To: David R. Humphrey
Amy Geddes
Margery Reich
RE: CHINA SOUTHERN AIRLINES COMPANY LIMITED ("THE COMPANY") AND ITS
SUBSIDIARIES ("THE GROUP")
FORM 20-F FOR THE YEAR ENDED DECEMBER 31, 2004
COMMISSION FILE NUMBER: 001-14660
QUESTION 1
WE NOTE THAT, THROUGHOUT YOUR DISCUSSION OF 2004 OPERATING RESULTS AS COMPARED
WITH 2003, YOU EXPLAIN INCREASES IN REVENUES AND EXPENSES PRIMARILY BY CITING
INCREASED PASSENGER LOAD AND FLEET SIZE; HOWEVER, YOU DO NOT EXPLAIN WHAT LED TO
THE INCREASED PASSENGER LOAD AND FLEET SIZE IN 2004. REVISE YOUR DISCLOSURE TO
INCLUDE ALL THE FACTS AND CIRCUMSTANCES SURROUNDING THESE INCREASES, INCLUDING
THOSE FACTS AND CIRCUMSTANCES LEADING TO INCREASED FLEET SIZE AND INCREASED
PASSENGER LOAD.
We have considered your comments and disclosure will be revised in the 2005 Form
20-F as follows:
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 by the Group 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
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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 the 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.
QUESTION 2
YOU STATE, ON PAGE F-16, THAT YOU IMPOSE A FUEL SURCHARGE ON CERTAIN FLIGHTS. AS
THAT SURCHARGE FORMS PART OF THE TRAFFIC REVENUE OF THE GROUP, IT WOULD BE
APPROPRIATE TO DISCLOSE AND QUANTIFY THE IMPACT OF FUEL SURCHARGE REVENUE IN
YOUR COMPARATIVE DISCUSSIONS OF OPERATING REVENUE. PLEASE REVISE.
We have considered your comments and disclosure will be revised in the 2005 Form
20-F. See our answer to question 1 above.
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QUESTION 3
WE NOTE THAT YOU HAVE INCLUDED THE PRINCIPAL BALANCE ONLY OF SHORT AND LONG TERM
DEBT IN YOUR TABLE OF CONTRACTUAL OBLIGATIONS. WE BELIEVE YOU SHOULD INCLUDE
ESTIMATED INTEREST PAYMENTS IN THE TABLE OR, IN THE ALTERNATIVE, INCLUDE
ADDITIONAL DISCLOSURE REGARDING INTEREST PAYMENTS IN A FOOTNOTE TO THE TABLE.
FOR VARIABLE RATE DEBT, YOU SHOULD INCLUDE A DISCUSSION OF THE METHODOLOGY USED
IN THE CALCULATION. AS SUCH, PLEASE INCLUDE YOUR PROPOSED REVISED DISCLOSURE AS
PART OF THE RECONCILIATION REQUESTED ABOVE. SEE SECTION IV.A OF FR-72 FOR
GUIDANCE.
Disclosure will be revised in the 2005 Form 20-F as follows:
AS OF DECEMBER 31, 2004
------------------------------------------------------------
PAYMENT DUE BY PERIOD
------------------------------------------------------------
LESS THAN AFTER 5
TOTAL 1 YEAR 1-3 YEARS 4-5 YEARS YEARS
(RMB MILLION)
CONTRACTUAL OBLIGATIONS
Short-term debt 9,925 9,925 - - -
Long-term debt 13,528 1,593 5,766 2,283 3,886
Capital lease obligations 11,743 2,144 5,428 3,479 692
Cash payable for CNA/ XJA 1,959 1,959 - - -
------------------------------------------------------------
TOTAL CONTRACTUAL OBLIGATIONS 37,155 15,621 11,194 5,762 4,578
------------------------------------------------------------
OTHER COMMERCIAL COMMITMENTS
Operating lease commitments 12,750 1,761 3,184 6,023 1,782
Aircraft purchase commitments (Note 1) 11,776 8,748 3,028 - -
Capital commitments in respect of
investments in the Guangzhou new
airport 824 824 - - -
Other capital commitments 700 595 105 - -
Investing commitments 83 83 - - -
------------------------------------------------------------
TOTAL COMMERCIAL OBLIGATIONS 26,133 12,011 6,317 6,023 1,782
------------------------------------------------------------
ESTIMATED FUTURE INTEREST PAYMENTS ON SHORT-TERM DEBT AND LONG-TERM DEBT
Fixed rate 1,076 364 406 219 87
Variable rate (note 2) 939 266 522 122 29
------------------------------------------------------------
2,015 630 928 341 116
------------------------------------------------------------
Note 1 Amount shown are net of previously paid purchase deposits.
Note 2 Variable rate debts bear interest at floating rates ranging from 3 months
LIBOR / 6 months LIBOR plus a margin between 0.3% and 1.2% per annum,
with maturities through 2014. The prevailing LIBOR rates effective on
December 31, 2004 was used in calculating the estimated future interest
payments.
