As filed with the Securities and Exchange Commission on June 30, 2005



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 
þANNUAL 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, 2005
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 fromto
Commission file number 1-14660
(CHINESE CHARACTERS)
(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, 2004.2005.
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
o

Yesþ 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 Yesþ 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
Yeso 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):
 
YesxNo
Large accelerated filero
Accelerated filerþNon-accelerated filero

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

Item 17   þ Item 18
If this is an annual report, indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
o Yesþ No




TABLE OF CONTENTS

China Southern Airlines Company Limited
     
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  8374 
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 EX-4.1 FORM OF DIRECTOR'S SERVICE AGREEMENT
 EX-4.2 FORM OF NON-EXECUTIVE DIRECTOR'S SERVICE AGREEMENT
 EX-8 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

3


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 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;
 
  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 of December 31, 20032004 and 20042005 (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

4


America (“U.S. GAAP”). Information relating to the nature and effect of such differences is presented in Note 3450 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,RMB8.0694, 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, 2004.2005. 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
   
“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
   
Equipment
  
   
“rotables” aircraft parts that are ordinarily repaired and reused
   
“expendables” aircraft parts that are ordinarily used up and replaced with new parts

25


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, 2004.2005. The selected data of consolidated statements of operations for each of the years in the three-year period ended December 31, 20042005 and consolidated balance sheets as of December 31, 20032004 and 20042005 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, 20002001 and 20012002 and IFRS consolidated balance sheets of December 31, 2000, 2001, 2002 and 20022003 are derived from the Company’s audited 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.
     With effect from January 1, 2005, in order to comply with IAS1 and IAS27, the Group has changed its accounting policy relating to the presentation of minority interests. In prior years, minority interests at the balance sheet date were presented separately from liabilities and equity in the consolidated balance sheet. Minority interests in the results of the Group for the year were also separately presented in the consolidated statements of operations as a deduction before arriving at the profit attributable to shareholders (the equity shareholders of the Company). Under the new policy, minority interests are presented as part of equity, separately from interests attributable to the equity shareholders of the Company. Minority interests in the results of the Group for the period are presented on the face of the consolidated statements of operations as an allocation of the total profit or loss for the period between the minority interests and the equity shareholders of the Company. These changes in presentation have been applied retrospectively with comparatives restated.
     In addition, with effect from January 1, 2005, the Group has changed its presentation of shares of affiliated companies and jointly controlled entities’ taxation in order to comply with IAS 1. In prior years, the Group’s share of taxation of affiliated companies and jointly controlled entities accounted for using the equity method was included as part of the Group’s income tax in the consolidated statements of operations. In accordance with the implementation guidance in IAS 1, the Group has changed the presentation and includes the share of taxation of affiliated companies and jointly controlled entities accounted for using the equity method in the respective shares of profit or loss reported in the consolidated statements of operations before arriving at the Group’s profit or loss before tax. These changes in presentation have been applied retrospectively with comparatives restated.
     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 theinthe 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. See Note 3450 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, 20032004 and 20042005 and for each of the years in the three-year period ended December 31, 20042005 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,
  2001 2002 2003 2004 2005 2005
  RMB RMB RMB RMB RMB US$
                 
  (in million, except per share data)
Income Statement Data:
                        
IFRS: (Restated) (Restated) (Restated) (Restated)        
Operating revenue  16,880   18,019   17,470   23,974   38,293   4,745 
Operating expenses  15,479   15,993   17,014   23,065   39,598   4,907 
Operating income/(loss)  1,401   2,026   456   909   (1,305)  (162)
Interest expense  (934)  (959)  (824)  (691)  (1,616)  (200)
Exchange gain/(loss), net  297   (176)  (164)  (59)  1,220   151 
Income/(loss) before taxation  788   1,130   (521)  220   (1,853)  (230)
Taxation (expense)/benefit  (313)  (389)  334   (65)  7   1 
Income/ (loss) for the year  475   741   (187)  155   (1,846)  (229)
Income/(loss) attributable to :                        
Equity shareholders of the Company  340   576   (358)  (48)  (1,848)  (229)
Minority interests  135   165   171   203   2    
Basic earnings/(loss) per share  0.10   0.17   (0.09)  (0.01)  (0.42)  (0.052)
Basic earnings/(loss) per ADS  5.04   8.53   (4.68)  (0.55)  (21.12)  (2.62)

                         
  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          

36


                        
 Year ended December 31,
 2001 2002 2003 2004 2005 2005
 RMB RMB RMB RMB RMB US$
 (in million, except per share data)
Cash dividends declared per share  0.02     
U.S. GAAP: 
Traffic revenue 23,615 24,854 24,897 33,235 37,419 4,637 
Other operating revenue 657 904 586 930 874 108 
Operating income/(loss) 1,584 1,948 366 1,877  (1,092)  (135)
Interest expense  (1,800)  (1,820)  (1,604)  (1,184)  (1,589)  (197)
Foreign currency exchange gain/(loss), net 532  (327)  (381)  (124) 1,220 151 
Income/(loss) before income taxes and minority interests 468  (145)  (1,549) 693  (1,574)  (193)
Income tax (expense)/benefit  (401)  (356) 536  (261) 46 4 
Minority interests (97) (154) (127) (193) (2)  
Net (loss)/income  (30)  (655)  (1,140) 239  (1,530)  (189)
Basic (loss)/earnings per share  (0.009)  (0.194)  (0.298) 0.055  (0.350)  (0.043)
Basic (loss)/earnings per ADS  (0.432)  (9.706)  (14.876) 2.732 (17.489) (2.172)
Cash dividend declared per share  0.02     
                                                
 December 31,  December 31,
 2000 2001 2002 2003 2004 2004  2001 2002 2003 2004 2005 2005
 RMB RMB RMB RMB RMB US$  RMB RMB RMB RMB RMB US$
 (in million)  (in million)
Balance Sheet Data:
  
IFRS:  (Restated) (Restated) (Restated) (Restated) 
Cash and cash equivalents 4,198 2,818 3,771 2,080 3,083 373  2,818 3,771 2,080 3,083 2,901 360 
Other current assets 1,692 1,561 1,835 1,922 4,182 505  1,561 1,835 1,922 4,286 4,320 535 
Property, plant and equipment, net 23,282 22,352 26,921 28,536 46,841 5,660  22,352 26,921 28,536 46,841 54,266 6,725 
Total assets 30,924 30,653 37,188 39,062 62,228 7,519  30,653 37,188 39,062 62,383 71,402 8,848 
Notes payable, including current installments of long term notes payable 783 2,178 5,241 7,097 11,518 1,392  2,178 5,241 7,097 11,518 16,223 2,010 
Current installments of obligations under capital leases 1,776 1,452 1,567 1,298 2,144 259  1,452 1,567 1,298 2,144 3,373 418 
Notes payable, excluding current installments 3,789 3,628 5,835 4,522 11,935 1,442  3,628 5,835 4,522 11,935 12,740 1,579 
Obligations under capital leases, excluding current installments 9,416 7,692 6,632 5,543 9,599 1,160  7,692 6,632 5,543 9,599 12,459 1,544 
Shareholders’ equity 8,881 9,222 9,613 11,896 11,848 1,432 
Total equity 10,600 11,130 13,569 13,903 11,936 1,479 
U.S. GAAP:  
Cash and cash equivalents 5,763 4,384 4,772 2,999 3,083 373  4,384 4,772 2,999 3,083 2,901 360 
Other current assets 3,196 3,065 3,391 3,034 4,401 532  3,065 3,391 3,034 4,505 4,551 561 
Property, plant and equipment, net 35,546 35,676 40,277 41,012 46,202 5,582  35,676 40,277 41,012 46,202 53,759 6,662 
Total assets 48,684 48,456 54,860 58,610 65,040 7,858  48,456 54,860 58,610 65,144 74,906 9,283 
Notes payable, including current portion of long term notes payable 3,965 5,359 10,304 8,600 11,518 1,392  5,359 10,304 8,600 11,518 16,223 2,010 
Current installments of obligations under capital leases 2,752 2,428 2,591 2,368 2,106 254  2,428 2,591 2,368 2,106 3,401 421 
Notes payable, excluding current portion 9,017 8,856 9,179 8,634 11,935 1,442  8,856 9,179 8,634 11,935 12,740 1,579 
Obligations under capital leases, excluding current installments 15,891 14,167 13,333 13,849 11,975 1,447  14,167 13,333 13,849 11,975 14,807 1,835 
Shareholders’ equity 7,432 7,315 6,796 13,098 11,169 1,349 
Net shareholders’ equity 7,315 6,796 13,098 11,169 9,639 1,194 

     Selected Operating Data

     The following selected operating data of the Group for the five years ended December 31, 20042005 have been derived from consolidated financial statements prepared in accordance with IFRS and other data provided by the Group and have not been audited.

     The operating data and the profit analysis and comparison for other years below is calculated and disclosed in accordance with the statistical standards, which has 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 

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  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 
                     
  Year ended December 31,
  2001 2002 2003 2004 2005
Capacity
                    
ASK (million)                    
— Domestic  31,393   33,753   32,590   41,330   72,107 
— Hong Kong and Macau  1,690   1,746   1,347   1,896   2,656 
— International  6,981   8,746   6,930   10,543   13,598 
Total  40,064   44,245   40,867   53,769   88,361 
ATK (million)                    
— Domestic  3,622   3,924   3,772   4,773   8,352 
— Hong Kong and Macau  185   193   150   211   315 
— International  1,317   1,798   1,999   2,462   2,842 
Total  5,124   5,915   5,921   7,446   11,509 
Kilometers flown (thousand)  234,051   258,379   249,068   324,827   539,844 
Hours flown (thousand)  365   405   385   501   846 
Number of landing and take-offs                    
— Domestic  183,651   194,776   191,460   243,410   394,069 
— Hong Kong and Macau  13,712   13,891   11,400   15,380   17,807 
— International  10,698   13,990   11,330   15,790   26,798 
Total  208,061   222,657   214,190   274,580   438,674 
Traffic
                    
RPK (million)                    
— Domestic  19,447   22,092   21,294   29,121   51,472 
— Hong Kong and Macau  1,060   1,081   778   1,203   1,549 
— International  4,550   5,767   4,315   6,872   8,902 
Total  25,057   28,940   26,387   37,196   61,923 
RTK (million)                    
— Domestic  2,217   2,532   2,424   3,206   5,571 
— Hong Kong and Macau  105   108   78   120   159 
— International  712   974   1,059   1,337   1,554 
Total  3,034   3,614   3,561   4,663   7,284 
Passengers carried (thousand)                    
— Domestic  16,499   18,535   18,259   25,002   39,545 
— Hong Kong and Macau  1,409   1,369   1,019   1,394   1,556 
— International  1,213   1,589   1,192   1,811   3,018 
Total  19,121   21,493   20,470   28,207   44,119 
Cargo and mail carried (tons)  398,000   470,000   464,000   545,000   775,000 
Load Factors
                    
Passenger load factor (RPK/ASK) (%)                    
— Domestic  61.9   65.5   65.3   70.5   71.4 
— Hong Kong and Macau  62.7   61.9   57.8   63.4   58.3 
— International  65.2   65.9   62.3   65.2   65.5 
Total  62.5   65.4   64.6   69.2   70.1 
Overall load factor (RTK/ATK) (%)                    
— Domestic  61.2   64.5   64.2   67.2   66.7 
— Hong Kong and Macau  56.8   55.8   52.2   56.9   50.4 
— International  54.1   54.2   53.0   54.3   54.7 
Total  59.2   61.1   60.1   62.6   63.3 
Breakeven load factor (%)  55.6   55.9   61.6   61.9   67.0 
                     
  Year ended December 31,
  2001 2002 2003 2004 2005
Yield
                    
Yield per RPK (RMB)                    
— Domestic  0.62   0.55   0.57   0.58   0.55 
— Hong Kong and Macau  1.06   0.98   0.96   0.92   0.77 
— International  0.41   0.42   0.47   0.46   0.56 
Total  0.60   0.54   0.57   0.57   0.55 
Yield per cargo and mail ton kilometers (RMB)  1.76   1.73   1.62   1.67   1.75 

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  Year ended December 31,
  2001 2002 2003 2004 2005
Yield per RTK (RMB)                    
— Domestic  5.83   5.21   5.40   5.53   5.30 
— Hong Kong and Macau  11.26   10.36   10.35   9.83   8.18 
— International  3.31   3.25   2.90   3.31   4.24 
Total  5.43   4.84   4.76   5.01   5.14 
Fleet
                    
— Boeing  91   102   108   137   140 
— Airbus  20   20   24   46   71 
— McDonnell Douglas           35   36 
— Others           13   14 
Total aircraft in service at period end  111   122   132   231   261 
Overall utilization rate (hours per day)  9.1   9.8   8.5   9.9   9.6 
Financial
                    
Operating cost per ASK (RMB)  0.39   0.36   0.42   0.43   0.45 
Operating cost per ATK (RMB)  3.02   2.70   2.87   3.10   3.44 
     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)      Average(1)    
Period Period End (RMB per US$) High Low  Period End (RMB per US$) High Low
Annual Exchange Rate
  
2000 8.2781 8.2784 8.2799 8.2768 
2001 8.2766 8.2766 8.2910 8.2642  8.2766 8.2766 8.2910 8.2642 
2002 8.2773 8.2773 8.2897 8.2152  8.2773 8.2773 8.2897 8.2152 
2003 8.2767 8.2772 8.2800 8.2769  8.2767 8.2772 8.2800 8.2769 
2004 8.2765 8.2765 8.2889 8.2641  8.2765 8.2765 8.2889 8.2641 
2005 8.0694 8.1825 8.2767 8.0702 

     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 2005 8.0808 8.0702
January 2006 8.0702 8.0601
February 2006 8.0616 8.0402
March 2006 8.0505 8.0172
April 2006 8.0240 8.0050
May 2006 8.0265 8.0025
June 2006 (up to June 28, 2006) 8.0230 7.9964


(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, 2004.2005. 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, 2004.2005.

Capitalization and Indebtedness

     Not applicable.

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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 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. The Company incurred a net exchange loss of RMB164 million and RMB59 million for 20032004 and 2004, respectively,a net exchange gain of RMB1,220 million for 2005, mainly as a result of Japanese Yen fluctuations.fluctuation in 2004 and Renminbi appreciation in July 2005, respectively. A majority of thesethis exchange losses wereloss or gain was unrealized in nature.

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, housing services 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, 20032004 and 2004,2005, the Group had short-term deposits of RMB366RMB406 million and RMB406RMB544 million, respectively, with SA Finance.

     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.

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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 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 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.

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     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.

Internal controls and management system
     The Company will become subject to Section 404 of the Sarbanes-Oxley Act of 2002 in the fiscal year ending December 31, 2006, which requires the Company to set out a management report containing an assessment on its internal controls over financial reporting in its annual report. It also requires an independent registered public accounting firm attest to and report on management’s assessment of the effectiveness of the Company’s internal controls over financial reporting. If the Company cannot implement the requirements of Section 404 of the Sarbanes-Oxley Act of 2002 in a timely manner or with adequate compliance, its independent auditors may not be able to provide a written attestation as to the effectiveness of its internal controls over financial reporting and it may be subject to sanctions or investigation by regulatory authorities, such as the Securities and Exchange Commission. It could also result in the loss of investor confidence in the Company, in particular the reliability of financial statements, which in turn could harm the Company’s business and negatively affect the market price of the Company’s ADSs or H Shares. Furthermore, the Company may be required to incur significant costs for compliance with Section 404, and thereby increasing its costs relative to its revenues and decreasing its operating margins.
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 20042005 accounted for 26.2%30.1% 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, 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

11


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, 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 is 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.

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 is 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. These 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.

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     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 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. It could also have a material adverse effect on the Company’sCompany's operations and financial condition, particularly in light ofconditions, given 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. BasedPRC 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. As a result, the value of the Renminbi against the U.S. dollar has appreciated by approximately 2%. Under the new policy, the value of Renminbi against the U.S. dollar has fluctuated on a daily basis within narrow ranges, but overall has further strengthened against the Company’s foreignU.S. dollar. 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 RenminbiReminbi 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.

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).

13

     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.

11


     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 realisingrealizing the ultimate goal of the Group’s reorganisation.

reorganization.

     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.
     During 2005, the economy of the PRC maintained its rapid growth, which in turn gave the civil aviation industry a powerful boost. In particular, the fast expansion of the fleet capacity of the industry encouraged market demand through a number of factors, including improvement of civil aviation facilities and service quality as well as favorable price offers, which in turn drove up the passenger and cargo carried volume, the passenger load factor and overall load factor. On the other hand, as the PRC government expedited the process of ‘open sky’ policy and relaxed restrictions for investment in domestic airlines, the fleet capacity and number of flights provided have significantly increased, which in turn intensified the competition in domestic and international routes. Together with the soaring jet fuel prices, these have exerted strong pressure on the operating costs for domestic airlines.
     In 2005, with the persistent joint efforts of the Company’s management and staff, the Group secured an exceptional safe flight operation record, and the enlarged operations after the joint recombination had undergone a smooth transition and gradually began to achieve the benefits from economies of scale. To cope with the increasing competition and the ever-changing demands of the aviation market, the Company is taking advantage of its own economies of scale and the potential market demands to stage a strategic transition from a city-pair operation model to a hubbing network operation model, so as to enhance the operational efficiency of the overall service network, and to maintain and increase its competitive edge in the market.
     With the approval of the Board, the Company established a branch company in Beijing and will add wide-body airplanes to the operation base in Beijing from the summer of 2006, with the view to expanding its Beijing aviation business and building another main hub there in addition to its Guangzhou base. The Board believes that the establishment of Guangzhou and Beijing hubs will facilitate the Group’s strategic refinement and enhancement of its route network operations in order to better position the Group to explore and seize the opportunities in the regional aviation market to be brought about by the 2008 Beijing Olympic Games.

14


     The Group had RMB6,351 million, RMB4,707 million, RMB6,631 million and RMB6,631RMB11,873 million capital expenditures in 2002, 2003, 2004 and 20042005 respectively. Of such capital expenditures in 2004, RMB5,0172005, RMB6,938 were financed by capital lease, RMB4,325 million were financed by bank borrowings while the remaining RMB1,614RMB610 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 buildingbuildings 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 by December 31,during 2005.

     The CNA/XJA Acquisitions have significantly expanded the fleet size and flight service network as well as the market share of the Group. Presently, the Group is implementing various measures to harnessing the expanded flight capacity and operations and integrating the business cultures and goals of the acquired operations with those of the Group.

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 2004,2005, 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, 2004,2005, the Group’s RPKs increased at a compound annual rate of 13.4%53.2%, from 28,94026,387 million in 20022003 to 37,19661,923 million in 2004,2005, while its capacity, measured in terms of ASKs, increased at a compound annual rate of 10.2%47.1%, from 44,24540,867 million in 20022003 to 53,76988,361 million in 2004.2005. In 2004,2005, the Group carried 28.2144.12 million passengers and had passenger revenue of RMB21,100RMB34,328 million (US$2,5504,254 million). NetThe loss for 20042005 attributable to equity shareholders of the Company was RMB48RMB1,848 million (US$6229 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 2004,2005, the Airline Subsidiaries carried 10.511.30 million passengers and had operating revenue of RMB7,436RMB8,019 million (US$898994 million) and accounted for 37.3%25.6% and 31.9%20.9% of the Group’s passengers carried and operating revenue, respectively.

     The Group also provides air cargo and mail services. The cargo and mail revenue of the Group increased by 14.8%37.7% to RMB2,244RMB3,091 million (US$271383 million) in 20042005 as compared with 2003.2004. 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 2004,2005, the Group operated 542559 routes, of which 434452 were domestic, 8578 were international and 2329 were Hong Kong regional.and Macau. The Group operates the most extensive domestic route network among all Chinese airlines. In 2004,2005, the Group operated an average of 5,2808,436 landings and take-offs per week, serving 143142 destinations. Its route network covers commercial centres or rapidly developing economic regions in Mainland China.

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

15


     In addition to its main route base in Guangzhou, the Group also maintains eighteencertain regional route bases in Beijing, Zhengzhou, Wuhan, Changsha, Shenzhen, Shenyang, Changchun, Dalian, Harbin, Urumqi, Haikou, Zhuhai, Xiamen, Fuzhou, Guilin, Beihai, Shantou, Guiyang, Sanya and Guiyang. AllBeihai. Most of theseits regional route bases are located in provincial capitals or major commercial centers in China.

     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 2004,2005, the Group had 2329 Hong Kong regionaland Macau routes and 8578 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.

12


     As of December 31, 2004,2005, the Group operated a fleet of 231261 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, 90 and 90, Cessna 208B, ATR-72 and Embraer 145 aircraft.etc. The average age of the Group’s fleet was 7.477.19 years as of the year end of 2004.

13

2005.


     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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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 carriedPassenger carried Cargo and Mail Carried (tons) Total traffic (tons kilometers) Passenger carried Cargo and Mail Carried (tons) Total traffic (tons kilometers)
 Increase Increase Increase  Increase Increase Increase
 (decrease) (decrease) (decrease)  (decrease) (decrease) (decrease)
 over over over  over over over
Year Total previous year Total previous year Total previous year  Total previous year Total previous year Total previous year
 (in million) (%) (in thousand) (%) (in million) (%)  (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  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  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) 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  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 

     Route Network

     Overview

     The Group operates the most extensive route network among the Chinese airlines. As of December 31, 2004,2005, the Group operated 542559 routes consisting of 434452 domestic routes, 2329 Hong Kong regionaland Macau routes and 8578 international routes. In 2004,2005, the Group conducted an average of 5,2808,436 landings and take-offs per week, serving 143142 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 base in Guangzhou, the Group maintains eighteencertain regional route bases in Beijing, Zhengzhou, Wuhan, Changsha, Shenzhen, Shenyang, Changchun, Dalian, Harbin, Urumqi, Haikou, Zhuhai, Xiamen, Fuzhou, 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 enables 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 2004,2005, the Group’s most profitable domestic routes were the routes between Guangzhou and Beijing, Shenzhen and Shanghai, Guangzhou and Shanghai, Beijing and Guangzhou, Shenzhen and Beijing, Shanghai and Guangzhou, Shenzhen and Shanghai, Beijing and Guangzhou, Urumqi and Beijing, Beijing and Urumqi, Shanghai and Shenzhen, Beijing and Shenzhen, Guangzhou and Chengdu, and among Guangzhou, Dalian and Harbin.

Changchun.

     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 regional routes also include routes between Hong Kong or Macau and other destinations in China, including Zhang Jia Jie and Wu Yi Shan,Zhanjiang, 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 2004,2005, the most profitable Hong Kong regional routes (other than these “charter” flights) were those between Hong Kong and each of Wuhan, Guangzhou, Beijing, Wuhan,Shantou, Guilin, Kunming Haikou, and Zhengzhou.

     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 2004,2005, the Group conducted a total of 15,38017,807 flights on its Hong Kong regionaland Macau routes, accounting for approximately 29.7%34.4% 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 2729 routes serving 11 Southeast Asian destinations, including Singapore and major cities in Indonesia, Thailand, Malaysia, the Philippines, Vietnam and Laos. In 2004,2005, the Group’s most profitable international routes were those between Seoul and Dalian, Guangzhou and Ho Chi Minh City, Guangzhou and Bangkok.Tokyo. 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 2729 routes serving 11 Southeast Asian destinations, the Group operates 1745 other international routes providing scheduled services to Amsterdam, Sharjah, Osaka, Tokyo, Fukuoka, Seoul, Los Angeles, Sydney, Melbourne, Dubai and Paris.

     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, 2004,2005, the Group operated a fleet of 231261 aircraft with an average age of 7.477.19 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.

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     The following table sets forth certain information regarding the Group’s fleet of 231261 aircraft as of December 31, 2004.2005.
                        
 Average  Average
 Number of Average age Passenger  Number of Average age Passenger
Model Aircraft (years) Capacity  Aircraft (years) Capacity
Boeing 777-200 5 8.53 380  4 9.53 380 
Boeing 777-21B 5 6.20 292  6 7.20 292 
Boeing 757-200 38 11.56 200  38 11.12 200 
Boeing 747F 2 2.42 n/a  2 3.42 n/a 
Boeing 737-800 12 1.86 167  15 2.32 167 
Boeing 737-700 17 2.42 138  29 2.85 138 
Boeing 737-500 18 12.09 132  15 12.80 130 
Boeing 737-300 38 10.96 145  31 11.89 145 
Boeing 737-300QC 2 15.97 128 
Airbus 300-600 6 9.86 274  6 10.96 272 
Airbus 319-100 8 1.43 128  21 1.05 128 
Airbus 320-200 24 5.09 158  30 5.38 158 
Airbus 321-100 8 2.72 185  10 2.50 182 
Airbus 330-200 4 0.72 264 
McDonnell Douglas 82 22 13.54 147  23 14.63 144 
McDonnell Douglas 90 13 6.88 157  13 7.85 157 
Embraer 145 Jet 5 0.20 50  6 1.23 50 
Cessna 208B 3 2.50 14  3 3.50 14 
ATR-72 5 7.02 72  5 7.95 72 
      
 231  261 
   

     During 2004,2005, the Group continued to expand and modernize its aircraft fleet. In 2004,2005, the Group’s major aircraft transactions included:

The addition of one B777-200 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.

     The addition of seven Airbus 319-100, two Boeing 737-700 and three Boeing 737-800 aircraft under operating lease and addition of one McDonnell Douglas 82 aircraft under wet lease agreement and the return of two Boeing 737-300, three Boeing 737-500 and two Boeing 737-300 QC under operating lease ; and
     The acquisition of five Boeing 737-700 aircraft, six Airbus 320-200, four Airbus 330-200, six Airbus 319-100, two Airbus 321-200 and one Embraer 145 Jet financed by a combination of internal funds and long term bank loans.
     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 for a term of seven years with total future lease payments totalling approximately RMB1,721 million, 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 Company, being one of the ultimate users for thirteen of the Boeing B7E7 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 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 termterms of the lease rangesleases range from ten to twelve years with total future lease payments totalling approximately RMB8,243 million.

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

     In August 2005, CSA as a lessee, entered into an agreement with an independent lessor for operating leases of three 737-800 aircraft for a term of 138 months, with total future lease payments totalling approximately Rmb986 million, scheduled for deliveries in 2006.

1719


     In November 2005, CSA, as a lessee, entered into an agreement with an independent lessor for operating leases of five A320-200 aircraft for a term of 140 months with total future lease payments totalling approximately Rmb1,694 million, scheduled for deliveries in 2006; and
     In August 2005, CSA entered into two separate purchase agreements with Boeing and Airbus SNC respectively for the purchase of ten B787 aircraft, which are scheduled for deliveries in 2008 to 2010, and ten A330 aircraft, which are scheduled for deliveries in 2007 and 2008.
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 ninefifteen years. As of December 31, 2004, 472005, 65 of the Group’s 231261 aircraft were operated under capital leases, 8486 were operated under operating leases, 5351 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, 2004,2005, 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


             
          Average
  Capital Operating Remaining
Model Lease Lease Lease Term
Boeing 777-200 and 777-21B  5   4   4.48 
Boeing 757-200     15   3.10 
Boeing 737-700     10   5.60 
Boeing 737-800     3   8.17 
Boeing 737-500     15   0.99 
Boeing 737-300  4   10   1.32 
Airbus 300-600  6      1.20 
Airbus 319-100  6   15   9.05 
Airbus 320-200  24   6   4.35 
Airbus 321-100  6      8.02 
Airbus 330-200  4      11.28 
McDonnell Douglas 82     8   2.17 
McDonnell Douglas 90  10      1.69 
             
   65   86     
             
             
          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     

Capital Leases

     As of December 31, 2004,2005, the Group’s aggregate future minimum lease payments (including future finance charges) required under its capital leases were RMB13,055RMB18,615 million (US$1,5772,307 million). As of year end 2004,2005, 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 ninetwelve 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 a customary in the case of capital leases, the Group’s obligations are secured by the related aircraft, as well as other collateral.

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Operating Leases

     As of December 31, 2004,2005, the Group’s aggregate future minimum lease payments required under its operating leases were RMB12,750RMB24,594 million (US$1,5413,048 million). As of year end 2004,2005, the Group’s operating leases had original terms generally ranging from eight to ten years from the date of delivery of the relevant aircraft, and the remaining terms of these leases generally ranged from one to ten 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 RMB14 million, RMB8 million, and RMB23 million and RMB55 million during 2002, 2003, 2004 and 20042005 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 2004,2005, the Group had 67 spare jet engines for its fleet. The Group determines its requirements for jet engines based on all relevant considerations, including manufacturers’ recommendations, the performance history of the jet engines and the planned utilization of its aircraft. Rotables and certain of the expendables for the Group’s aircraft are generally purchased 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 97 other Chinese airlines and 1319 international airlines. GAMECO provides heavy maintenance services to 5 other Chinese airlines and 911 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 2004.2005. For the year ended December 31, 2004,2005, the amount incurred by the Group for such repair and maintenance services was RMB659,850,000.

RMB535 million.

     Overhauls of jet engines are performed 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, 2004,2005, repair fees amounting to RMB499RMB583 million were paid to MTU Zhuhai.

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     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, 2004.2005. 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 0.13 in 2002, 2003, 2004 and 2004,2005, 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. 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 20042005 accounted for 26.2%30.1% 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 20042005 was RMB4,190RMB5,220 per ton. The average price paid by the Group in 20042005 was RMB3,772RMB4,846 per ton, which represents a 22.7%28.47% increase from that of 2003.

