UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
 
FORM 20-F
 
(Mark One)

¨
 
REGISTRATION STATEMENT PURSUANT TO SECTION 12(b) OR (g) OF THE SECURITIES EXCHANGE ACT OF 1934
 
OR

þ
 
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the fiscal year ended December 31, 2009  
 
OR

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

¨
 
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 from _________ to
 
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, 510405
 
PEOPLE’S REPUBLIC OF CHINA
 
(Address of principal executive offices)

Mr. Xie Bing
Telephone: +86 20 86124462
E-mail: ir@csair.com
Fax: +86 20 86659040
Address: 278 JI CHANG ROAD
GUANGZHOU, 510405
PEOPLE’S REPUBLIC OF CHINA

(Name, Telephone, E-mail and/or Facsimile number and Address of Company Contact Person)

Securities registered or to be registered pursuant to Section 12(b) of the Act.
 

 
Title of each class
 
Name of each exchange on which registered
     
Ordinary H Shares of par value
 
New York Stock Exchange, Inc.
RMB1.00 per share
   
represented by American
   
Depositary Receipts
   
 
Securities registered or to be registered pursuant to Section 12(g) of the 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.
 
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. 5,521,150,000 ordinary A Shares of par value RMB1.00 per share and 2,482,417,000 ordinary H Shares of par value RMB1.00 per share were issued and outstanding as of December 31, 2009.

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.

¨ Yes þ No

If this report is an annual or transition report, indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.

¨ Yes þ No

Note — Checking the box above will not relieve any registrant required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 from their obligations under those Sections.

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

þ Yes ¨ 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):

Large accelerated filer  þ    Accelerated filer  ¨  Non-accelerated filer ¨
 
Indicate by check mark which basis of accounting the registrant has used to prepare the financial statements included in this filing:
 
U.S. GAAP ¨
 
International Financial Reporting Standards þ
 
Other ¨
   
as issued by the International Accounting
   
   
Standards Board
   
 
If “Other” has been checked in response to the previous question, indicate by check mark which financial statement item the registrant has elected to follow.

¨  Item 17  ¨  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).

¨ Yes  þ  No

 
 

 

TABLE OF CONTENTS
China Southern Airlines Company Limited

 
Page
   
FORWARD-LOOKING STATEMENTS
1
   
INTRODUCTORY NOTE
1
   
GLOSSARY OF AIRLINE INDUSTRY TERMS
2
   
PART I
3
   
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
   
Reasons for the Offer and Use of Proceeds
6
   
Risk Factors
6
   
ITEM 4. INFORMATION ON THE COMPANY.
12
   
History and Development of the Company
12
   
Business Overview
13
   
Organizational Structure
29
   
Property, Plant and Equipment
31
   
ITEM 4A. UNRESOLVED STAFF COMMENTS.
32
   
ITEM 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS.
32
   
Critical Accounting Policies
32
   
Recently Pronounced International Financial Reporting Standards
33
   
Overview
33
   
Certain Financial Information and Operating Data by Geographic Region
34
   
Operating Results
35
   
Liquidity and Capital Resources
41
   
Contractual Obligations and Commitments
43
   
ITEM 6. DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES.
43
   
Directors, Senior Management and Employees
43
   
Compensation
48
   
Board Practices
49
 
 
i

 

Employees
50
   
Share Ownership
51
   
ITEM 7. MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS.
51
   
Major Shareholders
51
   
Related Party Transactions
52
   
Interests of Experts and Counsel
55
   
ITEM 8. FINANCIAL INFORMATION.
55
   
Consolidated Statements and Other Financial Information
55
   
Significant Changes
55
   
Legal Proceedings
55
   
Dividend Information
55
   
ITEM 9. THE OFFER AND LISTING.
55
   
Offer and Listing Details
55
   
Plan of Distribution
57
   
Markets
57
   
Selling Shareholders
57
   
Dilution
57
   
Expenses of the Issue
57
   
ITEM 10. ADDITIONAL INFORMATION.
57
   
A. Share Capital
57
   
B. Memorandum and Articles of Association
57
   
C. Material Contracts
61
   
D. Exchange Controls
61
   
E. Taxation
62
   
F. Dividends and Paying Agents
66
   
G. Statement by Experts
66
   
H. Documents on Display
66
   
I. Subsidiary Information
66
   
ITEM 11. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
66
   
ITEM 12. DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES.
68
   
PART II
70
 
 
ii

 

ITEM 13. DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES.
70
   
ITEM 14.  MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF PROCEEDS.
70
   
ITEM 15. CONTROLS AND PROCEDURES.
70
   
ITEM 16. RESERVED
71
   
ITEM 16A. AUDIT COMMITTEE FINANCIAL EXPERT.
71
   
ITEM 16B. CODE OF ETHICS.
72
   
ITEM 16C. PRINCIPAL ACCOUNTING FEES AND SERVICES.
72
   
ITEM 16D. EXEMPTIONS FROM THE LISTING STANDARDS FOR AUDIT COMMITTEE
72
   
ITEM 16E. PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED PURCHASERS.
72
   
ITEM 16F. CHANGES IN REGISTRANT’S CERTIFYING ACCOUNTANT.
72
   
ITEM 16G. CORPORATE GOVERNANCE.
72
   
PART III
75
   
ITEM 17. FINANCIAL STATEMENTS.
75
   
ITEM 18. FINANCIAL STATEMENTS.
75
   
ITEM 19. EXHIBITS.
75
   
Index to Exhibits
75
 
 
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 in markets where the Company operates, including changes in interest rates;

·
the effects of competition on the demand for and price of our services;

·
natural phenomena;

·
actions by government authorities, including changes in government regulations, and changes in the CAAC’s regulatory policies;

·
the Company’s relationship with China Southern Air Holding Company (the “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;

·
the availability of qualified flight personnel and airport facilities; 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 59.32% controlling interest in the Company as of May 7, 2010.

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 PRC. References to “Macau” or “Macau SAR” are to the Macau Special Administrative Region of the PRC.
 
 
1

 

The Company presents its consolidated financial statements in Renminbi. The consolidated financial statements of the Company for the year ended December 31, 2009 (the “Financial Statements”) have been prepared in accordance with all applicable International Financial Reporting Standards (“IFRSs”), which collective term includes all applicable individual International Financial Reporting Standards, International Accounting Standards (“IAS”) and interpretations issued by the International Accounting Standards Board (the “IASB”).

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 = RMB6.8282, 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, 2009. 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 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 tons of capacity available for the transportation of revenue load (passengers and cargo) multiplied by the kilometers flown
     
Traffic Measurements
   
     
“cargo ton kilometers”
 
the load in tons multiplied by the kilometers flown
     
“revenue passenger kilometers” or “RPKs”
 
the number of passengers carried multiplied by the kilometers flown
     
“revenue ton kilometers” or “RTKs”
 
the load (passenger and cargo) in tons multiplied by the kilometers flown
     
Yield Measurements
   
     
“average yield”
 
revenue from airline operations (passenger and cargo) divided by RTKs
     
“cargo yield”
 
revenue from cargo operations divided by cargo ton kilometers
     
“passenger yield”
 
revenue from passenger operations divided by RPKs
     
“ton”
 
a metric ton, equivalent to 2,204.6 pounds
     
Load Factors
   
     
“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
     
“overall load factor”
 
RTKs expressed as a percentage of ATKs
     
“passenger load factor”
 
RPKs expressed as a percentage of ASKs
 
 
2

 

Utilization
   
     
“utilization rates”
 
the actual number of flight and taxi hours per aircraft per operating day
     
Equipment
   
     
“expendables”
 
aircraft parts that are ordinarily used up and replaced with new parts
     
“rotables”
 
aircraft parts that are ordinarily repaired and reused
     
Liquidity Ratios
   
     
“current ratio”
 
current assets divided by current liabilities
     
“quick ratio”
 
current assets excluding inventories divided by current liabilities
     
Others
   
     
“ADR”
 
American Depositary Receipt
     
“A Shares” 
 
Shares issued by the Company to investors in the PRC for subscription in RMB, with par value of RMB1.00 each
     
“CAAC”
 
Civil Aviation Administration of China
     
“CAOSC”
 
China Aviation Oil Supplies Company
     
“CSRC”
 
China Securities Regulatory Commission
     
“H Shares” 
 
Shares issued by the Company, listed on the Stock Exchange of Hong Kong Limited and subscribed for and traded in Hong Kong dollars, with par value of RMB1.00 each
     
“Nan Lung”
 
Nan Lung Holding Limited (a wholly-owned subsidiary of CSAHC)
     
“NDRC”
 
National Development and Reform Commission of China
     
“SA Finance”
 
Southern Airlines Group Finance Company Limited
     
“SAFE”
 
State Administration of Foreign Exchange of China
     
“SEC”
 
United States Securities and Exchange Commission

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 Group as of and for each of the years in the five-year period ended December 31, 2009. The selected consolidated income statement data for each of the years in the three-year period ended December 31, 2009 and selected consolidated balance sheet data as of December 31, 2009 and 2008 excluding basic and diluted earnings/(loss) per ADR, are derived from the consolidated financial statements of the Company, including the related notes, included elsewhere in this Annual Report. The selected consolidated income statement data for the years ended December 31, 2006 and 2005 and selected consolidated balance sheet data as of December 31, 2007, 2006 and 2005 are derived from the Company’s audited consolidated financial statements that are not included in this Annual Report.

 
3

 

Moreover, the selected financial data should be read in conjunction with our consolidated financial statements together with accompanying notes and “Item 5. Operating and Financial Review and Prospects” are included elsewhere in this Annual Report. Our consolidated financial statements are prepared and presented in accordance with International Financial Reporting Standards, or IFRSs.

Year ended December 31,

   
2009
US$
   
2009
RMB
   
2008
RMB
   
2007
RMB
   
2006
RMB
   
2005
RMB
 
   
(in million, except per share data)
 
                                     
Consolidated Income Statement Data:
                                   
                                     
Operating revenue
    8,026       54,802       55,288       54,401       46,081       38,233  
Operating expenses
    (8,106 )     (55,351 )     (61,767 )     (52,956 )     (45,899 )     (39,598 )
Operating profit/(loss)
    211       1,440       (5,646 )     1,881       663       (1,323 )
profit/(loss) before taxation
    63       432       (4,724 )     2,879       227       (1,913 )
profit/(loss) for the year
    77       527       (4,786 )     2,032       104       (1,891 )
profit/(loss) attributable to:
                                               
Equity shareholders of the Company
    48       330       (4,823 )     1,839       106       (1,893 )
Minority interests
    29       197       37       193       (2 )     2  
Basic and diluted earnings/(loss) per share
    0.01       0.05       (0.74 )     0.28       0.02       (0.29 )
Basic and diluted earnings/(loss) per ADR
    0.34       2.33       (36.75 )     14.01       0.81       (14.43 )

Year ended December 31,

   
2009
US$
   
2009
RMB
   
2008
RMB
   
2007
RMB
   
2006
RMB
   
2005
RMB
 
   
(in million)
 
                                     
Consolidated Balance Sheet Data:
                                   
                                     
Cash and cash equivalents
   
636
     
4,343
     
4,649
     
3,824
     
2,264
     
2,901
 
Other current assets
   
701
     
4,785
     
4,599
     
4,966
     
4,419
     
4,320
 
Asset classified as held for sale
   
77
     
529
     
-
     
-
     
-
     
-
 
Property, plant and equipment, net
   
9,325
     
63,673
     
53,237
     
58,441
     
56,335
     
54,254
 
Total assets
   
13,876
     
94,750
     
83,042
     
82,006
     
75,689
     
71,491
 
Bank and other loans, including long-term bank and other loans due within one year
   
2,556
     
17,452
     
22,178
     
24,948
     
23,822
     
16,223
 
Short-term financing bills
   
-
     
-
     
2,000
     
-
     
-
     
-
 
Obligations under capital leases due within one year
   
210
     
1,431
     
1,781
     
2,877
     
3,091
     
3,373
 
Bank and other loans, excluding balance due within one year
   
4,082
     
27,875
     
17,429
     
9,074
     
10,018
     
12,740
 
Obligations under capital leases, excluding balance due within one year
   
1,741
     
11,887
     
11,157
     
12,858
     
12,307
     
12,459
 
Total equity
   
1,942
     
13,262
     
9,479
     
14,310
     
11,752
     
11,667
 
Number of shares (in million)
   
8,003
     
8,003
     
6,561
     
4,374
     
4,374
     
4,374
 

Selected Operating Data

The following selected operating data of the Group for each of the years in the five-year period ended December 31, 2009 have been derived from consolidated financial statements prepared in accordance with IFRSs and other data provided by the Group which have not been audited.
 
 
4

 

The operating data and the profit analysis and comparison for other years below is calculated and disclosed in accordance with the statistical standards, which have been implemented by the Group 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,

   
2009
   
2008
   
2007
   
2006
   
2005
 
Capacity
                             
ASK (million)
   
123,441
     
112,767
     
109,733
     
97,059
     
88,361
 
ATK (million)
   
15,446
     
14,276
     
14,208
     
12,656
     
11,509
 
Kilometers flown (thousand)
   
746,133
     
686,236
     
675,127
     
594,957
     
539,844
 
Hours flown (thousand)
   
1,195
     
1,106
     
1,075
     
931
     
846
 
Number of landing and take-offs
   
616,296
     
556,914
     
543,789
     
481,810
     
438,674
 
Traffic
                                       
RPK (million)
   
93,002
     
83,184
     
81,727
     
69,582
     
61,923
 
RTK (million)
   
10,067
     
9,200
     
9,250
     
8,071
     
7,284
 
Passengers carried (thousand)
   
66,281
     
58,237
     
56,903
     
49,206
     
44,119
 
Cargo and mail carried (tons)
   
862,000
     
835,000
     
872,000
     
819,000
     
775,000
 
Load Factors
                                       
Passenger load factor (RPK/ASK) (%)
   
75.3
     
73.8
     
74.5
     
71.7
     
70.1
 
Overall load factor (RTK/ATK) (%)
   
65.2
     
64.4
     
65.1
     
63.8
     
63.3
 
Breakeven load factor (%)
   
68.1
     
73.8
     
64.8
     
65.1
     
67.1
 
Yield
                                       
Yield per RPK (RMB)
   
0.54
     
0.61
     
0.61
     
0.60
     
0.55
 
Yield per cargo and mail ton
kilometers (RMB)
   
1.63
     
1.96
     
1.87
     
1.89
     
1.75
 
Yield per RTK (RMB)
   
5.26
     
5.86
     
5.75
     
5.57
     
5.13
 
Fleet
                                       
— Boeing
   
194
     
179
     
177
     
159
     
140
 
— Airbus
   
157
     
133
     
119
     
103
     
71
 
— McDonnell Douglas
   
16
     
25
     
25
     
36
     
36
 
— Others
   
11
     
11
     
11
     
11
     
14
 
Total aircraft in service at period end
   
378
     
348
     
332
     
309
     
261
 
Overall utilization rate (hours per day)
   
9.4
     
9.1
     
9.4
     
9.5
     
9.6
 
Cost
                                       
Operating cost per ATK (RMB)
   
3.58
     
4.33
     
3.73
     
3.63
     
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.
 
Period
 
Period End
   
Average (1)
(RMB per US$)
   
High
   
Low
 
                         
Annual Exchange Rate
                       
                                 
2005
   
8.0694
     
8.1825
     
8.2767
     
8.0702
 
2006
   
7.8041
     
7.9723
     
8.0702
     
7.8041
 
2007
   
7.2946
     
7.6058
     
7.8127
     
7.2946
 
2008
   
6.8225
     
6.9477
     
7.2946
     
6.7800
 
2009
   
6.8259
     
6.8307
     
6.8470
     
6.8176
 

(1)
Determined by averaging the rates on the last business day of each month during the relevant period.

