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

~~For the fiscal year ended December 31, 2004~~

For the fiscal year ended December 31, 2005


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


o		~~Commission file number: 1-14660~~SHELL COMPANY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Date of event requiring this shell company report.....................

For the transition period fromto

Commission file number 1-14660

(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)


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 ~~RMB1.00~~RMB 1.00 per share and 1,174,178,000 ordinary H Shares of par value ~~RMB1.00~~RMB 1.00 per share and 1,000,000 ordinary A Shares of par value ~~RMB1.00~~RMB 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.

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):


~~Yes~~xNo Large accelerated filero		Accelerated filerþ		Non-accelerated filero

Indicate by check mark which financial statement item the Registrant has elected to follow.

~~Item 17~~o~~Item 18~~x

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


				Page

Forward-Looking Statements		14
Introductory Note		14
Glossary of Airline Industry Terms		25
PART I
Item 1. Identity of Directors, Senior Management and Advisers		3
~~Item 2. Offer Statistics and Expected Timetable~~			3
~~Item 3. Key Information~~			3
	~~Selected Financial Data~~		3
	~~Capitalization and Indebtedness~~		6
Item 2. Offer Statistics and Expected Timetable		6
Item 3. Key Information		6
Selected Financial Data		6
Capitalization and Indebtedness		9
Reasons for the Offer and Use of Proceeds		610
	Risk Factors		710
Item 4. Information on the Company		1113
	History and Development of the Company		1113
	CNA/XJA Acquisitions		15
	Business Overview		1215
	Organizational Structure		31
Property, Plant and Equipment		32
Item 5. Operating and Financial Review and Prospects		33
Critical Accounting Policies		34
~~Property, Plant and Equipment~~Overview		35
~~Item 5. Operating and Financial Review and Prospects~~		36
	~~Critical Accounting Policies~~		36
	~~Overview~~		37
	Certain Financial Information and Operating Data by Geographic Region		3936
	Operating Results		4137
	Additional Information under U.S. GAAP		42
	Liquidity and Capital Resources		4847
	Contractual Obligations and Commercial Commitments		5049
Item 6. Directors, Senior Management and Employees		5149
	Directors and Senior Management		5149
	Compensation		54
Board Practices		54
Remuneration Committee		54
Employees		54
Share Ownership		56
Item 7. Major Shareholders and Related Party Transactions		56
Major Shareholders		56
Related Party Transactions		56
Interests of Experts and Counsel		60
Item 8. Financial Information		60
Consolidated Statements and Other Financial Information		60
Significant Changes		60
Dividend Information		60
Item 9. The Offer and Listing		61
Offer and Listing Details		61
Plan of Distribution		61
Markets		62
Selling Shareholders		62
Dilution		62
Expenses of the Issue		62
Item 10. Additional Information		62
Share Capital		62
Memorandum and Articles of Association		62
Material Contracts		66
Exchange Controls		67
Taxation		67


				Page

	~~Board Practices~~Dividends and Paying Agents		5668
	~~Remuneration Committee~~Statement by Experts		68
	~~Employees~~Documents on Display		5768
	~~Share Ownership~~Subsidiary Information		5868
~~Item 7. Major Shareholders and Related Party Transactions~~		58
	~~Major Shareholders~~		59
	~~Related Party Transactions~~		59
	~~Interests of Experts and Counsel~~
~~Item 8. Financial Information~~			64
	~~Consolidated Statements and Other Financial Information~~		64
	~~Significant Changes~~		64
	~~Legal Proceedings Dividend Information~~
~~Item 9. The Offer and Listing~~			65
	~~Offer and Listing Details~~		66
	~~Plan of Distribution~~		66
	~~Markets~~		67
	~~Selling Shareholders~~		67
	~~Dilution~~		67
	~~Expenses of the Issue~~		67
~~Item 10. Additional Information~~			67
	~~Share Capital~~		67
	~~Memorandum and Articles of Association~~		67
	~~Material Contracts~~		71
	~~Exchange Controls~~		73
	~~Taxation~~		73
	~~Dividends and Paying Agents~~		74
	~~Statement by Experts~~		74
	~~Documents on Display~~		74
	~~Subsidiary Information~~		74
	Comparison of New York Stock Exchange Corporate Governance Rules and China Corporate Governance Rules for Listed Companies		7568
Item 11. Quantitative and Qualitative Disclosures About Market Risk		7969
Item 12. Description of Securities other than Equity Securities		8070

	PART II
		~~Page~~

~~PART II~~
Item 13. Defaults, Dividend Arrearages and Delinquencies			8070
Item 14. Material Modifications to the Rights of Security Holders and Use of Proceeds		8070
Use of Proceeds
PART III
~~Item 15. Controls and Procedures~~			82
~~Item 16. [Reserved]~~			82
~~Item 16 A. Audit Committee Financial Expert~~			82
~~Item 16 B. Code of Ethics~~			82
~~Item 16 C. Principal Accounting Fees and Services~~			82
~~Exemptions from the Listing Standards for Audit Committee~~
Item 15. Controls and Procedures		71
Item 16. [Reserved]		72
Item 16 A. Audit Committee Financial Expert		73
Item 16 B. Code of Ethics		73
Item 16 C. Principal Accounting Fees and Services		73
Item 16 D. Exemptions from the Listing Standards for Audit Committee		74
Item 16 E. Purchases of Equity Securities By the Issuer and Affiliated Purchasers		8374
PART IV
Item 17. Financial Statements		8374
Item 18. Financial Statements		8374
Index to Financial Statements		8274
Item 19. Exhibits		8475
Signatures		8576
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 ~~CFO~~CHIEF FINANCIAL OFFICER
EX-13.1 SECTION 906 CERTIFICATION OF CHAIRMAN
EX-13.2 SECTION 906 CERTIFICATION OF PRESIDENT
EX-13.3 SECTION 906 CERTIFICATION OF ~~CFO~~CHIEF FINANCIAL OFFICER

~~iii~~

FORWARD-LOOKING STATEMENTS

This Annual Report contains forward-looking statements. These statements appear in a number of different places in this Annual Report. A forward 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, ~~2003~~2004 and ~~2004~~2005 (the “Financial Statements”) have been prepared in accordance with International Financial Reporting Standards (“IFRS”) promulgated by the International Accounting Standards Board. IFRS includes International Accounting Standards (“IAS”) and related interpretations. IFRS differs in certain significant respects from accounting principles generally accepted in the United States of

America (“U.S. GAAP”). Information relating to the nature and effect of such differences is presented in Note 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.

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

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, ~~2004~~2005 and consolidated balance sheets as of December 31, ~~2003~~2004 and ~~2004~~2005 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, ~~2000~~2001 and ~~2001~~2002 and IFRS consolidated balance sheets of December 31, ~~2000,~~ 2001, 2002 and ~~2002~~2003 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 the~~inthe consolidated financial statements. The results of the acquired operations and their related cash flows ~~will be~~was 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, ~~2003~~2004 and ~~2004~~2005 and for each of the years in the three-year period ended December 31, ~~2004~~2005 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 — — —


													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, ~~2004~~2005 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

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


	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.

Reasons for the Offer and Use of Proceeds

Not applicable.

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 ~~2003~~2004 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 ~~these~~this exchange ~~losses were~~loss 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, ~~2003~~2004 and ~~2004,~~2005, the Group had short-term deposits of ~~RMB366~~RMB406 million and ~~RMB406~~RMB544 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.

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 ~~Zhengzhou~~Haikou are leased by the Company from CSAHC. However, CSAHC lacks adequate documentation evidencing CSAHC’s rights to such land and buildings, and, as a consequence, the lease agreements between CSAHC and the Company for such land have not been registered with the relevant authorities. As a result, such lease agreements may not be enforceable. Lack of adequate documentation for land use rights and ownership of buildings subjects the Company to challenges and claims by third parties with respect to the Company’s use of such land and buildings.

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

Risks associated with Hong Kong ~~regional~~and 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 ~~2004~~2005 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.

Infrastructure limitations

The rapid increase in air traffic volume in China in recent years has put pressure on many components of the Chinese commercial aviation industry, including China’s air traffic control system, the availability of qualified flight personnel and airport facilities. Airlines, such as the Company, which have route networks that emphasize short- to medium-haul routes are generally more affected by insufficient aviation

infrastructure in terms of on-time performance and high operating costs due to fuel inefficiencies resulting from the relatively short segments flown, as well as the relatively high proportion of time on the ground during turnaround. All of these factors may adversely affect the perception of the service provided by an airline and, consequently, the airline’s operating results. In recent years, the CAAC has placed increasing emphasis on the safety of Chinese airline operations and has implemented measures aimed at improving the safety record of the industry. The ability of the Company to increase utilization rates and to provide safe and efficient air transportation in the future will depend in part on factors such as the improvement of national air traffic control and navigation systems and ground control operations at Chinese airports, 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.

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

Risks relating to the PRC

Foreign exchange risks

Under current Chinese foreign exchange regulations, Renminbi is fully convertible for current account transactions, but is not a freely convertible ~~currency, and the Company’s ability to obtain or retain foreign currencies is subject to regulation in China. Limitations on the availability of~~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. It could also have a material adverse effect on the ~~Company’s~~Company's operations and financial ~~condition, particularly in light of~~conditions, given the ~~Company’s~~Company's substantial foreign currency obligations.

The value of Renminbi is subject to changes in Chinese Government policies and depends to a large extent on China’s domestic and international economic and political developments, as well as supply and demand in the local market. Since 1994, the official exchange rate for the conversion of Renminbi to US dollars has been stable. There can be no assurance, however, that such rates will not be volatile or that there will be no further devaluation of the Renminbi against the ~~foreign currencies in which the Company’s obligations are denominated, principally the~~ US dollar and other foreign currencies may fluctuate and is affected by, among other things, changes in China's political and economic conditions. On July 21, 2005, the ~~Japanese Yen. Based~~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 ~~Company’s foreign~~U.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 between~~value of the Renminbi ~~and~~against 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 ~~devaluation~~revaluation of the ~~Renminbi~~Reminbi other than by retaining its foreign ~~exchange-denominated earnings~~currencies which it receives from its business and ~~receipts~~operational activities to the extent permitted by applicable law, any ~~future devaluation in~~significant revaluation of the Renminbi ~~could adversely affect~~may have a material adverse effect on the ~~Company’s results of operations~~Company'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 than~~and any dividends payable on, the ~~Renminbi~~Company'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”.

