As filed with the Securities and Exchange Commission on June 30, 200529, 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, 2004
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
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 ordinary A Shares of par value RMB1.00RMB 1.00 per share were issued and outstanding as of December 31, 2004.2006.
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 17o Item 17 þ Item 18Item 18x

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

China Southern Airlines Company Limited

 
Page
Forward-Looking StatementsPage2
Introductory Note
2
Forward-Looking Statements
1
Introductory Note
1
Glossary of Airline Industry Terms
2
PART I
2 
PART I
Item 1. Identity of Directors, Senior Management and Advisers
3
4
Item 2. Offer Statistics and Expected Timetable
3
4
Item 3. Key Information
3
4
Selected Financial Data
3
4
Capitalization and Indebtedness
6
8
Reasons for the Offer and Use of Proceeds
6
8
Risk Factors
Risk Factors
8
7
Item 4. Information on the Company
11
12
History and Development of the Company
11
12
Capital Expendition
CNA/XJA Acquisitions
13
Business Overview
Business Overview
13
12
Organizational Structure
Organizational Structure
28
33
Property, Plant and Equipment
35
29
Item 5. Operating and Financial Review and Prospects
36
30
Critical Accounting Policies
36
31
Overview
Overview
32
37
Certain Financial Information and Operating Data by Geographic Region
39
33
Operating Results
Operating Results
34
41
Additional Information under U.S. GAAP
38
Liquidity and Capital Resources
48
42
Contractual Obligations and Commercial Commitments
50
44
Item 6. Directors, Senior Management and Employees
51
44
Directors and Senior Management
51
44
Compensation
Compensation
48
56

i

Board Practices
49
Remuneration CommitteePage
50
Employees
50
Share Ownership
Board Practices
51
56
Remuneration Committee
Employees
57
Share Ownership
58
Item 7. Major Shareholders and Related Party Transactions
58
51
Major Shareholders
Major Shareholders
51
59
Related Party Transactions
59
51
Interests of Experts and Counsel
56
Item 8. Financial Information
64
56
Consolidated Statements and Other Financial Information
64
56
Significant Changes
Significant Changes
56
64
Dividend Information
Legal Proceedings Dividend Information
57
Item 9. The Offer and Listing
65
57
Offer and Listing Details
66
57
Plan of Distribution
66
58
Markets
Markets
58
67
Selling Shareholders
Selling Shareholders
58
67
Dilution
Dilution
58
67
Expenses of the Issue
67
59
Item 10. Additional Information
67
59
Share Capital
Share Capital
59
67
Memorandum and Articles of Association
59
Material Contracts
62
Exchange Controls67
64
Taxation
65

 
Material ContractsPage
71
Exchange Controls
73
Taxation
73
Dividends and Paying Agents
74
68
Statement by Experts
74
68
Documents on Display
74
68
Subsidiary Information
Subsidiary Information
68
74
Comparison of New York Stock Exchange Corporate Governance Rules and China Corporate Governance Rules for Listed Companies
69
75
Item 11. Quantitative and Qualitative Disclosures About Market Risk
79
72
Item 12. Description of Securities other than Equity Securities
73
PART II
80

ii

       
Page
PART II
Item 13. Defaults, Dividend Arrearages and Delinquencies
80
73
Item 14. Material Modifications to the Rights of Security Holders and Use of Proceeds
73
Use of Proceeds
73
PART III
80       
Use of Proceeds
PART III
Item 15. Controls and Procedures
82
75
Item 16. [Reserved]
82
75
Item 16 A. Audit Committee Financial Expert
82
75
Item 16 B. Code of Ethics
82
76
Item 16 C. Principal Accounting Fees and Services
82
76
Item 16 D. Exemptions from the Listing Standards for Audit Committee
76
Item 16 D.E. Purchases of Equity Securities By the Issuer and Affiliated Purchasers
76
PART IV
83       
PART IV
Item 17. Financial Statements
83
76
Item 18. Financial Statements
83
76
Index to Financial Statements
82
77
Item 19. Exhibits
84
78
Signatures
79

 85EX-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 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 CFOCHIEF 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 CFOCHIEF FINANCIAL OFFICER

iii

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” 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, 2003 and 20042006 (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 3451 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 = RMB8.2765,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, 2004.2006. 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, 2004.2006. The selected data of consolidated statements of operations for each of the years in the three-year period ended December 31, 20042006 and consolidated balance sheets as of December 31, 20032005 and 20042006, 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, 20002002 and 20012003 and IFRS consolidated balance sheets of December 31, 2000, 20012002, 2003 and 20022004 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, 2006 and consolidated balance sheets as of December 31, 2002, 2003, 2004, 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 will bewas included in the consolidated financial statements 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 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 all periods presented. the years ended December 31, 2002, 2003 and 2004.  
In addition, 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 effective January 1, 2005. Please refer to Note 45 to the consolidated financial statements for details. 
See Note 3451 to the consolidated 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, 20032005 and 20042006 and for each of the years in the three-year period ended December 31, 20042006 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, 
  2000  2001  2002  2003  2004  2004 
  RMB  RMB  RMB  RMB  RMB  US$ 
  (in million, except per share data) 
Income Statement Data:
                        
IFRS:                        
Operating revenue  15,178   16,880   18,019   17,470   23,974   2,897 
Operating expenses  13,996   15,479   15,993   17,014   23,065   2,787 
Operating income  1,182   1,401   2,026   456   909   110 
Equity income of affiliated companies  46   53   37   48   12   1 
Equity loss of jointly controlled entities  —   (4)  (3)  (39)  (5)  (1)
Gain/(loss) on sale of property, plant and equipment  373   (56)  171   (22)  (1)  — 
Interest expense  (1,074)  (934)  (959)  (824)  (691)  (84)
Exchange gain/(loss), net  318   297   (176)  (164)  (59)  (7)
Other, net  86   38   43   34   68   9 
Income/(loss) before taxation and minority interest  931   795   1,139   (511)  233   28 
Taxation (expense)/credit  (339)  (320)  (398)  324   (78)  (9)
Minority interests  (90)  (135)  (165)  (171)  (203)  (25)
Net income/(loss)  502   340   576   (358)  (48)  (6)
Basic earnings/(loss) per share  0.15   0.10   0.17   (0.09)  (0.01)  (0.001)
Basic earnings/(loss) per ADS  7.44   5.04   8.53   (4.68)  (0.55)  (0.07)
Cash dividends declared per share  —   —   0.02   —   —   — 
U.S. GAAP:                        
Traffic revenue  21,859   23,615   24,854   24,897   33,235   4,016 
Other operating revenue  1,083   657   904   586   930   112 
Operating income  1,462   1,584   1,948   366   1,877   227 
Equity income of affiliated companies  46   73   45   53   17   2 
Equity loss of jointly controlled entities  —   (20)  (12)  (37)  (3)  — 
Interest expense  (1,970)  (1,800)  (1,820)  (1,604)  (1,184)  (143)
Foreign currency exchange gain/(loss), net  554   532   (327)  (381)  (124)  (15)
Other, net  153   106   30   64   123   15 
Income/(loss) before income taxes and minority interest  245   475   (136)  (1,539)  706   85 
Income tax (expense)/benefit  (309)  (408)  (365)  526   (274)  (33)
Minority interests  (53)  (97)  (154)  (127)  (193)  (23)
Net (loss)/income  (117)  (30)  (655)  (1,140)  239   29 
Basic (loss)/earnings per share  (0.034)  (0.009)  (0.194)  (0.298)  0.055   0.007 
Basic (loss)/earnings per ADS  (1.684)  (0.432)  (9.706)  (14.876)  2.732   0.331 
Cash dividend 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, 
  2000  2001  2002  2003  2004  2004 
  RMB  RMB  RMB  RMB  RMB  US$ 
  (in million) 
Balance Sheet Data:
                        
IFRS:                        
Cash and cash equivalents  4,198   2,818   3,771   2,080   3,083   373 
Other current assets  1,692   1,561   1,835   1,922   4,182   505 
Property, plant and equipment, net  23,282   22,352   26,921   28,536   46,841   5,660 
Total assets  30,924   30,653   37,188   39,062   62,228   7,519 
Notes payable, including current installments of long term notes payable  783   2,178   5,241   7,097   11,518   1,392 
Current installments of obligations under capital leases  1,776   1,452   1,567   1,298   2,144   259 
Notes payable, excluding current installments  3,789   3,628   5,835   4,522   11,935   1,442 
Obligations under capital leases, excluding current installments  9,416   7,692   6,632   5,543   9,599   1,160 
Shareholders’ equity  8,881   9,222   9,613   11,896   11,848   1,432 
U.S. GAAP:                        
Cash and cash equivalents  5,763   4,384   4,772   2,999   3,083   373 
Other current assets  3,196   3,065   3,391   3,034   4,401   532 
Property, plant and equipment, net  35,546   35,676   40,277   41,012   46,202   5,582 
Total assets  48,684   48,456   54,860   58,610   65,040   7,858 
Notes payable, including current portion of long term notes payable  3,965   5,359   10,304   8,600   11,518   1,392 
Current installments of obligations under capital leases  2,752   2,428   2,591   2,368   2,106   254 
Notes payable, excluding current portion  9,017   8,856   9,179   8,634   11,935   1,442 
Obligations under capital leases, excluding current installments  15,891   14,167   13,333   13,849   11,975   1,447 
Shareholders’ equity  7,432   7,315   6,796   13,098   11,169   1,349 

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, 20042006 have been derived from consolidated financial statements prepared in accordance with IFRS and other data provided by the Group and have not been audited.

5
The operating data and the profit analysis and comparison for other years below is calculated and disclosed in accordance with the statistical standards, which hashave 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, 
  2000  2001  2002  2003  2004 
Capacity
                    
ASK (million)                    
— Domestic  28,345   31,393   33,753   32,590   41,330 
— Hong Kong regional  1,744   1,690   1,746   1,347   1,896 
— International  5,742   6,981   8,746   6,930   10,543 
Total  35,831   40,064   44,245   40,867   53,769 
ATK (million)                    
— Domestic  3,322   3,622   3,924   3,772   4,773 
— Hong Kong regional  198   185   193   150   211 
— International  1,087   1,317   1,798   1,999   2,462 
Total  4,607   5,124   5,915   5,921   7,446 
Kilometers flown (thousand)  209,431   234,051   258,379   249,068   324,827 
Hours flown (thousand)  326   365   405   385   501 
Number of landing and take-offs                    
— Domestic  165,726   183,651   194,776   191,460   243,410 
— Hong Kong regional  14,255   13,712   13,891   11,400   15,380 
— International  8,861   10,698   13,990   11,330   15,790 
Total  188,842   208,061   222,657   214,190   274,580 
Traffic
                    
RPK (million)                    
— Domestic  16,974   19,447   22,092   21,294   29,121 
— Hong Kong regional  1,074   1,060   1,081   778   1,203 
— International  3,605   4,550   5,767   4,315   6,872 
Total  21,653   25,057   28,940   26,387   37,196 
RTK (million)                    
— Domestic  1,941   2,217   2,532   2,424   3,206 
— Hong Kong regional  107   105   108   78   120 
— International  565   712   974   1,059   1,337 
Total  2,613   3,034   3,614   3,561   4,663 
Passengers carried (thousand)                    
— Domestic  14,450   16,499   18,535   18,259   25,002 
— Hong Kong regional  1,444   1,409   1,369   1,019   1,394 
— International  957   1,213   1,589   1,192   1,811 
Total  16,851   19,121   21,493   20,470   28,207 
Cargo and mail carried (tons)  353,000   398,000   470,000   464,000   545,000 
Load Factors
                    
Passenger load factor (RPK/ASK) (%)                    
— Domestic  59.9   61.9   65.5   65.3   70.5 
— Hong Kong regional  61.6   62.7   61.9   57.8   63.4 
— International  62.8   65.2   65.9   62.3   65.2 
Total  60.4   62.5   65.4   64.6   69.2 
Overall load factor (RTK/ATK) (%)                    
— Domestic  58.4   61.2   64.5   64.2   67.2 
— Hong Kong regional  54.0   56.8   55.8   52.2   56.9 
— International  52.0   54.1   54.2   53.0   54.3 
Total  56.7   59.2   61.1   60.1   62.6 
Breakeven load factor (%)  54.0   55.6   55.9   61.6   61.9 

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, 
  2000  2001  2002  2003  2004 
Yield
                    
Yield per RPK (RMB)                    
— Domestic  0.62   0.62   0.55   0.57   0.58 
— Hong Kong regional  1.06   1.06   0.98   0.96   0.92 
— International  0.43   0.41   0.42   0.47   0.46 
Total  0.61   0.60   0.54   0.57   0.57 
Yield per cargo and mail ton kilometers (RMB)  2.13   1.76   1.73   1.62   1.67 
Yield per RTK (RMB)                    
— Domestic  5.90   5.83   5.21   5.40   5.53 
— Hong Kong regional  11.19 �� 11.26   10.36   10.35   9.83 
— International  3.63   3.31   3.25   2.90   3.31 
Total  5.63   5.43   4.84   4.76   5.01 
Fleet
                    
— Boeing  89   91   102   108   137 
— Airbus  20   20   20   24   46 
— McDonnell Douglas  —   —   —   —   35 
— Others  —   —   —   —   13 
Total aircraft in service at period end  109   111   122   132   231 
Overall utilization rate (hours per day)  8.7   9.1   9.8   8.5   9.9 
Financial
                    
Operating cost per ASK (RMB)  0.39   0.39   0.36   0.42   0.43 
Operating cost per ATK (RMB)  3.04   3.02   2.70   2.87   3.10 

5

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
                
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 
2004  8.2765   8.2765   8.2889   8.2641 

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 2004  8.2889   8.2641 
January 2005  8.2889   8.2641 
February 2005  8.2889   8.2641 
March 2005  8.2889   8.2641 
April 2005  8.2889   8.2641 
May 2005  8.2889   8.2641 
June 2005 (up to June 21, 2005)  8.2889   8.2641 

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 dividends were paid during the year ended December 31, 2004.2006. The Board of Directors of the Company (“Board of Directors”) has not recommended payment of a final dividend in respect of the year ended December 31, 2004.2006.

Capitalization and Indebtedness

Not applicable.

Reasons for the Offer and Use of Proceeds

Not applicable.

6

Risk Factors

Risks Relating 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 U.S. dollar and the Japanese Yen.yen. The Company incurred a net exchange lossgain of RMB164RMB1,220 million and RMB59RMB1,492 million for 20032005 and 2004,2006, respectively, mainly as a result of Japanese 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. 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. Liu Shao Yong, the Chairman of the Board of Directors, also serves as the General 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 conditions. In particular, as part of its cash management system, the Company periodically places significant amount of demand deposits with 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, 20032005 and 2004,2006, the Group had short-term deposits of RMB366RMB 544 million and RMB406RMB 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 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 or claim by third parties. CSAHC has received written assurance from the General Administration of Civil Aviation of China (“CAAC”) to the effect that CSAHC is entitled to continued use and occupancy of the land 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 might 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, might apply for route rights for direct flights between Taiwan and Mainland 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 Mainland China could be obtained by Xiamen Airlines, if at all, or that 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.

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 20042006 accounted for 26.2%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 (“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 if it occurs, of CAAC regulations limiting or prohibiting 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 Airlines 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. For so long as the limitation on foreign ownership is in forrce,force, the Company will have no meaningful access to the international equity capital 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 airline iswas directed to consolidate into one of the three major airline groups in China: CSAHC, China National Aviation Holding Company and China Eastern Air Holding Group. As approved by the Company’s shareholders in an extraordinary general meeting on December 31, 2004, the Company acquired the airline operations and certain related assets of CNA and XJA. TheseThis consolidation and restructuring 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 / 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.

9

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 rate for the conversion of Renminbi to US dollars has 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, 2004,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 RMB260 million (US$31 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.

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, 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”.

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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 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 contributed RMB150 million (or US$18.12 million) in cash to acquire a 49% equity 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 of the joint venture company 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 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 Shares of par value of RMB1.00 each. The Company issued and listed its 1,000,000,000 A Shares with a par value of RMB1.00 each on the Shanghai Stock Exchange in July 2003.

     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 from 33% to 15% beginning from that date.

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     Instabilities in the world economy and in global politics continued to drive up the prices of aviation fuel in the international market. As a result, fuel costs rose substantially, accounting for more than 30% of the operating costs of the Group. The Group, without compromising flight safety, adopted various technical measures, including the preparation of precise flight plans and minimisation of turnaround time, so as to reduce fuel consumption. However, as an airline in China, the options available to the Group were limited in this respect. As such, the high aviation fuel price exerted immense pressure on the operating expenses of the Group.

     The Group has revamped its marketing management by designating an accountability system to each of its sales managers. These measures have encouraged the operating and marketing team of the Group to be more proactive and vigilant of the difficulties faced by the Group, thereby maximising the total revenue of the Group to the greatest possible extent. In addition, the commencement of operation of the new Guangzhou Baiyun International Airport, the main hub of the Group, provides a wider platform of development for the operations of the Company. Moreover, the Group has successfully secured the exclusive right to use Terminal No. 1 of the Beijing Capital International Airport, making a substantial step in carrying out the strategy of the Group to improve its flight routes network.

     Flight safety is a perennial concern to airlines. In this regard, the Group is committed to flight safety by strengthening internal safety checks, pilot training and aircraft maintenance. As a result, the Group was awarded the Golden Roc Cup, the highest award for flight safety in the Chinese civil aviation industry, for the fourth time in 2004.

     The acquisition of the airline operations of CNA and XJA was approved at the general meeting of the Company held on December 31, 2004. Such acquisition provides a robust platform for the Group to consolidate its market leadership and financial results. It also brought in various benefits to the Group by expanding its flight service network, fleet size and transport capacity, as well as lowering costs and improving overall efficiency. Given the investment incentive policies such as “Go West” and “Revitalising the Old Industrial Bases in the North-eastern Region” promulgated by the Chinese government, the economy in the western and north-eastern regions of China is expected to grow at a rapid pace in the coming decades, which in turn provides substantial growth potential for the Group. Ultimately, the acquisition will strengthen the Group’s position as the largest airline in China and will create positive value to its investors. At present, the management of the Group focuses on harnessing the expanded business capacity and operation scale of the Group, and on enhancing its overall management standards through an integration of corporate culture, innovation and development, thereby realising the ultimate goal of the Group’s reorganisation.

     Pursuant to “Pricing Reform of Domestic Civil Aviation” as approved by the State Council of China effective on April 20, 2004, prices on domestic routes now fluctuate freely within a predetermined range. Instead of direct supervision by setting prices of air tickets through local price bureau, the government now provides guidance on domestic flights and domestic civil aviation is controlled by the government indirectly. Market-oriented pricing policy was introduced and pricing system has been adjusted as a result of the above pricing reform.

     The Group had RMB6,351 million, RMB4,707 million and RMB6,631 million capital expenditures in 2002, 2003 and 2004 respectively. Of such capital expenditures in 2004, RMB5,017 million were financed by bank borrowings while the remaining RMB1,614 million were 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 building for operations.

CNA/XJA Acquisitions

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 shareholders 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 determined based on the fair value of the acquired assets. Such consideration was partly satisfied by assumption of debts and liabilities of CNA and XJA totaling RMB13,563 million outstanding as of December 31, 2004 and the remaining balance of RMB1,959 million is required to be satisfiedwas 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 December 31, 2005.

assumption of debts and liabilities of CSAHC Hainan totaling RMB289 million outstanding as of that date. The CNA/XJAremaining balance of RMB5 million was settled in cash during 2006.

Aircraft Acquisitions  have significantly expanded
Pursuant to the fleet sizeAirbus 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 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.
   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 Company during the period commencing from November 2008 to July 2010.
Pursuant to the Xiamen Aircraft Acquisition Agreement dated October 13, 2006 between Xiamen Airlines and Boeing, Xiamen Airlines will acquire 6 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 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 development strategy, improvement of the Company’s operating capacity, especially the expansion of freight services, It is also believed that the acquisitions will better serve the passenger with premium services and enhance the core competence of the Company. 
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Capital Expenditure
The Group had RMB6,631million, RMB11,873 million and RMB 6,403 million capital expenditures in 2004, 2005 and 2006, respectively. Of such capital expenditures in 2006, RMB 3,759 was financed by capital leases, RMB 2,076 million was financed by bank borrowings while the remaining RMB 568 million was financed by internal resources. The capital expenditures were primarily incurred on the additional investments in aircraft and flight service network as well asequipment under the market share of the Group. Presently, the Group is implementing various measuresGroup’s fleet expansion plans and Guangzhou new airport, and, to harnessing the expanded flight capacitya small extent, additional investments in other facilities and operations and integrating the business cultures and goals of the acquired operations with those of the Group.buildings for operations.

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 2004,2006, 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, 2004,2006, the Group’s RPKs increased at a compound annual rate of 13.4%36.8%, from 28,940 million in 2002 to 37,196 million in 2004 to 61,923 million in 2005, and to 69,582 million in 2006, while its capacity, measured in terms of ASKs, increased at a compound annual rate of 10.2%34.4%, from 44,245 million in 2002 to 53,769 million in 2004.2004 to 88,361 million in 2005, and to 97,059 million in 2006. In 2004,2006, the Group carried 28.2149.21 million passengers and had passenger revenue of RMB21,100RMB 41,549 million (US$2,5505,321 million). Net loss for 2004 was RMB48 million (US$6 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 2004,2006, the Airline Subsidiaries carried 10.512.90 million passengers, and had operatingtraffic revenue of RMB7,436RMB 8,726 million (US$898 1,118 million) and accounted for 37.3%26.2% and 31.9%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 14.8%14.5% to RMB2,244RMB3,538 million (US$271 453 million) in 20042006 as compared with 2003.2005. 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 of 2004,2006, the Group operated 542616 routes, of which 434501 were domestic, 8590 were international and 2325 were to/from Hong Kong regional.and Macau. The Group operates the most extensive domestic route network among all Chinese airlines. In 2004,2006, the Group operated an average of 5,2809,308 landings and take-offs per week, serving 143152 destinations. Its route network covers commercial centres orand 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 eighteenopportunities in the regional route bases in Zhengzhou, Wuhan, Changsha, Shenzhen, Shenyang, Changchun, Dalian, Harbin, Urumqi, Haikou, Zhuhai, Xiamen, Fuzhou, Guilin, Beihai, Shantou, Sanyaaviation 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 2004,2006, the Group had 2325 Hong Kong regionaland Macau routes and 8590 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, Dubai, Paris and 11 Southeast Asian destinations. The Group operates the most extensive Southeast Asian route network among Chinese airlines.

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As of December 31, 2004,2006, the Group operated a fleet of 231309 aircraft, consisting primarily of Boeing 737-300, 737-500, 737-700, 737-800, 747-400, 757-200, 777-200,737 series, 747, 757, 777, Airbus 320-200 and 319-100,300, 319, 320, 330, McDonnell Douglas 82, and 90, Cessna 208B, ATR-72 and Embraer 145 aircraft.90. The average age of the Group’s fleet was 7.476.37 years as of the year end of 2004.

2006.

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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’s continued ownership of the 2,200,000,000 Domestic Shares, represented 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 Shares of par value of RMB1.00 each. The Company issued 1,000,000,000 A Shares with a par value of RMB1.00 each in July 2003 and listed these shares on the Shanghai Stock Exchange. Subsequent to the A Share issue, the shareholding of CSAHC on the Company was reduced from 65.2% to 50.3%.

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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.
                         
Passenger carried  Cargo and Mail Carried (tons)  Total traffic (tons 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)  (%) 
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)
2004  28.21   37.8   545.0   17.5   4,663.0   30.9 

  
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 December 31, 2004,2006, the Group operated 542616 routes consisting of 434501 domestic routes, 2325 Hong Kong regionaland Macau routes and 8590 international routes. In 2004,2006, the Group conducted an average of 5,2809,308 landings and take-offs per week, serving 143152 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, including Delta Airlines, Asiana Airlines, Japan Air System, Vietnam Airlines, Royal Dutch Airlines and Garuda Indonesian. Under the code sharing agreements, the participating airlines are permitted to sell tickets on certain international routes operated by the Group to passengers using the Group’s codes. Similarly, the Group is permitted to sell tickets for the other participating airlines using its “CZ” code. The code sharing agreements help increase the number of the Group’s international sales outlets.

Route Bases

In addition to its main route basebases in Guangzhou and Beijing, the Group maintains eighteencertain regional route bases in Zhengzhou, Wuhan, Changsha, Shenzhen, Shenyang, Changchun, Dalian, Harbin, Urumqi, Haikou, Zhuhai, Xiamen, Fuzhou, Nanning, Guilin, Shantou, Guiyang, Sanya and Beihai. Most of its regional route bases are located in provincial capitals or major commercial centres in the 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. Current regulations of the CAAC generally limit airlines to operations principally conducted from their respective route bases.

     The Chinese Government approved a new Guangzhou airport project, which commenced construction in 2000 and completed in August 2004. The commencement of operation of the new Guangzhou Baiyun International Airport which is the main hub of the Group, provides a wider platform of development for the operations of the Company.

     Moreover, the Group has successfully secured the exclusive right to use Terminal No. 1 of the Beijing Capital International Airport, marking a substantial step in carrying out the strategy of the Group to improve its flight routes network.

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Domestic Routes

The Group’s domestic routes network serves substantially all provinces and autonomous regions in China, including Guangdong, Fujian, Hubei, Hunan, Hainan, Guangxi, Guizhou, Henan, Heilongjiang, Jilin, Liaoning and Xinjiang, and serves all four centrally-administered municipalities in China, namely, Beijing, Shanghai, Tianjin, and Chongqing. In 2004,2006, the Group’s most profitable domestic routes were the routes betweenbetween: Guangzhou and Beijing, ShenzhenGuangzhou and Shanghai, GuangzhouShanghai and Shanghai,Guangzhou, Beijing and Guangzhou, Shenzhen and Beijing, Shenzhen and Shanghai, Urumqi and Guangzhou, ShanghaiBeijing, Beijing and Shenzhen, Beijing and Shenzhen, GuangzhouUrumqi, and Chengdu,Beijing and among Guangzhou, Dalian and Harbin.

Dalian.

Hong Kong and Macau Regional 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 2004,2006, the most profitable Hong Kong regionaland Macau routes (other than these “charter” flights) were those betweenbetween: Hong Kong and each ofWuhan, Hong Kong and Guangzhou, Guangzhou and Hong Kong, Hong Kong and Beijing, Wuhan Kunming, Haikou, and Zhengzhou.

Hong Kong and Hong Kong and Shantou.

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The Group’s “charter” flights are regularly scheduled flights, but permission to operate these 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 the Hong Kong regional routes which it operates on a “charter” flight basis and believes that demand on such routes will continue. In 2004,2006, the Group conducted a total of 15,38016,949 flights on its Hong Kong regionaland Macau routes, accounting for approximately 29.7%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 2723 routes serving 11 Southeast Asian destinations, including Singapore and major cities in Indonesia, Thailand, Malaysia, the Philippines, Vietnam and Laos.Cambodia. In 2004,2006, the Group’s most profitable international routes were those between Guangzhou and Ho Chi Minh City, Guangzhou and Bangkok.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 2723 routes serving 11 Southeast Asian destinations, the Group operates 1767 other international routes providing scheduled services 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, Melbourne, DubaiTaegu, Tashkent, Teheran, Tokyo and Paris.

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 December 31, 2004,2006, the Group operated a fleet of 231309 aircraft with an average age of 7.476.37 years. Most 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.

16


The following table sets forth certain information regarding the Group’s fleet of 231309 aircraft as of December 31, 2004.2006.
             
          Average 
  Number of  Average age  Passenger 
Model Aircraft  (years)  Capacity 
Boeing 777-200  5   8.53   380 
Boeing 777-21B  5   6.20   292 
Boeing 757-200  38   11.56   200 
Boeing 747F  2   2.42   n/a 
Boeing 737-800  12   1.86   167 
Boeing 737-700  17   2.42   138 
Boeing 737-500  18   12.09   132 
Boeing 737-300  38   10.96   145 
Boeing 737-300QC  2   15.97   128 
Airbus 300-600  6   9.86   274 
Airbus 319-100  8   1.43   128 
Airbus 320-200  24   5.09   158 
Airbus 321-100  8   2.72   185 
McDonnell Douglas 82  22   13.54   147 
McDonnell Douglas 90  13   6.88   157 
Embraer 145 Jet  5   0.20   50 
Cessna 208B  3   2.50   14 
ATR-72  5   7.02   72 
            
   231         

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 2004,2006, the Group continued to expand and modernize its aircraft fleet. In 2004, theThe Group’s major aircraft transactions included:

•The addition of one B777-200

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 Airbus 320 aircraft under operating lease;
•The acquisition of two Boeing 757-200 aircraft, eight Boeing 737-700 and five Embraer 145 Jet financed by a combination of internal funds and long term bank loans; and
•The acquisition of seventy eight aircraft including seventeen Boeing, eighteen Airbus, thirty five McDonnell Douglas, three Cessna 208B and five ATR72 aircraft through the acquisition of the airline operations and certain related assets of China Northern Airlines Company and Xinjiang Airlines Company which was approved by the Company’s shareholders in an extraordinary general meeting on December 31, 2004.

     In January 2005, the Company, as a lessee, entered into an agreement with an independent lessor for operating leases of nine Boeing 737-800 aircraft foracquired in 2006 were financed by a termcombination of seven years with total futureinternal funds, long-term bank loans and finance lease payments totalling approximately RMB1,721 million, scheduled for deliveries in 2005 andagreements.

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 January 2005, China Aviation Supplies Import and Export Corporation, as a sole importing agent, entered into, on behalf of several PRC airlines includingAugust 2006, the Group a general purchase agreement with theexercised its option to change an order from three Boeing Company for the import of Boeing B7E7 aircraft. The Company, being one of the ultimate users for thirteen of the Boeing B7E7787 aircraft endorsed the general purchase agreement. The Company is currently in negotiation with the Boeing Company regarding the purchase agreements on such aircraft.