The following table sets out the range of high and low exchange rates, based on the Noon Buying Rate, between Renminbi and U.S. dollars, for the following periods. 

 
5

 
 
 
High
   
Low
 
Monthly Exchange Rate
           
November 2009
   
6.8300
     
6.8255
 
December 2009
   
6.8299
     
6.8299
 
January 2010
   
6.8295
     
6.8258
 
February 2010
   
6.8330
     
6.8258
 
March 2010
   
6.8270
     
6.8254
 
April 2010
   
6.8275
     
6.8229
 
May 2010 (up to May 7, 2010 the latest practicable date)
   
6.8265
     
6.8245
 

Dividend Payments

No interim dividends were paid during the year ended December 31, 2009. The Board of Directors of the Company did not recommend the payment of a final dividend in respect of the year ended December 31, 2009.

Capitalization and Indebtedness

Not applicable.

Reasons for the Offer and Use of Proceeds

Not applicable.

Risk Factors

Risks Relating to the Company

The Company is indirectly majority owned by the Chinese government, which may exert influence in a manner that may conflict with the interests of holders of ADRs, H Shares and A Shares.

Major Chinese airlines are wholly- or majority-owned either by the Chinese government or by provincial or municipal governments in China. CSAHC, an entity wholly-owned by the Chinese government, holds and exercises the rights of ownership of 59.32% of the equity of the Company. On August 21, 2009, the Company completed its capital injection from CSAHC directly, and indirectly through CSAHC’s wholly-owned subsidiary, Nan Lung, in an aggregate amount of approximately RMB3 billion.  On March 8, 2010, the Company entered into the A shares subscription agreement with CSAHC, pursuant to which CSAHC has conditionally agreed to subscribe and the Company has conditionally agreed to allot and issue new A shares of not more than 132,510,000 at the subscription price of not less than RMB5.66 per A share. In addition, the Company and Nan Lung, a wholly owned subsidiary of CSAHC entered into the H shares subscription agreement, pursuant to which Nan Lung has conditionally agreed to subscribe and the Company has conditionally agreed to allot and issue new H shares of not more than 312,500,000 at the subscription price of not less than HK$2.73 per H share. Upon completion of the foregoing subscriptions, CSAHC’s direct and indirect ownership in the Company will be approximately 51.50% of the issued share capital 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 ADRs, 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. In addition, the Company may accept further capital injection from CSAHC through non-public subscriptions, which may have dilutive impact for other holders of ADRs, H Shares and A Shares.

Due to high degree of operating leverage and high fixed costs, a decrease in revenues of the Group could result in a proportionately higher decrease in its net income. The results of the Group’s operations are also significantly exposed to fluctuations in foreign exchange rates.

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. Net exchange gain decreased by RMB2,499 million, from RMB2,592 million in 2008 to RMB93 million in 2009 because the exchange rate of RMB against USD was relatively stable in 2009 while RMB appreciated significantly against USD in 2008.

The Group has significant committed capital expenditures in the next three years, but may face challenges and difficulties as it seeks to maintain liquidity.

As of December 31, 2009, the Group’s current liabilities exceeded its current assets by RMB28,441 million. The Group generally maintains sound operating cash flow. However, both current ratio and quick ratio are below average, which have negatively impacted, or may in the future negatively impact our liquidity. In addition, the Group has significant committed capital expenditures in the next three years, due to aircraft acquisitions. In 2010 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 its ability to obtain adequate external financing to meet its committed future capital expenditures. However, the Group may not be able to meet its debt obligations as they fall due and commit future capital expenditures if certain assumptions about the operations and the availability of external financing on acceptable terms are inaccurate. In particular, our ability to access adequate external funding may be impacted by the economic stagnation globally.
 
 
6

 

As at December 31, 2009, the Group had banking facilities with several PRC commercial banks for providing loan finance up to approximately RMB128,175 million, of which approximately RMB50,455 million was utilized. The directors of the Company believe that sufficient financing will be available to the Group. However there can be no assurance that such loan financing will be available on terms acceptable to the Group.

CSAHC will continue to be the controlling shareholder of the Company, whose interests may conflict with those of the Group. CSAHC and certain of its associates will continue to provide certain important services to the Group. Any disruption of the provision of services by CSAHC or its associates could affect the Group’s operations and financial conditions.

CSAHC will continue to be the controlling shareholder of the Company. CSAHC and certain of its associates will continue to provide certain important services to the Group, including the import and export of aircraft spare parts and other flight equipment, advertising services, provision of air catering, air ticket selling services, cleaning services, property management services, leasing of properties and financial services. The interests of CSAHC may conflict with those of the Group. In addition, any disruption of the provision of services by CSAHC’s associates or a default by CSAHC of its obligations owed to the Group could affect the Group’s operations and financial conditions. In particular, as part of its cash management system, the Group periodically places significant amount of demand deposits with SA Finance, a PRC authorized financial institution controlled by CSAHC and an associate of the Company. The Group has taken certain measures to monitor the fund flows between itself and SA Finance and the placement of funds by SA Finance. Such monitoring measures may help to enhance the safety of the Group’s deposits with SA Finance. In addition, the Company has received a letter of undertakings from CSAHC dated March 31, 2009, in which, among other things, CSAHC warranted that the Group’s deposits and loans with SA Finance were definitely secure and that SA Finance would continue to operate in strict compliance with the relevant rules and regulations. However, the deposits may be exposed to the risks associated with the business of SA Finance over which the Group does not exercise control. As of December 31, 2008 and 2009, the Group had deposits of RMB1,139 million and RMB862 million, respectively, with SA Finance.

Certain transactions between the Company and CSAHC or its associates (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.

Both international and domestic economic fluctuations and Chinese government’s macroeconomic controls affect the demand for air travel, which will in turn cause volatility to the Group’s business and results of our operations.

The US subprime crisis meltdown is an ongoing economic problem manifesting itself through liquidity issues in the global banking system owing to foreclosures which accelerated in the United States in late 2006 and has an adverse impact on global economy in 2007 and 2008. The deepening global recession has continued into 2009. The aviation industry as a whole is experiencing significantly weaker demand for air travel driven by the severe downturn. The financial crisis and other global events may reduce consumer spending or cause shifts in spending. A general reduction or shift in discretionary spending can result in decreased demand for leisure and business travel and can also impact the Group’s ability to raise fares to counteract increased fuel and labour costs. No assurance can be given that capacity reductions or other steps we may take will be adequate to offset the effects of reduced demand.

The global economic slowdown has also negatively affected the growth rate of the Chinese economy. Chinese macroeconomic controls, taken to counteract such slowdown, such as financing adjustments, credit adjustments, price controls and exchange rate policies, would present unexpected changes to the aviation industry. As a result, the changing economic situation and Chinese macroeconomic controls may cause volatility to the Group’s business and results of our operations.

In summary, both international and domestic economic fluctuations and Chinese macroeconomic controls affect the demand for air travel. Additionally, increasingly strict security measures make air travel a hassle in the eyes of some consumers. These factors can have an uncertain impact on the development of the aviation industry.

The Group could be adversely affected by an outbreak of a disease or large scale natural disasters that affect travel behaviour.
 
The outbreak of the A/H1-N swine flu in March 2009 has had an adverse impact on the aviation industry globally (including the Group). The spread of the swine flu has been adversely affecting the Group’s international routes operations. If the swine flu spreads more widely, it could also affect the Group’s regional and domestic routes operations, and result in significant impact on our business operations. If there were another outbreak of a disease that affects travel behaviour in the future, it could have a material adverse impact on us.
 
 
7

 

In 2010, a number of large-scale natural disasters occurred globally, such as earthquakes in Haiti, Mexico and Qinghai province of China, and the volcanic eruption in Iceland in April 2010. Disasters such as these can affect the airline industry and the Group by reducing revenues and impacting travel behavior.

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

The Company has been occupying all of the land and buildings described above without challenge or claim by third parties. CSAHC has received written assurance from the 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 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.

Given the preliminary stage of direct flights arrangement between Taiwan and Mainland China, no assurance can be given that the Group will generate significant yields from such new route. In addition, any discontinuity or disruption in such arrangement may negatively affect the Group’s results.
 
Further to temporary lifts of the ban on direct flights between Taiwan and Mainland China during certain festivals, as of July 4, 2008, the ban has been further liberalized to allow direct charter flights on weekends. Previously, travellers between Taiwan and China have had to make use of intermediate stops in Hong Kong or elsewhere. The Company became the first Chinese carrier to fly non-stop from Mainland China to Taiwan. On November 4, 2008, the Mainland China and Taiwan agreed to regular direct passenger charter flights across the Taiwan Strait. On August 31, 2009, the Mainland China and Taiwan extended the number of regular cross-Strait direct passenger flights from 108 to 270 a week. As a result, the permitted direct flights may benefit the Group by shortening flights time, cutting fuel costs and reducing flight fares between Taiwan and Mainland China. However, given the preliminary stage of such direct flights arrangement, no assurance can be given that the Group will generate significant yields from the new route. In addition, the results of the Group’s operations will be negatively impacted by any discontinuity or disruption in the direct flight arrangement, which in turn will be subject to a number of factors beyond our control.
 
Terrorist attacks or the fear of such attacks, even if not made directly on the airline industry, could negatively affect the Company and the airline industry as a whole. The travel industry continues to face on-going security concerns and cost burdens.
 
The aviation industry as a whole has been beset with high-profile terrorist attacks, most notably on September 11, 2001 in the United States. The issue could also affect China. Notably, on March 7, 2008, on a China Southern Airlines flight boarding in Urumqi, crew members discovered a suspected terrorist. Thereafter, the CAAC implemented increased security measures. Additional terrorist attacks, even if not made directly on the airline industry, or the fear of or the precautions taken in anticipation of such attacks (including elevated threat warnings or selective cancellation or redirection of flights) could materially and adversely affect the Company and the airline industry. Among possible effects that the Company could experience from terrorist attacks are substantial flight disruption costs caused by grounding of fleet, significant increase of security costs and associated passenger inconvenience, increased insurance costs, substantially higher ticket refunds and significantly decreased traffic and revenue per revenue passenger kilometer.

The Group could be adversely affected by a failure or disruption of our computer, communications or other technology systems.

The Group is increasingly dependent on technology to operate its business. In particular, to enhance its management of flight operations, the Group’s computerized flight operations control system (SOC) began operation in May 1999. The system utilizes advanced computer and telecommunications technology to manage the Group’s flights on a centralized, real-time basis. The Group believes that the system will assist it to enhance the efficiency of flight schedule, increase the utilization of aircraft and improve the coordination of the Group’s aircraft maintenance and ground servicing functions. However, the computer and communications systems on which we rely could be disrupted due to various events, some of which are beyond our control, including natural disasters, power failures, terrorist attacks, equipment failures, software failures and computer viruses and hackers. The Group has taken certain steps to help reduce the risk of some of these potential disruptions. There can be no assurance, however, that the measures we have taken are adequate to prevent or remedy disruptions or failures of these systems. Any substantial or repeated failure of these systems could impact our operations and customer services, result in the loss of important data, loss of revenues, and increased costs, and generally harm our business. Moreover, a failure of certain of our vital systems could limit our ability to operate our flights for an extended period of time, which would have a material adverse impact on our operations and our business.
 
 
8

 

The Company’s failure to achieve and maintain effective internal control over financial reporting could result in the loss of investor confidence in the reliability of our financial statements, which in turn could harm our business and negatively impact the trading prices of our ADRs, H Shares or A Shares.

The United States Securities and Exchange Commission, or the SEC, as required by Section 404 of the Sarbanes-Oxley Act of 2002, adopted rules requiring every public company in the United States to include a management report on such company’s internal control over financial reporting in its annual report, which contains management’s assessment of the effectiveness of the company’s internal control over financial reporting. In addition, the Company’s independent registered public accounting firm is required to report on the effectiveness of the Company's internal control over financial reporting. Our independent registered public accounting firm may not be satisfied with our internal controls, the level of which our controls are documented, designed, operated and reviewed, or our independent registered public accounting firm may interpret the requirements, rules and regulations differently from us, then it may conclude that our internal control over financial reporting are not effective. Although our management concluded that our internal control over financial reporting as of December 31, 2009 was effective, we may discover other deficiencies in the course of our future evaluation of our internal control over financial reporting and may be unable to remediate such deficiencies in a timely manner. If we fail to maintain the adequacy of our internal control over financial reporting, we may not be able to conclude that we have effective internal control over financial reporting on an ongoing basis, in accordance with the Sarbanes-Oxley Act. Moreover, effective internal control is necessary for us to produce reliable financial reports and is important to prevent fraud. As a result, our failure to achieve and maintain effective internal control over financial reporting could result in the loss of investor confidence in the reliability of our financial statements, which in turn could harm our business and negatively impact the trading prices of our ADRs, H Shares or A Shares.

The Company could be classified as a passive foreign investment company by the United States Internal Revenue Service and may therefore be subject to adverse tax impact.

Depending upon the value of our shares and ADRs and the nature of our assets and income over time, we could be classified as a passive foreign investment company, or PFIC, by the United States Internal Revenue Service, or IRS, for U.S. federal income tax purposes. The Company believes that it was not a PFIC for the taxable year 2009. However, there can be no assurance that the Company will not be a PFIC for the taxable year 2010 and/or later taxable years, as PFIC status is re-tested each year and depends on the facts in such year.

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

If the Company were a PFIC, you would generally be subject to additional taxes and interest charges on certain “excess” distributions the Company makes 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 ADRs. An excess distribution would be either (1) a distribution with respect to ADRs that is greater than 125% of the average of such distributions over the preceding three years, or (2) 100% of the gain from the disposition of shares/ADRs. For more information on the United States federal income tax consequences to you that would result from our classification as a PFIC, please see Item 10, “Taxation — United States Federal Income Taxation — U.S. Holders — Passive Foreign Investment Company”.

Risks Relating to the Chinese Commercial Aviation Industry

The Group’s business is subject to extensive government regulations, and there can be no assurance as to the equal treatment of all airlines under those regulations.

The Group’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, 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 Group to respond to market conditions, competition or changes in the Group’s cost structure. The implementation of specific CAAC policies could from time to time adversely affect the Group’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.

 
9

 

The Group’s results may be negatively impacted by the fluctuation in domestic prices for jet fuel, and we would be adversely affected by disruptions in the supply of fuel.

The availability and cost of jet fuel have a significant impact on the Group’s results of operations. The Group’s jet fuel cost for 2009 accounted for 55.95% of its flight operations expenses. All of the domestic jet fuel requirements of Chinese airlines (other than at the Shenzhen, Zhuhai, Sanya, Haikou, Shanghai Pudong and other small airports) must be purchased from the exclusive providers, 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, Sanya, Haikou, Shanghai Pudong and other small 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 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.

Given the constant fluctuation in global oil prices, there is no way to assure that domestic prices for jet fuel do not fluctuate as well. For example, prior to 1994, domestic jet fuel prices were generally below international jet fuel prices. From 1994 to 2006, however, CAOSC’s domestic jet fuel prices were above international jet fuel prices, sometimes creating tensions over the fuel supply. In 2007 through the first half of 2008, the crude oil price in the international market reached its historic high level. In response to the pressure imposed by such rocketing price, NDRC increased the domestic price for jet fuel on November 1, 2007 and June 20, 2008, respectively. The increased fuel costs have significantly limited the Group’s ability to generate operating profit. In the second half of 2008, the crude oil price in the international market began to decrease continuously. In order to cushion fuel cost pressure faced by Chinese airlines, on December 19, 2008 and January 1, 2009, respectively, NDRC approved reductions in domestic prices for jet fuel. Starting from February 2009, the crude oil price in the international market started to pick up gradually. As a result, NDRC increased the domestic price for jet fuel in July 2009 and made several subsequent adjustments thereafter. (see “ Item 4, “Information on the Company - Business Overview - “Jet Fuel” section below for further discussion.)