     To address2004.

     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. On 28 March 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 distance flown being less than 800 kilometres, and from RMB40 to RMB60 for distance exceeding 800 kilometres, during the period temporarily from April 10, 2006 to October 10, 2006. 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.

2005.

     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.

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     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, realtime 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.

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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, students 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 student 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 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. Trainee pilots received 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 to 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. Zhuhai Xiang Yi currently leases the flight simulation facilities of Zhuhai Training Center from 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.

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     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 Baiyun International Airport in Guangzhou. At domestic airports, such fees are generally determined by the CAAC.

     At new 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 new 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 other airports in China are provided to the Group by local airport authorities or local airlines pursuant to various service agreements. Ground services and other services at airports outside China are provided to the Group by foreign services providers pursuant to various service agreements with such parties. All such agreements of the Group are short term and otherwise on terms that are customary in the industry.

23


     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 new 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 is combined with passenger flights services. Currently, the Group also has two Boeing 747-400 freighters servicing three international cargo routes, Shenzhen to Chicago and Shenzhen to Shanghai to Belgium and 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

and the construction was completed in 2005.


     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 Bangkok, Manila, Hanoi, Ho Chi Minh City, Singapore, Kuala Lumpur, Penang, Jakarta and Phnom Penh in Southeast Asia, as well as in Sendai, Toyame, Hiroshima, Nagoya, Niigata, Osaka, Fukuoka, Tokyo, Seoul, Daejeon, Daegu, Busan Amsterdam, Los Angeles, Sydney, Paris, Melbourne and Sharjah.

     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% 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 2004,2005, 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% of the ticket price, and pays independent sales agents outside China a commission ranging from 5% to 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 2004,2005, 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.

24


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 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 regional and international routes on the basis of price.

     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 2004,2005, the Group had approximately 3,500,0004,055,600 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, 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 added 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.

26


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.

25


     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.

     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 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.

27


     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 importer agent and is paid an agency fee for its services.

     Jet Fuel Supply and Pricing

26


     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.

28


     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 new Baiyun International Airport as of 2004,2005, 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.

27


     In the Chinese aviation industry, the three dominant airlines are the Group, Air China and China Eastern Airlines (“China Eastern”). In 2004,2005, these three airlines together controlled approximately 58.05%74.84% 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.

29


     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  Total traffic
 Passenger carried Cargo and Mail Carried (tons) (ton kilometers)  Passenger carried Cargo and Mail Carried (tons) (ton kilometers)
 Industry Group’s Industry Group’s Industry Group’s  Industry Group’s Industry Group’s Industry Group’s
Year Total Share Total Share Total Share  Total Share Total Share Total Share
 (in million) (% of total) (in thousand) (% of total) (in billion) (% of total)  (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  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  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  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  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  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  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

     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.

28


     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 2004.2005.
                        
 Cargo and Mail    Cargo and Mail   
 Passenger carried Carried Departing flight  Passenger carried Carried Departing flight
Airport (% of total) (% of total) (% of total)  (% of total) (% of total) (% of total)
Beijing 12.10 15.13 9.97   19.14%  19.06%  17.95%
Shanghai Pudong 7.26 6.19 6.83   9.86%  5.13%  10.38%
Guangzhou 50.57 43.11 49.10   54.71%  45.10%  53.75%
Shanghai Hongqiao 14.16 10.79 13.69   18.18%  18.41%  16.95%
Shenzhen 27.74 26.31 24.77   33.08%  31.59%  29.98%
Chengdu 10.97 14.57 8.90   13.99%  17.07%  10.72%
Kunming 20.12 14.12 14.57   21.71%  18.27%  18.24%
Hangzhou  38.31%  32.91%  35.00%
Xian  14.75%  19.69%  10.18%
Haikou 26.11 26.40 21.43   30.26%  33.19%  23.73%
Xian 8.91 13.32 5.80 
Hangzhou 27.89 20.63 19.58 

     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 8 busiest airports in southern and central China (excluding Guangzhou, Shenzhen and Haikou, which are included in the table above), based on passenger volume, in 2004.2005.
                        
 Cargo and Mail    Cargo and Mail   
 Passenger carried Carried Departing flight  Passenger carried Carried Departing flight
Airport (% of total ) (% of total) (% of total)  (% of total ) (% of total) (% of total)
Changsha  51.60%  71.54%  47.39%
Wuhan Tianhe 46.62 47.22 39.32   39.60%  43.56%  33.79%
Changsha 52.90 49.46 28.77 
Guilin 39.72 24.89 32.84   38.90%  38.26%  38.69%
Sanya  43.45%  29.70%  40.33%
Zhengzhou 68.17 73.62 49.83   71.79%  61.78%  59.17%
Sanya 28.41 11.06 30.09 
Nanning 44.90 34.68 33.49   43.60%  40.67%  35.27%
Zhang Jia Jie 33.87 26.35 28.36   40.45%  80.56%  38.33%
Shantou 81.85 70.65 65.87   81.64%  80.67%  69.55%

30


     Hong Kong Regionaland Macau Routes

     The Group dominates the routes operated by Chinese airlines between Hong Kong and Macau and China. In 2004,2005, the Group operated an average of more than 15,38017,807 “charter” and other scheduled flights per week between China and Hong Kong or Macau, accounting for approximately 29.7%34.4% 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, including 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.

29


     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 route 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 has 95% equity interest, the Company owns 60% equity interest in each of the remaining Airline Subsidiaries.

     As of December 31, 2004,2005, Xiamen Airlines operated under its own “MF” code a fleet of 2934 aircraft on 7196 domestic routes, 89 international route and 57 Hong Kong regionaland Macau routes. In 2004,2005, Xiamen Airlines carried a total of about 6.236.92 million passengers, or approximately 22.1%15.7% of the passengers carried by the Group in that year, and had RMB4,448RMB4,852 million in operating revenue.

     As of December 31, 2004,2005, Shantou Airlines operated under the Group’s “CZ” code 76 aircraft on 1612 domestic routes, 1 international route and 1 Hong Kong regionaland Macau route. In 2004,2005, Shantou Airlines carried a total of about 1.081.17 million passengers, or 3.8%2.7% of the passengers carried by the Group in that year. Total operating revenue of Shantou Airlines for the year ended December 31, 20042005 was RMB808RMB844 million.

     As of December 31, 2004,2005, Guangxi Airlines operated under the “CZ” code 65 aircraft on 1415 domestic routes, 4 international routes and 32 Hong Kong regionaland Macau routes. In 2004,2005, Guangxi Airlines carried a total of about 1.121.03 million passengers, or 4.0%2.3% of the total number of passengers carried by the Group in that year. Total operating revenue of Guangxi Airlines for the year ended December 31, 20042005 was RMB789RMB722 million.

31


     As of December 31, 2004,2005, Zhuhai Airlines operated under the “CZ” code 5 aircraft on 1110 domestic routes. In 2004,2005, Zhuhai Airlines carried a total of about 741,000834,000 passengers, or approximately 2.6%1.9% of the total number of passengers carried by the Group in that year. Total operating revenue of Zhuhai Airlines for the year ended December 31, 20042005 was RMB558RMB719 million.

     As of December 31, 2004,2005, Guizhou Airlines operated under the “CZ” code 6 aircraft on 1614 domestic routes. In 2004,2005, Guizhou Airlines carried a total of about 1.361.34 million passengers, or approximately 4.8%3.0% of the total number of passengers carried by the Group in 2004.2005. Total operating revenue of Guizhou Airlines was approximately RMB833RMB882 million for the year ended December 31, 2004.

2005.

     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 70,000RMB70,000 (approximately US$8,455) 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$20,000135,000 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.

30


     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���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.

32


Organizational Structure

     The following chart illustrates the corporate structure of the Group as of year end 20042005 and the aggregate effective equity interest of the Company in each of its principal subsidiaries, affiliated companies and jointly controlled entities.

(FLOW CHART)
Note a: Another 26% ownership interest is held by CSA’s subsidiaries.

(CHART)

3331


     The particulars of the Company’s principal subsidiaries as of December 31, 20042005 are as follows:
       
  Attributable equity
Place and date of interest to the Company 
  establishment DirectIndirectProportion of ownership
Name of company /operation %%interest held by the Company
Guangxi Airlines Company Limited PRC

April 28, 1994
  6095 
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 
Guangzhou Air Cargo Company LimitedPRC
March 31, 2004
  70 
Guangzhou Nanland Air CateringPRC
Company Limited PRC
November 21, 1989
  5175 
China Southern West AustralianAustralia
Flying College Pty Ltd. Australia
January 26, 1971
  65 
Guangzhou Baiyun InternationalPRC
Logistic Company Ltd PRC
July 23, 2002
  61 
Xinjiang Civil Aviation Property Management LimitedPRC
February 12, 2002
  51.8 

Affiliated Companies and Jointly Controlled Entities

     The particulars of the Group’s principal affiliated companies and jointly controlled entity as of December 31, 20042005 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    
               
    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
  49.3   32   26 
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     

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.

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.”

32


     The Group’s headquarters in Guangzhou occupy an area of approximately 149,000 square meters of land and a total gross floor area of approximately 149,000 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 Zhengzhou airports.

     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  Land Buildings 
 (in square meters) (in square meters)  (in square meters) (in square meters) 
 Owned Leased Owned Leased  Owned Leased Owned Leased 
Guangzhou  80,809 503,957 1,755  9,797 80,809 514,957 1,755 
Shenzhen 208,740  35,174   208,740  54,093  
Zhuhai 170,062  18,791   170,062  18,791  
Changsha 138,949  47,190   138,949  47,190  
Zhengzhou 290,841  60,582   290,841  60,582  
Haikou 5,265  59,543 19,633  5,265  63,570 19,633 
Wuhan  31,061 17,335    31,061 17,335  
Nanyang   12,156     12,156  

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 

     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.
     Certain IFRS comparative figures have been restated as a result of the changes in accounting policies. For details, please refer to item 3.

33


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. The Group believes that its critical accounting policies are limited to those described below. For a detailed discussion on the application of these 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, 20042005 was RMB874RMB1,413 million.

36


     Property, plant and equipment

     The Group havehas approximately RMB46,841RMB54,266 million fixed assets as of December 31, 2004.2005. 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, 2004 and 2004.2005. The Group records aircraft at acquisition cost. Depreciable life is determined through economic analysis, reviewing existing fleet plans, recommendations from manufacturers and comparing estimated lives to other airlines that operate similar fleets. Residual values are estimated based on our historical experience with regards to the sale of aircraft and are established in conjunction with the estimated useful lives of the aircraft. Residual values are based on current dollars when the aircraft are acquired and typically reflect asset values that have not reached the end of their physical life. Both depreciable lives and residual values are reviewed periodically to recognize changes in our fleet plan and changes in conditions.

     In addition, the Group evaluates fixed assets used in operations for impairment. Under IFRS, if circumstances indicate that the net book value of an 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 amount of impairment loss is the difference between the carrying amount of the asset and its 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 future 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 operations and estimated residual values. The Group will use all readily available information in determining an amount that is a reasonable approximation of recoverable amounts, including estimates based on industry trends and reference to market rates and transactions. Changes to the above estimates may have a material effect on the Group’s Financial Statements. As of December 31, 2004,2005, based on the result of evaluation, the Group considered that no impairment is required. Under U.S. GAAP, property, plant, and equipment of the Group are reviewed for impairment whenever events or changes 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 recognisedwas recognized on certain aircraft of CNA.
     Impairment loss for doubtful accounts
     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.
     Movements in impairment losses for doubtful accounts are as follows:
         
  Year ended December 31, 
  2004  2005 
  RMB  RMB 
At January 1  70   92 
Impairment losses for bad and doubtful accounts  27    
Through the CNA/XJA Acquistions  44    
Bad and doubtful accounts written off  (49)  (48)
At December 31  92   44 

34


Overview

     From

     As a result of the fast growing economy in the PRC, growth in airline market, has been carried on which was commenced in second halfand acquisition of 2003. Thethe airline operations and related assets of China Northern Airlines Company (“CNA”) and Xinjiang Airlines Company (“XJA”), the Group’s business was benefited from the increasing traffic demand in which both theincrease of transport capacity, passenger volume and passenger load factor were improved.cargo and mail carried. Nevertheless, the Group is facing pressure on its operation due to continuing increase of jet fuel cost and intensified competition.
     With effect from July 21, 2005, China began 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 (“RMB”) would no longer be pegged to the US 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 finance 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 purchase 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. On the other hand, RMB appreciation will also present the Group with a challenge in price competition in international route operations.
     According to the Notice 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 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 distance flown being less than 800 kilometres, and from RMB40 to RMB60 for distance exceeding 800 kilometres, 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 will help relieve, to a certain extent, the burden of high jet fuel cost.

37


     The continuing political tension incost on the Middle East led to high fuel prices which in turn caused an increase in the Group’s jet fuel cost. The Group has implemented various measures to control the increase 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.

Group.

     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 is 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 loss of RMB164RMB59 million and RMB59net exchange gain of RMB1,220 million in 20032004 and 2004,2005, respectively. These amounts represented mainly unrealized exchange differences resulting from the retranslation of the foreign currency borrowings.

     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, 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

35


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, 2003, 2004 and 2004:
2005:
                                        
 Year ended 2003 vs. 2002 2004 vs. 2003  Year ended 2004 vs. 2003 2005 vs. 2004
 December 31, % increase/ % increase/  December 31, % increase/ % increase/
 2002 2003 2004 (decrease) (decrease)  2003 2004 2005 (decrease) (decrease)
Traffic
  
RPK (million)  
Domestic 22,092 21,294 29,121  (3.6) 36.8  21,294 29,121 51,472 36.8 76.8 
Hong Kong regional 1,081 778 1,203  (28.0) 54.6 
Hong Kong and Macau 778 1,203 1,549 54.6 28.8 
International 5,767 4,315 6,872  (25.2) 59.3  4,315 6,872 8,902 59.3 29.5 
Total 28,940 26,387 37,196  (8.8) 41.0  26,387 37,196 61,923 41.0 66.5 
RTK (million)  
Domestic 2,532 2,424 3,206  (4.3) 32.3  2,424 3,206 5,571 32.3 73.8 
Hong Kong regional 108 78 120  (27.8) 53.8 
Hong Kong and Macau 78 120 159 53.8 32.5 
International 974 1,059 1,337 8.7 26.3  1,059 1,337 1,554 26.3 16.2 
Total 3,614 3,561 4,663  (1.5) 30.9  3,561 4,663 7,284 30.9 56.2 
Passengers carried (thousand)  
Domestic 18,535 18,259 25,002  (1.5) 36.9  18,259 25,002 39,545 36.9 58.2 
Hong Kong regional 1,369 1,019 1,394  (25.6) 36.8 
Hong Kong and Macau 1,019 1,394 1,556 36.8 11.6 
International 1,589 1,192 1,811  (25.0) 51.9  1,192 1,811 3,018 51.9 66.6 
Total 21,493 20,470 28,207  (4.8) 37.8  20,470 28,207 44,119 37.8 56.4 
Cargo and mail carried (thousand tons)  
Domestic 404 379 442  (6.2) 16.6  379 442 639 16.6 44.6 
Hong Kong regional 14 12 15  (14.3) 25.0 
Hong Kong and Macau 12 15 19 25.0 26.7 
International 52 73 88 40.4 20.5  73 88 117 20.5 33.0 
Total 470 464 545  (1.3) 17.5  464 545 775 17.5 42.2 

                     
  Year ended 2004 vs. 2003 2005 vs. 2004
  December 31, % increase/ % increase/
  2003 2004 2005 (decrease) (decrease)
Capacity
                    
ASK (million)                    
Domestic  32,590   41,330   72,107   26.8   74.5 
Hong Kong and Macau  1,347   1,896   2,656   40.8   40.1 
International  6,930   10,543   13,598   52.1   29.0 
Total  40,867   53,769   88,361   31.6   64.3 
ATK (million)                    
Domestic  3,772   4,773   8,352   26.5   75.0 
Hong Kong and Macau  150   211   315   40.7   49.3 
International  1,999   2,462   2,842   23.2   15.4 
Total  5,921   7,446   11,509   25.8   54.6 
Load Factors
                    
Passenger load factor (RPK/ASK) (%)                    
Domestic  65.3   70.5   71.4   8.0   1.3 
Hong Kong and Macau  57.8   63.4   58.3   9.7   (8.0)
International  62.3   65.2   65.5   4.7   0.5 
Overall  64.6   69.2   70.1   7.1   1.3 
Overall load factor (RTK/ATK) (%)                    
Domestic  64.2   67.2   66.7   4.7   (0.7)
Hong Kong and Macau  52.2   56.9   50.4   9.0   (11.4)
International  53.0   54.3   54.7   2.5   0.7 
Overall  60.1   62.6   63.3   4.2   1.1 
Yield
                    
Yield per RPK (RMB)                    
Domestic  0.57   0.58   0.55   1.8   (5.2)

3936


                                        
 Year ended 2003 vs. 2002 2004 vs. 2003  Year ended 2004 vs. 2003 2005 vs. 2004
 December 31, % increase/ % increase/  December 31, % increase/ % increase/
 2002 2003 2004 (decrease) (decrease)  2003 2004 2005 (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)
Hong Kong and Macau 0.96 0.92 0.77  (4.2)  (16.3)
International 0.42 0.47 0.46 11.9  (2.1) 0.47 0.46 0.56  (2.1) 21.7 
Overall 0.54 0.57 0.57 5.6   0.57 0.57 0.55   (3.5)
Yield per RTK (RMB)  
Domestic 5.21 5.40 5.53 3.6 2.4  5.40 5.53 5.30 2.4  (4.2)
Hong Kong regional 10.36 10.35 9.83  (0.1)  (5.0)
Hong Kong and Macau 10.35 9.83 8.18  (5.0)  (16.8)
International 3.25 2.90 3.31  (10.8) 14.1  2.90 3.31 4.24 14.1 28.1 
Overall 4.84 4.76 5.01  (1.7) 5.3  4.76 5.01 5.14 5.3 2.6 
Financial
 
IFRS
 
Financial IFRS
 
Passenger revenue (RMB million)  
Domestic 12,234 12,242 16,869 0.1 37.8  12,242 16,869 28,182 37.8 67.1 
Hong Kong regional 1,055 750 1,104  (28.9) 47.2 
Hong Kong and Macau 750 1,104 1,194 47.2 8.2 
International 2,407 2,018 3,127  (16.2) 55.0  2,018 3,127 4,952 55.0 58.4 
Total 15,696 15,010 21,100  (4.4) 40.6  15,010 21,100 34,328 40.6 62.7 
Cargo and mail revenue (RMB million) 1,786 1,955 2,244 9.5 14.8  1,955 2,244 3,091 14.8 37.7 
U.S. GAAP
  
Passenger revenue (RMB million)  
Domestic 18,145 18,679 24,773  2.9  32.6  18,679 24,773 28,182 32.6 13.8 
Hong Kong regional 1,144 781 1,151  (31.7) 47.4 
Hong Kong and Macau 781 1,151 1,194 47.4 3.7 
International 3,277 2,978 4,519  (9.1) 51.7  2,978 4,519 4,952 51.7 9.6 
Total 22,566 22,438 30,443  (0.6) 35.7  22,438 30,443 34,328 35.7 12.8 
Cargo and mail revenue (RMB million) 2,288 2,459 2,792 7.5 13.5  2,459 2,792 3,091 13.5 10.7 

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.
     2005 Compared with 2004
     The loss for 2005 attributable to equity shareholders of the Company is RMB1,848 million, as compared to a loss of RMB48 million for 2004. The scale of operations increased 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 RMB14,319 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 RMB16,533 million or 71.7% from RMB23,065 million in 2004 to RMB39,598 million in 2005. As the increase in operating revenue is smaller than the increase in operating expenses, operating profit decreased by 243.6% from an operating profit of RMB909 million in 2004 to an operating loss of RMB1,305 million in 2005. The Group’s net non-operating expenses decreased by 20.5%, from RMB689 million in 2004 to RMB548 million in 2005, mainly attributable to the combined effect of increase in exchange gain of RMB1,279 million, increase in interest expense of RMB925 million and a decrease in share of results of associates of RMB295 million.
Operating revenue
     Substantially all of the Group’s operating revenue is attributable to airline and airline related operations. Traffic revenue accounted for 97.7% and 97.4% of total operating revenue in 2005 and 2004 respectively. Passenger revenue and, cargo and mail revenue accounted for 91.7% and 8.3% respectively of total traffic revenue in 2005. 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.
     Operating revenue increased by 59.7% from RMB23,974 million in 2004 to RMB38,293 million in 2005. The increase was primarily due to a 62.7% rise in passenger revenue from RMB21,100 million in 2004 to RMB34,328 million in 2005 resulting from increased traffic volume. The total number of passengers carried increased by 56.4% to 44.12 million passengers and the ASKs increased by 64.3% 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 108 aircraft during 2005 which caused an increase in passenger capacity of 68.1%.

37


Passenger yield decreased slightly by RMB0.02. RPKs increased by 66.5% from 37,196 million in 2004 to 61,923 million in 2005, primarily as a result of the increase in passengers carried.
     Domestic passenger revenue, which accounted for 82.1% of the total passenger revenue in 2005, increased by 67.1% from RMB16,869 million in 2004 to RMB28,182 million in 2005. Domestic passenger traffic in RPKs increased by 76.8%, mainly due to an increase in passengers carried. Domestic passenger yield decreased slightly by RMB0.03 to RMB0.55 in 2005.
     Hong Kong and Macau passenger revenue, which accounted for 3.5% of total passenger revenue, increased by 8.2% from RMB1,104 million in 2004 to RMB1,194 million in 2005. For Hong Kong and Macau flights, passenger traffic in RPKs increased by 28.8%, while passenger capacity in ASKs increased by 40.1%, resulting in a 5.1 percentage point decrease in passenger load factor from 2004. Passenger yield decreased from RMB0.92 in 2004 to RMB0.77 in 2005 mainly due to intensified competition among airlines.
     International passenger revenue, which accounted for 14.4% of total passenger revenue, increased by 58.4% from RMB3,127 million in 2004 to RMB4,952 million in 2005. For international flights, passenger traffic in RPKs increased by 29.5%, while passenger capacity in ASKs increased by 29.0%, resulting in a 0.3 percentage point rise in passenger load factor from 2004. Passenger yield increased by 21.7% from RMB0.46 in 2004 to RMB0.56 in 2005 mainly resulted from higher ticket price and the 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 8.3% of the Group’s total traffic revenue and 8.1% of total operating revenue, increased by 37.7% from RMB2,244 million in 2004 to RMB3,091 million in 2005. The increase was attributable to the increasing traffic demand.
     Other operating revenue increased by 38.7% from RMB630 million in 2004 to RMB874 million in 2005. The increase was primarily due to the general growth in income from various auxiliary operations.
Operating expenses
     Total operating expenses in 2005 amounted to RMB39,598 million, representing an increase of 71.7% or RMB16,533 million over 2004, 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 increased from 96.2% in 2004 to 103.4% in 2005.
     Flight operations expenses, which accounted for 49.0% of total operating expenses, increased by 86.2% from RMB10,418 million in 2004 to RMB19,394 million in 2005, primarily as a result of increases in jet fuel costs, operating lease payments, catering expenses and labour costs for flight personnel. Jet fuel costs, which accounted for 61.5% of flight operations expenses, increased by 97.2% from RMB6,050 million in 2004 to RMB11,929 million in 2005 mainly as a result of increased fuel prices and fuel consumption. Operating lease payments increased by 50.0% from RMB1,665 million in 2004 to RMB2,497 million in 2005 primarily due to the additional rental payments for new aircraft under operating leases. Catering expenses increased by 69.6% from RMB705 million in 2004 to RMB1,196 million in 2005 due to the increase in number of passengers carried. Aircraft insurance costs decreased by 43.2% from RMB185 million in 2004 to RMB105 million in 2005, mainly because of the decrease in insurance premiums in 2005. Labour costs for flight personnel increased by 57.8% from RMB1,026 million in 2004 to RMB1,619 million in 2005, largely due to the increase in flying hours and allowance standard.
     Maintenance expenses which accounted for 11.6% of total operating expenses, increased by 32.7% from RMB3,459 million in 2004 to RMB4,589 million in 2005. The increase was mainly attributable to the fleet expansion in recent years.
     Aircraft and traffic servicing expenses, which accounted for 14.5% of total operating expenses, increased by 64.4% from RMB3,503 million in 2004 to RMB5,759 million in 2005. The increase primarily resulted from a 51.8% rise in landing and navigation fees from RMB3,222 million in 2004 to RMB4,891 million in 2005, due to an increase in number of landing and takeoffs.

38


     Promotional and marketing expenses, which accounted for 7.0% of total operating expenses, increased by 43.3% from RMB1,940 million in 2004 to RMB2,780 million in 2005. The increase was mainly resulted from the increase in sales volume, resulting in a 41.5% increase in sales commission expenses from RMB1,062 million in 2004 to RMB1,503 million in 2005.
     General and administrative expenses, which accounted for 6.2% of the total operating expenses, increased by 85.7% from RMB1,323 million in 2004 to RMB2,457 million in 2005. This was mainly attributable to increased scale of operations.
     Depreciation and amortisation, which accounted for 11.2% of total operating expenses, increased by 84.0% from RMB2,413 million in 2004 to RMB4,440 million in 2005, mainly resulting from the additional depreciation charge on aircraft delivered in 2004 and 2005.
Operating(loss))/Profit
     There is an operating loss of RMB1,305 million in 2005 as compared to an operating profit of RMB909 million in 2004. This was mainly because operating revenue increased by RMB14,319 million or 59.7% in 2005 while operating expenses increased by RMB16,533 million or 71.7% in the same period.
Non-operating income/(expenses)
     Interest expense increased by 133.9% from RMB691 million in 2004 to RMB1,616 million in 2005, mainly due to the increase in loans and lease obligations and interest rate. Interest income increased by 150.0% from RMB22 million in 2004 to RMB55 million in 2005, mainly attributable to the increase of interest rate.
     During 2005, the Group recorded a net exchange gain of RMB1,220 million (2004: Net exchange loss of RMB59 million) mainly resulted from Renminbi appreciation 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
     The statutory income tax rate in the PRC is 33%. Except for certain branches and subsidiaries, the Company and its subsidiaries are entitled to enjoy a preferential tax rate of 15% pursuant to approval documents issued by the relevant tax authorities.
     In 2005, the Group recorded an income tax benefit of RMB7 million and actual effective tax rate was 0.4% while the Group’s enacted tax rate is 15%. The difference is mainly due to the fact that a portion of tax loss is not recognized, the deferred tax effect of which is RMB135 million. In 2004, income tax expense of RMB65 million was recorded and actual effective tax rate was 30% while the Group’s enacted tax rate in 2004 was 15%. The difference is mainly due to the tax effect of non-deductible expenses of RMB29 million.
     2004 Compared with 2003

     The Group recorded a net loss of RMB48 million attributable to equity shareholder for 2004, as compared to a net loss of RMB358 million attributable to equity shareholder for 2003. The Group’s operating revenue increased by RMB6,504 million or 37.2% from RMB17,470 million in 2003 to RMB23,974 million in 2004. Passenger load factor increased by 4.6 percentage point from 64.6% in 2003 to 69.2% in 2004. Passenger yield (in passenger revenue per RPK) remain steady and at RMB0.57 in both years. Average yield (in traffic revenue per RTK) increased by 5.3% from RMB4.76 in 2003 to RMB5.01 in 2004. Operating expenses increased by RMB6,051 million or 35.6% from RMB17,014 million in 2003 to RMB23,065 million in 2004. As operating revenue increased more than operating expenses, operating profit increased by 99.3% from RMB456 million in 2003 to RMB909 million in 2004. The Group’s net non-operating expenses decreased by 30.1%, from RMB967 million in 2003 to RMB676 million in 2004, mainly attributable to a decrease in unfavourable movement in foreign exchange differences of RMB105 million and a decrease in interest expense of RMB133 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 2004 and 2003 accounted for 97.4% and 97.1% respectively of total operating revenue. Passenger revenue and, cargo and mail revenue accounted for 90.4% and 9.6% respectively of total traffic revenue in 2004. The balance of the Group’s operating revenue is derived

39


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 37.2% from RMB17,470 million in 2003 to RMB23,974 million in 2004. This increase was primarily due to a 40.6% rise in passenger revenue from RMB15,010 million in 2003 to RMB21,100 million in 2004 resulting from increased traffic volume. The PRC airline industry has fully recovered from the outbreak of severe acute respiratory syndrome (“SARS”) in China since August 2003. Coupling with the continued growth in domestic economic conditions, the aviation traffic volume in China attained a new highest record in 2004. The total number of passengers carried increased by 37.8% to 28.2 million passengers in 2004. The increase in 2004 compared to 2003 was attributable to the general increasing traffic demand in the PRC airline market and deliveries of 20 aircraft (excluding effect of CNA/XJA Acquisitions) during 2004 which caused an increase in passenger capacity of 31.6%. RPKs increased by 41.0% from 26,387 million in 2003 to RMB37,196 million in 2004, 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% of the total passenger revenue in 2004, increased by 37.8% from RMB12,242 million in 2003 to RMB16,869 million in 2004. Domestic passenger traffic in RPKs increased by 36.8%, mainly due to an increase in passengers carried. Passenger yield remained steady in 2004 and at RMB0.58.

