Act as of October 1, 1997, KT became a government invested institution regulated by the Korean Commercial Code and changed its name from Korea Telecom to Korea Telecom Corp. pursuant to an amendment to its Articles of Incorporation. Shares of KT were listed on the Korea Stock Exchange on December 23, 1998. KT issued 24,282,195 additional shares on May 29, 1999 and issued American Depository Shares (“ADS”) representing these new shares and government owned shares. On July 2, 2001, additional ADS representing 55,502,161 government-owned shares were issued.
The Korean government has gradually reduced its ownership interest in the Company since 1993 and completed the disposition of its ownership interest in the Company on May 24, 2002. On March 22, 2002, the Company changed its name from Korea Telecom Corp. to KT Corporation.
Under Korean law, the MIC and other government entities have extensive authority to regulate KT. The MIC has responsibility for approving rates for local service and interconnection services provided by KT. Beginning in January 1998, KT is allowed to set its own rates for domestic long-distance service, international long-distance service and other services without approval from the MIC.
In recent years, KT has been subject to increasing competition as a result of the government’s issuance of additional licenses to create competition in the telecommunications market and to foster new telecommunications business areas. Additionally, in June 1997, the MIC awarded a license to a second carrier to provide local telephone service. This new carrier commenced operations in 1999. A third carrier commenced international long-distance service in 1997 and domestic long-distance service in 1999. The entry of these new carriers into the local and long-distance telephone service markets has had, and is expected to continue to have, a negative impact on KT’s telephone service revenues and profitability.
(2) Summary of Significant Accounting Policies and Basis of Presenting Consolidated Financial Statements
(a) Basis of Presenting Consolidated Financial Statements
The accompanying consolidated financial statements have been extracted from KT’s Korean language consolidated financial statements that were prepared using the Financial Accounting Standards, as established by the Financial Supervisory Commission of the Republic of Korea. The consolidated financial statements have been translated from those issued in the Korean language into the English language, and have been modified to allow for the formatting of the consolidated financial statements in a manner which is different from the presentation under Korean financial statements practices. In addition, certain modifications have been made to the disclosures in the accompanying consolidated financial statements to bring the formal presentation into conformity with practices outside of Korea, and certain information included in the Korean language statutory consolidated financial statements, which management believes is not required for a fair presentation of KT’s financial position or results of operations, is not presented in the accompanying consolidated financial statements. Accordingly, the accompanying consolidated financial statements and their utilization are designed for those who are informed about Korean accounting principles, procedures and practices.
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Notes to Consolidated Financial Statements—(Continued)
In addition, effective January 1, 2003, the Company adopted Statements of Korea Accounting Standards No. 2 through No. 9. In accordance with these standards, a cumulative effect on prior years is recorded as an adjustment to the beginning balance of retained earnings and minority interest at January 1, 2003. Therefore, the Company adjusted organization costs of (Won)1,530 million to retained earnings and (Won)2,198 million of minority interest. In addition, certain amounts in prior year’s financial statements were reclassified to conform to the current year’s presentation. These reclassifications did not result in any change to reported stockholder’s equity except for the adoption of Statement of Korea Accounting Standards (SKAS) No. 6, “Events Occurring After the Balance Sheet Date”. As result of adopting SKAS No. 6, stockholders’ equity as of December 31, 2002 increased by (Won)212,887 million. This amount represents the dividends recorded in 2002 but not yet approved. Under the new standard, for comparative purposes, this amount was retroactively adjusted as of December 31, 2002.
The consolidated financial statements include the accounts of KT and the following controlled subsidiaries (collectively referred to as the “Company”) as of December 31, 2001, 2002 and 2003. Controlled subsidiaries include majority-owned entities by either the Company or a controlled subsidiary and other entities where the Company or its controlled subsidiary owns more than 30% of total outstanding common stock and is the largest shareholder. All significant intercompany balances and transactions have been eliminated in consolidation.
Subsidiary
Percentage
ownership (%)
Primary business
KT Powertel Co., Ltd. (“KTP”)
KT Solutions Corporation (“KTS”)
KT Linkus Co., Ltd.
KT Hitel Co., Ltd. (“KTH”)
Korea Telecom America, Inc.
Korea Telecom Philippines, Inc.
KT Submarine Co., Ltd. (“KTSC”)
KT Freetel Co., Ltd. (“KTF”)
New Telephone Company Inc. (“NTC”)
Korea Telecom Japan Co., Ltd.
KT ICOM Co., Ltd. (“KTICOM”)*
KTF Technologies Inc. (“KTFT”)**
KT Commerce Inc. (“KTC”)***
KT Rental Corp. (“KTR”)****
Korea Telecom China Co., Ltd. (“KTCC”)
KT Infotech Corporation*****
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In 2001, the Company acquired an additional 2,166,666 shares of common stock issued by New Telephone Company for (Won)8,487 million, increasing its equity ownership percentage to 68.9%. The Company’s ownership percentage in KTSC was reduced to 52.9% in 2001 as a result of KTSC’s issuance of new shares to investors other than the Company.
In 2002, KT and its subsidiaries, KTH and KTP, sold of their equity interests comprising 47,584,905 shares of common stock in KTICOM to KTF at (Won)18,227 per share. In addition, KTF purchased 24,685,070 shares of common stock of KTICOM from a third party for the same price. As a result, KTF increased its equity ownership percentage in KTICOM to 87.3%.
In 2002, KTF exercised its conversion right of convertible notes issued by KTFT. As a result of the conversion, KTF increased its ownership percentage in KTFT from 0% to 57.4%.
In 2002, the Company acquired an additional 6,856 shares of common stock issued by Korea Telecom Japan Co., Ltd. for (Won)3,461 million resulting in ownership of 100%.
In 2002, the Company acquired an additional 833,334 shares of common stock issued by New Telephone Company for (Won)3,331 million, increasing its equity ownership percentage to 72.5%.
The Company’s ownership percentage in KTSC and KT Linkus Co., Ltd. was reduced to 36.9% and 93.8%, respectively, in 2002 as a result of these companies’ issuance of new shares to investors other than the Company.
The Company invested (Won)7,000 million in KTC in 2002. The 100% ownership percentage in KTC represents the combined ownership of this entity by KT (19.0%) and KTH (81.0%).
The Company disposed of 1,628,927 shares of KT Infotech Corporation, representing 84.4% of the Company’s equity interest, and recognized a disposition loss of (Won)3,725 million in 2002. As a result of the disposition, the Company’s remaining interest in KT Infotech Corporation is accounted for under the equity method (see note 9).
On March 6, 2003, KTICOM was merged into KTF. This transaction was done by KTF issuing an additional 7,082,476 shares of its common stock to the minority shareholders of KTICOM, which has resulted in a decrease in the Company’s equity ownership interest but an increase in the Company’s capital surplus of (Won)26,181 million due to increase of net equity of KTF. In addition, during 2003, the Company acquired an additional 15,532,846 shares of KTF for (Won)399,996 million, increasing its equity ownership interest to 46.9%. The amount paid by KT exceeded the proportionate net assets of KTF by (Won)165,642 million. This difference was recorded as a reduction to capital surplus.
KTP acquired Anam Telecom Ltd. on February 5, 2003 through the issuance of common stock. As a result, the Company’s equity ownership interest decreased to 44.8%.
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KTS, a subsidiary of KT, purchased additional 50% of KTR shares and became the largest shareholder of KTR in 2003.
In March 2003, the Company invested (Won)1,245 million in KTCC, which is a wholly-owned subsidiary located in China.
As of December 31, 2003, KT or KTS has issued guarantees of consolidated subsidiaries’ indebtedness and contract performance as follows:
KTSC
NTC
KTR
Significant account balances which occurred in the normal course of business with and between consolidated subsidiaries as of December 31, 2002 and 2003 are summarized as follows (these amounts have been eliminated in consolidation):
Balance Sheet Items
Notes and accounts receivable—trade
Long-term accounts receivable—trade
Convertible notes of KTF and KTP
Key money deposits
Significant transactions which occurred in the normal course of business with and between consolidated subsidiaries for each of the years in the three-year period ended December 31, 2003 are summarized as follows (these amounts have been eliminated in consolidation):
Income Statement Items
Other income
(b) Cash Equivalents
The Company considers short-term financial instruments with maturities of three months or less at the acquisition date to be cash equivalents.
(c) Financial Instruments
Short-term financial instruments are instruments handled by financial institutions which are held for short-term cash management purposes or will mature within one year, including time deposits, installment savings deposits and restricted bank deposits.
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(d) Allowance for Doubtful Accounts
Notes and trade accounts receivable are recorded at the invoiced amount and do not bear interest. The allowance for doubtful accounts is the Company’s best estimate of the amount of probable credit losses in the Company’s existing notes and accounts receivable. The Company determines the allowance for doubtful notes and accounts receivable based on an analysis of portfolio quality and historical write-off experience. Account balances are charged off against the allowance after all means of collection have been exhausted and the potential for recovery is considered remote.
(e) Inventories
Inventories are stated at the lower of cost or net realizable value. Cost is determined by the moving-average cost method, except for materials in transit for which cost is determined by the specific identification method. Net realizable value is the estimated selling price in the ordinary course of business, less the estimated selling cost. When the net realizable value of inventory is less than the acquisition cost, the carrying amount is reduced to the net realizable value.
(f) Investments in Securities
Effective January 1, 2003, the Company adopted Statement of Korea Accounting Standards (SKAS) No. 8, “Investments in Securities”. In accordance with this standard, certain debt and equity securities should be classified into one of the three categories of held-to-maturity, available-for-sale, or trading securities at the time of acquisition and such determination should be reassessed at each balance sheet date. Investments in debt securities that the Company has the positive intention and ability to hold to maturity are classified as held-to-maturity. Securities that are bought and held principally for the purpose of selling them in the near term (thus held for only a short period of time) are classified as trading securities. Trading generally reflects active and frequent buying and selling, and trading securities are generally used to generate profit on short-term differences in price. Investments not classified as either held-to-maturity or trading securities are classified as available-for-sale securities.
Trading securities are carried at fair value, with unrealized holding gains and losses included in earnings. Available-for-sale securities are carried at fair value, with unrealized holding gains and losses reported as a capital adjustment. Investments in equity securities and limited partnerships that do not have readily determinable fair values are stated at cost. Declines in value judged to be other-than-temporary on available-for-sale securities are charged to current results of operations. Realized gains and losses are determined using the specific identification method based on the trade date of a transaction. Investments in debt securities that are classified into held-to-maturity are reported at amortized cost at the balance sheet date and such amortization is included in interest income.
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Marketable securities are at the quoted market prices as of the year end. Non-marketable debt securities are recorded at the fair values derived from the discounted cash flows by using an interest rate deemed to approximate the market interest rate. The market interest rate is determined by the issuers’ credit rate announced by the accredited credit rating agencies in Korea. Beneficiary certificates which are securities indicating beneficiary right on certain investment securities held by the investment management companies are recorded at fair value as determined by the investment management companies.
Trading securities shall be classified as current assets, whereas available-for-sale securities and held-to-maturity securities shall be classified as long-term investments. However, available-for-sale securities, whose maturity dates are due within one year from the balance sheet date or whose likelihood of being disposed of within one year from the balance sheet date is probable, shall be classified as current assets. Likewise, held-to-maturity securities whose maturity dates are due within one year from the balance sheet date shall be classified as current assets.
As allowed by this standard, certain amounts in the prior year financial statements were reclassified to conform to the current year presentation.
For investments in companies, whether or not publicly held, that are not controlled, but under the Company’s significant influence, the Company utilizes the equity method of accounting. Significant influence is generally deemed to exist if the Company can exercise influence over the operating and financial policies of an investee. The ability to exercise that influence may be indicated in several ways, such as the Company’s representation on its board of directors, the Company’s participation in its policy making processes, material transactions with the investee, interchange of managerial personnel, or technological dependency. Also, if the Company owns directly or indirectly 20% or more of the voting stock of an investee and the investee is not required to be consolidated, the Company generally presumes that the investee is under significant influence.
(g) Investment Securities under the Equity Method of Accounting
Under the equity method of accounting, the Company’s initial investment is recorded at cost and is subsequently increased to reflect the Company’s share of the investee income and reduced to reflect the Company’s share of the investee losses or dividends received. Any excess in the Company’s acquisition cost over the Company’s share of the investee’s identifiable net assets is generally recorded as goodwill or other intangibles and amortized by the straight-line method over the estimated useful life. The amortization of goodwill is recorded against the equity income (losses) of affiliates. When events or circumstances indicate that carrying amount may not be recoverable, the Company reviews goodwill for impairment.
Assets and liabilities of foreign-based companies accounted for using the equity method are translated at current rate of exchange at the balance sheet date while profit and loss items in the statement of earnings are translated at average rate and capital account at historical rate. The translation gains and losses arising from collective translation of the foreign currency financial statements of foreign-based companies are offset and the balance is accumulated as a capital adjustment.
Under the equity method of accounting, the Company does not record its share of losses of an affiliate or subsidiary not consolidated when such losses would make the Company’s investment in such entity less than zero unless the Company has guaranteed obligations of the investee or is otherwise committed to provide additional financial support.
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(h) Property, Plant and Equipment
Property, plant and equipment are stated at cost. Improvements that significantly extend the life of an asset or add to its productive capacity are capitalized. Expenditures for maintenance and repairs are charged to expense as incurred. Property, plant and equipment contributed by the government on January 1, 1982 are stated at net revalued amounts.
Prior to January 1, 2003, the Company capitalized interest costs, discounts and other financial charges, including certain foreign exchange transaction gains and losses, on all borrowings, incurred prior to completion of the acquisitions, as part of the cost of qualifying assets. However, effective January 1, 2003, the Company adopted Statement of Korea Accounting Standards No. 7, “Capitalization of Financing Costs.” In accordance with this standard, the Company elected to no longer capitalize interest costs, discounts and other financial charges, including certain foreign exchange transaction gains and losses on all borrowings. For the years ended December 31, 2001 and 2002, financing costs of (Won)131,092 million and (Won)83,851 million were capitalized, respectively.
Depreciation is computed using the declining-balance method (except for buildings, structures, underground access to cable tunnels, and concrete and steel telephone poles, and the assets of some subsidiaries which are depreciated using the straight-line method) based on the following estimated useful lives of the related units of property:
Machinery and equipment:
Underground access to cable tunnels, and concrete and steel telephone poles
Other
Tools, furniture and fixtures:
Steel safe boxes
Tools, computer equipment, furniture and fixtures
(i) Contributions Received for Capital Expenditures
Contributions received for capital expenditures are reflected as a reduction of the acquisition cost of the acquired assets and, accordingly, reduce depreciation expense related to the acquired assets over their useful lives. Contributions received, which have yet to be disbursed for capital expenditures, are presented as a deduction of received assets.
(j) Long-Lived Assets
Long-lived assets generally consist of property, plant and equipment and other intangible assets. The Company reviews long-lived assets for the impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. In addition, the Company evaluates its long-lived assets for impairment each year as part of its annual forecasting process. An impairment loss would be considered when estimated undiscounted future net cash flows expected to result from the use of the asset and its eventual disposition are less than its carrying amount. If such assets are considered to be impaired, the impairment to be recognized is measured as the amount by which the carrying amount of the assets exceeds the fair value of the assets.
F-13
(k) Intangible Assets
(i) Goodwill
Goodwill, which represents the excess of the acquisition cost over the fair value of net identifiable assets acquired related to entities that are being consolidated, is amortized on a straight-line basis over its estimated economic useful life.
Accounting for the difference between the acquisition cost and the amount of underlying equity of a purchased entity differs depending on whether (1) the acquisition of the controlling interest of an investee is the original acquisition or (2) the purchase represents an additional equity purchase of a controlled entity. When the Company first acquires a controlling financial interest of an entity, the difference between the acquisition cost and the corresponding proportionate share of the entity’s equity as of the most recently audited or reviewed balance sheet date is recorded as goodwill. However, for additional equity purchases of existing consolidated subsidiaries, such difference is recorded as a reduction of stockholders’ equity (capital surplus). Goodwill is amortized over its estimated useful life of 4 to 10 years.
Amortization of goodwill of (Won)301,292 million, (Won)294,652 million and (Won)294,306 million for the years ended December 31, 2001, 2002 and 2003, respectively, and amortization of negative goodwill of (Won)413 million, (Won)413 million and (Won)518 million for the years ended December 31, 2001, 2002 and 2003, respectively, are included in operating expenses and other income, respectively, in the consolidated statements of operations.
An impairment loss would be recognized when the carrying amount of goodwill exceeds estimated discounted future net cash flows expected from the entities that are being consolidated and its eventual disposition are less than its carrying amount.
(ii) Other Intangible Assets
Other intangible assets, consisting of rights to exclusive usage and deferred development costs, are stated at cost less accumulated amortization. Amortization is computed using the straight-line method over periods which range from 3 to 50 years. The Company has monopolistic and exclusive rights to control buildings and facilities utilization and copyrights by contract or related laws. Accordingly, the Company amortizes those intangible assets over the period of 30 or 50 years based on contract or related laws.
(iii) Research and Development Costs
The Company charges research and development costs to expense as incurred. However, the costs which are recoverable from future earnings are deferred and amortized over their estimated useful lives. In addition, the internal software development costs, after technological feasibility has been established, such as those associated with Broadband Integrated Services Digital Network (B-ISDN), Integrated Customer Information System (ICIS) and Enterprise Resource Planning (ERP), are accounted for as intangible assets and amortized by the straight-line method over their estimated economic useful lives from 3 to 6 years.
The Company incurred research and development costs of (Won)378,388 million, (Won)274,410 million and (Won)306,361 million, including deferred amounts of (Won)145,196 million, (Won)28,855 million and (Won)61,736 million for the years ended December 31, 2001, 2002 and 2003, respectively.
(l) Advertising Costs
The Company expenses advertising costs as they are incurred. These expenses include media and other promotional and sponsoring costs.
F-14
(m) Valuation of Receivables and Payables at Present Value
Receivables and payables arising from long-term installment transactions and other similar transactions are stated at present value and the difference between the nominal value and present value is deducted directly from the nominal value of related receivables or payables and is amortized using the effective interest method over the installment or redemption period. The amount amortized is included in interest expense or interest income.
(n) Convertible Notes and Bonds with Warrants
Effective January 1, 2003, the Company adopted Statement of Korea Accounting Standards No. 9, “Convertible Securities” related to convertible bonds, bonds with warrants and convertible preferred stock, which requires the separate recognition of the convertible features and warrant rights. However, as allowed by the transition clause of the Statement, the Company recognizes interest expense on convertible notes and bonds with warrants as determined using the effective interest method, and amortization of a redemption premium is recorded as long-term accrued interest expense.
(o) Retirement and Severance Benefits
Employees who have been with the Company for more than one year are entitled to lump sum payments based on current rates of pay and length of service when they leave the Company. The Company’s estimated liability under the plan which would be payable if all employees left on the balance sheet date is accrued in the accompanying consolidated balance sheets. A portion of the liability is covered by an employees’ severance pay insurance where the employees have a vested interest in the deposit with the insurance company. Therefore, such deposit for severance benefit insurance amounting to (Won)338,576 million and (Won)519,377 million as of December 31, 2002 and 2003, respectively, are reflected in the accompanying consolidated balance sheets as a reduction of the liability for retirement and severance benefits.
Through March 1999, under the National Pension Scheme of Korea, the Company transferred a certain portion of retirement allowances of employees to the National Pension Fund. The amount transferred will reduce the retirement and severance benefit amount to be payable to the employees when they leave the Company and is accordingly reflected in the accompanying consolidated balance sheets as a reduction from retirement and severance benefit liability. The cumulative balances of such transfers to the National Pension Fund were (Won)1,066 million and (Won)729 million as of December 31, 2002 and 2003, respectively. Beginning in April 1999, however, a new regulation applies and such transfers to the National Pension Fund are no longer required.
(p) Customer Call Bonus Program
The Company records an estimated liability for the marketing cost associated with providing gifts under the customer call bonus program when call bonus points are earned. The liability is recorded in other long-term liabilities on the accompanying consolidated balance sheets. The liability is adjusted periodically based on points earned, points redeemed, and changes in estimated costs.
(q) Contingent Liabilities
Contingent losses are generally recognized as a liability when probable and reasonably estimable.
(r) Revenue Recognition
Operating revenues are recognized on a service-rendered basis. Revenues from public telephone cards are recognized when the cardholder places a call. Sales and cost of sales of Personal Communication Service
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(“PCS”) handsets are recognized when delivered to the customer. The non-refundable service initiation fees for telephone, broadband Internet access, PCS services and leased-line service are recognized as revenue upon receipt.
Prior to April 15, 2001, customers could choose between alternative plans for initiating basic telephone services. Under these alternatives, customers could elect to place a fully refundable deposit (which is reflected as a liability) or pay a reduced non-refundable service initiation fee (which is included in operating revenues). Prior to this change, all customers were required to place fully refundable deposits.
Effective April 15, 2001, the Company revised the telephone installation deposit system. Under the revised system, new customers are required to pay a non-refundable service initiation fee. The non-refundable service initiation fee is included in operating revenues.
Effective January 1, 2003, the Company adopted Statement of Korea Accounting Standards No. 4, “Revenue Recognition,” clarifying existing standards regarding revenue recognition. The Company’s current policy for revenue recognition is not significantly different from the requirements of this Statement.
(s) Foreign Currency Translation
Monetary assets and liabilities denominated in foreign currencies are translated into Korean won at the balance sheet date. Unrealized foreign currency translation gains and losses on monetary assets and liabilities are included in current results of operations. As of December 31, 2002 and 2003, monetary assets and liabilities denominated in foreign currencies are translated into Korean won at (Won)1,200.4 to US$1 and (Won)1,197.8 to US$1, respectively, that are permitted by the Financial Accounting Standards. Non-monetary assets and liabilities denominated in foreign currencies, which are stated at historical cost, are translated into Korean won at the foreign exchange rate at the date of the transaction.
Prior to January 1, 2003, the Company accounted for foreign exchange translation gains and losses on all borrowings, capitalizing financing costs, as part of the cost of qualifying assets. However, the Company adopted Statement of Korea Accounting Standards No. 7, “Capitalization of Financing Costs,” effective January 1, 2003. In accordance with this standard, all foreign exchange translation gains and losses are included in the results of operations.
(t) Derivatives
Derivative instruments, regardless of whether they are entered into for trading or hedging purposes, are valued at fair value. Derivative contracts not meeting the requirements for hedge accounting treatment are classified as trading contracts with the changes in fair value included in current operations.
Derivative financial instruments used for hedging purposes are accounted for in a manner consistent with the accounting treatment appropriate for the transactions being hedged or associated with such contracts. The instruments are valued at fair value when underlying transactions are valued at fair value, and resulting unrealized valuation gains or losses are recorded in current results of operations. For instruments that are not valued at fair value, unrealized valuation gains or losses are recognized at the time of settlement.
(u) Leases
The Company accounts for and classifies its lease transactions as either an operating or capital lease, depending on the terms of the lease under Korean Lease Accounting Standards If a lease is substantially
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noncancellable and meets one or more of the criteria listed below, the present value of future minimum lease payments is reflected as an obligation under capital lease.
If the above criteria are not met, the lease is classified as an operating lease and lease payments are expensed under straight-line over the lease term.