ITEM 4. INFORMATION ON THE COMPANY.

History and Development of the Company

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

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

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

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

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

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

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

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

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

The Group had ~~RMB6,351 million,~~ RMB4,707 million, RMB6,631 million and ~~RMB6,631~~RMB11,873 million capital expenditures in ~~2002,~~ 2003, 2004 and ~~2004~~2005 respectively. Of such capital expenditures in ~~2004, RMB5,017~~2005, RMB6,938 were financed by capital lease, RMB4,325 million were financed by bank borrowings while the remaining ~~RMB1,614~~RMB610 million were financed by internal resources. The capital expenditures were primarily incurred on the additional investments in aircraft and flight equipment under the Group’s fleet expansion plans and Guangzhou new airport, and, to a small extent, additional investments in other facilities and ~~building~~buildings 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 satisfied~~was 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 ~~28,940~~26,387 million in ~~2002~~2003 to ~~37,196~~61,923 million in ~~2004,~~2005, while its capacity, measured in terms of ASKs, increased at a compound annual rate of ~~10.2%~~47.1%, from ~~44,245~~40,867 million in ~~2002~~2003 to ~~53,769~~88,361 million in ~~2004.~~2005. In ~~2004,~~2005, the Group carried ~~28.21~~44.12 million passengers and had passenger revenue of ~~RMB21,100~~RMB34,328 million (US$~~2,550~~4,254 million). ~~Net~~The loss for ~~2004~~2005 attributable to equity shareholders of the Company was ~~RMB48~~RMB1,848 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 ~~10.5~~11.30 million passengers and had operating revenue of ~~RMB7,436~~RMB8,019 million (US$~~898~~994 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 ~~RMB2,244~~RMB3,091 million (US$~~271~~383 million) in ~~2004~~2005 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 ~~542~~559 routes, of which ~~434~~452 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 ~~5,280~~8,436 landings and take-offs per week, serving ~~143~~142 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.

In addition to its main route base in Guangzhou, the Group also maintains ~~eighteen~~certain 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. All~~Beihai. Most of ~~these~~its 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 ~~regional~~and Macau and international flights. As of year end of ~~2004,~~2005, the Group had 2329 Hong Kong ~~regional~~and Macau routes and 8578 international routes. The Group’s Hong Kong ~~regional~~and 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.

As of December 31, ~~2004,~~2005, the Group operated a fleet of ~~231~~261 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 ~~7.47~~7.19 years as of the year end of ~~2004.~~

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 ~~the~~The 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%.

1416

Traffic

The following table sets forth certain statistical information with respect to the Group’s passenger and cargo and mail traffic for the years indicated.


Passenger carried	Passenger 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 ~~542~~559 routes consisting of ~~434~~452 domestic routes, 2329 Hong Kong ~~regional~~and Macau routes and 8578 international routes. In ~~2004,~~2005, the Group conducted an average of ~~5,280~~8,436 landings and take-offs per week, serving ~~143~~142 destinations.

The Group continually evaluates its network of domestic, Hong Kong ~~regional~~and 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 ~~regional~~and Macau and international routes is subject to approval of the CAAC, and the acquisition of Hong Kong ~~regional~~and 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 ~~eighteen~~certain 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.

1517

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 ~~15,380~~17,807 flights on its Hong Kong ~~regional~~and 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 ~~231~~261 aircraft with an average age of ~~7.47~~7.19 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.

1618

The following table sets forth certain information regarding the Group’s fleet of ~~231~~261 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 ~~term~~terms of the ~~lease ranges~~leases 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 ~~nine~~fifteen years. As of December 31, ~~2004, 47~~2005, 65 of the Group’s ~~231~~261 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.


					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 ~~RMB13,055~~RMB18,615 million (US$~~1,577~~2,307 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 ~~nine~~twelve 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.

Operating Leases

As of December 31, ~~2004,~~2005, the Group’s aggregate future minimum lease payments required under its operating leases were ~~RMB12,750~~RMB24,594 million (US$~~1,541~~3,048 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 ~~2004~~2005 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.

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$~~30.0~~30 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 ~~RMB499~~RMB583 million were paid to MTU Zhuhai.

2021

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 ~~was~~were 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 ~~2004~~2005 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 ~~2004~~2005 was ~~RMB4,190~~RMB5,220 per ton. The average price paid by the Group in ~~2004~~2005 was ~~RMB3,772~~RMB4,846 per ton, which represents a ~~22.7%~~28.47% increase from that of ~~2003.~~

~~To address~~2004.

According to the ~~problem~~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 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 surcharge~~cost 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.

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.

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.

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.

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.

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.~~

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.

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 ~~3,500,000~~4,055,600 members under these programs.

Regulation

The Chinese commercial aviation industry is subject to a high degree of regulation and oversight by the CAAC. Regulations and policies issued or implemented by the CAAC encompass substantially all aspects of airline operations, including the approval of domestic, Hong Kong ~~regional~~and 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 ~~regional~~and 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 ~~Regional~~and Macau Routes. Hong Kong ~~regional~~and 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.

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

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

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

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

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

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

Acquisition of Aircraft and Flight Equipment

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

Jet Fuel Supply and Pricing

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

Safety

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

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

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

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

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.

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.

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	%

Hong Kong ~~Regional~~and 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 ~~15,380~~17,807 “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 ~~regional~~and 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 ~~regional~~and 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 ~~regional~~and 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 ~~regional~~and Macau and international competitors. Many of the Group’s international competitors have larger sales networks and participate in reservation systems that are more comprehensive and convenient than those of the Group, or engage in promotional activities that may enhance their ability to attract international passengers.

Air China has the most extensive international route network among Chinese airlines. Beijing, the hub of Air China’s operations, has been the destination for most international flights to China. The Group competes against, among other airlines, Thai Airways International, Singapore Airlines, Malaysian Airlines System, Air China and China Eastern on flights to Southeast Asian destinations. In the case of its European routes, the Group’s competitors include Air France — KLM. The Group faces competition on its international 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. ~~The~~Except 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 ~~regional~~and Macau routes. In ~~2004,~~2005, Xiamen Airlines carried a total of about ~~6.23~~6.92 million passengers, or approximately ~~22.1%~~15.7% of the passengers carried by the Group in that year, and had ~~RMB4,448~~RMB4,852 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 ~~regional~~and Macau route. In ~~2004,~~2005, Shantou Airlines carried a total of about ~~1.08~~1.17 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, ~~2004~~2005 was ~~RMB808~~RMB844 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 ~~regional~~and Macau routes. In ~~2004,~~2005, Guangxi Airlines carried a total of about ~~1.12~~1.03 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, ~~2004~~2005 was ~~RMB789~~RMB722 million.

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 ~~741,000~~834,000 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, ~~2004~~2005 was ~~RMB558~~RMB719 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 ~~1.36~~1.34 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 ~~RMB833~~RMB882 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 70,000~~RMB70,000 (approximately US$8,455) per passenger. Under the Convention for the Unification of Certain Rules Relating to International Transportation by Air of 1929 (as amended by the protocol of 1955, the “Warsaw Convention”), unless a separate agreement has been entered into between China and a specific country, civil liability for injuries suffered by passengers on international flights is limited to US$~~20,000~~135,000 per passenger. The Group believes that it maintains adequate insurance coverage for the maximum civil liability that can be imposed in respect of injuries to passengers under Chinese law, the Warsaw Convention or any separate agreement applicable to the Group.

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

Intellectual Property

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

The names “China Southern” and ~~“China~~��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.

Organizational Structure

The following chart illustrates the corporate structure of the Group as of year end ~~2004~~2005 and the aggregate effective equity interest of the Company in each of its principal subsidiaries, affiliated companies and jointly controlled entities.

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

3331

The particulars of the Company’s principal subsidiaries as of December 31, ~~2004~~2005 are as follows:

~~Attributable equity~~

Place and date of

~~interest to the Company~~

establishment

~~Direct~~

~~Indirect~~

Proportion of ownership

Name of company

/operation

interest held by the Company

Guangxi Airlines Company Limited

PRC

April 28, 1994

—95

Southern Airlines ~~Group~~(Group) Shantou

~~PRC~~

Airlines Company Limited

PRC
July 20, 1993

—

Zhuhai Airlines Company Limited

PRC

May 8, 1995

—

Xiamen Airlines Company Limited

PRC

August 11, 1984

—

Guizhou Airlines Company Limited

PRC

November 12, 1991

Guangzhou Air Cargo Company Limited

PRC
March 31, 2004

—70

Guangzhou Nanland Air Catering

~~PRC~~

Company Limited

PRC
November 21, 1989

—75

China Southern West Australian

~~Australia~~

Flying College Pty Ltd.

Australia
January 26, 1971

—

Guangzhou Baiyun International

~~PRC~~

Logistic Company Ltd

PRC
July 23, 2002

Xinjiang Civil Aviation Property Management Limited

PRC
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, ~~2004~~2005 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

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.”

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 ~~Zhengzhou~~Haikou are leased by the Company from CSAHC. However, CSAHC lacks adequate documentation evidencing CSAHC’s rights to such land and buildings, and, as a consequence, the lease agreements between CSAHC and the Company for such land may not be registered with the relevant authorities. Lack of registration may affect the validity of such lease agreements. There are certain other parcels of land and buildings owned or used by the Group that lack adequate documentation. Lack of adequate documentation for land use rights and ownership of buildings may impair the ability of the Group to dispose of or mortgage such land use rights and buildings.

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

ITEM 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS.

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

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, ~~2004~~2005 was ~~RMB874~~RMB1,413 million.

Property, plant and equipment

The Group ~~have~~has approximately ~~RMB46,841~~RMB54,266 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 recognised~~was 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

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 half~~and acquisition of ~~2003. The~~the 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 the~~increase 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 effects~~rising 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 in~~extension of the duration of the same will help relieve, to a certain extent, the burden of high jet fuel ~~cost.~~

~~The continuing political tension in~~cost 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 ~~RMB164~~RMB59 million and ~~RMB59~~net exchange gain of RMB1,220 million in ~~2003~~2004 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

over route allocations. Any changes in the PRC government’s regulatory policies, or any implementation of such policies could have a significant impact on the Group’s future operations and its ability to implement its operating strategy.