Included in the 2004 domestic passenger revenue was fuel surcharge imposed on domestic flights of approximately RMB281 million (2003: RMB716 million). Excluding the effect of fuel surcharge revenue, the passenger yield increased from RMB0.54 in 2003 to RMB0.57 in 2004 as a combined result of the growth in traffic demand and fleet expansion during 2004.

     Hong Kong passenger revenue, which accounted for 5.3% of total passenger revenue, increased by 47.2% from RMB750 million in 2003 to RMB1,104 million in 2004. For Hong Kong regional flights, passenger traffic in RPKs increased by 54.6%, while passenger capacity in ASKs increased by 40.8%, resulting in a 5.6 percentage point increase in passenger load factor from 2003. Passenger yield decreased from RMB0.96 in 2003 to RMB0.92 in 2004 mainly due to intensified competition among airlines.

Included in 2004 Hong Kong passenger revenue was fuel surcharge imposed on Hong Kong regional flights of approximately RMB67 million (2003: RMB24 million). Excluding the effect of fuel surcharge revenue, the passenger yield decreased from RMB0.93 in 2003 to RMB0.86 in 2004.

     International passenger revenue, which accounted for 14.8% of total passenger revenue, increased by 55.0% from RMB2,018 million in 2003 to RMB3,127 million in 2004. For international flights, passenger traffic in RPKs increased by 59.3%, while passenger capacity in ASKs increased by 52.1%, resulting in a 2.9 percentage point rise in passenger load factor from 2003. Passenger yield decreased by 2.1% from RMB0.47 in 2003 to RMB0.46 in 2004 mainly resulted from the increases in traffic derived from long haul routes which generally had a lower yield than short haul routes.

     Cargo and mail revenue, which accounted for 9.6% of the Group’s total traffic revenue and 9.4% of total operating revenue, increased by 14.8% from RMB1,955 million in 2003 to RMB2,244 million in 2004. The increase was attributable to the increasing traffic demand.

     Other operating revenue increased by 24.8% from RMB505 million in 2003 to RMB630 million in 2004. 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.

40


     Total operating expenses in 2004 amounted to RMB23,065 million, representing an increase of 35.6% or RMB6,051 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.

Taxation

4341


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 creditbenefit of RMB324RMB334 million resulting from reduction in net deferred taxation liability balance of RMB392 million. In 2004, income tax expense of RMB78RMB65 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

Additional information under U.S. GAAP
     2005 Compared with 2002

2004

     The Group recorded a net loss for 2005 attributable to equity shareholders of RMB358the Company is RMB1,530 million, for 2003, as compared to a netan income of RMB576RMB239 million for 2002.2004. The scale of operations increased 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 decreasedincreased by RMB549RMB4,128 million or 3.0%12.1% from RMB18,019RMB34,165 million in 20022004 to RMB17,470RMB38,293 million in 2003.2005. Passenger load factor decreasedincreased by 0.81.2 percentage point from 65.4%68.9% in 20022004 to 64.6%70.1% in 2003.2005. Passenger yield (in passenger revenue per RPK) increaseddecreased slightly by 5.6% from RMB0.54 in 20023.1% to RMB0.57 in 2003.RMB0.55. Average yield (in traffic revenue per RTK) decreased by 1.7%1.6% from RMB4.84RMB5.22 in 20022004 to RMB4.76RMB5.14 in 2003.2005. Operating expenses increased by RMB1,021RMB7,097 million or 6.4%22.0% from RMB15,993RMB32,288 million in 20022004 to RMB17,014RMB39,385 million in 2003.2005. As the increase in operating revenue decreased whileis smaller than the increase in operating expenses, increased,operating income decreased by 158.2% from an operating profit decreased by 77.5% from RMB2,026of RMB1,877 million in 20022004 to RMB456an operating loss of RMB1,092 million in 2003.2005. The Group’s net non-operating expenses increaseddecreased by 9.1%60.8%, from RMB887RMB1,184 million in 20022004 to RMB967RMB464 million in 2003,2005, mainly dueattributable to a decreasethe combined effect of increase in exchange gain on disposal of fixed assets of RMB193RMB1,344 million, partly offset by a decreaseincrease in interest expense of RMB135RMB405 million and a decrease in share of results of associates of RMB280 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

revenue

     Substantially all of the Group’s operating revenue is attributable to airline and airline related operations. Traffic revenue in 2003 and 2002 accounted for 97.1%97.7% and 97.0% respectively97.3% of total operating revenue.revenue in 2005 and 2004 respectively. Passenger revenue and, cargo and mail revenue accounted for 88.5%91.7% and 11.5%8.3% and 91.6% and 8.4% respectively of total traffic revenue in 2003.2005 and 2004 respectively. The balance of the Group’sother operating revenue is mainly derived from commission income, income from general aviation operations, fees charged for ground services rendered to other Chinese airlines and for air catering services and net income from lease arrangements.

services.

     Operating revenue decreasedincreased by 3.0%12.1% from RMB18,019RMB34,165 million in 20022004 to RMB17,470RMB38,293 million in 2003. This decrease2005. The increase was primarily due to a 4.4% fall12.8% rise in passenger revenue from RMB15,696RMB30,443 million in 20022004 to RMB15,010RMB34,328 million in 20032005 resulting from lowerincreased traffic volume caused by SARS.volume. The total number of passengers carried decreasedincreased by 4.8%14.0% to 20.544.12 million passengers in 2003. RPKs decreasedand the ASKs increased by 8.8% from 28,94014.3% to 88,361 million in 20022005. The increase in 2005 compared to 26,3872004 was attributable to the general increasing traffic demand in the PRC airline market and deliveries of 30 aircraft during 2005 which caused an increase in passenger capacity of 12.4%. RPKs increased by 16.3% from 53,233 million in 2003,2004 to RMB61,923 million in 2005, primarily as a result of a decreasethe increase in passengers carried. However, passengerPassenger yield increaseddecreased slightly by 5.6% from RMB0.54 in 2002RMB0.02 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.

RMB0.55.

     Domestic passenger revenue, which accounted for 81.6%82.1% of the total passenger revenue in 2003,2005, increased slightly by 0.1%13.8% from RMB12,234RMB24,773 million in 20022004 to RMB12,242RMB28,182 million in 2003.2005. Domestic passenger traffic in RPKs decreasedincreased by 3.6%17.8%, mainly due to a decreasean increase in passengers carried. PassengerDomestic passenger yield however, increased fromdecreased slightly by RMB0.02 to RMB0.55 in 2002 to RMB0.57 in 2003, mainly as the result of the aforesaid exemption of CAAC Infrastructure Development Fund2005.

42


     Hong Kong and sales tax.

     Hong KongMacau passenger revenue, which accounted for 5.0%3.5% of total passenger revenue, decreasedincreased by 28.9%3.7% from RMB1,055RMB1,151 million in 20022004 to RMB750RMB1,194 million in 2003.2005. For Hong Kong and Macau flights, passenger traffic in RPKs decreasedincreased by 28.0%18.5%, while passenger capacity in ASKs decreasedincreased by 22.9%26.5%, resulting in a 4.14.0 percentage point decrease in passenger load factor from 2002.2004. Passenger yield decreased from RMB0.98RMB0.88 in 20022004 to RMB0.96RMB0.77 in 20032005 mainly due to slack in traffic volume.

intensified competition among airlines.

     International passenger revenue, which accounted for 13.4%14.4% of total passenger revenue, decreasedincreased by 16.2%9.6% from RMB2,407RMB4,519 million in 20022004 to RMB2,018RMB4,952 million in 2003.2005. For international flights, passenger traffic in RPKs decreasedincreased by 25.2%8.3%, while passenger capacity in ASKs decreasedincreased by 20.8%5.4%, resulting in a 3.61.8 percentage point fallrise in passenger load factor from 2002.2004. Passenger yield increased by 11.9%1.1% from RMB0.42RMB0.55 in 20022004 to RMB0.47RMB0.56 in 2003 mainly as the result of the aforesaid exemption of CAAC Infrastructure Development Fund and sales tax.

2005.

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

increasing traffic demand.

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

other operation.

     Operating Expensesexpenses

     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 20032005 amounted to RMB17,014RMB39,385 million, representing an increase of 6.4%22.0% or RMB1,021RMB7,097 million over 2002,2004, primarily due to the combinedtotal effect of increases in jet fuel costs, maintenance expenses and aircraft and traffic servicing expenses. Total operating expenses as a percentage of total operating revenue increased from 88.8%94.5% in 20022004 to 97.4%102.9% in 2003.

45

2005.


     Flight operations expenses, which accounted for 41.6%48.7% of total operating expenses, increased by 5.0%27.8% from RMB6,733RMB15,016 million in 20022004 to RMB7,070RMB19,183 million in 2003,2005, primarily as a result of increases in jet fuel costs, and operating lease payments, partly offset by a decrease in catering expenses.expenses and labour costs for flight personnel. Jet fuel costs, which accounted for 54.7%62.2% of flight operations expenses, increased by 9.9%39.4% from RMB3,519RMB8,555 million in 20022004 to RMB3,867RMB11,929 million in 20032005 mainly as a result of increased jet fuel prices.prices and fuel consumption. Operating lease payments increased by 8.4%12.6% from RMB1,417RMB2,109 million in 20022004 to RMB1,536RMB2,375 million in 2003,2005 primarily due to the full year effect of the addition 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%21.2% from RMB625RMB987 million in 20022004 to RMB510RMB1,196 million in 2003, primarily reflecting a tighter cost controls exercised by2005 due to the Group.increase in number of passengers carried. Aircraft insurance costs decreased by 23.4%60.8% from RMB256RMB268 million in 20022004 to RMB196RMB105 million in 2003, primarily2005, mainly because of a reductionthe decrease in the rate of aircraft insurance premiums prescribed by the PRC insurance company. Laborin 2005. Labour costs for flight personnel decreasedincreased by 6.8%4.8% from RMB781RMB1,545 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%11.7% of total operating expenses, increased by 11.0%0.2% from RMB2,333RMB4,578 million in 20022004 to RMB2,589RMB4,589 million in 2003. The increase was primarily attributable to an 11.3% increase in aircraft maintenance and repair charges from RMB2,135 million in 2002 to RMB2,377 million in 2003, mainly as the result of the effect of fleet expansion in recent years.

2005.

     Aircraft and traffic servicing expenses, which accounted for 16.3%14.6% of total operating expenses, increased by 10.2%20.3% from RMB2,511RMB4,789 million in 20022004 to RMB2,767RMB5,759 million in 2003.2005. The increase primarily resulted from an 8.9%a 10.0% rise in landing and navigation fees from RMB2,354RMB4,447 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%7.1% of total operating expenses, decreasedincreased by 1.3%6.7% from RMB1,500RMB2,606 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 17.0% increase in sales commission expenses from RMB248RMB1,285 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%39.7% from RMB1,060RMB1,759 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%11.2% of total operating expenses, increased by 10.8%25.1% from RMB1,840RMB3,523 million in 20022004 to RMB2,038RMB4,406 million in 2003. This increase was primarily as a result of2005, mainly resulting from the addition ofadditional depreciation charge on aircraft during 2003.

delivered in 2004 and 2005.

4643


     Operating Income(loss)/income

     Operating income decreased by 77.5% from RMB2,026

     There is an operating loss of RMB1,092 million in 20022005 as compared to RMB456an operating profit of RMB1,877 million in 2003.2004. This was mainly because operating revenue decreasedincreased by RMB549RMB4,128 million or 3.0% from 200212.1% in 2005 while operating expenses increased by RMB1,021RMB7,097 million or 6.4% over22.0% in the same period.

     Non-operating Income/(Expenses)income/(expenses)

     Interest expense decreasedincreased by 14.1%34.2% from RMB959RMB1,184 million in 20022004 to RMB824RMB1,589 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 75.2%66.7% from RMB53RMB33 million in 20022004 to RMB13RMB55 million in 2003. This was2005, mainly attributable to a decrease in average cash balances.

     The Group recorded a net loss on salethe increase 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.RMB124 million) mainly resulted from Renminbi appreciation in July 2005. Such amount comprised mostly unrealizedrepresented mainly unrealised translation loss.

exchange gain, resulting from exchange gains on translated year end foreign currency denominated liabilities, rather than foreign exchange transactions incurred during the year.

     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 statutory income tax rate in the PRC is 33%. Except for certain branches and a taxation approval document “Guangzhou Municipal State Tax Bureau Suo De Shui Zi Que 020043”,subsidiaries, the Company isand its subsidiaries are entitled to enjoy thea preferential tax policy implementedrate of 15% pursuant to approval documents issued by the relevant tax authorities.
     Income tax benefit for the year amounted to RMB46 million and actual effective tax rate was 3% in 2005 while the Guangzhou Economic & Technology Development Zone effective from October 1, 2003. AsGroup’s enacted tax rate is 15%. The difference is mainly due to a result,portion of tax loss with a deferred tax effect of RMB135 million not recognized as well as the Company’seffect of change in enacted income tax rate has been changed from 33%applicable to 15% beginning from that date.

     The Group recorded an income tax creditairline operations of RMB324 million for 2003 compared to anCNA and XJA of RMB79 million. In 2004, income tax expense of RMB398RMB261 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 RMB507CNA and XJA of RMB99 million, was reduced by RMB392rate differential on airline operations of CNA and XJA of RMB43 million and a net deferred tax creditnon-deductible expenses 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.RMB37 million.

Additional information under U.S. GAAP

     2004 Compared with 2003

     The Group’s operating revenue increased by RMB8,682 million or 34.1% from RMB25,483 million in 2003 to RMB34,165 million in 2004. Such growth was primarily attributable to growth in volume of passenger traffic carried by the Group as a result of the recovery of the Group’s traffic operations from SARS and flight capacity. Operating expenses increased by RMB7,171 million or 28.6% from RMB25,117 million in 2003 to RMB32,288 million in 2004. As operating revenue increased more than operating expenses, operating profit increased by 412.8% from RMB366 million in 2003 to RMB1,877 million in 2004. The Group’s net non-operating expenses decreased by 38.5%, from RMB1,905 million in 2003 to RMB1,171 million in 2004, primarily attributable to a decrease in unfavourable movement in foreign exchange differences of RMB257 million and a decrease in interest expense of RMB420 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 2004 and 2003 accounted for 97.3% and 97.7% respectively of total operating revenue. 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% from RMB25,483 million in 2003 to RMB34,165 million in 2004. This increase was primarily due to a 35.7% rise in passenger revenue from RMB22,438 million in 2003 to RMB30,443 million in 2004 resulting from increased traffic volume. The total number of passengers carried increased by 33.0% to 38.7 million passengers in 2004. RPKs increased by 34.3% from 39,626 million in 2003 to RMB53,233 million in 2004, primarily as a result of an increase in passengers carried. Passenger yield increased to RMB0.57.

     Domestic passenger revenue, which accounted for 81.4% of the total passenger revenue in 2004, increased by 32.6% from RMB18,679 million in 2003 to RMB24,773 million in 2004. Domestic passenger traffic in RPKs increased by 30.6%, mainly due to an increase in passengers carried. Passenger yield increased to RMB0.57 in 2004.

44


     Hong Kong passenger revenue, which accounted for 3.8% of total passenger revenue, increased by 47.4% from RMB781 million in 2003 to RMB1,151 million in 2004. For Hong Kong regional flights, passenger traffic in RPKs increased by 68.0%, while passenger capacity in ASKs increased by 55.8%, resulting in a 4.5 percentage point increase in passenger load factor from 2003. Passenger yield decreased from RMB1.00 in 2003 to RMB0.88 in 2004 mainly due to intensified competition among airlines.

     International passenger revenue, which accounted for 14.8% of total passenger revenue, increased by 51.7% from RMB2,978 million in 2003 to RMB4,519 million in 2004. For international flights, passenger traffic in RPKs increased by 52.8%, while passenger capacity in ASKs increased by 44.1%, resulting in a 3.6 percentage point rise in passenger load factor from 2003. Passenger yield remainedremain steady in 2004 and at RMB0.55.

     Cargo and mail revenue, which accounted for 8.4% of the Group’s total traffic revenue and 8.2% of total operating revenue, increased by 13.5% from RMB2,459 million in 2003 to RMB2,792 million in 2004. The increase was attributable to the increasing traffic demand.

     Other operating revenue increased by 58.7% from RMB586 million in 2003 to RMB930 million in 2004. The increase was primarily due to the general growth in income from various auxiliary 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.

     Total operating expenses in 2004 amounted to RMB32,288 million, representing an increase of 28.6% or RMB7,171 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 aan 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.

45


     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 as 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 creditbenefit of RMB526RMB536 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 creditbenefit 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% in 2002 to 98.6% in 2003.

     Flight operations expenses, which accounted for 41.2% of total operating expenses, increased by 2.9% from RMB10,062 million in 2002 to RMB10,351 million in 2003, primarily as a result of increases in jet fuel costs and operating lease payments, partly offset by a decrease in catering expenses. Jet fuel costs, which accounted for 54.7% of flight operations expenses, increased by 8.3% from RMB5,228 million in 2002 to RMB5,662 million in 2003 mainly as a result of increased jet fuel prices. Operating lease payments increased by 8.6% from RMB1,665 million in 2002 to RMB1,808 million in 2003, primarily due to the full year effect of the addition of new operating leases in respect of four Boeing 757-200 aircraft in late 2002 and four Airbus 319-100 aircraft and three Boeing 737-700 aircraft during 2003. Catering expenses decreased by 16.7% from RMB906 million in 2002 to RMB754 million in 2003, primarily reflecting a tighter cost controls exercised by the Group. Aircraft insurance costs decreased by 19.6% from RMB362 million in 2002 to RMB291 million in 2003, primarily because of a reduction in the rate of aircraft insurance premiums prescribed by the PRC insurance company. Labor costs for flight personnel decreased by 5.8% from RMB1,195 million in 2002 to RMB1,126 million in 2003, largely due to a decrease in flight hours.

     Maintenance expenses which accounted for 15.4% of total operating expenses, increased by 9.9% from RMB3,530 million in 2002 to RMB3,878 million in 2003. The increase was primarily attributable 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 of the effect of fleet expansion in recent years.

     Aircraft and traffic servicing expenses, which accounted for 15.1% of total operating expenses, increased by 10.8% from RMB3,433 million in 2002 to RMB3,803 million in 2003. The increase was primarily resulted from a 9.6% rise in landing and navigation fees from RMB3,228 million in 2002 to RMB3,539 million in 2003, and an increase in the charge rate for domestic landing and navigation fees effective September 2002.

     Promotional and marketing expenses, which accounted for 8.1% of total operating expenses, decreased by 0.4% from RMB2,034 million in 2002 to RMB2,043 million in 2003. The decrease was due to a 5.3% decrease in labor costs from RMB322 million in 2002 to RMB305 million in 2003, as fewer bonuses were given because of reduced sales volume in 2003.

     General and administrative expenses, which accounted for 5.6% of the total operating expenses, increased slightly by 1.5% from RMB1,377 million in 2002 to RMB1,397 million in 2003. This was mainly due to a decrease in scale of operations during SARS period.

     Depreciation and amortization, which accounted for 12.1% of total operating expenses, increased by 6.2% from RMB2,864 million in 2002 to RMB3,042 million in 2003. This increase was primarily as a result of the additions of aircraft during 2003.

     Asset impairment charges accounted for 2.0% of total operating expenses, amounted to RMB510 million in 2003. During 2003, the Group recorded an asset impairment charge 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 RMB1,948 million in 2002 to RMB366 million in 2003. This was mainly because operating revenue decreased by RMB275 million or 1.1% from 2002 while operating expenses increased by RMB1,307 million or 5.5% over the same period.

     Non-operating Income/(Expenses)

     Interest expense decreased by 11.9% from RMB1,820 million in 2002 to RMB1,604 million in 2003, mainly reflecting the combined effect of scheduled debt repayments and the replacement of certain RMB denominated bank loans with US$ denominated bank loans with lower interest rates.

     Interest income decreased by 67.1% from RMB82 million in 2002 to RMB27 million in 2003. This was mainly attributable to a decrease in average cash balances.

     During 2003, the Group recorded a net exchange loss of RMB381 million predominantly due to its Japanese yen denominated borrowings as a result of the Japanese yen appreciation. Such amount comprised mostly unrealized translation loss.

     Taxation

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

     The Group recorded an income tax credit of RMB526 million for 2003 compared to an income tax expense of RMB365 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 RMB625 million was reduced by RMB341 million and a net deferred tax credit 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.

4746


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, 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, 2004,2005, the Group had banking facilities with several PRC commercial banks for providing loan finance up to an approximate amount of RMB35,750RMB39,294 million to the Group. As of December 31, 2004,2005, an approximate amount of RMB11,525RMB28,242 million was utilized. As of December 31, 20032004 and 2004,2005, the Group’s cash and cash equivalents totaled RMB2,080RMB3,083 million and RMB3,083RMB2,901 million, respectively.

     Net cash inflows from operating activities in 2002, 2003, 2004 and 20042005 were RMB3,698 million, RMB2,129 million, and RMB3,596 million and RMB3,835 million, respectively.

     Net cash used in investing activities in 2002, 2003, 2004 and 20042005 was RMB5,895 million, RMB5,434 million, RMB8,824 million and RMB8,824RMB8,009 million, respectively. Cash capital expenditures in 2002, 2003, 2004 and 20042005 were RMB6,351 million, RMB4,707 million, RMB6,631 million and RMB6,631RMB4,935 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 RMB3,150 million, RMB1,615 million, and RMB6,231 million and RMB3,992 million in 2002, 2003, 2004 and 2004,2005, respectively.

     As of December 31, 2004,2005, the Group’s aggregate long-term debt and obligations under capital leases totaled RMB25,271RMB30,449 million. Based on such amount, in 2005, 2006, 2007, 2008, 2009, 2010 and thereafter, amounts payable under such debt and obligations will be RMB3,737RMB5,250 million, RMB4,489RMB7,246 million, RMB6,705RMB4,764 million, RMB3,608RMB2,812 million, RMB2,154RMB1,472 million and RMB4,578RMB8,905 million. 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 of 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, 2004,2005, the Group’s short term bank debt was RMB9,925RMB14,346 million with interest rates ranging from 1.40%3.15% to 5.31%.5.34% per annum. The Group’s weighted average interest rate on short-term bank notes payable was 1.60%4.83% per annum as of December 31, 2004.2005. 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.

     Through April 19, 2006, the Group renewed certain short-term bank debts of RMB2,611 million. The renewed debts are unsecured, bear interest at floating rates ranging from 3-month HIBOR/6-month LIBOR + 0.55% to 0.60% per annum and are repayable one year from their respective renewal dates. In addition, the Group entered into new short term bank debts agreement totalling RMB2,671 million subsequent to December 31, 2005. These new short term bank debts are unsecured and bear interest at floating rates ranging from 6-month LIBOR + 0.55% to 0.70% per annum with maturities through 2008.
     From April 20, 2006 to May 31, 2006, the Group entered into additional new bank debts agreements totalling RMB3,808 million. These additional bank debts are unsecured, bear interest at floating rates ranging from 6-month LIBOR + 0.53% to 0.55% per annum and repayable one year from these respective origination dates.
     As of December 31, 2004,2005, the Group had obligations under operating leases totaling RMB12,750RMB24,594 million, predominately for aircraft. Of such amount, RMB1,761RMB3,340 million, RMB1,622RMB2,881 million, RMB1,562RMB2,785 million, RMB5,259RMB2,609 million, RMB764RMB2,523 million and RMB1,782RMB10,456 million, respectively, was due in 2005, 2006, 2007, 2008, 2009, 2010 and thereafter.

4847


     As of December 31, 2004,2005, the Group had a working capital deficit of RMB18,855RMB25,907 million, as compared to a working capital deficit of RMB10,792RMB18,855 million as of December 31, 2003.2004. 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 20032004 to 20042005 was mainly because the Group sought increased short 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. The liquidity of the Group in the future will primarily be dependent on its ability to maintain adequate cash inflow from operations to meet its debt obligations as they become due and, on its ability to obtain adequate external financing to meet its committed future capital expenditures. The Group has obtained firm commitments from its principal bankerbankers to renew its short-term bank loans outstanding at December 31, 20042005 when they fall due during 2005. In relation2006. Subsequent to its future capital commitments and other financing requirements,December 31, 2005, the Group has already entered into loan financing agreements with several PRC banks to provide loan finance up to an approximate amountrenewed short-term debts of RMB24,225 million during 2005 and thereafter.RMB2,611 million.
     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 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, 2004,2005, the Group had capital commitments in 2005, 2006, 2007, 2008, 2009 and 20072010 of approximately RMB10,167RMB8,933 million, RMB3,049RMB9,445 million, RMB14,437 million, RMB5,300 and RMB84 million,RMB9,688 respectively. Of such amounts, RMB8,748 million in 2005, RMB2,996RMB7,341 million in 2006, and RMB32RMB8,945 million in 2007 and RMB14,354 million in 2008, RMB5,300 million in 2009 and RMB9,688 million in 2010 are related to the acquisition of aircraft and related flight equipment, and RMB824RMB840 million in 20052006 is related to the Group’s facilities and equipment to be constructed and installed at the Guangzhou new airport. The remaining amounts of RMB595RMB752 million in 2005 and RMB1052006, RMB500 million in 20062007 and RMB83 million in 2008 are related to the Group’s other airport and office facilities and equipment, overhaul and maintenance bases and training facilities.

     As of December 31, 2004,2005, the Group undertook to make a capital contribution of approximately RMB83 million to jointly controlled entities.

     As of December 31, 2004,2005, the cash and cash equivalents of the Group totaled RMB3,083RMB2,901 million. Of such balance, 24.2%20.4% was denominated in foreign currencies.

     No interim dividend was paid during the year ended December 31, 2004.2005. The Board of Directors does not recommend the payment of a final dividend in respect of the year ended December 31, 2004.

2005.

     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.

4948


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, 2004.2005.
                                            
 As of December 31, 2004  As of December 31, 2005 As of December 
 Payment due by period  Payment due by period 31, 2004 
 less than        less than         
 Total 1 year 1-3 years 4-5 years After 5 years  Total 1 year 1-3 years 4-5 years After 5 years Total 
 (RMB million)  (RMB million) 
Contractual obligations
  
Short-term debt 9,925 9,925    
Short-term debt (Note 2) 14,346 11,735 2,611   9,925 
Long-term debt 13,528 1,593 5,766 2,283 3,886  14,617 1,877 6,472 2,095 4,173 13,528 
Capital lease obligations 11,743 2,144 5,428 3,479 692  15,832 3,373 5,538 2,189 4,732 11,743 
Cash payable for CNA/XJA Acquisitions 1,959 1,959    
 
Cash payable for CNA/ XJA Acquisitions      1,959 
                        
Total contractual obligations
 37,155 15,621 11,194 5,762 4,578  44,795 16,985 14,621 4,284 8,905 37,155 
                        
Other commercial commitments
  
Operating lease commitments 12,750 1,761 3,184 6,023 1,782  24,594 3,340 5,666 5,132 10,456 12,750 
Aircraft purchase commitments (Note 1) 11,776 8,748 3,028    45,628 7,341 23,299 14,988  11,776 
Capital commitments in respect of investments in the Guangzhou new airport 824 824     840 840    824 
Other capital commitments 700 595 105    1,335 752 583   700 
Investing commitments 83 83     83 83    83 
                        
Total commercial obligations
 26,133 12,011 6,317 6,023 1,782  72,480 12,356 29,548 20,120 10,456 26,133 
                        
 
Estimated future interest payments on short term debt and long term debt
 
Fixed rates 3,285 785 1,071 640 789 2,388 
Variable rates 2,171 935 635 369 232 939 
             
 5,456 1,720 1,706 1,009 1,021 3,327 
             


Note 1 Amounts shown are net of previously paid purchase deposits.
Note 2 Short term bank debts included certain debts of RMB2,611 million which were renewed subsequent to December 31, 2005. The renewed debts are unsecured, bear interest at floating rates ranging from 3-month HIBOR/6-month LIBOR + 0.55% to 0.60% per annum and are repayable one year from their respective renewal dates.

50


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 2004.2005. There were certain changes in the Company’s Directors, Senior Management and Supervisors subsequent to December 31, 2004,2005, details of which are set forth below.
       