(v) Income Taxes
Income tax expense or benefit on earnings includes both current and deferred taxes. Current tax is the expected tax payable on the taxable income for the year, using tax rates enacted at the balance sheet date. Deferred tax is provided using the asset and liability method, providing for temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for taxation purposes. However, deferred taxes are not recognized for temporary differences related to unrealized gains and losses on available-for-sales securities that are reported in a separate component of stockholders’ equity. Deferred tax assets and liabilities are measured using tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period of the expected enactment date.
A deferred tax asset is recognized only to the extent that it is probable that such deferred tax asset is recoverable in a future period. Deferred tax assets are reduced to the extent that it is no longer probable that the related tax benefit will be realized.
(w) Stock Options
The stock option program allows the Company’s officers to acquire shares of the Company. The option exercise price is generally fixed at above the market price of underlying shares at the date of the grant. The Company values stock options based upon an option-pricing model (Black-Scholes model) under the fair value method and recognizes this value as an expense over the period in which the options vest.
When the options are exercised, equity is increased by the amount of the proceeds received, and the values of options exercised and credited to the capital adjustment account. When stock options are forfeited because the specified vesting requirements are not satisfied, previously recognized compensation costs and corresponding capital adjustment account are reversed to earnings. When stock options expire unexercised, previously recognized compensation costs and corresponding capital adjustment account are reversed to capital surplus.
(x) Dividends Payable and Appropriation of Retained Earnings
Effective January 1, 2003, the Company adopted Statement of Korea Accounting Standards No. 6, “Events Occurring After the Balance Sheet Date”. Under this standard, dividends are not recorded until approved by the shareholders. As a result, the Company adjusted stockholder’s equity as of December 31, 2002 by (Won)212,887 million. The amount represents the dividends payable recorded in 2002. In addition, appropriated retained earnings as of December 31, 2002 decreased by (Won)1,583,589 million while unappropriated retained earnings
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increased by the same amount because the amount of appropriations was declared by the Company but not yet approved at the shareholders’ meeting. Under the new standard, for the comparative purposes, this amount was retroactively adjusted as of December 31, 2002.
(y) Earnings Per Share
Basic earnings per common share are calculated by dividing net earnings available to common stock by the weighted-average number of shares of common stock holders outstanding during each period. Diluted earnings per share are calculated by dividing net earnings plus interest expenses, net of tax, of the convertible notes available to common stock holders by the weighted-average number of shares of common stock outstanding adjusted to include the potentially dilutive effect of the convertible notes.
Bonds with warrants and stock options were not considered when calculating diluted earnings per share because the exercise price of the warrants and stock options was greater than the average market price of the common share and, therefore, the effect would have been antidilutive.
(z) Minority Interest in Consolidated Subsidiaries
Minority interest in consolidated subsidiaries is presented as a separate component of stockholders’ equity in the consolidated balance sheets.
(aa) Foreign Currency Translation of Foreign Subsidiaries
Assets and liabilities of the Company’s foreign subsidiaries and operations are translated at current rate of exchange at the balance sheet date while profit and loss items in the statement of earnings are translated at average exchange rate and capital account at historical rate. Gains and losses resulting from such translation of financial statements are recognized as a foreign-based operations translation adjustment in stockholders’ equity.
(ab) Use of Estimates
The preparation of consolidated financial statements in conformity with Korean GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
(ac) Application of the Statements of Korea Financial Accounting Standards
The Korean Accounting Standards Board (“KASB”) has published a series of Statements of Korea Accounting Standards (“SKAS”), which will gradually replace the existing financial accounting standards, established by the Korea Financial Supervisory Board. The Company adopted SKAS No. 2 through No. 9 as of January 1, 2003. SKAS No. 10 “Inventories,” No. 12 “Construction-Type Contracts,” and No. 13 “Troubled Debt Restructuring” become effective for the Company on January 1, 2004 according to the effective date set forth by each SKAS. The Company does not expect the adoption of these Standards to have a material impact on the consolidated financial statements.
(ad) Accounting for the Disposition of an Equity Interest in a Consolidated Subsidiary
Gain or loss on the Company’s sale of a subsidiary’s stock is recognized in income if, after the sale of the equity interest, the investment is no longer required to be consolidated. If the entity is still required to be consolidated, the Company records the difference between net proceeds and the carrying amount of the stock as an adjustment to stockholders’ equity.
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(ae) Fair Value of Financial Instruments
The following methods and assumptions were used to estimate the fair value of each significant class of financial instruments for which it was practicable to estimate such value:
(i) Cash and cash equivalents, short-term financial instruments, notes and accounts receivable—trade, accounts receivable—other, trading securities, available-for-sale securities, notes and accounts payable—trade, short-term borrowings and accrued expenses. The carrying amount approximates fair value because these instruments are either carried at fair value or because of the short maturity of these instruments.
(ii) Investment Securities
The fair value of equity securities of non-affiliates and debt securities are estimated based on quoted market prices. The fair values of equity-linked securities are estimated based on quotes obtained from dealer. For those investments for which there were no quoted market prices, a reasonable estimate of fair value could not be made without incurring excessive costs. Additional information pertinent to the fair value of unquoted investments is provided below.
(iii) Loans included in other current assets and other assets
The carrying amount of loans included in other current assets approximate fair value due to the short term maturities of these investments. The fair value of long-term loans in other assets is estimated based on discounted cash flows using current rates offered for loans of the same remaining maturities.
(iv) Long-term debt
The fair value of the long-term debt, including the current portion, is estimated based on quoted market prices for the same or similar issues or on the current rates offered for debt of the same remaining maturities.
(v) Interest rate swap, interest rate swaption, currency swap and interest currency swap
The fair values of interest rate swap, interest rate swaption, currency swap and interest currency swap are estimated based on quotes obtained from dealers.
The estimated fair values of the Company’s significant financial instruments at December 31, 2002 and 2003 are summarized as follows:
Available-for-sale securities:
• Practicable to estimate fair value
• Not practicable
Loans included in other current assets and other assets
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Interest rate swap
Interest rate swaption
Long-term debt, including current portion
Interest currency swap
Currency swap
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It was not practicable to estimate the fair value of investments in unlisted companies. Additional unaudited information as to total assets, stockholders’ equity (deficit), revenues and net income (loss) for these investments as of and for the years ended December 31, 2002 and 2003 are summarized as follows:
Intelsat Ltd.
Inmarsat Venture plc
Korea Software Financial Cooperative
Korea Multinet Co.
Polytech Adventure Town, Inc.
Real Telecom Corporation
KT Internal Venture Fund No.1
Korea Information Certificate Authority, Inc.
Mirae Asset Securities Co., Ltd.
Korea Telecom Venture Fund No. 1
Kookmin Credit Information, Inc.
Korea Information Technology Fund
On Game Network Inc.
Online Pass Co., Ltd.
Danish Russian Japan Korean Telecommunication Group
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KT Internal Venture Fund No.2
Mirae Asset Securities Co., Ltd
(af) Consolidated Statements of Cash Flows
The Company paid (Won)669,690 million, (Won)574,795 million and (Won)681,595 million in interest (net of amounts capitalized) and (Won)67,789 million, (Won)329,816 million and (Won)747,700 million in income taxes for the years ended December 31, 2001, 2002 and 2003, respectively.
(ag) Segment Information
The Company has two reportable operating segments—wireline communications and PCS services (including IMT-2000 services). Wireline communications include all services provided to fixed line customers, including internet services, data communication services, wire and other facilities, leased line services and telephone services. Beginning in 2003, the IMT-2000 services operating segment is included within the PCS services operating segment due to the merger between the two separate legal entities, KTF and KTICOM during 2003. In prior years, IMT-2000 services was reported as a separate operating segment. PCS service is a digital wireless telephone system that uses light handsets with a long battery life to communicate via low-power antennas. PCS telephones have the capacity to receive and send data as well as voice transmission. IMT-2000 service is a third-generation, high-capacity wireless communication system that enables subscribers to utilize a full range of mobile multi-media services including video phone and wireless data transmission. The operations of all other entities which fall below the reporting thresholds are included in the “Miscellaneous” segment below, and include entities providing, among others, submarine cable construction and group telephone management.
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The Company’s reportable segments are separate legal entities that offer different products and services and/or serve different customers. No single customer accounted for revenues in excess of 10% of total revenues. The entities are managed differently since they utilize different technology and marketing strategies and have different capital requirements. Management primarily evaluates the performance of the segments based on operating income (loss).
The Company accounts for intersegment revenues and costs as if the related transactions were with third parties. The adjustments included in “Reconciling Adjustments,” line item “Other income (expenses), net” include minority interest in earnings of consolidated subsidiaries of (Won)(260,422) million, (Won)(316,918) million and (Won)(235,695) million in 2001, 2002 and 2003, respectively, and elimination of the parent company’s equity in net earnings of KTF and other subsidiaries of (Won)(175,911) million, (Won)(208,756) million and (Won)(160,161) million in 2001, 2002 and 2003, respectively. Reconciling adjustments also include reclassification of amortization of goodwill between the line items “Other income (expenses), net” and “Operating expenses—Depreciation and amortization” in the amount of (Won)301,292 million, (Won)294,652 million and (Won)294,306 million in 2001, 2002 and 2003, respectively. Additionally, reconciling adjustments include intersegment eliminations in all line items.
The following table provides information for each operating segment as of and for year ended December 31, 2001:
External customers
Intersegment
Operating income (loss)
Other income (expenses), net
Earnings (loss) before income taxes
Income taxes
Net earnings (loss)
Capital expenditures
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The following table provides information for each operating segment as of and for year ended December 31, 2002:
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The following table provides information for each operating segment as of and for the year ended December 31, 2003:
(3) Basis of Translating Consolidated Financial Statements
The consolidated financial statements are expressed in Korean won and, solely for the convenience of the reader, the consolidated financial statements as of and for the year ended December 31, 2003, have been translated into United States dollars at the rate of (Won)1,192.0 to US$1, the noon buying rate in the City of New York for cable transfers in Won as certified for customs purposes by the Federal Reserve Bank of New York at December 31, 2003. The translation should not be construed as a representation that any or all of the amounts shown could be converted into U.S. dollars at this or any other rate.
(4) Cash and Cash Equivalents
Cash and cash equivalents as of December 31, 2002 and 2003 are summarized as follows:
Cash on hand
Checking accounts
Passbook accounts
Cash in transit
Time deposits
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(5) Restricted Deposits
There are certain amounts included in cash and cash equivalents, short-term and long-term financial instruments which are restricted in use for expenditures for certain business purposes as of December 31, 2002 and 2003 as follows:
Long-term financial instruments
(6) Inventories
Inventories as of December 31, 2002 and 2003 are summarized as follows:
Construction and repair materials
PCS handsets
(7) Other Current Assets
Other current assets as of December 31, 2002 and 2003 are summarized as follows:
Current portion of long-term loans to employees
Prepaid expenses
Prepayments
Accrued interest income
Refundable deposits
Short-term loans
Interest rate swap (note 22)
Interest currency swap (note 22)
Interest rate swaption (note 22)
(8) Investments in Securities
Investments in securities as of December 31, 2002 and 2003 are summarized as follows:
(a) Trading securities (fair value)
Mutual funds
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(b) Available-for-sale securities
(i) Equity securities
Knowledge Plant, Inc.
SK Telecom Co., Ltd. (“SK Telecom”)
Investment assets:
New Skies Satellites N.V.
Inmarsat Ventures plc
K-3-I Co., Ltd.
KT Internal Venture Fund No. 1
KT Internal Venture Fund No. 2
Sky Life Contents fund
ICO Global Communication (Holdings) Limited
DAEGU Football Club
Kookmin Credit Information Inc. (formerly National Information & Credit Evaluation, Inc.)
GaeaSoft Corp.
KRTnet Corporation
Sports Toto
VACOM WIRELESS, INC.
ESTsoft Corp.
CEC Mobile
ONSE TELECOM
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Investments in equity securities for New Skies Satellites N.V., GaeaSoft Corp., Knowledge Plant, Inc., and KRTnet Corporation are recorded at fair value. All other equity securities that do not have readily determinable fair values are stated at cost.
The Company and SK Telecom agreed to an equity swap on December 20, 2002 under which each company sold all of the other’s equity shares it held in the other. According to the agreement, the Company exchanged 4,457,635 shares of SK Telecom for 15,454,659 shares of treasury stock plus cash of (Won)211,868 million on December 30, 2002. In addition, the Company exchanged 3,809,288 shares of SK Telecom for 14,353,674 shares of treasury stock plus cash of (Won)122,679 million on January 10, 2003 and the Company recognized a gain on disposition of available-for-sale securities in the amount of (Won)775,241 million for the year ended December, 31, 2003.
The Company recognized impairment loss of available-for-sale securities of (Won)8,856 million for the year ended December 31, 2003. This charge was related to other-than-temporary declines in the value of the investee company.
(ii) Debt securities
Beneficiary certificates
Equity-linked securities
KTF First Securitization Specialty Co., Ltd.
KTF Second Securitization Specialty Co., Ltd.(note 22(i))
On April 11, 2002, the Company purchased equity-linked securities of (Won)132,594 million from Citigroup Global Markets Inc. (“CGMI” and previously called “Saloman Smith Barney Holdings, Inc.”). These equity-linked securities have maturities of 2 and 2.5 years. The value of the equity-linked securities is linked to the weighted-average quoted price of 500,000 shares of SK Telecom stock, whereby the amount payable to the Company from CGMI will be adjusted based on the weighted-average quoted share price of SK Telecom. Generally, if the weighted-average quoted share price of the SK Telecom shares were to fall below (Won)150,930 and (Won)154,155 for the 2 year and 2.5 year notes, respectively, the amount payable to KT from CGMI would be zero and if the weighted-average quoted share price of SK Telecom shares were to exceed (Won)301,860 and (Won)308,310 for the 2 year and 2.5 year notes, respectively, then the amount payable to KT from CGMI would be the full value of 500,000 SK Telecom shares based on the weighted-average quoted share price of SK Telecom. In addition, if the weighted-average quoted share price were to fall between the prescribed ceiling and floor amounts, then the amount payable to KT by CGMI would be two times the weighted average quoted share price of SK Telecom shares less (Won)301,860 and (Won)308,310 for the 2 year and 2.5 year notes, respectively, calculated based on 500,000 SK Telecom shares.
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The Company’s investments in the equity-linked securities are recorded at fair value and unrealized holding gains and losses are recorded as a separate component of stockholders’ equity. The equity-linked securities were tested for impairment during 2003 due to the significant decrease of the quoted market value of SK Telecom shares. As a result of this impairment test, the Company recognized an impairment loss amounting to (Won)35,137 million on the equity-linked securities for the year ended December 31, 2003. If the quoted market value of SK Telecom shares continues to decline, the Company may be required to record additional impairment losses. As of December 31, 2003, SK Telecom shares were quoted at (Won)199,000 per share, resulting in unrealized loss of (Won)34,078 million.
(iii) Changes in unrealized holding gains (losses)
Changes in unrealized gains (losses) on available-for-sale securities for the year ended December 31, 2003 are summarized as follows:
Beginning balance
Realized gains on disposition of securities
Changes in unrealized losses, net
Net balance at end of year
(c) Held-to-maturity securities
Government and municipal bonds
Long-term assets:
Subordinated interest in securitized accounts receivable (note 22(j))
KTF retained the above subordinated interest in securitized accounts receivable issued by Shinhan Bank Trust in relation to the sale of trade accounts and notes receivable. KTF believes that the difference between fair value and acquisition cost, which may arise from the uncollectibility of the trade accounts and notes receivable, will not have a material effect on the operations or financial position of the Company.
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(9) Investments in Equity Securities of Affiliated Companies
Investments in affiliated companies accounted for using the equity method as of December 31, 2002 and 2003, are summarized as follows:
Listed:*
Hallim Venture Capital Corporation (“HVCC”)
Unlisted:
Mongolian Telecommunications Co.
Korea IT Venture Partners Inc.
KT Rental Corp. (note 2(a))**
KBSi Co., Ltd.
Korea Telephone Directory Co., Ltd.
eNtoB Corp.
KT Infotech Corporation
Korea Telecom Realty Development and Management Co., Ltd.
Korea Digital Satellite Broadcasting Co. (“KDB”)
Korea Information Data Corp.
Korea Information Service Corp.
KT Instrument & Communication Corp.
Bank Town Co., Ltd.
Korea Telecom Hitel Global Co., Ltd.
Sports TOTO On-Line
In December 2003, the Company purchased an additional 11,770,000 shares of KDB for (Won)82,390 million including (Won)49,119 million of goodwill. After making this cash purchase, the Company’s equity ownership interest increased to 29.9%.
The Company has recorded unrealized losses of (Won)4,266 million and (Won)2,691 million relating to the above affiliates as of December 31, 2002 and 2003, respectively, which have been accounted for as capital adjustments. These capital adjustments have been recorded as unrealized losses on equity securities of affiliates within stockholders’ equity.
The Company received dividends of (Won)1,995 million, (Won)469 million and (Won)554 million in the aggregate from affiliates for the years ended December 31, 2001, 2002 and 2003.
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(10) Insurance
Property, plant and equipment were insured against fire damage up to an amount of (Won)920,939 million and (Won)1,237,621 million as of December 31, 2002 and 2003, respectively. Additionally, the Company maintains insurance policies covering loss and liability arising from automobile accidents.
(11) Other Assets
Other assets as of December 31, 2002 and 2003 are summarized as follows:
Long-term loans to employees
Leasehold rights and deposits
Goodwill
Negative goodwill
Frequency usage right, net
Other intangible assets, net
Long-term accounts receivable—other
Deferred income tax assets (note 25)
During 2001, KTICOM acquired IMT-2000 frequency usage right and a license to operate the IMT-2000 business from the MIC for (Won)1,300 billion. As described in note 2(a), KTICOM was merged into KTF on March 6, 2003. The net amount of the frequency usage right of (Won)1,208,429 million is included in other assets in the accompanying consolidated balance sheet as of December 31, 2003. The Company paid 50%, or (Won)650 billion, of this amount in 2001 and the net present value of the remaining (Won)650 billion unpaid balance is recorded as long-term accounts payable—other in the accompanying consolidated balance sheet as of December 31, 2003. These rights have a contractual life of 15 years and will be amortized commencing on the date commercial service is initiated through the end of their contractual life. The Company started to amortize frequency usage right starting from December 1, 2003. In addition, the interest expense incurred from long-term accounts payable—other for frequency usage right was capitalized as frequency usage right through December 31, 2002. For the years ended December 31, 2002 and 2003, capitalized interest amounts to (Won)74,631 million and (Won)7,369 million, respectively. As described in note 2(h), effective January 1, 2003, the Company no longer capitalizes financing costs.
The net amount of the frequency usage right as of December 31, 2002 and 2003 is as follows:
Frequency usage right
Less: Accumulated amortization
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Long-term accounts payable—other related to frequency usage right is stated at the net present value of future cash flows, calculated using the effective interest rate(9.93%) at the time of receipt of the frequency use license. The balance as of December 31, 2003 is as follows:
Long-term accounts payable—other
Less: Present value discount
The maturities of the Company’s long-term accounts payable—other related to frequency usage right outstanding as of December 31, 2003 are as follows:
2009
2010
2011
(12) Short-term Borrowings
Short-term borrowings (all of which mature within one year) as of December 31, 2002 and 2003 are summarized as follows:
Interest rateper annum (%)
Commercial paper
Banks
Short-term borrowings in foreign currency
The weighted average interest rates on short-term borrowings were 5.20% and 4.63% at December 31, 2002 and 2003, respectively.
(13) Other Current Liabilities
Other current liabilities as of December 31, 2002 and 2003 are summarized as follows:
Advance receipt
Dividends payable
Payables for interest rate swap (note 22)
Payables for interest rate swaption (note 22)
Payables for currency swap (note 22)
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(14) Long-term Debt
Long-term debt as of December 31, 2002 and 2003 is summarized as follows:
Local currency (Won) debt:
Bonds issued
Convertible notes of KTF and KTFT
Convertible notes
Security companies
Information and Telecommunication Improvement Fund
Foreign currency debt:
Convertible notes (USD)
Bonds with warrants (USD)
Yankee bonds (USD)
Bonds (USD)
Bonds (JPY)
Loans (USD)
Add: Premium on bonds
Less:
Current portion, net of discount
Discount on bonds
Convertible notes and bonds with warrants issued by the Company are summarized as follows:
Issuance date
Issuance
amount(millions)
Bonds with warrants
Holders of convertible notes issued on January 4, 2002 are entitled to convert notes into shares of the Company’s common stock from January 4, 2003 to January 1, 2007. The exchange price is (Won)61,922 per share of common stock, which allowed the bondholders to obtain up to 27,500,099 shares. During 2002 and 2003, due to the early retirement of the convertible notes, the number of shares allowed to the bondholders was reduced to
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23,504,885 shares. However, in February 2004, the exchange price was changed to (Won)60,588 per share according to the notes covenants requiring the conversion price adjustment upon dividend amounts would increase more than 20%. As a result of the change of exchange price, the number of shares that convertible notes can be converted increased to 24,022,404 shares. These changes are subject to approval at the March 12, 2004 shareholders’ meeting. Holders of convertible notes have the option to redeem the convertible notes on January 4, 2005 at 100% of their principal amount of US$1,126,350 thousand plus accrued and unpaid interest to the redemption date.
Bonds with warrants were issued in connection with a strategic alliance with Microsoft Corp. Holders of bonds with warrants were entitled to exercise the warrants from January 4, 2003 to December 31, 2003. The warrants expired on December 31, 2003 and no warrants had been exercised.
Holders of convertible notes issued on May 25, 2002 are entitled to convert notes into shares of the Company’s common stock from June 25, 2002 to April 25, 2005. The exchange price is (Won)59,400 per share of common stock, which allowed the bondholders to obtain up to 23,524,392 shares. During 2002 and 2003, due to the early retirement of the convertible notes and 13,149 shares of common stock converted, the number of shares allowed to the bondholders was reduced to 22,265,372 shares. The convertible notes, if not converted, will be redeemed at 104.438% of their principal amount at maturity date. The Company recognizes interest expense on convertible notes using the effective interest method, and amortization of the redemption premium is recorded as long-term accrued interest expense.
On October 14, 2002, the Company purchased and retired convertible notes issued on January 4, 2002 with a face value of US$107,750 thousand and convertible notes issued on May 25, 2002 with a face value of (Won)74,000 million for US$116,743 thousand and (Won)77,839 million, with a loss on retirement of convertible notes of (Won)10,762 million.
On December 18, 2003, the Company purchased and retired convertible notes issued on January 4, 2002 with a face value of US$83,700 thousand for US$85,839 thousand with a gain on retirement of convertible notes of (Won)7,441 million.
Aggregate principal maturities for the Company’s long-term debt as of December 31, 2003 are as follows:
(15) Refundable Deposits for Telephone Installation
Through September 15, 1998, KT collected deposits for telephone installation in accordance with the Korea Public Telecommunication Business Law. Such deposits (which are reflected as a liability) are to be refunded without interest to the telephone subscribers upon termination of service. For changes in site classifications of telephones that were installed prior to January 1, 1990, KT is obligated to refund the original deposit received plus the increased deposit due to changes in site classifications.
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Beginning on September 15, 1998, KT allowed customers to choose between alternative plans for basic telephone service. Under such plan, customers were permitted the option to either place fully refundable deposits or pay a reduced non-refundable service initiation fee. The non-refundable service installation fees were recorded as operating revenues. Refundable deposits continue to be subject to the same provisions as described above. Effective April 15, 2001, all new customers are required to pay a non-refundable service initiation fee.