     In March 2005, the Company, as a lessee, entered into another agreement with an independent lessor for operating leases of a total of twenty-five aircraft comprising fiveto six Boeing 737-700 aircraft five Boeing 737-800 aircraft, five Airbus 320-200 aircraft and ten Airbus 321-200 aircraft with scheduled deliveries in 2006 and 2007. The termrespect of the lease ranges from ten to twelve years with total future lease payments totalling approximately RMB8,243 million.

an agreement signed on August 8, 2005.

In April 2005,July 2006, the Company entered into a purchase agreement with Airbus SNC for the purchase of fiveto acquire ten Airbus A380319-100, fifteen Airbus 320-200 and twenty-five Airbus 321-200 aircraft, scheduled for deliveries in 20072009 to 2010.

17

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 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, 2004, 472006, 81 of the Group’s 231309 aircraft were operated under capital leases, 84123 were operated under operating leases, 5319 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, 2004,2006, the number of aircraft operated by the Group pursuant to capital and operating leases and the remaining terms, expressed in years, of such leases.

18

 
 
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    

             
          Average 
  Capital  Operating  Remaining 
Model Lease  Lease  Lease Term 
Boeing 777-200 and 777-21B  5   4   5.63 
Boeing 757-200  —   15   4.23 
Boeing 737-700  —   8   5.22 
Boeing 737-500  —   18   1.91 
Boeing 737-300  4   12   2.23 
Boeing 737-300QC  —   2   4.00 
Airbus 300-600  6   —   2.20 
Airbus 319-100  —   8   9.02 
Airbus 320-200  18   6   3.72 
Airbus 321-100  4   —   7.24 
McDonnell Douglas 82  —   11   3.06 
McDonnell Douglas 90  10   —   2.69 
            
   47   84     

17
Capital Leases

As of December 31, 2004,2006, the Group’s aggregate future minimum lease payments (including future finance charges) required under its capital leases were RMB13,055RMB 18,403 million (US$1,577 2,357 million). As of year end 2004,2006, 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 nineten 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 ais 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, 2004,2006, the Group’s aggregate future minimum lease payments required under its operating leases were RMB12,750RMB 21,969 million (US$1,541 2,813 million). As of year end 2004,2006, 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 tentwelve 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 RMB14RMB23 million, RMB8RMB55 million and RMB23RMB60 million during 2002, 20032004, 2005 and 20042006 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 2004,2006, the Group had 6769 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. RotablesAcquisition 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.

19

Aircraft Maintenance

A major part of the maintenance for the Group’s fleet other than overhauls of jet engines is performed by GAMECO, a jointly controlled entity established by the Company, 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 9eight other Chinese airlines and 1317 international airlines. GAMECO provides heavy maintenance services to 5four other Chinese airlines and 9nine international airlines.

The Company and GAMECO had entered into an Aircraft Maintenance and Engineering Agreement for the provision of aircraft repair and maintenance services. On May 17, May, 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%16%, and labour costs at US$30.030 per hour during 2004.2006. For the year ended December 31, 2004,2006, the amount incurred by the Group for such repair and maintenance services was RMB659,850,000.

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, 2004,2006, repair fees amounting to RMB499RMB497 million were paid to MTU Zhuhai.

20

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, 2004.2006. 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 0.42,0.13, 0.13 and 0.130.065 in 2002, 20032004, 2005 and 2004,2006, respectively. In comparison, CAAC’s published maximum acceptable flight incident ratio was 1.5 in 2002 and 1.3 in 2003 and 0.9 in 2004.2004 and 0.29 in 2005 and 0.7 in 2006. This ratio is defined as the occurrence of one incident for every 10,000 hours of flight time. As a result, the Group was awarded the Golden Roc Cup, the highest award for flight safety in the PRC civil aviation industry, for the fourth time in 2004.

Jet Fuel

Jet fuel costs typically represent a major component of an airline’s operating expenses. The Group’s jet fuel costs for 20042006 accounted for 26.2%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 20042006 was RMB4,190RMB6,850 per ton. The average price paid by the Group in 20042006 was RMB3,772RMB 5,838 per ton, which represents a 22.7%20.5% increase from that of 2003.

     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 26.15%20% of the Group’s total jet fuel consumption in 2004.

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, realtimereal-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.

21

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.

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.

22

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 newGuangzhou 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 newGuangzhou 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 termshort-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 newGuangzhou 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.

23

Cargo and Mail


The Group also provides air cargo and mail services. A significant portion of these services isare combined with passenger flights services. Currently, the Group also 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.

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 2004, at a budgeted cost of Rmb254 million.

24

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 2004,2006, 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 2004,2006, 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 “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 2004,2006, the Group had approximately 3,500,0004,608,000 members under these programs.

25

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.

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. 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 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 Regionaland 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 government of Macau SAR. Such rights are allocated by the CAAC among the four Chinese airlines permitted to fly to Hong Kong or Macau.

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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. 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.

Air Fare Pricing Policy

Pursuant to “Pricing Reform of Domestic Civil Aviation” as approved by the State Council of the PRC effective on April 20, April, 2004, prices on domestic routes now 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 government indirectly. Market-oriented pricing policy was introduced and pricing system has been adjusted as a result of the 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.

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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.

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.

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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 newGuangzhou 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 2004,2006, these three airlines together controlled approximately 58.05%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.

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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.
                         
                  Total traffic 
  Passenger carried  Cargo and Mail 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) 
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 
2004  121.23   23.27   2,770   19.68   23.1   20.19 

  
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 10 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 eight 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 2004.2006.
             
      Cargo and Mail    
  Passenger carried  Carried  Departing flight 
Airport (% of total)  (% of total)  (% of total) 
Beijing  12.10   15.13   9.97 
Shanghai Pudong  7.26   6.19   6.83 
Guangzhou  50.57   43.11   49.10 
Shanghai Hongqiao  14.16   10.79   13.69 
Shenzhen  27.74   26.31   24.77 
Chengdu  10.97   14.57   8.90 
Kunming  20.12   14.12   14.57 
Haikou  26.11   26.40   21.43 
Xian  8.91   13.32   5.80 
Hangzhou  27.89   20.63   19.58 

   
 
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 8eight 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 2004.2006.
             
      Cargo and Mail    
  Passenger carried  Carried  Departing flight 
Airport (% of total )  (% of total)  (% of total) 
Wuhan Tianhe  46.62   47.22   39.32 
Changsha  52.90   49.46   28.77 
Guilin  39.72   24.89   32.84 
Zhengzhou  68.17   73.62   49.83 
Sanya  28.41   11.06   30.09 
Nanning  44.90   34.68   33.49 
Zhang Jia Jie  33.87   26.35   28.36 
Shantou  81.85   70.65   65.87 

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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% 

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Hong Kong Regionaland Macau Routes

The Group dominates the routes operated by Chinese airlines between Hong Kong and Macau and China. In 2004,2006, the Group operated an average of more than 15,38016,949 “charter” and other scheduled flights per week between China and Hong Kong or Macau, accounting for approximately 29.7%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 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, 2004,2006, Xiamen Airlines operated under its own “MF” code a fleet of 2941 aircraft on 7185 domestic routes, 811 international route and 5six Hong Kong regionaland Macau routes. In 2004,2006, Xiamen Airlines carried a total of about 6.237.78 million passengers, or approximately 22.1%15.8% of the passengers carried by the Group in that year, and had RMB4,448RMB5,982 million in operatingtraffic revenue.

As of December 31, 2004,2006, Shantou Airlines operated under the Group’s “CZ” code 7eight aircraft on 1612 domestic routes, 1one international route and 1one Hong Kong regionaland Macau route. In 2004,2006, Shantou Airlines carried a total of about 1.081.39 million passengers, or 3.8%2.8% of the passengers carried by the Group in that year. Total operatingtraffic revenue of Shantou Airlines for the year ended December 31, 20042006 was RMB808RMB1,042 million.

As of December 31, 2004,2006, routes previously operated by Guangxi Airlines operated under the “CZ” code 6nine aircraft on 1433 domestic routes, 4one international routes and 3two Hong Kong regional routes.and Macau routes were transferred to the Company. In 2004,2006, Guangxi Airlines carried a total of about 1.121.55 million passengers, or 4.0%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, 20042006 was RMB789RMB706 million.

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As of December 31, 2004,2006, Zhuhai Airlines operated under the “CZ” code 5five aircraft on 11nine domestic routes. In 2004,2006, Zhuhai Airlines carried a total of about 741,000868,700 passengers, or approximately 2.6%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, 20042006 was RMB558RMB780 million.

As of December 31, 2004,2006, Guizhou Airlines operated under the “CZ” code 6seven aircraft on 1620 domestic routes. In 2004,2006, Guizhou Airlines carried a total of about 1.361.35 million passengers, or approximately 4.8%2.7% of the total number of passengers carried by the Group in 2004.2006. Total operatingtraffic revenue of Guizhou Airlines was approximately RMB833RMB982 million for the year ended December 31, 2004.

2006.

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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 RMB 70,000RMB400,000 (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.

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27

Organizational Structure

The following chart illustrates the corporate structure of the Group as of year end 20042006 and the aggregate effective equity interest of the Company in each of its principal subsidiaries, affiliated companies and jointly controlled entities.

(CHART)

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Note a: Another 26% ownership interest is held by CSA’s subsidiaries.
The particulars of the Company’s principal subsidiaries as of December 31, 20042006 are as follows:

Name of company
 
Attributable equity
Place and date of
establishment
/operation
 
Proportion of ownership
interest toheld by the Company
establishmentDirectIndirect
Name of company/operation%%
Guangxi Airlines Company Limited PRC
April 28, 1994 60—100
Southern Airlines Group(Group) ShantouPRC
Airlines Company Limited PRC July 20, 1993 60—
Zhuhai Airlines Company Limited PRC
May 8, 1995 60—
Xiamen Airlines Company Limited PRC
August 11, 1984 60—
Guizhou Airlines Company Limited PRC
November 12, 1991 60
60Guangzhou Air Cargo Company Limited PRC March 31, 2004 —70
Guangzhou Nanland Air CateringPRC
Company Limited PRC November 21, 1989 51—75
China Southern West AustralianAustralia
Flying College Pty Ltd. Australia January 26, 1971 65—
Guangzhou Baiyun InternationalPRC
Logistic Company Ltd PRC July 23, 2002 61
61Xinjiang Civil Aviation Property Management Limited PRC February 12, 2002 —51.8

Affiliated Companies and Jointly Controlled Entities

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The particulars of the Group’s principal affiliated companies and jointly controlled entity as of December 31, 20042006 are as follows:
           
    Attributable equity 
  Place and date of interest to the Company 
  establishment Direct  Indirect 
Name of company /operation %  % 
Guangzhou Aircraft Maintenance PRC        
Engineering Company Limited October 28, 1989  50   — 
Southern Airlines Group PRC        
Finance Company Limited June 28, 1995  32   15.42 
Sichuan Airlines Corporation PRC        
Limited August 28, 2002  39   — 
China Postal Airlines Limited PRC        
  November 25, 1996  49   — 
MTU Maintenance Zhuhai Co. Ltd PRC        
  April 6, 2001  50   — 
Zhuhai Xiang Yi Aviation PRC        
Technology Company Limited July 10, 2002  51   — 

34

     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.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  —   80,809   503,957   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   17,335   — 
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  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 

   
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.

35

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 3451 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, 2004 was RMB874 million.

36

     Property, plant and equipment

     The Group have approximately RMB46,841 million fixed assets as of December 31, 2004. 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.

     There were no significant changes to the original estimated useful lives or residual values of the property, plant and equipment of the Group during 2002, 2003 and 2004. 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 assetsestimates used in operationsthe preparation of our financial statements.

Impairment for impairment. Under IFRS, iflong-lived assets
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, 2004, 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 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.
31
Overview
As a result of evaluation,the 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 considered that no impairment is required. Under U.S. GAAP, property, plant,has also strengthened its cost control strategy, particularly on saving jet fuel cost and equipmentrepairs 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 are reviewed for impairment whenever events or changesimproved in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to estimated undiscounted future cash flows expected to be generated by the asset. If the carrying amount of an asset exceeds its estimated future cash flows, an impairment charge is recognized by the amount by which the carrying amount of the asset exceeds the fair value of the asset. During 2002 and 2003, the impairment losses of RMB347 million and RMB510 million respectively were recognised on certain aircraft of CNA.2006.

Overview

     From the fast growing economy in the PRC, growth in airline market has been carried on which was commenced in second half of 2003. The Group’s business was benefited from the increasing traffic demand in which both the passenger volume and passenger load factor were improved.

Nevertheless, the Group is facing pressure on its operationoperations due to continuing increases of jet fuel costs and intensified competition.
Since July 21, 2005, the PRC Government 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 U.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 released a supplementary document on Issues Relating to the Introduction of Fuel Surcharge for Domestic Routes, stating that due to the seasonal effectsrising jet fuel price, the period of imposition of fuel surcharge by airlines was extended. On March 28, 2006, the NDRC and CAAC released another supplementary document 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 for distances flown less than 800 kilometers, and from RMB40 to RMB60 for distances exceeding 800 kilometers, during the period temporarily from April 10, 2006 to October 10, 2006. The introduction of fuel surcharge and the increase inextension of the duration of the same helped relieve, to a certain extent, the burden of high jet fuel cost.

37

     The continuing political tension incost on the Middle East ledGroup. NDRC and CAAC approved of the raise to highthe passenger fuel prices which in turn caused an increase insurcharge for domestic routes to help relieve the Group’ssoaring jet fuel cost. The Group has implemented various measures to controlcost for the increaseperiod in operating expenses.

     Pursuant to “Pricing Reform of Domestic Civil Aviation” as approved by the State Council of the PRC effective on April 20, 2004, prices on domestic routes now fluctuate freely within a predetermined range. Instead of direct supervision by setting prices of air tickets through local price bureau, the government now provides guidance on domestic flights and domestic civil aviation is controlled by the government indirectly. Market-oriented pricing policy was introduced and pricing system has been adjusted as a result of the above pricing reform.

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 RMB164RMB1,220 million and RMB59RMB1,492 million in 20032005 and 2004,2006, 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.

38

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, 2002, 20032004, 2005 and 2004:2006:
 
 
 
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 
                     
  Year ended 2003 vs. 2002  2004 vs. 2003 
  December 31,  % increase/  % increase/ 
  2002  2003  2004  (decrease)  (decrease) 
Traffic
                    
RPK (million)                    
Domestic  22,092   21,294   29,121   (3.6)  36.8 
Hong Kong regional  1,081   778   1,203   (28.0)  54.6 
International  5,767   4,315   6,872   (25.2)  59.3 
Total  28,940   26,387   37,196   (8.8)  41.0 
RTK (million)                    
Domestic  2,532   2,424   3,206   (4.3)  32.3 
Hong Kong regional  108   78   120   (27.8)  53.8 
International  974   1,059   1,337   8.7   26.3 
Total  3,614   3,561   4,663   (1.5)  30.9 
Passengers carried (thousand)                    
Domestic  18,535   18,259   25,002   (1.5)  36.9 
Hong Kong regional  1,369   1,019   1,394   (25.6)  36.8 
International  1,589   1,192   1,811   (25.0)  51.9 
Total  21,493   20,470   28,207   (4.8)  37.8 
Cargo and mail carried (thousand tons)                    
Domestic  404   379   442   (6.2)  16.6 
Hong Kong regional  14   12   15   (14.3)  25.0 
International  52   73   88   40.4   20.5 
Total  470   464   545   (1.3)  17.5 
33

39

                     
  Year ended 2003 vs. 2002  2004 vs. 2003 
  December 31,  % increase/  % increase/ 
  2002  2003  2004  (decrease)  (decrease) 
Capacity
                    
ASK (million)                    
Domestic  33,753   32,590   41,330   (3.4)  26.8 
Hong Kong regional  1,746   1,347   1,896   (22.9)  40.8 
International  8,746   6,930   10,543   (20.8)  52.1 
Total  44,245   40,867   53,769   (7.6)  31.6 
ATK (million)                    
Domestic  3,924   3,772   4,773   (3.9)  26.5 
Hong Kong regional  193   150   211   (22.3)  40.7 
International  1,798   1,999   2,462   11.2   23.2 
Total  5,915   5,921   7,446   0.1   25.8 
Load Factors
                    
Passenger load factor (RPK/ASK) (%)                    
Domestic  65.5   65.3   70.5   (0.3)  8.0 
Hong Kong regional  61.9   57.8   63.4   (6.6)  9.7 
International  65.9   62.3   65.2   (5.5)  4.7 
Overall  65.4   64.6   69.2   (1.2)  7.1 
Overall load factor (RTK/ATK) (%)                    
Domestic  64.5   64.2   67.2   (0.5)  4.7 
Hong Kong regional  55.8   52.2   56.9   (6.5)  9.0 
International  54.2   53.0   54.3   (2.2)  2.5 
Overall  61.1   60.1   62.6   (1.6)  4.2 
Yield
                    
Yield per RPK (RMB)                    
Domestic  0.55   0.57   0.58   3.6   1.8 
Hong Kong regional  0.98   0.96   0.92   (2.0)  (4.2)
International  0.42   0.47   0.46   11.9   (2.1)
Overall  0.54   0.57   0.57   5.6   — 
Yield per RTK (RMB)                    
Domestic  5.21   5.40   5.53   3.6   2.4 
Hong Kong regional  10.36   10.35   9.83   (0.1)  (5.0)
International  3.25   2.90   3.31   (10.8)  14.1 
Overall  4.84   4.76   5.01   (1.7)  5.3 
Financial
                    
IFRS
                    
Passenger revenue (RMB million)                    
Domestic  12,234   12,242   16,869   0.1   37.8 
Hong Kong regional  1,055   750   1,104   (28.9)  47.2 
International  2,407   2,018   3,127   (16.2)  55.0 
Total  15,696   15,010   21,100   (4.4)  40.6 
Cargo and mail revenue (RMB million)  1,786   1,955   2,244   9.5   14.8 
U.S. GAAP
                    
Passenger revenue (RMB million)                    
Domestic  18,145   18,679   24,773   2.9   32.6 
Hong Kong regional  1,144   781   1,151   (31.7)  47.4 
International  3,277   2,978   4,519   (9.1)  51.7 
Total  22,566   22,438   30,443   (0.6)  35.7 
Cargo and mail revenue (RMB million)  2,288   2,459   2,792   7.5   13.5 

40

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.

     2004

34
2006 Compared with 2003

2005

The Group recorded a net lossprofit for 2006 attributable to equity shareholders of RMB48the Company was RMB126 million, for 2004, as compared to a net loss of RMB358RMB1,786 million for 2003.2005. 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 RMB6,504RMB7,926 million or 37.2%20.7% from RMB17,470RMB38,293 million in 20032005 to RMB23,974RMB46,219 million in 2004.2006. Passenger load factor increased by 4.61.6 percentage pointpoints from 64.6%70.1% in 20032005 to 69.2%71.7% in 2004.2006. Passenger yield (in passenger revenue per RPK) remain steady and at RMB0.57 in both years.increased by 9.1% to RMB 0.60. Average yield (in traffic revenue per RTK) increased by 5.3%8.8% from RMB4.76RMB 5.14 in 20032005 to RMB5.01RMB 5.59 in 2004.2006. Operating expenses increased by RMB6,051RMB 6,455 million or 35.6%16.3% from RMB17,014RMB39,525 million in 20032005 to RMB45,980 million in 2006. As a result of improved passenger load factor and average yield, operating profit was RMB239 million in 2006 as compared to an operating loss of RMB1,232 million in 2005. The Group’s net non-operating income was RMB45 million in 2006 as compared to a net non-operating expense of RMB548 million in 2005. The improvement in non-operating results was mainly attributable to the 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 property, plant and equipment of RMB367 million. The increase in net operating income was partly offset by the increase in interest expense of RMB 454 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%, respectively, of total traffic revenue in 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 2004.2004 to RMB39,525 million in 2005. As operating revenue increased moreless than operating expenses, operating profit increaseddecreased by 99.3%235.5% from RMB456 million in 2003 tooperating profit of RMB909 million in 2004.2004 to operating loss of RMB1,232 million in 2005. The Group’s net non-operating expenses decreased by 30.1%20.5%, from RMB967 million in 2003 to RMB676RMB689 million in 2004 to RMB548 million in 2005, mainly attributable to a decreasethe combined effect of the increase in unfavourable movementexchange gain of RMB1,279 million, increase in foreign exchange differencesinterest expense of RMB105RMB925 million and a decrease in interest expenseshare of RMB133results of associates of RMB295 million. Overall, the Group recorded a net loss of RMB48 million in 2004, as compared to a net loss of RMB358 million in 2003.

Operating revenue

Substantially all of the Group’s operating revenue is attributable to airline and airline related operations. Traffic revenue in 20042005 and 20032004 accounted for 97.4%97.7% and 97.1%97.4%, respectively, of total operating revenue. Passenger revenue, and, cargo and mail revenue accounted for 90.4%91.7% and 9.6%8.3%, respectively, of total traffic revenue in 2004.2005. 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 air catering services.

36
Operating revenue increased by 37.2%59.7% from RMB17,470 million in 2003 to RMB23,974 million in 2004.2004 to RMB38,293 million in 2005. This increase was primarily due to a 40.6% rise62.7% increase in passenger revenue from RMB15,010 million in 2003 to RMB21,100 million in 2004 to RMB34,328 million in 2005 resulting from increased traffic volume. Due to the continued growth in domestic economic conditions, the aviation traffic volume in China attained a new high record in 2005. The total number of passengers carried increased by 37.8%56.4% to 28.244.12 million passengers and the ASKs increased by 64.3% to 88,361 million in 2004.2005. The increase in 2005 compared to 2004 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 41.0%66.5% from 26,387 million in 2003 to RMB37,196 million in 2004 to RMB61,923 million in 2005, primarily as a result of an increase in passengers carried. Passenger yield remained constant at RMB0.57.

Domestic passenger revenue, which accounted for 79.9%82.1% of the total passenger revenue in 2004,2005, increased by 37.8%67.1% from RMB12,242 million in 2003 to RMB16,869 million in 2004.2004 to RMB28,182 million in 2005. Domestic passenger traffic in RPKs increased by 36.8%76.8%, mainly due to an increase in passengers carried. Passenger yield remained steadydecreased slightly by RMB0.02 to RMB0.55 in 20042005.
Hong Kong and at RMB0.58.

     Hong KongMacau passenger revenue, which accounted for 5.3%3.5% of total passenger revenue, increased by 47.2%8.2% from RMB750 million in 2003 to RMB1,104 million in 2004.2004 to RMB1,194 million in 2005. For Hong Kong regionaland Macau flights, passenger traffic in RPKs increased by 54.6%28.8%, while passenger capacity in ASKs increased by 40.8%40.1%, resulting in a 5.65.1 percentage point increasedecrease in passenger load factor from 2003.2004. Passenger yield decreased from RMB0.96 in 2003 to RMB0.92 in 2004 to RMB0.77 in 2005 mainly due to intensified competition among airlines.

International passenger revenue, which accounted for 14.8%14.4% of total passenger revenue, increased by 55.0%58.4% from RMB2,018RMB 3,127 million in 20032004 to RMB3,127RMB4,952 million in 2004.2005. For international flights, passenger traffic in RPKs increased by 59.3%29.5%, while passenger capacity in ASKs increased by 52.1%29.0%, resulting in a 2.90.3 percentage point riseincrease in passenger load factor from 2003.2004. Passenger yield decreasedincreased by 2.1%21.7% from RMB0.47 in 2003 to RMB0.46 in 2004 to RMB0.56 in 2005 mainly resulted from higher ticket price and the increasesincrease in traffic derived from longshort haul routes which generally had a lowerhigher yield than shortlong haul routes.

Cargo and mail revenue, which accounted for 9.6%8.3% of the Group’s total traffic revenue and 9.4%8.1% of total operating revenue, increased by 14.8%37.7% from RMB1,955RMB2,224 million in 20032004 to RMB2,244RMB3,091 million in 2004.2005. The increase was attributable to the increasingincreased in traffic demand.

Other operating revenue increased by 24.8%38.7% from RMB505 million in 2003 to RMB630 million in 2004.2004 to RMB874 million in 2005. The increase was primarily due to the general growth in income from various auxiliary operations.

41

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 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.

Total operating expenses in 20042005 amounted to RMB23,065RMB39,525 million, representing an increase of 35.6%71.4% or RMB6,051RMB16,460 million over 2003, 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 decreased from 97.4% in 2003 to 96.2% in 2004.

     Flight operations expenses, which accounted for 45.2% of total operating expenses, increased by 47.4% from RMB7,070 million in 2003 to RMB10,418 million in 2004, primarily as a result of increases in jet fuel costs, operating lease payments, catering expenses, labour costs for flight personnel and inclusion of CAAC Infrastructure Development Fund of RMB466 million in operating expenses which is an usage charge since 2004 but was a turnover-based levy and deducted against the traffic revenue in 2003. Jet fuel costs, which accounted for 58.1% of flight operations expenses, increased by 56.5% from RMB3,867 million in 2003 to RMB6,050 million in 2004 mainly as a result of increased fuel prices and fuel consumption. Operating lease payments increased by 8.4% from RMB1,536 million in 2003 to RMB1,665 million in 2004, primarily due to the additional rental payments for new aircraft under operating leases. Catering expenses increased by 38.2% from RMB510 million in 2003 to RMB705 million in 2004, primarily due to increased passenger carried. Aircraft insurance costs decreased by 5.6% from RMB196 million in 2003 to RMB185 million in 2004, primarily because of a decrease in insurance premiums prescribed by the PRC insurance company. Labour costs for flight personnel increased by 40.9% from RMB728 million in 2003 to RMB1,026 million in 2004, largely due to the increase in flying hours.

     Maintenance expenses which accounted for 15.0% of total operating expenses, increased by 33.6% from RMB2,589 million in 2003 to RMB3,459 million in 2004. The increase was primarily attributable to an 32.9% increase in aircraft overhaul charges from RMB2,377 million in 2003 to RMB3,158 million in 2004, as resulted from fleet expansion in recent years.

42

     Aircraft and traffic servicing expenses, which accounted for 15.2% of total operating expenses, increased by 26.6% from RMB2,767 million in 2003 to RMB3,503 million in 2004. The increase primarily resulted from an 25.7% rise in landing and navigation fees from RMB2,563 million in 2003 to RMB3,222 million in 2004, due to an increase in number of landing and takeoffs.

     Promotional and marketing expenses, which accounted for 8.4% of total operating expenses, increased by 31.1% from RMB1,480 million in 2003 to RMB1,940 million in 2004. The increase was due to 44.4% increase in labour costs from RMB225 million in 2003 to RMB325 million in 2004, as more payments of performance bonus were made because of the increased traffic volume.

     General and administrative expenses, which accounted for 5.7% of the total operating expenses, increased by 25.6% from RMB1,053 million in 2003 to RMB1,323 million in 2004. This was mainly attributable to increased scale of operations.

     Depreciation and amortisation, which accounted for 10.5% of total operating expenses, increased by 18.4% from RMB2,038 million in 2003 to RMB2,413 million in 2004. This increase was primarily as a result of the additions of aircraft during 2004.

Operating profit

     Operating profit increased by 99.3% from RMB456 million in 2003 to RMB909 million in 2004. This was mainly because operating revenue increased by RMB6,504 million or 37.2% from 2003 and operating expenses increased by RMB6,051 million or 35.6% over the same period.

Non-operating income/(expenses)

     Interest expense decreased by 16.1% from RMB824 million in 2003 to RMB691 million in 2004, mainly reflecting the combined effect of scheduled debt repayments and the replacement of certain RMB denominated bank loans of higher interest rates with US$ denominated bank loans of lower interest rates.

     Interest income increased by 69.2% from RMB13 million in 2003 to RMB22 million in 2004. This was mainly attributable to an increase in average cash balances.

     During 2004, the Group recorded a net exchange loss of RMB59 million (2003:RMB164 million) mainly from its Japanese yen denominated borrowings as a result of the Japanese yen appreciation. Such amount comprised mostly unrealised translational exchange loss.

43

Taxation

     On October 17, 2003, the Company’s registered address was moved to Guangzhou Economic & Technology Development Zone, Guangzhou, China. 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 from 33% to 15% beginning from that date.

     In 2003, the Group recorded an income tax credit of RMB324 million resulting from reduction in net deferred taxation liability balance of RMB392 million. In 2004, income tax expense of RMB78 million was recorded.

Minority interests

     Minority interests increased by 18.7% from RMB171 million in 2003 to RMB203 million in 2004, primarily reflecting the increased net profits earned by certain of the Group’s airline subsidiaries for the year.

     2003 Compared with 2002

     The Group recorded a net loss of RMB358 million for 2003, as compared to a net income of RMB576 million for 2002. The Group’s operating revenue decreased by RMB549 million or 3.0% from RMB18,019 million in 2002 to RMB17,470 million in 2003. Passenger load factor decreased by 0.8 percentage point from 65.4% in 2002 to 64.6% in 2003. Passenger yield (in passenger revenue per RPK) increased by 5.6% from RMB0.54 in 2002 to RMB0.57 in 2003. Average yield (in traffic revenue per RTK) decreased by 1.7% from RMB4.84 in 2002 to RMB4.76 in 2003. Operating expenses increased by RMB1,021 million or 6.4% from RMB15,993 million in 2002 to RMB17,014 million in 2003. As operating revenue decreased while operating expenses increased, operating profit decreased by 77.5% from RMB2,026 million in 2002 to RMB456 million in 2003. The Group’s net non-operating expenses increased by 9.1%, from RMB887 million in 2002 to RMB967 million in 2003, mainly due to a decrease in gain on disposal of fixed assets of RMB193 million, partly offset by a decrease in interest expense of RMB135 million. Overall, the Group recorded a net loss of RMB358 million in 2003, as compared to a net profit of RMB576 million in 2002.