Name AgePosition PositionGenderAge
Liu Shao Yong Chairman of the Board46Male  Chairman of the Board of Directors48
Liu Ming Qi61Qi(1) Vice Chairman of the Board of DirectorsMale62
Peng An FaFa(2)DirectorMale  5758 Director
Wang Quan Hua Director51Male  Director52
Zhao Liu An Director57Male  Director58
Zhou Yong QianQian(3)DirectorMale  6061 Director
Si Xian Min Director, President47Male  Directors; President49
Zhou Yong JinJin(1)DirectorMale  6263 Director
Xu Jie Bo Director, Chief Financial Officer and Vice President40Male  Director; Chief Financial Officer; Vice President41
Wu Rong NanNan(1)DirectorMale  6364
Simon To(4)Independent Non-executive DirectorMale  Director
Simon To55 54Independent Non-Executive Director
Peter Lok Independent Non-executive Director69Male  Independent Non-Executive Director70
Wei Ming Hai Independent Non-executive Director41Male  Independent Non-Executive Director42

49


NamePositionGenderAge
Wang Zhi Independent Non-executive Director63Male  Independent Non-Executive Director64
Sui Guang Jun Independent Non-executive Director44Male  Independent Non-Executive Director45
Sun Xiao Yi51 Chairman of the Supervisory CommitteeMale52
Yang Guang Hua Supervisor52Male  Supervisor53
Yang Yi Hua Supervisor45Female  Supervisor46
Li KunKun(5)Vice PresidentMale  4546 Vice President
Yuan Xin An Vice President48Male  Vice President; Chief Engineer49
Zheng En RenRen(6)Vice PresidentMale  6061 Vice President
Hao Jian Hua Vice PresidentMale 55 
Ren Ji Dong(7) Vice PresidentMale41
Ren Ji DongHe Zong Kai(7)Vice PresidentMale55
Liu QianChief PilotMale  40 Vice President
He Zong Kai53Vice President
Liu Qian40Chief Pilot
Su Liang Company Secretary43Male  Company Secretary44
Chen Wei Hua General Counsel38Male  General Counsel40

     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 appointment of Liu Shao Yong as a Director, and the resignation of Yan Zhi Qing for age reason were approved at the first extraordinary general meeting 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


(1)The resignation of Liu Ming Qi, Zhou Yong Jin and Wu Rong Nan as Directors due to their retirement was approved at the first and second extraordinary general meetings of the Company on December 16, 2005.
(2)The removal of Peng An Fa as Director of the Company owing to suspicion that he had committed a crime was discussed and approved at the first extraordinary general meeting of the Company on December 16, 2005.
(3)The resignation of Zhou Yong Qian as Director of the Company due to his retirement was approved at the 2005 annual general meeting of the Company on June 15, 2006.
(4)The resignation of Simon To as independent non-executive Director upon the expiry of his six years’ term was approved at the second extraordinary general meeting of the Company on December 16, 2005.
(5)Li Kun was relocated to another position and his resignation as Vice President of the Company was approved by the Board of the Company on December 13, 2005.
(6)The resignation of Zheng En Ren as Vice President of the Company due to his retirement was approved by the Board of the Company on April 19, 2006.
(7)The appointment of Ren Ji Dong and He Zong Kai as Vice Presidents of the Company were approved by the Board on March 29, 2005.

     On December 31, 2004, the appointment of Si Xian Min as 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.

BOARD OF DIRECTORS

     Mr. Liu Shao Yongis the Chairmanchairman of the Board of Directors.Board. He is a 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 obtained a post-graduate degree in International Trading from Tianjin Institute of Finance and Economics in 1999. He is a qualified class one pilot. Save as disclosed above, Mr. Liu is not connected with any Directors, senior management, substantial shareholders or Supervisors ofbecame the Company.

Mr. Liu Ming Qiis the Vice Chairmanchairman 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.

on November 29 2004.

     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

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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.

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     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. Save as disclosed above,Airlines and has been the President of the Company since October 2004. Mr. Si is not connected with any Directors, senior management, substantial shareholders or Supervisors of the Company.

Mr. Zhou Yong Jinisbecame 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.

on December 31, 2004.

     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 master 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. Save as disclosed above, Mr. Xu is not connected with any of the Directors, senior management, substantial shareholders or Supervisors of the Company.

Mr. Wu Rong Nanisbecame 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 Tohas 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.

on April 16, 2001.

     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, 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 ten7 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.

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     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 in 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 master 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 Managementsenior 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.

became a Supervisor on June 16, 2004.

5452


     All Directors and Supervisors of the Company have entered into service contracts with the Company for a term of three years commencing 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.

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 thebecame a Vice President of the Company since 31in July 2003.

     Mr. Ren Ji Dongis 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 andbecame a Vice President of the Urumqi branch of the Company since 2004.

in March 2005.

     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. 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 master degree. During the period from 1998 to 1999, Mr. Su held the position as Deputy Manager of the Flight Operations Department, China Southern Airlines Shenzhen Co. and from 1999 to 2000, he was the Manager of the Planning and Administration Department of China Southern Airlines Shenzhen Co.. Mr. Su was in charge of the international cargo project of the Company, responsible for the planning and development of the Company’s North American cargo business. 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.

53

     None of the senior administrative officers above is connected with any Directors, senior management, substantial shareholders or Supervisors of the Company.


Compensation

     RMB255,000

     A total of RMB232,000 has been paid to independent non-executive Directors for the year ended December 31, 2004.2005. The aggregate compensation paid by the Company to all Directors (excluding non-executive Directors), Supervisors and senior managementSenior Management for 20042005 was RMB6.8RMB5.9 million. For the year ended December 31, 2004,2005, the Company accrued an aggregate of approximately RMB145,000RMB132,000 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, 2005 are set out below:
                         
          Salaries,           
          allowances      Retirement    
      Directors’  and benefits  Discretionary  scheme    
Name     fees  in kind  bonuses  contributions  Total 
  Note  RMB’000  RMB’000  RMB’000  RMB’000  RMB’000 
 
                         
Executive directors
                        
Liu Shao Yong  (i)     299      12   311 
Liu Ming Qi         242      10   252 
Peng An Fa         101      6   107 
Wang Quan Hua         237      12   249 
Zhao Liu An  (i)     237      12   249 
Zhou Yong Qian         237      12   249 
Si Xian Min         281      12   293 
Zhou Yong Jin         127      2   129 
Xu Jie Bo         226      12   238 
Wu Rong Nan         368   162   7   537 
                         
Supervisors
                        
Sun Xiao Yi         237      12   249 
Yang Guang Hua         225      12   237 
Yang Yi Hua         48   70   11   129 
                         
Independent non-executive directors
                        
Simon To  (ii)               
Peter Lok      58            58 
Wei Ming Hai      58            58 
Wang Zhi      58            58 
Sui Guang Jun      58            58 
 
                         
       232   2,865   232   132   3,461 
 
Notes:
(i)The above amounts included the salaries paid to these Directors as pilots of the Company.
(ii)Simon To received director’s fee of RMB1 during the year ended December 31, 2005.

Board Practices

     Each Directors’ service contractscontract with the Company or any of its subsidiaries provide 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 2005, 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,positions from finance department and 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.

Remuneration Committee

     The Remuneration Committeeremuneration committee comprises 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 20042005, 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”Group��. The remuneration committee is also responsible for assessing performance of executive Directors and approving the terms of executive Directors’ service contracts.

Employees

     As of December 31, 2004,2005, the Group had 18,22134,417 employees, including 1,9952,567 pilots, 3,2314,539 flight attendants, 2,6795,076 maintenance personnel, 2,19410,445 sales and marketing personnel, 3,243 administrative personnel and 8,122 administrative personnel.8,547 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

54


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%9% 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 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 establish a supplementary defined contribution retirement scheme for the benefit of employees. 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 rate of 4.5%rates ranging from 3% to 5% of total salaries. The Group has no obligation for the payment of pension benefits beyond the contributions described above. Contributions to the retirement schemes are charged to the income statement as and when incurred.

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     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-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, 2004,2005, the Company and the Group alreadyhad made payments totalling RMB191RMB168 million under the scheme and recorded its remaining contractual liabilities totalling RMB69RMB92 million as accrued expenses on itsthe balance sheet.sheets. 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 suffers 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.

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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, 2004,2006, the total share capital of the Company was divided into 4,374,178,000 shares, of which approximately 50.3% (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, 2004,2006, the following shareholders had an interest of 5% or more in the Company’s shares:
       
    Approximate Approximate
    Percentage Percentage
    of the Total
Name Number of Shares Number of Shares
CSAHC 2,200,000,000 domestic shares  50.30%50.30%
HKSCC Nominees Limited 1,151,953,9981,150,854,998 H shares  26.34%26.31%

     The table below sets forth, as of DecemberMay 31, 2004,2006, the following entities hold 5% or more of the total number of H shares issued by the Company.
              
 Approximate  Approximate
 Percentage of  Percentage of
 the Total  the Total
 Number of H  Number of H
Name Number of H Shares Shares  Number of H Shares Shares
HKSCC Nominees Limited 1,151,953,998  98.11% 1,150,854,998  98.01%

     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 2636 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 licence 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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     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. Unless CSAHC gives a written notice of termination three months before the expiration of the 10-year term of the agreement, the agreement will be 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 Guangzhou Baiyun International Airport. The total rental payment is RMB2.7 millionRMB2,651,000 per year. The term of the lease is five years commencing April 1, 1997, and is renewable by the Company thereafter.

both parties thereafter (subject to mutual agreement with respect to rental terms).

     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 millionRMB15,745,000 per year. The original term of each lease is one year, and is renewable annually by the Company thereafter.

parties thereafter (subject to mutual agreement with respect to rental terms).

     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 XJAXinjiang Airlines and CNANorthern Airlines 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, 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 is determined after arm’s length negotiation 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.

2nd extraordinary general meeting on December 31, 2004.

     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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     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 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 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.

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     Arrangements with CSAHC’s Affiliates

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

     The Company and SAIETC have entered into an agreement dated May 22, 1997 for the import and export of aircraft, flight equipment, special vehicles for airline use, communication and navigation facilities, and training facilities for a term extending from May 22, 1997 to May 22, 2000 which was subsequently extended to May 22, 2006 by mutual agreement between the parties. The parties have mutually agreed thatdetermined the agreement can be extended automatically.

various rates for import and export services provided by SAIETC after negotiations on a fair and equitable basis, which are not higher than the market rates for similar services.

     For the year ended December 31, 2004,2005, the amount incurred by the Group for the import and export of the above equipment was RMB1,117 million, inclusiveRMB31,714,000.
     In order to comply with the requirements under Rule 14A.35 of the Hong Kong Listing Rules so that SAIETC can continue to provide import and export services and custom clearing service after the expiry of the original agreement, the Company and SAIETC entered into a new import and export agency commissionframework agreement (the “Import and Export Agency Framework Agreement”) on 1 January, 2006, which became effective on April 25, 2006, having been approved by the Board of 1.5% aboveDirectors of the contract prices paidCompany. The Import and Export Agency Framework Agreement is valid for a term of three years, commencing from the date of the agreement, subject to SAIETC.

compliance with the relevant provisions of the Hong Kong Listing Rules by the Company. Both parties 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.

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

     In August 2002, the Company entered into a takeover agreement with CSAHC. As a result, the Company owns 90% 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 have entered into an agreement dated May 22, 1997 for the provision of advertising services for a term extending from May 22, 1997 to May 22, 2000. TheAfter extension of three years, the parties have mutually agreed to extend the agreement has been extendedfor another three years to May 22, 2006.

     In order to comply with the requirements under Rule 14A.35 of the Hong Kong Listing Rules, so that SAAC can continue to provide advertising service after the expiry of the original agreement, the Company and SAAC entered into a new advertising agency agreement (��Advertising Agency Agreement”) on January 1, 2006 for a term of three years commencing from the date of the agreement, which became effective on 25 April, 2006, having been approved by the Board of Directors of the Company.
     Under the agreement, SAAC will produce advertisement script, graphic and music to the Company with the copyright of such products belonging to the Company products belonging to the Company, provided that the Company shall comply with all relevant provisions under the Hong Kong Listing Rules. Both parties agreed that the agency rate for advertising under the Advertising Agency Agreement shall be determined after arm’s length negotiation and shall not higher than the market rate. For the year ended 31 December 31, 2004,2005, the amount incurred by the Group to SAAC for advertising services was RMB1.2 million.

RMB3,062,000.

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

     The Company has entered into a 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 22,21, 2000. As agreed by the parties, the agreement has beenwas extended for six years to May 22, 2006. In order to comply with the new requirements under the Hong Kong Listing Rules, so that SA Finance can 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), the Company and SA Finance entered into a new financial agreement on November 12, 2004, commencing from that date for a period of three years, and is renewable, subject to compliance with the 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.

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     As SA Finance is a connected person of the Company under the Hong Kong Listing Rules, the financial agreement constitutes a discloseable and non-exempt continuing connected transaction under Rule 14A.35 of the Hong Kong 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 Hong Kong 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 accept deposit of money from the Company deposits withat 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; make loans to the Company subject to the entering into of separate loan agreements, which will set out the Cap, terms and conditions of the loans, upon application by the Company during the term of the financial agreement. The maximum limit for amount of money deposit under the financial agreement is RMB1 billion. 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, terms and conditions of such services, upon request by the Company during the term of the financial agreement, and theagreement. The Company will comply with the Hong Kong Listing Rules when entering into such separate written agreements.

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     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, 2004,2005, the Group’s deposits placed with SA Finance amountingamounted to RMB406.0 million,RMB543,825,000, which earnedbore interest at the rate of 0.62% — 1.62%0.72% per annum.

annum; the balance of the loans extended to the Group by SA Finance amounted to RMB300,000,000.

     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.

     For the year ended December 31, 2004,2005, the amount paidincurred by the Group to Shenzhen Air Catering Company Limited for the provision of in-flight meals was approximately RMB50.2 million.

RMB60,542,000.

     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 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 DemergerDe-merger Agreement, the Company has assumed all the interests, rights and obligations of CSAHC under the Training Agreement.

     For the year ended December 31, 2004,2005, the amount paid by the Group to the Australian Pilot College for training services was RMB79.4 million.

RMB81,471,000.

     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.

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     For the year ended December 31, 2004,2005, 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.

RMB87,521,000.

     Ticket sales arrangements

     The CompanyGroup has entered into ticket 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% to 12% of the ticket price for Hong Kong and Macau regional/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 rates of commission are not higher than market rates for similar services.

     For the year ended December 31, 2004,2005, the aggregate amount of ticket sales of the Group conducted through the Agents was RMB32.0 million.

RMB451,121,000.

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

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     The Company and the Catering Company entered into a catering agreement dated November 12, 2004 under which the Catering Company would supply (a)(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 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 meals 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 flight it provides service. The Cap for the Catering Agreement is set at RMB220 millionRMB220,000,000 per year.

     For the year ended December 31, 2005, the Company paid the in-flight meals charge of RMB112,136,000 pursuant to the catering agreement.
     In-flight Meals Arrangement with NorthernChina Southern Airlines Group Passenger and Cargo Agent Company Limited (“PCACL”), a wholly owned subsidiary of CSAHC

     Following

     In order to comply with the announcementrequirements under Rule 14A.35 of the consolidationHong Kong Listing Rules so that PCACL can continue to provide ticket agency services, the Company and restructuring amongPCACL, a whollyowned subsidiary of CSAHC CNAwhose principal business activity is that of acting as an air ticket agent and XJAairfreight forwarding agent, entered into a new ticket agency framework agreement (the “New Ticket Agreement”) and a new airfreight forwarding agency framework agreement (the “New Airfreight Agreement”, together with New Ticket Agreement, the “Two Sales Agency Framework Agreements”) on October 11, 2002 (the “ConsolidationJanuary 1, 2006, which became effective on April 25, 2006, having been approved by the Board of Directors of the Company.
     The Two Sales Agency Framework Agreements are valid for a term of three years commencing from January 1, 2006, subject to the compliance of relevant requirements of the Hong Kong Listing Rules by the Company. The parties agreed that the agency fee shall be determined after arm’s length negotiation and Restructuring”shall not be higher than the market rate.
China Southern Airlines Group Travel Development Company Limited (“CSA Travel”), CNA has become a wholly owned subsidiary of CSAHC
     The Company and CSA Travel, whose principal business activity is that of operating tourism related business, entered into a connected personframework agreement on Lease, Operation and Management (“Framework Agreement on Lease and Operation”) on January 1, 2006 in order to allow Company to lease certain hotels belonging to it to CSA Travel for it to operate, and to provide certain relevant services in compliance with the requirements under Rule 14A.35 of the Company under the Hong Kong Listing Rules. The following agreements have been terminated followingRules for a term of three years, commencing from the acquisitiondate of the core operational assetsagreement. The Framework Agreement on Lease and Operation became effective on April 25, 2006, having been approved by the Board of CNADirectors of the Company. Pursuant to the agreement, the Company shall lease Guangzhou Airlines Hotel, Zhuhai Pilot Mansion and XJAcertain portions of CSA Guangzhou Hotel and Beijing CSA Hotel to the CSA Travel for operation and management of such hotels. With regard to the amount of rent payable under the agreement, the annual cap for the Framework Agreement on December 31, 2004.

Lease and Operation is set at RMB6,000,000 per annum for the entire term of the agreement.

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 by an independent third party, has been providing and will provide in-flight meals to CNA. Pursuant to anGCSAPMC, whose principal business activity is that of management of real property, entered into a framework agreement dated June 23, 2000, Nanland has been providing in-flight meals to CNA 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 CNA to Nanland for the provisionEngagement of in-flight means was approximately RMB5,221,000.

     Pursuant to an agreement dated October 30, 2001, CNA has been providing and will continueProperty Management (“Property Management Framework Agreement”) on January 1, 2006 in respect of engaging GCSAPMC to provide in-flight meals toproperty management and improvement services in compliance with the Group from time to time for a periodrequirements under Rule 14A.35 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.Rules for a term of three years, commencing from the date of the agreement. The followingProperty Management Framework Agreement became effective on April 25, 2006, having been approved by the Board of Directors of the Company. The Property Management Framework Agreement would become effective upon approval by the Board of Directors of the Company. Pursuant to the agreement, the Company has been terminated followingappointed 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 at the new Baiyun International Airport 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 shall be determined at an arm’s length between both parties. The agency fee is payable within the time period set out in the invoice to be delivered to the Company. The Company will fund the agency fee wholly by its internal resources.

     With regard to the approximate amount of agency fee payable for property management and improvement services under the agreement likely to be incurred each year during the term of the agreement, the annual cap for the Property Management Framework Agreement is set at RMB47,010,000 per annum for the entire term of the agreement.
CSAHC Hainan Co., Ltd., (“Hainan Co., Ltd.”), a subsidiary of CSAHC from Hainan Co., Ltd.
     In order to expand the assets size and competitive advantage of the Company’s airline operations and completely remove competition with CSAHC in the airline industry, the Board of Directors reviewed and approved the acquisition (the “Acquisition”) by the Company of the core operational assets (“Core Assets”) and liabilities (“Core Liabilities”) in relation to the airline operations of CNACSAHC Hainan Co., Ltd. (“Hainan Co., Ltd.”), a subsidiary of CSAHC from Hainan Co., Ltd., whose main business is that of civil aviation, on April 18, 2006.
     As agreed by the parties, the value of the Core Assets to be acquired and XJA on December 31, 2004.

     Inthe Core Liabilities to be assumed by the Company is determined in accordance with the valuation reports (Zhongqihuapingbaozi (2006) Report No. 024) on the transfer of business and assets of Hainan Co., Ltd. dated June 30, 2005 which was issued by China Enterprise Appraisal Co., Ltd., which sets out the estimated value of the Core Assets as RMB355,150,000, consisting mainly of RMB103,020,000 in cash, RMB55,110,000 for bill and trade receivables, RMB160,970,000 for airplanes, aviation equipment and productionrelated buildings and equipment, as well as RMB35,480,000 of land; and the Core Liabilities, which include airplane repair expenses, jet fuel and takeoff and landing fees, amount to RMB350,000,000. The Core Liabilities will be paid directly by the Company to the creditors in accordance with the terms and period as agreed by relevant requirementparties. After deducting the above-mentioned liabilities, the Company shall pay RMB5,150,000 in cash, being the difference in the estimated values of the Core Assets and industry practice,Core Liabilities, into the Group has entered into ticket agency arrangement with CNAbank account designated by Hainan Co., Ltd. The Company will fund the consideration for the sale of the Group’s air ticketsAcquisition wholly by CNA and for the sale of CNA air tickets by the Group. The selling party chargesits internal resources.

Nan Lung Travel & Express (Hong Kong) Ltd. (the “Nanlung”), 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 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, asubsidiary wholly owned subsidiary ofby CSAHC

     Following the announcement of the Consolidation and Restructuring, XJA

     As China Airlines (Hong Kong) Co., Ltd. has become a wholly owned subsidiary of CSAHC and a connected personceased to act as agent of the Company underin respect of its ticket sales, account settlement and the ground operations of its flights in Hong Kong region, for the purpose of maintaining the sales and operations of the Company in Hong Kong region, the Company entered into a new General Agency Agreement for Sale of Freight and Passenger Services (the “Agency Agreement”) with Nanlung on May 16, 2006, having been approved by the Board of Directors of the Company.
     The Agency Agreement is valid for a term of one year, commencing from January 1, 2006, subject to compliance with the relevant provisions of the Hong Kong Listing Rules. The following agreements have been terminated followingRules by the acquisitionCompany. Both parties agreed that prior to the establishment of any relevant entity in Hong Kong region by the Company, the Company authorizes Nanlung to act as agent in its sales and account settlement and the ground operations of its flights in Hong Kong region, and that the rates of the core operational assets of CNAvarious agency fees shall be determined after arm’s length negotiation 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 announcementshall not exceed those of the Consolidation and Restructuring, XJA has becomesame category that prevail in the market, with a wholly owned subsidiaryceiling set at 6% of CSAHC and a connected personthe revenue of the Company underthat is derived from freight and passenger services sold through the Hong Kong Listing Rules.agency of Nanlung (the total amount shall not exceed HK$60 million). The following agreement has been terminated followingagency fee is payable within 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 commissiontime period set out in the amount of 3% of the ticket price for domestic tickets and 5%invoice 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 XJAbe delivered to the Group forCompany. The Company will fund the year ended December 31, 2004 was approximately RMB78,207,000. The amount of commission paidagency fee wholly 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.its internal resources.

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 in a civil litigation (Hong Kong High Court Action No. 515 of 2001) (“Litigation”). According to the writ of summons for 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”) entered into an agreement with the defendants 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 unspecified damages for breach of the agreement. The Company has filed an objection in respect of the jurisdiction of the court, and has requested the court to transfer the case to the PRC for trial. 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.

Dividend Information

     No interim dividend was paid during the year ended December 31, 2004.2005. The Board of Directors does not recommend the payment of a final dividend in respect of the year ended December 31, 2004.

2005.

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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.

                         
  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, 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 
Fiscal Year ended December 31, 2005
  2.22   2.17   14.25   14.20   2.68   2.62 
                         
Quarterly Market Prices
                        
                         
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 
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 
Monthly Market Prices                        
December 2005  2.40   2.10   15.45   13.68   2.74   2.52 
January 2006  2.40   2.12   15.50   13.91   3.03   2.53 
February 2006  2.53   2.17   15.88   14.05   2.85   2.55 
March 2006  2.47   2.20   15.78   14.16   2.84   2.45 
April 2006  2.30   1.96   15.03   13.06   2.59   2.19 
May 2006  2.08   1.86   13.59   12.01   2.75   2.25 
June 19, 2006  1.94   1.68   12.65   10.76   2.97   2.53 
Plan of Distribution
     Not applicable.

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  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 
Markets
     See “Offer and Listing Details” above.

Offer and Listing details

Selling Shareholders
     Not applicable.

Plan of Distribution

66

Dilution


     Not applicable.

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

     Objects and Purpose
     Pursuant to Article 13 of the Articles of Association, the business purposes of the Company are: (i) to absorb domestic 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 domestic and foreign companies; (vi) to continuously improve the management of the Company; (vii) to enhance the market competitiveness of the Company; (viii) to generate economic and social benefits for the Company; and (ix) to generate steady income for the Company’s shareholders. Pursuant to Article 14 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) provision of scheduled and non-scheduled domestic, regional and international air transportation services for passengers, cargo, mail and luggage; (ii) undertaking general aviation services; (iii) provision of aircraft repair and maintenance services; (iv) acting as agent for other domestic and international airlines; (v) provision of air catering services and (vi) engaging in other airline or airline-related business, including advertising for such services.

     Directors
     Pursuant to Article 154179 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 108130 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.

62


     Pursuant to Article 162187 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)124(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 19 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.

     Pursuant to Article 20 of the Articles of Association,Shares 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 21 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 54 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;
(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 articles of 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 articles of association;

68


(6) the right to obtain relevant information in accordance with the provisions of these articles of association, including:

     (i) the right to obtain a copy of these articles of association, subject to payment of the cost of such copy;

63

(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.

     (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.
(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;
 
(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 articles of 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;
(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.

6964


     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;
(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 articles of association 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 cent of each of its existing issued Domestic-Invested Shares and Overseas-Listed Foreign-Invested Shares;
(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.

7065


     There are two types of shareholders’ general meetings: annual general meetings and extraordinary general meetings. Shareholders’ general meetings shall be convened by the board of 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 cent 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.

     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 board of directors 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.
(a) A sale and purchase agreement (the “Sale and Purchase Agreement”) dated November 12, 2004 between the Company, CSAHC, CNA, a wholly owned subsidiary of CSAHC, and XJA, a wholly owned subsidiary of CSAHC, 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. 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 Russia for a period of three years. The consideration for Lease Agreement 1 is RMB41,993,318.44 per year. It became effective upon approval by the shareholders of the Company on December 31, 2004.

(c) A lease 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, 2004 between the Company and CSAHC, pursuant to which CSAHC leases to the Company certain lands situated in Urumqi, Shenyang, Dalian and Harbin, by leasing the land use rights of such lands to the Company for a period of three years. The consideration for Lease Agreement 3 is RMB22,298,033 per year. It became effective upon approval by the shareholders of the Company on December 31, 2004.

(e) A catering agreement (the “Catering Agreement”) dated November 12, 2004 between the Company and China Southern Airlines Group Air Catering Company Limited (the “Catering Company”), a wholly owned subsidiary of CSAHC, pursuant to which the Catering Company supplies in-flight meal and catering services to the flights of the Company originating or stopping at the domestic airports, mainly in Northern China and Xinjiang regions where the Catering Company provides catering services for a period of three years. The consideration for the catering agreement is based on the price of each type of in-flight meals and the service price for each type of aircraft, and is capped at RMB220 million per year. It became effective upon approval by the shareholders of the Company on December 31, 2004.

(f) A financial agreement (the “Financial Agreement”) dated November 12, 2004, between the Company and Southern Airlines Group Finance Company Limited (“SA Finance”), a connected person of the Company which is 42% owned by CSAHC, 32% owned by the Company and 26% owned in aggregate by five subsidiaries of the Company. The Financial Agreement commenced from November 12, 2004 for a period of three years, and is renewable, subject to compliance with the 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. 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 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. It became effective upon approval by the shareholders of the Company on December 31, 2004.

(g) An aircraft acquisitionA framework agreement on lease and operation dated April 21, 2005January 1, 2006 between the Company and China Southern Airlines Group Travel Development Company Limited (the “CSA Travel”), a wholly owned subsidiary of CSAHC, pursuant to which the Company leases certain hotels belonging to it to CSA Travel for operation and management for a period of three years. The consideration for the framework agreement on lease and operation is based on the rent payable and fees for operation and management of the hotels, and is capped at RMB6 million per year. It became effective on April 25, 2006 has been approved by the directors of the Company.
(h)An advertising agency agreement dated January 1, 2006 between the Company and Southern Airlines (Group) ImportAdvertising Company (the “SAAC”), a related party that is 45% owned by the Company and Export Trading55% owned by CSAHC, pursuant to which the SAAC produces advertisement script, graphic and music for the Company with the copyright of such products belonging to the Company for a period of three years. The consideration for the advertising agency agreement is based on the fees payable for advertising services to be provided, and is capped at RMB30 million per year. It became effective on April 25, 2006 has been approved by the directors of the Company.
(i)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.
(j)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 Airbus SNCHainan Co., Ltd. has agreed to sell five new A380 aircraft.the assets and liabilities in relation to the airline operations of Hainan Co., Ltd. The total consideration payable by the Company, including the assets to be acquired and the liabilities to be assumed by the Company, was RMB5,150,000. It became effective upon approval by the directors of the Company on April 18, 2006.
(k)An agency agreement for sale of freight and passenger services dated May 16, 2006 between the Company and Nan Lung Travel & Express (Hong Kong) Ltd. (the “Nanlung”), a wholly owned subsidiary of CSAHC, pursuant to which the Nanlung acts as agent in the Company’s sales and account settlement and the ground operations of the Company’s flights in Hong Kong region for a period of one year. The consideration for the agency agreement is based on the fees payable for ticket sale and other services to be provided, and is capped at RMB60 million for the entire term of the agency agreement. It became effective on May 16, 2006 and was approved by the directors of the Company on December 24, 2005.

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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 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 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 exchange 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 exchange 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 exchange 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. As a result, the value of the Renminbi against the U.S. dollar has appreciated by approximately 2%. Under the new policy, the value of Renminbi against the U.S. dollar has fluctuated on a daily basis within narrow ranges, but overall has further strengthened against the U.S. dollar. 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.
     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.

     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

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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;
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.
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 or “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 2004. However, there can be no assurance that the Company will not be a PFIC for the taxable year 2005 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 2005 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.
     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 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, provide 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

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.

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.
   
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.

7868


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 borrowings is in the form of long-term fixed- 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.

2005.

     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.

2005.