(16) Retirement and Severance Benefits
Changes in retirement and severance benefits for each of the years in the three-year ended December 31, 2003 are summarized as follows:
Estimated severance benefit liability at beginning of year
Provision for the year
Increase (decrease) due to change of consolidated subsidiaries
Payments
Withdrawal from the National Pension Fund, net
Payment of deposit for severance benefit insurance
In 2001 and 2003, the Company implemented a voluntary early retirement plan for its employees. Employees electing voluntary early retirement plans in such years received additional amounts of retirement and severance benefits which were expensed in 2001 and 2003, amounting to (Won)74,337 million and (Won)831,535 million, respectively. In 2001 and 2003, the aggregate amounts of normal retirement and severance benefits, previously accrued as retirement and severance benefit liabilities, of the employees electing to retire pursuant to such programs amounted to (Won)13,017 million and (Won)110,932 million, respectively.
(17) Other Long-term Liabilities
Other long-term liabilities as of December 31, 2002 and 2003 are summarized as follows:
Accrual for customer call bonus points
Key money deposits from customers
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(18) Stockholders’ Equity
The composition of holders of common stock as of December 31, 2001, 2002 and 2003 are summarized as follows:
Ministry of Information and Communication
Employee Stock Ownership Associations
Treasury stock
Others, including private companies
Changes in common stock for the years ended December 31, 2002 and 2003 are as follows:
Balance at January 1, 2002
Retirement of treasury stock on October 9, 2002
Balance at December 31, 2002
Retirement of treasury stock on January 6, 2003
Retirement of treasury stock on June 20, 2003
Retirement of treasury stock on December 9, 2003
Balance at December 31, 2003
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As allowed by the Securities Exchange Law of the Republic of Korea, the Company retired its treasury shares by a charge to retained earnings rather than its common stock.
Changes in stockholders’ equity for the years ended December 31, 2001, 2002 and 2003 are as follows:
Balance at January 1, 2001
Appropriations of retained earnings
Increase in treasury stock, net
Decrease in unrealized gains on available-for-sale securities
Unrealized gain on equity securities of affiliate
Issuance of common stock of a consolidated subsidiary
Changes in subsidiaries included in consolidation
Effect of merger between KTF and KTM
Balance at December 31, 2001
Retirement of treasury stock
Increase (decrease) in unrealized gains on available-for-sale securities
Unrealized loss on equity securities of affiliate
Goodwill of additional equity in consolidated subsidiaries acquired during 2002
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Balance at January 1, 2003
Dividends (note 26)
Cumulative effect of an accounting Change (note 2(a))
Decrease of treasury stock, net (note 21)
Stock options
Changes in translation adjustments of foreign subsidiaries
Acquisition of additional equity in consolidated subsidiaries during 2003
Equity change of subsidiary from merger transaction
(19) Capital Surplus
Capital surplus as of December 31, 2001, 2002 and 2003 is summarized as follows:
Paid-in capital in excess of par value
Goodwill of additional equity in consolidated subsidiaries
The line item, Other, net, mainly consists of the effects of common stock issuance of subsidiaries and merger between subsidiaries.
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(20) Appropriated Retained Earnings
Retained earnings appropriated to various restricted reserves as of December 31, 2001, 2002 and 2003 are summarized as follows:
Involuntary reserve:
Legal reserve
Voluntary reserve:
Reserve for business rationalization
Reserve for technology and human resource development
Reserve for social overhead capital
Reserve for business expansion
Reserve for redemption of telephone bonds
Retained earnings appropriated to legal reserve are restricted in use as cash dividends under the applicable laws and regulations of the Republic of Korea. The Korean Commercial Code requires KT to appropriate to a legal reserve an amount equal to at least 10% of the cash dividend amount at the end of each accounting period until the reserve equals 50% of stated capital. The legal reserve may be used to reduce a deficit or may be transferred to stated capital.
The Company is allowed to appropriate from retained earnings amounts necessary to establish reserves for business expansion and research and development. These reserves may be used for research, development and facilities expansion of the Company.
Under the Special Tax Treatment Control Law, the Company is allowed to make certain deductions from taxable income. The Company is, however, required to transfer from retained earnings the amount of tax benefits obtained and transfer such amount into reserves for social overhead capital and technology and human resource development.
Through 2001, under the Special Tax Treatment Control Law, investment tax credits were allowed for certain investments. The Company was, however, required to transfer from retained earnings the amount of tax benefits obtained into a reserve for business rationalization. Effective December 11, 2002, the Company is no longer required to establish a reserve for business rationalization despite tax benefits received for certain investments, and consequently the existing balance is now regarded as a voluntary reserve.
Due to the adoption of Statement of Korea Accounting Standards No. 6, “Events Occurring After the Balance Sheet Date,” appropriated retained earnings as of December 31, 2002 decreased by (Won)1,583,589 million, the amount of appropriations declared by the Company but not yet approved by the shareholders’ meeting. In March 2003, the shareholders’ meeting approved this appropriation. As a result, under this standard, this amount was recorded during 2003.
(21) Treasury Stock
(a) Trust fund
During 2000, in order to stabilize the price of the Company’s common stock in the market, the Company established a treasury stock fund of (Won)100 billion. This trust fund is managed by a bank, which is used primarily
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as a vehicle for trading the common stock shares of the Company. The trust fund (which is recorded at cost) held treasury stock of 1,250,330 shares and 1,259,170 shares as of December 31, 2002 and 2003, respectively.
(b) Issuance to the notes holders
During 2003, certain holders of convertible notes (as described in note 14), which were issued on May 25, 2002, converted their notes into shares of the Company’s common stock. As part of this transaction, 2,356 shares of treasury stock were issued to the note holders.
(c) Purchase and retirement of treasury stock
The Company and SK Telecom agreed to an equity swap on December 20, 2002, under which each company sold all of the other’s equity shares it held in the other. According to the agreement, the Company exchanged 4,457,635 shares of SK Telecom for 15,454,659 shares of the Company’s common stock and cash of (Won)211,868 million on December 30, 2002 and retired this treasury stock for (Won)786,666 million by a charge to retained earnings on January 6, 2003. In addition, on January 10, 2003, the Company exchanged 3,809,288 shares of SK Telecom for 14,353,674 shares of the Company’s common stock amounting (Won)730,704 million and cash of (Won)122,679 million.
During 2003, the Company initiated a stock buyback and retirement program approved by the Board of Directors. The Company reacquired 8,773,600 shares of treasury stock during 2003 and retired these treasury shares amounting to (Won)411,833 million by a charge to retained earnings. As of December 31, 2003, no amounts under the stock buyback and retirement programs are outstanding.
(d) Sale and contribution to Employee Stock Ownership Association
On August 28, 2003, the Company sold 1,803,296 shares of treasury stock to the KT employee stock ownership association (“ESOA”). The difference between carrying value and the fair value of (Won)13,886 million was recorded as a loss on retirement of treasury stock and the difference between the fair value and the sales proceeds of (Won)40,754 million was expensed.
Changes in treasury stock for the year ended December 31, 2003 were as follows:
Purchase of the Company’s common stock
Issuance to the convertible note holders
Purchase by trust fund, net
Sale and contribution to ESOA
(22) Commitments and Contingencies
(a) Legal matters
On February 20, 2001, the Fair Trade Commission issued a cease and desist order prohibiting the Company from engaging in any activity amounting to an unfair intra-group transaction, claiming that certain of the
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transactions with the affiliates were in violation of the Fair Trade Laws. The Fair Trade Commission alleged that the Company had unfairly assisted the affiliates by paying them unreasonably high service fees. The Fair Trade Commission imposed a fine of approximately (Won)30 billion, and the Company made a provision of (Won)30 billion for this claim during 2001. On July 9, 2001, the Korean Fair Trade Commission rejected the Company’s appeal. The Company filed a second appeal in the Seoul High Court and intends to continue to seek redress in the courts. The case is still pending as of December 31, 2003.
In October 2000, approximately 4,500 of the former and current employees, who had previously been employed by the MIC and transferred to the Company in 1981, filed a lawsuit against the Company claiming that the Company owes them an additional (Won)27 billion for retirement and severance benefits. The claim was that the Company should have given them full credit for their military service, whereas the Company believed that the Company was in compliance with the laws in effect at that time. In July 2002, the Seoul District Court held in favor of the claimants. However, on July 7, 2003, the Seoul High Court reversed the Seoul District Court’s decision and ruled in favor of the Company. The case was appealed to the Supreme Court of Korea on October 8, 2003 by the plaintiffs and is still pending as of December 31, 2003. Consistent with prior year, the Company has not recorded an accrual for this matter. The Company is also in litigation as a defendant in other cases for damages allegedly resulting from various claims, disputes and legal actions in the normal course of operations. These claims amounted to (Won)84,795 million and (Won)71,188 million as of December 31, 2002 and 2003, respectively. The Company accrued (Won)11,441 million as contingent liabilities related to the claims as of December 31, 2003. Management believes that the ultimate settlement of these matters, and the matters described in the previous paragraphs, will not have a material adverse effect on the Company’s financial position, results of operations or cash flows.
(b) Interest rate swaption
In 2002, the Company entered into interest rate swaption contract with Citibank for variable rates of interest in place of fixed rates of interest. Details of interest rate swaption contract outstanding as of December 31, 2003 are as follows:
Under the interest swaption contract, the Company recognized a valuation gain of (Won)454 million and a valuation gain of (Won)2,448 million for the years ended December 31, 2002 and 2003, respectively.
(c) Interest rate swap
During 2002 and 2003, the Company entered into various interest rate swap contracts with financial institutions for variable rates of interest in place of fixed rates of interest.
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Details of interest rate swap contracts outstanding as of December 31, 2003 are as follows:
Fixed
Under the interest rate swap contracts, the Company recognized a valuation loss and gain of (Won)(2,253) million and (Won)16,442 million, respectively, for the year ended December 31, 2002, and a valuation loss and gain of (Won)(13,645) million and (Won)222 million, respectively, for the year ended December 31, 2003. In addition, the Company settled two contracts before the terminal date and recognized a transaction gain of (Won)8,170 million in 2003.
(d) Currency swap
The Company entered into two currency swap contracts for principal and interest denominated in Korean won in place of principal and interest of long-term debt denominated in U.S. dollars in June 2003.
Details of currency swap contracts outstanding as of December 31, 2003 are as follows:
Receiving interest rate
Paying interest rate
Under the currency swap contracts, the Company recognized a valuation loss of (Won)2,429 million for the year ended December 31, 2003.
(e) Interest currency swap
The Company entered into five interest currency swap contracts with financial institutions for principal and the variable rate of interest denominated in Korean won in place of principal and the fixed rate of interest of long-term debt denominated in U.S. dollars in October 2003. The principal amounts in Korean won will be adjusted according to the foreign exchange rate of the terminal date within certain ranges.
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Details of interest currency swap contracts outstanding as of December 31, 2003 are as follows:
(millions)
Fixedreceiving interestrate (1 year)
Variablepaying interestrate (6 months)
Under the interest currency swap contracts, the Company recognized a valuation gain of (Won)5,083 million for the year ended December 31, 2003.
(f) The Company established a labor welfare fund as a separate entity and contributed (Won)50,000 million and (Won)100,000 million in 2002 and 2003, respectively. In addition, the Company committed to contribute (Won)100,000 million for 2004.
(g) Loans and borrowings
As of December 31, 2003, the Company has entered into bank overdraft agreements with two banks for borrowings up to (Won)400,000 million and a collection agreement for foreign currency denominated checks up to US$1 million with Korea Exchange Bank. In addition, the Company has received letter of credits up to US$35 million with three banks.
(h) Guarantee provided by a third party
The Company is provided the guarantees covering contract biddings up to US$57,910 thousand and (Won)25,833 million by three banks including Kookmin Bank.
(i) Transfer of KTF accounts receivable
On December 16, 2002, KTF transferred the handset installment receivable of (Won)528,578 million and guarantee insurance and other incident rights to KTF First Securitization Specialty Co., Ltd. As a result of this transfer, the Company received cash of (Won)470,000 million and subordinate debt securities in the principal amount of (Won)43,430 million, and recognized a loss on disposition of trade accounts and notes receivable of (Won)15,148 million. KTF has provided a guarantee for uncollected receivables up to 14.3 percent of total amount transferred. As of December 31, 2003, the program was completed.
On November 4, 2003, KTF transferred handset installment receivables amounting (Won)339,677 million, related guarantee insurance and other incident rights to KTF Second Securitization Specialty Co., Ltd. As a result of this transfer, the Company received cash of (Won)312,000 million and subordinate debt securities in the principal amount of (Won)19,254 million and recognized a loss on disposition of trade accounts and notes receivable of (Won)8,423 million. As of December 31, 2003, the uncollected trade receivables under this program are (Won)218,035 million.
In addition, on December 19, 2003, KTF entered into a securitization agreement with Shinhan Bank to sell PCS service receivables of (Won)253,247 million as of October 31, 2003. The agreement allows the Company to sell trade receivables on an on-going basis until February 28, 2007. As a result of this transaction, the Company received cash of (Won)200,000 million and subordinated interest in the trade receivable of (Won)53,247 million. In addition, the Company incurred transaction cost expense of (Won)1,680 million. As of December 31, 2003, the uncollected trade receivables under this program are (Won)301,802 million.
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(j) Leases
(i) Operating leases
The Company maintains operating lease agreements for certain machinery and equipment from Macquarie IT KOREA Lease Company and others. Future lease payments under operating leases as of December 31, 2003 are as follows:
(ii) Capital leases
The Company has capital lease agreements for certain machinery and equipment, of which acquisition cost amounts to (Won)6,312 million from GE Capital Korea Ltd and others. Depreciation on the machinery and equipment for the year ended December 31, 2003 amounted to (Won)607 million. Annual future minimum payments under the lease agreements as of December 31, 2003 are as follows:
Less: amount representing interest
(23) Operating Revenues
Operating revenues for the years ended December 31, 2001, 2002 and 2003 are as follows:
Internet services
Data communication services
Leased line services
Telephone services
PCS services
Satellite services
Real estate rental services
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Starting from January 1, 2003, revenues from real estate rental services are accounted for as operating revenues. For comparative purposes, revenues from real estate rental services which were accounted for as other income in 2001 and 2002 are reclassified into operating revenues.
(24) Operating Expenses
Operating expenses for the years ended December 31, 2001, 2002 and 2003 are as follows:
Cost of services:
Salaries and wages
Provision for retirement and severance benefits, including early retirement payments (note 16)
Employee benefits
Communications
Utilities
Taxes and dues
Rent
Automobile maintenance
Commissions and professional fees
Entertainment
Advertising
Education and training
Research and development
Travel
Supplies
Cost of services (commissions for system integration service, and other miscellaneous service)
Interconnection charges
International line usage
Less: amounts included in construction in progress
Selling, general and administrative expenses
In September 2003, the Company offered a voluntary early retirement plan (the “Plan”) to its employees. Under the terms of the Plan, employees participating in the Plan would receive additional amounts of retirement and severance benefits. For the year ended December 31, 2003, the Company recorded costs of (Won)831,535 million related to this Plan covering 5,497 employees (approximately 12% of total employees). The aggregate amounts of normal retirement and severance benefits, previously accrued as retirement and severance benefits liabilities, of the employees electing to retire pursuant to this plan amounted to (Won)110,932 million. Substantially all of these costs were paid during the fourth quarter of 2003.
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Selling, general and administrative expenses for the years ended December 31, 2001, 2002 and 2003 are as follows:
Compensation expenses (note 28)
Commissions
Commissions to sales agent
Promotion
(25) Income Taxes
(a) The Company is subject to a number of income taxes based upon taxable income which results in the following normal tax rates (including resident tax):
Taxable earnings
Up to (Won)100 million
Over (Won)100 million
Starting from January 1, 2002, the corporate income tax rate (including resident tax) decreased to 29.7%. In addition, in December 2003, the Korean government reduced the corporate income tax rate (including resident tax) beginning in 2005. Specifically, effective from January 1, 2005, the income tax rate will be reduced from 29.7% to 27.5%. As a result, a change in deferred income taxes of (Won)14,706 million and (Won)33,974 million is charged to income tax expense for the year ended December 31, 2001 and 2003, respectively.
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The components of income tax expense for the years ended December 31, 2001, 2002 and 2003 are as follows:
Current income tax expense
Income taxes for the year
(b) The provision for income taxes calculated using tax rates differs from the actual provision for the years ended December 31, 2001, 2002 and 2003 for the following reasons:
Provision for income taxes at normal tax rate
Tax effect of prior years income tax additional payment (refund)
Tax effect of permanent differences, net
Utilization of loss carryforwards
Investment tax credits
Effect of tax rate change
Impairment of deferred tax asset
The effective tax rates, after adjustments for certain differences between amounts reported for financial accounting and income tax purposes, were approximately 23.5%, 24.7% and 33.1% for the years ended December 31, 2001, 2002 and 2003, respectively.
(c) The tax effects of temporary differences that result in significant portions of deferred income tax assets and liabilities as of December 31, 2002 and 2003 are presented below:
Deferred income tax assets:
Retirement and severance benefits
Allowance for doubtful accounts
Refundable deposits for telephone installation
Investment securities
Tax credit carryforwards
Total deferred income tax assets
Deferred income tax liabilities:
Accumulated depreciation
Total deferred income tax liabilities
Less: Valuation allowance
Net deferred income tax asset
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The exclusion and inclusion of subsidiaries from the consolidation in 2002 and 2003 resulted in a decrease in net deferred tax asset of (Won)1,288 million and an increase in net deferred tax asset of (Won)1,709 million, respectively. During 2003, the Korea National Tax Service initiated a tax audit of the Company for the periods from 1998 to 2002. In September 2003, the Company received a final notice from the Korean tax authorities asserting income tax deficiencies. As a result of the tax audit, the Company paid (Won)67,410 million which consisted of (Won)1,639 million of deferred income tax asset and (Won)65,771 million of prior year’s income tax additional expense for the year ended December 31, 2003. At December 31, 2003, the Company has investment tax credit carryforwards of (Won)25,816 million which are available to reduce future income taxes through 2008.
Following the Company’s acquisition of a controlling financial interest in KTM in July 2000, KTM reassessed its business plan, operations strategy, growth prospects and involvement with the Company in KTM’s future business. As part of the revised strategy, KTM’s intent was to seek a merger partner and undertake other operational changes. During December 2000, KTM concluded that it was not likely that it would be able to realize the tax benefit of its loss carryforward and, therefore, wrote off the related deferred tax assets in the amount of (Won)233,496 million as of December 31, 2000 by a charge to deferred income tax expense in 2000.
In 2001, KTM merged with KTF with the combined entity operating under the name of KTF. As a result of KTM’s operating performance in 2001 as well as a change in tax regulations, KTF was able to utilize KTM’s loss carryforward in the amount of (Won)97,062 million in 2001, (Won)150,653 million in 2002 and (Won)135,600 million in 2003. However, KTF concluded that it is not probable that the tax benefit of the loss carryforward generated by KTM can be realized in future years and therefore, did not recognize a deferred income tax asset related to KTM’s remaining loss carryforwards of (Won)290,081 million as of December 31, 2003, which will expire through 2005.
During 2003, the Company concluded that it was not probable that it would be able to realize the tax benefit of its equity in losses of affiliates and, therefore, wrote off the related deferred income tax assets in the amount of (Won)133,582 million by a charge to deferred income tax expense.
(26) Dividends
Dividends are generally proposed based on each year’s earnings and are declared and paid in the subsequent year. Dividends relating to each of the following years’ earnings based upon the par value of common stock are as follows:
Dividends proposed
Proposed dividends of (Won)421,517 million were not recorded in the 2003 financial statements. They will be recorded upon the approval by the shareholders in 2004.
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(27) Earnings Per Share
Earnings per share of common stock for the years ended December 31, 2001, 2002 and 2003 are calculated as follows:
(a) Basic earnings per share
Millions
(except number of shares
and earnings per share)
Weighted-average number of shares of common stock (in thousands)
Basic earnings per share (in Won)
(b) Diluted earnings per share
Net earnings (in millions of won)
Adjustments:
Interest expense on convertible notes
Net earnings available for common and common equivalent shares
Weighted-average number of common and common equivalent shares(in thousands)
Diluted earnings per share (in Won)
Diluted earnings per share are calculated based on the effect of dilutive securities that were outstanding during the year. The denominator for the diluted earnings per share computation is adjusted to include the number of additional common shares that would have been outstanding if the dilutive securities had been converted into common stock. In addition, the numerator is adjusted to include the after-tax amount of interest recognized associated with convertible notes.
Potentially dilutive securities as of December 31, 2002 and 2003 are as follows:
Potentially dilutiveshares
(thousands)
Convertible notes (note 14)
Bonds with warrants (note 14)
Stock options and bonds with warrants did not enter into the determination of diluted earnings per share in 2002 and 2003 because of an anti-dilutive effect on the exercise of warrants.
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(28) Stock Options
The Company granted stock options to its executive officers and directors in accordance with a stock option plan approved by the Board of Directors. The details of the stock options granted are as follows:
1st Grant
2nd Grant
3rd Grant
Grant date
December 26, 2002
September 16, 2003
December 12, 2003
Exercise price
(Won)70,000 per share
(Won)57,000 per share
(Won)65,000 per share
Number of shares
474,067 shares
36,400 shares
106,141 shares
Exercise period
December 27, 2004 ~
December 26, 2009
September 17, 2005 ~
September 16, 2010
December 13, 2005 ~
December 12, 2010
Valuation method
Fair value based method
(Black-Scholes model)
The first grant of stock options consisted of 680,000 shares of common stock, including 220,000 shares under performance condition at the option price of (Won)70,000 per share. However, the number of stock options decreased to 474,067 shares and the total cost of compensation from (Won)12,590 million to (Won)10,602 million because of the resignation of a number of officers.
The options are fully vested upon completion of two years mandatory service periods starting from the grant dates. The first and third granted option holders can exercise one third of total options annually from 2004 and 2005, respectively. The second granted options holders can exercise total options when the options are vested.
The Company adopted the fair value based method (Black-Scholes model) for the calculation of compensation costs which are amortized to expense over the option vesting periods.
The valuation assumptions of stock options based on the fair value method under the Black-Scholes model are as follows:
Risk free interest rate
Expected option life
Expected volatility
Expected dividend yield ratio
Fair value per option (in Won)
Total compensation cost (in millions)
Changes in the total cost of compensation for the year ended December 31, 2003 are summarized as follows:
Total cost of compensation
Accumulated cost recognized in prior years
Cost recognized for the year
Cost recognized in future year
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In addition, KTF and KTP granted stock options to its officers and adopted the fair value based method for the calculation of compensation expense which is amortized to expense over the option vesting period. KTF and KTP recognized aggregate stock option expense of (Won)1,266 million which was recorded as capital adjustments from 2000.
(29) Non-cash Financing and Investing Activities
Significant non-cash investing activities for the year ended December 31, 2003 are summarized as follows:
Change in unrealized gains on available-for-sale securities
Available-for-sale securities transferred to treasury stock
Construction in progress transferred to property, plant and equipment
Inventory transferred to property, plant and equipment
(30) Contribution Payments for Research and Development
The Company made contributions of (Won)97,248 million, (Won)69,314 million and (Won)63,407 million to the Korean government (Information and Telecommunication Improvement Fund), the Korea Electronic Telecommunication Research Institute (ETRI), and other institutes for the years ended December 31, 2001, 2002 and 2003, respectively.
