As filed with the Securities and Exchange Commission on June 30, 200429, 2007

UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington,WASHINGTON, D.C. 20549

FORM 20-F
(Mark One)
   
o 
REGISTRATION STATEMENT PURSUANT TO SECTION 12(b) OR (g) OF THE SECURITIES EXCHANGE ACT OF 1934

OR
OR
x 
þ
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2003
For the fiscal year ended December 31, 2006 
OR
   
OR
o
 
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
OR
   
o
 
Commission file number: 1-14660SHELL COMPANY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

(CHINA SOUTHERN AIRLINES COMPANY LIMITED LOGO)

Date of event requiring this shell company report _____________
For the transition period from _________ to 
Commission file number 1-14660
chinasouthern 
(Exact name of Registrant as specified in its charter)

CHINA SOUTHERN AIRLINES COMPANY LIMITED
(Translation of Registrant’s name into English)

THE PEOPLE’S REPUBLIC OF CHINA
(Jurisdiction of incorporation or organization)
278 JI CHANG ROAD

BAIYUN INTERNATIONAL AIRPORT
GUANGZHOU
PEOPLE’S REPUBLIC OF CHINA, 510405

(Address of principal executive offices)

Securities registered or to be registered pursuant to Section 12(b) of the Act:
Act.
   
Title of each class:class Name of each exchange on which registered:
registered
   
Ordinary H Shares of par value RMB1.00 per share
 
New York Stock Exchange, Inc.
RMB 1.00 per share
represented by American
Depositary Shares
  

Securities registered or to be registered pursuant to Section 12(g) of the Act: Act.
None

(Title of Class)
(Title of Class)
SEC 1852 (05-06)
Persons who respond to the collection of information contained in this form are not required to respond unless the form displays a currently valid OMB control number.
Securities for which there is a reporting obligation pursuant to Section 15(d) of the Act: Act.
None

(Title of Class)
Indicate the number of outstanding shares of each of the issuer’s classes of capital or common stock as of the close of the period covered by the annual report:report. 2,200,000,000 ordinary Domestic Shares of par value RMB1.00RMB 1.00 per share and 1,174,178,000 ordinary H Shares of par value RMB1.00RMB 1.00 per share and 1,000,000,0001,000,000 ordinary A Shares of par value RMB1.00RMB 1.00 per share were issued and outstanding as of December 31, 2003.2006.
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
o

Yes þ No

If this report is an annual or transition report, indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.
o Yes þ No
Note — Checking the box above will not relieve any registrant required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 from their obligations under those Sections.
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
þ
Yes o No
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):
 
YesLarge accelerated filer xo No
Accelerated filer þ
Non-accelerated filer o

Indicate by check mark which financial statement item the Registrant has elected to follow.
o
Item 17oItem 18x

Item 17 þ Item 18

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

TABLE OF CONTENTS

FORWARD-LOOKING STATEMENTS
INTRODUCTORY NOTE
GLOSSARY OF AIRLINE INDUSTRY TERMS
PART I
ITEM 1. IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS
ITEM 2. OFFER STATISTICS AND EXPECTED TIMETABLE
ITEM 3. KEY INFORMATION
Selected Financial Data
Capitalization and Indebtedness
Reasons for the Offer and Use of Proceeds
Risk Factors
ITEM 4. INFORMATION ON THE COMPANY
History and Development of the Company
Business Overview
Organizational Structure
Property, Plant and Equipment
ITEM 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS
Critical Accounting Policies
Overview
Certain Financial Information and Operating Data by Geographic Region
Operating Results
Liquidity and Capital Resources
Contractual Obligations and Commercial Commitments
ITEM 6. DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES
Directors and Senior Management
Compensation
Board Practices
Employees
Share Ownership
ITEM 7. MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS
Major Shareholders
Related Party Transactions
ITEM 8. FINANCIAL INFORMATION
Consolidated Statements and Other Financial Information
Significant Changes
ITEM 9. THE OFFER AND LISTING
Offer and Listing details
Plan of Distribution
Markets
Selling Shareholders
Dilution
Expenses of the Issue
ITEM 10. ADDITIONAL INFORMATION
Share Capital
Memorandum and Articles of Association
Material Contracts
Exchange Controls
Taxation
Dividends and paying Agents
Statement by Experts
Documents on Display
Subsidiary Information
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
PART III
ITEM 15. CONTROLS AND PROCEDURES
ITEM 16.
ITEM 16A. AUDIT COMMITTEE FINANCIAL EXPERT
ITEM 16B. CODE OF ETHICS
ITEM 16C. PRINCIPAL ACCOUNTING FEES AND SERVICES
ITEM 16D. PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED PURCHASERS
PART IV
ITEM 17. FINANCIAL STATEMENTS
ITEM 18. FINANCIAL STATEMENTS
ITEM 19. EXHIBITS
EX-1 ARTICLES OF ASSOCIATION
EX-4.1 FORM OF DIRECTOR'S SERVICE AGREEMENT
EX-4.2 NON-EXECUTIVE DIRECTOR'S SERVICE AGREEMENT
EX-8 SUBSIDIARIES OF THE COMPANY
EX-12.1 CERT CHAIRMAN OF THE BOARD OF DIRECTORS
EX-12.2 CERTIFICATION FROM THE PRESIDENT
EX-12.3 CERTIFICATION FROM THE CFO
EX-13.1 SECTION 906 CERT FROM THE CHAIRMAN
EX-13.2 SECTION 906 CERT FROM THE PRESIDENT
EX-13.3 SECTION 906 CERT FROM THE CFO

TABLE OF CONTENTS

China Southern Airlines Company Limited


 
Page
Forward-Looking Statements12
Introductory Note1
2
Glossary of Airline Industry Terms
2
PART I
Item 1. Identity of Directors, Senior Management and Advisers3
4
Item 2. Offer Statistics and Expected Timetable3
4
Item 3. Key Information3
4
Selected Financial Data3
4
Capitalization and Indebtedness7
8
Reasons for the Offer and Use of Proceeds7
8
Risk Factors7
8
Item 4. Information on the Company11
12
History and Development of the Company11
12
Capital Expendition
13
Business Overview12
13
Organizational Structure
28
Property, Plant and Equipment30
29
Item 5. Operating and Financial Review and Prospects31
30
Critical Accounting Policies
31
Overview31
32
Certain Financial Information and Operating Data by Geographic Region32
33
Operating Results
34
Additional Information under U.S. GAAP
38
Liquidity and Capital Resources38
42
Contractual Obligations and Commercial Commitments41
44
Item 6. Directors, Senior Management and Employees41
44
Directors and Senior Management41
44
Compensation43

i

48
Page
Board Practices
49
Remuneration Committee43
50
Employees44
50
Share Ownership45
51
Item 7. Major Shareholders and Related Party Transactions45
51
Major Shareholders45
51
Related Party Transactions46
51
InterestInterests of Experts and Counsel48
56
Item 8. Financial Information48
56
Consolidated Statements and Other Financial Information48
56
Significant Changes
56
Dividend Information49
57
Item 9. The Offer and Listing49
57
Offer and Listing Details50
57
Plan of Distribution50
58
Markets50
58
Selling Shareholders50
58
Dilution50
58
Expenses of the Issue50
59
Item 10. Additional Information50
59
Share Capital50
59
Memorandum and Articles of Association50
59
Material Contracts55
62
Exchange Controls
64
Taxation55
65

 Taxation55
Page
Dividends and Paying Agents56
68
Statement by Experts56
68
Documents on Display56
68
Subsidiary Information
68
Comparison of New York Stock Exchange Corporate Governance Rules and China Corporate Governance Rules for Listed Companies57
69
Item 11. Quantitative and Qualitative Disclosures About Market Risk57
72
Item 12. Description of Securities other than Equity Securities58
73
PART II

ii

       
Page
Item 13. Defaults, Dividend Arrearages and Delinquencies58
73
Item 14. Material Modifications to the Rights of Security Holders and Use of Proceeds
73
Use of Proceeds58
73
PART III
Item 15.     Control and Procedures60       
Item 16.15. Controls and Procedures60
75
Item 16A.16. [Reserved]
75
Item 16 A. Audit Committee Financial Expert60
75
Item 16B.16 B. Code of Ethics60
76
Item 16C.16 C. Principal AccountantAccounting Fees and Services60
76
Item 16D.16 D. Exemptions from the Listing Standards for Audit Committee Exemption
76
Item 16 E. Purchases of Equity Securities By the Issuer and Affiliated Purchasers60
76
PART IV
Item 17. Financial Statements60
76
Item 18. Financial Statements
76
Index to Financial Statements60
77
Item 19. Exhibits60
78
Signatures62
79

iii


 EX-1.1 AMENDED ARTICLES OF ASSOCIATION OF CHINA SOUTHERN AIRLINES COMPANY LIMITED
 EX-4.1 FORM OF DIRECTOR'S SERVICE AGREEMENT
 EX-4.2 FORM OF NON-EXECUTIVE DIRECTOR'S SERVICE AGREEMENT
 EX-8.1 SUBSIDIARIES OF THE COMPANY
 EX-12.1 SECTION 302 CERTIFICATION OF CHAIRMAN
 EX-12.2 SECTION 302 CERTIFICATION OF PRESIDENT
 EX-12.3 SECTION 302 CERTIFICATION OF CHIEF FINANCIAL OFFICER
 EX-13.1 SECTION 906 CERTIFICATION OF CHAIRMAN
 EX-13.2 SECTION 906 CERTIFICATION OF PRESIDENT
 EX-13.3 SECTION 906 CERTIFICATION OF CHIEF FINANCIAL OFFICER

FORWARD-LOOKING STATEMENTS

This Annual Report contains forward-looking statements. These statements appear in a number of different places in this Annual Report. A forward lookingforward-looking statement is usually identified by the use in this Annual Report of certain terminology such as “estimates”, “projects”, “expects”, “intends”, “believes”, “plans”, “anticipates”, or their negatives or other comparable words. Also look for discussions of strategy that involve risks and uncertainties. Forward-looking statements include statements regarding the outlook for the Company’s future operations, forecasts of future costs and expenditures, evaluation of market conditions, the outcome of legal proceedings (if any), the adequacy of reserves, or other business plans. You are cautioned that such forward-looking statements are not guarantees and involve risks, assumptions and uncertainties. The Company’s actual results may differ materially from those in the forward-looking statements due to risks facing the Company or due to actual facts differing from the assumptions underlying those forward-looking statements.

Some of these risks and assumptions, in addition to those identified under Item 3, “Key Information –- Risk Factors,” include:

 -
·
 general economic and business conditions, including changes in interest rates;
 
 -
·
 prices and other economic conditions;
 
 -
·
 natural phenomena;
 
 -
·
 actions by government authorities, including changes in government regulation;regulations;
 
 -
·
 the Company’s relationship with CSAHC;
 
 -
·
 uncertainties associated with legal proceedings;
 
 -
·
 technological development;
 
 -
·
 future decisions by management in response to changing conditions;
 
 -
·
 the Company’s ability to execute prospective business plans; and
 
 -
·
 misjudgments in the course of preparing forward-looking statements.

The Company advises you that these cautionary remarks expressly qualify in their entirety all forward-looking statements attributable to the Company, the Group and persons acting on their behalf.

INTRODUCTORY NOTE

In this Annual Report, unless the context indicates otherwise, the “Company” means China Southern Airlines Company Limited, a joint stock company incorporated in China on March 25, 1995, the “Group” means the Company and its consolidated subsidiaries, and CSAHC“CSAHC” means China Southern Air Holding Company, the Company’s parent company which holds a 50.3% controlling interest in the Company.

References to “China” or the “PRC” are to the People’s Republic of China, excluding Hong Kong, Macau and Taiwan. References to “Renminbi” or “RMB” are to the currency of China, references to “U.S. dollars”, “$” or “US$” are to the currency of the United States of America (the “U.S.” or “United States”), and reference to “HK$” is to the currency of Hong Kong. Reference to the “Chinese Government” is to the national government of China. References to “Hong Kong” or “Hong Kong SAR” are to the Hong Kong Special Administrative Region of the People’s Republic of China. References to “Macau” or “Macau SAR” are to the Macau Special Administrative Region of the People’s Republic of China.

The Company presents its consolidated financial statements in Renminbi. The consolidated financial statements of the Company as offor the year ended December 31, 2002 and 20032006 (the “Financial Statements”) have been prepared in accordance with International Financial Reporting Standards (“IFRS”) promulgated by the International Accounting Standards Board. IFRS includes International Accounting Standards (“IAS”) and related interpretations. IFRS differs in certain significant respects from accounting principles generally accepted in the United States of America (“U.S. GAAP”). Information relating to the nature and effect of such differences is presented in Note 3351 to the Financial Statements.

Solely for the convenience of the readers, this Annual Report contains translations of certain Renminbi amounts into U.S. dollars at the rate of US$1.00 = RMB8.2767,RMB 7.8087, which is the average of the buying and selling rates as quoted by the People’s Bank of China at the close of business on December 31, 2003.2006. No representation is made that the Renminbi amounts or U.S. dollar amounts included in this Annual Report could have been or could be converted into U.S. dollars or Renminbi, as the case may be, at any particular rate or at all. Any discrepancies in the tables included herein between the amounts listed and the totals are due to rounding.

1

GLOSSARY OF AIRLINE INDUSTRY TERMS

In this Annual Report, unless the context indicates otherwise, the following terms shall have the respective meanings set forth below.
Capacity Measurements
  
   
“available seat kilometers” or “ASKs” the number of seats made available for sale multiplied by the kilometers flown
2
“available ton kilometers” or “ATKs” the number of tons of capacity available for the transportation of revenue load (passengers and cargo) multiplied by the kilometers flown
   
Traffic Measurements
  
   
“revenue passenger kilometers” or “RPKs” the number of revenue passengers carried multiplied by the kilometers flown
   
“cargo ton kilometers” the cargo load in tons multiplied by the kilometers flown
   
“revenue ton kilometers” or “RTKs” the load (passenger and cargo) in tons multiplied by the kilometers flown
   
Yield Measurements
  
   
“passenger yield” revenue from passenger operations divided by RPKs
   
“cargo yield” revenue from cargo operations divided by cargo ton kilometers
   
“average yield” revenue from airline operations (passenger and cargo) divided by RTKs
   
“ton” a metric ton, equivalent to 2,204.6 pounds
   
Load Factors
  
   
“passenger load factor” RPKs expressed as a percentage of ASKs
   
“overall load factor” RTKs expressed as a percentage of ATKs
   
“breakeven load factor” the load factor required to equate scheduled traffic revenue with operating costs assuming that total operating surplus is attributable to scheduled traffic operations
   
Utilization
  
   
“utilization rate” the actual number of flight hours per aircraft per operating day
3
Equipment
  
   
“rotables” aircraft parts that are ordinarily repaired and reused
   
“expendables” aircraft parts that are ordinarily used up and replaced with new parts

2

PART I

ITEM 1.IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS.

Not applicable.

ITEM 2.OFFER STATISTICS AND EXPECTED TIMETABLE.

Not applicable.

ITEM 3.KEY INFORMATION.

Selected Financial Data

The following tables present selected financial data of the Company as of and for each of the years in the five-year period ended December 31, 2006. The selected data of consolidated statements of operations for each of the years in the three-year period ended December 31, 2006 and consolidated balance sheets as of December 31, 2005 and 2006, presented in IFRS section, have been derived from the consolidated financial statements of the Company, including the related notes, included elsewhere in this Annual Report. The selected IFRS data of consolidated statements of operations for the years ended December 31, 2002 and 2003 and IFRS consolidated balance sheets of December 31, 2002, 2003 and 2004 are derived from the Company’s audited consolidated financial statements that are not included in this Annual Report. The selected U.S. GAAP data of consolidated statements of operations for each of the years in the five-year period ended December 31, 20032006 and consolidated balance sheets for five years endedas of December 31, 2002, 2003, have been2004, 2005 and 2006 are derived from the Company’s unaudited consolidated financial statements that are not included in this Annual Report.
The consolidated financial statements of the Company are prepared and presented in accordance with IFRS.
Under IFRS, the purchase method of accounting was applied to account for the acquisition of the airline operations and certain related assets of China Northern Airlines Company (“CNA”) and Xinjiang Airlines Company (“XJA”) (“CNA/XJA Acquisitions”) (details of which are disclosed in “Item 4. Information on the Company — History and Development of the Company”) such that at December 31, 2004 only the acquired assets and liabilities are included in the consolidated financial statements. The results of the acquired operations and their related cash flows was included in the consolidated financial statements of the Company. SuchGroup beginning January 1, 2005. Under U.S. GAAP, such transaction is considered to be “a combination of entities under common control”. A combination of entities under common control is accounted for in a manner similar to a “pooling-of-interests”. Consequently, the assets and liabilities of CNA and XJA are reflected at their U.S. GAAP carrying values and the U.S. GAAP consolidated financial statements are restated to include the assets and liabilities of CNA and XJA, and their results of operations and cash flows for the years ended December 31, 2002, 2003 and 2004.  
In addition, the consolidated financial statements for the year ended December 31, 2005 have been audited by KPMG, Independent Registered Public Accounting Firm,revised to reflect the adoption of IAS 16 (amended 2004) Property, Plant and prepared in accordance with IFRS. IFRS differs in certain significant respects from U.S. GAAP. Equipment effective January 1, 2005. Please refer to Note 45 to the consolidated financial statements for details. 
See Note 3351 to the Financial Statementsconsolidated financial statements for the nature and effect of such differences and other significant differences related to the Group between IFRS and U.S. GAAP as of December 31, 20022005 and 20032006 and for each of the years in the three-year period ended December 31, 2003.2006 and the condensed consolidated financial statements prepared and presented in accordance with U.S. GAAP for the relevant periods. The following information should be read in conjunction with, and is qualified in its entirety by, the Financial Statements of the Group.
                         
          Year ended December 31,
  1999
 2000
 2001
 2002
 2003
 2003
  RMB RMB RMB RMB RMB US$
  (in million, except per share data)
Income Statement Data:
                        
IFRS:                        
Operating revenue  13,299.6   15,178.3   16,879.7   18,018.6   17,470.1   2,110.8 
Operating expenses  11,449.7   13,996.2   15,479.0   15,992.5   17,014.4   2,055.7 
Operating income  1,849.9   1,182.1   1,400.7   2,026.1   455.7   55.1 
Equity income of affiliated companies  36.1   45.9   53.0   37.0   47.8   5.8 
Equity loss of jointly controlled entities  —   —   (4.0)  (3.4)  (39.5)  (4.8)
(Loss)/gain on sale of fixed assets  (18.7)  372.6   (55.9)  170.7   (22.2)  (2.7)
Interest expense  (1,192.2)  (1,074.2)  (933.7)  (959.2)  (823.7)  (99.5)
Exchange (loss)/gain, net  (426.5)  318.5   296.8   (175.4)  (164.4)  (19.9)
Other, net  119.9   86.3   38.4   43.3   34.7   4.2 
Income/(loss) before taxation and minority interests  368.5   931.2   795.3   1,139.1   (511.6)  (61.8)
Taxation (expense)/credit  (128.0)  (338.9)  (320.5)  (398.2)  324.2   39.2 
Minority interests  (158.1)  (90.5)  (134.6)  (165.1)  (170.9)  (20.7)
Net income/(loss)  82.4   501.8   340.2   575.8   (358.3)  (43.3)
Basic earnings/(loss) per share  0.02   0.15   0.10   0.17   (0.09)  (0.01)
Basic earnings/(loss) per ADS  1.22   7.44   5.04   8.53   (4.68)  (0.56)
Cash dividends declared per share  —   —   —   0.02   —   —
U.S. GAAP:                        
Net income/(loss)  370.3   354.4   430.7   474.0   (359.6)  (43.5)
Basic earnings/(loss) per share  0.11   0.11   0.13   0.14   (0.09)  (0.01)
Basic earnings/(loss) per ADS  5.49   5.25   6.38   7.02   (4.69)  (0.57)
Cash dividends declared per share  —   —   —   0.02   —   —

3

  
Year ended December 31, 
  
2002
 
2003
 
2004
 
2005
 
2006
 
2006
 
  
RMB
 
RMB
 
RMB
 
RMB
 
RMB
 
US$
 
        
(revised)
     
  
(in million, except per share data)
 
Income Statement Data:
             
IFRS:             
Operating revenue  18,019  17,470  23,974  38,293  46,219  5,919 
Operating expenses  15,993  17,014  23,065  39,525  45,980  5,888 
Operating income/(loss)  2,026  456  909  (1,232) 239  31 
Interest expense  (959) (824) (691) (1,616) (2,070) (265)
Exchange (loss)/gain, net  (176) (164) (59) 1,220  1,492  191 
Income/(loss) before taxation  1,130  (521) 220  (1,780) 284  36 
Taxation (expense)/credit  (389) 334  (65) (4) (142) (18)
Income/(loss) for the year  741  (187) 155  (1,784) 142  18 
Income/(loss) attributable to :                   
Equity shareholders of the company  576  (358) (48) (1,786) 126  16 
Minority interests  165  171  203  2  16  2 
Basic and diluted earnings/(loss) per share  0.17  (0.09) (0.01) (0.41) 0.03  0.004 
Basic and diluted earnings/(loss) per ADS  8.53  (4.68) (0.55) (20.42) 1.44  0.18 
Cash dividends declared per share  0.02  —  —  —  —  — 
U.S. GAAP:                   
Traffic revenue  24,854  24,897  33,235  37,419  45,087  5,774 
Other operating revenue  904  586  930  874  1,132  145 
Operating income/(loss)  1,948  366  1,877  (1,019) 706  90 
Interest expense  (1,820) (1,604) (1,184) (1,589) (2,070) (265)
Exchange (loss)/gain, net  (327) (381) (124) 1,220  1,492  191 
Income/(loss) before income taxes and minority interests  (145) (1,549) 693  (1,501) 402  51 
Income tax (expense)/benefit  (356) 536  (261) 35  (170) (22)
Minority interests  (154) (127) (193) (2) (16) (2)
Net (loss)/income  (655) (1,140) 239  (1,468) 216  28 
Basic and diluted (loss)/earnings per share  (0.19) (0.30) 0.05  (0.34) 0.05  0.006 
Basic and diluted (loss)/earnings per ADS  (9.71) (14.88) 2.50  (17.00) 2.50  0.30 
Cash dividend declared per share  0.02  —  —  —  —  — 
                         
          December 31,
      
  1999
 2000
 2001
 2002
 2003
 2003
  RMB RMB RMB RMB RMB US$
  (in million)
Balance Sheet Data:
                        
IFRS:                        
Cash and cash equivalents  4,588.4   4,197.5   2,817.9   3,771.0   2,080.2   251.3 
Other current assets  1,715.2   1,691.9   1,560.5   1,834.8   1,921.3   232.1 
Fixed assets, net  24,211.2   23,282.1   22,352.2   26,920.8   28,535.9   3,447.7 
Total assets  32,557.7   30,924.0   30,653.1   37,188.0   39,062.1   4,719.5 
Notes payable, including current installments of long term notes payable  613.3   783.1   2,177.5   5,240.7   7,096.8   857.4 
Current installments of obligations under capital leases  1,999.7   1,776.2   1,451.9   1,566.7   1,297.9   156.8 
Notes payable, excluding current installments  4,424.2   3,788.7   3,627.6   5,835.4   4,521.7   546.3 
Obligations under capital leases, excluding current installments  11,490.9   9,416.3   7,691.6   6,631.8   5,543.1   669.7 
Shareholders’ equity  8,379.7   8,881.4   9,221.7   9,613.2   11,895.7   1,437.3 
U.S. GAAP:                        
Shareholders’ equity  8,227.4   8,527.3   8,958.0   9,287.3   11,568.5   1,397.7 

4
  
As of December 31, 
  
2002
 
2003
 
2004
 
2005
 
2006
 
2006
 
  
RMB
 
RMB
 
RMB
 
RMB
 
RMB
 
US$
 
        
(revised)
     
  
(in million)
Balance Sheet Data:
             
IFRS:             
Cash and cash equivalents  3,771  2,080  3,083  2,901  2,264  290 
Other current assets  1,835  1,922  4,286  4,320  4,419  566 
Property, plant and equipment, net  26,921  28,536  46,841  54,339  56,347  7,216 
Total assets  37,188  39,062  62,383  71,464  75,584  9,679 
Notes payable, including current installments of long term notes payable  5,241  7,097  11,518  16,223  23,822  3,051 
Current installments of obligations under capital leases  1,567  1,298  2,144  3,373  3,091  396 
Notes payable, excluding current installments  5,835  4,522  11,935  12,740  10,018  1,283 
Obligations under capital leases, excluding current installments  6,632  5,543  9,599  12,459  12,307  1,576 
Total equity  11,130  13,569  13,903  11,998  12,121  1,304 
U.S. GAAP:                   
Cash and cash equivalents  4,772  2,999  3,083  2,901  2,264  290 
Other current assets  3,391  3,034  4,505  4,551  4,681  599 
Property, plant and equipment, net  40,277  41,012  46,202  53,832  55,928  7,162 
Total assets  54,860  58,610  65,144  74,479  77,877  9.973 
Notes payable, including current portion of long term notes payable  10,304  8,600  11,518  13,612  19,652  2,517 
Current installments of obligations under capital leases  2,591  2,368  2,106  3,401  3,119  399 
Notes payable, excluding current portion  9,179  8,634  11,935  15,351  14,188  1,817 
Obligations under capital leases, excluding current installments  13,333  13,849  11,975  14,807  14,551  1,863 
Shareholders’ equity  6,796  13,098  11,169  9,701  9,917  1,270 
Selected Operating Data

The following selected operating data of the Group for the five years ended December 31, 20032006 have been derived from consolidated financial statements prepared in accordance with IFRS and other data provided by the Group and have not been audited. In accordance with Order No. 88 of the Civil Aviation Administration of China (the “CAAC”), titled Measures for the Administration of China’s Civil Aviation Statistics, new statistical standards have been implemented with effect from January 1, 2001.
5
The Group has not adjusted the operating data for the corresponding period in 1999 according to the new standards. The main differences between the two sets of standards are set forth below:

1.The standard passenger weight has been changed from 75 kg per person to 90 kg per person (luggage weight included). Luggage weight will not be separately calculated;

2.Number of scheduled flights has been changed to number of takeoffs;

3.Any passenger carried on flights which fly international routes will be counted as one domestic passenger and one international passenger; however, any passenger carried on an irregular flight will only be counted once; any cargo carried on flights which fly international routes will be counted as one domestic and one international cargo; however, cargo carried on an irregular flight will only be counted once.

     Apart from the data set out in the table below for year 1999, the operating data and the profit analysis and comparison for other years below is calculated and disclosed in accordance with the new statistical standards.standards, which have been implemented since January 1, 2001. See “Glossary of Airline Industry Terms” at the front of this Annual Report for definitions of certain terms used herein.

                     
      Year ended December 31,
    
  1999
 2000
 2001
 2002
 2003
Capacity
                    
ASK (million)                    
— Domestic  24,900   28,345   31,393   33,753   32,590 
— Hong Kong regional  1,791   1,744   1,690   1,746   1,347 
— International  5,155   5,742   6,981   8,746   6,930 
Total  31,846   35,831   40,064   44,245   40,867 
ATK (million)                    
— Domestic  2,865   3,322   3,622   3,924   3,772 
— Hong Kong regional  214   198   185   193   150 
— International  683   1,087   1,317   1,798   1,999 
Total  3,762   4,607   5,124   5,915   5,921 

4

  
Year ended December 31, 
 
  
2002
 
2003
 
2004
 
2005
 
2006
 
Capacity
           
ASK (million)
  44,245  40,867  53,769  88,361  97,059 
ATK (million)
  5,915  5,921  7,446  11,509  12,656 
Kilometers flown (thousand)  258,379  249,068  324,827  539,844  594,957 
Hours flown (thousand)  405  385  501  846  931 
Number of landing and take-offs
  222,657  214,190  274,580  438,674  481,810 
Traffic
                
RPK (million) 
  28,940  26,387  37,196  61,923  69,582 
RTK (million)
  3,614  3,561  4,663  7,284  8,071 
Passengers carried (thousand)
  21,493  20,470  28,207  44,119  49,206 
Cargo and mail carried (tons)  470,000  464,000  545,000  775,000  819,000 
Load Factors
                
Passenger load factor (RPK/ASK) (%)
  65.4  64.6  69.2  70.1  71.7 
Overall load factor (RTK/ATK) (%)  61.1  60.1  62.6  63.3  63.8 
Breakeven load factor (%)  55.9  61.6  61.9  67.0  65.0 

                     
      Year ended December 31,
    
  1999
 2000
 2001
 2002
 2003
Kilometers flown (thousand)  182,200   209,431   234,051   258,379   249,068 
Hours flown (thousand)  287   326   365   405   385 
Number of flights                    
— Domestic  126,120   —   —   —     
— Hong Kong regional  13,460   —   —   —     
— International  6,600   —   —   —     
Total  146,180   —   —   —     
Number of landing and take-offs                    
— Domestic  —   165,726   183,651   194,776   191,460 
— Hong Kong regional  —   14,255   13,712   13,891   11,400 
— International  —   8,861   10,698   13,990   11,330 
Total  —   188,842   208,061   222,657   214,190 
Traffic
                    
RPK (million)                    
— Domestic  14,511   16,974   19,447   22,092   21,294 
— Hong Kong regional  1,106   1,074   1,060   1,081   778 
— International  3,068   3,605   4,550   5,767   4,315 
Total  18,685   21,653   25,057   28,940   26,387 
RTK (million)                    
— Domestic  1,518   1,941   2,217   2,532   2,424 
— Hong Kong regional  106   107   105   108   78 
— International  379   565   712   974   1,059 
Total  2,003   2,613   3,034   3,614   3,561 
Passengers carried (thousand)                    
— Domestic  12,769   14,450   16,499   18,535   18,259 
— Hong Kong regional  1,434   1,444   1,409   1,369   1,019 
— International  909   957   1,213   1,589   1,192 
Total  15,112   16,851   19,121   21,493   20,470 
Cargo and mail carried (tons)  390,750   353,000   398,000   470,000   464,000 
Load Factors
                    
Passenger load factor (RPK/ASK) (%)                    
— Domestic  58.3   59.9   61.9   65.5   65.3 
— Hong Kong regional  61.8   61.6   62.7   61.9   57.8 
— International  59.5   62.8   65.2   65.9   62.3 
Total  58.7   60.4   62.5   65.4   64.6 
Overall load factor (RTK/ATK) (%)                    
— Domestic  53.0   58.4   61.2   64.5   64.2 
— Hong Kong regional  49.5   54.0   56.8   55.8   52.2 
— International  55.5   52.0   54.1   54.2   53.0 
Total  53.2   56.7   59.2   61.1   60.1 
Breakeven load factor (%)  47.5   54.0   55.6   55.9   61.6 
Yield
                    
Yield per RPK (RMB)                    
— Domestic  0.65   0.62   0.62   0.55   0.57 
— Hong Kong regional  1.00   1.06   1.06   0.98   0.96 
— International  0.42   0.43   0.41   0.42   0.47 
Total  0.63   0.61   0.60   0.54   0.57 
Yield per cargo and mail ton kilometers (RMB)  1.63   2.13   1.76   1.73   1.62 

5

                     
      Year ended December 31,
    
  1999
 2000
 2001
 2002
 2003
Yield per RTK (RMB)                    
— Domestic  6.69   5.90   5.83   5.21   5.40 
— Hong Kong regional  11.00   11.19   11.26   10.36   10.35 
— International  3.96   3.63   3.31   3.25   2.90 
  Total  6.40   5.63   5.43   4.84   4.76 
Fleet
                    
— Boeing  81   89   91   102   108 
— Airbus  20   20   20   20   24 
Total aircraft in service at period end  101   109   111   122   132 
Overall utilization rate (hours per day)  8.1   8.7   9.1   9.8   8.5 
Financial
                    
Operating cost per ASK (RMB)  0.36   0.39   0.39   0.36   0.42 
Operating cost per ATK (RMB)  3.04   3.04   3.02   2.70   2.87 
6

  
Year ended December 31, 
 
  
2002
 
2003
 
2004
 
2005
 
2006
 
Yield
           
Yield per RPK (RMB)
  0.54  0.57  0.57  0.55  0.60 
Yield per cargo and mail ton kilometers (RMB)  1.73  1.62  1.67  1.75  1.89 
Yield per RTK (RMB)
  4.84  4.76  5.01  5.14  5.59 
Fleet
                
— Boeing  102  108  137  140  159 
— Airbus  20  24  46  71  103 
— McDonnell Douglas  —  —  35  36  36 
— Others  —  —  13  14  11 
Total aircraft in service at period end  122  132  231  261  309 
Overall utilization rate (hours per day)  9.8  8.5  9.9  9.6  9.5 
Financial
                
Operating cost per ASK (RMB)  0.36  0.42  0.43  0.45  0.47 
Operating cost per ATK (RMB)  2.70  2.87  3.10  3.44  3.63 
Exchange Rate Information

The following table sets forth certain information concerning exchange rates, based on the noon buying rates in New York City for cable transfers in foreign currencies, as certified for customs purposes by the Federal Reserve Bank of New York (the “Noon Buying Rate”), between Renminbi and U.S. dollars for the five most recent financial years.
                 
    Average(1)        
  Period 
        
Period End (RMB per US$) High Low
 
   
 
Annual Exchange Rate
                
1999  8.2793   8.2793   8.2917   8.2669 
2000  8.2781   8.2784   8.2799   8.2768 
2001  8.2766   8.2766   8.2910   8.2642 
2002  8.2773   8.2773   8.2897   8.2152 
2003  8.2767   8.2772   8.2800   8.2769 

Period
  
Period End
  
Average(1)
(RMB per US$)
  
High
  
Low
 
Annual Exchange Rate             
2002  8.2773  8.2773  8.2897  8.2152 
2003  8.2767  8.2772  8.2800  8.2769 
2004  8.2765  8.2765  8.2889  8.2641 
2005  8.0694  8.1825  8.2767  8.0702 
2006  7.8041  7.9723  8.0702  7.8041 
(1)Determined by averaging the rates on the last business day of each month during the relevant period.
The following table sets out the range of high and low exchange rates, based on the Noon Buying Rate, between Renminbi and U.S. dollars, for the following periods.
         
Period
 High
 Low
Monthly Exchange Rate
        
December 2003  8.2772   8.2765 
January 2004  8.2772   8.2767 
February 2004  8.2773   8.2769 
March 2004  8.2774   8.2767 
April 2004  8.2772   8.2768 
May 2004  8.2773   8.2768 
June 2004 (up to June 25, 2004)  8.2768   8.2767 

Period
 
High
 
Low
 
Monthly Exchange Rate
     
December 2006  7.8350  7.8041 
January 2007  7.8127  7.7705 
February 2007  7.7632  7.7410 
March 2007  7.7454  7.7232 
April 2007  7.7345  7.7090 
May 2007  7.7065  7.6463 
June 2007 (up to June 27, 2007)  7.6680  7.6175 
7
(1)Determined by averaging the rates on the last business day of each month during the relevant period.

Dividend Payments

No interim dividend wasdividends were paid during the year ended December 31, 2003.2006. The Board of Directors of the Company (“Board of Directors”) doeshas not recommend therecommended payment of a final dividend in respect of the year ended December 31, 2003.

6

2006.

Capitalization and Indebtedness

Not applicable.

Reasons for the Offer and Use of Proceeds

Not applicable.

Risk Factors

Risks relatingRelating to the Company

Government ownership and control of the Company

     All

Major Chinese airlines are wholly- or majority-owned either by the Chinese Government or by provincial or municipal governments in China. CSAHC, an entity wholly-owned by the Chinese Government, holds and exercises the rights of ownership of all of the Domestic Shares or 50.3% of the equity of the Company. The interests of the Chinese Government in the Company and in other Chinese airlines may conflict with the interests of the holders of the ADSs, H Shares and A Shares. The public policy considerations of the Chinese Government in regulating the Chinese commercial aviation industry may also conflict with its indirect ownership interest in the Company.

High operating leverage and foreign exchange exposure

The airline industry is generally characterized by a high degree of operating leverage. In addition, due to high fixed costs, the expenses relating to the operation of any flight do not vary proportionately with the number of passengers carried, while revenues generated from a flight are directly related to the number of passengers carried and the fare structure of such flight. Accordingly, a decrease in revenues could result in a proportionately higher decrease in net income. Moreover, as the Group has substantial obligations denominated in foreign currencies, its results of operations are significantly affected by fluctuations in foreign exchange rates, particularly for the USU.S. dollar and the Japanese Yen.yen. The Company incurred a net exchange lossgain of RMB175RMB1,220 million and RMB164RMB1,492 million for 20022005 and 2003,2006, respectively, mainly as a result of yen fluctuations.Reminbi appreciation. A majority of thesethis exchange losses weregain was unrealized in nature.

Liquidity
As of December 31, 2006, the Group had net current liabiliies position of RMB32,180 million which was due to the use of short-term notes payable for the aircraft acquisitions and other capital expenditures. The Group’s short-term notes payable amounted to RMB23,822 million as at December 31, 2006. The liquiditiy of the Group primarily depends on its ability to maintain adequate cash inflows from operations and to obtain adequate external finance. The Group may not be able to meet its debt obligations as they fall due and committed future capital expenditures.
Potential conflicts of interest

CSAHC will continue to be the controlling shareholder of the Company andCompany. CSAHC and certain of its affiliated companies will continue to provide certain important services to the Company, including the import and export of aircraft spare parts and other flight equipment, housingadvertising services, provision of air catering and cabin supplies, pilot training services, air ticket selling services, cleaning services, leasing of properties and financial services. In addition, Mr. Yan Zhi Qing,Liu Shao Yong, the Chairman of the Board of Directors, also serves as the PresidentGeneral Manager of CSAHC. The interests of CSAHC may conflict with those of the Company. In addition, any disruption of the provision of services by CSAHC’s affiliated companies or a default by CSAHC of its obligations owed to the Company could affect the Company’s operations and financial condition.conditions. In particular, as part of its cash management system, the Company periodically places significant amount of demand deposits towith China Southern Airlines Group Finance Company Limited (“SA Finance”), a PRC authorized financial institution controlled by CSAHC and an affiliated company of the Company. As a result, the Company’s deposits with SA Finance are subject to the risks associated with the business of SA Finance over which the Company does not exercise control. As of December 31, 20022005 and 2003,2006, the Group had short-term deposits of RMB901RMB 544 million and RMB366RMB 629 million, respectively, with SA Finance.

8
Certain transactions between the Company and CSAHC or its affiliates (as defined in the Rules Governing the Listing of Securities on the Stock Exchange of Hong Kong Limited (the “Hong Kong Listing Rules”)) will constitute connected transactions of the Company under the Hong Kong Listing Rules and, unless exemptions are applicable or waivers are granted, will be subject to disclosure requirements and/or independent shareholders’ approval in a general meeting.

7

Risks relating to certain real property

Although systems for registration and transfer of land use rights and related real property interests in China have been implemented, such systems do not yet comprehensively account for all land and related property interests. The land in Guangzhou on which the Company’s headquarters buildings and related aircraft maintenance and other facilities are located and the buildings that the Company uses at its route basebases in Wuhan, Haikou and Zhengzhou are leased by the Company from CSAHC. However, CSAHC lacks adequate documentation evidencing CSAHC’s rights to such land and buildings, and, as a consequence, the lease agreements between CSAHC and the Company for such land have not been registered with the relevant authorities. As a result, such lease agreements may not be enforceable. Lack of adequate documentation for land use rights and ownership of buildings subjects the Company to challenges and claims by third parties with respect to the Company’s use of such land and buildings.


The Company has been occupying all of the land and buildings described above without challenge.challenge or claim by third parties. CSAHC has received written assurance from the CAACGeneral Administration of Civil Aviation of China (“CAAC”) to the effect that CSAHC is entitled to continued use and occupancy of the land in Guangzhou and certain related buildings and facilities. However, such assurance does not constitute formal evidence of CSAHC’s right to occupy such lands, buildings and facilities or the right to transfer, mortgage or lease such real property interests. The Company cannot predict the magnitude of the adverse effect on its operations if its use of any one or more of these parcels of land or buildings were successfully challenged. CSAHC has agreed to indemnify the Company and Guangzhou Aircraft Maintenance Engineering Company Limited (“GAMECO”), the Company’s jointly controlled entity, against any loss or damage caused by any challenge of, or interference with, the use by the Company and GAMECO of any of their respective land and buildings.

Risks associated with Hong Kong regionaland Macau routes

The Company’s Hong Kong regional routes benefit from traffic originating in Taiwan. The Company’s Hong Kong regional routes maymight be materially adversely affected if direct flights between Taiwan and Mainland China were permitted in the future. In such event, Xiamen Airlines Company Limited (“Xiamen Airlines”), the Company’s subsidiary, maymight apply for route rights for direct flights between Taiwan and mainlandMainland China, due partly to the proximity to Taiwan of Fujian province, where Xiamen Airlines is based. However, there can be no assurance that sufficient routes and flights between destinations in Taiwan and mainlandMainland China could be obtained by Xiamen Airlines, if at all, or as to thethat adequate yields will be generated on these routes and flights.


Risks associated with increased costs from the requirements of Section 404 of the Sarbanes Oxley Act of 2002 to evaluate internal controls over financial reporting
 Section 404 of the Sarbanes Oxley Act of 2002 requires that the Company evaluates and reports on the effectiveness of internal controls in providing reasonable assurance regarding the reliability of Financial Reporting. The initial compliance date for management to evaluate and report on internal control over financial reporting under Section 404 of the Sarbanes Oxley Act of 2002 for Foreign Accelerated Filers is for the financial year ending on or after July 15, 2006. The Company has prepared and implemented an internal plan for compliance and has completed the process of documenting and testing the system of internal controls over financial reporting to provide the basis for this report for the year ending December 31, 2006, which is set out in Item 15. The requirement to provide an auditors’ report on internal controls over financial reporting of the Group will apply for the financial year ending December 31, 2007.
Due to ongoing evaluation and testing of the Company’s internal controls and the uncertainties of the interpretation of these new requirements, the Company cannot assure that there will not be significant deficiencies or material weaknesses that would be required to be reported. In the event that significant deficiencies or material weaknesses are reported, investor perceptions may be adversely affected and may cause a decline in the market price of our stock.
The Company has incurred increased costs and has dedicated an increased amount of management time and external resources in order to comply with the above legislation by the end of 2006 and may continue to do so in years to come. The process of documenting and testing the Company’s internal controls over financial reporting and considering improvements has required the Company to hire additional personnel and outside advisory services, resulting in additional accounting and consultancy expenses.

Passive Foreign Investment Company
Depending upon the value of our shares and ADSs and the nature of our assets and income over time, we could be classified as a passive foreign investment company, or PFIC, by the United States Internal Revenue Service, or IRS, for U.S. federal income tax purposes. The Company believes that it was not a PFIC for the taxable year 2006. However, there can be no assurance that the Company will not be a PFIC for the taxable year 2007 and/or later taxable years, as PFIC status is re-tested each year and depends on the facts in such year.

The Company will be classified as a PFIC in any taxable year if either: (1) the average percentage value of its gross assets during the taxable year that produce passive income or are held for the production of passive income is at least 50% of the value of its total gross assets or (2) 75% or more of its gross income for the taxable year is passive income (such as certain dividends, interest or royalties). For purposes of the first test: (1) any cash, cash equivalents, and cash invested in short-term, interest bearing, debt instruments, or bank deposits that is readily convertible into cash, will generally count as producing passive income or held for the production of passive income and (2) the average value of the Company’s gross assets is calculated based on its market capitalization.

If the Company were a PFIC, you would generally be subject to additional taxes and interest charges on certain “excess” distributions the Company makes and on any gain realized on the disposition or deemed disposition of your ADSs, regardless of whether the Company continues to be a PFIC in the year in which you receive an “excess” distribution or dispose of or are deemed to dispose of your ADSs. Distributions in respect of your ADSs during a taxable year would generally constitute “excess” distributions if, in the aggregate, they exceed 125% of the average amount of distributions in respect of your ADSs over the three preceding taxable years or, if shorter, the portion of your holding period before such taxable year. For more information on the United States federal income tax consequences to you that would result from our classification as a PFIC, please see Item 10, “Taxation — United States Federal Income Taxation — U.S. Holders — Passive Foreign Investment Company”.
9
Risks Relating to the Chinese Commercial Aviation Industry

Government regulation

The Company’s ability to implement its business strategy will continue to be affected by regulations and policies issued or implemented by the CAAC, which encompasses substantially all aspects of the Chinese commercial aviation industry, including the approval of domestic, Hong Kong regional and international route allocation, air fares, aircraft acquisition, jet fuel prices and standards for aircraft maintenance, airport operations and air traffic control. Such regulations and policies limit the flexibility of the Company to respond to market conditions, competition or changes in the Company’s cost structure. The implementation of specific CAAC policies could from time to time adversely affect the Company’s operations. The CAAC has confirmed in writing that the Company will be treated equally with other Chinese airlines with respect to certain matters regulated by the CAAC. Nevertheless, there can be no assurance that the CAAC will, in all circumstances, apply its regulations and policies in a manner that results in equal treatment of all airlines that are similarly situated.

airlines.

Jet fuel supply and costs

The availability and cost of jet fuel have a significant impact on the Group’s results of operations. The Group’s jet fuel costs for 20032006 accounted for 22.7%35.2% of its operating expenses. All of the domestic jet fuel requirements of Chinese airlines (other than at the Shenzhen, Zhuhai and Sanya airports) must be purchased from the exclusive providers, China Aviation Oil Supplies Company (the “CAOSC”(“CAOSC”) and Bluesky Oil Supplies Company, companies controlled and supervised by the CAAC. Chinese airlines may also purchase their jet fuel requirements at the Shenzhen, Zhuhai and Sanya airports from joint ventures in which the CAOSC is a partner. Jet fuel obtained from the CAOSC’s regional branches is purchased at uniform prices throughout China that are determined and adjusted by the CAOSC from time to time with the approval of the CAAC and the pricing department of the State Planning Commission based on market conditions and other factors. As a result, the costs of transportation and storage of jet fuel in all regions of China are spread among all domestic airlines. Prior to 1994, domestic jet fuel prices were generally below international jet fuel prices. Since then, however, the domestic jet fuel price from CAOSC has always been higher than international jet fuel prices, sometimes creating tension in fuel supply. In addition, jet fuel shortages have occurred in China and, on limited occasions before 1993, required the Company to delay or cancel flights. Although such shortages have not materially affected the Company’s results of operations since 1993, there can be no assurance that such shortage will not occur in the future. If such shortage occurs in the future and the Company is forced to delay or cancel flights due to fuel shortage, its operational reputation among passengers and results of operations may suffer.

8

Infrastructure limitations

The rapid increase in air traffic volume in China in recent years has put pressure on many components of the Chinese commercial aviation industry, including China’s air traffic control system, the availability of qualified flight personnel and airport facilities. Airlines, such as the Company, which have route networks that emphasize short- to medium-haul routes are generally more affected by insufficient aviation infrastructure in terms of on-time performance and high operating costs due to fuel inefficiencies resulting from the relatively short segments flown, as well as the relatively high proportion of time on the ground during turnaround. All of these factors may adversely affect the perception of the service provided by an airline and, consequently, the airline’s operating results. In recent years, the CAAC has placed increasing emphasis on the safety of Chinese airline operations and has implemented measures aimed at improving the safety record of the industry. The ability of the Company to increase utilization rates and to provide safe and efficient air transportation in the future will depend in part on factors such as the improvement of national air traffic control and navigation systems and ground control operations at Chinese airports, factors which factors are beyond the control of the Company.

Competition

The CAAC’s extensive regulation of the Chinese commercial aviation industry has had the effect of managing competition among Chinese airlines. Nevertheless, competition has become increasingly intense in recent years due to a number of factors, including relaxation of certain regulations by the CAAC and an increase in the capacity, routes and flights of Chinese airlines. Competition in the Chinese commercial aviation industry has led to widespread price-cutting practices that do not in all respects comply with applicable regulations. Until the interpretation of these CAAC regulations limiting such price-cutting has been finalized and strictly enforced, discounted tickets from competitors will continue to have an adverse effect on the Company’s sales.

The Company faces varying degrees of competition on its Hong Kong regional routes from certain Chinese airlines and Hong Kong Dragon AirAirlines Limited and on its international routes, primarily from non-Chinese airlines, most of which have significantly longer operating histories, substantially greater financial and technological resources and greater name recognition than the Company. In addition, the public’s perception of the safety and service records of Chinese airlines could adversely affect the Company’s ability to compete against its Hong Kong regional and international competitors. Many of the Company’s international competitors have larger sales networks and participate in reservation systems that are more comprehensive and convenient than those of the Company, or engage in promotional activities, such as International Alliance programs, that may enhance their ability to attract international passengers.

Limitation on foreign ownership

Chinese Government policies limit foreign ownership in Chinese airlines. Under these policies, the percentage ownership of the Company’s total outstanding ordinary shares held by investors in Hong Kong and any country outside China (“Foreign Investors”) may not in the aggregate exceed 49%. Currently, 26.8% of the total outstanding ordinary shares of the Company isare held by Foreign Investors. As a result of thisFor so long as the limitation on foreign ownership is in force, the Company will have no meaningful access to the international equity capital markets unless the restriction on foreign ownership is lifted.

9

markets.

10

Consolidation and Restructuring

In 2000, the CAAC announced a restructuring plan with respect to the PRC aviation industry. Pursuant to such restructuring plan, each domestic airlines areairline was directed to consolidate on a voluntary basis, into one of the three major airline groups in China: CSAHC, China National Aviation Holding Company and China Eastern Air Holding Group. TheAs approved by the Company’s shareholders in an extraordinary general meeting on December 31, 2004, the Company announced that it will also participate in suchacquired the airline operations and certain related assets of CNA and XJA. This consolidation and restructuring pursuant to the CAAC directives. The Company has taken steps towards the purchase of the airline business of China Northern Airlines Company and Xinjiang Airlines Company, two wholly owned subsidiaries of CSAHC. These proposed acquisitions pursuant to the CAAC restructuring plan may involve uncertainties and risks over a long period of time, including the following:

 -
·
 failure to achieve the anticipated synergies, cost savings or revenue enhancing opportunities resulting from the restructuring activities;
 
 -
·
 diversion of management’s attention from existing business concerns and other business opportunities of the Group;
 
 -
·
 difficulty in integrating the assets and business of other airlines, including its employees, corporate culture, managerial systems and processes, business information systems and services;
 
 -
·
 difficulty in exercising control and supervision over various new operations within the Group;
 
 -
·
 failure to retain key personnel; and
 
 -
·
 increase in financial pressure due to assumption of recorded/recorded / unrecorded liabilities of the acquired businesses.

The inability to manage additional businesses or integrate successfully the acquired businesses without substantial expense, delay or other operational or financial problems, or the occurrence of one or more of the events enumerated above, could materially adversely affect the Group’s financial condition and results of operations.

Risks relating to the PRC

Foreign exchange risks

Under current Chinese foreign exchange regulations, Renminbi is fully convertible for current account transactions, but is not a freely convertible currency, and the Company’s ability to obtain or retain foreign currencies is subject to regulation in China. Limitations on the availability offor capital account transactions. Current account foreign exchange transactions can be undertaken without prior approval from the relevant Chinese Government agencies by producing commercial documents evidencing such transactions, provided that they are processed through Chinese banks licensed to engage in foreign exchange transactions. Conversion from Renminbi into a foreign currency or vice versa for purposes of capital account transactions requires the prior approval of relevant Chinese Government agencies. This restriction on capital account transactions could affect the ability of the Company to acquire foreign currency for capital expenditures. It could also have a material adverse effect on the Company’sCompany's operations and financial condition, particularly in light ofgiven the Company’sCompany's substantial foreign currency obligations.

The value of Renminbi is subject to changes in Chinese Government policies and depends to a large extent on China’s domestic and international economic and political developments, as well as supply and demand in the local market. Since 1994, the official exchange rates for the conversion of Renminbi to US dollars have been stable. There can be no assurance, however, that such rates will not be volatile or that there will be no further devaluation of the Renminbi against the foreign currencies in which the Company’s obligations are denominated, principally the US dollar and other foreign currencies may fluctuate and is affected by, among other things, changes in China's political and economic conditions. On July 21, 2005, the Japanese Yen. Based onPRC government changed its policy of pegging the Company’svalue of the Renminbi to the U.S. dollar so that the Renminbi is now permitted to fluctuate within a band against a basket of certain foreign currencies. On May 18, 2007, the People’s Bank of China announced that the floating band of Renminbi would be permitted to rise or fall by as much as 0.5%. The PRC government has stated publicly that it intends to further liberalize its currency denominated obligations as of December 31, 2003,policy, which could result in a 1%further and more significant change in the exchange rate betweenvalue of the Renminbi andagainst the US dollar, or between the Renminbi and Japanese Yen, would have resulted in an unrealized gain or loss of RMB152 million (US$18 million).U.S. dollar. As the Company is not able to hedge effectively against the devaluationrevaluation of the Renminbi other than by retaining its foreign exchange-denominated earningscurrencies which it receives from its business and receiptsoperational activities to the extent permitted by applicable law, any future devaluation insignificant revaluation of the Renminbi could adversely affectmay have a material adverse effect on the Company’s results of operationsCompany's financial performance, and financial condition. The Company’s results of operations and financial condition may also be affected by changes in the value of, currencies other thanand any dividends payable on, the RenminbiCompany's H Shares and ADSs in which the Company’s earnings and obligations are denominated.

10

foreign currency terms.

Developing legal system

The Chinese legal system is based on written statutes and is a system, unlike common law systems, in which decided legal cases have little precedential value. In 1979, China began to promulgate a more comprehensive system of laws. On December 29, 1993, the Chinese National People’s Congress promulgated the Company Law, which became effective on July 1, 1994. In August 1994, pursuant to the Company Law, the PRC State Council issued the PRC Special Regulations on Overseas Offering and Listing of Shares by Companies Limited by Shares to regulate joint stock companies that offer and list their shares overseas. These laws, regulations and legal requirements are relatively recent, and, like other laws, regulations and legal requirements applicable in China (including with respect to the commercial aviation industry), their interpretation and enforcement involve significant uncertainties.


New tax law
On March 16, 2007, the Fifth Plenary Session of the Tenth National People’s Congress passed the Corporate Income Tax Law of the People’s Republic of China (“new tax law”) which will take effect on January 1, 2008. The Company and certain subsidiaries of the Group are entitled to preferential income tax rates in the range of 15% to 27%. From January 1, 2008, the income tax rate of companies who are currently enjoying preferential income tax rates lower than 25% is expected to increase to the standard rate of 25% over a five-year transition period. However, the new tax law has not set out the details as to how the existing preferential tax rate will increase to the standard rate of 25%. It is uncertain whether the Group will be required to pay higher enterprise income tax when the implementation guidance of the new tax law is issued.
Taxation of holders of H Shares or ADS by China

Chinese tax law generally provides for the imposition of a withholding tax on dividends paid by a Chinese company to a non-Chinese shareholder at a rate of 20%. In a notice and a letter issued by the State Taxation Bureau of the PRC, and a letter issued by the State Taxation Bureau, however, the Chinese tax authorities confirmed that the imposition of this withholding tax on dividends paid by joint stock companies, such as the Company, had been suspended. Accordingly, for so long as this imposition is suspended and not replaced or supplemented with similar requirements, any future dividends to be paid by the Company to holders of H Shares or ADS who are foreign individuals not resident in China or which are foreign enterprises with no permanent establishment in China will not be subject to a Chinese withholding tax. In the event that the suspension of the withholding tax is lifted, such payments will be subject to withholding tax at the 20% rate unless the holder is entitled to a tax waiver or a lower tax rate under an applicable double-taxation treaty. See Item 10 “Additional Information –— Taxation”.
11

ITEM 4.INFORMATION ON THE COMPANY.

History and Development of the Company

The Company is a joint stock company incorporated in China on March 25, 1995, and is 50.3% owned by CSAHC. The registered address of the Company is Guangzhou Economic & Technology Development Zone, People’s Republic of China (telephone no: (86)20-8612-4738, website: www.cs-air.com).

     During 2001, the Company established a new 50%: 50% joint venture, namely MTU Maintenance Zhuhai Co. Ltd, with MTU Maintenance Gmbh, a subsidiary of Daimler-Benz Aerospace Group, to provide repair and maintenance services to aircraft engines. The registered capital is US$63.1 million.

     During 2002, the Company entered into an Interest Transfer and Capital Injection Agreement with China State Post Bureau, Shanghai Municipal Post Office, Post Office of the Inner Mongolian Autonomous Region and China Philately Corporation, pursuant to which the Company injected RMB150 million (equivalent to approximately US$18.12 million) in cash to acquire 49% interest in China Postal Airlines, Ltd. The China State Post Bureau holds the remaining 51%. In addition, the Company paid RMB136.5 million (equivalent to approximately US$16.5 million) to acquire 39% interest in Sichuan Airlines Corporation Limited to further expand its market shares in South-western China. The Group also jointly established a new 51%: 49% joint venture, namely Zhuhai Xiang Yi Aviation Technology Company Limited, the first sino-foreign joint venture company engaging in aviation training services in the PRC, with CAE. The registered capital is US$29.8 million.


On March 13, 2003, the Company obtained an approval certificate from the Ministry of Commerce to change to a permanent limited company with foreign investments and obtained the business license on October 17, 2003 obtained a business license for its new status, as a permanent limited company with foreign investments issued by the State Administration of Industry and Commerce of the People’s Republic of China.

Pursuant to an extraordinary general meeting of shareholders held on May 21, 2002, a resolution was passed authorizing the Company to issue not more than 1,000,000,000 A sharesShares of par value of RMB1.00 each. The Company issued and listed its 1,000,000,000 A sharesShares with a par value of RMB1.00 each on the Shanghai Stock Exchange in July 2003.

     On October 17, 2003,


Pursuant to a sale and purchase agreement dated November 12, 2004 between the Company, China Southern Airlines Holding Company, CNA and XJA which was approved by the Company’s registered addressshareholders in an extraordinary general meeting held on December 31, 2004, the Company acquired the airline operations and certain related assets of CNA and XJA with effect from December 31, 2004 (the “CNA/XJA Acquisitions”). The consideration payable for the CNA/XJA Acquisitions amounting to RMB15,522 million was moved to Guangzhou Economic & Technology Development Zone. In accordance withdetermined based on the Rules and Regulations for Implementation of Income Tax for Foreign Investment Enterprises and Foreign Enterprisesfair value of the PRCacquired assets. Such consideration was partly satisfied by assumption of debts and a taxation approval document “Guangzhou Municipal State Tax Bureau Suo De Shui Zi Que 020043”,liabilities of CNA and XJA totaling RMB13,563 million outstanding as of December 31, 2004 and the remaining balance of RMB1,959 million was fully paid in cash during 2005.

On April 30, 2006, the Company acquired certain assets of CSAHC Hainan Co., Ltd (“CSAHC Hainan”), a wholly-owned subsidiary of CSAHC, at a total consideration of RMB294 million, which was partly satisfied by assumption of debts and liabilities of CSAHC Hainan totaling RMB289 million outstanding as of that date. The remaining balance of RMB5 million was settled in cash during 2006.
Aircraft Acquisitions  
Pursuant to the Airbus Aircraft Acquisition Agreement dated July 6, 2006 between the Company and Airbus, the Company will acquire 50 Airbus A320 series aircraft from Airbus. The aggregate catalogue price for the Airbus Aircraft is entitledRMB26.526 billion (approximately US$3.316 billion). The aggregate consideration for the acquisition of the Airbus Aircraft is payable by cash in installments and the Airbus Aircraft will be delivered in stages to enjoy the preferential tax policy implementedCompany during the period commencing from 2009 to 2010.
   Pursuant to the Boeing Aircraft Acquisition Agreement dated October 13, 2006 between the Company and Boeing, the Company will purchase 6 Boeing B777F freighters from Boeing. The catalogue price of a Boeing B777F freighter is US$232 million. The aggregate consideration for the acquisition of the B777F Freighters is partly payable by cash of the Company, and partly by financing arrangements with banking institutions and the Boeing Aircraft will be delivered in stages to the Guangzhou Economic & Technology Development Zone effectiveCompany during the period commencing from November 2008 to July 2010.
Pursuant to the Xiamen Aircraft Acquisition Agreement dated October 1, 2003. As13, 2006 between Xiamen Airlines and Boeing, Xiamen Airlines will acquire 6 Boeing B737-800 aircraft from Boeing. The catalogue price of a result,Boeing B737-800 aircraft is US$66-US$75 million. Such catalogue price includes price for airframe and engine. The aggregate consideration for the acquisition of the B737-800 Aircraft is payable by cash in instalments and the B737-800 Aircraft will be delivered to Xiamen Airlines in 2010.
The acquisition of the Airbus Aircraft, the B777F Freighters and the B737-800 Aircraft is beneficial to implementation of the Company’s income tax rate has been changed to 15% from 33% beginning fromdevelopment strategy, improvement of the Company’s operating capacity, especially the expansion of freight services, It is also believed that date.

the acquisitions will better serve the passenger with premium services and enhance the core competence of the Company. 

12
Capital Expenditure
The Group had RMB1,492 million, RMB6,351RMB6,631million, RMB11,873 million and RMB4,707RMB 6,403 million capital expenditures in 2001, 20022004, 2005 and 20032006, respectively. Of such capital expenditures in 2003, RMB2,8182006, RMB 3,759 was financed by capital leases, RMB 2,076 million werewas financed by bank borrowings while the remaining RMB1,889RMB 568 million werewas financed by internal resources. The capital expenditures were primarily incurred on the additional investments in aircraft and flight equipment under the Group’s fleet expansion plans and Guangzhou new airport, and, to a small extent, additional investments in other facilities and buildingbuildings for operations.

     The Chinese Government has approved a new Guangzhou airport project, which commenced construction in 2000, with completion targeted in August 2004. Upon completion, the new airport will replace the Baiyun International Airport as the main hub of the Group’s route network. With the approval of the Chinese Government, the Group began construction of its facilities at the new Guangzhou airport in 2000. The Group’s total investment will be RMB3,540 million, of which RMB2,620 million will be financed by bank loans. Several major banks in the PRC have committed to finance the project. The balance of RMB920 million will be financed by internal resources. As of December 31, 2003, the Group invested a total of RMB1,445.8 million for this new airport project. The Group believes that the completion of the new airport will substantially enhance the Group’s operations in the Southern China region.

11

Business Overview

General

The Group provides commercial airline services throughout China, Hong Kong and Macau regions, Southeast Asia and other parts of the world. The Group is one of the three largest Chinese airlines and, as of year end 2003,2006, ranked first in terms of passengers carried, number of scheduled flights per week, number of hours flown and size of route network and aircraft fleet. During the three years ended December 31, 2003,2006, the Group’s RPKs increased at a compound annual rate of 2.6%36.8%, from 25,05737,196 million in 20012004 to 26,38761,923 million in 2003,2005, and to 69,582 million in 2006, while its capacity, measured in terms of ASKs, increased at a compound annual rate of 1.0%34.4%, from 40,06453,769 million in 20012004 to 40,86788,361 million in 2003.2005, and to 97,059 million in 2006. In 2003,2006, the Group carried 20.4749.21 million passengers and had passenger revenue of RMB15,010RMB 41,549 million (US$1,8145,321 million). Net loss for 2003 was RMB358 million (US$43 million).

The Group conducts a portion of its airline operations through its airline subsidiaries namely Xiamen Airlines, Southern Airlines Group(Group) Shantou Airlines Company Limited (“Shantou Airlines”), Guangxi Airlines Company Limited (“Guangxi Airlines”), Zhuhai Airlines Company Limited (“Zhuhai Airlines”) and Guizhou Airlines Company Limited (“Guizhou Airlines”) (collectively, the “Airline Subsidiaries”). In 2003,2006, the Airline Subsidiaries carried 7.6212.90 million passengers, and had operatingtraffic revenue of RMB5,368RMB 8,726 million (US$608 1,118 million) and accounted for 37.2%26.2% and 30.7%19.4 % of the Group’s passengers carried and operatingtraffic revenue, respectively.

Guangxi Airlines become a wholly-owned subsidiary of the Group in 2006. All the assets and liabilities of Guangxi Airlines were transferred to the Company on December 31, 2006.

The Group also provides air cargo and mail services. The cargo and mail revenue of the Group increased by 9.5%14.5% to RMB1,955RMB3,538 million (US$236 453 million) in 20032006 as compared with 2002.2005. The Group’s airline operations are fully integrated with its airline-related businesses, including aircraft and engine maintenance, flight simulation and air catering operations.

As of the year end 2006, the Group operated 616 routes, of which 501 were domestic, 90 were international and 25 were to/from Hong Kong and Macau. The Group operates the most extensive domestic route network among all Chinese airlines with a total of 334 routes as of December 31, 2003, including 274 domestic routes, 18 Hong Kong regional routes (which include Hong Kong routes and Macau routes), and 42 international routes.airlines. In 2003,2006, the Group operated an average of 4,118 landing9,308 landings and take-offs per week, serving 94 destinations, including major cities in China, such as Beijing, Shanghai, Tianjin, Guangzhou, Shenzhen, Wuhan, Changsha, Zhengzhou, Xiamen, Xian152 destinations. Its route network covers commercial centres and Chengdu. Most of the cities served by the Group are located in commercial centers or rapidly developing economic regions in Mainland China.

The Group’s corporate headquarters and principal base of operations are located in Guangzhou, which is the capital of Guangdong Province and the largest city in southern China. Located in the rapidly developing Pearl River Delta region, Guangzhou is also the transportation hub of southern China and one of China’s major gateway cities. Guangzhou’s significance has increased as the transportation infrastructure of Guangdong Province has developed through the construction and development of expressways, an extensive rail network and the port cities of Yantian, Shekou, Chiwan, Mawan, Huangpu and Zhuhai.


In December 2005, the Company established a branch company in Beijing and has added wide-body airplanes to its operation base in Beijing, with the view to expanding its Beijing aviation business and building another main hub there in addition to its mainGuangzhou base. The establishment of Guangzhou and Beijing hubs will facilitate strategic refinement and enhancement of its route basenetwork operations putting the Company in Guangzhou,a better position to explore and seize the Group also maintains twelveopportunities in the regional route bases in Zhengzhou, Wuhan, Changsha, Shenzhen, Zhuhai, Xiamen, Fuzhou, Haikou, Guilin, Beihai, Shantouaviation market expected to be brought about by the 2008 Beijing Olympic Games.

In 2006, the Comapny expedited the pace of its expansion into the international market by entering into an operation agreement to join the SkyTeam Alliance, a strategic partnership with foreign airlines. The Company broadened its global market coverage and Guiyang. All of these regional route bases are located in provincial capitals or major commercial centers in China.

successfully added 18 new international routes, including Lagos and Tehran, and nine international destinations.

The Group’s operations primarily focus on the domestic market. In addition, the Group also operates Hong Kong regionaland Macau and international flights. As of year end of 2003,2006, the Group had 1825 Hong Kong regionaland Macau routes and 4290 international routes. The Group’s Hong Kong regionaland Macau operations include flights between destinations in China and Hong Kong and Macau. The Group’s international operations include scheduled services to Tokyo, Osaka, Amsterdam, Sharjah, Los Angeles, Fukuoka, Seoul, Sydney and ten Southeast Asian destinations. The Group operates the most extensive Southeast Asian route network among Chinese airlines.

As of year end 2003,December 31, 2006, the Group operated a fleet of 132309 aircraft, consisting primarily of Boeing 737-300, 737-500, 737-700, 737-800, 747-400, 757-200 and 777-200 aircraft, and737 series, 747, 757, 777, Airbus 319-100 and 320-200 aircraft. Significant portions of these aircraft are held under capital and operating leases.300, 319, 320, 330, McDonnell Douglas 82, 90. The average age of the Group’s aircraftfleet was 7.826.37 years atas of the year end 2003.

12

of 2006.

13

Restructuring and Initial Public Offering

As part of China’s economic reforms in the 1980’s, the PRC State Council directed the CAAC to separate its governmental, administrative and regulatory role from the commercial airline operations that were being conducted by the CAAC and its regional administrators. As a result, CSAHC was established on January 26, 1991 for the purpose of assuming the airline and airline-related commercial operations of the Guangzhou Civil Aviation Administration, one of the six regional bureaus of the CAAC. CSAHC was one of the 55 large-scale enterprises designated by the Chinese Government to play a leading role in their respective industries.

CSAHC was restructured in 1994 and 1995 in anticipation of the initial public offering of the Company. The restructuring was effected through the establishment of the Company and the execution of the Demerger Agreement, dated as of March 25, 1995, as amended (the “Demerger Agreement”), between CSAHC and the Company. Upon the restructuring, the Company assumed substantially all of the airline and airline-related businesses, assets and liabilities of CSAHC, and CSAHC retained its non-airline and non-airline-related businesses, assets and liabilities, and the non-business assets and liabilities. Upon this separation, all interests, rights, duties and obligations of CSAHC, whenever created or accrued, were divided between the Company and CSAHC based on the businesses, assets and liabilities assumed by each of them under the Demerger Agreement. Under the Demerger Agreement, CSAHC agreed not to conduct or participate or hold any interest in, either directly or indirectly, any business, activity or entity in or outside China that competes or is likely to compete with the commercial interests of the Group, although CSAHC may continue to hold and control the affiliates of CSAHC existing on the date of the Demerger Agreement and may continue to operate the businesses of such affiliates.

In July 1997, the Company completed a private placement of 32,200,000 H Shares to certain limited partnership investment funds affiliated with Goldman Sachs & Co. and an initial public offering of 1,141,978,000 H Shares, par value RMB 1.00 per share, and listing of the H Shares on theThe Stock Exchange of Hong Kong Limited (the “Hong Kong Stock Exchange”) and American Depositary Shares (“ADSs”, each ADS representing 50 H Shares) on the New York Stock Exchange. Prior to the private placement and the initial public offering, all of the issued and outstanding shares of capital stock of the Company, consisting of 2,200,000,000 Domestic Shares, par value RMB 1.00 per share, were owned by CSAHC, which owns and exercises, on behalf of the Chinese Government and under the supervision of the CAAC, the rights of ownership of the Domestic Shares held by CSAHC. After giving effect to the private placement and the initial public offering, CSAHC continues to ownCSAHC’s continued ownership of the 2,200,000,000 Domestic Shares, representingrepresented approximately 65.2% of the total share capital of the Company, and will be entitled to elect all the directors of the Company and to control the management and policies of the Group. Domestic Shares and H Shares are both ordinary shares of the Company.

Pursuant to an extraordinary general meeting of shareholders held on May 21, 2002, a resolution was passed authorizing the Company to issue not more than 1,000,000,000 A sharesShares of par value of RMB1.00 each. The Company issued and listed its 1,000,000,000 A sharesShares with a par value of RMB1.00 each in July 2003 and listed these shares on the Shanghai Stock Exchange in July 2003.Exchange. Subsequent to the A shareShare issue, the shareholding of CSAHC on the Company was reduced from 65.2% to 50.3% from 65.2%.

Share Reform Plan
Pursuant to the regulations including the "Guidelines of the State Council for Promoting the Reform and Opening-up and Sustained Development of the Capital Market" promulgated by the State Council of the PRC and the "Guiding Opinions on the State Share Reform of the Listed Companies" jointly promulgated by the China Securities Regulatory Commission (“CSRC”), the State-owned Assets Supervision and Administration Commission of the State Council, the Ministry of Finance, People's Bank of China and the Ministry of Commerce, and pursuant to the operating procedures of share reform proposals, the Company announced the Share Reform Plan (“Plan”) on April 13, 2007 which was subsequently amended on April 23, 2007. Under the Plan, all the 2,200,000,000 non-tradable domestic shares held by CSAHC will be converted into tradable A shares 36 months after the commencement date of the Plan. In return, CSAHC will grant 1,400,000,000 put options to those holders of tradable A shares who are listed in the Shareholders’ register on the record date which is May 8, 2007, which will be equivalent to 1.5970 shares for every 10 A shares held by the holders of tradable A shares. The rights under the put options as referred above will be automatically exercised in a European way on the expiring date in that the exercise ratio will be 2 to 1 (i.e., the value of the exercise ratio is 0.5), the effective period will be 12 months period, the initial exercise price will be RMB7.43, and the put options will be paid in cash. The share reform plan was approved in the relevant shareholder’s meeting held on May 17, 2007.
Traffic

The following table sets forth certain statistical information with respect to the Group’s passenger, and cargo and mail traffic for the years indicated.
                         