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QUESTION 4
WE UNDERSTAND THAT YOU FOCUS ON THE POWER TO CONTROL IN DETERMINING WHETHER A
PARENT/SUBSIDIARY RELATIONSHIP EXISTS. UNDER U.S. GAAP, VARIABLE INTEREST
ENTITIES ("VIES") IN WHICH A PARENT DOES NOT HAVE A CONTROLLING VOTING INTEREST
BUT ABSORBS THE MAJORITY OF THE VIES EXPECTED LOSSES OR RETURNS MUST ALSO BE
CONSOLIDATED. PLEASE EXPLAIN HOW YOU HAVE CONSIDERED THIS APPARENT DIFFERENCE
BETWEEN IFRS AND U.S. GAAP WHEN PREPARING THIS FOOTNOTE. PLEASE BE DETAILED AND
SPECIFIC WHEN PREPARING YOUR RESPONSE.
As disclosed on page F-50, we identified the following six principal affiliated
companies and jointly controlled entities which were not consolidated in the
IFRS consolidated financial statements:
- ------------------------------------------------------------------------------------------------------------------------------
ATTRIBUTABLE
EQUITY INTEREST (%) PRINCIPAL ACTIVITIES
- ------------------------------------------------------------------------------------------------------------------------------
1 Southern Airlines Group Finance 47.42 Provision of financial services
Company Limited ("SA Finance")
- ------------------------------------------------------------------------------------------------------------------------------
2 Sichuan Airlines Corporation 39 Airline
Limited ("Sichuan Airlines")
- ------------------------------------------------------------------------------------------------------------------------------
3 Guangzhou Aircraft Maintenance 50 Provision of aircraft repair and maintenance services
Engineering Company Limited ("GAMECO")
- ------------------------------------------------------------------------------------------------------------------------------
4 MTU Maintenance Zhuhai Co. Ltd 50 Provision for engine repair and maintenance services
("MTU")
- ------------------------------------------------------------------------------------------------------------------------------
5 China Postal Airlines Limited 49 Airline
("China Postal")
- ------------------------------------------------------------------------------------------------------------------------------
6 Zhuhai Xiang Yi Aviation Technology 51 Provision of flight simulation training services
Company Limited ("Xiang Yi")
- ------------------------------------------------------------------------------------------------------------------------------
Other non-consolidated affiliated companies and jointly controlled entities of
the Group are not significant to the Group, both individually or in aggregate,
and have been accounted for using the equity accounting method in the IFRS
consolidated financial statements. The same accounting is used for US GAAP
purposes.
STEP (1)
- --------
We assessed whether any of the above six entities qualifies for the scope
exception set out in paragraph 4 of FIN46(R).
Sichuan Airlines, China Postal and Xiang Yi are deemed to be businesses under
the definition in Appendix C of FIN46(R) and did not meet any of the 4
conditions stated in paragraph 4.h. in FIN46(R). Accordingly, they are outside
the scope of FIN46(R).
SA Finance, GAMECO and MTU were identified as within the scope of FIN46(R).
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STEP (2)
- --------
We did not evaluate as to whether or not SA Finance, GAMECO and MTU are variable
interest entities ("VIEs") as defined in FIN46(R). Instead, we assumed they are
VIEs and performed the primary beneficiary evaluation.
The Group's has concluded that its only variable interest in each of these 3
entities is its equity interests. The Group holds effectively 47.42%, 50% and
50% equity interests in SA Finance, GAMECO and MTU respectively. Consequently it
will not absorb a majority of the expected losses of these entities nor receive
a majority of their expected residual returns. Based on the above, the Group has
concluded it is not the primary beneficiary of SA Finance, GAMECO and MTU and
therefore they were not consolidated under U.S. GAAP.
STEP (3)
- --------
As Sichuan Airlines, China Postal and Xiang Yi were outside the scope of
FIN46(R), we applied provisions of FAS94 "Consolidation of All Majority-Owned
Subsidiaries" and EITF96-16 "Investor's Accounting for an Investee When the
Investor Has a Majority of the Voting Interest but the Minority Shareholder or
Shareholders Have Certain Approval or Veto Rights" to assess whether these
entities should be consolidated.
(1) Sichuan Airlines and China Postal
The Group does not have majority voting interest in these entities.
Consequently they were not consolidated under US GAAP.
(2) Xiang Yi
According to the articles of association of Xiang Yi, all financial and
operating decisions have to be passed by more than 75% of the directors of
Xiang Yi. The board of directors of Xiang Yi comprises 2 directors. They
are appointed by the Company and the other 49% equity shareholder
respectively. Although the Company holds 51% equity interest in Xiang Yi,
the Company does not have a majority voting interest in Xiang Yi. Even if
the Company did have a majority of the voting interest, the minority
shareholder has been granted substantive participating rights because it
participates in the voting of all financial and operating decisions.
Consequently, Xiang Yi was not consolidated under US GAAP.
The Company hereby acknowledges that:
(1) the Company is responsible for the adequacy and accuracy of the disclosure
in this filing;
(2) staff comments or changes to disclosure in response to staff comments do
not foreclose the Commission from taking any action with respect to this
filing; and
(3) the Company may not assert staff comments as a defense in any proceeding
initiated by the Commission or any person under the federal securities laws
of the United States.
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