(31) Contributions Received for Losses on Universal Telecommunications Services
Starting on January 1, 2000, all telecommunications service providers must contribute towards the supply of universal telecommunications services in Korea. Telecommunications service providers designated as universal service providers by the MIC are required to provide universal telecommunications services, including local services, local public telephone services, telecommunications services for remote islands and wireless communication services for ships. The Company has been designated a universal service provider. The losses incurred by universal service providers in connection with providing these universal telecommunications services are to be apportioned among the service providers based on their respective annual revenues. For the years ended December 31, 2001, 2002 and 2003, amounts reimbursed to the Company were (Won)50,764 million, (Won)113,908 million and (Won)28,539 million, respectively.
(32) Fourth Quarter Information (Unaudited)
Operating revenues, operating income, net earnings and earnings per share are for the three-month periods ended December 31, 2002 and 2003 are as follows:
(except per share data)
(33) Economic Environment
In common with other Asian countries, the economic environment in the Republic of Korea continues to be volatile. In addition, the Korean government and the private sector continue to implement structural reforms to
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historical business practices including corporate governance. The Company may be either directly or indirectly affected by these economic conditions and the reform program described above. The accompanying consolidated financial statements reflect management’s assessment of the impact to date of the economic environment on the financial position and results of operations of the Company. Actual results may differ materially from management’s current assessment.
(34) Reconciliation to United States Generally Accepted Accounting Principles
The consolidated financial statements are prepared in accordance with Korean GAAP which differ in certain respects from accounting principles generally accepted in the United States of America (“U.S. GAAP”). In addition, there are various classification differences between Korean GAAP and U.S. GAAP on the balance sheets, statements of earnings and retained earnings and cash flows. These reclassifications do not have any impact on the shareholders’ equity, net income or earnings per share amounts reported under U.S. GAAP. The significant differences between Korean GAAP and U.S. GAAP that affect the Company’s financial statements are described below.
(a) Companies Included in Consolidation
Under Korean GAAP, all majority-owned subsidiaries and entities of which the Company or a controlled subsidiary owns more than 30% of total outstanding voting stock and is the largest stockholder are included in the consolidation. However, U.S. GAAP generally requires that majority-owned subsidiaries be consolidated and that any entity of which the Company owns twenty to fifty percent of total outstanding voting stock not be consolidated; rather that entity should be accounted for under the equity method. Accordingly, the following entities are excluded from consolidation under U.S. GAAP and instead are accounted for under the equity method:
Entity
KTF
KTP
In addition, under Korean GAAP, the Company consolidates KTFT (owned 57.4% by KTF) as of December 31, 2002 and 2003, KTICOM of which KTF owned 87.3% as of December 31, 2002 and merged into KTF on March 6, 2003. These entities are also accounted for under the equity method under U.S. GAAP.
Presented below is summarized combined financial information of the above companies in accordance with Korean GAAP as of December 31, 2002 and 2003, and for each of the years in three-year period ended December 31, 2003.
Current assets
Other assets
Current liabilities
Other liabilities
Net assets
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The Company’s proportionate share of U.S. GAAP adjustments of KTF, KTICOM, KTSC, KTFT and KTP are presented in the line item “U.S. GAAP adjustments of equity method affiliates” in the U.S. GAAP reconciliation of net earnings and shareholders’ equity. Condensed consolidated balance sheets as of December 31, 2002 and 2003, and condensed consolidated income statements of the Company under U.S. GAAP for each of the years in three-year period ended December 31, 2003 are presented elsewhere in note 34.
(b) Debt and Equity Securities
Under Korean GAAP, prior to January 1, 2003, investments in equity securities and debt securities which were held for short-term cash management purposes were included in “marketable securities” and reported at fair value with unrealized gains and losses included in earnings. Investments in marketable equity securities and equity linked securities held for long-term investment purposes were reported at fair value with unrealized gains and losses excluded from earnings and reported in a separate component of stockholders’ equity. Non-marketable investments in equity securities were reported at cost unless there was a significant decline in value which was not expected to be recovered. Investments in debt securities held for long-term investment purposes were carried at amortized cost for all periods.
However, effective January 1, 2003, the Company adopted Statement of Korea Accounting Standards (“SKAS”) No. 8 “Investment in Securities”. This new Standard is similar to existing U.S. GAAP as below except the accounting for non-marketable equity securities. For Korean GAAP purposes, non-marketable securities should be classified as available-for-sale and carried at fair value, with unrealized holding gains and losses reported as a capital adjustment. For U.S. GAAP purposes, non-marketable securities are classified as cost method investments and carried at cost.
Under SKAS No. 8, certain debt and equity securities should be classified into one of the three categories of held-to-maturity, available-for-sale, or trading securities at the time of acquisition and such determination should be reassessed at each balance sheet date. Investments in debt securities that the Company has the positive intent and ability to hold to maturity are classified as held-to-maturity. Securities that are bought and held principally for the purpose of selling them in the near term (thus held for only a short period of time) are classified as trading securities. Trading generally reflects active and frequent buying and selling, and trading securities are generally used to generate profit on short-term differences in price. Investments not classified as either held-to-maturity or trading securities are classified as available-for-sale securities.
Through 2002, the Company classified trading securities as current assets, whereas available-for-sale securities and held-to-maturity securities were recorded as non-current investments. Effective January 1, 2003, however, available-for-sale securities, whose maturity dates are due within one year from the balance sheet date or whose likelihood of being disposed of within one year from the balance sheet date is probable, are classified as current assets. Likewise, held-to-maturity securities whose maturity dates are due within one year from the balance sheet date are classified as current assets.
Effective January 1, 2003, trading securities are carried at fair value, with unrealized holding gains and losses included in earnings. Available-for-sale securities are carried at fair value, with unrealized holding gains and losses reported as a capital adjustment. Investments in debt securities that are classified into held-to-maturity are reported at amortized cost at the balance sheet date and such amortization is included in interest income.
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For U.S. GAAP purposes, the Company accounts for investments under the provisions of Statement of Financial Accounting Standards (“SFAS”) No. 115, “Accounting for Certain Investments in Debt and Equity Securities.” SFAS No. 115 requires that marketable equity securities and all debt securities be classified in three categories and accounted for as follows:
Under Korean GAAP, the equity-linked debt securities are treated as available-for-sale securities and are reported at fair value based on the quoted price of SK Telecom shares. Unrealized gains and losses are excluded from earnings and reported in a separate component of stockholders equity.
For U.S. GAAP purposes, the equity-linked debt securities are considered a hybrid instrument with an equity based derivative embedded in a debt instrument. In accordance with SFAS No. 133, the equity-based embedded derivative is separated from the debt instrument and accounted for separately. The embedded derivative is recorded at fair value with gains and losses included in earnings. The debt instrument has been classified as an available-for-sale debt security and reported at fair value, with unrealized gains and losses excluded from earnings and reported as a separate component of stockholders’ equity.
Under Korean GAAP, prior to January 1, 2003, the convertible notes were treated as long-term investment securities and are reported at cost. However, effective January 1, 2003, the Company adopted Statement of Korea Accounting Standards No. 9 “Convertible Securities.” As a result, the convertible notes are treated as available-for-sale securities and are reported at fair value. The Company recognizes interest income on convertible notes as determined using the effective interest method and unrealized holding gain and losses of the difference between fair value and book value as the component of the stockholders’ equity. However, since these convertible notes are between KT and KTF (consolidated subsidiary under Korean GAAP), the convertible notes and related interest income/expense are eliminated in consolidation.
For U.S. GAAP purposes, KTF is treated as an equity method investment. As a result, the convertible notes are considered a hybrid instrument with a conversion option embedded in a debt instrument. In accordance with SFAS No. 133, the conversion option is separated from the debt instrument and accounted for separately. The conversion option is recorded at fair value with gains and losses included in earnings. The debt instrument has been classified as an available-for-sale debt security and reported at fair value, with unrealized gains and losses excluded from earnings and reported as a separate component of stockholders’ equity.
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Information under U.S. GAAP with respect to investments under SFAS No. 115 at December 31, 2002 and 2003 is as follows:
Cost oramortized
cost
Grossunrealizedholding
gains
losses
value
Equity securities (available-for-sale)
Debt securities (available-for-sale)
Debt securities (held-to-maturity)
In addition, the Company has trading securities of (Won)27,750 million and (Won)16,340 million as of December 31, 2002 and 2003.
The proceeds from sales of available-for-sale securities were (Won)700,620 million in 2001, (Won)306,552 million in 2002 and (Won)166,281 million in 2003. The gross realized gains on those sales were (Won)603,159 million in 2001, (Won)1,128,442 million in 2002 and (Won)763,779 million in 2003. The average cost method is used to calculate gains or losses from the sale of available-for-sale securities.
In addition, prior to 1995, the Company’s investment in SK Telecom was accounted for under the equity method for both Korean GAAP and U.S. GAAP. In 1995, the Company’s investment in SK Telecom decreased to below 20% and the Company concluded that it no longer had significant influence with respect to its investment in SK Telecom. As a result, under both Korean GAAP and U.S. GAAP, the Company discontinued the use of the equity method. However, under Korean GAAP, certain previously recognized equity in earnings were reversed as an adjustment to retained earnings. As a result, the Company’s cost basis for its investment in SK Telecom was higher under U.S. GAAP than under Korean GAAP. This difference was eliminated since the investment in SK Telecom was reported at fair value under both Korean GAAP and U.S. GAAP, with the unrealized gain reported in a separate component of stockholders’ equity until realized.
In 2002 and 2003, as described in note 8, the Company sold all of its shares in SK Telecom. As a result of the higher cost basis under U.S. GAAP, an adjustment has been recorded in the net earnings reconciliation to reduce U.S. GAAP net earnings.
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In December 2003, the Emerging Issues Task Force (EITF) 03-1, “The meaning of Other-Than-Temporary Impairment and Its application to Certain Investments” and addresses how to define an “other-than-temporary impairment” as well as its application to investments classified as either “available-for-sale” and “held-to-maturity” under SFAS 115. The EITF requires disclosure of securities in a continuous unrealized loss position to be stratified based on length of time those securities were carried in such a position (less than 12 months or 12 months more). Comparative information for earlier periods is not required. The Company has included the new disclosure requirements of EITF 03-1 in the following paragraph.
The following table shows the investments’ gross unrealized losses and fair value, aggregated by investment category and length of time that individual securities have been a continuous unrealized loss position as of December 31, 2003:
Equity-linked notes
Common stock
Total temporarily impaired securities
(c) Business Combinations
Under Korean GAAP, upon acquiring a controlling financial interest in a subsidiary, either the difference between the Company’s cost of an acquired business and the fair value of tangible and identifiable intangible assets acquired or the difference between the cost of an acquired business and the corresponding share of stockholders’ equity (book value) of an acquired business, depending on the availability of fair value information, is presented as goodwill. In addition, acquisitions are accounted for assuming such transactions occur as of the date of the audited or reviewed financial statements of the acquired business which are closest to the date of acquisition.
Under U.S. GAAP, the cost of an acquired business is allocated to the fair value of net tangible and identifiable intangible assets acquired and liabilities assumed, with any excess presented as goodwill and the acquisitions are accounted for as of the date the transaction occurred.
(d) Goodwill
Under Korean GAAP, goodwill, which represents the excess of the acquisition cost over the fair value of net identifiable assets acquired, is amortized on a straight-line basis over its estimated economic useful life. When it is no longer probable that goodwill will be recovered from expected future economic benefits, it is expensed immediately. Also, for investments in affiliated companies accounted for using the equity method, the excess of acquisition cost of the affiliates over the Company’s share of their net assets at the acquisition date is being amortized by the straight-line method over its estimated useful life.
Effective January 1, 2002, KT adopted SFAS No. 142, “Goodwill and Other Intangible Assets.” SFAS No. 142 requires that goodwill and indefinite-lived intangible assets no longer be amortized, but instead be tested for impairment at least annually. Intangible assets that have finite useful lives will continue to be amortized over their useful lives. In addition, the amortization period for intangible assets with finite lives will no longer be limited to 40 years. In accordance with SFAS No. 142, goodwill is tested for impairment on an annual basis by comparing the fair value of the Company’s reporting units to their carrying amounts.
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The following tables present the impact of SFAS No. 142 on net income and earnings per share had the standard been in effect on January 1, 2001:
In millions of Won,
except earnings per share
Net income
Add back: Goodwill amortization
Add back: Goodwill amortization related to equity investee
Adjusted net income
Basic earnings per share:
Goodwill amortization
Goodwill amortization related to equity investee
Diluted earnings per share:
Diluted earnings per share
Adjusted diluted earnings per share
Identifiable intangible assets as of December 31, 2002 and 2003, are as follows:
Amortized intangible assets:
Internal-use software
Buildings and facilities utilization rights
Purchased consumer data
Amortization expense:
For the year ended December 31, 2002
For the year ended December 31, 2003
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Estimated amortization expense:
For years ended December 31,
The weighted average amortization period of total amortized intangible assets, internal-use software and right of utilization are 9 years, 6 years and 20 years, respectively. The Company has no identifiable intangible assets that are not subject to amortization.
The changes in the carrying amount of goodwill for the years ended December 31, 2002 and 2003 are as follows:
Balance as of January 1, 2002
Goodwill acquired during the period
Impairment loss
Balance as of December 31, 2002
Balance as of January 1, 2003
Balance as of December 31, 2003
KTF, an equity investee accounted for using the equity method of accounting included in the PCS service segment, was tested for impairment during 2002 and 2003 because of the significant decrease of the quoted market value of its stock. In 2002 and 2003, the Company recognized an impairment loss amounting to (Won)663,345 million and (Won)789,503 million, respectively, relating to KTF.
KTH, a consolidated subsidiary included in the miscellaneous segment, was tested for impairment during 2002. Due to the significant decrease of the quoted market value of KTH the Company recognized an impairment loss amounting to (Won)12,947 million relating to KTH during 2002.
(e) Additional Equity Investments in and Transactions of Subsidiaries
Under Korean GAAP, subsequent to acquiring a controlling financial interest in a subsidiary, additional equity investments by the Company in subsidiaries stock and other equity transactions of subsidiaries are accounted for assuming such transactions occur as of the date of audited or reviewed financial statements of the acquired subsidiary closest to the date of acquisition. In addition, the difference between the Company’s cost of the acquired additional interest and the corresponding share of stockholders’ equity of the acquired subsidiary is presented as an adjustment to capital surplus.
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Under U.S. GAAP, such equity investments in and transactions of affiliates and subsidiaries are recorded and accounted for as of the date the transaction occurs. As a result, the Company has a different basis in its equity investments in the subsidiaries under Korean GAAP as compared to U.S. GAAP. Therefore, any gains or losses recorded by the Company (which are recorded as capital transactions in stockholders’ equity) when an equity investee sells shares of its stock will be different under U.S. GAAP as compared to Korean GAAP. In addition, under U.S. GAAP, the cost of an additional equity interest would be allocated based on the fair value of net tangible and identifiable assets acquired and liabilities assumed, with the excess allocated to goodwill.
(f) Depreciation
In 1995, KT adopted a method of depreciation, as allowed under Korean GAAP, whereby property, plant and equipment placed in service at any time in the first half of the year received a full year of depreciation expense, and property, plant and equipment placed in service at any time in the second half of the year received one-half year of depreciation. Also, as permitted under Korean GAAP, depreciation of these assets was based on lives which are shorter than their economic useful lives. In 1996, KT readopted the policy utilized, also acceptable under Korean GAAP, whereby property, plant and equipment is depreciated from the actual date it is placed in service, while continuing to use useful lives which are shorter than the economic useful lives of such assets. In 1998, under Korean GAAP, as required under a ruling by the National Tax Service (which is also applicable under Korean GAAP), the Company changed the estimated useful lives of certain assets, including underground access to cable tunnels and concrete and steel telephone poles acquired after 1995, from 6 years to periods ranging from 20 years to 40 years, and changed the depreciation method from the declining-balance method to the straight-line method.
In 1999, under Korean GAAP, the Company changed its depreciation method for buildings and structures acquired before December 31, 1994, from the declining-balance method to the straight-line method in order to be consistent with the method applied to buildings and structures acquired after January 1, 1995.
Under U.S. GAAP, property, plant and equipment is generally depreciated over its estimated useful life in a systematic and rational manner. In addition, the depreciation method in the year of acquisition based on the Company’s in-service dates for its capital additions in 1995 described above, does not comply with U.S. GAAP in that significant depreciation expense is recognized prior to the actual use of the asset. The change in estimated useful lives in 1998, and the changes in 1998 and 1999 from the declining-balance method to the straight-line method would also not be appropriate under U.S. GAAP. Accordingly, adjustments have been reflected for U.S. GAAP purposes for the effect of each of these items.
Under U.S. GAAP, property, plant and equipment is generally depreciated by using the declining-balance method except for the assets of certain subsidiaries, buildings and structures acquired in 1995 and thereafter which are depreciated using the straight-line method.
Under U.S. GAAP, the useful lives of property, plant and equipment are summarized as follows:
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(g) Special Depreciation
Special depreciation was an acceleration of depreciation on certain assets under Korean GAAP. The U.S. GAAP reconciliation reflects the adjustment of special depreciation to a declining balance method, based on the economic useful life of the asset. During 2002, the assets under special depreciation were fully depreciated under U.S. GAAP. Therefore, the adjustment under U.S. GAAP is no longer required in 2003.
(h) Interest Capitalization
Under Korean GAAP, prior to January 1, 2003, interest was capitalized on borrowings related to the construction of all property, plant and equipment and IMT-2000 frequency usage right, incurred prior to completing the acquisition, as part of the cost of such assets. Effective January 1, 2003, the Company adopted Statement of Korea Accounting Standards No. 7 “Capitalization of Financing Costs”. As allowed by this standard, the Company has elected to expense all interest costs as incurred beginning in 2003.
Under U.S. GAAP, interest is capitalized in the amount that would have theoretically been avoided had expenditures not been made for assets which require a period of time to get them ready for their intended use. Under U.S. GAAP, details of interest capitalization for the years ended December 31, 2001, 2002 and 2003 are as follows:
Total interest costs incurred
Less amounts charged to expense
Interest capitalized
(i) Intangible Assets
Under Korean GAAP, pre-operating costs and research costs are expensed as incurred, and development costs and organization costs are deferred and amortized over estimated useful lives provided such costs are recoverable from future earnings. Effective January 1, 2003, the Company adopted Statement of Korea Accounting Standards No. 3 “Intangible Assets”, which requires that organization costs are to be expensed as incurred. In addition, the cumulative effects on prior years of this change in accounting method of (Won)1,530 million have been charged to the retained earnings and (Won)2,198 million of minority interest as of January 1, 2003. All of these costs are expensed as incurred under U.S. GAAP except for capitalized internal software costs. Therefore, adoption of SKAS No.3 does not require any U.S. GAAP adjustments.
(j) Bonds with Stock Warrants
Under Korean GAAP, prior to January 1, 2003, all proceeds received for bonds issued with detachable stock warrants, are recorded as a debt obligation and are not allocated between the debt and stockholders’ equity components. Effective January 1, 2003, the Company adopted Statement of Korea Accounting Standards No. 9, “Convertible Securities”, which requires that the proceeds from the issuance of bonds with detachable stock warrants should be allocated between the debt obligation and the warrants. In accordance with SKAS No. 9, the new requirements are applicable on a prospective basis to bonds with warrants issued or modified after December 31, 2002.
Under U.S. GAAP and consistent with SKAS No. 9, the proceeds from the issuance of bonds with detachable stock warrants should be allocated between the debt obligation and the warrants. The allocations is based on the relative fair values at the date of issuance and the portion of proceeds allocated to the stock warrants is recorded in stockholders’ equity.
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(k) Revenue Recognition
Under Korean GAAP, non-refundable service initiation fees for telephone, broadband Internet access, PCS services and leased-line service are recognized as revenue upon receipt.
Under U.S. GAAP, service installation fees related to activation of ongoing service are deferred and recognized to revenue over the expected estimated terms of customer relationships. The Company defers service installation fees over the expected terms of customer relationship. The expected terms of customer relationships for telephone, broadband Internet access, PCS services and leased-line service are 15 years, 3 years, 4 years and 3 years, respectively. Incremental direct costs related to customer acquisition are expensed as incurred.
(l) Foreign Currency Transactions
Under Korean GAAP, prior to January 1, 2003, all unrealized foreign currency translation gains and losses on monetary assets and liabilities, except for amounts included in the cost of property, plant and equipment, are included in results of operations. Effective January 1, 2003 the Company adopted Statement of Korea Accounting Standards No. 7, “Capitalization of Financing Costs”. As allowed by the Standard, the Company elected to include all unrealized foreign currency translation gains and losses (including property, plant and equipment) in the results of operations.
Under U.S. GAAP, all foreign exchange transaction gains and losses (referred to as translation gains and losses under Korean GAAP) are included in the results of operations for the current period and therefore, the amounts included in property, plant and equipment under Korean GAAP are reversed.
Under Korean GAAP, the convertible notes denominated in a foreign currency are regarded as non-monetary liabilities since they have equity like characteristics, and the Company does not recognize the associated foreign currency translation gain or loss.
Under U.S. GAAP, the convertible notes denominated in a foreign currency are translated at the rate of exchange on the balance sheet date, and the resulting foreign currency transaction gain or loss is included in the results of operations.
(m) Equity-Linked Securities
Under Korean GAAP, the equity-linked securities owned by the Company are considered as available-for-sale securities and recorded at fair value at the balance sheet date. Fair value is calculated based on the quoted market price of SK Telecom shares. Unrealized holding gains and losses are recorded as a separate component of stockholders’ equity.
Under U.S. GAAP, the equity-linked securities are separated into two components, the host contract and the embedded derivative. The host contract is recorded as an available-for-sale debt security and unrealized holding gains and losses are excluded from earnings and included as a separate component of stockholder’s equity. The fair value of the debt security is based on the third party’s appraisal value. The embedded derivative is recorded at fair value and unrealized gains and losses are recorded in results of operations. The fair value of the derivative is based on commonly accepted valuation methods.
(n) Convertible Notes
Under Korean GAAP, prior to January 1, 2003, the convertible notes entered into between KT and KTF during 2002 were treated as long-term investment securities and were reported at cost. However, effective
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January 1, 2003, the Company adopted Statement of Korea Accounting Standards No. 9, “Convertible Securities”, which requires that convertible notes are treated as available-for-sale securities and are reported at fair value. The Company recognizes interest income on convertible notes as determined using the effective interest method and unrealized holding gain and losses of the difference between fair value and book value as a component of stockholders’ equity. However, since these convertible notes are between the parent and the consolidated subsidiary under Korean GAAP, the convertible notes and related interest income/expense are eliminated in consolidation.
(o) Income Taxes
Under Korean GAAP, deferred taxes are not recognized for temporary differences related to unrealized gains and losses on investment securities that are reported in a separate component of stockholders’ equity. Any income tax refund (payment) attributable to a prior year is included in other income (expense).
Under U.S. GAAP, deferred taxes are recognized on the temporary difference related to unrealized gains and losses on investment securities that are reported in other comprehensive income. Any income tax refund (payment) attributable to a prior year is included in income tax benefit (expense).
Under Korean GAAP, deferred tax asset provided for equity in losses for affiliates are recognized only to extent that it is probable that such deferred tax asset is recoverable within 5 years.
Under U.S. GAAP, there is no prescribed time limit with respect to the realization of a deferred tax asset provided on the excess tax basis over book basis of an investment in an equity method investee.