          Cargo and Mail Carried Total Traffic
Passengers Carried (tons) (ton kilometers)
 
 
      Increase     Increase     Increase
      (decrease)     (decrease)     (decrease)
      over     over     over
Year Total previous year Total previous year Total previous year
 
 
 
 
 
 
  (in million) (%) (in thousand) (%) (in million) (%)
1999  15.11   0.4   390.8   12.3   2,003.0   4.6 
2000  16.85   11.5   353.0   (9.7)  2,613.0   30.5 
2001  19.12   13.5   398.0   12.7   3,034.0   16.1 
2002  21.49   12.4   470.0   18.1   3,614.0   19.1 
2003  20.47   (4.7)  464.0   (1.3)  3,561.0   (1.5)

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Passenger carried
 
Cargo and Mail Carried (tons)
 
Total traffic (tons kilometers)
 
    
Increase
   
Increase
   
Increase
 
    
(decrease)
   
(decrease)
   
(decrease)
 
    
over
   
over
   
over
 
 
Total
 
previous year
 
Total
 
previous year
 
Total
 
previous year
 
Year
 
(in million)
 
(%)
 
(in thousand)
 
(%)
 
(in million)
 
(%)
 
2002  21.49  12.4  470.0  18.1  3,614.0  19.1 
2003  20.47  (4.7) 464.0  (1.3) 3,561.0  (1.5)
2004  28.21  37.8  545.0  17.5  4,663.0  30.9 
2005  44.12  56.4  775.0  42.2  7,284.0  56.2 
2006  49.21  11.6  819.0  5.4  8,071.0  10.8 
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Route Network

Overview

The Group operates the most extensive route network among the Chinese airlines. As of year end 2003,December 31, 2006, the Group operated 334616 routes consisting of 274501 domestic routes, 1825 Hong Kong regionaland Macau routes and 4290 international routes. At such date,In 2006, the Group’s route network served 71 destinations within ChinaGroup conducted an average of 9,308 landings and 23 destinations outside of China.

take-offs per week, serving 152 destinations.

The Group continually evaluates its network of domestic, Hong Kong regionaland Macau and international routes in light of its operating profitability and efficiency. The Group seeks to coordinate flight schedules with the Airline Subsidiaries on shared routes to maximize load factors and utilization rates. The acquisition of domestic, Hong Kong regionaland Macau and international routes is subject to approval of the CAAC, and the acquisition of Hong Kong regionaland Macau and international routes is also subject to the existence and the terms of agreements between the Chinese Government and the government of the Hong Kong SAR, the government of Macau Special Administrative Region of the People’s Republic of China (“Macau SAR”) and the government of the proposed foreign destination.

In order to expand the Group’s international route network, the Group has entered into code-sharing agreements with several international airlines, such asincluding Delta Airlines, Asiana Airlines, Japan Air System, Vietnam Airlines, Royal Dutch Airlines and Garuda Indonesian, etc.Indonesian. Under the code sharing agreements, the participating airlines are permitted to sell tickets on certain international routes foroperated by the Group to passengers using theirthe Group’s codes. Similarly, the Group is permitted to sell tickets for thesethe other participating airlines using its “CZ” code. The code sharing agreements help increase the number of the Group’s international sales outlets.

Route Bases

     The Group’s

In addition to its main route base isbases in Guangzhou. TheGuangzhou and Beijing, the Group maintains twelvecertain regional route bases in Zhengzhou, Wuhan, Changsha, Shenzhen, Shenyang, Changchun, Dalian, Harbin, Urumqi, Haikou, Zhuhai, Xiamen, Fuzhou, Haikou,Nanning, Guilin, Beihai, Shantou, Guiyang, Sanya and Guiyang. AllBeihai. Most of theseits regional route bases are located in provincial capitals or major commercial centerscentres in China. The Group’s network of route bases provides the Group with routes covering all of China, except for Inner Mongolia, Tibet and Ningxia.

PRC.

The Group believes that its extensive network of route bases enablesenable it to coordinate flights and deploy its aircraft more effectively and to provide more convenient connecting flight schedules and access service and maintenance facilities for its aircraft. The Group believes that the number and location of these route bases may enhance the Group’s ability to obtain the CAAC’s approval of requests by the Group to open new routes and provide additional flights between these bases and other destinations in China. Under currentCurrent regulations of the CAAC generally limit airlines are generally expected to operate mainlyoperations principally conducted from their respective route bases.

     The Chinese Government has approved a new Guangzhou airport project, which commenced construction in 2000, with completion targeted in August 2004. Upon completion, the new airport will replace the Baiyun International Airport as the main hub of the Group’s route network. With the approval of the Chinese Government, the Group began construction of its facilities at the new Guangzhou airport in 2000. The Group’s total investment will be RMB3,540 million, of which RMB2,620 million will be financed by bank loans. Several major banks in the PRC have committed to finance the project. The balance of RMB920 million will be financed by internal resources. As of December 31, 2003, the Group invested a total of RMB1,445.8 million for this new airport project. The Group believes that the completion of the new airport will substantially enhance the Group’s operations in the Southern China region.

Domestic Routes

The Group’s domestic routeroutes network serves substantially all provinces and autonomous regions in China, including Guangdong, Fujian, Hubei, Hunan, Hainan, Guangxi, Jiangsu, Zhejiang,Guizhou, Henan, Heilongjiang, Jilin, Liaoning and Anhui,Xinjiang, and serves all four centrally-administered municipalities in China, namely, Beijing, Shanghai, Tianjin, and Chongqing. In 2003,2006, the Group’s most profitable domestic routes were the routes betweenbetween: Guangzhou and Beijing, Guangzhou and Shanghai, ShenzhenShanghai and Shanghai,Guangzhou, Beijing and Guangzhou, Shenzhen and Beijing, Shenzhen and Shanghai, Urumqi and Guangzhou,Beijing, Beijing and Shenzhen, GuangzhouBeijing and Zhengzhou, ZhengzhouUrumqi, and GuangzhouBeijing and between Guangzhou, Dalian and Harbin.

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Dalian.

Hong Kong Regionaland Macau Routes


The Group offers scheduled service between Hong Kong and Guangzhou, Kunming, Xiamen, Shantou, Beijing, Guilin, Meixian, Haikou, Wuhan, Zhengzhou, Nanning, Changsha, Quanzhou and Sanya; and between Macau and Fuzhou, Hangzhou and Xiamen. The Group’s Hong Kong and Macau regional routes also include routes between Hong Kong orand Zhanjiang and Macau and other destinations in China, including Zhang Jia Jie and Wu Yi Shan, which the Group operates on a “charter” flight basis, as explained below. The Group believes that the routes on which it operates these “charter” flights are among its highest yielding routes, primarily because the Group faces limited competition on such routes and is consequently less subject to downward pricing pressures. In 2003,2006, the most profitable Hong Kong regionaland Macau routes (other than these “charter” flights) were those betweenbetween: Hong Kong and Wuhan, Hong Kong and Guangzhou, Guangzhou and Hong Kong, Hong Kong and Guangzhou, Hong Kong and Wuhan,Beijing, Wuhan and Hong Kong Kunming and Hong Kong Hong Kong and Xiamen, Hong Kong and Zhengzhou, Hong Kong and Kunming, Zhengzhou and Hong Kong, Hong Kong and Changsha.

Shantou.

15
The Group’s “charter” flights are essentially regularly scheduled flights, but in theory permission to operate these “charter” flights is subject to monthly review by the CAAC and the Civil Aviation Department of the Hong Kong SAR. The CAAC has informally indicated that it primarily considers market demand and airline capability in granting permission for such flights. The Group has been able to maintain all of itsthe Hong Kong regional routes on which it operates on a “charter” flight basis and believes that demand on such routes will continue. In 2003,2006, the Group operatedconducted a total of 11,39516,949 flights on its Hong Kong regionaland Macau routes, accounting for approximately 29.8%28.8% of all passengers carried by Chinese airlines on routes between Hong Kong or Macau and destinations in China.

International Routes

The Group is the principal Chinese airline connecting the rapidly developing Pearl River Delta region of China to Southeast Asia, with 2423 routes serving ten11 Southeast Asian destinations, including Singapore and major cities in Indonesia, Thailand, Malaysia, the Philippines, Vietnam and Laos.Cambodia. In 2003,2006, the Group’s most profitable Southeast Asianinternational routes were those between Manila, Xiamen and Beijing; Beijing, Xiamen and Manila; Guangzhou and Singapore, and Guangzhou and Bankok.were: Shenyang-Seoul, Guangzhou-Tokyo, Seoul-Dalian, Guangzhou-Los Angeles. The Group believes that, among Chinese airlines, it is well-positioned to benefit from the business opportunities arising out of increased air traffic and the growing economic relationships between China and Southeast Asian countries.

In addition to the 2423 routes serving ten11 Southeast Asian destinations, the Group also operates 1867 other international routes providing scheduled serviceservices to Almaty, Amsterdam, Sharjah, Osaka, Tokyo,Baku, Bishkek, Cheju, Cheong Ju City, Dubai, Dushanbe, Fukuoka, Seoul,Hiroshima, Islamabad, Irkutsk, Khabarovsk, Kita Kyushu, Kwangju, Lagos, Los Angeles, Melbourne, Moscow, Nagoya, Nigata, Novosibirsk, Osaka, Paris, Pusan, Pyongyang, Sapporo, Sendai, Seoul, Sharjah, Sydney, Taegu, Tashkent, Teheran, Tokyo and Melbourne.

Toyama.

Aircraft Fleet

The Group’s fleet plan in recent years has emphasized expansion and modernization through the acquisition of new aircraft, the acquisition of existing aircraft in conjunction with our acquisition of CNA and XJA, and the retirement of less efficient, older aircraft. As of year end 2003,December 31, 2006, the Group operated a fleet of 132309 aircraft with an average age of 7.826.37 years. AllMost aircraft of the Group are Boeing and Airbus aircraft. The Group has the largest fleet among Chinese airline companies. Most of the aircraft operated by the Group are leased pursuant to various types of leasing arrangements.


The following table sets forth certain information regarding the Group’s fleet of 132309 aircraft as of December 31, 2003.
             
          Average
  Number of Average Age Passenger
Model Aircraft (years) Capacity
 
 
 
Boeing 777-200  4   7.51   380 
Boeing 777-21B  5   6.27   292 
Boeing 757-200  25   11.48   200 
Boeing 747F  2   1.42   n/a 
Boeing 737-800  12   0.78   167 
Boeing 737-700  10   3.39   138 
Boeing 737-500  18   11.10   132 
Boeing 737-300  32   10.16   145 
Airbus 319-100  4   0.42   128 
Airbus 320-200  20   5.64   158 
   
         
   132         

15

2006.

Model 
 
Number of
Aircraft 
 
Average age
(years) 
 
Average
Passenger
Capacity 
 
Boeing 777-200  4  10.53  380 
Boeing 777-21B  6  8.20  292 
Boeing 757-200  34  11.58  200 
Boeing 747F  2  4.42  n/a 
Boeing 737-800  38  2.86  167 
Boeing 737-700  38  3.01  138 
Boeing 737-500  8  12.57  130 
Boeing 737-300  29  12.72  145 
Airbus 300-600  6  11.96  272 
Airbus 319-100  27  1.66  128 
Airbus 320-200  49  4.09  158 
Airbus 321-200  17  2.24  182 
Airbus 330-200  4  1.72  264 
McDonnell Douglas 82  23  21.54  144 
McDonnell Douglas 90  13  8.85  157 
Embraer 145 Jet  6  2.23  50 
ATR-72  5  8.95  72 
   309       
During 2003,2006, the Group continued to expand and modernize its aircraft fleet. In 2003, theThe Group’s major aircraft transactions included:

(i)The acquisition of seven Boeing 737-800 aircraft financed by a combination of internal funds and long term bank loans;
(ii)The addition of four Airbus 319-100 aircraft and three Boeing 737-700 aircraft under operating leases;
(iii)The early retirement of two Boeing 737-200 aircraft;
(iv)The expiry of two Boeing 747 cargo freighters under short-term wet leases; and
(v)The extension of four Boeing 737-300 under operating leases for another 2 to 5 years.


In 2006, the Company exercised purchase options of ten Boeing 737-300, three McDonnell Douglas 90, seven McDonnell Douglas 82 and three Airbus 300-600 upon expiry of the respective lease terms.
16

Six Airbus 319-100, ten Airbus 320-200, seven Airbus 321-200, five Boeing 737-700, ninteen 737-800 aircraft were acquired under operating lease, and two Boeing 737-300, nine Boeing 737-500, one Boeing 757-200 aircraft under operating lease were returned during 2006. In addition, nine Airbus 320-200, four Boeing 737-700 and four Boeing 737-800 aircraft acquired in 2006 were financed by a combination of internal funds, long-term bank loans and finance lease agreements.
On April 30, 2006, the Company acquired one McDonnell Douglas 82 aircraft through the acquisition of the assets from CSAHC Hainan, originally operated by the Company under a wet lease agreement. The wet lease agreement was discontinued on April 30, 2006.

In August 2006, the Group exercised its option to change an order from three Boeing 787 aircraft to six Boeing 737-700 aircraft in respect of an agreement signed on August 8, 2004,2005.
In July 2006, the Company entered into ana purchase agreement with Airbus SNC for the acquisition ofto acquire ten Airbus 319-100, fifteen Airbus 320-200 aircraft and sixtwenty-five Airbus 319-100321-200 aircraft, scheduled for deliveries in 20052009 to 2010.
In October 2006, the Company executed the Boeing Aircraft Acquisition Agreement for the purchase of six Boeing 777F freighters. The freighters will be delivered in stages to the Company in 2008 to 2010.
In October 2006, the Group executed the Boeing Aircraft Acquisition Agreement for the purchase of six Boeing 737-800 aircraft, scheduled for deliveries in 2010.

In 2006, the Company disposed of three Boeing 757-200 and 2006.

three Cessna 208B aircraft.

Aircraft Financing Arrangements

Overview

A significant portion of the Group’s aircraft is acquired under long-term capital or operating leases or long-term mortgage loans with remaining terms to maturity ranging from one to ninetwelve years. As of December 31, 2003, 292006, 81 of the Group’s 132309 aircraft were operated under

16

capital leases, 54123 were operated under operating leases, 2719 were financed by long-term mortgage loans, while the remaining were acquired either with cash proceeds or acquired by exercising the purchase options upon expiry of the respective capital leases. The Group’s planned acquisition of aircraft in the foreseeable future will generally be made pursuant to operating leases or financed by long-term mortgaged loans.capital leases. The Group’s determination as to its acquisition strategy depends on the Group’s evaluation at the time of its capacity requirements, anticipated deliveries of aircraft, the Group’s capital structure and cash flow, prevailing interest rates and other general market conditions.

The following table sets forth, as of December 31, 2003,2006, the number of Boeing and Airbus aircraft operated by the Group pursuant to capital and operating leases and the remaining terms, expressed in years, of such leases.
             
          Average
  Capital Operating Remaining
Model Lease Lease Lease Term
 
 
 
Boeing 777-200 and 777-21B  5   3   7.66 
Boeing 757-200  1   10   4.78 
Boeing 737-700  —   4   6.13 
Boeing 737-500  —   18   2.28 
Boeing 737-300  5   13   3.24 
Airbus 320-200  18   2   4.60 
Airbus 319-100  —   4   9.57 
   
   
     
   29   54     

 
 
Model 
 
 
Capital
Lease
 
 
Operating
Lease
 
Average
Remaining
Lease Term 
 
Boeing 777-200 and 777-21B  6  4  3.48 
Boeing 757-200  2  14  2.29 
Boeing 737-700  11  15  6.37 
Boeing 737-800  —  22  7.45 
Boeing 737-500  —  8  1.81 
Boeing 737-300  5  8  1.31 
Airbus 300-600  —  3  0.77 
Airbus 319-100  6  21  8.42 
Airbus 320-200  33  16  6.16 
Airbus 321-100  6  7  9.47 
Airbus 330-200  4  —  10.28 
McDonnell Douglas 82  —  5  — 
McDonnell Douglas 90  
8
  
—
  1.09 
   81  123    

17
Capital Leases

As of December 31, 2003,2006, the Group’s aggregate future minimum lease payments (including future finance charges) required under its capital leases were RMB7,961RMB 18,403 million (US$962 2,357 million). As of year end 2003,2006, a majority of the Group’s capital leases had original terms ranging from ten to fifteen years from the date of delivery of the relevant aircraft, and the remaining terms of these leases ranged from one to sixten years. The Group’s capital leases typically cover a significant portion of the relevant aircraft’s useful life and transfer the benefits and risks of ownership to the Group. Under its capital leases, the Group generally has an option to purchase the aircraft at or near the end of the lease term. As is customary in the case of capital leases, the Group’s obligations are secured by the related aircraft, as well as other collateral.

Operating Leases

As of December 31, 2003,2006, the Group’s aggregate future minimum lease payments required under its operating leases were RMB8,120RMB 21,969 million (US$981 2,813 million). As of year end 2003,2006, the Group’s operating leases had original terms generally ranging from eightfive to tenfifteen years from the date of delivery of the relevant aircraft, and the remaining terms of these leases generally ranged from one to ninetwelve years. Pursuant to the terms of the operating leases, the Group is obligated to make rental payments based on the lease term, with no termination payment obligations or purchase option, and the lessor bears the economic benefits and risks of ownership. Under its operating leases, the Group has no option to purchase the aircraft and is required to return the aircraft in the agreed condition at the end of the lease term. Although title to the aircraft remains with the lessor, the Group is responsible during the lease term for the maintenance, servicing, insurance, repair and overhaul of the aircraft.

Pursuant to capital or operating leases, the Group is obligated to indemnify the lessors against any withholding or similar taxes that may be imposed on the lessors by taxing authorities in China with regard to payments made pursuant to such leases. In accordance with relevant PRC tax regulations, a PRC lessee is liable to pay PRC withholding tax in respect of any lease payments regularly made to an overseas lessor. Depending on the circumstances, this tax is generally imposed at a fixed rate ranging from 10% to 20% of the lease payments, or in certain cases, the interest components of such payments. Pursuant to an approval document from the State Taxation Bureau, lease arrangements executed prior to September 1, 1999 are exempt from PRC withholding tax. The PRC withholding tax payable in respect of the operating leases executed after September 1, 1999 of RMB12RMB23 million, RMB14RMB55 million and RMB8RMB60 million during 2001, 20022004, 2005 and 20032006 respectively, have been included as part of the operating lease charges.

Aircraft Flight Equipment

The jet engines used in the Group’s aircraft fleet are manufactured by General Electric Corporation, Rolls-Royce plc, United Technologies International, Inc., CFM International, Inc. and International Aviation Engines Corporation. As of year end 2003,2006, the Group had 3469 spare jet engines for its fleet. The Group determines its requirements for jet engines based on all relevant considerations, including manufacturers’ recommendations, the performance history of the jet engines and the planned utilization of its aircraft.

     Rotables Acquisition of rotables and certain of the expendables for the Group’s aircraft are generally purchasedhandled by Southern Airlines (Group) Import & Export Trading Corporation (“SAIETC”), a subsidiary of CSAHC acting as agent for the Group, in consideration of an agency fee. The Group arranges the ordering of aircraft, jet engines and other flight equipment for the Airline Subsidiaries and keeps an inventory of rotables and expendables for the Airline Subsidiaries.

17

Aircraft Maintenance

A major part of the maintenance for the Group’s fleet other than overhauls of jet engines is performed by GAMECO, a joint venturejointly controlled entity established by the Company, and Hutchison Whampoa (“Hutchison”), and South China International Aircraft Engineering Company Limited, consistent with the Group’s strategy to achieve fully integrated airline operations and to assure continued access to a stable source of high quality maintenance services. The remaining part of the maintenance for the Group’s fleet other than overhauls of jet engines is performed by service providers in China and overseas. GAMECO performs all types of maintenance services, ranging from maintenance inspections performed on aircraft before, after and between flights (“line maintenance services”) to major overhaul performed at specified intervals. GAMECO was the first of three aircraft maintenance facilities in China having been certified as a repair station by both the CAAC and the FAA. In March 1998, GAMECO received an approval certificate from the United Kingdom Civil Aviation Authority for the repair and maintenance of aircraft and aircraft engines.

The Group believes that GAMECO performs major maintenance checks on the Group’s aircraft within time periods generally consistent with those of large international airline maintenance centers. GAMECO’s repair and maintenance capabilities include overhaul of more than 90% of the Group’s aircraft. Although rotables for the Group’s aircraft are generally imported through SAIETC, a portion of expendables and other maintenance materials are directly imported by GAMECO. GAMECO also provides line maintenance services to 12eight other Chinese airlines and 1117 international airlines. GAMECO provides heavy maintenance services to 11four other Chinese airlines and sevennine international airlines.

     Under the

The Company and GAMECO had entered into an Aircraft Maintenance and Engineering Agreement entered into between GAMECOfor the provision of aircraft repair and the Company (the “Aircraft Maintenance Agreement”), GAMECO charges the Group for expendables on a cost plus basis, and for labor based on a formula that takes into account projected flight hours, costs and other relevant factors. Fees under the Aircraft Maintenance Agreement are payable 50% in Renminbi and 50% in U.S. dollars. Each year,maintenance services. On May 17, 1996, the Company and GAMECO determineentered into an agreement regarding the componentsfee arrangement for the provision of such repair and maintenance services (the “Fee Agreement”). Pursuant to the pricing formula.Fee Agreement and subsequent agreements, GAMECO charged the Company for expendables at cost plus 16%, and labour costs at US$30 per hour during 2006. For the year ended December 31, 2003, GAMECO’s revenue (excluding Value Added Tax) totaled RMB569 million, approximately 88.2% of which2006, the amount incurred by the Group for such repair and maintenance services was derived from services provided to the Group.

RMB 686 million.

18

Overhauls of jet engines are performed by MTU Maintenance Zhuhai Co., Ltd., (“MTU Zhuhai”), a jointly controlled entity of the Company and MTU Aero Engines Gmbh, and also by overseas qualified service providers in Germany, Malaysia, Canada and England. Starting from 2003, MTU Maintenance Zhuhai Co., Ltd., (“MTU Zhuhai”) a jointly controlled entity of the Company and MTU Aero Engines Gmbh., also performed overhauls of certain jet engines for the Group. For the year ended December 31, 2003, a total of eleven jet engines2006, repair fees amounting to RMB497 million were major overhauled bypaid to MTU Zhuhai with total repair costs of RMB106 million.

Zhuhai.

Safety

The Group endeavors to maintain strict compliance with all laws and regulations applicable to flight safety. In addition, the Group has adopted measures to eliminate or minimize factors that may impair flight safety, including specialized training programs and safety manuals. The Air Safety Management Department of the Company implements safety-related training programs on an ongoing basis in all of the Group’s operations to raise the safety awareness of all employees. As a result, overall flight safety has gradually improved. There waswere no serious incidents involving casualty or flight damage throughout the three years ended December 31, 2003.2006. For minor “incidents” which include various events and conditions prescribed by the CAAC which do not involve serious personal injury or material damage to flight equipment, the Group has kept the number consistently below the standard prescribed by the CAAC. For example, the Company’s “flight incident” ratio was 0.19, 0.420.13, 0.13 and 0.130.065 in 2001, 20022004, 2005 and 2003,2006, respectively. In comparison, CAAC’s published maximum acceptable flight incident ratio was 1.60.9 in 20012004 and 1.50.29 in 20022005 and 1.30.7 in 2003.2006. This ratio is defined as the occurrence of one incident for every 10,000 hours of flight time.

Jet Fuel

Jet fuel costs typically represent a major component of an airline’s operating expenses. The Group’s jet fuel costs for 20032006 accounted for 22.7%35.2% of the Group’s operating expenses. Like all Chinese airlines, the Group is generally required by the Chinese Government to purchase its jet fuel requirements from regional branches of CAOSC and Bluesky Oil Supplies Company, except at the Shenzhen, Zhuhai and Sanya airports which are supplied by Sino-foreign joint ventures in which CAOSC is a joint venture partner. CAOSC is a State-owned organization controlled and supervised by the CAAC that controls the importation and distribution of jet fuel throughout China.

Jet fuel obtained from CAOSC’s regional branches is purchased at uniform prices throughout China that are determined and adjusted by CAOSC from time to time with the approval of the CAAC and the pricing department of the National Development and Reform Commission (“NDRC”) based on market conditions and other factors. As a result, the costs of transportation and storage of jet fuel in all regions of China are spread among all domestic airlines. Jet fuel costs in China are influenced by costs at State-owned oil refineries and limitations in the transportation infrastructure, as well as by insufficient storage facilities for jet fuel in certain regions of China.

Prior to 1994, domestic jet fuel prices were generally below international jet fuel prices. The Chinese Government had gradually increased domestic jet fuel prices in order to reflect more accurately the costs of supplying jet fuel in China. As a result, domestic jet fuel prices have become higher than those in the international market since the beginning of 1994. With the WTO entry, the jet fuel price in China will probably be trimmed by the market force to be in line with the international market.

CAOSC’s maximum fuel price in 20032006 was RMB3,500RMB6,850 per ton. The average price paid by the Group in 20032006 was RMB3,074RMB 5,838 per ton, which represents a 13.2%20.5% increase from that of 2002.

     To address2005.

According to the problemNotice of the National Development and Reform Commission (“NDRC”) and the Civil Aviation Administration of China (“CAAC”) on Issues Relating to Introduction of the Fuel Surcharge for Domestic Routes, domestic airlines imposed fuel surcharges for all the domestic routes (excluding those from the mainland PRC to Hong Kong and Macau) with effect from August 1, 2005 (based on flight time). On February 16, 2006, the NDRC and CAAC released a supplementary document on Issues Relating to the Introduction of Fuel Surcharge for Domestic Routes, stating that due to the rising jet fuel price, the period of imposition of fuel surcharge by airlines was extended. The NDRC and CAAC released separate supplementary documents on Issues Relating to the Introduction of Fuel Surcharge for Domestic Routes on March 28 and September 1, respectively, thereby adjusting the amount of fuel surcharges in a range of RMB20 to RMB60 per passenger for distance, flown less than 800 kilometers, and in a range of RMB40 to RMB100 for distance, exceeding 800 kilometers, during the period temporarily from April 10, 2006 to October 10, 2006. On January 21, 2007, the NDRC and CAAC released additional supplementary documents on Issues Relating to the Introduction of Fuel Surcharge for Domestic Routes, thereby adjusting the amount of fuel surcharges from RMB60 to RMB50 per passenger for distance, flown less than 800 kilometers, and from RMB100 to RMB80 for distance exceeding 800 kilometers.The introduction of fuel surcharge, and the extension of the duration of the same will help relieve, to a certain extent, the burden of high jet fuel prices since 2000, CAAC has announced a policy permitting airlines to impose a fuel surchargecost, on passengers carried by their domestic and Hong Kong regional flights for the purpose of offsetting the effect of rising jet fuel prices. Such surcharges have been imposed by the Group since November 1, 2000 at the prescribed rates set by the CAAC.

Group.

In addition to purchases of jet fuel from CAOSC, the Group is also permitted by the Chinese Government to purchase a portion of its jet fuel requirements for its international flights from foreign fuel suppliers located outside China at prevailing international market prices. Jet fuel purchased from such sources outside China accounted for approximately 10.0%20% of the Group’s total jet fuel consumption in 2003.

18

2006.

19

Flight Operations

Flight operations for the Group’s flights originating in Guangzhou are managed by the Company’s flight operations and marketing divisions, which are responsible for formulating flight plans and schedules consistent with route and flight approvals received from the CAAC. The Company’s flight operations center in Guangzhou is responsible for the on-site administration of flights, including the dispatch and coordination of flights, deployment of aircraft, ground services and crew staffing. In addition, each of the Airline Subsidiaries maintains flight operations centers at all servicing airports for on-site administration of their flights. The Company’s general dispatch offices are responsible for monitoring conditions on the Group’s route network, administering the Group’s flight plans, collecting and monitoring navigation data and analyzing and monitoring airport conditions.


To enhance its management of flight operations, the Group’s computerized flight operations control system (SOC) began operation in May 1999. The system utilizes advanced computer and telecommunications technology to manage the Group’s flights on a centralized, real-time basis. The Group believes that the system will assist it to (i) compile flight schedules more efficiently; (ii) increase the utilization of aircraft; (iii) allow real-time tracking of all of the Group’s flights; and (iv) improve coordination of the Group’s aircraft maintenance and ground servicing functions.

Training of Pilots and Flight Attendants

The Group believes that its pilot training program which was established in cooperation with the CAAC affiliated Beijing Aeronautics and Aviation University (the “BAAU”) has significantly improved the quality of the training received by the Group’s pilots and has helped maintain the quality of the Group’s staff of pilots at a level consistent with the expansion of operations called for by the Group’s business strategy.

In the Group’s pilot training program, trainees have two years of theoretical training at the BAAU. After successful completion of academic and physical examinations, studentsthe trainees receive flight training for a period of approximately 20 months at China Southern West Australian Flying College Pty Ltd. (the “Australian Pilot College”), a company that is 65% owned by the Company and 35% owned by CSAHC. Each studenttrainee at the Australian Pilot College is required to fly at least 230 hours before being awarded a flight certificate. Graduates of the BAAU and the Australian Pilot College are hired by the Group as trainee pilots after passing a CAAC-administered examination to obtain a pilot license. The total training period for the Group’s trainee pilots is approximately five years. About 110 trainee pilots graduated from the Australian Pilot College each year.

     Prior to January 2003, as


As part of the pilot training program, the Group also operated a flight simulator training center in Zhuhai, Guangdong Province (the “Zhuhai Training Center”), which was equipped with simulators for all models of aircraft currently operated by the Group. Traineetrainee pilots receivedreceive their initial training in the operation of a specific aircraft at the Zhuhai Training Center, which also provided training to pilots from other Chinese airlines. Such flight simulation training has been shifted towith Zhuhai Xiang Yi Aviation Technology Company Limited (“Zhuhai Xiang Yi), a jointly controlled entity between the Company and CAE International Holdings Limited, since January 2003.which also provides training to pilots from other Chinese airlines. Zhuhai Xiang Yi is equipped with simulators for all models of aircraft currently leases the flight simulation facilities of Zhuhai Training Center fromoperated by the Group and provides flight simulation training services to the Group.

The Group’s pilots are required to be licensed by the CAAC, which requires an annual recertification examination. The Group’s pilots attend courses in simulator training twice annually and in simulator emergency procedures annually. The Group also conducts regular advanced training courses for captains and captain candidates. Pilots advance in rank based on number of hours flown, types of aircraft flown and their performance history.

19

The Group conducts theoretical and practical training programs for its flight attendants at its Flight Attendants Training Center in Guangzhou (the “Guangzhou Training Center”). The Guangzhou Training Center is equipped with computerized training equipment, as well as simulator cabins for all models of aircraft currently operated by the Group. At the Guangzhou Training Center, flight attendants of the Group receive comprehensive training in areas such as in-flight service, emergency evacuation and water rescue.

Ground Services

The Group makes arrangements with airport authorities, other airlines or ground services companies for substantially all ground facilities, including jet-ways, waiting areas, ticket counters and support services buildings, at each airport that it serves. The Group pays landing, parking and other fees to such airports, including Guangzhou Baiyun International Airport in Guangzhou.Airport. At domestic airports, such fees are generally determined by the CAAC.

At Guangzhou Baiyun International Airport, in Guangzhou, the Group operates its own passenger check-in, cargo, mail and baggage handling, aircraft maintenance and cleaning services. The Group also provides such services to other airlines that operate in Guangzhou Baiyun International Airport.

Ground services at the airports in Shenzhen, Changsha, Wuhan, Zhengzhou, Haikou, Zhuhai, Xiamen, Fuzhou, Guilin, Shantou, Guiyang and Beihai are primarily operated directly by the Group. Ground services at the airport in Beijing are primarily provided by Beijing Southern Airlines Ground Services Company Limited, a jointly controlled entity between the Company and Beijing Aviation Ground Services Co. Ltd., since April 2004. Ground services at other airports in China are provided to the Group by local airport authorities or local airlines pursuant to various service agreements. Ground services and other services at airports outside China are provided to the Group by foreign services providers pursuant to various service agreements with such parties. All such agreements of the Group are short-term and otherwise on terms that are customary in the industry.

20
Air Catering

The Company owns a 51%75% equity interest in Guangzhou Nanland Air Catering Company Limited (“Nanland”). Nanland provides in-flight meals, snacks, drinks and related services for all of the Group’s flights originating in Guangzhou and substantially all other flights departing from Guangzhou Baiyun International Airport. The Group contracts with various air catering suppliers with respect to in-flight catering services for flights originating from other airports, generally on an annual basis and otherwise on terms that are customary in the industry.

Cargo and Mail


The Group also provides air cargo and mail services. Previously, aA significant portion of these services isare combined with passenger flights services. Currently, the Group has two Boeing 747-400 freighters mainly servicing threefour international cargo routes, Shenzhen to Shanghai to Anchorage to Chicago, Shenzhen to Anchorage to Chicago, Shanghai to Anchorage to Chicago and Belgium andShenzhen to Shanghai to Amsterdam. Route Shanghai to Amsterdam was newly opened in October 2003. In October 2003, the Group took delivery of its first Boeing 737-300 QC (Quick Change) cargo aircraft. The QC aircraft is designed to provide maximum utilization of aircraft by allowing passenger use during the day and cargo operations at night.

Currently, the Group conducts its cargo business primarily through its cargo division in Shenzhen. To further tap into the growing cargo market, the Group has commenced the construction of a cargo centre in the Guangzhou new airport in 2003, at a cost of Rmb190 million.

20

Sales, Reservations and Marketing

Passenger Ticket Sales and Reservations

The Group’s ticket sales and reservations are conducted by or through independent sales agents and the Group’s own network of exclusive sales offices as well as the CAAC’s sales offices and CSAHC’s affiliates. The Group has sales offices in Guangzhou and its other route bases. In addition, the Group maintains regional sales offices in other cities in China, including Beijing and Shanghai. The Group maintains international sales offices in Almaty, Amsterdam, Baku, Bangkok, Manila,Bishkek, Cheju, Cheong Ju City, Daejeon, Dubai, Dushanbe, Fukuoka, Hanoi, Hiroshima, Ho Chi Minh City, Singapore,Islamabad, Irkutsk, Jakarta, Khabarovsk, Kita Kyushu, Kuala Lumpur, Kwangju, Lagos, Los Angeles, Manila, Melbourne, Moscow, Nagoya, Nigata, Novosibirsk, Osaka, Paris, Penang, Jakarta and Phnom Penh, in Southeast Asia, as well as in Osaka, Fukuoka,Pusan, Pyongyang, Sapporo, Sendai, Seoul, Sharjah, Singapore, Sydney, Taegu, Tashkent, Teheran, Tokyo, Seoul, Amsterdam, Los Angeles, Sydney, MelbourneToyama and Sharjah.

Vladivostok.

In Hong Kong, ticket sales and reservations services are provided to the Group by China National Aviation Corporation and Nanlung Travel Agency Limited (a subsidiary of CSAHC) for a commission of 3% – 9%6% of the ticket price. The Group also has agency agreements with airlines in the Asia-Pacific region, Europe, the United States and Africa for the processing of ticket sales and reservations on a reciprocal basis. In 2003,2006, approximately 30% of all ticket sales for the Group’s scheduled flights were made by the Group’s and CAAC’s network of sales offices and CSAHC’s affiliates. The Group also sells tickets and accepts reservations through an extensive network of non-exclusive independent sales agents, substantially all of whom operate in cities throughout China, with the remainder operating principally in Hong Kong and other Southeast Asian destinations served by the Group. Under the agency agreements with these sales agents, the Group pays commissions based on the value of tickets sold. The Group pays independent sales agents in China a commission of 3%1.5%-9.0% of the ticket price, and pays independent sales agents outside China a commission ranging from 5% to3% - 9% of the ticket price. Sales agents are typically permitted to withhold their commission from the proceeds of ticket sales that are remitted to the Group. In 2003,2006, independent sales agents accounted for approximately 70% of the Group’s ticket sales for its scheduled flights.

Substantially all of the Group’s sales offices and agents in China are linked electronically to the CAAC’s computerized ticketing and reservations system, which is in turn linked to all domestic airlines for flights throughout China. The Group has also entered into membership agreements with several international reservation systems, including ABACUS in Southeast Asia, SABRE and GALILEO in the United States, AMADEUS in Europe and INFINI in Japan. These systems facilitate reservations and sales of tickets for the Group’s international flights.

Cargo

The Group’s cargo and mail services are promoted through its own cargo divisions and independent cargo agents both within and outside China that track available space among all airlines. In particular, the Group employs a number of cargo agents in the Pearl River delta region. The Group generally pays such agents a commission of 4% and- 5% of the relevant cargo freight rate for domestic and international services, respectively.

services.

Promotional and Marketing Activities

The Group engages in regular promotional and marketing activities in an effort to increase its market share. The Group’s promotional and marketing activities for domestic routes emphasize safety, passenger comfort and the frequency of the Group’s flights. The Group’s promotional and marketing activities for international and Hong Kong and Macau regional passengers emphasize the Group’s quality of service, extensive route network in China and greater frequency of flights relative to other Chinese airlines. In addition, the Group also promotes and markets its Hong Kong and Macau regional and international routes on the basis of price.

21
The Group has been seeking to increase its name recognition by offering new services to passengers. For example, the Group was the first Chinese airline to provide off-airport check-in services. The Group also offers transfer and baggage “thru-handling”“through-handling” services to passengers connecting to other airlines, including passengers connecting in Hong Kong for flights to Taiwan.

To enhance relationships with its passengers, the Group has launched two frequent flyer programs, namely the “China Southern Airlines Sky Pearl Club”, and the “Egret Mileage Plus”. By the end of 2003,2006, the Group had approximately 3,041,2004,608,000 members under these programs.

Regulation

The Chinese commercial aviation industry is subject to a high degree of regulation and oversight by the CAAC. Regulations and policies issued or implemented by the CAAC encompass substantially all aspects of airline operations, including the approval of domestic, Hong Kong regionaland Macau and international route allocation, published airfares,air fares, aircraft acquisition, jet fuel prices and standards for aircraft maintenance, airport operations and air traffic control. The Civil Aviation Law, which became effective in March 1996, provides a framework for regulation of many of these aspects of commercial aviation activities. Although China’s airlines operate under the supervision and regulation of the CAAC, they are accorded an increasingly significant degree of operational autonomy, including with respect to the application for domestic, Hong Kong regionaland Macau and international routes, the allocation of aircraft among routes, the purchase of flight equipment, the pricing of air fares within a certain range, the training and supervision of personnel and their day-to-day operations.

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As an airline providing services on international routes, the Group is also subject to a variety of bilateral civil air transport agreements that provide for the exchange of air traffic rights between China and various other countries. In addition, China is a contracting state, as well as a permanent member, of the International Civil Aviation Organization (the “ICAO”), an agency of the United Nations established in 1947 to assist in the planning and development of international air transport, and is a party to many other international aviation conventions. The ICAO establishes technical standards for the international aviation industry. The Group believes that it, in all material respects, complies with all such technical standards.

Route Rights

Domestic Routes.Routes. The right of any Chinese airline to carry passengers or cargo on any domestic route must be obtained from the CAAC. Non-Chinese airlines are not permitted to provide domestic air service between destinations in China. The CAAC’s policy is to assign a domestic route to the Chinese airline that is best suited to serve the route based, in part, on the location of the airline’s main or regional base at the point of origin. Under current regulations, airlines are generally expected to operate mainly from their route bases, and flights within a particular region are expected to be served by airlines based in that region. The Group believes that these regulatory parameters benefit airlines, such as the Group, that have a large number of regional route bases. The CAAC also considers other factors that may make a particular airline suitable to operate a domestic route, including the applicant’s general operating authority, compliance with pricing regulations and regulations applicable to safety and service quality, market demand, the ability of the applicant in terms of its existing route,routes, and airport facilities and related support services.

The CAAC considers market conditions for a domestic route in determining whether the route should be allocated to one or more airlines. The CAAC requires the passenger load factor on a particular route to reach 75% before additional flights may be addedput on that route. Airlines serving the route are given priority for such additional flights, and only if such airlines cannot operate more flights will the CAAC permit another airline to commence service.

Hong Kong Regional Routes.and Macau Routes. Hong Kong regionaland Macau routes and landing rights are derived from agreements between the Chinese Government and the government of the Hong Kong SAR, and between the Chinese Government and the Portuguese government before December 20, 1999 and the government of Macau SAR on and after December 20, 1999.SAR. Such rights are allocated by the CAAC among the sevenfour Chinese airlines permitted to fly to Hong Kong or Macau.

The Group understands that the criteria for determining whether a Hong Kong regionaland Macau route will be allocated to a particular airline include market demand, the ability of the airline to service the route and the appropriateness of the airline’s aircraft for such route.

A number of Hong Kong regional routes are operated by Chinese airlines on a “charter” flight basis. Permission to operate these flights is in theory subject to monthly review by the CAAC and the Hong Kong Civil Aviation Department. The CAAC has informally indicated that it primarily considers market demand and airline capability in granting permission for such flights.

International Routes.Routes. International route rights, as well as the corresponding landing rights, are derived from air services agreements negotiated between the Chinese Government, through the CAAC, and the government of the relevant foreign country. Each government grants to the other the right to designate one or more domestic airlines to operate scheduled service between certain destinations within each of such countries. Upon entering into an air services agreement, the CAAC determines the airline to be awarded such routes based on various criteria, including the availability of appropriate aircraft, flight and management personnel, safety record, the overall size of the airline, financial condition and sufficiency of assets to bear civil liabilities in international air services. These route rights may be terminated by the CAAC under special circumstances.

The criteria for determining whether an international route will be allocated to a second airline generally include (i) the terms of the relevant bilateral civil aviation agreement; (ii) consistency with overall national plans and the national interest and the enhancement of reasonable competition; and (iii) whether the international airports to be used are sufficient for the aircraft flown and employ security measures consistent with international standards.

22
In addition, if the relevant bilateral civil aviation agreement permits more than one Chinese airline to operate a particular international route, the CAAC will only permit a second airline to operate on such route if the number of passengers carried annually exceeds 100,000 and if there is a minimum average load factor of 68% for routes with at least five weekly flights by Chinese airlines, or 80% for routes with four or fewer weekly flights by Chinese airlines.

22

Air Fare Pricing Policy

     Published air fares

Pursuant to “Pricing Reform of Chinese airlines forDomestic Civil Aviation” as approved by the State Council of the PRC effective on April 20, 2004, prices on domestic routes are establishednow fluctuate freely within a predetermined range. Instead of direct supervision by setting prices of air tickets through a local price bureau, the government now provides guidance on domestic flights and domestic civil aviation is controlled by the CAACgovernment indirectly. Market-oriented pricing policy was introduced and the pricing departmentsystem has been adjusted as a result of the NDRC. The CAAC determines and adjusts from time to time the published fare for each domestic route based on several factors, including average airline operating costs, market conditions, national transportation requirements and the ability of consumers to pay increased fares. Airlines may offer discounts within a range specified by the CAAC under certain circumstances.

above pricing reform.

Published air fares of Chinese airlines for the Hong Kong regionaland Macau routes are determined by the CAAC and the relevant civil aviation authorities in Hong Kong or Macau, subject to consultation between the relevant Chinese airlines and Hong Kong or Macau airlines. Airlines may offer discounts on flights on their Hong Kong regional routes.

Published air fares of Chinese airlines for international routes are determined through consultation between the relevant Chinese airlines and foreign airlines in accordance with the civil aviation agreements between the Chinese Government and the relevant foreign government, taking into account the international air fare standards established through the International Air Transport Association. All air fares for international routes must be approved by the CAAC. Discounting of published international air fares is permitted.

Acquisition of Aircraft and Flight Equipment

The CAAC requires all Chinese airlines to acquire their aircraft through China Aviation Supplies Import and Export Corporation (“CASC”), an entity controlled by the CAAC. If a Chinese airline plans to acquire an aircraft, the airline must first seek approval from the CAAC and NDRC. The airline must, as a condition of approval, provide specific acquisition plans, which are subject to modification by the CAAC and NDRC. If the CAAC and NDRC approve an aircraft acquisition, the airline negotiates the terms of the acquisition with the manufacturer together with CASC because CASC possesses the license required to import or export aircraft, and CASC receives a commission in respect thereof. Most Chinese airlines are also required to acquire their aircraft engines, spare parts and other flight equipment through CASC. The Company and a few other Chinese airlines are permitted to import jet engines and other flight equipment for their own use without the participation of CASC. In the case of the Company, SAIETC acts as its importerimport agent and is paid an agency fee for its services.

Jet Fuel Supply and Pricing


CAOSC and Bluesky Oil Supplies Company, companies controlled and supervised by the CAAC, are the only jet fuel supply companies in China, with the exception of the joint venture jet fuel supply companies that supply the Shenzhen, Zhuhai and Sanya airports, in each of which CAOSC is a partner. Airlines are generally not permitted to buy jet fuel from other suppliers in their domestic operations, since the direct import of jet fuel for domestic purposes is prohibited. As a result, all Chinese airlines purchase their domestic jet fuel supply requirements (other than in respect of their Shenzhen, Zhuhai or Sanya operations) from the seven regional branches of CAOSC. Jet fuel obtained from such regional branches is purchased at uniform prices throughout China that are determined and adjusted by CAOSC from time to time with the approval of the CAAC and the pricing department of the NDRC based on market conditions and other factors.

Safety

The CAAC has made the improvement of air traffic safety in China a high priority and is responsible for the establishment of operational safety, maintenance and training standards for all Chinese airlines. The Chinese airlines are required to provide monthly flight safety reports to the CAAC, including reports of flight or other incidents or accidents and other safety related problems involving such airline’s aircraft occurring during the relevant reporting period. The CAAC periodically conducts safety inspections on individual airlines.

23

The CAAC oversees the standards of all Chinese airline pilots through its operation of the CAAC Aviation College. The CAAC Aviation College is a monitoring unit located in Tianjin which implements a uniform pilot certification process applicable to all Chinese airline pilots and is responsible for the issuance, renewal, suspension and cancellation of pilot licenses. Every pilot is required to pass CAAC-administered examinations before obtaining a pilot license and is subject to an annual recertification examination.

All aircraft operated by Chinese airlines, other than a limited number of leased aircraft registered in foreign countries, are required to be registered with the CAAC. All aircraft operated by Chinese airlines must have a valid certificate of airworthiness, which is issued annually by the CAAC. In addition, maintenance permits are issued to a Chinese airline only after its maintenance capabilities have been examined and assessed by the CAAC. Such maintenance permits are renewed annually. All aircraft operated by Chinese airlines may be maintained and repaired only by CAAC-certified maintenance facilities, whether located within or outside China. Aircraft maintenance personnel must be certified by the CAAC before assuming aircraft maintenance posts.

23
Security

The CAAC establishes and supervises the implementation of security standards and regulations for the Chinese commercial aviation industry. Such standards and regulations are based on Chinese laws, as well as standards developed by international commercial aviation organizations. Each airline and airport in China is required to submit to the CAAC an aviation security handbook describing specific security procedures established by such airline or airport for the day-to-day operations of commercial aviation and procedures for staff training on security. Such security procedures must be based on relevant CAAC regulations and international commercial aviation treaties. Chinese airports and airlines that operate international routes must also adopt security measures in accordance with the requirements of the relevant international agreements.

Noise and Environmental Regulation

All airlines in China must comply with the noise and environmental regulations of the PRC State Environmental Protection Agency. Applicable regulations of the CAAC permit Chinese airports to refuse take-off and landing rights to any aircraft that does not comply with noise regulations.

Chinese Airport Policy

The CAAC supervises and regulates all civilian airports in China. The local government of the PRC manages the administration of most civilian airports in China, including the Guangzhou Baiyun International Airport as of 2004,2006, with limited exceptions. Airports in China are also subject to regulation and ongoing review by the CAAC, which determines take-off and landing charges, as well as charges for the use of airports and airport services.

Competition

The CAAC’s extensive regulation of the Chinese commercial aviation industry has had the effect of managing competition among Chinese airlines. Nevertheless, competition has become increasingly intense in recent years due to a number of factors, including relaxation of certain regulations by the CAAC, an increase in the number of Chinese airlines and an increase in the capacity, routes and flights of Chinese airlines.

In the Chinese aviation industry, the three dominant airlines are the Group, Air China and China Eastern Airlines (“China Eastern”). In 2003,2006, these three airlines together controlled approximately 56%72.48% of the commercial aviation market in China as measured by passengers carried.

Most major Chinese airlines have in recent years significantly expanded their fleets, while at the same time passenger traffic has not increased proportionately. This has resulted in a reduction in the passenger load factors for most Chinese airlines. As a result, Chinese airlines are required to be more competitive with respect to, for example, quality of service, including ticketing and reservations, in-flight services, flight scheduling and timeliness.

The Group expects that competition in China’s commercial aviation industry will continue to be intense. The Group will also face increasing competition from alternative means of transport, such as highway and rail, as China’s transportation infrastructure improves.

Relative to other Chinese airlines, however, the Group believes that it possesses certain competitive advantages. The Group has the most extensive route network and the largest number of regional route bases among Chinese airlines, which the Group believes places it in a favorable position in the route allocation process. The Group also has the largest aircraft fleet of any Chinese airline, which, together with the Group’s planned aircraft acquisitions, will permit the Group to expand its operations and to improve the deployment of the aircraft in its fleet. The Group also believes that its dominant presence in the populous and economically developed southern and central regions of China provides it with a competitive advantage in attracting new customers and that its fully integrated flight training, aircraft and engine maintenance, and air catering operations enable it to achieve and maintain high quality service to its customers.

24

The following table sets forth the Group’s market share of passengers carried, cargo and mail carried and total traffic of Chinese airlines for the years indicated.
                         
  Passengers Cargo and Mail Total Traffic
  Carried
 Carried (tons)
 (ton kilometers)
  Industry Group's Industry Group's Industry Group's
Year
 Total
 Share
 Total
 Share
 Total
 Share
  (in million) (% of total) (in thousand) (% of total) (in billion) (% of total)
1997  56.3   27.1   1,247   25.0   8.7   20.7 
1998  57.5   26.2   1,401   24.9   9.3   20.4 
1999  60.9   24.8   1,704   22.9   10.6   18.9 
2000  67.2   24.9   1,967   22.5   12.3   20.0 
2001  75.2   25.4   1,709   23.3   14.1   21.5 
2002  85.9   25.0   2,021   23.3   16.5   21.9 
2003  87.6   23.4   2,190   21.2   17.1   20.8 

  
Passenger carried
 
Cargo and Mail Carried (tons)
 
Total traffic (ton kilometers)
 
  
 Industry
 
 Group’s
 
 Industry
 
 Group’s
 
 Industry
 
 Group’s
 
 
 Total
 
 Share
 
 Total
 
 Share
 
 Total
 
 Share
 
Year
 
 (in million)
 
 (% of total)
 
 (in thousand)
 
 (% of total)
 
 (in billion)
 
 (% of total)
 
2000  67.2  24.9  1,967  22.5  12.3  20.0 
2001  75.2  25.4  1,709  23.3  14.1  21.5 
2002  85.9  25.0  2,021  23.3  16.5  21.9 
2003  87.6  23.4  2,190  21.2  17.1  20.8 
2004  121.2  23.3  2,770  19.7  23.1  20.2 
2005  138.3  31.8  3,067  25.3  26.1  27.9 
2006  159.7  30.8  3,494  23.4  30.6  26.4 
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Domestic Routes

The Group competes against its domestic competitors primarily on the basis of flight schedule, route network, quality of service, safety, type and age of aircraft and, to a lesser extent and until recently, price. The Group competes against nine10 other Chinese airlines in its various domestic route markets. Of these competitors, the largest are two airlines owned or controlled by the Chinese Government, and the remaining sixeight airlines are operated by or under the control of various Chinese provincial or municipal governments.


The following table sets forth the Group’s market share of the passengers carried, cargo and mail carried on departing flights and total departing flights at the ten busiest airports in China, based on passenger volume, in 2003.2006.
             
  Passengers Cargo and Departing
Airport
 Carried (% of total)
 Mail Carried (% of total)
 Flights (% of total)
Beijing  12.1   11.0   10.8 
Shanghai Hongqiao  15.4   8.3   15.9 
Guangzhou  51.0   40.7   50.3 
Shenzhen  27.9   28.0   24.9 
Kunming  15.0   12.3   14.2 
Chengdu  11.0   14.5   10.0 
Haikou  25.3   33.6   19.5 
Xian  8.6   11.3   6.2 
Shanghai Pudong  7.8   7.0   7.9 
Hangzhou  26.5   20.7   27.2 

   
 
Cargo and Mail
 
 
 
 
 
 Passenger carried
 
Carried
 
Departing flight
 
Airport
 
 (% of total)
 
(% of total)
 
(% of total)
 
Beijing  
18.6%
  13.2%  17.6% 
Shanghai Pudong  9.2%  4.4%  9.6% 
Guangzhou  53.1%  42.1%  53.6% 
Shanghai Hongqiao  18.7%  19.9%  17.7% 
Shenzhen  30.8%  26.3%  29.9% 
Chengdu  13.7%  15.8%  11.7%  
Kunming  18.4%  18.9%  17.3% 
Hangzhou  37.5%  32.9%  35.6% 
Xian  15.3%  18.0%  13.8% 
Chongqing  21.3%  24.9%  19.0% 
The following table sets forth the Group’s market share of the passengers carried, cargo and mail carried on departing flights and total departing flights at seveneight busiest airports in southern and central China (excluding Guangzhou Shenzhen and Haikou,Shenzhen, which are included in the table above), based on passenger volume, in 2003.2006.
             
  Passengers Cargo and Departing
Airport
 Carried (% of total)
 Mail Carried (% of total)
 Flights (% of total)
Wuhan Tianhe  43.6   45.1   38.1 
Changsha  40.4   42.5   35.7 
Zhengzhou  68.1   67.1   54.1 

25

    
Cargo and Mail 
   
  
 Passenger carried 
 
Carried 
 
Departing flight
 
Airport
 
 (% of total ) 
 
(% of total) 
 
(% of total)
 
Changsha  29.1%  33.6%  25.2% 
Wuhan Tianhe  51.4%  68.9%  50.7% 
Guilin  38.3%  41.1%  35.2% 
Sanya  41.1%  41.1%  40.7% 
Zhengzhou  41.2%   31.1%  41.9% 
Nanning  65.2%  67.1%  56.1% 
Zhang Jia Jie  38.4%  40.4%  33.2% 
Shantou  30.7%  35.5%  33.5% 

             
  Passengers Cargo and Departing
Airport
 Carried (% of total)
 Mail Carried (% of total)
 Flights (% of total)
Guiyang  32.6   44.9   29.3 
Shantou  77.6   67.9   69.4 
Guilin  36.8   22.9   35.6 
Zhuhai  60.8   62.3   28.8 
Xiamen  61.3   38.7   55.8 

25
Hong Kong Regionaland Macau Routes

The Group dominates the routes operated by Chinese airlines between Hong Kong and Macau and China. In 2003,2006, the Group operated an average of more than 21916,949 “charter” and other scheduled flights per week between China and Hong Kong or Macau, accounting for approximately 29.8%28.8% of the total number of passengers carried by all Chinese airlines on the Hong Kong regionaland Macau routes. The Group believes that the routes on which it operates “charter” flights are among its highest yielding routes, primarily because the Group faces limited competition on such routes and is consequently less subject to downward pricing pressures. Dragon Air, which is a Hong Kong-based airline, competes with the Group on many of the Group’s Hong Kong regionaland Macau routes.

Air Macau Group Ltd. (“Air Macau”), a Macau-based airline, started to operate routes in 1996 between Macau and China, includingto destinations such as Beijing, Shanghai, Xiamen and Wuhan. Air Macau also operates routes between Macau and Taiwan, including flights which allow passengers to travel between Taiwan and China through Macau. The air fares on some of Air Macau’s routes are significantly less than air fares on comparable routes of the Group. Air Macau’s routes provide an alternative to, and compete with, the Group’s Hong Kong regionaland Macau routes for passengers travelling between Taiwan and China.

International Routes

The Group competes with Air China, China Eastern and many well-established foreign airlines on its international routes. Most of these international competitors have significantly longer operating histories, substantially greater financial and technological resources and greater name recognition than the Group. In addition, the public’s perception of the safety and service records of Chinese airlines may adversely affect the Group’s ability to compete against its Hong Kong regionaland Macau and international competitors. Many of the Group’s international competitors have larger sales networks and participate in reservation systems that are more comprehensive and convenient than those of the Group, or engage in promotional activities that may enhance their ability to attract international passengers.


Air China has the most extensive international route network among Chinese airlines. Beijing, the hub of Air China’s operations, has been the destination for most international flights to China. The Group competes against, among other airlines, Thai Airways International, Singapore Airlines, Malaysian Airlines System, Air China and China Eastern on flights to Southeast Asian destinations. In the case of its European routes, the Group’s competitors include KLM-Royal Dutch Airlines.Air France — KLM. The Group faces competition on its international routeroutes from Air China and China Eastern, each of which operates several routes between destinations in China and the United States, as well as international airlines that fly to Los Angeles from Hong Kong. The Group competes in the international market primarily on the basis of safety, price, timeliness and convenience of scheduling.

Airline Subsidiaries

The Airline Subsidiaries are joint ventures established by the Company and local companies in the provinces or special economic zones where the Airline Subsidiaries are based and are engaged in providing airline and related services. TheExcept for Guangxi Airlines, of which the Company owns a 100% equity interest, the Company owns a 60% equity interest in each of the remaining Airline Subsidiaries.

As of December 31, 2003,2006, Xiamen Airlines operated under its own “MF” code a fleet of 2741 aircraft on 8185 domestic routes, five11 international route and foursix Hong Kong regionaland Macau routes. In 2003,2006, Xiamen Airlines carried a total of about 4.917.78 million passengers, or approximately 24.0%15.8% of the passengers carried by the Group in that year, and had RMB3,460RMB5,982 million in operatingtraffic revenue.

As of December 31, 2003,2006, Shantou Airlines operated under the Group’s “CZ” code 5eight aircraft on 5212 domestic routes, one international route and twoone Hong Kong regionaland Macau route. In 2003,2006, Shantou Airlines carried a total of about 742,0001.39 million passengers, or 3.6%2.8% of the passengers carried by the Group in that year. Total operatingtraffic revenue of Shantou Airlines for the year ended December 31, 20032006 was RMB546RMB1,042 million.

As of December 31, 2003,2006, routes previously operated by Guangxi Airlines operated under the “CZ” code 5nine aircraft on 3433 domestic routes, twoone international routes and threetwo Hong Kong regional routes.and Macau routes were transferred to the Company. In 2003,2006, Guangxi Airlines carried a total of about 678,0001.55 million passengers, or 3.3%3.1% of the total number of passengers carried by the Group in that year. Total operatingtraffic revenue of Guangxi Airlines for the year ended December 31, 20032006 was RMB457RMB706 million.

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As of December 31, 2003,2006, Zhuhai Airlines operated under the “CZ” code 4five aircraft on 34nine domestic routes. In 2003,2006, Zhuhai Airlines carried a total of about 602,000868,700 passengers, or approximately 2.9%1.8% of the total number of passengers carried by the Group in that year. Total operatingtraffic revenue of Zhuhai Airlines for the year ended December 31, 20032006 was RMB436RMB780 million.

As of December 31, 2003,2006, Guizhou Airlines operated under the “CZ” code 6seven aircraft on 1920 domestic routes. In 2003,2006, Guizhou Airlines carried a total of about 691,0001.35 million passengers, or approximately 3.4%2.7% of the total number of passengers carried by the Group in 2003.2006. Total operatingtraffic revenue of Guizhou Airlines was approximately RMB469RMB982 million for the year ended December 31, 2003.

2006.

26
Insurance

The CAAC maintains fleet and legal liability insurance on behalf of the Group and all other Chinese airlines with the People’s Insurance Company of China (“PICC”) under the PICC master policy. The Group maintains aviation hull all risks, spares and airline liability insurance, aircraft hull all risks and spare engines deductible insurance, aviation hull war and allied perils policy of the type and in the amount customary in the Chinese aviation industry.

Under Chinese law, civil liability of Chinese airlines for injuries suffered by passengers on domestic flights is limited to RMB70,000RMB400,000 (approximately US$8,455)51,225) per passenger. Under the Convention for the Unification of Certain Rules Relating to International Transportation by Air of 1929 (as amended by the protocol of 1955, the “Warsaw Convention”), unless a separate agreement has been entered into between China and a specific country, civil liability for injuries suffered by passengers on international flights is limited to US$20,000122,000 per passenger. The Group believes that it maintains adequate insurance coverage for the maximum civil liability that can be imposed in respect of injuries to passengers under Chinese law, the Warsaw Convention or any separate agreement applicable to the Group.

The CAAC allocates insurance premiums payable in respect of the PICC master policy to each participating airline based on the value of the airline’s insured aircraft or, in the case of leased aircraft, based on the amount required by the terms of the lease. Insurance claims made by any participating airline may cause the premiums paid by the Group under the PICC master policy to increase. PICC’s practice has been to reinsure a substantial portion of its aircraft insurance business through reinsurance brokers on the London reinsurance market.


Intellectual Property

The Group’s businesses and operations, other than the businesses and operations of Xiamen Airlines, are conducted under the names “China Southern” and “China Southern Airlines” in both English and Chinese. The Group uses as its logo a stylized rendition of a kapok plant. Xiamen Airlines conducts its businesses and operations under the name of “Xiamen Airlines” in English and Chinese and uses its own logo depicting a stylized rendition of an egret.

The names “China Southern” and “China Southern Airlines” contain Chinese words of common usage and are therefore not eligible for registration as tradenames under current Chinese law. The kapok logo is a trademark registered in China and recorded with the International Air Transport Association (“IATA”), the rights to which are owned by CSAHC. The Company and CSAHC have entered into a trademark license agreement (the “Trademark License Agreement”), pursuant to which CSAHC has licensed to the Group the right to use the names “China Southern” and “China Southern Airlines” in both English and Chinese and granted the Company a 10-year renewable license from 1997 to use the kapok logo on a world-wide basis. CSAHC has retained the right to use the kapok logo in connection with its non-airline related businesses conducted as of the date of the Trademark License Agreement and to permit its affiliates that do not compete, directly or indirectly, with the Group to use the kapok logo. Xiamen Airlines owns all rights to its egret logo, which is a trademark registered in China, and recorded with the IATA.

The Company owns all rights to three trademarks, being SKY PEARL CLUB, the logo relating to Easy Cargo 5000 and “SKY PEARL CARD” which are registered in China, and recorded with Trademark Office of the State Administration for Industry and Commerce. Zhuhai Airlines Company Limited owns all rights to the airline logo which is registered with the Trademark Office of the State Administration for Industry and Commerce.

27

Organizational Structure

The following chart illustrates the corporate structure of the Group as of year end 20032006 and the aggregate effective equity interest of the Company in each of its principal subsidiaries, affiliated companies and jointly controlled entities.

(ORGANIZATIONAL STRUCTURE CHART)

28

Note a: Another 26% ownership interest is held by CSA’s subsidiaries.
The particulars of the Company’s principal subsidiaries as of December 31, 20032006 are as follows:

Name of company
 
Attributable equity
Place and date ofestablishment/operation 
Proportion of ownership
interest toheld by the Company
Name of companyestablishment/operationCompany
DirectIndirect
%%
Guangxi Airlines Company Limited PRC60—
April 28, 1994 100
Southern Airlines Group(Group) ShantouPRC60
Airlines Company Limited PRC July 20, 1993 60
Zhuhai Airlines Company Limited PRC60
May 8, 1995 60
Xiamen Airlines Company Limited PRC60—
August 11, 1984 ��60
Guizhou Airlines Company Limited PRC60—
November 12, 1991 60
Guangzhou Air Cargo Company Limited PRC March 31, 2004 70
Guangzhou Nanland Air CateringPRC51—
Company Limited PRC November 21, 1989 75
China Southern West AustralianAustralia65—
Flying College Pty Ltd. Australia January 26, 1971 
China Southern Airlines (Group)PRC100—
Zhuhai Helicopter Company LimitedAugust 31, 199365
Guangzhou Baiyun InternationalPRC61—
Logistic Company Ltd PRC July 23, 2002 61
Xinjiang Civil Aviation Property Management Limited PRC February 12, 2002 51.8

     Affiliated Companies and Jointly Controlled Entities

28
The particulars of the Group’s principal affiliated companies and jointly controlled entity as of December 31, 20032006 are as follows:
Place and date ofAttributable equity interest
Name of companyestablishment/operationto the company
DirectIndirect
%%
Guangzhou Aircraft MaintenancePRC50—
Engineering Company LimitedOctober 28, 1989

29

             
  Place and date of Attributable equity interest
Name of company establishment/operation to the company
 
 
      Direct Indirect
      % %
Southern Airlines Group PRC  32   15.42 
Finance Company Limited June 28, 1995        
Sichuan Airlines Corporation PRC  39   — 
Limited August 28, 2002        
China Postal Airlines Limited PRC  49   — 
  November 25, 1996        
MTU Maintenance Zhuhai PRC  50   — 
Co. Ltd. April 6, 2001        
Zhuhai Xiang Yi Aviation PRC  51   — 
Technology Company Limited July 10, 2002        

     Certain of the Company’s subsidiaries, affiliated companies and jointly controlled entities are PRC joint ventures which have limited duration pursuant to PRC law.


    
Proportion of ownership
   
  
Place and date of
 
interest held by
 
 
 
 
 
establishment
 
Group 
 
 
 
 
 
Name of company
 
/operation
 
effective interest 
 
The Company
 
Subsidiaries
 
Guangzhou Aircraft Maintenance Engineering Company Limited  PRC October 28, 1989  50  50  — 
China Southern Airlines Group Finance Company Limited  PRC June 28, 1995  34  21.1  12.9 
Sichuan Airlines Corporation Limited  PRC August 28, 2002  39  39  — 
China Postal Airlines Limited  PRC November 25, 1996  49  49  — 
MTU Maintenance Zhuhai Co. Ltd  PRC April 6, 2001  50  50  — 
Zhuhai Xiang Yi Aviation Technology Company Limited  PRC July 10, 2002  51  51  — 
Beijing Southern Airlines Ground Service Company Limited  PRC April 1, 2004  50  50  — 

Property, Plant and Equipment

For a discussion of the Group’s aircraft, see Item 4, “Information on the Company — History and development of the Company -Aircraft Fleet.— Aircraft Acquisitions.”


The Group’s headquarters in Guangzhou occupy an area of approximately 149,00090,606 square meters of land and a total gross floor area of approximately 149,000516,712 square meters. The Group leases from CSAHC the land in Guangzhou on which the Group’s headquarters and other facilities are located. The Group also leases from CSAHC certain buildings at the Wuhan and Haikou and ZhengzhouZengzhou airports.

29
The Company’s principal properties are located at its headquarters site and at its route bases. The following table sets forth certain information with respect to the Company’s properties at its headquarters in Guangzhou and certain route bases as of the date hereof.
                         
  Land Buildings
  
 
  (in square meters) (in square meters)
  Owned     Leased Owned Leased
  
     
 
 
Guangzhou  —       80,909       103,957   1,755 
Shenzhen  208,740       —       35,174   — 
Zhuhai  170,062       —       18,791   — 
Changsha  138,949       —       47,190   — 
Zhengzhou  290,841       —       60,582   — 
Haikou  5,265       —       59,543   19,633 
Wuhan  —       31,061       435   26,061 
Nanyang  —       —       12,156   — 

   
Land
(in square meters)
  
Buildings
(in square meters)
 
   
Owned
  
 Leased
  
Owned
  
 Leased
 
Guangzhou  9,797  80,809  514,957  1,755 
Shenzhen  208,740  —  54,093  — 
Zhuhai  170,062  —  18,791  — 
Changsha  138,949  —  47,190  — 
Zhengzhou  290,841  —  60,582  — 
Haikou  5,265  —  63,570  19,633 
Wuhan  —  31,061  17,335  22,831 
Nanyang  —  —  12,156  60,003 
Sanya  106,680  —  16,968  — 
Shenyang  —  134,356  79,626  94,661 
Dalian  —  14,403  17,250  37,134 
Jilin  —  160,106  33,656  25,220 
Harbin  —  293,648  36,925  3,457 
Xinjiang  —  548,556  177,710  13,829 
The following table sets forth certain information with respect to the properties of the Airline Subsidiaries as of the date hereof.
                 
  Land Buildings
  
 
  (in square meters) (in square meters)
  Owned Leased Owned Leased
  
 
 
 
Xiamen  211,632   —   29,292   1,564 
Shantou  20,292   —   27,810   3,127 
Zhuhai  53,797   —   29,697   1,513 
Guilin  —   —   14,594   349 

30

                 
  Land Buildings
  
 
  (in square meters) (in square meters)
  Owned Leased Owned Leased
  
 
 
 
Guizhou  270,001   —   10,466   — 

   
Land
(in square meters)
  
Buildings
(in square meters)
 
   
Owned
  
Leased
  
Owned
  
Leased
 
Xiamen  451,121  —  355,038  12,509 
Shantou  36,931  55,407  40,624  — 
Zhuhai  68,186  —  54,398  2,135 
Guilin  72,563  —  73,379  139 
Guizhou  259,879  —  93,390  3,533 
As systems for registration and transfer of land use rights and related real property interests in China have been implemented relatively recently, such systems do not yet comprehensively account for all land and related property interests. The land in Guangzhou on which the Group’s headquarters and other facilities are located and the buildings that the Group uses at its route base in Wuhan Haikou and ZhengzhouHaikou are leased by the Company from CSAHC. However, CSAHC lacks adequate documentation evidencing CSAHC’s rights to such land and buildings, and, as a consequence, the lease agreements between CSAHC and the Company for such land may not be registered with the relevant authorities. Lack of registration may affect the validity of such lease agreements. There are certain other parcels of land and buildings owned or used by the Group that lack adequate documentation. Lack of adequate documentation for land use rights and ownership of buildings may impair the ability of the Group to dispose of or mortgage such land use rights and buildings.

     The Group has been occupying all of the land and buildings described above without challenge. CSAHC has received written assurance from the CAAC to the effect that CSAHC is entitled to continued use and occupancy of the land in Guangzhou. The Group understands that the CAAC is basing its conclusion on an agreement among certain governmental authorities relating to such land. CSAHC has agreed to indemnify the Group against any loss or damage caused by any challenge of, or interference with, the use by the Group of any of their respective land and buildings.

ITEM 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS.

The following discussion and analysis should be read in conjunction with the Financial Statements of the Group contained elsewhere in this Annual Report. The Group maintains its books and accounts in accordance with PRC Accounting Rules and Regulations (“PRC GAAP”) and prepares its financial statements in accordance with both PRC GAAP and IFRS. The Financial Statements contained elsewhere in this Annual Report have been prepared in accordance with IFRS. IFRS differs in certain significant respects from U.S. GAAP. Information relating to the nature and effect of such differences is presented in Note 3351 to the Financial Statements.

The consolidated financial statements for the year ended December 31, 2005 have been revised to reflect the adoption of IAS 16 (amended 2004) Property, Plant and Equipment (“revised policy”) effective January 1, 2005. The effect of adoption of the revised policy was not reflected in the 2005 Annual Report as management determined the impact to the 2005 consolidated financial statements was immaterial. Further details are set out in Note 45 to the consolidated financial statements.
30

Critical Accounting Policies

The discussion and analysis of the Group’s financial condition and results of operations are based upon the consolidated financial statements, which have been prepared in accordance with IFRS. The preparation of such consolidated financial statements requires the Group to make estimates and judgments that affect the reported amount of assets and liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities at the date of the consolidated financial statements. Actual results may differ from these estimates under different assumptions or conditions.

Critical accounting policies are defined as those that are reflective of significant judgments and uncertainties, and potentially result in materially different results under different assumptions and conditions. Our principal accounting policies are set forth in Note 2 to the consolidated financial statements. The Group believes that itsthe following critical accounting policies are limited to those described below. For a detailed discussion oninvolve the application of thesemost significant judgments and other accounting policies, see Note 2 to the Financial Statements.

     Revenue Recognition

     The Group records sales of passenger, cargo and mail tickets as “Sales in advance of carriage”, a current liability, on the consolidated balance sheet. Passenger, cargo and mail revenues are recognized and the related current liability is reduced when the transportation is provided. Sales in advance of carriage therefore represents ticket sold for future travel dates and estimated future refunds and exchanges of tickets sold for past travel dates. The Group’s balance of sales in advance of carriage as of December 31, 2003 was RMB466 million.

     Estimating the amount of tickets that will be refunded, exchanged, or expired involves some level of subjectivity and judgment. According to the relevant rulesestimates used in the PRC in relation to air transportation, the valid periodpreparation of our financial statements.

Impairment for tickets sold is up to a year from the date of sale. Sales in advance of carriage, therefore, includes an estimate of the amount of future refunds and exchanges, and expired tickets. These estimates are based on historical experience over many years. The Group and members of the airline industry have consistently applied this accounting method to estimate revenue from expired tickets. Estimated future refunds and exchanges included in sales in advance of carriage account are constantly evaluated based on subsequent refund and exchange activity to validate the accuracy of the Group’s estimates with respect to expired tickets.