In summary, given the constant fluctuation of volatile fuel price, no assurance can be given that the Group’s results will not be negatively impacted by the fluctuation in domestic prices for jet fuel. 

In addition, jet fuel shortages have occurred in China and, on some rare occasions prior to 1993, required the Group to delay or even cancel flights. Although such shortages have not materially affected the Group’s operations since 1993, there can be no assurance that such a shortage will not occur in the future. If such a shortage occurs in the future and the Group is forced to delay or cancel flights due to fuel shortage, its operational reputation among passengers as well as its operations may suffer.

In 2009, a reasonable possible increase or decrease of 10% in jet fuel price affects the Group’s annual fuel costs by approximately RMB1,639 million, assuming no change in volume of fuel consumed. Accordingly, even if the jet fuel supply remains uninterrupted, increases in jet fuel prices will nevertheless adversely impact our financial results.

The Group’s net income may suffer from an unexpected volatility caused by any fluctuation in the level of fuel surcharges.

The level of fuel surcharges, which is regulated by Chinese government, affects domestic customers’ air travel demand as well as the Group’s ability to generate net incomes. On January 14, 2009, the NDRC and the CAAC jointly announced the suspension of the collection of passenger fuel surcharge for domestic routes since January 15, 2009. In response to the pick up of international fuel prices, the NDRC and CAAC issued a notice to introduce a new pricing mechanism of fuel surcharge that links it with airlines’ jet fuel costs on November 11, 2009. According to the new mechanism, when the purchase cost of jet fuel is lower than RMB 4,140 per ton (i.e., the benchmark price of jet fuel), airlines should not charge fuel surcharge. When the purchase cost of jet fuel exceeds RMB 4,140 per ton, the airlines may charge appropriate fuel surcharge provided that such airlines should digest at least 20 percent of the rising cost. As such, following a suspension period of more than one year, in November, 2009, the Group resumed the imposing of fuel surcharges for the domestic routes. However, the Group’s net income may suffer from an unexpected change in the fuel surcharge collection policy and a number of factors beyond our control.

The Group’s results of operations tend to be volatile and fluctuate due to seasonality.

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. As a result, the Group’s results tend to be volatile and subject to rapid and unexpected change.

The Group’s operations may be adversely affected by insufficient aviation infrastructure in Chinese commercial aviation industry.

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 Group, 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 Group to increase utilization rates and to provide safe and efficient air transportation in the future will depend in part on factors such as the improvement of national air traffic control and navigation systems and ground control operations at Chinese airports, factors which are beyond the control of the Group.
 
 
10

 

The Group faces increasingly intense competition both in domestic aviation industry and in the international market, as well as from alternative means of transportation.

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

The Group faces varying degrees of competition on its regional routes from certain Chinese airlines and Cathay Pacific Airways, Dragonair and Air Macau, 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 Group. In addition, the public’s perception of the safety and service records of Chinese airlines could adversely affect the Group’s ability to compete against its regional 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.

Furthermore, for short-distance transportation, airplanes, trains and buses are alternatives to each other. Given the recent development of high-speed train, the construction of nationwide high-speed railway network and the improvement of inter-city expressway network, the commercial aviation sector as a whole faces increasing competition from the alternative means of transportation such as railways and highways. In particular, the so-called “Four Longitudinal and Four Horizontal” high-speed railways under construction may have a huge negative impact on the domestic commercial aviation sector once it goes into operation. Since the Group has the most extensive domestic route network and the largest number of flights in China, the Group may be affected by the increasing popularity of high-speed trains to certain extent. For example, 38 lines of the “Four Longitudinal and Four Horizontal” overlap with current flights of the Group, 21 of which run for a distance of less than 4 hours. If the high-speed railways go into full operation, according to the statistic of the Group, 13 out of the total 18 airline subsidiaries and branches of the Group involving 798 flights (i.e. to and fro flights/week) may be seriously impacted.

Due to limitation on foreign ownership imposed by Chinese government policies, the Company may have no meaningful access to the international equity capital markets.

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, we estimate that 31.02%of the total outstanding ordinary shares of the Company are held by Foreign Investors. For so long as the limitation on foreign ownership is in force, the Company will have no meaningful access to the international equity capital markets.

Risks Relating to the PRC

The Group has significant exposure to foreign currency risk as majority of the Group’s lease obligations and bank and other loans are denominated in foreign currencies. Due to rigid foreign exchange control by Chinese government, the Group may face difficulties in obtaining sufficient foreign exchange to pay dividends or satisfy our foreign exchange liabilities.

Under current Chinese foreign exchange regulations, Renminbi is fully convertible for current account transactions, but is not freely convertible for capital account transactions. All foreign exchange transactions involving Renminbi must take place either through the People’s Bank of China or other institutions authorized to buy and sell foreign exchange or at a swap centre.

The Group has significant exposure to foreign currency risk as substantially all of the Group’s obligations under leases and bank and other loans are denominated in foreign currencies, principally US dollars. 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 SAFE, or subject to certain restrictive conditions, entering into foreign exchange forward option contracts with authorized banks. However, SAFE may limit or eliminate the Group’s ability to purchase and retain foreign currencies in the future. In addition, foreign currency transactions under the capital account are still subject to limitations and require approvals from SAFE. This may affect our ability to obtain foreign exchange through debt or equity financing, including by means of loans or capital contributions. No assurance can be given that the Group will be able to obtain sufficient foreign exchange to pay dividends or satisfy our foreign exchange liabilities.
 
 
11

 

The Group also has exposure to foreign currency risk in respect of net cash inflow denominated in Japanese Yen from ticket sales in overseas branch office after payment of expenses. The Group entered into certain foreign exchange forward option contracts to manage this foreign currency risk. However, like other derivative products, there can be no assurance that such option contracts can provide, at any given time, particular level of protection against foreign exchange risks.

The Group’s operations are subject to immature development of legal system in China. Lack of uniform interpretation and effective enforcement of laws and regulations may cause significant uncertainties to the Group’s operations.

The members of the Group are organized under the laws of China. 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. Since 1979, the Chinese government has been developing a comprehensive system of commercial laws and considerable progress has been made in the promulgation of laws and regulations dealing with economic matters, such as corporate organization and governance, foreign investments, commerce, taxation and trade. 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.

The PRC new tax law has deprived, or may in the future deprive the Company of preferential income tax rates, which the Company previously enjoyed.

On March 16, 2007, the Fifth Plenary Session of the Tenth National People’s Congress passed the Corporate Income Tax Law of the PRC which took effect on January 1, 2008. As a result of the new tax law, the statutory income tax rate adopted by the Company and its subsidiaries has been changed from 33% to 25% with effect from January 1, 2008. Prior to enactment of the new tax law, the headquarters of the Company was taxed at a preferential rate of 18% and the branches and subsidiaries were taxed at rates ranging from 15% to 33%. Pursuant to the new tax law, the income tax rates of entities that previously enjoyed preferential tax rates of 15% and 18% have been revised to 18%, 20%, 22%, 24% and 25% for 2008, 2009, 2010, 2011 and 2012 onwards respectively.

The PRC new tax law may have negative tax impact on holders of H Shares or ADRs of the Company, by requiring the imposition of a withholding tax on dividends paid by a Chinese company to a non-resident enterprise.

The new tax law generally provides for the imposition of a withholding tax on dividends paid by a Chinese company to a non-resident enterprise at a rate of 10%.

For individuals, Chinese tax law generally provides that an individual who receives dividends from the Company is subject to a 20% income tax. A 50% reduction of income tax is granted by Chinese tax law for an individual receiving dividends from a listed company on Shanghai Stock Exchange or Shenzhen Stock Exchange. As a result, the effective tax rate for dividends received by A Share individual holder is 10%. Currently, dividend income received by any foreign individual that holds overseas shares in any Chinese domestic enterprise is temporarily exempt from income tax. In the event that the exemption is discontinued, such payments will be subject to individual income 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.

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 59.32% owned by CSAHC. The registered address of the Company is Guangzhou Economic & Technology Development Zone, People’s Republic of China (telephone no: (86)20-8612-4462, website: www.csair.com).

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.

Pursuant to a sale and purchase agreement dated November 12, 2004 between the Company, CSAHC, China Northern Airlines Company (“CNA”) and Xinjiang Airlines Company (“XJA”) which was approved by the Company’s shareholders in an extraordinary general meeting held on December 31, 2004, the Company acquired the airline operations and certain related assets of CNA and XJA with effect from December 31, 2004 at a total consideration of RMB1,959 million.

On April 30, 2006, the Company acquired certain assets of CSAHC Hainan Co., Limited, a wholly owned subsidiary of CSAHC, at a total consideration of RMB294 million.
 
 
12

 

On June 16, 2007, the Company together with an independent third party established Chongqing Airlines Company Limited (“Chongqing Airlines”), a non-wholly owned subsidiary of the Company. Up to December 31, 2009, the Company has transferred four aircraft to Chongqing Airlines as capital contribution.

On August 14, 2007, the Company signed an agreement to acquire a 51% equity interest of Nan Lung International Freight Company Limited beneficially owned by and registered in the name of Nan Lung Travel & Express (Hong Kong) Limited which is a wholly owned subsidiary of CSAHC and a 100% equity interest in Southern Airlines (Group) Catering Co., Limited, a wholly owned subsidiary of CSAHC for a total consideration of RMB112 million.

On August 14, 2007, the Company signed an agreement to dispose of its 90% equity interest in Guangzhou Aviation Hotel Company Limited to CSAHC at a consideration of RMB75 million.

In August 2008, the Company entered into an agreement with China Post Group to dispose of all of its 49% equity interest in China Postal Cargo Airlines Limited, its jointly controlled entity which China Post Group is the other venturer, at a consideration of RMB210 million and recorded a gain on disposal of RMB143 million.

In December 2008, the Company acquired a 26% equity interest in the China Southern West Australian Flying College Pty Ltd. (the “Australian Pilot College”), a subsidiary of the Company, from CSAHC, and Australian Pilot College became a 91% owned subsidiary of the Company.

In June 2009, the Company acquired 50% equity interest in a jointly controlled entity of the Company, Beijing Southern Airlines Ground Services Company Limited (“Beijing Ground Service”) from the other venturer, which has become a wholly-owned subsidiary of the Company since then.

On September 28, 2009, the Company entered into an agreement with CSAHC to dispose of its 50% equity interest in MTU Maintenance Zhuhai Co., Ltd (“MTU”), a jointly controlled entity of the Company, to CSAHC at a consideration of RMB1,607,850,000. The transfer was completed in February 2010.

Aircraft Acquisitions

Pursuant to the Xiamen Aircraft Acquisition Agreement dated April 18, 2008 between Xiamen Airlines Company Limited (“Xiamen Airlines”) and Boeing, Xiamen Airlines will acquire 20 Boeing B737 series aircraft from Boeing. According to the information provided by Boeing, the aggregate catalogue price for those aircraft is around US$1,500 million, including price for airframe and engines. The aggregate consideration for the acquisition will be partly payable in cash by Xiamen Airlines, and partly through financing arrangements with banking institutions. The Boeing aircraft will be delivered in stages to Xiamen Airlines during the period commencing from April 2014 to October 2015.

Pursuant to the Aircraft General Terms Agreement dated January 20, 2010 between the Company and the Airbus S.A.S. and A320 Family Aircraft Purchase Agreement dated January 20, 2010 between the Company and Airbus SNC, the Company will acquire 20 Airbus 320 series aircraft from Airbus SNC. According to the information provided by Airbus SNC, the catalogue price of an Airbus 320 aircraft is around US$77 million including price for airframe and engine. The aggregate consideration for the acquisition will be partly payable in cash and partly through financing arrangements with banking institutions. The Airbus aircraft will be delivered in stages to the Company from 2011 to 2013.

Capital Expenditure

The Group had RMB17,178 million, RMB8,645 million and RMB 9,832 million capital expenditures in 2009, 2008 and 2007, respectively. Of such capital expenditures in 2009, RMB 2,171 million was financed by capital leases, RMB7,293 million was financed by bank borrowings while the remaining RMB7,714 million was 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, to a small extent, additional investments in other facilities and buildings for operations.

Business Overview

General

The Group provides commercial airline services throughout China, Hong Kong, Macau and Taiwan regions, Southeast Asia and other parts of the world. Based on the statistics from the CAAC, the Group is one of the largest Chinese airlines and, as of year end of 2009, ranked first in terms of number of passengers carried, number of scheduled flights per week, number of hours flown, number of routes and size of aircraft fleet. During the three years ended December 31, 2009, the Group’s RPKs increased at a compound annual growth rate of 6.7% from 81,727 million in 2007 to 83,184 million in 2008, and to 93,002 million in 2009, while its capacity, measured in terms of ASKs, increased at a compound annual growth rate of 6.1%, from 109,733 million in 2007 to 112,767 million in 2008, and to 123,441 million in 2009. In 2009, the Group carried 66.28 million passengers and had passenger revenue of RMB50,059 million (US$7,331 million).
 
 
13

 

The Group conducts a portion of its airline operations through its airline subsidiaries namely Xiamen Airlines, Southern Airlines Shantou Airlines Company Limited (“Shantou Airlines”), Zhuhai Airlines Company Limited (“Zhuhai Airlines”), Guizhou Airlines Company Limited (“Guizhou Airlines”) and Chongqing Airlines Company Limited (“Chongqing Airlines”) (collectively, the “Airline Subsidiaries”). In 2009, the Airline Subsidiaries carried 16.87 million passengers and had passenger revenue of RMB11,314 million (US$1,657 million) and accounted for 25% and 23% of the Group’s passengers carried and passenger revenue, respectively.
The Group also provides air cargo and mail services. The cargo and mail revenue of the Group decreased by 16.9% to RMB2,908 million (US$426 million) in 2009 as compared with that of 2008. 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 2009, the Group operated 655 routes, of which 528 were domestic, 99 were international and 38 were regional. The Group operates the most extensive domestic route network among all Chinese airlines. Its route network covers commercial centers and rapidly developing economic regions in Mainland China.

The Group’s corporate headquarters and principal base of operations are located in Guangzhou, 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 Guangzhou, Shenzhen, Zhanjiang, Zhuhai Shantou and etc.

In December 2005, the Company established a branch company in Beijing and has added wide-body airplanes to its operation base in Beijing, with the view to expanding its Beijing aviation business and building another main hub there in addition to its Guangzhou base. The establishment of Guangzhou and Beijing hubs will facilitate strategic refinement and enhancement of its route network operations, putting the Company in a better position to explore and seize the opportunities in the aviation market.
 
The Group’s operations primarily focus on the domestic market. In addition, the Group also operates regional routes and international flights. As of the year end of 2009, the Group had 38 regional routes and 99 international routes. The Group’s regional operations include flights between destinations in China and Hong Kong, Macau and Taiwan. The Group’s international operations include scheduled services to the cities in Australia, Bangladesh, France, India, Japan, Kazakhstan, Korea, Kyrgyzstan, Maldives, Nepal, Netherlands, Nigeria, Pakistan, Russia, Saudi Arabia, Tajikistan, UAE, USA and Southeast Asian destinations.
After joining Skyteam Alliance, the Group has established a network reaching 905 destinations globally, connecting 169 countries of regions and covering major cities around the world.