44

Operating Revenue

     Substantially all of the Group’s operating revenue is attributable to airline operations. Traffic revenue in 2003 and 2002 accounted for 97.1% and 97.0% respectively of total operating revenue. Passenger revenue and, cargo and mail revenue accounted for 88.5% and 11.5% respectively of total traffic revenue in 2003. The balance of the Group’s operating revenue is derived from commission income, income from general aviation operations, fees charged for ground services and for air catering services and net income from lease arrangements.

     Operating revenue decreased by 3.0% from RMB18,019 million in 2002 to RMB17,470 million in 2003. This decrease was primarily due to a 4.4% fall in passenger revenue from RMB15,696 million in 2002 to RMB15,010 million in 2003 resulting from lower traffic volume caused by SARS. The total number of passengers carried decreased by 4.8% to 20.5 million passengers in 2003. RPKs decreased by 8.8% from 28,940 million in 2002 to 26,387 million in 2003, primarily as a result of a decrease 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% of the total passenger revenue in 2003, increased slightly by 0.1% from RMB12,234 million in 2002 to RMB12,242 million in 2003. Domestic passenger traffic in RPKs decreased by 3.6%, mainly due to a decrease in passengers carried. Passenger yield, however, increased from RMB0.55 in 2002 to RMB0.57 in 2003, mainly as the result of the aforesaid exemption of CAAC Infrastructure Development Fund and sales tax.

     Hong Kong passenger revenue, which accounted for 5.0% of total passenger revenue, decreased by 28.9% from RMB1,055 million in 2002 to RMB750 million in 2003. For Hong Kong flights, passenger traffic in RPKs decreased by 28.0%, while passenger capacity in ASKs decreased by 22.9%, resulting in a 4.1 percentage point decrease in passenger load factor from 2002. Passenger yield decreased from RMB0.98 in 2002 to RMB0.96 in 2003 mainly due to slack in traffic volume.

     International passenger revenue, which accounted for 13.4% of total passenger revenue, decreased by 16.2% from RMB2,407 million in 2002 to RMB2,018 million in 2003. For international flights, passenger traffic in RPKs decreased by 25.2%, while passenger capacity in ASKs decreased by 20.8%, resulting in a 3.6 percentage point fall in passenger load factor from 2002. Passenger yield increased by 11.9% from RMB0.42 in 2002 to RMB0.47 in 2003 mainly as the result of the aforesaid exemption of CAAC Infrastructure Development Fund and sales tax.

     Cargo and mail revenue, which accounted for 11.5% of the Group’s total traffic revenue and 11.1% of total operating revenue, increased by 9.5% from RMB1,786 million in 2002 to RMB1,955 million in 2003. The increase was primarily due 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.

     Other operating revenue decreased by 6.0% from RMB537 million in 2002 to RMB505 million in 2003. The decrease was primarily due to a decrease in aircraft short-term lease income of RMB46 million.

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 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.

     Total operating expenses in 2003 amounted to RMB17,014 million, representing an increase of 6.4% or RMB1,021 million over 2002, 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%96.2% in 20022004 to 97.4%103.2% in 2003.

45

2005.

Flight operations expenses, which accounted for 41.6%49.1% of total operating expenses, increased by 5.0%86.2% from RMB6,733RMB10,418 million in 20022004 to RMB7,070RMB19,394 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, labour costs for flight personnel. Jet fuel costs, which accounted for 54.7%61.5% of flight operations expenses, increased by 9.9%97.2% from RMB3,519RMB 6,050 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%50.0% from RMB1,417RMB1,665 million in 20022004 to RMB1,536RMB2,497 million in 2003,2005, primarily due to the full year effect of the addition ofadditional rental payments for new aircraft under 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.leases. Catering expenses decreasedincreased by 18.4%69.6% from RMB625RMB705 million in 20022004 to RMB510RMB1,196 million in 2003,2005, primarily reflecting a tighter cost controls exercised by the Group.due to increased passenger carried. Aircraft insurance costs decreased by 23.4%43.2% from RMB256RMB185 million in 20022004 to RMB196RMB105 million in 2003,2005, primarily because of a reductiondecrease in the rate of aircraft insurance premiums prescribed by the PRC insurance company. Laborin 2005. Labour costs for flight personnel decreasedincreased by 6.8%57.8% from RMB781RMB1,026 million in 20022004 to RMB728RMB1,619 million in 2003,2005, largely due to a decreasethe increase in flight hours.

flying hours and allowance standard.

Maintenance expenses which accounted for 15.2%10.2% of total operating expenses, increased by 11.0%17.1% from RMB2,333RMB3,459 million in 20022004 to RMB2,589RMB4,051 million in 2003.2005. 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%14.6% of total operating expenses, increased by 10.2%64.4% from RMB2,511RMB3,503 million in 20022004 to RMB2,767RMB5,759 million in 2003.2005. The increase primarily resulted from an 8.9% rise51.8% increase in landing and navigation fees from RMB2,354RMB3,222 million in 20022004 to RMB2,563RMB4,891 million in 2003,2005, due to an increase in the charge rate for domesticnumber of landing and navigation fees effective September 2002.

takeoffs.

Promotional and marketing expenses, which accounted for 8.7%7.0% of total operating expenses, decreasedincreased by 1.3%43.3% from RMB1,500RMB1,940 million in 20022004 to RMB1,480RMB2,780 million in 2003.2005. The decreaseincrease was due to 9.3% decreasemainly resulted from the increase in labor costssales volume, resulting in a 41.5% increase in sales commission expenses from RMB248RMB1,062 million in 20022004 to RMB225RMB1,503 million in 2003, as fewer bonuses were given because of reduced sales volume in 2003.

2005.

General and administrative expenses, which accounted for 6.2% of the total operating expenses, decreased slightlyincreased by 0.7%85.7% from RMB1,060RMB1,323 million in 20022004 to RMB1,053RMB2,457 million in 2003.2005. This was mainly dueattributable to a decrease inincreased scale of operations during SARS period.

operations.

Depreciation and amortization,amortisation, which accounted for 12.0%12.4% of total operating expenses, increased by 10.8%103.3% from RMB1,840RMB 2,413 million in 20022004 to RMB2,038RMB4,905 million in 2003.2005. This increase was primarily as a result of the additionadditional depreciation charge on aircraft delivered in 2004 and 2005.
37
Operating (loss) / profit
The Group recored an operating loss of aircraft during 2003.

46

Operating Income

     Operating income decreased by 77.5% from RMB2,026RMB1,232 million in 20022005 as compared to RMB456an operating profit of RMB909 million in 2003.2004. This was mainly because an increase in operating revenue decreased by RMB549RMB14,319 million or 3.0% from 200259.7% in 2005 while operating expenses increased by RMB1,021RMB16,460 million or 6.4% over71.4% in the same period.


Non-operating Income/(Expenses)

income/(expenses)

Interest expense decreasedincreased by 14.1%133.9% from RMB959RMB691 million in 20022004 to RMB824RMB1,616 million in 2003,2005, mainly reflectingdue to the combined effect of scheduled debt repaymentsincrease in loans, lease obligations and the replacement of certain RMB denominated bank loans with US$ denominated bank loans with lower interest rates.

rate.

Interest income decreasedincreased by 75.2%150.0% from RMB53RMB22 million in 20022004 to RMB13RMB55 million in 2003. This2005. It was mainly attributable to a decreasean increase 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.

interest rate.


During 2003,2005, the Group recorded a net exchange gain of RMB1,220 million (2004: Net exchange loss of RMB164 million predominantly due to its Japanese yen denominated borrowings as a result of the Japanese yen appreciation.RMB59 million) mainly resulted from Renminbi appreciation since July 2005. Such amount comprised mostly unrealizedrepresents mainly unrealised translation loss.

Taxation

     On October 17, 2003,exchange gain, resulting from exchange gains on translated year end foreign currency denominated liabilities, rather than foreign exchange transactions incurred during the Company’s registered address was moved to Guangzhou Economic & Technology Development Zone. year.

Taxation

In accordance with2005, 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 from 33% to 15% beginning from that date.

     The Group recorded an income tax creditexpenses of RMB324RMB4 million for 2003 compared to anresulting from recognition of RMB159 million deferred tax assets in respect of a portion of tax losses. In 2004, income tax expenseexpenses 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.RMB65 miilion were recorded.

Additional information under U.S. GAAP

     2004

2006 Compared with 2003

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 RMB8,682RMB7,926 million or 34.1%20.7% from RMB25,483RMB38,293 million in 20032005 to RMB34,165RMB46,219 million in 2004. Such growth2006. 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 attributabledue to growtha 21.0% rise in volumepassenger revenue from RMB 34,328 million in 2005 to RMB41,549 million in 2006 resulting from increased traffic volume. The total number of passenger trafficpassengers carried increased by the Group11.5% 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 recoveryincrease 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 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 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 SARSRMB19,183 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 capacity.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 RMB7,171RMB7,024 million or 28.6%21.8% from RMB25,117 million in 2003 to RMB32,288 million in 2004.2004 to RMB39,312 million in 2005. As operating revenue increased moresmaller than operating expenses, operating income decreased by 154.3% from operating profit increased by 412.8% from RMB366 million in 2003 toof RMB1,877 million in 2004.2004 to operating loss of RMB1,019 million in 2005. The Group’s net non-operating expenses decreased by 38.5%59.3%, from RMB1,905 million in 2003 to RMB1,171RMB1,184 million in 2004 primarilyto RMB482 million in 2005, mainly attributable to a decreasethe combined effect of increase in unfavourable movementexchange gain of RMB1,344 million, increase in foreign exchange differencesinterest expense of RMB257RMB405 million and a decrease in interest expenseshare of RMB420results of associates of RMB295 million. Overall, the Group recorded a net income of RMB239 million in 2004, as compared to a net loss of RMB1,140 million in 2003.

Operating revenue

Substantially all of the Group’s operating revenue is attributable to airline and airline related operations. Traffic revenue in 20042005 and 20032004 accounted for 97.3%97.7% and 97.7%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 34.1%12.1% from RMB25,483 million in 2003 to RMB34,165 million in 2004.2004 to RMB38,293 million in 2005. This increase was primarily due to a 35.7% rise12.8% increase in passenger revenue from RMB22,438 million in 2003 to RMB30,443 million in 2004 to RMB34,328 million in 2005 resulting from increased traffic volume. The total number of passengers carried increased by 33.0%14.0% to 38.744.12 million passengers in 2004.2005 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 34.3%16.3% from 39,62653,233 million in 20032004 to RMB53,233RMB61,923 million in 2004,2005, primarily as a result of an increase in passengers carried. Passenger yield increaseddecreased by RMB0.02 to RMB0.57.

RMB0.55.

Domestic passenger revenue, which accounted for 81.4%82.1% of the total passenger revenue in 2004,2005, increased by 32.6%13.8% from RMB18,679 million in 2003 to RMB24,773 million in 2004.2004 to RMB28,182 million in 2005. Domestic passenger traffic in RPKs increased by 30.6%17.8%, mainly due to an increase in passengers carried. PassengerDomestic passenger yield increaseddecreased by RMB0.02 to RMB0.57RMB0.55 in 2004.

2005.

Hong Kong and Macau passenger revenue, which accounted for 3.8%3.5% of total passenger revenue, increased by 47.4%3.7% from RMB781 million in 2003 to RMB1,151 million in 2004.2004 to RMB1,194 million in 2005. For Hong Kong and Macau regional flights, passenger traffic in RPKs increased by 68.0%18.5%, while passenger capacity in ASKs increased by 55.8%26.5%, resulting in a 4.54.0 percentage point increasedecrease in passenger load factor from 2003.2004. Passenger yield decreased from RMB1.00 in 2003 to RMB0.88 in 2004 to RMB0.77 in 2005 mainly due to intensified competition among airlines.

International passenger revenue, which accounted for 14.8%14.4% of total passenger revenue, increased by 51.7%9.6% from RMB2,978 million in 2003 to RMB4,519 million in 2004.2004 to RMB4,952 million in 2005. For international flights, passenger traffic in RPKs increased by 52.8%8.3%, while passenger capacity in ASKs increased by 44.1%5.4%, resulting in a 3.61.8 percentage point rise in passenger load factor from 2003.2004. Passenger yield remained steadyincreased by 1.1% from RMB0.55 in 2004 to RMB0.56 in 2005 mainly resulted from higher ticket price and at RMB0.55.

the 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 8.4%8.3% of the Group’s total traffic revenue and 8.2%8.1% of total operating revenue, increased by 13.5%10.7% from RMB2,459 million in 2003 to RMB2,792 million in 2004.2004 to RMB3,091 million in 2005. The increase was attributable to the increasing traffic demand.

Other operating revenue increaseddecreased by 58.7%6.0% from RMB586 million in 2003 to RMB930 million in 2004.2004 to RMB874 million in 2005. The increasedecrease was primarily due to the general growth in income from various auxiliaryreduced scale of other operations.

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 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 and from asset impairment charges.

40
Total operating expenses in 20042005 amounted to RMB32,288RMB39,312 million, representing an increase of 28.6%21.8% or RMB7,171RMB7,024 million over 2003, primarily due to the combined effect of increases in jet fuel costs, maintenance expenses and aircraft and traffic servicing expenses. In addition, in 2003, the Group recorded an asset impairment charge of RMB510 million on certain aircraft of CNA. The Group did not incur any asset impairment charges on its aircraft in 2004. Total operating expenses as a percentage of total operating revenue decreased from 98.6% in 2003 to 94.5% in 2004.

     Flight operations expenses, which accounted for 46.5% of total operating expenses, increased by 45.1% from RMB10,351 million in 2003 to RMB15,016 million in 2004, primarily as a result of increases in jet fuel costs, operating lease payments, catering expenses, labour costs for flight personnel and inclusion of CAAC Infrastructure Development Fund of RMB632 million in operating expenses which is an usage charge since 2004 but was a turnover-based levy and deducted against the traffic revenue in 2003. Jet fuel costs, which accounted for 57.0% of flight operations expenses, increased by 51.1% from RMB5,662 million in 2003 to RMB8,555 million in 2004 mainly as a result of increased fuel prices and fuel consumption. Operating lease payments increased by 16.6% from RMB1,808 million in 2003 to RMB2,109 million in 2004, primarily due to the additional rental payments for new aircraft under operating leases. Catering expenses increased by 30.9% from RMB754 million in 2003 to RMB987 million in 2004, primarily due to increase in number of passengers carried. Aircraft insurance costs decreased by 7.9% from RMB291 million in 2003 to RMB268 million in 2004, primarily because of a decrease in insurance premiums prescribed by the PRC insurance company. Labour costs for flight personnel increased by 37.2% from RMB1,126 million in 2003 to RMB1,545 million in 2004, largely due to the increase in flying hours.

     Maintenance expenses which accounted for 14.2% of total operating expenses, increased by 18.1% from RMB3,878 million in 2003 to RMB4,578 million in 2004. The increase was primarily attributable to a 16.7% increase in aircraft overhaul charges from RMB2,913 million in 2003 to RMB3,399 million in 2004, which was resulted from fleet expansion in recent years.

     Aircraft and traffic servicing expenses, which accounted for 14.8% of total operating expenses, increased by 25.9% from RMB3,803 million in 2003 to RMB4,789 million in 2004. The increase was primarily resulted from an 25.7% rise in landing and navigation fees from RMB3,539 million in 2003 to RMB4,447 million in 2004, and an increase in number of landing and takeoffs.

     Promotional and marketing expenses, which accounted for 8.1% of total operating expenses, increased by 27.6% from RMB2,043 million in 2003 to RMB2,606 million in 2004. The increase was due to 40.0% increase in labour costs from RMB305 million in 2003 to RMB427 million in 2004, as more payments of performance bonus were made because of the increased traffic volume.

     General and administrative expenses, which accounted for 5.4% of the total operating expenses, increased by 25.9% from RMB1,397 million in 2003 to RMB1,759 million in 2004. This was mainly attributable to increased scale of operations.

     Depreciation and amortisation, which accounted for 11.0% of total operating expenses, increased by 15.8% from RMB3,042 million in 2003 to RMB3,523 million in 2004. This increase was primarily a result of the additions of aircraft during 2004.

     Operating income

     Operating income increased by 412.8% from RMB366 million in 2003 to RMB1,877 million in 2004. This was mainly because operating revenue increased by RMB8,682 million or 34.1% from 2003 and operating expenses increased by RMB7,171 million or 28.6% over the same period.

     Non-operating income/(expenses)

     Interest expense decreased by 26.2% from RMB1,604 million in 2003 to RMB1,184 million in 2004, mainly reflecting the combined effect of scheduled debt repayments and the replacement of certain RMB denominated bank loans of higher interest rates with US$ denominated bank loans of lower interest rates.

     Interest income increased by 22.2% from RMB27 million in 2003 to RMB33 million in 2004. This was mainly attributable to an increase in average cash balances.

     During 2004, the Group recorded a net exchange loss of RMB124 million (2003: RMB381 million) mainly from its Japanese yen denominated borrowings as a result of the Japanese yen appreciation. Such amount comprised mostly unrealised translational exchange loss.

     Taxation

     On 17 October, 2003, the Company’s registered address was moved to Guangzhou Economic & Technology Development Zone, Guangzhou, China. 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 1 October, 2003. As a result, the Company’s income tax rate has been changed from 33% to 15% beginning from that date. In 2003, the Group recorded an income tax credit of RMB526 million resulting from a reduction in net deferred taxation liability balance of RMB341 million.

     The airline operations of CNA and XJA were subject to PRC income tax at 33% during 2003 and up to 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 are subject to PRC income tax at the applicable rate of 15% beginning that date. Consequently, the airline operations of CNA and XJA recorded an income tax credit of RMB99 million. Overall, net income tax expenses of the airline operations of CNA and XJA amounted to RMB274 million for 2004.

     Minority interests

     Minority interests increased by 52.0% from RMB127 million in 2003 to RMB193 million in 2004, primarily reflecting the increased net profits earned by certain of the Group’s airline subsidiaries for the year.

2003 Compared with 2002

     The Group’s operating revenue slightly decreased by RMB275 million or 1.1% from RMB25,758 million in 2002 to RMB25,483 million in 2003. The Group’s traffic operations were badly hit by the outbreak of SARS during 2003 which reduced the traffic revenue of the Group during the affected period from April to July 2003. Operating expenses increased by RMB1,307 million or 5.5% from RMB23,810 million in 2002 to RMB25,117 million in 2003. As operating revenue decreased while operating expenses increased, operating profit decreased by 81.2% from RMB1,948 million in 2002 to RMB366 million in 2003. The Group’s net non-operating expenses decreased by 8.6%, from RMB2,084 million in 2002 to RMB1,905 million in 2003, mainly due to a decrease in interest expense of RMB 216 million, partly offset by an increase in foreign exchange loss of RMB54 million. Overall, the Group recorded a net loss of RMB1,140 million in 2003, as compared to a net loss of RMB655 million in 2002.

     Operating Revenue

     Substantially all of the Group’s operating revenue is attributable to airline operations. Traffic revenue in 2003 and 2002 accounted for 97.7% and 96.5% respectively of total operating revenue. Passenger revenue and, cargo and mail revenue accounted for 90.1% and 9.9% respectively of total traffic revenue in 2003. The balance of the Group’s operating revenue is derived from commission income, income from general aviation operations, fees charged for ground services and for air catering services and net income from lease arrangements.

     Operating revenue decreased by 1.1% from RMB25,758 million in 2002 to RMB25,483 million in 2003. This decrease was primarily due to a 0.6% fall in passenger revenue from RMB22,566 million in 2002 to RMB22,438 million in 2003 resulting from lower traffic volume caused by SARS. The total number of passengers carried decreased by 1.4% to 20.5 million passengers in 2003. RPKs decreased by 4.8% from 41,642 million in 2002 to 39,626 million in 2003, primarily as a result of a decrease in number of 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 83.2% of the total passenger revenue in 2003, increased slightly by 2.9% from RMB18,145 million in 2002 to RMB18,679 million in 2003. Domestic passenger traffic in RPKs decreased by 0.6%, mainly due to a decrease in passengers carried. Passenger yield, however, increased from RMB0.54 in 2002 to RMB0.56 in 2003, mainly as the result of the aforesaid exemption of CAAC Infrastructure Development Fund and sales tax.

     Hong Kong passenger revenue, which accounted for 3.5% of total passenger revenue, decreased by 31.7% from RMB1,144 million in 2002 to RMB781 million in 2003. For Hong Kong flights, passenger traffic in RPKs decreased by 28.0%, while passenger capacity in ASKs decreased by 22.9%, resulting in a 4.1 percentage point decrease in passenger load factor from 2002. Passenger yield decreased from RMB1.06 in 2002 to RMB1.00 in 2003 mainly due to slack in traffic volume.

     International passenger revenue, which accounted for 13.3% of total passenger revenue, decreased by 9.1% from RMB3,277 million in 2002 to RMB2,978 million in 2003. For international flights, passenger traffic in RPKs decreased by 22.1%, while passenger capacity in ASKs decreased by 17.8%, resulting in a 3.2 percentage point fall in passenger load factor from 2002. Passenger yield increased by 17.0% from RMB0.47 in 2002 to RMB0.55 in 2003 mainly as the result of the aforesaid exemption of CAAC Infrastructure Development Fund and sales tax.

     Cargo and mail revenue, which accounted for 9.9% of the Group’s total traffic revenue and 9.6% of total operating revenue, increased by 7.4% from RMB2,289 million in 2002 to RMB2,459 million in 2003. The increase was primarily due 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.

     Other operating revenue decreased by 35.2% from RMB904 million in 2002 to RMB586 million in 2003. The decrease was primarily due to a decrease in aircraft short-term lease income of RMB130 million and the inclusion of the gain on the disposal of property, plant and equipment of RMB194 million in 2002.

     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 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, and from assets impairment charges.

     Total operating expenses in 2003 amounted to RMB25,117 million, representing an increase of 5.5% or RMB1,307 million over 2002, 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 92.4%94.5% in 20022004 to 98.6%102.7% in 2003.

2005.

Flight operations expenses, which accounted for 41.2%48.8% of total operating expenses, increased by 2.9%27.8% from RMB10,062RMB15,016 million in 20022004 to RMB10,351RMB19,183 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 8.3%39.4% from RMB5,228RMB8,555 million in 20022004 to RMB5,662RMB11,929 million in 20032005 mainly as a result of increased jet fuel prices.prices and fuel consumption. Operating lease payments increased by 8.6%12.4% from RMB1,665RMB2,109 million in 20022004 to RMB1,808RMB2,375 million in 2003,2005, primarily due to the full year effect of the addition ofadditional rental payments for new aircraft under 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.leases. Catering expenses decreasedincreased by 16.7%21.2% from RMB906RMB987 million in 20022004 to RMB754RMB1,196 million in 2003,2005, primarily reflecting a tighter cost controls exercised by the Group.due to an increase in number of passengers carried. Aircraft insurance costs decreased by 19.6%60.8% from RMB362RMB268 million in 20022004 to RMB291RMB105 million in 2003,2005, primarily because of a reductiondecrease in the rate of aircraft insurance premiums prescribed by the PRC insurance company. Laborin 2005. Labour costs for flight personnel decreasedincreased by 5.8%4.8% from RMB1,195RMB1,545 million in 20022004 to RMB1,126RMB1,619 million in 2003,2005, largely due to a decreasethe increase in flight hours.

flying hours and allowance standard.

Maintenance expenses which accounted for 15.4%10.3% of total operating expenses, increaseddecreased by 9.9%11.5% from RMB3,530RMB4,578 million in 20022004 to RMB3,878RMB4,051 million in 2003.2005. The increasedecrease was primarily attributablemainly due to a 9.6% increase in aircraft maintenance and repair charges from RMB2,657 million in 2002 to RMB2,913 million in 2003, which was result ofcertain major overhaul costs capitalized during the effect of fleet expansion in recent years.

year. 

Aircraft and traffic servicing expenses, which accounted for 15.1%14.6% of total operating expenses, increased by 10.8%20.3% from RMB3,433RMB4,789 million in 20022004 to RMB3,803RMB5,759 million in 2003.2005. The increase was primarily resulted from a 9.6%10.0% rise in landing and navigation fees from RMB3,228RMB4,447 million in 20022004 to RMB3,539RMB4,891 million in 2003, and2005, as a result of an increase in the charge rate for domesticnumber of landing and navigation fees effective September 2002.

takeoffs.

Promotional and marketing expenses, which accounted for 8.1%7.1% of total operating expenses, decreasedincreased by 0.4%6.7% from RMB2,034RMB2,606 million in 20022004 to RMB2,043RMB2,780 million in 2003.2005. The decreaseincrease was mainly due to the increase in sales volume, resulting in a 5.3% decrease17.0% increase in labor costssales commission expenses from RMB322RMB1,285 million in 20022004 to RMB305RMB1,503 million in 2003, as fewer bonuses were given because of reduced sales volume in 2003.

2005.

General and administrative expenses, which accounted for 5.6%6.3% of the total operating expenses, increased slightly by 1.5%39.7% from RMB1,377RMB1,759 million in 20022004 to RMB1,397RMB2,457 million in 2003.2005. This was mainly dueattributable to a decrease inincreased scale of operations during SARS period.

operations.

Depreciation and amortization,amortisation, which accounted for 12.1%12.4% of total operating expenses, increased by 6.2%38.3% from RMB2,864RMB3,523 million in 20022004 to RMB3,042RMB4,871 million in 2003.2005. This increase was primarily as a result of the additions ofthe additional depreciation charge on aircraft during 2003.

     Asset impairment charges accounted for 2.0% of total operating expenses, amounted to RMB510 milliondelivered in 2003. During 2003, the2004 and 2005 and depreciation charge on capitalized major overhaul costs.

Operating (loss)/income

The Group recorded an asset impairment chargeoperating loss of RMB510 million on twenty-three McDonnell Douglas 82 aircraft operated by CNA. During 2002, the Group incurred an asset impairment charge of RMB347 million on four McDonnell Douglas 82 aircraft, eleven McDonnell Douglas 90 aircraft and six Airbus 300-600 aircraft operated by CNA. These asset impairment charges were recorded as a result of the carrying amount of the individual aircraft exceeding their corresponding estimated future cash flows. These asset impairment charges were recognized by the amount by which the carrying amount of the individual aircraft exceeded their corresponding fair value.

     Operating Income

     Operating income decreased by 81.2% from RMB1,948RMB1,019 million in 20022005 as compared to RMB366an operating profit of RMB1,877 million in 2003. This2004. The loss was mainly becausedue to an operating revenue decreased by RMB275increase of RMB4,128 million or 1.1% from 2002 while12.1% in 2005 and an operating expensesexpense increase of RMB7,024 million or 21.8% in the same period.

Non-operating income/(expenses)

Interest expense increased by RMB1,307 million or 5.5% over the same period.

     Non-operating Income/(Expenses)

     Interest expense decreased by 11.9%34.2% from RMB1,820RMB1,184 million in 20022004 to RMB1,604RMB1,589 million in 2003,2005, mainly reflectingdue to the combined effect of scheduled debt repaymentsincrease in loans and the replacement of certain RMB denominated bank loans with US$ denominated bank loans with lowerlease obligations and interest rates.

rate.


Interest income decreasedincreased by 67.1%66.7% from RMB82RMB33 million in 20022004 to RMB27RMB55 million in 2003. This was2005, mainly attributable to a decrease in average cash balances.

     During 2003, the increase of interest rate.

41
The Group recorded a net exchange gain of RMB1,220 million in 2005, compared to a net exchange loss of RMB381RMB124 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 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 implementedchange in the Guangzhou Economic & Technology Development Zone effective from October 1, 2003. As a result, the Company’senacted income tax rate has been changed from 33%applicable to 15% beginning from that date.

     The Group recorded an income tax creditairline operations of RMB526 million for 2003 compared to anCNA and XJA of RMB79 million. In 2004, income tax expense of RMB365RMB261 million for 2002. As a resultwas 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 reductionchange in enacted income tax rate the Company’s net deferred taxation liability balance brought forward from December 31, 2002applicable to airline operations of RMB625CNA and XJA of RMB99 million, was reduced by RMB341rate differential on airline operations of CNA and XJA of RMB43 million and a net deferred tax creditnon-deductible expenses of RMB341 million was recognized in 2003 for such reduction in income tax rate accordingly.

     Minority Interests

     Minority interests decreased by 17.5% from RMB154 million in 2002 to RMB127 million in 2003, primarily reflecting the net income earned by certain of the Group’s airline subsidiaries for the year.

47

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.

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 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 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, 2004,2006, the Group had banking facilities with several PRC commercial banks for providing loan finance up to an approximate amount of RMB35,750RMB49,041 million to the Group. As of December 31, 2004,2006, an approximate amount of RMB11,525RMB28,295 million was utilized. As of December 31, 20032005 and 2004,2006, the Group’s cash and cash equivalents totaled RMB2,080RMB2,901 million and RMB3,083RMB2,264 million, respectively.

Net cash inflows from operating activities in 2002, 20032004, 2005 and 20042006 were RMB3,698RMB3,574 million, RMB2,129RMB4,417 million and RMB3,596RMB2,217 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 2002, 20032004, 2005 and 20042006 was RMB5,895RMB8,824 million, RMB5,434RMB8,547 million and RMB8,824RMB5,404 million, respectively. Cash capital expenditures in 2002, 20032004, 2005 and 20042006 were RMB6,351RMB6,631 million, RMB4,707RMB5,473 million and RMB6,631RMB2,566 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 inflows of RMB3,150RMB6,231 million, RMB1,615RMB3,992 million and RMB6,231RMB2,550 million in 2002, 20032004, 2005 and 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 additional cash is for capital expenditures and general working capital. Repayment of capital 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 leases.