     Events and circumstances outside of historical fare sale activity or historical customer travel patterns, as noted above, can result in actual refunds, exchanges, or expired tickets differing significantly from estimates. The Group evaluates its estimates within a narrow range of acceptable amounts. If actual refunds, exchanges, or expiry experience results in an amount outside of this range, estimates and assumptions are reviewed and adjustments to “Sales in advance of carriage” and to “Passenger revenue” are recorded as necessary. The Group’s estimation techniques have been consistently applied from year to year; however, as with any estimates, actual refund and exchange activity may vary from estimated amounts. Furthermore, the Group believes it is unlikely that materially different estimates for future refunds, exchanges, and forfeited tickets would be reported based on other reasonable assumptions or conditions suggested by actual historical experience and other data available at the time estimates were made.

     Up to date, the Group has not experienced any material fluctuations in estimated refunds and exchanges, and correspondingly, expired tickets, due to many of the factors described above.

     Fixedlong-lived assets

     The Group have approximately RMB28,536 million fixed assets as of December 31, 2003. In addition to the original cost of these assets, their recorded value is impacted by a number of policy elections, including the estimation of useful lives and residual values and when necessary, impairment charges.

     The Group records aircraft at acquisition cost. Depreciable life is determined through economic analysis, reviewing existing fleet plans, recommendations from manufacturers and comparing estimated lives to other airlines that operate similar fleets. Residual values are estimated based on our historical experience with regards to the sale of aircraft and are established in conjunction with the estimated useful lives of the aircraft. Residual values are based on current dollars when the aircraft are acquired and typically reflect asset values that have not reached the end of their physical life. Both depreciable lives and residual values are reviewed periodically to recognize changes in our fleet plan and changes in conditions.

     In addition, the Group evaluates fixed assets used in operations for impairment.

If circumstances indicate that the net book value of ana long-lived asset may not be recoverable, this asset may be considered “impaired”, and an impairment loss may be recognized in accordance with IAS 36 “Impairment of Assets”. The amountcarrying amounts of long-lived assets are reviewed periodically in order to assess whether the recoverable amounts have declined below the carrying amounts. These assets are tested for impairment loss is the difference betweenwhenever events or changes in circumstances indicate that their recorded carrying amounts may not be recoverable. When such a decline has occurred, the carrying amount of the asset and itsis reduced to recoverable amount. The recoverable amount is the greater of the net selling price and the value in use. In determining the value in use, the Group utilizes certain assumptions, including, but not limited to: (i) estimated fair market value of the assets, and (ii) estimated futureexpected cash flows expected to be generated by these assets, which are based on additional assumptions such as asset utilization, length of service the asset will be used in the Group’s operationsare discounted to their present value, which requires significant judgment relating to level of traffic revenue and estimated residual values.amount of operating costs. The Group will useuses all readily available information in determining an amount that is a reasonable approximation of recoverable amounts,amount, including estimates based on industry trendsreasonable and referencesupportable assumptions and projections of traffic revenue and amount of operating costs.
Depreciation
Property, plant and equipment are depreciated on a straight-line basis over their estimated useful lives, after taking into account the estimated residual value. The Group reviews the estimated useful lives of the assets regularly in order to market rates and transactions. Changesdetermine the amount of depreciation expense to the above estimates may have a material effectbe recorded during any reporting period. The useful lives are based on the Group’s Financial Statements. Ashistorical experience with similar assets and taking into account anticipated technological changes. The depreciation expense for future periods is adjusted if there are significant changes from previous estimates.
Impairment of December 31, 2003, basedtrade receivables
The Group maintains an impairment loss for doubtful accounts for estimated losses resulting from the inability of the debtors to make required payments. The Group bases the estimates of future cash flows on the result of evaluation, the Group considered that no impairment is required.

Overview

     In 2003, the Group encountered the most unprecedented challenges and difficulties. The outbreakageing of the Severe Acute Respiratory Syndrome (“SARS”) earlier 2003 severely hit the PRC aviation industry. From April to June 2003, the Group’s passenger volumetrade receivables balance, debtors’ credit-worthiness, and passenger load factor dropped which caused the revenue passenger kilometers (“RPK”) for April, May and June of 2003 to fall by 40%, 83.5% and 61.5% respectively, as compared to same period in 2002. In order to minimize the negative impact of SARS, the Group implemented various measures to adjust its operating capacity, for example by reducing the number of flights and suspending certain routes, in response to the reduced air traffic demand caused by the negative impact of SARS. The SARS was effectively under control in the PRC in July 2003 and the domestic market started to recover in the third quarter of 2003. The Group gradually resumed all its suspended flights since July 2003.

     In order to alleviatehistorical write-off experience. If the financial pressure suffered bycondition of the PRC civil aviation industry asdebtors were to deteriorate, actual write-offs would be higher than estimated.

31
Overview
As a result of the SARS epidemic,continuous growth in demand in the airline market and acquisitions, of airline operations, the Group’s business benefited from an increase of transport capacity, passenger volume and cargo and mail carried. On the other hand, the Group has also strengthened its cost control strategy, particularly on saving jet fuel cost and repairs and maintenance expenses. Together with improving allocation of transport capacity between peak and non peak season, expanding the profitable routes and enhancing the ticket revenue management system, the revenue and the operation efficiency of the Group improved in 2006.
Nevertheless, the Group is facing pressure on its operations due to continuing increases of jet fuel costs and intensified competition.
Since July 21, 2005, the PRC government waivedGovernment has begun to adopt a managed floating exchange rate system based on market supply and demand of currencies, which is subject to adjustments with reference to a basket of currencies. The exchange rate of Renminbi would no longer be pegged to the leviesU.S. dollar only and a more flexible exchange rate system was established. The exchange rate of U.S. dollar and RMB was at USD1.00: RMB8.11. Because the Group finances its aircraft acquisitions mainly through capital leases or bank loans in U.S. dollars, and there are a substantial amount of transactions and obligations denominated in U.S. dollars in relation to its global purchases of jet fuel, lease and purchase of aviation equipment as well as major repairs, in addition to the landing fees of its international flights in the airports of other countries, the Group benefited from the RMB appreciation. RMB appreciation has brought a one-off exchange gain to the Group and reduced its operating costs which are denominated in foreign currencies. However, RMB appreciation also presents the Group with a challenge in price competition in international route operations.
According to the Notice of NDRC and CAAC on Issues Relating to Introduction of the Fuel Surcharge for Domestic Routes, domestic airlines imposed fuel surcharges for all the domestic routes (excluding those from the mainland PRC to Hong Kong and Macau) with effect from August 1, 2005 (based on flight time). On February 16, 2006, the NDRC and CAAC Infrastructure Development Fund, sales taxreleased a supplementary document on Issues Relating to the Introduction of Fuel Surcharge for Domestic Routes, stating that due to the rising jet fuel price, the period of imposition of fuel surcharge by airlines was extended. On March 28, 2006, the NDRC and relatedCAAC released another supplementary taxesdocument on Issues Relating to the Introduction of Fuel Surcharge for Domestic Routes, thereby adjusting the amount of fuel surcharges from RMB20 to RMB30 per passenger revenue payable by the PRC airlines,for distances flown less than 800 kilometers, and from RMB40 to RMB60 for distances exceeding 800 kilometers, during the period temporarily from May 1, 2003April 10, 2006 to December 31, 2003.

31

     In addition,October 10, 2006. The introduction of fuel surcharge and the political tension inextension of the Middle East, in particularduration of the Iraq war in March 2003, ledsame helped relieve, to a surge in oil prices which in turn caused an increase incertain extent, the Group’sburden of high jet fuel cost.

     The Group conducts a portioncost on the Group. NDRC and CAAC approved of its airline operations through the Airline Subsidiaries. Operating resultsraise to the passenger fuel surcharge for domestic routes to help relieve the soaring jet fuel cost for the Airline Subsidiaries are includedperiod in each of the years presented in the Financial Statements. The Airline Subsidiaries, which derive substantially all of their operating revenue from passenger traffic, accounted for 26.8% and 30.7% of the Group’s total operating revenue, and 34.5% and 37.2% of the Group’s total passengers carried, in 2002 and 2003, respectively. Xiamen Airlines is the largest member of the Airline Subsidiaries, with operating revenue of RMB3,278 million and RMB3,460 million in 2002 and 2003, respectively, or 18.2% and 19.8% of the Group’s total operating revenue.

2006.

The Group’s operating revenue is substantially dependent on the passenger and cargo traffic volume carried, which is subject to seasonal and other changes in traffic patterns, the availability of appropriate time slots for the Group’s flights and alternative routes, the degree of competition from other airlines and alternate means of transportation, as well as other factors that may influence passenger travel demand and cargo and mail volume. In particular, the Group’s airline revenue is generally higher in the second and third quarters than in the first and fourth quarters.

Like most airlines, the Group is subject to a high degree of financial and operating leverage. A significant percentage of the Group’s operating expenses isare fixed costs that do not vary proportionally based on the Group’s yields or the load factors. These fixed costs include depreciation expense, jet fuel costs, landing and navigation fees, financing costs, operating lease payments, aircraft maintenance costs and labor for flight crew, cabin crew and ground personnel. Thus, a minor change in the Group’s yields or load factors would have a material effect on the Group’s results of operations. In addition, certain of these expenses, primarily financing costs and operating lease payments, labor costs and depreciation do not vary based on the number of flights flown. Thus, the Group’s operating results can also be substantially affected by minor changes in aircraft utilization rates. The Group is and will continue to be highly leveraged with substantial obligations denominated in foreign currencies and, accordingly, the results of its operations are significantly affected by fluctuations in foreign exchange rates, particularly for the U.S. dollar and the Japanese yen. The Group recognized a net exchange lossgain of RMB175RMB1,220 million and RMB164RMB1,492 million in 20022005 and 2003,2006, respectively. These amounts represented mainly unrealized exchange differences resulting from the retranslation of the foreign currency borrowings.

32
A number of other external variables, including political and economic conditions in China, tend to have a major impact on the Group’s performance. The Group’s financial performance is also significantly affected by factors arising from operating in a regulated industry. As substantially all aspects of the Group’s airline operations are regulated by the PRC government, the Group’s operating revenues and expenses are directly affected by the PRC government’s policies with respect to domestic airfares,air fares, jet fuel prices and landing and navigation fees, among others. The nature and extent of airline competition and the ability of Chinese airlines to expand are also affected by CAAC’s control over route allocations. Any changes in the PRC government’s regulatory policies, or any implementation of such policies could have a significant impact on the Group’s future operations and its ability to implement its operating strategy.

Certain Financial Information and Operating Data by Geographic Region

The following table sets forth certain financial information and operating data by geographic region for the years ended December 31, 20022004, 2005 and 2003:2006:
             
  Year ended December 31,
 2003 vs. 2002
          % Increase/
  2002
 2003
 (Decrease)
Traffic
            
RPK (million)            
Domestic  22,092   21,294   (3.6)
Hong Kong regional  1,081   778   (28.0)
International  5,767   4,315   (25.2)
Total  28,940   26,387   (8.8)
RTK (million)            
Domestic  2,532   2,424   (4.3)
Hong Kong regional  108   78   (27.8)
International  974   1,059   8.7 
Total  3,614   3,561   (1.5)
RTK (million)            
Passenger ton kilometers  2,584   2,356   (8.8)
Cargo and mail ton kilometers  1,030   1,205   17.0 
Total  3,614   3,561   (1.5)

32

 
 
 
Year ended
December 31, 
 
2005 vs. 2004
% increase/ 
 
2006 vs. 2005
% increase/ 
 
  
2004 
 
2005
 
2006
 
(decrease) 
 
(decrease) 
 
Traffic
           
RPK (million)
Domestic
  29,121  51,472  58,128  76.8  12.9 
Hong Kong and Macau  1,203  1,549  1,541  28.8  (0.5)
International  6,872  8,902  9,913  29.5  11.4 
Total  37,196  61,923  69,582  66.5  12.4 
RTK (million)                
Domestic  3,206  5,571  6,226  73.8  11.8 
Hong Kong and Macau  120  159  156  32.5  (1.9)
International  1,337  1,554  1,689  16.2  8.7 
Total  4,663  7,284  8,071  56.2  10.8 
Passengers carried (thousand)                
Domestic  25,002  39,545  44,225  58.2  11.8 
Hong Kong and Macau  1,394  1,556  1,545  11.6  (0.7)
International  1,811  3,018  3,436  66.6  13.9 
Total  28,207  44,119  49,206  56.4  11.5 
Cargo and mail carried (thousand tons)                
Domestic  442  639  674  44.6  5.5 
Hong Kong and Macau  15  19  16  26.7  (15.7)
International  88  117  129  33.0  10.4 
Total  545  775  819  42.2  5.7 

 
 
 
Year ended
December 31,
 
2005 vs. 2004
% increase/ 
 
2006 vs. 2005
% increase/ 
 
  
2004
 
2005
 
2006
 
(decrease) 
 
(decrease) 
 
Capacity
           
ASK (million)
Domestic
  41,330  72,107  79,773  74.5  10.6 
Hong Kong and Macau  1,896  2,656  2,459  40.1  (7.4)
International  10,543  13,598  14,827  29.0  9.0 
Total  53,769  88,361  97,059  64.3  9.8 
ATK (million)
Domestic
  4,773  8,352  9,311  75.0  11.5 
Hong Kong and Macau  211  315  289  49.3  (8.3)
International  2,462  2,842  3,056  15.4  7.5 
Total  7,446  11,509  12,656  54.6  10.0 
Load Factors
                
Passenger load factor (RPK/ASK) (%)                
Domestic  70.5  71.4  72.9  1.3  2.1 
Hong Kong and Macau  63.4  58.3  62.7  (8.0) 7.5 
International  65.2  65.5  66.9  0.5  2.1 
Overall  69.2  70.1  71.7  1.3  2.3 
Overall load factor (RTK/ATK) (%)                
Domestic  67.2  66.7  66.9  (0.7) 0.3 
Hong Kong and Macau  56.9  50.4  53.8  (11.4) 7.1 
International  54.3  54.7  55.3  0.7  1.1 
Overall  62.6  63.3  63.8  1.1  0.8 
Yield
                
Yield per RPK (RMB)                
Domestic  0.58  0.55  0.59  (5.2) 7.8 
Hong Kong and Macau  0.92  0.77  0.80  (16.3) 3.8 
International  0.46  0.56  0.62  21.7  10.7 
Overall  0.57  0.55  0.60  (3.5) 9.1 
Yield per RTK (RMB)                
Domestic  5.53  5.30  5.74  (4.2) 8.3 
Hong Kong and Macau  9.83  8.18  8.52  (16.8) 4.2 
International  3.31  4.24  4.77  28.1  12.5 
Overall  5.01  5.14  5.59  2.6  8.8 
Financial-IFRS
                
Passenger revenue (RMB million)                
Domestic  16,869  28,182  34,174  67.1  21.3 
Hong Kong and Macau  1,104  1,194  1,230  8.2  3.0 
International  3,127  4,952  6,145  58.4  24.1 
Total  21,100  34,328  41,549  62.7  21.0 
Cargo and mail revenue (RMB million)  2,244  3,091  3,538  37.7  14.5 
Financial-U.S. GAAP
                
Passenger revenue (RMB million)                
Domestic  24,773  28,182  34,174  13.8  21.3 
Hong Kong and Macau  1,151  1,194  1,230  3.7  3.0 
International  4,519  4,952  6,145  9.6  24.1 
Total  30,443  34,328  41,549  12.8  21.0 
Cargo and mail revenue (RMB million)  2,792  3,091  3,538  10.7  14.5 
33

             
  Year ended December 31,
 2003 vs. 2002
          % Increase/
  2002
 2003
 (Decrease)
Passengers carried (thousand)            
Domestic  18,535   18,259   (1.5)
Hong Kong regional  1,369   1,019   (25.6)
International  1,589   1,192   (25.0)
Total  21,493   20,470   (4.8)
Cargo and mail carried (thousand tons)            
Domestic  404   379   (6.2)
Hong Kong regional  14   12   (14.3)
International  52   73   40.4 
Total  470   464   (1.3)
Capacity
            
ASK (million)            
Domestic  33,753   32,590   (3.4)
Hong Kong regional  1,746   1,347   (22.9)
International  8,746   6,930   (20.8)
Total  44,245   40,867   (7.6)
ATK (million)            
Domestic  3,924   3,772   (3.9)
Hong Kong regional  193   150   (22.3)
International  1,798   1,999   11.2 
Total  5,915   5,921   0.1 
Load Factors
            
Passenger load factor (RPK/ASK) (%)            
Domestic  65.5   65.3   (0.3)
Hong Kong regional  61.9   57.8   (6.6)
International  65.9   62.3   (5.5)
Overall  65.4   64.6   (1.2)
Overall load factor (RTK/ATK) (%)            
Domestic  64.5   64.2   (0.5)
Hong Kong regional  55.8   52.2   (6.5)
International  54.2   53.0   (2.2)
Overall  61.1   60.1   (1.6)
Yield
            
Yield per RPK (RMB)            
Domestic  0.55   0.57   3.6 
Hong Kong regional  0.98   0.96   (2.0)
International  0.42   0.47   11.9 
Overall  0.54   0.57   5.6 
Yield per RTK (RMB)            
Domestic  5.21   5.40   3.6 
Hong Kong regional  10.36   10.35   (0.1)
International  3.25   2.90   (10.8)
Overall  4.84   4.76   (1.7)
Financial
            
Passenger revenue (RMB million)            
Domestic  12,234   12,242   0.1 
Hong Kong regional  1,055   750   (28.9)
International  2,407   2,018   (16.2)
Total  15,696   15,010   (4.4)
Cargo and mail revenue (RMB million)  1,786   1,955   9.5 

33

Operating Results

The historical results of operations discussed below may not be indicative of the Group’s future operating performance. In addition to the factors discussed under “Overview” above, the Group’s future operations will be affected by, among other things, changes in the aviation market, the cost of jet fuel, aircraft acquisition and leasing costs, aircraft maintenance expenses, take-off and landing charges, wages, salaries and benefits and other operating expenses, foreign exchange rates and the rates of income taxes paid.

     2003

34
2006 Compared with 2002

2005

The Group recorded a net lossprofit for 2006 attributable to equity shareholders of RMB358the Company was RMB126 million, for 2003, as compared to a net incomeloss of RMB576RMB1,786 million for 2002.2005. The scale of operations increased as a result of continued growth in China’s economy and strong demand in air transportation. The Group’s operating revenue decreasedincreased by RMB549RMB7,926 million or 3.0%20.7% from RMB18,019RMB38,293 million in 20022005 to RMB17,470RMB46,219 million in 2003.2006. Passenger load factor decreasedincreased by 0.81.6 percentage pointpoints from 65.4%70.1% in 20022005 to 64.6%71.7% in 2003.2006. Passenger yield (in passenger revenue per RPK) increased by 5.6% from RMB0.54 in 20029.1% to RMB0.57 in 2003.RMB 0.60. Average yield (in traffic revenue per RTK) decreasedincreased by 1.7%8.8% from RMB4.84RMB 5.14 in 20022005 to RMB4.76RMB 5.59 in 2003.2006. Operating expenses increased by RMB1,021RMB 6,455 million or 6.4%16.3% from RMB15,993RMB39,525 million in 20022005 to RMB17,014RMB45,980 million in 2003.2006. As operating revenue decreased while operating expenses increased,a result of improved passenger load factor and average yield, operating profit decreased by 77.5% from RMB2,026was RMB239 million in 20022006 as compared to RMB456an operating loss of RMB1,232 million in 2003.2005. The Group’s net non-operating expenses increased by 9.1%, from RMB887income was RMB45 million in 20022006 as compared to RMB967a net non-operating expense of RMB548 million in 2003,2005. The improvement in non-operating results was mainly dueattributable to a decreasethe increase in exchange gain of RMB272 million, an increase in share of results of associates and jointly controlled entities of RMB369 million and an increase in gain on disposal of fixed assetsproperty, plant and equipment of RMB193 million,RMB367 million. The increase in net operating income was partly offset by a decreasethe increase in interest expense of RMB135RMB 454 million. Overall, the Group recorded a net loss of RMB358 million in 2003, as compared to a net profit of RMB576 million in 2002.

Operating Revenue

revenue

Substantially all of the Group’s operating revenue is attributable to airline and airline related operations. Traffic revenue in 2003 and 2002 accounted for 97.1%97.6% and 97.0% respectively97.7% of total operating revenue.revenue in 2006 and 2005, respectively. Passenger revenue and, cargo and mail revenue accounted for 88.5%92.2% and 11.5%7.8%, respectively, of total traffic revenue in 2003.2006. The other operating revenue is mainly derived from commission income, income from general aviation operations, fees charged for ground services rendered to other Chinese airlines and air catering services.
The increase in operating revenue was primarily due to a 21.0% rise in passenger revenue from RMB34,328 million in 2005 to RMB41,549 million in 2006 resulting from increased traffic volume. The total number of passengers carried increased by 11.5 % to 49.21 million passengers in 2006.
Passenger yield increased slightly by RMB0.05. RPKs increased by 12.4% from 61,923 million in 2005 to 69,582 million in 2006, primarily as a result of the increase in passengers carried.
Domestic passenger revenue, which accounted for 82.2% of the total passenger revenue in 2006, increased by 21.3% from RMB28,182 million in 2005 to RMB34,174 million in 2006. Domestic passenger traffic in RPKs increased by 12.9%, mainly due to an increase in passengers carried. Domestic passenger yield increased from RMB0.55 in 2005 to RMB 0.59 in 2006.
Hong Kong and Macau passenger revenue, which accounted for 3.0% of total passenger revenue, increased by 3.0% from RMB1,194 million in 2005 to RMB1,230 million in 2006. For Hong Kong and Macau flights, passenger traffic in RPKs decreased slightly by 0.5%, while passenger capacity in ASKs decreased by 7.4%, resulting in a 4.4 percentage point increase in passenger load factor from 2005. Passenger yield increased from RMB0.77 in 2005 to RMB0.80 in 2006 mainly due to higher ticket price as a result of soaring jet fuel cost.
International passenger revenue, which accounted for 14.8 % of total passenger revenue, increased by 24.1% from RMB 4,952 million in 2005 to RMB6,145 million in 2006. For international flights, passenger traffic in RPKs increased by 11.4%, while passenger capacity in ASKs increased by 9.0%, resulting in a 1.4 percentage point rise in passenger load factor from 2005. Passenger yield increased by 10.7% from RMB0.56 in 2005 to RMB0.62 in 2006 mainly due to the continued growth of demand in international flights in the PRC.
Cargo and mail revenue, which accounted for 7.8% of the Group’s total traffic revenue and 7.7% of total operating revenue, increased by 14.5% from RMB3,091 million in 2005 to RMB3,538 million in 2006. The increase was attributable to the increasing traffic demand.
Other operating revenue increased by 29.5 % from RMB874 million in 2005 to RMB1,132 million in 2006. The increase was primarily due to the general growth in income from various auxiliary operations.
Operating expenses
Total operating expenses in 2006 amounted to RMB45,980 million, representing an increase of 16.3% or RMB6,455 million over 2005, primarily due to the total effect of increases in jet fuel costs, maintenance expenses and aircraft and traffic servicing expenses. Total operating expenses as a percentage of total operating revenue decreased from 103.2 % in 2005 to 99.5% in 2006.
Flight operations expenses, which accounted for 53.6% of total operating expenses, increased by 27.2% from RMB19,394 million in 2005 to RMB24,667 million in 2006, primarily as a result of increases in jet fuel costs, operating lease payments, catering expenses and labour costs for flight personnel. Jet fuel costs, which accounted for 65.6% of flight operations expenses, increased by 35.7 % from RMB11,929 million in 2005 to RMB16,193 million in 2006 mainly as a result of increased fuel prices and fuel consumption. Operating lease payments increased by 21.2 % from RMB2,497 million in 2005 to RMB3,027 million in 2006 primarily due to the additional rental payments for new aircraft under operating leases. Catering expenses increased by 4.0% from RMB1,196 million in 2005 to RMB1,244 million in 2006 due to the increase in number of passengers carried. Labour costs for flight personnel increased by 5.9% from RMB1,619 million in 2005 to RMB1,714 million in 2006, largely due to the increase in flying hours and allowance standard. CAAC Infrastructure Development Fund Contributions increased by 15.2% from RMB978 million in 2005 to RMB1,127 million in 2006. 
35
Maintenance expenses which accounted for 8.9% of total operating expenses, increased by 0.6% from RMB4,051 million in 2005 to RMB4,077 million in 2006.
Aircraft and traffic servicing expenses, which accounted for 13.5% of total operating expenses, increased by 8.0% from RMB 5,759 million in 2005 to RMB6,219 million in 2006. The increase primarily resulted from a 6.7 % rise in landing and navigation fees from RMB4,891 million in 2005 to RMB5,220 million in 2006, due to an increase in the number of landings and takeoffs.
Promotional and marketing expenses, which accounted for 6.1% of total operating expenses, increased by 1.1% from RMB2,780 million in 2005 to RMB2,811 million in 2006.
General and administrative expenses, which accounted for 6.8% of the total operating expenses, increased by 27.8% from RMB2,457 million in 2005 to RMB3,140 million in 2006. This was mainly attributable to increased scale of operations and a provision for early retirement benefits of RMB 392 million in 2006.
Depreciation and amortisation, which accounted for 10.8% of total operating expenses, increased by 1.2% from RMB4,905 million in 2005 to RMB4,966 million in 2006, mainly resulting from the additional depreciation charge on aircraft delivered in 2005 and 2006.
Operating profit/(loss)
The Group recorded an operating profit of RMB239 million in 2006 as compared to an operating loss of RMB1,232 million in 2005. The gain was mainly due to an increase in operating revenue by RMB7,926 million or 20.7% in 2006 while operating expenses increased by RMB6,455 million or 16.3% in the same period.
Non-operating income/(expenses)
Interest expense increased by 28.1% from RMB1,616 million in 2005 to RMB2,070 million in 2006, mainly due to the increase in loans and lease obligations and changes in interest rates. Interest income decreased by 25.5% from RMB55 million in 2005 to RMB41 million in 2006, mainly attributable to the decrease in average bank balances in 2006.
Net exchange gain increased by 22.3% from RMB1,220 million in 2005 to RMB1,492 million in 2006, mainly resulting from Renminbi appreciation during 2006. Such amount mainly represents unrealised translation gain on re-translation of foreign currency denominated liabilities at the end of fiscal year.

Net gain on disposal of property, plant and equipment was RMB335 million in 2006 as compared to a net loss on disposal of property, plant and equipment of RMB32 million in 2005. The gain in 2006 was mainly due to the disposal of three Boeing 757-200 aircrafts to independent third parties.
Taxation

Income tax expense increased from RMB4 million in 2005 to RMB142 million in 2006. This is mainly attributable to the improved financial performance of the Group and the increase in non-deductible salaries and welfare.
2005 Compared with 2004
The Group recorded a net loss of RMB1,786 million attributable to equity shareholders for 2005, as compared to a net loss of RMB48 million attributable to equity shareholders for 2004. The loss was mainly due to the increased in scale of operations as a result of the acquisition of the airline operations and related assets of CNA and XJA on December 31, 2004. The Group’s operating revenue increased by RMB 14,319 million or 59.7% from RMB23,974 million in 2004 to RMB38,293 million in 2005. Passenger load factor increased by 0.9 percentage point from 69.2% in 2004 to 70.1% in 2005. Passenger yield (in passenger revenue per RPK) decreased slightly by 3.5% to RMB0.55. Average yield (in traffic revenue per RTK) increased by 2.6% from RMB5.01 in 2004 to RMB5.14 in 2005. Operating expenses increased by RMB16,460 million or 71.4% from RMB23,065 million in 2004 to RMB39,525 million in 2005. As operating revenue increased less than operating expenses, operating profit decreased by 235.5% from operating profit of RMB909 million in 2004 to operating loss of RMB1,232 million in 2005. The Group’s net non-operating expenses decreased by 20.5%, from RMB689 million in 2004 to RMB548 million in 2005, mainly attributable to the combined effect of the increase in exchange gain of RMB1,279 million, increase in interest expense of RMB925 million and a decrease in share of results of associates of RMB295 million. 
Operating revenue
Substantially all of the Group’s operating revenue is attributable to airline and airline related operations. Traffic revenue in 2005 and 2004 accounted for 97.7% and 97.4%, respectively, of total operating revenue. Passenger revenue, cargo and mail revenue accounted for 91.7% and 8.3%, respectively, of total traffic revenue in 2005. The balance of the Group’s operating revenue is derived from commission income, income from general aviation operations, fees charged for ground services rendered to other Chinese airlines and for air catering services and net income from lease arrangements.

services.

36
Operating revenue decreasedincreased by 3.0%59.7% from RMB18,019RMB23,974 million in 20022004 to RMB17,470RMB38,293 million in 2003.2005. This decreaseincrease was primarily due to a 4.4% fall62.7% increase in passenger revenue from RMB15,696RMB21,100 million in 20022004 to RMB15,010RMB34,328 million in 20032005 resulting from lowerincreased traffic volume. Due to the continued growth in domestic economic conditions, the aviation traffic volume caused by SARS.in China attained a new high record in 2005. The total number of passengers carried decreasedincreased by 4.8%56.4% to 20.544.12 million passengers in 2003. RPKs decreasedand the ASKs increased by 8.8% from 28,94064.3% to 88,361 million in 20022005. The increase in 2005 compared to 26,3872004 was attributable to the general increasing traffic demand in the PRC airline market and deliveries of 108 aircraft during 2005 which lead to an increase in passenger capacity of 68.1%. Passenger yield decreased slightly by RMB0.02. RPKs increased by 66.5% from RMB37,196 million in 2003,2004 to RMB61,923 million in 2005, primarily as a result of a decreasean increase in passengers carried. However, passenger yield increased by 5.6% from RMB0.54 in 2002 to RMB0.57 in 2003, mainly as the result of the exemption of CAAC Infrastructure Development Fund and sales tax during the period from May 1, 2003 to December 31, 2003.

Domestic passenger revenue, which accounted for 81.6%82.1% of the total passenger revenue in 2003,2005, increased slightly by 0.1%67.1% from RMB12,234RMB16,869 million in 20022004 to RMB12,242RMB28,182 million in 2003.2005. Domestic passenger traffic in RPKs decreasedincreased by 3.6%76.8%, mainly due to a decreasean increase in passengers carried. Passenger yield however, increased fromdecreased slightly by RMB0.02 to RMB0.55 in 2002 to RMB0.57 in 2003, mainly as the result of the aforesaid exemption of CAAC Infrastructure Development Fund2005.
Hong Kong and sales tax.

     Hong KongMacau passenger revenue, which accounted for 5.0%3.5% of total passenger revenue, decreasedincreased by 28.9%8.2% from RMB1,055RMB1,104 million in 20022004 to RMB750RMB1,194 million in 2003.2005. For Hong Kong and Macau flights, passenger traffic in RPKs increased by 28.8%, while passenger capacity in ASKs increased by 40.1%, resulting in a 5.1 percentage point decrease in passenger load factor from 2004. Passenger yield decreased from RMB0.92 in 2004 to RMB0.77 in 2005 mainly due to intensified competition among airlines.

International passenger revenue, which accounted for 14.4% of total passenger revenue, increased by 58.4% from RMB 3,127 million in 2004 to RMB4,952 million in 2005. For international flights, passenger traffic in RPKs increased by 29.5%, while passenger capacity in ASKs increased by 29.0%, resulting in a 0.3 percentage point increase in passenger load factor from 2004. Passenger yield increased by 21.7% from RMB0.46 in 2004 to RMB0.56 in 2005 mainly resulted from higher ticket price and the increase in traffic derived from short haul routes which generally had a higher yield than long haul routes.
Cargo and mail revenue, which accounted for 8.3% of the Group’s total traffic revenue and 8.1% of total operating revenue, increased by 37.7% from RMB2,224 million in 2004 to RMB3,091 million in 2005. The increase was attributable to the increased in traffic demand.
Other operating revenue increased by 38.7% from RMB630 million in 2004 to RMB874 million in 2005. The increase was primarily due to the general growth in income from various auxiliary operations.
Operating expenses
Total operating expenses in 2005 amounted to RMB39,525 million, representing an increase of 71.4% or RMB16,460 million over 2004, primarily due to the combined effect of increases in jet fuel costs, maintenance expenses and aircraft and traffic servicing expenses. Total operating expenses as a percentage of total operating revenue increased from 96.2% in 2004 to 103.2% in 2005.
Flight operations expenses, which accounted for 49.1% of total operating expenses, increased by 86.2% from RMB10,418 million in 2004 to RMB19,394 million in 2005, primarily as a result of increases in jet fuel costs, operating lease payments, catering expenses, labour costs for flight personnel. Jet fuel costs, which accounted for 61.5% of flight operations expenses, increased by 97.2% from RMB 6,050 million in 2004 to RMB11,929 million in 2005 mainly as a result of increased fuel prices and fuel consumption. Operating lease payments increased by 50.0% from RMB1,665 million in 2004 to RMB2,497 million in 2005, primarily due to the additional rental payments for new aircraft under operating leases. Catering expenses increased by 69.6% from RMB705 million in 2004 to RMB1,196 million in 2005, primarily due to increased passenger carried. Aircraft insurance costs decreased by 43.2% from RMB185 million in 2004 to RMB105 million in 2005, primarily because of a decrease in insurance premiums in 2005. Labour costs for flight personnel increased by 57.8% from RMB1,026 million in 2004 to RMB1,619 million in 2005, largely due to the increase in flying hours and allowance standard.
Maintenance expenses which accounted for 10.2% of total operating expenses, increased by 17.1% from RMB3,459 million in 2004 to RMB4,051 million in 2005. The increase was primarily attributable to the fleet expansion in recent years.
Aircraft and traffic servicing expenses, which accounted for 14.6% of total operating expenses, increased by 64.4% from RMB3,503 million in 2004 to RMB5,759 million in 2005. The increase primarily resulted from 51.8% increase in landing and navigation fees from RMB3,222 million in 2004 to RMB4,891 million in 2005, due to an increase in number of landing and takeoffs.
Promotional and marketing expenses, which accounted for 7.0% of total operating expenses, increased by 43.3% from RMB1,940 million in 2004 to RMB2,780 million in 2005. The increase was mainly resulted from the increase in sales volume, resulting in a 41.5% increase in sales commission expenses from RMB1,062 million in 2004 to RMB1,503 million in 2005.
General and administrative expenses, which accounted for 6.2% of the total operating expenses, increased by 85.7% from RMB1,323 million in 2004 to RMB2,457 million in 2005. This was mainly attributable to increased scale of operations.
Depreciation and amortisation, which accounted for 12.4% of total operating expenses, increased by 103.3% from RMB 2,413 million in 2004 to RMB4,905 million in 2005. This increase was primarily as a result of the additional depreciation charge on aircraft delivered in 2004 and 2005.
37
Operating (loss) / profit
The Group recored an operating loss of RMB1,232 million in 2005 as compared to an operating profit of RMB909 million in 2004. This was mainly because an increase in operating revenue by RMB14,319 million or 59.7% in 2005 while operating expenses increased by RMB16,460 million or 71.4% in the same period.
Non-operating income/(expenses)
Interest expense increased by 133.9% from RMB691 million in 2004 to RMB1,616 million in 2005, mainly due to the increase in loans, lease obligations and interest rate.
Interest income increased by 150.0% from RMB22 million in 2004 to RMB55 million in 2005. It was mainly attributable to an increase in interest rate.

During 2005, the Group recorded a net exchange gain of RMB1,220 million (2004: Net exchange loss of RMB59 million) mainly resulted from Renminbi appreciation since July 2005. Such amount represents mainly unrealised translation exchange gain, resulting from exchange gains on translated year end foreign currency denominated liabilities, rather than foreign exchange transactions incurred during the year.
Taxation

In 2005, the Group recorded an income tax expenses of RMB4 million resulting from recognition of RMB159 million deferred tax assets in respect of a portion of tax losses. In 2004, income tax expenses of RMB65 miilion were recorded.
Additional information under U.S. GAAP
2006 Compared with 2005
The net income for 2006 is RMB216 million, as compared to a loss of RMB1,468 million for 2005. The scale of operations increased as a result of continued growth in China’s economy and strong demand in air transportation. The Group’s operating revenue increased by RMB7,926 million or 20.7% from RMB38,293 million in 2005 to RMB46,219 million in 2006. Passenger load factor increased by 1.6 percentage points from 70.1% in 2005 to 71.7% in 2006. Passenger yield (in passenger revenue per RPK) increased by 9.1% to RMB0.60. Average yield (in traffic revenue per RTK) increased by 8.8% from RMB5.14 in 2005 to RMB5.59 in 2006. Operating expenses increased by RMB 6,201 million or 15.8% from RMB39,312 million in 2005 to RMB45,513 million in 2006. As a result of improved passenger load factor and average yield, operating profit was RMB706 million in 2006 as compared to an operating loss of RMB1,019 million in 2005. The Group’s net non-operating expense decreased by RMB178 million or 36.9% from RMB482 million in 2005 to RMB304 million in 2006. The decrease was mainly attributable to the combined effect of increase in exchange gain of RMB272 million, increase in interest expense of RMB481 million, increase in share of results of affiliated companies and jointly controlled entities of RMB348 million.
Operating revenue
Substantially all of the Group’s operating revenue is attributable to airline and airline related operations. Traffic revenue accounted for 97.6 % and 97.7 % of total operating revenue in 2006 and 2005 respectively. Passenger revenue and, cargo and mail revenue accounted for 92.2% and 7.8% of total traffic revenue in 2006 respectively. The other operating revenue is mainly derived from commission income, income from general aviation operations, fees charged for ground services rendered to other Chinese airlines and air catering services.
The increase in opearating revenue was primarily due to a 21.0% rise in passenger revenue from RMB 34,328 million in 2005 to RMB41,549 million in 2006 resulting from increased traffic volume. The total number of passengers carried increased by 11.5% to 49.21 million passengers. RPKs increased by 12.4% from RMB61,923 million in 2005 to RMB69,582 million in 2006, primarily as a result of the increase in passengers carried. Passenger yield increased by RMB0.05.
Domestic passenger revenue, which accounted for 82.2% of the total passenger revenue in 2006, increased by 21.3% from RMB28,182 million in 2005 to RMB34,174 million in 2006. Domestic passenger traffic in RPKs increased by 12.9%, mainly due to an increase in passengers carried. Domestic passenger yield increased from RMB0.55 to RMB0.59 in 2006.
38
Hong Kong and Macau passenger revenue, which accounted for 3.0% of total passenger revenue, increased by 3.0% from RMB1,194 million in 2005 to RMB1,230 million in 2006. For Hong Kong and Macau flights, passenger traffic in RPKs decreased slightly by 28.0%0.5%, while passenger capacity in ASKs decreased by 22.9%7.4%, resulting in a 4.14.4 percentage point increase in passenger load factor from 2005. Passenger yield increased from RMB0.77 in 2005 to RMB0.80 in 2006 mainly due to higher ticket price as a result of soaring jet fuel cost.
International passenger revenue, which accounted for 14.8% of total passenger revenue, increased by 24.1% from RMB4,952 million in 2005 to RMB6,145 million in 2006. For international flights, passenger traffic in RPKs increased by 11.4%, while passenger capacity in ASKs increased by 9.0%, resulting in a 1.4 percentage point rise in passenger load factor from 2005. Passenger yield increased by 10.7% from RMB0.56 in 2005 to RMB0.62 in 2006 mainly resulting from the continued growth in demand for international flights in PRC.
Cargo and mail revenue, which accounted for 7.8% of the Group’s total traffic revenue and 7.7% of total operating revenue, increased by 14.5% from RMB3,091 million in 2005 to RMB3,538 million in 2006. The increase was attributable to the increased in traffic demand.
Other operating revenue increased by 29.5% from RMB874 million in 2005 to RMB1,132 million in 2006. The increase was primarily due to the general growth in income from various auxiliary operations.
Operating expenses
Total operating expenses in 2006 amounted to RMB45,513 million, representing an increase of 15.8% or RMB6,201 million over 2005, primarily due to the total effect of increases in jet fuel costs, maintenance expenses and aircraft and traffic servicing expenses. Total operating expenses as a percentage of total operating revenue decreased from 102.7% in 2005 to 98.5% in 2006.
Flight operations expenses, which accounted for 54.0% of total operating expenses, increased by 28.1% from RMB19,183 million in 2005 to RMB24,574 million in 2006, primarily as a result of increases in jet fuel costs, operating lease payments, catering expenses and labour costs for flight personnel. Jet fuel costs, which accounted for 65.9% of flight operations expenses, increased by 35.7% from RMB11,929 million in 2005 to RMB16,193 million in 2006 mainly as a result of increased fuel prices and fuel consumption. Operating lease payments increased by 34.5% from RMB2,375 million in 2005 to RMB3,194 million in 2006 primarily due to the additional rental payments for new aircraft under operating leases. Catering expenses increased by 4.0% from RMB1,196 million in 2005 to RMB1,244 million in 2006 due to the increase in number of passengers carried. Labour costs for flight personnel increased by 5.9% from RMB1,619 million in 2005 to RMB1,714 million in 2006, largely due to the increase in flying hours and allowance standard. CAAC Infrastructure Development Fund Contributions increased by 15.2% from RMB978 million in 2005 to RMB1,127 million in 2006.
Maintenance expenses which accounted for 9.0% of total operating expenses, increased by 0.6% from RMB4,051 million in 2005 to RMB4,077 million in 2006.
Aircraft and traffic servicing expenses, which accounted for 13.7% of total operating expenses, increased by 8.0% from RMB 5,759 million in 2005 to RMB6,219 million in 2006. The increase primarily resulted from a 6.7% rise in landing and navigation fees from RMB4,891 million in 2005 to RMB5,220 million in 2006, due to an increase in number of landing and takeoffs.
Promotional and marketing expenses, which accounted for 6.2% of total operating expenses, increased by 1.1% from RMB2,780 million in 2005 to RMB2,811 million in 2006.
General and administrative expenses, which accounted for 6.2% of the total operating expenses, increased by 14.2% from RMB2,457 million in 2005 to RMB2,805 million in 2006. This was mainly attributable to increased scale of operations and retirement benefits in 2006.
Depreciation and amortisation, which accounted for 10.8% of total operating expenses, increased by 1.1% from RMB4,871 million in 2005 to RMB4,927 million in 2006, mainly resulting from the additional depreciation charge on aircraft delivered in 2005 and 2006.
Operating income/(loss)
The Group recorded an operating income of RMB706 million in 2006 as compared to an operating loss of RMB1,019 million in 2005. It was mainly due to the operating revenue increased by RMB7,926 million or 20.7% in 2006 while operating expenses increased by RMB6,201 million or 15.8% in the same period.
Non-operating income/(expenses)
Interest expense increased by 30.3% from RMB1,589 million in 2005 to RMB2,070 million in 2006, mainly due to the increase in loans and interest rate. Interest income decreased by 25.5% from RMB55 million in 2005 to RMB41 million in 2006, mainly attributable to the decrease in average bank balances in 2006.
Net exchange gain increased by 22.3% from RMB1,220 million in 2005 to RMB1,492 million in 2006, mainly resulting from Renminbi appreciation during 2006. Such amount mainly represents unrealised translation gain on re-translation of foreign currency denominated liabilities at the end of the year.
39
Taxation

Income tax expense for the year amounted to RMB170 million as compared to an income tax benefit of RMB35 million in 2005. This is mainly attributable to the improved financial performance of the Group.
2005 Compared with 2004
The Group recorded a loss of RMB1,468 million attributable to equity shareholders for 2005, as compared to a income of RMB239 million attributable to equity shareholders for 2004. The loss was mainly due to the increased in scale of operations as a result of acquisition of the airline operations and related assets of CNA and XJA on December 31, 2004. The Group’s operating revenue increased by RMB4,128 million or 12.1% from RMB34,165 million in 2004 to RMB38,293 million in 2005. Passenger load factor increased by 0.9 percentage point from 69.2% in 2004 to 70.1% in 2005. Passenger yield (in passenger revenue per RPK) decreased by 3.5% to RMB0.55. Average yield (in traffic revenue per RTK) increased by 2.6% from RMB5.01 in 2004 to RMB5.14 in 2005. Operating expenses increased by RMB7,024 million or 21.8% from RMB32,288 million in 2004 to RMB39,312 million in 2005. As operating revenue increased smaller than operating expenses, operating income decreased by 154.3% from operating profit of RMB1,877 million in 2004 to operating loss of RMB1,019 million in 2005. The Group’s net non-operating expenses decreased by 59.3%, from RMB1,184 million in 2004 to RMB482 million in 2005, mainly attributable to the combined effect of increase in exchange gain of RMB1,344 million, increase in interest expense of RMB405 million and a decrease in share of results of associates of RMB295 million.
Operating revenue
Substantially all of the Group’s operating revenue is attributable to airline and airline related operations. Traffic revenue in 2005 and 2004 accounted for 97.7% and 97.3% respectively of total operating revenue. Passenger revenue and cargo and mail revenue accounted for 91.7% and 8.3% respectively of total traffic revenue in 2005. Passenger revenue and cargo and mail revenue accounted for 91.6% and 8.4% respectively of total traffic revenue in 2004. The balance of the Group’s operating revenue is derived from commission income, income from general aviation operations, fees charged for ground services rendered to other Chinese airlines and air catering services.
Operating revenue increased by 12.1% from RMB34,165 million in 2004 to RMB38,293 million in 2005. This increase was primarily due to a 12.8% increase in passenger revenue from RMB30,443 million in 2004 to RMB34,328 million in 2005 resulting from increased traffic volume. The total number of passengers carried increased by 14.0% to 44.12 million passengers in 2005 and the ASKs increased by 14.3% to 88,361 million in 2005. The increase in 2005 compared to 2004 was attributable to the general increasing traffic demand in the PRC airline market and deliveries of 30 aircraft during 2005 which caused an increase in passenger capacity of 12.4%. RPKs increased by 16.3% from 53,233 million in 2004 to RMB61,923 million in 2005, primarily as a result of an increase in passengers carried. Passenger yield decreased by RMB0.02 to RMB0.55.
Domestic passenger revenue, which accounted for 82.1% of the total passenger revenue in 2005, increased by 13.8% from RMB24,773 million in 2004 to RMB28,182 million in 2005. Domestic passenger traffic in RPKs increased by 17.8%, mainly due to an increase in passengers carried. Domestic passenger yield decreased by RMB0.02 to RMB0.55 in 2005.
Hong Kong and Macau passenger revenue, which accounted for 3.5% of total passenger revenue, increased by 3.7% from RMB1,151 million in 2004 to RMB1,194 million in 2005. For Hong Kong and Macau regional flights, passenger traffic in RPKs increased by 18.5%, while passenger capacity in ASKs increased by 26.5%, resulting in a 4.0 percentage point decrease in passenger load factor from 2002.2004. Passenger yield decreased from RMB0.98RMB0.88 in 20022004 to RMB0.96RMB0.77 in 20032005 mainly due to slack in traffic volume.

intensified competition among airlines.

International passenger revenue, which accounted for 13.4%14.4% of total passenger revenue, decreasedincreased by 16.2%9.6% from RMB2,407RMB4,519 million in 20022004 to RMB2,018RMB4,952 million in 2003.2005. For international flights, passenger traffic in RPKs decreasedincreased by 25.2%8.3%, while passenger capacity in ASKs decreasedincreased by 20.8%5.4%, resulting in a 3.61.8 percentage point fallrise in passenger load factor from 2002.2004. Passenger yield increased by 11.9%1.1% from RMB0.42RMB0.55 in 20022004 to RMB0.47RMB0.56 in 20032005 mainly asresulted from higher ticket price and the result of the aforesaid exemption of CAAC Infrastructure Development Fund and sales tax.

increases in traffic derived from short haul routes which generally had a higher yield than long haul routes.

Cargo and mail revenue, which accounted for 11.5%8.3% of the Group’s total traffic revenue and 11.1%8.1% of total operating revenue, increased by 9.5%10.7% from RMB1,786RMB2,792 million in 20022004 to RMB1,955RMB3,091 million in 2003.2005. The increase was primarily dueattributable to the full year effect of the opening of two international cargo routes to Los Angeles of the United States of America and Leige of Belgium in late 2002.

increasing traffic demand.

Other operating revenue decreased by 6.0% from RMB537RMB930 million in 20022004 to RMB505RMB874 million in 2003.2005. The decrease was primarily due to a decrease in aircraft short-term lease incomethe reduced scale of RMB46 million.

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other operations.

Operating Expenses

expenses

Substantially all of the Group’s operating expenses result from its airline operations. The vast majority of such expenses relate directly to flight operations, aircraft and traffic servicing, aircraft repair and maintenance and to depreciation and amortisation in respect of aircraft and flight equipment. Expenses associated directly with the Group’s flight operations (collectively, “flight operations expenses”) include fuel costs, operating lease payments, catering expenses, aircraft insurance, flight personnel payroll and welfare and training expenses. Expenses associated directly with repairs and maintenance in respect of the Group’s aircraft (collectively, “repairs and maintenance expenses”) include repairs and maintenance and overhaul charges, the costs of consumables and other maintenance materials and labour costs for maintenance personnel. Expenses associated directly with the Group’s aircraft and traffic servicing operations (collectively “aircraft and traffic servicing expenses”) include landing and navigation fees, rental payments and charges in respect of terminal and other ground facilities and labour costs for ground personnel. The balance of the Group’s operating expenses result from promotional and marketing activities (collectively, “promotional and marketing expenses”) such as sales commissions, fees for use of the CAAC’s reservation system, ticket-printing and sales office expenses, advertising and promotional expenses, and from general and administrative expenses, such as administrative salaries and welfare and other personnel benefits and office expenses.

expenses and from asset impairment charges.

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Total operating expenses in 20032005 amounted to RMB17,014RMB39,312 million, representing an increase of 6.4%21.8% or RMB1,021RMB7,024 million over 2002,2004, primarily due to the combined effect of increases in jet fuel costs, maintenance expenses and aircraft and traffic servicing expenses. Total operating expenses as a percentage of total operating revenue increased from 88.8%94.5% in 20022004 to 97.4%102.7% in 2003.

2005.

Flight operations expenses, which accounted for 41.6%48.8% of total operating expenses, increased by 5.0%27.8% from RMB6,733RMB15,016 million in 20022004 to RMB7,070RMB19,183 million in 2003,2005, primarily as a result of increases in jet fuel costs, and operating lease payments, partly offset by a decrease in catering expenses.expenses and labour costs for flight personnel. Jet fuel costs, which accounted for 54.7%62.2% of flight operations expenses, increased by 9.9%39.4% from RMB3,519RMB8,555 million in 20022004 to RMB3,867RMB11,929 million in 20032005 mainly as a result of increased jet fuel prices.prices and fuel consumption. Operating lease payments increased by 8.4%12.4% from RMB1,417RMB2,109 million in 20022004 to RMB1,536RMB2,375 million in 2003,2005, primarily due to the full year effect of the addition of new operating leases in respect of four Boeing 757-200 aircraft in late 2002 and four Airbus 319-100 aircraft and three Boeing 737-700 aircraft during 2003. Catering expenses decreased by 18.4% from RMB625 million in 2002 to RMB510 million in 2003, primarily reflecting a tighter cost controls exercised by the Group. Aircraft insurance costs decreased by 23.4% from RMB256 million in 2002 to RMB196 million in 2003, primarily because of a reduction in the rate of aircraft insurance premiums prescribed by the PRC insurance company. Labor costs for flight personnel decreased by 6.8% from RMB781 million in 2002 to RMB728 million in 2003, largely due to a decrease in flight hours.

     Maintenance expenses which accounted for 15.2% of total operating expenses, increased by 11.0% from RMB2,333 million in 2002 to RMB2,589 million in 2003. The increase was primarily attributable to an 11.3% increase in aircraft maintenance and repair charges from RMB2,135 million in 2002 to RMB2,377 million in 2003, mainly as the result of the effect of fleet expansion in recent years.

     Aircraft and traffic servicing expenses, which accounted for 16.3% of total operating expenses, increased by 10.2% from RMB2,511 million in 2002 to RMB2,767 million in 2003. The increase primarily resulted from an 8.9% rise in landing and navigation fees from RMB2,354 million in 2002 to RMB2,563 million in 2003, due to an increase in the charge rate for domestic landing and navigation fees effective September 2002.

     Promotional and marketing expenses, which accounted for 8.7% of total operating expenses, decreased by 1.3% from RMB1,500 million in 2002 to RMB1,480 million in 2003. The decrease was due to 9.3% decrease in labor costs from RMB248 million in 2002 to RMB225 million in 2003, as fewer bonuses were given because of reduced sales volume in 2003.

     General and administrative expenses, which accounted for 6.2% of the total operating expenses, decreased slightly by 0.7% from RMB1,060 million in 2002 to RMB1,053 million in 2003. This was mainly due to a decrease in scale of operations during SARS period.

     Depreciation and amortization, which accounted for 12.0% of total operating expenses, increased by 10.8% from RMB1,840 million in 2002 to RMB2,038 million in 2003. This increase was primarily as a result of the addition of aircraft during 2003.

Operating Income

     Operating income decreased by 77.5% from RMB2,026 million in 2002 to RMB456 million in 2003. This was mainly because operating revenue decreased by RMB549 million or 3.0% from 2002 while operating expenses increased by RMB1,021 million or 6.4% over the same period.

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Non-operating Income/(Expenses)

     Interest expense decreased by 14.1% from RMB959 million in 2002 to RMB824 million in 2003, mainly reflecting the combined effect of scheduled debt repayments and the replacement of certain RMB denominated bank loans with US$ denominated bank loans with lower interest rates.

     Interest income decreased by 75.2% from RMB53 million in 2002 to RMB13 million in 2003. This was mainly attributable to a decrease in average cash balances.

     The Group recorded a net loss on sale of fixed assets of RMB22 million in 2003, mainly resulting from retirement of two old Boeing 737-200 aircraft.

     During 2003, the Group recorded a net exchange loss of RMB164 million predominantly due to its Japanese yen denominated borrowings as a result of the Japanese yen appreciation. Such amount comprised mostly unrealized translation loss.

Taxation

     On October 17, 2003, the Company’s registered address was moved to Guangzhou Economic & Technology Development Zone. In accordance with the Rules and Regulations for Implementation of Income Tax for Foreign Investment Enterprises and Foreign Enterprises of the PRC and a taxation approval document “Guangzhou Municipal State Tax Bureau Suo De Shui Zi Que 020043”, the Company is entitled to enjoy the preferential tax policy implemented in the Guangzhou Economic & Technology Development Zone effective from October 1, 2003. As a result, the Company’s income tax rate has been changed to 15% from 33% beginning from that date.

     The Group recorded an income tax credit of RMB324 million for 2003 compared to an income tax expense of RMB398 million for 2002. As a result of the reduction in income tax rate, the Company’s net deferred taxation liability balance brought forward from December 31, 2002 of RMB507 million was reduced by RMB392 million and a net deferred tax credit of RMB392 million was recognized in 2003 for such reduction in income tax rate accordingly.

Minority Interests

     Minority interests increased by 3.6% from RMB165 million in 2002 to RMB171 million in 2003, primarily reflecting the net income earned by certain of the Group’s airline subsidiaries for the year.

     2002 Compared with 2001

     The Group recorded a net income of RMB576 million for 2002, as compared to a net income of RMB340 million for 2001. The Group’s operating revenue increased by RMB1,139 million or 6.7% from RMB16,880 million in 2001 to RMB18,019 million in 2002. Passenger load factor increased by 2.9 percentage points from 62.5% in 2001 to 65.4% in 2002. Passenger yield (in passenger revenue per RPK) decreased by 10.0% from RMB0.60 in 2001 to RMB0.54 in 2002. Average yield (in traffic revenue per RTK) decreased by 10.9% from RMB5.43 in 2001 to RMB4.84 in 2002. Operating expenses increased by RMB514 million or 3.3% from RMB15,479 million in 2001 to RMB15,993 million in 2002. As operating revenue increased more than operating expenses, operating profit increased by 44.7% from RMB1,401 million in 2001 to RMB2,026 million in 2002. The Group’s net non-operating expenses increased by 46.5%, from RMB605 million in 2001 to RMB887 million in 2002, mainly due to an unfavorable movement in exchange differences of RMB472 million, partly offset by a gain on disposal of four Boeing 757-200 aircraft of RMB199 million. Overall, the Group’s net income increased by 69.2%, from RMB340 million in 2001 to RMB576 million in 2002.

Operating Revenue

     Substantially all of the Group’s operating revenue is attributable to its airline operations. Traffic revenue in 2002 and 2001 accounted for 97.0% and 97.5% respectively of total operating revenue. Passenger revenue and, cargo and mail revenue accounted for 89.8% and 10.2% respectively of total traffic revenue in 2002. The balance of the Group’s operating revenue is derived from commission income, income from general aviation operations, fees charged for ground services rendered to other Chinese airlines that operate flights in and out of airports in Southern China (including the airports in Guangzhou, Shenzhen, Xiamen and Wuhan), air catering services and aircraft lease income.

     Operating revenue increased by 6.7% from RMB16,880 million in 2001 to RMB18,019 million in 2002. This increase was primarily due to a 4.3% rise in passenger revenue from RMB15,055 million in 2001 to RMB15,696 million in 2002 due to higher traffic volume. The total number of passengers carried increased by 12.4% to 21.49 million passengers in 2002. RPKs increased by 15.5% from 25,057 million in

36

2001 to 28,940 million in 2002, primarily as a result of an increase in passengers carried. However, passenger yield decreased by 10.0% from RMB0.60 in 2001 to RMB0.54 in 2002, mainly as a result of a fall in the average fares resulting from increased competition.

     Domestic passenger revenue, which accounted for 78.0% of total passenger revenue in 2002, increased by 1.4% from RMB12,068 million in 2001 to RMB12,234 million in 2002. For the Group’s domestic routes, passenger traffic in RPKs increased by 13.6%, while passenger capacity in ASKs increased by 7.5%, resulting in 3.6 percentage points increase in passenger load factor, or an increase of 5.8% from 2001. Passenger yield, however, decreased from RMB0.62 in 2001 to RMB0.55 in 2002 mainly as a result of increased competition among the PRC airlines.

     Hong Kong passenger revenue, which accounted for 6.7% of total passenger revenue, decreased by 6.5% from RMB1,128 million in 2001 to RMB1,055 million in 2002. For Hong Kong flights, passenger traffic in RPKs increased by 2.0%, while passenger capacity in ASKs increased by 3.3%, resulting in 0.8 percentage point decrease in passenger load factor, or a decrease of 1.3% from 2001. Passenger yield decreased from RMB1.06 in 2001 to RMB0.98 in 2002 mainly due to slack in traffic volume.

     International passenger revenue, which accounted for 15.3% of total passenger revenue, increased by 29.4% from RMB1,860 million in 2001 to RMB2,407 million in 2002. For international flights, passenger traffic in RPKs increased by 26.7%, while passenger capacity in ASKs increased by 25.3%, resulting in a 0.7 percentage point gain in passenger load factor, or an increase of 1.1% from 2001. Passenger yield increased slightly by 2.4% from RMB0.41 in 2001 to RMB0.42 in 2002.

     Cargo and mail revenue, which accounted for 10.2% of the Group’s total traffic revenue and 9.9% of total operating revenue, increased by 27.0% from RMB1,406 million in 2001 to RMB1,786 million in 2002. The increase was primarily due to the opening of two international cargo routes in 2002.

     Other operating revenue increased by 28.4% from RMB418 million in 2001 to RMB537 million in 2002. The increase was primarily due to increase in fees charged for ground services rendered to other Chinese airlines as the traffic volume increased as well as an income from a lease arrangement effected during the year.

Operating Expenses

     Substantially all of the Group’s operating expenses result from its airline operations. The vast majority of such expenses relate directly to flight operations, aircraft and traffic servicing, aircraft repairs and maintenance and to depreciation and amortization in respect of aircraft and flight equipment. Expenses associated directly with the Group’s flight operations (collectively, “flight operations expenses”) include fuel costs, operating lease payments, catering expenses, aircraft insurance, flight personnel payroll and welfare and training expenses. Expenses associated directly with repairs and maintenance in respect of the Group’s aircraft (collectively, “maintenance expenses”) include repairs and maintenance and overhaul charges, the costs of consumables and other maintenance materials and labor costs for maintenance personnel. Expenses associated directly with the Group’s aircraft and traffic servicing operations (collectively “aircraft and traffic servicing expenses”) include landing and navigation fees,additional rental payments and charges in respect of terminal and other ground facilities and labor costs for ground personnel. The balance of the Group’snew aircraft under operating expenses result from promotional and marketing activities (collectively, “promotion and sales expenses”) such as sales commissions, fees for use of the CAAC’s reservation system, ticket-printing and sales office expenses, advertising and promotional expenses, and from general and administrative expenses, such as administrative salaries and welfare and other personnel benefits and office expenses.

     Total operating expenses in 2002 amounted to RMB15,993 million, representing an increase of 3.3% or RMB514 million over 2001, primarily due to the combined effect of the growth in operations and increase in maintenance expenses. Total operating expenses as a percentage of total operating revenue decreased from 91.7% in 2001 to 88.76% in 2002 as the increase in operating revenue exceeded the increase in operating expenses.

     Flight operations expenses, which accounted for 42.1% of total operating expenses, decreased by 2.5% from RMB6,906 million in 2001 to RMB6,733 million in 2002, mainly due to a decrease in operating lease rentals. Fuel costs, which accounted for 52.3% of flight operations expenses decreased by 0.8% from RMB3,549 million in 2001 to RMB3,519 million in 2002 mainly resulting from decreased fuel prices. Operating lease rentals decreased by 25.9% from RMB1,913 million in 2001 to RMB1,417 million in 2002, primarily due to the termination of wet leases of five Boeing 737-300/37K aircraft from Zhongyuan Airlines in January 2002.leases. Catering expenses increased by 12.8%21.2% from RMB554RMB987 million in 20012004 to RMB625RMB1,196 million in 2002, reflecting2005, primarily due to an increase in number of passengers carried. Aircraft insurance costs increaseddecreased by 108.1%60.8% from RMB123RMB268 million in 20012004 to RMB105 million in the rates2005, primarily because of aircrafta decrease in insurance premiums subsequent to the 911 incident of the United States. Laborin 2005. Labour costs for flight personnel increased by 18.9%4.8% from RMB657RMB1,545 million in 20012004 to RMB781RMB1,619 million in 2002,2005, largely due to anthe increase in flightflying hours as well as an increaseand allowance standard.

Maintenance expenses which accounted for 10.3% of total operating expenses, decreased by 11.5% from RMB4,578 million in bonuses for flight personnel.

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     Maintenance2004 to RMB4,051 million in 2005. The decrease was mainly due to certain major overhaul costs capitalized during the year. 

Aircraft and traffic servicing expenses, which accounted for 14.6% of total operating expenses, increased by 15.8%20.3% from RMB2,015RMB4,789 million in 20012004 to RMB2,333RMB5,759 million in 2002. The increase was primarily attributable to a 15.7% increase in aircraft maintenance and repair charges from RMB1,845 million in 2001 to RMB2,135 million in 2002, mainly as a result of the effect of fleet expansion in recent years and the growth in operations.

     Aircraft and traffic servicing expenses, which accounted for 15.7% of total operating expenses, increased by 9.3% from RMB2,298 million in 2001 to RMB2,511 million in 2002.2005. The increase primarily resulted from 9.1%a 10.0% rise in landing and navigation fees from RMB2,157RMB4,447 million in 20012004 to RMB2,353RMB4,891 million in 2002,2005, as thea result of an increase in number of flights increased.

landing and takeoffs.

Promotional and salesmarketing expenses, which accounted for 9.4%7.1% of total operating expenses, decreasedincreased by 2.7%6.7% from RMB1,541RMB2,606 million in 20012004 to RMB1,500RMB2,780 million in 2002.2005. The decreaseincrease was mainly due to 15.9% decreasethe increase in sale commissions and bonuses paidsales volume, resulting in a 17.0% increase in sales commission expenses from RMB1,285 million in 2004 to sales agents because of tighter cost controls exercised by the Group.

RMB1,503 million in 2005.

General and administrative expenses, which accounted for 6.6%6.3% of the total operating expenses, increased by 39.7% from RMB1,759 million in 2004 to RMB2,457 million in 2005. This was mainly attributable to increased scale of operations.
Depreciation and amortisation, which accounted for 12.4% of total operating expenses, increased by 18.8%38.3% from RMB892RMB3,523 million in 20012004 to RMB1,060RMB4,871 million in 2002.2005. This increase was primarily a result of the the additional depreciation charge on aircraft delivered in 2004 and 2005 and depreciation charge on capitalized major overhaul costs.
Operating (loss)/income

The Group recorded an operating loss of RMB1,019 million in 2005 as compared to an operating profit of RMB1,877 million in 2004. The loss was mainly due to an increase in staff salaries and welfare benefits of 27.8% from RMB439 million in 2001 to RMB561 million in 2002 and increased scale of operations.

     Depreciation and amortization, which accounted for 11.5% of total operating expenses, increased by 1.4% from RMB1,815 million in 2001 to RMB1,840 million in 2002. This was primarily as a result of the additions of aircraft during 2002.

Operating Income

     Operating income increased by 44.7% from RMB1,401 million in 2001 to RMB2,026 million in 2002, as operating revenue increased by RMB1,139increase of RMB4,128 million or 6.7% from 2001, while12.1% in 2005 and an operating expenses increased by RMB514expense increase of RMB7,024 million or 3.3% over21.8% in the same period.


Non-operating Income/(Expenses)

income/(expenses)


Interest expense increased by 2.7%34.2% from RMB934RMB1,184 million in 20012004 to RMB959RMB1,589 million in 2002,2005, mainly reflectingdue to the additional bankincrease in loans borrowed to finance the acquisitions of aircraft, partly offset by scheduled debt repayments during the year.

and lease obligations and interest rate.


Interest income increased by 5.5%66.7% from RMB50RMB33 million in 20012004 to RMB53RMB55 million in 2002. This was2005, mainly dueattributable to anthe increase in cash balances.

     The Group recognized a net gain on sale of fixed assets of RMB171 million in 2002, mainly resulting from disposal of four Boeing 757-200 aircraft.

     During 2002, theinterest rate.

41
The Group recorded a net exchange gain of RMB1,220 million in 2005, compared to a net exchange loss of RMB175RMB124 million predominantlyin 2004, mainly resulting from Renminbi appreciation in July 2005. Such amount represents mainly unrealised translation exchange gain, resulting from exchange gains on translated year end foreign currency denominated liabilities, rather than foreign exchange transactions incurred during the year.
Taxation

Income tax benefit for the year amounted to RMB35 million and the actual effective tax rate was 3% in 2005 while the Group’s enacted tax rate was 15%. The difference is mainly due to its Japanese yen denominated borrowingsa portion of tax loss with a deferred tax effect of RMB135 million not recognized, as a resultwell as the effect of change in the enacted income tax rate applicable to airline operations of CNA and XJA of RMB79 million. In 2004, income tax expense of RMB261 million was recorded and actual effective tax rate was 38% while the Group’s enacted tax rate in 2004 was 15%. The difference is mainly due to the effect of the Japanese yen appreciation. Such amount comprised mostly unrealized translation loss.

Taxation

     The Group is subject to PRCchange in enacted income tax at a rate applicable to airline operations of 33%.

     Taxation expense increased by 24.2% from RMB321CNA and XJA of RMB99 million, in 2001 to RMB398rate differential on airline operations of CNA and XJA of RMB43 million in 2002, reflecting primarily an increase in profit before taxation. A deferred tax assetand non-deductible expenses of RMB149 million was recognized at December 31, 2002 in respect of the unrelieved PRC tax losses brought forward from prior years. Such tax losses are available for carry-forward to offset against future PRC taxable profits for a maximum period of 5 years.

Minority Interests

     Minority interests increased by 22.7% from RMB135 million in 2001 to RMB165 million in 2002, primarily as a result of an increase in net profits of the Group’s Airline Subsidiaries.RMB37 million.

Liquidity and Capital Resources

Prior to the initial public offering of the Company, the Group met its working capital and capital expenditure requirements through cash from its operations, the proceeds of certain long-term and short-term bank loans, capital lease financing and rebates available under certain of the Group’s aircraft leases.
In July 1997, the Company received net proceeds of RMB5,459 million from its initial public offering.

38

A majority part of these net proceeds was utilized to finance the Group’s working capital and capital expenditure requirements. In July 2003, the Company issued 1,000,000,000 A sharesShares with a par value of RMB1.00 each at issue price of RMB2.70 by way of a public offering to natural persons and institutional investors in the PRC. The proceeds received by the Company of RMB2,641 million, net of the issuance costs of RMB59,233, amounted to RMB2,641 million and have been used for the purchase of Boeing 737-800 aircraft in accordance with the disclosure in the Prospectus for Offering of the A Shares.

As of December 31, 2003,2006, the Group had loanbanking facilities fromwith several PRC commercial banks for providing loan finance up to an approximate amount of RMB9,860RMB49,041 million to the Group. As of December 31, 2003,2006, an approximate amount of RMB4,412RMB28,295 million was utilized. As of December 31, 20022005 and 2003,2006, the Group’s cash and cash equivalents totaled RMB3,771RMB2,901 million and RMB2,080RMB2,264 million, respectively.

Net cash inflows from operating activities in 2001, 20022004, 2005 and 20032006 were RMB2,224RMB3,574 million, RMB3,698RMB4,417 million and RMB2,129RMB2,217 million, respectively.

Cash from operations was RMB4,533 million, RMB6,001 million and RMB4,641 million in 2004, 2005 and 2006 respectively. The increase in cash from operations in 2005 was due to the delay in payment of liabilitieis. Interest expense increasd from RMB754 million in 2004, to RMB1,616 million in 2005 and further to RMB2,419 million in 2006 as a result of the increased borrowings during the years.

Net cash used in investing activities in 2001, 20022004, 2005 and 20032006 was RMB3,036RMB8,824 million, RMB5,895RMB8,547 million and RMB5,434RMB5,404 million, respectively. Cash capital expenditures in 2001, 20022004, 2005 and 20032006 were RMB1,492RMB6,631 million, RMB6,351RMB5,473 million and RMB4,707RMB2,566 million, respectively, reflecting predominantly additional investments in aircraft and flight equipment under the Group’s fleet expansion plans and Guangzhou new airport, and, to a small extent, additional investments in other facilities and buildings for operations.

Financing activities resulted in net cash (outflows)/inflows of RMB(568)RMB6,231 million, RMB3,150RMB3,992 million and RMB1,614RMB2,550 million in 2001, 20022004, 2005 and 2003,2006, respectively. Net cash from new notes payable and repayments amounted to RMB7,447 million, RMB6,045 million and RMB5,870 in 2004, 2005 and 2006, respectively. The netadditional cash outflowsis for capital expenditures and general working capital. Repayment of 2001 were primarily as a result of making scheduled repayments of bank borrowingscapital leases in 2004, 2005 and 2006 was RMB1,272 million, RMB2,050 million and RMB3,313 milion, respectively, resulting from the aircraft acquisitions under capital lease obligations in excess of proceeds from new bank borrowings.

leases.

As of December 31, 2003,2006, the Group’s aggregate long-term debt and obligations under capital leases totaled RMB12,051RMB29,330 million. Based on such amount, in 2004, 2005, 2006,In 2007, 2008, 2009, 2010, 2011 and thereafter, amounts payable under such debt and obligations will be RMB1,986RMB7,005 million, RMB1,716RMB5,786 million, RMB1,601RMB3,853 million, RMB1,660RMB1,831 million, RMB1,872RMB6,474 million and RMB3,216 million.RMB4,381 million respectively. Such borrowings were denominated, to a larger extent, in United States dollars and, to a smaller extent, in Japanese yen and Hong Kong dollars, with a significant portion being fixed interest rate borrowings. In the normal course of business, the Group is exposed to fluctuations in foreign currencies. The Group’s exposure to foreign currencies was primarily as a result ofresults from its foreign currency debts. Depreciation or appreciation of the Renminbi against foreign currencies affects the Group’s results significantly because the Group’s foreign currency payments generally exceed its foreign currency receipts. The Group is not able to hedge its foreign currency exposure effectively other than by retaining its foreign currency denominated earnings and receipts to the extent permitted by the State Administration of Foreign Exchange, or subject to certain restrictive conditions, entering into forward foreign exchange contracts with authorised PRC banks.

As of December 31, 2003,2006, the Group’s short term bank debt was RMB6,409 million with interest rates ranging from 1.48% to 5.31%.RMB19,908 million. The Group’s weighted average interest rate on short-term bank notes payable was 1.76%5.77% per annum as of December 31, 2003.2006. The primary use of the proceeds of the Group’s short-term debt is to finance working capital needs. The Group has generally been able to arrange short-term bank loans with domestic banks in China as necessary and believes it can continue to obtain them based on its well-established relationships with various lenders.