As of December 31, 2009, the Group had a fleet of 378 aircraft, consisting primarily of Boeing 737 series, 747, 757, 777, Airbus 320 series, 300, 330 and McDonnell Douglas 82 and 90. The average age of the Group’s registered aircraft was 6.32 years as of the year end of 2009.
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 effect through the establishment of the Company and the execution of the De-merger Agreement on March 25, 1995 by and between CSAHC and the Company. Upon the restructuring, the Company assumed substantially the entire airline and airline-related businesses, assets and liabilities of CSAHC, and CSAHC retained its non-airline-related businesses, assets and liabilities. 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 De-merger Agreement. Under the De-merger 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 its associates existing on the date of the De-merger Agreement and may continue to operate the businesses of such associates. Under the De-merger Agreement, CSAHC and the Company also agreed to indemnify each other against any and all losses, claims, damage, debts or expenses arising out of or in connection with the restructuring. As of the date of this Annual Report, no indemnity has been provided by either CSAHC or the Company.

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 RMB1.00 per share, and listing of the H Shares on the Stock Exchange of Hong Kong Limited (the “Hong Kong Stock Exchange”) and ADRs 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 non-tradable Domestic Shares, par value RMB1.00 per share, were owned by CSAHC, which owned and exercised, on behalf of the Chinese government and under the supervision of the CAAC, the rights of ownership of such Domestic Shares. After giving effect to the private placement and the initial public offering, CSAHC maintained its ownership of the 2,200,000,000 Domestic Shares (representing approximately 65.2% of the total share capital of the Company), and were 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.
 
 
14

 

In July 2003, the Company issued 1,000,000,000 A Shares with a par value of RMB1.00 each and listed these shares on the Shanghai Stock Exchange. Subsequent to the A Share issue, the shareholding of CSAHC in the Company was reduced from 65.2% to 50.30%.
 
Share Reform Scheme

Pursuant to relevant PRC laws, the Company launched the share reform scheme in May 2007, whereby all the 2,200,000,000 non-tradable Domestic Shares held by CSAHC shall be converted into tradable A Shares. Upon the completion of such scheme on June 20, 2008, all the non-tradable Domestic Shares have been successfully converted into tradable A Shares, subject to the restriction that CSAHC shall not transfer or trade these shares within 36 months after the commencement date of the share reform scheme (which is June 18, 2007).

Bonus Shares Issue by Conversion of Share Premium

On June 25, 2008, the shareholders of the Company approved a bonus share issue by way of conversion of share premium, and on August 14, 2008, the Ministry of Commerce approved the bonus share issue. The issue has been effected by conversion of share premium on the basis of 5 new shares, credited as fully paid, for every 10 existing shares. Upon the completion of the bonus share issue, which is based on 4,374,178,000 shares in issue as at December 31, 2007, the number of paid up shares has increased by 2,187,089,000 shares to 6,561,267,000 shares.

Non-Public Subscriptions

On December 10, 2008, the Company entered into an A Shares subscription agreement with CSAHC, pursuant to which CSAHC has conditionally agreed to subscribe and the Company has conditionally agreed to allot and issue 721,150,000 new A Shares for a consideration of RMB2,278,834,000, equivalent to the subscription price of RMB3.16 per new A Share. Separately and on the same date, the Company and Nan Lung (a wholly-owned subsidiary of CSAHC) entered into a H Shares subscription agreement, pursuant to which Nan Lung has conditionally agreed to subscribe and the Company has conditionally agreed to allot and issue 721,150,000 new H Shares for a consideration of RMB721, 150,000, equivalent to the subscription price of RMB1.00 (equivalent to approximately HK$1.13) per new H Share.  The subscription agreements were approved in the Extraordinary General Meeting and the respective Class Meetings of shareholders of A and H Shares on February 26, 2009. On June 3, 2009, the Company received the formal approval from CSRC for the proposed non-public issue of H Shares. On August 14, 2009, the Company received the formal approval from CSRC for the proposed non-public issue of A Shares. The issuance of 721,150,000 new A Shares to CSAHC and 721,150,000 new H Shares to Nan Lung were completed on August 20, 2009 and August 21, 2009, respectively.

On March 8, 2010, the board of the Company approved (i) the placement of not more than 1,766,780,000 new A shares to not more than 10 specific investors (subject to the maximum number as permitted by PRC laws and regulations at the time of the issuance) including CSAHC, at the same subscription price of not less than RMB5.66 per A share; and (ii) the placement of not more than 312,500,000 new H shares to Nan Lung, at the subscription price of not less than HKD2.73 per H share.

On the same date, the Company entered into the A shares subscription agreement with CSAHC, pursuant to which CSAHC conditionally agreed to subscribe and the Company conditionally agreed to allot and issue new A shares of not more than 132,510,000 at the subscription price of not less than RMB5.66 per A share. In addition, the Company and Nan Lung entered into the H shares subscription agreement, pursuant to which Nan Lung conditionally agreed to subscribe and the Company conditionally agreed to allot and issue new H shares of not more than 312,500,000 at the subscription price of not less than HKD2.73 per H share. The above placement and subscription agreements were approved in the Extraordinary General Meeting and the respective Class Meetings of shareholders of A and H shares on April 30, 2010 and are pending approval from the relevant security regulatory authorities.

Issuance of Short-term Financing Bills and Medium Term Notes

On April 18, 2008, the Company’s Board approved the proposed issue of short-term financing bills in the principal amount of up to RMB4 billion in the PRC, and the submission of this proposal to the annual general meeting for the shareholders’ approval. On June 25, 2008, shareholders of the Company approved such proposed bill issue at the annual general meeting for the year 2007. The Company believes that the bill issue will provide a further source of funding at an interest rate which is expected to be lower than that for loans from commercial banks, lower the financing cost of borrowings for the Company, and is in the interests of the Company and its shareholders as a whole. The Company has received the acceptance from National Association of Financial Market Institutional Investors to register the Company’s short-term financing bills in the amount of RMB3.5 billion for a period up to September 10, 2010. The bills would be jointly underwritten by China CITIC Bank Cooperation Limited and Bank of China Limited. In October 2008, the Company issued short-term financing bills with total face value of RMB2 billion, bearing coupon interest rate at 4.7% with a maturity period of one year for funding of the business activities of the Company.

On May 28, 2008, the Board approved the proposed issue of medium term notes by the Company in the principal amount of up to RMB1.5 billion and the submission of such proposal to the shareholders for their consideration and approval. On June 25, 2008, shareholders of the Company approved such notes issue at the annual general meeting for the year 2007. The Company believes that the notes issue will provide a further source of medium to long term funding at an interest rate lower than the best lending rate for loans from commercial bank, lower the finance costs of borrowings for the Company and improve the debt structure of the Company.
 
 
15

 

Traffic

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

   
Passenger carried
   
Cargo and Mail 
Carried (tons)
   
Total traffic 
(tons kilometers)
 
Year
 
Total
(in million)
   
Increase
(decrease)
over
previous 
year (%)
   
Total
(in
thousand)
   
Increase
(decrease)
over
previous 
year (%)
   
Total
(in million)
   
Increase
(decrease)
over
previous
year (%)
 
2007
   
56.90
     
15.6
     
872.0
     
6.5
     
9,250.0
     
14.6
 
2008
   
58.24
     
2.3
     
835.0
     
(4.2
)
   
9,200.0
     
(0.5
)
2009
   
66.28
     
13.8
     
862.0
     
3.2
     
10,067.0
     
9.4
 

Route Network

Overview

The Group operates the most extensive route network among the Chinese airlines. As of December 31, 2009, the Group operated 655 routes consisting of 528 domestic routes, 38 regional routes and 99 international routes.

The Group continually evaluates its network of domestic, regional 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, regional and international routes is subject to approval of the CAAC, and the acquisition of regional 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 the Macau SAR, the government of Taiwan province 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, Korean Air, Japan Air System, Vietnam Airlines, Air France, KLM Royal Dutch Airlines, Garuda Indonesian, Malaysian Airline, KENYA AIRWAYS, Pakistan International Airlines, Aeroflot-Russian Airlines and CSA Czech Airlines. 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. After joining Skyteam Alliance, the Group has further established a network reaching 905 destinations globally, connecting 169 countries of regions and covering major cities around the world.

Route Bases

In addition to its main route bases in Guangzhou and Beijing, the Group maintains certain regional route bases in Zhengzhou, Wuhan, Changsha, Shenzhen, Shenyang, Changchun, Dalian, Harbin, Urumqi, Haikou, Zhuhai, Xiamen, Shanghai, Xi’an, Fuzhou, Nanning, Guilin, Shantou, Guiyang, Chongqing and Sanya. Most of its regional route bases are located in provincial capitals or major commercial centers in the PRC.

The Group believes that its extensive network of route bases enable 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. 

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 2009, the Group’s most profitable domestic routes were between: Guangzhou-Beijing, Beijing-Guangzhou, Shenzhen-Beijing, Fuzhou-Beijing, Beijing-Shenzhen, Shanghai-Guangzhou, Guangzhou-Shanghai, Xiamen-Beijing, Urumqi-Beijing, and Beijing-Urumqi.
 
 
16

 

Regional Routes

The Group offers scheduled service between Hong Kong and Guangzhou, Shenyang, Wu Yi Shan, Zhang Jia Jie, Changchun, Yinchuan, Xiamen, Shantou, Beijing, Guilin, Meixian, Haikou, Wuhan, Zhengzhou, Nanning, Changsha, Sanya and Hohhot; between Macau and Hangzhou, Xiamen and Tianjin; between Taipei and Guangzhou, Shanghai, Fuzhou, Hangzhou, Xiamen, Shenyang, Changsha, Wuhan, Dalian, Guilin, Harbin, Guiyang, Zhengzhou and Shenzhen. In 2009, the most profitable scheduled regional routes were between: Taipei-Shanghai, Xiamen-Hong Kong, Shanghai-Taipei, Xiamen-Taipei, Taipei-Guangzhou, Fuzhou-Taipei, Guangzhou-Taipei, Hong Kong-Beijing, Changchun-Guangzhou-Hong Kong, and Hong Kong-Wuhan.

In 2009, the Group conducted a total of 12,227 flights on its regional routes, accounting for approximately 24.75% of all passengers carried by Chinese airlines on routes between Hong Kong, Macau or Taiwan and destinations in China according to CAAC statistics.

Previously, direct flights between Taiwan and Mainland China had only been available during certain festivals. And travelers between Taiwan and China have had to make use of intermediate stops in Hong Kong or elsewhere. Since July, 2008, however, the ban on direct flights has been further liberalized to allow direct charter flights on weekends. The Company became the first Chinese carrier to fly nonstop to Taiwan. On November 4, 2008, the Mainland China and Taiwan agreed to regular direct passenger charter flights across the Taiwan Strait. On August 31, 2009, the Mainland China and Taiwan increased the number of regular cross-Strait direct passenger flights from 108 to 270 a week. The 108 direct passenger flights previously operating were all classed as charter flights. The new services comprise both regular charter and scheduled flights. 

In order to further strengthen its presence in Taiwan, on June 23, 2008, the Company entered into a memorandum of cooperation with China Airlines, which is the largest carrier in Taiwan in terms of route network. Based on the memorandum, the scope of cooperation between the parties will cover passenger and cargo carrying, maintenance, and ground handling services.

International Routes

The Group is the principal Chinese airline serving Southeast Asian destinations, including Singapore and major cities in Indonesia, Thailand, Malaysia, the Philippines, Vietnam, Myanmar and Cambodia.

In addition, the Group also provides scheduled services to the cities in Australia, Bangladesh, France, India, Japan, Kazakhstan, Maldives, Korea, Kyrgyzstan, Nepal, Netherlands, Nigeria, Pakistan, Russia, Saudi Arabia, Tajikistan, Turkmenistan, UAE and USA.

After joining Skyteam Alliance, the Group has established a network reaching 905 destinations globally, connecting 169 countries of regions and covering major cities around the world.

In 2009, the Group’s most profitable international routes were: Tianjin-Xiamen-Singapore, Beijing-Guangzhou-Phnom Penh, Guangzhou-Beijing-Amsterdam, Guangzhou-Sydney, Guangzhou-Los Angeles, Phnom Penh-Guangzhou-Beijing, Singapore-Guangzhou-Shenyang, Guangzhou-Tokyo, Beijing-Guangzhou-Hanoi, Shenyang-Guangzhou-Singapore.

Aircraft Fleet

The Group’s fleet plan in recent years has emphasized expansion and modernization through the acquisition of new aircraft and the retirement of less efficient, older aircraft. As of December 31, 2009, the Group operated a fleet of 378 aircraft with an average age of 6.32 years. Most aircraft of the Group are Boeing and Airbus aircraft. The Group has the largest fleet among Chinese airline companies. Among all the aircraft, 203 aircraft operated by the Group are leased pursuant to various types of leasing arrangements.
 
 
17

 

The following table sets forth certain information regarding the Group’s fleet of 378 aircraft as of December 31, 2009.

Model
 
Number of
Aircraft
   
Average age
(years)
   
Average
Passenger
Capacity
 
Boeing 777-200A
 
4
   
13.71
   
380
 
Boeing 777-200B
 
6
   
11.36
   
292
 
Boeing 757-200
 
27
   
10.76
   
200
 
Boeing 747F
 
2
   
7.53
   
n/a
 
Boeing 737-800
 
80
   
3.09
   
167/170
 
Boeing 737-700
 
46
   
5.32
   
126
 
Boeing 737-500
 
2
   
13.53
   
130
 
Boeing 737-300
 
25
   
15.35
   
145
 
Boeing 777F
 
2
   
0.08
   
n/a
 
Airbus 319-100
 
44
   
3.36
   
128
 
Airbus 300-600
 
5
   
15.19
   
272
 
Airbus 320-200
 
54
   
6.26
   
158
 
Airbus 321-200
 
40
   
3.10
   
185
 
Airbus 330-200
 
6
   
4.10
   
264
 
Airbus 330-300
 
8
   
1.57
   
292
 
McDonnell Douglas 82
 
3
   
17.89
   
144
 
McDonnell Douglas 90
 
13
   
12.02
   
157
 
Embraer 145 Jet
 
6
   
5.31
   
50
 
ATR-72
 
5
   
12.58
   
72/79
 
                   
Total
 
378
             

During 2009, the Group continued to expand and modernize its aircraft fleet. The Group’s major aircraft transactions included:

In 2009, the Group took scheduled delivery of 36 aircraft during the year (eight A319-100 aircraft, six A320-200 aircraft, nine A321-200 aircraft, three B737-700 aircraft and ten B737-800 aircraft). The acquisition was financed by bank loans and the Group’s own funds. In addition, the Group took schedule delivery of two B777F Freighters, which was financed by a capital lease agreement with a ten-year lease term.

In 2009, the Group exercised purchase options of seven leased aircraft (one B777-200B aircraft, five A320-200 aircraft and one MD90 aircraft) upon expiry of the respective lease terms.

In 2009, four B737-800, three A319-100 were acquired under operating lease; one B757-200 aircraft, three B737-500 aircraft and one A320-200 aircraft under operating lease were returned during 2009.

In 2009, two MD82 aircraft were modified as simulators for training purpose and were reclassified as other flying equipment.

In 2009, the Group disposed of seven MD82 aircraft and one A300-600 aircraft.

In January, 2010, the Company entered into Aircraft General Terms Agreement and A320 Family Aircraft Purchase Agreement, pursuant to which the Company agreed to purchase 20 Airbus A 320 series aircraft from Airbus SNC, scheduled for delivery from 2011 to 2013.

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 eleven years. As of December 31, 2009, 55 of the Group’s 378 aircraft were operated under capital leases, 148 were operated under operating leases, 60 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 through acquisition by bank loans and the Group’s own funds, and pursuant to operating leases or 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.