As of December 31, 2004,2006, the Group’s aggregate long-term debt and obligations under capital leases totaled RMB25,271RMB29,330 million. Based on such amount, in 2005, 2006,In 2007, 2008, 2009, 2010, 2011 and thereafter, amounts payable under such debt and obligations will be RMB3,737RMB7,005 million, RMB4,489RMB5,786 million, RMB6,705RMB3,853 million, RMB3,608RMB1,831 million, RMB2,154RMB6,474 million and RMB4,578 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, 2004,2006, the Group’s short term bank debt was RMB9,925 million with interest rates ranging from 1.40% to 5.31%.RMB19,908 million. The Group’s weighted average interest rate on short-term bank notes payable was 1.60%5.77% per annum as of December 31, 2004.2006. 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, 2004,2006, the Group had obligations under operating leases totaling RMB12,750RMB21,969 million, predominately for aircraft. Of such amount, RMB1,761RMB3,077 million, RMB1,622RMB2,965 million, RMB1,562RMB2,775 million, RMB5,259RMB2,613 million, RMB764RMB2,493 million and RMB1,782RMB8,046 million, respectively, wasis due in 2005, 2006, 2007, 2008, 2009, 2010, 2011 and thereafter.

48


As of December 31, 2004,2006, the Group had a working capital deficit of RMB18,855RMB32,180 million, as compared to a working capital deficit of RMB10,792RMB25,907 million as of December 31, 2003.2005. 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 20032005 to 20042006 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. The Group has obtained firm commitments from its principal banker to renew its short-term bank loans outstanding atAt December 31, 2004 when they fall due during 2005. In relation to its future capital commitments and other financing requirements,2006, the Group has already entered into loan financing agreements with several PRC banks to provide loan financefinancing up to an approximate amount of RMB24,225RMB49,041 million during 20052007, 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 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, 2004,2006, the Group had capital commitments in 2005, 2006 and 2007 of approximately RMB10,167 million, RMB3,049 million and RMB84 million, respectively. Of such amounts, RMB8,748 million in 2005, RMB2,996 million in 2006 and RMB32 million in 2007 are related to the acquisition of aircraft and related flight equipment, and RMB824 million in 2005 is related to the Group’s facilities and equipment to be constructed and installed at the Guangzhou new airport. The remaining amounts of RMB595 million in 2005 and RMB105 million in 2006 are related to the Group’s otheras follows:
 
 
 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, 2004,2006, the Group undertook to make a capital contribution of approximately RMB83 million to a jointly controlled entities.

entity.

As of December 31, 2004,2006, the cash and cash equivalents of the Group totaled RMB3,083RMB2,264 million. Of such balance, 24.2%15.0% was denominated in foreign currencies.

     No interim dividend was paid during the year ended December 31, 2004. The Board of Directors does not recommend the payment of a final dividend in respect of the year ended December 31, 2004.

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.

49

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, 2004.2006.
                     
  As of December 31, 2004 
  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  9,925   9,925   —   —   — 
Long-term debt  13,528   1,593   5,766   2,283   3,886 
Capital lease obligations  11,743   2,144   5,428   3,479   692 
Cash payable for CNA/XJA Acquisitions  1,959   1,959   —   —   — 
                
Total contractual obligations
  37,155   15,621   11,194   5,762   4,578 
                
Other commercial commitments
                    
Operating lease commitments  12,750   1,761   3,184   6,023   1,782 
Aircraft purchase commitments (Note 1)  11,776   8,748   3,028   —   — 
Capital commitments in respect of investments in the Guangzhou new airport  824   824   —   —   — 
Other capital commitments  700   595   105   —   — 
Investing commitments  83   83   —   —   — 
                
Total commercial obligations
  26,133   12,011   6,317   6,023   1,782 
                

Note 1 Amounts shown are net of previously paid purchase deposits.

50

  
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 2004.2006. There were certain changes in the Company’s Directors, Senior Management and Supervisors subsequent to December 31, 2004,2006, details of which are set forth below.
Name
 
Position
 
Gender
 
Name
Age
Position
Liu Shao Yong 46Chairman of the Board of Directors
Liu Ming Qi 61Male Vice Chairman of the Board of Directors49
Peng An FaLi Wen Xin (1) DirectorMale 57Director
Wang Quan Hua 51Director MaleDirector53
Zhao Liu An 57Director Director
Zhou Yong QianMale 60Director59
Si Xian Min 47Director, President Directors; President
Zhou Yong JinMale 50
62Tan Wan Geng (2) Director, Vice PresidentMale43
Xu Jie Bo 40Director, Chief Financial Officer and Vice President Director; Chief Financial Officer; Vice President
Wu Rong NanMale 42
63Chen Zhen You (2) Director
Simon ToMale 54Independent Non-Executive Director55
Peter Lok 69Independent Non-executive Director MaleIndependent Non-Executive Director71
Wei Ming Hai 41Independent Non-executive Director MaleIndependent Non-Executive Director43
Wang Zhi 63Independent Non-executive Director MaleIndependent Non-Executive Director65
Sui Guang Jun 44Independent Non-executive Director MaleIndependent Non-Executive Director46
Sun Xiao Yi51 Chairman of the Supervisory CommitteeMale53
Yang Guang Hua 52Supervisor MaleSupervisor54
Yang Yi Hua 45Supervisor Supervisor
Li KunFemale 45Vice President47
Yuan Xin An 48Vice President Vice President; Chief Engineer
Zheng En RenMale 60Vice President50
Hao Jian Hua 55Vice President Vice President
Ren Ji DongMale 40Vice President56
He Zong Kai 53Vice President MaleVice President56
Liu Qian 40Chief Pilot Male41
Dong Su Guang(3) Chief PilotEngineerMale53
Su Liang 43Company Secretary MaleCompany Secretary45
Chen Wei Hua 38General Counsel MaleGeneral Counsel41

     On June 16, 2004, the appointment of Sun Xiao Yi, Yang Guang Hua and Yang Yi Hua as Supervisors and the resignation of Liang Hua Fu, Gan Yu Hua and Li Qi Hong as Supervisors were approved at the annual general meeting of the shareholders of the Company. On the same date, the Supervisory Committee of the Company elected Sun Xiao Yi as the Chairman of the Supervisory Committee of the Company.

     On October 8, 2004, the resignation of Yan Zhi Qing as the Chairman of the Board of Directors of the Company was approved by the Board of Directors.

     On October 28, 2004, the Board of Directors resolved to appoint Si Xian Min as the President of the Company and to accept the resignation of Wang Chang Shun as the President of the Company.

     On November 29, 2004, the

(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 Shao Yong as a Director, andis the resignation of Yan Zhi Qing for age reason were approved at the first extraordinary general meetingchairman of the shareholders of the Company. On the same date, the Board of Directors of the Company elected Liu Shao Yong as the Chairman of the Board of Directors of the Company.

51

     On December 31, 2004, the appointment of Si Xian Min asBoard. He is a Director, and the resignation of Wang Chang Shun as a Director were approved at the second extraordinary general meeting of the shareholders of the Company.

     On March 29, 2005, the Board of Directors resolved to appoint Ren Ji Dong and He Zong Kai as Vice Presidents of the Company, and to remove Jiang Ping as a Vice President of the Company.

Mr. Liu Shao Yongis the Chairman of the Board of Directors.qualified class one pilot. He joined the Company sincein November 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 of 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 Shanxi 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 obtainedbecame the chairman of the Board on November 29, 2004.

Mr. Li Wen Xin is currently a post-graduate degreeDirector of the Company. Mr. Li was a graduate majoring in International Trading from Tianjin Institute of Finance and Economics in 1999.economic management. He is a qualified class one pilot.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 party committee and vice general manager of China General Aviation Corporation successively between 1991 and 1998. He was appointed the party secretary and vice general manager of the Shanxi 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 supervisory committee of China Eastern Airlines Corporation Limited. He has been the party secretary and vice president of China Southern Air Holding Company since September 2006. Save as disclosed above, Mr. LiuLi is not connected with any Directors, senior management,Senior Management, substantial shareholders or Supervisors 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 Supervisors of the Company.

Mr. Peng An Fais currently a Director of the Company and the Vice President of CSAHC and became the employee of the Company since March 1995 after the establishment of the Company. Mr. Peng graduated from the pilot department of China Civil Aviation Flying College and the department of Chinese language and literature of South China Normal University. Mr. Peng began his career in civil aviation in 1969, and successively served as the Pilot Director, Vice Party Secretary and Party Secretary of the Sixth Squadron of the Civil Aviation Administration. In July 1994, Mr. Peng held office as the Party Secretary of the Flight Operations Department of China Southern Airlines. In March 1998, Mr. Peng served as the President and Vice Secretary of China Southern Airlines Shenzhen Co. From August 2001 to October 2002, Mr. Peng served as the Vice President of CSAHC. Mr. Peng is concurrently the Vice Chairman of Shenzhen Air Catering Co., Ltd and CATIC (Hong Kong). Save as disclosed above, Mr. Peng is not connected with any Directors, senior management, substantial shareholders or Supervisors of the Company.

45
Mr. Wang Quan Huais currently a Director of the Company and Vice President of CSAHC and became the employee of the Company sincein March 1995 after the establishment of the Company. Mr. Wang graduated from the Economic Management Department of Central Communist Party College. Mr. Wang began his career in civil aviation in 1972, and successively served as the Director of Planning Department of Guangzhou Civil Aviation Administration, the Office Director of China Southern Airlines Shenzhen Co., 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. Save as disclosed above, Mr. Wang is not connected with any Directors, senior management, substantial shareholders or Supervisorsbecame a Director of the Company.

Company on May 13, 2003.

Mr. Zhao Liu Anis a Director of the Company and the Vice President of CSAHC. Mr. Zhao joined the Company sincein May 2003. Mr. Zhao began his career in civil aviation in 1966, and 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. Save as disclosed above, Mr. Zhao is not connected with any Directors, senior management, substantial shareholders or Supervisors of the Company.

Mr. Zhou Yong Qianis currentlybecame a Director of the Company and the Vice President of CSAHC and the President of China Northern Airlines. Mr. Zhou joined the Company sinceon May 13, 2003. Mr. Zhou graduated from Nanjing Institute of Meteorology. Mr. Zhou began his career in civil aviation in 1990, and successively served as Minister of the Organization Division of the Northeastern Civil Aviation Administration, Vice Secretary of Shenyang Taoxian International Airport, Vice Secretary of the Northeastern Civil Aviation Administration and the President of China Northern Airlines. Save as disclosed above, Mr. Zhou is not connected with any Directors, senior management, substantial shareholders or Supervisors of the Company.

52

Mr. Si Xian Minis 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, he 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.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. SiTan is not connected with any of the Directors, senior management,Senior Management, substantial shareholders or Supervisors of the Company.

Mr. Zhou Yong Jinis a Director of the Company. He joined the CSAHC in January 1991 and became an employee of the Company upon its establishment in March 1995, and has successively served as a Director of the Propaganda Department of the CSAHC, Party Secretary of the Transportation Department (Guangzhou) of the Company, and Party Secretary of the Company’s Shenzhen branch. He served as Chairman of the Labour Union of the Company. Save as disclosed above, Mr. Zhou is not connected with any Directors, senior management, substantial shareholders or Supervisors of the Company.

Mr. Xu Jie Bois 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 with a mastermaster'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 Assistant General ManagerVice 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 on April 16, 2001.
Mr. Chen Zhen You is a Director and Chairman of the Labour Union of the Company, graduated from South China Normal University with a bachelor’s degree in English. Mr. Chen, an economist, holds an MBA from Murdoch University in Australia. He worked as the Vice Director of the Office of International 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 a member of the Party Committee and Chairman of the Labour Union of the Company since February 2005. Save as disclosed above, Mr. XuChen is not connected with any of the Directors, senior management,Senior Management, substantial shareholders or Supervisors of the Company.

Mr. Wu Rong Nanis a Director of the Company. He joined CSAHC in January 1991 and became an employee of the Company upon its establishment in March 1995. Mr. Wu is an air traffic control engineer. He was once employed as the Director of Flight Operations of the Guangzhou Civil Aviation Administration and has been President of Xiamen Airlines since 1986. Mr. Wu is not connected with any Directors, senior management, substantial shareholders or Supervisors 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, substantial shareholders or Supervisors of the Company.

Mr. Peter Lokhas 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, substantial shareholders or Supervisors of the Company.

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, substantial shareholders or Supervisors of the Company.

53

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 Institute 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, substantial shareholders or Supervisors 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 anycurrently the Deputy Vice Chancellor of Guangdong University of Foreign Studies.
The independent non-executive Directors senior management, substantial shareholders or Supervisors of the Company.

     Supervisory Committee

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.

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 Management of the Company, including the Board of Directors, executive officers and other Senior Managementsenior management personnel, to ensure that they act in the interests of the Company, its shareholders and employees, as well as in compliance with the applicable laws.law. The Supervisory Committee consists of three Supervisors. Two of the Supervisors are shareholder’sshareholder representatives appointed by shareholders, of the Company, and the remainingone Supervisor is a representative of the Company’s employees. The Supervisors serve terms of three years and may serve consecutive terms.

Mr. Sun Xiao Yiis a member of Party Committee and head of Discipline Supervision Team of China Southern Air Holding Company. Mr. Sun graduated from the Civil Aviation University of China with a degree in Economics and Administration and is currently a postgraduate law student of 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 Hubei branch of the Company, Party Secretary of the Flight Operations Department of the Company, and Vice Party Secretary of China Southern Air Holding Company. Save as disclosed above, Mr. Sun is not connected with any Directors, senior management, substantial shareholders or Supervisors of the Company.

became a Supervisor on June 16, 2004.

Mr. Yang Guang Huais the Vice Party Secretary and Discipline Supervision Secretary of the Company. Mr. Yang is an engineer with university qualification. Mr. Yang has successively served as Deputy General Manager of the Hunan branch of the Company, General Manager of Southern Airlines (Group) Zhuhai Helicopters Company Limited, General Manager of the Hunan branch of the Company, and Deputy General Manager of the Company. Save as disclosed above, Mr. Yang is not connected with any Directors, senior management, substantial shareholders or Supervisors of the Company.

became a Supervisor on June 16, 2004.

Ms. Yang Yi Huais 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, Manager of the Financial Office of the Company’s Financial Division, and Deputy General Manager of the Company’s Audit Department. Save as disclosed above,She has been the President of Xiamen Airlines since September 2005. Ms. Yang is not connected with any Directors, senior management, substantial shareholders or Supervisors of the Company.

54

     All Directors and Supervisors of the Company have entered into service contracts with the Company forbecame a term of three years commencingSupervisor on June 16, 2004 (except that the service contract of Mr. Liu Shao Yong and Mr. Si Xian Min which commenced from November 29, 2004 and December 31, 2004 respectively will expire at the end of the term for the current session of the Board). Except for such service contracts, none of the Directors or Supervisors of the Company has entered or proposed to enter into any 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.

2004.

SENIOR ADMINISTRATIVE OFFICERS

Mr. Li Kunis a Managing Vice President of the Company. He graduated from the CAAC Management Institute specializing in Air Transport Management. Mr. Li was the General Manager of the Thailand Office, China Southern Airlines from 1993 to 1995. He became the General Manager of Transportation Department of the Company from 1998 to 2000. Mr Li has been holding the position as a Vice President of the Company since 2000.

Mr. Yuan Xin Anis a Vice President and Chief Engineer of the Company. He graduated from the Air Engineering College. Mr. Yuan 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 has becomebecame the Chief Engineer of the Company sincein 2000, and he has been appointed as a Vice President of the Company fromin April 2002.

Mr. Zheng En Renis a Vice President of the Company. He graduated from the CAAC Advanced Flying College and possesses the qualification as a First Class Pilot. Mr. Zheng has over 40 years of experience in the Chinese aviation industry. He served as the Captain of the Sixth Squadron of the Civil Aviation Administration, Chairman of the Labour Union and Deputy Chief Captain. During the period from 1996 to 1999, he held the position as President of Southern Airlines (Group) Shantou Airlines Company Limited. Mr. Zheng was an Assistant to the President of the Company from 1999 to April 2002. He has been appointed as a Vice President of the Company from April 2002.

Mr. Hao Jian Huais currently the Vice President of the Company. He completed his pilotingpilot 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 has been the Vice President of the Company since 31 July, 2003.

Mr. Ren Ji Dongisbecame a Vice President of the Company who graduated from the College of Energy and Power Engineering Department of Nanjing University of Aeronautics and Astronautics with a major degree in motor design, is a senior engineer. Mr. Ren assumed various offices in the aircraft maintenance workshop of Xinjiang Airlines Company, including Head of Workshop, Deputy Director of Workshop and President of the Engineering Department. Mr. Ren served as the Deputy Director of Urumqi Civil Aviation Administration and Vice President of Xinjiang Airlines Company. He was the Vice President of Xinjiang Airlines from 2002 to 2004. Mr. Ren has assumed the offices of the Party Secretary and Vice President of the Urumqi branch of the Company since 2004.

July 2003.

47
Mr. He Zong Kaiis 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 2003.

2003 and became a Vice President of the Company in March 2005.

Mr. Liu Qianis 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 has assumed the offices of the Deputy Chief Pilot and Chief Pilot of the Company sincein November 2004.

55

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 Liangis 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 mastera 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..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. From 2000 to date, Mr. Su isbecame the Company Secretary.

Secretary on June 26, 2000.

Mr. Chen Wei Huais the Chief Company CounselLegal Adviser to the Company. Mr. Chen graduated from the school of law of Peking University. He is a qualified solicitor and a qualified corporate legal counsellor. Mr. Chen joined the Civil Aviation Administration of China in 1998. He then joined the CSAHC in January 1991. From 1997 to 2003, he served as Vice Director and Director of the Legal Affairs Office of the Company. Currently, he is President of the Legal Department of the Company. Since December 2003, Mr. Chen has been the Chief Legal Adviser to the Company. He is also a Director of Xiamen Airlines Company Limited.

     None

Compensation
A total of the senior administrative officers above is connected with any Directors, senior management, substantial shareholders or Supervisors of the Company.

Compensation

     RMB255,000RMB402,000 has been paid to independent non-executive Directors for the year ended December 31, 2004.2006. The aggregate compensation paid by the Company to all Directors (excluding non-executive Directors), Supervisors and senior managementSenior Management for 20042006 was RMB6.8 million.RMB6,638,000. For the year ended December 31, 2004,2006, the Company accruedpaid an aggregate of approximately RMB145,000RMB220,000 on behalf of its executive Directors, 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

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.

56

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 Remuneration Committee comprisesremuneration committee is comprised of three members. The Remuneration CommitteeCurrently, 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 Remuneration Committeeterm 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. The remuneration committee met once in 20042006, which meeting was attended by all members. In addition, the Remuneration Committeeremuneration committee also meets as and when required to consider remuneration related matters.

The responsibilities of the Remuneration Committeeremuneration committee are to approve the remuneration packages of Directors and senior managementSenior 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 Directors and approving the terms of executive Directors’ service contracts.
Employees

Employees

As of December 31, 2004,2006, the Group had 18,22145,575 employees, including 1,9953,480 pilots, 3,2316,644 flight attendants, 2,6795,912 maintenance personnel, 2,1944,706 sales and marketing personnel, 14,686 administrative and 8,122 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.

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 located. The Group is required to contribute to these schemes at the rates ranging from 14%10% to 20%23% 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.

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 at a ratenot exceeding one-twelfth of 4.5% ofthe prior year’s total salaries. The

In 2006, the Group has no obligationimplemented an early retirement plan for eligible employees. Employees at certain positions reaching a predetermined age are eligible for the paymentplan. The approved employees are entitled to a fixed percentage of pension benefits beyondsalaries and bonus on a monthly or yearly basis from the contributions described above. Contributionsearly retirement date to the normal retirement schemes are charged to the income statement as and when incurred.

57

age.

Furthermore, pursuant to the comprehensive services agreement (the “Services Agreement”) dated May 22, 1997 between the Company and CSAHC, CSAHC agrees to provide adequateprovided quarters to eligible employees of the Group as and when required.Group. In return, the Group agrees to paypaid a fixed annual fee of RMB85 million to CSAHC for a ten-yearten year period effective January 1, 1995.

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 housing. Such expenditure has been deferred and amortised 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 vesting benefit 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 income statement. As atof December 31, 2004,2006, the Company and the Group alreadyhad made payments totalling RMB191RMB170 million under the scheme and recorded its remaining contractual liabilities totalling RMB69RMB90 million as accrued expenses on itsthe balance sheet. Housing allowances are payable when 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.
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    
              % to the  total  total    
              total  issued  issued    
  The          issued  domestic  share    
  Company/      Number  H shares  shares  capital    
  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   0.009%  —   0.002%  — 

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 Securities and Futures Ordinance.

ITEM 7. MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS.

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Major Shareholders

Share Capital Structure

As of DecemberMay 31, 2004,2007, 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, 2004,2007, the following shareholders had an interest of 5% or more in the Company’s shares:
Name
 
Number of Shares
 
Approximate
Percentage
of the Total
Name
Number of Shares
Number of Shares 
CSAHC 2,200,000,000 domestic shares  50.30%
HKSCC Nominees Limited 1,151,953,9981,156,215,998 H shares  26.3426.43%

The table below sets forth, as of DecemberMay 31, 2004,2007, the following entities hold 5% or more of the total number of H shares issued by the Company.
       
    Approximate 
    Percentage of 
    the Total 
    Number of H 
Name Number of H Shares Shares 
HKSCC Nominees Limited 1,151,953,998  98.11%

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 2637 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 have been entered into by the Group in the ordinary and usual course of its business on either normal commercial terms or terms no less favourable than terms available to or from independent third parties that are fair and reasonable so far asin accordance with the shareholders are concerned.

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.

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 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.


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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.

The Company and CSAHC entered into a lease 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 authorizedauthorised 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 metres,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 designeddesignated lands under lease agreement is RMB22,298,033RMB22,298,000 per year, payable in arrear by cheque, in cash or by bank transfer on or before the 10th day of each calendar month, and iswas determined after arm’s length negotiationnegotiations between the parties. The Capmaximum aggregate annual limit (“Cap”) for the lease agreement is set at RMB22,298,033RMB22,298,000 per year.

Comprehensive Services and Employee Benefits

The Company and CSAHC have entered into a comprehensive serviceslease agreement dated May 22, 1997, pursuant to which CSAHC agrees to provide adequate quarters to eligible employeeswas approved by the shareholders of the Group as and when required. In return,Company at the Group agrees to pay a fixed annual fee of RMB85 million to CSAHC for a ten-year period effective January 1, 1995.

     Arrangements with CSAHC and CSAHC’s Affiliates

Sale and Purchase Agreement

     The Company, CSAHC, CNA, a wholly owned subsidiary of CSAHC, and XJA, a wholly owned subsidiary of CSAHC, entered into a sale and purchase agreement (the “Sale and Purchase Agreement”) dated November 12, 2004, pursuant to which the Company agreed to acquire, and CSAHC, CNA and XJA agreed to sell certain airlines and airlines-related operations, assets and properties of CNA, XJA and their respective subsidiaries, which included aircraft, engines, spare parts, aviation equipment and facilities, properties, office facilities, and other fixed, current and intangible assets. In addition, the Company will also assume all indebtedness in the aggregate sum of RMB13,438,191,000 owed by XJA, CNA and their respective subsidiaries in connection with their civil aviation business. The total consideration, including the assumption of the debts under the Sale and Purchase Agreement was RMB15,397,524,000.

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second extraordinary general meeting on December 31, 2004.

Leases

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 RMB41,993,318RMB43,758,000 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 RMB41,993,318RMB43,758,000 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 RMB5,797,909RMB5,798,000 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 RMB5,797,909RMB5,798,000 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 the Demerger agreement dated March 25, 1995 (as amended). Under the De-merger Agreement, CSAHC has agreed to indemnify the Company against claims, liabilities and expenses incurred by it relating to the business, assets held or assumed by the Company pursuant to 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, 2004,2006, the amount incurredcommission expense paid by the Group forin respect of the import and export of the above equipment was RMB1,117 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.

Company and 50% owned by CSAHC


The Company and Southern Airlines Advertising Company (“SAAC”), which is 45% owned by the Company and 55% owned by CSAHC

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

     On 3 September, 2004, CSAHC increased its shareholdings from 10% to 55% by the creation of RMB3 million authorized share capital from RMB2 million. Such capital injection from CSAHC diluted the Company’s shareholdings of SAAC from 90% to 45%.

     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, 2004,2006, the amount incurred by the Group to SAAC for advertising servicesSACM was RMB1.2 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 Hong KongListing 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 cancould continue to provide deposit of money service and other financial services (subject to execution of separate agreements and further compliance with the Hong Kong Listing Rules),Company. Therefore, the Company and SA Finance entered into a new financial agreementFinancial Agreement on November 12,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 relevant 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.

61


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; (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 (c) SA Finance will

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,Cap and terms and conditions of such services, upon request by the Company during the term of the financial agreement, and thenew Financial Agreement. The Company will comply with the Hong Kong, Listing Rules when entering into such separate written agreements.

     The Company is not subject to any extra charges for depositing money with SA Finance. For the other financial services provided by SA Finance under the financial agreement, the Company is liable to pay SA Finance the standard charging rates set by the People’s Bank of China. The PRC commercial banks also charge similar charging rates set by the People’s Bank of China. The Company will make payment for such interest, fees and commissions in accordance with the payment terms of the separate agreements for the provision of loans or other financial services as might be entered into between the Company and SA Finance.

     The Cap for the provision of deposit service under the financial agreement is set at RMB1 billion per year. The Company usually receives interest on its money deposited with SA Finance at rates which are more favourable than the benchmark interest rates set by the People’s Bank of China, usually in the range between the benchmark interest rates set by the People’s Bank of China and the inter-bank offer rates of interest. This arrangement allows the Company to achieve a more efficient use of its current capital, since the Company can enjoy better interest rates on depositing its current capital with SA Finance than the benchmark rates of interest set by the People’s Bank of China that the PRC commercial banks can offer to the Company.

     Subject to the entering into of further separate agreements, the Company can borrow from SA Finance at interest rates not higher than those set by the People’s Bank of China for similar loans. In addition, the Company is not precluded under the financial agreement to borrow money from other PRC commercial banks where the terms and conditions are favourable. The Company can also enjoy the convenience of other financial services at the rates of fees and commissions set by the People’s Bank of China, which are comparable to the rates charged by PRC commercial banks for similar services.


As of December 31, 2004,2006, the Group’s deposits placed with SA Finance amountingamounted to RMB406.0 million,RMB629,366,000, which earnedbore interest at the rate of 0.62% — 1.62%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, 2004,2006, the amount paidincurred by the Group to Shenzhen Air Catering Company Limited for the provision of in-flight meals was approximately RMB50.2 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 2004.

     For the year ended December 31, 2004, the amount incurred by the Company for such repair and maintenance services was RMB659.9 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, 2004,2006, the amount paid by the Group to the Australian Pilot College for training services was RMB79.4 million.

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.

62


For the year ended December 31, 2004,2006, 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 RMB65.6 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, 2004,2006, the aggregate amount of ticket sales of the GroupCompany conducted through the Agents was RMB32.0 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 (a)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 (b)(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 agreementCatering 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 mealsmeal 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 flightflights it provides service.service for. The Capcap for the Catering Agreement is set at RMB220 millionRMB220,000,000 per year.

In-flight Meals Arrangement with Northern


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

     Following


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 announcementCompany 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 consolidation and restructuring among CSAHC, CNA and XJA on October 11, 2002 (the “Consolidation and Restructuring”), CNA has become a wholly owned subsidiary of CSAHC and a connected person of the Company under the Hong Kong Listing Rules. The following agreements have been terminated following the acquisition of the core operational assets of CNA and XJA on December 31, 2004.

Company.


Guangzhou Nanland air CateringChina Southern Airlines Property Management Company Limited (“Nanland”(the “GCSAPMC”), which is 51%90% owned by CSAHC and 10% owned by the Company’s Union

The Company and 49% owned byGCSAPMC 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 party,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 providing and will provide in-flight meals to CNA. Pursuant to an agreement dated June 23, 2000, Nanland has been providing in-flight meals to CNA from time to time for a periodapproved by the independent non-executive Directors of one year. The agreement will then be automatically renewed annually. the Company.
For the year ended December 31, 2004,2006, the amountCompany paid by CNA to Nanland for the provisionproperty management and maintenance fee of in-flight means was approximately RMB5,221,000.

     Pursuant to an agreement dated October 30, 2001, CNA has been providing and will continue to provide in-flight mealsRMB26,402,000 pursuant to the Group from timeProperty Management Framework Agreement.

Please also see note 37 to time for a period of one year. The agreement will then be automatically renewed annually. For the year ended December 31, 2004, the amount paid by the Group to CNA for the provision of in-flight meals was approximately RMB3,303,000.

Ticket Sales Arrangement with Northern Airlines, a wholly owned subsidiary of CSAHC

     Following the announcement of the Consolidation and Restructuring, CNA has become a wholly owned subsidiary of CSAHC and a connected person of the Company under the Hong Kong Listing Rules. The following agreement has been terminated following the acquisition of the core operational assets of CNA and XJA on December 31, 2004.

     In accordance with the relevant requirement and industry practice, the Group has entered into ticket agency arrangement with CNA for the sale of the Group’s air tickets by CNA and for the sale of CNA air tickets by the Group. The selling party charges a commissionour consolidated financial statements included elsewhere in the amount of 3% of the ticket price for domestic tickets and 5% to 12% of the ticket price for Hong Kong regional and international tickets. These commission rates are based on the rates stipulated by the CAAC and IATA. The amount of commission paid by CNA to the Group for the year ended December 31, 2004 was approximately RMB160,848,000. The amount of commission paid by the Group to CNA for the year ended December 31, 2004 was approximately RMB13,074,000.

     The amounts payable under the above aforesaid transactions are based on the rates stipulated by the CAAC and IATA.