(p) Minority Interest in Consolidated Subsidiaries
Under Korean GAAP, minority interests in consolidated subsidiaries are presented for all periods as a component of stockholders’ equity in the consolidated balance sheet.
Under U.S. GAAP, minority interests in consolidated subsidiaries are not included in stockholders’ equity in the consolidated balance sheet.
(q) Other
Korean GAAP requires gains and losses from the sale of assets and impairment write-downs to be included as part of “non-operating income (expenses)”. For U.S. GAAP purposes, gains and losses from the sale of assets and impairment write-downs are required to be recorded as a component of “operating income”.
(r) Comprehensive Income
Under U.S. GAAP, the Company applies the provisions of SFAS No. 130 which requires the reporting and display of comprehensive income and its components (revenues, expenses, gains and losses). Such presentation is
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not required under Korean GAAP. Comprehensive income for the years ended and accumulated other comprehensive income balances as of December 31, 2001, 2002 and 2003 are summarized as follows:
Net earnings as adjusted in accordance with U.S. GAAP
Other comprehensive income, net of taxes:
Foreign currency translation adjustments
Unrealized gains (losses) on investments :
Unrealized holding gains (losses) net of tax of, (Won)43,910 million, (Won)(54,057) million and (Won)6,215 million in 2001, 2002 and 2003, respectively
Less: reclassification adjustment, net of tax of, (Won)189,062 million, (Won)396,319 million and (Won)226,842 million in 2001, 2002 and 2003, respectively
Comprehensive income (loss) as adjusted in accordance with U.S. GAAP
Accumulated other comprehensive income (loss) balances:
Unrealized gains on investments
(s) Statement of Cash Flows
Statements of cash flows under Korean GAAP include the cash flows of KTF, KTFT, KTICOM, KTSC and KTP, which are accounted for under the equity method under U.S. GAAP.
(t) Recent Changes in U.S. GAAP
In December 2003, the FASB issued FASB Interpretation No. 46 (revised December 2003), “Consolidation of Variable Interest Entities”, which addresses how a business enterprise should evaluate whether it has a controlling financial interest in an entity through means other than voting rights and accordingly should consolidate the entity. FIN 46R replaces FASB Interpretation No. 46, “Consolidation of Variable Interest Entities”, which was issued in January 2003. The Company will be required to apply FIN 46R to variable interests in VIEs created after December 31, 2003. For variable interests in VIEs created before January 1, 2004, the Interpretation will be applied beginning on January 1, 2005. For any VIEs that must be consolidated under FIN 46R that were created before January 1, 2004, the assets, liabilities and non-controlling interests of the VIE initially would be measured at their carrying amounts with any difference between the net amount added to the balance sheet and any previously recognized interest being recognized as the cumulative effect of an accounting change. If determining the carrying amounts is not practicable, fair value at the date FIN 46R first applies may be
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used to measure the assets, liabilities and non-controlling interest of the VIE. The Company currently does not have any VIEs that are within the scope of this Statement.
FASB Statement No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity”, was issued in May 2003. This Statement establishes standards for the classification and measurement of certain financial instruments with characteristics of both liabilities and equity. The Statement also includes required disclosures for financial instruments within its scope. For the Company, the Statement was effective for instruments entered into or modified after May 31, 2003 and otherwise will be effective as of January 1, 2004, except for mandatorily redeemable financial instruments. For certain mandatorily redeemable financial instruments, the Statement will be effective for the Company on January 1, 2005. The effective date has been deferred indefinitely for certain other types of mandatorily redeemable financial instruments. The Company currently does not have any financial instruments that are within the scope of this Statement.
In April 2003, the FASB issued Statement of Financial Standards (SFAS) No. 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities.” This standard amends and clarifies the accounting for derivative instruments, including certain derivative instruments embedded in other contracts, and hedging activities under SFAS No. 133, “ Accounting for Derivative Instruments and Hedging Activities”. This statement is effective prospectively for contracts entered into or modified after December 31, 2003, and for hedging relationships designated after December 31, 2003. SFAS No. 149 will not have an impact upon initial adoption and is not expected to have a material effect on the Company’s results of operations, financial position and cash flows.
In May 2003, the EITF reached a consensus on Issue 00-21, “Revenue Arrangements with Multiple Deliverables.” Issue 00-21 provides guidance on how to recognize revenue for arrangements that have multiple deliverables. The guidance in 00-21 was effective for arrangements entered into in fiscal periods beginning after June 15, 2003. The Company has adopted the consensus reached in Issue 00-21. Adoption did not have a significant impact on the Company’s financial condition or results of operations.
In March 2004, the EITF reached a consensus regarding EITF 03-1, “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments.” The consensus provides guidance for evaluating whether an investment is other-than-temporarily impaired. The EITF 03-1 guidance for determining other-than-temporary impairment will be effective beginning with the second half of 2004. The Company adopted EITF 03-01 disclosure requirement of certain disclosures for securities accounted for under FASB statement 115, which was reached a consensus on December 13, 2003 meeting. The Company is currently evaluating the impact that EITF 03-1 may have on its consolidated financial statements.
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(u) U.S. GAAP Reconciliations
The effects of the significant adjustments to net earnings and stockholders’ equity which would be required if U.S. GAAP were to be applied instead of Korean GAAP are summarized as follows:
Net earnings in accordance with Korean GAAP
Intangible assets
Special depreciation
Equity in earnings of equity method affiliates
Reversal of goodwill amortization
Different useful life of intangibles
Additional acquisitions of equity investees
Impairment loss relating to equity investee
Goodwill impairment
U.S. GAAP adjustments of equity method affiliates
Interest capitalization (including related depreciation), net
Capitalized foreign exchange transactions, net
Foreign currency translation of convertible notes
Service installation fees
Reversal of gain on disposition of investment
Convertible notes of KTF
Bonds with stock warrants
Deferred income tax—methodology difference
Deferred income tax effects of U.S. GAAP adjustments
Basic earnings per share in accordance with U.S. GAAP
Diluted earnings per share in accordance with U.S. GAAP
Dividend per share in accordance with U.S. GAAP
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The following table sets forth the computation of basic and diluted earnings per share:
Net earnings available to common shareholders
Dilutive effect of convertible notes
Weighted average outstanding shares of common stock
Common stock and common stock equivalents
Basic earnings per share is computed on the basis of the weighted average number of common shares outstanding. Diluted earnings per share is computed on the basis of the weighted average number of common shares outstanding plus the effect of outstanding convertible notes using the “if-converted method”. The denominator of the diluted earnings per share computation is adjusted to include the number of additional common shares that would have been outstanding had the dilutive potential common stock been issued. In addition, the numerator is adjusted to include the after-tax amount of interest and foreign currency translation gain(loss) recognized associated with convertible notes. Bonds with warrants and stock options were not considered when calculating diluted earnings per share because the exercise price of the warrants and stock options was greater than the average market price of the common share and, therefore, the effect would have been antidilutive.
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Stockholders’ equity in accordance with Korean GAAP
Equity in earnings of equity method affiliates:
Interest capitalization, net
Deferred service installation fees
Deferred tax effects of U.S. GAAP adjustments
Deferred tax-methodology difference
Deferred income taxes on investment securities
Minority interests
Stockholders’ equity as adjusted in accordance with U.S. GAAP
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(v) Condensed Consolidated U.S. GAAP Financial Information
Consolidated balance sheets in accordance with U.S. GAAP as of December 31, 2002 and 2003 are summarized as follows:
Other current assets
Property, plant and equipment
Other current liabilities
Long-term debt, excluding current portion
Other long-term liabilities
Stockholders’ equity
Condensed consolidated income statements in accordance with U.S. GAAP for the years ended December 31, 2001, 2002 and 2003 are summarized as follows:
Cost of services
Gross profit
Selling, general and administration expenses
Other operating expense, net
Earnings before income tax and minority interest
Income tax
Minority interest in losses (earnings) of consolidated subsidiaries
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Changes in consolidated stockholders’ equity in accordance with U.S. GAAP for the years ended December 31, 2001, 2002 and 2003 are as follows:
Beginning of year
Unrealized losses on investments, net of tax
Gains on sales of stock by subsidiaries and equity affiliates
End of year
Condensed consolidated statements of cash flows in accordance with U.S. GAAP for the years ended December 31, 2001, 2002 and 2003, respectively, are set out below:
Equity in losses (gains) of affiliates including equity method goodwill amortization
Deferred income tax expense (benefit)
Gain on disposition of available-for-sale securities
Increase in retirement and severance benefits
Increase in trade notes and accounts receivable
Increase (decrease) in trade notes and accounts payable
Increase in prepaid expenses
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Decrease in accrued expenses
Increase (decrease) in accounts payable-other
Decrease in refundable deposits of telephone installation
Decrease (increase) in accounts receivables—other
Additions to property, plant and equipment
Proceeds from the sale of available-for-sale securities
Proceeds from the sale of equity security of affiliates
Purchase of equity security of affiliates
Increase (decrease) in short-term borrowings, net
Repayments of long-term debt
Proceeds from long-term debt
Increase (decrease) in cash and cash equivalents
Supplemental schedule of non-cash investing and financing activities*
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(w) Additional U.S. GAAP Disclosures
The Company is subject to a number of income taxes based upon earnings which result from the application of a statutory corporate income tax rate (including resident tax) of approximately 30.8%, 29.7% and 29.7% for the years ended December 31, 2001, 2002 and 2003, respectively.
Starting from January 1, 2002, the corporate income tax rate (including resident tax) decreased to 29.7%. In addition, in December 2003, the Korean government reduced the corporate income tax rate (including resident tax) beginning in 2005. Specifically, effective from January 1, 2005, the income tax rate will be reduced from 29.7% to 27.5%. As a result, a change in deferred income taxes of (Won)12,795 and (Won)64,820 million is charged to income tax expense for the year ended December 31, 2001 and 2003, respectively.
Deferred income net expense (benefit)
Income tax expense
Substantially all pretax income and related income tax expense (benefit) is attributable to domestic operations. The provision for income taxes using statutory tax rates differs from the actual provision for the years ended December 31, 2001, 2002 and 2003 for the following reasons:
Provision for income taxes at statutory tax rates
Prior years income tax additional payment (refund)
Nondeductible expense
Nontaxable income
Actual provision for income taxes
The effective tax rates after adjustments of certain differences between amounts reported for financial accounting and income tax purpose, were approximately 19.8%, 25.3% and 28.2% for the years ended December 31, 2001, 2002 and 2003, respectively.
At December 31, 2003, the Company does not have any remaining investment tax credit carryforwards.
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The tax effects of temporary differences that resulted in significant portions of the deferred tax assets and liabilities at December 31, 2002 and 2003, computed under U.S. GAAP, and a description of financial statement items that created these differences are as follows:
Deferred tax assets
Unearned income
Equity securities of affiliates
Total deferred tax assets
Deferred tax liabilities
Total deferred tax liabilities
Net deferred tax assets
In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Management considers the scheduled reversal of deferred tax liabilities, projected future taxable income, and tax planning strategies in making this assessment. Based upon the level of historical taxable income and projections for future taxable income over the periods which the deferred tax assets are deductible, management believes that it is more likely than not the Company will realize the benefits of these deductible differences.
Gross and net property, plant and equipment under U.S. GAAP at December 31, 2002 and 2003 are summarized as follows:
Gross property, plant and equipment
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(35) Event (Unaudited) Subsequent to the Date of the Report of the Independent Registered Public Accounting Firm
In April 2004, the Company received a preliminary notice as a result of an ongoing audit by the National Tax Service with respect to prior year income taxes, of an additional assessment related to such prior years in the amount of (Won)73,793 million. Although the Company has appealed to the National Tax Tribunal, it has provided for the tax assessment in its fiscal 2004 consolidated financial statements.
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REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Shareholders and Board of Directors of
KT Freetel Co., Ltd.:
We have audited the accompanying consolidated balance sheets of KT Freetel Co., Ltd. and its subsidiaries (collectively referred to as the “Company”) as of December 31, 2003 and 2002, and the related consolidated statements of income, changes in shareholders’ equity and cash flows for the years then ended, all expressed in Korean won. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits. We did not audit the financial statements of KT ICOM Co., Ltd. (“KT ICOM”), which statements reflect 23 percent of the total consolidated assets as of December 31, 2002. Those financial statements were audited by other auditors whose reports have been furnished to us, and our opinion, insofar as it relates to the amounts included for KT ICOM is based solely on the reports of the other auditors.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, based on our audits and the reports of other auditors, the financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2003 and 2002, and the results of its operations, the changes in its shareholders’ equity and its cash flows for the years then ended in conformity with financial accounting standards in the Republic of Korea.
The translated amounts in the accompanying financial statements have been translated into U.S. dollars, solely for the convenience of the reader, on the basis set forth in Note 2.
As explained in Note 20, revenues and expenses to and from related parties amounted to (Won)609,634 million and (Won)481,956 million, respectively, for the year ended December 31, 2003 and (Won)555,700 million and (Won)1,272,712 million, respectively, for the year ended December 31, 2002. Related receivables and payables amounted to (Won)160,209 million and (Won)356,445 million, respectively, as of December 31, 2003 and (Won)161,008 million and (Won)325,442 million, respectively, as of December 31, 2002.
As explained in Note 24, effective March 6, 2003, KT ICOM, a former affiliate, was merged into the Company. In connection with the merger, KT ICOM transferred to the Company its net assets of (Won)1,818,604 million at book value as shown in the consolidated financial statements of KT Corporation, the parent company. As a result of the merger, the investment securities of KT ICOM accounted for using the equity method of (Won)1,590,360 million were eliminated, and capital stock with a par value of (Won)35,412 million was issued to KT ICOM’s shareholders. The difference between the carrying value of the investment securities and the value of net assets transferred amounting to (Won)228,244 million, less capital stock issued with a par value of (Won)35,412 million and the issuance cost of (Won)177 million, was recorded as paid-in capital in excess of par value.
Accounting practices used by the Company in preparing the accompanying financial statements conform with generally accepted accounting principles in the Republic of Korea, but do not conform with generally accepted accounting principles in the United States of America. The description of the significant differences and the reconciliation of net income and shareholders’ equity to U.S. generally accepted accounting principles are set forth in Note 25.
Anjin Deloitte LLC
March 27, 2004
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KT FREETEL CO., LTD. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
AS OF DECEMBER 31, 2003 AND 2002
Translation into
U.S. Dollars (Note 2)
CURRENT ASSETS:
Cash and cash equivalents (Note 18)
Short-term financial instruments (Note 3)
Short-term investment securities (Note 7)
Trade accounts and notes receivable, net of allowance for doubtful accounts of (Won)163,016 million in 2003 and (Won)160,212 million in 2002 (Notes 2, 5, 18 and 20)
Accounts receivable-other, net of allowance for doubtful accounts of (Won)4,714 million in 2003 and (Won)3,405 million in 2002 (Notes 2 and 20)
Short-term loans (Note 6)
NON-CURRENT ASSETS:
Long-term financial instruments (Notes 3 and 4)
Long-term investment securities (Note 8)
Investment securities using the equity method(Note 9)
Long-term loans (Notes 6 and 18)
Guarantee deposits, net of allowance for doubtful accounts of (Won)4,989 million in 2003 and 2002
Deferred income tax assets (Note 17)
Property and equipment, net (Notes 10 and 12)
Intangibles (Note 11)
Other non-current assets
Total Assets
(continued)
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CONSOLIDATED BALANCE SHEETS (CONTINUED)
CURRENT LIABILITIES:
Short-term borrowings (Note 13)
Trade accounts and notes payable (Notes 18 and 20)
Current portion of long-term debt, net of discount on debentures of (Won)4,997 million in 2003 and (Won)5,181 million in 2002 (Notes 12, 13 and 14)
Accounts payable-other (Notes 18 and 20)
Income tax payable
LONG-TERM LIABILITIES:
Debentures, net (Note 14)
Long-term debt, net of current portion (Note 13)
Long-term accounts payable-other, net (Note 15)
Long-term obligation under capital lease, net of current portion (Note 12)
Accrued severance indemnities, net (Note 2)
Total Liabilities
SHAREHOLDERS’ EQUITY:
Common stock (Note 16)
Retained earnings
Treasury stock (Note 16)
Loss on disposal of treasury stock (Note 16)
Loss on valuation of available-for-sale securities (Notes 7 and 8)
Stock compensation (Note 16)
Minority interest
Total Shareholders’ Equity
Total Liabilities and Shareholders’ Equity
A-3
CONSOLIDATED STATEMENTS OF INCOME
FOR THE YEARS ENDED DECEMBER 31, 2003 AND 2002
(In millions,
except per share amounts)
(In thousands,
OPERATING REVENUE (Notes 19, 20 and 22)
OPERATING EXPENSES (Notes 19 and 20)
OPERATING INCOME
OTHER INCOME (EXPENSES), NET:
Rental income
Gain on foreign currency transactions, net
Gain (loss) on foreign currency translation, net
Loss on disposal of trade accounts and notes receivable (Note 5)
Loss on valuation of inventories
Loss on valuation using the equity method of accounting (Note 9)
Loss on disposal of short-term investment securities, net
Loss on disposal of long-term investment securities, net
Loss on disposal of property and equipment, net
Impairment loss on investment securities(Note 8)
Recovery of impairment loss on investment securities (Note 7)
ORDINARY INCOME
EXTRAORDINARY ITEMS
INCOME BEFORE INCOME TAX EXPENSE
INCOME TAX EXPENSE (Note 17)
MINORITY INTEREST IN NET LOSS OF CONSOLIDATED SUBSIDIARIES
NET INCOME
EARNINGS PER SHARE (Note 2)
DILUTED EARNINGS PER SHARE (Note 2)
A-4
CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY
Common
stock
Capital
surplus
Retained
earnings
(deficit)
adjustments
Minority
interests
Net income for 2002
Effect of changes in consolidated subsidiaries
Compensation expense incurred in connection with stock options
Loss on valuation of investment securities using the equity method
Gain on valuation of available-for-sale securities
Purchase of treasury stock
Net income for 2003
Merger
Amortization of organization cost
Gain on valuation of investment securities using the equity method
Translation into U.S. Dollars (In thousands) (Note 2)
A-5
CONSOLIDATED STATEMENTS OF CASH FLOWS
CASH FLOWS FROM OPERATING ACTIVITIES:
Addition of expenses not involving cash outflows:
Amortization of intangibles
Long-term accrued interest
Amortization of discounts on debentures
Amortization of discounts on long-term payable-other
Provision for severance indemnities
Loss on disposal of trade accounts and notes receivable
Loss on valuation using the equity method of accounting
Loss on foreign currency translation, net
Stock compensation
Impairment loss on investment securities
Bad debt expense
Deduction of revenues not involving cash inflows:
Gain on foreign currency translation, net
Recovery of impairment loss in investment securities
Minority interest in net loss of consolidated subsidiaries
Changes in assets and liabilities resulting from operations:
Increase in trade accounts and notes receivable
Decrease (Increase) in accounts receivable-other
Decrease (Increase) in prepaid expenses
Decrease (Increase) in other current assets
Payment of severance indemnities
Increase (Decrease) in trade accounts and notes payable
Increase (Decrease) in accounts payable-other
Increase in accrued expenses
Decrease in withholdings
Increase (Decrease) in income tax payable
Decrease in other current liabilities
Decrease in National Pension
Increase in deferred income tax assets
Increase in other long-term liabilities
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CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
CASH FLOWS FROM INVESTING ACTIVITIES:
Cash inflows from investing activities
Proceeds from sale of short-term investment securities
Collection of short-term loans
Proceeds from sale of long-term investment securities
Withdrawal of guarantee deposits
Withdrawal of short-term financial instruments
Proceeds from disposal of property and equipment
Proceeds from disposal of intangibles
Cash outflow from financing activities
Purchase of short-term financial instrument
Purchase of short-term investment securities
Purchase of long-term investment securities
Payment of guarantee deposits
Acquisition of property and equipment
Increase in intangibles
Payment of long-term loans
CASH FLOWS FROM FINANCING ACTIVITIES:
Cash inflows from financing activities
Proceeds from sale of trade accounts and notes receivable
Proceeds from short-term borrowings
Proceeds from issuance of debentures
Increase from merger
Cash outflows from financing activities
Repayment of short-term borrowings
Repayment of debentures
Repayment of current portion of long-term debt
Repayment of other non-current liabilities
NET DECREASE IN CASH AND CASH EQUIVALENTS
INCREASE (DECREASE) FROM CHANGES IN CONSOLIDATED SUBSIDIARIES
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR
CASH AND CASH EQUIVALENTS, END OF YEAR
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SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
TRANSACTIONS NOT INVOLVING CASH:
Transfer of trade accounts and notes receivable to long-term investments securities
Transfer of debentures to current portion of long term debt
Transfer of long-term obligation under capital lease to current portion of long-term debt
Transfer of interest expense to construction in progress
Transfer of long-term debt to current portion of long-term debt
Transfer of long-term loans to short-term loans
Transfer of long-term investments securities to trade accounts and notes receivable
Transfer of long-term investments securities to short-term investments securities
Recognition of loss on valuation of investments securities using the equity method as capital adjustments
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. GENERAL:
(1) KT Freetel Co., Ltd.
KT Freetel Co., Ltd. (“KT Freetel”) was incorporated on January 3, 1997, under the Commercial Code of the Republic of Korea, and listed on the Korean Securities Dealers Association Automated Quotation System (the KOSDAQ) in December 1999. The Company is currently engaged in providing personal communications service (“PCS”), value added services and sale and lease of personal communication devices.
As of December 31, 2003, the shareholders of KT Freetel are as follows:
Percentage of
Qualcomm Incorporated
HyoSung Corp.
SSB Capital Communications
Microsoft Corp.
Millcate Mater Fund Ltd.
In common with other Asian countries, the economic environment in the Republic of Korea continues to be volatile. In addition, the Korean government and the private sector continue to implement structural reforms to historical business practices including corporate governance. The Company may be either directly or indirectly affected by these economic conditions and the reform program described above. The accompanying financial statements reflect management’s assessment of the impact to date of the economic environment on the financial position and results of operations of the Company. Actual results may differ materially from management’s current assessment.
(2) Consolidated Subsidiaries
The consolidated financial statements include the accounts of KT Freetel and the controlled subsidiaries listed below (collectively referred to as the “Company”), of which KT Freetel owns a majority of the issued shares. Significant inter-company accounts and transactions have been eliminated in consolidation.
Subsidiaries
Ownershippercentage (%)
KTF Technologies Co., Ltd.
(“KTF Technologies”)
Developing and manufacturing of PCS handsets
KT ICOM Co., Ltd.
(“KT ICOM”)
IMT 2000 Service
On November 30, 2002, KT Freetel exercised the conversion right of convertible bonds at (Won)5 thousand per share to acquire an additional 400,000 shares of common stock of KTF Technologies.
The acquisition of KTF Technologies was recorded in accordance with the purchase method of accounting, with the (Won)2,589 million excess of the fair value of KTF Technologies’ net assets over the acquisition cost being
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
assigned as negative goodwill. Negative goodwill will be recognized as income on a systematic basis over the remaining weighted average useful life (5 years) of the identifiable acquired depreciable or amortizable assets.
As KT ICOM, a former affiliate, was merged into the Company, effective March 6, 2003, KT ICOM was excluded from the consolidated subsidiaries (Note 24).