 
18

 

The following table sets forth, as of December 31, 2009, the number of aircraft operated by the Group pursuant to capital and operating leases and the remaining terms, expressed in years, of such leases.
 
Model
 
Capital
Lease
   
Operating
Lease
   
Average
Remaining
Lease Term
 
Boeing 777-200A and 777-200B
   
0
     
4
     
2.95
 
Boeing 757-200
   
0
     
8
     
1.21
 
Boeing 737-700
   
9
     
15
     
4.60
 
Boeing 737-800
   
12
     
40
     
6.25
 
Boeing 737-500
   
0
     
2
     
0.11
 
Boeing 737-300
   
0
     
4
     
2.36
 
Boeing 777F
   
2
     
0
     
9.92
 
Airbus 319-100
   
6
     
30
     
6.20
 
Airbus 320-200
   
15
     
15
     
6.23
 
Airbus 321-100
   
7
     
20
     
8.20
 
Airbus 330-200
   
4
     
2
     
7.90
 
Airbus 330-300
   
0
     
8
     
10.68
 
Total
   
55
     
148
         

Capital leases

The majority of the capital leases in respect to aircraft and related equipment have terms of ten to twelve years expiring during the years 2011 to 2019. As of December 31, 2009, the Group’s aggregate future minimum lease payments (including future finance charges) required under its capital leases were RMB15,812 million. The Group’s capital leases typically cover a significant portion of the relevant aircraft’s useful life and transfer the benefits and risks of ownership to the Group. Under its capital leases, the Group generally has an option to purchase the aircraft at or near the end of the lease term. As is customary in the case of capital leases, the Group’s obligations are secured by the related aircraft, as well as other collateral.

Operating Leases

As of December 31, 2009, the Group’s aggregate future minimum lease payments required under its operating leases were RMB30,366 million. As of the year end of 2009, the Group’s operating leases had original terms generally ranging from six to fifteen years from the date of delivery of the relevant aircraft, and the remaining terms of these leases ranged from one to eleven 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.

For capital leases 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 withhold 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 6% to 10% of the lease payments, or in certain cases, the interest components of such payments for capital lease. The PRC withholding tax payable in respect of the lease arrangements amounting RMB198 million, RMB142 million and RMB143 million during 2009, 2008 and 2007 respectively, have been included as part of the lease charges.

In August 2008, Xiamen Airlines, a non wholly-owned subsidiary of the Company entered into an operating lease agreement with GE Commercial Aviation Services, and such agreement has been approved by the Board of the Company on August 18, 2008.  Pursuant to the agreement, Xiamen Airlines plans to lease seven Boeing B737-800 aircraft by way of operating lease. The term of the lease is eight years from 2011 to 2019, with the price for the operating lease to be determined by the two parities with reference to the prevailing market price. The Board believes that the introduction of new aircraft under the operating lease is beneficial to the implementation of the Group’s development strategy, will improve the Group’s operating capacity to accommodate the continuous growth in demand for aviation services in the PRC, serve passengers with better services, and enhance the competitiveness of the Group.
 
 
19

 

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. The Group had 69 and 66 spare jet engines for its fleet as of the year end of 2009 and 2008, respectively. 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. Acquisition of rotables and certain of the expendables for the Group’s aircraft are generally handled 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 (“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 Federal Aviation Administration. 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 capacity include overhaul of more than 70% 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 13 other Chinese airlines and 19 international airlines. GAMECO provides heavy maintenance services to 7 other Chinese airlines and 6 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, 1996, the Company and GAMECO entered into an agreement regarding the fee arrangement for the provision of such repair and maintenance services.
 
Overhauls of jet engines are performed by MTU, a jointly controlled entity of the Company and MTU Aero Engines Gmbh, and also by overseas qualified service providers in Germany, Malaysia, Canada and England. On September 28, 2009, the Company entered into an agreement with CSAHC to dispose of its 50% equity interest in MTU to CSAHC at a consideration of RMB1,607,850,000. The transfer was completed in February 2010.
 
The amounts incurred by the Group for comprehensive maintenance services provided by GAMECO and MTU were RMB1,344 million, RMB1,129 million, and RMB1,047 million for the years ended December 31, 2009, 2008 and 2007, respectively.
 
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 were no serious incidents involving casualty or flight damage throughout the three years ended December 31, 2009. 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 “Accident Signs Per Ten Thousands Hours Ratio” was 0.089, 0.064 and 0.065 in 2009, 2008 and 2007, respectively. In comparison, CAAC’s published maximum acceptable Accident Signs Per Ten Thousands Hours Ratio was 0.6, 0.6, 0.7 in 2009, 2008 and 2007, respectively. This ratio is defined as the occurrence of one incident for every 10,000 hours of flight time. In 2009, the Group strengthened its flight safety management as per the internal and external safety requirements. In 2008, the Group received the “Five-Star Flight Safety Award” from CAAC, making it the first in the aviation industry to receive such a great honor. By December 2009, the Company’s continuous safe flight span totaled to 6.53 million hours.
Jet Fuel

Jet fuel costs typically represent a major component of an airline’s operating expenses. The Group’s jet fuel costs accounted for 29.6%, 37.4% and 34.6% of the Group’s operating expenses for the years ended December 31, 2009, 2008 and 2007, respectively. 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, Sanya, Haikou, Shanghai Pudong and other small airports where jet fuel is supplied by Sino-foreign joint venture 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.
 
 
20

 

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 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. In 2007 through the first half of 2008, the crude oil prices in the international market reached historic highs. In response to the pressure imposed by such rocketing prices, on November 1, 2007 and June 20, 2008, respectively, NDRC increased the domestic price for jet fuel. Thereafter, in order to cushion fuel cost pressure faced by Chinese airlines, on December 19, 2008 and January 1, 2009, respectively, NDRC approved reductions in domestic prices for jet fuel. However, starting from February 2009, the crude oil price in the international market started to pick up gradually. As a result, NDRC increased the domestic price for jet fuel in July 2009 and made several subsequent adjustments thereafter.

Jet fuel costs decreased from RMB23,086 million in 2008 to RMB16,390 million in 2009 as a result of decrease in average jet fuel price by 35.3%.

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 7% and 9% of the Group’s total jet fuel consumption in 2009 and 2008, respectively.

Fuel Surcharge

According to the relevant regulations promulgated by the NDRC and the CAAC, 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). The imposition of the fuel surcharge helped relieve, to a certain extent, the burden of high jet fuel cost, on the Group. The level of fuel surcharges, and any adjustment of which, are determined by CAAC and NDRC based on such factors as jet fuel price, route miles and the location of destination. Due to the downward trend in domestic fuel prices, on December 19, 2008, the CAAC and the NDRC decided, on December 25, 2008, to reduce fuel surcharges for both domestic and international routes. Thereafter, the CAAC and the NDRC called for a stop on imposing fuel surcharges for domestic routes by Chinese airlines with effect from January 15, 2009. Such suspension on imposing fuel surcharge lasted until November 2009. As international fuel prices gradually pick up, and in response to rises in the fuel cost, on November 11, 2009, the NDRC issued a notice to introduce a new pricing mechanism of fuel surcharge that links it with airlines’ jet fuel costs. According to the new mechanism, when the purchase cost of jet fuel is lower than RMB 4,140 per ton (i.e., the benchmark price of jet fuel), airlines should not charge fuel surcharge. When the purchase cost of jet fuel exceeds RMB 4,140 per ton, the airlines may charge appropriate fuel surcharge provided that such airlines should digest at least 20 percent of the rising cost. As such, following a suspension period of almost one year, in November 2009, the Group resumed the imposing of fuel surcharges for domestic routes.

Flight Operations

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

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

Training of Pilots and Flight Attendants

The Group believes that its pilot training program which was established in cooperation with the CAAC affiliated Beijing Aeronautics and Aviation University (the “BAAU”) has significantly improved the quality of the training received by the Group’s pilots and has helped maintain the quality of the Group’s staff of pilots at a level consistent with the expansion of operations called for by the Group’s business strategy.
 
 
21

 

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, the trainees receive flight training for a period of approximately 20 months at Australian Pilot College, a company that is 91% owned by the Company and 9% owned by CSAHC. Each trainee 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 four years. The Group has about 1,720 trainees as at the end of May 7, 2010, about 790 trainees are expected to graduate in 2010.

As part of the pilot training program, trainee pilots receive their initial training in the operation of a specific aircraft with Zhuhai Xiang Yi Aviation Technology Company Limited (“Zhuhai Xiang Yi”), a jointly controlled entity between the Company and CAE International Holdings Limited, which also provides training to pilots from other Chinese airlines. Zhuhai Xiang Yi is equipped with simulators for all models of aircraft currently operated by the Group and provides flight simulation training services to the Group.

The Group’s pilots are required to be licensed by the CAAC, which requires an annual recertification examination. The Group’s pilots attend courses in simulator training twice annually and in simulator emergency procedures annually. The Group also conducts regular advanced training courses for captains and captain candidates. Pilots advance in rank based on number of hours flown, types of aircraft flown and their performance history.
 
The Group used to fund the training of its recruited pilots in previous years and, as a result, incurred significant costs over the years. Recently, there has been a trend in the financing of pilot training worldwide from employer-sponsored to self-sponsored scheme. Such a change will not only cut down the Group’s training expenses significantly, but also ensures the long-term dedicated service of the pilots. Starting from 2007, the Group began to recruit pilots under the self-sponsored training arrangement. On December 5, 2007, August 27, 2008 and August 27, 2009, the Board approved the Company to provide a guarantee with joint liability for the loans incurred under the self-sponsored pilot training program in an aggregate amount of RMB90,858,000, not more than RMB213,600,000 and not more than RMB184,750,000 respectively. On December 29, 2009, Xiamen Airlines, a 60%-owned subsidiary of the Company agreed to provide a guarantee with joint liability for the loans incurred under the partial self-sponsored pilot training program in an aggregate amount of not more than RMB100 million covering a period till December 31, 2011. As of December 31, 2009, the Group has provided a guarantee with joint liability for the loans of such self-sponsored pilots in an aggregate amount of RMB292,586,000, under which an aggregate of personal bank loans of RMB60,025,500 were drawn down from the banks.

Under the program, the self-sponsored pilots are bound to enter into service contracts with the Group when they finish their training courses. They have the choices to repay their loans in advance or in instalments.

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

Ground Services

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

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

Ground services at the airports in Shenzhen, Changsha, Wuhan, Zhengzhou, Haikou, Zhuhai, Xiamen, Fuzhou, Guilin, Shantou, Guiyang and Beihai are primarily operated directly by the Group. Ground services at the airport in Beijing are primarily provided by Beijing Ground Service, which has become a wholly-own subsidiary of the Company in June 2009, since April 2004. Ground services at other airports in China are provided to the Group by local airport authorities or local airlines pursuant to various service agreements. Ground services and other services at airports outside China are provided to the Group by foreign services providers pursuant to various service agreements with such parties. All such agreements of the Group are short-term and otherwise on terms that are customary in the industry.

Air Catering

The Company owns a 55% equity interest in Guangzhou Nanland Air Catering Company Limited (“Nanland”) as of December 31, 2009. Nanland provides in-flight meals, snacks, drinks and related services for all of the Group’s flights originating in Guangzhou and substantially all other flights departing from Guangzhou Baiyun 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.

To facilitate the Company to optimize its assets structure, better tightening its cost control, reduce the number of connected transactions and enhance the independence of the Company’s operations in the long-run, the Company acquired 100% interest in China Southern Airlines Group Air Catering Company Limited (“SAG Air Catering”) on August 31, 2007 from CSAHC. SAG Air Catering mainly provides in-flight meals to airlines for different flights of the Company originating or stopping at the domestic airports, mainly in northern China and Xinjiang regions.
 
 
22

 

Cargo and Mail

The Group also provides air cargo and mail services. A significant portion of these services are combined with passenger flights services. Currently, the Group has two Boeing 747 freighters and two Boeing 777 freighters mainly servicing four international cargo routes, Shanghai to Amsterdam, Shanghai to Anchorage to Chicago, Shanghai to Frankfurt and Shanghai to Urumchi to Frankfurt.

Currently, the Group conducts its cargo business primarily through its cargo division in Guangzhou and Shenzhen.

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 associates. The Group has sales offices in Guangzhou and its other route bases. In addition, the Group maintains regional sales offices in other cities in China, including Beijing and Shanghai. The Group maintains international sales offices in Almaty, Amsterdam, Ashkhabad, Astana, Baku, Bangkok, Bishkek, Brisbane, Busan, Chicago, Daegu, Daejeon, Delhi, Dubai (Sharjah), Dushanbe, Frankfurt, Fukuoka, Hanoi, Ho Chi Minh City, Islamabad, Irkutsk, Jakarta, Jeddah, Khabarovsk, Kathmandu, Kuala Lumpur, Lagos, Lahore, London, Los Angeles, Luanda, Manila, Melbourne, Moscow, New York, Novosibirsk, Osaka, Osh, Paris, Penang, Phnom Penh, Samarkand, Sapporo, Seoul, Singapore, Sydney, Tashkent, Tehran, Tokyo, Vancouver, Vladivostok and Yangon.

The Group 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 2009, approximately 11.02% of all ticket sales for the Group’s scheduled flights were made by the Group’s network of sales offices and CSAHC’s associates. The Group also sells tickets and accepts reservations through an extensive network of non-exclusive independent sales agents. 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 a commission of 3%-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 2009, independent sales agents accounted for approximately 88.98% 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. During 2008, the Group further improved and optimized its online sales network, and launched Tencent sales counters in cooperation with Tencent Technology Limited, thus expanded the consumer sales network of the Group. Meanwhile, the Group upgraded and reconstructed the SMS platform, and launched the 95539 services hotlines, which provide SMS information services on mileage, flight schedule, flight status, and air ticket price.

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% - 5% of the relevant cargo freight rate for domestic and international services.

Promotional and Marketing Activities

The Group engages in regular promotional and marketing activities in an effort to increase its market share. The Group’s promotional and marketing activities for domestic routes emphasize safety, passenger comfort and the frequency of the Group’s flights. The Group’s promotional and marketing activities for international and 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 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. The Group widened its use of information technology and introduced new services such as cell phone check-in, and SMS platforms. During the Beijing Olympic Games, the Group launched a special promotion known as “Welcome the Olympic Games with Gold Medal Services” and successfully fulfilled its duties to deliver quality services for the Beijing Olympic Games and Paralympics Games.
 
 
23

 

On the wake of permitted direct flights on weekends between Taiwan and Mainland China starting from July 4, 2008, the Company became the first Chinese carrier to fly nonstop to Taiwan. By taking advantage of such further liberalized air travel policy between Taiwan and Mainland China, the Company has taken measures to explore opportunities presented by and increase its name recognition in Taiwan market. On June 23, 2008, the Company entered into a memorandum of cooperation with China Airlines, which is the largest carrier in Taiwan by route network. Based on the memorandum, the scope of cooperation between the parties will cover passenger, cargo, maintenance, and ground handling services. The Company believes that its strategic collaboration with China Airlines will be beneficial to both parities, expand their route network worldwide, increase their freight load factors, reduce labor and operating costs, and enhance the competitiveness of both airlines in the global air travel market.

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 2009, the Group had approximately 8,483,053 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, regional and international route allocation, published air fares, aircraft acquisition, jet fuel prices and standards for aircraft maintenance, airport operations and air traffic control. The Civil Aviation Law, which became effective in March 1996, provides a framework for regulation of many of these aspects of commercial aviation activities. Although China’s airlines operate under the supervision and regulation of the CAAC, they are accorded an increasingly significant degree of operational autonomy, including with respect to the application for domestic, regional 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. Generally, the CAAC requires the passenger load factor on certain route should be above the average rate of the whole market in the last flight season before additional flights and participants may be put on that route.