Certain Financial Information and Operating Data by Geographic Region

The following table sets forth certain financial information and operating data by geographic region for the years ended December 31, ~~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

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%.

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.

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

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.

Operating expenses

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

Total operating expenses in 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.

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 ~~credit~~benefit of ~~RMB324~~RMB334 million resulting from reduction in net deferred taxation liability balance of RMB392 million. In 2004, income tax expense of ~~RMB78~~RMB65 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 ~~RMB358~~the Company is RMB1,530 million, ~~for 2003,~~ as compared to ~~a net~~an income of ~~RMB576~~RMB239 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 ~~decreased~~increased by ~~RMB549~~RMB4,128 million or ~~3.0%~~12.1% from ~~RMB18,019~~RMB34,165 million in ~~2002~~2004 to ~~RMB17,470~~RMB38,293 million in ~~2003.~~2005. Passenger load factor ~~decreased~~increased by ~~0.8~~1.2 percentage point from ~~65.4%~~68.9% in ~~2002~~2004 to ~~64.6%~~70.1% in ~~2003.~~2005. Passenger yield (in passenger revenue per RPK) ~~increased~~decreased slightly by ~~5.6% from RMB0.54 in 2002~~3.1% to ~~RMB0.57 in 2003.~~RMB0.55. Average yield (in traffic revenue per RTK) decreased by ~~1.7%~~1.6% from ~~RMB4.84~~RMB5.22 in ~~2002~~2004 to ~~RMB4.76~~RMB5.14 in ~~2003.~~2005. Operating expenses increased by ~~RMB1,021~~RMB7,097 million or ~~6.4%~~22.0% from ~~RMB15,993~~RMB32,288 million in ~~2002~~2004 to ~~RMB17,014~~RMB39,385 million in ~~2003.~~2005. As the increase in operating revenue ~~decreased while~~is smaller than the increase in operating expenses, ~~increased,~~operating income decreased by 158.2% from an operating profit ~~decreased by 77.5% from RMB2,026~~of RMB1,877 million in ~~2002~~2004 to ~~RMB456~~an operating loss of RMB1,092 million in ~~2003.~~2005. The Group’s net non-operating expenses ~~increased~~decreased by ~~9.1%~~60.8%, from ~~RMB887~~RMB1,184 million in ~~2002~~2004 to ~~RMB967~~RMB464 million in ~~2003,~~2005, mainly ~~due~~attributable to ~~a decrease~~the combined effect of increase in exchange gain ~~on disposal~~ of ~~fixed assets of RMB193~~RMB1,344 million, ~~partly offset by a decrease~~increase in interest expense of ~~RMB135~~RMB405 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.~~

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% respectively~~97.3% 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’s~~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 ~~for~~ air catering ~~services and net income from lease arrangements.~~

services.

Operating revenue ~~decreased~~increased by ~~3.0%~~12.1% from ~~RMB18,019~~RMB34,165 million in ~~2002~~2004 to ~~RMB17,470~~RMB38,293 million in ~~2003. This decrease~~2005. The increase was primarily due to a ~~4.4% fall~~12.8% rise in passenger revenue from ~~RMB15,696~~RMB30,443 million in ~~2002~~2004 to ~~RMB15,010~~RMB34,328 million in ~~2003~~2005 resulting from ~~lower~~increased traffic ~~volume caused by SARS.~~volume. The total number of passengers carried ~~decreased~~increased by ~~4.8%~~14.0% to ~~20.5~~44.12 million passengers ~~in 2003. RPKs decreased~~and the ASKs increased by ~~8.8% from 28,940~~14.3% to 88,361 million in ~~2002~~2005. The increase in 2005 compared to ~~26,387~~2004 was attributable to the general increasing traffic demand in the PRC airline market and deliveries of 30 aircraft during 2005 which caused an increase in passenger capacity of 12.4%. RPKs increased by 16.3% from 53,233 million in ~~2003,~~2004 to RMB61,923 million in 2005, primarily as a result of ~~a decrease~~the increase in passengers carried. ~~However, passenger~~Passenger yield ~~increased~~decreased slightly by ~~5.6% from RMB0.54 in 2002~~RMB0.02 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 ~~RMB12,234~~RMB24,773 million in ~~2002~~2004 to ~~RMB12,242~~RMB28,182 million in ~~2003.~~2005. Domestic passenger traffic in RPKs ~~decreased~~increased by ~~3.6%~~17.8%, mainly due to ~~a decrease~~an increase in passengers carried. ~~Passenger~~Domestic passenger yield ~~however, increased from~~decreased 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 Fund~~2005.

Hong Kong and ~~sales tax.~~

~~Hong Kong~~Macau passenger revenue, which accounted for ~~5.0%~~3.5% of total passenger revenue, ~~decreased~~increased by ~~28.9%~~3.7% from ~~RMB1,055~~RMB1,151 million in ~~2002~~2004 to ~~RMB750~~RMB1,194 million in ~~2003.~~2005. For Hong Kong and Macau flights, passenger traffic in RPKs ~~decreased~~increased by ~~28.0%~~18.5%, while passenger capacity in ASKs ~~decreased~~increased by ~~22.9%~~26.5%, resulting in a ~~4.1~~4.0 percentage point decrease in passenger load factor from ~~2002.~~2004. Passenger yield decreased from ~~RMB0.98~~RMB0.88 in ~~2002~~2004 to ~~RMB0.96~~RMB0.77 in ~~2003~~2005 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, ~~decreased~~increased by ~~16.2%~~9.6% from ~~RMB2,407~~RMB4,519 million in ~~2002~~2004 to ~~RMB2,018~~RMB4,952 million in ~~2003.~~2005. For international flights, passenger traffic in RPKs ~~decreased~~increased by ~~25.2%~~8.3%, while passenger capacity in ASKs ~~decreased~~increased by ~~20.8%~~5.4%, resulting in a ~~3.6~~1.8 percentage point ~~fall~~rise in passenger load factor from ~~2002.~~2004. Passenger yield increased by ~~11.9%~~1.1% from ~~RMB0.42~~RMB0.55 in ~~2002~~2004 to ~~RMB0.47~~RMB0.56 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 ~~RMB1,786~~RMB2,792 million in ~~2002~~2004 to ~~RMB1,955~~RMB3,091 million in ~~2003.~~2005. The increase was ~~primarily due~~attributable 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 ~~RMB537~~RMB930 million in ~~2002~~2004 to ~~RMB505~~RMB874 million in ~~2003.~~2005. The decrease was primarily due to ~~a decrease in aircraft short-term lease income~~the reduced scale of ~~RMB46 million.~~

other operation.

Operating ~~Expenses~~expenses

Total operating expenses in ~~2003~~2005 amounted to ~~RMB17,014~~RMB39,385 million, representing an increase of ~~6.4%~~22.0% or ~~RMB1,021~~RMB7,097 million over ~~2002,~~2004, primarily due to the ~~combined~~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 ~~88.8%~~94.5% in ~~2002~~2004 to ~~97.4%~~102.9% in ~~2003.~~

2005.

Flight operations expenses, which accounted for ~~41.6%~~48.7% of total operating expenses, increased by ~~5.0%~~27.8% from ~~RMB6,733~~RMB15,016 million in ~~2002~~2004 to ~~RMB7,070~~RMB19,183 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 ~~RMB3,519~~RMB8,555 million in ~~2002~~2004 to ~~RMB3,867~~RMB11,929 million in ~~2003~~2005 mainly as a result of increased ~~jet~~ fuel ~~prices.~~prices and fuel consumption. Operating lease payments increased by ~~8.4%~~12.6% from ~~RMB1,417~~RMB2,109 million in ~~2002~~2004 to ~~RMB1,536~~RMB2,375 million in ~~2003,~~2005 primarily due to the ~~full year effect of the addition of~~additional 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 ~~decreased~~increased by ~~18.4%~~21.2% from ~~RMB625~~RMB987 million in ~~2002~~2004 to ~~RMB510~~RMB1,196 million in ~~2003, primarily reflecting a tighter cost controls exercised by~~2005 due to the ~~Group.~~increase in number of passengers carried. Aircraft insurance costs decreased by ~~23.4%~~60.8% from ~~RMB256~~RMB268 million in ~~2002~~2004 to ~~RMB196~~RMB105 million in ~~2003, primarily~~2005, mainly because of ~~a reduction~~the decrease in ~~the rate of aircraft~~ insurance premiums ~~prescribed by the PRC insurance company. Labor~~in 2005. Labour costs for flight personnel ~~decreased~~increased by ~~6.8%~~4.8% from ~~RMB781~~RMB1,545 million in ~~2002~~2004 to ~~RMB728~~RMB1,619 million in ~~2003,~~2005, largely due to ~~a decrease~~the 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 ~~RMB2,333~~RMB4,578 million in ~~2002~~2004 to ~~RMB2,589~~RMB4,589 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 ~~RMB2,511~~RMB4,789 million in ~~2002~~2004 to ~~RMB2,767~~RMB5,759 million in ~~2003.~~2005. The increase primarily resulted from ~~an 8.9%~~a 10.0% rise in landing and navigation fees from ~~RMB2,354~~RMB4,447 million in ~~2002~~2004 to ~~RMB2,563~~RMB4,891 million in ~~2003,~~2005, due to an increase in ~~the charge rate for domestic~~number of landing and ~~navigation fees effective September 2002.~~

takeoffs.

Promotional and marketing expenses, which accounted for ~~8.7%~~7.1% of total operating expenses, ~~decreased~~increased by ~~1.3%~~6.7% from ~~RMB1,500~~RMB2,606 million in ~~2002~~2004 to ~~RMB1,480~~RMB2,780 million in ~~2003.~~2005. The ~~decrease~~increase was ~~due to 9.3% decrease~~mainly resulted from the increase in ~~labor costs~~sales volume, resulting in a 17.0% increase in sales commission expenses from ~~RMB248~~RMB1,285 million in ~~2002~~2004 to ~~RMB225~~RMB1,503 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 slightly~~increased by ~~0.7%~~39.7% from ~~RMB1,060~~RMB1,759 million in ~~2002~~2004 to ~~RMB1,053~~RMB2,457 million in ~~2003.~~2005. This was mainly ~~due~~attributable to ~~a decrease in~~increased 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 ~~RMB1,840~~RMB3,523 million in ~~2002~~2004 to ~~RMB2,038~~RMB4,406 million in ~~2003. This increase was primarily as a result of~~2005, mainly resulting from the ~~addition of~~additional 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 ~~2002~~2005 as compared to ~~RMB456~~an operating profit of RMB1,877 million in ~~2003.~~2004. This was mainly because operating revenue ~~decreased~~increased by ~~RMB549~~RMB4,128 million or ~~3.0% from 2002~~12.1% in 2005 while operating expenses increased by ~~RMB1,021~~RMB7,097 million or ~~6.4% over~~22.0% in the same period.