42
Through May 31, 2007, the Group refinanced certain short-term bank debts of RMB4,170 million. The refinanced bank debts are unsecured, bear interest at floating rates ranging from 3-month LIBOR/6-month LIBOR +0.50% to 0.55% per annum and are repayable one year from their respective refinanced dates. In addition, the Group entered into new short term bank debts agreement totalling RMB6,435 million subsequent to December 31, 2006. These new short-term bank debts are unsecured and bear interest at floating rates ranging from 3-month/6-month/12-month LIBOR + 0.45% to 0.55% per annum with are repayable from five months to one year from their respective origination dates.
As of December 31, 2003,2006, the Group had obligations under operating leases totaling RMB8,120RMB21,969 million, predominately for aircraft. Of such amount, RMB1,483RMB3,077 million, RMB1,412RMB2,965 million, RMB1,144RMB2,775 million, RMB921RMB2,613 million, RMB771RMB2,493 million and RMB2,389RMB8,046 million, respectively, wasis due in 2004, 2005, 2006, 2007, 2008, 2009, 2010, 2011 and thereafter.


As of December 31, 2003,2006, the Group had a working capital deficit of RMB10,792RMB32,180 million, as compared to a working capital deficit of RMB7,016RMB25,907 million as of December 31, 2002.2005. Historically, the Group operated in a negative working capital position, relying on cash inflow from operating activities and short-term bank debt refinancings to meet its short-term liquidity and working capital needs. The increase in the Group’s working capital deficit from 20022005 to 20032006 was mainly because the Group sought increased short termshort-term debts to finance its aircraft acquisitions. Upon deliveries of the aircraft, the Group continued to seek renewal of its short-term debts instead of replacing such debts with long-term debts, as the interest rates for short-term debts are lower. TheIn 2007 and thereafter, the liquidity of the Group in the future willis primarily be dependent on its ability to maintain adequate cash inflowinflows from operations to meet its debt obligations as they become due and on its ability to obtain adequate external financing to meet both its debt obligations as they fall due and committed future capital expenditures. With regard to its short-term debt outstanding as ofAt December 31, 2003,2006, the Group has obtained firm commitments from its principal banker to renew relevant debts as they fall due during 2004. With regard to its future capital commitments and other financing requirements, the Group has already entered into loan financing agreements with several PRC banks to provide loan financefinancing up to an appropriate amount of RMB8,450RMB49,041 million during 20042007, of which approximately RMB28,295 million was utilized. Subsequent to December 31, 2006 and thereafter. up to May 31, 2007, the Group entered into additional loan financing agreements to obtain financing up to RMB5,045 million during 2007. The directors of the Company believe that sufficient financing will be available to the Group.
As the Group is subject to a high degree of operating leverage, a minor decrease in the Group’s yield and/or load factor could result in a significant decrease in its operating revenue and hence its operating cashflows. This could arise in such circumstances as where competition between Chinese airlines increases or

39

where PRC aviation demand decreases. Similarly, a minor increase in the jet fuel prices, particularly those in the domestic market, could result in a significant increase in the Group’s operating expenses and hence a significant decrease in its operating cashflows. This could be caused by fluctuations in supply and demand in international oil market. Currently, the Group’s existing debt and lease facilities do not contain any financial covenants. Nevertheless, as the Group is subject to a high degree of financial leverage, an adverse change in the Group’s operating cashflows could adversely affect its financial health and hence weaken its ability to obtain additional debt and lease facilities and to renew its short-term debt facilities as they fall due.


As of December 31, 2003,2006, the Group had capital commitments in 2004 and 2005 of approximately RMB6,243 million and RMB7,385 million, respectively. Of such amounts, RMB4,585 million in 2004 and RMB6,030 million in 2005 are related to the acquisition of aircraft and related flight equipment, and RMB1,000 million in 2004 and RMB1,072 million in 2005 are related to the Group’s facilities and equipment to be constructed and installed at the Guangzhou new airport. This new airport is expected to commence operations in August 2004 to replace the Guangzhou Baiyun International Airport as the Group’s main route base. The remaining amounts of RMB658 million in 2004 and RMB283 million in 2005 are related to the Group’s otherfollows:
 
 
 2007 2008 2009 2010 2011 
 
Total 
 
  (RMB million) 
              
Acquision of aircraft and related equipment  12,299  22,572  17,483  14,232  295  66,881 
Others  945  328  261  145  145  1,824 
                    
   13,244  22,900  17,744  14,377  440  68,705 

Others mainly represent airport and office facilities and equipment, overhaul and maintenance bases and training facilities.

 
As of December 31, 2003,2006, the Group undertook to make a capital contribution of approximately RMB446RMB83 million to a jointly controlled entities.

entity.

As of December 31, 2003,2006, the cash and cash equivalents of the Group totaled RMB2,080RMB2,264 million. Of such balance, 22.2%15.0% was denominated in foreign currencies.

     No interim dividend was paid during the year ended December 31, 2003. The Board of Directors does not recommend the payment of a final dividend in respect of the year ended December 31, 2003.

The Group expects that the Group’s cash from operations and short-term and long-term bank borrowings will be sufficient to meet its cash requirements in the foreseeable future.

40

43

Contractual Obligations and Commercial Commitments

The following table sets forth the Group’s obligations and commitments to make future payments under contracts and under contingent commitments as of December 31, 2003.2006.
                     
      As of December 31, 2003
      Payment due by period
      less than      
  Total
 1 year
 1-3 years
 4-5 years
 After 5 years
          (RMB million)    
Contractual obligations
                    
Short-term debt  6,409   6,409   —   —   — 
Long-term debt  5,210   688   1,426   953   2,143 
Capital lease obligations  6,841   1,298   3,551   1,725   267 
   
 		   
 		   
 		   
 		   
 		 
Total contractual obligations
  18,460   8,395   4,977   2,678   2,410 
   
 		   
 		   
 		   
 		   
 		 
Other commercial commitments
                    
Operating lease commitments  8,120   1,483   3,477   1,412   1,748 
Aircraft purchase commitments (Note 1)  10,615   4,585   6,030   —   — 
Capital commitments in respect of investments in the Guangzhou new airport  2,072   1,000   1,072   —   — 
Other capital commitments  941   658   283   —   — 
Investing commitments  446   446   —   —   — 
   
 		   
 		   
 		   
 		   
 		 
Total commercial obligations
  22,194   8,172   10,862   1,412   1,748 
   
 		   
 		   
 		   
 		   
 		 

  
As of December 31, 2006
Payment due by period
 
As of December 31, 2005
 
  
Total
 
less than
1 year
 
1-3
years
 
3-5
years
 
After 5
years
 
Total
 
  
(RMB million)
 
Contractual obligations
             
Short-term debt  
19,908
  19,908  —  —  —  14,346 
Long-term debt  
13,932
  3,914  5,205  2,314  2,499  14,617 
Capital lease obligations  
15,398
  3,091  4,434  5,991  1,882  15,832 
Total contractual obligations
  
49,238
  
26,913
  
9,639
  
8,305
  
4,381
  
44,795
 
Other commercial commitments
                   
Operating lease commitments  
21,969
  3,077  5,740  5,106  8,046  24,594 
Aircraft purchase commitments (Note 1)  
66,881
  12,299  40,055  14,527  —  45,628 
Capital committments in respect of investments in the Guangzhou new airport  —   —  —  —  —  840 
Other capital commitments  
1,824
  945  589  290  —  1,335 
Investing commitments  
83
  83  —  —  —  83 
Total commercial obligations
  
90,757
  
16,404
  
46,384
  
19,923
  
8,046
  
72,480
 
                    
Estimated future interest payments on short term debt and long term debt
                   
Fixed rates  
3,374
  774  1,071  1,184  345  3,056 
Variable rates  
3,075
  1,230  829  545  471  2,171 
   
6,449
  
2,004
  
1,900
  
1,729
  
816
  
5,227
 
Note 1 Amounts shown are net of previously paid purchase deposits.

ITEM 6. DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES.

Directors, and Senior Management and Employees

The following table sets forth certain information concerning directors (“Directors”), senior management (“Senior Management”) and supervisors (“Supervisors”) of the Company in 2003.2006. There were certain changes in the Company’s Directors, Senior Management and Supervisors subsequent to December 31, 2003,2006, details of which are set forth below.
Name
 
Position
 
Gender
 
Age
NameAgePosition
Yan Zhi Qing62Liu Shao Yong Chairman of the Board of Directors
Liu Ming Qi 60Male Vice Chairman of the Board of Directors49
Wang Chang Shun47Vice Chairman of the Board of Directors; President
Peng An Fa56Li Wen Xin (1) DirectorMale57
Wang Quan Hua 50Director MaleDirector53
Zhao Liu An 56Director Director
Zhou Yong QianMale 59
Si Xian Min Director,
Zhou Yong Jin President 61Male 50
Tan Wan Geng (2) Director, Vice PresidentMale43
Xu Jie Bo 39Director, Chief Financial Officer and Vice President Director; Chief Financial Officer; Vice President
Wu Rong NanMale 42
62Chen Zhen You (2) Director
Simon ToMale 53Independent Non-Executive Director55
Peter Lok 68Independent Non-executive Director MaleIndependent Non-Executive Director71
Wei Ming Hai 40Independent Non-executive Director MaleIndependent Non-Executive Director43
Wang Zhi 62Independent Non-executive Director MaleIndependent Non-Executive Director65
Sui Guang Jun 43Independent Non-executive Director Independent Non-Executive Director
Liang Hua FuMale 46
62Sun Xiao Yi Chairman of the Supervisory CommitteeMale53
Gan YuYang Guang Hua 76Supervisor Male54
Yang Yi Hua Supervisor
Li Qi HongFemale 56Supervisor
Jiang Ping54Vice President
Li Kun44Vice President

41

NameAgePosition
47
Yuan Xin An 47Vice President Vice President
Zheng En RenMale 59Vice President50
Hao Jian Hua 54Vice President Male56
He Zong Kai Vice PresidentMale56
Liu QianChief PilotMale41
Dong Su Guang(3)Chief EngineerMale53
Su Liang 42Company Secretary MaleCompany Secretary45
Chen Wei HuaGeneral CounselMale41

     On May 13, 2003,

(1)The appointment of Li Wen Xin as the Director of the Company was approved at the first extraordinary general meeting 2006 of the Company held on December 28, 2006.
(2)The appointments of Tan Wan Geng and Chen Zhen You as the Directors of the Company were approved at 2005 annual general meeting of the Company held on June 15, 2006.
(3)The appointment of Dong Su Guang as the chief engineer of the Company was approved on April 8, 2006.
44
BOARD OF DIRECTORS
Mr. Liu Ming Qi, Mr. Peng An Fa, Mr. Wang Quan Hua, Mr. Zhao Liu An, Mr. ZhouShao Yong Qian, Mr. Wang Zhi and Mr. Sui Guang Jun respectively were appointed as Directorsis the chairman of the Company at the Shareholders’ meeting of the Company.

     On May 13, 2003, Mr. Wang Shao Xi and Mr. Zhang Rui Ai tendered their resignations to the Company as Directors of the Company due to retirement. Their resignations were approved at the Shareholders’ meeting of the Company.

     On July 30, 2003, the Board of Directors resolved to appoint Mr. Hao Jian Hua and Mr. Xu Jie Bo as Vice Presidents of the Company. On the same day, Mr. Yang Guang Hua resigned as Vice President of the Company due to work arrangement.

Mr. Yan Zhi QingBoard. He is the Chairman of the Board of Directors.a qualified class one pilot. He became an employee ofjoined the Company in February 1996. AdministrativeNovember 2004. Mr. Liu graduated from China Civil Aviation Flying College and obtained an EMBA from Tsinghua University in 2005. He joined the civil aviation industry in 1978. He held the positions which Mr. Yan has held includeof Captain of the Flying Squadron of China General Aviation Corporation and was appointed as the Deputy General Manager of China General Aviation Corporation, Deputy Director of Flight Operations of the HunanShanxi Provincial Civil Aviation Administration, General Manager of the Shanxi branch of China Eastern Airlines Corporation Limited and the Chief of the Flying Model Division of the Civil Aviation Administration of China. He served as the General Manager of China Eastern Airlines Corporation Limited and was appointed as the Vice Minister of Civil Aviation Administration of China. Since August 2004, Mr. Liu has served as the General Manager of China Southern Air Holding Company. Mr. Liu became the chairman of the Board on November 29, 2004.

Mr. Li Wen Xin is currently a Director of the Guangxi Provincial Civil Aviation Administration, DirectorCompany. Mr. Li was a graduate majoring in economic management. He is a senior expert of political science. Mr. Li joined the civil aviation industry in 1969. He was the secretary to the disciplinary committee, deputy secretary of the Centralparty committee and Southernvice general manager of China CivilGeneral Aviation Administration, DirectorCorporation successively between 1991 and 1998. He was appointed the party secretary and vice general manager of the Political DepartmentShanxi branch of China Eastern Airlines Corporation Limited in February 1998. He became the vice party secretary and secretary to the disciplinary committee of China Eastern Air Holding Company in June 2000. In September 2002, he was appointed the party secretary and vice president of China Eastern Air Holding Company. Between June 2000 and September 2006, he was the chairman of the CAACsupervisory committee of China Eastern Airlines Corporation Limited. He has been the party secretary and Party Secretary and Managing Vice Presidentvice president of the CSAHC Group. Mr. Yan is currently the President and Vice Party Secretary of CSAHC. Mr. Yan graduated from the School of Aviation Administration and Flight Control in 1962.China Southern Air Holding Company since September 2006. Save as disclosed above, Mr. YanLi is not connected with any directors, senior management,Directors, Senior Management, substantial shareholders or controlling shareholdersSupervisors of the Company.

Mr. Liu Ming Qiis the Vice Chairman of the Board of Directors of the Company and joined the Company since May 2003. Mr. Liu graduated from South China Normal University and obtained a master’s degree in economics from Fudan University. Mr. Liu is currently the Party Secretary and the Vice President of CSAHC. Mr. Liu began his career in 1968, and has successively served as the Municipal Secretary and Mayor of Sanya city of Hainan province, the Vice Governor of Hainan province, the Vice Director of Hong Kong and Macao Affairs office of the State Council and the Vice Director of Macao Liaison Office of the Central Government. Save as disclosed above, Mr. Liu is not connected with any directors, senior management, substantial shareholders or controlling shareholders of the Company.

45
Mr. Wang Chang Shunis the Vice Chairman of the Board of Directors and the President of the Company and joined the Company in April 2001. He began his career in civil aviation in February 1976, mainly involved in air traffic control. He has held positions as Director of the Flight Operations Office of the Urumqi Civil Aviation Administration, Director of the Flight Meteorology and Flight Safety Monitoring Division, Deputy General Manager of Xinjiang Airlines and Deputy Director of Urumqi Civil Aviation Administration, Party Secretary and Deputy General Manager of Xinjiang Airlines and Party Secretary of Urumqi Civil Aviation Administration. Mr. Wang is also the Vice President of CSAHC. Mr. Wang graduated from the School of the Chinese Academy of Social Sciences as a post graduate in Business Management and is qualified as a Senior Expert of Political Science. Save as disclosed above, Mr. Wang is not connected with any directors, senior management, substantial shareholders or controlling shareholders of the Company.

Mr. Peng An FaQuan Hua is currently a Director of the Company and the Vice President of CSAHC and became the employee of the Company sincein March 1995 after the establishment of the Company. Mr. PengWang graduated from the pilot departmentEconomic Management Department of China Civil Aviation Flying College and the department of Chinese language and literature of South China Normal University.Central Communist Party College. Mr. PengWang began his career in civil aviation in 1969,1972, and successively served as the Pilot Director Vice Party Secretary and Party Secretary of the Sixth SquadronPlanning Department of theGuangzhou Civil Aviation Administration. In July 1994, Mr. Peng held office asAdministration, the Party Secretary of the Flight Operations Department of China Southern Airlines. In March 1998, Mr. Peng served as the President and Vice SecretaryOffice Director of China Southern Airlines Shenzhen Co. From August 2001 to October 2002, Mr. Peng served as, the Director of the Planning and Operation Division of CSAHC, the President of Strategy and Development Department of China Southern Airlines Company Limited and the Vice President of CSAHC. Mr. Peng Wang became a Director of the Company on May 13, 2003.

Mr. Zhao Liu An is concurrentlya Director of the Company and the Vice ChairmanPresident of Shenzhen Air Catering Co., LtdCSAHC. Mr. Zhao joined the Company in May 2003. Mr. Zhao began his career in civil aviation in 1966, and CATIC (Hong Kong).successively served as the Director of Flight Meteorology and Flight Safety Monitoring Division, Director of Science Education Division, the Director of Flying Model Division of Urumqi Civil Aviation Administration, Captain of the Ninth Squadron of the Civil Aviation Administration, the Vice President and President of Urumqi Civil Aviation Administration and Xinjiang Airlines. Mr. Zhao became a Director of the Company on May 13, 2003.
Mr. Si Xian Min is a Director and President of the Company. Mr. Si graduated from No. 14 Aviation College as an aircraft piloting major with an associate degree. Mr. Si, a professional political tutor, began his career in civil aviation in 1975. He held positions as Director of the political division of China Southern Airlines Henan Branch, Party Secretary and Vice President of Guizhou Airlines, Deputy Party Secretary of China Southern Airlines Company Limited, Secretary of the Disciplinary Department of China Southern Airlines Company Limited and Party Secretary of China Northern Airlines and has been the President of the Company since October 2004. Mr. Si became a Director of the Company on December 31, 2004.
Mr. Tan Wan Geng is a Director, Vice President and Secretary of the CPC Committee. Mr. Tan is an engineer graduated from Economic Geography Department in Sun Yat-sen University, with major in regional economy, with qualification of post graduate degree, and a master's degree in economics. Mr. Tan has previously served as the Head of the Infrastructure Department and Director of Human Resources Department of the Beijing Aircraft Maintenance and Engineering Corporation from 1990 to 1996, the Deputy Director of Human Resources Division (Personnel and Education Division) in the General Administration of Civil Aviation of China from 1996 to 2000, and has been the Director General and Secretary of Chinese Communist Party Committee of Northeastern Regional Civil Aviation Administration from December 2000 to January 2006. He has been the Vice President of the Company since January 2006. Save as disclosed above, Mr. PengTan is not connected with any directors, senior management,of the Directors, Senior Management, substantial shareholders or controlling shareholdersSupervisors of the Company.

Mr. Wu Rong NanXu Jie Bo is a Director, Vice President and Chief Financial Officer of the Company. Mr. Xu joined the Company in July 1998. He graduated from the Management Department of Tianjin University and was subsequently awarded a master's degree in business administration from Hong Kong Baptist University. A qualified senior accountant by profession, Mr. Xu started his career in August 1986 and worked as Supervisor of the Financial Management Office for Infrastructure Projects of Guangzhou Civil Aviation Administration. In December 1992, he took up the posts of Deputy Director and Director of the Financial Department of Central and Southern China Civil Aviation Administration. In July 1998, he became General Manager of the Financial Department and Chief Financial Officer of the Company. Currently, he is a Director and the Vice President and Chief Financial Officer of the Company. He is also a Director of Guizhou Airlines Company Limited, Vice Chairman of Sichuan Airlines Corporation Limited, and Vice Chairman of Xiamen Airlines Company Limited. Mr. Xu became a Director of the Company. He joined CSAHC in January 1991Company on April 16, 2001.
Mr. Chen Zhen You is a Director and became an employeeChairman of the Labour Union of the Company, upon its establishmentgraduated from South China Normal University with a bachelor’s degree in March 1995.English. Mr. Wu isChen, an air traffic control engineer.economist, holds an MBA from Murdoch University in Australia. He was once employedworked as the Vice Director of Flight Operationsthe Office of theInternational Affairs of Guangzhou Civil Aviation Administration, Vice Director of the Office of Overseas Business of the Company and General Manager of the Department of Foreign Affairs of the Company from 1991 to 2001. From 2001 to 2005, he was the Office Director of CSAHC and the Director of the Planning and Investment Department of China Southern Air Holding Company. He has been Presidenta member of Xiamen Airlinesthe Party Committee and Chairman of the Labour Union of the Company since 1986.February 2005. Save as disclosed above, Mr. WuChen is not connected with any directors, senior management orof the Directors, Senior Management, substantial shareholders or controlling shareholdersSupervisors of the Company.

Mr. Simon ToPeter Lok has been an Independent Non-Executive Director of the Company since June 1999. Mr. To is currently the Managing Director of Hutchison Whampoa (China) Limited, and also serves as director of several companies in Hong Kong and Foreign-invested companies in China. Mr. To has managed investment projects in China since early 1980’s and is familiar with the laws and regulations of Hong Kong and China. Mr. To graduated from the Stanford University with a Master degree in Business Administration. Mr. To is not connected with any directors, senior management or substantial shareholders or controlling shareholders of the Company.

Mr. Peter Lok has been an Independent Non-Executive Director of the Company since JuneApril 16, 2001. He is also a veteran in the civil aviation industry. Mr. Lok joined the Civil Aviation Department of Hong Kong in 1956 and became its Assistant Director in 1982, Deputy Director in 1988, and Director from 1990 to 1996. From 1997 to 2000, Mr. Lok was an advisor and president of Hong Kong Commercial Airlines Center. Mr. Lok has sat on various Committees such as the Evaluation Committees for the Design of Shanghai’s Pudong Airport, Committee for China’s Zhuhai Aviation and Spaceflight Fair, Evaluation Committees for the IATA Eagle Award. He is also independent director of several listed airline companies. Mr. Lok is not connected with any directors, senior management or substantial shareholders or controlling shareholders of the Company.

42

Mr. Wei Ming Haihas been an Independent Non-Executive Director of the Company since JuneApril 16, 2001. He is a Professor and Dean of the School of Management of Zhongshan University. Professor Wei has worked in Jiangxi Provincial Accounting Association, and he started working in Zhongshan University from 1991. In 1993 he became the chairman of the Accounting Department in the School of Management of Zhongshan University. In 1996 he became the Deputy Dean of the School of Management in Zhongshan University. In January 2000, he became Dean of the School of Management in Zhongshan University. Since 1998, Professor Wei has been a doctorate advisor for Accounting Information and Investment Analysis. Professor Wei is also on the board of directors of China Accountants Association, Vice Chairman of Accountants Association of Guangdong Province, Vice Chairman of Auditors Association of Guangzhou, Executive Member of the Research Institute of Financial Costs for Young and Middle-aged Accountants and member of American Accounting Association. Professor Wei holds a Ph.D degree in economics and has an MBA degree from Tulane University in the United States of America. He has published over tenseven academic books or textbooks, and over 6080 academic papers. Mr. Wei is not connected with any directors, senior management or substantial shareholders or controlling shareholders of the Company.

46
Mr. Wang Zhihas been an Independent Non-Executive Director of the Company since May 2003. Mr. Wang graduated from the Aircraft Design Department of Harbin instituteInstitute of Technology. Mr. Wang began his career in 1965, and has successively served as the Director and Senior Engineer of Aeronautics Research Institute of China, the Vice Director and Vice Secretarysecretary of the First Research Institute of Civil Aviation, the Vice Director and Director of the Planning Bureau of CAAC and the Director of the Planning Technology System Reform Department and the Planning Technology Department of CAAC. Mr. Wang is also a professor inat several universities. Mr. Wang is not connected with any directors, senior management or substantial shareholders or controlling shareholders of the Company.

Mr. Sui Guang Junhas been an independentIndependent Non-Executive Director of the Company since May 2003. Mr. Sui graduated from the Economic Department of Jinan University and obtained a mastermaster's degree. Mr. Sui obtained a doctor degree in the Management of Organizations of Jinan University. He has successively served as the Vice Director of the Research Institute of Hong Kong and Macao Economies, and the Dean of Corporate Administration Departmentcorporate administration department of Jinan University. Mr. Sui is currentlyUniversity and the Chief of the Post-doc Committee of Applied Economics and the Dean of Management College in Jinan University. Mr. Sui is not connected with any directors, senior management or substantial shareholders or controllingcurrently the Deputy Vice Chancellor of Guangdong University of Foreign Studies.
The independent non-executive Directors of the Company are nominated by the Board of Directors, and their appointment must be approved by the shareholders of the Company.

     Supervisory Committee

Company in a general meeting. The executive Directors of the Company are nominated by CSAHC, the controlling shareholder of the Company, and their appointment must be approved by the shareholders of the Company in a general meeting.

SUPERVISORY COMMITTEE
As required by the Company Law and the Articles of Association, the Company has a supervisory committee (the “Supervisory Committee”) which is primarily responsible for the supervision of senior managementSenior Management of the Company, including the Board of Directors, executive officers and other senior management personnel, to ensure that they act in the interests of the Company, its shareholders and employees, as well as in compliance with applicable law. The Supervisory Committee consists of three Supervisors. Two of the Supervisors are shareholder representatives appointed by shareholders, and one Supervisor is a representative of the Company’s employees. The Supervisors serve terms of three years and may serve consecutive terms.

Mr. Liang Hua FuSun Xiao Yi is the Chairmana member of the SupervisoryParty Committee and head of theDiscipline Supervision Team of China Southern Air Holding Company. He became an employee ofMr. Sun graduated from the Company since its establishment in March 1995. Mr. Liang held numerous positions in the Guangzhou Civil Aviation University of China with a degree in Economics and Administration including Chiefand is currently a postgraduate law student of the Navigation Division,Central Communist Party College. Mr. Sun is a senior expert of Political Science and Economics with an associate degree. Mr. Sun has successively served as Vice Party Secretary of the Transportation Department,Hubei branch of the Company, Party Secretary of the DisciplinaryFlight Operations Department and Director of Administration and Supervision. Mr. Liang attended Tianjin Aviation School and Guangzhou Political Science College. Mr. Liang is not connected with any directors, senior management or substantial shareholders or controlling shareholders of the Company, and Vice Party Secretary of China Southern Air Holding Company.

Mr. Gan Yu HuaisSun became a Supervisor on June 16, 2004.

Mr. Yang Guang Hua is the Vice Party Secretary and Discipline Supervision Secretary of the Company. He becameMr. Yang is an employeeengineer with university qualification. Mr. Yang has successively served as Deputy General Manager of the Hunan branch of the Company, since its establishment in March 1995. Mr. Gan held various positions in the Chinese commercial aviation industry, including Deputy DirectorGeneral Manager of Southern Airlines (Group) Zhuhai Helicopters Company Limited, General Manager of the Finance Department,Hunan branch of the Company, and Deputy Chief Accountant and DirectorGeneral Manager of the Company. Mr. Yang became a Supervisor on June 16, 2004.
Ms. Yang Yi Hua is the General Manager of the Audit Department of the Company. Ms. Yang is an internationally qualified internal auditor. She has successively served as Deputy Manager of the Clearance and Settlement Office of the Financial Division of the Guangzhou Civil Aviation Administration. He holdsAdministration, Manager of the Financial Office of the Company’s Financial Division, and Deputy General Manager of the Company’s Audit Department. She has been the President of Xiamen Airlines since September 2005. Ms. Yang became a Senior Accountant Certificate and Supervisor on June 16, 2004.
SENIOR ADMINISTRATIVE OFFICERS
Mr. Yuan Xin An is a member of the International Auditors Association. Mr. Gan graduated from Shanghai Li Xin Accounting College in 1948. Mr. Gan is not connected with any directors, senior management or substantial shareholders or controlling shareholdersVice President of the Company.

He graduated from the Air Engineering College. Mr. Li Qi Hongis a SupervisorYuan has over 25 years of experience in the Chinese aviation industry. He has been the Manager of Quality Assurance and Deputy Controller of Quality Control of Guangzhou Aircraft Maintenance Engineering Company Limited, Deputy General Manager of the Aircraft Engineering Department of the Company, and Vice President of Guangzhou Aircraft Maintenance Engineering Company Limited. Mr. Yuan became the RepresentativeChief Engineer of the Labour UnionCompany in 2000, and a Vice President of the Company in April 2002.

Mr. Hao Jian Hua is currently the Vice President of the Company. He completed his pilot training at the CAAC Advanced Flying College. Mr. Hao has held positions as Captain, then Deputy Chief Captain, and subsequently Chief Captain of the Sixth Squadron of the Civil Aviation Administration during the period from 1989 to 1994. He then became a Deputy General Manager, from 1994 to 1998, and the General Manager, from 1998 to 1999, of the Flying Aviation Department of the Company. He became an employeea Vice President of the Company in July 2003.
47
Mr. He Zong Kai is a Vice President of the Company who graduated from Bejing Foreign Language Institute with a major degree in French, is a senior economist. Mr. He served as the Deputy Manager of the Operation Department of the Company, Manager of Passenger Transportation Department, Head of Seats Arrangement Department, Vice General Manager of the Marketing Department and General Manager of the Ground Services Department. He assumed the offices of the President and Deputy Party Secretary of Hubei branch of the Company since its establishment2003 and became a Vice President of the Company in March 1995. 2005.
Mr. LiLiu Qian is the Chief Pilot of the Company who graduated from China Civil Aviation Flying College with specialty in aircraft piloting. Mr. Liu served the Civil Aviation Administration of China as assistant researcher of the piloting skills supervision division of the piloting standards department, as assistant researcher of the operation supervision division of the piloting standards department, as assistant researcher of the freight transportation piloting standards division of the piloting standards department, and as the Deputy Head of the Piloting Standards Division of the Piloting Standards Department. He assumed the offices of the Deputy Chief Pilot and Chief Pilot of the Company in November 2004.
Mr. Dong Su Guang is the Chief Engineer of the Company. Mr. Dong graduated from Northwestern Industry University major in aircraft design. He is an engineer with University qualification. He served as General Manager of Aircraft Engineering Department of the Company from May 2002 and Deputy General Manager of Guangzhou Aircraft Maintaining and Engineering Co., Ltd. Since April 2006, Mr. Dong has been the General Manager of Aircraft Engineering Department and Chief Engineer of the Company.
Mr. Su Liang is currently holding the position as Company Secretary. He was a graduate of the Cranfield College of Aeronautics, University of Cranfield, United Kingdom, specialising in Air Transport Management Engineering. Mr. Su is a holder of a master's degree. During the period from 1998 to 1999, Mr. Su held the position as Deputy Manager of the Flight Operations Department, China Southern Airlines Shenzhen Co. and from 1999 to 2000, he was the Manager of the Planning and Administration Department of China Southern Airlines Shenzhen Co. Mr. Su was in charge of the international cargo project of the Company, responsible for the planning and development of the Company’s North American cargo business. Mr. Su became the Company Secretary on June 26, 2000.
Mr. Chen Wei Hua is the Chief Legal Adviser to the Company. Mr. Chen graduated from the CAACschool of law of Peking University. He is a qualified solicitor and a qualified corporate legal counsellor. Mr. Chen joined the Civil Aviation CollegeAdministration of China in 1968,1998. He then joined the CSAHC in January 1991. From 1997 to 2003, he served as Vice Director and held various administrative positions in the commercial aviation industry in China. Mr. Li is not connected with any directors, senior management or substantial shareholders or controlling shareholdersDirector of the Company.

     All Directors and SupervisorsLegal Affairs Office of the Company have entered into service contracts with the Company for a term of three years commencing on April 16, 2001. The service contracts of Mr. Liu Ming Qi, Mr. Peng An Fa, Mr. Wang Quan Hua, Mr. Zhao Liu An, Mr. Zhou Yong Qian, Mr. Wang Zhi and Mr. Sui Guang Jun entered into on May 13, 2003 will expire at the endCompany. Currently, he is President of the termLegal Department of the current sessionCompany. Since December 2003, Mr. Chen has been the Chief Legal Adviser to the Company. He is also a Director of the Board. Except for such service contracts, noneXiamen Airlines Company Limited.

Compensation
A total of the Directors or Supervisors of the Company has entered or proposed to enter into any other service contracts with the Company or its subsidiaries. None of the Directors or Supervisors has entered into any service contracts with the Company which is not determinable by the Company within one year without payment of compensation, other than statutory compensation.

Compensation

     RMB0.2 millionRMB402,000 has been paid to independent non-executive directorsDirectors for the year ended December 31, 2003.2006. The aggregate compensation paid by the Company to all directorsDirectors (excluding non-executive directors)Directors), supervisorsSupervisors and senior managementSenior Management for 20032006 was RMB1.5 million.RMB6,638,000. For the year ended December 31, 2003,2006, the Company accruedpaid an aggregate of approximately RMB25,000RMB220,000 on behalf of its executive directors, supervisorsDirectors, Supervisors and senior managementSenior Management pursuant to the SA Pension Scheme and the retirement plans operated by various municipal governments in which the Company participates.

Details of Directors’ and Supervisors’ emoluments for the year ended December 31, 2006 are set out below:

 
 
 
 
Note
 
Directors’ fees
 
Salaries, allowances and benefits in kind
 
 
Discretionary bonus
 
Retirement scheme contributions
 
 
Total
 
    
RMB’000
 
RMB’000
 
RMB’000
 
RMB’000
 
RMB’000
 
Executive directors
             
Liu Shao Yong  (i) -  472  -  14  486 
Li Wen Xin     -  87  -  3  90 
Wang Quan Hua     -  374  -  14  388 
Zhao Liu An  (i) -  374  -  14  388 
Si Xian Min     -  442  -  13  455 
Tan Wan Geng     -  271  -  11  282 
Xu Jie Bo     -  357  -  13  370 
Chen Zhen You     -  253  -  13  266 
Zhou Yong Qian     -  146  -  3  149 
                    
Supervisors
                   
Sun Xiao Yi     -  374  -  14  388 
Yang Guang Hua     -  374  50  13  437 
Yang Yi Hua     -  220  -  13  233 
                    
Independent non-executive directors
                   
Peter Lok     102  -  -  -  102 
Wei Ming Hai     100  -  -  -  100 
Wang Zhi     100  -  -  -  100 
Sui Guang Jun     100  -  -  -  100 
      402  3,744  50  138  4,334 
48
Notes:
(i)The above amounts included the salaries paid to these Directors as pilots of the Company.

Board Practices

Each Directors’ service contractscontract with the Company or any of its subsidiaries provideprovides prorated monthly salary upon termination of employment in accordance with his contract. The Director is entitled to paid leave in accordance with his contract.

The term of office of a Director is three years. The term of office of the current Directors will end in 2007. A Director may serve consecutive terms upon re-election.

Audit Committee

43

The audit committee is appointed by the Board of Directors and consists of fivethree independent non-executive Directors. The current members of the audit committee are Mr. Simon To, Mr. Peter Lok, Mr. Wei Ming Hai, Mr. Wang Zhi and Mr. Sui Guang Jun. Wei Ming Hai is the chairman of the audit committee. The term of office of each member is three years. The term of office of the current members will end in 2007. A member may serve consecutive terms upon re-election. At least once a year, the committee is required to meet with the Company’s external auditors without any executive members of the Board in attendance. The quorum necessary for the transaction of any business is two committee members. The committee will normally meet four times a year.Audit Committee held nine meetings in 2006, which were attended by all members. The external auditors or the Chief Financial Officer of the Company may request a meeting of the audit committee.

The audit committee selects and engages, on behalf of the Company, external auditors to audit the Company’s annual financial statements and considers questions regarding the audit fees and the resignation or dismissal of the external auditors. The audit committee also reviews and approves the planned scope of the Company’s annual audit. In addition, the audit committee reviews the annual and interim financial statements, the preliminary announcement of results and any other announcement regarding the Company’s results or other financial information to be made public, before submission to the Board of Directors. Moreover, the committee discusses problems arising from the audit and reviews the external auditors’ management letter and management’s response. Furthermore, the audit committee reviews the effectiveness of the system of internal financial controls from information provided by the Executive Directorate and management of the Company and ensures adherence to the Company’s control policies so that the Company’s assets are safeguarded and that the financial records are complete and accurate. The audit committee meets regularly with the Company’s senior financial,officers from the finance department, the internal audit department and the external auditors to consider the Company’s financial reporting, the nature and scope of audit review and the effectiveness of the systems of internal control. The audit committee also reviews any significant transactions that are not in the ordinary course of business.

The Company has an internal audit department which reviews procedures in all major financial and operational activities. This department is led by the head of internal audit who is directly responsible to the Chairman of the Board and submits regular reports to the audit committee.

49
Remuneration Committee
The Company does not have a Remuneration Committee.remuneration committee is comprised of three members. Currently, the remuneration committee is chaired by independent non-executive Director Sui Guang Jun with independent non-executive Director Wei Ming Hai and executive Director Wang Quan Hua as members. The executive compensation programterm of office of each member is three years. The term of office of the Companycurrent members will end in 2007. A member may serve consecutive terms upon re-election. The remuneration committee met once in 2006, which meeting was attended by all members. In addition, the remuneration committee also meets as and when required to consider remuneration related matters.
The responsibilities of the remuneration committee are to approve the remuneration packages of Directors and Senior Management of the Group, and the Company’s “preliminary proposals on annual emoluments of the directors and senior management of the Group”. The remuneration committee is administered byalso responsible for assessing performance of executive Directors and approving the Boardterms of Directors.executive Directors’ service contracts.
Employees

Employees

As of December 31, 2003,2006, the Group had 17,56945,575 employees, including 1,9433,480 pilots, 2,9846,644 flight attendants, 2,3175,912 maintenance personnel, 4,1464,706 sales and marketing personnel, 14,686 administrative and 3,873 administrative personnel.other personnel and 10,147 temporary employees. All of the Group’s pilots, flight attendants, technicalmaintenance personnel, managementadministrative personnel and sales and marketing personnel are contract employees, and most of the Group’s ancillary service workers are temporary employees. Contract employees are hired by the Group pursuant to renewable employment contracts with terms ranging from three to five years. Temporary employees generally are hired by the Group pursuant to at-will employment contracts or employment contracts with a term of one year.

The Company’s employees are members of a trade union organized under the auspices of the All-China’s Federation of Trade Unions, which is established in accordance with the Trade Union Law of China. A representative of the Company labor union currently serves on the Supervisory Committee of the Company. Each of the Company’s subsidiaries has its own trade union. The Group has not experienced any strikes, slowdowns or labor disputes that have interfered with its operations, and the Group believes that its relations with its employees are good.

All employees of the Group receive cash remuneration and certain non-cash benefits. Cash remuneration consists of salaries, bonuses and cash subsidies provided by the Group. Salaries are determined in accordance with the national basic wage standards. The total amount of wages payable by the Group to its employees is subject to a maximum limit based on the profitability of the Group and other factors. Bonuses are based on the profitability of the Group. Cash subsidies are intended as a form of cost-of-living adjustment. In addition to cash compensation, the Group’s contract employees receive certain non-cash benefits, including housing, education and health services, and the Group’s temporary employees receive limited health services, but not housing or education. CSAHC provides certain services in respect of these benefits to the Group’s employees in consideration of certain fees and other charges.

     Pension Programs

     Historically, the Group participated in an industry-wide pension scheme managed by the CAAC. With effect from January 1, 1998, the pension scheme of the CAAC was replaced by several new retirement schemes operated under the auspices of various municipal governments.

Retirement And Housing Benefits
Employees of the Group participate in several defined contribution retirement schemes organised separately by PRC municipal governments in regions where the major operations of the Group are currently covered by such schemes. Under such schemes, thelocated. The Group is required to pay quarterly premiumscontribute to these schemes at the relevant municipal governments. The premiums rangerates ranging from 14%10% to 19%23% of salary costs including certain allowances. A member of the total monthlyretirement schemes is entitled to pension benefits equal to a fixed proportion of the salary bonusesat the retirement date. The retirement benefit obligations of all existing and other benefits paid byfuture retired staff of the Group to its employees.

44

are assumed by these schemes.

In addition, the Group was selected as one of the pilot enterprises to establishhas established a supplementary defined contribution retirement scheme forin accordance with relevant regulations in the benefit of employees.PRC. In this connection, employees of the Group participate in a supplementary defined contribution retirement scheme whereby the Group is required to make defined contributions atnot exceeding one-twelfth of the rate of 4.5% ofprior year’s total salaries.

In 2006, the Group implemented an early retirement plan for eligible employees. Employees at certain positions reaching a predetermined age are eligible for the plan. The approved employees are entitled to a fixed percentage of salaries and bonus on a monthly or yearly basis from the early retirement date to the normal retirement age.
Furthermore, pursuant to the comprehensive services agreement (the “Services Agreement”) dated May 22, 1997 between the Company and CSAHC, CSAHC provided quarters to eligible employees of the Group. In return, the Group paid a fixed annual fee of RMB85 million to CSAHC for a ten year period from 1995 to 2004. The agreement expired by December 31, 2004 and no further payment was made in 2005.
Pursuant to an additional staff housing benefit scheme effective September 2002, the Group agreed to pay lump sum housing allowances to certain employees who have not received quarters from CSAHC or the Group according to the relevant PRC housing reform policy, for subsidising their purchases of houses. An employee who quits prior to the end of the vesting benefit period is required to pay back a portion of the lump sum housing benefits determined on a pro-rata basis of the vesting benefit period. The Group has no obligation for the paymentright to effect a charge on the employee’s house and to enforce repayment through selling the house in the event of pension benefits beyonddefault in repayment. Any shortfall in repayment would be charged against income statement. As of December 31, 2006, the contributions described above. Contributions toCompany and the retirement schemesGroup had made payments totalling RMB170 million under the scheme and recorded its remaining contractual liabilities totalling RMB90 million as accrued expenses on the balance sheet. Housing allowances are charged to consolidated statement of operations as andpayable when incurred.

applications are received from eligible employees.

Workers’ Compensation

There is no workers’ compensation or other similar compensation scheme under the Chinese labor and employment system. As required by Chinese law, however, the Group, subject to certain conditions and limitations, pays for the medical expenses of any contract employee who sufferssuffer a work-related illness, injury or disability and continues to pay the full salary of, and provides all standard cash subsidies to, such employee during the term of such illness, injury or disability. The Group also pays for certain medical expenses of its temporary employees.

     At no time during 2003 had any Director, Supervisor or member of the Senior Management or any of their spouses or minor children, been granted or exercised or subscribed for shares or debentures or options of the Company.

50

Share Ownership

     Except as disclosed herein, as

As of the date of this Annual Report, no Director, Senior Management or Supervisor of the Company is a beneficial owner of any shares of the Company’s capital stock. As of the date of this Annual Report, no arrangement has been put in place involving issue or grant of options or shares or securities of the Company to any of the Director, Senior Management, Supervisor or employees of the Company.
                       
            % to the % to the    
            total total % to the  
            issued issued total  
  The         share domestic issued  
  Company/     Number capital shares H shares  
  associated Types of Type of of shares of the of the of the Short
Name
 corporation
 interest
 shares
 held
 Company
 Company
 Company
 position
Simon To the Company Interest of spouse (Note 1) H Shares  100,0000   0.002% —  0.009% —

Note 1:The spouse of Mr. Simon To is the owner of these 100,000 H Shares of the Company and accordingly, Mr. Simon To, is taken to be interested in these 100,000 H Shares by virtue of the SFO.

ITEM 7. MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS.

Major Shareholders

Share Capital Structure

As of DecemberMay 31, 2003,2007, the total share capital of the Company was divided into 4,374,178,000 shares, of which approximately 50.3%50.30% (2,200,000,000 domestic shares) iswas held by CSAHC, approximately 26.84% (1,174,178,000 H shares) iswas held by Hong Kong and overseas shareholders and approximately 22.86% (1,000,000,000 A shares) iswas held by domestic shareholders.

CSAHC owns 50.30% of the total share capital of the Company, therefore it is entitled to exercise all the rights of a controlling shareholder, including the election of executive Directors.

Substantial Shareholders

As of DecemberMay 31, 2003,2007, the following shareholders had an interest of 5% or more in the Company’s shares:
Name
 
Number of Shares
 
Approximate
Percentage
of the Total
Number of Shares
 
CSAHC Approximate Percentage
NameNumber of Sharesof the Total Number of Shares
CSAHC 2,200,000,000 domestic shares  50.30%
HKSCC Nominees Limited 1,149,955,9981,156,215,998 H shares  26.2926.43%

The table below sets forth, as of DecemberMay 31, 2003,2007, the following entities hold 5% or more of the total number of H shares issued by the Company.
         
      Approximate Percentage of
Name Number of H Shares the Total Number of H Shares
 
 
HKSCC Nominees Limited  1,149,955,998   97.94%

45

Name
 
Number of H Shares
 
Approximate
Percentage of
the Total
Number of H
Shares
 
HKSCC Nominees Limited  1,156,215,998  98.47%
Domestic shares and H shares have identical voting rights.

Related Party Transactions

The Company enters into transactions from time to time with CSAHC and its affiliates. For a description of such transactions, see Note 2537 to the Financial Statements. In particular, the following arrangements, which the Company believes are material to its operations, have been made between the Company and CSAHC and its affiliates. The Company believes that these arrangements are effectedhave been entered into by the Group in the prevailing market ratesordinary course of business and are commercially reasonable and on terms no less favorable than terms available from third parties.

in accordance with the agreements governing such transactions.

Arrangements with CSAHC

Trademark License Agreement

The Company and CSAHC have entered into the Trademark License Agreementa ten year trademark license agreement dated May 22, 1997 pursuant to which CSAHC has acknowledgedacknowledges that the GroupCompany has the right to use the name “China Southern” and “China Southern Airlines” in both Chinese and English, and has granted togrants the Company a 10-year renewable royalty free license to use the kapok logo on a world-wideworldwide basis in connection with itsthe Company’s airline and airline-related businesses. As CSAHC has retained the right to use the kapok logo in connection with its non-airline related businesses conducted as of the date of the Trademark License Agreement and to permit its affiliates that dodid not compete, directly or indirectly, with the Group to use the kapok logo. Unless CSAHC givesgive a written notice of termination three months before the expiration of the 10-year term of the agreement, the agreement will beis automatically extendedrenewed for another 10-yearten year term.


51
Leases

The Company as lessee and CSAHC as lessor have entered into the following lease agreements:

The Company and CSAHC have entered into a land lease agreement dated May 22, 1997, in respect of the land used by the Company within Baiyun International Airport. The total rental payment is RMB2.7 million per year. The term of the lease is five years commencing April 1, 1997, and is renewable by the Company thereafter.

     The Company and CSAHC have separately entered into four lease agreements dated May 22, 1997, in respect of office premises located at the east wing of the Guangzhou Railway Station on Guangzhou Huanshi Dong Road, office premises at Haikou Airport, office premises in Haikou City, and office premises at Tianhe Airport in Wuhan, Hubei Province. The aggregate rental payment under the four leases is RMB12.6 million per year. The original term of each lease is one year and is renewable annually by the Company thereafter.

     The Company and CSAHC have entered into an indemnification agreement dated May 22, 1997 in which CSAHC has agreed to indemnify the Company against any loss or damage caused by or arising from any challenge of, or interference with, the Company’s right to use certain land and buildings.

Comprehensive Services and Employee Benefits

The Company and CSAHC have entered into a comprehensive serviceslease agreement dated November 12, 2004, under which CSAHC leases to the Company certain lands by leasing the land use rights of such lands to the Company. These lands had been administratively allocated to XJA and CNA for the purposes of their civil aviation and related businesses. Subsequently, CSAHC was authorised to deal with the land use rights of such lands, including leasing, but not transferring, such land use rights. Total area of the lands leased is 1,182,297 square meters, and the locations of such lands are in Urumqi, Shenyang, Dalian and Harbin. The lease is for a fixed term of three years, commencing from the effective date of the lease, and is renewable, subject to compliance with the relevant requirements of the Hong Kong Listing Rules by the Company, by an application in writing by the Company to the lessor three months before the end of the fixed term. The rent for the land use rights of the designated lands under lease agreement is RMB22,298,000 per year, payable in arrear by cheque, in cash or by bank transfer on or before the 10th day of each calendar month, and was determined after arm’s length negotiations between the parties. The maximum aggregate annual limit (“Cap”) for the lease agreement is set at RMB22,298,000 per year. The lease agreement was approved by the shareholders of the Company at the second extraordinary general meeting on December 31, 2004.
The Company, CSAHC and CNA entered into a lease agreement dated November 12, 2004, under which CSAHC and CNA lease to the Company certain buildings, facilities and other infrastructure related to the civil aviation businesses of CNA situated at various locations in Shenyang, Dalian, Jilin, Harbin, Chaoyang and Russia. The lease is for a fixed term of three years, commencing from the date of the lease, and is renewable, subject to compliance with the relevant requirements of the Hong Kong Listing Rules by the Company, by an application in writing by the Company to the lessor three months before the end of the fixed term. The consideration for the lease agreement is RMB43,758,000 per year, payable in arrear by cheque, in cash or by bank transfer on or before the 10th day of each calendar month, and is determined after arm’s length negotiation between the parties. The Cap for the lease agreement is set at RMB43,758,000 per year. The lease agreement was approved by the shareholders of the Company at the 2nd extraordinary general meeting on December 31, 2004.
The Company, CSAHC and XJA entered into a lease agreement dated November 12, 2004, under which CSAHC and XJA lease to the Company certain buildings, facilities and other infrastructure related to the civil aviation businesses of XJA situated in Xinjiang and Russia. The lease is for a fixed term of three years, commencing from the effective date of the lease, and is renewable, subject to compliance with the relevant requirements of the Hong Kong Listing Rules by the Company, by an application in writing by the Company to the lessor three months before the end of the fixed term. The consideration for the lease agreement is RMB5,798,000 per year, payable in arrear by cheque, in cash or by bank transfer on or before the 10th day of each calendar month, and is determined after arm’s length negotiation between the parties. The Cap for the lease agreement is set at RMB5,798,000 per year. The lease agreement was approved by the shareholders of the Company at the 2nd extraordinary general meeting on December 31, 2004.
The Company and CSAHC entered into a lease agreement dated December 19, 2006 (“Lease Agreement”). The Lease Agreement supersedes and replaces the lease agreements entered into between the Company and CSAHC dated May 22, 1997, in which CSAHC leased to the Company certain parcels of land and office premises used at Guangzhou Baiyun Airport, Haikou Airport and Tianhe Airport, and the lease agreement entered into between the Company and CSAHC dated May 15, 2001, in which CSAHC leased to the Company certain parcels of land, properties, and civil aviation structures and facilities at various locations at Hengyang, Jingzhou (previously known as “Shashi”) and Nanyang for a term of 5 years.
 The Lease Agreement takes effect retrospectively on January 1, 2006, and is valid for a term of three years. Under the Lease Agreement, the annual rents payable for the years 2006, 2007 and 2008 are RMB27,543,606.01, RMB28,657,966.99 and RMB29,828,046.01, respectively. The rent is payable in advance semiannually by the Company wholly out of its internal funds.
Sale of Properties
The Company and CSAHC entered into a properties sale agreement (the “Properties Sale Agreement”), dated December 28, 2006, according to which the Company would sell to CSAHC the properties with a total area of 12,008.09 square meters including the 757 aircraft supplies depot, 737 aircraftsupplies depot, 777 aircraft supplies depot, Building no. 143 aircraft supplies depot, Building No. 144 aircraft supplies depot and a new engine depot located within the vicinity of old Guangzhou Baiyun Airport (the “Properties”).

The consideration payable under the Properties Sale Agreement is RMB23,347,170.60. The net book value of the Properties is RMB19,886,352.67 as of June 30, 2006. The consideration was determined after arm’s length negotiations by the Company and CSAHC, with consideration given also to the existing conditions of the Properties and relevant assets valuation report. The Properties, situated at the old Guangzhou Baiyun Airport, are not used by the Company since the moving of the Company’s business and operations to the new Guangzhou Baiyun Airport. The Properties are part of the assets transferred by CSAHC to the Company pursuant to whichthe Demerger agreement dated March 25, 1995 (as amended). Under the De-merger Agreement, CSAHC agreeshas agreed to provide adequate quartersindemnify the Company against claims, liabilities and expenses incurred by it relating to eligible employees of the Group as and when required. In return,business, assets held or assumed by the Group agreesCompany pursuant to pay a fixed annual fee of RMB85 million to CSAHC for a ten-year period effective January 1, 1995.

the Demerger Agreement, including the Properties.

52
Arrangements with CSAHC’s Affiliates

Southern Airlines (Group)(Groups) Import and Export Trading Company (“SAIETC”("SAIETC"), a wholly-ownedwholly owned subsidiary of CSAHC


The Company and SAIETC have entered into an agreementImport and Export Agency Framework Agreement dated May 22, 1997,January 1, 2006 for the import and export of aircraft, flight equipment, special vehicles for airline use, communication and navigation facilities, and training facilitiesfacilities. The Import and Export Agency Framework Agreement is valid for a term extendingof three years, commencing from May 22, 1997the date of agreement, subject to May 22, 2000 which was subsequently extended to May 22, 2006compliance with the relevant provisions of the Hong Kong Listing Rules by mutual agreement between the parties. TheCompany. Both parties have mutually agreed that the agency fee for import and export shall be determined after arm’s length negotiation and shall not be higher than the market rate. The annual cap for such agreement canshall be extended automatically.

RMB80,000,000 per annum. The independent non-executive Directors of the Company have approved the Import and Export Agency Framework Agreement.


For the year ended December 31, 2003,2006, the amount incurredcommission expense paid by the Group forin respect of the import and export of the above equipment was RMB1,155 million, inclusive of agency commission of 1.5% aboveRMB28,872,000.
Southern Airlines Culture and Media Co., Ltd. (“SACM”), which is 50% owned by the contract prices paid to SAIETC.

46

Company and 50% owned by CSAHC


The Company and Southern Airlines Advertising Company (“SAAC”), which is 90% owned by the Group and 10% owned by CSAHC

     In August 2002, the Group entered into a takeover agreement with CSAHC. As a result, the Group owns 90%new Advertising Agency Agreement dated January 1, 2006. SAAC and CSAHC owns 10% of SAAC.

     The Company and SAAC haveSACM entered into an acquisition agreement dated May 22, 1997, forin 2006 whereby SACM acquired and merged with SAAC and assumed the provisionrights, obligations and business of advertising servicesSAAC.


The Advertising Agency Agreement is valid for a term extendingof three years commencing from May 22, 1997the date of the agreement. Under the agreement, SACM will produce advertisement script, graphic and music for the Company with the copyright of such products belonging to May 22, 2000.the Company, subject to compliance with the relevant provisions of the Hong Kong Listing Rules. The agreement has been extended to May 22,parties have determined the various rates for providing advertising services after negotiations on a fair and equitable basis, which are not higher than the market rates for similar advertising services. The cap for the advertising agency fee shall be RMB30,000,000 for 2006.

The independent non-executive Directors of the Company have approved such Advertising Agency Agreement.


For the year ended December 31, 2003,2006, the amount incurred by the Group to SAAC for advertising servicesSACM was RMB1.3 million.

RMB3,707,000.

53

China Southern Airlines Group Finance Company Limited (“SA Finance”), which is 42%66% owned by CSAHC, 32%21% owned by the Company 26%and 13% owned in aggregate by fivefour subsidiaries of the Company


The Company has entered into a financial agreementFinancial Agreement (“Financial Agreement”) dated May 22, 1997 with SA Finance for the provision of financial services such as deposit and loan facilities, credit facilities, financial guarantees and credit references for a term extendingcommencing from May 22, 1997 to May 22, 2000. As agreed by the parties, theThe agreement has beenwas extended for six years to May 22, 2006.

In order to comply with the new requirements under the Listing Rules, the Company was required to enter into separate agreement with SA Finance and comply with other provisions of the Listing Rules, so that SA Finance could continue to provide deposit of money service and other financial services to the Company. Therefore, the Company and SA Finance entered into a new Financial Agreement on December 31, 2004, commencing from that date for a period of three years, and is renewable, subject to compliance with the relevant requirements of the Hong Kong Listing Rules by the Company, by an application in writing by the Company not less than 30 days before the end of the fixed term.


As the new Financial Agreement constitutes a discloseable and non-exempt continuing connected transaction under Rule 14A.35 of the Listing Rules and requires the Company to comply with the reporting and announcement requirement and the independent shareholders’ approval requirement under Rule 14A.48 of the Listing Rules. The independent shareholders of the Company approved the Financial Agreement at the second extraordinary general meeting of the Company held on December 31, 2004.

Under such agreement, (a) all funds thatSA Finance agrees to provide to the Company deposits withthe following financial services:

accept deposit of money from the Company at interest rates not lower than those set by the People’s Bank of China for the same term of deposit. SA Finance will be depositedin turn deposit the whole of such sums of money with certain banks including Bank of Agriculture, Bank of Communications, China Construction Bank and Industrial and Commercial Bank of China. The maximum limit for amount of money deposit under the Financial Agreement is RMB1 billion;

make loans to the Company subject to the entering into of separate loan agreements, which will set out the maximum cap and terms and conditions of the loans, upon application by the Company during the term of the Financial Agreement. The Company will comply with the Hong Kong Listing Rules when entering into such separate written agreements. SA Finance shall not charge interest rates higher than those set by the People’s Bank of China for similar loans. The total amount of outstanding loans extended by SA Finance with the Commercial and Industrial Bank of China, Bank of Communications, Bank of Agriculture, China Construction Bank, or other banks of similar creditworthiness; and (b) SA Finance will not at any time have outstanding loans in excess of the amount representing the aggregate of (i) deposits received from entities other thanto the Company (ii)must not exceed the sum of SA Finance’s shareholders’ equity, capital reserves and (iii) capital reserves.

money deposit received from other parties (except the Company); and


provide credit facilities, financial guarantees, credit references, and other financial services subject to the entering into of separate agreements, which will set out the Cap and terms and conditions of such services, upon request by the Company during the term of the new Financial Agreement. The Company will comply with the Hong Kong, Listing Rules when entering into such separate written agreements.

As of December 31, 2003,2006, the Group had short-termGroup’s deposits placed with SA Finance amountingamounted to RMB365.9 million,RMB629,366,000, which earnedbore interest at the rate of 1.98% — 3.00%0.72% during the year.

As of December 31, 2006, loans from SA Finance to the Group amounted up to RMB300,000,000 which bore interest at rates ranging from 5.02% to 5.26% per annum.

annum during the year.


Shenzhen Air Catering Company Limited, which is 33% owned by CSAHC, and 67% owned by two independent third parties


The Company and Shenzhen Air Catering Company Limited have entered into an agreement dated May 23, 1997 for the sale and purchase of in-flight meals for flights originating or stopping at the airport in Shenzhen. Pursuant to such agreement, Shenzhen Air Catering Company Limited wouldwill supply in-flight meals to the Group from time to time during the term from May 23, 1997 to May 23, 1998. The parties have mutually agreed that the agreement can be extendedrenewed automatically.

In order to comply with the various requirements under the Hong Kong Listing Rules, the Company intends to enter into negotiation with Shenzhen Air Catering Company Limited to revise the agreement. The Company will comply with its obligations under the Hong Kong Listing Rules upon execution of the revised agreement.

54

For the year ended December 31, 2003,2006, the amount paidincurred by the Group to Shenzhen Air Catering Company Limited for the provision of in-flight meals was approximately RMB28.2 million.

GAMECO, which is 50% owned by the Company and 50% owned by an independent third party

     The Company and GAMECO have entered into an Aircraft Maintenance and Engineering Agreement for the provision of aircraft repair and maintenance services. On May 17, 1996, the Company and GAMECO entered into an agreement regarding the fee arrangement for the provision of such repair and maintenance services (the “Fee Agreement”). Pursuant to the Fee Agreement and subsequent agreements, GAMECO charged the Company for expendables at cost plus 15%, and labor costs at US$30.0 per hour during 2003.

     For the year ended December 31, 2003, the amount incurred by the Company for such repair and maintenance services was RMB587.3 million.

The RMB56,204,000.


China Southern West Australian Flying College Pty Ltd (the “Australian Pilot College”), which is 65% owned by the Company and 35% owned by CSAHC.

CSAHC


CSAHC and the Australian Pilot College entered into an agreement dated October 7, 1993 for the provision of pilot training in Australia to the cadet pilots of CSAHC (the “Training Agreement”). The Training Agreement will remain in force unless terminated by either party upon 90 days’ prior written notice to the other party. Pursuant to the Demerger Agreement, the Company has assumed all the interests, rights and obligations of CSAHC under the Training Agreement.

In order to comply with the various requirements under the Hong Kong Listing Rules, the Company intends to enter into negotiation with Australian Pilot College to revise the Training Agreement. The Company will comply with its obligations under the Listing Rules upon execution of the revised agreement.


For the year ended December 31, 2003,2006, the amount paid by the Group to the Australian Pilot College for training services was RMB82.4 million.

47

RMB95,124,000.


Southern Airlines (Group) Economic Development Company, (“SAGEDC”), which is 61% owned by CSAHC and 39% owned by an independent third party.

party


The Company and SAGEDC haveSouthern Airlines (Group) Economic Development Company entered into an agreement dated May 22, 1997 for the provision of drinks, snacks, liquor, souvenirs and other products for a term extending from May 22, 1997 to May 22, 2007.


For the year ended December 31, 2003,2006, the amount paid by the Group to Southern Airlines (Group) Economic Development Company for the provision of drinks, snacks, liquor, souvenirs and other products was RMB42.8 million.

RMB85,849,000.


Ticket sales arrangements


The CompanyGroup has entered into ticket agency agreementsTicket Agency Agreements for the sale of the Group’s air tickets with several subsidiaries of CSAHC (the “Agents”). The Agents charge a commission at a rate prescribedon the basis of the rates stipulated by the CAAC and the International Air Transport Association for each air ticket sold(“IATA”). The Agents charge a commission in the amount of 3% of the ticket price for domestic tickets and 5% — 12%3% to 6% of the ticket price for Hong Kong regional/and Macau/international tickets, respectively. In addition to the Agents, the Companytickets. The Group has other air ticket sales agents in China who also charge commission at the same rates. The Agents also act as air ticket sales agents for other Chinese airlines and charge the same rates of commission to such other airlines as those charged to the Company.

Group.


The Company and China Southern Airlines Group Passenger and Cargo Agent Company Limited (“PCACL”), a wholly-owned subsidiary of CSAHC, have entered into a new ticket agency framework agreement and a new airfreight forwarding agency framework dated January 1, 2006 (“Two Sales Agency Framework Agreements”).

The Two Sales Agency Framework Agreements are valid for a term of three years commencing from the date of the agreements, subject to the compliance of relevant provisions under the Hong Kong Listing Rules. The parties agreed that the agency fee shall be determined after arm’s length negotiation and shall not be higher than the market rate. The annual cap under each of the Two Sales Agency Framework Agreements is set at RMB10,000,000 per annum. The independent non-executive Directors of the Company have approved these Two Sales Agency Framework Agreement.

For the year ended December 31, 2003,2006, the aggregate amount of ticket sales of the GroupCompany conducted through the Agents was RMB143.0 million.

RMB701,441,000.


China Southern Airlines Group Air Catering Company Limited (the “Catering Company”), a wholly owned subsidiary of CSAHC

The Company and the Catering Company entered into a catering agreement dated November 12, 2004 (“Catering Agreement”) under which the Catering Company would supply: (1) in-flight meals in accordance with the menus of in-flight meals to be agreed with the Company from time to time, and in such quantity as the Company shall advise the Catering Company in advance; and (2) catering services for different flights of the Company (including normal, additional, chartered and temporary flights) originating or stopping at the domestic airports, mainly in northern China and the Xinjiang regions where the Catering Company provides catering services.

The Catering Agreement is for a fixed term of three years, commencing from the date of the agreement. The parties have agreed, after arm’s length negotiation, on the price of each type of in-flight meal and the service charges for each type of aircraft. The prices of in-flight meals and the service charges are not higher than the market rate of comparable in-flight meals and service charges. The Catering Company will issue an invoice listing out the quantity of in-flight meals supplied, the agreed unit price and the total price payable for each of the Company flights it provides service for. The cap for the Catering Agreement is set at RMB220,000,000 per year.

For the year ended December 31, 2006, the Company paid an in-flight meals charge of RMB138,084,000 pursuant to the Catering Agreement.
55

China Southern Airlines Group Travel Development Company Limited (“CSA Travel”), a wholly owned subsidiary of CSAHC

The Company and CSA Travel entered into a Framework Agreement on Lease, Operation and Management (“Framework Agreement on Lease and Operation”) dated January 1, 2006 regarding hotel leasing and providing relevant service for a fixed term of three years. According to this agreement, the Company will lease certain hotels or certain divisions of these hotels to CSA Travel for it to operate, and the Company is entitled to employ CSA Travel to provide property cleaning or ticket agent service according to business development, which is subject to separate agreement according to the Framework Agreement on Lease and Operation. The relevant fee was determined at an arm’s length between both parties and the price shall not be higher than the market rate. The annual cap for the Framework Agreement on Lease and Operation is set at RMB6,000,000 per annum. The Framework Agreement on Lease and Operation has been approved by the independent non-executive Directors of the Company.

Guangzhou China Southern Airlines Property Management Company Limited (the “GCSAPMC”), which is 90% owned by CSAHC and 10% owned by the Company’s Union

The Company and GCSAPMC entered into a Framework Agreement for the Engagement of Property Management (“Property Management Framework Agreement”) dated January 1, 2006 in respect of engaging GCSAPMC to provide property management and improvement service with a term of three years from the date of this agreement. Pursuant to the agreement, the Company has appointed GCSAPMC to provide management and maintenance services for the Company’s headquarters in Guangzhou and to provide maintenance and management services for the 110KV transformer substation to ensure the ideal working conditions of the Company’s production and office facilities and physical environment, and the normal operation of equipment. The fee charging schedule (or charge standard) shall be determined at an arm’s length between both parties, and will not be higher than the fee charging schedule of independent third parties in similar industry. The annual cap for the Property Management Framework Agreement Framework Agreement is set at RMB47,010,000 per annum. The Property Management Framework Agreement has been approved by the independent non-executive Directors of the Company.
For the year ended December 31, 2006, the Company paid the property management and maintenance fee of RMB26,402,000 pursuant to the Property Management Framework Agreement.
Please also see note 37 to our consolidated financial statements included elsewhere in this Form 20-F.
Interests of Experts and Counsel

Not applicable.

ITEM 8. FINANCIAL INFORMATION.

Consolidated Statements and Other Financial Information

See “Item 18. Financial Statements” for financial statements filed as part of this Annual Report.

48

Significant Changes

No significant changes have occurred since the date of the financial statements provided in Item 18 below.


Legal Proceedings

     The Company is currently involved


From time to time, we may be subject to various claims and legal actions arising in a civil litigation (Hong Kongthe ordinary course of business. In May 2007, we received the court summons from the High People’s Court Action No. 515 of 2001) (“Litigation”). AccordingGuangdong Province with respect to the writ of summons forcontractual dispute lawsuit filed against us by Taiwan J & P International Tours Co., Ltd. and Taiwan China Southern Aviation Travel Co., Ltd. (the "Plaintiffs").
In August 2004, we entered into a cooperation agreement with the Litigation, New Link Consultants Limited, the plaintiff, claimed against the Company (as one of the defendants to the Litigation) on the basis of certain evidence proving that United Aero-Supplies System of China, Limited (“UASSC”Plaintiffs and, in September 2004, Nan Lung Travel & Express (H.K.) Ltd., our Hong Kong sales agent, entered into an air ticket sales agency agreement with the defendants for exclusive purchasePlaintiffs. The performance of aviation equipment consigned to UASSC for sale and, that as the defendants failed to perform the agreement, UASSC has the right to compensation. Since UASSC is in the course of its winding up proceedings, all the rights and benefits of UASSC in connection with the claim have been transferred to the plaintiff. The Company, as one of the defendants to the Litigation,both agreements has been claimedcompleted. The Plaintiffs, however, have filed a lawsuit against us for unspecifiedliquidated damages for breach of the agreement. Given thatprovisions on air ticket sales commissions and other payments under those two agreements. The amount of the Litigationclaim is approximately RMB107 million. We are currently in the process of retaining legal counsel and will actively defend ourselves.

Although the proceeding is still at its preliminaryan early stage, we believe it is pre-matured to predictwill not have any material effect on the resultbusiness operations and financial position of the court judgment. Based on the opinion given by its instructing solicitors, the Company’s directors consider that the Company has a reasonable chance of success in its defense to the claim. At present, the Company has filed an objection in respect of the jurisdiction of the court, and has requested the court to transfer the case to the PRC for trial. Accordingly, the Directors of the Company consider that a provision for such claim and/or the associated legal costs is not required.

     Other than the above legal proceeding, the Company is not party to any material legal proceedings.

Company.

56
Dividend Information

No interim dividend was paid during the year ended December 31, 2003.2006. The Board of Directors does not recommend the payment of a final dividend in respect of the year ended December 31, 2003.2006.

ITEM 9. THE OFFER AND LISTING.

Offer and Listing Details
The principal trading market for the Company’s H Shares is the Hong Kong Stock Exchange, and the Company’s trading code is “1055”. The ADSs, each representing 50 H Shares, are evidenced by ADRs issued by The Bank of New York as the Depositary for the ADRs, and are listed on the New York Stock Exchange under the symbol “ZNH.” As of May 31, 2004, approximately 104,740,000 of the Company’s H Shares in the form of 2,094,800 ADSs were held in the U.S. by approximately 42 record holders in the U.S., including the Depository Trust Company.

“ZNH”.

In July 2003, the Company issued and listed 1,000,000,000 A shares on the Shanghai Stock Exchange with trading code of “600029”. The 2,200,000,000 Domestic Shares held by CSAHC are not listed on any stock exchange and are essentially not transferrable by CSAHC.

Set forth below for the periods indicated are the high and low sales prices of H Shares on the Hong Kong Stock Exchange, ADSs on the New York Stock Exchange and A Shares on the Shanghai Stock Exchange.
                          
   The Stock Exchange The New York The Shanghai
   of Hong Kong Stock Exchange Stock Exchange
   Price per H Share Price per ADS Price per A Share
   (HK$) (US$) (RMB)
   
 
 
  High Low High Low High Low
  
 
 
 
 
 
Annual Market Prices            
 
Fiscal Year ended December 31, 1998
  2.40   0.50   14.75   3.06   N/A   N/A  
 
Fiscal Year ended December 31, 1999
  2.25   0.61   13.94   3.88   N/A   N/A  
 
Fiscal Year ended December 31, 2000
  2.93   1.02   18.38   6.06   N/A   N/A  
 
Fiscal Year ended December 31, 2001
  2.95   1.35   18.10   8.00   N/A   N/A  
 
Fiscal Year ended December 31, 2002
  3.60   1.50   22.25   10.35   N/A   N/A  
 
Fiscal Year ended December 31, 2003
  3.50   1.46   22.78   9.53   5.34   3.75  
Quarterly Market Prices
                        
 
Fiscal Year ended December 31, 2000
                        
 
First Quarter
  1.86   1.02   11.19   6.88   N/A   N/A  
 
Second Quarter
  2.05   1.06   12.44   6.06   N/A   N/A  
 
Third Quarter
  2.93   1.63   18.38   10.19   N/A   N/A  
 
Fourth Quarter
  2.40   1.46   15.06   9.56   N/A   N/A  
 
Fiscal Year ended December 31, 2001
                        
 
First Quarter
  2.70   1.83   17.38   12.22   N/A   N/A  
 
Second Quarter
  2.95   1.89   18.10   12.00   N/A   N/A  
 
Third Quarter
  2.53   1.35   16.50   8.00   N/A   N/A  
 
Fourth Quarter
  2.42   1.66   15.25   9.8   N/A   N/A  
 
Fiscal Year ended December 31, 2002
                        

49


  
The Hong Kong 
Stock Exchange
Price per H Share
(HK$)
 
The New York
Stock Exchange
Price per ADS
(US$)
 
The Shanghai
Stock Exchange
Price per A Share
(RMB)
 
  
High
 
Low
 
High
 
Low
 
High
 
Low
 
Annual Market Prices
             
Fiscal Year ended December 31, 2002
  3.60  1.50  22.25  10.35  N/A  N/A 
Fiscal Year ended December 31, 2003
  3.50  1.46  22.78  9.53  5.34  3.75 
Fiscal Year ended December 31, 2004
  4.68  2.47  29.73  15.95  6.87  3.96 
Fiscal Year ended December 31, 2005
  2.22  2.17  14.25  14.20  2.68  2.62 
Fiscal Year ended December 31, 2006
  3.42  1.60  22.43  14.00  4.09  2.24 
              
Quarterly Market Prices
             
              
Fiscal Year ended December 31, 2005
             
First Quarter
  3.10  2.47  19.93  16.10  5.30  3.56 
Second Quarter  2.72  2.20  17.33  14.72  4.02  2.95 
Third Quarter  2.20  2.03  16.86  13.50  3.00  2.35 
Fourth Quarter  2.40  1.83  15.45  11.68  2.77  2.23 
Fiscal Year ended December 31, 2006
             
First Quarter
  2.45  2.18  15.82  14.00  2.97  2.48 
Second Quarter  2.30  1.66  14.96  10.82  2.92  2.24 
Third Quarter  2.25  1.60  14.86  10.51  2.94  2.27 
Fourth Quarter  3.42  2.29  22.43  14.06  4.09  2.95 
Monthly Market Prices                   
December 2006  3.16  2.83  20.45  18.31  4.09  3.66 
January 2007  4.22  3.25  26.82  21.48  6.26  4.26 
February 2007  4.02  3.48  25.86  21.70  6.12  4.93 
March 2007  3.74  3.29  23.83  20.81  7.43  5.43 
April 2007  3.72  3.44  23.98  22.10  9.03  7.80 
May 2007  4.98  3.37  31.29  21.94  9.48  9.48 
June 2007 (up to June 27, 2007)  5.59  4.20  35.64  27.53  9.48  8.31 
57

                          
   The Stock Exchange The New York The Shanghai
   of Hong Kong Stock Exchange Stock Exchange
   Price per H Share Price per ADS Price per A Share
   (HK$) (US$) (RMB)
   
 
 
  High Low High   Low High Low
  
 
 
 
 
 
 
First Quarter
  2.83   2.22   17.63   14.80   NA   NA 
 
Second Quarter
  3.42   2.33   21.74   14.95   NA   NA 
 
Third Quarter
  3.60   1.89   22.25   12.00   NA   NA 
 
Fourth Quarter
  2.42   1.50   15.00   10.35   NA   NA 
Fiscal Year ended December 31, 2003                        
 
First Quarter
  2.62   1.71   16.50   11.75   N/A   N/A 
 
Second Quarter
  2.40   1.46   14.85   9.53   N/A   N/A 
 
Third Quarter
  2.88   2.03   18.59   13.25   4.15   3.75 
 
Fourth Quarter
  3.50   2.50   22.78   16.76   5.34   3.86 
Monthly Market Prices
                        
 
December 2003
  3.50   2.92   22.78   19.00   5.34   4.46 
 
January 2004
  3.95   3.35   25.18   21.94   6.30   4.95 
 
February 2004
  4.68   3.20   29.73   20.91   6.73   5.70 
 
March 2004
  4.47   3.30   28.60   21.00   6.57   5.77 
 
April 2004
  3.90   3.20   24.89   21.07   6.24   5.49 
 
May 2004
  3.53   2.47   22.62   15.95   6.10   4.82 
Plan of Distribution

Not applicable.
OfferMarkets
See “Offer and Listing detailsDetails” above.
Selling Shareholders

Not applicable.
Dilution

Plan of Distribution

Not applicable.
58

Markets

     Not applicable.