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
Basis of Financial Statement Presentation
The Company maintains its official accounting records in Korean won and prepares statutory financial statements in the Korean language (Hangul) in conformity with the accounting principles generally accepted in the Republic of Korea. Certain accounting principles applied by the Company that conform with financial accounting standards and accounting principles in the Republic of Korea may not conform with generally accepted accounting principles in other countries. Accordingly, these financial statements are intended for use by those who are informed about Korean accounting principles and practices. The accompanying financial statements have been condensed, restructured and translated into English (with certain expanded descriptions) from the Korean language financial statements.
The U.S. dollar amounts presented in these financial statements were computed by translating the Korean won into U.S. dollars based on the noon buying rate of (Won)1,192.00 to US$1.00 at December 31, 2003 in the City of New York for cable transfers in won as certified for customs purposes by the Federal Reserve Bank of New York, solely for the convenience of the reader. This convenience translation into U.S. dollars should not be construed as a representation that the Korean won amounts have been, could have been, or could in the future be, converted at this or any other rate of exchange.
Significant accounting policies followed by the Company in preparing the accompanying financial statements are summarized as follows:
Adoption of Newly Effective Statements of Korea Accounting Standards
The Company prepared its financial statements in accordance with the Statements of Korea Accounting Standards (“SKAS”), which are effective from January 1, 2003. The revised accounting standards include SKAS No.2—“Interim Financial Reporting”, No.3—“Intangible Assets”, No.4—“Revenue Recognition”, No.5—“Tangible Assets”, No.6—“Events Occurring After Balance Sheet Dates”, No.7—“Capitalization of Financing Costs”, No.8—“Investment in Securities” and No.9—“Convertible Securities”. The comparative financial statements were restated applying these accounting standards.
Use of Estimates
The preparation of financial statements in accordance with Korean GAAP requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. The most significant estimates and assumptions relate to the allowance for doubtful accounts and depreciation. Actual results could differ from those estimates and may affect amounts reported in future periods. Management believes that the estimates are reasonable.
Revenue Recognition
The Company’s revenues are principally derived from sales of PCS handsets and PCS service revenues, which consist of non-refundable initial subscription fees, fixed monthly access fees and usage charges. The
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Company recognizes sales on PCS handsets when they are delivered to the dealers, fixed monthly access fees in the period earned, and usage charges and non-refundable initial subscription fees at the time services are rendered.
Allowance for Doubtful Accounts
The allowance for doubtful accounts is provided based on the estimated loss on uncollectible accounts and historical bad debt experience.
Changes in allowance for doubtful trade accounts and notes receivable and accounts receivable-other for the years ended December 31, 2003 and 2002 are summarized as follows (won in millions):
Increase from changes in consolidated subsidiaries
Inventories are stated at the lower of cost or net realized value, cost being determined using the average cost method. If the net realizable value of inventories is lower than cost, inventories are adjusted to net realizable value and the difference between cost and revalued amount is charged to current operations.
Investment Securities Other than those Accounted for Using the Equity Method
(1) Classification of Securities
At acquisition, the Company classifies securities into one of the three categories: trading, held-to-maturity or available-for-sale. Trading securities are those that were acquired principally to generate profits from short-term fluctuations in prices. Held-to-maturity securities are those with fixed and determinable payments and fixed maturity that an enterprise has the positive intent and ability to hold to maturity. Available-for-sale securities are those not classified as either held-to-maturity or trading securities. Trading securities are classified as short-term investment securities, whereas available-for-sale securities and held-to-maturity securities are classified as long-term investment securities, except for those maturity dates or whose likelihood of being disposed of are within one year from balance sheet date, which are classified as short-term investment securities.
(2) Valuation of Securities
Securities are recognized initially at cost, which includes the market value of the consideration given and incidental expenses. If the market price of the consideration given is not available, the market prices of the securities purchased are used as the basis of measurement. If neither the market price of the consideration given nor those of the acquired securities are available, the acquisition cost is measured at the best estimates of its fair value.
After initial recognition, held-to-maturity securities are valued at amortized cost. The difference between their acquisition costs and face values is amortized over the remaining term of the securities by applying the
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effective interest method and added to or subtracted from the acquisition costs and interest income of the remaining period. Trading securities are valued at fair value, with unrealized gains or losses included in current operations. Available-for-sale securities are also valued at fair value, with unrealized gains or losses included in capital adjustments, until the securities are sold or if the securities are determined to be impaired and the lump-sum cumulative amount of capital adjustments are reflected in current operations. However, available-for-sale securities that are not traded in an active market and whose fair values cannot be reliably estimated are accounted for at acquisition costs. For those securities that are traded in an active market (marketable securities), fair values refer to the quoted market prices, which are measured as the closing price at the balance sheet date. The fair values of non-marketable securities are measured at the discounted future cash flows by using the discount rate that appropriately reflects the credit rating of the issuing entity assessed by a publicly reliable independent credit rating agency. If application of such measurement method is not feasible, estimates of the fair values may be made using a reasonable valuation model or quoted market prices of similar debt securities issued by entities conducting similar business in similar industries.
Securities are evaluated at each balance sheet date to determine whether there is any objective evidence of impairment loss. When any such evidence exists, unless there is a clear counter-evidence that recognition of impairment is unnecessary, the Company estimates the recoverable amount of the impaired security and recognizes any impairment loss in current operations. The amount of impairment loss of held-to-maturity security or non-marketable equity security is measured as the difference between the recoverable amount and the carrying amount. The recoverable amount of held-to maturity security is the present value of expected future cash flows discounted at the securities’ original effective interest rate. For available-for-sale debt or equity security, the amount of impairment loss to be recognized in the current period is determined by subtracting the amount of impairment loss of debt or equity security already recognized in prior period from the amount of amortized cost in excess of the recoverable amount for debt security or from the amount of acquisition cost in excess of fair value for equity security.
If the realizable value subsequently recovers, in case of a security stated at fair value, the increase in value in recorded in current operations, up to the amount of the previously recognized impairment loss, while security stated at amortized cost or acquisition cost, the increase in value is recorded in current operations, so that its recovered value does not exceed what its amortized cost would be as of the recovery date if there had been no impairment loss.
(3) Reclassification of Securities
When transfers of securities between categories are needed because of changes in an entity’s intention and ability to hold those securities, such transfer is accounted for as follows: trading securities cannot be reclassified into available-for-sale and held-to-maturity securities, and vice versa, except when certain trading securities lose their marketability. Available-for-sale securities and held-to-maturity securities can be reclassified into each other after fair value recognition. When held-to-maturity security is classified into available-for-sale security, the difference between fair value and book value is recorded as capital adjustments. Whereas, in case available-for-sale security is reclassified into held-to-maturity security, the difference is recorded as capital adjustments and amortized using effective interest rate method for the remaining periods.
Investment Securities Using the Equity Method
Equity securities held for investments in companies in which the Company is able to exercise significant influence over the investees are accounted for using the equity method. The Company’s share in net income or net loss of investees is reflected in current operations. Changes in the retained earnings, capital surplus or other capital accounts of investees are accounted for as an adjustment to retained earnings or to capital adjustments.
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Property and Equipment
Property and equipment are stated at cost. Routine maintenance and repairs are expensed as incurred. Expenditures that result in enhancement of the value or extension of the useful lives of the facilities involved are capitalized as additions to property and equipment.
Depreciation is computed using the straight-line method based on the estimated useful lives of the assets as follows:
Estimated useful lives
Capitalization of Financing Costs
Interest expense, discount and other financial charges, including certain foreign exchange translation gains and losses on borrowings associated with the manufacture, purchase, or construction of property and equipment, incurred prior to the completion of the acquisition, are capitalized until the year ended December 31, 2002, and are no longer capitalized from January 1, 2003 in compliance with SKAS No. 7. The amount of capitalized interest for the year ended December 31, 2002 was (Won)34,116 million.
Long-Lived Assets
Long-lived assets are subject to review for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. An impairment loss would be recognized when estimated undiscounted future net cash flows expected to result from the use of the asset and its eventual disposition are less than its carrying amount. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds the fair value of the assets.
Leases
Lease agreements that include a bargain purchase option, result in the transfer of ownership by the end of the lease term, have a term equal to at least 75% of the estimated economic life of the leased property or where the present value of the minimum lease payments at the beginning of the lease term equals or exceeds 90% of the fair value of the leased property are accounted for as capital leases. All other leases are accounted for as operating leases. Assets and liabilities related to capital leases are recorded as property, plant and equipment and long-term debt, respectively, and the related interest is calculated using the effective interest rate method. In respect to operating leases, the future minimum lease payments are expensed ratably over the lease term while contingent rentals are expensed as incurred.
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Intangibles
Intangible assets are stated at cost, net of accumulated amortization computed using the straight-line method over the useful lives of the assets as described below.
Frequency use rights
Intellectual property rights
Facility use rights
Development costs
Convertible bonds
Interest expense on convertible bonds is recognized using the effective interest rate, which equalizes the issued amount of bonds to the present value of the future cash outflow of bonds. Accordingly, the differences between accrued interest and interest paid are presented as an addition to the normal value of bonds in the long-term accrued interest account.
Discounts on Debentures
Discounts on debentures are amortized over the redemption period of the debentures using the effective interest rate method. Amortization of discounts is recognized as interest expense.
Accrued Severance Indemnities
All employees with more than one year of service are entitled to receive a lump-sum payment upon termination of their employment with the Company, based on their length of service and rate of pay at the time of termination. The severance indemnities that would be payable assuming all eligible employees were to resign amount to (Won)33,897 million and (Won)31,604 million as of December 31, 2003 and 2002, respectively.
Before April 1999, the Company and its employees paid 3 percent and 6 percent, respectively, of monthly pay (as defined) to the National Pension Fund in accordance with the National Pension Law of Korea. The Company paid half of the employees’ 6 percent portion and is paid back at the termination of service by offsetting the receivable against the severance payments. Such receivables, with a balance of (Won)1,157 million and (Won)932 million as of December 31, 2003 and 2002, respectively, are presented as deduction from accrued severance indemnities. Starting April 1999, the Company and its employees each pay 4.5 percent of monthly pay to the National Pension Fund under the revised National Pension Law of Korea.
Changes in accrued severance indemnities for the years ended December 31, 2003 and 2002 are as follows (won in millions):
Severance payments
Increase due to merger
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Accounting for Foreign Currency Transactions and Translation
The Company maintains its accounts in Korean won. Transactions in foreign currencies are recorded in Korean won based on the prevailing rates of exchange on the transaction date. Monetary accounts with balances denominated in foreign currencies are recorded and reported in the accompanying financial statements at the exchange rates prevailing at the balance sheet date and the translation gains or losses are reflected in current operations. The balances have been translated using the rate announced by the Bank of Korea basic rate, which was (Won)1,197.80 and (Won)1,200.40.10 to US$ 1.00 at December 31, 2003 and 2002, respectively.
Income Tax
The provision for income tax consists of the corporate income tax and resident surtax currently payable and changes in deferred income taxes for the period. The Company recognizes deferred taxes arising from temporary differences between amounts reported for financial accounting and income tax purposes. Deferred income taxes will be offset against those incurred in the future, if any. Deferred income taxes are recalculated based on the actual rate, effective at each balance sheet date.
Stock Compensation Expense
The Company records the difference between the present value of the exercise price and the stock price at the grant date as compensation expense with a corresponding credit to the capital adjustment account (using the fair value method). The computed deferred compensation expenses are allocated over the contracted vesting period. When the stock options are exercised with the issuance of new shares, the difference between the exercise price plus the stock option cost recorded in the capital adjustment account and the par value of the new shares issued, is recorded as additional paid-in capital.
Basic and Diluted Ordinary Income Per Share and Earnings Per Share
Ordinary income per share and earnings per share are computed by dividing ordinary income (after deducting the income tax effect) and net income by the weighted average number of common shares outstanding during the period. The number of shares used in computing earnings and ordinary income per share is 187,405 thousand shares and 183,236 thousand shares for the years ended December 31, 2003 and 2002, respectively.
Diluted ordinary income per share and earnings per share are computed by dividing ordinary income (after deducting the income tax effect) and net income by the weighted average number of common shares outstanding, including the additional common share that would have been outstanding if the dilutive potential common shares had been issued during the period. The number of shares used in computing diluted earnings and ordinary income per share is 197,322 thousand shares and 184,108 thousand shares for the years ended December 31, 2003 and 2002, respectively. Diluted ordinary income and earnings are (Won)415,315 million and (Won)532,732 million for the years ended December 31, 2003 and 2002, respectively.
The dilutive potential shares as of December 31, 2003 are as follows:
common shares to be issued
Stock warrants
”
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Comparative Presentation
Certain amounts of prior year’s financial statements are reclassified to conform to the current year’s presentation. This reclassification does not affect the net income and net assets of the prior period.
3. SHORT-TERM AND LONG-TERM FINANCIAL INSTRUMENTS:
(1) Short-term financial instruments as of December 31, 2003 and 2002 are as follows (won in millions):
Repurchase agreements
(2) Long-term financial instruments as of December 31, 2003 and 2002 are as follows (won in millions):
Deposits for checking accounts
4. RESTRICTED DEPOSITS:
As of December 31, 2003 and 2002, the deposits under long-term financial instruments amounting to (Won)52 million and (Won)61 million, respectively, are subject to withdrawal restriction as collateral for borrowings and guarantee of checking accounts.
5. DISPOSAL OF TRADE ACCOUNTS AND NOTES RECEIVABLE:
On November 4, 2003, the Company transferred the handset installment receivable of (Won)339,677 million and guarantee insurance and other incident rights to KTF Second Securitization Specialty Co., Ltd. As a result of this disposal, the Company received cash of (Won)312,000 million and subordinate debt securities of (Won)19,254 million, and the Company recognized a loss on disposal of trade accounts and notes receivable of (Won)8,423 million.
In addition, the Company entered in to a contract with Shinhan Bank Trust for the transfer of trade receivables as of October 31, 2003 and future trade receivables, which were expected to be incurred until February 28, 2007. On December 19, 2003, the Company transferred PCS service receivables of (Won)253,247 million and received cash of (Won)200,000 million and beneficiary certificates of (Won)53,247 million. As a result of the above transaction, the Company recognized a loss on disposal of trade and notes receivables of (Won)1,680 million. The Company subsequently transferred trade receivables of (Won)453,567 million won and additionally received (Won)46,667 million of beneficiary certificates.
6. LOANS TO EMPLOYEES:
As of December 31, 2003 and 2002, the Company has provided loans to its employees for housing and purchase of KT Freetel’s stock with the balance of (Won)1,697 million and (Won)2,237 million, respectively, in short-term loans and (Won)5,235 million and (Won)8,698 million, respectively, in long-term loans.
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7. SHORT-TERM INVESTMENT SECURITIES:
(1) Short-term investment securities as of December 31, 2003 and 2002 are as follows (won in millions):
Trading securities:
Listed equity securities
(2) Trading securities as of December 31, 2003 and 2002 are as follows (won in millions):
Loss on
valuation
(3) Listed equity securities as of December 31, 2003 is as follows (won in millions):
Knowledge Power Plant, Inc.
The gain on valuation of the above listed equity securities is recorded in capital adjustments. As the realizable value has been recovered, the impairment loss of (Won)3,579 million charged to prior operation was reversed and recognized as current earnings within the limit of acquisition cost.
8. LONG-TERM INVESTMENT SECURITIES:
(1) Long-term investment securities as of December 31, 2003 and 2002 are as follows (won in millions):
Non-listed equity securities
Investments in funds
Debt securities
Held-to maturity securities:
(2) Listed equity securities as of December 31, 2003 and 2002 are as follows (won in millions):
Gain (loss) on
Wide Telecom Co.
Dreamline Co.
Gaeasoft Co., Ltd.
KRTnet Corp.
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The gain (loss) on valuation of the above listed equity securities is included in capital adjustments.
(3) Non-listed equity securities as of December 31, 2003 and 2002 are as follows (won in millions):
Ownership
(%)
Acquisition
Net asset
Book
Mondex Korea Co., Ltd.
Internet Metix Inc.
Geotel Co., Ltd.
Mobilians Co., Ltd.
Inews24. Co., Ltd.
ENtoB Corp.
The Radio News Co., Ltd.
Korea Information & Communications, Inc.
Prime Venture Capital Co.
Onse Telecom Corp.
NAZCA Entertainment Co., Ltd.
Toysoft Co., Ltd
Ohmylove Co., Ltd.
Vacom Wireless, Inc.
In 2003, the Company recognized an additional impairment loss of (Won)2,280 million on non-listed equity securities of Onse Telecom Corp. and other companies for which the net equity value had declined compared to the acquisition cost and it is not expected to recover.
(4) Investments in funds as of December 31, 2003 and 2002 are as follows (won in millions):
CEC Mobile Ltd.
PT. KTF Indonesia
Korea IT Fund
Korea Telecom Strategy Fund
KT Freetel Internal Venture
PT. KTF Indonesia is not subject to the equity method in accordance with the interpretation 42-59 of the financial accounting standards in Korea.
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(5) Debt securities as of December 31, 2003 and 2002 are as follows (won in millions):
KTF Second Securitization Specialty Co., Ltd.
Government bonds
(6) Maturities of debt securities as of December 31, 2003 are as follows (won in millions):
(7) Held-to-maturity securities as of December 31, 2003 are as follows (won in millions):
The Company acquired the above beneficiary certificates issued by Shinhan Bank Trust in relation to the disposal of trade accounts and notes receivable (Note 5). The Company believes that the difference between fair value and acquisition cost, which may arise from the uncollectibility of the trade accounts and notes receivable, will not have a material effect on the operations or financial positions of the Company.
9. INVESTMENT SECURITIES USING THE EQUITY METHOD:
(1) Investment securities using the equity method as of December 31, 2003 and 2002 are as follows (won in millions):
Korea Digital Satellite Broadcasting Co., Ltd.
(2) Details of valuation using the equity method for the year ended December 31, 2003 are as follows (won in millions):
Beginning
of year
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10. PROPERTY AND EQUIPMENT:
Changes in property and equipment for the year ended December 31, 2003 are as follows (won in millions):
Changes in
consolidated
subsidiaries
End
Less: Accumulated depreciation
Accumulated impairment loss
The market value of the Company’s land based on the official price of land (published by Ministry of Construction and Traffic) is (Won)94,517 million as of December 31, 2003.
Depreciable assets are insured against fire and other casualty losses up to (Won)368,244 million as of December 31, 2003.
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11. INTANGIBLES:
(1) Changes in intangibles for the year ended December 31, 2003 are as follows (won in millions):
Organization cost
(2) (Won)18,325 million and (Won)19,991 million of ordinary development costs were charged to expense for the years ended December 31, 2003 and 2002, respectively.
(3) On December 15, 2000, KT ICOM acquired the license to provide third generation mobile services utilizing 2Ghz frequency band (“IMT-2000 service”) with W-CDMA technology. KT ICOM paid (Won)650 billion of the total license fee of (Won)1,300 billion on March 20, 2001 and the remaining balance was required to be paid including interest for the period from 2007 to 2011. On December 4, 2001, MIC granted the license to KT ICOM and assigned the related frequency band, giving KT ICOM the right to provide IMT-2000 services using W-CDMA technology for 15 years from that date.
On March 6, 2003, KT ICOM was merged into the Company, and the Company started to provide IMT-2000 service on December 28, 2003.
12. LEASED ASSETS:
(1) The Company maintains operating lease agreements for certain machinery and equipment. The following are the future minimum rental payments under operating leases as of December 31, 2003 (won in millions):
Operating
lease payment
(2) The Company also has capital lease agreements for certain machinery and equipment, of which acquisition cost amounts to (Won)3,145 million. Depreciation on the machinery and equipment for the year ended December 31, 2003 amounted to (Won)295 million.
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Annual future payments on the foreign currency lease agreements as of December 31, 2003 are as follows (Korean won in millions and U.S dollars in thousands):
Won
equivalent
Less: Current portion
13. BORROWINGS:
(1) Short-term borrowings as of December 31, 2003 and 2002 are as follows (won in millions, JPY in millions, U.S dollars in thousands):
Interest rate
per annum (%)
General loans
Discounted promissory notes
Usance
(2) Long-term debt as of December 31, 2003 and 2002 are as follows (won in millions, U.S dollars in thousands):
Long-term debt in local currency:
Facility loans
Long-term debt in foreign currency:
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14. DEBENTURES:
(1) Debentures as of December 31, 2003 and 2002 are as follows (won in millions):
General debentures
Discount on debentures
Add: Long-term accrued interest
(2) General debentures as of December 31, 2003 and 2002 are as follows (won in millions, JPY in millions):
Due date
19th
20th
21st
22nd
23rd
28th
31st
32nd
33rd
34th
37th
38th
40th
41st
42nd
Discounts on debentures are amortized over the period from the issue date to due date, using effective interest rate, and the amortized amounts are charged as interest expense.
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(3) Convertible bonds as of December 31, 2003 are as follows (won in millions):
2nd
3rd
43rd
For the bonds not converted, the Company will redeem them with a premium calculated by applying the compound interest rate method to the difference between the guaranteed interest rate and the coupon interest rate. In relation to these convertible bonds, the Company recorded (Won)8,089 million as long term accrued interest, which is shown as addition to debentures, as of December 31, 2003.
(4) Payment schedules for the Company’s debentures as of December 31, 2003 are as follows (won in millions):
15. LONG-TERM ACCOUNTS PAYABLE-OTHER:
Long-term account payable-other is related to frequency use right and required to be paid including applicable interest from 2007 to 2011.
Long-term accounts payable-other as of December 31, 2003 is stated at the net present value of future cash flows, calculated using the effective interest rate (9.93%) at the time of receipt of frequency use license as follows (won in millions):
Long-term account payable-other
Discount
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The maturities of the Company’s long-term account payable-other as of December 31, 2003 are as follows (won in millions):
16. SHAREHOLDERS’ EQUITY:
(1) Capital stock
The Company has authorized 400,000,000 shares of (Won)5,000 par value common stock and issued 191,140,519 shares as of December 31, 2003.
(2) Treasury stock
In 2003, the Company contributed 132,864 shares of treasury stock to Employee Stock Ownership Plan (“ESOP”). The fair value of treasury stock of (Won)2,969 million is recorded as salaries and wages, and the difference between the acquisition cost and the fair value amounting to (Won)1,535 million is recorded as capital adjustments. As of December 31, 2003, the Company holds 2,966,741 shares of treasury stock and intends to dispose of the treasury stock in near future.
(3) Stock Option Plan
The Company entered into stock option agreements with the Chief Executive Officer and senior managers. The details of the stock options granted as of December 31, 2003 are as follows (won in millions):
Employee
shares
Exercise
price/share
Methods
2001. 3.29
2002. 3.25
2003. 9. 8
New stock issue,
treasury stock, compensation of difference
The Company values stock options granted based on the fair value method (see Note 2). Total compensation expense of (Won)7,428 million was allocated over the vesting period, and the compensation expense charged to operations for the year ended December 31, 2003 is (Won)1,591 million.
(4) Dividends
The Company is scheduled to pay cash dividends of (Won)94,137 million for the 188,274 thousand outstanding shares at (Won)500 dividend per share and the dividend pay out ratio (Dividend / Net income) is 23.1% in 2003.