Regional Routes. Hong Kong 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 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 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.

Previously, direct flights between Taiwan and Mainland China had only been available during certain festivals. Since July 4, 2008, however, the ban on direct flights has been further liberalized to allow direct charter flights on weekends. On November 4, 2008, the Mainland China and Taiwan agreed to regular direct passenger charter flights across the Taiwan Strait. On August 31, 2009, the Mainland China and Taiwan extended the number of regular cross-Strait direct passenger flights from 108 to 270 a week. The 108 direct passenger flights previously operating were all classed as charter flights. The new services comprise both regular charter and scheduled flights. The Company became the first Chinese carrier to fly nonstop to Taiwan. Previously, travelers between Taiwan and China have had to make use of intermediate stops in Hong Kong or elsewhere.
 
 
24

 

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, 2004, prices on domestic routes now fluctuate freely within a predetermined range. Instead of direct supervision by setting prices of air tickets through a local price bureau, the government now provides guidance on domestic flights and domestic civil aviation is controlled by the government indirectly. Market-oriented pricing policy was introduced and pricing system has been adjusted as a result of the above pricing reform.

Published air fares of Chinese airlines for the Hong Kong 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. With respect to the Taiwan routes, the air fares are currently determined by Chinese airlines at their own discretion and may be subject to certain pricing guidance to be issued by the CAAC in the future.

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 import 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, Sanya, Haikou, Shanghai Pudong and other small 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 the above mentioned exceptions) 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.
 
 
25

 

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 Guangzhou Baiyun Airport with limited exceptions. Airports in China are also subject to regulation and ongoing review by the CAAC, which determines take-off and landing charges, as well as charges for the use of airports and airport services.

Competition

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

In the Chinese aviation industry, the three dominant airlines are the Group, Air China and China Eastern Airlines. In 2009, these three airlines together controlled approximately 69.8% 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. In particular, the so-called “Four Longitudinal and Four Horizontal” high-speed railways under construction may have a huge negative impact on the domestic commercial aviation sector once it goes into operation. 38 lines of the “Four Longitudinal and Four Horizontal” overlap with current flights of the Group, 21 of which run for a distance of less than 4 hours. If the high-speed railways go into full operation, according to the statistic of the Group, 13 out of the total 18 subsidiaries and branches of the Company involving 798 flights (i.e. to and fro flights/week) may be seriously impacted.

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. In light of increasing competition from high speed trains, the Group intends to place more flight fleet to the international routes, where the Group enjoys an advantageous market position. The Group also believes that its optimized route network, increased operational efficiency and improved service quality will attract more customers. The proposed cooperation between the Company and the high speed trains operators will also enable the Group to render a seamless air-ground service to customers which will bring a win-win suition for both the Group and the high speed trains operators.
 
 
26

 

According to CAAC statistics, 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.

   
Passenger carried
   
Cargo and Mail
Carried (tons)
   
Total traffic
(ton kilometers)
 
Year
 
Industry
Total
(in millions)
   
Group’s
Share
(% of total)
   
Industry
Total
(in
thousands)
   
Group’s
Share
(% of total)
   
Industry
Total
(in billion)
   
Group’s
Share
(% of total)
 
2005
   
138.3
     
31.8
     
3,067
     
25.3
     
26.1
     
27.9
 
2006
   
159.7
     
30.8
     
3,494
     
23.4
     
30.6
     
26.4
 
2007
   
185.8
     
30.6
     
4,018
     
21.7
     
36.5
     
25.3
 
2008
   
192.5
     
30.3
     
4,076
     
20.5
     
37.7
     
24.4
 
2009
   
230.5
     
28.8
     
4,455
     
19.3
     
42.7
     
23.6
 

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 ten 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 data from CAAC statistics, in 2009. 
         
Cargo and Mail
       
Airport
 
Passenger carried
(% of total)
   
Carried
(% of total)
   
Departing flight
(% of total)
 
Beijing
   
18.05
%
   
11.33
%
   
17.22
%
Shanghai Pudong
   
8.68
%
   
2.83
%
   
9.18
%
Guangzhou
   
49.26
%
   
26.84
%
   
48.73
%
Shanghai Hongqiao
   
15.78
%
   
18.69
%
   
15.53
%
Shenzhen
   
29.06
%
   
21.96
%
   
27.69
%
Chengdu
   
15.01
%
   
15.71
%
   
13.67
%
Kunming
   
16.91
%
   
19.24
%
   
15.75
%
Hangzhou
   
37.47
%
   
31.99
%
   
36.06
%
Xi’an
   
19.27
%
   
23.03
%
   
17.97
%
Chongqing
   
23.12
%
   
26.43
%
   
21.85
%
 
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 eight busiest airports in southern and central China (excluding Guangzhou and Shenzhen, which are included in the table above), based on passenger volume data from CAAC statistics, in 2009.

         
Cargo and Mail
       
Airport
 
Passenger carried
(% of total )
   
Carried
(% of total)
   
Departing flight
(% of total)
 
Wuhan
   
44.41
%
   
54.06
%
   
39.91
%
Changsha
   
45.25
%
   
63.73
%
   
44.35
%
Haikou
   
26.16
%
   
26.05
%
   
25.21
%
Sanya
   
27.47
%
   
27.50
%
   
28.28
%
Zhengzhou
   
51.48
%
   
63.05
%
   
47.41
%
Guilin
   
37.03
%
   
47.16
%
   
36.13
%
Nanning
   
37.05
%
   
36.68
%
   
32.22
%
Zhang Jia Jie
   
36.28
%
   
30.54
%
   
38.02
%
 
 
27

 

Regional Routes

In 2009, the Group conducted a total of 12,227 flights on its regional routes, accounting for approximately 24.75% of all passengers carried by Chinese airlines on routes between Hong Kong, Macau or Taiwan and destinations in China. The Group faces less competition on regional routes than that on domestic and international, and earns higher operating margin. Air China, Eastern Airlines, Air Macau, Dragon Air and Cathay Pacific Airways compete with the Group in the regional traffic markets.

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 regional 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 Cathay Pacific Airways. The Group faces competition on its international routes 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 Company owns a 60% equity interest in each of the Airline Subsidiaries.

As of December 31, 2009, Xiamen Airlines operated under its own “MF” code with a fleet of 57 aircraft on 100 domestic routes, 7 international routes and 10 regional routes. In 2009, Xiamen Airlines carried a total of about 11.12 million passengers, or approximately 16.78% of the passengers carried by the Group in that year, and had RMB7,622 million in traffic revenue.
 
As of December 31, 2009, Shantou Airlines operated under the Group’s “CZ” code with a fleet of ten aircraft. In 2009, under the centralized allocation of flight routes of the Group, Shantou Airlines carried a total of about 1.95 million passengers, or 2.94% of the passengers carried by the Group in that year. Total traffic revenue of Shantou Airlines for the year ended December 31, 2009 was RMB1,422 million.
As of December 31, 2009, Chongqing Airlines operated under the “OQ” code with a fleet of seven aircraft. In 2009, under the centralized allocation of flight routes of the Group, Chongqing Airlines carried a total of about 1.41 million passengers, or 2.13% of the total number of passengers carried by the Group in that year. Total traffic revenue of Chongqing Airlines for the year ended December 31, 2009 was RMB779 million.

As of December 31, 2009, Zhuhai Airlines operated under the “CZ” code with a fleet of five aircraft. In 2009, under the centralized allocation of flight routes of the Group, Zhuhai Airlines carried a total of about 0.87 million passengers, or approximately 1.30% of the total number of passengers carried by the Group in that year. Total traffic revenue of Zhuhai Airlines for the year ended December 31, 2009 was RMB673 million.

As of December 31, 2009, Guizhou Airlines operated under the “CZ” code with a fleet of eight aircraft. In 2009, under the centralized allocation of flight routes of the Group, Guizhou Airlines carried a total of about 1.52 million passengers, or approximately 2.29% of the total number of passengers carried by the Group in that year. Total traffic revenue of Guizhou Airlines was approximately RMB1,172 million for the year ended December 31, 2009.

Insurance

The CAAC maintains fleet and legal liability insurance on behalf of the Group and all other Chinese airlines with PICC Property and Casualty Company Limited, or PICCP&C, and China Pacific Property Insurance Company Ltd., under the PICCP&C 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 the relevant PRC laws, civil liability of Chinese airlines for death or injuries suffered by passengers on domestic flights is limited to RMB400,000 (approximately US$58,581) per passenger. As of July 31, 2006, the Convention for the Unification of Certain Rules for International Carriage by Air of 1999, or Montreal Convention, became effective in China. Under the Montreal Convention, carriers of international flights are strictly liable for proven damages up to 100,000 Special Drawing Rights and beyond that, carriers are only able to exclude liability if they can prove that the damage was not due to negligence or other wrongful act of the carrier (and its agents), or the damage arose solely from the negligence or other wrongful act of a third party. The Group believes that it maintains adequate insurance coverage for the civil liability that can be imposed in respect of death or injuries to passengers under Chinese law, the Montreal Convention and any agreement which the Group is subject to.
 
 
28

 

The CAAC allocates insurance premiums payable in respect of the PICCP&C 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 PICCP&C master policy to increase. PICCP&C’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 and Chongqing 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. Chongqing Airlines conducts its business and operations under the name of “Chongqing Airlines” in English and Chinese and uses its own logo depicting a cross of two rivers.
 
The names “China Southern” and “China Southern Airlines” contain Chinese words of common usage and are therefore not eligible for registration as tradenames under current Chinese law. The kapok logo is a trademark registered in China and recorded with the International Air Transport Association (“IATA”), the rights to which are owned by CSAHC. The Company and CSAHC have entered into a trademark license agreement (the “Trademark License Agreement”), pursuant to which CSAHC has licensed to the Group the right to use the names “China Southern” and “China Southern Airlines” in both English and Chinese and granted the Company a 10-year renewable license from 1997 to use the kapok logo on a world-wide basis. CSAHC has retained the right to use the kapok logo in connection with its non-airline related businesses conducted as of the date of the Trademark License Agreement and to permit its associates 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 agreement, the agreement will be automatically renewed for another ten-year term. In May of 2007, the Trademark License Agreement has been renewed by the two parties for another ten-year term ending 2017. Xiamen Airlines owns all rights to its egret logo, which is a trademark registered in China, and recorded with the IATA. Chongqing Airlines also owns all rights to its 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 December 31, 2009 and the aggregate effective equity interest of the Company in each of its principal subsidiaries, associates and jointly controlled entities.

 
29

 


Note a: Including 13% ownership interest held by CSA’s subsidiaries.

The particulars of the Group’s principal subsidiaries as of December 31, 2009 are as follows:

Name of company
 
Place and date of
establishment
/operation
 
Proportion of
ownership
interest held 
by the Company
 
Southern Airlines Shantou Airlines Company Limited
 
PRC July 20, 1993
   
60
%
Zhuhai Airlines Company Limited
 
PRC May 8, 1995
   
60
%
Xiamen Airlines Company Limited
 
PRC August 11, 1984
   
60
%
Guizhou Airlines Company Limited
 
PRC November 12, 1991
   
60
%
Chongqing Airlines Company Limited
 
PRC June 16, 2007
   
60
%
Guangzhou Nanland Air Catering Company Limited
 
PRC November 21, 1989
   
55
%
China Southern West Australian Flying College Pty Limited
 
Australia January 26, 1971
   
91
%
Guangzhou Baiyun International Logistics Company Limited
 
PRC July 23, 2002
   
61
%
Xinjiang Civil Aviation Property Management Limited
 
PRC February 12, 2002
   
51.8
%
China Southern Airlines Group Air Catering Company Limited
 
PRC December 25, 2003
   
100
%
Nan Lung International Freight Limited
 
Hong Kong October 1, 1996
   
51
%
Beijing Southern Airlines Ground Service Company Limited
 
PRC April 1, 2004
   
100
%
 
 
30

 
 
The particulars of the Group’s principal associates and jointly controlled entities as of December 31, 2009 are as follows:

       
Proportion of ownership
interest held by
 
Name of company
 
Place and date of
establishment
/operation
 
Group
effective
interest
   
The
Company
   
Subsidiaries
 
Guangzhou Aircraft Maintenance Engineering Company Limited
 
PRC October 28, 1989
   
50
%
   
50
%
   
 
Southern Airlines Group Finance Company Limited
 
PRC June 28, 1995
   
34
%
   
21.1
%
   
12.9
%
Sichuan Airlines Corporation Limited
 
PRC August 28, 2002
   
39
%
   
39
%
   
 
MTU Maintenance Zhuhai Co., Limited
 
PRC April 6, 2001
   
50
%
   
50
%
   
 
Zhuhai Xiang Yi Aviation Technology Company Limited
 
PRC July 10, 2002
   
51
%
   
51
%
   
 
Guangzhou China Southern Zhongmian Dutyfree Store Co., Limited
 
PRC September 29, 2006
   
50
%
   
50
%
   
 

Property, Plant and Equipment

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

The Company’s headquarters in Guangzhou occupy an area of approximately 429,833 square meters of land and a total gross floor area of approximately 653,043 square meters. The Company leases from CSAHC the land in Guangzhou on which the Company’s headquarters and other facilities are located. The Company also leases from CSAHC certain buildings mainly at the Haikou, Wuhan, Nanyang, Shenyang, Dalian, Jilin, Harbin and Xinjiang.

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
(in square meters)
   
Buildings
(in square meters )
 
   
Owned
   
Leased
   
Owned
   
Leased
 
Guangzhou
   
330,163
     
99,670
     
624,667
     
28,376
 
Shenzhen
   
208,740
     
     
105,040
     
 
Zhuhai
   
170,062
     
     
18,791
     
 
Changsha
   
138,949
     
     
52,552
     
 
Zhengzhou
   
290,841
     
     
66,542
     
 
Haikou
   
5,265
     
1,711
     
83,923
     
20,917
 
Wuhan
   
     
31,061
     
17,335
     
22,831
 
Nanyang
   
     
     
18,156
     
60,035
 
Sanya
   
106,680
     
     
16,968
     
 
Shenyang
   
     
167,502
     
79,626
     
93,445
 
Dalian
   
     
14,403
     
20,290
     
33,597
 
Jilin
   
134,488
     
65,076
     
38,210
     
7,767
 
Harbin
   
     
286,871
     
36,925
     
3,188
 
Xinjiang
   
17,460
     
631,094
     
177,710
     
4,135
 
Guilin
   
72,563
     
     
73,379
     
139
 

The following table sets forth certain information with respect to the properties of the Airline Subsidiaries as of the date hereof.

   
Land
(in square meters)
   
Buildings
(in square meters)
 
   
Owned
   
Leased
   
Owned
   
Leased
 
Xiamen
   
581,401
     
     
511,847
     
26,044
 
Shantou
   
36,931
     
53,000
     
61,468
     
2,773
 
Zhuhai
   
99,306
     
     
57,730
     
1,800
 
Guizhou
   
259,879
     
     
106,245
     
2,032
 
Chongqing
   
     
     
6,785
     
3,482
 
 
 
31

 

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 Company’s headquarters and other facilities are located and the buildings that the Company uses at its route base in Wuhan and 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. As of May 7, 2010, the Group was in the process of applying for the land use right certificates and property title certificates in respect of the properties located in Guangzhou (including Guangzhou Baiyun International Airport), Xiamen, Heilongjiang, Hainan, Jilin, Dalian, Hunan, Xinjiang, Henan and Shenzhen, in which the Group has interests and for which such certificates have not been granted. 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.
 