     As of December 31, 2004,2005, 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, 20042005 and 2003:2004:
                                           
 As of December 31, 2004 As of December 31, 2003  As of December 31, 2005 As of December 31, 2004
 Expected maturity date        Expected maturity date      
 Total Total    Total Total  
 recorded recorded    recorded recorded  
 2005 2006 2006 2008 2009 Thereafter amount Fair value(2) amount Fair value(2)  2006 2007 2008 2009 2010 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 
Fixed-rate notes payable In US$ 484 449 303 266 215 697 2,414 2,440 2,252 2,464 
Average interest rate 6.09% 6.52% 6.41% 6.41% 6.41% 6.82% 6.09%  6.79%    6.47%  6.47%  6.47%  6.62%  6.47%  6.47%  6.47%  6.09% 
Variable-rate notes payable 
In US$ 6,421 905 3,557 777 996 2,671 15,327 15,327 8,372 8,372 
Variable-rate notes payable In US$(3) 12,169 5,188 1,801 1,047 345 2,924 23,474 23,474 15,327 15,327 
Average interest rate 2.26% 2.60% 2.60% 2.60% 2.60% 2.26% 2.40%  1.63%    4.57%  4.52%  4.44%  4.44%  4.46%  4.46%  4.57%  2.40% 
In HKD 3,327      3,327 3,327   
In HKD(3) 657 1,238     1,895 1,895 3,327 3,327 
Average interest rate 1.42%      1.42%       4.11% 4.83      4.11%  1.42% 
In RMB 1,003 276 181 27 27 1,033 2,547 2,547 620 620  302 52 52 122 100 552 1,180 1,180 2,547 2,547 
Average interest rate 5.13% 5.65% 5.20% 5.02% 5.02% 5.20% 5.04%  4.46%    5.06%  5.12%  5.12%  5.12%  5.12%  2.75%  4.15%  5.04% 


(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, 20042005 and 2003.2004.
(3)Short term bank debts included certain debts of RMB2,611 million which were renewed subsequent to December 31, 2005. The renewed debts are unsecured, bear interest at floating rates ranging from 3-month HIBOR/6-month LIBOR + 0.55% to 0.60% per annum and are repayable one year from their respective renewal dates.

     The following table provides information regarding the Group’s material foreign currency sensitive financial instruments and capital commitments as of December 31, 20042005 and 2003:

2004:
                                         
  As of December 31, 2005 As of December 31, 2004
  Expected maturity date          
                          Total     Total  
                          recorded     recorded  
  2006 2007 2008 2009 2010 Thereafter amount Fair value(2) amount Fair value(2)
Debt                                        
Fixed-rate notes payable In US$  484   449   303   266   215   697   2,414   2,440   2,252   2,464 
Average interest rate  6.47%  6.47%  6.47%  6.62%  6.47%  6.47%  6.47%      6.09%    
Variable-rate notes payable in US$(3)  12,169   5,188   1,801   1,047   345   2,924   23,474   23,474   15,327   15,327 
Average interest rate  4.57%  4.52%  4.44%  4.44%  4.46%  4.46%  4.57%      2.40%    
In HKD(3)  657   1,238               1,895   1,895   3,327   3,327 
Average interest rate  4.11%  4.83               4.11%      1.42%    
Capital commitment in US$  7,341   8,945   14,354   5,300   9,688      45,628   45,628   11,776   11,776 

7969


                                         
  As of December 31, 2004  As of December 31, 2003 
  Expected maturity date              
                          Total      Total    
                          recorded      recorded    
  2004  2005  2006  2007  2008  Thereafter  amount  Fair value(2)  amount  Fair value(2) 
Debt                                        
Fixed-rate notes payable In US$  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%          
Capital commitment in US$  8,748   2,996   32            11,776   11,776  10,615   10,615 


(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, 20032005 and 2004.
(3)Short term bank debts included certain debts of RMB2,611 million which were renewed subsequent to December 31, 2005. The renewed debts are unsecured, bear interest at floating rates ranging from 3-month HIBOR/6-month LIBOR + 0.55% to 0.60% per annum and are repayable one year from their respective renewal dates.

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, 2004.2005.

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.

 (ii) Name of the managing underwriter:
Goldman Sachs (Asia) L.L.C. (global coordinator).
 
 (iii) and (iv)
                
 Aggregate Aggregate                 
 price of offering  Aggregate Aggregate
Title of each offering price of  price of offering
class of Amount amount Amount amount  offering price of
securities registered registered(1) registered(2) sold(3) sold(4) 
securities Amount amount Amount amount
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  861,823,000 shares US$528,469,864 851,501,000 shares US$522,140,413 

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

8070


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.

(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.
(vii) As of December 31, 2005, 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.
(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.

     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 has been no significant change in our internal controls over financial reporting during the period covered by this Annual Report that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

71


ITEM 16. [RESERVED]

72


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. See “Item 6 Directors, Senior Management and Employees — Directors and Senior Management”.

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, 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 such director 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, 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 20032004 and 2004:2005:
             
  Audit Fees Audit-Related Fees Tax FeesOther Fees
2003RMB8.2 millionRMB7.0 millionRMB0.17 millionRMB1.1 million
2004 RMB8.9 million RMB6.6 million RMB0.11 million
2005 RMB13.9 million RMB5.8 millionRMB0.11 million

82


Audit-related fees

     Services provided primarily consist of the following:

a) Review of the Group’s 20042005 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.

Tax fees

     Services provided primarily consist of tax compliance services.

73

Others


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

     Before our principal accountants were engaged by the Company to render audit or non-audit services, the engagement has 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 20042005 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
     
  Page 
CONSOLIDATED FINANCIAL STATEMENTS OF CHINA SOUTHERN AIRLINES COMPANY LIMITED
    
Report of Independent Registered Public Accounting Firm  F-1 
Consolidated Statements of Operations for the years ended December 31, 2002, 2003, 2004 and 20042005  F-2 
Consolidated Balance Sheets as of December 31, 20032004 and 20042005  F-3
Consolidated Statements of Cash Flows for the years ended December 31, 2002, 2003 and 2004F-4 
Consolidated Statements of Changes in Shareholders’ Equity for the years ended December 31, 2002, 2003, 2004 and 20042005  F-5
Consolidated Statements of Cash Flows for the years ended December 31, 2003, 2004 and 2005F-7 
Notes to Consolidated Financial Statements  F-6F-9 

8374


ITEM 19. EXHIBITS.
   
Exhibit No. Description of Exhibit
4.1 Form of Director’s Service Agreement is incorporated by reference in Exhibit 4(c).1 of Form 20-F for the year of 2004.2005.
 4.2 
4.2 Form of Non-Executive Director’s Service Agreement is incorporated by reference in Exhibit 4(c).2 of Form 20-F for the year of 2004.2005.
 8 
8 Subsidiaries of the Company
 12.1 
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

8475


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 30, 2005

2006

8576



REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

The Board of Directors and Shareholders of
China Southern Airlines Company 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, 20032004 and 2004,2005, and the related consolidated statements of operations, cash flows and changes in shareholders’ equity for each of the three years in the three-year period ended December 31, 2004,2005, 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, 20032004 and 2004,2005, and the results of their operations and their cash flows for each of the three years in the three-year period ended December 31, 20042005 in conformity with International Financial Reporting Standards promulgated by the International Accounting Standards Board.

     As more fully described in Note 3 to the consolidated financial statements, the Group changed the presentation of share of affiliated companies’ and jointly controlled entities’ taxation in the consolidated statements of operations in order to comply with IAS 1, “Presentation of financial statements”. In addition, the Group changed the manner in which it presents minority interests in the consolidated balance sheets and consolidated statements of operations in order to comply with IAS 1 and IAS 27, “Consolidated and separate financial statements”.
     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 as of and for the year ended December 31, 20042005 have been translated into United States dollars solely for the convenience of the reader.readers. 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.

KPMG

Hong Kong, China
April 25, 2005

19, 2006, except as to Note 44, which is as of May 31, 2006.

F-1


CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS
For the years ended December 31, 2002, 2003, 2004 and 20042005

(Amounts in millions, except per share data)
                    
 Note 2003 2004 2005 2005
                   RMB RMB RMB U.S. dollars
 Note 2002 2003 2004 2004  (restated, (restated, 
 RMB RMB RMB U.S. dollars  Note 3) Note 3) 
Operating revenue:    
Traffic revenue 3 17,482 16,965 23,344 2,821  4 16,965 23,344 37,419 4,637 
Other operating revenue 4,26 537 505 630 76  4 505 630 874 108 
 
                    
Total operating revenue   18,019 17,470 23,974 2,897  17,470 23,974 38,293 4,745 
                    
    
Operating expenses:    
Flight operations 5, 26 6,733 7,070 10,418 1,259  5 7,070 10,418 19,394 2,403 
Maintenance 6, 26 2,333 2,589 3,459 418  6 2,589 3,459 4,589 569 
Aircraft and traffic servicing 7, 26 2,511 2,767 3,503 423  7 2,767 3,503 5,759 714 
Promotion and sales 8, 26 1,500 1,480 1,940 234  8 1,480 1,940 2,780 345 
General and administrative 9 1,060 1,053 1,323 160  9 1,053 1,323 2,457 304 
Depreciation and amortization   1,840 2,038 2,413 292  10 2,038 2,413 4,440 550 
Other   16 17 9 1 
Others 17 9 179 22 
 
                    
Total operating expenses   15,993 17,014 23,065 2,787  17,014 23,065 39,598 4,907 
                    
    
Operating income   2,026 456 909 110 
Operating income/(loss) 456 909  (1,305)  (162)
                    
    
Non-operating income/(expenses):    
Interest income 26 52 13 22 3  13 22 55 7 
Interest expense 17, 26  (959)  (824)  (691)  (84) 12  (824)  (691)  (1,616)  (200)
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 
Equity income/(loss) of affiliated companies 23 45 10  (285)  (35)
Equity (loss)/income of jointly controlled entities 24  (46)  (16) 36 4 
Loss on sale of property, plant and equipment  (22)  (1)  (32)  (4)
Exchange (loss)/gain, net  (164)  (59) 1,220 151 
Others, net 21 46 74 9 
 
                    
Total net non-operating expenses    (887)  (967)  (676)  (82)  (977)  (689)  (548)  (68)
                    
    
Income/(loss) before taxation and minority interests   1,139  (511) 233 28 
Loss/(income) before taxation  (521) 220  (1,853)  (230)
    
Taxation (expense)/credit 10  (398) 324  (78)  (9)
Income tax benefit/(expense) 13 334  (65) 7 1 
            
Income/(loss) before minority interests   741  (187) 155 19 
            
(Loss)/income for the year  (187) 155  (1,846)  (229)
         
 
Attributable to: 
Equity shareholders of the Company  (358)  (48)  (1,848)  (229)
Minority interests    (165)  (171)  (203)  (25) 171 203 2  
            
Net income/(loss)   576  (358)  (48)  (6)
         
Net (loss)/income  (187) 155  (1,846)  (229)
                    
    
Basic earnings/(loss) per share 2(ab) 0.17  (0.09)  (0.01)  (0.001)
Basic loss per share 15  (0.09)  (0.01)  (0.42)  (0.052)
                    

See accompanying notes to consolidated financial statements.

F-2


CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS
As of December 31, 20032004 and 20042005

(Amounts in millions)
                
 Note 2004 2005 2005
               RMB RMB U.S. dollars
 Note 2003 2004 2004  (restated, 
 RMB RMB U.S. dollars  Note 3) 
ASSETS
ASSETS
 
CURRENT ASSETS    
Cash and cash equivalents 11 2,080 3,083 373  16 3,083 2,901 360 
Trade receivables 12 834 1,203 145  17 1,203 1,518 188 
Inventories 18 1,302 1,382 171 
Short term investments 19 683   
Other receivables   296 616 74  20 720 956 119 
Inventories   544 1,302 157 
Prepaid expenses and other current assets   248 378 46  378 380 47 
Short term investments 13  683 83 
Amounts due from related companies 30  84 10 
       
         
Total current assets   4,002 7,265 878  7,369 7,221 895 
       
NON-CURRENT ASSETS    
Property, plant and equipment, net 14 28,536 46,841 5,660  21 46,841 54,266 6,725 
Construction in progress 15 1,630 565 68  22 565 674 84 
Other investments 19 272 320 40 
Interest in affiliated companies 23 429 142 18 
Interest in jointly controlled entities 24 782 805 99 
Lease prepayments   349 346 42  346 333 41 
Investments 16 1,357 1,483 179 
Lease and equipment deposits   2,933 5,397 652  5,397 7,265 900 
Deferred tax assets 25 51 74 9 
Other assets   255 331 40  26 331 302 37 
       
         
Total non-current assets   35,060 54,963 6,641  55,014 64,181 7,953 
                
TOTAL ASSETS   39,062 62,228 7,519  62,383 71,402 8,848 
                
 
LIABILITIES AND SHAREHOLDERS’ EQUITY
LIABILITIES AND SHAREHOLDERS’ EQUITY
 
CURRENT LIABILITIES    
Notes payable, including current installments of long-term notes payable 17 7,097 11,518 1,392  27 11,518 16,223 2,010 
Current installments of obligations under capital leases 18 1,298 2,144 259  28 2,144 3,373 418 
Accounts payables   928 1,554 188 
Bills payable   438 136 16 
Trade and bills payables 29 1,690 3,929 487 
Sales in advance of carriage   466 874 106  874 1,413 175 
Taxes payable   90 39 5 
Amounts due to related companies 26 929 2,330 282  30 2,434 116 14 
Accrued expenses 19 2,528 4,551 549  31 4,551 4,250 527 
Other liabilities   1,020 2,974 359  32 2,974 3,796 471 
Taxes payable 39 28 3 
       
         
Total current liabilities   14,794 26,120 3,156  26,224 33,128 4,105 
                
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 
         

See accompanying notes to consolidated financial statements.

F-3


CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWSBALANCE SHEETS
For the years endedAs of December 31, 2002, 20032004 and 20042005

(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 
               
                 
  Note 2004 2005 2005
      RMB RMB U.S. dollars
      (restated,        
      Note 3)        
NON-CURRENT LIABILITIES                
Notes payable, excluding current installments  27   11,935   12,740   1,579 
Obligations under capital leases, excluding current installments  28   9,599   12,459   1,544 
Provision for major overhauls  33   284   301   37 
Deferred tax liabilities  25   338   342   42 
Deferred credits      100   496   62 
                 
 
Total non-current liabilities      22,256   26,338   3,264 
                 
 
TOTAL LIABILITIES      48,480   59,466   7,369 
                 
                 
SHAREHOLDERS’ EQUITY                
Equity attributable to equity shareholders of the Company  34,35   11,848   10,000   1,239 
Minority interests      2,055   1,936   240 
                 
 
TOTAL SHAREHOLDERS’ EQUITY      13,903   11,936   1,479 
                 
 
TOTAL LIABILITIES AND TOTAL SHAREHOLDERS’ EQUITY      62,383   71,402   8,848 
                 

See accompanying notes to consolidated financial statements.

F-4


CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES

CONSOLIDATED STATEMENTS
OF CHANGES IN SHAREHOLDERS’ EQUITY
For the years ended December 31, 2002, 2003, 2004 and 20042005

(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 
                  
                             
  Attributable to equity shareholders of the company    
              Retained        
              earnings/        
  Share Share Other (accumulated     Minority Total
  capital premium reserves loss) Total interests equity
  RMB RMB RMB RMB RMB RMB RMB
          (Note (i))         (Note (ii))    
At December 31, 2002  3,374   3,684   586   1,969   9,613   1,516   11,129 
                             
Issue of A Shares  1,000   1,641         2,641      2,641 
(Loss)/income for the year           (358)  (358)  171   (187)
Appropriations to reserves        25   (25)         
Capital contributions from minority shareholders                 1   1 
Distributions to minority shareholders                 (15)  (15)
                             
                             
At December 31, 2003  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 
                             

See accompanying notes to consolidated financial statements.

F-5


CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS
OF CHANGES IN SHAREHOLDERS’ EQUITY
For the years ended December 31, 2003, 2004 and 2005
(Amounts in millions)
                             
  Attributable to equity shareholders of the company    
              Retained        
              earnings/        
  Share Share Other (accumulated     Minority Total
  capital premium reserves loss) Total interests equity
  RMB RMB RMB RMB RMB RMB RMB
          (Note (i))         (Note (ii))    
At December 31, 2004  4,374   5,325   672   1,477   11,848   2,055   13,903 
                             
(Loss)/income for the year           (1,848)  (1,848)  2   (1,846)
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   (390)  10,000   1,936   11,936 
                             
                             
Total equity at December 31, 2005 in U.S. dollars  542   660   85   (48)  1,239   240   1,479 
                             
See accompanying notes to consolidated financial statements.
Notes:
(i) Other reserves represent statutory surplus reserve, statutory public welfare fund and discretionary surplus reserve. Details are set out in Note 35.
(ii) Minority interests were presented separately from liabilities and equity at December 31, 2003 and 2004. Minority interests are presented within the equity with effect from January 1, 2005 and the presentation of minority interests for the comparative years has been restated accordingly. Details are set out in Note 3.

F-6


CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the years ended December 31, 2003, 2004 and 2005
(Amounts in millions)
                     
  Note 2003 2004 2005 2005
      RMB RMB RMB U.S. dollars
      (restated, (restated,        
      Note 3) Note 3)        
(Loss)/income before taxation      (521)  220   (1,853)  (230)
Adjustments to reconcile (loss)/income before taxation to cash inflows from operations                    
Depreciation of property, plant and equipment      1,998   2,363   4,420   548 
Other amortization      40   50   40   5 
Amortization of deferred credits      (2)  (4)  (78)  (10)
Equity (loss)/income of affiliated companies      (45)  (10)  285   36 
Equity income/(loss) of jointly controlled entities      46   16   (36)  (5)
Loss on sale of property, plant and equipment      22   1   32   4 
Interest income      (13)  (22)  (55)  (7)
Interest expense      824   691   1,616   200 
Net realised and unrealised gain on equity securities held for trading         (15)  (6)  (1)
Non-cash exchange loss/(gain), net      177   42   (1,164)  (144)
Decrease/(increase) in inventories      2   (29)  46   6 
Increase in trade receivables      (162)  (218)  (315)  (39)
Decrease/(increase) in other receivables      77   (166)  (236)  (29)
Increase in prepaid expenses and other current assets      (6)  (31)  (2)   
Increase in deferred expenditure         (2)      
Increase/(decrease) in net amounts due from/(to) related companies      404   (586)  (493)  (61)
(Decrease)/increase in trade and bills payables      (466)  (30)  2,239   277 
Increase in sales in advance of carriage      76   408   539   67 
Increase/(decrease) in accrued expenses      203   541   (399)  (49)
Increase in other liabilities      373   1,223   822   102 
Increase in provision for major overhauls      48   113   17   2 
                     
                     
Cash inflows from operations      3,075   4,555   5,419   672 
Interest received      13   22   55   7 
Interest paid      (924)  (754)  (1,616)  (200)
Income tax paid      (35)  (227)  (23)  (3)
                     
Net cash inflows from operating activities      2,129   3,596   3,835   476 
                     
See accompanying notes to consolidated financial statements.

F-7


CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the years ended December 31, 2003, 2004 and 2005
(Amounts in millions)
                     
  Note 2003 2004 2005 2005
      RMB RMB RMB U.S. dollars
      (restated, (restated,        
      Note 3) Note 3)        
Investing activities:                    
Proceeds from sale of property, plant and equipment      57   47   238   30 
Proceeds from sale of other investments            689   85 
Increase in deferred credits            57   7 
Dividends received from affiliated companies         12   2    
Dividends received from jointly controlled entities         5   39   5 
Dividends received from other non-current assets            4   1 
Dividends received from equity securities held for trading         13       
Decrease/(increase) in other non-current assets      6   (9)  4   1 
Payment for the CNA/XJA Acquisitions            (1,959)  (243)
Payment for acquisition of equity interest held by minority shareholders            (118)  (15)
Payment of lease and equipment deposits      (1,852)  (3,151)  (6,649)  (824)
Refund of lease and equipment deposits      1,066   1,253   4,619   572 
Capital expenditures      (4,707)  (6,631)  (4,935)  (612)
Purchase of other investments      (1)  (680)      
Investments in an affiliated company         (9)      
Investments in jointly controlled entities      (3)  (72)      
Effect of the CNA/XJA Acquisitions  40(a)     398       
                     
Net cash used in investing activities      (5,434)  (8,824)  (8,009)  (993)
                     
Net cash outflows before financing activities      (3,305)  (5,228)  (4,174)  (517)
                     
Financing activities:                    
Proceeds from A Shares issue, net of issuance costs      2,641          
Proceeds from notes payable      8,914   14,555   18,238   2,260 
Repayment of notes payable      (8,371)  (7,108)  (12,193)  (1,511)
Repayment of principal under capital lease obligations      (1,555)  (1,272)  (2,050)  (254)
Capital contributions received from minority shareholders      1   71   17   2 
Dividends paid to minority shareholders      (15)  (15)  (20)  (2)
                     
Net cash inflows from financing activities      1,615   6,231   3,992   495 
                     
Decrease/(increase) in cash and cash equivalents      (1,690)  1,003   (182)  (22)
Cash and cash equivalents at January 1      3,770   2,080   3,083   382 
                     
Cash and cash equivalents at December 31      2,080   3,083   2,901   360 
                     
See accompanying notes to consolidated financial statements.

F-8


CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(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.

     The Company was established in the People’s Republic of China (the “PRC”, “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”) 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”) which are listed on the Shanghai Stock Exchange.

     Pursuant to a sale

     The Company acquired the airline operations and purchase agreement dated November 12, 2004 between the Company, CSAHC,certain related assets of China Northern Airlines Company (“CNA”) and Xinjiang Airlines Company (“XJA”) which was approved by the Company’s shareholders in an extraordinary general meeting heldfrom its parent company, CSAHC, 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)40).

     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. SolelyTranslation of amounts from RMB into United States dollar (“US$”) solely for the convenience of readers the 2004 financial statements havehas been translated into United States dollarsmade at the rate of US$1.00 = RMB 8.2765,to RMB8.0694, being the rateaverage of the buying and selling rates as quoted by the People’s Bank of China (the “PBOC”) at the close of business on December 31, 2004.2005. No representation is made that the RMB amounts could have been, or could be, converted into United States dollars (“US$”) at that rate or at any other certain rate on December 31, 20042005 or at any other certain date.

F-6


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 International Financial Reporting Standards (“IFRS”IFRSs”) promulgated by the International Accounting Standards Board. IFRS includesBoard (the “IASB”). IFRSs include International Accounting Standards (“IAS”) and related interpretations.

     The IASB has issued a number of new and revised IFRSs that are effective for accounting periods beginning on or after January 1, 2005. Information on the changes in accounting policies resulting from initial application of these new and revised IFRSs for the current and prior accounting periods reflected in these financial statements is provided in Note 3.
     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.(''U.S. GAAP’’) are set forth in Note 34.51.

F-9


CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(Amounts in millions, except share data)
(b) Basis of preparation

     As of December 31, 2005, the Group’s current liabilities exceeded its current assets by RMB25,907, which includes current instalments of notes payable of RMB16,223. In preparing the consolidated financial statements, the directors have considered the Group’s sources of liquidity and believe that adequate funding is available to fulfil the Group’s short term obligations and capital expenditure requirements. Accordingly, the consolidated financial statements have been prepared on the basis that the Group will be able to continue as a going concern. Further details are set out in Note 41.
     The consolidated financial statements are prepared oncomprise 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 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(d)); and
Short term investments (Note 2(h)).
     The preparation of financial statements in conformity with IFRSIFRSs requires management to make judgements, 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 judgements 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

     Judgements made by management in the application of IFRSs that have been applied consistently bysignificant effect on the Groupfinancial statements and estimates with a significant risk of material adjustment in the next year are consistent with those useddisclosed in previous years.

Note 47.

(c) Basis of consolidation
(i) Subsidiaries

F-10

     The consolidated financial statements include the financial statements of the Company and all of its subsidiaries (see Note 30 for details of the Company’s principal subsidiaries) made up to December 31, each year.


CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(Amounts in millions, except share data)
     A subsidiary is an entity controlled by the Company. Control exists when the Company 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 in 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

F-7


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, but only to the extent that there is no evidence of impairment.

(d) Cash and cash equivalents

     Cash and cash equivalents consist of cash in hand and balances with banks and other financial institutions with an original maturity within three months. For the purposes of the consolidated statements of cash flows, cash and cash equivalents are presented net of bank overdrafts, if any.

(e) Trade and other receivables

     Trade and other receivables are stated at cost less allowance for doubtful accounts. Allowance for doubtful accounts are established based on evaluation of the recoverability of these accounts

     Minority interests at the balance sheet date. In establishing such allowance,date, being the Group considers various factors including its historical write-off experience and industry economic trend. Past due balances over a specific period and balances over a specific amountportion of the net assets of subsidiaries attributable to equity interests that are reviewed individually for collectibility. All other balancesnot owned by the Company, whether directly or indirectly through subsidiaries, are reviewed on a pooled basis.

(f) Inventories

     Inventories, which consist primarily of expendable spare parts and supplies, are 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 at fair value, with any resultant gain or loss recognizedprepared in the consolidated statementsbalance sheet and statement of operations.

     Wherechanges in shareholders’ equity within equity, separately from, equity attributable to the equity shareholders of the Company. Minority interests in the results of the Group hasare presented on 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 instruments represent unquoted available-for-sale equity securities of companies established in the PRC. There is no quoted market price for such equity securities and accordingly a reasonable estimateface of the fair value could not be made without incurring excessive costs.

F-8


CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES

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

(h) Property, plant and equipment and depreciation

(i) Owned assets

     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. Subsequent to the revaluation (see Note 14), which was based on depreciated replacement costs, 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. Revaluations are 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.

     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 asset and are recognized in the consolidated statements of operations on the date of retirement or disposal. Any related revaluation surplus is transferred from the revaluation reserve to retained profits.

(ii) Leased assets

     Leases in terms of which the Group assumes substantially all the risks and rewards of ownership are classified as capital leases.

     Flight equipment acquired by way of capital leases is stated at an amount equal to lower of its fair value and the present value of minimum lease payments at inception of the lease, less accumulated depreciation and impairment losses (see accounting policy m) and the corresponding liabilities, net of finance charges are recorded as obligations under capital leases. Subsequent to 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 date of the revaluation less any subsequent accumulated depreciation and impairment losses. Revaluations are 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.

     The finance charge is allocated to each period during the lease term so as to produce a constant periodic rate of interest on the remaining balance of the liability. Contingent rentals are written off as an expense of the period in which they are incurred.

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

F-9


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 statementsstatement of operations as an integral partallocation of the total lease expense.

(iii) Subsequent costs

     The Group recognizesincome or loss for the year between minority interest and the equity shareholders of the Company.

     Where losses applicable to the minority exceed the minority’s interest in the carrying amountsequity of an item of property, planta subsidiary, the excess, and equipmentany further losses applicable to the cost of replacing part of such an item when that cost is incurred if it is probableminority, are charged against the Group’s interest except to the extent that the future economic benefits embodied withminority has a binding obligation to, and is able to, make additional investment to cover the item will flow tolosses. 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 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:has been recovered.

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.

F-10


CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES

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

(k)(ii) Affiliated companycompanies and jointly controlled entity

entities

     An affiliated company is an entity in which the Group has significant influence, but not control or joint 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 associatesaffiliated companies 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.

F-11


CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(Amounts in millions, except share data)
     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.

F-12


CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(Amounts in millions, except share data)
(iii) 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 accumulated impairment losses. Goodwill is allocated to cash-generating units and is tested annually for impairment (Note 2(l)). In the consolidated balance sheets, the investments inrespect of affiliated companies andor jointly controlled entities, the carrying amount of goodwill is included in the carrying amount of the interest in the affiliated company or jointly controlled entity.
     Any excess of the Group’s interest in the net fair value of the acquiree’s identifiable assets, liabilities and contingent liabilities over the cost of a business combination or an investment in an affiliated company or a jointly controlled entity is recognized immediately in income or loss.
     On disposal of a cash generating unit, an affiliated company or a jointly controlled entity during the year, any attributable amount of purchased goodwill is included in the calculation of the gain or loss on disposal.
(d) Property, plant and equipment and depreciation
(i) Owned assets
     An item of property, plant and equipment is initially recorded at cost less accumulated depreciation (see (iv) below) and impairment losses (Note 2(l)). 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 and the initial estimate, where relevant, of the costs of dismantling and removing the item and restoring the site on which it is located. Subsequent to the revaluation (Note 21), which was based on depreciated replacement costs, 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. Revaluations are performed with 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.
     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 item and are recognized in the statement of operations on the date of retirement or disposal. Any related revaluation surplus is transferred from the revaluation reserve to retained earnings.

F-13


CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(Amounts in millions, except share data)
(ii) Leased assets
     Leases in terms of which the Group assumes substantially all the risks and rewards of ownership are classified as capital leases.
     Flight equipment acquired by way of capital leases is stated at an amount equal to lower of its fair value and the Group’s attributablepresent value of minimum lease payments at inception of the lease, less accumulated depreciation (see (iv) below) and impairment losses (Note 2(l)) and the corresponding liabilities, net of finance charges are recorded as obligations under capital leases. Subsequent to the revaluation (Note 21), which was based on depreciated replacement costs, leased assets are carried at revalued amount, being the fair value at the date of the revaluation less any subsequent accumulated depreciation and impairment losses. Revaluations are performed with 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.
     The finance charge is allocated to each period during the lease term so as to produce a constant periodic rate of interest on the remaining balance of the liability. Contingent rentals are written off as an expense of the period in which they are incurred.
     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 are recognized immediately if the transactions are established at fair value. Any difference between the sales price over fair value is deferred and amortized over the period the assets are expected to be used.
     Where the Group has the use of assets held under operating leases, payments made under operating leases are charged to the statement of operations 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 the statement of operations as an integral part of the aggregate net lease payments. Contingent rentals are charged to the consolidated statement of operations in the accounting period in which they are incurred.
(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 statement of operations as an expense as incurred.