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17. INCOME TAX AND DEFERRED INCOME TAXES:
(1) The statutory corporate income tax rate (including resident surtax) applicable to the Company is approximately 29.7 percent and 30.8 percent in 2003 and 2002, respectively. Income tax expense for the years ended December 31, 2003 and 2002 is as follows (won in millions):
Income before income tax
Permanent differences
Temporary differences, net
Taxable income before tax loss carryforward
Tax loss carryforward
Taxable income
Tax rate (%)
Tax calculated on taxable income
Tax credit
Income tax currently payable
Foreign income tax
Decrease (Increase) in deferred income taxes:
Temporary differences
Utilization of accumulated tax losses carried forward
Utilization of accumulated tax credit carried forward
(2) The changes in deferred income taxes for the years ended December 31, 2003 and 2002 are as follows (won in millions):
Increase
Decrease
Decrease from changes in consolidated subsidiaries
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18. ASSETS AND LIABILITIES DENOMINATED IN FOREIGN CURRENCIES:
As of December 31, 2003 and 2002, assets and liabilities denominated in foreign currencies, other than the lease obligations under capital lease, long-term debt and debentures in foreign currencies described in Notes 12, 13 and 14, are as follows (foreign currencies other than U.S. dollars are translated into U.S. dollars; Korean won in millions):
Account
Trade accounts and notes receivable
Long-term loans
Trade accounts and notes payable
19. OPERATING REVENUE AND EXPENSES:
(1) Operating revenue for the years ended December 31, 2003 and 2002 consist of the following (won in millions):
Sales of PCS handsets
(2) Operating expenses for the years ended December 31, 2003 and 2002 are summarized below (won in millions).
Employee welfare
Lease
Tax and dues
Leased line charges
Ordinary development costs
Sales promotion
Sales commissions
Advertisements
Bad debt
Water and electricity
Cost of PCS handset sales
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20. RELATED PARTY TRANSACTIONS:
(1) Transactions with related parties for the years ended December 31, 2003 and 2002 are as follows (won in millions):
Revenues:
Transaction
KT Solutions
KT Hitel
Expenses:
(2) Receivables and payables with related parties as of December 31, 2003 and 2002 are as follows (won in millions):
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21. COMMITMENTS:
The Company has entered into an agreement covering the resale of PCS with KT Corporation. As compensation for providing telecommunications network, the Company receives certain amount by multiplying outgoing call generated from KT Corporation’s subscribers by rate per minute.
22. SEGMENT INFORMATION:
The Company’s reportable segments are separate legal entities that offer different products and services. The segments are managed separately based on the difference in products and services. The Company has three reportable operating segments: PCS service, IMT 2000 service and sales of PCS handsets. The accounting policies of the segments are the same as those described in Note 2.
Details of the Company’s business segment operations for the years ended December 31, 2003 and 2002 are as follows (won in millions):
Manufacturingof PCS
handsets
Operating revenue
Ordinary income
Property and equipment, net(*)
23. EVENT OCCURRING AFTER BALANCE SHEET DATES:
On February 19 and March 15, 2004, the Company issued debentures amounting to (Won)360,000 million and (Won)320,000 million, respectively.
24. MERGER:
Effective March 6, 2003, KT ICOM, a former affiliate, was merged into the Company. The overview of the merger is as follows:
(1) Relation of two companies
Prior to the merger, both KT ICOM and the Company were subsidiaries of KT Corporation.
(2) Schedule of merger
The merger was approved at the general meeting of shareholders on January 28, 2003. The effective date of the merger was March 6, 2003.
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(3) Exchange rate of stocks
0.55636 share of the Company was issued in exchange for one share of KTI COM, and KT ICOM had 100,000,000 issued shares of (Won)5,000 par value at the time of the merger. Newly issued shares to KT ICOM shareholders were 7,082,476 common shares.
(4) Result of merger
Assets, liabilities and treasury stock transferred from KT ICOM to the Company at book value as shown on the consolidated financial statements of the parent company were (Won)2,458,989 million, (Won)707,162 million and (Won)66,777 million, respectively.
As a result of the merger, the investment securities of KT ICOM accounted for using the equity method of (Won)1,590,360 million were eliminated. The capital stock with a par value of (Won)35,412 million won was issued to KT ICOM’s shareholders and the value of net assets transferred was (Won)1,818,604 million. The difference between the carrying value of the investment securities and the value of net assets transferred amounting to (Won)228,244 million, less capital stock issued with a par value of (Won)35,412 million and the issuance cost of (Won)177 million, was recorded as paid-in capital in excess of par value.
(5) Summarized financial statements of KT ICOM are as follows (won in millions):
Summarized Balance Sheets
Non-current assets
Long-term liabilities
Capital stock
Capital surplus
Accumulated retained earnings
Capital adjustments
Total shareholders’ equity
Total liabilities and shareholders equity
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Summarized Statements of Income
Operating loss
Ordinary loss
Extraordinary items
Loss before income tax expense
Income tax benefits
Net income (loss)
25. RECONCILIATION TO ACCOUNTING PRINCIPLES GENERALLY ACCEPTED IN THE UNITED STATES:
Accounting practices used by the Company in preparing the accompanying financial statements conform with generally accepted accounting principles in the Republic of Korea, but do not conform with accounting principles generally accepted in the United States of America (“U.S. GAAP”). The significant differences applicable to the Company are described below. Other differences do not have a significant effect on either net income or shareholders’ equity.
(1) Capitalization of foreign currency translation gain (loss)
Under previous Korean GAAP, certain unrealized foreign exchange translation gains and losses were excluded from the results of operations and included in the cost of property and equipment. However, under U.S. GAAP, all unrealized foreign currency translation gains and losses on monetary assets and liabilities are to be included in the current year’s results of operations.
The amounts of foreign exchange translation gains and losses included in property and equipment under Korean GAAP were adjusted to comply with U.S. GAAP.
(2) Interest Capitalization
As explained in Note 2, under Korean GAAP, starting from January 1, 2003, interest expense is no longer capitalized. However, under U.S. GAAP, the Company’s policy is to capitalize interest in the amount that would have theoretically been avoided had expenditures not been made for assets, which require a period of time to get them ready for their intended uses.
(3) Licensing Cost
Under Korean GAAP, the licensing cost paid with funds collected from the initial shareholders to obtain the operating licenses prior to the establishment of the Company were not recorded in the accounts of the Company.
Under U.S. GAAP, licensing costs were accounted for as an intangible asset and capital surplus at the time of establishment of the Company.
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(4) Deferred Charges
Deferred charges in intangibles consist primarily of development costs and organization costs, which are deferred under Korean GAAP.
Under U.S. GAAP, development costs and organization costs are charged to expenses when incurred and are classified as operating expenses.
(5) Revenue Recognition
Under Korean GAAP, activation fees are recorded as revenue when billed and the related direct incremental acquisition costs are expensed as incurred.
Under U.S. GAAP, such amount should be deferred and recognized over the period of the customer relationship.
(6) Merger with KTM.Com Co., Ltd.
Under Korean GAAP, as KT Freetel and KTM.Com Co., Ltd. were subsidiaries of KT Corporation prior to merger, assets and liabilities were transferred from KTM.Com Co., Ltd. to KT Freetel at book value as shown in the consolidated statements of KT Corporation and the difference between the par value of capital stock issued and the value of net assets transferred was recorded in the capital surplus account.
Under U.S. GAAP, assets and liabilities were transferred from KTM.Com Co., Ltd. to KT Freetel at fair value and the difference between the fair value of capital stock issued and the fair value of net assets transferred was recorded as intangible assets.
The Company classified the intangible assets into two components: subscriber base and goodwill.
(7) Merger with KT ICOM
Under Korean GAAP, as KT Freetel and KT ICOM were subsidiaries of KT Corporation prior to merger, assets and liabilities were transferred from KT ICOM to KT Freetel at book value as shown on the consolidated statements of KT Corporation and the difference between the par value of capital stock issued and the value of net assets transferred was recorded in the capital surplus account.
Under U.S. GAAP, assets and liabilities were transferred from KT ICOM to KT Freetel at fair value. As the fair value of net assets transferred exceed the fair value of capital stock issued, the non-current assets are reduced proportionally.
(8) Goodwill and other intangibles
Under Korean GAAP, the purchase price over the fair value of net assets being acquired was recorded as goodwill and it is amortized over 20 years. An impairment loss is recognized when the carrying amount of goodwill exceeds the fair value.
Under U.S. GAAP, SFAS No. 142—“Goodwill and Intangible Assets”, intangible assets with finite lives continue to be amortized over their useful economic lives. Goodwill and intangible assets with indefinite lives are not amortized, but tested for impairment, at least annually, in accordance with SFAS No.142.
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In accordance with SFAS No. 142, the goodwill and intangibles acquired from KTM.Com and KT ICOM and amortization expense for the years ended December 31, 2003 and 2002 are as follows (won in millions):
KTM .Com
Subscriber base
License cost
KT ICOM
Frequency use right
(9) Disposal of trade accounts and notes receivable
Under Korea GAAP, the transactions between KT Freetel and KTF First Securitization Specialty Co., Ltd., between KT Freetel and KTF Second Securitization Specialty Co., Ltd. and between KT Freetel and Shinhan Bank Trust are recorded as a sale of trade accounts and notes receivable. Under U.S. GAAP, the transaction does not qualify for sale accounting and transaction is classified as a borrowing.
(10) Minority Interest in Consolidated Subsidiary
Under Korean GAAP, minority interest in consolidated subsidiary is presented as a component of shareholders’ equity in the consolidated balance sheets. Under U.S. GAAP, minority interest in consolidated subsidiary is not included in shareholders’ equity; rather, it is presented between liability and shareholders’ equity in the consolidated balance sheets.
(11) Comprehensive Income
Under the Korean GAAP, there is no requirement to present comprehensive income. Under U.S. GAAP, effective for fiscal years beginning after December 15, 1997, comprehensive income and its components must be presented in the financial statements. Comprehensive income includes all changes in shareholders’ equity during a period except those resulting from investment by, or distribution to, owners, including certain items not included in the current year’s results of operations.
Comprehensive income for the years ended December 31, 2003 and 2002 is summarized as follows:
Net income as adjusted in accordance with U.S. GAAP
Other comprehensive income, net of tax:
Unrealized gain (loss) on investments, net of tax of (Won)1,540 million in 2003 and (Won)745 million in 2002
Comprehensive income as adjusted in accordance with U.S. GAAP
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(12) Effect on Net Earnings and Shareholders’ Equity
The effects of the significant adjustments to net earnings and shareholders’ equity that are required if U.S. GAAP were applied instead of Korean GAAP are summarized as follows (won in millions, except for share amounts):
Net income under Korean GAAP
(1) Capitalization of foreign currency translation gain (loss), net
(2) Interest capitalization
(4) Deferred charges
(5) Revenue recognition
(8) Amortization of goodwill
Deferred tax effect of U.S. GAAP adjustments
Adjusted net income under U.S. GAAP
Shareholders’ equity under Korean GAAP
(3) Licensing cost
(6) Merger with KTM.Com
(7) Merge with KT ICOM
(10) Minority interest in consolidated subsidiaries
Shareholders’ equity under U.S. GAAP
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The condensed balance sheets in accordance with U.S. GAAP as of December 31, 2003 and 2002 are summarized as follows (won in millions):
Assets:
Property and equipment
Liabilities:
Shareholders’ equity
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We have audited the accompanying consolidated balance sheets of KT Freetel Co., Ltd. and its subsidiaries (collectively referred to as the “Company”) as of December 31, 2002 and 2001, and the related consolidated statements of income, shareholder’s equity and cash flows for the years then ended, all expressed in Korean won. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits. We did not audit the financial statements of KT ICOM Co., Ltd. (“KT ICOM”), which statements reflect 23 percent of the total consolidated assets as of December 31, 2002. Those financial statements were audited by other auditors whose reports have been furnished to us, and our opinion, insofar as it relates to the amounts included for KT ICOM is based solely on the reports of the other auditors.
We conducted our audits in accordance with the standards of Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, based on our audits and the reports of other auditors, the financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2002 and 2001, and the results of its operations, the changes in its shareholders’ equity and its cash flows for the years then ended in conformity with financial accounting standards in the Republic of Korea.
As discussed in Note 1, on December 13, 2002, the Company acquired shares of KT ICOM from the following related parties: 700 thousand shares from KT Hitel, 300 thousand shares from KT Powertel and 46,585 thousand shares from KT Corporation all at (Won) 18,227 per share. The Company also acquired 24,685 shares of KT ICOM from a third party for the same price. For the acquisition of KT ICOM’s shares from KT Corporation, the Company paid cash of (Won) 540,000 million and gave a note for (Won) 309,103 million, due in March 2003. The Company paid cash to the third party, KT Hitel and KT Powertel. On November 30, 2002, KT Freetel Co., Ltd. exercised the conversion right of convertible bonds at (Won) 5 thousand per share to acquire an additional 400,000 shares of common stock of KTF Technologies Co., Ltd (“KTF Technologies”). The assets and liabilities and results of operations of KT ICOM and KTF Technologies are included in the consolidated balance sheet as of December 31, 2002. The results of operations of KT ICOM from the acquisition date to December 31, 2002 are excluded from the consolidated statement of income for the year ended December 31, 2002 since they do not have a significant effect on the Company’s consolidated results of operations.
As discussed in Note 22, on January 28, 2003, the Board of Directors approved the merger with KT ICOM. The transaction is deemed to be a “small-scale merger” as defined in the Commercial Code of the Republic of Korea, which states that the total number of new shares to be issued by the acquiring company does not exceed 5 percent of the total issued shares of the acquiring company. In accordance with the Commercial Code of the Republic of Korea, the approval by the general shareholders of the Company may be replaced by the approval of the board of directors of the Company. The exchange ratio of common shares between the Company and KT ICOM is 1 to 0.55636. The merger was completed on March 6, 2003.
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Accounting practices used by the Company in preparing the accompanying financial statements conform with generally accepted accounting principles in the Republic of Korea, but do not conform with generally accepted accounting principles in the United States of America. The description of the significant differences and the reconciliation of net loss and shareholders’ equity to U.S. generally accepted accounting principles are set forth in Note 23.
March 7, 2003
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AS OF DECEMBER 31, 2002 AND 2001
Cash and cash equivalents (Note 16)
Short-term financial instruments (Notes 3 and 4)
Marketable securities (Note 5)
Trade accounts and notes receivable, net of allowance for doubtful accounts of (Won)160,212 million in 2002 and (Won)172,927 million in 2001 (Notes 2, 18 and 20)
Accounts receivable-other, net of allowance for doubtful accounts of (Won)3,405 million in 2002 and (Won)3,386 million in 2001 (Notes 2 and 18)
Investment securities (Note 7)
Long-term loans (Note 6)
Guarantee deposits, net of allowance for doubtful accounts of (Won)4,989 million in 2002 and (Won)4,719 in 2001
Deferred income tax assets (Note 15)
Property and equipment, net (Notes 8 and 10)
Intangibles (Note 9)
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Short-term borrowings (Note 11)
Trade accounts and notes payable (Note 18)
Current portion of long-term debt, net of discount on debentures of (Won)5,181 million in 2002 and (Won)29,100 million in 2001 (Notes 10, 11 and 12)
Accounts payable-other (Notes 1, 16 and 18)
Debentures, net (Note 12)
Long-term debt, net of current portion (Note 11)
Long-term accounts payable-other, net (Note 13)
Long-term obligation under capital lease, net of current portion (Note 10)
Accrued severance indemnities, net of payments to National Pension of (Won)932 million in 2002 and (Won)1,257 million in 2001 (Note 2)
Common stock (Note 14)
(Net income of (Won)532,163 million in 2002 and (Won)433,027 million in 2001)
Treasury stock (Note 14)
Loss on valuation of investment securities (Note 7)
Stock compensation (Note 14)
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FOR THE YEARS ENDED DECEMBER 31, 2002 AND 2001
(In millions, except per share
amounts)
OPERATING REVENUE (Notes 17 and 18)
OPERATING EXPENSES (Notes 17 and 18)
Gain on disposal of marketable securities, net
Gain (loss) on foreign currency transactions, net
Gain on retirement of debentures
Loss on disposal of trade accounts and notes receivable (Note 20)
Gain (loss) on disposal of investment securities, net
Impairment loss on investment securities (Note 7)
INCOME TAX EXPENSE (Note 15)
B-5
Earnings
(Deficit)
Balance at December 31, 2000
Net income for 2001
Merger with KTM. Com
Loss on valuation of investment securities
Issuance of common stock for exercise of stock warrants
Gain on valuation of investment securities
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Loss on disposal of investment securities, net
Impairment losses on investment securities
Gain on disposal of investment securities, net
Decrease in accounts receivable-other
Decrease (Increase) in inventories
Increase in other current assets
Increase (Decrease) in accrued expenses
Increase (Decrease) in withholdings
Increase in income tax payable
Increase (Decrease) in other current liabilities
Decrease (Increase) in deferred income tax assets
B-7
Proceeds from sale of marketable securities
Proceeds from sale of investment securities
Withdrawal of short term financial instruments
Proceeds from disposal of intangible assets
Purchase of marketable securities
Purchase of investment securities
Net cash provided by financing activities
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
INCREASE FROM CHANGES IN CONSOLIDATED SUBSIDIARIES
B-8
Transfer of trade accounts and notes receivable to investments securities
Transfer of bonds to current portion of long term debt
Transfer of bonds with stock warrants to common stock
Transfer of long-term prepaid expenses to short-term prepaid expenses
Transfer of accounts receivable-other to property and equipment
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As of December 31, 2002, the shareholders of KT Freetel are as follows:
JPMCB-CAP RE EM GTH FD
In response to general unstable economic conditions, the Korean government and the private sector have been implementing structural reforms to historical business practices. Implementation of these reforms is progressing slowly, particularly in the areas of restructuring private enterprises and reforming the banking industry. The Korean government continues to apply pressure to Korean companies to restructure into more efficient and profitable firms. The Company may be either directly or indirectly affected by these general unstable economic conditions and the reform program described above. The accompanying financial statements reflect management’s assessment of the impact to date of the economic situation on the financial position of the Company. Actual results may differ materially from management’s current assessment.
On December 13, 2002, KT Freetel acquired shares of KT ICOM from the following related parties: 700 thousand shares from KT Hitel, 300 thousand shares from KT Powertel and 46,585 thousand shares from KT Corporation all at (Won)18,227 per share. KT Freetel also acquired 24,685 shares of KT ICOM from a third party for
B-10
the same price. For the acquisition of KT ICOM’s shares from KT Corporation, KT Freetel paid cash of (Won) 540,000 million and gave a note for (Won)309,103 million, due in March 2003. KT Freetel paid cash to the third party, KT Hitel and KT Powertel. As KT Freetel and KT ICOM were subsidiaries of KT Corporation prior to KT Freetel’s additional acquisition of KT ICOM’s shares, KT Freetel recorded the assets and liabilities of KT ICOM at book value.
On November 30, 2002, KT Freetel exercised the conversion right of convertible bonds at (Won) 5 thousand per share to acquire an additional 400,000 shares of common stock of KTF Technologies.
The acquisition of KTF Technologies was recorded in accordance with the purchase method of accounting, with the (Won) 2,589 million excess of the fair value of KTF Technologies’ net assets over the acquisition cost being assigned to negative goodwill. Negative goodwill will be recognized as income on a systematic basis over the remaining weighted average useful life (5 years) of the identifiable acquired depreciable or amortizable assets.
The assets and liabilities and results of operations of KT ICOM and KTF Technologies are included in the consolidated balance sheet as of December 31, 2002. The results of operations of KT ICOM and KTF Technologies from the acquisition dates to December 31, 2002 are excluded from the consolidated statement of income for the year ended December 31, 2002 since they do not have a significant effect on the Company’s consolidated results of operations.
The Company maintains its official accounting records in Korean won and prepares statutory financial statements in the Korean language (Hangul) in conformity with the accounting principles generally accepted in the Republic of Korea. Certain accounting principles applied by the Company that conform with financial accounting standards and accounting principles in the Republic of Korea may not conform with generally accepted accounting principles in other countries. Accordingly, these financial statements are intended for use by those who are informed about Korean accounting principles and practices. The accompanying financial statements have been condensed, restructured, and translated into English (with certain expanded descriptions) from the Korean language financial statements.
The U.S. dollar amounts presented in these financial statements were computed by translating the Korean won into U.S. dollars based on the noon buying rate of (Won)1,186.30 to US$1.00 at December 31, 2002 in the City of New York for cable transfers in won as certified for customs purposes by the Federal Reserve Bank of New York, solely for the convenience of the reader. This convenience translation into U.S. dollars should not be construed as a representation that the Korean won amounts have been, could have been, or could in the future be, converted at this or any other rate of exchange.
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The Company’s revenues are principally derived from sales of PCS handsets and PCS service revenues, which consist of non-refundable initial subscription fees, fixed monthly access fees and usage charges. The Company recognizes sales on PCS handsets when they are delivered to the dealers, fixed monthly access fees in the period earned, and usage charges and non-refundable initial subscription fees at the time services are rendered.
Marketable Securities
Marketable securities are stated at acquisition cost plus incidental expenses. If the fair value of marketable securities differs from the book value determined by the individual moving average method, marketable securities are stated at fair value and the unrealized gain or loss is reflected in current operations.
Changes in allowance for doubtful trade accounts and notes receivable and accounts receivable-other for the years ended December 31, 2002 and 2001 are summarized as follows (won in millions):
Investment Securities
(1) Equity Securities
Equity securities held for investment (excluding those of affiliates and subsidiaries discussed in the next paragraph) that are not actively quoted (unlisted security) are stated at acquisition cost. Actively quoted (listed) securities, including those traded over-the-counter, are stated at fair value and the valuation gain or loss is recorded as a capital adjustment. If the fair value of a listed equity security or the net equity value of an unlisted equity security held for investment declines compared to acquisition cost and is not expected to recover (an impaired investment security), the value of the equity security is adjusted to fair value or net equity value and the valuation loss is charged to current operations.
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Equity securities held for investment in companies in which the Company is able to exercise significant influence over the investees are accounted for using the equity method. The Company’s share in net income or net loss of investees is reflected in current operations. Changes in the retained earnings, capital surplus or other capital accounts of investees are accounted for as an adjustment to retained earnings or to capital adjustments.
(2) Debt Securities
Debt securities held for investment are classified as either held-to-maturity investment debt securities or available-for-sale investment debt securities at the time of purchase. Investments in debt securities are classified as available-for-sale investment debt securities as follows:
Held-to-maturity investment debt securities are stated at acquisition cost determined by the individual moving average method. When the face value of a held-to-maturity investment debt security differs from its acquisition cost, the effective interest method is applied to amortize the difference over the remaining term of the security. Available-for-sale investment debt securities are stated at fair value and the valuation gains or losses are recorded as a capital adjustment. If the fair value of a held-to-maturity or a available-for-sale investment debt security declines compared to the acquisition cost and is not expected to recover (an impaired investment security), the carrying value of the debt security is adjusted to fair value and the valuation loss is charged to current operations.
(3) Gain or Loss on Valuation of Investment Securities
The net unrealized gain or loss is presented as gain or loss on valuation of investment securities in capital adjustments. An unrealized valuation gain or loss of investment securities incurred in subsequent periods is deducted from or added to the previous balance of unrealized valuation gain or loss of investment securities. When investment securities are sold, the unrealized valuation gain or loss of investment securities included in the capital adjustment account is added to or deducted from the gain or loss on disposal. With respect to an impaired investment security, any unrealized valuation gain or loss on the security previously included in the capital adjustment account is reversed.