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

Interest expense ~~decreased~~increased by ~~14.1%~~34.2% from ~~RMB959~~RMB1,184 million in ~~2002~~2004 to ~~RMB824~~RMB1,589 million in ~~2003,~~2005, mainly ~~reflecting~~due to the ~~combined effect of scheduled debt repayments~~increase in loans and ~~the replacement of certain RMB denominated bank loans with US$ denominated bank loans with lower~~lease obligations and interest ~~rates.~~

rate. Interest income ~~decreased~~increased by ~~75.2%~~66.7% from ~~RMB53~~RMB33 million in ~~2002~~2004 to ~~RMB13~~RMB55 million in ~~2003. This was~~2005, mainly attributable to ~~a decrease in average cash balances.~~

~~The Group recorded a net loss on sale~~the 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 unrealized~~represented 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

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 ~~the~~a preferential tax ~~policy implemented~~rate 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. As~~Group’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’s~~effect 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 credit~~airline operations of ~~RMB324 million for 2003 compared to an~~CNA and XJA of RMB79 million. In 2004, income tax expense of ~~RMB398~~RMB261 million ~~for 2002. As a result~~was recorded and actual effective tax rate was 38% while the Group’s enacted tax rate in 2004 was 15%. The difference is mainly due to the effect of ~~the reduction~~change in enacted income tax rate ~~the Company’s net deferred taxation liability balance brought forward from December 31, 2002~~applicable to airline operations of ~~RMB507~~CNA and XJA of RMB99 million, ~~was reduced by RMB392~~rate differential on airline operations of CNA and XJA of RMB43 million and ~~a net deferred tax credit~~non-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.

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 ~~remained~~remain 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

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.

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 ~~credit~~benefit of ~~RMB526~~RMB536 million resulting from a reduction in net deferred taxation liability balance of RMB341 million.

The airline operations of CNA and XJA were subject to PRC income tax at 33% during 2003 and up to December 30, 2004. As a result of the CNA/XJA Acquisitions having been effective December 31, 2004, the airline operations of CNA and XJA have become divisions of the Company and are subject to PRC income tax at the applicable rate of 15% beginning that date. Consequently, the airline operations of CNA and XJA recorded an income tax ~~credit~~benefit 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~~

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 ~~RMB35,750~~RMB39,294 million to the Group. As of December 31, ~~2004,~~2005, an approximate amount of ~~RMB11,525~~RMB28,242 million was utilized. As of December 31, ~~2003~~2004 and ~~2004,~~2005, the Group’s cash and cash equivalents totaled ~~RMB2,080~~RMB3,083 million and ~~RMB3,083~~RMB2,901 million, respectively.

Net cash inflows from operating activities in ~~2002,~~ 2003, 2004 and ~~2004~~2005 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 ~~2004~~2005 was ~~RMB5,895 million,~~ RMB5,434 million, RMB8,824 million and ~~RMB8,824~~RMB8,009 million, respectively. Cash capital expenditures in ~~2002,~~ 2003, 2004 and ~~2004~~2005 were ~~RMB6,351 million,~~ RMB4,707 million, RMB6,631 million and ~~RMB6,631~~RMB4,935 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 ~~RMB25,271~~RMB30,449 million. Based on such amount, in ~~2005,~~ 2006, 2007, 2008, 2009, 2010 and thereafter, amounts payable under such debt and obligations will be ~~RMB3,737~~RMB5,250 million, ~~RMB4,489~~RMB7,246 million, ~~RMB6,705~~RMB4,764 million, ~~RMB3,608~~RMB2,812 million, ~~RMB2,154~~RMB1,472 million and ~~RMB4,578~~RMB8,905 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 ~~RMB9,925~~RMB14,346 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 ~~RMB12,750~~RMB24,594 million, predominately for aircraft. Of such amount, ~~RMB1,761~~RMB3,340 million, ~~RMB1,622~~RMB2,881 million, ~~RMB1,562~~RMB2,785 million, ~~RMB5,259~~RMB2,609 million, ~~RMB764~~RMB2,523 million and ~~RMB1,782~~RMB10,456 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 ~~RMB18,855~~RMB25,907 million, as compared to a working capital deficit of ~~RMB10,792~~RMB18,855 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 ~~2003~~2004 to ~~2004~~2005 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 ~~banker~~bankers to renew its short-term bank loans outstanding at December 31, ~~2004~~2005 when they fall due during ~~2005. In relation~~2006. 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 amount~~renewed 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 ~~2007~~2010 of approximately ~~RMB10,167~~RMB8,933 million, ~~RMB3,049~~RMB9,445 million, RMB14,437 million, RMB5,300 and ~~RMB84 million,~~RMB9,688 respectively. Of such amounts, ~~RMB8,748 million in 2005, RMB2,996~~RMB7,341 million in 2006, ~~and RMB32~~RMB8,945 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 ~~RMB824~~RMB840 million in ~~2005~~2006 is related to the Group’s facilities and equipment to be constructed and installed at the Guangzhou new airport. The remaining amounts of ~~RMB595~~RMB752 million in ~~2005 and RMB105~~2006, RMB500 million in ~~2006~~2007 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 ~~RMB3,083~~RMB2,901 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.

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

~~Age~~Position

~~Position~~Gender

Age

Liu Shao Yong

Chairman of the Board

Male

~~Chairman of the Board of Directors~~48

Liu Ming Qi

Qi(1)

Vice Chairman of the Board ~~of Directors~~

Male

Peng An FaFa(2)

Director

Male

5758

~~Director~~

Wang Quan Hua

Director

Male

~~Director~~52

Zhao Liu An

Director

Male

~~Director~~58

Zhou Yong ~~Qian~~Qian(3)

Director

Male

6061

~~Director~~

Si Xian Min

Director, President

Male

~~Directors; President~~49

Zhou Yong ~~Jin~~Jin(1)

Director

Male

6263

~~Director~~

Xu Jie Bo

Director, Chief Financial Officer and Vice President

Male

~~Director; Chief Financial Officer; Vice President~~41

Wu Rong ~~Nan~~Nan(1)

Director

Male

6364

Simon To(4)

Independent Non-executive Director

Male

~~Director~~

~~Simon To~~55

~~Independent Non-Executive Director~~

Peter Lok

Independent Non-executive Director

Male

~~Independent Non-Executive Director~~70

Wei Ming Hai

Independent Non-executive Director

Male

~~Independent Non-Executive Director~~42

Name

Position

Gender

Age

Wang Zhi

Independent Non-executive Director

Male

~~Independent Non-Executive Director~~64

Sui Guang Jun

Independent Non-executive Director

Male

~~Independent Non-Executive Director~~45

Sun Xiao Yi

Chairman of the Supervisory Committee

Male

Yang Guang Hua

Supervisor

Male

~~Supervisor~~53

Yang Yi Hua

Supervisor

Female

~~Supervisor~~46

Li ~~Kun~~Kun(5)

Vice President

Male

4546

~~Vice President~~

Yuan Xin An

Vice President

Male

~~Vice President; Chief Engineer~~49

Zheng En ~~Ren~~Ren(6)

Vice President

Male

6061

~~Vice President~~

Hao Jian Hua

Vice President

Male

Ren Ji Dong(7)

Vice President

Male

~~Ren Ji Dong~~He Zong Kai(7)

Vice President

Male

Liu Qian

Chief Pilot

Male

~~Vice President~~

~~He Zong Kai~~

~~Vice President~~

~~Liu Qian~~

~~Chief Pilot~~

Su Liang

Company Secretary

Male

~~Company Secretary~~44

Chen Wei Hua

General Counsel

Male

~~General Counsel~~40

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.


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

~~Mr. Peng An Fa~~is 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 ~~since~~in March 1995 after the establishment of the Company. Mr. Wang graduated from the Economic Management Department of Central Communist Party College. Mr. Wang began his career in civil aviation in 1972, and successively served as the Director of Planning Department of Guangzhou Civil Aviation Administration, the Office Director of China Southern Airlines Shenzhen Co., the Director of the Planning and Operation Division of CSAHC, the President of Strategy and Development Department of China Southern Airlines

Company Limited and the Vice President of CSAHC. ~~Save as disclosed above,~~ Mr. Wang ~~is not connected with any Directors, senior management, substantial shareholders or Supervisors~~became 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 ~~since~~in 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 Qian~~~~is currently~~became a Director of the Company ~~and the Vice President of CSAHC and the President of China Northern Airlines. Mr. Zhou joined the Company since~~on 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.

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 Jin~~isbecame 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 Manager~~Vice President and Chief Financial Officer of the Company. He is also a Director of Guizhou Airlines Company Limited, Vice Chairman of Sichuan Airlines Corporation Limited, and Vice Chairman of Xiamen Airlines Company Limited. ~~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 Nan~~isbecame 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 To~~has been an Independent Non-Executive Director of the Company since June 1999. Mr. To is currently the Managing Director of Hutchison Whampoa (China) Limited, and also serves as director of several companies in Hong Kong and Foreign-invested companies in China. Mr. To has managed investment projects in China since early 1980’s and is familiar with the laws and regulations of Hong Kong and China. Mr. To graduated from the Stanford University with a Master degree in Business Administration. Mr. To is not connected with any Directors, senior management, substantial shareholders or Supervisors of the Company.

on April 16, 2001.

Mr. Peter Lokhas been an Independent Non-Executive Director of the Company since ~~June~~April 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 ~~June~~April 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 ~~ten~~7 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.~~

5351

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 ~~Secretary~~secretary 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 ~~independent~~Independent 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 Department~~corporate administration department of Jinan ~~University. Mr. Sui is currently~~University and the Chief of the Post-doc Committee of Applied Economics and the Dean of Management College in Jinan University. Mr. Sui is ~~not connected with any~~currently the Deputy Vice Chancellor of Guangdong University of Foreign Studies.