In-flight Meals Arrangement with Xinjiang Airlines, a wholly owned subsidiary of CSAHC

     Following the announcement of the Consolidation and Restructuring, XJA has become a wholly owned subsidiary of CSAHC and a connected person of the Company under the Hong Kong Listing Rules. The following agreements have been terminated following the acquisition of the core operational assets of CNA and XJA on December 31, 2004.

     Pursuant to an agreement dated March 24, 2001, Nanland has been providing and will continue to provide in-flight meals to XJA from time to time for a period of one year. The agreement will then be automatically renewed annually. For the year ended December 31, 2004, the amount paid by XJA to Nanland for the provision of in-flight meals was approximately RMB2,326,000.

     Pursuant to an agreement dated September 20, 1999, XJA has been providing and will provide in-flight meals to the Group for a period of one year. The agreement will then be automatically extended annually. The amount paid by the Group to XJA for the provision of in-flight meals for the year ended December 31, 2004 was approximately RMB2,298,050.

Ticket Sales Arrangement with Xinjiang Airlines, a wholly owned subsidiary of CSAHC

     Following the announcement of the Consolidation and Restructuring, XJA has become a wholly owned subsidiary of CSAHC and a connected person of the Company under the Hong Kong Listing Rules. The following agreement has been terminated following the acquisition of the core operational assets of CNA and XJA on December 31, 2004.

     The Group has entered into ticket agency arrangement with XJA for the sale of the Group’s air tickets by XJA and for the sale of XJA air tickets by the Group. The selling party charges a commission in the amount of 3% of the ticket price for domestic tickets and 5% to 12% of the ticket price for Hong Kong regional and international tickets. These commission sales are based on the rates stipulated by the CAAC and IATA. The amount of commission paid by XJA to the Group for the year ended December 31, 2004 was approximately RMB78,207,000. The amount of commission paid by the Group to XJA for the year ended December 31, 2004 was approximately RMB7,585,000.

     The amounts payable under the above aforesaid transactions are based on the rates stipulated by the CAAC and IATA.this Form 20-F.

Interests of Experts and Counsel

Not applicable.

63

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.

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 Group (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 defendantsPlaintiffs. The performance of both agreements has been completed. The Plaintiffs, however, have filed a lawsuit against us for exclusive purchase of aviation equipment consigned to UASSC for sale. As the defendants failed to perform the agreement, UASSC should have 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, is being claimed for unspecifiedliquidated damages for breach of the agreement.provisions on air ticket sales commissions and other payments under those two agreements. The Company has filed an objection in respectamount of the jurisdictionclaim 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 an early stage, we believe it will not have any material effect on the business operations and financial position of the court, and has requested the court to transfer the case to the PRC for trial. On 3 May, 2004, the court made an award in favor of the Company for the transfer to the PRC, against which the plaintiff has filed an appeal. Based on the opinion given by the Company’s legal advisors, the directors of the Company consider that it is not probable that the Company will have an unfavorable outcome from the claim and 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, 2004.2006. The Board of Directors does not recommend the payment of a final dividend in respect of the year ended December 31, 2004.

64

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 the date of this Annual Report, 2005, approximately 103,159,000 of the Company’s H Shares in the form of 2,063,180 ADSs were held in the U.S. by approximately 38 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.

65


  
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 
                         
  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, 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 
Fiscal Year ended December 31, 2004
  4.68   2.47   29.73   15.95   6.87   3.96 
Quarterly Market Prices
                        
                         
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
                        
First Quarter
  2.83   2.22   17.63   14.80   N/A
   N/A
 
Second Quarter
  3.42   2.33   21.74   14.95   N/A
   N/A
 
Third Quarter
  3.60   1.89   22.25   12.00   N/A
   N/A
 
Fourth Quarter
  2.42   1.50   15.00   10.35   N/A
   N/A
 
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 
Fiscal Year ended December 31, 2004
                        
First Quarter
  4.68   3.20   29.73   20.91   6.87   4.95 
Second Quarter  3.90   2.47   24.89   15.95   6.24   4.14 
Third Quarter  3.17   2.47   20.17   16.00   5.19   4.16 
Fourth Quarter  3.53   2.55   22.74   16.71   5.40   3.96 
Monthly Market Prices                        
January 2005  3.10   2.65   19.93   17.19   5.30   4.28 
February 2005  2.92   2.75   18.72   17.81   4.81   4.30 
March 2005  2.90   2.47   18.35   16.10   4.62   3.56 
April 2005  2.67   2.20   17.03   14.72   4.02   3.11 
May 2005  2.72   2.50   17.33   16.26   3.70   3.24 
June 2005  2.67   2.50   16.98   16.25   3.46   2.95 
57
Plan of Distribution

Offer

Not applicable.
Markets
See “Offer and Listing details

Details” above.

Selling Shareholders
Not applicable.
Dilution

Plan of Distribution

66

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.

     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

67

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.

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;

68

(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:

(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.

69

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.

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.

70

61

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.

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 and other than those described in this Item 10, Item 4, “Information on the Company” or elsewhere in this annual report on Form 20-F.
62
(a) A saleframework agreement on lease and purchase agreement (the “Sale and Purchase Agreement”)operation dated November 12, 2004January 1, 2006 between the Company CSAHC, CNA, a wholly owned subsidiary of CSAHC, and XJA,China Southern Airlines Group Travel Development Company Limited (the “CSA Travel”), a wholly owned subsidiary of CSAHC, pursuant to which the Company agreedleases certain hotels belonging to acquire,it to CSA Travel for operation and CSAHC, CNA and XJA agreed to sell certain airlines and airlines-related operations, assets and properties of CNA, XJA and their respective subsidiaries, which included aircraft, engines, spare parts, aviation equipment and facilities, properties, office facilities, and other fixed, current and intangible assets. In addition, the Company will also assume all indebtedness in the aggregate sum of RMB13,438,191,000 owed by XJA, CNA and their respective subsidiaries in connection with their civil aviation business. The total consideration, including the assumption of the debts under the Sale and Purchase Agreement was RMB15,397,524,000. It became effective upon approval by the shareholders of the Company on December 31, 2004.

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(b)A lease agreement (the “Lease Agreement 1”) dated November 12, 2004 between the Company, CSAHC and CNA, pursuant to which CSAHC and CNA lease to the Company certain buildings, facilities and other infrastructure related to the civil aviation business of CNA situated at various locations in Shenyang, Dalian, Jilin, Harbin, Chaoyang and Russiamanagement for a period of three years. The consideration for Lease Agreement 1the framework agreement on lease and operation is RMB41,993,318.44based on the rent payable and fees for operation and management of the hotels, and is capped at RMB6 million per year. It became effective upon approvalon April 25, 2006 and has been approved by the shareholdersDirectors of the Company on December 31, 2004.Company.

(c)
(b) A leaseAn advertising agency agreement (the “Lease Agreement 2”) dated November 12, 2004 between the Company, CSAHC and XJA, pursuant to which CSAHC and XJA lease to the Company certain buildings, facilities and other infrastructure related to the civil aviation business of XJA situated at Xinjiang and Russia for a period of three years. The consideration for Lease Agreement 2 is RMB5,797,908.61 per year. It became effective upon approval by the shareholders of the Company on December 31, 2004.

(d)A lease agreement (the “Lease Agreement 3”) dated November 12, 2004January 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 CSAHC leases tothe SAAC produces advertisement script, graphic and music for the Company certain lands situated in Urumqi, Shenyang, Dalian and Harbin, by leasingwith the land use rightscopyright of such landsproducts belonging to the Company for a period of three years. The consideration for Lease Agreement 3the advertising agency agreement is RMB22,298,033based 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 shareholdersDirectors of the Company on December 31, 2004.April 18, 2006.

(e) A cateringAn agency agreement (the “Catering Agreement”)for sale of freight and passenger services dated November 12, 2004May 16, 2006 between the Company and China Southern Airlines Group Air Catering Company Limited (the “Catering Company”Nan Lung Travel & Express (Hong Kong) Ltd. (“Nanlung”), a wholly owned subsidiary of CSAHC, pursuant to which Nanlung acts as agent in the Catering Company supplies in-flight mealCompany’s sales and catering services toaccount settlement and the flightsground operations of the Company originating or stopping at the domestic airports, mainlyCompany’s flights in Northern China and Xinjiang regions where the Catering Company provides catering servicesHong Kong region for a period of three years.one year. The consideration for the cateringagency agreement is based on the price of each type of in-flight mealsfees payable for ticket sale and the service price for each type of aircraft,other services to be provided, and is capped at RMB220RMB60 million per year.for the entire term of the agency agreement. It became effective upon approvalon May 16, 2006 and was approved by the shareholdersDirectors of the Company on December 31, 2004.24, 2005.

(f) A financial agreement (the “Financial Agreement”)An Airbus Aircraft Acquisition Agreement dated November 12, 2004,July 6, 2006 between the Company and Southern Airlines Group FinanceAirbus, the Company Limited (“SA Finance”),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 connected personBoeing B777F freighter is US$232 million. The aggregate consideration for the acquisition of the B777F Freighters is partly payable by cash of the Company, which is 42% ownedand partly by CSAHC, 32% owned byfinancing 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 26% owned inBoeing, 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 by five subsidiariesconsideration for the acquisition of the Company. The Financial Agreement commenced from November 12, 2004 for a period of three years,B737-800 Aircraft is payable by cash in installments and is renewable, subjectthe B737-800 Aircraft will be delivered to compliance with the requirements of the relevant Hong Kong Listing Rules by the Company, by an applicationXiamen Airlines in writing by the Company not less than 30 days before the end of the fixed term. Under the Financial Agreement, SA Finance provides deposit of money service and, subject to the execution of further agreements with the Company, other financial services like loan facilities, credit facilities, financial guarantees and credit references to the Company. The Company is not subject to any extra charges for depositing money with SA Finance. For the other financial services provided by SA Finance under the financial2010.
(i)A lease agreement the Company is liable to pay SA Finance the standard charging rates set by the People’s Bank of China. The PRC commercial banks also charge similar charging rates set by the People’s Bank of China. The Company will make payment for such interest, fees and commissions in accordance with the payment terms of the separate agreements for the provision of loans or other financial services as might bedated December 19, 2006 entered into between the Company and SA Finance. It became effective upon approvalCSAHC (“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 shareholdersCompany wholly out of the Company on December 31, 2004.its internal funds.

(g)An aircraft acquisition agreement dated April 21, 2005 pursuant to which the Company and Southern Airlines (Group) Import and Export Trading Company agreed to acquire and Airbus SNC agreed to sell five new A380 aircraft.

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(h)An aircraft acquisition agreement dated April 29, 2005 pursuant to which the Company and Xiamen Airlines Company Limited have agreed to acquire and The Boeing Company has agreed to sell the 12 new B737-700 aircraft and 33 new B737-800 aircraft.

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.

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.

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

You can also obtain copies of this Annual 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"“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.

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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 has not established a nominating 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
   
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.
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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.

76

   
The written charter of the compensation committee must state, at least, the following purposes and responsibilities: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.
(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.
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.

77

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 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 Board of Directors of the Company has established an audit committee that satisfies relevant domestic requirements and the audit committee has a written charter.
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
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 ethicsEthics for directors, officersDirectors, Officers and employees
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.

78

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 fifteen 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, 2004.

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, 2004.

2006.

As of December 31, 2004,2006, the Group operated a total of 131151 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 1828 to the Financial Statements.

The following table provides information regarding the Group’s material interest rate sensitive financial instruments as of December 31, 20042006 and 2003:2005:
                                         
  As of December 31, 2004  As of December 31, 2003 
  Expected maturity date              
                          Total      Total    
                          recorded      recorded    
  2005  2006  2006  2008  2009  Thereafter  amount  Fair value(2)  amount  Fair value(2) 
Debt                                        
Fixed-rate notes payable                                        
In US$  767   445   402   251   205   182   2,252   2,464  2,627   2,915 
Average interest rate  6.09%  6.52%  6.41%  6.41%  6.41%  6.82%  6.09%      6.79%  — 
Variable-rate notes payable                                        
In US$  6,421   905   3,557   777   996   2,671   15,327   15,327  8,372   8,372 
Average interest rate  2.26%  2.60%  2.60%  2.60%  2.60%  2.26%  2.40%      1.63%  — 
In HKD  3,327   —   —   —   —   —   3,327   3,327   —   — 
Average interest rate  1.42%  —   —   —   —   —   1.42%      —   — 
In RMB  1,003   276   181   27   27   1,033   2,547   2,547   620   620 
Average interest rate  5.13%  5.65%  5.20%  5.02%  5.02%  5.20%  5.04%      4.46%  — 

  
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
  2,252  2,464 
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
  15,327  15,327 
Average interest rate  
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  
532
  
52
  
122
  
100
  
-
  
3
  
809
  
809
  2,547  2,547 
Average interest rate  
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, 20042006 and 2003.2005.

72
The following table provides information regarding the Group’s material foreign currency sensitive financial instruments and capital commitments as of December 31, 20042006 and 2003:

79

2005:

                                        
 As of December 31, 2004 As of December 31, 2003 
 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$ 767 445 402 251 205 182 2,252 2,464 2,627 2,915   
430
 
293
 
257
 
208
 
90
 
585
 
1,863
 
1,861
 2,414 2,440 
Average interest rate 6.09% 6.52% 6.41% 6.41% 6.41% 6.82% 6.09%  6.79% —   
5.94
%
 
5.91
%
 
5.95
%
 
6.01
%
 
5.74
%
 
5.74
%
           
Variable-rate notes payable in US$ 6,421 905 3,557 777 996 2,671 15,327 15,327 8,372 8,372   
17,442
 
6,414
 
1,841
 
432
 
1,485
 
1,886
 
29,500
 
29,500
 23,474 23,474 
Average interest rate 2.26% 2.60% 2.60% 2.60% 2.60% 2.26% 2.40%  1.63% —   
5.85
%
 
5.77
%
 
5.70
%
 
5.11
%
 
5.71
%
 
5.22
%
           
In HKD 3,327 — — — — — 3,327 3,327  —  —   
1,651
 
4
 
4
 
4
 
4
 
-
 
1,667
 
1,667
 1,895 1,895 
Average interest rate 1.42% — — — — — 1.42%  —  —   
4.34
%
 
-
  
-
  
-
  
-
  
-
  
-
         
Capital commitment in US$ 8,748 2,996 32 — — — 11,776 11,776 10,615 10,615   
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, 20032006 and 2004.2005.

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, 2004.2006.

Use of Proceeds

(1) Effective date of the Securities Act registration statement for which the use of proceeds information is being disclosed:
 
  
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) (i) The offering was not terminated prior to the sale of all securities registered under the registration statement.
73
 (ii) Name of the managing underwriter:
Goldman Sachs (Asia) L.L.C. (global coordinator).
 
 (iii) and (iv)
                 
      Aggregate      Aggregate 
      price of      offering 
Title of each     offering      price of 
class of Amount  amount  Amount  amount 
securities registered registered(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 

80

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)

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)
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 sharesUS$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)
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) Net offering proceeds to the Company after deducting the total expenses in item (4)(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.

(vii) As of December 31, 2004, the net offering proceeds to the Company was used up as follows:

Construction of plant, building and facilitiesUS$41.9 million
Purchase and installation of machinery and equipmentUS$394.6 million
Purchase of real estate—
Acquisition of other business(es)—
Repayment of indebtednessUS$192.4 million
Working CapitalUS$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.

(vi) Net offering proceeds to the Company after deducting the total expenses in item (4)(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) The uses of proceeds do not represent a material change in the use of proceeds described in the prospectus.

81

PART III

ITEM 15. CONTROLS AND PROCEDURES.

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.

     There

Management’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 been no significant change inassessed 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 duringwas not subject to auditor attestation as of December, 31 2006 pursuant to temporary rules of the period covered bySecurities 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 changes in our internal control over financial reporting that hashave materially affected, or isare reasonably likely to materially affect, our internal control over financial reporting.

ITEM 16. [RESERVED]

ITEM 16A. AUDIT COMMITTEE FINANCIAL EXPERT.

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. 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 ETHICS.

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 SERVICES.

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 20032005 and 2004:2006:

  
Audit Fees
Audit-Related Fees
Tax Fees
Other Fees
2005  
Audit FeesAudit-Related FeesTax FeesOther Fees
2003RMB8.2RMB13.9 million  RMB7.0RMB5.8 millionRMB0.17 millionRMB1.1 million
2004RMB8.9 millionRMB6.6 million  RMB0.11 million  -—
2006RMB8.5 millionRMB4.0 millionRMB0.47 millionRMB3.7 million 

82

Audit-related fees

     Services provided primarily consist of the following:

a)Review of the Group’s 20042006 interim financial report prepared under IFRS; and
b)In connection with the Company’s acquisition of the airline operations and related assets of China Northern Airlines Company and Xinjiang Airlines Company;
–     Audit of the financial statements of China Northern Airlines Company and Xinjiang Airlines Company;
–     Issuance of comfort letter on profit forecast;
–     Issuance of comfort letter on working capital forecast; and
–     Issuance of report on statement of indebtedness.IFRS.

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 PURCHASERS.

The Company and its affiliated companies have not purchased any issued common shares of the Company during 20042006 and up to the date of this Annual Report.

PART IV

ITEM 17. FINANCIAL STATEMENTS.

Not applicable.

ITEM 18. FINANCIAL STATEMENTS.

Index to Financial Statements

76
CHINA 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
 F-1 
Consolidated Statements of Operations
for the years ended December 31, 2002, 20032004, 2005 and 20042006 F-2
 
Consolidated Balance Sheets as of December 31, 20032005 and 20042006 F-3
Consolidated Statements of Cash Flows for the years ended December 31, 2002, 2003 and 2004  F-4 
Consolidated Statements of Changes in Shareholders’ Equity
for the years ended December 31, 2002, 20032004, 2005 and 20042006 F-5
Notes to Consolidated Financial StatementsF-6

83

ITEM 19. EXHIBITS.

Exhibit No.Description of Exhibit
4.1Form of Director’s Service Agreement is incorporated by reference in Exhibit 4(c).1 of Form 20-F for the year of 2004.
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 2004.
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

84

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

   
/s/ Liu Shao Yong
Name:  Liu Shao Yong 
Title:  ChairmanConsolidated Statements of the Board of Directors 

Date: June 30, 2005

85

CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

Cash Flows  
Page
Report of Independent Registered Public Accounting Firm
F-1
Consolidated Statements of Operations for the years ended December 31, 2002, 20032004, 2005 and 2004
2006		 F-2F-6
Consolidated Balance Sheets as of December 31, 2003 and 2004
F-3
Consolidated Statements of Cash Flows for the years ended December 31, 2002, 2003 and 2004
F-4
Consolidated Statements of Changes in Shareholders’ Equity for the years ended December 31, 2002, 2003 and 2004
F-5
   
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, 20032005 and 2004,2006, 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, 2004,2006, 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, 20032005 and 2004,2006, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 20042006 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 3451 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, 2004 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 25, 2005

F-1

CHINA SOUTHERN AIRLINES COMPANY LIMITED

AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS
For the years ended December 31, 2002, 20032004, 2005 and 2004

2006


(Amounts in millions, except per share data)
                   
  Note 2002  2003  2004  2004 
    RMB  RMB  RMB  U.S. dollars 
Operating revenue:                  
Traffic revenue 3  17,482   16,965   23,344   2,821 
Other operating revenue 4,26  537   505   630   76 
               
Total operating revenue    18,019   17,470   23,974   2,897 
               
                   
Operating expenses:                  
Flight operations 5, 26  6,733   7,070   10,418   1,259 
Maintenance 6, 26  2,333   2,589   3,459   418 
Aircraft and traffic servicing 7, 26  2,511   2,767   3,503   423 
Promotion and sales 8, 26  1,500   1,480   1,940   234 
General and administrative 9  1,060   1,053   1,323   160 
Depreciation and amortization    1,840   2,038   2,413   292 
Other    16   17   9   1 
               
Total operating expenses    15,993   17,014   23,065   2,787 
               
                   
Operating income    2,026   456   909   110 
               
                   
Non-operating income/(expenses):                  
Interest income 26  52   13   22   3 
Interest expense 17, 26  (959)  (824)  (691)  (84)
Equity income of affiliated companies    37   48   12   1 
Equity loss of jointly controlled entities    (3)  (39)  (5)  (1)
Gain/(loss) on sales of property, plant and equipment 14, 25  171   (22)  (1)  — 
Exchange loss, net    (176)  (164)  (59)  (7)
Other, net    (9)  21   46   6 
               
Total net non-operating expenses    (887)  (967)  (676)  (82)
               
                   
Income/(loss) before taxation and minority interests    1,139   (511)  233   28 
                   
Taxation (expense)/credit 10  (398)  324   (78)  (9)
               
Income/(loss) before minority interests    741   (187)  155   19 
                   
Minority interests    (165)  (171)  (203)  (25)
               
Net income/(loss)    576   (358)  (48)  (6)
               
                   
Basic earnings/(loss) per share 2(ab)  0.17   (0.09)  (0.01)  (0.001)
               

  
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, 20032005 and 2004

2006


(Amounts in millions)
               
  Note 2003  2004  2004 
    RMB  RMB  U.S. dollars 
ASSETS
CURRENT ASSETS              
Cash and cash equivalents 11  2,080   3,083   373 
Trade receivables 12  834   1,203   145 
Other receivables    296   616   74 
Inventories    544   1,302   157 
Prepaid expenses and other current assets    248   378   46 
Short term investments 13  —   683   83 
            
Total current assets    4,002   7,265   878 
NON-CURRENT ASSETS              
Property, plant and equipment, net 14  28,536   46,841   5,660 
Construction in progress 15  1,630   565   68 
Lease prepayments    349   346   42 
Investments 16  1,357   1,483   179 
Lease and equipment deposits    2,933   5,397   652 
Other assets    255   331   40 
            
Total non-current assets    35,060   54,963   6,641 
            
TOTAL ASSETS    39,062   62,228   7,519 
            
LIABILITIES AND SHAREHOLDERS’ EQUITY
CURRENT LIABILITIES              
Notes payable, including current installments of long-term notes payable 17  7,097   11,518   1,392 
Current installments of obligations under capital leases 18  1,298   2,144   259 
Accounts payables    928   1,554   188 
Bills payable    438   136   16 
Sales in advance of carriage    466   874   106 
Taxes payable    90   39   5 
Amounts due to related companies 26  929   2,330   282 
Accrued expenses 19  2,528   4,551   549 
Other liabilities    1,020   2,974   359 
            
Total current liabilities    14,794   26,120   3,156 
            
NON-CURRENT LIABILITIES              
Notes payable, excluding current installments 17  4,522   11,935   1,442 
Obligations under capital leases, excluding current installments 18  5,543   9,599   1,160 
Provision for major overhauls 6  189   284   34 
Deferred credits 20  47   100   12 
Deferred tax liabilities 21  398   287   35 
            
Total non-current liabilities    10,699   22,205   2,683 
            
TOTAL LIABILITIES    25,493   48,325   5,839 
MINORITY INTERESTS    1,673   2,055   248 
SHAREHOLDERS’ EQUITY 22,23  11,896   11,848   1,432 
            
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY    39,062   62,228   7,519 
            


  
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-3

F-4


CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES

CONSOLIDATED STATEMENTS
OF CASH FLOWS
CHANGES IN SHAREHOLDERS’ EQUITY
For the years ended December 31, 2002, 20032004, 2005 and 2004

2006


(Amounts in millions)
                   
  Note 2002  2003  2004  2004 
    RMB  RMB  RMB  U.S. dollars 
Cash inflows from operations 29(a)  4,763   3,075   4,555   550 
Interest received    53   13   22   3 
Interest paid    (1,051)  (924)  (754)  (91)
Income tax paid    (67)  (35)  (227)  (27)
               
Net cash inflows from operating activities    3,698   2,129   3,596   435 
               
Investing activities:                  
Proceeds from disposal of aircraft    778   29   —   — 
Proceeds from disposal of other property, plant and equipment    47   28   47   6 
Dividends received from affiliated companies    3   —   12   1 
Dividends received from jointly controlled entities    —   —   5   1 
Dividends received from equity securities held for trading    —   —   13   2 
(Increase)/decrease in other assets    (1)  6   (9)  (1)
Payment of lease and equipment deposits    (1,999)  (1,852)  (3,151)  (381)
Refund of lease and equipment deposits    2,117   1,066   1,253   151 
Capital expenditures    (6,351)  (4,707)  (6,631)  (801)
Purchase of investments in equity securities    (7)  (1)  (680)  (82)
Investments in affiliated companies    (136)  —   (9)  (1)
Investments in jointly controlled entities    (296)  (3)  (72)  (9)
Governmental subsidy for safety related capital expenditures    40   —   —   — 
Effect of acquisition, net of cash and cash equivalents acquired 29(c)  (90)  —   398   48 
               
Net cash used in investing activities    (5,895)  (5,434)  (8,824)  (1,066)
               
                   
Net cash outflows before financing activities    (2,197)  (3,305)  (5,228)  (631)
               
                   
Financing activities:               ��  
Proceeds from A Shares issue, net of issuance costs    —   2,641   —   — 
Proceeds from bank notes payable    6,997   8,914   14,555   1,759 
Repayment of bank notes payable    (2,194)  (8,371)  (7,108)  (859)
Repayment of principal under capital lease obligations    (1,546)  (1,555)  (1,272)  (154)
Minority shareholders’ contributions    10   1   71   9 
Dividends paid to shareholders    (68)  —   —   — 
Dividends paid to minority shareholders    (49)  (15)  (15)  (1)
               
Net cash inflows from financing activities    3,150   1,615   6,231   754 
               
Increase/(decrease) in cash and cash equivalents    953   (1,690)  1,003   123 
Cash and cash equivalents at beginning of year    2,817   3,770   2,080   250 
               
Cash and cash equivalents at end of year    3,770   2,080   3,083   373 
               

  
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.

F-4


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 CHANGES IN SHAREHOLDERS’ EQUITY
CASH FLOWS
For the years ended December 31, 2002, 20032004, 2005 and 2004

2006


(Amounts in millions)
                       
    Share  Share  Other  Retained    
  Note capital  premium  reserves  profits  Total 
    RMB  RMB  RMB  RMB  RMB 
Shareholders’ equity at December 31, 2002    3,374   3,684   586   1,969   9,613 
                       
Issue of A Shares 22  1,000   1,641   —   —   2,641 
Net loss    —   —   —   (358)  (358)
Appropriations to reserves    —   —   25   (25)  — 
                  
Shareholders’ equity at December 31, 2003    4,374   5,325   611   1,586   11,896 
                       
Net loss    —   —   —   (48)  (48)
Appropriations to reserves    —   —   61   (61)  — 
                  
Shareholders’ equity at December 31, 2004    4,374   5,325   672   1,477   11,848 
                  
                       
Shareholders’ equity at December 31, 2004 in U.S. dollars    529   643   81   179   1,432 
                  

  
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-5


F-7

CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES

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


1. BASIS OF PRESENTATION


China Southern Airlines Company Limited (the “Company”) and its subsidiaries (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 new 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 reorganization (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 (“H Shares”)Shares and American Depositary Shares (“ADS”) (each ADS representing 50 H Shares) have been listed on The 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 shares (“A Shares”)Shares which are listed on the Shanghai Stock Exchange.

     Pursuant to a sale and purchase agreement dated November 12, 2004 between the Company, CSAHC, China Northern Airlines Company (“CNA”) and Xinjiang Airlines Company (“XJA”) which was approved by the Company’s shareholders 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 was determined based on the fair value of the acquired assets. Such consideration was partly satisfied by assumption of debts and liabilities of CNA and XJA totaling RMB13,563 outstanding as of December 31, 2004 and the remaining balance of RMB1,959 is required to be satisfied in cash by December 31, 2005 (Note 26).

     As the above acquisitions were completed on December 31, 2004, they have no impact on the Company’s consolidated income statement for the year ended December 31, 2004.

     Further details of the CNA/XJA Acquisitions are set out in Note 29 to the consolidated financial statements.

     The consolidated financial statements have been prepared in Renminbi (“RMB”), the national currency of the PRC. Solely for the convenience of readers, the 2004 financial statements have been translated into United States dollars at the rate of US$1.00 = RMB 8.2765, the rate quoted by the People’s Bank of China on December 31, 2004. No representation is made that the RMB amounts could have been, or could be, converted into United States dollars (“US$”) at that rate or at any other certain rate on December 31, 2004 or at any other certain date.

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CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES

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

2. PRINCIPAL ACCOUNTING POLICIES


(a) Statement of compliance

     The


These consolidated financial statements 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’’) are set forth in Note 34.

51.

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CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES

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

(b) Basis of 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 are prepared onfor the year ended December 31, 2006 comprise the Company and its subsidiaries and the Group’s interest in affiliated companies and jointly controlled entities.

The measurement basis used in the preparation of the consolidated financial statements is the historical cost basis except that the following assets and liabilities are stated at their fair value as modified byexplained in the revaluation of certain property, plant and equipment (Note 14).

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 IFRSIFRSs requires management to make judgements,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 judgementsjudgments 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.

     The accounting policies set out below


Judgments made by management in the application of IFRSs that have been applied consistently bysignificant effect on the Group and are consistent with those used in previous years.

(c) Basis of consolidation

     The consolidated financial statements includeand estimates with a significant risk of material adjustment in the financial statements of the Companynext year are discussed in Note 47.

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CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES

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

(c) Subsidiaries and all of its subsidiaries (see Note 30 for details of the Company’s principal subsidiaries) made up to December 31, each year. A subsidiary is an entityminority interests

Subsidiaries are entities controlled by the Company.Group. Control exists when the CompanyGroup has the power directly or indirectly, to govern the financial and operating policies of an entity so as to obtain benefits from its activities. In assessing control, potential voting rights that presently are exercisable or convertible are taken into account. The financial statements of subsidiaries are included

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

     The results of subsidiaries are included in the consolidated statements of operations, and the share attributable to minority shareholders is deducted from or added to the consolidated income after taxation. Losses attributable to minority shareholders of partly owned subsidiaries

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CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES

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

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 minority shareholders. Thereafter, all further losses are assumed by the Company.