Selling Shareholders

     Not applicable.

Dilution

     Not applicable.

Expenses of the Issue

Not applicable.

ITEM 10. ADDITIONAL INFORMATION.

Share Capital

Not applicable.

Memorandum and Articles of Association

The following is a summary of certain provisions of our articles of association. As this is a summary, it does not contain all the information that may be important to you. You and your advisors should read the text of our articles of association for further information.
The Company is registered with and has obtained a business license from the State Administration Bureau of Industry and Commerce of the People’s Republic of China on March 25, 1995. The Company’s business license number is 1000001001760.

On March 13, 2003, the Company obtained an approval certificate from the Ministry of Commerce to change to a permanent limited company with foreign investments and obtained the business license (Qi Gu Guo Zi Di No. 000995) on October 17, 2003 issued by the State Administration of Industry and Commerce of the People’s Republic of China.

50

     Director

Other Senior Administrative Officers
Pursuant to the Article 1316 of the Articles of Association, the business purposesother senior administrative officers of the Company are: (i)refer to absorb domesticvice president, chief financial officer, the board secretary, general economist, chief engineer, chief pilot, and foreign capital; (ii) to assist in developing the aviation industry of China; (iii) to promote the development of the national economy of China; (iv) to utilize corporate incentive mechanisms of privatization; (v) to draw on the advanced management expertise of other domesticgeneral legal counsel and foreign companies; (vi) to continuously improve the management of the Company; (vii) to enhance the market competitiveness of the Company; (viii) to generate economicchief information officer.
Objects and social benefits for the Company; and (ix) to generate steady income for the Company’s shareholders. Purpose

Pursuant to the Article 1418 of the Articles of Association, the scope of business of the Company shall be consistent with and subject to the scope of business approved by the relevant supervisory department of the State. The scope of business of the Company includes: (i)(I) provision of scheduled and non-scheduled domestic, regional and international air transportation services for passengers, cargo, mail and luggage; (ii)(II) undertaking general aviation services; (iii)(III) provision of aircraft repair and maintenance services; (iv)(IV) acting as agent for other domestic and international airlines; (v)(V) provision of air catering servicesservices; (VI) provision of hotel business; (VII) acting as sale agent for aircraft leasing and (vi)aviation accident insurance; and (VIII) engaging in other airline or airline-related business, including advertising for such services.

(subject to approved of  State Administration of Industry and Commerce).

Directors
Pursuant to Article 154244 of the Articles of Association, where a directorDirector of the Company is in any way, directly or indirectly, materially interested in a contract, transaction or arrangement or proposed contract, transaction or arrangement with the Company, (other than his contract of service with the Company), he shall declare the nature and extent of his interests to the boardBoard of directorsDirectors at the earliest opportunity, whether or not the contract, transaction or arrangement or proposal therefor is otherwise subject to the approval of the boardBoard of directors.

Directors.

Pursuant to Article 108174 of the Articles of Association, where a directorDirector is interested in any resolution proposed at a board meeting, such directorDirector shall not be present and shall not have a right to vote. Such directorDirector shall not be counted in the quorum of the relevant meeting.

Pursuant to Article 162252 of the Articles of Association, the Company shall, with the prior approval of shareholders in general meeting, enter into a contract in writing with a directorDirector wherein his emoluments are stipulated. The aforesaid emoluments include, emoluments in respect of his service as director, supervisorDirector, Supervisor or senior administrative officer of the Company or any subsidiary of the Company; emoluments in respect of the provision of other services in connection with the management of the affairs of the Company and any of its subsidiaries; and payment by way of compensation for loss of office, or as consideration for or in connection with his retirement from office.

Pursuant to Article 102(6)162(6) of the Articles of Association, the boardBoard of directorsDirectors has the power to formulate proposals for increases or reductions in the Company’s registered capital and the issue of debentures of the Company; such resolutions must be passed by more than two-thirds of all the directors.

Directors.

There is no mandatory retirement age for the directorsDirectors of the Company. The directorsDirectors of the Company are not required to hold shares of the Company.

Ordinary Shares

Pursuant to Article 1926 of the Articles of Association,subject to the approval of the securities authority of the State Council, the Company may issue and offer shares to domestic investors or foreign investors for subscription. Foreign investors are those investors of foreign countries and regions of Hong Kong, Macau and Taiwan who subscribe for shares issued by the Company. Domestic investors are those investors within the territory of the PRC (excluding investors of the regions referred to in the preceding sentence) who subscribe for shares issued by the Company.

59
Pursuant to Article 2027 of the Articles of Association,Sharesshares issued by the Company to domestic investors for subscription in Renminbi shall be referred to as “Domestic-Invested Shares”. Shares issued by the Company to foreign investors for subscription in foreign currencies shall be referred to as “Foreign-Invested Shares”. Foreign-Invested Shares which are listed overseas are called “Overseas-Listed Foreign-Invested Shares”. The foreign currencies mean the legal currencies (apart from Renminbi) of other countries or districts which are recognized by the foreign exchange control authority of the Statestate and can be used to pay the Company for the share price.

Pursuant to Article 2128 of the Articles of Association,Domestic-Invested Shares issued by the Company shall be called “A Shares”. Overseas-Listed Foreign-Invested Shares issued by the Company and listed in Hong Kong shall be called “H Shares”. H Shares are shares which have been admitted for listing on The Stock Exchange of Hong Kong Limited, the par value of which is denominated in Renminbi and which are subscribed for and traded in Hong Kong dollars. H Shares can also be listed on a stock exchange in the United States of America in the form of American depositary receipts.

51

The Company has issued a total of 4,374,178,000 ordinary shares, of which (a) 2,200,000,000 domestic shares are Domestic Shares held by CSAHC, (b) 1,174,178,000 are H shares areShares held by Hong Kong and overseas shareholders and (c) 1,000,000,000 are A shares areShares held by the PRC shareholders.

Pursuant to Article 5462 of the Articles of Association, the ordinary shareholders of the Company shall enjoy the following rights:

(1)the right to attend or appoint a proxy to attend shareholders’ general meetings and to vote thereat;
 
(2)the right to dividends and other distributions in proportion to the number of shares held;
 
(3)the right of supervisory management over the Company’s business operations, and the right to present proposals or enquiries;
(4)the right to transfer, donate or pledge his shares in accordance with laws, administrative regulations and provisions of these articlesArticles of association;Association;
(5)the right of knowledge and decision making power with respect to important matters of the Company in accordance with laws, administrative regulations and these articlesArticles of association;Association;
(6)the right to obtain relevant information in accordance with the provisions of these articlesArticles of association,Association, including:

(i)the right to obtain a copy of these articles of association, subject to payment of the cost of such copy;
(ii)the right to inspect and copy, subject to payment of a reasonable charge:
     (a)     all parts of the register of shareholders;
     (b)     personal particulars of each of the Company’s directors, supervisors, president and other senior administrative officers, including:
          (aa)          present name and alias and any former name or alias;
          (bb)          principal address (residence);
          (cc)          nationality;
          (dd)          primary and all other part-time occupations and duties;
          (ee)          identification documents and their relevant numbers;
     (c)     state of the Company’s share capital;
     (d)     reports showing the aggregate par value, quantity, highest and lowest price paid in respect of each class of shares repurchased by the Company since the end of last accounting year and the aggregate amount paid by the Company for this purpose;
     (e)     minutes of shareholders’ general meetings;
     (f)     interim and annual reports of the Company.

(i) the right to obtain a copy of these Articles of Association, subject to payment of the cost of such copy;
(ii) the right to inspect and copy, subject to payment of a reasonable charge;
(a) all parts of the register of shareholders;
(b) personal particulars of each of the Company’s directors, supervisors, president and other senior administrative officers, including:
(aa) present name and alias and any former name or alias;
(bb) principal address (residence);
(cc) nationality;
(dd) primary and all other part-time occupations and duties;
(ee) identification documents and their relevant numbers;
(c) state of the Company’s share capital;
(d) reports showing the aggregate par value, quantity, highest and lowest price paid in respect of each class of shares repurchased by the Company since the end of last accounting year and the aggregate amount paid by the Company for this purpose;
(e) minutes of shareholders’ general meetings; and
(f) interim and annual reports of the Company.
(7) in the event of the termination or liquidation of the Company, to participate in the distribution of surplus assets of the Company in accordance with the number of shares held; and
 
(8) other rights conferred by laws, administrative regulations and these articles of association.

Pursuant to Article 55 of the Articles of Association, the ordinary shareholders of the Company shall assume the following obligations:

52

(1) to abide by these articlesArticles of association;Association;
(2) to pay subscription monies according to the number of shares subscribed and the method of subscription;
 
(3) no right to return shares to the Company unless laws and regulations provide otherwise; and
60
(4) other obligations imposed by laws, administrative regulations and these articles of association.

Shareholders are not liable to make any further contribution to the share capital other than as agreed by the subscriber of the relevant shares on subscription.

Action necessary to change rights of shareholders

Pursuant to Article 92112 of the Articles of Association, those shareholders who hold different classes of shares are shareholders of different classes.

The holders of the Domestic-Invested sharesShares and holders of Overseas-Listed Foreign-Invested Shares shall be deemed to be shareholders of different classes.

Pursuant to Article 93113 of the Articles of Association, rights conferred on any class of shareholders in the capacity of shareholders (“class rights”) may not be varied or abrogated unless approved by a special resolution of shareholders in general meeting and by holders of shares of that class at a separate meeting conducted in accordance with Articles 95115 to 99.

119.

Pursuant to Article 95115 of the Articles of Association,shareholders of the affected class, whether or not otherwise having the right to vote at shareholders’ general meetings, shall nevertheless have the right to vote at class meetings in respect of matters concerning sub-paragraphs (2) to (8), (11) and (12) of Article 94,114, but interested shareholder(s) shall not be entitled to vote at class meetings. “Interested shareholder(s)” is:

(1) in the case of a repurchase of shares by offers to all shareholders or public dealing on a stock exchange under Article 31, a “controlling shareholder” within the meaning of Article 57;
(2) in the case of a repurchase of share by an off-market contract under Article 31, a holder of the shares to which the proposed contract relates; and
(3) in the case of a restructuring of the Company, a shareholder within a class who bears less than a proportionate obligation imposed on that class under the proposed restructuring or who has an interest in the proposed restructuring different from the interest of shareholders of that class.

Pursuant to Article 96116 of the Articles of Association, resolutions of a class of shareholders shall be passed by votes representing more than two-thirds of the voting rights of shareholders of that class represented at the relevant meeting who, according to Article 95,115, are entitled to vote at class meetings.

Pursuant to Article 97117 of the Articles of Association, written notice of a class meeting shall be given forty-five (45) days before the date of the class meeting to notify all of the shareholders in the share register of the class of the matters to be considered, the date and the place of the class meeting. A shareholder who intends to attend the class meeting shall deliver his written reply concerning attendance at the class meeting to the Company twenty (20) days before the date of the class meeting.

If the number of shares carrying voting rights at the meeting represented by the shareholders who intend to attend the class meeting reaches more than one half of the voting shares at the class meeting, the Company may hold the class meeting; if not, the Company shall within five (5) days notify the shareholders again by public notice of the matters to be considered, the date and the place for the class meeting. The Company may then hold the class meeting after such publication of notice.

Pursuant to Article 98118 of the Articles of Association, notice of class meetings need only be served on shareholders entitled to vote thereat.

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Meeting of any class of shareholders shall be conducted in a manner as similar as possible to that of general meetings of shareholders. The provisions of these articlesArticles of associationAssociation relating to the manner to conduct any shareholders’ general meeting shall apply to any meeting of a class of shareholders.

Pursuant to Article 99119 of the Articles of Association, the special procedures for voting at any meeting of a class of shareholders shall not apply to the following circumstances:

(1) where the Company issues, upon the approval by special resolution of its shareholders in general meeting, either separately or concurrently once every twelve months, not more than 20 per centpercent of each of its existing issued Domestic-Invested Shares and Overseas-Listed Foreign-Invested Shares; and
(2) where the Company’s plan to issue Domestic-Invested Shares and Overseas-Listed Foreign-Invested Shares at the time of its establishment is carried out within fifteen (15) months from the date of approval of the Securities Committee of the State Council.

Meetings of shareholders

Shareholders’ general meetings is the organ of authority of the Company and shall exercise its functions and powers, among other things, to decide on the Company’s operational policies and investment plans, to elect and replace directors and decide on matters relating to the remuneration of directors, to examine and approve reports of the board of directors, etc.

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There are two types of shareholders’ general meetings: annual general meetings and extraordinary general meetings. Shareholders’ general meetings shall be convened by the boardBoard of directors.Directors. Annual general meetings are held once every year and within six (6) months from the end of the preceding financial year.

Under any of the following circumstances, the boardBoard of directorsDirectors shall convene an extraordinary general meeting within two (2) months:

(1) when the number of directorsDirectors is less than the number of directorsDirectors required by the Company Law or two thirds of the number of directorsDirectors specified in the Articles of Association;
(2) when the unrecovered losses of the Company amount to one third of the total amount of its share capital;
(3) when shareholder(s) holding 10 per centpercent or more of the Company’s issued and outstanding shares carrying voting rights request(s) in writing the convening of an extraordinary general meeting;
 
(4) when deemed necessary by the boardBoard of directorsDirectors or as requested by the supervisory committee.Supervisory Committee.

When the Company convenes a shareholders’ general meeting, written notice of the meeting shall be given forty five (45) days before the date of the meeting to notify all of the shareholders in the share register of the matters to be considered and the date and the place of the meeting. A shareholder who intends to attend the meeting shall deliver his written reply concerning the attendance of the meeting to the Company twenty (20) days before the date of the meeting.

The Company shall, based on the written replies received twenty (20) days before the date of the shareholders’ general meeting from the shareholders, calculate the number of voting shares represented by the shareholders who intend to attend the meeting. If the number of voting shares represented by the shareholders who intend to attend the meeting reaches one half or more of the Company’s total voting shares, the Company may hold the meeting; if not, then the Company shall within five (5) days notify the shareholders again by public notice of the matters to be considered, the place and date for, the meeting. The Company may then hold the meeting after such publication of notice.

Limitation on right to own securities

The PRC Special Regulations on Overseas Offering and the Listing of Shares by Companies Limited by Share (the “Special Regulations”) and the Mandatory Provisions for Articles of Association of Companies to be Listed Overseas (the “Mandatory Provisions”) provide for different classes of shares to be subscribed for and traded by local and overseas investors respectively. Shares which can be traded by overseas investors must be in registered form and while denominated in Renminbi, they are traded in foreign currency with dividends payable in foreign currency. Local investors are prohibited from dealing in such shares.

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Merger, acquisition or corporate restructuring

Pursuant to Article 193221 of the Articles of Association, in the event of the merger or division of the Company, a plan shall be presented by the Company’s boardBoard of directorsDirectors and shall be approved in shareholders’ general meeting and the relevant examining and approving formalities shall be processed as required by law. A shareholder who objects to the plan of merger or division shall have the right to demand the Company or the shareholders who consent to the plan of merger or division to acquire that dissenting shareholder’s shareholding at a fair price. The contents of the resolution of merger or division of the Company shall be made into special documents for shareholders’ inspection. Such special documents shall be sent by mail to holders of Overseas-Listed Foreign-Invested Shares.

The Articles of Association do not contain any provisions governing the ownership threshold above which shareholder ownership must be disclosed.

Material Contracts

The Company has not entered into any material contracts other than in the ordinary course of business duringand other than those described in this Item 10, Item 4, “Information on the preceding two years.Company” or elsewhere in this annual report on Form 20-F.
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(a)A framework agreement on lease and operation dated January 1, 2006 between the Company and China Southern Airlines Group Travel Development Company Limited (the “CSA Travel”), a wholly owned subsidiary of CSAHC, pursuant to which the Company leases certain hotels belonging to it to CSA Travel for operation and management for a period of three years. The consideration for the framework agreement on lease and operation is based on the rent payable and fees for operation and management of the hotels, and is capped at RMB6 million per year. It became effective on April 25, 2006 and has been approved by the Directors of the Company.
(b)An advertising agency agreement dated January 1, 2006 between the Company and SAAC, a related party that is 45% owned by the Company and 55% owned by CSAHC, pursuant to which the SAAC produces advertisement script, graphic and music for the Company with the copyright of such products belonging to the Company for a period of three years. The consideration for the advertising agency agreement is based on the fees payable for advertising services to be provided, and is capped at RMB30 million per year. It became effective on April 25, 2006 has been approved by the Directors of the Company.
(c)A property management framework agreement dated January 1, 2006 between the Company and Guangzhou China Southern Airlines Property Management Company Limited (the “GCSAPMC”), a related party that is 90% owned by CSAHC and 10% owned by the Company’s union, pursuant to which the GCSAPMC provides property management and improvement services for certain properties of the Company for a period of three years. The consideration for the property management framework agreement is based on the fees payable for management and maintenance services to be provided, and is capped at RMB47,010,000 per year. It became effective on April 25, 2006 has been approved by the Directors of the Company.
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(d)An acquisition agreement dated April 1, 2006 between the Company and CSAHC Hainan Co., Ltd. (the “Hainan Co., Ltd.”), a subsidiary of CSAHC, pursuant to which the Company has agreed to acquire and Hainan Co., Ltd. has agreed to sell the assets and liabilities in relation to the airline operations of Hainan Co., Ltd. The total consideration payable by the Company, including the assets to be acquired and the liabilities to be assumed by the Company, was RMB5,150,000. It became effective upon approval by the Directors of the Company on April 18, 2006.
(e)An agency agreement for sale of freight and passenger services dated May 16, 2006 between the Company and Nan Lung Travel & Express (Hong Kong) Ltd. (“Nanlung”), a wholly owned subsidiary of CSAHC, pursuant to which Nanlung acts as agent in the Company’s sales and account settlement and the ground operations of the Company’s flights in Hong Kong region for a period of one year. The consideration for the agency agreement is based on the fees payable for ticket sale and other services to be provided, and is capped at RMB60 million for the entire term of the agency agreement. It became effective on May 16, 2006 and was approved by the Directors of the Company on December 24, 2005.
(f)An Airbus Aircraft Acquisition Agreement dated July 6, 2006 between the Company and Airbus, the Company would acquire 50 Airbus A320 series aircraft from Airbus. The aggregate catalogue price for the Airbus Aircraft is RMB26.526 billion (approximately US$3.316 billion). The aggregate consideration for the acquisition of the Airbus Aircraft is payable by cash in installments and the Airbus Aircraft will be delivered in stages to the Company during the period commencing from 2009 to 2010.
(g)A Boeing Aircraft Acquisition Agreement dated October 13, 2006 between the Company and Boeing, the Company would purchase 6 Boeing B777F freighters from Boeing. The catalogue price of a Boeing B777F freighter is US$232 million. The aggregate consideration for the acquisition of the B777F Freighters is partly payable by cash of the Company, and partly by financing arrangements with banking institutions and the Boeing Aircraft will be delivered in stages to the Company during the period commencing from November 2008 to July 2010.
(h)A Xiamen Aircraft Acquisition Agreement dated October 13, 2006 between Xiamen Airlines and Boeing, Xiamen Airlines would acquire six Boeing B737-800 aircraft from Boeing. The catalogue price of a Boeing B737-800 aircraft is US$66-US$75 million. Such catalogue price includes price for airframe and engine. The aggregate consideration for the acquisition of the B737-800 Aircraft is payable by cash in installments and the B737-800 Aircraft will be delivered to Xiamen Airlines in 2010.
(i)A lease agreement dated December 19, 2006 entered into between the Company and CSAHC (“Lease Agreement”). The Lease Agreement takes effect retrospectively on January 1, 2006, and is valid for a term of 3 years. Under the Lease Agreement, the annual rents payable for the year 2006, 2007 and 2008 are RMB27,543,606.01, RMB28,657,966.99 and RMB29,828,046.01 respectively. Each year, the rent is payable in advance semiannually by the Company wholly out of its internal funds.

Exchange Controls

Under current Chinese foreign exchange regulations, Renminbi is fully convertible for current account transactions, but is not freely convertible for capital account transactions. Current account foreign currency transactions can be undertaken without prior approval from the relevant Chinese Government agencies by producing commercial documents evidencing such transactions, provided that they are processed through Chinese banks licensed to engage in foreign currency transactions. Conversion from Renminbi into a foreign currency or vice versa for purposes of capital account transactions requires prior approvals of relevant Chinese Government agencies.

This restriction on capital account transactions could affect the ability of the Company to acquire foreign currency for capital expenditures.

The Company is generally required by law to sell all its foreign exchangecurrency revenues to Chinese banks at the exchange rates published by Chinese banks on each business day, which rates may deviate only within a very narrow range from the official rate published daily by the People’s Bank of China, China’s central bank.

banks. The Company may purchase foreign exchangecurrency directly from Chinese banks for any current account transactions, such as trade transactions in its usual and normal course of business, including acquisition of aircraft, jet fuel and flight equipment (such acquisition requires approvals from the relevant Chinese Government agencies).

Payment of dividends by the Company to holders of the Company’s H Shares and ADSs is also considered a current account transaction under Chinese law. Therefore, there is no legal restriction on the conversion of Renminbi into foreign exchangecurrency for the purpose of paying dividends to such holders of H Shares and ADSs. In addition, the Company’s Articles of Association require the Company to pay dividends to holders of the Company’s H Shares and ADSs in foreign exchange.

currency.

On July 21, 2005, the PRC government changed its policy of pegging the value of the Renminbi to the U.S. dollar so that the Renminbi is now permitted to fluctuate within a band against a basket of certain foreign currencies. On May 18, 2007, the People’s Bank of China announced that the floating band of Renminbi would be permitted to rise or fall by as much as 0.5%. The PRC government has stated publicly that it intends to further liberalize its currency policy, which could result in a further and more significant change in the value of the Renminbi against the U.S. dollar. Any significant revaluation of the Renminbi may have a material adverse effect on the Company's financial performance, and the value of, and any dividends payable on, the Company's H Shares and ADSs in foreign currency terms.
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Other Limitations

There are no limitations on the right of non-resident or foreign owners to hold or vote H Shares or ADSs imposed by Chinese law or by the Articles of Association or other constituent documents of the Company. However, under current Chinese law, foreign ownership of the Company may not exceed 49%.
Taxation

Chinese Taxation

The following is a general summary of certain Chinese tax consequences of the acquisition, ownership and disposition of H Shares and ADSs. This summary is based upon tax laws of China as in effect on the date of this Annual Report, including the income tax treaty between the United States and China (the “U.S.-PRC Tax Treaty”), all of which are subject to change or different interpretation.

In general, for Chinese tax purposes, holders of ADSs will be treated as the owners of the H Shares represented by those ADSs, and exchanges of H Shares for ADSs, and ADSs for H Shares, will not be subject to taxation under the laws of China.

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This summary does not purport to address all material tax consequences for holders or prospective purchasers of H Shares or ADSs, and does not take into account the specific circumstances of such investors. Investors should consult their own tax advisors as to Chinese or other tax consequences of the acquisition, ownership and disposition of H Shares or ADSs.


In March 2007, the National People’s Congress of China enacted a new Enterprise Income Tax Law, which will become effective on January 1, 2008. The new tax law would impose a unified income tax rate of 25.0% on all domestic enterprises and foreign-invested enterprise unless they qualify under certain limited exceptions. The new tax law provides for a five-year transition period for FIEs, during which they are permitted to continue to enjoy their existing preferential tax treatment until such treatment expires in accordance with its current terms. The implementation guidance as to how the existing preferential tax rate will increase to the standard rate of 25% is not yet issued.
Dividends

Chinese tax law generally provides for the imposition of a withholding tax on dividends paid by a Chinese company to a non-Chinese shareholder at a rate of 20%. However, the Chinese tax authorities have temporarily suspended imposition of this withholding tax. Accordingly, dividends paid by the Company to holders of H Shares or ADSs who are foreign individuals not resident in China or which are foreign enterprises with no permanent establishment in China will currently not be subject to Chinese withholding tax. In the event that the suspension of the withholding tax is lifted, such payments will be subject to withholding tax at the 20% rate unless the holder is entitled to a tax waiver or a lower tax rate under an applicable double-taxation treaty.

China currently has double-taxation treaties with a number of countries, including Australia, Canada, France, Germany, Japan, Malaysia, the Netherlands, Singapore, the United Kingdom and the United States. Under the U.S.-PRC Tax Treaty, China may tax a dividend paid by the Company to a U.S. holder up to a maximum of 10% of the gross amount of such dividend.

Capital Gains from Transfer or Disposition of Shares

Chinese tax law generally provides that an individual who transfers or otherwise disposes of a company’s shares of capital stock is subject to a 20% capital gains tax. Currently, foreign enterprises and all individuals are temporarily exempt from capital gains tax on transfers of shares of capital stock of joint stock companies, such as the Company. Should such temporary exemption be discontinued, such holders may be subject to a 20% capital gains tax unless reduced by an applicable double-taxation treaty. Under the U.S.-PRC Tax Treaty, for example, China may only impose a 20% capital gains tax from the sale or other disposition by a U.S. holder of H Shares or ADSs representing an interest in the Company of 25% or more.

Stamp Duty

Transfers of shares of capital stock of a company are not subject to Chinese stamp duty if the transfer does not take place within China (excluding Hong Kong, Macau and Taiwan).
United States Federal Income Taxation
This discussion describes the material U.S. federal income tax consequences of the purchase, ownership and disposition of the Company’s ADSs. This discussion does not address any aspect of U.S. federal gift or estate tax, or the state, local or foreign tax consequences of an investment in the Company’s ADSs. This discussion applies to you only if you hold and beneficially own the Company’s ADSs as capital assets for tax purposes. This discussion does not apply to you if you are a member of a class of holders subject to special rules, such as:
•
dealers in securities or currencies;
•
traders in securities that elect to use a mark-to-market method of accounting for securities holdings;
•
banks or other financial institutions;
•
insurance companies;
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•
tax-exempt organizations;
•
partnerships and other entities treated as partnerships for U.S. federal income tax purposes or persons holding ADSs through any such entities;
•
persons that hold ADSs as part of a hedge, straddle, constructive sale, conversion transaction or other integrated investment;
•
U.S. Holders (as defined below) whose functional currency for tax purposes is not the U.S. dollar;
•
persons liable for alternative minimum tax; or
•
persons who actually or constructively own 10% or more of the total combined voting power of all classes of the Company’s shares (including ADSs) entitled to vote.
This discussion is based on the U.S. Internal Revenue Code of 1986, as amended, which is referred to in this discussion as the Code, its legislative history, existing and proposed regulations promulgated thereunder, published rulings and court decisions, all as currently in effect. These laws are subject to change, possibly on a retroactive basis. In addition, this discussion relies on the assumptions regarding the value of the Company’s shares and the nature of its business over time. Finally, this discussion is based in part upon the representations of the depositary and the assumption that each obligation in the deposit agreement and any related agreement will be performed in accordance with its terms. For U.S. federal income tax purposes, as a holder of ADSs, you are treated as the owner of the underlying ordinary shares represented by such ADSs.
You should consult your own tax advisor concerning the particular U.S. federal income tax consequences to you of the purchase, ownership and disposition of the Company’s ADSs, as well as the consequences to you arising under the laws of any other taxing jurisdiction.
For purposes of the U.S. federal income tax discussion below, you are a “U.S. Holder” if you beneficially own ADSs and are:
•
a citizen or resident of the United States for U.S. federal income tax purposes;
•
a corporation, or other entity taxable as a corporation, that was created or organized in or under the laws of the United States or any political subdivision thereof;
•
an estate the income of which is subject to U.S. federal income tax regardless of its source; or
•
a trust if (a) a court within the United States is able to exercise primary supervision over its administration and one or more U.S. persons have the authority to control all substantial decisions of the trust, or (b) the trust has a valid election in effect to be treated as a U.S. person.
If you are not a U.S. person, please refer to the discussion below under “Non-U.S. Holders.”
For U.S. federal income tax purposes, income earned through a foreign or domestic partnership or other flow-through entity is attributed to its owners. Accordingly, if a partnership or other flow-through entity holds ADSs, the tax treatment of the holder will generally depend on the status of the partner or other owner and the activities of the partnership or other flow-through entity.
U.S. Holders
Dividends on ADSs
Subject to the “Passive Foreign Investment Company” discussion below, if the Company makes distributions and you are a U.S. Holder, the gross amount of any distributions you receive on your ADSs will generally be treated as dividend income if the distributions are made from the Company’s current or accumulated earnings and profits, calculated according to U.S. federal income tax principles. Dividends will generally be subject to U.S. federal income tax as ordinary income on the day you actually or constructively receive such income. However, if you are an individual and have held your ADSs for a sufficient period of time, dividend distributions on the Company’s ADSs will generally constitute qualified dividend income taxed at a preferential rate (generally 15% for dividend distributions before January 1, 2009) as long as the Company’s ADSs continue to be readily tradable on the New York Stock Exchange and certain other conditions apply. You should consult your own tax adviser as to the rate of tax that will apply to you with respect to dividend distributions, if any, you receive from us.
Distributions on the Company’s ADSs, if any, will generally be taxed to you as dividend distributions for U.S. tax purposes. Even if you are a corporation, you will not be entitled to claim a dividends-received deduction with respect to distributions you receive from the Company. Dividends generally will constitute foreign source passive income for U.S. foreign tax credit limitation purposes.
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Sales and other dispositions of ADSs
Subject to the “Passive Foreign Investment Company” discussion below, when you sell or otherwise dispose of the Company’s ADSs, you will generally recognize capital gain or loss in an amount equal to the difference between the amount realized on the sale or other disposition and your adjusted tax basis in the ADSs, both as determined in U.S. dollars. Your adjusted tax basis will generally equal the amount you paid for the ADSs. Any gain or loss you recognize will be long-term capital gain or loss if your holding period in the Company’s ADSs is more than one year at the time of disposition. If you are an individual, any such long-term capital gain will be taxed at preferential rates. Your ability to deduct capital losses will be subject to various limitations.
Passive Foreign Investment Company
If the Company were a Passive Foreign Investment Company (“PFIC”) in any taxable year in which you hold the Company’s ADSs, as a U.S. Holder, you would generally be subject to adverse U.S. tax consequences, in the form of increased tax liabilities and special U.S. tax reporting requirements.
The Company will be classified as a PFIC in any taxable year if either: (1) the average percentage value of its gross assets during the taxable year that produce passive income or are held for the production of passive income is at least 50% of the value of its total gross assets; or (2) 75% or more of its gross income for the taxable year is passive income (such as certain dividends, interest or royalties). For purposes of the first test: (1) any cash, cash equivalents, and cash invested in short-term, interest bearing, debt instruments, or bank deposits that is readily convertible into cash, will generally count as producing passive income or held for the production of passive income; and (2) the average value of the Company’s gross assets is calculated based on its market capitalization.
The Company believes that it was not a PFIC for the taxable year 2006. However, there can be no assurance that the Company will not be a PFIC for the taxable year 2007 and/or later taxable years, as PFIC status is re-tested each year and depends on the facts in such year. For example, the Company would be a PFIC for the taxable year 2006 if the sum of its average market capitalization, which is its share price multiplied by the total amount of its outstanding shares, and its liabilities over that taxable year is not more than twice the value of its cash, cash equivalents, and other assets that are readily converted into cash.
If the Company were a PFIC, you would generally be subject to additional taxes and interest charges on certain “excess” distributions the Company makes and on any gain realized on the disposition or deemed disposition of your ADSs, regardless of whether the Company continues to be a PFIC in the year in which you receive an “excess” distribution or dispose of or are deemed to dispose of your ADSs. Distributions in respect of your ADSs during a taxable year would generally constitute “excess” distributions if, in the aggregate, they exceed 125% of the average amount of distributions in respect of your ADSs over the three preceding taxable years or, if shorter, the portion of your holding period before such taxable year.
To compute the tax on “excess” distributions or any gain, (1) the “excess” distribution or the gain would be allocated ratably to each day in your holding period, (2) the amount allocated to the current year and any tax year before the Company became a PFIC would be taxed as ordinary income in the current year, (3) the amount allocated to other taxable years would be taxable at the highest applicable marginal rate in effect for that year, and (4) an interest charge at the rate for underpayment of taxes for any period described under (3) above would be imposed with respect to any portion of the “excess” distribution or gain that is allocated to such period. In addition, if the Company were a PFIC, no distribution that you receive from the Company would qualify for taxation at the preferential rate discussed in the “Dividends on ADSs” section above.
If the Company were a PFIC in any year, as a U.S. Holder, you would be required to make an annual return on IRS Form 8621 regarding your ADSs. However, the Company does not intend to generate, or share with you, information that you might need to properly complete IRS Form 8621. You should consult with your own tax adviser regarding reporting requirements with regard to your ADSs.
If the Company were a PFIC in any year, you would generally be able to avoid the “excess” distribution rules described above by making a timely so-called “mark-to-market” election with respect to your ADSs provided the Company’s ADSs are “marketable”. The Company’s ADSs will be “marketable” as long as they remain regularly traded on a national securities exchange, such as the New York Stock Exchange. If you made this election in a timely fashion, you would generally recognize as ordinary income or ordinary loss the difference between the fair market value of your ADSs on the first day of any taxable year and their value on the last day of that taxable year. Any ordinary income resulting from this election would generally be taxed at ordinary income rates and would not be eligible for the reduced rate of tax applicable to qualified dividend income. Any ordinary losses would be limited to the extent of the net amount of previously included income as a result of the mark-to-market election, if any. Your basis in the ADSs would be adjusted to reflect any such income or loss. You should consult with your own tax adviser regarding potential advantages and disadvantages to you of making a “mark-to-market” election with respect to your ADSs. Separately, if the Company were a PFIC in any year, you would be able to avoid the “excess” distribution rules by making a timely election to treat us as a so-called “Qualified Electing Fund” or “QEF.” You would then generally be required to include in gross income for any taxable year (1) as ordinary income, your pro rata share of the Company’s ordinary earnings for the taxable year, and (2) as long-term capital gain, your pro rata share of the Company’s net capital gain for the taxable year. However, the Company does not intend to provide you with the information you would need to make or maintain a “QEF” election and you will, therefore, not be able to make or maintain such an election with respect to your ADSs.
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Non-U.S. Holders
If you beneficially own ADSs and are not a U.S. Holder for U.S. federal income tax purposes (a “Non-U.S. Holder”), you generally will not be subject to U.S. federal income tax or withholding tax on dividends received from the Company with respect to ADSs unless that income is considered effectively connected with your conduct of a U.S. trade or business and, if an applicable income tax treaty so requires as a condition for you to be subject to U.S. federal income tax with respect to income from your ADSs, such dividends are attributable to a permanent establishment that you maintain in the United States. You generally will not be subject to U.S. federal income tax, including withholding tax, on any gain realized upon the sale or exchange of ADSs, unless:
•
that gain is effectively connected with the conduct of a U.S. trade or business and, if an applicable income tax treaty so requires as a condition for you to be subject to U.S. federal income tax with respect to income from your ADSs, such gain is attributable to a permanent establishment that you maintain in the United States; or
•
you are a nonresident alien individual and are present in the United States for at least 183 days in the taxable year of the sale or other disposition and either (1) your gain is attributable to an office or other fixed place of business that you maintain in the United States or (2) you have a tax home in the United States.
If you are engaged in a U.S. trade or business, unless an applicable tax treaty provides otherwise, the income from your ADSs, including dividends and the gain from the disposition of the Company’s ADSs, that is effectively connected with the conduct of that trade or business will generally be subject to the rules applicable to U.S. Holders discussed above. In addition, if you are a corporation, you may be subject to an additional branch profits tax at a rate of 30% or any lower rate under an applicable tax treaty.
U.S. information reporting and backup withholding rules
In general, dividend payments with respect to the ADSs and the proceeds received on the sale or other disposition of those ADSs may be subject to information reporting to the IRS and to backup withholding (currently imposed at a rate of 28%). Backup withholding will not apply, however, if you (1) are a corporation or come within certain other exempt categories and, when required, can demonstrate that fact or (2) provide a taxpayer identification number, certify as to no loss of exemption from backup withholding and otherwise comply with the applicable backup withholding rules. To establish your status as an exempt person, you will generally be required to provide certification on IRS Form W-9, W-8BEN or W-8ECI, as applicable. Any amounts withheld from payments to you under the backup withholding rules will be allowed as a refund or a credit against your U.S. federal income tax liability, provided that you furnish the required information to the IRS.
HOLDERS OF THE COMPANY’S ADSS SHOULD CONSULT WITH THEIR OWN TAX ADVISORS REGARDING THE APPLICATION OF THE U.S. FEDERAL INCOME TAX LAWS TO THEIR PARTICULAR SITUATIONS AS WELL AS ANY TAX CONSEQUENCES RESULTING FROM PURCHASING, HOLDING OR DISPOSING OF THE ADSS, INCLUDING THE APPLICABILITY AND EFFECT OF THE TAX LAWS OF ANY STATE, LOCAL OR FOREIGN JURISDICTION AND INCLUDING ESTATE, GIFT, AND INHERITANCE LAWS.

Dividends and payingPaying Agents

Not applicable.

Statement by Experts

Not applicable.

Documents on Display

The Company has filed this Annual Report on Form 20-F with the Securities and Exchange Commission under the Securities Exchange Act of 1934, as amended. Statements made in this annual reportAnnual Report as to the contents of any document referred to are not necessarily complete. With respect to each such document filed as an exhibit to this annual report,Annual Report, reference is made to the exhibit for a more complete description of the matter involved, and each such statement shall be deemed qualified in its entirety by such reference.

The Company is subject to the informational requirements of the Exchange Act and file reports and other information with the Securities and Exchange Commission. Reports and other information which the Company filed with the Securities and Exchange Commission, including this Annual Report on Form 20-F, may be inspected and copied at the public reference room of the Securities and Exchange Commission at

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450 Fifth Street N.W. Washington D.C. 20549

20549.

You can also obtain copies of this materialAnnual Report on Form 20-F by mail from the Public Reference Section of the Securities and Exchange Commission, 450 Fifth Street, N.W., Washington D.C. 20549, at prescribed rates. Additionally, copies of this material may be obtained from the Securities and Exchange Commission’s Internet site at http://www.sec.gov. The Commission’s telephone number is 1-800-SEC-0330.

Subsidiary Information

Not applicable.
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Comparison of New York Stock Exchange Corporate Governance Rules and China Corporate Governance Rules for Listed Companies

Under the amended Corporate Governance Rules of New York Stock Exchange (NYSE), foreign issuers (including the Company) listed on the NYSE are required to disclose a summary of the significant differences between their domestic corporate governance rules and NYSE corporate governance rules that would apply to a U.S. domestic issuer. A summary of such differences is listed below:
NYSE corporate governance rules
Corporate governance rules applicable to the domestically listed companies in China and the Company’s governance practices
Director Independence
A listed company must have a majority of independent directors on its board of directors. No director qualifies as “independent” unless the board of directors affirmatively determines that the director has no material relationship with the listed company (either directly or as a partner, shareholder or officer of an organization that has a relationship with the company). In addition, a director must meet certain standards to be deemed independent. For example, a director is not independent if the director is, or has been within the last three years, an employee of the listed company, or if the director has received, during any twelve-month period within the last three years, more than US$100,000 in direct compensation from the listed company.
Director Independence
Any listed company must establish an independent director system and set forth specific requirements for the qualification of independent directors. An independent director shall not hold any other position in the listed company other than being a director and shall not be influenced by the main shareholders or the controlling persons of the listed company, or by any other entities or persons with whom the listed company has a significant relationship.
The Company’s governance practices
The Company has complied with the relevant Chinese corporate governance rules and has implemented internal rules governing the independence and responsibilities of independent directors. The Company determines the independence of independent directors every year.
The non-management directors of each listed company must meet at regularly scheduled executive sessions without management.No similar requirements.
Nominating/Corporate Governance Committee
Listed companies must have a nominating/corporate governance committee composed entirely of independent directors.
The nominating/corporate governance committee must have a written charter that addresses the committee’s purposes and responsibilities which, at minimum, must be to: search for eligible people for the board of directors, select and nominate directors for the next session of the shareholders’ annual meeting, study and propose corporate governance guidelines, supervise the evaluation of the board of directors and management, and evaluate the performance of the committee every year.
Nominating/Corporate Governance Committee
The board of directors of a listed company may, through the resolution of the shareholders’ meeting, establish a nominating committee composed entirely of directors, of which the independent directors shall be the majority and the convener.
The Company’s governance practices
The Company has not established a nominating committee. The independent non-executive Directors of the Company are nominated by the Board of Directors, and their appointment must be approved by the shareholders of the Company in a general meeting. The executive Directors of the Company are nominated by CSAHC, the controlling shareholder of the Company, and their appointment must be approved by the shareholders of the Company in a general meeting.
Compensation Committee
Listed companies must have a compensation committee composed entirely of independent directors.
Compensation Committee
The board of directors of a listed company can, through the resolution of shareholders’ meeting, have a compensation and evaluation committee composed entirely of directors, of whom the independent directors are the majority and act as the convener.
69
The Company’s governance practices
The Company has established a remuneration committee consisting of three members. The remuneration committee is chaired by independent non-executive Director Sui Guang Jun with independent non-executive Director Wei Ming Hai and executive Director Wang Quan Hua as members.
The written charter of the compensation committee must state, at least, the following purposes and responsibilities:
(1) review and approve the corporate goals associated with CEO’s compensation, evaluate the performance of the CEO in fulfilling these goals, and based on such evaluation determine and approve the CEO’s compensation level;
(2) make recommendations to the board with respect to non-CEO executive officer compensation, and incentive-compensation and equity-based plans that are subject to board approval;
(3) produce a committee report on executive compensation as required by the SEC to be included in the annual proxy statement or annual report filed with the SEC.
The charter must also include the requirement for an annual performance evaluation of the compensation committee.
The responsibilities are similar to those stipulated by the NYSE rules, but the committee is not required to produce a report on the executive compensation or make an annual performance evaluation of the committee. The responsibilities of the remuneration committee are to approve the remuneration packages of Directors and senior management of the Group, and the Company’s “preliminary proposals on annual emoluments of the directors and senior management of the Group”. The remuneration committee is also responsible for assessing performance of executive director and approving the terms of executive directors’ service contracts.
Audit Committee
Listed companies must have an audit committee that satisfies the requirements of Rule 10A-3 of Exchange Act. It must have a minimum of three members, and all audit committee members must satisfy the requirements for independence set forth in Section 303A.02 of NYSE Corporate Governance Rules as well as the requirements of Rule 10A-3b (1) of the Exchange Act.
Audit Committee
The board of directors of a listed company can, through the resolution of the shareholders’ meeting, establish an audit committee composed entirely of directors, of which the independent directors are the majority and act as the convener, and, at minimum, one independent director is an accounting professional.
The written charter of the audit committee must specify that the purpose of the audit committee is to assist the board oversight of the integrity of financial statements, the company’s compliance with legal and regulatory requirements, qualifications and independence of independent auditors and the performance of the listed company’s internal audit function and independent auditors.
The written charter must also require the audit committee to prepare an audit committee report as required by the SEC to be included in the listed company’s annual proxy statement as well as an annual performance evaluation of the audit committee.
The responsibilities of the audit committee are similar to those stipulated by the NYSE rules, but according to the domestic practices, the Company is not required to make an annual performance evaluation of the audit committee and the audit committee is not required to prepare an audit report to be included in the Company’s annual proxy statement.
The Company’s governance practices
The Board of Directors of the Company has established an audit committee that satisfies relevant domestic requirements and the audit committee has a written charter.
Each listed company must have an internal audit department.China has a similar regulatory provision, and the Company has an internal audit department.
Shareholders must be given the opportunity to vote on equity-compensation plans and material revisions thereto, except for employment incentive plans, certain awards and plans in the context of mergers and acquisitions.The relevant regulations of China require the board of directors to propose plans and types of director compensation for the shareholders’ meeting to approve. The compensation plan of executive officers is subject to approval by the board and announced at the shareholders’ meeting and disclosed to the public upon the approval of the board of directors. The approval of director compensation and compensation plan of executive officers of the Company satisfies relevant domestic requirements.
70
Corporate Governance Guidelines
Listed companies must adopt and disclose corporate governance guidelines, involving director qualification standards, director compensation, director continuing education, annual performance evaluation of the board of directors, etc.
Corporate Governance Guidelines
China Securities Regulatory Commission (“CSRC”) has issued the Corporate Governance Rules, with which the Company has complied.
Code of Ethics for Directors, Officers and Employees
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.
Code of Ethics for Directors, Officers and Employees
China does not have such requirement for a code for ethics. But, the directors and officers must perform their legal responsibilities in accordance with the Company Law of PRC, relative requirements of CSRC and Mandatory Provisions to the Charter of Companies Listed Overseas.
The Company’s governance practices
The Company does not have, in form, a code of ethics that applies to the president, chief financial officer and principal accounting officer, or collectively, the senior corporate officers. The senior executive officers, all of whom currently serve as our directors, are subject to the director service contracts that they have with the Company. Under the director service contracts, the directors, including the senior corporate officers, agree that each director owes a fiduciary and diligence obligation to the Company and that no director shall engage in any activities in competition with the Company’s business or carry any activities detrimental to the interests of the Company. Each of the directors, including the senior corporate officers, also agreed to perform their respective duties as directors and senior officers in accordance with the Company Law of the PRC, relevant rules and regulations promulgated by China Securities Regulatory Commission and the Mandatory Provisions of Articles of Association of Overseas Listed Companies.
Each listed company CEO must certify to the NYSE each year that he or she is not aware of any violation by the company of NYSE corporate governance listing standards and he or she must promptly notify the NYSE on writing of any material non-compliance with any applicable provisions of Section 303A.No similar requirements.
71
ITEM 11. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

The Group is subject to market risks due to fluctuations in interest rates. The majority of the Group’s borrowingsborrowing is in the form of long-term fixed-fixed-rate and variable-rate debts with original maturities ranging from two to 12fifteen years. Fluctuations in interest rates can lead to significant fluctuations in the fair value of such debt instruments. From time to time, the Group may enter into interest rate swaps designed to mitigate exposure relating to interest rate risks. No such contract was outstanding as of December 31, 2003.

2006.

The Group is also exposed to foreign currency risk as a result of its aircraft and flight equipment being sourced from overseas suppliers. Specifically, the Group’s foreign currency exposure relates primarily to its foreign currency long-term debts used to finance such capital expenditures and its capital commitments. Subject to certain restrictive conditions imposed by the State Administration of Foreign Exchange, the Group may, from time to time, enter into forward foreign exchange contracts to mitigate its foreign currency exposures. No such contract was outstanding as of December 31, 2003.

2006.

As of December 31, 2003,2006, the Group operated a total of 83151 aircraft under operating and capital leases at rates that are substantially fixed. Such leases expose the Group to market risks; however, in accordance with Item 305 of Regulation S-K, such leases have been excluded from the following market risk tables. Commitments under operating and capital leases are disclosed in Note 1728 to the Financial Statements.

The following table provides information regarding the Group’s material interest rate sensitive financial instruments as of December 31, 20032006 and 2002:2005:

57

                     
 As of December 31, 2003
 As of December 31, 2002
 Expected maturity date
      
 Total Total   
As of December 31, 2006 
 
As of December 31, 2005 
 
 recorded recorded   
Expected maturity date
         
 2004
 2005
 2006
 2007
 2008
 Thereafter
 amount
 Fair value(2)
 amount
 Fair value(2)
 
 
 
2007 
 
 
 
2008 
 
 
 
2009 
 
 
 
2010 
 
 
 
2011
 
 
 
Thereafter 
 
Total
recorded
amount
 
Fair
value(2)
 
Total
recorded
amount
 
Fair value(2)
 
Debt                      
Fixed-rate notes payable                      
In US$ 624 645 402 370 217 369 2,627 2,915 3,429 3,793   
430
 
293
 
257
 
208
 
90
 
585
 
1,863
 
1,861
 2,252 2,464 
Average interest rate  6.81%  6.78%  6.78%  6.78%  6.78%  6.79%  6.79% —  6.86% —   
5.94
%
 
5.91
%
 
5.95
%
 
6.01
%
 
5.74
%
 
5.74
%
 
 
         
Variable-rate notes payable                       
In US$ 5,867 — — — 229 2,276 8,372 8,372 2,254 2,254   
17,442
 
6,414
 
1,841
 
432
 
1,485
 
1,886
 
29,500
 
29,500
 15,327 15,327 
Average interest rate  1.91% — — —  1.48%  1.49%  1.63% —  2.10% —   
5.85
%
 
5.77
%
 
5.70
%
 
5.11
%
 
5.71
%
 
5.53
%
         
In HKD  
1,651
 
4
 
4
 
4
 
4
 
-
 
1,667
 
1,667
 3,327 3,327 
Average interest rate  
4.34
%
 
-
 
-
 
-
 
-
 
-
       
In RMB 606 5 2 2 2 3 620 620 5,393 5,393   
532
 
52
 
122
 
100
 
-
 
3
 
809
 
809
 2,547 2,547 
Average interest rate  4.16%  3.43%  5.14%  5.14%  5.14%  5.14%  4.46% —  4.65% —   
5.22
%
 
5.50
%
 
5.50
%
 
5.51
%
 
-
 
-
           

(1)These interest rates are calculated based on the year end indices.
 
(2)Fair value of debt instruments was estimated based on the interest rates applicable to similar debt instruments as of December 31, 20032006 and 2002.2005.

72
The following table provides information regarding the Group’s material foreign currency sensitive financial instruments and capital commitments as of December 31, 20032006 and 2002:2005:
                                         
  As of December 31, 2003
 As of December 31, 2002
  Expected maturity date
          
                          Total     Total  
                          recorded     recorded  
  2004
 2005
 2006
 2007
 2008
 Thereafter
 amount
 Fair value(2)
 amount
 Fair value(2)
Debt                                        
Fixed-rate notes payable                                        
In US$  624   645   402   370   217   369   2,627   2,915   3,429   3,793 
Average interest rate  6.81%  6.78%  6.78%  6.78%  6.78%  6.79%  6.79%  —   6.86%  — 
Variable-rate notes payable                                        
In US$  5,867   —   —   —   229   2,276   8,372   8,372   2,254   2,254 
Average interest rate  1.91%  —   —   —   1.48%  1.49%  1.63%  —   2.10%  — 
Capital commitment in US$  4,585   6,030   —   —   —   —   10,615   10,615   5,876   5,876 

  
As of December 31, 2006
 
As of December 31, 2005 
 
  
Expected maturity date
         
 
 
 
 
 
 
2007
 
 
 
2008
 
 
 
2009
 
 
 
2010
 
 
 
2011
 
 
 
Thereafter
 
Total
recorded
amount
 
Fair
value(2) 
 
Total
recorded
amount 
 
Fair
value(2) 
 
Debt                     
Fixed-rate notes payable In US$  
430
  
293
  
257
  
208
  
90
  
585
  
1,863
  
1,861
  2,414  2,440 
Average interest rate  
5.94
%
 
5.91
%
 
5.95
%
 
6.01
%
 
5.74
%
 
5.74
%
            
Variable-rate notes payable in US$  
17,442
  
6,414
  
1,841
  
432
  
1,485
  
1,886
  
29,500
  
29,500
  23,474  23,474 
Average interest rate  
5.85
%
 
5.77
%
 
5.70
%
 
5.11
%
 
5.71
%
 
5.22
%
            
In HKD  
1,651
  
4
  
4
  
4
  
4
  
-
  
1,667
  
1,667
  1,895  1,895 
Average interest rate  
4.34
%
 
-
  
-
  
-
  
-
  
-
  
-
          
Capital commitment in US$  
12,299
  
22,572
  
17,483
  
14,232
  
295
  
—
  
66,881
  
66,881
  45,628  45,628 
(1)These interest rates are calculated based on the year end indices.
 
(2)Fair value of debt instruments was estimated based on the floating interest rates applicable to similar debt instruments as of December 31, 20022006 and 2003.2005.

ITEM 12. DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES.

Not applicable.

PART II

ITEM 13. DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES.

None.

ITEM 14. MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF PROCEEDS.

There were no material modifications affecting the rights of securities holders made during the fiscal year ended December 31, 2003.

2006.

Use of Proceeds

(1) Effective date of the Securities Act registration statement for which the use of proceeds information is being disclosed:

58

July 23, 1997.
 
  
July 23, 1997.
SEC file number assigned to such registration statement: 333-7114.
 
(2) The offering commenced on July 23, 1997.
 
(3) The offering was not terminated prior to the sale of any securities registered under the registration statement.

(4) (i) The offering was not terminated prior to the sale of all securities registered under the registration statement.

73
 (ii)(ii)Name of the managing underwriter:
Goldman Sachs (Asia) L.L.C. (global coordinator).
 
 (iii)(iii) and (iv)
Title of each class of securities registered
 
Amount
registered(1)
 
Aggregate
price of
offering
amount
registered(2)
 
Amount
sold(3)
 
Aggregate
offering
price of
amount
sold(4)
 
AggregateAggregate
price ofoffering
Title of eachofferingprice of
class ofAmountamountAmountamount
securities registeredregistered(1)registered(2)sold(3)sold(4)
Ordinary H Shares of par value RMB 1.00 per share represented by American Depositary Shares 861,823,000 shares 
US$528,469,864
 851,501,000 shares US$522,140,413

Notes:

(1)     The amount does not include 322,677,000 H Shares (some of which in the form of ADSs) which have not been registered with the SEC, of which 290,477,000 H Shares were sold to certain corporate investors in Hong Kong as part of the global offering of the Company in July 1997 and 32,200,000 H Shares were sold to certain limited partnership investment funds affiliated with Goldman, Sachs & Co. in a private placement in June 1997 prior to the Company’s global offering.

(2)     Assumes that all H Shares were sold in the form of ADSs. The price to public for each ADS is US$30.66. Each ADS represents 50 H Shares.

(3)     The amount does not include 322,677,000 H Shares referred to in note (1) above.

(4)       The amount does not include US$197,865,536 which represents the proceeds from the sale of 322,677,000 H Shares referred to in note (1) above. If the latter amount is included, the aggregate amount of proceeds to the Company would be US$720,005,950. In addition, the aggregate amount is calculated on the assumption that all H Shares were sold in the form of ADSs. Based on the actual sale of H Shares and ADSs, the aggregate amount of proceeds to the Company was US$719,494,700. The issue price per H Share was HK$4.70.

(v)

 
Notes:
(1)The amount does not include 322,677,000 H Shares (some of which in the form of ADSs) which have not been registered with the SEC, of which 290,477,000 H Shares were sold to certain corporate investors in Hong Kong as part of the global offering of the Company in July 1997 and 32,200,000 H Shares were sold to certain limited partnership investment funds affiliated with Goldman, Sachs & Co. in a private placement in June 1997 prior to the Company’s global offering.
(2)Assumes that all H Shares were sold in the form of ADSs. The price to public for each ADS is US$30.66. Each ADS represents 50 H Shares.
(3)The amount does not include 322,677,000 H Shares referred to in note (1) above.
(4)The amount does not include US$197,865,536 which represents the proceeds from the sale of 322,677,000 H Shares referred to in note (1) above. If the latter amount is included, the aggregate amount of proceeds to the Company would be US$720,005,950. In addition, the aggregate amount is calculated on the assumption that all H Shares were sold in the form of ADSs. Based on the actual sale of H Shares and ADSs, the aggregate amount of proceeds to the Company was US$719,494,700. The issue price per H Share was HK$4.70.
(v)
Underwriting discounts and commissions US$36,593,000
Finder’s fees  — 
Expenses paid to or for underwriters US$2,958,000
Other expenses US$21,411,000
Total expenses US$60,962,000

Note:     No direct or indirect payments were made to directors, officers, general partners of the Company or their associates, or to persons owning ten percent or more of any class of equity securities of the Company, or to affiliates of the Company. All payments were made to third parties.

(vi)Note: Net offering proceedsNo direct or indirect payments were made to directors, officers, general partners of the Company after deductingor their associates, or to persons owning ten percent or more of any class of equity securities of the total expenses in item (4)(v) above:
US$658,532,700Company, or to affiliates of the Company. All payments were made to third parties.

59

Note:     The amount is calculated on the basis of the actual aggregate amount of

(vi) Net offering proceeds to the Company and includesafter deducting the proceeds from the sale of 322,677,000 H Shares referred tototal expenses in note (1) of item (4)(iv) above.

(vii)As of December 31, 2003, the net offering proceeds to the Company was used up as follows:

(v) above:
US$658,532,700
   
Note:The amount is calculated on the basis of the actual aggregate amount of proceeds to the Company, and includes the proceeds from the sale of 322,677,000 H Shares referred to in note (1) of item (4)(iv) above.
74
(vii) As of December 31, 2006, the net offering proceeds to the Company was used up as follows:
Construction of plant, building and facilities US$41.9 million
Purchase and installation of machinery and equipment US$394.6 million
Purchase of real estate —
Acquisition of other business(es) —
Repayment of indebtedness US$192.4 million
Working Capital US$29.6 million

Note:     No direct or indirect payments were made to directors, officers, general partners of the Company or their associates, or to persons owning ten percent or more of any class of equity securities of the Company, or to affiliates of the Company. All payments were made to third parties.

(viii)Note: The usesNo direct or indirect payments were made to directors, officers, general partners of proceeds do not represent a material change in the useCompany or their associates, or to persons owning ten percent or more of proceeds described inany class of equity securities of the prospectus.Company, or to affiliates of the Company. All payments were made to third parties.

(viii) The uses of proceeds do not represent a material change in the use of proceeds described in the prospectus.
PART III

ITEM 15. CONTROLS AND PROCEDURESPROCEDURES.

Disclosure controls and procedures
Our president and chief financial officer have evaluated the effectiveness of our disclosure controls and procedures (as defined in the Exchange Act Rules 13a-15(e) or 15d-15(e)), and concluded that, based on their evaluation, our disclosure controls and procedures are effective as of the end of the period covered by this Annual Report to ensure that material information required to be included in this Annual Report would be made known to them by others on a timely basis.

     ThereManagement’s annual report on internal control over financial reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting.  The management of the Company has assessed the effectiveness of internal control over financial reporting based on the Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission ("COSO").
The major existing internal control deficiencies are  (1)  lack of independent risk management department; (2) lack of employee’s code of conduct handbook , and (3) lack of valuation standard for work performed by the Audit Committee and its members as of December 31, 2006. Our management, however, believes that none of these internal control deficiencies are identified as material weakness or has had a material effect on our financial condition or results of operations or caused our financial statements as of and for the year ended December 31, 2006 to contain a material misstatement.
The management’s assessment of internal controls over financial reporting was not subject to auditor attestation as of December, 31 2006 pursuant to temporary rules of the Securities and Exchange Commission.  Accordingly, this Annual Report does not include an attestation report by our independent registered public accounting firm regarding internal control over financial reporting.
Changes in internal control over financial reporting
During the year ended December 31, 2006, there have been no significant changechanges in our internal controlscontrol over financial reporting that have materially affected, or in other factors that could significantlyare reasonably likely to materially affect, these controls subsequent to the Evaluation Date.our internal control over financial reporting.  

ITEM 16. [RESERVED]

ITEM 16A. AUDIT COMMITTEE FINANCIAL EXPERTEXPERT.

The Board of Directors has determined that Mr. Wei Ming Hai qualifies as an audit committee financial expert in accordance with the terms of Item 16.A16. A of Form 20-F. Mr. Hai satisfies as an “independent director” within the meaning of NYSE Manual Section 303A and meets the criteria for independence set forth in Section 10A(m)(3) of the US Securities Exchange Act of 1934, as amended, or the Exchange Act, and Rule 10A-3under the Exchange Act. See “Item 6 Directors, Senior Management and Employees — Directors and Senior Management”.
75

ITEM 16B. CODE OF ETHICSETHICS.

As of the date of this Annual Report, the Company does not have, in form, a code of ethics that applies to the president, chief financial officer and principal accounting officer, or collectively, the senior corporate officers. The senior executive officers, all of whom currently serve as our directors,Directors, are subject to the director service contracts that they have with the Company. Under the director service contracts, the directors,Directors, including the senior corporate officers, agree that each directorDirector owes a fiduciary and diligence obligation to the Company and that no such directorDirector shall engage in any activities in competition with the Company’s business or carry out any activities detrimental to the interests of the Company. Each of the directors,Directors, including the senior corporate officers, also agreed to perform their respective duties as directors and senior officers in accordance with the Company Law of the PRC, relevant rules and regulations promulgated by China Securities Regulatory Commission and the Mandatory Provisions of Articles of Association of Overseas Listed Companies.

ITEM 16C. PRINCIPAL ACCOUNTING FEES AND SERVICESSERVICES.

The following table sets forth the aggregate audit fees, audit-related fees, tax fees of the Company’s principal accountants and all other fees billed for products and services provided by the Company’s principal accountants other than the audit fees, audit-related fees and tax fees for each of the fiscal years 20022005 and 2003:2006:

  
Audit Fees
Audit-Related Fees
Tax Fees
Other Fees
2005  
Audit Fees
Audit-Related Fees
Tax Fees
Other Fees
2002
RMB8.2RMB13.9 million  RMB4.1RMB5.8 million  RMB0.14RMB0.11 million  —- 
2003
2006		 RMB8.2RMB8.5 million  RMB7.0RMB4.0 million  RMB0.17RMB0.47 million  RMB1.1RMB3.7 million 

Audit-related fees

     Services provided primarily consist of the following:

a)Review of the Group’s 20032006 interim financial report prepared under IFRS;IFRS.

b)Audits of the Group’s financial statements prepared under PRC Accounting Rules and Regulations in connection with the Company’s listing of its A shares in the PRC; and
c)Audits of the financial statements of China Northern Airlines Company and Xinjiang Airlines Company in connection with the Company’s proposed acquisition of these airlines.

Tax fees

Services provided primarily consist of tax compliance services.

Others

     Services provided primarily consist of services to assist the Group in documenting its internal controls over financial reporting and provide observations and recommendations.

Other fees
Provison of Sarbanes Oxley Act of 2002 advisory services.
Before our principal accountantsaccountant were engaged by the Company or our subsidiaries to render the audit or non-auditnon audit services, the engagement hasengagements have been approved by our audit committee.

ITEM 16D. Exemptions from the Listing Standards for Audit Committee

Not applicable.

ITEM 16D.16E. PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED PURCHASERSPURCHASERS.

The Company and its affiliated companies have not purchased any issued common shares of the Company during 20032006 and up to the date of this Annual Report.

PART IV

ITEM 17. FINANCIAL STATEMENTS.

Not applicable.

ITEM 18. FINANCIAL STATEMENTS.

76
Index to Financial StatementsCHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
  
Page
 Page
CONSOLIDATED FINANCIAL STATEMENTS OF
CHINA SOUTHERN AIRLINES COMPANY LIMITED		  
Report of Independent Registered Public Accounting Firm F-1
Consolidated Statements of Operations for the years ended December 31, 2001, 2002 and 2003 F-2
Consolidated Balance Sheets as of December 31, 2002 and 2003F-3
Consolidated Statements of Cash Flows for the years ended December 31, 2001, 2002 and 2003F-4
Consolidated Statements of Changes in Shareholders’ Equity for the years
      ended December 31, 2001, 2002 and 2003F-5
Notes to Consolidated Financial StatementsF-6

ITEM 19. EXHIBITS.

60

Exhibit No.Description of Exhibit
1Articles of Association
4.1Form of Director’s Service Agreement is incorporated by reference in Exhibit 4(c).1 of Form 20-F for the year of 2003.
4.2Form of Non-Executive Director’s Service Agreement is incorporated by reference in Exhibit 4(c).2 of Form 20-F for the year of 2003.
8Subsidiaries of the Company
12.1Section 302 Certification of Chairman
12.2Section 302 Certification of President
12.3Section 302 Certification of Chief Financial Officer
13.1Section 906 Certification of Chairman
13.2Section 906 Certification of President
13.3Section 906 Certification of Chief Financial Officer

61

CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

Page
Report of Independent Registered Public Accounting FirmF-1 
Consolidated Statements of Operations
for the years ended December 31, 2001, 20022004, 2005 and 20032006 F-2
 
Consolidated Balance Sheets as of December 31, 20022005 and 20032006 F-3
Consolidated Statements of Cash Flows for the years ended December 31, 2001, 2002 and 2003  F-4 
Consolidated Statements of Changes in Shareholders’ Equity
for the years ended December 31, 2001, 20022004, 2005 and 20032006F-5
  
F-5Consolidated Statements of Cash Flows 
for the years ended December 31, 2004, 2005 and 2006F-6
Notes to Consolidated Financial Statements
 F-6F-8


REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

The Board of Directors and Shareholders of
China Southern Airlines Company Limited:

Limited


We have audited the accompanying consolidated balance sheets of China Southern Airlines Company Limited (the “Company”) and its subsidiaries (the “Group”) as of December 31, 20022005 and 2003,2006, and the related consolidated statements of operations, cash flows and changes in shareholders’ equity and cash flows for each of the years in the three-year period ended December 31, 2003,2006, all expressed in Renminbi. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.


We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.


In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of China Southern Airlines Company Limited and its subsidiaries as of December 31, 20022005 and 2003,2006, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 20032006 in conformity with International Financial Reporting Standards promulgated by the International Accounting Standards Board.


International Financial Reporting Standards vary in certain significant respects from accounting principles generally accepted in the United States of America. Information relating to the nature and effect of such differences is presented in Note 3351 to the consolidated financial statements.

     The accompanying consolidated financial statements

/s/ KPMG
Hong Kong, China
April 16, 2007, except as to Note 44(a)(ii), (c) and (d), which are as of and for the year ended DecemberMay 31, 2003 have been translated into United States dollars solely for the convenience of the reader. We have audited the translation, and in our opinion, the consolidated financial statements expressed in Renminbi have been translated into United States dollars on the basis set forth in Note 1 to the consolidated financial statements.

KPMG2007

F-1

Hong Kong
April 23, 2004

F-1

CHINA SOUTHERN AIRLINES COMPANY LIMITED

AND SUBSIDIARIES


CONSOLIDATED STATEMENTS OF OPERATIONS
For the years ended December 31, 2001, 20022004, 2005 and 2003

2006


(Amounts in thousands,millions, except per share data)
                     
  Note
 2001
 2002
 2003
 2003
      RMB RMB RMB U.S. dollars
Operating revenue:                    
Traffic revenue, net  3   16,461,532   17,481,892   16,964,800   2,049,706 
Other revenue  4   418,126   536,728   505,323   61,053 
       
 		   
 		   
 		   
 		 
Total operating revenue      16,879,658   18,018,620   17,470,123   2,110,759 
       
 		   
 		   
 		   
 		 
Operating expenses:                    
Flight operations  5   6,905,628   6,732,543   7,070,031   854,209 
Maintenance  6   2,014,579   2,333,419   2,588,613   312,759 
Aircraft and traffic servicing  7   2,297,521   2,511,284   2,767,488   334,371 
Promotion and sales  8   1,540,780   1,499,587   1,480,168   178,836 
General and administrative  9   892,233   1,060,010   1,053,319   127,263 
Depreciation and amortization      1,814,974   1,839,871   2,037,971   246,230 
Other      13,270   15,829   16,804   2,029 
       
 		   
 		   
 		   
 		 
Total operating expenses      15,478,985   15,992,543   17,014,394   2,055,697 
       
 		   
 		   
 		   
 		 
Operating income      1,400,673   2,026,077   455,729   55,062 
       
 		   
 		   
 		   
 		 
Non-operating income/(expenses):                    
Equity income of affiliated companies      53,077   36,988   47,798   5,775 
Equity loss of jointly controlled entities      (4,034)  (3,352)  (39,495)  (4,772)
(Loss)/gain on sale of fixed assets  13, 24   (55,889)  170,740   (22,217)  (2,684)
Interest income      49,878   52,618   13,061   1,578 
Interest expense  16   (933,717)  (959,193)  (823,725)  (99,523)
Exchange gain/(loss), net      296,777   (175,451)  (164,443)  (19,868)
Other, net      (11,509)  (9,328)  21,682   2,619 
       
 		   
 		   
 		   
 		 
Total non-operating expenses      (605,417)  (886,978)  (967,339)  (116,875)
       
 		   
 		   
 		   
 		 
Income/(loss) before taxation and minority interests      795,256   1,139,099   (511,610)  (61,813)
Taxation (expense)/credit  10   (320,519)  (398,227)  324,277   39,179 
       
 		   
 		   
 		   
 		 
Income/(loss) before minority interests      474,737   740,872   (187,333)  (22,634)
Minority interests      (134,512)  (165,111)  (170,934)  (20,652)
       
 		   
 		   
 		   
 		 
Net income/(loss)      340,225   575,761   (358,267)  (43,286)
       
 		   
 		   
 		   
 		 
Basic earnings/(loss) per share  2(w)   0.10   0.17   (0.09)  (0.01)
       
 		   
 		   
 		   
 		 

  
Note
 
2004
 
2005
 
2006
 
    
RMB
 
RMB
 
RMB
 
       (Note 45)   
Operating revenue         
Traffic revenue  3  23,344  37,419  45,087 
Other operating revenue  3  630  874  1,132 
Total operating revenue     23,974  38,293  46,219 
              
Operating expenses             
Flight operations  4  10,418  19,394  24,667 
Maintenance  5  3,459  4,051  4,077 
Aircraft and traffic servicing  6  3,503  5,759  6,219 
Promotion and sales  7  1,940  2,780  2,811 
General and administrative  8  1,323  2,457  3,140 
Depreciation and amortization  9  2,413  4,905  4,966 
Others     9  179  100 
Total operating expenses     23,065  39,525  45,980 
Operating income/(loss)     909  (1,232) 239 
              
Non-operating income/(expenses)             
Interest income     22  55  41 
Interest expense  11  (691) (1,616) (2,070)
Equity income/(loss) of affiliated companies  22  10  (285) 5 
Equity (loss)/income of jointly             
controlled entities  23  (16) 36  115 
Loss on derivative financial instruments, net     -  -  (19)
(Loss)/gain on sale of property,             
plant and equipment  12  (1) (32) 335 
Exchange (loss)/gain, net     (59) 1,220  1,492 
Others, net     46  74  146 
Total net non-operating (expenses)/income     (689) (548) 45 
              
Income/(loss) before taxation     220  (1,780) 284 
Income tax expense  13  (65) (4) (142)
Income/(loss) for the year     155  (1,784) 142 
              
Attributable to             
Equity shareholders of the Company     (48) (1,786) 126 
Minority interests     203  2  16 
Net income/(loss)     155  (1,784) 142 
              
(Loss)/earnings per share             
Basic  15  (0.01) (0.41) 0.03 
Diluted  15  (0.01) (0.41) 0.03 

See accompanying notes to consolidated financial statements

F-2

CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS
As of December 31, 2002 and 2003

(Amounts in thousands)

                 
  Note
 2002
 2003
 2003
      RMB RMB U.S. dollars
ASSETS
                
CURRENT ASSETS                
Cash and cash equivalents  11   3,771,043   2,080,174   251,329 
Trade receivables  12   671,776   833,604   100,717 
Other receivables      372,586   296,047   35,769 
Inventories      545,700   543,777   65,700 
Prepaid expenses and other current assets      244,690   247,926   29,954 
       
 		   
 		   
 		 
TOTAL CURRENT ASSETS      5,605,795   4,001,528   483,469 
FIXED ASSETS  13   26,920,829   28,535,907   3,447,739 
CONSTRUCTION IN PROGRESS  14   661,352   1,629,689   196,901 
LEASE PREPAYMENTS      201,854   348,652   42,124 
INVESTMENTS  15   1,355,842   1,358,495   164,135 
LEASE AND EQUIPMENT DEPOSITS      2,147,038   2,932,591   354,319 
OTHER ASSETS      295,337   255,233   30,838 
       
 		   
 		   
 		 
TOTAL ASSETS      37,188,047   39,062,095   4,719,525 
       
 		   
 		   
 		 
LIABILITIES AND SHAREHOLDERS’ EQUITY
                
CURRENT LIABILITIES                
Notes payable, including current installments of long-term notes payable  16   5,240,726   7,096,846   857,449 
Current installments of obligations under capital leases  17   1,566,698   1,297,855   156,808 
Accounts payable      532,480   928,093   112,133 
Bills payable      1,299,680   438,135   52,936 
Sales in advance of carriage      390,531   466,087   56,313 
Taxes payable      78,145   89,954   10,868 
Amounts due to related companies      525,090   929,003   112,243 
Accrued expenses  18   2,341,454   2,527,794   305,411 
Other liabilities      646,989   1,019,811   123,215 
       
 		   
 		   
 		 
TOTAL CURRENT LIABILITIES      12,621,793   14,793,578   1,787,376 
NOTES PAYABLE, EXCLUDING CURRENT INSTALLMENTS  16   5,835,434   4,521,735   546,321 
OBLIGATIONS UNDER CAPITAL LEASES, EXCLUDING CURRENT INSTALLMENTS  17   6,631,751   5,543,084   669,722 
PROVISION FOR MAJOR OVERHAULS  6   141,887   189,464   22,891 
DEFERRED CREDITS  19   48,095   46,554   5,625 
DEFERRED TAXATION  20   779,234   398,305   48,124 
       
 		   
 		   
 		 
TOTAL LIABILITIES      26,058,194   25,492,720   3,080,059 
MINORITY INTERESTS      1,516,646   1,673,668   202,214 
SHAREHOLDERS’ EQUITY  21,22   9,613,207   11,895,707   1,437,252 
       
 		   
 		   
 		 
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY      37,188,047   39,062,095   4,719,525 
       
 		   
 		   
 		 

See accompanying notes to consolidated financial statements.