The independent non-executive Directors ~~senior management, substantial shareholders or Supervisors~~ of the ~~Company.~~

~~Supervisory Committee~~

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

SUPERVISORY COMMITTEE

As required by the Company Law and the Articles of Association, the Company has a supervisory committee (the “Supervisory Committee”) which is primarily responsible for the supervision of ~~Senior Management~~senior management of the Company, including the Board of Directors, executive officers and other ~~Senior Management~~senior 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’s~~shareholder representatives appointed by shareholders, ~~of the Company,~~ and ~~the remaining~~one 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 Kun~~is 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 become~~became the Chief Engineer of the Company ~~since~~in 2000, and ~~he has been appointed as~~ a Vice President of the Company ~~from~~in April 2002.
~~Mr. Zheng En Ren~~is 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 ~~piloting~~pilot training at the CAAC Advanced Flying College. Mr. Hao has held positions as Captain, then Deputy Chief Captain, and subsequently Chief Captain of the Sixth Squadron of the Civil Aviation Administration during the period from 1989 to 1994. He then became a Deputy General Manager, from 1994 to 1998, and the General Manager, from 1998 to 1999, of the Flying Aviation Department of the Company. He ~~has been the~~became a Vice President of the Company ~~since 31~~in 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 and~~became 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 ~~since~~in 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 Counsel~~Legal Adviser to the Company. Mr. Chen graduated from the school of law of Peking University. He is a qualified solicitor and a qualified corporate legal counsellor. Mr. Chen joined the Civil Aviation Administration of China in 1998. He then joined the CSAHC in January 1991. From 1997 to 2003, he served as Vice Director and Director of the Legal Affairs Office of the Company. Currently, he is President of the Legal Department of the Company. Since December 2003, Mr. Chen has been the Chief Legal Adviser to the Company. He is also a Director of Xiamen Airlines Company Limited.

~~None 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 management~~Senior Management for ~~2004~~2005 was ~~RMB6.8~~RMB5.9 million. For the year ended December 31, ~~2004,~~2005, the Company accrued an aggregate of approximately ~~RMB145,000~~RMB132,000 on behalf of its executive Directors, Supervisors and ~~senior management~~Senior 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 ~~contracts~~contract 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 ~~five~~three 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 Committee~~remuneration committee comprises three members. ~~The Remuneration Committee~~Currently, the remuneration committee is chaired by independent non-executive Director Sui Guang Jun with independent non-executive Director Wei Ming Hai and executive Director Wang Quan Hua as members. The ~~Remuneration Committee~~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. The remuneration committee met once in ~~2004~~2005, which meeting was attended by all members. In addition, the ~~Remuneration Committee~~remuneration committee also meets as and when required to consider remuneration related matters.

The responsibilities of the ~~Remuneration Committee~~remuneration committee are to approve the remuneration packages of Directors and ~~senior management~~Senior 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 ~~18,221~~34,417 employees, including ~~1,995~~2,567 pilots, ~~3,231~~4,539 flight attendants, ~~2,679~~5,076 maintenance personnel, ~~2,194~~10,445 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, ~~technical~~maintenance personnel, ~~management~~administrative personnel and sales and marketing personnel are contract employees, and most of the Group’s ancillary service workers are temporary employees. Contract employees are hired by the Group pursuant to renewable employment contracts with terms ranging from

three to five years. Temporary employees generally are hired by the Group pursuant to at-will employment contracts or employment contracts with a term of one year.

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

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

Retirement And Housing Benefits

Employees of the Group participate in several defined contribution retirement schemes organised separately by PRC municipal governments in regions where the major operations of the Group are located. The Group is required to contribute to these schemes at the rates ranging from ~~14%~~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.~~
57

Furthermore, pursuant to the comprehensive services agreement (the “Services Agreement”) dated May 22, 1997 between the Company and CSAHC, CSAHC ~~agrees to provide adequate~~provided quarters to eligible employees of the ~~Group as and when required.~~Group. In return, the Group ~~agrees to pay~~paid 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 ~~already~~had made payments totalling ~~RMB191~~RMB168 million under the scheme and recorded its remaining contractual liabilities totalling ~~RMB69~~RMB92 million as accrued expenses on ~~its~~the 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.

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.
58
Major Shareholders
     Share Capital Structure
     As of ~~December~~May 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 ~~December~~May 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 ~~1,151,953,998~~1,150,854,998 H shares ~~26.34~~ %26.31%
     The table below sets forth, as of ~~December~~May 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 as~~in 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 Agreement~~a ten year trademark licence agreement dated May 22, 1997 pursuant to which CSAHC ~~has acknowledged~~acknowledges that the ~~Group~~Company has the right to use the name “China Southern” and “China Southern Airlines” in both Chinese and English, and ~~has granted to~~grants the Company a ~~10-year~~ renewable royalty free license to use the kapok logo on a ~~world-wide~~worldwide basis in connection with ~~its~~the Company’s airline and airline-related businesses.
59
     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 ~~extended~~renewed for another ~~10-year~~ten-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 million~~RMB2,651,000 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 million~~RMB15,745,000 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 ~~XJA~~Xinjiang Airlines and ~~CNA~~Northern Airlines for the purposes of their civil aviation and related businesses. Subsequently, CSAHC was ~~authorized~~authorised to deal with the land use rights of such lands, including leasing, but not transferring, such land use rights. Total area of the lands leased is 1,182,297 square 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 ~~designed~~designated lands under lease agreement is ~~RMB22,298,033~~RMB22,298,000 per year, payable in arrear by cheque, in cash or by bank transfer on or before the 10th day of each calendar month, and is determined after arm’s length negotiation between the parties. The ~~Cap~~maximum aggregate annual limit (“Cap”) for the lease agreement is set at ~~RMB22,298,033~~RMB22,298,000 per year.
~~Comprehensive Services and Employee Benefits~~
The ~~Company and CSAHC have entered into a comprehensive services~~lease agreement ~~dated May 22, 1997, pursuant to which CSAHC agrees to provide adequate quarters to eligible employees~~was 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.
60

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 ~~RMB41,993,318~~RMB43,758,000 per year, payable in arrear by cheque, in cash or by bank transfer on or before the 10th day of each calendar month, and is determined after arm’s length negotiation between the parties. The Cap for the lease agreement is set at ~~RMB41,993,318~~RMB43,758,000 per year.
The lease agreement was approved by the shareholders of the Company at the 2nd extraordinary general meeting on December 31, 2004.

The Company, CSAHC and XJA entered into a lease agreement dated November 12, 2004, under which CSAHC and XJA lease to the Company certain buildings, facilities and other infrastructure related to the civil aviation businesses of XJA situated in Xinjiang and Russia. The lease is for a fixed term of three years, commencing from the effective date of the lease, and is renewable, subject to compliance with the relevant requirements of the Hong Kong Listing Rules by the Company, by an application in writing by the Company to the lessor three months before the end of the fixed term. The consideration for lease agreement is ~~RMB5,797,909~~RMB5,798,000 per year, payable in arrear by cheque, in cash or by bank transfer on or before the 10th day of each calendar month, and is determined after arm’s length negotiation between the parties. The Cap for the lease agreement is set at ~~RMB5,797,909~~RMB5,798,000 per year. The lease agreement was approved by the shareholders of the Company at the 2nd extraordinary general meeting on December 31, 2004.

Arrangements with CSAHC’s Affiliates

Southern Airlines (Group) Import and Export Trading Company (“SAIETC”), a ~~wholly-owned~~wholly 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 that~~determined 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, inclusive~~RMB31,714,000.

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 ~~commission~~framework 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% above~~Directors of the ~~contract prices paid~~Company. 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. ~~The~~After extension of three years, the parties have mutually agreed to extend the agreement ~~has been extended~~for 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 ~~extending~~commencing from May 22, 1997 to May ~~22,~~21, 2000. As agreed by the parties, the agreement ~~has been~~was 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.
61

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 that~~SA Finance agrees to accept deposit of money from the Company ~~deposits with~~at interest rates not lower than those set by the People’s Bank of China for the same term of deposit. SA Finance will ~~be deposited~~in 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 the~~agreement. The Company will comply with the Hong Kong Listing Rules when entering into such separate written agreements.

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

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

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

As of December 31, ~~2004,~~2005, the Group’s deposits placed with SA Finance ~~amounting~~amounted to ~~RMB406.0 million,~~RMB543,825,000, which ~~earned~~bore 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 ~~would~~will 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 ~~extended~~renewed automatically.

For the year ended December 31, ~~2004,~~2005, the amount ~~paid~~incurred 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 ~~Demerger~~De-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 have~~Southern 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 ~~Company~~Group 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 prescribed~~on 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 Company~~tickets. 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

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 million~~RMB220,000,000 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 Northern~~China Southern Airlines Group Passenger and Cargo Agent Company Limited (“PCACL”), a wholly owned subsidiary of CSAHC
~~Following~~

In order to comply with the ~~announcement~~requirements under Rule 14A.35 of the ~~consolidation~~Hong Kong Listing Rules so that PCACL can continue to provide ticket agency services, the Company and ~~restructuring among~~PCACL, a whollyowned subsidiary of CSAHC ~~CNA~~whose principal business activity is that of acting as an air ticket agent and ~~XJA~~airfreight 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 “Consolidation~~January 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 person~~framework 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 following~~Rules for a term of three years, commencing from the ~~acquisition~~date of the ~~core operational assets~~agreement. The Framework Agreement on Lease and Operation became effective on April 25, 2006, having been approved by the Board of ~~CNA~~Directors of the Company. Pursuant to the agreement, the Company shall lease Guangzhou Airlines Hotel, Zhuhai Pilot Mansion and ~~XJA~~certain 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 Catering~~China 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 an~~GCSAPMC, 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 ~~provision~~Engagement of ~~in-flight means was approximately RMB5,221,000.~~
     ~~Pursuant to an agreement dated October 30, 2001, CNA has been providing and will continue~~Property Management (“Property Management Framework Agreement”) on January 1, 2006 in respect of engaging GCSAPMC to provide ~~in-flight meals to~~property management and improvement services in compliance with the ~~Group from time to time for a period~~requirements 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 ~~following~~Property 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 following~~appointed GCSAPMC to provide management and maintenance services for the Company’s headquarters in Guangzhou and to provide maintenance and management services for the 110KV transformer substation 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 ~~CNA~~CSAHC 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 ~~requirement~~parties. 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 CNA~~bank account designated by Hainan Co., Ltd. The Company will fund the consideration for the ~~sale of the Group’s air tickets~~Acquisition wholly by ~~CNA and for the sale of CNA air tickets by the Group. The selling party charges~~its 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, a~~subsidiary wholly owned ~~subsidiary of~~by 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 person~~ceased to act as agent of the Company ~~under~~in 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 following~~Rules by the ~~acquisition~~Company. 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 CNA~~various 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 announcement~~shall not exceed those of the ~~Consolidation and Restructuring, XJA has become~~same category that prevail in the market, with a ~~wholly owned subsidiary~~ceiling set at 6% of ~~CSAHC and a connected person~~the revenue of the Company ~~under~~that 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 following~~agency 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 commission~~time 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 XJA~~be delivered to the ~~Group for~~Company. The Company will fund the ~~year ended December 31, 2004 was approximately RMB78,207,000. The amount of commission paid~~agency 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

6460

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.