Intra-group balances and transactions and any unrealized profitsincome 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 income,gains but only to the extent that there is no evidence of impairment.

(d) Cash


Minority interests represent the portion of the net assets of subsidiaries attributable to interests that are not owned by the Company, whether directly or indirectly through subsidiaries, and cash equivalents

     Cash and cash equivalents consistin respect of cashwhich the Group has not agreed any additional terms with the holders of those interests which would result in hand and balances with banks and otherthe Group as a whole having a contractual obligation in respect of those interests that meets the definition of a financial institutions with an original maturityliability. Minority interests are presented in the consolidated balance sheet within three months. Forequity, separately from equity attributable to the purposesequity shareholders of the Company. Minority interests in the results of the Group are presented on the face of the consolidated statementsstatement of cash flows, cashoperations as an allocation of the total income or loss for the year between minority interests and cash equivalentsthe 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 charged 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 Group has been recovered.

Loans from holders of minority interests and other contractual obligations towards these holders are presented netas financial liabilities in the consolidated balance sheet in accordance with Notes 2(o) or (p) depending on the nature of bank overdrafts, if any.

(e) Tradethe 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 receivables

     Tradeparties, where the contractual arrangement establishes that the Group or Company and one or more of the other receivablesparties share joint control over the economic activities of the entity.

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CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES

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

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 case they are recognized immediately in income or loss.
(e) Goodwill

Goodwill represents the excess of the 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 contingent liabilities.

Goodwill is stated at cost less allowanceaccumulated impairment losses. Goodwill is allocated to cash-generating units and is tested annually for doubtful accounts. Allowance for doubtful accounts are established based on evaluationimpairment (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 recoverabilityinterest in the affiliated company or jointly controlled entity.

Any excess of these accounts at the balance sheet date. In establishing such allowance,Group’s interest in the Group considers various factors including its historical write-off experiencenet fair value of the acquiree’s identifiable assets, liabilities and industry economic trend. Past due balancescontingent liabilities over the cost of a specific periodbusiness 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 attributable amount of purchased goodwill is included in the calculation of the gain or loss on disposal.
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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 investments in equity securities, other than investments in subsidiaries, affiliated companies and balances over a specific amountjointly controlled entities, are reviewed individually for collectibility. All other balancesas follows:

Investments in equity securities are reviewed on a pooled basis.

(f) Inventories

     Inventories, which consist primarily of expendable spare parts and supplies, areinitially stated at cost, less any applicable provision for obsolescence, and are expensed when used in operations. Cost represents the average unit cost. Inventories held for disposal are stated at the lower of cost and net realizable value. Net realizable value represents estimated resale price.

(g) Other investments

     Financial instruments held for trading are classified as current assets and are stated atwhich is their transaction price unless fair value with any resultant gain or loss recognizedcan 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 the consolidated statements of operations.

     Where the Group has the positive intent and ability to hold bonds to maturity, they are stated at amortized cost less impairment losses (see accounting policy m).

     Other financial instruments are stated at cost less impairment losses (see accounting policy m). Other financial instrumentsequity securities represent unquoted available-for-saleunlisted equity securities of companies established in the PRC. There is noThey do not have a quoted market price for such equity securitiesin an active market and accordingly a reasonable estimate ofwhose 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 they expire.

(g) Derivative financial instruments

Derivative financial instruments are recognized at fair value. At each balance sheet date the fair value could not be made without incurring excessive costs.

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is remeasured. The gain or loss on remeasurement to fair value is charged immediately to income or loss.

CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES

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

(h) Property, plant and equipment

Items of property, plant and equipment are initially stated at cost, less accumulated depreciation

(i) Owned assets

     An and impairment losses (Note 2(l)). The cost of an item of property, plant and equipment is initially recorded at cost less accumulated depreciation (see (iv) below) and impairment losses (see accounting policy m). The cost of an asset comprises its purchase price and any directly attributable costs of bringing the asset to working condition and location for its intended use. 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 (see Note 14)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 and impairment losses. 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.

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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 estimated net disposal proceeds and the carrying amount of the assetitem and are recognized in the consolidated statements of operationsincome or loss on the date of retirement or disposal. Any related revaluation surplus is transferred from the revaluation reserve to retained profits.

(ii)earnings.


Depreciation is calculated to write off the cost or valuation of items of property, plant and equipment, less their estimated residual value, if any, using the straight line method over their estimated useful lives as follows:

Buildings15 to 40 years
Owned and leased aircraft15 to 20 years
Other flight equipment
Jet engines15 to 20 years
Others, including rotable spares8 to 15 years
Machinery and equipment
5 to 10 years
Vehicles6 years

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.
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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.

(j) Leased assets

     Leases in terms


An arrangement, comprising a transaction or a series of whichtransactions, is or contains a lease if the Group assumesdetermines 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.

     Flight equipment 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 by wayunder capital leases

Where the Group acquires the use of assets under capital leases, is stated at an amount equal to lower of itsthe amounts representing the fair value andof the leased asset, or, if lower, the present value of the minimum lease payments, at inception of the lease, less accumulated depreciationsuch assets are included in property, plant and impairment losses (see accounting policy m)equipment and the corresponding liabilities, net of finance charges, are recorded as obligations under capital leases. Subsequent toDepreciation is provided at rates which write off the revaluation (see Note 14), which was based on depreciated replacement costs, leased assets are carried at revalued amount, being the fair value at the datecost or valuation of the revaluation less any subsequent accumulated depreciation and impairment losses. Revaluationsassets over the term of the relevant lease or, where it is likely the Group will obtain ownership of the asset, the life of the asset, as set out in Note 2(h). Impairment losses are performed periodically to ensure thataccounted for in accordance with the carrying amount does not differ materially from that which would be determined using fair value at the balance sheet date.

     The finance charge is allocated to each period duringaccounting policy as set out in Note 2(l). Finance charges implicit in the lease termpayments are charged to income or loss over the period of the leases so as to produce aan approximately constant periodic rate of interestcharge on the remaining balance of the liability. Contingent rentalsobligations for each accounting period.

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CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Amounts in 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 written offcharged 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 expenseintegral part of the period inaggregate 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 they are incurred.

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 immediately if the transactions are established at fair value. Any difference between the sales price overand the fair value is deferred and amortized over the period the assets are expected to be used.

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CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES

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

     Payments made under operating leases are recognized in the consolidated statements of operations on a straight-line basis over the terms of the leases. Lease incentives received are recognized in the consolidated statements of operations as an integral part of the total lease expense.

(iii) Subsequent costs

     The Group recognizes in the carrying amounts of an item of property, plant and equipment the cost of replacing part of such an item when that cost is incurred if it is probable that the future economic benefits embodied with the item will flow to the Group and the cost of the item can be measured reliably. All other costs are recognized in the consolidated statements of operations as an expense as incurred.

(iv) Depreciation

     Depreciation is calculated to write off the cost or revalued amount of items of property, plant and equipment over their estimated useful lives on a straight line basis, after taking into account their residual values, as follows:

Depreciable lifeResidual value
Buildings15 to 40 yearsNil
Owned and leased aircraft8 to 15 years28.75%
Other flight equipment
- Jet engines8 to 15 years3%
- Others, including rotable spares8 to 15 yearsNil
Machinery and equipment5 to 10 years3%
Vehicles6 years3%

     Depreciation for leased assets is provided at rates which write off the cost of the assets in equal annual amounts over the term of the relevant lease or, where it is likely the Group will obtain ownership of the asset, the life of the asset, as set out above.

(i) 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 property, plant and equipment 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.

(j)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.

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CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES

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

(k) Affiliated company and jointly controlled entity

     An affiliated company is an entity in which the Group has significant influence, but not control, over its the financial and operating policies. The consolidated financial statements include the Group’s share of the total recognized gains and losses of associates on an equity accounted basis, from the date that significant influence commences until the date that significant influence ceases. When the Group’s share of losses exceeds its interest in an affiliated company, the Group’s carrying amount 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 an affiliated company.

     A jointly controlled entity is an entity over whose activities the Group has joint control, established by contractual agreement. The consolidated financial statements include the Group’s share of the total recognized gains and losses of jointly controlled entities on an equity accounted basis, from the date that joint control commences until the date that joint control ceases. When the Group’s share of losses exceeds its interest in a jointly controlled entity, the Group’s carrying amount 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 a jointly controlled entity.

     Unrealized income arising from transactions with affiliated companies and jointly controlled entities are eliminated to the extent of the Group’s interest in the entity. Unrealized losses are eliminated in the same way as unrealized income, but only to the extent that there is no evidence of impairment.

     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.

(l) 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.

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

(l) Impairment of assets

(i) Impairment of investments in equity securities and other receivables

Investments in equity securities and other current and non-current receivables that are stated at cost or amortized cost are reviewed at each balance sheet date to determine 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 impairment loss is measured as the 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 material. Impairment losses for equity securities are not reversed.

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CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES


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

(m) Impairment loss

     The carrying amounts of the Group’s assets, other than inventories (see accounting policy f),

· For trade and other current receivables (see accounting policy e) and deferred taxother financial assets (see accounting policy r)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 periodicallyat each balance sheet date to identify indications that the following assets may be impaired or, except in order to assess whetherthe 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 amounts have declined below the carrying amounts. These assets are tested for impairment whenever events or changes in circumstances indicate that their recorded carrying amounts may not be recoverable. When such a decline has occurred, the carrying amount is reduced to the recoverable amount. 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).
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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 favorablefavourable 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 as depreciation hadin prior years. Reversals of impairment losses are credited to income or loss in the write-downyear 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 write-off not occurred.

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 costthe amount initially recognized and redemption value being recognized in the consolidated statements of operationsincome or loss over the period of the borrowings, on antogether with any interest and fees payable, using the effective interest basis.

(o) Provisions

     A provisionmethod.

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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 deferred income within trade and other payables. Where consideration is received or receivable for the issuance of the guarantee, the consideration is recognized in accordance with the consolidated balance sheetsGroup’s policies applicable to that category of asset. Where no such consideration is received or receivable, 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. If the effect is material, provisions are determined by discounting the expected future cash flows atobligations and a pre-tax rate that reflects current market assessments ofreliable estimate can be made. Where the time value of money and, where appropriate,is material, provisions are stated at the risks specificpresent value of the expenditures expected to settle the liability.

(p)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 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.

F-12

CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES

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

(q)

(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.

(r) Deferred taxation

     Deferred


(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 providedthe expected tax payable on the taxable income for the year, using tax rates enacted or substantively enacted at the balance sheet liability method on alldate, 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 millions, except share data)

Apart from certain limited exceptions, all deferred tax liabilities, and all deferred tax assets to the amounts usedextent 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 taxationtax purposes, except differences relating to the initial recognition of assets or liabilities whichthat affect neither accounting nor taxable income/loss.

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 valuerecognized is measured based on the expected manner of losses expected to be available for utilization against future taxable income is recognized asrealisation 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 offset against the deferred tax liability attributable to the same legal tax unit and jurisdiction. Net deferred tax assets areis 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 realized.

(s)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 as sales in advance of carriage. Revenues from airline-related business are recognized when services are rendered. Revenue is stated net of sales tax. In addition, prior to May 1, 2003, revenue was stated net

(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 contributionspattern of benefits to be derived from the Civil Aviation Administrationuse of China (“CAAC”) Infrastructure Development Fund.

(ii) Interestthe leased asset. Lease incentives granted are recognized in income is recognized on a time proportion basis according toor loss as an integral part of the outstanding principal and the applicable interest rate.

aggregate net lease payments receivables.

(iii) Dividend income is recognized when the Group’sshareholder’s right to receive payment is established.


(iv) Operating leaseGovernment grants are recognized in the balance sheet initially when there is reasonable assurance that they will be received and that the Group will comply with the conditions attaching to them. Grants that compensate the Group 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 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 on a straight line basis overas it accrues using the terms of the respective leases.

(t)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 on the consolidated balance sheetssheet as a prepaid expense.

F-13

F-21


CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES


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

(u)


(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 ofagreements. 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 be incurred at the lessors.

(v)end of the lease is estimated and accrued over the remaining period of the lease. Differences between the estimated costs and the actual costs of overhauls are charged to income or loss in the 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.


The capitalization of borrowing costs as part of the cost of a qualifying asset commences when expendituresexpenditure for the asset areis 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.

(w) Retirement


(z) Short term employee benefits

     Contributions 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 additional retirementthe 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 millions, except share data)

(aa) Termination benefits paid

Termination benefits are recognized when, and only when, the group demonstrably commits itself to retired employees are chargedterminate employment or to the consolidated statementsprovide benefits as a result of operations as and when incurred (Note 25).

(x)voluntary redundancy by having a detailed formal plan which is without realistic possibility of 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.

(y)


(cc) Translation of foreign currencies

     Transactions in foreign


Foreign currencies transactions during the year are translated into Renminbi at the applicable rates of exchange quoted by the People’s Bank of China (“PBOC rates”) prevailing on the transaction dates. Monetary assets and liabilities denominated in foreign currencies at the balance sheet date are translated into Renminbi at the PBOC exchange rates atprevailing 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 PBOC exchange rates prevailing on the transaction dates.

F-14

CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(Amounts Non-monetary assets and liabilities denominated in millions, except share data)

(z)foreign currencies that are stated at fair value are translated into Renminbi at the PBOC exchange rates prevailing on the dates the fair value 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;

(iii) the party is an affiliated company of the Group or a joint venture in which the Group is a venturer;
F-23

CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Amounts in 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 common significant influence. Related partiesinfluence 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 individualsexpected to influence, or entities.

(aa)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.

(ab) Basic earnings/(loss) per share

     Basic earnings/(loss) per share


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 years ended December 31, 2002, 2003 and 2004 have been computed by dividing net income/(loss)purposes of RMB576, RMB(358), and RMB(48) respectively, by the weighted average number of shares in issue of 3,374,178,000 in 2002, 3,831,712,000 in 2003, and 4,374,178,000 in 2004, 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, 2002, 2003 and 2004.

F-15

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. In addition, traffic revenue for the year ended December 31, 2002 and four-month period ended April 30, 2003 was stated net of contributions to the CAAC Infrastructure Development Fund. An analysis of traffic revenueturnover is as follows:
             
Year ended December 31,
 
 Year ended December 31,  
2004
 
2005
 
2006
 
 2002 2003 2004  
RMB
 
RMB
 
RMB
 
 RMB RMB RMB        
Traffic revenue       
Passenger 15,696 15,010 21,100   21,100  34,328  41,549 
Cargo and mail 1,786 1,955 2,244   2,244  3,091  3,538 
         23,344  37,419  45,087 
 17,482 16,965 23,344           
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 sales 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 traffic revenue in respect of domestic flights and outbound international/international, Hong Kong regional flightsand Macau flights. Sales tax incurred by the Group during the years ended December 31, 2002, 20032004, 2005 and 2004,2006, 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 when 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, 2002, 20032004, 2005 and 2004, netted off against revenue, amounted to RMB558, RMB206, and RMB7162006, 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 is requiredrecognized a RMB329 gain on sale of three Boeing 757-200 aircraft to pay contributions toindependent third parties, being the CAAC Infrastructure Development Fund. Prior to May 1, 2003, contributions to CAAC Infrastructure Development Fund were payable at 5% and 2% respectivelyexcess of the domestic and international/Hong Kong regional traffic revenue. Forsale proceeds over the period from May 1, 2003 to March 31, 2004, the Group was exempted from paying any contributions. Effective from April 1, 2004, contributions to the CAAC Infrastructure Development Fund are payable based on the traffic capacity deployed by the Group on its routes. The contributions now form partcarrying amounts of the flight operations expensesassets and amounted to RMB466 million for the year ended December 31, 2004. The contributions for the years ended December 31, 2002 and 2003 amounted to RMB798 and RMB251, respectively were netted off against traffic revenue.

     Pursuant 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 part of the traffic revenue of the Group. For the years ended December 31, 2002, 2003 and 2004, the fuel surcharge revenue of the Group totaled approximately RMB554, RMB740 and RMB348, respectively.

F-16

related selling costs.


F-29


CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES


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

4. OTHER OPERATING REVENUE


             
  Year ended December 31, 
  2002  2003  2004 
  RMB  RMB  RMB 
Commission income  138   140   203 
General aviation income  68   40   55 
Ground services income  79   99   146 
Air catering income  38   31   53 
Net income from lease arrangements (Note 14)  52   69   — 
Rental income  —   40   45 
Aircraft lease income  47   —   11 
Other  115   86   117 
          
   537   505   630 
          
13. INCOME TAX EXPENSE

5. FLIGHT OPERATIONS EXPENSES

             
  Year ended December 31, 
  2002  2003  2004 
  RMB  RMB  RMB 
Fuel costs  3,519   3,867   6,050 
Operating lease rentals  1,417   1,536   1,665 
Air catering expenses  625   510   705 
Aircraft insurance  256   196   185 
Flight personnel payroll and welfare  781   728   1,026 
Training expenses  39   123   183 
CAAC Infrastructure Development fund  —   —   466 
Other  96   110   138 
          
   6,733   7,070   10,418 
          

F-17

(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 33%.

The Company is taxed at the preferential rate of 15%, 15% and 18% during the years ended December 31, 2004, 2005 and 2006, except for certain branches which are taxed at following rates:

2006  15% or 33% 
2005
  33% 
2004  33% 
The subsidiaries of the Group are taxed at rates ranging from 15% to 33%.

F-30


CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES


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

6. MAINTENANCE EXPENSES


             
  Year ended December 31, 
  2002  2003  2004 
  RMB  RMB  RMB 
Repairing and maintenance charges  1,842   2,077   2,734 
Maintenance materials  292   300   422 
Labor costs  130   139   227 
Other  69   73   76 
          
   2,333   2,589   3,459 
          

     Details of provision for major overhauls in respect of aircraft held under operating leases are as follows:

             
  Year ended December 31, 
  2002  2003  2004 
  RMB  RMB  RMB 
Balance at beginning of year  187   194   200 
Additional amount provided  49   68   89 
Through the CNA/XJA Acquisitions  —   —   70 
Amount utilized  (42)  (62)  — 
          
Balance at end of year  194   200   359 
          

     Balance of provision for major overhauls(b) Reconciliation between tax expense and accounting income/(loss) at December 31, 2003 and 2004 consisted of:

         
  December 31, 
  2003  2004 
  RMB  RMB 
Current portion (included in accrued expenses) (Note 19)  11   75 
Non-current portion  189   284 
       
   200   359 
       

F-18

CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES

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

7. AIRCRAFT AND TRAFFIC SERVICING EXPENSES

             
  Year ended December 31, 
  2002  2003  2004 
  RMB  RMB  RMB 
Landing and navigation fees  2,353   2,562   3,222 
Ground service charges  158   205   281 
          
   2,511   2,767   3,503 
          

8. PROMOTION AND SALES EXPENSES

             
  Year ended December 31, 
  2002  2003  2004 
  RMB  RMB  RMB 
Sales commissions  750   757   1,062 
Ticket office expenses  516   504   552 
Computer reservation services  175   175   233 
Advertising and promotion  31   24   36 
Other  28   20   57 
          
   1,500   1,480   1,940 
          

9. GENERAL AND ADMINISTRATIVE EXPENSES

             
  Year ended December 31, 
  2002  2003  2004 
  RMB  RMB  RMB 
General corporate expenses  659   680   696 
Salaries and welfare  380   339   575 
Provision for doubtful accounts (Note 33)  1   12   27 
Other taxes and levies  20   22   25 
          
   1,060   1,053   1,323 
          

F-19

CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(Amounts in millions, 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 preferentialapplicable 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 from 33% to 15% beginning from that date.

     As a result of the reduction in income tax rate, the Company’s net deferred tax liability balance at January 1, 2003 of RMB507 was reduced by RMB392. Accordingly, a net deferred tax credit of RMB392 was recognized 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 the PRC government, or has sustained tax losses in these overseas jurisdictions. Accordingly, no provision for overseas tax has been made for the years ended December 31, 2002, 2003 and 2004.

     Taxation expense/(credit) consisted of:rates

             
  Year ended December 31, 
  2002  2003  2004 
  RMB  RMB  RMB 
PRC income tax:            
Company and subsidiaries  72   47   176 
Affiliated companies  9   3   2 
Jointly controlled entities  —   7   11 
          
   81   57   189 
             
Deferred tax (Note 21)            
- current year  317   11   (111)
- adjustment for change in enacted tax rate  —   (392)  — 
          
   398   (324)  78 
          

F-20

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 statements of operations for the years ended December 31, 2002, 2003 and 2004 differed from the amounts computed by applying the PRC income tax rate of 33%, 15% and 15%, respectively, to income/(loss) before taxation and minority interests as a result of the following:
  
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 

             
  Year ended December 31, 
  2002  2003  2004 
  RMB  RMB  RMB 
Expected PRC taxation expense/(credit)  376   (77)  35 
Adjustments:            
Gains on sale and leaseback transactions and their amortization  (1)  —   — 
Effect on change in income tax rate on deferred taxation  —   (392)  — 
Rate differential on subsidiaries  (60)  5   — 
Non-deductible expenses  61   80   40 
Unrecognized tax losses  —   22   — 
Expired tax losses  —   34   — 
Other, net  22   4   3 
          
   398   (324)  78 
          

All but an insignificant amount of income/(loss) before taxation is from domestic sources.

     In accordance with relevant PRC tax regulations,


14. DIVIDENDS

No interim dividend was paid during the years ended December 31, 2004, 2005 and 2006.

The board of directors of the Company does not recommend the payment of a PRC lessee is liable to pay PRC withholding taxfinal dividend 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%year ended December 31, 2006. No final dividend was paid in respect of the lease payments, or in certain cases, the interest componentsyears ended December 31, 2004 and 2005.

15. (LOSS)/EARNINGS PER SHARE

The calculation of such payments. Pursuant to an approval document from the State Tax Bureau, lease arrangements executed prior to September 1, 1999 were exempted from PRC withholding tax.

     The PRC withholding tax payable by the Groupbasic (loss)/earnings per share for the years ended December 31, 2002, 20032004, 2005 and 2004 of RMB14, RMB8 and RMB23, respectively, in respect2006 is based on the (loss)/earnings attributable to equity shareholders of the operating leases executed after September 1, 1999 has been included as partCompany 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 operating lease rentals.

F-21

three 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, 2004, 2005 and 2006.

F-31


CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES


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

11.


16. CASH AND CASH EQUIVALENTS

     As of December 31, 2003 and 2004, 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, 2003 and 2004 were simultaneously placed with several designated major PRC banks by SA Finance. As of December 31, 20032005 and 2004,2006, the Group’s deposits with SA Finance amounted to RMB366RMB544 and RMB406,RMB629, respectively (Note 26)37(d)).

12.


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, 
  2003  2004 
  RMB  RMB 
Trade receivables, principally traffic  904   1,295 
Less: Allowance for doubtful accounts (Note 33)  70   92 
       
   834   1,203 
       

13. SHORT TERM INVESTMENTS

         
  December 31, 
  2003  2004 
  RMB  RMB 
Equity securities held for trading  —   523 
Debt security held-to-maturity  —   160 
       
   —   683 
       
  
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 

     Net realized gains on equity securities held

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 trading during the year ended December 31, 2003bad and 2004 were RMB Nil and RMB 13, respectively, and are included in consolidated statement of operations. Net unrealized gains on equity securities held for trading during the year ended December 31, 2003 and 2004 were RMB Nil and RMB 3, respectively, and are included in consolidated statement of operations.

F-22

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 millions, except share data)

     The amortized cost, gross unrealized holding gains, gross unrealized holding losses, and fair value of debt security held-to-maturity as

As of December 31, 20032005 and 2004 were as follows:2006, the Group had an amount due from a fellow subsidiary of RMB42 and RMBNil, respectively, which was included in trade receivables.
                 
      Gross  Gross    
      unrealized  unrealized    
  Amortized  holding  holding    
  cost  gains  losses  Fair value 
  RMB  RMB  RMB  RMB 
As of December 31, 2003                
Debt security held-to-maturity  —   —   —   — 
             
                 
As of December 31, 2004                
Debt security held-to-maturity  160   —   —   160 
             

F-23

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)

14. PROPERTY, PLANT AND EQUIPMENT, NET


                         
              Other flight       
      Aircraft  equipment,  Machinery,    
          Held under  including  equipment    
          finance  rotable  and    
  Buildings  Owned  leases  spares  vehicles  Total 
Cost or valuation:                        
At 1 January 2004  3,288   17,222   10,463   6,842   1,930   39,745 
Exchange adjustments  5   —   —   —   12   17 
Reclassification on exercise of purchase options  —   550   (550)  —   —   — 
Additions  336   4,156   —   525   5   5,022 
Transferred from construction in progress  2,472   —   —   —   235   2,707 
Through the CNA/XJA Acquisitions  915   5,206   4,616   1,753   490   12,980 
Disposals  (28)  —   —   (76)  (73)  (177)
                   
At 31 December 2004  6,988   27,134   14,529   9,044   2,599   60,294 
                   
                         
Representing:                        
Cost  6,633   20,905   10,189   6,870   2,115   46,712 
Valuation — 1996  355   6,229   4,340   2,174   484   13,582 
                   
   6,988   27,134   14,529   9,044   2,599   60,294 
                   
                         
Accumulated depreciation:                        
At 1 January 2004  594   3,192   2,605   3,644   1,174   11,209 
Exchange adjustments  1   —   —   —   9   10 
Reclassification on exercise of purchase options  —   183   (183)  —   —   — 
Charge for the year  179   956   472   544   212   2,363 
Written back on disposal  (17)  —   —   (51)  (61)  (129)
                   
At 31 December 2004  757   4,331   2,894   4,137   1,334   13,453 
                   
                         
Net book value:                        
At 31 December 2004  6,231   22,803   11,635   4,907   1,265   46,841 
                   
                         
At 31 December 2003  2,694   14,030   7,858   3,198   756   28,536 
                   
18. INVENTORIES

F-24


  
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,
 
  
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 periods 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, RMB15totalling RMB2, RMB24 and RMB18RMB22 were paid to CSAHC for each of the years ended December 31, 2002, 20032004, 2005 and 20042006, respectively in respect of these leases (Note 24).

     The Group is obligated under various capital leases for aircraft that expire at various dates during the next nine years. The gross amount of aircraft and related accumulated amortization recorded under capital leases are as follows:leases.

         
  December 31, 
  2003  2004 
  RMB  RMB 
Aircraft  10,463   14,529 
Less: Accumulated amortization  2,605   2,894 
       
   7,858   11,635 
       

     As of December 31, 2003 and 2004, certain aircraft of the Group with an aggregate carrying amount of approximately RMB6,718 and RMB11,927, respectively, were mortgaged under certain loan agreements (Note 17).

(b) In compliance with the PRC rules and regulations governing initial public offering of shares by PRC joint stock limited companies, the property, 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 property, plant and equipment of the Group are carried at revalued 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 property, plant and equipment 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 property, plant and equipment did not differ materially from their respective fair value.

F-25

CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES

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

     The effect

At December 31, 2006, the carrying amount of such revalued property, plant and equipment approximated the above revaluation was to increase annualhistorical carrying value of such assets had they been stated at cost less accumulated depreciation chargesand impairment losses.

(c) As of December 31, 2005 and 2006, certain aircraft of the Group bywith an aggregate carrying amount of approximately RMB33, RMB33RMB30,408 and RMB13,RMB30,075, respectively, for 2002, 2003were mortgaged under certain notes payable and 2004.

     During 2002, pursuant to certain salelease agreements (Notes 27 and leaseback arrangements, the Group sold four Boeing 757-200 aircraft, 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 RMB199, 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. During 2003, the Group incurred a loss of RMB20 on early retirement of two old Boeing 737-200 aircraft. Such gain/loss was included under the sub-item “Gain/(loss) on sale of property, plant and equipment” under “Non-operating income/(expenses)” in the consolidated statements of operations.

     In 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. The leases with initial one-year term are automatically renewable for another one year unless either party gives appropriate notice of termination.includes contingent rentals. In this connection, rental income totaling RMB34RMB31, RMB31 and RMB35, respectively, was received by the Group forin 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 were receivable within one year and amounted to RMB35.

The cost and accumulated depreciation of 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, 20032004, 2005 and 20042006 totaled RMB15, RMB15 and RMB21, respectively.
F-37

CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Amounts in respect of the leases. As of December 31, 2004, the cost and accumulated depreciation of the relevant property, plant and equipment totaled RMB787 and RMB514, respectively. Depreciation of relevant property, plant and equipment recognized for each of the year ended December 31, 2003 and 2004 amounted to RMB55. As of December 31, 2004, the Group’s rental receivable in respect of the leases due in 2005 amounted to RMB34.

     During 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.

millions, except share data)

(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. The 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. Provided 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 property, plant and equipment. As of December 31, 20032005 and 2004,2006, the net present value of the lease commitments and the corresponding defeased deposits and debt securities amounted to RMB2,409RMB2,376 and RMB 2,462,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 Group received net cash benefits of RMB52 and RMB69 in 2002 and 2003, respectively, which have been recognized as income for the respective years.

F-26

year.

CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES

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

(g) As of December 31, 20042006 and up to the date of approval of these consolidated financial statements, the Group is in the process of applying for the land use right certificates and property title certificates in respect of the properties located in the Guangzhou new airport, Guangzhou Baiyun International Airport, in which the Group has interests and for which such certificates have not been granted. As of December 31, 2004,2005 and 2006, carrying value of such properties of the Group amounted to RMB2,477.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.

15.