ITEM 4A. UNRESOLVED STAFF COMMENTS.

Not applicable.

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 Standards for Business Enterprises (“PRC GAAP”) and prepares its financial statements in accordance with both PRC GAAP and IFRSs. The Financial Statements contained elsewhere in this Annual Report have been prepared in accordance with IFRSs.

The discussion and analysis of the Group’s financial condition and results of operations are based on the consolidated financial statements, which have been prepared in accordance with IFRSs.

Critical Accounting Policies

The preparation of the consolidated financial statements requires the Group to make estimates and judgments that affect the reported amount of assets and liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities at the date of the consolidated financial statements. Actual results may differ from these estimates under different assumptions or conditions.

Critical accounting policies are defined as those that are reflective of significant judgments and uncertainties, and potentially result in materially different results under different assumptions and conditions. Our principal accounting policies are set forth in Note 2 to the consolidated financial statements. The Group believes that the following critical accounting policies involve the most significant judgments and estimates used in the preparation of our financial statements.

Impairment for long-lived assets

If circumstances indicate that the net book value of a long-lived asset may not be recoverable, this asset may be considered “impaired”, and an impairment loss may be recognized in accordance with IAS 36, Impairment of Assets. The carrying amounts of long-lived assets are reviewed periodically in order to assess whether the recoverable amounts have declined below the carrying amounts. These assets are tested for impairment whenever events or changes in circumstances indicate that their recorded carrying amounts may not be recoverable. When such a decline has occurred, the carrying amount is reduced to the recoverable amount. The recoverable amount is the greater of the fair value less costs to sell and 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 the level of traffic revenue and the 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 reasonable and supportable assumptions for 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 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.

 
32

 

Recently Pronounced International Financial Reporting Standards

Information relating to the recently pronounced IFRSs is presented in Note 56 to the consolidated financial statements.

Overview

2009 proved to be an unusual year. In view of the complicated and ever-changing environment of China and elsewhere throughout the year, the Group prudently analyzed the changes in the market, and made quick response by putting effective measures into practice. It assured the safe operation for the whole year under its enhanced safety management. In addition, through network structure optimization, market development, additional sales activities as well as deeper strategic transformation, the Group controlled costs stricter and took advantage of all policy supports. As such, the fast growth of its operations was ensured that led to a turnaround from loss to profit for the year.

The Group secured a record of safe operation during 2009 by highlighting the importance of safety, enhancing the training and standard of safety, and intensifying the safety information management and system control. Up to December 2009, the Company had achieved records of 122 consecutive safe flight months, 6.53 million accumulated safe flight hours and 186 consecutive months of air security.

In 2009, facing the sustainable slump in the international aviation market and new conditions such as the rapid change in the domestic aviation market, the Group endeavored to react and adjust itself to the changing market. The centralized deployment of traffic capacity was strengthened with emphasis on major and high-profit markets. Moreover, we tried hard to grasp opportunities quicker and increase our income and profitability by developing major markets and making full use of all favorable opportunities, including the Lunar New Year, Canton Fairs and high seasons for the market; and making a series of actions to explore a new operation model. Such actions included pushing on with the centralized scheduling and sales management, commencing the operation of air express, implementing the electronic ticket and transport networking system, as well as strengthening the strategic cooperation.

The Group staged the activities of “Year of Branded Services Improvement Campaign” during 2009. Through enhanced operation management and improved flight on-schedule rate, our passengers were provided with more punctual and convenient services. In addition, the Group proactively explored the control model of service system, and strengthened the standardization of services. We continued to optimize the whole process and each step of services so as to improve its service capability. Also, enhancement in both highend customer service and passenger load factor of first class and business class lounges together with the new transit business of “Through Check-In” further elevated our brand value and market influence.

In 2009, the Company successfully obtained a capital injection of RMB3 billion through a non-public issue of 721,150,000 A shares to CSAHC and another non-public issue of 721,150,000 H shares to Nan Lung a foreign wholly-owned subsidiary of CSAHC. The proceeds replenished the Company’s capital and lowered the gearing ratio, thereby laying a solid foundation for improvement in the financial position as well as the future development. To further reduce the gearing ratio and financial burden and support the strategic development with funds, the Company is planning to raise an amount of RMB10 billion through non-public issues of A shares and H shares in 2010.

In 2009, the Group continued to give back to society with love and contribution in fulfilling its responsibility of corporate citizen. During 2009, our Ten Cent Care Foundation continued to sponsor poor undergraduates and provided 22 flights for specific purposes, peacekeeping, evacuation of compatriots living abroad, etc. On our principle of “Green Flight”, we continuously increased the energy utilization rate and decreased the emission of greenhouse gases through fleet upgrade, route network optimization and aircraft weight reduction.

Nevertheless, the development of the airlines industry meets with a number of challenges, such as more factors making the recovery of global economy unstable and uncertain, faster growth in the total traffic capacity of the industry, impact of substitutive services such as Express Rail, as well as sharp fluctuation in oil price.

Since July 21, 2005, the PRC government has begun to adopt a managed floating exchange rate system based on market supply and demand of currencies, which is subject to adjustments with reference to a basket of currencies. The exchange rate of Renminbi would no longer be pegged to the U.S. dollar only and a more flexible exchange rate system was established. Because the Group finances its aircraft acquisitions mainly through capital leases or bank loans in U.S. dollars, and there are a substantial amount of transactions and obligations denominated in U.S. dollars in relation to its global purchases of jet fuel, lease and purchase of aviation equipment as well as major repairs, in addition to the landing fees of its international flights in the airports of other countries, the Group benefited from the RMB appreciation. RMB appreciation has brought a one-off exchange gain to the Group and reduced its operating costs which are denominated in foreign currencies. However, RMB appreciation also presents the Group with a challenge in price competition in international route operations.

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.
 
 
33

 

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 are 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. Net exchange gain decreased by RMB2,499 million, from RMB2,592 million in 2008 to RMB93 million in 2009 because the exchange rate of RMB against USD was relatively stable in 2009 while RMB appreciated significantly against USD in 2008.

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 air fares, jet fuel prices and landing and navigation fees, among others. The nature and extent of airline competition and the ability of Chinese airlines to expand are also affected by CAAC’s control over route allocations. Any changes in the PRC government’s regulatory policies or any implementation of such policies could have a significant impact on the Group’s future operations and its ability to implement its operating strategy.

Certain Financial Information and Operating Data by Geographic Region

The following table sets forth certain financial information and operating data by geographic region for the years ended December 31, 2009, 2008 and 2007:

   
Year ended December 31,
   
2009 vs. 2008
% increase
   
2008 vs. 2007
% increase
 
Traffic
 
2009
   
2008
   
2007
   
(decrease)
   
(decrease)
 
RPK (million)
                                       
Domestic
   
80,697
     
70,619
     
68,369
     
14.3
     
3.3
 
Regional
   
1,337
     
1,139
     
1,180
     
17.4
     
(3.5
)
International
   
10,968
     
11,426
     
12,178
     
(4.0
)
   
(6.2
)
Total
   
93,002
     
83,184
     
81,727
     
11.8
     
1.8
 
RTK (million)
                                       
Domestic
   
8,342
     
7,392
     
7,219
     
12.9
     
2.4
 
Regional
   
126
     
110
     
115
     
14.5
     
(4.3
)
International
   
1,599
     
1,698
     
1,916
     
(5.8
)
   
(11.4
)
Total
   
10,067
     
9,200
     
9,250
     
9.4
     
(0.5
)
Passengers carried (thousand)
                                       
Domestic
   
61,130
     
53,063
     
51,326
     
15.2
     
3.4
 
Regional
   
1,276
     
1,220
     
1,339
     
4.6
     
(8.9
)
International
   
3,875
     
3,954
     
4,238
     
(2.0
)
   
(6.7
)
Total
   
66,281
     
58,237
     
56,903
     
13.8
     
2.3
 
Cargo and mail carried (thousand tons)
                                       
Domestic
   
750
     
713
     
733
     
5.2
     
(2.7
)
Regional
   
9
     
11
     
12
     
(18.2
)
   
(8.3
)
International
   
103
     
111
     
127
     
(7.2
)
   
(12.6
)
Total
   
862
     
835
     
872
     
3.2
     
(4.2
)
 
 
34

 

   
Year ended December 31,
   
2009 vs. 2008
%increase
   
2008 vs. 2007
%increase
 
Capacity
 
2009
   
2008
   
2007
   
(decrease)
   
(decrease)
 
ASK (million)
                                       
Domestic
   
105,379
     
93,384
     
89,452
     
12.8
     
4.4
 
Regional
   
1,916
     
1,790
     
1,881
     
7.0
     
(4.8
)
International
   
16,146
     
17,593
     
18,400
     
(8.2
)
   
(4.4
)
Total
   
123,441
     
112,767
     
109,733
     
9.5
     
2.8
 
ATK (million)
                                       
Domestic
   
12,425
     
10,985
     
10,440
     
13.1
     
5.2
 
Regional
   
219
     
200
     
210
     
9.5
     
(4.8
)
International
   
2,802
     
3,091
     
3,558
     
(9.3
)
   
(13.1
)
Total
   
15,446
     
14,276
     
14,208
     
8.2
     
0.5
 
Load Factors
                                       
Passenger load factor (RPK/ASK) (%)
                                       
Domestic
   
76.6
     
75.6
     
76.4
     
1.3
     
(1.0
)
Regional
   
69.8
     
63.6
     
62.7
     
9.7
     
1.4
 
International
   
67.9
     
64.9
     
66.2
     
4.6
     
(2.0
)
Overall
   
75.3
     
73.8
     
74.5
     
2.0
     
(0.9
)
Overall load factor (RTK/ATK) (%)
                                       
Domestic
   
67.1
     
67.3
     
69.1
     
(0.3
)
   
(2.6
)
Regional
   
57.7
     
55.0
     
55.1
     
4.9
     
(0.2
)
International
   
57.1
     
54.9
     
53.8
     
4.0
     
2.0
 
Overall
   
65.2
     
64.4
     
65.1
     
1.2
     
(1.1
)
Yield
                                       
Yield per RPK (RMB)
                                       
Domestic
   
0.53
     
0.59
     
0.60
     
(10.2
)
   
(1.7
)
Regional
   
0.75
     
0.84
     
0.91
     
(10.7
)
   
(7.7
)
International
   
0.55
     
0.67
     
0.63
     
(17.9
   
6.3
 
Overall
   
0.54
     
0.61
     
0.61
     
(11.5
   
0.0
 
Yield per RTK (RMB)
                                       
Domestic
   
5.36
     
5.90
     
5.89
     
(9.2
   
0.2
 
Regional
   
8.30
     
9.23
     
9.91
     
(10.1
)
   
(6.9
)
International
   
4.52
     
5.47
     
5.03
     
(17.4
   
8.7
 
Overall
   
5.26
     
5.86
     
5.75
     
(10.2
   
1.9
 
Financial
                                       
Passenger revenue (RMB million)
                                       
Domestic
   
43,033
     
41,854
     
40,717
     
2.8
     
2.8
 
Regional
   
1,000
     
952
     
1,074
     
5.0
     
(11.4
)
International
   
6,026
     
7,606
     
7,708
     
(20.8
)
   
(1.3
)
Total
   
50,059
     
50,412
     
49,499
     
(0.7
   
1.8
 
Cargo and mail revenue (RMB million)
   
2,908
     
3,051
     
3,697
     
(4.7
)
   
(17.5
)
 
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.

2009 compared with 2008

The profit attributable to equity shareholders of the Company of RMB330 million was recorded in 2009 as compared to the loss attributable to equity shareholders of the Company of RMB4,823 million in 2008, mainly due to the increase in revenue excluding fuel surcharge income and the decrease in fuel costs, which exceeded the drop in fuel surcharge income. Due to the decrease of fuel cost, the Group’s operating costs decreased sharply. The Group’s operating revenue decreased by RMB486 million or 0.9% from RMB55,288 million in 2008 to RMB54,802 million in 2009 resulting from the decrease in fuel surcharge income. Excluding the fuel surcharge income of RMB8,197 million and RMB1,986 million for 2008 and 2009, operating revenue increased from RMB47,091 million in 2008 to RMB52,816 million in 2009. Passenger load factor increased by 1.5 percentage point, from 73.8% in 2008 to 75.3% in 2009. Passenger yield (in passenger revenue per RPK) decreased by RMB0.07 or 11.5% from RMB0.61 in 2008 to RMB0.54 in 2009. Average yield (in traffic revenue per RTK) decreased by 10.2% from RMB5.86 in 2008 to RMB5.26 in 2009. Operating expenses decreased by RMB6,416 million or 10.4% from RMB61,767 million in 2008 to RMB55,351 million in 2009 due to the decrease of fuel cost from RMB23,086 million in 2008 to RMB16,390 million in 2009. As a result of the decrease in operating expenses, operating profit of RMB1,440 million was recorded in 2009 as compared to operating loss of RMB5,646 million in 2008.
 
 
35

 

Operating revenue

   
2009
   
2008
       
   
Operating
revenue
   
Percentage
   
Operating
revenue
   
Percentage
   
Change in
revenue
 
   
RMB million
   
%
   
RMB million
   
%
   
%
 
Traffic revenue
    52,967       96.7 %     53,913       97.5 %     (1.8 )
Including: Passenger revenue
    50,059               50,412               (0.7 )
– Domestic
    43,033               41,854               2.8  
– Hong Kong, Macau and Taiwan
    1,000               952               5.0  
– International
    6,026               7,606               (20.8 )
Cargo and mail revenue
    2,908               3,501               (16.9 )
Other operating revenue
    1,835       3.3 %     1,375       2.5 %     33.5  
Mainly including: Commission income
    342               317               7.9  
 Ground service income
    320               250               28.0  
 Expired sales in advance of carriage
    350               276               26.8  
                                         
Total operating revenue
    54,802       100.0 %     55,288       100.0 %     (0.9 )
Less: fuel surcharge income
    (1,986 )             (8,197 )             (75.8 )
                                         
Total operating revenue excluding fuel surcharge
    52,816               47,091               12.2  

Traffic revenue composition

   
2009
   
2008
       
   
Traffic
revenue
   
Percentage
   
Traffic
revenue
   
Percentage
   
Change in traffic
revenue
 
   
RMB million
   
%
   
RMB million
   
%
   
%
 
Passenger Revenue
    50,059       94.5 %     50,412       93.5 %     (0.7 )
Cargo and Mail Revenue
    2,908       5.5 %     3,501       6.5 %     (16.9 )
Traffic revenue
    52,967       100.0 %     53,913       100.0 %     (1.8 )
     
Passenger revenue composition

   
2009
   
2008
       
   
Passenger
revenue
   
Percentage
   
Passenger
revenue
   
Percentage
   
Change in passenger
revenue 
 
   
RMB million
   
%
   
RMB million
   
%
   
%
 
Domestic
    43,033       86.0 %     41,854       83.0 %     2.8  
Hong Kong, Macao and Taiwan
    1,000       2.0 %     952       1.9 %     5.0  
International
    6,026       12.0 %     7,606       15.1 %     (20.8 )
                                         
Passenger revenue
    50,059       100.0 %     50,412       100.0 %     (0.7 )
    
Substantially all of the Group’s operating revenue is attributable to airline and airline related operations. Traffic revenue accounted for 96.7% and 97.5% of total operating revenue in 2009 and 2008 respectively. Passenger revenue and cargo and mail revenue accounted for 94.5% and 5.5% respectively of the total traffic revenue in 2009. 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 income from expired sales in advance of carriage.