6561

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~~

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 ~~154~~179 of the Articles of Association, where a ~~director~~Director 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 ~~board~~Board of ~~directors~~Directors at the earliest opportunity, whether or not the contract, transaction or arrangement or proposal therefor is otherwise subject to the approval of the ~~board~~Board of ~~directors.~~
Directors.

Pursuant to Article ~~108~~130 of the Articles of Association, where a ~~director~~Director is interested in any resolution
67

proposed at a board meeting, such ~~director~~Director shall not be present and shall not have a right to vote. Such ~~director~~Director shall not be counted in the quorum of the relevant meeting.

Pursuant to Article ~~162~~187 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 ~~director~~Director wherein his emoluments are stipulated. The aforesaid emoluments include, emoluments in respect of his service as ~~director, supervisor~~Director, 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 ~~board~~Board of ~~directors~~Directors 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 ~~directors~~Directors of the Company. The ~~directors~~Directors 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 ~~State~~state 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 are~~Shares held by Hong Kong and overseas shareholders and (c) 1,000,000,000 are A ~~shares are~~Shares 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;

(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;

~~(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 ~~shares~~Shares 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.

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There are two types of shareholders’ general meetings: annual general meetings and extraordinary general meetings. Shareholders’ general meetings shall be convened by the 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 ~~board~~Board of ~~directors~~Directors shall convene an extraordinary general meeting within two (2) months:

(1)		when the number of ~~directors~~Directors is less than the number of ~~directors~~Directors required by the Company Law or two thirds of the number of ~~directors~~Directors 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 ~~board~~Board of ~~directors~~Directors 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 ~~193~~221 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.

(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 acquisition~~A framework agreement on lease and operation dated ~~April 21, 2005~~January 1, 2006 between the Company and China Southern Airlines Group Travel Development Company Limited (the “CSA Travel”), a wholly owned subsidiary of CSAHC, pursuant to which the Company leases certain hotels belonging to it to CSA Travel for operation and management for a period of three years. The consideration for the framework agreement on lease and operation is based on the rent payable and fees for operation and management of the hotels, and is capped at RMB6 million per year. It became effective on April 25, 2006 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) Import~~Advertising Company (the “SAAC”), a related party that is 45% owned by the Company and ~~Export Trading~~55% owned by CSAHC, pursuant to which the SAAC produces advertisement script, graphic and music for the Company with the copyright of such products belonging to the Company for a period of three years. The consideration for the advertising agency agreement is based on the fees payable for advertising services to be provided, and is capped at RMB30 million per year. It became effective on April 25, 2006 has been approved by the directors of the Company.
(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 SNC~~Hainan 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

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 ~~paying~~Paying 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.
74

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.


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.


~~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.


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 ~~ethics~~Ethics for ~~directors, officers~~Directors, 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 ~~131~~151 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, ~~2004~~2005 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, ~~2004~~2005 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, ~~2004~~2005 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, ~~2003~~2005 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

price of

offering

Aggregate

Title of each

offering

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 facilities~~	~~US$~~	~~41.9 million~~
~~Purchase and installation of machinery and equipment~~	~~US$~~	~~394.6 million~~
~~Purchase of real estate~~		—
~~Acquisition of other business(es)~~		—
~~Repayment of indebtedness~~	~~US$~~	~~192.4 million~~
~~Working Capital~~	~~US$~~	~~29.6 million~~

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

(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 facilities		US$41.9 million
Purchase and installation of machinery and equipment		US$394.6 million
Purchase of real estate		—
Acquisition of other business(es)		—
Repayment of indebtedness		US$192.4 million
Working Capital		US$29.6 million


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

(viii) The uses of proceeds do not represent a material change in the use of proceeds described in the prospectus.
81

PART III

ITEM 15. CONTROLS AND PROCEDURES.

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.

ITEM 16. [RESERVED]

ITEM 16A. AUDIT COMMITTEE FINANCIAL EXPERT.

The Board of Directors has determined that Mr. Wei Ming Hai qualifies as an audit committee financial expert in accordance with the terms of Item 16. A of Form 20-F. 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 ~~2003~~2004 and ~~2004:~~2005:

Audit Fees

Audit-Related Fees

Tax Fees

~~Other Fees~~

~~2003~~

~~RMB8.2 million~~

~~RMB7.0 million~~

~~RMB0.17 million~~

~~RMB1.1 million~~

2004

RMB8.9 million

RMB6.6 million

RMB0.11 million

2005

—RMB13.9 million

RMB5.8 million

RMB0.11 million

Audit-related fees

Services provided primarily consist of the following:

a)		Review of the Group’s ~~2004~~2005 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.

~~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 ~~2004~~2005 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 ~~2004~~2005			F-2
Consolidated Balance Sheets as of December 31, ~~2003~~2004 and ~~2004~~2005			F-3
~~Consolidated Statements of Cash Flows for the years ended December 31, 2002, 2003 and 2004~~			~~F-4~~
Consolidated Statements of Changes in Shareholders’ Equity for the years ended December 31, ~~2002,~~ 2003, 2004 and ~~2004~~2005			F-5
Consolidated Statements of Cash Flows for the years ended December 31, 2003, 2004 and 2005			F-7
Notes to Consolidated Financial Statements			~~F-6~~F-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

CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS


			Page
Report of Independent Registered Public Accounting Firm			F-1

Consolidated Statements of Operations for the years ended December 31, ~~2002,~~ 2003, 2004 and ~~2004~~ 2005			F-2

Consolidated Balance Sheets as of December 31, ~~2003~~2004 and ~~2004~~ 2005			F-3

~~Consolidated Statements of Cash Flows for the years ended December 31, 2002, 2003 and 2004~~			~~F-4~~

Consolidated Statements of Changes in Shareholders’ Equity for the years ended December 31, ~~2002,~~ 2003, 2004 and ~~2004~~ 2005			F-5
Consolidated Statements of Cash Flows for the years ended December 31, 2003, 2004 and 2005			F-7
Notes to Consolidated Financial Statements			~~F-6~~F-9

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, ~~2003~~2004 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, ~~2003~~2004 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, ~~2004~~2005 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, ~~2004~~2005 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 ~~2004~~2005

(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, ~~2003~~2004 and ~~2004~~2005

(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 FLOWS~~BALANCE SHEETS
~~For the years ended~~As of December 31, ~~2002, 2003~~2004 and ~~2004~~2005

(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 ~~2004~~2005

(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 ~~regional~~and 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 held~~from 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. ~~Solely~~Translation of amounts from RMB into United States dollar (“US$”) solely for the convenience of readers ~~the 2004 financial statements have~~has been ~~translated into United States dollars~~made at the rate of US$1.00 ~~= RMB 8.2765,~~to RMB8.0694, being the ~~rate~~average of the buying and selling rates as quoted by the People’s Bank of China (the “PBOC”) at the close of business on December 31, ~~2004.~~2005. No representation is made that the RMB amounts could have been, or could be, converted into ~~United States dollars (“~~US$”) at that rate or at any other certain rate on December 31, ~~2004~~2005 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 includes~~Board (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 ~~IFRS~~IFRSs 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 on~~comprise the Company and its subsidiaries and the Group’s interest in affiliated companies and jointly controlled entities.

The measurement basis used in the preparation of the consolidated financial statements is the historical cost basis except that the following assets are stated at their fair value as ~~modified by~~explained 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 ~~IFRS~~IFRSs 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 by~~significant effect on the ~~Group~~financial statements and estimates with a significant risk of material adjustment in the next year are ~~consistent with those used~~disclosed 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 ~~profits~~income arising from intra-group transactions, are eliminated in full in preparing the consolidated financial statements. Unrealized losses resulting from intra-group transactions are eliminated in the same way as unrealized 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 amount~~portion of the net assets of subsidiaries attributable to equity interests that are ~~reviewed individually for collectibility. All other balances~~not 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 recognized~~prepared in the consolidated ~~statements~~balance sheet and statement of ~~operations.~~
     ~~Where~~changes in shareholders’ equity within equity, separately from, equity attributable to the equity shareholders of the Company. Minority interests in the results of the Group ~~has~~are 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 part~~allocation of the total ~~lease expense.~~

~~(iii) Subsequent costs~~

~~The Group recognizes~~income 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 amounts~~equity of ~~an item of property, plant~~a subsidiary, the excess, and ~~equipment~~any further losses applicable to the ~~cost of replacing part of such an item when that cost is incurred if it is probable~~minority, are charged against the Group’s interest except to the extent that the ~~future economic benefits embodied with~~minority has a binding obligation to, and is able to, make additional investment to cover the ~~item will flow to~~losses. If the subsidiary subsequently reports income, the Group’s interest is allocated all such income until the minority’s share of losses previously absorbed by the Group ~~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 life~~		~~Residual value~~
~~Buildings~~		~~15 to 40 years~~	~~Nil~~
~~Owned and leased aircraft~~		~~8 to 15 years~~	~~28.75%~~
~~Other flight equipment~~
~~- Jet engines~~		~~8 to 15 years~~	3%
~~- Others, including rotable spares~~		~~8 to 15 years~~	~~Nil~~
~~Machinery and equipment~~		~~5 to 10 years~~	3%
~~Vehicles~~	~~6 years~~		3%

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 ~~company~~companies 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 ~~associates~~affiliated 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 in~~respect of affiliated companies ~~and~~or jointly controlled entities, the carrying amount of goodwill is included in the carrying amount of the interest in the affiliated company or jointly controlled entity.