F-3

F-2


CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES


CONSOLIDATED STATEMENTS OF CASH FLOWS
For the years endedBALANCE SHEETS
As of December 31, 2001, 20022005 and 2003

2006


(Amounts in thousands)millions)
                     
  Note
 2001
 2002
 2003
 2003
      RMB RMB RMB U.S. dollars
Cash inflows from operations  28(a)  3,185,523   4,762,923   3,074,718   371,491 
Interest received      49,878   52,618   13,061   1,578 
Interest paid      (970,734)  (1,051,027)  (923,901)  (111,627)
Income tax paid      (40,724)  (66,970)  (35,129)  (4,244)
       
 		   
 		   
 		   
 		 
Net cash inflows from operating activities      2,223,943   3,697,544   2,128,749   257,198 
       
 		   
 		   
 		   
 		 
Investing activities:                    
Proceeds from sale of aircraft      566,493   778,047   29,275   3,537 
Proceeds from sale of other fixed assets      38,892   47,150   27,802   3,359 
Proceeds from sale of investments in equity securities      —   68   —   — 
Dividends received from affiliated companies      5,946   3,093   —   — 
(Increase)/decrease in other assets      (345)  (943)  5,654   683 
Payment of lease and equipment deposits      (2,027,063)  (1,999,233)  (1,851,726)  (223,727)
Refund of lease and equipment deposits      200,029   2,117,386   1,066,086   128,806 
Capital expenditures      (1,492,126)  (6,351,030)  (4,706,740)  (568,674)
Purchase of investments in equity securities      (1,241)  (6,721)  (1,065)  (129)
Investments in affiliated companies      (147,875)  (136,500)  —   — 
Investments in jointly controlled entities      (178,372)  (295,670)  (2,999)  (362)
Governmental subsidy for safety related capital expenditures      —   40,240   —   — 
Effect of acquisition of subsidiaries, net of cash and cash equivalents acquired  28(c)  —   (90,491)  —   — 
       
 		   
 		   
 		   
 		 
Net cash used in investing activities      (3,035,662)  (5,894,604)  (5,433,713)  (656,507)
       
 		   
 		   
 		   
 		 
Net cash outflows before financing activities      (811,719)  (2,197,060)  (3,304,964)  (399,309)
       
 		   
 		   
 		   
 		 
Financing activities:                    
Proceeds from A share issue, net of issuance costs      —   —   2,640,767   319,060 
Proceeds from bank notes payable      2,123,613   6,996,780   8,913,992   1,076,998 
Repayment of bank notes payable      (890,228)  (2,194,630)  (8,371,362)  (1,011,437)
Repayment of principal under capital lease obligations      (1,756,098)  (1,546,185)  (1,555,390)  (187,924)
Minority shareholders’ contributions      707   10,625   1,050   127 
Dividends paid to shareholders      —   (67,484)  —   — 
Dividends paid to minority shareholders      (45,867)  (48,866)  (14,962)  (1,807)
       
 		   
 		   
 		   
 		 
Net cash (outflows)/inflows from financing activities      (567,873)  3,150,240   1,614,095   195,017 
       
 		   
 		   
 		   
 		 
(Decrease)/increase in cash and cash equivalents      (1,379,592)  953,180   (1,690,869)  (204,292)
Cash and cash equivalents at beginning of year      4,197,455   2,817,863   3,771,043   455,621 
       
 		   
 		   
 		   
 		 
Cash and cash equivalents at end of year      2,817,863   3,771,043   2,080,174   251,329 
       
 		   
 		   
 		   
 		 


  
Note
 
2005
 
2006
 
    
RMB
 
RMB
 
     (Note 45)   
ASSETS 
       
CURRENT ASSETS       
Cash and cash equivalents  16  2,901  2,264 
Trade receivables  17  1,518  1,512 
Inventories  18  1,382  1,315 
Other receivables  19  956  879 
Prepaid expenses and other current assets     380  585 
Amounts due from related companies  30  84  128 
Total current assets     7,221  6,683 
           
NON-CURRENT ASSETS          
Property, plant and equipment, net  20  54,339  56,347 
Construction in progress  21  674  951 
Lease prepayments     333  441 
Interest in affiliated companies  22  142  149 
Interest in jointly controlled entities  23  805  870 
Other investments in equity securities  24  320  330 
Lease and equipment deposits     7,265  9,458 
Deferred tax assets  25  63  95 
Other assets  26  302  260 
Total non-current assets     64,243  68,901 
TOTAL ASSETS     71,464  75,584 
           
LIABILITIES AND SHAREHOLDERS' EQUITY
          
CURRENT LIABILITIES          
Financial liabilities     -  26 
Notes payable, including current installments of long-term          
notes payable  27  16,223  23,822 
Current installments of obligations under capital leases  28  3,373  3,091 
Trade and bills payables  29  3,929  1,909 
Sales in advance of carriage     1,413  1,436 
Taxes payable     28  126 
Amounts due to related companies  30  116  254 
Accrued expenses  31  4,250  4,942 
Other liabilities  32  3,796  3,257 
Total current liabilities     33,128  38,863 
F-3

CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS - (Continued)
As of December 31, 2005 and 2006

(Amounts in millions)

  
Note
 
2005
 
2006
 
    
RMB
 
RMB
 
     (Note 45)   
NON-CURRENT LIABILITIES       
Notes payable, excluding current installments  27  12,740  10,018 
Obligations under capital leases, excluding          
current installments  28  12,459  12,307 
Provision for major overhauls  33  301  805 
Provision for early retirement benefits  34  -  306 
Deferred tax liabilities  25  342  372 
Deferred credits     496  792 
Total non-current liabilities     26,338  24,600 
TOTAL LIABILITIES     59,466  63,463 
           
SHAREHOLDERS' EQUITY          
Equity attributable to equity shareholders of the Company  35, 36  10,062  10,188 
Minority interests     1,936  1,933 
Total shareholders' equity     11,998  12,121 
TOTAL LIABILITIES AND TOTAL SHAREHOLDERS' EQUITY     71,464  75,584 
See accompanying notes to consolidated financial statements.

F-4


CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES


CONSOLIDATED STATEMENTS
OF CHANGES IN SHAREHOLDERS’ EQUITY
For the years ended December 31, 2001, 20022004, 2005 and 2003

2006


(Amounts in thousands)millions)
                         
      Share Share Other Retained  
  Note
 capital
 premium
 reserves
 profits
 Total
      RMB RMB RMB RMB RMB
Shareholders’ equity at January 1, 2001      3,374,178   3,813,659   664,945   1,028,656   8,881,438 
Net income      —   —   —   340,225   340,225 
Appropriations to reserves      —   —   22,229   (22,229)  — 
       
 		   
 		   
 		   
 		   
 		 
Shareholders’ equity at December 31, 2001      3,374,178   3,813,659   687,174   1,346,652   9,221,663 
Land use rights adjustment  22(f)  —   (129,703)  —   12,970   (116,733)
Adjustments from adoption of new PRC                        
accounting regulations  22(c)  —   —   (185,540)  185,540   — 
Dividend paid      —   —   —   (67,484)  (67,484)
Net income      —   —   —   575,761   575,761 
Appropriations to reserves      —   —   83,738   (83,738)  — 
       
 		   
 		   
 		   
 		   
 		 
Shareholders’ equity at December 31, 2002      3,374,178   3,683,956   585,372   1,969,701   9,613,207 
Issue of A shares  21   1,000,000   1,640,767   —   —   2,640,767 
Net loss      —   —   —   (358,267)  (358,267)
Appropriations to reserves      —   —   24,969   (24,969)  — 
       
 		   
 		   
 		   
 		   
 		 
Shareholders’ equity at December 31, 2003      4,374,178   5,324,723   610,341   1,586,465   11,895,707 
       
 		   
 		   
 		   
 		   
 		 
Shareholders’ equity at December 31, 2003 in U.S. dollars      528,493   643,339   73,741   191,679   1,437,252 
       
 		   
 		   
 		   
 		   
 		 

  
Attributable to equity shareholders of the Company
     
        
Retained
       
        
earnings/
       
  
Share
 
Share
 
Other
 
(accumulated
   
Minority
 
Total
 
  
capital
 
premium
 
reserves
 
losses)
 
Total
 
interests
 
equity
 
  
RMB
 
RMB
 
RMB
 
RMB
 
RMB
 
RMB
 
RMB
 
      
(Note)
         
                
At January 1, 2004  4,374  5,325  611  1,586  11,896  1,673  13,569 
                       
(Loss)/income for the year  -  -  -  (48) (48) 203  155 
Appropriations to reserves  -  -  61  (61) -  -  - 
Capital contributions                    - 
from minority shareholders  -  -  -  -  -  71  71 
Distributions to minority                    - 
shareholders  -  -  -  -  -  (15) (15)
Through the CNA/XJA                      
Acquisitions  -  -  -  -  -  123  123 
                       
At December 31, 2004  4,374  5,325  672  1,477  11,848  2,055  13,903 
                       
(Loss)/income for the year (Note 45)  -  -  -  (1,786) (1,786) 2  (1,784)
Appropriations to reserves  -  -  19  (19) -  -  - 
Capital contributions                      
from minority shareholders  -  -  -  -  -  17  17 
Acquisition of equity interest                      
held by minority shareholders  -  -  -  -  -  (118) (118)
Distributions to minority                      
shareholders  -  -  -  -  -  (20) (20)
At December 31, 2005  4,374  5,325  691  (328) 10,062  1,936  11,998 
                       
Income for the year  -  -  -  126  126  16  142 
Appropriations to reserves  -  -  41  (41) -  -  - 
Acquisition of equity interest                      
held by minority shareholders  -  -  -  -  -  (12) (12)
Distributions to minority                      
shareholders  -  -  -  -  -  (7) (7)
                       
At December 31, 2006  4,374  5,325  732  (243) 10,188  1,933  12,121 

See accompanying notes to consolidated financial statements.


Note:Other reserves represent statutory surplus reserve, statutory public welfare fund and discretionary surplus reserve. Details are set out in Note 36.

F-5


CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES


CONSOLIDATED STATEMENTS OF CASH FLOWS
For the years ended December 31, 2004, 2005 and 2006

(Amounts in millions)

  
Note
 
2004
 
2005
 
2006
 
    
RMB
 
RMB
 
RMB
 
      (Note 45)    
Income/(loss) before taxation     220  (1,780) 284 
Adjustments to reconcile income/(loss) before taxation             
to cash inflows from operations             
Depreciation of property, plant and equipment     2,363  4,885  4,994 
Other amortization     50  40  33 
Amortization of deferred credits     (4) (78) (61)
Equity (loss)/income of affiliated companies     (10) 285  (5)
Equity income/(loss) of jointly controlled entities     16  (36) (115)
Loss/(gain) on sale of property, plant and equipment     1  32  (335)
Interest income     (22) (55) (41)
Interest expense     691  1,616  2,070 
Loss on derivative financial instruments, net     -  -  19 
Net realized and unrealized gain on equity securities             
held for trading     (15) (6) - 
Dividend income from other investments in equity securities     -  -  (7)
Non-cash exchange loss/(gain), net     20  (1,120) (1,492)
(Increase)/decrease in inventories     (29) 46  95 
(Increase)/decrease in trade receivables     (218) (315) 36 
(Increase)/decrease in other receivables     (166) (236) 152 
Increase in prepaid expenses and other current assets     (31) (2) (205)
Increase in deferred expenditure     (2) -  - 
(Decrease)/increase in net amounts due from/(to)             
related companies     (586) (493) 113 
(Decrease)/increase in trade and bills payables     (30) 2,239  (2,048)
Increase in sales in advance of carriage     408  539  23 
Increase/(decrease) in accrued expenses     541  (399) 568 
Increase/(decrease) in other liabilities     1,223  822  (247)
Increase in provision for major overhauls     113  17  504 
Increase in provision for early retirement benefits     -  -  306 
Cash in flows from operations     4,533  6,001  4,641 
Interest received     22  55  41 
Interest paid     (754) (1,616) (2,419)
Income tax paid     (227) (23) (46)
Net cash inflows from operating activities     3,574  4,417  2,217 
F-6

CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS - (Continued)
For the years ended December 31, 2004, 2005 and 2006

(Amounts in millions)

  
Note
 
2004
 
2005
 
2006
 
    
RMB
 
RMB
 
RMB
 
      (Note 45)   
Investing activities         
Proceeds from sale of property, plant and equipment     47  238  492 
Proceeds from sale of other investments     -  689  - 
Net cash settlement of derivative financial instruments     -  -  7 
Increase in deferred credits     -  57  - 
Dividends received from affiliated companies     12  2  33 
Dividends received from jointly controlled entities     5  39  50 
Dividends received from other non-current assets     -  4  7 
Dividends received from equity securities held for trading     13  -  - 
Decrease/(increase) in other non-current assets     (9) 4  16 
Payment for the CNA/XJA Acquisitions     -  (1,959) - 
Payment for acquisition of equity interest held by             
minority shareholders     -  (118) (12)
Payment of lease and equipment deposits     (3,151) (6,649) (5,464)
Refund of lease and equipment deposits     1,253  4,619  2,031 
Capital expenditures     (6,631) (5,473) (2,566)
Purchase of other investments     (680) -  - 
Investments in affiliated companies     (9) -  (31)
Investments in jointly controlled entities     (72) -  - 
Effect of the CNA/XJA Acquisitions  
40(b)
  398  -  - 
Effect of acquisition of CSAHC Hainan  
40(c)
  -  -  33 
              
Net cash used in investing activities     (8,824) (8,547) (5,404)
Net cash outflows before financing activities     (5,250) (4,130) (3,187)
              
Financing activities:             
Proceeds from notes payable     14,555  18,238  24,983 
Repayment of notes payable     (7,108) (12,193) (19,113)
Repayment of principal under capital lease obligations     (1,272) (2,050) (3,313)
Capital contributions received from minority shareholders     71  17  - 
Dividends paid to minority shareholders     (15) (20) (7)
              
Net cash inflows from financing activities     6,231  3,992  2,550 
Increase/(decrease) in cash and cash equivalents     981  (138) (637)
Cash and cash equivalents at January 1     2,080  3,083  2,901 
Effect of foreign exchange rate changes     22  (44) - 
Cash and cash equivalents at December 31     3,083  2,901  2,264 
See accompanying notes to consolidated financial statements.

F-7
CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- (Continued)
(Amounts in thousands,millions, except share data)


1. BASIS OF PRESENTATION


China Southern Airlines Company Limited (the “Company”) and its subsidiary companies (hereinafter collectively referred to as thesubsidiaries (the “Group”) are principally engaged in the provision of domestic, Hong Kong regionaland Macau and international passenger, and cargo and mail airline services, with flights operating primarily from the Guangzhou Baiyun International Airport, which is both the main hub of the Group’s route network and the location of its corporate headquarters.

services.


The Company was established in the People’s Republic of China (the “PRC”, or “China” or the “State”) on March 25, 1995 as a joint stock limited company as part of the Reorganizationreorganization (the “Reorganization”) of the Company’s holding company, China Southern Air Holding Company (“CSAHC”). CSAHC is a state-owned enterprise under the supervision of the PRC central government.


The Company’s H Shares and American Depositary Shares (“ADS”) (each ADS representing 50 H Shares) arehave been listed on theThe Stock Exchange of Hong Kong Limited and the New York Stock Exchange, respectively since July 1997. In July 2003, the Company issued 1,000,000,000 A sharesShares which are listed on the Shanghai Stock Exchange.

     The


2. PRINCIPAL ACCOUNTING POLICIES

(a) Statement of compliance

These consolidated financial statements have been prepared in Renminbi (“RMB”), the national currency of China. Solely for the convenience of the reader, the 2003 financial statements have been translated into United States dollars at the rate of US$ 1.00 = RMB 8.2767, the rate quoted by the People’s Bank of China on December 31, 2003. No representation is made that the RMB amounts could have been, or could be, converted into United States dollars (“US$”) at that rate or at any other certain rate on December 31, 2003 or at any other certain date.

2.     PRINCIPAL ACCOUNTING POLICIES

(a)     Statement of compliance

     The consolidated financial statements of the Group have been prepared in accordance with all applicable International Financial Reporting Standards (“IFRS”IFRSs”), which collective term includes all applicable individual International Financial Reporting Standards, International Accounting Standards (“IASs”) and Interpretations promulgated by the International Accounting Standards Board. IFRS includes International Accounting Standards (“IAS”Board (the “IASB”).


The IASB has issued certain new and related interpretations.

revised IFRSs that are first effective or available for early adoption for the current accounting period of the Group and the Company. The following summarizes the accounting policies of the Group after these developments to the extent that they are relevant to the Group.


Information relating to the nature and effect of the significant differences between IFRSIFRSs and accounting principles generally accepted in the United States of America (“(‘‘U.S. GAAP”GAAP’’) are set forth in Note 33.

(b)     Basis of preparation

     The consolidated financial statements of the Group are prepared on the historical cost basis as modified by the revaluation of certain fixed assets (Note 13). The accounting policies have been consistently applied by the Group and except for a change in accounting policy for land use rights in 2002 (Note 22(f)), are consistent with those used in previous years.

F-6

51.

F-8


CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Amounts in thousands,millions, except share data)

(c)


(b) Basis of consolidation

preparation of the consolidated financial statements


At December 31, 2006, the Group’s current liabilities exceeded its current assets by RMB32,180, which includes current installments of notes payable of RMB23,822. In preparing the consolidated financial statements, the directors have considered the Group’s sources of liquidity and believe that adequate funding is available to fulfill the Group’s short term obligations and capital expenditure requirements. Accordingly, the consolidated financial statements have been prepared on a basis that the Group will be able to continue as a going concern. Further details are set out in Note 41(a).

The consolidated financial statements includefor the financial statements ofyear ended December 31, 2006 comprise the Company and all of its subsidiaries (see Note 29 for detailsand the Group’s interest in affiliated companies and jointly controlled entities.

The measurement basis used in the preparation of the Company’s principal subsidiaries)consolidated financial statements is the historical cost basis except that the following assets and liabilities are stated at their fair value as explained in the accounting policies set out below:
·Certain property, plant and equipment (Note 2(h));
·Certain assets held under capital leases (Note 2(j)); and
·Derivative financial instruments (Note 2(g)).

The preparation of the consolidated financial statements in conformity with IFRSs requires management to make judgments, estimates and assumptions that affect the application of policies and reported amounts of assets and liabilities, income and expenses. The estimates and associated assumptions are based on historical experience and various other factors that are believed to be reasonable under the circumstances, the results of which form the basis of making the judgments about carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates.

The estimates and underlying assumptions are reviewed on an ongoing basis. Revisions to accounting estimates are recognized in the period in which the estimate is revised if the revision affects only that period, or in the period of the revision and future periods if the revision affects both current and future periods.

Judgments made up to December 31, each year. by management in the application of IFRSs that have significant effect on the consolidated financial statements and estimates with a significant risk of material adjustment in the next year are discussed in Note 47.
F-9

CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Amounts in millions, except share data)

(c) Subsidiaries and minority interests

Subsidiaries are those enterprisesentities controlled by the Group. Control exists when the Group has the power directly or indirectly, to govern the financial and operating policies of an enterpriseentity so as to obtain benefits from its activities. The financial statements of subsidiariesIn assessing control, potential voting rights that presently are includedexercisable are taken into account.

An investment in a subsidiary is consolidated into the consolidated financial statements from the date that control effectively commences until the date that control effectively ceases.

     The results Intra-group balances and transactions and any unrealized income arising from intra-group transactions are eliminated in full in preparing the consolidated financial statements. Unrealized losses resulting from intra-group transactions are eliminated in the same way as unrealized gains but only to the extent that there is no evidence of subsidiary companiesimpairment.


Minority interests represent the portion of the net assets of subsidiaries attributable to interests that are includednot owned by the Company, whether directly or indirectly through subsidiaries, and in respect of which the Group has not agreed any additional terms with the holders of those interests which would result in the Group as a whole having a contractual obligation in respect of those interests that meets the definition of a financial liability. Minority interests are presented in the consolidated statements of operations, and the share attributable to minority shareholders is deductedbalance sheet within equity, separately from or added to the consolidated income after taxation. Losses attributable to minority shareholders of partly owned subsidiaries are accounted for based on the respective equity owned by the minority shareholders up to the amount of the capital contribution and reserves attributable to the equity shareholders of the Company. Minority interests in the results of the Group are presented on the face of the consolidated statement of operations as an allocation of the total income or loss for the year between minority shareholders. Thereafter, allinterests and the equity shareholders of the Company.

Where losses applicable to the minority exceed the minority’s interest in the equity of a subsidiary, the excess, and any further losses applicable to the minority, are assumedcharged against the Group’s interest except to the extent that the minority has a binding obligation to, and is able to, make additional investment to cover the losses. If the subsidiary subsequently reports income, the Group’s interest is allocated all such income until the minority’s share of losses previously absorbed by the Company.

     All significant intercompany balancesGroup has been recovered.


Loans from holders of minority interests and transactions have been eliminated on consolidation.

(d)     Interest- bearing borrowings

     Interest-bearing borrowingsother contractual obligations towards these holders are recognized initially at cost, less attributable transaction costs. Subsequent to initial recognition, interest-bearing borrowings are stated at amortized cost with any difference between cost and redemption value being recognizedpresented as financial liabilities in the consolidated statementsbalance sheet in accordance with Notes 2(o) or (p) depending on the nature of operationsthe liability.


(d) Affiliated companies and jointly controlled entities

An affiliated company is an entity in which the Group or the Company has significant influence, but not control or joint control, over its management, including participation in the financial and operating policies.

A jointly controlled entity is an entity which operates under a contractual arrangement between the Group or Company and other parties, where the contractual arrangement establishes that the Group or Company and one or more of the other parties share joint control over the periodeconomic activities of the borrowings on an effective interest basis.

(e)     Cash and cash equivalents

     Cash and cash equivalents consist of cash in hand and balances with banks and other financial institutions with an original maturity within three months. For the purposes of the consolidated statements of cash flows, the Group considers all highly liquid debt instruments purchased with an original maturity of three months or less to be cash equivalents. None of the Group’s cash and cash equivalents is restricted as to withdrawal.

(f)     Trade and other receivables

     Trade and other receivables are stated at cost less allowance for doubtful accounts. Allowance for doubtful accounts are established based on evaluation of the recoverability of these accounts at the balance sheet date. In establishing such allowance, the Group considers various factors including its historical write-off experience and industry economic trend. Past due balances over a specific period and balances over a specific amount are reviewed individually for collectibility. All other balances are reviewed on a pooled basis.

F-7

entity.

F-10


CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Amounts in thousands,millions, except share data)

(g)     Inventories

     Inventories,


An investment in an affiliated company or a jointly controlled entity is accounted for in the consolidated financial statements under the equity method and is initially recorded at cost and adjusted thereafter for the post acquisition change in the Group’s share of the affiliated company’s or the jointly controlled entity’s net assets. The consolidated statement of operations includes the Group’s share of the post-acquisition, post-tax results of the affiliated companies and jointly controlled entities for the year, including any impairment loss on goodwill relating to the investment in affiliated companies and jointly controlled entities recognized for the year (Notes 2(e) and (l)).

When the Group’s share of losses exceeds its interest in the affiliated company or the jointly controlled entity, the Group’s interest is reduced to nil and recognition of further losses is discontinued except to the extent that the Group has incurred legal or constructive obligations or made payments on behalf of the affiliated company or the jointly controlled entity. For this purpose, the Group’s interest in the affiliated company or the jointly controlled entity is the carrying amount of the investment under the equity method together with the Group’s long-term interests that in substance form part of the Group’s net investment in the affiliated company or the jointly controlled entity.

Unrealized income and losses arising from transactions between the Group and its affiliated company and jointly controlled entities are eliminated to the extent of the Group’s interest in the affiliated company or jointly controlled entity, except where unrealized losses provide evidence of an impairment of the asset transferred, in which consist primarilycase they are recognized immediately in income or loss.
(e) Goodwill

Goodwill represents the excess of expendable spare partsthe cost of a business combination or an investment in an affiliated company or a jointly controlled entity over the Group’s interest in the net fair value of the acquiree’s identifiable assets, liabilities and supplies, arecontingent liabilities.

Goodwill is stated at cost less accumulated impairment losses. Goodwill is allocated to cash-generating units and is tested annually for impairment (Note 2(l)). In respect of affiliated companies or jointly controlled entities, the carrying amount of goodwill is included in the carrying amount of the interest in the affiliated company or jointly controlled entity.

Any excess of the Group’s interest in the net fair value of the acquiree’s identifiable assets, liabilities and contingent liabilities over the cost of a business combination or an investment in an affiliated company or a jointly controlled entity is recognized immediately in income or loss.

On disposal of a cash generating unit, an affiliated company or a jointly controlled entity during the year, any applicable provisionattributable amount of purchased goodwill is included in the calculation of the gain or loss on disposal.
F-11

CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Amounts in millions, except share data)

(f) Other investments in equity securities

The policy for obsolescence,investments in equity securities, other than investments in subsidiaries, affiliated companies and jointly controlled entities, are expensed when usedas follows:

Investments in operations. Cost represents the average unit cost. Inventories held for disposal is stated at the lower of cost and net realizable value. Net realizable value represents estimated resale price.

(h)     Fixed assets and depreciation

     Fixed assetsequity securities are initially stated at cost, which is their transaction price unless fair value can be more reliably estimated using valuation techniques whose variables include only data from observable markets. Cost includes attributable transaction costs.


The Group’s other investments in equity securities represent unlisted equity securities of companies established in the PRC. They do not have a quoted market price in an active market and whose fair value cannot be reliably measured. Accordingly, they are recognized in the balance sheet at cost less impairment losses (Note 2(l)).

Investments are recognized / derecognized on the date the Group commits to purchase / sell the investments or revalued amountsthey expire.

(g) Derivative financial instruments

Derivative financial instruments are recognized at fair value. At each balance sheet date the fair value is remeasured. The gain or loss on remeasurement to fair value is charged immediately to income or loss.

(h) Property, plant and equipment

Items of property, plant and equipment are initially stated at cost, less accumulated depreciation and impairment losses (refer(Note 2(l)). The cost of an item of property, plant and equipment comprises its purchase price and any directly attributable costs of bringing the asset to accounting policy n). working condition and location for its intended use and the initial estimate, where relevant, of the costs of dismantling and removing the items and restoring the site on which they are located.

Subsequent to the revaluation of the Group’s property, plant and equipment as at December 31, 1996 (Note 20(b)), which was based on depreciated replacement costs, certain of the Group’s property, plant and equipment are carried at revalued amount, being the fair value at the date of the revaluation less any subsequent accumulated depreciation.

Revaluations are performed periodicallywith sufficient regularity to ensure that the carrying amount of these assets does not differ materially from that which would be determined using fair value at the balance sheet date.

F-12

CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Amounts in millions, except share data)

Changes arising on the revaluation of property, plant and equipment are generally dealt with in reserves. The only exceptions are as follows:

·When a deficit arises on revaluation, it will be charged to income or loss to the extent that it exceeds the amount held in the reserve in respect of that same asset immediately prior to the revaluation; and

·When a surplus arises on revaluation, it will be credited to income or loss to the extent that a deficit on revaluation in respect of that same asset had previously been charged to income or loss.

The cost of self-constructed items of property, plant and equipment includes the cost of materials, the initial estimate, where relevant, of the costs of dismantling and removing the items and restoring the site on which they are located, and an appropriate proportion of production overheads and borrowing costs (Note 2(y)).

Gains or losses arising from the retirement or disposal of an item of property, plant and equipment are determined as the difference between the net disposal proceeds and the carrying amount of the item and are recognized in income or loss on the date of retirement or disposal. Any related revaluation surplus is transferred from the revaluation reserve to retained earnings.

Depreciation is providedcalculated to write off the costs,cost or revalued amounts where appropriate,valuation of items of property, plant and equipment, less their estimated residual value, if any, using the fixed assets on a straight line basismethod over their estimated useful lives to residual values, as follows:

Depreciable life
Residual value
Buildings15 to 40 yearsNil
Owned and leased aircraft815 to 1520 years28.75%
Other flight equipment 
- Jet engines15 to 20 years
Others, including rotable spares8 to 15 years3%
- Others, including rotable spares8 to 15 yearsNil
Machinery and equipment
5 to 10 years3%
Vehicles6 years3%


Where parts of an item of property, plant and equipment have different useful lives, the cost or valuation of the item is allocated on a reasonable basis between the parts and each part is depreciated separately. Both the useful life of an asset and its residual value, if any, are reviewed annually.
F-13

CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Amounts in millions, except share data)

(i) Construction in progress

Construction in progress represents office buildings, various infrastructure projects under construction and equipment pending installation, and is stated at cost less impairment losses (Note 2(l)). Capitalisation of these costs ceases and the construction in progress is transferred to property, plant and equipment when the asset is substantially ready for its intended use, notwithstanding any delay in the issue of the relevant commissioning certificates by the relevant PRC authorities.

No depreciation is provided in respect of construction in progress.

(i)


(j) Leased assets

     Flight equipment


An arrangement, comprising a transaction or a series of transactions, is or contains a lease if the Group determines that the arrangement conveys a right to use a specific asset or assets for an agreed period of time in return for a payment or a series of payments. Such a determination is made based on an evaluation of the substance of the arrangement and is regardless of whether the arrangement takes the legal form of a lease.

(i) Classification of assets leased to the Group

Assets that are held by the Group under leases which transfer to the Group substantially all the risks and rewards of ownership are classified as being held under capital leases. Leases which do not transfer substantially all the risks and rewards of ownership to the Group are classified as operating leases, except for land held for own use under an operating lease, the fair value of which cannot be measured separately from the fair value of a building situated thereon at the inception of the lease, is accounted for as being under a capital lease, unless the building is also clearly held under an operating lease. For these purposes, the inception of the lease is the time that the lease was first entered into by the Group, or taken over from the previous lessee.
(ii) Assets acquired under capital leases is stated at an amount equal to lower

Where the Group acquires the use of itsassets under capital leases, the amounts representing the fair value andof the leased asset, or, if lower, the present value of the minimum lease payments, of such assets are included in property, plant and equipment and the corresponding liabilities, net of finance charges, are recorded as obligations under capital leases. Depreciation is provided at inceptionrates which write off the cost or valuation of the lease, and is amortized on a straight line basisassets over the shorterterm of the relevant lease term or, estimated usefulwhere it is likely the Group will obtain ownership of the asset, the life of the asset, to residual values. In cases where title toas set out in Note 2(h). Impairment losses are accounted for in accordance with the asset will be acquired by the Group at the end of the lease, the asset is amortized on a straight line basis over the estimated useful life of the asset to its residual value.

     Amounts payableaccounting policy as set out in respect of capital leases are apportioned between interestNote 2(l). Finance charges and reductions of obligations based on the interest rates implicit in the leases. Interest chargeslease payments are included incharged to income or loss over the consolidated statementsperiod of operationsthe leases so as to provide aproduce an approximately constant periodic rate of charge overon the lease term.

F-8

remaining balance of the obligations for each accounting period.

F-14


CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Amounts in thousands,millions, except share data)


(iii) Operating lease charges

Where the Group has the use of assets held under operating leases, payments made under the leases are charged to income or loss in equal instalments over the accounting periods covered by the lease term, except where an alternative basis is more representative of the pattern of benefits to be derived from the leased asset. Lease incentives received are recognized in income or loss as an integral part of the aggregate net lease payments made.

The cost of acquiring land held under operating lease is amortized on a straight-line basis over the respective periods of lease terms which ranged from 30 to 70 years.

(iv) Sale and leaseback transactions

Gains or losses on aircraft sale and leaseback transactions which result in capital leases are deferred and amortized over the terms of the related leases. Gains or losses on other aircraft sale and leaseback transactions which result in operating leases are recognized as income immediately if the transactions are established at fair value. Any excess ofdifference between the sales price overand the fair value is deferred and amortized over the period the assets are expected to be used.

     Operating lease payments are charged to the consolidated statements of operations on a straight line basis over the terms of the related leases.

(j)     Construction in progress

     Construction in progress represents office buildings, various infrastructure projects under construction and equipment pending installation, and is stated at cost. Cost comprises direct costs of construction as well as interest charges during the periods of construction and installation. Capitalization of these costs ceases and the construction in progress is transferred to fixed assets when the asset is substantially ready for its intended use, notwithstanding any delays in the issue of the relevant commissioning certificates by the relevant PRC authorities.


(k)     Lease prepayments

     Lease prepayments represent the purchase costs of land use rights and are amortized on a straight line basis over the period of land use rights (Note 22(f)).

(l)     Investments

     An affiliated company is an entity in which the Group has significant influence, but not control or joint control, over its management, including participating in the financial and operating policy decisions.

     A jointly controlled entity is an entity over whose activities the Group has joint control, established by contractual agreement.

     The consolidated statements of operations include the Group’s share of the results of its affiliated companies and jointly controlled entities for the year. In the consolidated balance sheets, the investments in affiliated companies and jointly controlled entities are stated at the Group’s attributable share of net assets. When the Group’s share of losses exceeds the carrying amount of the affiliated company or jointly controlled entity, the carrying amount is reduced to nil and recognition of further losses is discontinued except to the extent that the Group has incurred obligations in respect of the affiliated company or jointly controlled entity.

     Other investments are stated at cost less impairment losses (refer to accounting policy n). Other investments represent unquoted available-for-sale equity securities of companies established in the PRC. There is no quoted market price for such equity securities and accordingly a reasonable estimate of the fair value could not be made without incurring excessive costs.

F-9

CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Amounts in thousands, except share data)

(m) Deferred expenditure


Custom duties and other direct costs in relation to modifying, introducing and certifying certain operating leased aircraft are deferred and amortized over the terms of the related leases.


Lump sum housing benefits payable to employees of the Group are deferred and amortized on a straight line basis over a period of 10 years, which represents the benefit vesting benefit period of the employees.

(n)


Deferred expenditure is stated at cost less impairment losses (Note 2(l)).

(l) Impairment loss

     The carrying amounts of the Group’s assets


(i) Impairment of investments in equity securities and other than inventories (refer to accounting policy g)receivables

Investments in equity securities and deferred tax assets (refer to accounting policy u)other current and non-current receivables that are stated at cost or amortized cost are reviewed periodically in orderat each balance sheet date to assessdetermine whether there is objective evidence of impairment. If any such evidence exists, any impairment loss is determined and recognized as follows:

· For unquoted equity securities carried at cost, the recoverable amounts have declined belowimpairment loss is measured as the carrying amounts. These assets are tested for impairment whenever events or changes in circumstances indicate that their recorded carrying amounts may not be recoverable. When such a decline has occurred,difference between the carrying amount of the financial asset and the estimated future cash flows, discounted at the current market rate of return for a similar financial asset where the effect of discounting is reducedmaterial. Impairment losses for equity securities are not reversed.

F-15

CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Amounts in millions, except share data)
· For trade and other current receivables and other financial assets carried at amortized cost, the impairment loss is measured as the difference between the asset’s carrying amount and the present value of estimated future cash flows, discounted at the financial asset’s original effective interest rate (i.e. the effective interest rate computed at initial recognition of these assets), where the effect of discounting is material.

If in a subsequent period the amount of an impairment loss decreases and the decrease can be linked objectively to an event occurring after the impairment loss was recognized, the impairment loss is reversed through income or loss. A reversal of an impairment loss shall not result in the asset’s carrying amount exceeding that which would have been determined had no impairment loss been recognized in prior years.

(ii) Impairment of other assets

Internal and external sources of information are reviewed at each balance sheet date to identify indications that the following assets may be impaired or, except in the case of goodwill, an impairment loss previously recognized no longer exists or may have decreased:
·Property, plant and equipment carried at cost less accumulated depreciation;

·Construction in progress;

·Lease and equipment deposits;

·Lease prepayments;

·Deferred expenditure;

·Investments in subsidiaries, affiliated companies and jointly controlled entities; and

·Goodwill.

If any such indication exists, the asset’s recoverable amount is estimated. For goodwill, the recoverable amount. amount is estimated annually whether or not there is any indication of impairment.

·Calculation of recoverable amount

The recoverable amount of an asset is the greater of theits net selling price and the value in use. In determining theassessing value in use, expectedthe estimated future cash flows generated by the asset are discounted to their present value. Thevalue using a pre-tax discount rate that reflects current market assessments of time value of money and the risks specific to the asset. Where an asset does not generate cash inflows largely independent of those from other assets, the recoverable amount is determined for the smallest group of assets that generates cash inflows independently (i.e. a cash-generating unit).
F-16

CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Amounts in millions, except share data)

·Recognition of impairment losses

An impairment loss is recognized in income or loss whenever the carrying amount of an asset, or the cash-generating unit to which it belongs, exceeds its recoverable amount. Impairment losses recognized in respect of cash-generating units are allocated first to reduce the carrying amount of any goodwill allocated to the cash-generating unit (or group of units) and then, to reduce the carrying amount of the reduction is recognized as an expenseother assets in the consolidated statementsunit (or group of operations.

     The Group assesses at each balance sheet date whether there is any indicationunits) on a pro rata basis, except that an impairment loss recognized forthe carrying value of an asset will not be reduced below its individual fair value less costs to sell, or value in prior years may no longer exist. Anuse, if determinable.


·Reversals of impairment losses

In respect of assets other than goodwill, an impairment loss is reversed if there has been a favourable change in the estimates used to determine the recoverable amount. An impairment loss in respect of goodwill is not reversed.

A subsequent increase in the recoverable amountreversal of an asset, when the circumstances and events that ledimpairment loss is limited to the write-down or write-off cease to exist, is recognized as income. The reversal is reduced by theasset’s carrying amount that would have been determined had no impairment loss been recognized in prior years. Reversals of impairment losses are credited to income or loss in the year in which the reversals are recognized.

(m) Inventories

Inventories, which consist primarily of expendable spare parts and supplies, are stated at cost less any applicable provision for obsolescence, and are charged to income or loss when used in operations. Cost represents the average unit cost.

Inventories held for disposal are carried at the lower of cost and net realisable value. Net realisable value is the estimated selling price in the ordinary course of business less the estimated costs of completion and the estimated costs necessary to make the sale.
(n) Trade and other receivables

Trade and other receivables are initially recognized at fair value and thereafter stated at amortized cost less impairment losses for bad and doubtful debts (Note 2(l)), except where the effect of discounting would be immaterial. In such cases, the receivables are stated at cost less impairment losses for bad and doubtful debts (Note 2(l)).

(o) Interest-bearing borrowings

Interest-bearing borrowings are recognized initially at fair value less attributable transaction costs. Subsequent to initial recognition, interest-bearing borrowings are stated at amortized cost with any difference between the amount initially recognized and redemption value being recognized in income or loss over the period of the borrowings, together with any interest and fees payable, using the effective interest method.
F-17

CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Amounts in millions, except share data)

(p) Trade and other payables

Trade and other payables are initially recognized at fair value and thereafter stated at amortized cost unless the effect of discounting would be immaterial, in which case they are stated at cost.

(q) Cash and cash equivalents

Cash and cash equivalents comprise cash at bank and on hand, demand deposits with banks and other financial institutions having been within three months of maturity at acquisition. Bank overdrafts that are repayable on demand and form an integral part of the Group’s cash management are also included as a component of cash and cash equivalents for the purpose of the consolidated statement of cash flows.

(r) Financial guarantees issued, provisions and contingent liabilities

(i) Financial guarantees issued

Financial guarantees are contracts that require the issuer (i.e. the guarantor) to make specified payments to reimburse the beneficiary of the guarantee (the “holder”) for a loss the holder incurs because a specified debtor fails to make payment when due in accordance with the terms of a debt instrument.

Where the Group issues a financial guarantee, the fair value of the guarantee (being the transaction price, unless the fair value can otherwise be reliably estimated) is initially recognized as depreciation haddeferred income within trade and other payables. Where consideration is received or receivable for the write-downissuance of the guarantee, the consideration is recognized in accordance with the Group’s policies applicable to that category of asset. Where no such consideration is received or write-offreceivable, an immediate expense is recognized in income or loss on initial recognition of any deferred income.

The amount of the guarantee initially recognized as deferred income is amortized in income or loss over the term of the guarantee as income from financial guarantees issued. In addition, provisions are recognized in accordance with note 2(r)(ii) if and when (i) it becomes probable that the holder of the guarantee will call upon the Group under the guarantee, and (ii) the amount of that claim on the Group is expected to exceed the amount currently carried in trade and other payables in respect of that guarantee i.e. the amount initially recognized, less accumulated amortization.

(ii) Provisions and contingent liabilities

Provisions are recognized for liabilities of uncertain timing or amount when the Group or the Company has a present legal or constructive obligation as a result of a past event, and it is probable that an outflow of economic benefits will be required to settle the obligations and a reliable estimate can be made. Where the time value of money is material, provisions are stated at the present value of the expenditures expected to settle the obligation.
F-18

CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Amounts in millions, except share data)

Where it is not occurred.

(o)probable that an outflow of economic benefits will be required, or the amount cannot be estimated reliably, the obligation is disclosed as a contingent liability, unless the probability of outflow of economic benefits is remote. Possible obligations, whose existence will only be confirmed by the occurrence or non-occurrence of one or more future events are also disclosed as contingent liabilities unless the probability of outflow of economic benefits is remote.

(s) Defeasance of long-term liabilities

Where long-term liabilities have been defeased by the placement of security deposits, those liabilities and deposits (and income and charge arising therefrom) are netted off in order to reflect the overall commercial effect of the arrangements. Such netting off has been effected where a right is held by the Group to insist on net settlement of the liability and deposit including in all situations of default and where that right is assured beyond doubt.

(t) Deferred credits


In connection with the acquisitionacquisitions or operating leaseleases of certain aircraft and engines, the Group receives various credits. Such credits are deferred until the aircraft and engines are delivered, at which time they are either applied as a reduction of the cost of acquiring the aircraft and engines, resulting in a reduction of future depreciation, or amortized as a reduction of rental expense for aircraft and engines under operating leases.

F-10


(u) Income tax

Income tax for the year comprises current and movements in deferred tax assets and liabilities. Current tax and movements in deferred tax assets and liabilities are recognized in income or loss except to the extent that they relate to items recognized directly in equity, in which case they are recognized in equity.

Current tax is the expected tax payable on the taxable income for the year, using tax rates enacted or substantively enacted at the balance sheet date, and any adjustment to tax payable in respect of previous years.

Deferred tax assets and liabilities arise from deductible and taxable temporary differences respectively, being the differences between the carrying amounts of assets and liabilities for financial reporting purposes and their tax bases. Deferred tax assets also arise from unused tax losses and unused tax credits.
F-19


CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Amounts in thousands,millions, except share data)

(p)


Apart from certain limited exceptions, all deferred tax liabilities, and all deferred tax assets to the extent that it is probable that future taxable income will be available against which the asset can be utilized, are recognized. Future taxable income that may support the recognition of deferred tax assets arising from deductible temporary differences include those that will arise from the reversal of existing taxable temporary differences, provided those differences relate to the same taxation authority and the same taxable entity, and are expected to reverse either in the same period as the expected reversal of the deductible temporary difference or in periods into which a tax loss arising from the deferred tax asset can be carried back or forward. The same criteria are adopted when determining whether existing taxable temporary differences support the recognition of deferred tax assets arising from unused tax losses and credits, that is, those differences are taken into account if they relate to the same taxation authority and the same taxable entity, and are expected to reverse in a period, or periods, in which the tax loss or credit can be utilized.

The limited exception to the recognition of deferred tax assets and liabilities are those temporary differences arising from goodwill not deductible for tax purposes, the initial recognition of assets or liabilities that affect neither accounting nor taxable income (provided they are not part of a business combination), and temporary differences relating to investments in subsidiaries to the extent that, in the case of taxable differences, the Group controls the timing of the reversal and it is probable that the differences will not reverse in the foreseeable future, or in the case of deductible differences, unless it is probable that they will reverse in the future.

The amount of deferred tax recognized is measured based on the expected manner of realisation or settlement of the carrying amount of the assets and liabilities, using tax rates enacted or substantively enacted at the balance sheet date. Deferred tax assets and liabilities are not discounted.

The carrying amount of a deferred tax asset is reviewed at each balance sheet date and is reduced to the extent that it is no longer probable that sufficient taxable income will be available to allow the related tax benefit to be utilized. Any such reduction is reversed to the extent that it becomes probable that sufficient taxable income will be available.

Current tax balances and deferred tax balances, and movements therein, are presented separately from each other and are not offset. Current tax assets are offset against current tax liabilities, and deferred tax assets against deferred tax liabilities, if the Company or the Group has the legally enforceable right to set off current tax assets against current tax liabilities and the following additional conditions are met:

·in the case of current tax assets and liabilities, the Company or the Group intends either to settle on a net basis, or to realise the asset and settle the liability simultaneously; or
F-20

CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Amounts in millions, except share data)
· in the case of deferred tax assets and liabilities, if they relate to income taxes levied by the same taxation authority on either:

-the same taxable entity; or

-different taxable entities, which, in each future period in which significant amounts of deferred tax liabilities or assets are expected to be settled or recovered, intend to realise the current tax assets and settle the current tax liabilities on a net basis or realise and settle simultaneously.

(v) Revenue recognition


Provided it is probable that the economic benefits will flow to the Group and the revenue and costs, if applicable, can be measured reliably, revenue is recognized in income or loss as follows:

(i) Passenger, cargo and mail revenues are recognized when the transportation is provided. Ticket sales for transportation not yet provided are included in current liabilities of the consolidated balance sheets as sales in advance of carriage. RevenueRevenues from airline-related business isare recognized when services are rendered. Revenue is stated net of sales taxtax.

(ii) Rental income receivable under operating leases is recognized in income or loss in equal instalments over the periods covered by the lease term, except where an alternative basis is more representative of the pattern of benefits to be derived from the use of the leased asset. Lease incentives granted are recognized in income or loss as an integral part of the aggregate net lease payments receivables.
(iii) Dividend income is recognized when the shareholder’s right to receive payment is established.

(iv) Government grants are recognized in the balance sheet initially when there is reasonable assurance that they will be received and contributionsthat the Group will comply with the conditions attaching to them. Grants that compensate the Civil Aviation AdministrationGroup for expenses incurred are recognized as revenue in income or loss on a systematic basis in the same periods in which the expenses are incurred. Grants that compensate the Group for the cost of China (“CAAC”) Infrastructure Development Fund.

an asset are deducted in arriving at the carrying amount of the asset and consequently are recognized in income or loss over the useful life of the asset.

(v) Interest income is recognized as it accrues unless collectibility is in doubt. Dividend income is recognized whenusing the Group’s right to receive payment is established.

     Operating lease income is recognized on a straight line basis over the terms of the respective leases.

(q)effective interest method.


(w) Traffic commissions


Traffic commissions are expensed in income or loss when the transportation is provided and the related revenue is recognized. Traffic commissions for transportation not yet provided are recorded inon the consolidated balance sheetssheet as a prepaid expense.

(r)

F-21

CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Amounts in millions, except share data)

(x) Maintenance and overhaul costs


Routine maintenance, and repairs and overhauls inare charged to income or loss as and when incurred.

In respect of owned and capital leased aircraft, andcomponents within the aircraft held under capital leasessubject to replacement during major overhauls are expenseddepreciated over the average expected life between major overhauls. When each major overhaul is performed, its cost is recognized in the consolidated statementscarrying amount of operations asproperty, plant and when incurred. equipment and is depreciated over the estimated period between major overhauls. Any remaining carrying amount of cost of previous major overhaul is derecognized and charged to income or loss.

In respect of aircraft held under operating leases, a provision is made over the Group has responsibility to fulfil certain return conditions under relevant lease term for the estimated cost of scheduledagreements. In order to fulfil these return conditions, major overhauls are required to be performedconducted on a regular basis. Accordingly, estimated costs of major overhauls are accrued and charged to income or loss over the relatedestimated period between overhauls. After the aircraft has completed its last overhaul cycle prior to their returnbeing returned, expected cost of overhaul to the lessors.

(s)     Translation of foreign currencies

     Foreign currency transactions during the year are translated into Renminbibe incurred at the applicable ratesend of exchange prevailing on the transaction dates.

     Foreign currency monetary balances atlease is estimated and accrued over the balance sheet dateremaining period of the lease. Differences between the estimated costs and the actual costs of overhauls are translated into Renminbi at the exchange rates quoted by the People’s Bank of China ruling at the balance sheet date. Exchange differences are dealt withcharged to income or loss in the consolidated statements of operations.

(t)period when the overhaul is performed.


(y) Borrowing costs


Borrowing costs are expensed in income or loss in the consolidated statements of operations as and whenperiod in which they are incurred, except to the extent that they are capitalized as being directly attributable to the acquisition or construction of an asset which necessarily takes a substantial period of time to get ready for its intended use.

F-11


The capitalization of borrowing costs as part of the cost of a qualifying asset commences when expenditure for the asset is being incurred, borrowing costs are being incurred and activities that are necessary to prepare the asset for its intended use are in progress. Capitalization of borrowing costs is suspended or ceases when substantially all the activities necessary to prepare the qualifying asset for its intended use are interrupted or complete.

(z) Short term employee benefits and contributions to defined contribution retirement schemes

Salaries, annual bonuses and contributions to defined contribution retirement schemes are accrued in the year in which the associated services are rendered by employees. Where payment or settlement is deferred and the effect would be material, these amounts are stated at their present values.
F-22


CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Amounts in thousands,millions, except share data)

(u)     Deferred taxation

     Deferred tax is provided using


(aa) Termination benefits

Termination benefits are recognized when, and only when, the balance sheet liability method on all temporary differences between the carrying amounts for financial reporting purposes and the amounts used for taxation purposes, except differences relatinggroup demonstrably commits itself to the initial recognition of assetsterminate employment or liabilities which affect neither accounting nor taxable profit/loss.

     The tax value of losses expected to be available for utilization against future taxable income is recognizedprovide benefits as a deferred tax asset and offset against the deferred tax liability attributable to the same legal tax unit and jurisdiction. Net deferred tax assets are reduced to the extent that itresult of voluntary redundancy by having a detailed formal plan which is no longer probable that the related tax benefit will be realized.

(v)     Retirement benefits

     Contributions to retirement schemes and additional retirement benefits paid to retired employees are charged to the consolidated statementswithout realistic possibility of operations as and when incurred (Note 24).

(w)Basic earnings/(loss) per share

     Basic earnings/(loss) per share for the years ended December 31, 2001, 2002 and 2003 have been computed by dividing net income/(loss) of RMB340,225, RMB575,761 and RMB(358,267), respectively, by the weighted average number of shares in issue of 3,374,178,000 in 2001 and 2002, and 3,831,712,000 in 2003, respectively.

     The amount of diluted earnings/(loss) per share is not presented, as there were no dilutive potential ordinary shares in existence during the years ended December 31, 2001, 2002 and 2003.

(x)withdrawal.


(bb) Frequent flyer award programs

programmes


The Group maintains two frequent flyer award programs,programmes, namely, the China Southern Airlines Sky Pearl Club and the Egret Mileage Plus, which provide travel awards to members based on accumulated mileage. The estimated incremental cost to provide free travel is recognized as an expense and accrued as a current liability as members accumulate mileage. As members redeem awards or their entitlements expire, the incremental cost liability is reduced accordingly to reflect the acquittal of the outstanding obligations.


Revenue from mileage sales to third parties under the frequent flyer award programsprogrammes is recognized when the related transportation services are provided.

F-12

CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)

(cc) Translation of foreign currencies

(Amounts
Foreign currencies transactions during the year are translated into Renminbi at the applicable rates of exchange quoted by the PBOC prevailing on the transaction dates. Monetary assets and liabilities denominated in thousands, except share data)

(y)     Provisions

     A provision isforeign currencies are translated into Renminbi at the PBOC exchange rates prevailing on the balance sheet date. Exchange gains and losses are recognized in income or loss.


Non-monetary assets and liabilities that are measured in terms of historical cost in a foreign currency are translated into Renminbi at the consolidated balance sheets whenPBOC exchange rates prevailing on the Group has a legal or constructive obligation as a result of a past event,transaction dates. Non-monetary assets and it is probableliabilities denominated in foreign currencies that an outflow of economic benefits will be required to settleare stated at fair value are translated into Renminbi at the obligations. IfPBOC exchange rates prevailing on the effect is material, provisions are determined by discountingdates the expected future cash flows at a pre-tax rate that reflects current market assessments of the timefair value of money and, where appropriate, the risks specific to the liability.

(z)was determined.


(dd) Related parties


For the purposes of these consolidated financial statements, parties area party is considered to be related to the Group ifif:

(i) the Groupparty has the ability, directly or indirectly through one or more intermediaries, to control the partyGroup or exercise significant influence over the partyGroup in making financial and operating policy decisions, or vice versa, or wherehas joint control over the Group;

(ii) the Group and the party are subject to common control or common significant influence. Related parties may be individuals or entities.

(aa)     Segmental reporting

     The Group operates principally as a single business segment forcontrol;


(iii) the provision of air transportation services. The analysis of operating revenue and operating income by geographical segmentparty is based on the following criteria:

(i)Traffic revenue from domestic services within the PRC (excluding Hong Kong) is attributed to the domestic operation. Traffic revenue from inbound/outbound services between the PRC and Hong Kong, and the PRC and overseas destinations is attributed to the Hong Kong regional operation and international operation, respectively.
(ii)Other revenue from ticket selling, general aviation and ground services, air catering and other miscellaneous services is attributed on the basis of where the services are performed.

(ab)     Use of estimates

     The preparation of the consolidated financial statementsan affiliated company of the Group or a joint venture in accordance with IFRS requires management to make estimates and assumptions that affectwhich 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 periods. Actual results could differ from those estimates.

F-13

Group is a venturer;

F-23


CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Amounts in thousands,millions, except share data)


(iv) the party is a member of key management personnel of the Group or the Group’s parent, or a close family member of such an individual, or is an entity under the control, joint control or significant influence of such individuals;

(v) the party is a close family member of a party referred in (i) or is an entity under the control, joint control or significant influence of such individuals; or

(vi) the party is a post-employment benefit plan which is for the benefit of employees of the Group or of any entity that is a related party of the Group.

Close family members of an individual are those family members who may be expected to influence, or be influenced by, that individual in their dealings with the entity.

(ee) Segmental reporting

A segment is a distinguishable component of the Group that is engaged either in providing products or services (business segment), or in providing products or services within a particular economic environment (geographical segment), which is subject to risks and rewards that are different from those of other segments.

In accordance with the Group’s internal financial reporting system, the Group has chosen business segment information as the primary reporting format and geographical segment information as the secondary reporting format for the purposes of these consolidated financial statements.
F-24

CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Amounts in millions, except share data)


3. TRAFFIC REVENUE

     Traffic revenueTURNOVER

Turnover comprises revenues from airline and airline-related business and is stated net of sales tax and levies paid to PRC authorities and consists of:tax. An analysis of turnover is as follows:
             
Year ended December 31,
 
 Year ended December 31,
 
2004
 
2005
 
2006
 
 2001
 2002
 2003
 
RMB
 
RMB
 
RMB
 
 RMB RMB RMB       
Traffic revenue       
Passenger 15,055,496 15,695,622 15,009,885   21,100  34,328  41,549 
Cargo and mail 1,406,036 1,786,270 1,954,915   2,244  3,091  3,538 
 
 		 
 		 
 		   23,344  37,419  45,087 
 16,461,532 17,481,892 16,964,800           
Other operating revenue          
Commission income  203  237  238 
General aviation income  55  77  91 
Ground services income  146  195  184 
Air catering income  53  25  50 
Rental income  45  69  107 
Aircraft lease income  11  1  - 
Others  117  270  462 
 
 		 
 		 
 		   630  874  1,132 
  23,974  38,293  46,219 


Pursuant to various PRC revenuesales tax rules and regulations, the Group is required to pay sales tax to national and local tax authorities at the rate of approximately 3% of the ticket valuetraffic revenue in respect of domestic flights originated inand outbound international, Hong Kong and Macau flights. Sales tax incurred by the PRCGroup during the years ended December 31, 2001, 20022004, 2005 and 2003,2006, netted off against revenue, amounted to RMB 716, RMB1,111 and RMB1,300, respectively.
F-25

CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Amounts in millions, except forshare data)

4. FLIGHT OPERATIONS EXPENSES

  
Year ended December 31,
 
  
2004
 
2005
 
2006
 
  
RMB
 
RMB
 
RMB
 
        
Jet fuel costs  6,050  11,929  16,193 
Operating lease rentals          
- Aircraft and flight equipment  1,665  2,497  3,027 
- Land and buildings  109  302  260 
Air catering expenses  705  1,196  1,244 
Aircraft insurance  185  283  274 
Flight personnel payroll and welfare  1,026  1,619  1,714 
Training expenses  183  373  419 
CAAC Infrastructure Development          
Fund contributions  466  978  1,127 
Others  29  217  409 
   10,418  19,394  24,667 
5. MAINTENANCE EXPENSES

  
Year ended December 31,
 
  
2004
 
2005
 
2006
 
  
RMB
 
RMB
 
RMB
 
        
Repairing and maintenance charges (Note 45)  3,247  3,615  3,663 
Maintenance materials  212  436  414 
   3,459  4,051  4,077 
6. AIRCRAFT AND TRAFFIC SERVICING EXPENSES

  
Year ended December 31,
 
  
2004
 
2005
 
2006
 
  
RMB
 
RMB
 
RMB
 
        
Landing and navigation fees  3,222  4,891  5,220 
Ground service charges  281  868  999 
   3,503  5,759  6,219 
F-26

CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Amounts in millions, except share data)

7. PROMOTION AND SALES EXPENSES

  
Year ended December 31,
 
  
2004
 
2005
 
2006
 
  
RMB
 
RMB
 
RMB
 
        
Sales commissions  1,062  1,503  1,489 
Ticket office expenses  552  659  689 
Computer reservation services  233  417  439 
Advertising and promotion  36  32  43 
Others  57  169  151 
   1,940  2,780  2,811 
8. GENERAL AND ADMINISTRATIVE EXPENSES

  
Year ended December 31,
 
  
2004
 
2005
 
2006
 
  
RMB
 
RMB
 
RMB
 
        
General corporate expenses  1,260  2,408  3,098 
Impairment losses for trade and other receivables
  27  -  - 
Auditors' remuneration  11  12  13 
Other taxes and levies  25  37  29 
   1,323  2,457  3,140 
F-27

CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Amounts in millions, except share data)

9. DEPRECIATION AND AMORTIZATION

  
Year ended December 31,
 
  
2004
 
2005
 
2006
 
  
RMB
 
RMB
 
RMB
 
        
Depreciation (Note 45)       
- Owned assets  1,891  3,459  3,657 
- Assets acquired under capital leases  472  1,426  1,337 
Amortization of deferred credits  -  (20) (61)
Other amortization  50  40  33 
   2,413  4,905  4,966 
10. STAFF COSTS

  
Year ended December 31,
 
  
2004
 
2005
 
2006
 
  
RMB
 
RMB
 
RMB
 
        
Salaries, wages and welfare  2,260  3,515  3,854 
Retirement schemes contributions  168  472  584 
Early retirement benefits (Note 34)  -  -  392 
   2,428  3,987  4,830 
Staff costs relating to flight operations, maintenance, aircraft and traffic servicing, promotion and sales and general and administrative expenses are also included in the periodrespective total amounts disclosed separately in Notes 4 to 8 above.
F-28

CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Amounts in millions, except share data)

11. INTEREST EXPENSE

  
Year ended December 31,
 
  
2004
 
2005
 
2006
 
  
RMB
 
RMB
 
RMB
 
        
Interest on bank and other notes payable wholly       
repayable within five years  221  995  1,675 
Interest on other notes payable  156  93  138 
Finance charges on obligations under capital leases  348  626  716 
Less: borrowing costs capitalized  (34) (98) (459)
   691  1,616  2,070 
The borrowing costs have been capitalized at rates ranging from May 1, 20031.51% to December 31, 2003 during which passenger revenue was exempted from sales tax. Sales tax incurred by the Group3.48% per annum, 4.14% to 5.27% per annum and 5.29% to 5.61% per annum for the years ended December 31, 2001, 20022004, 2005 and 2003 amounted to RMB535,473, RMB557,784 and RMB205,925,2006, respectively.

     In addition,


12. (LOSS)/GAIN ON SALE OF PROPERTY, PLANT AND EQUIPMENT, NET

  
Year ended December 31,
 
  
2004
 
2005
 
2006
 
  
RMB
 
RMB
 
RMB
 
        
Aircraft and spare engines  -  -  329 
Other property, plant and equipment  (1) (32) 6 
   (1) (32) 335 

During the year, the Group recognized a RMB329 gain on sale of three Boeing 757-200 aircraft to independent third parties, being the excess of the sale proceeds over the carrying amounts of the assets and related selling costs.

F-29

CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Amounts in millions, except share data)

13. INCOME TAX EXPENSE

(a) Income tax expense in the consolidated statement of operations

  
Year ended December 31,
 
  
2004
 
2005
 
2006
 
  
RMB
 
RMB
 
RMB
 
        
PRC income tax       
- provision for the year  176  12  160 
- over-provision in prior year  -  -  (16)
   176  12  144 
           
           
Deferred tax (Notes 25, 45)  (111) (8) (2)
   65  4  142 
The statutory income tax rate in the PRC is required to pay contributions to the CAAC Infrastructure Development Fund which were calculated33%.

The Company is taxed at the ratespreferential rate of 5%15%, 15% and 2%, respectively, of the domestic and international/Hong Kong regional traffic revenue18% during the years ended December 31, 2001, 20022004, 2005 and 2003,2006, except for certain branches which are taxed at following rates:

2006  15% or 33% 
2005
  33% 
2004  33% 
The subsidiaries of the periodGroup are taxed at rates ranging from May 1, 200315% to 33%.

F-30

CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Amounts in millions, except share data)

(b) Reconciliation between tax expense and accounting income/(loss) at applicable tax rates

  
Year ended December 31,
 
  
2004
 
2005
 
2006
 
  
RMB
 
RMB
 
RMB
 
        
Income/(loss) before tax 220 (1,780) 284 
        
Expected tax on income/(loss) before tax, calculated       
at 15%, 15% and 18% for the years ended       
 December 2004, 2005 and 2006 respectively  33  (267) 51 
Adjustments for tax effect of:          
 Rate differential on subsidiaries/branches  3  7  (20)
 Non-deductible expenses        
Salaries and welfare  25  71  114 
Other  4  11  17 
 Non-taxable income  -  (8) - 
 Change in tax rate of the Company and its          
 certain branches from 15% to 18%  -  -  (21)
 Share of results of affiliated companies          
 and jointly controlled entities  (1) 37  (22)
 Unutilised tax losses  -  135  39 
Over-provision in prior year  -  -  (16)
Others  1  18  - 
Actual tax expense  65  4  142 
All but an insignificant amount of income/(loss) before taxation is from domestic sources.

14. DIVIDENDS

No interim dividend was paid during the years ended December 31, 2003 during which2004, 2005 and 2006.

The board of directors of the GroupCompany does not recommend the payment of a final dividend in respect of the year ended December 31, 2006. No final dividend was exempted from payingpaid in respect of the contributions. Contributions to the CAAC Infrastructure Development Fund payable by the Groupyears ended December 31, 2004 and 2005.

15. (LOSS)/EARNINGS PER SHARE

The calculation of basic (loss)/earnings per share for the years ended December 31, 2001, 20022004, 2005 and 2003 totaled RMB759,385, RMB798,386 and RMB250,802, respectively.

     Pursuant2006 is based on the (loss)/earnings attributable to approval documents issued by the CAAC, the Group imposes a fuel surcharge on passengers carried by its domestic and Hong Kong regional flights at certain prescribed rates on ticket fares. The fuel surcharge forms partequity shareholders of the traffic revenueCompany of RMB(48), RMB(1,786) and RMB126, respectively, and the weighted average number of shares in issue of 4,374,000,000 in each of the Group. Forthree years.


The amounts of diluted (loss)/earnings per share are the same as basic (loss)/earnings per share as there were no dilutive potential ordinary shares in existence during the years ended December 31, 2001, 20022004, 2005 and 2003, the fuel surcharge revenue totaled RMB1,001,000, RMB554,000 and RMB740,000, respectively.

F-14

2006.


F-31


CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Amounts in thousands,millions, except share data)

4.     OTHER OPERATING REVENUE


             
  Year ended December 31,
  2001
 2002
 2003
  RMB RMB RMB
Commission income  129,157   137,928   140,180 
General aviation income  61,292   68,225   40,309 
Ground services income  55,388   78,616   99,130 
Air catering income  29,523   38,077   30,756 
Net income from lease arrangements (Note 13)  —   51,682   69,121 
Rental income  —   —   40,307 
Aircraft lease income  65,486   46,640   — 
Other  77,280   115,560   85,520 
   
 		   
 		   
 		 
   418,126   536,728   505,323 
   
 		   
 		   
 		 

5.     FLIGHT OPERATIONS EXPENSES

             
  Year ended December 31,
  2001
 2002
 2003
  RMB RMB RMB
Fuel costs  3,548,860   3,519,005   3,866,932 
Operating lease rentals  1,912,832   1,416,524   1,536,466 
Air catering expenses  554,165   625,489   509,839 
Aircraft insurance  123,439   256,238   195,700 
Flight personnel payroll and welfare  657,193   781,223   728,175 
Training expenses  24,374   38,908   123,438 
Other  84,765   95,156   109,481 
   
 		   
 		   
 		 
   6,905,628   6,732,543   7,070,031 
   
 		   
 		   
 		 

F-15

CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Amounts in thousands, except share data)

6.     MAINTENANCE EXPENSES

             
  Year ended December 31,
  2001
 2002
 2003
  RMB RMB RMB
Repairing and maintenance charges  1,558,331   1,842,213   2,076,916 
Maintenance materials  286,505   292,492   299,719 
Labor costs  104,949   130,254   139,355 
Other  64,794   68,460   72,623 
   
 		   
 		   
 		 
   2,014,579   2,333,419   2,588,613 
   
 		   
 		   
 		 

     An analysis of provision for major overhauls in respect of aircraft held under operating leases is as follows:

             
  Year ended December 31,
  2001
 2002
 2003
  RMB RMB RMB
Balance at beginning of year  241,895   187,125   193,887 
Additional amount provided  12,889   49,051   68,620 
Amount utilized  (67,659)  (42,289)  (62,326)
   
 		   
 		   
 		 
Balance at end of year  187,125   193,887   200,181 
   
 		   
 		   
 		 

     Balance of provision for major overhauls at December 31, 2002 and 2003 consisted of:

         
  December 31,
  2002
 2003
  RMB RMB
Current portion (included in accrued expenses) (Note 18)  52,000   10,717 
Non-current portion  141,887   189,464 
   
 		   
 		 
   193,887   200,181 
   
 		   
 		 

F-16

CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Amounts in thousands, except share data)

7.     AIRCRAFT AND TRAFFIC SERVICING EXPENSES

             
  Year ended December 31,
  2001
 2002
 2003
  RMB RMB RMB
Landing and navigation fees  2,157,392   2,353,412   2,562,488 
Ground service charges  140,129   157,872   205,000 
   
 		   
 		   
 		 
   2,297,521   2,511,284   2,767,488 
   
 		   
 		   
 		 

8.     PROMOTION AND SALES EXPENSES

             
  Year ended December 31,
  2001
 2002
 2003
  RMB RMB RMB
Sales commissions  891,646   749,953   757,423 
Ticket office expenses  440,445   515,648   503,623 
Computer reservation services  153,409   174,547   175,197 
Advertising and promotion  26,434   31,513   23,756 
Other  28,846   27,926   20,169 
   
 		   
 		   
 		 
   1,540,780   1,499,587   1,480,168 
   
 		   
 		   
 		��

9.     GENERAL AND ADMINISTRATIVE EXPENSES

             
  Year ended December 31,
  2001
 2002
 2003
  RMB RMB RMB
General corporate expenses  557,083   658,833   680,141 
Salaries and welfare  312,396   379,406   339,343 
Provision for doubtful accounts (Note 32)  1,729   1,304   12,031 
Other taxes and levies  21,025   20,467   21,804 
   
 		   
 		   
 		 
   892,233   1,060,010   1,053,319 
   
 		   
 		   
 		 

F-17

CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Amounts in thousands, except share data)

10.     TAXATION EXPENSE/(CREDIT)

     On October 17, 2003, the Company’s registered address was moved to Guangzhou Economic & Technology Development Zone. In accordance with the Rules and Regulations for Implementation of Income Tax for Foreign Investment Enterprises and Foreign Enterprises of the PRC and a taxation approval document “Guangzhou Municipal State Tax Bureau Suo De Shui Zi Que 020043”, the Company is entitled to enjoy the preferential tax policy implemented in the Guangzhou Economic & Technology Development Zone effective October 1, 2003. As a result, the Company’s income tax rate has been changed to 15% from 33% beginning from that date.

     As a result of the reduction in income tax rate, the Company’s net deferred taxation liability balance brought forward from December 31, 2002 of RMB507,077 was reduced by RMB392,137 and a net deferred tax credit of RMB392,137 was recognized for such reduction in income tax rate in the consolidated statement of operations for the year ended December 31, 2003.

     In respect of the Group’s overseas airline activities, the Group has either obtained exemptions from overseas taxation pursuant to the bilateral aviation agreements between the overseas governments and PRC governments, or has sustained tax losses in these overseas jurisdictions. Accordingly, no provision for overseas tax has been made for the years ended December 31, 2001, 2002 and 2003.