F-14


CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(Amounts in millions, except share data)
(iv) Depreciation
     Depreciation is calculated to write off the cost or revalued amount of net assets.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:
Buildings 15 to 40 years
Owned and leased aircraft 15 to 20 years
Other flight equipment
Jet engines 8 to 15 years
Others, including rotable spares 8 to 15 years
Machinery and equipment 5 to 10 years
Vehicles 6 years
     Depreciation for assets acquired under capital leases is calculated to 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.
     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.
(e) 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)). Cost comprises direct costs of construction and the initial estimate, where relevant, of the costs of dismantling and removing the item and restoring the site on which it is located 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 delay in the issue of the relevant commissioning certificates by the relevant PRC authorities.
     No depreciation is provided in respect of construction in progress.
(f)Lease prepayments
     Lease prepayments represent land use rights paid to the PRC’s governmental authorities. Land use rights are carried at cost less impairment losses (Note 2(l)) and are charged to the statement of operations on a straight-line basis over the respective periods of the rights which range from 30 to 50 years.

F-15

(l)


CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(Amounts in millions, except share data)
(g) 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.

     Deferred expenditure is carried at cost less impairment losses (Note 2(l)).
(h) Other investments in debt and equity securities
     The Group’s policies for investments in debt and equity securities, other than investments in subsidiaries, affiliated companies and jointly controlled entities, are as follows:
     Investments in securities held for trading are classified as current assets and are initially stated at fair value. At the balance sheet date the fair value is remeasured, with any resultant gain or loss recognized in the statement of operations.
     Dated debt securities that the Group has the positive ability and intention to hold to maturity are classified as held-to-maturity securities. Held-to-maturity securities are initially recognized in the balance sheet at fair value plus transaction costs. Subsequently, they are stated in the balance sheet at amortized cost less impairment losses (Note 2(l)).
     Other financial instruments are stated at cost less impairment losses (Note 2(l)). Other financial instruments represent unquoted available-for-sale equity securities of companies established in the PRC. There is no quoted market price for such equity securities and accordingly a reasonable estimate of the fair value could not be measured reliably.
(i) Inventories
     Inventories, which consist primarily of expendable spare parts and supplies, are 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.
(j) 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)).

F-11F-16


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

(k) 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 assets, other than inventories (see accounting policy f), tradecash management are also included as a component of cash and cash equivalents for the purposes of the consolidated statement of cash flows.
(l)Impairment of assets
(i)Impairment of investments in debt and equity securities and other receivables
     Investments in debt and equity securities and other current and non-current receivables (see accounting policy e) and deferred tax assets (see accounting policy r)that are stated at cost or amortized cost are reviewed periodicallyat 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 and current receivables that are 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 current receivables are reversed if in a subsequent period the amount of the impairment loss decreases. Impairment losses for equity securities are not reversed.
For financial assets carried at amortized cost, the impairment loss is measured as the difference between the asset’s carrying amount and the present value of estimated future cash flows, discounted at the financial asset’s original effective interest rate (i.e. the effective interest rate computed at initial recognition of these assets).
     If in ordera subsequent period the amount of an impairment loss decreases and the decrease can be linked objectively to assess whetheran event occurring after the recoverable amounts have declined belowimpairment loss was recognized, the carrying amounts. These assets are tested for impairment whenever events or changesloss is reversed through the statement of operations. A reversal of an impairment loss shall not result in circumstances indicate that their recorded carrying amounts may not be recoverable. When such a decline has occurred, the asset’s carrying amount exceeding that which would have been determined had no impairment loss been recognized in prior years.

F-17


CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(Amounts in millions, except share data)
(ii) Impairment of other assets
     Internal and external sources of information are reviewed at each balance sheet date to identify indications that the following assets may be impaired or an impairment loss previously recognized no longer exists or may have decreased:
Property, plant and equipment;
Construction in progress;
Lease and equipment deposits;
Lease prepayments;
Deferred expenditure; and
Interests in affiliated companies and jointly controlled entities.
If any such indication exists, the asset’s recoverable amount is reduced to the recoverable amount.estimated.
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).
Recognition of impairment losses
     An impairment loss is recognized in the statement of operations 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 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.use, if determinable.

Reversals of impairment losses

F-18


CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(Amounts in millions, except share data)
     An impairment loss is reversed if there has been a favorable change in the estimates used to determine the recoverable amount.
     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 the write-down or write-off not occurred.statement of operations in the year in which the reversals are recognized.

F-19

(n) Interest-bearing


CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(Amounts in millions, except share data)
(m) 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 cost and redemption value being recognized in the consolidated statementsstatement of operations over the period of the borrowings on anusing the effective interest basis.

method.

(n) 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.
(o) Provisions

     A provision is and contingent liabilities

     Provisions are recognized in the consolidated balance sheetsfor liabilities of uncertain timing or amount when the Group 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.

obligation.

     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 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.
(p) 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.

(q) Deferred credits

F-12F-20


CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES

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

(q) Deferred credits

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

F-21


CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(Amounts in millions, except share data)
(r) Deferred taxation

     DeferredIncome tax

     Income tax for the year comprises current and movement in deferred tax assets and liabilities. Current tax and movements in deferred tax assets and liabilities are recognized in the statement of operations 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.
     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 exceptions 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.

profit (provided they are not part of a business combination), and temporary differences relating to investment 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 difference 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

F-22


CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(Amounts in millions, except share data)
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.

available.

          Additional income taxes that arise from the distribution of dividends are recognized when the liability to pay the related dividends is recognized.
          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 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 Group intends either to settle on a net basis, or to realize the asset and settle the liability simultaneously; or
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 realize the current tax assets and settle the current tax liabilities on a net basis or realize and settle simultaneously.
(s) Revenue recognition

(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 of the contributions to the Civil Aviation Administration of China (“CAAC”) Infrastructure Development Fund.

(ii) Interest income is recognized on a time proportion basis according to the outstanding principal and the applicable interest rate.

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

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

(ii)Interest income is recognized as it accrues using the effective interest method.
(iii)Dividend income is recognized when the Group’s right to receive dividend is established.
(iv)Operating lease income is recognized on a straight line basis over the terms of the respective leases.
(t) Traffic commissions

     Traffic commissions are expensed 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-13F-23


CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES

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

(u) Maintenance and overhaul costs

     Routine maintenance, and repairs and overhauls in respect of owned aircraft and aircraft held under capital leases are expensed in the consolidated statementsstatement of operations as and when incurred.
     In respect of owned and capital leased aircraft, components within the aircraft subject to replacement during major overhauls are depreciated over the average expected life between major overhauls. When each major overhaul is performed, its cost is recognized in the carrying amount of property, plant and 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 the statement of operations.
     In respect of aircraft held under operating leases, a provision is made over the lease term for the estimated cost of overhauls required to be performed on the related aircraft prior to their return to the lessors.

(v) Borrowing costs

     Borrowing costs are expensed in the consolidated statementsstatement of operations as and when 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 expenditures for the asset are 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 ceases when substantially all the activities necessary to prepare the qualifying asset for its intended use are complete.

(w) Retirement benefits

     Contributions to retirement schemes and additional retirement benefits paid to retired employees are charged toaccrued in the consolidated statements of operations as and when incurred (Note 25).

year in which the associated services are rendered by employees.

(x) Frequent flyer award programs

     The Group maintains two frequent flyer award programs, 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 programs is recognized when the related transportation services are provided.

F-24


CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(Amounts in millions, except share data)
(y) Translation of foreign currencies

     Transactions in foreign currencies 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 at the balance sheet date. Foreign exchange differences arising on translation are recognized in the statement of operations. 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)

foreign currencies that are stated at fair value are translated into Renminbi at the PBOC exchange rates at the dates the fair value was determined.

(z) Related parties

     For the purposes of these consolidated financial statements, parties are considered to be related to the Group if the Group has the ability, directly or indirectly, to control the party or exercise significant influence over the party in making financial and operating decisions, or vice versa, or where the Group and the party are subject to common control or common significant influence. Related parties may be individuals (being members of key management personnel, significant shareholders and/ or entities.

their close family members) or other entities and include entities which are under the significant influence of related parties of the Group where those parties are individuals, and post-employment benefit plans which are for the benefit of employees of the Group or of any entity that is a related party of the Group.

(aa) 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

3. NEW AND REVISED IFRSs
     The IASB has issued a number of new and revised IFRSs that are effective for accounting periods beginning on or after January 1, 2005.
     The accounting policies of the Group after the adoption of these new and revised IFRSs have been summarized in Note 2. The following sets out information on the significant changes in accounting policies for the years ended December 31, 2002, 2003current and 2004 have been computed by dividing net income/(loss) of RMB576, RMB(358), and RMB(48) respectively, by the weighted average number of sharesprior accounting periods reflected in issue of 3,374,178,000 in 2002, 3,831,712,000 in 2003, and 4,374,178,000 in 2004, respectively.

these financial statements.

     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-15F-25


CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(Amounts in millions, except share data)
     The Group has not applied any new standard or interpretation that is not yet effective for the current accounting period (Note 48).

F-26

3. TRAFFIC REVENUE


     Traffic revenue

CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(Amounts in millions, except share data)
(a) Changes in presentation of share of affiliated companies’ and jointly controlled entities’ taxation (IAS 1, Presentation of Financial Statements)
     In prior years, the Group’s share of taxation of affiliated companies and jointly controlled entities accounted for using the equity method was included as part of the Group’s income tax in the consolidated statement of operations. With effect from January 1, 2005, in accordance with the implementation guidance in IAS 1, the Group has changed the presentation and includes the share of taxation of affiliated companies and jointly controlled entities accounted for using the equity method in the respective shares of income or loss reported in the consolidated statement of operations before arriving at the Group’s income or loss before tax. These changes in presentation have been applied retrospectively with comparatives restated.
     As a result of these changes in presentation, the Group’s share of results of affiliated companies and jointly controlled entities and income tax expense/benefit have been adjusted. Share of income of affiliated companies for the years ended December 31, 2003 and 2004 decreased by RMB3 and RMB2, respectively. Share of losses of affiliated companies for the year ended December 31, 2005 decreased by RMB15. Share of losses of jointly controlled entities increased by RMB7 and RMB11 for the years ended December 31, 2003 and 2004, respectively, and decreased by RMB3 for the year ended December 31, 2005. The Group’s income tax expense has decreased by RMB10 and RMB13 during the years ended December 31, 2003 and 2004, respectively and income tax benefit has decreased by RMB18 during the year ended December 31, 2005. Accordingly, there is no effect on the net results and net assets of the Group in periods presented.
(b)Changes in presentation of minority interests (IAS 1, Presentation of financial statements and IAS 27, Consolidated and separate financial statements)
     In prior years, minority interests at the balance sheet date were presented separately from liabilities and equity in the consolidated balance sheet. Minority interests in the results of the Group for the year were also separately presented in the consolidated statement of operations as a deduction before arriving at the results attributable to shareholders (the equity shareholders of the Company).
     With effect from January 1, 2005, in order to comply with IAS 1 and IAS 27, the Group has changed its accounting policy relating to presentation of minority interests. Under the new policy, minority interests are presented as part of equity, separately from interests attributable to the equity shareholders of the Company. Further details of the new policy are set out in Note 2(c). These changes in presentation have been applied retrospectively with comparatives restated.

F-27


CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(Amounts in millions, except share data)
     As a result of these changes in presentation, the Group’s loss for the years ended December 31, 2003, 2004 and 2005 have decreased by RMB171, RMB203 and RMB2, respectively and the Group’s total equity as of December 31, 2004 and 2005 have increased by RMB2,055 and RMB1,936, respectively.

F-28


CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(Amounts in millions, except share data)
(c) Scope of related parties (IAS 24, Related party disclosures)
     As a result of the adoption of revised IAS 24, the definition of related parties as disclosed in Note 2(z) has been expanded such that state-controlled entities are included. The revised IAS 24 also requires the compensation of key management personnel to be disclosed. The Group has included these additional disclosures in these consolidated financial statements.
4. TURNOVER
     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, 
 2002 2003 2004  2003 2004 2005 
 RMB RMB RMB  RMB RMB RMB 
Traffic revenue 
Passenger 15,696 15,010 21,100  15,010 21,100 34,328 
Cargo and mail 1,786 1,955 2,244  1,955 2,244 3,091 
              
 17,482 16,965 23,344  16,965 23,344 37,419 
              
Other operating revenue 
Commission income 140 203 237 
General aviation income 40 55 77 
Ground services income 99 146 195 
Air catering income 31 53 25 
Net income from lease arrangements (Note 21) 69   
Rental income 40 45 69 
Aircraft lease income  11 1 
Others 86 117 270 
       
 505 630 874 
       
 17,470 23,974 38,293 
       

     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/Hong Kong regional flights during the years ended December 31, 2002, 2003 and 2004, except for the period from May 1, 2003 to December 31, 2003 when passenger revenue was exempted from sales tax.Macau flights. Sales tax incurred by the Group for the years ended December 31, 2002, 2003, 2004 and 2004,2005, netted off against revenue, amounted to RMB558, RMB206, RMB716, and RMB716RMB1,111, respectively.

F-29


CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(Amounts in millions, except share data)
     In addition, the Group is required to pay contributions to the CAAC Infrastructure Development Fund. Prior to May 1, 2003, contributions to CAAC Infrastructure Development Fund were payable at 5% and 2%, respectively, of the domestic and international/Hong Kong regionaland Macau traffic revenue. For 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 part of the flight operations expenses and amounted to RMB466 millionand RMB978 for the years ended December 31, 2004 and 2005, respectively (Note 5). The contributions 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-16F-30


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 
          

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


CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES

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

5. FLIGHT OPERATIONS EXPENSES
             
  Year ended December 31, 
  2003  2004  2005 
  RMB  RMB  RMB 
Jet fuel costs  3,867   6,050   11,929 
Operating lease rentals            
- Aircraft and flight equipment  1,536   1,665   2,497 
- Land and buildings  136   109   302 
Air catering expenses  474   705   1,196 
Aircraft insurance  196   185   105 
Flight personnel payroll and welfare  728   1,026   1,619 
Training expenses  123   183   373 
CAAC Infrastructure Development Fund contributions (Note 4)     466   978 
Others  10   29   395 
          
   7,070   10,418   19,394 
          
6. MAINTENANCE EXPENSES
                        
 Year ended December 31,  Year ended December 31, 
 2002 2003 2004  2003 2004 2005 
 RMB RMB RMB  RMB RMB RMB 
Repairing and maintenance charges 1,842 2,077 2,734  2,289 3,247 4,153 
Maintenance materials 292 300 422  300 212 436 
Labor costs 130 139 227 
Other 69 73 76 
              
 2,333 2,589 3,459  2,589 3,459 4,589 
              

     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 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-18F-31


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,  Year ended December 31, 
 2002 2003 2004  2003 2004 2005 
 RMB RMB RMB  RMB RMB RMB 
Landing and navigation fees 2,353 2,562 3,222  2,562 3,222 4,891 
Ground service charges 158 205 281  205 281 868 
              
 2,511 2,767 3,503  2,767 3,503 5,759 
              

8. PROMOTION AND SALES EXPENSES
                        
 Year ended December 31,  Year ended December 31, 
 2002 2003 2004  2003 2004 2005 
 RMB RMB RMB  RMB RMB RMB 
Sales commissions 750 757 1,062  757 1,062 1,503 
Ticket office expenses 516 504 552  504 552 659 
Computer reservation services 175 175 233  175 233 417 
Advertising and promotion 31 24 36  24 36 32 
Other 28 20 57 
Others 20 57 169 
              
 1,500 1,480 1,940  1,480 1,940 2,780 
              

9. GENERAL AND ADMINISTRATIVE EXPENSES
                        
 Year ended December 31,  Year ended December 31, 
 2002 2003 2004  2003 2004 2005 
 RMB RMB RMB  RMB RMB RMB 
General corporate expenses 659 680 696  1,011 1,260 2,408 
Salaries and welfare 380 339 575 
Provision for doubtful accounts (Note 33) 1 12 27 
Impairment losses for trade and other receivables (Note 17) 12 27  
Auditors’ remuneration 8 11 12 
Other taxes and levies 20 22 25  22 25 37 
              
 1,060 1,053 1,323  1,053 1,323 2,457 
              

F-19F-32


CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(Amounts in millions, except share data)
10. DEPRECIATION AND AMORTIZATION
             
  Year ended December 31, 
  2003  2004  2005 
  RMB  RMB  RMB 
Depreciation            
- Owned assets  1,502   1,891   3,292 
- Assets acquired under capital leases  496   472   1,128 
Amortization of deferred credits        (20)
Other amortization  40   50   40 
          
   2,038   2,413   4,440 
          
     Depreciation of property, plant and equipment leased out under operating leases amounted to RMB55, RMB55 and RMB35 for the years ended December 31, 2003, 2004 and 2005, respectively.
11. STAFF COSTS
             
  Year ended December 31, 
  2003  2004  2005 
  RMB  RMB  RMB 
Salaries, wages and welfare  1,496   2,260   3,515 
Retirement schemes contributions  150   168   472 
          
   1,646   2,428   3,987 
          
     Staff costs relating to flight operations, maintenance, aircraft and traffic servicing, promotion and sales and general and administrative expenses are also included in the respective total amounts disclosed separately in Notes 5 to 9 above.

F-33

10. TAXATION EXPENSE/(CREDIT)


CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(Amounts in millions, except share data)
12. INTEREST EXPENSE
             
  Year ended December 31, 
  2003  2004  2005 
  RMB  RMB  RMB 
Interest on bank and other notes payable wholly repayable within five years  288   221   211 
Interest on other notes payable  176   156   877 
Finance charges on obligations under capital leases  443   348   626 
Less: borrowing costs capitalized  (83)  (34)  (98)
          
   824   691   1,616 
          
     The borrowing costs have been capitalized at rates ranging from 1.62% to 5.46% per annum, 1.51% to 3.48% per annum, and 4.14% to 5.27% per annum for the years ended December 31, 2003, 2004 and 2005, respectively.
13. INCOME TAX (BENEFIT)/EXPENSE
a) Income tax (benefit)/expense in the consolidated statements of operations
             
  Year ended December 31, 
  2003  2004  2005 
  RMB  RMB  RMB 
  (restated,  (restated,     
  Note 3)  Note 3)     
PRC income tax  47   176   12 
             
Deferred tax (Note 25)            
- current year  11   (111)  (19)
- adjustment for change in enacted tax rate  (392)      
          
   (334)  65   (7)
          
     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.

F-34


CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(Amounts in millions, except share data)
     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, 2004 and 2004.

2005.
b) Reconciliation between tax (benefit)/expense and accounting (loss)/income at applicable tax rates
             
  Year ended December 31, 
  2003  2004  2005 
  RMB  RMB  RMB 
  (restated,  (restated,     
  Note 3)  Note 3)     
(Loss)/income before tax  (521)  220   (1,853)
          
             
Expected tax on (loss)/income before tax calculated at 15% for the years ended December 31, 2003, 2004 and 2005  (78)  33   (278)
Adjustments:            
Effect on change in income tax rate on deferred taxation  (392)      
Rate differential on subsidiaries/branches  5   3   7 
Tax effect of non-deductible expenses  80   29   82 
Tax effect of non-taxable income        (8)
Tax effect of share of results of affiliated companies and jointly controlled entities  (9)  (1)  37 
Tax effect of unused tax losses not recognized  22      135 
Expired tax losses  34       
Others  4   1   18 
          
Actual tax (benefit)/expense  (334)  65   (7)
          
     All but an insignificant amount of (loss)/income before taxation is from domestic sources.

     Taxation expense/(credit) consisted of:

             
  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-20F-35


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, 
  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, 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 Tax Bureau, lease arrangements executed prior to September 1, 1999 were exempted from PRC withholding tax.

     The PRC withholding tax payable by the Group for the years ended December 31, 2002, 2003, 2004 and 20042005 of RMB14, RMB8, RMB23 and RMB23,RMB55, respectively, in respect of the operating leases executed after September 1, 1999 has been included as part of the operating lease rentals.

F-21


CHINA SOUTHERN AIRLINES COMPANY LIMITED14. DIVIDENDS
AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(Amounts

     No interim dividend was paid during the years ended December 31, 2003, 2004 and 2005.
     The board of directors of the Company does not recommend the payment of a final dividend in millions, exceptrespect of the year ended December 31, 2005. No final dividend was paid in respect of the years ended December 31, 2003 and 2004.
15. BASIC LOSS PER SHARE
     The calculation of basic loss per share data)

11.for the years ended December 31, 2003, 2004 and 2005 is based on the loss attributable to equity shareholders of the Company of RMB358, RMB48, and RMB1,848, respectively, and the weighted average number of shares in issue of 3,831,712,000, 4,374,178,000, and 4,374,178,000, respectively.

     The amount of diluted loss per share is not presented as there were no dilutive potential ordinary shares in existence during the years ended December 31, 2003, 2004 and 2005.
16. CASH AND CASH EQUIVALENTS

     As of December 31, 20032004 and 2004,2005, cash and cash equivalents comprise cash at bank and in hand and 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 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, 20032004 and 2004,2005, the Group’s deposits with SA Finance amounted to RMB366RMB406 and RMB406, respectively (Note 26).

RMB544, respectively.

12. 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 
       

     Net realized gains on equity securities held for trading during the year ended December 31, 2003 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-22F-36


CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(Amounts in millions, except share data)
     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, 
  2004  2005 
United States Dollars US$    37  US$    24 
Japanese Yen JPY1, 272  JPY1, 161 

F-37


CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(Amounts in millions, except share data)
17. TRADE RECEIVABLES
         
  December 31,
  2004 2005
  RMB RMB
Trade receivables, principally traffic  1,295   1,562 
Less: Impairment losses for bad and doubtful accounts  (92)  (44)
         
   1,203   1,518 
         
     Credit terms granted by the Group to sales agents and other customers generally range from one to three months. An ageing analysis of trade receivables, net of impairment losses for bad and doubtful accounts, is set out below:
         
  December 31,
  2004 2005
  RMB RMB
Within 1 month  998   1,366 
More than 1 month but less than 3 months  163   137 
More than 3 months but less than 12 months  42   14 
More than 12 months     1 
         
   1,203   1,518 
         
     As of December 31, 2004 and 2005, the Group had an amount due from a fellow subsidiary of RMB52 and RMB42, respectively, which was included in trade receivables.
     All of the trade receivables are expected to be recovered within one year.
     Included in trade receivables are the following amounts denominated in a currency other than the functional currency of the entity to which they relate:
         
  December 31, 
  2004  2005 
United States Dollars US$11  US$15 
       

F-38


CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(Amounts in millions, except share data)
     Movements in impairment losses for bad and doubtful accounts comprise:
         
  Year ended December 31,
  2004 2005
  RMB RMB
At January 1  70   92 
Impairment losses for bad and doubtful accounts (Note 9)  27    
Through the CNA/XJA Acquisitions  44    
Bad and doubtful accounts written off  (49)  (48)
         
At December 31  92   44 
         
18. INVENTORIES
         
  December 31,
  2004 2005
  RMB RMB
Expendable spare parts and maintenance materials  1,175   1,241 
Other supplies  127   141 
         
   1,302   1,382 
         
     The analysis of the amount of inventories recognized as an expense is as follows:
         
  December 31,
  2004 2005
  RMB RMB
Consumption  596   720 
Write-down of inventories     209 
         
   596   929 
         
As a result of fleet adjustment, inventories have been written down by RMB209 at December 31, 2005.

F-39


CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(Amounts in millions, except share data)
19. OTHER INVESTMENTS
         
  December 31,
  2004 2005
  RMB RMB
Non-current investments
        
Unlisted equity securities available for sale, at cost  272   320 
         
         
Current investments
        
Listed equity securities held for trading  523    
Listed debt securities held-to-maturity  160    
         
   683    
         
         
Market value of listed securities  683    
         
     The current investments at December 31, 2004 were listed outside Hong Kong.
     Net realized and unrealized gain on trading securities of the Group amounted to RMBNil, RMB15 and RMB6 during the years ended December 31, 2003, 2004 and 2005, respectively.
     Dividend income from unlisted securities of the Group amounted to RMBNil, RMB14 and RMB4 during the years ended December 31, 2003, 2004 and 2005, respectively.
     The amortized cost, gross unrealized holding gains, gross unrealized holding losses, and fair value of debt security held-to-maturity as of December 31, 20032004 and 20042005 were as follows:
                 
      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 
             
                 
      Gross Gross  
      unrealized unrealized  
  Amortized holding holding  
  cost gains losses Fair value
  RMB RMB RMB RMB
As of December 31, 2004                
 
Debt securities held-to-maturity  160         160 
                 
 
As of December 31, 2005                
 
Debt securities held-to-maturity            
                 

F-23F-40


CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES

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

14.20. OTHER RECEIVABLES
     As of December 31, 2004 and 2005, other receivables of the Group included an amount due from Zhongyuan Airlines Company Limited (“Zhongyuan Airlines”) of RMB104 and RMB98, respectively. As of December 31, 2005 and up to date of approval of these consolidated financial statements, the Group is in the process of applying for transfer of certain properties held by Zhongyuan Airlines for settlement of the balance.
21. 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 
                   
                         
              Other flight    
      Aircraft equipment, Machinery,  
          Held including equipment  
          under capital rotable and  
  Buildings Owned leases spares vehicles Total
Cost or valuation:
                        
At January 1, 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 
Transfer 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 December 31, 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 (Note (b))  355   6,229   4,340   2,174   484   13,582 
                         
 
   6,988   27,134   14,529   9,044   2,599   60,294 
                         
                         
At January 1, 2005  6,988   27,134   14,529   9,044   2,599   60,294 
Exchange adjustments  (6)           (14)  (20)
Additions  64   1,827   8,146   1,336   307   11,680 
Transfer from construction in progress  513            56   569 
Transfer to inventories           (126)     (126)
Disposals  (256)        (207)  (81)  (544)
                         
 
At December 31, 2005  7,303   28,961   22,675   10,047   2,867   71,853 
                         
                         
Representing:                        
Cost  6,948   22,732   18,335   7,873   2,383   58,271 
Valuation - 1996 (Note (b))  355   6,229   4,340   2,174   484   13,582 
                         
   7,303   28,961   22,675   10,047   2,867   71,853 
                         

F-24F-41


CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES

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

                         
              Other flight    
      Aircraft equipment, Machinery,  
          Held including equipment  
          under capital rotable and  
  Buildings Owned leases spares vehicles Total
Accumulated depreciation:
                        
                         
At January 1, 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 
Disposals  (17)        (51)  (61)  (129)
                         
 
At December 31, 2004  757   4,331   2,894   4,137   1,334   13,453 
                         
                         
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   1,546   1,108   1,121   418   4,420 
Disposals  (74)        (145)  (55)  (274)
                         
 
At December 31, 2005  909   5,877   4,002   5,113   1,686   17,587 
                         
                         
Net book value:
                        
                         
At December 31, 2004  6,231   22,803   11,635   4,907   1,265   46,841 
                         
                         
At December 31, 2005  6,394   23,084   18,673   4,934   1,181   54,266 
                         
(a) Substantially all of the Group’s buildings are located in the PRC. The Group was formally granted the rights to use the twenty 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 five 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, RMB15RMB2, RMB2 and RMB18RMB24 were paid to CSAHC for each of the years ended December 31, 2002, 2003, 2004 and 20042005, respectively in respect of these leases (Note 24)36).

     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:

         
  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.

F-42

     In accordance with IAS 16 “Property, Plant and Equipment”, subsequent


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. Revaluation is performed periodicallywith sufficient regularity 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

Consequently, no additional fair value adjustment was recorded during the year ended December 31, 2005.


CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES

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

     The effect     At December 31, 2005, 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, 2004 and 2005, certain aircraft of the Group bywith an aggregate carrying amount of approximately RMB33, RMB33RMB23,562 and RMB13,RMB30,408, 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. 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.

28).

(d) In 2003, the Group entered into operating lease arrangements to lease certain flight training facilities and buildings to Zhuhai Xiang Yi Aviation Technology Company Limited (“Zhuhai Xiang Yi”), a jointly controlled entity of the Group. The leases with initial one-year term are automatically renewable for anotheradditional subsequent one year unless either party gives appropriate notice of termination. In this connection, rental income totaling RMB34RMB31, RMB31 and RMB31 was received by the Group for each of the years ended December 31, 2003, 2004 and 20042005 in respect of the leases. As of December 31, 2004, the costleases (Note 36). The carrying amount and accumulated depreciation of the relevant property, plant and equipment totaled RMB787 and RMB514 at December 31, 2004, and RMB862 and RMB664 at December 31, 2005, respectively. Depreciation of relevant property, plant and equipment recognized for each of the yearyears ended December 31, 2003, 2004 and 20042005 amounted to RMB55.RMB55, RMB55 and RMB35, respectively. As of December 31, 2004,2005, the Group’s rentaltotal future minimum lease payments under non-cancellable operating leases were receivable in respect of the leases due in 2005within one year and amounted to RMB34.RMB31.

F-43

     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.


CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(Amounts in 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, 20032004 and 2004,2005, the net present value of the lease commitments and the corresponding defeased deposits and debt securities amounted to RMB2,409RMB2,462 and RMB 2,462,RMB2,376, respectively. As a result of the Arrangements, the Group received net cash benefitsbenefit of RMB52 and RMB69 in 2002 and 2003, respectively, which have beenwas recognized as income for the respective years.

F-26

2003.


CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES

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

(f) As of December 31, 20042005 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 and 2005, carrying value of such properties of the Group amounted to RMB2,477.RMB2,319 and RMB2,316, 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.

22. CONSTRUCTION IN PROGRESS

     As

         
  December 31,
  2004 2005
  RMB RMB
At January 1  1,630   565 
Additions  1,616   678 
Through the CNA/XJA Acquisitions  26    
Transfer to property, plant and equipment  (2,707)  (569)
         
At December 31  565   674 
         
     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 relation2005 mainly related to the construction of facilities inprojects at the Guangzhou, new airport.Jilin and Fuzhou airports, Shenzhen cargo centre and Beijing branch.

F-44

16. INVESTMENTS

         
  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 
       


CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(Amounts in millions, except share data)
23. INTEREST IN AFFILIATED COMPANIES
         
  December 31,
  2004 2005
  RMB RMB
Share of net assets  429   142 
         
     Details of the Group’s principal affiliated companies andare set out in Note 50, all of which are unlisted corporate entities.
     Summary financial information on affiliated companies:
                         
  100% Group’s effective interest
  December 31, December 31,
  2003 2004 2005 2003 2004 2005
  RMB RMB RMB RMB RMB RMB
Non-current assets      4,254   5,334       1,672   2,081 
Current assets      2,165   2,275       1,049   455 
Non-current liabilities      (2,918)  (3,897)      (1,290)  (1,520)
Current liabilities      (2,568)  (3,318)      (1,002)  (874)
                         
Net assets      933   394       429   142 
                         
                         
Revenues  1,756   2,676   3,314   682   1,042   1,318 
Expenses  (1,637)  (2,633)  (3,798)  (634)  (1,030)  (1,618)
Taxation  (6)  (5)  (39)  (3)  (2)  15 
                         
Income/(loss) for the year  113   38   (523)  45   10   (285)
                         
24. INTEREST IN JOINTLY CONTROLLED ENTITIES
         
  December 31, 
  2004  2005 
  RMB  RMB 
Share of net assets  782   805 
       
     Details of the Group’s principal jointly controlled entities are set out in Note 30.

50, all of which are unlisted corporate entities.

F-27F-45


CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(Amounts in millions, except share data)
     Summary financial information on jointly controlled entities:
             
  Group’s effective interest
  December 31,
  2003 2004 2005
  RMB RMB RMB
Non-current assets      845   920 
Current assets      794   877 
Non-current liabilities      (389)  (524)
Current liabilities      (468)  (468)
             
 
Net assets      782   805 
             
             
Revenues  545   762   1,115 
Expenses  (585)  (767)  (1,082)
Taxation  (6)  (11)  3 
             
 
(Loss)/income for the year  (46)  (16)  36 
             
25. DEFERRED TAX ASSETS/LIABILITIES
     Movements of net deferred tax (liabilities)/assets are as follows:
         
  December 31,
  2004 2005
  RMB RMB
At January 1  (398)  (287)
Credited to consolidated statements of operations (Note 13)  111   19 
         
 
At December 31  (287)  (268)
         

F-46

17. DEBT

Short-term notes payable

         
  December 31, 
  2003  2004 
  RMB  RMB 
Short-term notes payable  6,409   9,925 
       


CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(Amounts in millions, except share data)
     The deferred tax (liabilities)/assets as of December 31, 2004 and 2005 were made up of the following tax effects:
         
  December 31,
  2004 2005
  RMB RMB
Deferred tax assets:        
Tax losses  39   159 
Repair charges capitalized  254   275 
Accrued expenses  275   175 
Others  21   29 
         
         
Total deferred tax assets  589   638 
         
 
         
Deferred tax liabilities:        
Accrued expenses  75   58 
Depreciation allowances in excess of the related depreciation  752   832 
Others  49   16 
         
 
Total deferred tax liabilities  876   906 
         
         
   (287)  (268)
         
         
Net deferred tax asset recognized on the consolidated balance sheet  51   74 
 
Net deferred tax liability recognized on the consolidated balance sheet  (338)  (342)
         
         
   (287)  (268)
         

F-47


CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(Amounts in millions, except share data)
     As of December 31, 20032004 and 2004, borrowings under short-term notes payable of2005, the Group had tax losses for PRC income tax purposes totaling RMB130approximately RMB260 and RMB411, respectively, were guaranteed by CSAHC.RMB1,601. Such tax losses are available for carry forward to set off against future PRC assessable income for a maximum period of five years and will expire in 2011. In addition,accordance with accounting policy set out in Note 2(r), as of December 31, 2003, borrowings2004 and 2005, the Group has not recognized deferred tax assets in respect of tax losses to the extent of approximately Nil and RMB710 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.
     As of December 31, 2004 and 2005, the Group has also not recognized deferred tax assets in respect of cumulative tax losses from operations in Hong Kong of approximately RMB303, as it is not probable that future taxable income against which the losses can be utilized will be available. The tax losses do not expire under short-term notes payablecurrent tax legislation.
26. OTHER ASSETS
     As of December 31, 2004 and 2005, other assets of the Group totaling RMB63include lump sum housing benefits of RMB197 and RMB21 were guaranteed by Guangzhou Baiyun International Airport Company Limited and Shenzhen Yingshun Investment Development Company Limited,RMB171, respectively. These notes payable were fully repaidFurther details are set out in 2004.

Note 37.

     Movements of lump sum housing benefits are as follows:
         
  December 31,
  2004 2005
  RMB RMB
At January 1  223   197 
Amortization for the year  (26)  (26)
         
At December 31  197   171 
         
27.DEBT
Short-term notes payable
         
  December 31,
  2004 2005
  RMB RMB
Short-term notes payable  9,925   14,346 
Current installments of long-term notes payable  1,593   1,877 
         
   11,518   16,223 
         
     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%3.15% to 5.31%.5.34% per annum. The Group’s weighted average interest rate on short-term notes payable was 1.76%1.60% and 1.60%,4.83% per annum, respectively, as of December 31, 20032004 and 2004.

2005.
     Short-term notes payable include certain notes payable of RMB2,611 which were renewed subsequent to December 31, 2005. The renewed notes payable are unsecured, bear interest at floating rates ranging from 3-month HIBOR/6-month LIBOR + 0.55% to 0.60% per annum and are repayable within one year from their respective renewal dates.
      In addition, the Group entered into new notes payable agreements totalling RMB2,671 subsequent to December 31, 2005. These new notes payable are unsecured and bear interest at floating rates ranging from 6-month LIBOR + 0.55% to 0.70% per annum with maturities through 2008.

F-28F-48


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 
       
         
  December 31,
Interest rate and final maturity 2004 2005
  RMB RMB
Renminbi denominated notes payable
        
         
Non-interest bearing loan from a municipal government authority repayable on demand  3   3 
         
Floating interest rates ranging from 5.02% to 5.51% per annum as of December 31, 2005, with maturities through 2011  1,217   877 
         
United States Dollars denominated notes payable
        
         
Fixed interest rates ranging from 4.43% to 7.73% per annum as of December 31, 2005, with maturities through 2015  2,676   2,414 
         
Floating interest rates ranging from 3 months LIBOR + 0.70% to 0.90% per annum as of December 31, 2005, with maturities through 2012  1,426   3,610 
         
Floating interest rates ranging from 6 months LIBOR + 0.3% to 1.20% per annum as of December 31, 2005, with maturities through 2013  8,206   7,713 
         
   13,528   14,617 
         
Less: current installments  (1,593)  (1,877)
         
   11,935   12,740 
         

     As of December 31, 20032004 and 2004, borrowings under long-term2005, bank and other notes payable of the Group totaling RMB2,565RMB8,620 and RMB2,172,RMB8,116, respectively, were guaranteed by certain financial institutions and secured by the mortgages over certain of the Group’s aircraft. In addition, asaircraft with carrying amount of December 31, 2003RMB11,927 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.RMB11,735, respectively.

F-49


CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(Amounts in millions, except share data)
     As of December 31, 2004 and 2005, certain bank and other notes payable were guaranteed by the following parties:
         
  December 31,
  2004 2005
  RMB RMB
Guarantors
        
         
Short-term notes payable
        
CSAHC  411   300 
         
Long-term notes payable
        
Industrial Commercial Bank of China  149   111 
Export-Import Bank of the United States  1,732   1,171 
Bank of China  291   155 
CSAHC  2,041   1,608 
Shenzhen Yingshun Investment Development Company Limited     22 
SA Finance  9   7 
         
   4,633   3,374 
         
     As of December 31, 2005, the Group had banking facilities with several PRC commercial banks for providing loan finance up to an approximate amount of RMB35,750.RMB39,294. As of December 31, 2005, an approximate amount of RMB28,242 was utilized.
     As of December 31, 2004 an approximate amount of RMB11,525 was utilized.and 2005, loans to the Group from SA Finance amounted to RMB256 and RMB300, respectively (Note 36(b)).

F-50


CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(Amounts in millions, except share data)
     The aggregate annual maturities of long-term notes payable for each of the five years subsequent to December 31, 20042005 and thereafter are as follows:

     
  RMB
Year ending December 31,
    
2006  1,877 
2007  4,316 
2008  2,156 
2009  1,435 
2010  660 
Thereafter  4,173 
     
   14,617 
     
     Included in bank and other loans are the following amounts denominated in a currency other than the functional currency of the entity to which they related:
         
  December 31,
  2004 2005
United States Dollars US$1,969 US$3,208
Hong Kong Dollars HK$2,678 HK$1,821
      

F-29F-51


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 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 at 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


CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES

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

18.28. LEASE OBLIGATIONS

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 fromexpiring during the years 2006 to 2017.
     As of December 31, 2005, through 2013.

future payments under these capital leases are as follows:

             
  Payments *Interest Obligations
  RMB RMB RMB
Year ending December 31,
            
2006  4,030   657   3,373 
2007  3,423   493   2,930 
2008  3,016   408   2,608 
2009  1,684   307   1,377 
2010  1,050   238   812 
Thereafter  5,412   680   4,732 
             
   18,615   2,783   15,832 
             
             
Less: current installments of obligations under capital leases          (3,373)
             
           12,459 
             
*Interest rates ranging from 1.44% to 8.01% per annum
     As of December 31, 2004, 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  Payments *Interest Obligations
 RMB RMB RMB  RMB RMB RMB
Year ending December 31,
Year ending December 31,
 
2005 2,580 436 2,144  2,580 436 2,144 
2006 3,213 350 2,863  3,213 350 2,863 
2007 2,844 279 2,565  2,844 279 2,565 
2008 2,699 146 2,553  2,699 146 2,553 
2009 997 71 926  997 71 926 
Thereafter 722 30 692  722 30 692 
              
 13,055 1,312 11,743  13,055 1,312 11,743 
          
Less: current instalments of obligations under capital leases  (2,144)
Less: current installments of obligations under capital leases  (2,144)
      
 9,599  9,599 
      
 
* Interest rates rangedranging from 1.92% to 8.48% per annum

F-52


CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(Amounts in millions, except share data)
     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.

     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, 2004 and 2005, certain of the Group’s aircraft with an aggregate carrying amount of RMB7,858RMB11,635 and RMB11,635,RMB18,673, respectively as of December 31, 2003 and 2004 were mortgaged to secure facilities with financial institutions grantedfinance lease obligations RMB11,743 and RMB15,832, 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 RMB6,841which they relate:
         
  December 31,
  2004 2005
United States Dollars US$958 US$1,556
Japanese Yen JPY47,840 JPY47,795
     
Operating leases
     As of December 31, 2005, future minimum lease payments under non-cancellable aircraft and RMB11,743, respectively, on these dates.

flight equipment operating leases were as follows (principally denominated in U.S. dollars):
     
  RMB
Year ending December 31,
    
2006  3,340 
2007  2,881 
2008  2,785 
2009  2,609 
2010  2,523 
Thereafter  10,456 
     
 
Total minimum lease payments  24,594 
     

F-31F-53


CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES

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

Operating leases

     As of December 31, 2004, future minimum lease payments under non-cancellable aircraft and flight equipment operating leases were as follows (principally denominated in U.S. dollars):
     
  RMB
Year ending December 31,
    
2005  1,761 
2006  1,622 
2007  1,562 
2008  5,259 
2009  764 
Thereafter  1,782 
     
 
Total minimum lease payments  12,750 
     

     Amounts charged to rental expenses for operating leases for

29.TRADE AND BILLS PAYABLES
         
  December 31,
  2004 2005
  RMB RMB
Trade payables  1,554   3,033 
Bills payable  136   896 
         
   1,690   3,929 
         
     The following is the years endedageing analysis of trade and bills payables:
         
  December 31,
  2004 2005
  RMB RMB
Within 1 month  735   2,000 
More than 1 month but less than 3 months  431   1,225 
More than 3 months but less than 6 months  524   704 
         
   1,690   3,929 
         
     As of December 31, 2002, 20032004 and 2004 totaled RMB1,348, RMB1,4092005, the Group had an amount due to a fellow subsidiary of RMB838 and RMB1,475, respectively.

RMB859, respectively, which was included in trade and bills payables.

     All of the Group’s obligations under capitaltrade and operating leasesbills payables are guaranteed by financial institutions.

expected to be settled within one year.

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-32F-54


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     Included in trade and bills payables are the following amounts denominated in a currency other than the functional currency of the entity to certain aircraft operating lease arrangements, the Group received cash rebateswhich they relate:

         
  December 31,
  2004 2005
United States Dollars US$108  US$147 
30.AMOUNTS DUE FROM/TO RELATED COMPANIES
(a)Amounts due from related companies
         
  December 31,
  2004 2005
  RMB RMB
Jointly controlled entities  84
     The amounts due from the lessors. Such rebatesrelated companies were unsecured, interest free and have been deferred and amortized over theno fixed terms of the respective leases.

Governmental subsidy for safetyrepayment.

(b)Amounts due to related companies
         
  December 31,
  2004 2005
  RMB RMB
CSAHC and its subsidiaries  2,094   12 
An affiliated company     5 
Jointly controlled entities  340   99 
         
   2,434   116 
         
     The amounts due to related capital expenditures

     During 2002, the Group received governmental subsidy for safety related capital expenditures amounting to RMB40 for enhancing future flight protectioncompanies were unsecured, interest free and safety standards. Such governmental subsidy is to be amortized over the depreciable lives of the related property, plant and equipment.

Capital lease rebates

     Pursuant 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 thehave no fixed terms of the respective leases to reduce the future capital lease charges.

repayment.

F-33F-55


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)
       

     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  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


CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(Amounts in millions, except share data)
31.ACCRUED EXPENSES
         
  December 31,
  2004 2005
  RMB RMB
Jet fuel costs  743   686 
Operating lease charges  29   86 
Air catering expenses  192   132 
Salaries and welfare  349   193 
Lump sum housing benefits payable  108   92 
Repairs and maintenance  976   996 
Provision for major overhauls (Note 33)  75   151 
Landing and navigation fees  1,331   1,129 
Computer reservation services  195   190 
Interest expense  240   338 
Duties and levies  71   12 
Property management fee     37 
Others  242   208 
         
   4,551   4,250 
         
32.OTHER LIABILITIES
         
  December 31,
  2004 2005
  RMB RMB
CAAC Infrastructure Development fund  161   177 
Airport construction surcharge  316   542 
Airport tax  112   198 
Construction cost payable  864   793 
Advance payment on chartered flights  119   104 
Sales agent deposits  182   198 
Other tax payable  332   441 
Others  888   1,343 
         
   2,974   3,796 
         

F-56

     As of December 31, 2004, the Group had tax losses 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 asset in respect of such tax losses as it would not be probable that future taxable profits will be available against which the taxable losses can be utilized.

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, 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


CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(Amounts in the PRC. Themillions, except share premium received by the Company, net of the issuance costs of RMB59, amounted to RMB1,641 and was credited to share premium account.

data)

33.PROVISION FOR MAJOR OVERHAULS
Details of provision for major overhauls in respect of aircraft held under operating leases are as follows:
         
  Year ended December 31,
  2004 2005
  RMB RMB
At January 1  200   359 
Provision for the year  89   129 
Through the CNA/XJA Acquisitions  70    
Amount utilized     (36)
         
         
At December 31  359   452 
Less: current portion included in accrued expenses (Note 31)  (75)  (151)
         
         
   284   301 
         
34.SHARE CAPITAL
         
  December 31,
  2004 2005
  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, 20032004 and 2004,2005, the retained earningsearnings/accumulated loss of the Group included RMB112RMB81 and RMB81,RMB(200), respectively, of undistributed earningsearnings/losses of companies which are 50% or less owned by the Group and accounted for under the equity method.

F-35F-57


CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES

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

23. OTHER35. 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, 
  2004  2005 
  RMB RMB
Share premium
        
At January 1 and December 31  5,325   5,325 
       
         
Statutory surplus reserve (Note (a))
        
At 1 January  361   402 
Transfer from retained earnings  41   8 
       
At December 31  402   410 
       
         
Statutory public welfare fund (Note (b))
        
At 1 January  173   193 
Transfer from retained earnings  20   5 
       
At December 31  193   198 
       
         
Discretionary surplus reserve (Note (c))
        
At 1 January  77   77 
Transfer from retained earnings     6 
       
At December 31  77   83 
       
         
Retained earnings/(accumulated loss)
        
At 1 January  1,586   1,477 
Loss for the year  (48)  (1,848)
Appropriations to reserves  (61)  (19)
       
At December 31  1,477   (390)
       
         
Total
  7,474   5,626 
       
 
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.

     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-36F-58


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.

(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

     Pursuantlisted. As of December 31, 2005, the Company did not have any distributable reserves.

36. RELATED PARTY TRANSACTIONS
     In addition to the Reorganisationbalances discussed in Notes 16, 17, 21, 27, 29 and 30 to these consolidated financial statements, the Group entered into the following material related party transactions.
(a) Significant transactions with related companies
     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 effected in 1995 (Note 1),was under the Company assumeddirect control of the airline and airline-related businesses togetherCivil Aviation Administration of China (the “CAAC”). However, such control has been shifted to the China State-owned Assets Administration Bureau since early 2003. Consequently, transactions with the relevant assetsCAAC and liabilitiesits affiliates beginning from CSAHC. The Company has been advised by its PRC lawyers that, except for liabilities constituting or arising out of or relating to the businesses assumed by the Company in the Reorganisation,2003 are 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 occupancylonger presented as related party transactions 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.

Group.

F-37F-59


CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(Amounts in millions, except share data)
Details of the significant transactions carried out are as follows:
               
    2003 2004 2005
  Note RMB RMB RMB
Expenses paid to CSAHC and its affiliates
              
               
Handling charges (i)  27   33   32 
Air catering supplies (ii)  90   170   173 
Wet lease rentals (iii)  36       
Commission expense (iv)  5   2   26 
Sundry aviation supplies (v)  43   66   88 
Lease charges for aircraft (vi)        10 
Lease charges for land and buildings (vii)  15   18   90 
Property management fee (viii)        28 
Housing benefits (ix)  85   85    
               
Expenses paid to affiliated companies and jointly controlled entities
              
               
Ground service expenses (x)        32 
Repairing charges (xi)  693   1,159   1,118 
Flight simulation service charges (xii)  101   100   126 
Interest expense (xiii)     3   37 
               
Income received from affiliated companies and jointly controlled entities
              
               
Rental income (xii)  31   31   31 
Interest income (xiii)  3   4   3 
               
Others
              
               
CNA/XJA Acquisitions (xiv)     15,522    
Operating expenses recharged to related companies (xv)     65    
Short term advances from CSAHC (xvi)  166       
Refund of medical benefit payments (xvii)  58       
(i)The Group acquires aircraft, flight equipment and other airline-related facilities through Southern Airlines (Group) Import and Export Trading Company (“SAIETC”), a wholly-owned subsidiary of CSAHC.

F-60

     The Company is involved


CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(Amounts in a civil litigation (Hong Kong High Court Action No. 515 of 2001) (“Litigation”) which commencedmillions, except share data)
(ii)The Group purchases certain inflight meals and related services from Shenzhen Air Catering Company Limited, a co-operative joint venture established in the PRC, in respect of which CSAHC is entitled to 33% of its income after tax, and Southern Airlines (Group) Catering Co., Ltd, a wholly owned subsidiary of CSAHC.
(iii)During 2003, wet lease rentals totaling RMB36, were paid to XJA, 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.
(iv)Commission is earned by certain subsidiaries of CSAHC in connection with the air tickets sold by them on behalf of the Group. Commission is calculated based on a fixed rate ranging from 1.5% to 12% on the ticket value.
(v)Certain sundry aviation supplies are purchased from Southern Airlines (Group) Economic Development Company (“SAGEDC”), a subsidiary of CSAHC.
(vi)The Group leases an aircraft from China Southern Airlines (Group) Hainan Co., Ltd, a subsidiary of CSAHC.
(vii)The Group leases certain land and buildings in the PRC from CSAHC. Rental payments for land and buildings amounted to RMB2 (Note 21(a)) and RMB13, respectively, RMB2 (Note 21(a)) and RMB16, respectively, and RMB24 (Note 21(a)) and RMB66, respectively were paid to CSAHC in 2003, 2004 and 2005, respectively.
(viii)China Southern Airlines (Group) Property Management Co., Ltd, a subsidiary of CSAHC, provides property management services to the Group.
(ix)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 37). No such payment was made in 2005.
(x)Airport ground service was provided by Beijing Southern Airlines Ground Services Company Limited, a jointly controlled entity of the Company.
(xi)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.
(xii)The Group has a 51% equity interest in Zhuhai Xiang Yi, which 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 (Note 21(d)).

F-61


CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(Amounts in 2003. Accordingmillions, except share data)
(xiii)Interest income was received from deposits with SA Finance. The applicable interest rates are determined in accordance with the deposit rates published by the PBOC (Note 16).
The Group obtained loans from SA Finance. The interest rates ranged from 3.30% to 5.02% per annum during the year ended December 31, 2005.
(xiv)On December 31, 2004, the Group acquired the airline operations and certain related assets of CNA and XJA at a total consideration of RMB15,522, which 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.
(xv)In 2004, the Group provided administrative services to CNA and XJA. Operating expenses amounted to RMB65 million were recharged to CNA and XJA on a cost basis.
(xvi)In 2003, CSAHC made short term advances to the Group. These advances were unsecured, interest free and fully repaid in 2004.
(xvii)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. In 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.
     In addition to the writabove, certain subsidiaries of summonsCSAHC 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 Litigation, New Link Consultants Limited, the plaintiff claimed unspecified damages againstyear.

F-62


CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(Amounts in millions, except share data)
(b)Loans from SA Finance
Loans from SA Finance are unsecured and have the following terms:
             
      December 31, 
      2004  2005 
Interest rate Guarantee  RMB  RMB 
Floating interest rate at 90% of interest rates as published by the PBOC, repayable within 1 year No guarantee  76    
             
Floating interest rate at 90% of interest rates as published by the PBOC, repayable within 1 year Guaranteed by CSAHC  180   300 
           
       256   300 
           
(c)Key management personnel remuneration
Remuneration for key management personnel is as follows:
         
  December 31, 
  2004  2005 
  RMB  RMB 
Short-term employees benefits  6,748   5,926 
Post-employment benefits  182   221 
       
   6,930   6,147 
       
Directors and supervisors  4,684   3,461 
Senior management  2,246   2,686 
       
   6,930   6,147 
       
Total remuneration is included in “staff costs” (Note 11).
(d)The Group participates in various defined contribution retirement plans organized by municipal and provincial governments for its staff. Details of the Group’s employee benefits plan are disclosed in Note 37.

F-63


CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(Amounts in millions, except share data)
(e) Transactions with other state-owned enterprises
     The Group is a state-owned entity and operates in an economic regime currently predominated by state-owned entities. Apart from transactions with CSAHC and its affiliates, the Group (as oneconducts a majority of its business activities with entities directly or indirectly owned or controlled by the defendantsPRC government and numerous government authorities and agencies (collectively referred to as “state-owned entities”) in the Litigation) for breachordinary course of the agreement on the basisbusiness. These transactions, which include sales and purchase of certain evidence provinggoods and ancillary materials, rendering and receiving services, lease of assets, purchase of property, plant and equipment and obtaining finance, are carried out at terms similar to those that United Aero-Supplies System of China, Limited (“UASSC”)would be entered into an agreement with the defendants for exclusive purchase of aviation equipment consigned to UASSC for salenon-state-owned entities and that as the defendants failed to perform the agreement, UASSC should have the right to compensation. Since UASSC is in the course of winding up proceedings, all the rights and benefits of UASSC in connection with the claim have been transferred to the plaintiff. Based on the opinion given by the Company’s legal advisors, the directors of the Company considerreflected in these financial statements. The management believes 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.

     Ashas provided meaningful disclosure of December 31, 2004, the Group had on order 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.party transactions as summarized above.

37. 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 and 9% to 19%)20% during the year ended December 31, 2005, 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 establish a supplementary defined contribution retirement scheme for the benefit of employees. 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 rate of 4.5%rates ranging from 3% to 5% of total salaries. 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 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 to CSAHC for a ten-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.

F-64

     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


CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(Amounts 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, pursuantmillions, except share data)

     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 ofat December 31, 2004 and 2005, the Group alreadyhad made payments totaling RMB191RMB152 and RMB168, respectively, under the scheme and recorded its remaining contractual liabilities totaling RMB69RMB108 and RMB92, respectively, as accrued expenses on itsthe consolidated balance sheet (Note 19).sheets. Housing allowances are payable when applications are received from eligible employees.

26. RELATED PARTY TRANSACTIONS

38. 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 financial services providedoperating income/(loss) by CSAHC and its affiliates, andgeographical segment is based on 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. The principal related party transactions are described as follows:

following criteria:
(i)Traffic revenue from domestic services within the PRC (excluding Hong Kong and Macau) is attributed to the domestic operation. Traffic revenue from inbound/outbound services between the PRC and Hong Kong/Macau, and the PRC and overseas destinations is attributed to the Hong Kong and Macau operation and international operation respectively.
(ii)Other revenue from ticket selling, general aviation and ground services, air catering and other miscellaneous services is attributed on the basis of where the services are performed.
                 
      Hong Kong       
  Domestic  and Macau  International*  Total 
  RMB  RMB  RMB  RMB 
2003
                
Traffic revenue  13,087   808   3,070   16,965 
Other operating revenue  436      69   505 
             
Turnover  13,523   808   3,139   17,470 
             
Operating income/(loss)  440   (29)  45   456 
Depreciation and amortization  1,581   85   372   2,038 
 
Significant non-cash items other than depreciation and amortization:                
 
Impairment losses for trade and other receivables  12         12 

F-39F-65


CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES

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

Allocation

                 
      Hong Kong       
  Domestic  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  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  3,663   139   638   4,440 
 
Significant non-cash items other than depreciation and amortization:                
                 
Write-down of inventories        209   209 
*Asian market accounted for approximately 70%, 67% and 74%, respectively, of the Group’s total international traffic revenue for the years ended December 31, 2003, 2004 and 2005. The remaining portion was mainly derived from the Group’s flights to/from European, North American and Australian regions.
     The major revenue-earning assets of routes 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 remainder of the Group’s jet fuel was purchased from domestic markets and, to a lesser extent, from international markets.

Aircraft insurance

     Aviation insurance covering hull, war and passenger liability risk is arranged by the CAAC on behalf of all PRC airlines with the People’s Insurance (Property) Company of China (“PICC”) under a master policy. PICC reinsures a substantial portion of its aircraft insurance business through the international reinsurance market. Insurance premiumsfleet, all 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


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 fees 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, participates in the CAAC’s computer reservation system, under which the Group purchases computer reservation services from the CAAC at rates determined based on the utilization 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 fees 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 established in the PRC, in respect of which CSAHC is entitled to 33% of its income after tax. Such purchases amounted to RMB29, RMB28 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 behalf of the Group. Commission is calculated based on a fixed rate ranging from 1.5% to 12% on the ticket value. Commission expenses incurred by the Group in respect of tickets sold by certain subsidiaries of CSAHC totaled RMB17, RMB5 and RMB2, respectively, during 2002, 2003 and 2004.

F-41


CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES

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

     Commission is earned by the CAAC’s sales offices and various PRC airlines in connection with the air tickets sold by them on behalf of the Group. Commission is calculated based on a fixed rate ranging from 1.5% to 12% on the ticket value. Commission expenses incurred by the Group in respect of tickets sold by the CAAC’s sales offices and various PRC airlines 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 subsidiary 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 subsidiary of CSAHC up to July 2002. In August 2002, 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 subsidiary 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 acquisitionsSince the Group’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 Group’s non-aircraft assets are not considered significantlocated 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,PRC.

39. MATERIAL NON-CASH TRANSACTIONS
     During 2004, the Group acquired the airline operationsoperation and certain related assets of CNA and XJA at a total consideration of RMB15,522, which was partlypartially satisfied by assumption of debts and liabilities of CNA and XJA totalingtotalling RMB13,563 outstanding as of that date. The remaining consideration payable of RMB1,959 is required to be satisfied in cash by December 31, 2005.