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

On disposal of a cash generating unit, an affiliated company or a jointly controlled entity during the year, any 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 attributable~~present 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.

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-11~~F-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), trade~~cash 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 ~~periodically~~at each balance sheet date to determine whether there is objective evidence of impairment. If any such evidence exists, any impairment loss is determined and recognized as follows:

–		For unquoted equity securities 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 ~~order~~a subsequent period the amount of an impairment loss decreases and the decrease can be linked objectively to ~~assess whether~~an event occurring after the ~~recoverable amounts have declined below~~impairment loss was recognized, the ~~carrying amounts. These assets are tested for~~ impairment ~~whenever events or changes~~loss 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 ~~the~~its net selling price and the value in use. In ~~determining the~~assessing value in use, ~~expected~~the estimated future cash flows ~~generated by the asset~~ are discounted to their present ~~value. The~~value 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 expense~~other assets in the ~~consolidated statements~~unit (or group of ~~operations.~~
~~The Group assesses at each balance sheet date whether there is any indication~~units) on a pro rata basis, except that ~~an impairment loss recognized for~~the 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 amount~~reversal of an ~~asset, when the circumstances and events that led~~impairment loss is limited to the ~~write-down or write-off cease to exist, is recognized as income. The reversal is reduced by the~~asset’s carrying amount that would have been determined had no impairment loss been recognized ~~as depreciation had~~in 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 ~~statements~~statement of operations over the period of the borrowings ~~on an~~using 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 sheets~~for 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 at~~obligations and a ~~pre-tax rate that reflects current market assessments of~~reliable estimate can be made. Where the time value of money ~~and, where appropriate,~~is material, provisions are stated at the ~~risks specific~~present 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-12~~F-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~~
~~Deferred~~Income 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 ~~provided~~the expected tax payable on the taxable income for the year, using tax rates enacted or substantively enacted at the balance sheet ~~liability method on all~~date, and any adjustment to tax payable in respect of previous years.

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

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

The limited exceptions to the recognition of deferred tax assets and liabilities are those temporary differences arising from goodwill not deductible for ~~taxation~~tax purposes, ~~except differences relating to~~ the initial recognition of assets or liabilities ~~which~~that 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 ~~value~~recognized is measured based on the expected manner of ~~losses expected to be available for utilization against future taxable income is recognized as~~realisation or settlement of the carrying amount of the assets and liabilities, using tax rates enacted or substantively enacted at the balance sheet date. Deferred tax assets and liabilities are not discounted.

The carrying amount of a deferred tax asset is reviewed at each balance sheet date and ~~offset against the deferred tax liability attributable to the same legal tax unit and jurisdiction. Net deferred tax assets are~~is 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 ~~sheets~~sheet as a prepaid expense.

~~F-13~~F-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 statements~~statement 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 statements~~statement 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 to~~accrued 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, 2003~~current and ~~2004 have been computed by dividing net income/(loss) of RMB576, RMB(358), and RMB(48) respectively, by the weighted average number of shares~~prior 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-15~~F-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 revenue~~turnover 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 ~~RMB716~~RMB1,111, 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 ~~regional~~and 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 ~~million~~and 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-16~~F-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-18~~F-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-19~~F-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 )

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-20~~F-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 ~~2004~~2005 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 LIMITED~~14. 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, except~~respect 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, ~~2003~~2004 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, ~~2003~~2004 and ~~2004,~~2005, the Group’s deposits with SA Finance amounted to ~~RMB366~~RMB406 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-22~~F-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, ~~2003~~2004 and ~~2004~~2005 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-23~~F-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-24~~F-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 ~~Group~~Company 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, RMB15~~RMB2, RMB2 and ~~RMB18~~RMB24 were paid to CSAHC for each of the years ended December 31, ~~2002,~~ 2003, 2004 and ~~2004~~2005, 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 ~~periodically~~with 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 the~~Based 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 ~~amounts~~value 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 annual~~historical carrying value of such assets had they been stated at cost less accumulated depreciation ~~charges~~and impairment losses.

(c) As of December 31, 2004 and 2005, certain aircraft of the Group bywith an aggregate carrying amount of approximately ~~RMB33, RMB33~~RMB23,562 and ~~RMB13,~~RMB30,408, respectively, ~~for 2002, 2003~~were mortgaged under certain notes payable and ~~2004.~~
~~During 2002, pursuant to certain sale~~lease 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 ~~another~~additional subsequent one year unless either party gives appropriate notice of termination. In this connection, rental income totaling ~~RMB34~~RMB31, RMB31 and RMB31 was received by the Group for each of the years ended December 31, 2003, 2004 and ~~2004~~2005 in respect of the ~~leases. As of December 31, 2004, the cost~~leases (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 ~~year~~years ended December 31, 2003, 2004 and ~~2004~~2005 amounted to ~~RMB55.~~RMB55, RMB55 and RMB35, respectively. As of December 31, ~~2004,~~2005, the Group’s ~~rental~~total future minimum lease payments under non-cancellable operating leases were receivable ~~in respect of the leases due in 2005~~within 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 ~~favour~~favor 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, ~~2003~~2004 and ~~2004,~~2005, the net present value of the lease commitments and the corresponding defeased deposits and debt securities amounted to ~~RMB2,409~~RMB2,462 and ~~RMB 2,462,~~RMB2,376, respectively. As a result of the Arrangements, the Group received net cash ~~benefits~~benefit of ~~RMB52 and~~ RMB69 in ~~2002 and~~ 2003, ~~respectively,~~ which ~~have been~~was 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, ~~2004~~2005 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 relation~~2005 mainly related to ~~the construction of facilities in~~projects 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 ~~and~~are 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-27~~F-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, ~~2003~~2004 and ~~2004, borrowings under short-term notes payable of~~2005, the Group had tax losses for PRC income tax purposes totaling ~~RMB130~~approximately 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, borrowings~~2004 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 payable~~current tax legislation.

26. OTHER ASSETS

As of December 31, 2004 and 2005, other assets of the Group ~~totaling RMB63~~include 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 repaid~~Further 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, ~~2003~~2004 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-28~~F-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, ~~2003~~2004 and ~~2004, borrowings under long-term~~2005, bank and other notes payable of the Group totaling ~~RMB2,565~~RMB8,620 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, as~~aircraft with carrying amount of ~~December 31, 2003~~RMB11,927 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, ~~2004~~2005 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-29~~F-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 aircraft~~has commitments under capital ~~leases.~~lease agreements in respect of aircraft and related equipment. The majority of these leases have terms of 10 to 15 years ~~and expiry dates range from~~expiring 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 ~~ranged~~ranging 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 ~~others~~flight 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 ~~RMB7,858~~RMB11,635 and ~~RMB11,635,~~RMB18,673, respectively ~~as of December 31, 2003 and 2004~~ were mortgaged to secure ~~facilities with financial institutions granted~~finance 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 RMB6,841~~which 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-31~~F-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 ended~~ageing 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, 2003~~2004 and ~~2004 totaled RMB1,348, RMB1,409~~2005, 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 capital~~trade and ~~operating leases~~bills 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-32~~F-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 rebates~~which 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 rebates~~related companies were unsecured, interest free and have ~~been deferred and amortized over the~~no fixed terms of ~~the respective leases.~~
~~Governmental subsidy for safety~~repayment.

(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 protection~~companies 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 the~~have no fixed terms of ~~the respective leases to reduce the future capital lease charges.~~
repayment.

~~F-33~~F-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. The~~millions, 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, ~~2003~~2004 and ~~2004,~~2005, the retained ~~earnings~~earnings/accumulated loss of the Group included ~~RMB112~~RMB81 and ~~RMB81,~~RMB(200), respectively, of undistributed ~~earnings~~earnings/losses of companies which are 50% or less owned by the Group and accounted for under the equity method.

~~F-35~~F-57

CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES

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

~~23. OTHER~~35. 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 ~~incomes~~income after taxation, as determined under relevant PRC accounting rules and regulations, to a statutory surplus reserve until the reserve balance reaches 50% of the registered capital. The transfer to this reserve must be made before distribution of a dividend to shareholders.

Statutory surplus reserve can be used to offset prior years’ losses, if any, and may be converted into share capital by the issue of new shares to shareholders in proportion to their existing shareholding or by increasing the par value of the shares currently held by them, provided that the balance after such issue is not less than 25% of the registered capital.

~~F-36~~F-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 ~~Board~~board of ~~Directors,~~directors, after consideration of the transfers referred to above and making up cumulative prior years’ ~~losses, if any.~~losses. Pursuant to the Articles of Association of the Company, the net income of the Company for the purpose of dividend distribution is deemed to be the lesser of (i) net income determined in accordance with the PRC accounting rules and regulations, and (ii) the net income determined in accordance with ~~IFRS;~~IFRSs; or if the financial statements of the Company are not prepared in accordance with ~~IFRS,~~IFRSs, the accounting standards of one of the countries in which its shares are ~~listed (Note 28).~~
~~24. COMMITMENTS AND CONTINGENCIES~~
~~Pursuant~~listed. As of December 31, 2005, the Company did not have any distributable reserves.

36. RELATED PARTY TRANSACTIONS

In addition to the ~~Reorganisation~~balances 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 assumed~~direct control of the ~~airline and airline-related businesses together~~Civil 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 assets~~CAAC and ~~liabilities~~its 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 occupancy~~longer 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-37~~F-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 commenced~~millions, 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. According~~millions, 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 ~~writ~~above, certain subsidiaries of ~~summons~~CSAHC also provided hotel and other services to the Group during the year. The total amount involved is not material to the results of the Group for the ~~Litigation, New Link Consultants Limited, the plaintiff claimed unspecified damages against~~year.