21. CONSTRUCTION IN PROGRESS

     As


  
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, 2003 and 2004, included in construction in progress was an amount of RMB1,446 and RMB319, respectively, in relation2006 mainly related to the construction of facilities inprojects at the Guangzhou, new airport.

16. INVESTMENTSJilin and Fuzhou airports, Shenzhen cargo centre and Beijing branch.

         
  December 31, 
  2003  2004 
  RMB  RMB 
Share of net assets in affiliated companies  422   429 
Share of net assets in jointly controlled entities  731   782 
Other investments, at cost  204   272 
       
   1,357   1,483 
       

F-38

CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES

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

22. INTEREST IN AFFILIATED COMPANIES

  
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 30.

F-27

49, all of which are unlisted corporate entities.

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)

17. DEBT

Short-term notes payable


         
  December 31, 
  2003  2004 
  RMB  RMB 
Short-term notes payable  6,409   9,925 
       
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, 20032005 and 2004, 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 RMB130RMB8,116 and RMB411,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 RMB63Group’s aircraft with carrying amount of RMB11,735 and RMB21 were guaranteed by Guangzhou Baiyun International Airport Company Limited and Shenzhen Yingshun Investment Development Company Limited,RMB10,345, respectively. These notes payable were fully repaid in 2004.

     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 1.17% to 5.31%. The Group’s weighted average interest rate on short-term notes payable was 1.76% and 1.60%, respectively, as of December 31, 2003 and 2004.

F-28


F-44


CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES


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

Long-term notes payable


         
  December 31, 
Interest rate and final maturity 2003  2004 
  RMB  RMB 
Renminbi denominated notes payable:
        
         
Fixed interest rates ranging from 4.80% to 6.03% per annum as of December 31, 2004, with maturities through 2009.  —   1,628 
         
Floating interest rates ranging from 4.94% to 5.76% per annum as of December 31, 2004, with maturities through 2004.  76   1,217 
         
Non-interest bearing loan from a municipal government authority, repayable in 2005.  3   3 
         
U.S. dollar denominated notes payable:
        
         
Fixed interest rates ranging from 2.18% to 8.35% per annum as of December 31, 2004, with maturities through 2014.  2,626   2,676 
         
Floating interest rates ranging from 6 months LIBOR + 0.3% to 1.20% per annum as of December 31, 2004, with maturities through 2014.  2,505   6,578 
         
Floating interest rates ranging from 3 months LIBOR + 0.65% to 0.90% per annum as of December 31, 2004, with maturities through 2011.  —   1,426 
       
   5,210   13,528 
Less: current installments  (688)  (1,593)
       
   4,522   11,935 
       

(e) As of December 31, 20032005 and 2004, borrowings under long-term2006, certain bank and other notes payable of the Group totaling RMB2,565 and RMB2,172, 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, 2003 and 2004, borrowings under long-term notes payable of the Group totaling RMB229 and RMB2,041, respectively, were guaranteed by CSAHC and RMB10 and RMB9, 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, 2004,2005 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 approximate amountapproximately RMB49,041, of RMB35,750. As of December 31, 2004, an approximate amount of RMB11,525which approximately RMB28,295 was utilized.


(h) The aggregate annual maturities of long-term notes payable for each of the five years subsequent to December 31, 20042006 and thereafter are as follows:

F-29


  
December 31,
 
  
2005
 
2006
 
  
RMB
 
RMB
 
Year ending December 31,
     
2006  1,877  - 
2007  4,316  3,914 
2008  2,156  2,986 
2009  1,435  2,219 
2010  660  740 
2011  -  1,574 
Thereafter  4,173  2,499 
   14,617  13,932 
F-45


CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS —- (Continued)
(Amounts in millions, except share data)
     
  RMB 
Year ending December 31,
    
2005  1,593 
2006  1,626 
2007  4,139 
2008  1,055 
2009  1,228 
Thereafter  3,887 
    
   13,528 
    

     Interest expense, net

(i) Included in bank and other notes payable are the following amounts denominated in a currency other than the functional currency of the amounts capitalized, represents:
             
  Year ended December 31, 
  2002  2003  2004 
  RMB  RMB  RMB 
Interest incurred  1,023   907   725 
Interest capitalized  (64)  (83)  (34)
          
Interest expense  959   824   691 
          

     Interest rates per annum atentity to which borrowing costs were capitalized were 5.70%, 1.62% to 5.46%, and 1.51% to 3.48% respectively, for the years ended December 31, 2002, 2003 and 2004.

F-30

they relate:

CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES

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

18.

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, 2004, the

The Group leased 47 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 expiry dates range from 2005 through 2013.

expiring during the years 2007 to 2016. As of December 31, 2004,2006, future payments under these capital leases which were 67% and 33%, respectively, denominated in U.S. dollars and Japanese yen, are as follows:

             
  Payments  *Interest  Obligations 
  RMB  RMB  RMB 
Year ending December 31,
2005  2,580   436   2,144 
2006  3,213   350   2,863 
2007  2,844   279   2,565 
2008  2,699   146   2,553 
2009  997   71   926 
Thereafter  722   30   692 
          
   13,055   1,312   11,743 
           
Less: current instalments of obligations under capital leases  (2,144)
            
           9,599 
            

  
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    
 
*Interest rates ranged from 1.92% to 8.48%

Under the terms of the leases, the Group has an 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 14), As of December 31, 2005 and 2006, certain of the Group’s aircraft with an aggregate carrying amount of RMB7,858RMB18,723 and RMB11,635,RMB19,730, respectively as of December 31, 2003 and 2004 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 RMB6,841 and RMB11,743, respectively, on these dates.

F-31

which they relate:

CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(Amounts in millions, 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, 2004,2006, 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,
      
2005 1,761 
2006 1,622   3,340  - 
2007 1,562   2,881  3,077 
2008 5,259   2,785  2,965 
2009 764   2,609  2,775 
2010  2,523  2,613 
2011  -  2,493 
Thereafter 1,782   10,456  8,046 
   
Total minimum lease payments 12,750   24,594  21,969 
   

     Amounts charged to rental expenses for operating leases for the years ended December 31, 2002, 2003 and 2004 totaled RMB1,348, RMB1,409 and RMB1,475, respectively.

     All of the Group’s obligations under capital and operating leases are guaranteed by financial institutions.

19. ACCRUED EXPENSES

         
  December 31, 
  2003  2004 
  RMB  RMB 
Landing and navigation fees  826   1,331 
Duties and levies  337   71 
Fuel  255   743 
Interest  158   240 
Lease charges  18   29 
Accrued salaries, wages and benefits  197   349 
Repairs and maintenance  287   976 
Seat reservation  55   195 
Air catering  114   192 
Current portion of provision for major overhauls (Note 6)  11   75 
Lump sum housing benefits payable (Note 25)  129   69 
Other  141   281 
       
   2,528   4,551 
       

F-32

F-47


CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES


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

20. DEFERRED CREDITS

         
  December 31, 
  2003  2004 
  RMB  RMB 
Operating lease rebates  7   39 
Governmental subsidy for safety related capital expenditures  40   40 
Capital lease rebates  —   21 
       
   47   100 
       
         
Movements during the year are as follows:        
Balance at beginning of year  48   47 
Additions through the CNA/XJA Acquisitions  —   56 
Transferred to consolidated statements of operations  (1)  (3)
       
Balance at end of year  47   100 
       

Operating lease rebates

     Pursuant to certain aircraft operating lease arrangements,

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 from the lessors. Such rebates have been deferredhad an amount due to a fellow subsidiary of RMB859 and amortized over the termsRMB11, respectively, which was included in trade and bills payables.
All of the respective leases.

Governmental subsidy for safety related capital expenditures

     During 2002, the Group received governmental subsidy for safety related capital expenditures amounting to RMB40 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 property, plant and equipment.

Capital lease rebates

     Pursuantentity to certain aircraft capital lease arrangements, the Group received cash rebates upon the inception of the respective leases. The benefits are initially deferred and amortized over the terms of the respective leases to reduce the future capital lease charges.

F-33

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 millions, except share data)

21. DEFERRED TAX LIABILITIES

     Movements in net deferred tax liabilities are as follows:

         
  December 31, 
  2003  2004 
  RMB  RMB 
Balance at beginning of year  (779)  (398)
Transferred to consolidated statements of operations (Note 10)        
— current year  (11)  111 
— adjustment for change in income tax rate  392   — 
       
Balance at end of year  (398)  (287)
       

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 (liabilities)/assets asamounts due from related companies were unsecured, interest free and have no fixed terms of December 31, 2003 and 2004 were made uprepayment.

All of the following taxation effects:amounts due from related companies are expected to be recovered within one year.
         
  December 31, 
  2003  2004 
  RMB  RMB 
Deferred tax assets:        
Tax losses  223   39 
Repair charges capitalized  261   254 
Accrued expenses  107   275 
Other  9   21 
       
Total deferred tax assets  600   589 
       
         
Deferred tax liabilities:        
Accrued expenses  81   75 
Depreciation of property, plant and equipment  848   752 
Other  69   49 
       
Total deferred tax liabilities  998   876 
       
         
Net deferred tax liabilities  (398)  (287)
       

F-34

(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 millions, except share data)

     As

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 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 December 31, 2004, the Group had tax lossesprovision for PRC income tax purposes totaling approximately RMB260. 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 RMB33, RMB42 and RMB185 will expire after December 31, 2007, 2008 and 2009, respectively. As of December 31, 2004, the Group recorded a deferred tax asset of RMB39 for such tax losses.

     As of December 31, 2004, the Group had tax losses of approximately RMB303 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 assetmajor overhauls in respect of such tax lossesaircraft held under operating leases are as it would not be probable that future taxable profits will be available against whichfollows:


  
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 taxable losses can be utilized.

22. SHARE CAPITAL

         
  December 31, 
  2003  2004 
  RMB  RMB 
Registered capital:        
2,200,000,000 domestic shares of RMB 1.00 each  2,200   2,200 
1,174,178,000 H shares of RMB 1.00 each  1,174   1,174 
1,000,000,000 A share of RMB1.00 each  1,000   1,000 
       
   4,374   4,374 
       
Issued and paid up capital:        
2,200,000,000 domestic shares of RMB 1.00 each  2,200   2,200 
1,174,178,000 H shares of RMB 1.00 each  1,174   1,174 
1,000,000,000 A share of RMB1.00 each  1,000   1,000 
       
   4,374   4,374 
       

     In July 2003,Group implemented an early retirement plan for certain employees. The benefits of the Company issued 1,000,000,000 A shares with a parearly 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 RMB1.00 each at issue price of RMB2.70 by way of a public offeringthe future cash flows expected to natural persons and institutional investors inbe required to settle the PRC. The share premium received by the Company, net of the issuance costs of RMB59, amounted to RMB1,641 and was credited to share premium account.

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, 2003 and 2004, the retained earnings of the Group included RMB112 and RMB81, respectively, of undistributed earnings of companies which are 50% or less owned by the Group and accounted for under the equity method.

F-35

F-52


CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES


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

23. OTHER


36. RESERVES
         
  December 31, 
  2003  2004 
  RMB  RMB 
Statutory surplus reserve (Note (a))
        
Balance at beginning of year  337   361 
Transferred from consolidated statements of operations  24   41 
       
Balance at end of year  361   402 
       
       
Statutory public welfare fund (Note (b))
        
Balance at beginning of year  172   173 
Transferred from consolidated statements of operations  1   20 
       
Balance at end of year  173   193 
       
       
Discretionary surplus reserve (Note (c))
        
Balance at beginning of year and at end of year  77   77 
       
Total
  611   672 
       

  
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 
 

Notes:

(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 incomesincome 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.

F-36

CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES

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

(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 fund must be made before distribution of a dividend to shareholders.

shareholders and is subject to respective shareholders’ approval.


According to the revised PRC Company Law effective January 1, 2006, appropriation to the statutory public welfare fund is no longer required and the balance of statutory public welfare fund as of December 31, 2005 was transferred to statutory surplus reserve.

(c) The appropriation of this reserve is subject to shareholders’ approval. The usage of this reserve is similar to that of statutory surplus reserve.

(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 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 the PRC accounting rules and regulations, and (ii) the net income determined in accordance with IFRS;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 28).

24. COMMITMENTS AND CONTINGENCIES

     Pursuant to the Reorganisationlisted. As of CSAHC effected in 1995 (Note 1),December 31, 2005 and 2006, the Company assumeddid not have any distributable reserves.


As of December 31, 2005 and 2006, the airlineaccumulated losses of the Group included RMB243 and airline-related businesses together with the relevant assets and liabilities from CSAHC. The Company has been advised by its PRC lawyers that, except for liabilities constitutingRMB251, respectively, of undistributed earnings of companies which are 50% or arising out of or relating to the businesses assumedless owned by the Company inGroup and accounted for under the Reorganisation, 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 Reorganisation. There are not, however, any definitive PRC regulations or other pronouncements confirming such conclusion.

     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.

     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 occupancy of the land 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 their uses 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.

F-37

equity method.

F-54


CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES


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

     The Company is involved in a civil litigation (Hong Kong High Court Action No. 515

37. RELATED PARTY TRANSACTIONS

(a) Key management personnel remuneration

Remuneration for key management personnel of 2001) (“Litigation”) which commenced in 2003. According to the writ of summons for the Litigation, New Link Consultants Limited, the plaintiff claimed unspecified damages against the Group (as oneis 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 post-employment benefit plans

The Group participates in various defined contribution retirement plans organized by municipal and provincial governments for its staff. Details of the defendants toGroup’s employee benefits plan are disclosed in Note 38.
F-55

CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES

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

(c) Transactions with CSAHC and its affiliates (the “CSAHC Group”), and the Litigation) for breachaffiliated companies and jointly controlled entities of the agreement onGroup

The Group obtained various operational services provided by the basisCSAHC Group and the affiliated companies and jointly controlled entities of certain evidence proving that United Aero-Supplies System of China, Limited (“UASSC”) entered into an agreement with the defendants for exclusive purchase of aviation equipment consigned to UASSC for sale and, that asGroup during the defendants failed to perform the agreement, UASSC should have the right to compensation. Since UASSC is in thenormal course of winding up proceedings, allits business.
Details of the rightssignificant 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 benefitsother airline-related facilities through Southern Airlines (Group) Import and Export Trading Company (“SAIETC”), a wholly-owned subsidiary of UASSCCSAHC.

(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 claim have been transferredair 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 plaintiff. BasedGroup.

(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, 2004, the Group acquired the airline operations and certain related assets of China Northern Airlines Company (“CNA”) and Xinjiang Airlines Company (“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, 2005 and 2006, 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 following:

·
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 products 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 opinion given by the Company’s legal advisors,consolidated financial statements, the directors of the Company consider that it is not probableare of the opinion that the Company will have an unfavorable outcomefollowing transactions with other state-controlled entities require disclosure:
(i) The 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 claim and thatPRC

  
December 31,
 
  
2005
 
2006
 
  
RMB
 
RMB
 
      
Guarantees on certain bank notes payable of the Group  266  201 

(g) Loan from a provision for such claim and/or the associated legal costs is not required.

     As of December 31, 2004,minority shareholder


During 2006, the Group had on orderobtained a loan from a minority shareholder amounting to RMB19. The loan is unsecured, interest free and repayable within five Boeing 737-700 aircraft, six Airbus 319-100 aircraft, fifteen Airbus 320-200 aircraft, two Airbus 321-200 aircraft, four Airbus 330-200 aircraft, one Embraer ERJ-145 aircraft and certain flight equipment, scheduled for deliveries in 2005 to 2007. Deposits of RMB4,640 have been made towards the purchase of these aircraft and related equipment. As of December 31, 2004, the approximate total future payments, including estimated amounts for price escalation through anticipated delivery dates for these aircraft and related equipment totaled approximately RMB 11,776.

     As of December 31, 2004, additional capital expenditures of approximately RMB1,524 have been authorized, of which approximately RMB242 have been committed, for the Group’s principal facilities. Such expenditures comprised mainly RMB824 for facilities and equipment at the Guangzhou new airport and RMB700 for other airport and office facilities and equipment, overhaul and maintenance bases and training centers.

     As of December 31, 2004, the Group was committed to make capital contributions of approximately RMB83 to its jointly controlled entities.

25. years.

38.RETIREMENT AND HOUSING 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 20% (2003: 14%during the year ended December 31, 2004, 9% to 19%)20% during the year ended December 31, 2005, and 10% 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 RMB112, RMB131 and RMB143, respectively, during 2002, 2003 and 2004.

F-38

CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES

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

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 at a ratenot exceeding one-twelfth of 4.5% ofthe prior 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 RMB19, RMB19 and RMB25, respectively, during 2002, 2003 and 2004.

     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 to CSAHC for a ten-year period effective January 1, 1995.

     During 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 2002, the Group recognized a loss of RMB18, being the excess of the cost of these quarters over the considerations received by the Group from the employees, under the sub-item “Gain/(loss) on sale of property, plant and equipment” under “Non-operating income/(expenses)” in the consolidated statements of operations.

     Subsequently, pursuant


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 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. 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, 2004, 2005 and 2006, the Group alreadyhad made payments totaling RMB191RMB22, RMB16 and RMB2, respectively, under the scheme and recorded its remaining contractual liabilities totaling RMB69RMB108, RMB92 and RMB90, respectively, as accrued expenses on itsat the respective consolidated balance sheet (Note 19).sheet. Housing allowances are payable when applications are received from eligible employees.

26. RELATED PARTY TRANSACTIONS

39. SEGMENTAL INFORMATION

The Group obtained various operationaloperates principally as a single business segment for the provision of air transportation services. The analysis of turnover and financialoperating income/(loss) by geographical segment is based on the following criteria:

(i) Traffic revenue from domestic services provided by CSAHCwithin the PRC (excluding Hong Kong and its affiliates,Macau) is attributed to the domestic operation. Traffic revenue from inbound/outbound services between the PRC and Hong Kong/Macau, and the Group’s affiliated companiesPRC 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 shiftedoverseas destinations is attributed to the China State-owned Assets Administration Bureau since early 2003. Consequently, transactions withHong Kong and Macau 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 CAAC and its affiliates beginning from 2003basis of where the services are no longer presented as related party transactions of the Group. The principal related party transactions are described as follows:

F-39

performed.

F-62


CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES


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

Allocation of routes


  
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 air fares

     Both domestic and international routes on which the Group and other PRC airlines offer scheduled 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 CAAC and the PRC Price Administrative Bureau.

Procurement of aircraft, flight equipment and other airline-related facilities

     Certain PRC airlines, including the Group, were granted permission to acquire aircraft, flight equipment and other airline-related facilities directly from manufacturers subject to 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 RMB584, RMB1,155 and RMB1,177, respectively, for 2002, 2003 and 2004. Handling fees totaling RMB36, RMB27 and RMB33, respectively, were paid to SAIETC for 2002, 2003 and 2004.

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 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 RMB2,374 for 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 purchasedmainly derived from domestic marketsthe Group’s flights to/from European, North American 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 of RMB256 were incurred by the Group for 2002.

F-40

Australian regions.

F-63


CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES


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

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 guarantees from the CAAC. Guarantee feesmajor revenue-earning assets of RMB1 were paid to these financial institutions for 2002.

     Interest income is received from deposits with SA Finance. The applicable interest rate is determined in accordance with the deposit rate published by the People’s Bank of China. Interest income totaling RMB11, RMB3 and RMB4, respectively, was earned by the Group on such deposits during 2002, 2003 and 2004 (Note 11).

     During 2003, CSAHC made short-term advances to the Group. These advances were unsecured, interest free and fully repaid in 2004.

Airline-related services

     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 for 2002 totaled RMB107.

     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 of RMB62 were by the Group to the CAAC for 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 of RMB1,668 were paid to various PRC airports for 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 RMB29, RMB28RMBNil, RMB6,938 and RMB50, respectively, during 2002, 2003 and 2004.

     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 RMB17, RMB5 and RMB2, respectively, during 2002, 2003 and 2004.

F-41

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 millions, except share data)

     Commission is earned by


Had the CAAC’s sales offices and various PRC airlines in connection with the air tickets sold by themCNA/XJA Acquisitions been effected on behalfJanuary 1, 2004, results 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 respectoperations of tickets sold by the CAAC’s sales offices and various PRC airlines amounted RMB465 for 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 RMB82 for 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 RMB40 for 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 RMB592, RMB693 and RMB1,159, respectively, were incurred by the Group for services provided by GAMECO and MTU Zhuhai during 2002, 2003 and 2004.

     Certain sundry aviation supplies are purchased from Southern Airlines (Group) Economic Development Company (“SAGEDC”), a subsidiarythe year 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 CSAHC. Supplies totaling RMB101, RMB43 and RMB66, respectively, were purchased by the Group from SAGEDC during 2002, 2003 and 2004.

     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 and RMB100 were incurred by the Group for services provided by Zhuhai Xiang Yi during 2003 and 2004 respectively. In addition, the Group entered into operating lease agreements to lease certain flight training facilities and buildings to Zhuhai Xiang Yi. Rental income received by the Group amounted to RMB34 each during 2003 and 2004 (Note 14).

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 RMB3 were incurred by the Group for services provided by SA Advertising for 2002.

Wet lease rentals

     During 2002 and 2003, wet lease rentals totaling RMB26 and RMB36 respectively, were paid to Xinjiang Airlines Company, a subsidiarycertain assets of CSAHC pursuant to a wet lease agreement in respect of a Boeing 757-200 aircraft effective October 2002. The wet lease agreement was terminated in April 2003.

F-42

CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES

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

     During the period from August to October 2002, the Group received wet lease rentals totaling RMB28 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 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 agreement.

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 RMB1,097. The consideration was satisfied by cash of approximately RMB132 together with an assumption by the Group of Zhongyuan Airlines’ debts of approximately RMB965. In addition, the Group obtained reimbursements of wet lease rentals totaling RMB150 which it paid to Zhongyuan Airlines during the period from July 1, 2001 to December 31, 2001. Such reimbursements receivable were applied to reduce the cash payable for the acquired assets.

Acquisition of subsidiaries

     In August 2002, the Group acquired 90% equity 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 RMB108. Such consideration is determined by reference to the valuation reports prepared by Guangzhou Zhongtian Valuation Company Limited, a firm of independent valuers registered in the PRC. These acquisitions are not considered significant in the context of the Group.

Acquisition of airline business related assets and liabilities

     As disclosed in Note 1 to the consolidated financial statements, on December 31, 2004, the Group acquired the airline operations and certain related assets of CNA and XJAHainan at a total consideration of RMB15,522,RMB294, which was partly satisfied by assumption of debts and liabilities of CNA and XJACSAHC Hainan totaling RMB13,563RMB289 outstanding as ofat that date. The remaining consideration payable of RMB1,959 is required to be satisfied in cash by December 31, 2005.

F-43

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 millions, except share data)

Amounts due


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 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. The balance as of December 31, 2004 also included the above-mentioned cash consideration payable for the CNA/XJA Acquisitions of RMB1,959 (Note 1).

     In addition to the above, certain business undertakings 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.

     The directors of the Company are of the opinion that the above transactions with related parties were entered intoliquidity, interest rate, 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.

27. FAIR VALUE OF FINANCIAL INSTRUMENTS AND CONCENTRATIONS OF RISK

     Financial assets of the Group include cash and cash equivalents, trade receivables, other receivables and short-term investments. Financial liabilities of the Group include notes payables, amounts due to related companies, accounts payables, bills payable, other liabilities and taxes payable.

practices described below.


(a) Liquidity risk


As of December 31, 2003 and 2004,2006, the Group’s net current liabilities amounted to RMB10,792 and RMB18,855, respectively.exceeded its current assets by RMB32,180. For the yearsyear ended December 31, 2002, 2003 and 2004,2006, the Group recorded a net cash inflow from operating activities of RMB3,698, RMB2,129 and RMB3,596, respectively,RMB2,217, a net cash outflow from investing activities of RMB5,404 and a net cash inflow from financing activities of RMB2,745, RMB3,819 and RMB2,593, respectively, and an increase/(decrease)RMB2,550, resulting in a net decrease in cash and cash equivalents of RMB953, RMB(1,690) and RMB1,003, respectively.

RMB637.


In 20052007 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. The Group has obtained firm commitments from its principal bankers to renew its short-term bank loans outstanding atAt December 31, 2004 when they fall due during 2005. In relation to its future capital commitments and other financing requirements,2006, 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 RMB24,225which 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 2005 and thereafter.2007. The directors of the Company believe that suchsufficient financing will be available to the Group.

F-44

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, 2005.2007. 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.

Business risk

     The Group conducts its principal operations in the PRC and accordingly is subject to special considerations and significant risks not typically associated with investments in equity securities of 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 maturity information 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 1727 and 18,28, 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. 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, 20032005 and 2004,2006, the balance due from BSP agents amounted to RMB446RMB782 and RMB411,RMB863, respectively.

F-45

The credit risk exposure to BSP and the remaining trade receivables balance has been monitored by the Group on an ongoing basis and 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 millions, except share data)

Self insurance risk

     The Group maintains a limited amount of property insurance in respect of certain personal and real property.

(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, 20032005 and 2004 are set out below.2006.
                 
  December 31, 
  2003  2004 
  Carrying  Fair  Carrying  Fair 
  amount  value  amount  value 
  RMB  RMB  RMB  RMB 
Cash and cash equivalents  2,080   2,080   3,083   3,083 
Trade receivables  834   834   1,203   1,203 
Other receivables  296   296   616   616 
Short term investments  —   —   683   683 
Notes payables  11,619   11,907   23,453   23,665 
Amounts due to related companies  929   929   2,330   2,330 
Accounts payables  928   928   1,554   1,554 
Bills payable  438   438   136   136 
Other liabilities  1,020   1,020   2,974   2,974 
Taxes payable  90   90   39   39 

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 investments, amounts due to related companies, accountsand other current assets, trade and bills payables, billstaxes payable and other liabilities and taxes payableliabilities.


The carrying values approximate their fair valuevalues because of the short maturities of these instruments.

F-46

CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

·
Financial liabilities

(Amounts in millions, except share data)

(ii) Notes payable

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.

     Other investments represents 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 measured reliably.


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.

28. 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-47

these balances.

F-69

CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES


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

29. RECONCILIATION AND SUPPLEMENTARY STATEMENTS OF CASH FLOWS INFORMATION

(a)The reconciliation of income/(loss) before taxation and minority interests to cash inflows from operations is as follows:

             
  Year ended December 31, 
  2002  2003  2004 
  RMB  RMB  RMB 
Income/(loss) before taxation and minority interests  1,139   (511)  233 
Adjustments to reconcile income/(loss) before taxation and minority interests to cash inflows from operations:            
Depreciation and amortization of property, plant and equipment  1,839   1,998   2,363 
Other amortization  10   40   50 
Amortization of deferred credits  (7)  (2)  (4)
Equity income of affiliated companies  (37)  (48)  (12)
Equity loss of jointly controlled entities  3   39   5 
(Gain)/loss on sale of aircraft  (199)  20   — 
Loss on sale of other property, plant and equipment  29   2   1 
Interest income  (53)  (13)  (22)
Net realised and unrealised gain on equity securities held for trading  —   —   (15)
Interest expense  959   824   725 
Non-cash exchange loss, net  175   177   42 
Increase in trade receivables  (111)  (162)  (218)
(Increase)/decrease in other receivables  (166)  77   (166)
Increase in deferred expenditure  —   —   (2)
(Increase)/decrease in inventories  (76)  2   (29)
Decrease/(increase) in prepaid expenses and other current assets  124   (6)  (31)
(Decrease)/increase in accounts payables  (62)  396   344 
Increase/(decrease) in bills payable  1,300   (862)  (374)
Increase in sales in advance of carriage  20   76   408 
(Decrease)/increase in amounts due to related companies  (193)  404   (586)
Increase in accrued expenses  86   203   507 
(Decrease)/increase in other liabilities  (33)  373   1,223 
Increase in provision for major overhauls  16   48   113 
          
Cash inflows from operations  4,763   3,075   4,555 
          

(b) Disclosure of non-cash investing and financing activities:

     During 2002,

42. COMMITMENTS
(a) Capital commitments
At December 31, 2006, the Group assumed from Zhongyuan Airlines debts totaling RMB965 in partial satisfactionhad capital commitments as follows:
  
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 consideration payable for acquisition of five Boeing 737-300/37KGroup had on order 130 aircraft and other assets from Zhongyuan Airlines (Note 26).

F-48

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 millions, except share data)

     During 2004, the Group acquired the airline operation and related assets of CNA and XJA at a total consideration of RMB15,522, which was partially satisfied by assumption of debts and liabilities of CNA and XJA totaling RMB13,563 outstanding as

As of December 31, 2004 (Note 1).

(c) Effect2006, the Group’s attributable share of acquisition:the capital commitments of jointly controlled entities was as follows:

             
  Year ended December 31, 
  2002  2003  2004 
  RMB  RMB  RMB 
Net assets acquired:            
             
Property, plant and equipment  97   —   12,980 
Cash and cash equivalents  17   —   398 
Trade receivables  21   —   314 
Inventories  —   —   729 
Other  —   —   1,101 
          
   135   —   15,522 
          
             
Notes payable  —   —   4,587 
Obligations under capital leases  —   —   6,125 
Accounts payables  4   —   343 
Accrued expenses and other liabilities  11   —   1,475 
Other  —   —   1,033 
          
   15   —   13,563 
          
Net assets value  120   —   1,959 
Minority interests’ share of net assets value  12   —   — 
          
Net assets value acquired by the Group  108   —   1,959 
          
             
Consideration paid  108   —   — 
Cash and cash equivalents acquired  18   —   398 
          
Net cash outflow/(inflow) from acquisition  90   —   (398)
          

F-49

  
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)

30. PRINCIPAL

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) Share reform
On April 13, 2007, the Company issued a notice to holders of the 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 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)PRCRMB170,900,000100%Airline
Southern Airlines (Group) Shantou Airlines Company Limited (a)PRCRMB280,000,00060%Airline
Zhuhai Airlines Company Limited (a)PRCRMB250,000,00060%Airline
Xiamen Airlines Company Limited (a)PRCRMB700,000,00060%Airline
Guizhou Airlines Company Limited (a)PRCRMB80,000,00060%Airline
Guangzhou Air Cargo Company Limited (a)PRCRMB238,000,00070%Cargo services
Guangzhou Baiyun International Logistic Company Limited (a)PRCRMB50,000,00061%Logistics operations
Guangzhou Nanland Air Catering Company Limited (b)PRCRMB120,000,00075%Air catering
China Southern West Australian Flying College Pty LimitedAustraliaAUD100,00065%Pilot training services
Xinjiang Civil Aviation Property Management Limited (a)PRCRMB251,332,83251.8%Property management
(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 millions, except share data)
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, 20042006 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 Air Cargo Company
Limited		 PRC  70   —  Cargo services
Guangzhou Baiyun International
Logistics Company Limited		 PRC  61   —  Logistics operations
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 training services

     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-50

F-78

CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES


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

31. 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 by geographical segment 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.