Taxation expense/(credit) consisted of:

             
  Year ended December 31,
  2001
 2002
 2003
  RMB RMB RMB
Provision for PRC income tax:            
Company and subsidiaries  37,032   71,651   46,938 
Affiliated companies  8,085   9,424   3,342 
Jointly controlled entities  —   —   6,372 
   
 		   
 		   
 		 
   45,117   81,075   56,652 
Deferred taxation (Note 20)            
- current year  275,402   317,152   11,208 
- adjustment for change in income tax rate  —   —   (392,137)
   
 		   
 		   
 		 
   320,519   398,227   (324,277)
   
 		   
 		   
 		 

F-18

CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Amounts in thousands, except share data)

     Actual taxation amount in the consolidated statements of operations for the years ended December 31, 2001, 2002 and 2003 differed from the amounts computed by applying the PRC income tax rate of 33%, 33% and 15%, respectively, to income/(loss) before taxation and minority interests as a result of the following:

             
  Year ended December 31,
  2001
 2002
 2003
  RMB RMB RMB
Expected PRC taxation expense/(credit)  262,434   375,903   (76,742)
Adjustments:            
Gains on sale and leaseback transactions and their amortization  (5,075)  (851)  — 
Effect on change in income tax rate on deferred taxation  —   —   (392,137)
Rate differential on subsidiaries  (51,245)  (60,530)  5,140 
Non-deductible expenses  154,152   61,454   79,907 
Unrecognized tax losses  —   —   21,894 
Expired tax losses  —   —   34,218 
Other, net  (39,747)  22,251   3,443 
   
 		   
 		   
 		 
   320,519   398,227   (324,277)
   
 		   
 		   
 		 

     In accordance with relevant PRC tax regulations, a PRC lessee is liable to pay PRC withholding tax in respect of any lease payments regularly made to an overseas lessor. Depending on the circumstances, this tax is generally imposed at a fixed rate ranging from 10% to 20% of the lease payments, or in certain cases, the interest components of such payments. Pursuant to an approval document from the State Taxation Bureau, lease arrangements executed prior to September 1, 1999 are exempted from PRC withholding tax.

     The PRC withholding tax payable in respect of the operating leases executed after September 1, 1999 of RMB11,962, RMB14,305 and RMB7,706, respectively, during 2001, 2002 and 2003 has been included as part of the operating lease rentals.

11.16. CASH AND CASH EQUIVALENTS

     As of December 31, 2002 and 2003, cash and cash equivalents comprise cash at bank and in hand and deposits with


  
December 31,
 
  
2005
 
2006
 
  
RMB
 
RMB
 
      
Deposits with banks  23  26 
Cash at bank and in hand  2,878  2,238 
   2,901  2,264 
Southern Airlines Group Finance Company Limited (“SA Finance”), is a PRC authorized financial institution controlled by CSAHC and is an affiliated company of the Group. In accordance with the financial agreement dated May 22, 1997 and subsequently revised on December 31, 2004 between the Company and SA Finance, all the Group’s deposits accepted by SA Finance as of December 31, 2002 and 2003 were simultaneously placed with several designated major PRC banks by SA Finance. As of December 31, 20022005 and 2003,2006, the Group’s deposits with SA Finance totaled RMB900,979amounted to RMB544 and RMB365,906,RMB629, respectively (Note 25)37(d)).

F-19


Included in cash and cash equivalents are the following amounts denominated in a currency other than the functional currency of the entity to which they relate:

December 31,
2005
2006
United States DollarsUS$24US$16
Japanese YenJPY1,161JPY1,006
17. TRADE RECEIVABLES

  
December 31,
 
  
2005
 
2006
 
  
RMB
 
RMB
 
      
Trade receivables  1,562  1,552 
Less: Impairment losses for bad and doubtful accounts  (44) (40)
   1,518  1,512 
Credit terms granted by the Group to sales agents and other customers generally range from one to three months. An ageing analysis of trade receivables, net of impairment losses for bad and doubtful accounts, is set out below:

  
December 31,
 
  
2005
 
2006
 
  
RMB
 
RMB
 
      
Within 1 month  1,366  1,355 
More than 1 month but less than 3 months  137  131 
More than 3 months but less than 12 months  14  24 
More than 12 months  1  2 
   1,518  1,512 
F-32


CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Amounts in thousands,millions, except share data)

12.TRADE

As of December 31, 2005 and 2006, the Group had an amount due from a fellow subsidiary of RMB42 and RMBNil, respectively, which was included in trade receivables.

All of the trade receivables are expected to be recovered within one year.

Included in trade receivables are the following amounts denominated in a currency other than the functional currency of the entity to which they relate:

December 31,
2005
2006
United States DollarsUS$15US$19
Movements in impairment losses for bad and doubtful accounts comprise:

  
December 31,
 
  
2005
 
2006
 
  
RMB
 
RMB
 
      
At January 1  92  44 
Bad and doubtful accounts written off  (48) (4)
At December 31  44  40 
F-33

CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Amounts in millions, except share data)

18. INVENTORIES

  
December 31,
 
  
2005
 
2006
 
  
RMB
 
RMB
 
      
Expendable spare parts and maintenance materials  1,241  1,236 
Other supplies  141  79 
   1,382  1,315 
The analysis of the amount of inventories recognized as an expense is as follows:

  
December 31,
 
  
2005
 
2006
 
  
RMB
 
RMB
 
      
Consumption  720  694 
Write-down of inventories  209  161 
   929  855 
Inventories were written down as a result of a plan to phase out certain old model aircraft in the coming years.

19. OTHER RECEIVABLES
         
  December 31,
  2002
 2003
  RMB RMB
Trade receivables, principally traffic  731,894   903,601 
Less: Allowance for doubtful accounts (Note 32)  60,118   69,997 
   
 		   
 		 
   671,776   833,604 
   
 		   
 		 

13.FIXED ASSETS

         
  December 31,
  2002
 2003
  RMB RMB
Buildings  3,160,073   3,287,593 
Aircraft  24,970,695   27,684,935 
Flight equipment, including rotable spares  6,283,470   6,842,064 
Machinery, equipment and vehicles  1,782,400   1,930,273 
   
 		   
 		 
   36,196,638   39,744,865 
Less: Accumulated depreciation and amortization  9,275,809   11,208,958 
   
 		   
 		 
   26,920,829   28,535,907 
   
 		   
 		 
  
December 31,
 
  
2005
 
2006
 
  
RMB
 
RMB
 
      
Manufacturers' credit  417  448 
Amount due from Zhangyuan Airlines Company Limited ("Zhongyuan Airlines")
  98  - 
Deposit and prepayment  65  85 
Others  376  346 
   956  879 

The amount due from Zhongyuan Airlines of RMB98 at December 31, 2005 was fully settled during 2006 by a transfer of certain properties of Zhongyuan Airlines to the Group.
F-34

CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Amounts in millions, except share data)

20. PROPERTY, PLANT AND EQUIPMENT, NET

    
Aircraft
     
      

Held
under capital
 
Other flight
equipment,
including
rotable
 

Machinery,
equipment
and
   
  
Buildings
 
Owned
 
leases
 
spares
 
vehicles
 
Total
 
  
RMB
 
RMB
 
RMB
 
RMB
 
RMB
 
RMB
 
Cost or valuation:             
              
At January 1, 2005  6,988  27,134  14,529  9,044  2,599  60,294 
Exchange adjustments  (6) -  -  -  (14) (20)
Additions  64  1,937  8,494  1,416  307  12,218 
Transfer from construction in progress
  513  -  -  -  56  569 
Transfer to inventories  -  -  -  (126) -  (126)
Disposals  (256) (66) (314) (287) (81) (1,004)
At December 31, 2005  7,303  29,005  22,709  10,047  2,867  71,931 
                    
Representing:                   
Cost  6,948  22,776  18,369  7,873  2,383  58,349 
Valuation - 1996 (Note (b))  355  6,229  4,340  2,174  484  13,582 
   7,303  29,005  22,709  10,047  2,867  71,931 
                    
At January 1, 2006  7,303  29,005  22,709  10,047  2,867  71,931 
Additions  -  1,476  4,487  769  339  7,071 
Transfer from construction in progress
  516  -  96  12  46  670 
Acquired from CSAHC Hainan (Note 40(c))
  34  39  -  41  17  131 
Reclassification on exercise of purchase option
  -  3,273  (3,273) -  -  - 
Reclassification  (172) -  -  -  172  - 
Disposals  (780) (580) (204) (575) (133) (2,272)
At December 31, 2006  6,901  33,213  23,815  10,294  3,308  77,531 
                    
Representing:                   
Cost  6,546  27,420  19,475  8,120  2,824  64,385 
Valuation - 1996 (Note (b))  355  5,793  4,340  2,174  484  13,146 
 6,901  33,213  23,815  10,294  3,308  77,531 
F-35

CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Amounts in millions, except share data)

    
Aircraft
     
  
Buildings
 
Owned
 

Held
under capital
leases
 
Other flight
equipment,
including
rotable
spares
 

Machinery,
equipment
and
vehicles
 
Total
 
  
RMB
 
RMB
 
RMB
 
RMB
 
RMB
 
RMB
 
Accumulated depreciation:             
              
At January 1, 2005  757  4,331  2,894  4,137  1,334  13,453 
Exchange adjustments  (1) -  -  -  (11) (12)
Charge for the year  227  1,679  1,406  1,155  418  4,885 
Disposals  (74) (66) (314) (225) (55) (734)
At December 31, 2005  909  5,944  3,986  5,067  1,686  17,592 
                    
At January 1, 2006  909  5,944  3,986  5,067  1,686  17,592 
Charge for the year  248  1,917  1,337  1,041  451  4,994 
Reclassification on exercise of purchase option
  -  1,034  (1,034) -  -  - 
Reclassification  (41) -  -  -  41  - 
Disposals  (56) (510) (204) (513) (119) (1,402)
At December 31, 2006  1,060  8,385  4,085  5,595  2,059  21,184 
                    
Net book value:                   
                    
At December 31, 2005  6,394  23,061  18,723  4,980  1,181  54,339 
                    
At December 31, 2006  5,841  24,828  19,730  4,699  1,249  56,347 
(a) Substantially all of the Group’s buildings are located in the PRC. The Group was formally granted the rights to use the twenty onetwenty-one parcels of land in Guangzhou, Shenzhen, Zhuhai, Beihai, Changsha, Shantou, Haikou, Zhengzhou, Guiyang and Wuhan by the relevant PRC authorities for a periodperiods of 30 to 70 years, which expire between 2020 and 2068. For other land in the PRC on which the Group’s buildings are erected, the Group was formally granted the rights to use such land for periods of one to fivethree years commencing in the second quarter of 1997 pursuant to various lease agreements between the GroupCompany and CSAHC. The leases with initial one-year term are automatically renewable for another one-year period unless the Group gives appropriate notice of termination. In this connection, rental payments totaling RMB15,224totalling RMB2, RMB24 and RMB22 were paid to CSAHC for each of the years ended December 31, 2001, 20022004, 2005 and 20032006, respectively in respect of these leases (Note 23).

     The Group is obligated under various capital leases for aircraft that expire at various dates during the next six years. The gross amount of aircraft and related accumulated amortization recorded under capital leases are as follows:

F-20

leases.

CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Amounts in thousands, except share data)

         
  December 31,
  2002
 2003
  RMB RMB
Aircraft  11,459,978   10,462,575 
Less: Accumulated amortization  2,499,495   2,605,406 
   
 		   
 		 
   8,960,483   7,857,169 
   
 		   
 		 

     As of December 31, 2002 and 2003, certain aircraft of the Group with an aggregate carrying amount of approximately RMB5,822,076 and RMB6,718,737, respectively, were pledged as security under certain loan agreements (Note 16).

(b) In compliance with the PRC rules and regulations governing initial public offering of shares by PRC joint stock limited companies, the fixed assetsproperty, plant and equipment of the Group as of December 31, 1996 were revalued. This revaluation was conducted by Guangzhou Assets Appraisal Corp., a firm of independent valuers registered in the PRC, on a depreciated replacement cost basis, and approved by the China State-owned Assets Administration Bureau.

     In accordance with IAS 16 “Property, Plant and Equipment”, subsequent


F-36

CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Amounts in millions, except share data)

Subsequent to the 1996 revaluation, which was based on replacement costs, the fixed assetsproperty, plant and equipment of the Group are carried at revalued amounts,amount, being the fair value at the date of the revaluation less any subsequent accumulated depreciation and impairment losses.depreciation. Revaluation is performed periodically to ensure that the carrying amount does not differ materially from that which would be determined using fair value at the balance sheet date. In accordance with theBased on a revaluation performed by the directors in respect of fixed assets held by the Group as of December 31, 2000,September 30, 2005, by Savills Valuation & Professional Services Limited, a firm of independent valuers, on a depreciated replacement cost basis, the carrying amountsvalue of fixed assetsproperty, plant and equipment did not differ materially from their respective fair value.

     The effect


At December 31, 2006, the carrying amount of such revalued property, plant and equipment approximated the historical carrying value of such assets had they been stated at cost less accumulated depreciation and impairment losses.

(c) As of December 31, 2005 and 2006, certain aircraft of the above revaluations was to increase annual depreciation charges byGroup with an aggregate carrying amount of approximately RMB65,000, RMB33,000RMB30,408 and RMB 33,000,RMB30,075, respectively, for 2001, 2002were mortgaged under certain notes payable and 2003.

     During 2003, the Group incurred a loss of RMB20,405 on early retirement of two old Boeing 737-200 aircraft. During 2001lease agreements (Notes 27 and 2002, pursuant to certain sale and leaseback arrangements, the Group sold two Airbus 320-200 aircraft and four Boeing 757-200 aircraft, respectively, to independent third parties and then entered into operating leases with such parties to lease back the aircraft for a period of eight to nine years.28).


(d) The Group recognized a gain of RMB59,855 and RMB199,394, respectively, in 2001 and 2002, being the excess of the sale proceeds which approximated the aircraft’s fair value on the date of disposal over the aircraft’s net book value and related disposal costs. Such loss/gain was included under the sub-item “(Loss)/gain on sale of fixed assets” under “Non-operating income/(expenses)” in the consolidated statements of operations.

     During 2003, the Group entered into operating lease arrangements to leaseleased out certain flight training facilities and buildings to Zhuhai Xiang Yi Aviation Technology Company Limited (“Zhuhai Xiang Yi”), a jointly controlled entityentity. The leases typically run for an initial period of one to three years, with an option to renew the lease after that date at which time all terms are renegotiated. None of the Group. leases includes contingent rentals. In this connection, rental income totaling RMB31, RMB31 and RMB35, respectively, was received by the Group in respect of the leases during the years ended December 31, 2004, 2005 and 2006 (Note 37(c)(xi)).


The Group’s total future minimum lease payments under non-cancellable operating leases with initial one-year term are automatically renewable for anotherwere receivable within one year unless either party gives appropriate noticeand amounted to RMB35.

The cost and accumulated depreciation of

F-21

the relevant properties leased out by the Group under the operating leases amounted to RMB237 and RMB84 as of December 31, 2005, and RMB221 and RMB94 as of December 31, 2006, respectively. Depreciation of the relevant properties recognized during each of the years ended December 31, 2004, 2005 and 2006 totaled RMB15, RMB15 and RMB21, respectively.

F-37


CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Amounts in thousands,millions, except share data)

termination. In this connection, rental income totaling RMB34,175 was received by the Group during 2003 in respect of the leases. As of December 31, 2003, the cost and accumulated amortization of the relevant fixed assets totaled RMB787,432 and RMB462,281, respectively. As of December 31, 2003, the Group’s rental receivable in respect of the leases due in 2004 amounted to RMB34,175.

     During 2001 and 2002, the Group entered into arrangements to lease several of its aircraft to independent third parties. The terms of such leases generally range from one to twelve months.

(e) The Group entered into two separate arrangements (the “Arrangements”) with certain independent third parties during each of 2002 and 2003. Under each of the Arrangements, the Group sold an aircraft and then immediately leased back the aircraft for an agreed period. As agreed, theThe lease payment obligations, with pre-determined net present value, are to be satisfied solely out of the sale proceeds and such amount has been placed irrevocably by the Group in form of deposits and debt securities in favourfavor of the lessors.lessor. The Group has an option to purchase the aircraft at a pre-determined date and an agreed purchase price to be satisfied by the balances of the deposits and debt securities outstanding at that date. In the event that the lease agreement is early terminated by the Group, the Group is liable to pay a pre-determined penalty to the lessor. As long asProvided that the Group complies with the lease agreements, the Group is entitled to the continued possession and operation of the aircraft. Since the Group retains substantially all risks and rewards incident to ownership of the aircraft and enjoys substantially the same rights to their use as before the Arrangements, no adjustment has been made to the fixed assets.property, plant and equipment. As of December 31, 20022005 and 2003,2006, the net present value of the lease commitments and the corresponding defeased deposits and debt securities amounted to RMB1,322,843RMB2,376 and RMB2,409,252,RMB2,272, respectively.

(f) As agreed with the companies having operations at Guangzhou Baiyun International Airport, the allocation of common facilities at the airport was revised during 2006. As a result, certain property, plant and equipment of the Arrangements,Group at Guangzhou Baiyun International Airport with a carrying amount of RMB539 were transferred out during the year.

(g) As of December 31, 2006 and up to the date of approval of these consolidated financial statements, the Group received net cash benefitsis in the process of RMB51,682 and RMB69,121 in 2002 and 2003, respectively, which have been recognized as incomeapplying for the respective years.

F-22

land use right certificates and property title certificates in respect of the properties located in the Guangzhou Baiyun International Airport, in which the Group has interests and for which such certificates have not been granted. As of December 31, 2005 and 2006, carrying value of such properties of the Group amounted to RMB2,316 and RMB1,586, respectively. The directors of the Company are of the opinion that the use of and the conduct of operating activities at the properties referred to above are not affected by the fact that the Group has not yet obtained the relevant land use right certificates and property title certificates.


21. CONSTRUCTION IN PROGRESS

  
December 31,
 
  
2005
 
2006
 
  
RMB
 
RMB
 
      
At January 1  565  674 
Additions  678  947 
Transfer to property, plant and equipment  (569) (670)
At December 31  674  951 
The construction in progress as of December 31, 2006 mainly related to projects at the Guangzhou, Jilin and Fuzhou airports, Shenzhen cargo centre and Beijing branch.
F-38


CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Amounts in thousands,millions, except share data)

14.CONSTRUCTION


22. INTEREST IN PROGRESS

     As of December 31, 2002 and 2003, included in construction in progress was an amount of RMB432,580 and RMB1,445,760, respectively, in relation to the construction of Guangzhou New Airport.

15.INVESTMENTSAFFILIATED COMPANIES

         
  December 31,
  2002
 2003
  RMB RMB
Share of net assets in affiliated companies  692,026   422,201 
Share of net assets in jointly controlled entities  461,962   731,323 
Other investments, at cost  201,854   204,971 
   
 		   
 		 
   1,355,842   1,358,495 
   
 		   
 		 

  
December 31,
 
  
2005
 
2006
 
  
RMB
 
RMB
 
      
Share of net assets  142  149 
Details of the Group’s principal affiliated companies andare set out in Note 50, all of which are unlisted corporate entities.
Summary of financial information on affiliated companies:

  
100 Percent
 
Group’s effective interest
 
  
December 31,
 
December 31,
 
  
2004
 
2005
 
2006
 
2004
 
2005
 
2006
 
  
RMB
 
RMB
 
RMB
 
RMB
 
RMB
 
RMB
 
              
Non-current assets     5,334  6,042     2,081  2,319 
Current assets     2,275  2,281     455  502 
Non-current liabilities     (3,897) (3,525)    (1,520) (1,372)
Current liabilities     (3,318) (4,110)    (874) (1,300)
Net assets     394  688     142  149 
                    
Revenues  2,676  3,314  4,485  1,042  1,318  1,727 
Expenses  (2,638) (3,837) (4,487) (1,032) (1,603) (1,722)
Income/(loss) for the year  38  (523) (2) 10  (285) 5 
F-39

CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Amounts in millions, except share data)
23. INTEREST IN JOINTLY CONTROLLED ENTITIES

  
December 31,
 
  
2005
 
2006
 
  
RMB
 
RMB
 
      
Share of net assets  805  870 
Details of the Group’s principal jointly controlled entities are set out in Note 29.

16.DEBT

Short-term notes payable49, all of which are unlisted corporate entities.

         
  December 31,
  2002
 2003
  RMB RMB
Short-term notes payable  4,422,926   6,408,806 
   
 		   
 		 

Summary of financial information on jointly controlled entities:

  
Group's effective interest
 
  
December 31,
 
  
2004
 
2005
 
2006
 
  
RMB
 
RMB
 
RMB
 
        
Non-current assets     920  925 
Current assets     877  1,111 
Non-current liabilities     (369) (335)
Current liabilities     (623) (831)
Net assets     805  870 
           
Revenues  762  1,115  1,464 
Expenses  (778) (1,079) (1,349)
(Loss)/income for the year  (16) 36  115 
24. OTHER INVESTMENTS IN EQUITY SECURITIES

  
December 31,
 
  
2005
 
2006
 
  
RMB
 
RMB
 
      
Unlisted equity securities, at cost  320  330 
Net realized and unrealized gain on trading securities of the Group amounted to RMB15, RMB6 and RMBNil during the years ended December 31, 2004, 2005 and 2006, respectively.

Dividend income from unlisted securities of the Group amounted to RMB14, RMB4 and RMB7 during the years ended December 31, 2004, 2005 and 2006, respectively.
F-40

CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Amounts in millions, except share data)

25. DEFERRED TAX ASSETS/(LIABILITIES)

Movements of net deferred tax liabilities are as follows:

  
December 31,
 
  
2005
 
2006
 
  
RMB
 
RMB
 
  (Note 45)   
      
At January 1  (287) (279)
Credited to consolidated statement of operations (Note 13)  8  2 
At December 31  (279) (277)
The deferred tax assets/(liabilities) as of December 31, 2005 and 2006 were made up of the following tax effects:

  
December 31,
 
  
2005
 
2006
 
  
RMB
 
RMB
 
  (Note 45)   
Deferred tax assets:     
Tax losses  159  - 
Repair charges capitalized  275  203 
Accrued expenses  175  465 
Others  29  38 
Total deferred tax assets  638  706 
        
Deferred tax liabilities:       
Accrued expenses  (58) (105)
Depreciation allowances in excess of the related depreciation
  (843) (878)
Others  (16) - 
Total deferred tax liabilities  (917) (983)
   (279) (277)
        
Net deferred tax asset recognized on the consolidated balance sheet
  63  95 
Net deferred tax liability recognized on the consolidated balance sheet
  (342) (372)
   (279) (277)
F-41

CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Amounts in millions, except share data)

  
December 31,
 
  
2005
 
2006
 
  
RMB
 
RMB
 
      
Gross amount of unused tax losses     
Expected to be utilized  891  - 
Not expected to be utilized  710  423 
   1,601  423 

Tax losses in the PRC are available for carry forward to set off future PRC assessable income for a maximum period of five years. Of the RMB423 tax losses as of December 31, 2006, approximately RMB33, RMB44, RMB87, RMB130 and RMB129 will expire in 2007, 2008, 2009, 2010 and 2011 respectively. In accordance with accounting policy set out in Note 2(u), the Group had not recognized deferred tax asset in respect of these unused tax losses as it was determined by management that it is not probable that future taxable income against which the losses can be utilized will be available before they expire.

26. OTHER ASSETS
As of December 31, 20022005 and 2003, borrowings under2006, other assets of the Group include lump sum housing benefits of RMB171 and RMB145, respectively. Further details are set out in Note 38.
Movements of lump sum housing benefits are as follows:

  
December 31,
 
  
2005
 
2006
 
  
RMB
 
RMB
 
      
At January 1  197  171 
Amortization for the year  (26) (26)
At December 31  171  145 
F-42
CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Amounts in millions, except share data)

27. DEBT
(a) As of December 31, 2006, bank and other notes payable are analyzed as follows:

  
December 31,
 
  
2005
 
2006
 
  
RMB
 
RMB
 
      
Short-term notes payable  14,346  19,908 
Current installments of long-term notes payable  1,877  3,914 
   16,223  23,822 
Non-current installments of long-term notes payable  12,740  10,018 
   28,963  33,840 
        
Representing:
       
        
Bank notes payable  28,960  33,818 
Other notes payable  3  22 
   28,963  33,840 
(b) As of December 31, 2005 and 2006, the Group’s weighted average interest rates on short-term notes payable were 4.83% per annum and 5.77% per annum, respectively.
F-43

CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Amounts in millions, except share data)

(c) Details of bank and other notes payable with original maturity over one year are as follows:

  
December 31,
 
  
2005
 
2006
 
  
RMB
 
RMB
 
Renminbi denominated notes payable
     
      
Non-interest bearing loan from a municipal government authority  3  3 
        
Floating interest rates ranging from 5.10% to 5.51% per annum       
as of December 31, 2006, with maturities through 2010  877  325 
        
United States Dollars denominated notes payable
       
        
Fixed interest rates ranging from 4.43% to 7.48% per annum       
as of December 31, 2006, with maturities through 2015  2,414  1,863 
        
Floating interest rates ranging from 3-month LIBOR       
+ 0.65% to 0.90% per annum as of December 31, 2006,       
with maturities through 2009  3,610  1,727 
        
Floating interest rates ranging from 6-month LIBOR       
+ 0.30% to 1.20% per annum as of December 31, 2006,       
with maturities through 2016  7,713  9,995 
        
Hong Kong Dollars denominated notes payable
       
        
Non-interest bearing loan from a minority shareholder repayable       
within five years (Note 37(g))  -  19 
   14,617  13,932 
Less: current installments classified as current liabilities  (1,877) (3,914)
   12,740  10,018 
(d) As of December 31, 2005 and 2006, bank and other notes payable of the Group totaling RMB1,450,000RMB8,116 and RMB130,500,RMB8,726, respectively, were guaranteedsecured by CSAHC. In addition, as of December 31, 2003, borrowings under short-term notes payablemortgages over certain of the Group totaling RMB63,000Group’s aircraft with carrying amount of RMB11,735 and RMB21,000 were guaranteed by Guangzhou Baiyun International Airport Company Limited and Shenzhen Yingshun Investment Development Company Limited,RMB10,345, respectively.

     Borrowings under short-term notes payable are used primarily to finance working capital needs and are repayable in full on the respective due dates with interest rates ranging from 1.42% to 5.31%. The Group’s weighted average interest rate on short-term notes payable was 3.11% and 1.76%, respectively, as of December 31, 2002 and 2003.

F-23


F-44


CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Amounts in thousands,millions, except share data)

Long-term notes payable


           
    December 31,
  Interest rate and final maturity
 2002
 2003
    RMB RMB
Renminbi denominated notes payable:          
Loans for construction projects Floating interest rates ranging from 4.94%        
  to 5.25% per annum as of December 31, 2003,        
  with maturities through 2009.  893,838   12,357 
  Non-interest bearing loan from a municipal        
  government authority, repayable in 2005  3,000   3,000 
Loans for purchase of aircraft Floating interest rate of 5.49% per annum        
  as of December 31, 2003, with maturities        
  through 2004  2,310,268   63,500 
U.S. dollar denominated notes payable:          
Loans for purchase of aircraft Fixed interest rates ranging from 5.00%        
  to 8.33% per annum as of December 31, 2003,        
  with maturities through 2011.  3,426,038   2,612,687 
  Floating interest rates ranging from 1.48% to        
  1.50% per annum as of December 31, 2003        
  with maturities through 2013  —   2,505,134 
Loan for purchase of flight equipment Fixed interest rate of 8.35% per annum        
  as of December 31, 2003, with maturity        
  in 2004  20,090   13,097 
     
 		   
 		 
     6,653,234   5,209,775 
Less: current installments    (817,800)  (688,040)
     
 		   
 		 
     5,835,434   4,521,735 
     
 		   
 		 

(e) As of December 31, 20022005 and 2003, borrowings under long-term2006, certain bank and other notes payable of the Group totaling RMB3,360,945 and RMB2,564,586, respectively, were guaranteed by certain financial institutions and secured by the mortgages over certain of the Group’s aircraft. In addition, as of December 31, 2002 and 2003, borrowings under long-term notes payable of the Group totaling RMB1,890,118 and RMB228,800, respectively, were guaranteed by CSAHC and RMB561,531 and RMB10,052, respectively, were guaranteed by SA Finance.

following parties:


  
December 31,
 
  
2005
 
2006
 
  
RMB
 
RMB
 
      
Guarantors
     
      
Industrial Commercial Bank of China  111  79 
Export-Import Bank of the United States  1,171  828 
Bank of China  155  74 
CSAHC  1,908  1,484 
Shenzhen Yingshun Investment Development Company Limited  22  22 
SA Finance  7  5 
Industrial Bank Co.,Ltd  -  48 
   3,374  2,540 

(f) As of December 31, 2003,2005 and 2006, loans to the Group from SA Finance amounted to RMB300 (Note 37(d)).

(g) As of December 31, 2006, the Group had banking facilities with several PRC commercial banks for providing loan financefinancing up to an amountapproximately RMB49,041, of RMB9,860,000. As of December 31, 2003, an amount ofwhich approximately RMB4,412,000RMB28,295 was utilized.

F-24

CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Amounts in thousands, except share data)

(h) The aggregate annual maturities of long-term notes payable for each of the five years subsequent to December 31, 20032006 and thereafter are as follows:
 
December 31,
 
     
2005
 
2006
 
 RMB 
RMB
 
RMB
 
Year ending December 31,
      
2004 688,040 
2005 649,492 
2006 403,994   1,877  - 
2007 372,251   4,316  3,914 
2008 447,465   2,156  2,986 
2009  1,435  2,219 
2010  660  740 
2011  -  1,574 
Thereafter 2,648,533   4,173  2,499 
 
 		   14,617  13,932 
 5,209,775 
 
 		 

     Interest expense, net of the amounts capitalized, represents:

             
  Year ended December 31,
  2001
 2002
 2003
  RMB RMB RMB
Interest incurred  938,944   1,023,379   906,802 
Interest capitalized  (5,227)  (64,186)  (83,077)
   
 		   
 		   
 		 
Interest expense  933,717   959,193   823,725 
   
 		   
 		   
 		 

     Interest rates per annum at which borrowing costs were capitalized were 5.70%, 5.70% and 1.62% to 5.46%, respectively, for the years ended December 31, 2001, 2002 and 2003.

F-25

F-45


CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Amounts in thousands,millions, except share data)

17.     

(i) Included in bank and other notes payable are the following amounts denominated in a currency other than the functional currency of the entity to which they relate:

December 31,
2005
2006
United States DollarsUS$3,208US$4,016
Hong Kong DollarsHK$1,821HK$1,659
28.LEASE OBLIGATIONS

(a) Capital leases

     As of December 31, 2003, the

The Group leased 29 aircrafthas commitments under capital leases.lease agreements in respect of aircraft and related equipment. The majority of these leases have terms of 10 to 15 years and expiration dates range from 2004 through 2009.

expiring during the years 2007 to 2016. As of December 31, 2003,2006, future scheduled minimum lease payments under these capital leases which were 74% and 26%, respectively, denominated in U.S. dollars and Japanese yen, are as follows:

             
  Payments *Interest Obligations
  RMB RMB RMB
Year ending December 31,
            
2004  1,648,141   350,286   1,297,855 
2005  1,356,614   290,163   1,066,451 
2006  1,405,424   208,566   1,196,858 
2007  1,445,207   157,349   1,287,858 
2008  1,497,604   73,503   1,424,101 
Thereafter  608,124   40,308   567,816 
   
 		   
 		   
 		 
   7,961,114   1,120,175   6,840,939 
   
 		   
 		     
Less: current instalments of obligations under capital leases          (1,297,855)
           
 		 
           5,543,084 
           
 		 

     *Interest rates ranged from 2.23% to 9.36%.

  
December 31, 2005
 
December 31, 2006
 
  
Payments
 
*Interest
 
Obligations
 
Payments
 
*Interest
 
Obligations
 
  
RMB
 
RMB
 
RMB
 
RMB
 
RMB
 
RMB
 
              
Year ending December 31,
           
2006  4,030  657  3,373  —  —  — 
2007  3,423  493  2,930  3,769  678  3,091 
2008  3,016  408  2,608  3,330  530  2,800 
2009  1,684  307  1,377  2,049  415  1,634 
2010  1,050  238  812  1,442  351  1,091 
2011  -  -  -  5,663  763  4,900 
Thereafter  5,412  680  4,732  2,150  268  1,882 
   18,615  2,783  15,832  18,403  3,005  15,398 
Less: current instalments of obligations            
under capital leases        (3,373)       (3,091)
         12,459        12,307 
                    
Average interest rates  1.44% to 8.01% per annum      2.21% to 8.01%per annum    
Under the terms of the leases, the Group has thean option to purchase, at or near the end of the lease term, certain aircraft at fair market value and othersflight equipment at either fair market value or a percentage of the respective lessor’s defined cost of the aircraft.

cost.

F-46

CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Amounts in millions, except share data)

Security, including charges over the assets concerned and relevant insurance policies, is provided to the lessors.

     In addition to the assets mortgaged as security under certain loan agreements (Note 13), As of December 31, 2005 and 2006, certain of the Group’s aircraft with an aggregate carrying amount of RMB8,960,483RMB18,723 and RMB7,857,169,RMB19,730, respectively as of December 31, 2002 and 2003 were mortgaged to secure facilities with financial institutions grantedfinance lease obligations RMB15,832 and RMB15,398, respectively.


Included in obligations under capital leases are the following amounts denominated in a currency other than the functional currency of the entity to lessors totaling RMB8,198,449 and RMB6,840,939, respectively, on these dates.

F-26

which they relate:

CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Amounts in thousands, except share data)

December 31,
2005
2006
United States DollarsUS$1,556US$1,674
Japanese YenJPY47,795JPY35,400
(b) Operating leases

As of December 31, 2003,2006, the total future minimum lease payments under non-cancellable aircraft and flight equipment operating leases wereare as follows (principally denominated in U.S. dollars):follows:
 
December 31,
 
     
2005
 
2006
 
 RMB 
RMB
 
RMB
 
Year ending December 31,
      
2004 1,482,888 
2005 1,411,520 
2006 1,143,745   3,340  - 
2007 921,456   2,881  3,077 
2008 771,374   2,785  2,965 
2009  2,609  2,775 
2010  2,523  2,613 
2011  -  2,493 
Thereafter 2,388,874   10,456  8,046 
 
 		 
Total minimum lease payments 8,119,857   24,594  21,969 
 
 		 

     Amounts charged to rental expenses for operating leases for the years ended December 31, 2001, 2002 and 2003 totaled RMB1,723,338, RMB1,348,277 and RMB1,408,574, respectively.

     All of the Group’s obligations under capital and operating leases are guaranteed by financial institutions.

18.     ACCRUED EXPENSES

         
  December 31,
  2002
 2003
  RMB RMB
Landing and navigation fees  497,372   825,811 
Duties and levies  360,827   336,839 
Fuel  297,626   254,801 
Interest  174,626   157,527 
Lease charges  40,900   18,144 
Accrued salaries, wages and benefits  245,124   197,332 
Repairs and maintenance  198,465   286,636 
Current portion of provision for major overhauls (Note 6)  52,000   10,717 
Lump sum housing benefits payable (Note 24)  213,675   129,521 
Other  260,839   310,466 
   
 		   
 		 
   2,341,454   2,527,794 
   
 		   
 		 

F-27

F-47


CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Amounts in thousands,millions, except share data)

19.     DEFERRED CREDITS

         
  December 31,
  2002
 2003
  RMB RMB
Operating lease rebates  7,857   6,316 
Governmental subsidy for safety related capital expenditures  40,238   40,238 
   
 		   
 		 
   48,095   46,554 
   
 		   
 		 
Movements during the year are as follows:        
Balance at beginning of year  15,072   48,095 
Additions during the year  40,238   — 
Transferred to consolidated statement of operations  (7,215)  (1,541)
   
 		   
 		 
Balance at end of year  48,095   46,554 
   
 		   
 		 

Operating lease rebates

     Pursuant to several operating lease arrangements for aircraft commenced in January 1998,

29. TRADE AND BILLS PAYABLES

  
December 31,
 
  
2005
 
2006
 
  
RMB
 
RMB
 
      
Trade payables  3,033  1,909 
Bills payable  896  - 
   3,929  1,909 
The following is the ageing analysis of trade and bills payables:

  
December 31,
 
  
2005
 
2006
 
  
RMB
 
RMB
 
      
Within 1 month or on demand  2,000  1,125 
More than 1 month but less than 3 months  1,225  448 
More than 3 months but less than 6 months  704  336 
   3,929  1,909 
As of December 31, 2005 and 2006, the Group received cash rebates totaling RMB24,838 fromhad an operating lessoramount due to a fellow subsidiary of RMB859 and RMB11, respectively, which was included in 1998. Such rebates have been deferredtrade and amortized over the termsbills payables.
All of the respective lease to reduce the future operating lease charges.

Governmental subsidy for safety related capital expenditures

     During 2002, the Group received governmental subsidy for safety related capital expenditures amounting to RMB40,240 for enhancing future flight protectiontrade and safety standards. Such governmental subsidy isbills payables are expected to be amortized oversettled within one year.


Included in trade and bills payables are the depreciable livesfollowing amounts denominated in a currency other than the functional currency of the related fixed assets.

F-28

entity to which they relate:


December 31,
2005
2006
United States DollarsUS$147US$61
F-48


CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Amounts in thousands,millions, except share data)

20.     DEFERRED TAXATION

     Movements in net deferred tax liabilities are as follows:

         
  December 31,
  2002
 2003
  RMB RMB
Balance at beginning of year  (519,577)  (779,234)
Land use rights adjustment (Note 22(f))  57,495   — 
Transferred to consolidated statement of operations (Note 10)        
- current year  (317,152)  (11,208)
- adjustment for change in income tax rate  —   392,137 
   
 		   
 		 
Balance at end of year  (779,234)  (398,305)
   
 		   
 		 

30. AMOUNTS DUE FROM/TO RELATED COMPANIES
(a) Amounts due from related companies

  
December 31,
 
  
2005
 
2006
 
  
RMB
 
RMB
 
      
CSAHC and its affiliates  -  4 
An affiliated company  -  2 
Jointly controlled entities  84  122 
   84  128 
The net deferred tax liabilitiesamounts due from related companies were made upunsecured, interest free and have no fixed terms of repayment.

All of the following taxation effects:amounts due from related companies are expected to be recovered within one year.
         
  December 31,
  2002
 2003
  RMB RMB
Deferred tax assets:        
Tax losses carried forward  149,338   222,936 
Fixed assets, principally due to repair charges capitalized  319,697   261,312 
Accrued expenses  375,789   106,491 
Other  129,423   8,989 
   
 		   
 		 
Total deferred tax assets  974,247   599,728 
   
 		   
 		 
Deferred tax liabilities:        
Undistributed profits of subsidiaries  254,210   — 
Accrued expenses  78,083   80,545 
Fixed assets, principally due to difference in depreciation  1,403,278   847,781 
Other  17,910   69,707 
   
 		   
 		 
Total deferred tax liabilities  1,753,481   998,033 
   
 		   
 		 
Net deferred tax liabilities  (779,234)  (398,305)
   
 		   
 		 

F-29

(b) Amounts due to related companies


  
December 31,
 
  
2005
 
2006
 
  
RMB
 
RMB
 
      
CSAHC and its affiliates  12  167 
An affiliated company  5  - 
Jointly controlled entities  99  87 
   116  254 
The amounts due to related companies were unsecured, interest free and have no fixed terms of repayment.
F-49


CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Amounts in thousands,millions, except share data)

     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 profits during the periods in which those temporary differences become deductible. Management considers the scheduled reversal of deferred tax liabilities and projected future taxable profits in making this assessment. Based upon the projections for future taxable profits over the periods in which the deferred tax assets are deductible, management believes it is more likely than not that the Group will realize the benefits of these deductible differences. The amount of the deferred tax assets considered realizable, however, could be reduced in the near term if estimates of future taxable profits during the carryforward period are reduced.

     As of December 31, 2003, the Group had tax losses for PRC income tax purposes totaling approximately RMB1,486,240. Such tax losses are available for carry forward to set-off against future PRC assessable income for a maximum period of five years. Of these tax losses, approximately RMB262,957, RMB106,156 and RMB1,117,127 will expire after December 31, 2004, 2007 and 2008, respectively. As of December 31, 2003, the Group recorded a deferred tax asset of RMB222,936 for such tax losses.

     As of December 31, 2003, the Group had tax losses of approximately RMB303,000 available for offset against future assessable profits arising from Hong Kong profits, if any, over an indefinite period. The Group has not recognized a deferred tax asset in respect of such tax losses as it would not be probable that future taxable profits will be available against which the taxable losses can be utilized.

21.     SHARE CAPITAL

         
  December 31,
  2002
 2003
  RMB RMB
Registered capital as of December 31:        
2,200,000,000 domestic shares of RMB 1.00 each  2,200,000   2,200,000 
1,174,178,000 H shares of RMB 1.00 each  1,174,178   1,174,178 
1,000,000,000 A share of RMB1.00 each  —   1,000,000 
   
 		   
 		 
   3,374,178   4,374,178 
   
 		   
 		 
Issued and paid up capital as of December 31:        
2,200,000,000 domestic shares of RMB 1.00 each  2,200,000   2,200,000 
1,174,178,000 H shares of RMB 1.00 each  1,174,178   1,174,178 
1,000,000,000 A share of RMB1.00 each  —   1,000,000 
   
 		   
 		 
   3,374,178   4,374,178 
   
 		   
 		 

     In July 2003, the Company issued 1,000,000,000 A shares with a par value of RMB1.00 each at issue price of RMB2.70 by way of a public offering to natural persons and institutional investors in the PRC. The share premium received by the Company, net of the issuance costs of RMB59,233, amounted to RMB1,640,767 and was credited to share premium account.

F-30

31. ACCRUED EXPENSES


  
December 31,
 
  
2005
 
2006
 
  
RMB
 
RMB
 
      
Jet fuel costs  686  1,020 
Operating lease charges  86  - 
Air catering expenses  132  153 
Salaries and welfare  193  346 
Lump sum housing benefits payable  92  - 
Repairs and maintenance  996  1,281 
Provision for major overhauls (Note 33)  151  255 
Provision for early retirement benefits (Note 34)  -  86 
Landing and navigation fees  1,129  1,168 
Computer reservation services  190  66 
Interest expense  338  448 
Duties and levies  12  - 
Property management fee  37  - 
Others  208  119 
   4,250  4,942 
F-50


CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Amounts in thousands,millions, except share data)

32. OTHER LIABILITIES

  
December 31,
 
  
2005
 
2006
 
  
RMB
 
RMB
 
      
CAAC Infrastructure Development fund  177  189 
Airport construction surcharge  542  404 
Airport tax  198  288 
Construction cost payable  793  130 
Advance payment on chartered flights  104  100 
Sales agent deposits  198  221 
Other tax payable  441  494 
Lump sum housing benefits payable  -  90 
Others  1,343  1,341 
   3,796  3,257 
33. PROVISION FOR MAJOR OVERHAULS

Details of provision for major overhauls in respect of aircraft held under operating leases are as follows:

  
December 31,
 
  
2005
 
2006
 
  
RMB
 
RMB
 
      
At January 1  359  452 
Provision for the year  129  683 
Provision utilized during the year  (36) (75)
At December 31  452  1,060 
Less: current portion included in accrued expenses (Note 31)  (151) (255)
   301  805 
F-51

CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Amounts in millions, except share data)
34. PROVISION FOR EARLY RETIREMENT BENEFITS

Details of provision for early retirement benefits in respect of obligations to early retired employees are as follows:

December 31,
2006
RMB
At January 1-
Provision for the year (Note 10)392
At December 31392
Less: current portion included in accrued expenses (Note 31)(86)
306

During 2006, the Group implemented an early retirement plan for certain employees. The benefits of the early retirement plan are calculated based on factors including the remaining number of years of services from the date of early retirement to the normal retirement date and the salary amount on the date of early retirement of the employees. The present value of the future cash flows expected to be required to settle the obligations is recognized as provision for early retirement benefits.
35. SHARE CAPITAL

  
December 31,
 
  
2005
 
2006
 
  
RMB
 
RMB
 
Registered, issued and paid up capital:     
2,200,000,000 domestic state-owned shares of RMB1.00 each  2,200  2,200 
1,174,178,000 H shares of RMB1.00 each  1,174  1,174 
1,000,000,000 A shares of RMB1.00 each  1,000  1,000 
   4,374  4,374 
All the domestic state-owned, H and A shares rank pari passu in all material respects.

     As of December 31, 2002 and 2003, the retained earnings of the Group included RMB135,010 and RMB112,985, respectively, of undistributed earnings of companies which are 50% or less owned by the Group and accounted for under the equity method.

22.     RESERVES

     Movements of reserves are as follows:

         
  December 31,
  2002
 2003
  RMB RMB
Statutory surplus reserve (Note (a))
        
Balance at beginning of year  391,867   337,195 
Adjustments from adoption of PRC accounting regulations (Note (c))  (106,007)  — 
Transferred from consolidated statement of operations  51,335   23,856 
   
 		   
 		 
Balance at end of year  337,195   361,051 
   
 		   
 		 
Statutory public welfare fund (Note (b))
        
Balance at beginning of year  225,440   171,574 
Adjustments from adoption of PRC accounting regulations (Note (c))  (79,533)  — 
Transferred from consolidated statement of operations  25,667   1,113 
   
 		   
 		 
Balance at end of year  171,574   172,687 
   
 		   
 		 
Discretionary surplus reserve (Note (d))
        
Balance at beginning of year  69,867   76,603 
Transferred from consolidated statement of operations  6,736   — 
   
 		   
 		 
Balance at end of year  76,603   76,603 
   
 		   
 		 
   585,372   610,341 
   
 		   
 		 

F-31

F-52


CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Amounts in thousands,millions, except share data)

Notes:


36. RESERVES

  
December 31,
 
  
2005
 
2006
 
  
RMB
 
RMB
 
      
Share premium
     
At January 1 and December 31  5,325  5,325 
        
Statutory surplus reserve (Note (a))
       
At January 1  402  410 
Transfer from retained earnings/(accumulated losses)  8  12 
Transfer from statutory public welfare fund  -  198 
At December 31  410  620 
        
Statutory public welfare fund (Note (b))
       
At January 1  193  198 
Transfer from retained earnings/(accumulated losses)  5  - 
Transfer to statutory public welfare fund  -  (198)
At December 31  198  - 
        
Discretionary surplus reserve (Note (c))
       
At January 1  77  83 
Transfer from retained earnings/(accumulated losses)  6  29 
At December 31  83  112 
        
Retained earnings/(accumulated losses) (Note (d))
       
At January 1  1,477  (328)
(Loss)/profit for the year  (1,786) 126 
Appropriations to reserves  (19) (41)
At December 31  (328) (243)
Total
  5,688  5,814 

(a) According to the PRC Company Law and the Articles of Association of the Company and certain of its subsidiaries, the Company and the relevant subsidiaries are required to transfer 10% of their annual net income after taxation, as determined under relevant PRC accounting rules and regulations, to a statutory surplus reserve until the reserve balance reaches 50% of the registered capital. The transfer to this reserve must be made before distribution of a dividend to shareholders.

shareholders when there are retained earnings at the financial year end.

F-53

CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Amounts in millions, except share data)

Statutory surplus reserve can be used to offset prior years’ losses, if any, and may be converted into share capital by the issue of new shares to shareholders in proportion to their existing shareholding or by increasing the par value of the shares currently held by them, provided that the balance after such issue is not less than 25% of the registered capital.


(b) According to the PRC Company Law and the Articles of Association of the Company and certain of its subsidiaries, the Company and the relevant subsidiaries are required to transfer between 5% to 10% of their annual net income after taxation, as determined under PRC accounting rules and regulations, to the statutory public welfare fund. This fund can only be utilized on capital items for the collective benefits of the Company’s and the relevant subsidiaries’ employees such as the construction of dormitories, canteen and other staff welfare facilities. This fund is non-distributable other than in liquidation. The transfer to this reservefund must be made before distribution of a dividend to shareholders.

     (c) During 2002, the Group adopted certain new PRC accounting regulations which resulted in adjustmentsshareholders and is subject to respective shareholders’ approval.


According to the amounts of the Group’s income determined underrevised PRC accounting regulations in respect of prior years and corresponding adjustments to amounts appropriatedCompany Law effective January 1, 2006, appropriation to the statutory surplus reserve, statutory public welfare fund is no longer required and discretionarythe balance of statutory public welfare fund as of December 31, 2005 was transferred to statutory surplus reserve.

(c) The appropriation of this reserve for the prior years.

     (d)is subject to shareholders’ approval. The usage of this reserve is similar to that of statutory surplus reserve.

     (e)

(d) Dividend distributions may be proposed at the discretion of the Company’s Boardboard of Directors,directors, after consideration of the transfers referred to above and making up cumulative prior years’ losses, if any.losses. Pursuant to the Company’s Articles of Association of the Company, the net income of the Company for the purpose of dividend distribution is deemed to be the lesser of (i) net income determined in accordance with (i)the PRC accounting principlesrules and financial regulations, and (ii) IFRS;the net income determined in accordance with IFRSs; or if the financial statements of the Company are not prepared in accordance with IFRS,IFRSs, the accounting standards of one of the countries in which its shares are listed (Note 27).

     (f) The Group adopted IAS 40 “Investment Property” in 2002. According to IAS 40,listed. As of December 31, 2005 and 2006, the land use rights which were previously included in fixed assets at revaluation base are now presented as lease prepayments and carried at historical cost base with effect from January 1, 2002. Accordingly, the unamortized surplus on previous revaluations of the land use rights, net of related deferred tax asset, are reversed to the share premium and retained profits accounts. The IAS 40 was adopted prospectively in 2002 as the effect of this changeCompany did not have a material impact onany distributable reserves.


As of December 31, 2005 and 2006, the Group’s financial conditionaccumulated losses of the Group included RMB243 and resultsRMB251, respectively, of operations inundistributed earnings of companies which are 50% or less owned by the periods prior toGroup and accounted for under the change.

F-32

equity method.

F-54


CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Amounts in thousands,millions, except share data)

23.COMMITMENTS AND CONTINGENCIES

     The Company has been advised by its Chinese legal counsel that, except

37. RELATED PARTY TRANSACTIONS

(a) Key management personnel remuneration

Remuneration for liabilities constituting or arising outkey management personnel of or relatingthe Group is as follows:

  
December 31,
 
  
2004
 
2005
 
2006
 
  
RMB
 
RMB
 
RMB
 
        
Short-term employees benefits  6.75  5.93  6.64 
Post-employment benefits  0.18  0.22  0.22 
   6.93  6.15  6.86 
           
Directors and supervisors  4.68  3.46  4.34 
Senior management  2.25  2.69  2.52 
   6.93  6.15  6.86 
Total remuneration is included in “staff costs” (Note 10).

(b) Contribution to the business assumed by the Company in the Reorganization (Note 1), no other liabilities were assumed by the Company, and the Company is not jointly and severally liable for other debts and obligations incurred by CSAHC prior to the Reorganization, except for certain loans from PRC banks which were fully repaid by CSAHC. There are not, however, any definitive PRC regulations or other pronouncements confirming such conclusion.

post-employment benefit plans


The Group leases from CSAHC certain landparticipates in Guangzhouvarious defined contribution retirement plans organized by municipal and certain land and buildings in Wuhan, Haikou and Zhengzhou. The Group has a significant investment in buildings and other leasehold improvements located on such land. However, such land in Guangzhou and such land and buildings in Wuhan, Haikou and Zhengzhou lack adequate documentation evidencing CSAHC’s rights thereto and the lease agreements between CSAHC and the Group may not be registered with the relevant authorities. Lack of registration may affect the validity of such lease agreements.

     With respect to the facilities in Guangzhou, CSAHC has received written assurance from the CAAC to the effect that CSAHC is entitled to continued use and occupancyprovincial governments for its staff. Details of the landGroup’s employee benefits plan are disclosed in Guangzhou. The Group understands that the CAAC is basing its conclusion on an agreement among certain government authorities relating to such land. Such assurance does not constitute formal evidence of CSAHC’s right to transfer, mortgage or lease such real property interests. The Group cannot predict the magnitude of the effect on its financial condition or results of operations to the extent that its use of one or more of these parcels of land or the related facilities were successfully challenged. CSAHC has agreed to indemnify the Group against any loss or damage caused by any challenge or interference with the Group’s use of any of its land and buildings.

     The Group is currently involved in a civil litigation ( the “Litigation”). According to the writ of summons for the Litigation, the plaintiff, claimed against the Group for unspecified damages for breach of certain agreement. Given that the Litigation is still at its preliminary stage, it is pre-matured to predict the outcome. Based on the opinion given by the Company’s instructing solicitors, the directors of the Company consider that the Group has a reasonable chance of success in its defense to the claim. Accordingly, the directors of the Company consider that a provision for such claim and/or the associated legal costs is not required.

     As of December 31, 2003, the Group had on order two Boeing 757-200 aircraft, thirteen Boeing 737-700 aircraft, four Airbus 330-200 aircraft, six Embraer ERJ-145 aircraft and certain flight equipment, scheduled for deliveries in 2004 to 2005. Deposits of RMB2,494,853 have been made towards the purchase of these aircraft and related equipment. As of December 31, 2003, the aggregate future payments, including estimated amounts for price escalation through anticipated delivery dates for these aircraft and related equipment totaled approximately RMB10,615,079.

     As of December 31, 2003, additional capital expenditures of approximately RMB3,012,607 have been authorized, of which approximately RMB849,847 have been committed, for the Group’s principal facilities. Such expenditures comprised mainly RMB2,071,938 for facilities and equipment at the Guangzhou New Airport and RMB940,669 for other airport and office facilities and equipment, overhaul and maintenance bases and training centers.

F-33

Note 38.

F-55


CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Amounts in thousands,millions, except share data)

     As


(c) Transactions with CSAHC and its affiliates (the “CSAHC Group”), and the affiliated companies and jointly controlled entities of the Group

The Group obtained various operational services provided by the CSAHC Group and the affiliated companies and jointly controlled entities of the Group during the normal course of its business.
Details of the significant transactions carried out by the Group are as follows:

    
December 31,
 
  
Note
 
2004
 
2005
 
2006
 
    
RMB
 
RMB
 
RMB
 
          
Expenses paid to the CSAHC Group
         
          
Handling charges  
(i)
 33  32  29 
Air catering supplies  
(ii)
 170  173  194 
Commission expense  
(iii)
 2  26  43 
Sundry aviation supplies  
(iv)
 66  88  86 
Lease charges for aircraft  
(v)
 -  10  3 
Lease charges for land and buildings  
(vi)
 18  90  99 
Property management fee  
(vii)
 -  28  26 
Housing benefits  
(viii)
 85  -  - 
              
Expenses paid to jointly controlled entities
             
              
Ground service expenses  
(ix)
 -  32  43 
Repairing charges  
(x)
 1,159  1,118  1,183 
Flight simulation service charges  
(xi)
 100  126  133 
              
Income received from jointly controlled entities
             
              
Rental income  
(xi)
 31  31  35 
              
Others
             
              
CNA/XJA Acquisitions  
(xii)
 15,522  -  - 
Operating expenses recharged to related             
companies  
(xiii)
 65  -  - 
Acquisition of CSAHC Hainan  
(xiv)
 -  -  5 
Disposal of properties to the CSAHC Group  
(xv)
 -  -  23 
F-56

CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Amounts in millions, except share data)
(i) The Group acquires aircraft, flight equipment and other airline-related facilities through Southern Airlines (Group) Import and Export Trading Company (“SAIETC”), a wholly-owned subsidiary of CSAHC.

(ii) The Group purchases certain inflight meals and related services from Shenzhen Air Catering Company Limited, and Southern Airlines (Group) Catering Co., Ltd which are an affiliated company and a wholly owned subsidiary of CSAHC, respectively.

(iii) Commission is earned by certain subsidiaries of CSAHC in connection with the air tickets sold by them on behalf of the Group. Commission is calculated based on a fixed rates ranging from 3% to 6% on the ticket value.

(iv) Certain sundry aviation supplies are purchased from Southern Airlines (Group) Economic Development Company (“SAGEDC”), a subsidiary of CSAHC.

(v) The Group leased an aircraft from China Southern Airlines (Group) Hainan Co., Ltd (“CSAHC Hainan”), a wholly-owned subsidiary of CSAHC. The lease was terminated on April 30, 2006.

(vi) The Group leases certain land and buildings in the PRC from CSAHC.

(vii) Guangzhou China Southern Airlines Property Management Co., Ltd, a subsidiary of CSAHC, provides property management services to the Group.

(viii) The Group paid a fixed annual fee of RMB85 to CSAHC from 1995 to 2004 in respect of the provision of quarters to the eligible employees of the Group (Note 38). No such payment was made in 2005 and 2006.

(ix) Beijing Ground Services Co., Ltd, a jointly controlled entity of the Group, provides airport ground services to the Group.

(x) Guangzhou Aircraft Maintenance Engineering Company Limited and MTU Maintenance Zhuhai Co., Ltd, jointly controlled entities of the Group, provide comprehensive maintenance services to the Group.

(xi) Zhuhai Xiang Yi, a jointly controlled entity of the Group, provides flight simulation services to the Group. In addition, the Group entered into operating lease agreements to lease certain flight training facilities and buildings to Zhuhai Xiang Yi.

(xii) On December 31, 2003,2004, the Group was committed to make a capital contribution of approximately RMB446,000 to jointly controlled entities.

     The Group has taken steps towards the purchase ofacquired the airline businessoperations and certain related assets of China Northern Airlines Company (“CNA”) and Xinjiang Airlines Company. No contractual obligations existedCompany (“XJA”) at a total consideration of RMB15,522 (the “CNA/XJA Acquisitions”). CNA and XJA are wholly owned subsidiaries of CSAHC. The consideration was partly satisfied by assumption of debts and liabilities of CNA and XJA totalling RMB13,563 outstanding as of that date. The remaining consideration of RMB1,959 was fully paid in cash during 2005.

F-57

CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Amounts in millions, except share data)

(xiii) In 2004, the Group provided administrative services to CNA and XJA. Operating expenses amounted to RMB65 were recharged to CNA and XJA on a cost basis.

(xiv) On April 30, 2006, the Company acquired certain assets of CSAHC Hainan at a total consideration of RMB294, which was partly satisfied by assumption of liabilities of CSAHC Hainan totaling RMB289 outstanding as at that date. The remaining balance of RMB5 had been settled in cash during the year (Note 40(c)).

(xv) On December 28, 2006, the Company disposed of certain properties to CSAHC at a consideration of RMB23.

In addition to the above, certain subsidiaries of CSAHC also provided hotel and other services to the Group during the year. The total amount involved is not material to the results of the Group for the year.

Details of amounts due from/to the CSAHC Group, and the affiliated companies and jointly controlled entities of the Group:
  
December 31,
 
  
2005
 
2006
 
  
RMB
 
RMB
 
      
Receivables:
     
The CSAHC Group  42  4 
An affiliated company  -  2 
Jointly controlled entities  84  122 
        
Payables:
       
The CSAHC Group  871  178 
An affiliated company  5  - 
Jointly controlled entities  99  87 

The amounts due from/to the CSAHC Group, the affiliated company and jointly controlled entities of the Group are unsecured, interest free and have no fixed terms of repayment.
F-58

CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Amounts in millions, except share data)

(d) Notes payable to and deposits placed with SA Finance

(i) Notes payable to SA Finance

As of December 31, 20032005 and up2006, notes payable to SA Finance by the Group amounted to RMB300. The notes payable are unsecured and repayable within one year.

Interest expense paid on such notes payable amounted to RMB3, RMB37 and RMB16 during the years ended December 31, 2004, 2005 and 2006, respectively. The interest rates of the notes payable was at 4.78% per annum during the year ended December 31, 2004, ranged from 3.30% to 5.02% per annum during the year ended December 31, 2005, and 5.02% to 5.26% per annum during the ended December 31, 2006, respectively.

The loans are guaranteed by CSAHC (included in the amount as disclosed in Note 37 (e) below).

(ii) Deposits placed with SA Finance

As of December 31, 2005 and 2006, the Group’s deposits with SA Finance amounted to RMB544 and RMB629, respectively. The applicable interest rates are determined in accordance with the rates published by the PBOC.

Interest income received on such deposits amounted to RMB4, RMB3 and RMB5 during the years ended December 31, 2004, 2005 and 2006, respectively.
(e) Guarantees from CSAHC and SA Finance

Certain bank loans of the Group were guaranteed by the following related parties:

  
December 31,
 
  
2005
 
2006
 
  
RMB
 
RMB
 
      
CSAHC  1,908  1,484 
SA Finance  7  5 
F-59

CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Amounts in millions, except share data)

(f) Transactions with other state-controlled enterprises

The Company is a state-controlled entity and operates in an economic regime currently dominated by entities directly or indirectly controlled by the PRC government (“state-controlled entities”) through its government authorities, agencies, affiliations and other organizations.

Other than those transactions with the CSAHC Group, and the affiliated companies and jointly controlled entities of the Group as disclosed in Notes 37(c), (d) and (e) above, the Group conducts transactions with other state-controlled entities which include but are not limited to the datefollowing:

·
Transportation services
·
Leasing arrangements
·
Purchase of equipment, materials and spare parts
·
Ancillary and social services; and
·
Financial services arrangement.

These transactions are conducted in the ordinary course of the Group’s business on terms comparable to those with other entities that are not state-controlled. The Group has established its pricing strategy, buying and approval process for purchases and sales of theseproducts and services. Such buying, pricing strategy and approval processes do not depend on whether the counterparties are state-controlled entities or not.

Having considered the potential for transactions to be impacted by related party relationships, the Group’s pricing strategy, buying and approval processes, and what information would be necessary for an understanding of the potential effect of the relationship on the consolidated financial statements.statements, the directors of the Company are of the opinion that the following transactions with other state-controlled entities require disclosure:
(i) The purchase price has not yet been determined.

24.Group’s transactions with other state-controlled entities, including state-controlled banks in the PRC


  
December 31,
 
  
2005
 
2006
 
  
RMB
 
RMB
 
      
Jet fuel cost  9,592  13,054 
Interest income  48  33 
Interest expenses  694  1,405 
F-60

CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Amounts in millions, except share data)

(ii) The Group’s balances with other state-controlled entities, including state-controlled banks in the PRC

  
December 31,
 
  
2005
 
2006
 
  
RMB
 
RMB
 
      
Cash and deposits at bank  2,001  1,434 
Short-term bank notes payable and       
current installments of long-term bank notes payable  14,319  21,209 
Non-current instalments of long-term bank notes payable  10,175  8,223 

(iii) Guarantees from other state-controlled entities, including state-controlled banks in the PRC

  
December 31,
 
  
2005
 
2006
 
  
RMB
 
RMB
 
      
Guarantees on certain bank notes payable of the Group  266  201 

(g) Loan from a minority shareholder

During 2006, the Group obtained a loan from a minority shareholder amounting to RMB19. The loan is unsecured, interest free and repayable within five years.
38.RETIREMENT AND POST-RETIREMENT MEDICALHOUSING BENEFITS


Employees of the Group participate in several defined contribution retirement schemes organized separately by PRC municipal governments in regions where the major operations of the Group are located. The Group is required to contribute to these schemes at the rates ranging from 14% to 17% for 2001, 14%20% during the year ended December 31, 2004, 9% to 19% for 200220% during the year ended December 31, 2005, and 200310% to 23% during the year ended December 31, 2006, respectively, of salary costs including certain allowances. A member of the retirement schemes is entitled to pension benefits equal to a fixed proportion of the salary at the retirement date. The retirement benefit obligations of all existing and future retired staff of the Group are assumed by these schemes. Contributions to the retirement schemes are charged to consolidated statements of operations as and when incurred. Contributions to the retirement schemes amounted to RMB62,833, RMB112,285 and RMB131,327, respectively, during 2001, 2002 and 2003.


In addition, the Group was selected as one of the pilot enterprises to establishhas established a supplementary defined contribution retirement scheme for the benefit of employees.employees in accordance with relevant regulations in the PRC. In this connection, employees of the Group participate in a supplementary defined contribution retirement scheme whereby the Group is required to make defined contributions atnot exceeding one-twelfth of the rate of 4.5% ofprior year’s total salaries.
F-61

CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Amounts in millions, except share data)

Furthermore, pursuant to the comprehensive services agreement dated May 22, 1997 between the Company and CSAHC, CSAHC provided quarters to eligible employees of the Group. In return, the Group paid a fixed annual fee of RMB85 to CSAHC for a ten-year period from 1995 to 2004. The agreement expired by December 31, 2004 and no further payment was made in 2005 and 2006.

The Group has no obligation for the payment of pension benefits beyond the contributions described above. Contributions to the retirement schemes are charged to consolidated statements of operations as and when incurred. Contributions to the retirement schemes amounted to RMB15,000, RMB19,337 and RMB19,120, respectively, during 2001, 2002 and 2003.

     Furthermore, pursuant to the comprehensive services agreement (the “Services Agreement”) dated May 22, 1997 between the Company and CSAHC, CSAHC agrees to provide adequate quarters to eligible employees of the Group as and when required. In return, the Group agrees to pay a fixed annual fee of RMB85,000 to CSAHC for a ten-year period effective January 1, 1995.

     During 2001 and 2002, the Group provided additional quarters at its own expense to certain employees who are not eligible for quarters pursuant to the Services Agreement. These quarters were provided to the employees in accordance with the relevant PRC housing reform policy. In 2001 and 2002, the Group recognized a loss of RMB110,723 and RMB17,624, respectively, being the excess of the cost of these quarters over the considerations received by the Group from the employees, under the sub-item “(Loss)/gain on sale of fixed assets” under “Non-operating income/(expenses)” in the consolidated statements of operations.

F-34

CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Amounts in thousands, except share data)

     Subsequently, pursuant

Pursuant to an additional staff housing benefit scheme effective September 2002, the Group has agreed to pay lump sum housing allowances to certain employees who have not received quarters from CSAHC or the Group according to the relevant PRC housing reform policy, for subsidizing their purchases of housing. Such expenditure has been deferred and amortized on a straight line basis over a period of 10 years, which represents the vesting benefit period of the employees.houses. An employee who quits prior to the end of the vesting benefit period is required to pay back a portion of the lump sum housing benefits determined on a pro-rata basis of the benefit vesting benefit period remained.period. The Group has the right to effect a charge on the employee’s house and to enforce repayment through selling the house in the event of default in repayment. Any shortfall in repayment would be charged against consolidated statements of operations. As ofincome or loss. During the years ended December 31, 2003,2004, 2005 and 2006, the Group alreadyhad made payments totaling RMB130,479RMB22, RMB16 and RMB2, respectively, under the scheme and recorded its remaining contractual liabilities totaling RMB129,521RMB108, RMB92 and RMB90, respectively, as accrued liabilitiesat the respective consolidated balance sheet. Housing allowances are payable when applications are received from eligible employees.
39. SEGMENTAL INFORMATION

The Group operates principally as a single business segment for the provision of air transportation services. The analysis of turnover and operating income/(loss) by geographical segment is based on the consolidated balance sheets (Note 18).

25.RELATED PARTY TRANSACTIONS

     The Group obtained various operationalfollowing criteria:


(i) Traffic revenue from domestic services within the PRC (excluding Hong Kong and financial services provided by CSAHC and its affiliates, and the Group’s affiliated companies and jointly controlled entities during the normal course of its business. In the past, CSAHC was under the direct control of the CAAC. However, such control has been shiftedMacau) is attributed to the State Assets Administration Committee since early 2003. Consequently, transactions with the CAAC and its affiliates beginningdomestic operation. Traffic revenue from 2003 are no longer presented as related party transactions of the Group. The principal related party transactions are described as follows:

Allocation of routes and air fares

     Both domestic and international routes on which the Group and other PRC airlines offer scheduledinbound/outbound services are allocated by the CAAC.

     International air fares are subject to bilateral agreements between the CAAC, acting on behalf of the PRC government, and other governments. Domestic air fares are regulated jointly by the CAACHong Kong/Macau, and the PRC Price Administrative Bureau.

Procurement of aircraft, flight equipmentand overseas destinations is attributed to the Hong Kong and Macau operation and international operation respectively.


(ii) Other revenue from ticket selling, general aviation and ground services, air catering and other airline-related facilities

     Certain PRC airlines, includingmiscellaneous services is attributed on the Group, were granted permission to acquire aircraft, flight equipment and other airline-related facilities directly from manufacturers subject tobasis of where the approval of their fleet expansion plans by the relevant PRC government authorities.

     The Group acquires aircraft, flight equipment and other airline-related facilities through Southern Airlines (Group) Import and Export Trading Company (“SAIETC”), a wholly-owned subsidiary of CSAHC. Total purchases amounted to RMB324,998, RMB583,548 and RMB1,154,553, respectively, for 2001, 2002 and 2003. Handling fees totaling RMB16,161, RMB 36,306 and RMB27,051, respectively, were paid to SAIETC for 2001, 2002 and 2003.

F-35

services are performed.

F-62


CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Amounts in thousands,millions, except share data)

Jet fuel supplies

     Jet fuel is subject to allocation in the PRC. The Group is required to purchase jet fuel domestically from the China Aviation Oil Supply Company


  
Domestic
 
Hong Kong and Macau
 
International*
 
Total
 
  
RMB
 
RMB
 
RMB
 
RMB
 
          
2004
         
Traffic revenue  17,742  1,180  4,422  23,344 
Other operating revenue  630  -  -  630 
Turnover  18,372  1,180  4,422  23,974 
              
Operating income/(loss)  650  67  192  909 
              
Depreciation and amortization  1,876  99  438  2,413 
              
Significant non-cash items other than depreciation and amortization:             
Impairment losses for trade and other receivables
  27  -  -  27 
              
2005
             
Traffic revenue  29,533  1,298  6,588  37,419 
Other operating revenue  874  -  -  874 
Turnover  30,407  1,298  6,588  38,293 
              
Operating loss  (282) (97) (926) (1,305)
              
Depreciation and amortization  4,128  139  638  4,905 
              
Significant non-cash items other than depreciation and amortization:             
Write-down of inventories  209  -  -  209 
              
2006
             
Traffic revenue  35,707  1,329  8,051  45,087 
Other operating revenue  1,132  -  -  1,132 
Turnover  36,839  1,329  8,051  46,219 
              
Operating income/(loss)  925  4  (617) 312 
              
Depreciation and amortization  4,138  132  696  4,966 
              
Significant non-cash items other than depreciation and amortization:             
Write-down of inventories  161  -  -  161 
*Asian market accounted for approximately 67%, 74% and Lan Tian Oil Supply Company, companies controlled by the CAAC, at prices set by such suppliers in conjunction with the CAAC and other PRC government authorities. During the periods presented, such prices exceeded the international market prices. The cost of jet fuel purchased by the Group in accordance with such allocation was RMB2,586,688 and RMB2,373,956, respectively, during 2001 and 2002. The remainder64% of the Group’s jet fueltotal international traffic revenue for the years ended December 31, 2004, 2005 and 2006, respectively. The remaining portion was purchased from domestic markets and, to a lesser extent, from international markets.

Aircraft insurance

     Aviation insurance covering hull, war and passenger liability risk is arranged by the CAAC on behalf of all PRC airlines with the People’s Insurance (Property) Company of China (“PICC”) under a master policy. PICC reinsures a substantial portion of its aircraft insurance business through the international reinsurance market. Insurance premiums are allocated to each individual PRC airline by the CAAC based on the value of the airline’s aircraft and after taking into account the claims history of the airline. Insurance premiums totaling RMB123,439 and RMB256,238, respectively, were incurred by the Group during 2001 and 2002.

Financial arrangements

     The Group’s obligations under various lease and bank loan arrangements in connection with aircraft acquisitions are secured by guarantees provided by certain PRC financial institutions which obtained back-to-back guaranteesmainly derived from the CAAC. Guarantee fees totaling RMB1,490Group’s flights to/from European, North American and RMB1,025, respectively, were paid to these financial institutions during 2001 and 2002.

     Interest income is received from short-term deposits with SA Finance. The applicable interest rate is determined in accordance with the savings rate published by the People’s Bank of China. Interest income totaling RMB13,771, RMB10,530 and RMB3,100, respectively, was earned by the Group on such deposits during 2001, 2002 and 2003 (Note 11).

     During 2003, CSAHC made short-term advances to the Group. These advances are unsecured, non-interest bearing and repayable on demand. As of 31 December, 2003, the advances amounted to RMB165,995.

F-36

Australian regions.

F-63


CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Amounts in thousands,millions, except share data)

Airline-related services

The major revenue-earning assets of the Group jointly with other PRC airlines, participatesare its aircraft fleet, all of which are registered in the CAAC’s computer reservation system, under whichPRC. Since the Group purchases computer reservation services from the CAAC at rates determined based on the utilizationGroup’s aircraft fleet is employed flexibly across its route network, there is no suitable basis of allocating such assets to geographic segments. Most of the system. Service fees paid by the Group to the CAAC during 2001 and 2002 totaled RMB110,134 and RMB107,234, respectively.

     The Group utilizes the passenger departure and cargo handling computer systems installed by the CAAC at certain PRC airports. Service feesGroup’s non-aircraft assets are levied by the CAAC based on the utilization of these systems. Service fees totaling RMB57,424 and RMB62,111, respectively, were paid by the Group to the CAAC during 2001 and 2002.

     The Group is required to pay landing and navigation fees to various PRC airports in respect of take-off and landing slots allocated to the Group and other ancillary services provided. Fees are payable by the Group based on the scale rates published by the CAAC. Landing and navigation fees totaling RMB1,527,600 and RMB1,667,706, respectively, were paid to various PRC airports during 2001 and 2002.