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 one~~conducts a majority of its business activities with entities directly or indirectly owned or controlled by the ~~defendants~~PRC government and numerous government authorities and agencies (collectively referred to as “state-owned entities”) in the ~~Litigation) for breach~~ordinary course of ~~the agreement on the basis~~business. These transactions, which include sales and purchase of ~~certain evidence proving~~goods 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 sale~~non-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 consider~~reflected 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 adequate~~provided quarters to eligible employees of the ~~Group as and when required.~~Group. In return, the Group ~~agrees to pay~~paid 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, pursuant~~millions, 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 ~~already~~had made payments totaling ~~RMB191~~RMB152 and RMB168, respectively, under the scheme and recorded its remaining contractual liabilities totaling ~~RMB69~~RMB108 and RMB92, respectively, as accrued expenses on ~~its~~the 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 operational~~operates principally as a single business segment for the provision of air transportation services. The analysis of turnover and ~~financial services provided~~operating income/(loss) by ~~CSAHC and its affiliates, and~~geographical 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-39~~F-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 premiums~~fleet, 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 acquisitions~~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. Most of the Group’s non-aircraft assets are ~~not considered significant~~located 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 ~~operations~~operation and ~~certain~~ related assets of CNA and XJA at a total consideration of RMB15,522, which was ~~partly~~partially satisfied by assumption of debts and liabilities of CNA and XJA ~~totaling~~totalling 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-43~~F-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 results~~operations of the Group for the ~~year.~~
     ~~The directors of the Company~~year 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, bills~~taxes 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 ~~years~~year 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, RMB3,819~~RMB4,017, 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 ~~2005~~2006 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 loans~~notes payable outstanding at December 31, ~~2004~~2005 when they fall due during ~~2005. In relation~~2006. 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 amount~~renewed short-term notes payable outstanding of ~~RMB24,225 during 2005 and thereafter.~~RMB2,611 (Notes 27). The directors of the Company believe that ~~such~~sufficient 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 under~~maturity information of the Group’s capital leases ~~of the Group~~obligations 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, ~~2003~~2004 and ~~2004,~~2005, the balance due from BSP agents amounted to ~~RMB446~~RMB411 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 personal~~on 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 estimated~~not materially different from their fair values ~~of significant financial assets and liabilities~~ as of December 31, ~~2003~~2004 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, accounts~~and other current assets. Obligation under capital leases, trade and bills payables, ~~bills~~taxes payable and other ~~liabilities and taxes payable~~liabilities.

The carrying values approximate their fair ~~value~~values 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 Bank~~economic 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 for~~capital leases vary from lease ~~and debt payments and for dividends. Any amounts of foreign exchange that the Group receives in excess of~~to lease. It is impractical to compare such ~~amount must be converted into Renminbi at the rate~~leases with those prevailing in the ~~PRC inter-bank market. The Group will have access to foreign currency through~~market within the ~~inter-bank system, subject to the approval~~constraints 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 Renminbi~~timeliness and ~~paid to holders of the H shares in Hong Kong dollars at the average closing exchange rate for Hong Kong dollars as announced by the People’s Bank of China~~cost for the ~~calendar week preceding~~purpose of estimating the ~~date~~fair 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-47~~F-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 are~~2005, 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-50~~F-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 registered~~committed 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-52~~F-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

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 resources		January 1, 2006

IFRS 7, Financial instruments: disclosure		January 1, 2007

IFRIC 4, Determining whether an arrangement contains a lease		January 1, 2006

IFRIC 5, Rights to interests arising from decommissioning, restoration environmental rehabilitation funds		January 1, 2006

IFRIC 6, Liabilities arising from participating in a specific market – Waste electrical and electronic equipment		December 1, 2005

IFRIC 7, Applying the restatement approach under IAS 29, Financial reporting in hyperinflationary economies		March 1, 2006

IFRIC 8, Scope of IFRS 2		May 1, 2006

IFRIC 9, Reassessment of embedded derivatives		June 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 statements		January 1, 2007

— capital disclosures

Amendments to IAS 19, Employee benefits — actuarial gains and losses, group plans and disclosures		January 1, 2006

Amendments to IAS 39, Financial instruments: recognition and measurement		January 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 contracts		January 1, 2006

— Financial guarantee contracts

Amendment to IAS 21, The effects of changes in foreign exchange rates		January 1, 2006

— Net investment in a foreign operation

Amendments to IFRS 1, First-time adoption		January 1, 2006

Amendments to IFRS 1, First-time adoption and IFRS 6, Exploration for and evaluation of mineral resources		For 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 contracts		For 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 of

ownership

establishment

interest held by

Principal

Name of company

/operation

Registered capital

the Company

activities

Guangxi Airlines Company Limited (a)

PRC

RMB170,900,000

Airline

Southern Airlines (Group) Shantou Airlines Company Limited (a)

PRC

RMB280,000,000

Airline

Zhuhai Airlines Company Limited (a)

PRC

RMB250,000,000

Airline

Xiamen Airlines Company Limited (a)

PRC

RMB700,000,000

Airline

Guizhou Airlines Company Limited (a)

PRC

RMB80,000,000

Airline

Guangzhou Air Cargo Company Limited (a)

PRC

RMB238,000,000

Cargo services

Guangzhou Baiyun International Logistic Company Limited (a)

PRC

RMB50,000,000

Logistics operations

Guangzhou Nanland Air Catering Company Limited (b)

PRC

RMB120,000,000

Air catering

China Southern West Australian Flying College Pty Limited

Australia

AUD100,000

Pilot training services

Xinjiang Civil Aviation Property Management
Limited (a)

PRC

RMB251,332,832

51.8

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 ~~IFRS~~IFRSs 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 be~~were included in the consolidated financial statement of the Group beginning January 1, 2005.

Under U.S. GAAP, such transaction is considered to be “a combination of entities under common control”. A combination of entities under common control is accounted for in a manner similar to a “pooling-of-interests”. Consequently, the assets and liabilities of CNA and XJA are reflected at their ~~U.S. GAAP~~historical net asset carrying values and the U.S. GAAP consolidated financial statements of the Group are restated to include the historical carrying values of assets and liabilities of CNA and XJA, and their results of operations and cash flows for all the periods presented.

(b) Sale and leaseback accounting

Under ~~IFRS,~~IFRSs, gains on sale and leaseback transactions where the subsequent lease is an operating lease are recognized as income immediately, if the transactions are established at fair value. Differences between the sale price and fair value are deferred and amortized over the period for which the assets are expected to be used. Under U.S. GAAP, such gains are deferred and amortized over the term of the lease.

(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 ~~RMB2,409~~RMB2,462 and ~~RMB2,462~~RMB2,376 as of December 31, ~~2003~~2004 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 ~~IFRS~~IFRSs in 1996 and the additional depreciation charges recorded in the ~~eight~~nine 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-56~~F-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-57~~F-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 ~~amount~~valuation 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 RMB741~~Company, 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 addresses~~results of the ~~accounting~~Group for ~~transactions~~the year are presented in ~~which~~the 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 on~~total net income for the ~~normal capacity~~year between the minority interests and the equity shareholders of the ~~production facilities. This Statement will be effective~~Company. 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 adoption~~year are also separately presented in the consolidated statement of ~~FASB No. 151 will have~~operations as a ~~material impact on its consolidated financial statements.~~
~~FASB No. 153~~
     ~~In December 2004, the FASB issued FASB Statement No. 153, Exchanges~~component 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-58~~F-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-59~~F - 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 ~~IFRS~~IFRSs 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-60~~F - 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 Group~~operations, 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 Group~~changes in total shareholders’ equity under U.S. GAAP for each of the two years ~~have been~~ended 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. Consequently~~interests 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 are~~Acquisitions were completed on December 31, 2004, condensed consolidated balance sheets ~~of the Group as of~~under U.S. GAAP at December 31, ~~2003 and~~ 2004 and ~~the related~~2005 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 period~~year 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-61~~F-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)~~

~~Condensed~~the 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)~~
~~(Amounts~~statements 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, 2001~~		~~7,315~~

~~Net loss~~		~~(655~~	)
~~Dividend paid~~		~~(67~~	)
~~Distributions to CSAHC~~		~~(89~~	)
~~Contributions from CSAHC~~		~~292~~

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 ~~profit~~income		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-65~~F-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 ~~are~~is not recorded under U.S. GAAP. However, a deferred tax asset is recognized for the tax deductibility of the resulting net revaluation surpluses with a corresponding credit to the equity under U.S. GAAP.

(c)		As a result of the CNA/XJA Acquisitions, the tax losses attributable to the airline operations of CNA and XJA are no longer available for utilization against future taxable income of such operations. Accordingly, the deferred tax assets arising from such tax losses and related valuation allowance was eliminated against equity.

~~F-66~~F-88

CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES

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

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

Operating revenue


	Year ended December 31,						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 ~~ended~~from 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-68~~F-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-69~~F-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 shifted~~addition 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)		~~Handling~~For the years ended December 31, 2003 and 2004, repairing charges ~~represent fees payable to Southern Airlines (Group) Import~~of RMB701 and ~~Export Trading Company, a wholly owned subsidiary of CSAHC, in connection with the procurement of aircraft and flight equipment on the behalf of~~RMB1,159, 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-74~~F-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

•		~~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.


		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		—


						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


~~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.


		~~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	~~1,151,953,998~~1,150,854,998 H shares			~~26.34~~	%26.31%


	The Stock Exchange				The New York				The Shanghai
	of Hong Kong				Stock Exchange				Stock Exchange
	Price per H Share				Price per ADS				Price per A Share
	(HK$)				(US$)				(RMB)
	High		Low		High		Low		High		Low
Annual Market Prices
Fiscal Year ended December 31, 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

	~~(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.~~


(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.


(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 acquisition~~A framework agreement on lease and operation dated ~~April 21, 2005~~January 1, 2006 between the Company and China Southern Airlines Group Travel Development Company Limited (the “CSA Travel”), a wholly owned subsidiary of CSAHC, pursuant to which the Company leases certain hotels belonging to it to CSA Travel for operation and management for a period of three years. The consideration for the framework agreement on lease and operation is based on the rent payable and fees for operation and management of the hotels, and is capped at RMB6 million per year. It became effective on April 25, 2006 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) Import~~Advertising Company (the “SAAC”), a related party that is 45% owned by the Company and ~~Export Trading~~55% owned by CSAHC, pursuant to which the SAAC produces advertisement script, graphic and music for the Company with the copyright of such products belonging to the Company for a period of three years. The consideration for the advertising agency agreement is based on the fees payable for advertising services to be provided, and is capped at RMB30 million per year. It became effective on April 25, 2006 has been approved by the directors of the Company.

(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 SNC~~Hainan 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.


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


(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.


	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


									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


	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	)


	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


			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


	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


			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


	2004		2005
	RMB		RMB
Authorized and contracted for		—		—
Authorized but not contracted for		156		74

		156		74


		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


	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