2004. Details are set out in Note 40.
     During 2005, aircraft acquired under capital leases amounted to RMB6,938.

F-43F-66


CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(Amounts in millions, except share data)
40. EFFECT OF THE CNA/XJA ACQUISITIONS
(a) Supplementary information for consolidated statements of cash flows
             
  Year ended December 31, 
  2003  2004  2005 
  RMB  RMB  RMB 
Assets acquired:            
 
Property, plant and equipment, net     12,980    
Inventories     729    
Trade receivables     314    
Cash and cash equivalents     398    
Other assets     1,101    
          
      15,522    
          
Liabilities assumed:            
             
Notes payable     4,587    
Obligations under capital leases     6,125    
Trade payables     343    
Accrued expenses     1,475    
Other liabilities     1,033    
          
      13,563    
          
Net identifiable assets and liabilities     1,959    
          
             
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-67


CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(Amounts due to related companies

     Amounts due to related companies, which represent balance with CSAHC and its affiliates, and the Group’s affiliated companies and jointly controlled entities, are unsecured, non-interest bearing and repayable within one year. The balance as of December 31, 2002 also included balances with the CAAC and its affiliates. Balances with other State-owned enterprises are excluded from this caption, as other State-owned enterprises are not considered related parties of the Group. The balance as of December 31, 2004 also included the above-mentioned cash consideration payable forin millions, except share data)

     (b) Had the CNA/XJA Acquisitions been effected on January 1, 2004, results 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 resultsoperations of the Group for the year.

     The directors of the Companyyear ended December 31, 2004 are of the opinion that the above transactions with related parties were entered into in the normal course of business and on normal commercial terms or in accordance with the agreements governing such transactions.

27. FAIR VALUE OF FINANCIAL INSTRUMENTS AND CONCENTRATIONS OF RISK

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 
          
41.FINANCIAL INSTRUMENTS
     Financial assets of the Group include cash and cash equivalents, other investments, trade receivables, other receivables, other current assets and short-term investments.amounts due from related companies. Financial liabilities of the Group include notes payable, obligations under capital leases, trade and bills payables, amounts due to related companies, accounts payables, billstaxes payable and other liabilities and taxes payable.

liabilities.

Liquidity risk

     As ofat December 31, 2003 and 2004,2005, the Group’s net current liabilities amounted to RMB10,792 and RMB18,855, respectively.exceeded its current assets by RMB25,907. For the yearsyear ended December 31, 2002, 2003 and 2004,2005, the Group recorded a net cash inflow from operating activities of RMB3,698, RMB2,129 and RMB3,596, respectively,RMB3,835, a net cash outflow from investing activities and financing activities of RMB2,745, RMB3,819RMB4,017, and RMB2,593, respectively, and an increase/(decrease)a decrease in cash and cash equivalents of RMB953, RMB(1,690) and RMB1,003, respectively.

RMB182.

     In 20052006 and thereafter, the liquidity of the Group is primarily dependent on its ability to maintain adequate cash inflow from operations 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 loansnotes payable outstanding at December 31, 20042005 when they fall due during 2005. In relation2006. Subsequent to its future capital commitments and other financing requirements,December 31, 2005, the Group has already entered into loan financing agreements with several PRC banks to provide loan finance up to an approximate amountrenewed short-term notes payable outstanding of RMB24,225 during 2005 and thereafter.RMB2,611 (Notes 27). The directors of the Company believe that suchsufficient financing will be available to the Group.

F-44


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, 2005.2006. 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 loan finance which may impact the operations of the Group during the next twelve-month period. The directors are of the opinion that the assumptions and sensitivities which are included in the cash flow forecast are reasonable. However, as with all assumptions in regard to future events, these are subject to inherent limitations and uncertainties and some or all of these assumptions may not be realized.

F-68

Business risk


     The Group conducts its principal operations

CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(Amounts 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.

millions, except share data)

Interest rate risk

     The interest rates and maturity information of the Group’s notes payable, and obligations undermaturity information of the Group’s capital leases of the Groupobligations are disclosed in Notes 1727 and 18,28, respectively.

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 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 State Administration of Foreign Exchange (“SAFE”) based on the Group’s expected payment obligations in foreign currencies for lease and debt payments and for dividends. Any amounts of foreign exchange that the Group receives in excess of such amount must be converted into Renminbi at the rate prevailing in the PRC inter-bank market. The Group will have access to foreign currency through the inter-bank system, subject to the approval of the SAFE, to satisfy its foreign exchange requirements where these exceed the amount of foreign exchange that the Group has retained.
     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”),SAFE, or subject to certain restrictive conditions, entering into forward foreign exchange contracts with authorized PRC banks.

     On July 21, 2005, the PBOC announced that the PRC government reformed the exchange rate regime by moving into a managed floating exchange rate regime based on market supply and demand with reference to a basket of foreign currencies. In particular, the exchange rate of US dollar against Renminbi was adjusted upward to 8.11 yuan per US dollar with effect from the close of business on July 21, 2005.
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.

F-69


CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(Amounts in millions, except share data)
     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, 20032004 and 2004,2005, the balance due from BSP agents amounted to RMB446RMB411 and RMB411,RMB782, respectively.

F-45


CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES

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

Self insurance risk

The credit risk exposure to BSP and the remaining trade receivables balance has been monitored by the Group maintains a limited amount of property insurance in respect of certain personalon an ongoing basis and real property.

the impairment losses for bad and doubtful accounts have been within management’s expectations.

Fair value

     The carrying

(a) 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, 20032004 and 2004 are set out below.2005 except the following:
                 
  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 
                 
  December 31, 
  2004  2005 
  Carrying  Fair  Carrying  Fair 
  amount  value  amount  value 
  RMB  RMB  RMB  RMB 
Notes payable  23,453   23,665   28,963   28,989 
             

     The following methods and assumptions were used to estimate the fair value for each class of financial instrument:

(i) Cash and cash equivalents, short term investments, trade receivables, other receivables short-term investments, amounts due to related companies, accountsand other current assets. Obligation under capital leases, 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)
(Amounts in millions, except share data)

(ii) 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.

(iii)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

(b) 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 to the approvalconstraints of the SAFE, to satisfy its foreign exchange requirements where these exceed the amount of foreign exchange that the Group has retained.

     The Articles of Association of the Company require cash dividends be declared in Renminbitimeliness 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 Chinacost for the calendar week precedingpurpose of estimating the datefair value 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.

such leases.

F-47F-70


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, the Group assumed from Zhongyuan Airlines debts totaling RMB965 in partial satisfaction of the consideration payable for acquisition of five Boeing 737-300/37K aircraft and other assets from Zhongyuan Airlines (Note 26).

F-48


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 of December 31, 2004 (Note 1).

(c) Effect of acquisition:

             
  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


CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES

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

30. PRINCIPAL SUBSIDIARIES, AFFILIATED COMPANIES AND JOINTLY CONTROLLED ENTITIES

     Details of the Company’s principal subsidiaries, affiliated companies and jointly controlled entities as of

42.COMMITMENTS
(a)Capital commitments
     At December 31, 2004 are2005, the Group had capital commitments 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
         
  2004  2005 
  RMB  RMB 
Commitments in respect of aircraft and flight equipment        
— authorized and contracted for  11,776   45,628 
— authorized but not contracted for  13,571    
       
   25,347   45,628 
       
         
Commitments in respect of investments in the Guangzhou new airport        
— authorized and contracted for  110   79 
— authorized but not contracted for  714   761 
       
   824   840 
       
         
Other commitments        
— authorized and contracted for  132   11 
— authorized but not contracted for  568   1,324 
       
   700   1,335 
       
   26,871   47,803 
       

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

F-50F-71


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

     At December 31, 2005, the Group had on order 82 aircraft and certain flight equipment, scheduled for deliveries in 2006 to 2010. Deposits of RMB6,351 million have been made towards the purchase of these aircraft and related equipment. As of December 31, 2005, the approximate total future payments, including estimated amounts for price escalation through anticipated delivery dates for these aircraft and flight equipment are as follows:
         
  2004  2005 
  RMB  RMB 
2005  8,748    
2006  2,996   7,341 
2007  32   8,945 
2008     14,354 
2009     5,300 
2010     9,688 
       
   11,776   45,628 
       
     At December 31, 2005, the Group’s attributable share of the capital commitments of jointly controlled entities was as follows:
         
  2004  2005 
  RMB  RMB 
Authorized and contracted for      
Authorized but not contracted for  156   74 
       
   156   74 
       
(b) Investing commitments
     At December 31, 2005, the Group are its aircraft fleet, most of which are registeredcommitted to make capital contributions 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.

respect of:
         
  2004  2005 
  RMB  RMB 
Subsidiaries  181    
Jointly controlled entities  83   83 
       
   264   83 
       

F-52F-72


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)
43.CONTINGENCIES
     (a) Pursuant to the Reorganization of CSAHC effected in 1995 (Note 1), the Company assumed the airline 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 constituting or arising out of or relating to the businesses assumed by the Company in the Reorganization, no other liabilities were assumed by the Company, and the Company is not jointly and severally liable for other debts and obligations incurred by CSAHC prior to the Reorganization. There are not, however, any definitive PRC regulations or other pronouncements confirming such conclusion.
     (b) The Group leases from CSAHC certain land in Guangzhou and certain land and buildings in Wuhan and Haikou. 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 and Haikou 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 the Company and CSAHC, 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.
44.SUBSEQUENT EVENT
      From April 20, 2006 to May 31, 2006, the Group entered into additional new notes payable agreements totalling RMB3,808. These additional new notes payable are unsecured, bear interest at floating rates ranging from 6-month LIBOR + 53% to 55% per annum and repayable one year from their respective origination dates.
45.COMPARATIVE FIGURES
     Certain comparative figures have been adjusted or re-classified as a result of the changes in accounting policies. Further details are disclosed in Note 3.
46.PARENT AND ULTIMATE HOLDING COMPANY
     As of December 31, 2005, 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.

F-73

34.


CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(Amounts in millions, except share data)
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 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 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 financial statements.
Impairments
     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.

F-74


CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(Amounts in millions, except share data)
Impairment loss for doubtful accounts
     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.
48.RECENTLY ISSUED ACCOUNTING STANDARDS
     New standards and interpretations which are not yet effective for the accounting period ending December 31, 2005 and which have not been adopted in these consolidated financial statements are as follows:
Effective for
accounting periods
beginning on or after
IFRS 6, Exploration for and evaluation of mineral resourcesJanuary 1, 2006
IFRS 7, Financial instruments: disclosureJanuary 1, 2007
IFRIC 4, Determining whether an arrangement contains a leaseJanuary 1, 2006
IFRIC 5, Rights to interests arising from decommissioning, restoration environmental rehabilitation fundsJanuary 1, 2006
IFRIC 6, Liabilities arising from participating in a specific market – Waste electrical and electronic equipmentDecember 1, 2005
IFRIC 7, Applying the restatement approach under IAS 29, Financial reporting in hyperinflationary economiesMarch 1, 2006
IFRIC 8, Scope of IFRS 2May 1, 2006
IFRIC 9, Reassessment of embedded derivativesJune 1, 2006

F-75


CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(Amounts in millions, except share data)
Effective for
accounting periods
beginning on or after
Amendments to IAS 1, Presentation of financial statementsJanuary 1, 2007
— capital disclosures
Amendments to IAS 19, Employee benefits — actuarial gains and losses, group plans and disclosuresJanuary 1, 2006
Amendments to IAS 39, Financial instruments: recognition and measurementJanuary 1, 2006
— Cash flow hedge accounting of forecast intragroup transactions
— The fair value option
Amendments to IAS 39, Financial instruments: recognition and measurement, and IFRS 4, Insurance contractsJanuary 1, 2006
— Financial guarantee contracts
Amendment to IAS 21, The effects of changes in foreign exchange ratesJanuary 1, 2006
— Net investment in a foreign operation
Amendments to IFRS 1, First-time adoptionJanuary 1, 2006
Amendments to IFRS 1, First-time adoption and IFRS 6, Exploration for and evaluation of mineral resourcesFor entities that adopt IFRSs for the first time before 1 January 2006 and choose to apply IFRS 6 before that date
Revised guidance on implementing IFRS 4, Insurance contractsFor entities that begin to apply IFRS 7 on or after 1 January 2007 or choose to apply IFRS 7 before that date

F-76


CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(Amounts in millions, except share data)
     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 these amendments and new standards and new interpretations in future periods is unlikely to have a significant impact on the Group’s results of operations and financial position.

F-77


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, 2005 are as follows:
Proportion of
Place ofownership
establishmentinterest held byPrincipal
Name of company/operationRegistered capitalthe Companyactivities
Guangxi Airlines Company Limited (a)PRCRMB170,900,00095%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 liabilities companies.
(b)This subsidiary is a Sino-foreign equity joint venture company established in the PRC.
(c)Certain of the Group’s subsidiaries are PRC joint ventures which have limited lives pursuant to the PRC law.

F-78


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
     The particulars of the Group’s principal affiliated companies and jointly controlled entities as of December 31, 2005 are as follows:
                     
      Proportion of  
      ownership interest held by  
  Place of Group’s        
  establishment effective The     Principal
Name of company /operation interest Company subsidiaries activities
Guangzhou Aircraft Maintenance Engineering Company Limited (a) PRC  50%  50%    Provision of aircraft repair and maintenance services
                     
China Southern Airlines Group Finance Company Limited PRC  49.3%  32%  26% 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 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.
(b)Certain of the Group’s jointly controlled entities are PRC joint ventures which have limited lives pursuant to the PRC law.

F-79


CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(Amounts in millions, except share data)
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 1 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 1421 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 arrangements,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 RMB2,409RMB2,462 and RMB2,462RMB2,376 as of December 31, 20032004 and 2004,2005, respectively, would be recognized on the consolidated balance sheets, as such commitments are not deemed as extinguished by the placement of security deposits.

F-80


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 1 and 1421 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 eightnine years ended December 31, 2004,2005, 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-56F-81


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, 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 statements 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, the Group acquired 90% equity interest in certain subsidiaries from CSAHC. Under IFRS, the purchase method of accounting was applied to such business combination such that as from the date of combination, the results of the acquired subsidiaries and their assets and liabilities are included in the consolidated financial statements of the Group.

     Under U.S. GAAP, such transaction is considered to be “a combination of entities under common control”. As described 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 633 to the consolidated financial statements prepared under IFRS, in respect of aircraft held under operating leases, a provision is made over the lease term for the estimated cost of overhauls required to be performed on the related aircraft prior to their return to the lessors.

     Under U.S. GAAP, a liability is recorded at the outset 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.

2004 and RMB941 and RMB489 respectively as of December 31, 2005.

     The effect of above difference on the net income/(loss) and shareholders’ equity reported under U.S. GAAP was not material tofor the years presented.

(h) Classification of short-term obligations expected to be refinanced
     As described in Note 27 to the consolidated financial statements prepared under IFRSs, the short-term notes payable included certain notes payable of RMB2,611 which were renewed subsequent to December 31, 2005. The maturity dates of these notes payable are extended for twelve months to after December 31, 2006.
     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 current liabilities would be RMB18,834 and RMB35,739, respectively, at December 31, 2005.

F-57F-82


CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES

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

(i) Financial statements presentation and disclosure

(i)  Gain/(loss) on sale of property, plant and equipment
     In the consolidated statements of operations presented under IFRS, IFRSs, gain/(loss)/gain on sale of property, plant and equipment is classified under “Non-operating income/(expenses)”. Under U.S. GAAP, such gain/(loss)/gain is classified under “Operating income/(expenses) General and administrative”.

(ii) Presentation of dividends received in the consolidated statements of cash flows
     In the consolidated statements 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.
(iii) 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.
     The U.S. GAAP presentation of deferred tax assets/(liabilities) as of December 31, 2004 and 2005 are as follows:
         
  December 31, 
  2004  2005 
  RMB  RMB 
Deferred tax assets:        
Tax losses  92   347 
Repair charges capitalized  254   275 
Accrued expenses  275   175 
Others  21   29 
       
Total deferred tax assets  642   826 
Less: valuation allowance  (53)  (188)
       
   589   638 
       
         
Deferred tax liabilities:        
Accrued expenses  75   58 
Depreciation allowances in excess of the related depreciation  752   832 
Others  49   16 
       
Total deferred tax liabilities  876   906 
       
         
   (287)  (268)
       
         
Representing:        
         
Deferred tax assets — current portion  161   61 
Deferred tax assets — non-current portion  428   577 
Deferred tax liabilities — current portion  (75)  (58)
Deferred tax liabilities — non-current portion  (801)  (848)
       
   (287)  (268)
       
     The valuation allowance was RMB48 as of January 1, 2003. During the years ended December 31, 2003, 2004 and 2004,2005, the amountvaluation allowance increased by RMB5, RMBNil and RMB135, respectively.
(iv)  Minority interests
     Under IFRS, minority interests at the balance sheet date are presented in the consolidated balance sheet within equity, separately from the equity attributable to the equity shareholders of the deferred tax asset valuation allowances approximated RMB741Company, and RMB53, respectively.

(j) New accounting pronouncements

FASB No. 123R

     In December 2004,minority interests in the FASB issued FASB Statement No. 123 (revised 2004), Share-Based Payment, which addressesresults of the accountingGroup for transactionsthe year are presented in whichthe consolidated statement of operations as 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. 123 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 offer any share-based compensation to its employees.

FASB 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 ontotal net income for the normal capacityyear between the minority interests and the equity shareholders of the production facilities. This Statement will be effectiveCompany. Under US GAAP, minority interests at the balance sheet date are presented in the consolidated balance sheet either as liabilities or separately from liabilities and equity. Minority interests in the results of the Group for inventory costs incurred during fiscal years beginning after January 1, 2006. The Group does not expect the initial adoptionyear are also separately presented in the consolidated statement of FASB No. 151 will haveoperations as a material impact on its consolidated financial statements.

FASB No. 153

     In December 2004, the FASB issued FASB Statement No. 153, Exchangescomponent of Nonmonetary Assets, which eliminates an exception in APB 29 for nonmonetary exchanges of similar productive assets and replaces it with a general exception for exchanges of nonmonetary assets that do not have commercial substance. This Statement will be effective for nonmonetary asset exchanges occurring on or after January 1, 2006.

net income.

F-58F-83


CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES

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

(v)  Share of taxation of affiliated companies and jointly controlled entities
     During the years ended December 31, 2003 and 2004, the Group’s share of taxation of affiliated companies and jointly controlled entities accounted for using the equity method was included as part of the Group’s income tax in the consolidated statements of operations under both IFRS and U.S. GAAP. As discussed in Note 3, with effect from January 1, 2005, the Group has changed the presentation and includes the share of taxation of affiliated companies and jointly controlled entities accounted for using the equity method in the respective shares of income or loss reported in the consolidated statements of operations before arriving at the Group’s income or loss before tax. These changes in presentation have been applied retrospectively with comparatives restated for both IFRS and U.S. GAAP.
     Income tax (benefit)/expense under U.S. GAAP for the years ended December 31, 2003 and 2004 have been restated as follows:
         
  2003  2004 
  RMB  RMB 
Income tax (benefit)/expense as previously reported under U.S. GAAP  (526)  274 
Reclassification for share of taxation of affiliated companies and jointly controlled entities  (10)  (13)
         
Income tax (benefit)/expense as restated under U.S. GAAP  (536)  261 
         
     Effect on net income/(loss) of significant differences between IFRS and U.S. GAAP is as follows:
                                      
 Reference Year ended December 31,  Reference Year ended December 31,
 in Note 2002 2003 2004 2004  in Note 2003 2004 2005 2005
 above RMB RMB RMB U.S. dollars  above RMB RMB RMB U.S. dollars
 (restated) (restated) 
Net income/(loss) under IFRS 576  (358)  (48)  (6)
Loss attributable to equity shareholders of the Company under IFRSs    (358)  (48)  (1,848)  (229)
U.S. GAAP adjustments:    
Net (loss)/income before tax attributable to airline operations of CNA and XJA (a)  (1,114)  (1,042) 354 43  (a)  (1,042) 354 159 19 
Sale and leaseback accounting (b)  (101) 115 115 14  (b) 115 115 115 14 
Lease arrangements (c)  (50)  (64) 7 1  (c)  (64) 7 7 1 
Capitalized interest (d)  (31)  (33) (13) (2) (d)  (33)  (13)  (9)  (1)
Reversal of additional depreciation arising from revaluation of property, plant and equipment (e) 33 33  13  2  (e) 33 13   
Investments in affiliated company and jointly controlled entity (f)  (1) 7 7 1  (f) 7 7 7 1 
Deferred tax effects    
— current year 48  (8)  (16)  (2)    (8)  (16)  (17)  (2)
— effect on change in the Company’s income tax rate   (51)       (51)    
— tax effect of acquisitions of airline operations of CNA and XJA operations of CNA and XJA  (15) 261  (81)  (10)
— tax effect of acquisitions of airline operations of CNA and XJA   261  (81)  (23)  (3)
— effect on change in income tax rate applicable to airline operations of CNA and XJA    (99)  (12)     (99) 79 10 
           
         
Net (loss)/income under U.S. GAAP  (655)  (1,140) 239 29     (1,140) 239  (1,530)  (190)
                    
   
Basic (loss)/earnings per share under U.S. GAAP  (0.194)  (0.298) 0.055 0.007     (0.298) 0.055  (0.350)  (0.043)
           
            
Basic (loss)/earnings per ADS under U.S. GAAP*  (9.706)  (14.876) 2.732 0.331     (14.876) 2.732  (17.489)  (2.172)
                    
 
* Basic (loss)/earnings per ADS is calculated on the basis that one ADS is equivalent to 50 H shares.

F-59F - 84


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,  Reference December 31,
 in Note 2003 2004 2004  in Note 2004 2005 2005
 above RMB RMB U.S. Dollars  above RMB RMB U.S. Dollars
 (restated) 
Shareholders’ equity under IFRS 11,896 11,848 1,432 
Total shareholders’ equity under IFRSs   13,903 11,936 1,479 
U.S. GAAP adjustments:    
Shareholders’ equity before tax effect attributable to airline operations of CNA and XJA  (a) 1,347  (531)  (64)
Shareholders’ equity attributable to airline operations of CNA and XJA (a)  (531)  (372)  (46)
Sale and leaseback accounting  (b)  (472)  (357)  (43) (b)  (357)  (242)  (30)
Lease arrangements  (c)  (114)  (107)  (13) (c)  (107)  (100)  (13)
Capitalized interest  (d) 348 335 40  (d) 335 326 41 
Revaluation of property, plant and equipment, net of depreciation  (e)  (13)   
Investments in affiliated company and jointly controlled entity  (f)  (111)  (104)  (13) (f)  (104)  (97)  (12)
Deferred tax effect on airline operations of CNA and XJA 182 66 8    66 122 15 
Deferred tax effects 35 19 2    19 2  
Minority interests (h)  (2,055)  (1,936)  (240)
                
Shareholders’ equity under U.S. GAAP 13,098 11,169 1,349 
       
Net shareholders’ equity under US GAAP   11,169 9,639 1,194 
         

F-60F - 85


CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES

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

     As a result

     The following are condensed consolidated statements of the Groupoperations, cash flows and the airline operations of CNA and XJA acquired on December 31, 2004 being under common control, the condensed financial information of the Groupchanges in total shareholders’ equity under U.S. GAAP for each of the two years have beenended December 31, 2003 and 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, 2003 and 2004 and the related2005 and condensed consolidated statements of operations, cash flows and changes in total shareholders’ equity under U.S. GAAP for each of the years in the three-year periodyear ended December 31, 2004, prepared on a U.S. GAAP basis.

2005 are not presented in these consolidated financial statements.

Condensed consolidated statements of operations

         
  2003 2004
  RMB RMB
Operating revenue:        
Traffic revenue  24,897   33,235 
Other operating revenue  586   930 
         
Total operating revenue  25,483   34,165 
         
         
Operating expenses:        
Flight operations  10,351   15,016 
Maintenance  3,878   4,578 
Aircraft and traffic servicing  3,803   4,789 
Promotion and sales  2,043   2,606 
General and administrative  1,397   1,759 
Depreciation and amortization  3,042   3,523 
Asset impairment charges  510    
Others  93   17 
         
 
Total operating expenses  25,117   32,288 
         
 
Operating income  366   1,877 
         
         
Non-operating income/(expenses):        
Interest income  27   33 
Interest expense  (1,604)  (1,184)
Equity income/(loss) of affiliated companies  50   15 
Equity (loss)/income of jointly controlled entities  (44)  (14)
Investment income     5 
Exchange (loss)/gain, net  (381)  (124)
Others, net  37   85 
         
 
Total net non-operating expenses  (1,915)  (1,184)
         
         
(Loss)/income before income tax and minority interests  (1,549)  693 
         
Income tax benefit/(expense)  536   (261)
         
         
(Loss)/income before minority interests  (1,013)  432 
         
Minority interest  (127)  (193)
         
         
(Loss)/income for the year  (1,140)  239 
         

F-61F-86


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     The Group has changed the presentation and includes the share of taxation of affiliated companies and jointly controlled entities accounted for using the equity method in millions, except share data)

Condensedthe respective shares of income or loss reported in the 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)
(Amountsstatements of operations before arriving at the Group’s income or loss before tax. These changes in millions, except share data)

presentation have been applied retrospectively with comparatives restated for both IFRS and U.S. GAAP. Further details are set out in Note 3 and Note 51(i).

Condensed consolidated statements 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  2003 2004
 RMB RMB RMB  RMB RMB
Net cash inflow/(outflow) from  
Operating activities 4,364 2,965 5,419  2,965 5,419 
Investing activities  (6,204)  (7,558)  (9,507)  (7,558)  (9,507)
Financing activities 2,230 2,820 4,172  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 
(Decrease)/increase in cash and cash equivalents  (1,773) 84 
Cash and cash equivalents at January 1 4,772 2,999 
            
Cash and cash equivalents at December 31 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)

     
  Total
  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, 2002  6,796 
     
Issue of A shares  2,641 
Net loss  (1,140)
Net liabilities assumed by CSAHC (note a)  4,552 
Recognition of deferred tax assets (note b)  246 
Contributions from CSAHC  3 
    
Shareholders’ equity at December 31, 2003  13,098 
     
Net profitincome  239 
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, 2004  11,169 
    

F-65F-87


CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES

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

Notes:
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 areis 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-66F-88


CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES

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

     The following additional financial statement disclosures are required under U.S. GAAP and are presented on a U.S. GAAP basis.

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

F-67


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% for the year ended December 31, 2002 and period endedfrom January 1 to September 30, 2003. The Company is subject to PRC income tax at 15% beginning October 1, 2003.
     The airline operations of CNA and XJA were subject to PRC income tax at 33% during 2002, 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.

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-68F-89


CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(Amounts in millions, except share data)
     Taxation (expense)/benefit consisted of:
         
  Year ended December 31,
  2003 2004
  RMB RMB
PRC income tax  (47)  (259)
 
Deferred tax        
— current year  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)
         
   536   (261)
         
         
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-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 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,  Year ended December 31,
 2002 2003 2004  2003 2004
 RMB RMB RMB  RMB RMB
Expected PRC taxation (expense)/benefit 45 231  (105) 232  (104)
Adjustments:  
Effect of change in the Company’s income tax rate  341   341  
Effect of change in the income tax rate applicable to the airline operations of CNA and XJA    (99)   (99)
Rate differential on subsidiaries 60  (5)    (5) 3 
Rate differential on airline operations of CNA and XJA  196  (43) 196  (43)
Non-deductible expenses  (155)  (90)  (37)  (90)  (37)
Increase in deferred tax valuation allowance  (296)  (110)  (4)  (110)  (4)
Expired tax losses   (34)    (34)  
Non-taxable income   17   17 
Effect of share of results of affiliated companies and jointly controlled entities 9 12 
Other, net  (19)  (3)  (3)  (3)  (6)
            
  (365) 526  (274) 536  (261)
            

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

F-69F-91


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


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 shiftedaddition 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 disclosed in Note 36, the Group and the airline operations of CNA and XJA had entered into the Group.

following material related party transactions.

(a) HandlingFor the years ended December 31, 2003 and 2004, repairing charges represent fees payable to Southern Airlines (Group) Importof RMB701 and Export Trading Company, a wholly owned subsidiary of CSAHC, in connection with the procurement of aircraft and flight equipment on the behalf ofRMB1,159, respectively, was incurred by 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”)GAMECO and MTU Maintenance Zhuhai Co., Ltd. (“MTU Zhuhai”).Zhuhai. GAMECO and MTU Zhuhai are jointly controlled entities of the Company.
 
(c)(b) Operating lease charges of RMB15 and RMB82, respectively, 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. The operating lease charges are determined based on prevailing market price.PRC for the years ended December 31, 2003 and 2004.
 
(d)(c) Aircraft lease income of RMBNil and RMB111, respectively, for the years ended December 31, 2003 and 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 CAAC.CSAHC.

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 the 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 operations as and when incurred. Contributions to the retirement schemes amounted to RMB184, RMB231 and RMB243, respectively, during 2002, 2003 and 2004.

F-74F-92


EXHIBIT INDEX
   
Exhibit No. Description of Exhibit
4.1 Form of Director’s Service Agreement is incorporated by reference in Exhibit 4(c).1 of Form 20-F for the year of 2004.2005.
 4.2 
4.2 Form of Non-Executive Director’s Service Agreement is incorporated by reference in Exhibit 4(c).2 of Form 20-F for the year of 2004.2005.
 8 
8 Subsidiaries of the Company
 12.1 
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