     The Group purchases certain inflight meals and related services from Shenzhen Air Catering Company Limited, a cooperative joint venture establishedlocated in the PRC, in respectPRC.

40. NON-CASH TRANSACTIONS

(a) Acquisitions of which CSAHC is entitled to 33% of its income after tax. Such purchasesaircraft

During the year ended December 31, 2004, 2005 and 2006, aircraft acquired under capital leases amounted to RMB22,707, RMB29,058RMBNil, RMB6,938 and RMB28,199, respectively, during 2001, 2002 and 2003.

     Commission is earned by certain subsidiaries of CSAHC in connection with the air tickets sold by them on behalfRMB3,759, respectively.

(b) Effect of the Group. Commission is calculated based on a fixed rate ranging from 1.5% to 12% on the ticket value. Commission expenses incurred by the Group in respect of tickets sold by certain subsidiaries of CSAHC totaled RMB37,017, RMB16,725 and RMB4,896, respectively, during 2001, 2002 and 2003.

     Commission is earned by the CAAC’s sales offices and various PRC airlines in connection with the air tickets sold by them on behalf of the Group. Commission is calculated based on a fixed rate ranging from 1.5% to 12% on the ticket value. Commission expenses incurred by the Group in respect of tickets sold by the CAAC’s sales offices and various PRC airlines totaled RMB510,169 and RMB464,721, respectively, during 2001 and 2002. Commission income received from other PRC airlines in connection with air tickets sold by the Group, calculated based on a fixed rate ranging from 3% to 9% on the ticket value, totaled RMB89,842 and RMB81,931, respectively, during 2001 and 2002.

     Ground service fees are received from other PRC airlines in respect of ground services provided by the Group and Baiyun International Airport Group at Guangzhou Baiyun International Airport. The Group was entitled to 50% of the service fees. The Group’s share of ground service fees received totaled RMB23,513 and RMB39,735, respectively, during 2001 and 2002.

     The Group has a 50% equity interest in both Guangzhou Aircraft Maintenance Engineering Company Limited (“GAMECO”) and MTU Maintenance Zhuhai Co., Ltd (“MTU Zhuhai”), which provide comprehensive maintenance services to the Group. Maintenance fees totaling RMB534,828, RMB592,311 and RMB693,303, respectively, were incurred by the Group for services provided by GAMECO and MTU Zhuhai during 2001, 2002 and 2003.

F-37

CNA/XJA Acquisitions


Year ended
December 31,
2004
RMB
Assets acquired:
Property, plant and equipment, net12,980
Inventories729
Trade receivables314
Cash and cash equivalents398
Other assets1,101
15,522
Liabilities assumed:
Notes payable4,587
Obligations under capital leases6,125
Trade payables343
Accrued expenses1,475
Other liabilities1,033
13,563
Net identifiable assets and liabilities1,959
Cash consideration payable and not yet settled at December 31, 2004
1,959
Net cash inflow from acquisitions - cash and cash equivalents acquired
398
F-64


CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Amounts in thousands,millions, except share data)

     Certain aircraft sundry supplies are purchased from Southern Airlines (Group) Economic Development Company (“SAGEDC”), a subsidiary


Had the CNA/XJA Acquisitions been effected on January 1, 2004, results of CSAHC. Supplies totaling RMB86,386, RMB101,350 and RMB42,389, respectively, were purchased by the Group from SAGEDC during 2001, 2002 and 2003.

     The Group has a 51% equity interest in Zhuhai Xiang Yi, which provides flight simulation services to the Group. Flight simulation service charges totaling RMB101,355 were incurred byoperations of the Group for services provided by Zhuhai Xiang Yi during 2003. In addition, the Group entered into operating lease agreements to lease certain flight training facilities and buildings to Zhuhai Xiang Yi. Rental income received byyear ended December 31, 2004 would have been as follows:


  
The Group
 
Results of
   
  
(without effect
 
airline
   
  
of CNA/XJA
 
operations
   
  
Acquisitions)
 
of CNA/XJA
 
Combined
 
  
RMB
 
RMB
 
RMB
 
        
Turnover  23,974  10,057  34,031 
Income for the year  155  170  325 
(c) Effect of the Group amounted to RMB34,175 during 2003 (Note 13).

Advertising services

     Advertising services are provided by Southern Airlines Advertising Company (“SA Advertising”). SA Advertising was a subsidiaryacquisition of CSAHC up to July 2002. In August 2002,Hainan


On April 30, 2006, the Group acquired 90% equity interest in SA Advertising from CSAHC. Expenses totaling RMB9,940 and RMB3,275, respectively, were incurred by the Group for services provided by SA Advertising during 2001 and 2002.

Wet lease rentals

     Pursuant to certain wet lease arrangements effected in August and November 2000, the Group incurred RMB300,000 during 2001 in respect of five Boeing 737-300/37K aircraft leased from Zhongyuan Airlines, a subsidiary of CSAHC. Such lease arrangements were terminated in January 2002.

     During 2002 and 2003, wet lease rentals totaling RMB26,164 and RMB35,751, respectively, were paid to Xinjiang Airlines Company, a subsidiaryassets of CSAHC pursuant toHainan at a wet lease agreement in respecttotal consideration of a Boeing 757-200 aircraft effective October 2002. The wet lease agreementRMB294, which was terminated in April 2003.

     During the period from August to October 2002, the Group received wet lease rentalspartly satisfied by assumption of liabilities of CSAHC Hainan totaling RMB27,599 from wet leasing of an Airbus 320-200 aircraft to Sichuan Airlines Corporation Limited, an affiliated company of the Group.

Refund of medical benefit payments

     Prior to January 1, 2002, the Group paid a fixed annual fee to CSAHC in return for CSAHC providing medical benefit, transportation subsidies and other welfare facilities to the retirees of the Group. Such arrangement was terminated on January 1, 2002. During 2003, CSAHC refunded RMB58,120 to the Group which represented the difference between the aggregate fixed annual fees received from the Group and the aggregate cost of services incurred by CSAHC under the above arrangement.

F-38

RMB289 outstanding as at that date. Details are as follows:


Year ended
December 31,
2006
RMB
Assets acquired:
Property, plant and equipment, net131
Lease prepayment35
Inventories28
Trade receivables30
Cash and cash equivalents38
Other receivables32
294
Liabilities assumed:
Trade payables28
Accrued expenses14
Other liabilities247
289
F-65


CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Amounts in thousands,millions, except share data)

Acquisition of aircraft and related spare parts and vehicles

     During 2002, the Group acquired five Boeing 737-300/37K aircraft and related spare parts and certain vehicles from Zhongyuan Airlines, a subsidiary of CSAHC, at a consideration of approximately RMB1,096,866. The consideration was satisfied by cash of approximately RMB132,130 together with an assumption by the Group of Zhongyuan Airlines’ debts of approximately RMB964,736. In addition, the Group received reimbursements of wet lease rentals totaling RMB150,000 which it paid


Year ended
December 31,
2006
RMB
Net identifiable assets and liabilities5
Satisfied by:
Cash5
Analysis of the net inflow of cash and cash equivalents in respect of the acquisition:
Cash consideration(5)
Cash and cash equivalents acquired38
Cash and cash equivalents acquired33
41. FINANCIAL INSTRUMENTS

Exposure to Zhongyuan Airlines during the period from July 1, 2001 to December 31, 2001. Such reimbursements have been applied to reduce the purchase costs of the acquired assets.

Acquisition of subsidiaries

     In August 2002, the Group acquired 90% equityliquidity, interest in each of Guangzhou Aviation Hotel, Southern Airlines Advertising Company and South China International Aviation & Travel Services Company from CSAHC at an aggregate cash consideration of approximately RMB107,846. Such consideration is determined by reference to the valuation reports prepared by GZAA Incorporated, a firm of independent valuers registered in the PRC. These acquisitions are not considered significant in the context of the Group.

Amounts due to related companies

     Amounts due to related companies, which represent balance with CSAHC and its affiliates, and the Group’s affiliated companies and jointly controlled entities, are unsecured, non-interest bearing and repayable within one year. The balance as of December 31, 2002 also included balances with the CAAC and its affiliates. Balances with other State-owned enterprises are excluded from this caption, as other State-owned enterprises are not considered related parties of the Group.

     In addition to the above, certain business undertakings of CSAHC also provided hotel and other services to the Group. The total amount involved is not material to the results of the Group.

     The directors of the Company are of the opinion that the above transactions with related parties were entered intorate, currency, jet fuel price risk credit risks arises in the normal course of businessthe Group’s business. These risks are limited by the Group’s financial management policies and on normal commercial terms or in accordance with the agreements governing such transactions.

F-39

practices described below.

CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Amounts in thousands, except share data)

26.FAIR VALUE OF FINANCIAL INSTRUMENTS AND CONCENTRATIONS OF RISK

     Financial assets of the Group include cash and cash equivalents, investments, trade receivables and other receivables. Financial liabilities of the Group include notes payable, accounts payable, bills payable, sales in advance of carriage, amounts due to related companies, accrual expenses, other liabilities and obligations under capital leases.

(a) Liquidity risk


As of December 31, 2002 and 2003,2006, the Group’s net current liabilities amounted to RMB7,015,998 and RMB10,792,050, respectively.exceeded its current assets by RMB32,180. For the yearsyear ended December 31, 2001, 2002 and 2003,2006, the Group recorded a net cash inflow from operating activities of RMB2,223,943, RMB3,697,544 and RMB2,128,749, respectively,RMB2,217, a net cash outflow from investing activities of RMB5,404 and a net cash inflow from financing activities of RMB3,603,535, RMB2,744,364 and RMB3,819,618, respectively, andRMB2,550, resulting in a (decrease)/increasenet decrease in cash and cash equivalents of RMB(1,379,592), RMB953,180 and RMB(1,690,869), respectively.

     With regard to 2004RMB637.


In 2007 and thereafter, the liquidity of the Group is primarily dependent on its ability to maintain adequate cash inflowinflows from operations and to obtain adequate external finance to meet its debt obligations as they fall due and on its ability to obtain adequate external finance to meet its committed future capital expenditures. With regard to its short-term notes payable outstanding as ofAt December 31, 2003,2006, the Group has obtained firm commitments from its principal bankers to renew relevant loans as they fall due during 2004. With regard to its future capital commitments and other financing requirements, the Group has already entered into loan financing agreements with several PRC banks to provide loan financefinancing up to an approximate amountRMB49,041 during 2007, of RMB8,450,000which approximately RMB28,295 was utilized. Subsequent to December 31, 2006, the Group entered into additional loan financing agreements to obtain financing up to RMB5,045 during 2004 and thereafter.2007. The directors of the Company believe that suchsufficient financing will be available to the Group.

F-66
CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Amounts in millions, except share data)
The directors of the Company have carried out a detailed review of the cash flow forecast of the Group for the twelve months ending December 31, 2004.2007. Based on such forecast, the directors have determined that adequate liquidity exists to finance the working capital and capital expenditure requirements of the Group during that period. In preparing the cash flow forecast, the directors have considered historical cash requirements of the Group as well as other key factors, including the availability of the above-mentioned loannotes payable finance which may impact the operations of the Group during the next twelve-month period. The directors are of the opinion that the assumptions and sensitivities which are included in the cash flow forecast are reasonable. However, as with all assumptions in regard to future events, these are subject to inherent limitations and uncertainties and some or all of these assumptions may not be realized.

F-40

CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Amounts in thousands, except share data)

Business risk

     The Group conducts its principal operations in PRC and accordingly is subject to special considerations and significant risks not typically associated with investments in equity securities of the United States of America and Western European companies. These include risks associated with, among others, the political, economic and legal environment, influence of the CAAC over many aspects of its operations and competition in the passenger, cargo and mail airline services industry.

(b) Interest rate risk


The interest rates and termsmaturity information of repayment of the Group’s bank and other notes payable, and obligations undermaturity information of the Group’s capital leases of the Groupobligations are disclosed in Notes 1627 and 17,28, respectively.


(c) Foreign currency risk


The Renminbi is not freely convertible into foreign currencies. All foreign exchange transactions involving Renminbi must take place either through the PBOC or other institutions authorized to buy and sell foreign exchange or at a swap center.

The Group has significant exposure to foreign currency as substantially all of the Group’s lease obligations and notes payable are denominated in foreign currencies, principally US dollars, and to a lesser extent, Japanese yen.Yen. Depreciation or appreciation of the Renminbi against foreign currencies affects the Group’s results significantly because the Group’s foreign currency payments generally exceed its foreign currency receipts. The Group is not able to hedge its foreign currency exposure effectively other than by retaining its foreign currency denominated earnings and receipts to the extent permitted by the State Administration of Foreign Exchange, (“SAFE”), or subject to certain restrictive conditions, entering into forward foreign exchange contracts with authorized PRC banks.


The exchange rate of Renminbi to US dollar was set by the PBOC and had fluctuated within a narrow band prior to July 21, 2005. Since then, a managed floating exchange rate regime based on market supply and demand with reference to a basket of foreign currencies has been used and US dollar exchange rate has gradually declined against the Renminbi.
F-67
CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Amounts in millions, except share data)
(d) Jet fuel price risk

The Group allows for the judicious use of approved derivative instruments such as swaps and options with approved counter-parties and within approved limits to manage the risk of surge of jet fuel price. In addition, counter-party credit risk is generally restricted to any gains on changes in fair value at any time, and not the principal amount of the instrument. Therefore, the possibility of material loss arising in the event of non-performance by counter-party is considered to be unlikely.

The fair values of derivative financial instruments of the Group at the balance sheet date are as follows:
December 31,
2005
2006
Assets
Liabilities
Assets
Liabilities
RMB
RMB
RMB
RMB
Fuel option contracts---26
As of December 31, 2006, the Group had outstanding fuel option contracts to buy approximately 6,150,000 barrels of crude oil at prices ranging from US$55 to US$79 per barrel. On the other hand, the Group sold fuel put option contracts to approved counter-parties and had outstanding option contracts at December 31, 2006 of approximately 12,300,000 barrels of crude oil at prices ranging from US$43 to US$60 per barrel. All contracts will expire between 2007 and 2008.

(e) Credit risk


Substantially all of the Group’s cash and cash equivalents are deposited with PRC financial institutions.

institutions, which management believes are of high credit quality.


A significant portion of the Group’s air tickets are sold by agents participating in the Billing and Settlement Plan (“BSP”), a clearing scheme between airlines and sales agents organized by International Air Transportation Association.Association which has insignificant credit risk to the Group. As of December 31, 20022005 and 2003,2006, the balance due from BSP agents amounted to RMB353,246RMB782 and RMB446,399,RMB863, respectively.

Self insurance The credit risk

     The exposure to BSP and the remaining trade receivables balance has been monitored by the Group maintains a limited amount of property insurance in respect of certain personalon an ongoing basis and real property.

F-41

the impairment losses for bad and doubtful debts have been within management’s expectations.

F-68

CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Amounts in thousands,millions, except share data)

(f) Fair value

     The carrying


(i) All financial instruments are carried at amounts and estimatednot materially different from their fair values of significant financial assets and liabilities as of December 31, 20022005 and 2003 are set out below.2006.
                 
  December 31,
  2002
 2003
  Carrying Fair Carrying Fair
  amount
 value
 amount
 value
  RMB RMB RMB RMB
Cash and cash equivalents  3,771,043   3,771,043   2,080,174   2,080,174 
Trade receivables  671,776   671,776   833,604   833,604 
Other receivables  372,586   372,586   296,047   296,047 
Notes payable, including current installments of long-term notes payable  5,240,726   5,326,511   7,096,846   7,164,216 
Accounts payable  532,480   532,480   928,093   928,093 
Bills payable  1,299,680   1,299,680   438,135   438,135 
Sales in advance of carriage  390,531   390,531   466,087   466,087 
Amounts due to related companies  525,090   525,090   929,003   929,003 
Accrued expenses  2,341,454   2,341,454   2,527,794   2,527,794 
Other liabilities  646,989   646,989   1,019,811   1,019,811 
Notes payable, excluding current installments  5,835,434   6,111,052   4,521,735   4,743,128 

The following methods and assumptions were used to estimate the fair value for each class of financial instrument:

instruments:


(i) 
·
Cash and cash equivalents, trade receivables, other receivables short-term notes payable, accounts payable, bills payable, sales in advance of carriage, amounts due to related companies, accrued expenses and other liabilitiescurrent assets, trade and bills payables, taxes payable and other liabilities.


The carrying amountsvalues approximate their fair valuevalues because of the short maturities of these instruments.


(ii) Long-term
·
Financial liabilities

The fair values of fuel option contracts are determined based on dealer price quotations and options pricing model without any deduction for transaction costs.

·
Bank and other notes payable


The fair value has been estimated by applying a discounted cash flow approach using interest rates available to the Group for similar indebtedness.

     The economic characteristics of the Group’s capital leases vary from lease to lease. It is impractical to compare such leases with those prevailing in the market within the constraints of timeliness and cost for the purpose of estimating the fair value of such leases. Investments are unquoted equity securities of companies established in the PRC. There is no quoted market price for such equity securities and accordingly a reasonable estimate of the fair value could not be made without incurring excessive costs.

F-42

CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Amounts in thousands, except share data)

Fair value estimates are made at a specific point in time and based on relevant market information about the financial instruments. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in assumptions could significantly affect the estimates.

27.     FOREIGN CURRENCY EXCHANGE


(ii) The Renminbi is not freely convertible into foreign currencies. All foreign exchange transactions involving Renminbi must take place either through the People’s Bankeconomic characteristics of China or other institutions authorized to buy and sell foreign exchange or at a swap center.

     The Group currently maintains bank accounts in currencies other than the Renminbi to engage in foreign exchange transactions. The amount of foreign exchange that can be retained by the Group under this system is determined by the SAFE based on the Group’s expected payment obligations in foreign currencies forcapital leases vary from lease and debt payments and for dividends. Any amounts of foreign exchange that the Group receives in excess ofto lease. It is impractical to compare such amount must be converted into Renminbi at the rateleases with those prevailing in the PRC inter-bank market. The Group will have access to foreign currency throughmarket within the inter-bank system, subject toconstraints of timeliness and cost for the approvalpurpose of estimating the fair value of such leases.


(iii) Other non-current investments represent unlisted equity securities of companies established in the PRC. There is no quoted market price for such equity securities and accordingly a reasonable estimate of the SAFE, fair value could not be measured reliably.

(iv) Amounts due from/to satisfy its foreign exchange requirements whererelated companies are unsecured, interest-free and have no fixed terms of repayment. Given these exceed the amountterms, it is not meaningful to disclose fair values of foreign exchange that the Group has retained.

     The Articles of Association of the Company require cash dividends be declared in Renminbi and paid to holders of the H shares in Hong Kong dollars at the average closing exchange rate for Hong Kong dollars as announced by the People’s Bank of China for the calendar week preceding the date of the dividend declaration. To the extent that the Company is unable to pay dividends in foreign currency out of its own resources, it will have to obtain foreign currency through the swap centers and PRC banks. Hong Kong dollar dividend payments will be converted by the depositary and distributed to holders of American Depositary Shares in United States dollars.

F-43

these balances.

F-69

CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Amounts in thousands,millions, except share data)

28.     RECONCILIATION AND SUPPLEMENTARY STATEMENTS OF CASH FLOWS INFORMATION

42. COMMITMENTS
(a) The reconciliation of income/(loss) before taxation and minority interests to cash inflows from operations isCapital commitments
At December 31, 2006, the Group had capital commitments as follows:
             
  Year ended December 31,
  2001
 2002
 2003
  RMB RMB RMB
Income/(loss) before taxation and minority interests  795,256   1,139,099   (511,610)
Adjustments to reconcile income/(loss) before taxation and minority interests to cash inflows from operations:            
Depreciation and amortization of fixed assets  1,802,462   1,839,293   1,997,882 
Other amortization  12,512   9,816   40,089 
Amortization of deferred credits  (18,483)  (7,217)  (1,541)
Equity income of affiliated companies  (53,077)  (36,988)  (47,798)
Equity loss of jointly controlled entities  4,034   3,352   39,495 
(Gain)/loss on sale of aircraft  (59,855)  (199,394)  20,405 
Loss on sale of other fixed assets  115,744   28,654   1,812 
Interest income  (49,878)  (52,618)  (13,061)
Interest expense  933,717   959,193   823,725 
Non-cash exchange (gain)/loss, net  (292,630)  174,978   177,356 
Decrease/(increase) in trade receivables  232,228   (110,749)  (161,828)
Decrease/(increase) in other receivables  42,938   (166,004)  76,539 
(Increase)/decrease in inventories  (2,033)  (76,472)  1,923 
(Increase)/decrease in prepaid expenses and other current assets  (136,600)  123,924   (6,045)
(Decrease)/increase in accounts payable  (167,599)  (61,843)  395,613 
Increase/(decrease) in bills payable  —   1,299,680   (861,545)
Increase in sales in advance of carriage  31,036   19,985   75,556 
Increase/(decrease) in amounts due to related companies  98,040   (193,175)  403,913 
(Decrease)/increase in accrued expenses  (132,121)  86,215   203,439 
Increase/(decrease) in other liabilities  70,254   (33,032)  372,822 
(Decrease)/increase in provision for major overhauls  (40,422)  16,226   47,577 
   
 		   
 		   
 		 
Cash inflows from operations  3,185,523   4,762,923   3,074,718 
   
 		   
 		   
 		 

(b)Disclosure of non-cash investing and financing activities:

     During 2002,

  
December 31,
 
  
2005
 
2006
 
  
RMB
 
RMB
 
      
Commitments in respect of aircraft and flight equipment     
- authorized and contracted for  45,628  66,881 
        
Other commitments       
- authorized and contracted for  90  420 
- authorized but not contracted for  2,085  1,404 
   2,175  1,824 
   47,803  68,705 
As of December 31, 2006, the Group assumed from Zhongyuan Airlines debts totaling RMB964,736 in partial satisfaction of the consideration payable for acquisition of five Boeing 737-300/37Khad on order 130 aircraft and other assets from Zhongyuan Airlines (Note 25).

F-44

certain flight equipment, scheduled for deliveries in 2007 to 2011. Deposits of RMB8,692 have been made towards the purchase of these aircraft and related equipment. As of December 31, 2006, the approximate total future payments, including estimated amounts for price escalation through anticipated delivery dates for these aircraft and flight equipment are as follows:


  
December 31,
 
  
2005
 
2006
 
  
RMB
 
RMB
 
      
2006  7,341  - 
2007  8,945  12,299 
2008  14,354  22,572 
2009  5,300  17,483 
2010  9,688  14,232 
2011  -  295 
   45,628  66,881 
F-70


CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Amounts in thousands,millions, except share data)

As of December 31, 2006, the Group’s attributable share of the capital commitments of jointly controlled entities was as follows:
  
December 31,
 
  
2005
 
2006
 
  
RMB
 
RMB
 
      
Authorized but not contracted for  74  1 
(b) Investing commitments
At December 31, 2006, the Group committed to make capital contributions in respect of:
  
December 31,
 
  
2005
 
2006
 
  
RMB
 
RMB
 
      
A jointly controlled entity  83  83 
        
43. CONTINGENCIES
The Group leases from CSAHC certain land in Guangzhou and certain land and buildings in Wuhan, Haikou and Zhengzhou. The Group has a significant investment in buildings and other leasehold improvements located on such land. However, such land in Guangzhou and such land and buildings in Wuhan, Haikou and Zhengzhou lack adequate documentation evidencing CSAHC’s rights thereto.
The Group cannot predict the magnitude of the effect on its financial condition or results of operations to the extent that their uses of one or more of the above parcels of land or the related facilities were successfully challenged. Pursuant to an indemnification agreement dated May 22, 1997 entered into between CSAHC and the Company, CSAHC has agreed to indemnify the Group against any loss or damage caused by any challenge or interference with the Group’s use of any of its land and buildings.
F-71
CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Amounts in millions, except share data)
44. NON-ADJUSTING POST BALANCE SHEET EVENTS

(a) Notes payable refinanced/obtained subsequent to December 31, 2006

(i) During January 1, 2007 to April 16, 2007

From January 1, 2007 to April 16, 2007, the Group refinanced certain short-term notes payable of RMB4,170. The refinanced bank notes payable are unsecured, bear interest at floating rates ranging from 3-month/6-month LIBOR +0.50% to 0.55% per annum and are repayable within one year from their respective refinanced dates.

In addition, the Group entered into new notes payable totaling RMB3,234 subsequent to December 31, 2006 and up to April 16, 2007. These new notes payable are unsecured and bear interest at floating rates ranging from 3-month/6-month/12-month LIBOR +0.45% to 0.55% per annum and are repayable within five months to one year from their respective origination dates.

(ii) During April 17, 2007 to May 31, 2007
From April 17, 2007 to May 31, 2007, the Group entered into additional new notes payable totaling RMB3,201. These additional new notes payable are unsecured, bear interest at floating rate of 6-month LIBOR + 0.45% to 0.55% per annum and repayable within six months to one year from their respective origination dates.

(b) New tax law

On March 16, 2007, the Fifth Plenary Session of the Tenth National People’s Congress passed the Corporate Income Tax Law of the People’s Republic of China (“new tax law”) which will take effect on January 1, 2008. The Company and certain subsidiaries of the Group are entitled to preferential income tax rates in the range of 15% to 27%. From January 1, 2008, the income tax rate of companies who are currently enjoying preferential income tax rates lower than 25% is expected to increase to the standard rate of 25% over a five-year transition period. However, the new tax law has not set out the details as to how the existing preferential tax rate will increase to the standard rate of 25%. Consequently, the Group is not able to make an estimate of the expected financial effect of the new tax law on its deferred tax assets and liabilities. The expected financial effect of the new tax law, if any, will be reflected in the Company’s 2007 consolidated financial statements. The enactment of the new tax law is not expected to have any financial effect on the amounts accrued in the consolidated balance sheet in respect of current tax payable.
F-72
CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Amounts in millions, except share data)
(c) EffectShare reform
On April 13, 2007, the Company issued a notice to holders of acquisitionthe listed and circulating A Shares (“Circulating A Shares”) to convene a relevant shareholders’ meeting on May 17, 2007 (“Relevant Shareholders’ Meeting”) for the purpose of subsidiaries:seeking shareholders’ approval of the proposal for converting all the Company’s unlisted and non-circulating shares (“Non-circulating Shares”) to Circulating A Shares (“Share Reform Proposal”). CSAHC is the only holder of the Non-circulating Shares.

As disclosed in the announcement dated April 13, 2007 and subsequently revised on 23 April, 2007, the consideration payable as proposed by CSAHC to the holders of Circulating A Shares in connection with the Share Reform Proposal is a total of 1,400,000,000 put warrants of the Company’s shares (“Put Warrants”). The holders of the Circulating A Shares registered on the shareholders’ register on May 8, 2007 will be granted 14 Put Warrants for every 10 A Shares held by such shareholders, equivalent to 1.5970 shares for every 10 A Shares. The exercise ratio is two warrants to one share and the initial exercise price of the Put Warrant is RMB7.43. The rights of the Put Warrants (European style) are exercisable by the holders during the last five trading days of the warrant period which is twelve months. CSAHC will announce the exercise method of rights under the Put Warrants within six months after the listing of the Put Warrants.

CSAHC undertakes that it will not trade or transfer any of the Company’s shares it holds for a thirty-six-month period commencing from the effective date of the Share Reform Proposal (“Lock-up Period”). After expiration of the Lock-up Period, CSAHC may sell the Non-circulating Shares through trading on the Shanghai Stock Exchange, and the number of shares it will sell within the 12-month period and 24-month period will not exceed 5% and 10%, respectively, of the total number of shares held by CSAHC. The shares subject to restriction as mentioned above do not include those shares purchased by CSAHC upon the exercise of rights under the Put Warrants after the implementation of the share reform plan.

In accordance with the provisions of “Provisional Measures of the Shanghai Stock Exchange for Warrants” and the relevant requirements of the Shanghai Stock Exchange, CSAHC will place deposits to China Securities Depository and Clearing Corporation Limited Shanghai Branch as a performance bond for the Put Warrants.

CSAHC also undertakes that at the annual shareholders meetings of the Company in respect of 2007 through 2009, CSAHC will propose that the dividends of the Company be distributed in cash and will vote in favor of such distribution plan so that the average annual percentage of dividend to be distributed in cash in respect of 2007 through 2009 will not be lower than 50% of the total income distributable to the equity shareholders in these three years.

The share reform plan was approved in the Relevant Shareholders’ Meeting held on May, 17 2007.
(d) Litigation

A writ of summons was issued on May 30, 2007 by certain sales agents in Taiwan (the “plaintiffs”) against the Company for the alleged breach of certain terms and conditions of a cooperative agreement (the “cooperative agreement”). The plaintiffs have made a claim against the Company for a total sum of approximately RMB107 in respect of the alleged non-payment of sales commission on air tickets sold in Taiwan, annual bonus and interest on late payment during the period from September 1, 2004 to August 31, 2006. The plaintiffs have also claimed against the Company for an unspecified compensation for early termination of the cooperative agreement. Both the plaintiffs and the Company are required to present the evidence to the Court on July 25, 2007 and the first hearing will be held on July 30, 2007.

The directors consider that, given the nature of the claims and the preliminary status of the proceedings, it is not possible to estimate the eventual outcome of the claims, with reasonable certainty at this stage. However, the directors are of the opinion that the claims are without merit and have instructed its legal advisor to defend the claims vigorously. The directors consider that the outstanding claim should have no material adverse effect on the financial position of the Group.
F-73
CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Amounts in millions, except share data)
45. COMPARATIVE FIGURES

IAS 16 (amended 2004) Property, Plant and Equipment (“revised policy”) is effective on January 1, 2005. Under the revised policy, overhaul cost is capitalized in the carrying amount of property, plant and equipment when the major overhaul is performed. Any remaining carrying amount of the cost of the previous inspection is derecognized. The effect of adoption of the revised policy was not reflected in the 2005 consolidated financial statements as management determined the impact to the consolidated financial statements was immaterial.

For the purpose of the preparation of the 2006 consolidated financial statements, the following comparative figures for the year ended December 31, 2005 have been corrected for immaterial errors to reflect the impact of the prospective adoption of the revised policy on January 1, 2005:

  
As originally reported
 
Adjustments
 
As adjusted
 
  
RMB
 
RMB
 
RMB
 
        
Statement of operations line items:
       
Maintenance  4,589  (538) 4,051 
Depreciation and amortization  4,440  465  4,905 
Income tax expense  7  (11) (4)
Loss for the year  (1,846) 62  (1,784)
Basic and diluted loss per share  (0.42) 0.01  (0.41)
           
Balance sheet line items:
          
Property, plant and equipment, net  54,266  73  54,339 
Deferred tax assets  74  (11) 63 
Total assets  71,402  62  71,464 
Accumulated losses  (390) 62  (328)
Total equity  11,936  62  11,998 

46. IMMEDIATE AND ULTIMATE CONTROLLING PARTY

As of December 31, 2006, the directors of the Company consider the parent and ultimate holding company of the Group to be CSAHC, a state-owned enterprise established in the PRC. This entity does not produce financial statements available for public use.

47. ACCOUNTING ESTIMATES AND JUDGMENTS

The Groups’ financial position and results of operations are sensitive to accounting methods, assumptions and estimates that underlie the preparation of the consolidated financial statements. The Group bases the assumptions and estimates on historical experience and on various other assumptions that the Group believes to be reasonable and which form the basis for making judgments about matters that are not readily apparent from other sources. On an on-going basis, management evaluates its estimates. Actual results may differ from those estimates as facts, circumstances and conditions change.

The selection of critical accounting policies, the judgments and other uncertainties affecting application of those policies and the sensitivity of reported results to changes in condition and assumptions are factors to be considered when reviewing the consolidated financial statements. The principal accounting policies are set forth in Note 2. The Group believes the following critical accounting policies involve the most significant judgments and estimates used in the preparation of the consolidated financial statements.
F-74
CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Amounts in millions, except share data)
Impairment of long-lived assets
If circumstances indicate that the net book value of a long-lived asset may not be recoverable, this asset may be considered “impaired”, and an impairment loss may be recognized in accordance with IAS 36 “Impairment of Assets”. The carrying amounts of long-lived assets are reviewed periodically in order to assess whether the recoverable amounts have declined below the carrying amounts. These assets are tested for impairment whenever events or changes in circumstances indicate that their recorded carrying amounts may not be recoverable. When such a decline has occurred, the carrying amount is reduced to recoverable amount. The recoverable amount is the greater of the net selling price and the value in use. In determining the value in use, expected cash flows generated by the asset are discounted to their present value, which requires significant judgment relating to level of traffic revenue and amount of operating costs. The Group uses all readily available information in determining an amount that is a reasonable approximation of recoverable amount, including estimates based on a reasonable and supportable assumptions and projections of traffic revenue and amount of operating costs.

Depreciation

Property, plant and equipment are depreciated on a straight-line basis over the estimated useful lives, after taking into account the estimated residual value. The Group reviews the estimated useful lives of the assets regularly in order to determine the amount of depreciation expense to be recorded during any reporting period. The useful lives are based on the Group’s historical experience with similar assets and taking into account anticipated technological changes. The depreciation expense for future periods is adjusted if there are significant changes from previous estimates.

Impairment of trade receivables

The Group maintains an impairment loss for doubtful accounts for estimated losses resulting from the inability of the debtors to make required payments. The Group bases the estimates of future cash flows on the ageing of the trade receivables balance, debtors’ credit-worthiness, and historical write-off experience. If the financial condition of the debtors were to deteriorate, actual write-offs would be higher than estimated.
F-75
CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Amounts in millions, except share data)
48. POSSIBLE IMPACT OF AMENDMENTS, NEW STANDARDS AND INTERPRETATION ISSUED BUT NOT YET EFFECTIVE FOR THE YEAR ENDED DECEMBER 31, 2006

Up to the date of issue of these consolidated financial statements, the IASB has issued a number of amendments, new standards and interpretations which are not yet effective for the year ended December 31, 2006 and which have not been adopted in these consolidated financial statements.

The Group is in the process of making an assessment of what the impact of these amendments, new standards and new interpretations is expected to be in the period of initial application. So far it has concluded that the adoption of them is unlikely to have a significant impact on the Group’s results of operations and financial position.

In addition, the following developments may result in new or amended disclosures in the consolidated financial statements:

Effective for accounting periods beginning on or after
   
IFRS 7, Financial instruments: disclosureJanuary 1, 2007
Amendments to IAS 1, Presentation of financial statements
- capital disclosures
 January 1, 2007
F-76
CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Amounts in millions, except share data)
49. SUBSIDIARIES
The particulars of the Group’s principal subsidiaries as of December 31, 2006 are as follows:
Name of company
Place of establishment / operationRegistered capitalProportion of ownership interest held by the CompanyPrincipal activities
         
Guangxi Airlines Company Limited (a) Year ended December 31,
PRC 2001
RMB170,900,000		 2002
100%		 2003
Airline
RMBRMBRMB
Net assets acquired:         
Fixed assetsSouthern Airlines (Group) Shantou Airlines Company Limited (a) —PRC RMB280,000,000 96,63660% —Airline
Cash and cash equivalents      17,355  
Trade receivables and other current assetsZhuhai Airlines Company Limited (a) —PRC RMB250,000,000 20,68160% —Airline
 
—134,672—
Accounts payable      3,623
Xiamen Airlines Company Limited (a)PRCRMB700,000,00060%Airline
     
Accrued expenses and other liabilitiesGuizhou Airlines Company Limited (a) —PRC RMB80,000,000 11,22060% —Airline
   
 		   
 		 
Guangzhou Air Cargo Company Limited (a) 
PRC		 RMB238,000,00070%Cargo services
   —   14,843
Guangzhou Baiyun International Logistic Company Limited (a) PRC —RMB50,000,000 61%Logistics operations
   
 		   
 		 
Net assets valueGuangzhou Nanland Air Catering Company Limited (b) —PRC RMB120,000,000 119,82975% —
Minority interests’ share of net assets value—11,983—Air catering
   
 		   
 		 
Net assets value acquired by the GroupChina Southern West Australian Flying College Pty Limited —Australia AUD100,000 107,84665% —Pilot training services
   
 		   
 		 
Consideration paidXinjiang Civil Aviation Property Management Limited (a) —PRC RMB251,332,832 107,84651.8% —
Cash and cash equivalents acquired—17,355—
Net cash outflow from acquisition of subsidiaries—90,491—
Property management

F-45

(a) These subsidiaries are PRC limited liability companies.

(b) This subsidiary is Sino-foreign equity joint venture company established in the PRC.
F-77
CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Amounts in thousands,millions, except share data)

29.     PRINCIPAL SUBSIDIARIES,

50. AFFILIATED COMPANIES AND JOINTLY CONTROLLED ENTITIES

     Details

The particulars of the Company’sGroup’s principal subsidiaries, affiliated companies and jointly controlled entities as of December 31, 20032006 are as follows:
             
    Attributable  
  Place of equity interest
  
  establishment Direct Indirect Principal
Name of company
 /operation
 %
 %
 activities
Subsidiaries
            
Guangxi Airlines Company Limited PRC  60   —  Airline
Southern Airlines Group Shantou Airlines Company Limited PRC  60   —  Airline
Zhuhai Airlines Company Limited PRC  60   —  Airline
Guizhou Airlines Company Limited PRC  60   —  Airline
Xiamen Airlines Company Limited PRC  60   —  Airline
Guangzhou Nanland Air Catering Company Limited PRC  51   —  Air catering
Affiliated companies
            
Southern Airlines Group Finance Company Limited PRC  32   15.42  Provision of financial services
Sichuan Airlines Corporation Limited PRC  39   —  Airline
Jointly controlled entities
            
Guangzhou Aircraft Maintenance Engineering Company Limited (Note) PRC  50   —  Provision of aircraft repair and maintenance services
MTU Maintenance Zhuhai Co. Ltd. PRC  50   —  Provision of engine repair and maintenance services
China Postal Airlines Limited PRC  49   —  Airline
Zhuhai Xiang Yi Aviation Technology Company Limited PRC  51   —  Provision of flight simulation services

Note: Guangzhou Aircraft Maintenance Engineering Company Limited has been reclassified from an affiliated company to a jointly controlled entity since 2003 due to a change in the composition of its shareholders in 2003.

     Certain of the Company’s subsidiaries, affiliated companies and

      Proportion of ownership interest held by     
Name of company  Place of establishment/ operation  Group’s effective interest  The Company  subsidiaries  Principal activities 
                 
Guangzhou Aircraft Maintenance Engineering Company Limited (a),(b)PRC
50%
 
 50%
 
-
Provision of aircraft repair and maintenance services
                 
China Southern Airlines Group Finance Company Limited
PRC
34%
 
21.1%
 
12.9%
 
 Provision of financial services
                 
Sichuan Airlines Corporation Limited
PRC
39%
 
39%
 
-
Airline 
                 
MTU Maintenance Zhuhai Co. Ltd (a) 
PRC
50%
 
50%
 
-
Provision of engine repair and maintenance services
 
                 
China Postal Cargo Airlines Limited (a)
PRC
 
49%
 
49%
 
-
Airline
 
                 
Zhuhai Xiang Yi Aviation Technology Company Limited (a)
PRC
51%
 
51%
 
-
Provision of flight simulation services
 
                 
Beijing Southern Airlines Ground Services Company Limited (a)
PRC
50%
 
50%
 
-
Provision of airport ground services
 
(a) These are jointly controlled entities areentities.

(b) This jointly controlled entity is PRC joint ventures which have limited liveslife pursuant to the PRC law.

F-46

F-78

CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Amounts in thousands,millions, except share data)

30.     SEGMENTAL INFORMATION

     The Group operates primarily as a single business segment for the provision of air transportation services. Geographic information about the Group’s operating revenue and income are as follows:

                 
  Domestic
 Hong Kong
 International*
 Total
  RMB RMB RMB RMB
Year ended December 31, 2001
                
Traffic revenue  12,924,892   1,182,492   2,354,148   16,461,532 
Other revenue  359,895   58,231   —   418,126 
   
 		   
 		   
 		   
 		 
   13,284,787   1,240,723   2,354,148   16,879,658 
   
 		   
 		   
 		   
 		 
Operating income  1,090,154   219,686   90,833   1,400,673 
   
 		   
 		   
 		   
 		 
Year ended December 31, 2002
                
Traffic revenue  13,197,589   1,118,695   3,165,608   17,481,892 
Other revenue  485,046   —   51,682   536,728 
   
 		   
 		   
 		   
 		 
   13,682,635   1,118,695   3,217,290   18,018,620 
   
 		   
 		   
 		   
 		 
Operating income  1,614,975   193,440   217,662   2,026,077 
   
 		   
 		   
 		   
 		 
Year ended December 31, 2003
                
Traffic revenue  13,086,939   807,677   3,070,184   16,964,800 
Other revenue  436,122   —   69,201   505,323 
   
 		   
 		   
 		   
 		 
   13,523,061   807,677   3,139,385   17,470,123 
   
 		   
 		   
 		   
 		 
Operating income / (loss)  440,158   (29,210)  44,781   455,729 
   
 		   
 		   
 		   
 		 

*Asian market accounted for approximately 75%, 70% and 70%, respectively, of the Group’s total international traffic revenue for the years ended December 31, 2001, 2002 and 2003. The remaining portion was mainly derived from the Group’s flights to/from European and North American regions.

     The major revenue-earning assets of the Group are its aircraft fleet, most of which are registered in the PRC. Since the Group’s aircraft fleet is employed flexibly across its route network, there is no suitable basis of allocating such assets to geographic segments. Substantially all of the Group’s non-aircraft identifiable assets are located in PRC.

F-47

CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Amounts in thousands, except share data)

31.     SUBSEQUENT EVENTS

     In April 2004, the Company entered into a purchase agreement with Airbus SNC for the acquisition of fifteen Airbus 320-200 aircraft and six Airbus 319-100 aircraft, scheduled for deliveries in 2005 and 2006.

32.     SUPPLEMENTARY INFORMATION

     Movements in allowance for doubtful accounts comprise:

             
  Year ended December 31,
  2001
 2002
 2003
  RMB RMB RMB
Balance at beginning of year  72,644   59,019   60,118 
Provision for doubtful accounts (Note 9)  1,729   1,304   12,031 
Doubtful accounts written-off  (15,354)  (205)  (2,152)
   
 		   
 		   
 		 
Balance at end of year (Note 12)  59,019   60,118   69,997 
   
 		   
 		   
 		 

33.51. SIGNIFICANT DIFFERENCES BETWEEN IFRS AND U.S. GAAP


The Group’s accounting policies conform with IFRSIFRSs which differ in certain materialsignificant respects from U.S. GAAP. Information relating to the nature and effect of such differences areis set out below.


(a) CNA/XJA Acquisitions

As disclosed in Note 37(c) to the consolidated financial statements prepared under IFRSs, the Group acquired the airline operations and certain related assets and liabilities of CNA and XJA with effect from December 31, 2004. Under IFRSs, the purchase method of accounting was applied to such business combination such that at December 31, 2004 only the acquired assets and assumed liabilities are included in the consolidated financial statements of the Group. The results of the acquired operations and their related cash flows were included in the consolidated financial statement of the Group beginning January 1, 2005.

Under U.S. GAAP, such transaction is considered to be “a combination of entities under common control”. A combination of entities under common control is accounted for in a manner similar to a “pooling-of-interests”. Consequently, the assets and liabilities of CNA and XJA are reflected at their historical net asset carrying values and the U.S. GAAP consolidated financial statements of the Group are restated to include the historical carrying values of assets and liabilities of CNA and XJA, and their results of operations and cash flows for all the periods presented.

(b) Sale and leaseback accounting


Under IFRS,IFRSs, gains on sale and leaseback transactions where the subsequent lease is an operating lease are recognized as income immediately, if the transactions are established at fair value. Differences between the sale price and fair value are deferred and amortized over the period for which the assets are expected to be used. Under U.S. GAAP, such gains are deferred and amortized over the term of the lease.

(b)


(c) Lease arrangements


As disclosed in Note 1320 to the consolidated financial statements, during 2002 and 2003, the Group entered into two separate arrangements with certain independent third parties under which the Group sold aircraft and then immediately leased back the aircraft for a pre-determined period.

As a result of the lease arrangements, the Group received a net cash benefit of RMB51,682RMB52 and RMB69,121RMB69 in 2002 and 2003, respectively, which has beenwere recognized as income under IFRS.IFRSs. Under U.S. GAAP, such benefits are deferred and amortized over the minimum lease period.

F-48

CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Amounts in thousands, except share data)

In addition, under the lease arrangements, the commitments by the Group to make long-term lease payments have beenare defeased by the placement of security deposits. As such, under IFRS,IFRSs, such commitments and deposits are not recognized on the consolidated balance sheets. Under U.S. GAAP, such commitments and deposits amounting to RMB1,322,843RMB2,376 and RMB2,409,252RMB2,272 as of December 31, 20022005 and 2003,2006, respectively, would be recognized on the consolidated balance sheets, as such commitments are not deemed as extinguished by the placement of security deposits.

(c)

F-79
CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Amounts in millions, except share data)
(d) Capitalized interest


Under IFRS,IFRSs, the Group capitalizes interest costs to the extent the related borrowings are directly attributable to the acquisition or construction of an asset.


Under U.S. GAAP, interest costs capitalized are determined based on specific borrowings related to the acquisition or construction of an asset, if an entity’s financing plans associate a specific new borrowing with a qualifying asset. If average accumulated expenditures for the asset exceed the amounts of specific new borrowings associated with the asset, additional interest costs capitalized are based on the weighted average interest rate applicable to other borrowings of the entity.

(d)


(e) Revaluation of fixed assets

property, plant and equipment


In connection with the Reorganization in 1996, the fixed assetsproperty, plant and equipment of the Group were revalued as of December 31, 1996 (see Notes 12 and 1320 to the consolidated financial statements). Such fixed asset revaluation resulted in an increase in shareholders’ equity with respect to the increase in carrying amount of certain fixed assetsproperty, plant and equipment above their historical cost bases, while a charge to the consolidated statement of operations was recorded with respect to the reduction in carrying amount of certain fixed assetsproperty, plant and equipment below their historical cost bases. In addition, the revalued fixed assetproperty, plant and equipment amounts serve as the tax bases of fixed assetsproperty, plant and equipment for years beginning in 1997. Accordingly, the fixed asset revaluation eliminated certain of the temporary differences which gave rise to a deferred tax asset as of December 31, 1996. Such tax asset was offset against the revaluation surplus.

Under U.S. GAAP, fixed assetsproperty, plant and equipment are stated at their historical cost unless an impairment loss has been recorded. An impairment loss on fixed assetsproperty, plant and equipment is recorded under U.S. GAAP if the carrying amount of such asset exceeds its future undiscounted cash flows, excluding finance costs. The future undiscounted cash flows, excluding finance costs, of the Group’s fixed assetsproperty, plant and equipment whose carrying amount was reduced in connection with the Reorganization, exceed their historical cost carrying amount and, therefore, impairment of such assets is not appropriate under U.S. GAAP. Accordingly, the revaluation reserve recorded directly to shareholders’ equity and the charge recorded under IFRSIFRSs in 1996 and the additional depreciation charges recorded in the seven years ended December 31, 2003, as a result of the Reorganization are reversed for U.S. GAAP purposes.


However, as a result of the tax deductibility of the net revaluation reserve, a deferred tax asset related to the reversal of the net revaluation reserve is created under U.S. GAAP with a corresponding increase in shareholders’ equity as of December 31, 1996. Such deferred tax asset will be reversed upon depreciation of the net revaluation surplus included in the fixed assetsproperty, plant and equipment beginning 1997.

F-49


The net revaluation surplus was fully depreciated and the related deferred tax asset recorded was fully reversed in 2004.
F-80

CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Amounts in thousands,millions, except share data)

(e)

(f) Investments in affiliated company and jointly controlled entity


During 2002, the Group invested in an affiliated company and a jointly controlled entity, which were PRC state-owned enterprises. Under IFRS,IFRSs, such investments are initially recorded on a fair value basis at the cost of purchases borne by the Group. In the consolidated statements of operations,income, the equity share of results of the investees are measured based on the fair value of underlying net assets determined on the datedates of acquisitions.


Under U.S. GAAP, such transactions would beare considered to be “combinations of businesses under common control”. Under U.S. GAAP,Consequently, such investments are initially recorded at the Group’s equity share of net assets of the investees determined on a historical cost basis. The differences between such amounts and the cost of purchases are reflected as movements in the shareholders’ equity. In the consolidated statementsstatement of operations, the equity share of results of the investees are measured based on the historical cost basis.

(f)     Acquisition of subsidiaries from CSAHC

     During 2002,

(g) Minority interests

Under IFRSs, minority interests at the Group acquired 90%balance sheet date are presented in the consolidated balance sheet within equity, interest in certain subsidiaries from CSAHC. Under IFRS, the purchase method of accounting was applied to such business combination such that asseparately from the dateequity attributable to the equity shareholders of combination,the Company, and minority interests in the results of the acquired subsidiaries and their assets and liabilitiesGroup for the year are includedpresented in the consolidated financial statementsstatement of operations as an allocation of the Group.

total net income/(loss) for the year between the minority interests and the equity shareholders of the Company. Under U.S. GAAP, such transaction would be considered to be “a combination of entities under common control”. Under U.S. GAAP, combination of entities under common controlminority interests at the balance sheet date are accounted for under the “as if pooling-of-interests method” where assets and liabilities are accounted for at historical cost and financial statements of previously separate entities for periods prior to the combination generally are restated on a combined basis. The effect of this difference was not material to the years presented.

(g)     Provision for major overhauls

     As disclosedpresented in Notes 2(r) and 6 to the consolidated financial statements prepared under IFRS,balance sheet either as liabilities or separately from liabilities and equity. Minority interests in respectthe results of aircraft held under operating leases, a provision is made over the lease termGroup for the estimated costyear are also separately presented in the consolidated statement of scheduled overhauls required to be performed on the related aircraft prior to their return to the lessors.

     Under U.S. GAAP,operations as a liability would be recorded at the outsetcomponent of the operating leases for the fair value of contractual obligations to perform the overhauls and a deferred asset would be recorded for the corresponding amount, which would be amortized over the term of the operating leases. The carrying amounts of such liability and asset would amount to approximately RMB486,660 and RMB292,773 respectively as of December 31, 2002 and RMB569,860 and RMB369,679 respectively as of December 31, 2003.

     The effect of above difference on the net income/(loss) and shareholders’ equity reported under U.S. GAAP was not material to the years presented.

.

F-81
CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Amounts in millions, except share data)
(h) Financial statements presentation and disclosure

(i) (Loss)/gain on sale of property, plant and equipment

In the consolidated statementsstatement of operations presented under IFRS,IFRSs, (loss)/gain on sale of fixed assetsproperty, plant and equipment is classified under “Non-operating income/(expenses)”. Under U.S. GAAP, such (loss)/gain would beis classified under “Operating income/(expenses) —expenses - General and administrative”.


(ii) Classification of short-term obligations expected to be refinanced

As described in Note 44(a)(i) to the consolidated financial statements prepared under IFRSs, the short-term notes payable included certain notes payable of RMB4,170 which were refinanced subsequent to December 31, 2006. The maturity of these notes payable is extended for twelve months to a date after December 31, 2007.

Under U.S. GAAP, such short-term obligations which were refinanced on a long-term basis after the balance sheet date but before issuance of financial statements are classified as non-current liabilities. Consequently, under U.S. GAAP, short-term notes payable and consolidated net current liabilities at December 31, 2006 would be RMB19,652 and RMB28,010, respectively.

(iii) Presentation of dividends received in the consolidated statement of cash flows

In the consolidated statement of cash flows presented under IFRSs, dividends received are classified within investing activities. Under U.S. GAAP, such dividends received are classified within operating activities.

(iv) Presentation of cash flows from purchases, sales and maturities of trading securities in the consolidated statement of cash flows

In the consolidated statements of cash flows presented under IFRSs, cash flows from purchases, sales and maturities of trading securities are classified within investing activities. Under U.S. GAAP, such cash flows are classified within operating activities.

(v) Deferred tax assets/liabilities

As disclosed in Note 2025 to the consolidated financial statements, deferred tax assets are presented on a net basis under IFRS.IFRSs. Under U.S. GAAP, the gross amounts of such deferred tax assets and any applicable valuation allowances would beare separately disclosed. As of December 31, 2002 and 2003, the amount of valuation allowances which have been netted off with

In addition, deferred tax liabilities and assets amounted to approximately RMB48,480should be classified as non-current when a classified balance sheet is presented under IFRSs. Under U.S. GAAP, an enterprise shall separate deferred tax liabilities and RMB53,000, respectively.

F-50

assets into a current amount and a non-current amount based on the classification of the related asset or liability for financial reporting.

F-82

CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Amounts in thousands,millions, except share data)

The U.S. GAAP presentation of deferred tax assets/(liabilities) as of December 31, 2005 and 2006 are as follows:
  
December 31,
 
  
2005
 
2006
 
  
RMB
 
RMB
 
Deferred tax assets:     
Tax losses  347  153 
Repair charges capitalized  264  203 
Accrued expenses  175  465 
Others  29  38 
Total deferred tax assets  815  859 
Less: valuation allowance  (188) (153)
   627  706 
Deferred tax liabilities:       
Accrued expenses  58  105 
Depreciation allowances in excess of the related depreciation  832  878 
Others  16  - 
Total deferred tax liabilities  906  983 
   (279) (277)
Representing:       
        
Deferred tax assets - current portion  60  234 
Deferred tax assets - non-current portion  3  - 
Deferred tax liabilities - current portion  (57) (43)
Deferred tax liabilities - non-current portion  (285) (468)
   (279) (277)
The valuation allowance was RMB53 as of January 1, 2004. During the years ended December 31, 2004, 2005 and 2006, the valuation allowance increased by RMBNil, RMB135 and decreased by RMB35, respectively.
F-83
CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Amounts in millions, except share data)
(i) NewRecently issued accounting standards

(i) SAB 108

In September 2006, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 108 (“SAB 108”) which addresses how the effects of prior-year uncorrected misstatements should be considered when quantifying misstatements in current-year financial statements. SAB 108 requires registrants to quantify misstatements using both the balance-sheet and income-statement approaches and to evaluate whether either approach results in quantifying an error that is material in light of relevant quantitative and qualitative factors. SAB 108 is effective for fiscal years ending after November 15, 2006. The adoption of SAB 108 in 2006 did not have any impact on the Group’s consolidated financial statements.

(ii) SFAS No. 157

In September 2006, the FASB issued SFAS No. 157 “Fair Value Measurements” which defines fair value, provides a framework for measuring fair value, and expands the disclosures required for fair value measurements. SFAS No. 157 applies to other accounting pronouncements

that require fair value measurements and does not require any new fair value measurements. SFAS No. 157 is effective for fiscal years beginning after November 15, 2007. Currently, the Group does not expect the adoption of SFAS No. 157 will have a material impact on its consolidation financial statements.


(iii) FIN 46R

No. 48


In December 2003,June 2006, the FASB issued FASB Interpretation No. 46 (revised December 2003) “Consolidation48 “Accounting for Uncertainty in Income Taxes - an interpretation of Variable Interest Entities” which addresses how a business enterprise should evaluate whether it has a controlling financial interestSFAS No. 109” (“FIN 48”). FIN 48 requires that the Group recognizes 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 Group 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 noncontrolling interests of the VIE initially would be measured at their carrying amounts with any difference between the net amount added to the consolidated balance sheets 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 used to measure the assets, liabilities and noncontrolling interest of the VIE. The Group is evaluatingfinancial statements the impact of applyinga tax position, if that position is more likely than not of being sustained upon examination, based on the technical merits of the position. FIN 46R to existing VIEs in which it has variable interests and has not yet completed this evaluation.

FASB No. 150

     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 Group, 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 Statement48 will be effective for the Group on January 1, 2005. The effective date has been deferred indefinitely for certain other types of mandatorily redeemable financial instruments.first fiscal year beginning after December 15, 2006. The Group is currently doesevaluating the impact of adopting FIN48 on its results of operations and financial position.


(iv) FSP AUG AIR-1

In September 2006, the FASB issued FASB Staff Position No. AUG AIR-1, “Accounting for Planned Major Maintenance Activities” (“FSP AUG AIR-1”). This guidance prohibits the use of the accrue-in-advance method of accounting for planned major overhaul activities because an obligation has not have anyoccurred and therefore a liability should not be recognized. FSP AUG AIR-1 will be effective for the first fiscal year beginning after December 15, 2006. The Group is in the process of assessing the impact of adopting FSP AUG AIR-1 on its results of operations and financial instruments that are within the scope of this Statement.

F-51

position.

F-84

CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Amounts in thousands,millions, except share data)

In respect of aircraft held under operating leases, major overhauls are required to be performed on the aircraft during the period of the leases (“regular major overhauls”) and upon return of the aircraft. The Group’s current policy under both IFRSs and U.S. GAAP is to accrue for estimated costs of regular major overhauls over the estimated period between overhauls in respect of these aircraft. After the aircraft has completed its last regular major overhaul, the expected cost of overhaul to be incurred at the end of the lease is estimated and accrued over the remaining period of the lease. As a result of FSP AUG AIR-1, the Group intends to change its policy under U.S. GAAP to the direct expense method for accounting for the regular major overhauls in respect of these aircraft. Accordingly, the Group anticipates that due to the prohibition by FSP AUG AIR-1 of accrual of cost of major overhauls before the maintenance is performed, under U.S. GAAP the provision of RMB219 at December 31, 2006 will be reversed upon adoption of FSP AUG AIR-1 through a prior period adjustment.

Effect on net income/(loss) of significant differences between IFRSIFRSs and U.S. GAAP is as follows:
                     
  Reference Year ended December 31,
  in Note        
  above
 2001
 2002
 2003
 2003
      RMB RMB RMB U.S. dollars
Net income/(loss) under IFRS      340,225   575,761   (358,267)  (43,286)
U.S. GAAP adjustments:                    
Sale and leaseback accounting  (a)  54,254   (100,664)  114,635   13,850 
Lease arrangements  (b)  —   (49,960)  (64,140)  (7,749)
Capitalized interest  (c)  18,000   (31,473)  (32,961)  (3,982)
Reversal of additional depreciation arising from revaluation of fixed assets  (d)  65,000   33,000   33,000   3,987 
Investments in affiliated company and jointly controlled entity  (e)  3,546   (541)  7,044   851 
Deferred tax effects                    
- current year      (50,369)  47,849   (7,580)  (916)
- effect on change in income tax rate on deferred taxation      —   —   (51,368)  (6,206)
       
 		   
 		   
 		   
 		 
Net income/(loss) under U.S. GAAP      430,656   473,972   (359,637)  (43,451)
       
 		   
 		   
 		   
 		 
Basic earnings/(loss) per share under U.S. GAAP      0.13   0.14   (0.09)  (0.01)
       
 		   
 		   
 		   
 		 
Basic earnings/(loss) per ADS under U.S. GAAP*      6.38   7.02   (4.69)  (0.57)
       
 		   
 		   
 		   
 		 

*Basic earnings/(loss) per ADS is calculated on the basis that one ADS is equivalent to 50 H shares.

   
Reference
  
Year ended December 31,
 
   
in Note
  
2004
  
2005
  
2006
 
   
above
  
RMB
  
RMB
  
RMB
 
(Loss)/income attributable to the equity shareholders             
of the Company under IFRSs     (48) (1,786) 126 
U.S. GAAP adjustments:             
Net income before tax attributable to             
acquisition of airlines operations of             
CNA and XJA  (a) 354  159  74 
Sale and leaseback accounting  (b) 115  115  86 
Lease arrangements  (c) 7  7  7 
Capitalized interest  (d) (13) (9) (35)
Reversal of additional depreciation arising from             
revaluation of property, plant and equipment  (e) 13  -  - 
Investments in affiliated company and             
jointly controlled entity  (f) 7  7  (14)
Deferred tax effects             
- current year     (16) (17) (11)
- effect on the change in the Company's income tax rate     -  -  1 
- tax effect of acquisition of airline             
operations of CNA and XJA     (81) (23) (25)
- effect on the change in income tax rate applicable             
to airline operations of CNA and XJA     (99) 79  7 
Net income/(loss) under U.S. GAAP     239  (1,468) 216 
              
Basic and diluted earnings/(loss) per share under U.S. GAAP     0.05  (0.34) 0.05 
              
Basic and diluted earnings/(loss) per ADS under U.S. GAAP *     2.50  (17.00) 2.50 
* Basic earnings/(loss) per ADS is calculated on the basis that one ADS is equivalent to 50 H shares.
F-85
CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Amounts in millions, except share data)
Effect on shareholders’ equity of significant differences between IFRSIFRSs and U.S. GAAP is as follows:
                 
  Reference December 31,
  in Note      
  above
 2002
 2003
 2003
      RMB RMB U.S. Dollars
Shareholders’ equity under IFRS      9,613,207   11,895,707   1,437,252 
U.S. GAAP adjustments:                
Sale and leaseback accounting  (a)  (586,989)  (472,354)  (57,070)
Lease arrangements  (b)  (49,960)  (114,100)  (13,786)
Capitalized interest  (c)  381,021   348,060   42,053 
Revaluation of fixed assets, net of depreciation  (d)  (46,120)  (13,120)  (1,585)
Investments in affiliated company and jointly controlled entity  (e)  (118,003)  (110,959)  (13,406)
Deferred tax effects      94,175   35,227   4,256 
       
 		   
 		   
 		 
Shareholders’ equity under U.S. GAAP      9,287,331   11,568,461   1,397,714 
       
 		   
 		   
 		 

F-52

  
Reference
 
December 31,
 
  
in Note
 
2005
 
2006
 
  
above
 
RMB
 
RMB
 
        
Total shareholders' equity under IFRSs     11,998  12,121 
U.S. GAAP adjustments:          
Shareholders' equity effect attributable          
to airline operations of CNA and XJA  (a) (372) (298)
Sale and leaseback accounting  (b) (242) (156)
Lease arrangements  (c) (100) (93)
Capitalized interest  (d) 326  291 
Investments in affiliated company and          
jointly controlled entity  (f) (97) (111)
Deferred tax asset effect on acquisition of airlines          
operations of CNA and XJA     122  104 
Deferred tax effects     2  (8)
Minority interest  (g) (1,936) (1,933)
Net shareholders' equity under U.S. GAAP     9,701  9,917 

Movement of changes in total shareholders’ equity under U.S. GAAP is as follows:

RMB
Shareholders' equity at January 1, 200413,098
Net income239
Net assets distributed to CSAHC (note a)(28)
Elimination of net deferred tax assets (note b)(181)
Distributions to CSAHC(1,959)
Shareholders' equity at December 31, 200411,169
Net loss(1,468)
Shareholders' equity at December 31, 20059,701
Net income216
Shareholders' equity at December 31, 20069,917
Notes:
(a) In connection with the CNA/XJA Acquisitions, certain assets and liabilities of CNA and XJA which were not to be acquired by the Company were transferred during 2004 to CSAHC, the owner of CNA and XJA.

(b) As a result of the CNA/XJA Acquisitions, the tax losses attributable to the airline operations of CNA and XJA are no longer available for utilization against future taxable income of such operations. Accordingly, the deferred tax assets arising from such tax losses and related valuation allowance were eliminated against equity.

F-86

CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Amounts in millions, except share data)
The following are condensed consolidated statement of operations, cash flows and changes in total shareholders’ equity under U.S. GAAP for the year ended December 31, 2004 and additional financial information restated to reflect the impact of the effects of the combination of CNA and XJA and the Group in a manner similar to a pooling of interests prepared on a U.S. GAAP basis. As the CNA/XJA Acquisitions were completed on December 31, 2004, condensed consolidated balance sheets under U.S. GAAP at December 31, 2005 and 2006 and condensed consolidated statements of income, cash flows and changes in total shareholders’ equity under U.S. GAAP for each of the years ended December 31, 2005 and 2006 are not presented in these consolidated financial statements.

Condensed consolidated statement of operations
Year ended
December 31, 2004
RMB
Operating revenue
Traffic revenue33,235
Other operating revenue930
Total operating revenue34,165
Operating expenses
Flight operations15,016
Maintenance4,578
Aircraft and traffic servicing4,789
Promotion and sales2,606
General and administrative1,759
Depreciation and amortization3,523
Others17
Total operating expenses32,288
Operating income1,877
Non-operating income/(expenses):
Interest income33
Interest expense(1,184)
Equity income of affiliated companies15
Equity loss of jointly controlled entities(14)
Exchange loss, net(124)
Others, net90
Total net non-operating expenses(1,184)
Income before taxation693
Income tax expense(261)
Income for the year432
Attributable to
Equity shareholders of the Company239
Minority interests193
Net income432
F-87

CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Amounts in millions, except share data)
Condensed consolidated statement of cash flows

The Group applies IAS 7 “Cash Flow Statements”. Its objectives and principles are similar to those set out in Statement of Financial Accounting Standards No. 95, “Statement of Cash Flows” (“SFAS 95”) for U.S. GAAP. The principal differences between the standards relate to classification. Dividend received classified as investing activities under IAS 7 are classified as operating activities under SFAS 95. Summarized cash flows data by operating, investing and financing activities in accordance with SFAS 95 are as follows:

Year ended
December 31, 2004
RMB
Net cash inflow/(outflow) from
Operating activities5,419
Investing activities(9,507)
Financing activities4,172
Increase in cash and cash equivalents84
Cash and cash equivalents at January 12,999
Cash and cash equivalents at December 313,083

F-88

CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Amounts in millions, except share data)
The following additional financial statement disclosures are required under U.S. GAAP and are presented on a U.S. GAAP basis.

Operating revenue

Year ended
December 31, 2004
RMB
Traffic revenue
Passenger30,443
Cargo and mail2,792
33,235
Other operating revenue
Commission income227
General aviation income55
Ground services income202
Air catering income53
Rental income45
Aircraft lease income145
Maintenance services income23
Utility services income28
Other152
930
Total operating revenue
34,165

F-89

CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Amounts in millions, except share data)
Income tax

The Company was subject to PRC income tax at 15% for the year ended December 31, 2004.
The airline operations of CNA and XJA were subject to PRC income tax at 33% during the year ended December 30, 2004. As a result of the CNA/XJA Acquisitions having been effective December 31, 2004, the airline operations of CNA and XJA have become divisions of the Company and were subject to PRC income tax at the applicable rate of 15% at December 31, 2004.

Taxation (expense)/benefit consisted of:

Year ended
December 31, 2004
RMB
PRC income tax(259)
Deferred tax
- current year97
- adjustment for change in applicable tax rate for
airline operations of CNA and XJA(99)
(261)
Additional income tax was allocated as follows:
Shareholders' equity, for elimination of deferred tax assets of the
airline operations of CNA and XJA no longer available(181)
F-90

CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Amounts in millions, except share data)
Actual taxation amount in the consolidated statement of operations for the year ended December 31, 2004 differed from the amounts computed by applying the PRC income tax rate of 15% to income before taxation as a result of the following:
Year ended
December 31, 2004
RMB
Expected PRC expense(104)
Adjustments:
Effect of change in the income tax rate applicable to
the airline operations of CNA and XJA(99)
Rate differential on subsidiaries3
Rate differential on airline operations of CNA and XJA(43)
Non-deductible expenses(37)
Increase in deferred tax valuation allowance(4)
Non-taxable income17
Effect of share of results of affiliated companies and
jointly controlled entities12
Others, net(6)
(261)
All but an insignificant amount of income before taxation is from domestic sources.
Related party transactions

In addition to the material related party transactions disclosed in Note 37, the Group and the airline operations of CNA and XJA had entered into the following material related party transactions.

(a) For the year ended December 31, 2004, repairing charges of RMB1,159 was incurred by the Group and the airline operations of CNA and XJA in connection with aircraft repair and maintenance services rendered by GAMECO and MTU Zhuhai. GAMECO and MTU Zhuhai are jointly controlled entities of the Company.

(b) Operating lease charges of RMB82 were paid by the Group and the airline operations of CNA and XJA to CSAHC under lease arrangement for certain land and buildings in the PRC for the year ended December 31, 2004.

(c) Aircraft lease income of RMB111 for the year ended December 31, 2004, represents rental receivables in respect of short term leasing of aircraft by the Group and the airline operations of CNA and XJA to certain airlines controlled by the CSAHC.

F-91
CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Amounts in millions, except share data)
Post-retirement benefit

Employees of the Group and the airline operations of CNA and XJA participate in several defined contribution retirement schemes organized separately by PRC municipal governments in regions where the major operations of the Group and the airline operations of CNA and XJA are located. The Group and the airline operations of CNA and XJA are required to contribute to these schemes at certain rates of salary costs including certain allowances. A member of the retirement schemes is entitled to pension benefits equal to a fixed proportion of the salary at the retirement date. The retirement benefit obligations of all the existing and future retired staff are assumed by these schemes. Contributions to the retirement schemes are charged to consolidated statements of income as and when incurred. Contributions to the retirement schemes amounted to RMB243 during the year ended December 31, 2004.

F-92
ITEM 19. EXHIBITS.
Exhibit No.
Description of Exhibit
1.1Amended Articles of Association of China Southern Airlines Company Limited
4.1Form of Director’s Service Agreement (Incorporated by reference to the Exhibit 4.1 to our Form 20-F (File No. 001-14660) for the year ended December 31, 2005 filed with the Securities and Exchange Commission on June 30, 2006)
4.2Form of Non-Executive Director’s Service (Incorporated by reference to the Exhibit 4.2 to our Form 20-F (File No. 001-14660) for the year ended December 31, 2005 filed with the Securities and Exchange Commission on June 30, 2006)
8.1Subsidiaries of China Southern Airlines Company Limited
10.1Airbus Aircraft Acquisition Agreement entered into between China Southern Airlines Company Limited and Airbus dated July 6, 2006 (Incorporated by reference to the Exhibit 99.1 to our Form 6-K (File No. 001-14660) filed with the Securities and Exchange Commission on July 11, 2006)
10.2Boeing Aircraft Acquisition Agreement entered into between China Southern Airlines Company Limited and Boeing dated October 13, 2006 (Incorporated by reference to the Exhibit 99.1 to our Form 6-K (File No. 001-14660) filed with the Securities and Exchange Commission on October 17, 2006)
10.3Xiamen Aircraft Acquisition Agreement entered into between Xiamen Airlines and Boeing dated October 13, 2006 (Incorporated by reference to the Exhibit 99.1 to our Form 6-K (File No. 001-14660) filed with the Securities and Exchange Commission on October 17, 2006)
12.1Section 302 Certification of Chairman
12.2Section 302 Certification of President
12.3Section 302 Certification of Chief Financial Officer
13.1Section 906 Certification of Chairman
13.2Section 906 Certification of President
13.3Section 906 Certification of Chief Financial Officer
78
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.
 CHINA SOUTHERN AIRLINES COMPANY LIMITED
  
CHINA SOUTHERN AIRLINES COMPANY LIMITED
(Registrant)
  /s/ Liu Shao Yong
  
Name: Liu Shao Yong
 /s/ Yan Zhi Qing
                    Name: Yan Zhi Qing
Title: Chairman of the Board of Directors

Date: June 30, 2004

29, 2007

79

EXHIBIT INDEX
Exhibit No.
 
Description of Exhibit
Exhibit No.1.1 Description of Exhibit
1Amended Articles of Association of China Southern Airlines Company Limited
   
4.1 Form of Director’s Service Agreement (Incorporated by reference to the Exhibit 4.1 to our Form 20-F (File No. 001-14660) for the year ended December 31, 2005 filed with the Securities and Exchange Commission on June 30, 2006)
   
4.2 Form of Non-Executive Director’s Service Agreement (Incorporated by reference to the Exhibit 4.2 to our Form 20-F (File No. 001-14660) for the year ended December 31, 2005 filed with the Securities and Exchange Commission on June 30, 2006)
   
88.1 Subsidiaries of theChina Southern Airlines Company Limited
 
10.1Airbus Aircraft Acquisition Agreement entered into between China Southern Airlines Company Limited and Airbus dated July 6, 2006 (Incorporated by reference to the Exhibit 99.1 to our Form 6-K (File No. 001-14660) filed with the Securities and Exchange Commission on July 11, 2006)
10.2Boeing Aircraft Acquisition Agreement entered into between China Southern Airlines Company Limited and Boeing dated October 13, 2006 (Incorporated by reference to the Exhibit 99.1 to our Form 6-K (File No. 001-14660) filed with the Securities and Exchange Commission on October 17, 2006)
10.3Xiamen Aircraft Acquisition Agreement entered into between Xiamen Airlines and Boeing dated October 13, 2006 (Incorporated by reference to the Exhibit 99.1 to our Form 6-K (File No. 001-14660) filed with the Securities and Exchange Commission on October 17, 2006)
12.1 Section 302 Certification of Chairman
 
12.2 Section 302 Certification of President
 
12.3 Section 302 Certification of Chief Financial Officer
 
13.1 Section 906 Certification of Chairman
 
13.2 Section 906 Certification of President
 
13.3 Section 906 Certification of Chief Financial Officer

80