(4) Recovery of Impaired Investment Securities
For commercial companies, the recovery of previously impaired investment securities is accounted for as follows:
For marketable equity securities and available for sale debt securities, the recovery is recorded in capital adjustment. For unlisted equity securities and held-to-maturity debt securities, the recovery is recorded in current operations up to the amount of previously recognized impairment loss.
(5) Reclassification of Securities
If the Company’s objectives change, a trading security can be reclassified to investment securities, but only as of a balance sheet date. The difference between the fair value of the security as of the balance sheet date and the book value is recognized as gain or loss on valuation of trading securities and credited or charged to current operations. Investment securities cannot be reclassified to trading securities.
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Property and equipment are stated at cost. Routine maintenance and repairs are expensed as incurred. Expenditures that result in enhancement of the value or extension of the useful lives of the facilities involved are capitalized as additions to property and equipment. In addition, interest expense and other financing charges for borrowings (that were used for the manufacture, purchase, or construction of property and equipment) incurred prior to completion of the asset are capitalized as part of the cost of such asset. Interest capitalization for the years ended December 31, 2002 and 2001 are as follow (won in millions):
Total interest incurred
Charged to expense
Capitalized gain on foreign currency transactions and translation, net
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Organization costs
Frequency use rights has a contractual life of 15 years. Frequency use rights will be amortized over the useful life commencing from the date of initiating commercial service through expiration of the right of use. The Company has not amortized frequency use rights for the year ended December 31, 2002 since the related commercial services have not been provided during the year.
Discounts on debentures are amortized over the redemption period of the debenture using the effective interest rate method. Amortization of discounts is recognized as interest expense.
All employees with more than one year of service are entitled to receive a lump-sum payment upon termination of their employment with the Company, based on their length of service and rate of pay at the time of termination. The severance indemnities that would be payable assuming all eligible employees were to resign amount to (Won)31,604 million and (Won)25,792 million as of December 31, 2002 and 2001, respectively.
Before April 1999, the Company and its employees paid 3 percent and 6 percent, respectively, of monthly pay (as defined) to the National Pension Fund in accordance with the National Pension Law of Korea. The Company paid half of the employees’ 6 percent portion and is paid back at the termination of service by offsetting the receivable against the severance payments. Such receivables, with a balance of (Won)932 million and (Won)1,257 million as of December 31, 2002 and 2001, respectively, are presented as deduction from accrued severance indemnities. Starting April 1999, the Company and its employees each pay 4.5 percent of monthly pay to the National Pension Fund under the revised National Pension Law of Korea.
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Changes in accrued severance indemnities for the years ended December 31, 2002 and 2001 are as follows (won in millions):
Increase due to merger and other
The Company maintains its accounts in Korean won. Transactions in foreign currencies are recorded in Korean won based on the prevailing rates of exchange on the transaction date. Monetary accounts with balances denominated in foreign currencies are recorded and reported in the accompanying financial statements at the exchange rates prevailing at the balance sheet date and the translation gains or losses are reflected in current operations. The balances have been translated using the rate announced by the Bank of Korea Basic Rate, which was (Won)1,200.40 and (Won)1,326.10 to US$ 1.00 at December 31, 2002 and 2001, respectively.
The provision for income tax consists of the corporate income tax and resident surtax currently payable and changes in deferred income taxes for the period. The Company recognizes deferred taxes arising from temporary differences between amounts reported for financial accounting and income tax purposes. Deferred income taxes will be offset against those incurred in the future, if any. Deferred income taxes will be recalculated based on the actual rate, effective at each balance sheet date.
Ordinary income per share and earnings per share are computed by dividing ordinary income (after deducting the income tax effect) and net income by the weighted average number of common shares outstanding during the period. The number of shares used in computing earnings and ordinary income per share is 186,236 thousand shares and 168,652 thousand shares for the years ended December 31, 2002 and 2001, respectively.
Diluted ordinary income per share and earnings per share are computed by dividing ordinary income (after deducting the income tax effect) and net income by the weighted average number of common shares outstanding, including the additional common share that would have been outstanding if the dilutive potential common shares had been issued during the period. The number of shares used in computing diluted earnings and ordinary income
B-16
per share is 184,108 thousand shares and 168,652 thousand shares for the years ended December 31, 2002 and 2001, respectively. Diluted ordinary income and earnings are (Won)532,732 million and (Won)433,027 million for the years ended December 31, 2002 and 2001, respectively.
The dilutive potential shares as of December 31, 2002 are as follows:
(1) Short-term financial instruments as of December 31, 2002 and 2001 are as follows (won in millions):
Interest rate per annum (%)
(2) Long-term financial instruments as of December 31, 2002 and 2001 are as follows (won in millions):
As of December 31, 2002 and 2001, the following deposits are subject to withdrawal restriction as collateral for borrowings and guarantee for checking accounts (won in millions):
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5. MARKETABLE SECURITIES:
Marketable securities as of December 31, 2002 are as follows (won in millions):
Beneficiary Certificates
As of December 31, 2002 and 2001, the Company has provided loans to its employees for housing and purchase of KT Freetel’s stock with the balance of (Won)2,237 million and (Won)2,131 million, respectively, which is recorded in short-term loans and (Won)8,698 million and (Won)12,396 million, respectively, in long-term loans.
7. INVESTMENT SECURITIES:
(1) Investment securities as of December 31, 2002 and 2001 are as follows (won in millions):
Investments in affiliates
(2) Listed equity securities as of December 31, 2002 and 2001 are as follows (won in millions):
Fair value
Gain (Loss) on
Dream line Co.
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(3) Non-listed equity securities as of December 31, 2002 and 2001 are as follows (won in millions):
EntoB Corp.
NAZCA entertainment Co., Ltd.
Media Valley, Inc.
In 2002, the Company recognized an additional impairment loss of (Won)2,774 million on non-listed equity securities of Mondex Korea Co., Ltd. and 7 other companies for which the net equity value had declined compared to the acquisition cost and it is not expected to recover. For the other non-listed equity securities, the Company’s management believes that the decline in value is temporary and is expected to recover, thus, the Company did not recognize an impairment loss.
(4) Investments in affiliates accounted for using the equity method of accounting as of December 31, 2002 are as follows (won in millions):
B-19
(5) Investments in funds as of December 31, 2002 and 2001 are as follows (won in millions):
(6) Debt securities as of December 31, 2002 and 2001 are as follows (won in millions):
Subordinated bonds
8. PROPERTY AND EQUIPMENT:
Property and equipment as of December 31, 2002 and 2001 are as follows (won in millions):
B-20
The market value of the Company’s land based on the official price of land (published by Ministry of Construction and Traffic) is (Won)84,856 million as of December 31, 2002.
Depreciable assets are insured against fire and other casualty losses up to (Won)225,899 million as of December 31, 2002.
9. INTANGIBLES:
(1) Intangibles, net of amortization, as of December 31, 2002 and 2001 are as follows (won in millions):
Property rights of industry
(2) Amortization of intangibles for the years ended December 31, 2002 and 2001 are as follows (won in millions):
(3) (Won)19,991 million and (Won)10,074 million of ordinary development costs were charged to expense for the years ended December 31, 2002 and 2001, respectively.
(4) Changes in development costs (intangibles) for the years ended December 31, 2002 and 2001 are as follows (won in millions):
B-21
(5) On December 15, 2000, the right to purchase one of two licenses to provide third generation mobile telecommunication services utilizing 2GHz frequency band (“IMT-2000”) with W-CDMA technology was acquired by a consortium comprised of KT Corporation, KT Freetel, KT Hitel Co., Ltd., KT Powertel Co., Ltd. and others. The consortium formed KT ICOM for the purpose of acquiring the license and providing the related services. The total license cost was (Won)1,300 billion. KT ICOM paid (Won)650 billion to the Ministry of Information and Communication (“MIC”) on March 20, 2001 and the remaining balance was required to be paid including interest for the period from 2002 to 2011. On December 4, 2001, MIC granted the license to KT ICOM and assigned the related frequency band, giving KT ICOM the right to provide IMT-2000 services using W-CDMA technology for 15 years from that date.
10. LEASED ASSETS:
(1) The Company maintains operating lease agreements for certain machinery and equipment. The following are the future minimum rental payments under operating leases as of December 31, 2002 (won in millions):
(2) The Company also has capital lease agreements for certain machinery and equipment, of which acquisition cost amounts to (Won)8,163 million. Depreciation on the machinery and equipment for the year ended December 31, 2002 amounts to (Won)1,348 million.
Annual future payments on the local currency lease agreements as of December 31, 2002 are as follows (won in millions):
Annual future payments on the foreign currency lease agreements as of December 31, 2002 are as follows (Korean won in millions and U.S dollars in thousands):
B-22
11. BORROWINGS:
(1) Short-term borrowings as of December 31, 2002 and 2001 are as follows (won in millions):
(2) Long-term debt as of December 31, 2002 and 2001 are as follows (won in millions):
(3) Payment schedules for the Company’s long-term debt as of December 31, 2002 are as follows:
As of December 31, 2002, the Company has been provided payment guarantees amounting to US$11,800 thousand by KT Corporation, a major shareholder. Also, the Company provided one blank check to Samsung Capital Co., Ltd. and one blank check to KTB Network Co., Ltd. as collateral.
B-23
12. DEBENTURES:
(1) Debentures as of December 31, 2002 and 2001 are as follows (won in millions):
(2) General debentures as of December 31, 2002 and 2001 are as follows (won in millions):
B-24
Discounts on debentures are amortized over the period from the issue date to due date, using the effective interest rate method, and the amortized amounts are charged as interest expense.
(3) Convertible bonds as of December 31, 2002 are as follows (won in millions):
For the bonds not converted, the Company will redeem them with a premium calculated by applying the compound interest rate method to the difference between the guaranteed interest rate and the coupon interest rate. In relation to these convertible bonds, the Company recorded (Won)833 million as long term accrued interest, which is shown as addition to debentures, as of December 31, 2002.
(4) Payment schedules for the Company’s debentures as of December 31, 2002 are as follows (won in millions):
13. LONG-TERM ACCOUNTS PAYABLE-OTHER:
Long-term accounts payable-other as of December 31, 2002 is stated at the net present value of future cash flows, calculated using the effective interest rate (9.93%) at the time of receipt of frequency use license as follows (won in millions):
B-25
The maturities of the Company’s long-term account payable-other as of December 31, 2002 are as follows (won in millions):
14. SHAREHOLDERS’ EQUITY:
The Company has authorized 400,000,000 shares of (Won)5,000 par value common stock and issued 184,058,043 shares as of December 31, 2002.
As of December 31, 2002, the Company holds 822,331 treasury shares consisting of 21,711 collateralized shares received from its sales agencies as payment for receivables and 800,620 shares purchased in connection with the merger. The Company intends to dispose of the treasury stock in near future.
The Company entered into stock option agreements with the former Chief Executive Officer and senior managers. The details of the stock options granted as of December 31, 2002 are as follows (won in millions):
Grant Date
The Company values stock options granted based on the fair value method (see Note 2). Total compensation expense of (Won)1,881 million was allocated over the vesting period, and the compensation expense charged to operations for the year ended December 31, 2002 is (Won)1,064 million.
B-26
15. INCOME TAX AND DEFERRED INCOME TAXES:
(1) The statutory corporate income tax rate (including resident surtax) applicable to the Company is approximately 29.7 percent and 30.8 percent in 2002 and 2001, respectively. Income tax expense for the years ended December 31, 2002 and 2001 is as follows (won in millions):
Tax loss carryforward from KTM.Com
Taxable income (loss)
(2) The changes in deferred income taxes for the years ended December 31, 2002 and 2001 are as follows (won in millions):
16. ASSETS AND LIABILITIES DENOMINATED IN FOREIGN CURRENCIES:
As of December 31, 2002 and 2001, assets and liabilities denominated in foreign currencies, other than the lease obligations under capital lease, long-term debt and debentures in foreign currencies described in Notes 8, 9 and 10, are as follows (foreign currencies other than U.S. dollars are translated into U.S. dollars; Korean won in millions):
B-27
17. OPERATING REVENUE AND EXPENSES:
(1) Operating revenue for the years ended December 31, 2002 and 2001 consist of the following (won in millions):
(2) Operating expenses for the years ended December 31, 2002 and 2001 are summarized below (won in millions):
18. RELATED PARTY TRANSACTIONS:
(1) Transactions with related parties for the years ended December 31, 2002 and 2001 are as follows (won in millions):
KTM.Com
B-28
KTF Technologies Co., Ltd
(2) Receivables and payables with related parties as of December 31, 2002 and 2001 are as follows (won in millions):
19. COMMITMENTS:
The Company has entered into an agreement covering the resale of PCS with KT Corporation. As compensation for providing the telecommunications network, the Company receives some portion of the monthly revenues generated from KT Corporation’s subscribers.
20. DISPOSAL OF TRADE ACCOUNTS AND NOTES RECEIVABLE:
On December 16, 2002, the Company transferred the handset installment receivable of (Won)528,578 million and guarantee insurance and other incident rights to KTF First Securitization Specialty Co., Ltd. As a result of this disposal, the Company received cash of (Won)470,000 million and the subordinate debt investment of (Won) 43,430 million, and the Company recognized a loss on disposal of trade accounts and notes receivable of (Won)15,147 million. The Company has provided a guarantee for uncollected receivables up to 14.3 percent of total amount transferred. As of December 31, 2002, the uncollected securitized trade receivable is (Won)400,200 million.
21. SEGMENT INFORMATION:
B-29
Segment information for the years ended December 31, 2002 is as follows (won in millions):
Revenue
Tangible and intangible assets
Capital expenditure and advance payments for property and equipment
22. SUBSEQUENT EVENT:
On January 28, 2003, the Board of Directors approved the merger with KT ICOM. The transaction is deemed to be a “small-scale merger” as defined in the Commercial Code of the Republic of Korea, which states that the total number of new shares to be issued by the acquiring company does not exceed 5 percent of the total issued shares of the acquiring company. In accordance with the Commercial Code of the Republic of Korea, the approval by the general shareholders of KT Freetel may be replaced by the approval of the board of directors of KT Freetel. The exchange ratio of common share between KT Freetel and KT ICOM is 1 to 0.55636 and the merger was completed on March 6, 2003.
23. RECONCILIATION TO ACCOUNTING PRINCIPLES GENERALLY ACCEPTED IN THE UNITED STATES:
(1) Marketable Securities and Investments Securities
Under Korean GAAP, use of the equity method for certain minority-owned (more than 20%) investments is required except for companies with assets of less than (Won)7 billion as of the previous year-end. However, under U.S. GAAP, use of the equity method for investments in 50% or less owned affiliates is generally required.
Under Korean GAAP, marketable securities in listed companies that the Company does not expect to hold for long-term investment purposes are reported at fair value with unrealized gains and losses are charged to the current operations. Investments in listed companies held for long-term investment purposes are reported at fair value, and the unrealized gains and losses reported in a separate component of stockholders’ equity. Investments in unlisted companies are reported at cost unless there is a significant decline in value and the value is not expected to recover. Investments in debt securities are carried at amortized cost.
Under U.S. GAAP, Statement of Financial Accounting Standards No. 115 (SFAS No. 115)—“Accounting for Certain Investments in Debt and Equity Securities” requires that marketable equity securities and all debt securities be classified into three categories and be accounted for as follows:
(i) Debt securities that the Company has the positive intent and ability to hold to maturity are classified as held-to-maturity securities and reported at amortized cost.
B-30
(ii) Debt and equity securities that are bought and held principally for the purpose of selling them in the near term are classified as trading securities and reported at fair value, with the unrealized gains and losses included in current operations.
(iii) Debt and equity securities not classified as either held-to-maturity securities or trading securities are classified as available-for-sale securities and reported at fair value, with the unrealized gains and losses excluded from income and reported as a separate component of shareholders’ equity.
Under U.S. GAAP, the Company classified its marketable securities as trading securities and listed equity securities of investment securities as available-for-sale securities. Non-listed equity securities and debt securities of investment securities that the Company intends to hold to maturity are classified as “held-to maturity”.
(2) Capitalization of foreign currency translation gain (loss)
As explained in Note 2, under Korean GAAP, certain unrealized foreign exchange translation gains and losses were excluded from the results of operations and included in the cost of property and equipment. However, under U.S.GAAP, all unrealized foreign currency translation gains and losses on monetary assets and liabilities are to be included in the current year’s results of operations.
The amounts of foreign exchange translation gains and losses included in property and equipment under Korean GAAP were adjusted to comply with U.S.GAAP.
(3) Interest Capitalization
Under Korean GAAP, interest is capitalized on borrowings related to the construction of all property and equipment, incurred prior to completing the acquisition, as part of the cost of such assets. Under U.S. GAAP, the Company’s policy is to capitalize interest in the amount that would have theoretically been avoided had expenditures not been made for assets, which require a period of time to get them ready for their intended uses.
(4) Licensing Cost
Under U.S.GAAP, licensing costs were accounted for as an intangible asset and capital surplus at the time of establishment of the Company.
(5) Deferred Charges
Under U.S.GAAP, development costs and organization costs are charged to expenses when incurred and are classified as operating expenses.
(6) Revenue Recognition
Under U.S.GAAP, such amount should be deferred and recognized over the period of the customer relationship.
B-31
(7) Merger with KTM.Com Co., Ltd.
Under Korean GAAP, as KT Freetel and KTM.Com Co., Ltd. were subsidiaries of KT Corporation prior to merger, assets and liabilities were transferred from KTM.Com Co., Ltd. to KT Freetel at book value as shown in the consolidated statements of KT Corporation and the difference between the par value of capital stock issued and the value of net assets transferred was recorded in the capital surplus accounts.
Under U.S.GAAP, assets and liabilities were transferred from KTM.Com Co., Ltd. to KT Freetel at fair value and the difference between the fair value of capital stock issued and the fair value of net assets transferred was recorded as intangible assets.
The Company classified the intangible assets into two components: f subscriber base and goodwill.
(8) Consolidation of KT ICOM
Under Korean GAAP, KT Freetel consolidated KT ICOM as of December 31, 2002. U.S. GAAP requires that the accounts of KT ICOM be consolidated as of the acquisition date that is December 13, 2002. However, since the results of operations of KT ICOM are not significant for the period from December 14 to December 31, 2002, they have not been reflected in the accompanying reconciliation of U.S. GAAP to Korean GAAP.
Under Korean GAAP, as KT Freetel and KT ICOM were subsidiaries of KT Corporation prior to consolidation, KT Freetel consolidated the assets and liabilities of KT ICOM at book value as shown in the consolidated statements of KT Corporation and the difference between the purchase price and the value of net assets was recorded in the capital surplus accounts. However, under U.S. GAAP, assets and liabilities of KT ICOM were recorded at fair value and the difference between the purchase price and the fair value of net assets was recorded as goodwill.
(9) Goodwill and other intangibles
Under Korean GAAP, the purchase price over the fair value of net assets being acquired was recorded as goodwill and it should be amortized within 20 years. However, the impairment loss should be recognized when the carrying amount of goodwill exceeds the fair value.
In accordance with SFAS No. 142, the goodwill and intangibles acquired from KTM.Com and KT ICOM and amortization expense for the years ended December 31, 2002 and 2001 are as follows (won in millions):
The Company evaluated indefinite lives intangibles and goodwill for impairment on goodwill in accordance with the standard’s guidance and determined these assets were not impaired.
B-32
The following table reconciles reported net income under U.S. GAAP to adjusted net income, which excludes amortization expense related to goodwill and indefinite lived intangibles, assuming the adoption of SFAS No. 142 had occurred on January 1 of each of the years presented (won in millions):
Reported net income under U.S. GAAP
Add: Goodwill amortization, net of tax effect
(10) Disposal of trade accounts and notes receivable
Under Korea GAAP, the transaction between KT Freetel and KTF First Securitization Specialty Co., Ltd. purport to be a sale of trade accounts and notes receivable. Under U.S.GAAP, the transaction does not purport to be a sale and transaction is classified as a borrowing.
(11) Minority Interest in Consolidated Subsidiaries
Under Korean GAAP, minority interest in consolidated subsidiaries is presented as a component of shareholders’ equity in the consolidated balance sheets. Under U.S.GAAP, minority interest in consolidated subsidiaries is not included in shareholders’ equity; rather, it is presented between liability and shareholders’ equity in the consolidated balance sheets.
(12) Comprehensive Income
Under the Korean GAAP, there is no requirement to present comprehensive income. Under U.S.GAAP, effective for fiscal years beginning after December 15, 1997, comprehensive income and its components must be presented in the financial statements. Comprehensive income includes all changes in shareholders’ equity during a period except those resulting from investment by, or distribution to, owners, including certain items not included in the current year’s results of operations.
Comprehensive income for the years ended December 31, 2002 and 2001 is summarized as follows:
Net income as adjusted in accordance with U.S.GAAP
Unrealized gain (loss) on investments, net of tax of (Won)745 million in 2002 and (Won)127 million in 2001
Comprehensive income as adjusted in accordance with U.S.GAAP
B-33
(13) Effect on Net Earnings and Shareholders’ Equity
The effects of the significant adjustments to net earnings and shareholders’ equity that are required if U.S.GAAP were applied instead of Korean GAAP are summarized as follows (won in millions, except for share amounts):
(2) Capitalization of foreign currency translation gain (loss), net
(3) Interest capitalization
(4) Licensing cost
(5) Deferred charges
(6) Revenue recognition
(7) Amortization of goodwill
Deferred tax effect of U.S.GAAP adjustments
(7) Merger with KTM.Com
(11) Minority interest in consolidated subsidiaries
Shareholders’ equity under U.S.GAAP
B-34
The condensed balance sheets in accordance with U.S. GAAP as of December 31, 2002 and 2001 are summarized as follows (won in millions):
B-35
Independent Auditor’s Report
To the Board of Directors and Shareholders of
KT ICOM Co., Limited
We have audited the accompanying balance sheets of KT ICOM Co., Limited. (the “Company”) as of December 31, 2002 and 2001 and the related statements of operations, appropriations of retained earnings and cash flows for the year ended December 31, 2002 and for the period from March 16, 2001 (date of inception) to December 31, 2001, expressed in Korean Won. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in conformity with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of KT ICOM Co., Limited. as of December 31, 2002 and 2001 and the results of its operations, the changes in its retained earnings and its cash flows for the year ended December 31, 2002 and for the period from March 16, 2001 (date of inception) to December 31, 2001, in conformity with financial accounting standards generally accepted in the Republic of Korea (“Korea”).
As discussed in Note 16 to the accompanying financial statements, the Company has entered into a merger agreement with KT Freetel on December 20, 2002.
Accounting principles generally accepted in the Republic of Korea vary in certain important respects from accounting principles generally accepted in the United States of America. The application of the latter would have affected the determination of net earnings for the year ended December 31, 2002 and for the period from March 16, 2001 (date of inception) to December 31, 2001 and the determination of shareholders’ equity at December 31, 2002 and 2001 to the extent summarized in Note 18 to the financial statements. A description of the significant differences and a reconciliation of net income and shareholders’ equity to accounting principles generally accepted in the United States of America are set forth in Note 18 to the financial statements.
The amounts expressed in U.S. Dollar are provided solely for the convenience of the reader and have been translated on the basis set forth in Note 3 to the accompanying financial statements.
Samil Accounting Corporation
January 14, 2003
C-1
SIGNATURES
The registrant hereby certifies that it meets all of the requirements for filing on Form 20-F and that it has duly caused and authorized the undersigned to sign this annual report on its behalf.
(Registrant)
/s/ Yong-Kyung Lee
Date: June 25, 2004
Exhibit Index