                 
      Hong Kong       
  Domestic  regional  International*  Total 
  RMB  RMB  RMB  RMB 
Year ended December 31, 2002
                
Traffic revenue  13,198   1,119   3,165   17,482 
Other revenue  485   —   52   537 
             
   13,683   1,119   3,217   18,019 
             
Operating income  1,615   193   218   2,026 
             
                 
Year ended December 31, 2003
                
Traffic revenue  13,087   808   3,070   16,965 
Other revenue  436   —   69   505 
             
   13,523   808   3,139   17,470 
             
                 
Operating income / (loss)  440   (29)  45   456 
             
                 
Year ended December 31, 2004
                
Traffic revenue  17,742   1,180   4,422   23,344 
Other revenue  630   —   —   630 
             
   18,372   1,180   4,422   23,974 
             
                 
Operating income  650   67   192   909 
             
 
*Asian market accounted for approximately 70%, 70% and 67%, respectively, of the Group’s total international traffic revenue for the years ended December 31, 2002, 2003 and 2004. The remaining portion was mainly derived from the Group’s flights to/from European and North American regions.

F-51

CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES

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

     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-52

CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES

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

32. SUBSEQUENT EVENTS

     In January 2005, the Group, as a lessee, entered into an agreement with an independent lessor for operating leases of nine Boeing 737-800 aircraft for a term of seven years with total future lease payments totalling approximately RMB1,721, scheduled for deliveries in 2005 and 2006.

     In January 2005, China Aviation Supplies Import and Export Corporation, as a sole importing agent, entered into, on behalf of several PRC airlines including the Group, a general purchase agreement with the Boeing Company for the import of Boeing B7E7 aircraft. The Group, being one of the ultimate users for thirteen of the Boeing B7E7 aircraft, endorsed the general purchase agreement. The Group is currently in negotiation with the Boeing Company regarding the purchase agreements on such aircraft.

     In March 2005, the Group, as a lessee, entered into another agreement with an independent lessor for operating leases of a total of twenty-five aircraft comprising five Boeing 737-700 aircraft, five Boeing 737-800 aircraft, five Airbus 320-200 aircraft and ten Airbus 321-200 aircraft with scheduled deliveries in 2006 and 2007. The term of the lease ranges from ten to twelve years with total future lease payments totalling approximately RMB8,243.

     In April 2005, the Group entered into a purchase agreement with Airbus SNC for the purchase of five Airbus A380 aircraft, scheduled for deliveries in 2007 to 2010.

33. SUPPLEMENTARY INFORMATION

     Movements in allowance for doubtful accounts comprise:

             
  Year ended December 31, 
  2002  2003  2004 
  RMB  RMB  RMB 
Balance at beginning of year  59   60   70 
Provision for doubtful accounts (Note 9)  1   12   27 
Through the CNA/XJA acquisitions  —   —   44 
Doubtful accounts written-off  —   (2)  (49)
          
Balance at end of year (Note 12)  60   70   92 
          

F-53

CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES

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

34.51. SIGNIFICANT DIFFERENCES BETWEEN IFRS AND U.S. GAAP


The Group’s accounting policies conform with IFRSIFRSs which differ in certain significant respects from U.S. GAAP. Information relating to the nature and effect of such differences is set out below.


(a) CNA/XJA Acquisitions


As disclosed in Note 137(c) to the consolidated financial statements prepared under IFRS,IFRSs, the Group acquired the airline operations and certain related assets and liabilities of CNA and XJA with effect from December 31, 2004. Under IFRS,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 will bewere 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 U.S. GAAPhistorical 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.


(c) Lease arrangements


As disclosed in Note 1420 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.

F-54

CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES

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

As a result of the lease arrangements, the Group received a net cash benefit of RMB52 and RMB69 in 2002 and 2003, respectively, which were recognized as income under IFRS.IFRSs. Under U.S. GAAP, such benefits are deferred and amortized over the minimum lease period.


In addition, under the lease arrangements, the commitments by the Group to make long-term lease payments are 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 RMB2,409RMB2,376 and RMB2,462RMB2,272 as of December 31, 20032005 and 2004,2006, respectively, would be recognized on the consolidated balance sheets, as such commitments are not deemed as extinguished by the placement of security deposits.

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.


(e) Revaluation of property, plant and equipment


In connection with the Reorganization in 1996, the property, plant and equipment of the Group were revalued as of December 31, 1996 (see Notes 12 and 1420 to the consolidated financial statements). Such revaluation resulted in an increase in shareholders’ equity with respect to the increase in carrying amount of certain property, 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 property, plant and equipment below their historical cost bases. In addition, the revalued property, plant and equipment amounts serve as the tax bases of property, plant and equipment for years beginning in 1997. Accordingly, the 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, property, plant and equipment are stated at their historical cost unless an impairment loss has been recorded. An impairment loss on property, 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 property, 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 eight years ended December 31, 2004, as a result of the Reorganization are reversed for U.S. GAAP purposes.

F-55

CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES

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

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 property, plant and equipment beginning 1997.

F-56


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 millions, except share data)

(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 dates of acquisitions.


Under U.S. GAAP, such transactions are considered to be “combinations of businesses under common control”. 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.

(g) Acquisition of other subsidiaries from CSAHC

     During 2002,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 is considered to be “a combination of entities under common control”. As describedminority interests at the balance sheet date are presented in Note 34(a), a combination of entities under common control is accounted for in a manner similar to a “pooling-of-interests”. The effect of this difference in accounting was not material to the years presented.

(h) Provision for major overhauls

     As disclosed in Notes 2(u) 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 overhauls required to be performed on the related aircraft prior to their return to the lessors.

     Under U.S. GAAP,operations as a liability is recorded at the outsetcomponent of the operating leases for the fair value of contractual obligations to perform the overhauls and a deferred asset is recorded for the corresponding amount, which is amortized over the term of the operating lease. The carrying amounts of such liability and asset amounted to approximately RMB570 and RMB370 respectively as of December 31, 2003 and RMB749 and RMB390 respectively as of December 31, 2004.

     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-57

.

F-81

CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES


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

(i)

(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 property, plant and equipment is classified under “Non-operating income/(expenses)”. Under U.S. GAAP, such (loss)/gain is 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 2125 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 are separately disclosed. As

In addition, deferred tax liabilities and assets should 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 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 millions, except share data)
The U.S. GAAP presentation of deferred tax assets/(liabilities) as of December 31, 20032005 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 amountvaluation 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) Recently 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 deferred tax asset valuation allowances approximated RMB741balance-sheet and RMB53, respectively.

(j) New accounting pronouncements

FASBincome-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. 123R

157


In December 2004,September 2006, the FASB issued FASB StatementSFAS No. 123 (revised 2004), Share-Based Payment,157 “Fair Value Measurements” which addressesdefines 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 for transactions in which an entity exchanges its equity instruments for goods or services, with a primary focus on transactions in which an entity obtains employee services in share-based payment transactions. This new pronouncement replaces the existing requirements under FASB No. 123pronouncements that require fair value measurements and APB Opinion No. 25, Accounting for Stock Issued to Employees, and will be effective for financial statements on January 1, 2006. The Group currently does not offerrequire any share-based compensation to its employees.

FASBnew fair value measurements. SFAS No. 151

     In December 2004, the FASB issued FASB Statement No.151, Inventory Costs. This statement clarifies the accounting for abnormal amounts of idle facility expense, freight, handling costs, and wasted material (spoilage) which will be recognized as current-period charges. In addition, the Statement requires that allocation of fixed production overheads to the costs of conversion be based on the normal capacity of the production facilities. This Statement will be157 is effective for inventory costs incurred during fiscal years beginning after January 1, 2006. TheNovember 15, 2007. Currently, the Group does not expect the initial adoption of FASBSFAS No. 151157 will have a material impact on its consolidatedconsolidation financial statements.

FASB


(iii) FIN No. 153

48


In December 2004,June 2006, the FASB issued FASB StatementInterpretation No. 153, Exchanges48 “Accounting for Uncertainty in Income Taxes - an interpretation of Nonmonetary Assets, which eliminates an exceptionSFAS No. 109” (“FIN 48”). FIN 48 requires that the Group recognizes in APB 29 for nonmonetary exchangesthe consolidated financial statements the impact of similar productive assets and replaces it with a general exception for exchangestax position, if that position is more likely than not of nonmonetary assets that do not have commercial substance. This Statementbeing sustained upon examination, based on the technical merits of the position. FIN 48 will be effective for nonmonetary asset exchanges occurringthe first fiscal year beginning after December 15, 2006. The Group is currently evaluating the impact of adopting FIN48 on orits 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 occurred and therefore a liability should not be recognized. FSP AUG AIR-1 will be effective for the first fiscal year beginning after January 1,December 15, 2006.

F-58

The Group is in the process of assessing the impact of adopting FSP AUG AIR-1 on its results of operations and financial position.

F-84

CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS —- (Continued)
(Amounts in 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  2002  2003  2004  2004 
  above  RMB  RMB  RMB  U.S. dollars 
      (restated)  (restated)         
Net income/(loss) under IFRS      576   (358)  (48)  (6)
U.S. GAAP adjustments:                    
Net (loss)/income before tax attributable to airline operations of CNA and XJA  (a)   (1,114)  (1,042)  354   43 
Sale and leaseback accounting  (b)   (101)  115   115   14 
Lease arrangements  (c)   (50)  (64)  7   1 
Capitalized interest  (d)   (31)  (33)  (13)  (2)
Reversal of additional depreciation arising from revaluation of property, plant and equipment  (e)   33   33   13   2 
Investments in affiliated company and jointly controlled entity  (f)   (1)  7   7   1 
Deferred tax effects                    
— current year      48   (8)  (16)  (2)
— effect on change in the Company’s income tax rate      —   (51)  —   — 
— tax effect of acquisitions of airline operations of CNA and XJA operations of CNA and XJA      (15)  261   (81)  (10)
— effect on change in income tax rate applicable to airline operations of CNA and XJA      —   —   (99)  (12)
                 
Net (loss)/income under U.S. GAAP      (655)  (1,140)  239   29 
                 
Basic (loss)/earnings per share under U.S. GAAP      (0.194)  (0.298)  0.055   0.007 
                 
Basic (loss)/earnings per ADS under U.S. GAAP*      (9.706)  (14.876)  2.732   0.331 
                 
   
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)/earnings per ADS is calculated on the basis that one ADS is equivalent to 50 H shares.

F-59

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  2003  2004  2004 
  above  RMB  RMB  U.S. Dollars 
      (restated)         
Shareholders’ equity under IFRS      11,896   11,848   1,432 
U.S. GAAP adjustments:                
Shareholders’ equity before tax effect attributable to airline operations of CNA and XJA  (a)   1,347   (531)  (64)
Sale and leaseback accounting  (b)   (472)  (357)  (43)
Lease arrangements  (c)   (114)  (107)  (13)
Capitalized interest  (d)   348   335   40 
Revaluation of property, plant and equipment, net of depreciation  (e)   (13)  —   — 
Investments in affiliated company and jointly controlled entity  (f)   (111)  (104)  (13)
Deferred tax effect on airline operations of CNA and XJA      182   66   8 
Deferred tax effects      35   19   2 
              
Shareholders’ equity under U.S. GAAP      13,098   11,169   1,349 
              

F-60

  
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 

CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(Amounts

Movement of changes in millions, except share data)

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 Group andCNA/XJA Acquisitions, the tax losses attributable to the airline operations of CNA and XJA acquired on December 31, 2004 being under common control,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 financial informationconsolidated statement of the Groupoperations, cash flows and changes in total shareholders’ equity under U.S. GAAP for the years have beenyear 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. Consequentlyinterests prepared on a U.S. GAAP basis. As the assets and liabilities of CNA and CNA/XJA are reflected at their historical carrying values and the consolidated financial statements have been restated to include the financial statements of CNA and XJA for all periods presented.

     The following areAcquisitions were completed on December 31, 2004, condensed consolidated balance sheets of the Group as ofunder U.S. GAAP at December 31, 20032005 and 2004,2006 and the related condensed consolidated statements of operations,income, cash flows and changes in total shareholders’ equity under U.S. GAAP for each of the years in the three-year period ended December 31, 2004, prepared on a U.S. GAAP basis.

2005 and 2006 are not presented in these consolidated financial statements.


Condensed consolidated statementsstatement of operations

F-61

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)
             
  2002  2003  2004 
  RMB  RMB  RMB 
Operating revenue:            
Traffic revenue  24,854   24,897   33,235 
Other operating revenue  904   586   930 
          
Total operating revenue  25,758   25,483   34,165 
          
             
Operating expenses:            
Flight operations  10,062   10,351   15,016 
Maintenance  3,530   3,878   4,578 
Aircraft and traffic servicing  3,433   3,803   4,789 
Promotion and sales  2,034   2,043   2,606 
General and administrative  1,377   1,397   1,759 
Depreciation and amortization  2,864   3,042   3,523 
Asset impairment charges  347   510   — 
Other  163   93   17 
          
Total operating expenses  23,810   25,117   32,288 
          
Operating income  1,948   366   1,877 
          
             
Non-operating income/(expenses):            
Interest income  82   27   33 
Interest expense  (1,820)  (1,604)  (1,184)
Equity income of affiliated companies  45   53   17 
Equity loss of jointly controlled entities  (12)  (37)  (3)
Investment income  —   —   5 
Foreign currency exchange loss, net  (327)  (381)  (124)
Other, net  (52)  37   85 
          
Total net non-operating expenses  (2,084)  (1,905)  (1,171)
          
             
(Loss)/income before income taxes and minority interests  (136)  (1,539)  706 
             
Income tax (expense)/benefit  (365)  526   (274)
          
(Loss)/income before minority interests  (501)  (1,013)  432 
Minority interests  (154)  (127)  (193)
          
Net (loss)/income  (655)  (1,140)  239 
          

F-62

CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES

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

Condensed consolidated balance sheets

         
  2003  2004 
  RMB  RMB 
ASSETS
CURRENT ASSETS        
Cash and cash equivalents  2,999   3,083 
Trade receivables  943   1,203 
Other receivables  521   616 
Deferred tax assets  137   271 
Inventories  1,138   1,250 
Prepaid expenses and other current assets  295   378 
Short term investments  —   683 
       
TOTAL CURRENT ASSETS  6,033   7,484 
PROPERTY, PLANT AND EQUIPMENT, NET  41,012   46,202 
CONSTRUCTION IN PROGRESS  2,196   1,049 
LEASE PREPAYMENTS  349   346 
INVESTMENTS  1,314   1,379 
LEASE AND EQUIPMENT DEPOSITS  6,731   7,859 
DEFERRED TAX ASSETS  332   — 
OTHER ASSETS  643   721 
       
TOTAL ASSETS  58,610   65,040 
       
LIABILITIES AND SHAREHOLDERS’ EQUITY
CURRENT LIABILITIES        
Notes payable, including current installments of long-term notes payable  8,600   11,518 
Current installments of obligations under capital leases  2,368   2,106 
Accounts payable  1,144   1,554 
Bills payable  438   136 
Sales in advance of carriage  663   874 
Taxes payable  92   39 
Deferred tax liabilities  91   71 
Amounts due to related companies  511   2,330 
Accrued expenses  3,890   4,551 
Other liabilities  1,496   2,974 
       
TOTAL CURRENT LIABILITIES  19,293   26,153 
NOTES PAYABLE, EXCLUDING CURRENT INSTALLMENTS  8,634   11,935 
OBLIGATIONS UNDER CAPITAL LEASES, EXCLUDING CURRENT INSTALLMENTS  13,849   11,975 
PROVISION FOR MAJOR OVERHAULS  742   674 
DEFERRED CREDITS  851   693 
DEFERRED TAX LIABILITIES  389   402 
       
TOTAL LIABILITIES  43,758   51,832 
MINORITY INTERESTS  1,754   2,039 
SHAREHOLDERS’ EQUITY  13,098   11,169 
       
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY  58,610   65,040 
       

F-63

CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES

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

Condensed consolidated statementsstatement 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:
             
  2002  2003  2004 
  RMB  RMB  RMB 
Net cash inflow/(outflow) from            
Operating activities  4,364   2,965   5,419 
Investing activities  (6,204)  (7,558)  (9,507)
Financing activities  2,230   2,820   4,172 
          
Increase/(decrease) in cash and cash equivalents  390   (1,773)  84 
Cash and cash equivalents at beginning of year  4,382   4,772   2,999 
          
Cash and cash equivalents at end of year  4,772   2,999   3,083 
          

Condensed consolidated statements of changes in total shareholders’ equity

F-64

CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES

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

  
Year ended
 
  Total
December 31, 2004
 
  
RMB
Shareholders’ equity at December 31, 20017,315
Net loss(655)
Dividend paid(67)
Distributions to CSAHC(89)
Contributions from CSAHC292 
    
Shareholders’ equity at December 31, 20026,796
Net cash inflow/(outflow) from   
Issue of A sharesOperating activities  2,6415,419 
Net lossInvesting activities  (1,1409,507)
Net liabilities assumed by CSAHC (note a)Financing activities  4,5524,172 
Recognition of deferred tax assets (note b)Increase in cash and cash equivalents  24684 
Contributions from CSAHCCash and cash equivalents at January 1  32,999 
Cash and cash equivalents at December 31  
Shareholders’ equity at December 31, 200313,098
Net profit239
Net assets distributed to CSAHC (note a)(28)
Elimination of net deferred tax assets (note c)(181)
Distributions to CSAHC(1,959)
Shareholders’ equity at December 31, 200411,169
3,083 

F-65


F-88


CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES


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

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 to CSAHC, the owner of CNA and XJA during 2003 and 2004.
(b)In connection with the CNA/XJA Acquisitions, the property, plant and equipment of CNA and XJA were revalued as of December 31, 2003 according to the relevant PRC rules and regulations. The revalued amount serves as the tax base for future years. Such revaluation are not recorded under U.S. GAAP. However, a deferred tax asset is recognized for the tax deductibility of the resulting net revaluation surpluses with a corresponding credit to the equity under U.S. GAAP.
(c)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 was eliminated against equity.

F-66

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, 
  2002  2003  2004 
  RMB  RMB  RMB 
Traffic revenue
            
Passenger  22,565   22,438   30,443 
Cargo and mail  2,289   2,459   2,792 
          
   24,854   24,897   33,235 
          
             
Other operating revenue
            
Commission income  167   157   227 
General aviation income  68   40   55 
Ground services income  95   123   202 
Air catering income  38   31   53 
Rental income  —   40   45 
Aircraft lease income  166   36   145 
Gain on disposal of property, plant and equipment  194   —   — 
Maintenance services income  22   30   23 
Income on transfer of surplus pilot trainees  10   —   — 
Utility services income  —   14   28 
Other  144   115   152 
          
   904   586   930 
          
             
Total operating revenue
  25,758   25,483   34,165 
          

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-67


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 33%15% for the year ended December 31, 2002 and period ended September 30, 2003. The Company is subject to PRC income tax at 15% beginning October 1, 2003. 2004.
The airline operations of CNA and XJA were subject to PRC income tax at 33% during 2002, 2003 and up tothe 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 arewere subject to PRC income tax at the applicable rate of 15% beginning that date.

at December 31, 2004.


Taxation (expense)/benefit consisted of:
             
  Year ended December 31, 
  2002  2003  2004 
  RMB  RMB  RMB 
PRC income tax:            
Company and subsidiaries  (72)  (47)  (259)
Affiliated companies  (9)  (3)  (2)
Jointly controlled entities  —   (7)  (11)
          
   (81)  (57)  (272)
Deferred tax            
- current year  (284)  242   97 
- adjustment for change in the Company’s enacted tax rate  —   341   — 
- adjustment for change in applicable tax rate for airline operations of CNA and XJA  —   —   (99)
          
   (365)  526   (274)
          
Additional income taxes were allocated as follows            
 
Shareholders’ equity, for deferred tax asset recognized in connection with the tax deductibility
resulting from net revaluation surpluses		  —   246   — 
 
Shareholders’ equity, for elimination of deferred tax assets of the airline operations of CNA and XJA no longer available  —   —   (181)
          
   —   246   (181)
          

F-68

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 statementsstatement of operations for the yearsyear ended December 31, 2002, 2003 and 2004 differed from the amounts computed by applying the PRC income tax rate of 33%, 15% and 15%, respectively, to income/(loss)income before taxation and minority interests as a result of the following:
             
  Year ended December 31, 
  2002  2003  2004 
  RMB  RMB  RMB 
Expected PRC taxation (expense)/benefit  45   231   (105)
Adjustments:            
Effect of change in the Company’s income tax rate  —   341   — 
Effect of change in the income tax rate applicable to the airline operations of CNA and XJA  —   —   (99)
Rate differential on subsidiaries  60   (5)  — 
Rate differential on airline operations of CNA and XJA  —   196   (43)
Non-deductible expenses  (155)  (90)  (37)
Increase in deferred tax valuation allowance  (296)  (110)  (4)
Expired tax losses  —   (34)  — 
Non-taxable income  —   —   17 
Other, net  (19)  (3)  (3)
          
   (365)  526   (274)
          

     All but an insignificant amount of income/(loss) before taxation is from domestic sources.

F-69

CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES

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

     The net deferred tax (liabilities)/assets as of December 31, 2003 and 2004 were made up of the following taxation effects:

         
  December 31, 
  2003  2004 
  RMB  RMB 
Deferred tax assets:        
Tax losses  1,192   92 
Repair charges capitalized  261   254 
Accrued expenses  107   275 
Gains on sale and leaseback transactions  88   69 
Property, plant and equipment  148   89 
Inventories  25   — 
Other  9   21 
       
Total deferred tax assets  1,830   800 
Valuation allowance  (741)  (53)
       
   1,089   747 
       
         
Deferred tax liabilities:        
Accrued expenses  (81)  (75)
Property, plant and equipment  (945)  (825)
Inventories  (5)  — 
Other  (69)  (49)
       
Total deferred tax liabilities  (1,100)  (949)
       
Net deferred tax (liabilities)/assets  (11)  (202)
       
         
Representing:        
         
Net deferred tax assets — current portion  137   271 
Net deferred tax assets — non-current portion  332   — 
Net deferred tax liabilities — current portion  (91)  (71)
Net deferred tax liabilities — non-current portion  (389)  (402)
       
   (11)  (202)
       

F-70

CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(Amounts in 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 and tax loss utilized. 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 and tax losses. 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 carry forward period are reduced.

     The valuation allowance was RMB335 at January 1, 2002. During the years ended December 31, 2002, 2003 and 2004, the valuation allowance increased/(decreased) by RMB296, RMB110 and RMB(688), respectively. During 2004, the decrease in valuation allowance of RMB688 included a write-off of valuation allowance of RMB692 upon the CNA/XJA Acquisitions.

Property, plant and equipment, net

         
  December 31, 
  2003  2004 
  RMB  RMB 
Buildings  4,120   7,136 
Aircraft        
— owned  23,824   27,208 
— held under capital leases  22,312   21,388 
Other flight equipment, including rotable spares  12,069   10,301 
Machinery, equipment and vehicles  1,327   3,222 
       
   63,652   69,255 
Less: Accumulated depreciation and amortization  22,640   23,053 
       
   41,012   46,202 
       

F-71

CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES

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

Capital leases

     The Company is obligated under capital leases covering certain aircraft that expire at various dates during the next twenty-two years. At December 31, 2003 and 2004, the gross amount of aircraft and related accumulated amortization recorded under capital leases were as follows:

         
  December 31, 
  2003  2004 
  RMB  RMB 
Cost  22,312   21,388 
Less: Accumulated depreciation and amortization  6,804   7,136 
       
   15,508   14,252 
       

     As of December 31, 2004, future payments under these capital leases, which were 73% and 27%, respectively, denominated in U.S. dollars and Japanese yen, are as follows:

             
  Payments  *Interest  Obligations 
  RMB  RMB  RMB 
Year ending December 31,
            
2005  2,755   649   2,106 
2006  3,395   537   2,858 
2007  3,026   437   2,589 
2008  2,850   295   2,555 
2009  1,200   236   964 
Thereafter  4,600   1,591   3,009 
          
   17,826   3,745   14,081 
           
Less: current instalments of obligations under capital leases          (2,106)
            
           11,975 
            
*  Interest rates ranged from 1.92% to 8.48%

F-72

Year ended

CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES

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

Related party transactions

               
  Note 2002  2003  2004 
    RMB  RMB  RMB 
Expenses
              
               
Paid to CSAHC and its affiliates
              
Handling charges (a)  40   27   33 
Air-catering expenses    29   28   50 
Sundry aviation supplies    101   43   66 
Commission expenses    17   5   2 
Operating lease charges for land and buildings (c)  15   15   82 
               
Paid to affiliates and jointly controlled entities
              
Maintenance fees (b)  592   701   1,159 
Flight simulation service charges    —   104   100 
               
Paid to CAAC and its affiliates
              
Commission expenses    541   —   — 
Jet fuel supplies    3,989   —   — 
Aircraft insurance    361   —   — 
Guarantee fee    1   —   — 
Ticket reservation service charges    185   —   — 
Passenger departure and cargo handling charges    90   —   — 
Aircraft and traffic service charges    2,377   —   — 
Advertising service charges    3   —   — 
Interest expense    8   —   — 
               
Income
              
               
Received from CSAHC, its affiliates and other related parties
              
Interest income    11   3   4 
Aircraft lease income (d)  28   —   111 
               
Received from CAAC and its affiliates
              
Commission income    107   —   — 
Ground service fee income    53   —   — 
Maintenance service income    22   —   — 
Aircraft lease income    62   —   — 
               
Others
              
               
Acquisition of aircraft and related spare parts and vehicles    1,097   —   — 
Short term advances from CSAHC    —   166   — 
Refund of medical benefit payments    —   —   58 
           

F-73

CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES

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

Notes:

The Group obtained various operational 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 shifted to the China State-owned Assets Administration Bureau since early 2003. Consequently, transactions with the CAAC and its affiliates beginning from 2003 are no longer presented as related party transactions of the Group.

(a) Handling charges represent fees payable to Southern Airlines (Group) Import and Export Trading Company, a wholly owned subsidiary of CSAHC, in connection with the procurement of aircraft and flight equipment on the behalf of the Group and the airline operations of CNA and XJA. Handling charges are calculated based on a fixed percentage of the purchase value and other charges.
 
(b) Repairing charges represent fees incurred by the Group and the airline operations of XJA in connection with aircraft repair and maintenance services rendered by Guangzhou Aircraft Maintenance Engineering Company Limited (“GAMECO”) and MTU Maintenance Zhuhai Co., Ltd. (“MTU Zhuhai”). GAMECO and MTU Zhuhai are jointly controlled entities of the Company.
December 31, 2004
 
RMB
(c) Operating lease charges were paid by
Expected PRC expense(104)
Adjustments:
Effect of change in the Group and income tax rate applicable to
the airline operations of CNA and XJA to CSAHC under lease arrangement for certain land and buildings in the PRC. The operating lease charges are determined based(99)
Rate differential on prevailing market price.subsidiaries
3 
(d)Aircraft lease income represents rental receivables in respect of short term leasing of aircraft by the Group and theRate differential on airline operations of CNA and XJA to certain airlines(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 by the CAAC.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 thecertain rates ranging from 14% to 20% 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 operationsincome as and when incurred. Contributions to the retirement schemes amounted to RMB184, RMB231 and RMB243 respectively, during 2002, 2003 andthe year ended December 31, 2004.

F-74


F-92
ITEM 19. EXHIBITS.

EXHIBIT INDEX

Exhibit No.
 
Description of Exhibit
1.1Amended Articles of Association of China Southern Airlines Company Limited
   
Exhibit No.Description of Exhibit
4.1 Form of Director’s Service Agreement is incorporated(Incorporated by reference into the Exhibit 4(c).1 of4.1 to our Form 20-F (File No. 001-14660) for the year of 2004.ended December 31, 2005 filed with the Securities and Exchange Commission on June 30, 2006)
 4.2 
4.2 Form of Non-Executive Director’s Service Agreement is incorporated(Incorporated by reference into the Exhibit 4(c).2 of4.2 to our Form 20-F (File No. 001-14660) for the year of 2004.ended December 31, 2005 filed with the Securities and Exchange Commission on June 30, 2006)
 8 
8.1 Subsidiaries of theChina Southern Airlines Company Limited
 12.1 
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 
12.2 Section 302 Certification of President
 12.3 
12.3 Section 302 Certification of Chief Financial Officer
 13.1 
13.1 Section 906 Certification of Chairman
 13.2 
13.2 Section 906 Certification of President
 13.3 
13.3 Section 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
/s/ Liu Shao Yong
Name: Liu Shao Yong
Title: Chairman of the Board of Directors
Date: June 29, 2007
79
EXHIBIT INDEX
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 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)
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
80