The decrease in operating revenue was primarily due to a 0.7% decrease in passenger revenue from RMB50,412 million in 2008 to RMB50,059 million in 2009. The total number of passengers carried increased by 13.8% to 66.28 million passengers in 2009. RPKs increased by 11.8% from 83,184 million in 2008 to 93,002 million in 2009, primarily as a result of the increase in number of passengers carried. Passenger yield per RPK decreased from RMB0.61 in 2008 to RMB0.54 in 2009. Passenger revenue and passenger yield per RPK decreased mainly due to the decrease in fuel surcharge income.

Fuel surcharge income, which accounted for 3.6% and 14.8% of total operating revenue in 2009 and 2008, decreased by 75.8% or RMB6,211 million, from RMB8,197 million in 2008 to RMB1,986 million in 2009. On January 14, 2009, the National Development and Reform Commission (NDRC) and the CAAC jointly announced the suspension of the collection of passenger fuel surcharge since January 15, 2009. On November 11, 2009, the NDRC and the CAAC announced to resume the collection of fuel surcharge income and issued a new pricing mechanism, which was effective on November 14, 2009. Under the new pricing mechanism, domestic airline companies could adjust the fuel surcharge level within a prescribed range set by the pricing mechanism without prior approval of the relevant authorities. In addition, the Group reduced the fuel surcharge level of international routes in view of the decrease in fuel prices.
 
 
36

 

Domestic passenger revenue, which accounted for 86.0% of the total passenger revenue in 2009, increased by 2.8% from RMB41,854 million in 2008 to RMB43,033 million in 2009. Passenger capacity in ASKs increased by 12.8%, while domestic passenger traffic in RPKs increased by 14.3%, resulting in an increase in passenger load factor by 1.0 percentage point from 75.6% in 2008 to 76.6% in 2009. Domestic passenger yield per RPK decreased from RMB0.59 in 2008 to RMB0.53 in 2009.

Hong Kong, Macau and Taiwan passenger revenue, which accounted for 2.0% of total passenger revenue, increased by 5.0% from RMB952 million in 2008 to RMB1,000 million in 2009. For Hong Kong, Macau and Taiwan flights, passenger capacity in ASKs increased by 7.0%, while passenger traffic in RPKs increased by 17.4%, resulting in an increase in passenger load factor by 6.2 percentage points from 63.6% in 2008 to 69.8% in 2009. Passenger yield per RPK decreased from RMB0.84 in 2008 to RMB0.75 in 2009, mainly resulted from the decrease of fuel surcharge income and stronger competition in the region during the year.

International passenger revenue, which accounted for 12.0% of total passenger revenue, decreased by 20.8% from RMB7,606 million in 2008 to RMB6,026 million in 2009. For international flights, passenger capacity in ASKs decreased by 8.2%, while passenger traffic in RPKs decreased by 4.0%, resulting in a 3.0 percentage point increase in passenger load factor from 64.9% in 2008 to 67.9% in 2009. Passenger yield per RPK decreased by 17.9% from RMB0.67 in 2008 to RMB0.55 in 2009, mainly due to the decrease in fuel surcharge income and stronger competition in international routes during the year.

Cargo and mail revenue, which accounted for 5.5% of the Group’s total traffic revenue and 5.3% of total operating revenue, decreased by 16.9% from RMB3,501 million in 2008 to RMB2,908 million in 2009. The decrease was attributable to reduced cargo traffic demand under global financial crisis.

Other operating revenue increased by 33.5% from RMB1,375 million in 2008 to RMB1,835 million in 2009. The increase was primarily due to the general growth in income from various auxiliary operations.

Operating expenses

Total operating expenses in 2009 amounted to RMB55,351 million, representing a decrease of 10.4% or RMB6,416 million over 2008, primarily due to the total effect of decreases in jet fuel costs and impairment on property, plant and equipment. Total operating expenses as a percentage of total operating revenue decreased from 111.7% in 2008 to 101.0% in 2009.
 
   
2009
   
2008
   
Change in
operating expenses
 
   
RMB million
   
Percentage
   
RMB million
   
Percentage
   
%
 
Flight operations
    29,296       52.9 %     34,982       56.6 %     (16.3 )
Mainly including: Jet fuel costs
    16,390               23,086               (29.0 )
 Operating lease charges
    5,123               4,527               13.2  
 Flight personnel payroll and welfare
    2,622               2,490               5.3  
Maintenance
    4,446       8.0 %     4,890       7.9 %     (9.1 )
Aircraft and traffic servicing
    9,169       16.6 %     8,476       13.7 %     8.2  
Promotion and sales
    4,170       7.5 %     3,491       5.7 %     19.5  
General and administrative
    1,844       3.3 %     2,041       3.3 %     (9.7 )
Impairment on property, plant and equipment
    26       0.1 %     1,884       3.1 %     (98.6 )
Depreciation and amortisation
    5,971       10.8 %     5,746       9.3 %     3.9  
Others
    429       0.8 %     257       0.4 %     66.9  
                                         
Total operating expenses
    55,351       100.0 %     61,767       100.0 %     (10.4 )

Flight operations expenses, which accounted for 52.9% of total operating expenses, decreased by 16.3% from RMB34,982 million in 2008 to RMB29,296 million in 2009, primarily as a result of significant decrease in jet fuel costs. Jet fuel costs, which accounted for 55.9% of flight operations expenses, decreased by 29.0% from RMB23,086 million in 2008 to RMB16,390 million in 2009 mainly as a result of decrease in average fuel costs by 35.3%.
 
 
37

 

Maintenance expenses, which accounted for 8.0% of total operating expenses, decreased by 9.1% from RMB4,890 million in 2008 to RMB4,446 million in 2009. The decrease was mainly due to the decrease in number of engines repaired during the year.

Aircraft and traffic servicing expenses, which accounted for 16.6% of total operating expenses, increased by 8.2% from RMB8,476 million in 2008 to RMB9,169 million in 2009. The increase was primarily due to a 10.4% rise in landing and navigation fees from RMB6,135 million in 2008 to RMB6,772 million in 2009, due to the increase in number of flights.

Promotional and sales expenses, which accounted for 7.5% of total operating expenses, increased by 19.5% from RMB3,491 million in 2008 to RMB4,170 million in 2009, which is in line with the increase in operating revenue excluding fuel surcharge income.

General and administrative expenses, which accounted for 3.3% of the total operating expenses, decreased by 9.7% from RMB2,041 million in 2008 to RMB1,844 million in 2009. The decrease was due to stricter cost control implemented by the Group in 2009.

Impairment on property, plant and equipment decreased by RMB1,858 million from RMB1,884 million in 2008 to RMB26 million in 2009. Please see Note 20(g) to the Financial Statements for more details.

Depreciation and amortization, which accounted for 10.8% of total operating expenses, increased by 3.9% from RMB5,746 million in 2008 to RMB5,971 million in 2009, mainly due to the additional depreciation charges on aircraft delivered in 2009.

Operating profit/(loss)

Operating profit of RMB1,440 million was recorded in 2009 as compared to operating loss of RMB5,646 million in 2008. The increase in profit was mainly due to the net effect of decrease in operating revenue by RMB486 million or 0.9% in 2009, decrease in operating expenses by RMB6,416 million or 10.4% and the receipt of CAAC Infrastructure Development Fund contributions of RMB1,328 million in 2009.

Other (expenses)/income

Interest expense decreased by 24.7% from RMB1,987 million in 2008 to RMB1,497 million in 2009, mainly due to the decrease in average effective interest rate of bank and other loans and obligations under finance leases.

Net exchange gain decreased by RMB2,499 million, from RMB2,592 million in 2008 to RMB93 million in 2009 because the exchange rate of RMB against USD was relatively stable in 2009 while RMB appreciated significantly against USD in 2008.

Taxation

Income tax credit of RMB95 million was recorded in 2009 as compared to an income tax expense of RMB62 million in 2008, mainly due to the utilization of unused tax losses not recognized in prior year.

2008 compared with 2007

The loss attributable to equity shareholders of the Company of RMB4,823 million was recorded in 2008 as compared to a profit attributable to equity shareholders of the Company of RMB1,839 million in 2007. The Group experienced a slow down of growth in traffic revenue and rising operating expenses as a result of global financial crisis and increase of jet fuel cost. The Group’s operating revenue increased by RMB887 million or 1.6% from RMB54,401 million in 2007 to RMB55,288 million in 2008. Passenger load factor decreased by 0.7 percentage point, from 74.5% in 2007 to 73.8% in 2008. Passenger yield (in passenger revenue per RPK) was RMB0.61, which was unchanged from 2007. Average yield (in traffic revenue per RTK) increased by 1.9% from RMB5.75 in 2007 to RMB5.86 in 2008. Operating expenses increased by RMB8,811 million or 16.6% from RMB52,956 million in 2007 to RMB61,767 million in 2008. As a result of the increase in operating expenses which outweighed the growth in revenue, operating loss of RMB5,646 million was recorded in 2008, as compared to operating profit of RMB1,881 million in 2007.
 
 
38

 

Operating revenue

   
2008
   
2007
       
   
Operating
revenue
   
Percentage
   
Operating
revenue
   
Percentage
   
Change in
revenue
 
   
RMB million
   
%
   
RMB million
   
%
   
%
 
Traffic revenue
    53,913       97.5 %     53,196       97.8 %     1.3  
Including: Passenger revenue
    50,412               49,499               1.8  
– Domestic
    41,854               40,717               2.8  
– Hong Kong, Macau and Taiwan
    952               1,074               (11.4 )
– International
    7,606               7,708               (1.3 )
Cargo and mail revenue
    3,501               3,697               (5.3 )
Other operating revenue
    1,375       2.5 %     1,205       2.2 %     14.1  
Mainly including: Commission income
    317               281               12.8  
 Ground service income
    250               241               3.7  
 Expired sales in advance of carriage
    276               273               1.1  
                                         
Total operating revenue
    55,288       100.0 %     54,401       100.0 %     1.6  
Less: fuel surcharge income
    (8,197 )             (5,359 )             53.0  
                                         
Total operating revenue excluding fuel surcharge
    47,091               49,042               (4.0 )

Traffic revenue composition

   
2008
   
2007
       
   
Traffic
revenue
   
Percentage
   
Traffic
revenue
   
Percentage
   
Change in traffic
revenue
 
   
RMB million
   
%
   
RMB million
   
%
   
%
 
Passenger Revenue
    50,412       93.5 %     49,499       93.1 %     1.8  
Cargo and Mail Revenue
    3,501       6.5 %     3,697       6.9 %     (5.3 )
                                         
Traffic revenue
    53,913       100.0 %     53,196       100.0 %     1.3  

Passenger revenue composition

   
2008
   
2007
       
   
Passenger
revenue
   
Percentage
   
Passenger
revenue
   
Percentage
   
Change in passenger
revenue
 
   
RMB million
   
%
   
RMB million
   
%
   
%
 
Domestic
    41,854       83.0 %     40,717       82.3 %     2.8  
Hong Kong, Macao and Taiwan
    952       1.9 %     1,074       2.1 %     (11.4 )
International
    7,606       15.1 %     7,708       15.6 %     (1.3 )
                                         
Passenger revenue
    50,412       100.0 %     49,499       100.0 %     1.8  

Substantially all of the Group’s operating revenue is attributable to its air transport and related operations. Traffic revenue accounted for 97.5% and 97.8% of the total operating revenue in 2008 and 2007 respectively. Passenger revenue and, cargo and mail revenue accounted for 93.5% and 6.5% respectively of the total traffic revenue in 2008. 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 income from expired sales in advance of carriage.

The increase in operating revenue was primarily due to a 1.8% rise in passenger revenue from RMB49,499 million in 2007 to RMB50,412 million in 2008 resulting from increase in fuel surcharge income. The total number of passengers carried increased by 2.3% to 58.24 million passengers in 2008. RPKs increased by 1.8% from 81,727 million in 2007 to 83,184 million in 2008, primarily as a result of the increase in number of passengers carried. Passenger yield per RPK was RMB0.61, which was unchanged from 2007.

 The Group recorded an amount of fuel surcharge income in respect of passenger operation of RMB7,497 million (2007: RMB4,910 million). Excluding fuel surcharges, the passenger revenue of the Group decreased by 3.8%, from RMB44,589 million in 2007 to RMB42,915 million in 2008, and the passenger yield per RPK (excluding fuel surcharges) decreased from RMB0.55 in 2007 to RMB0.52 in 2008.
 
 
39

 

Domestic passenger revenue accounted for 83.0% of the total passenger revenue in 2008. Domestic passenger revenue increased by 2.8% from RMB40,717 million in 2007 to RMB41,854 million in 2008 (2007: increased by 19.6% from RMB34,037 million in 2006 to RMB40,717 million in 2007). The decrease in growth in domestic passenger revenue was mainly attributable to various unfavorable factors, including large-scale natural disasters occurred in China, such as the southern China snow storms in January 2008, the May 12 earthquake in Sichuan province, and the strict security measures and visa control for foreigners for the Beijing Olympic Games. Domestic passenger traffic in RPKs increased by 3.3%, mainly due to an increase in number of passengers carried. Domestic passenger yield per RPK decreased from RMB0.60 in 2007 to RMB0.59 in 2008.

Regional passenger revenue, which accounted for 1.9% of total passenger revenue, decreased by 11.4% from RMB1,074 million in 2007 to RMB952 million in 2008, as a result of strong competition from Cathay Pacific Airways and Dragonair for routes connecting Hong Kong and domestic cities of the PRC. For regional flights, passenger traffic in RPKs decreased by 3.5%, while passenger capacity in ASKs decreased by 4.8%, resulting in an increase in passenger load factor by 0.9 percentage point from 62.7% in 2007 to 63.6% in 2008. Passenger yield per RPK decreased from RMB0.91 in 2007 to RMB0.84 in 2008, mainly resulted from stronger competition in the region during the year.

International passenger revenue, which accounted for 15.1% of total passenger revenue, decreased by 1.3% from RMB7,708 million in 2007 to RMB7,606 million in 2008, as a result of the decreased market demand due to the visa restriction for foreigners during the Beijing Olympic Games period and the global financial crisis. For international flights, passenger traffic in RPKs decreased by 6.2%, while passenger capacity in ASKs decreased by 4.4%, resulting in a 1.3 percentage point decrease in passenger load factor from 2007. Passenger yield increased by 6.3% from RMB0.63 in 2007 to RMB0.67 in 2008, mainly due to the increase in fuel surcharge income.

Cargo and mail revenue, which accounted for 6.5% of the Group’s total traffic revenue and 6.3% of total operating revenue, decreased by 5.3% from RMB3,697 million in 2007 to RMB3,501 million in 2008. The decrease was attributable to reduced cargo traffic demand under global financial crisis.

Other operating revenue increased by 14.1% from RMB1,205 million in 2007 to RMB1,375 million in 2008. The increase was primarily due to the general growth in income from various auxiliary operations.

Operating expenses

   
2008
   
2007
   
Change in
operating expenses
 
   
RMB million
   
Percentage
   
RMB million
   
Percentage
   
%
 
Flight operations
    34,982       56.6 %     29,082       54.9 %     20.3  
Mainly including: Jet fuel costs
    23,086               18,316               26.0  
 Operating lease charges
    4,527               4,055               11.6  
 Flight personnel payroll and welfare
    2,490               2,226               11.9  
Maintenance
    4,890       7.9 %     4,643       8.8 %     5.3  
Aircraft and traffic servicing
    8,476       13.7 %     8,160       15.4 %     3.9  
Promotion and sales
    3,491       5.7 %     3,421       6.5 %     2.0  
General and administrative
    2,041       3.3 %     1,874       3.5 %     8.9  
Impairment on property, plant and equipment
    1,884       3.1 %     109       0.2 %  
>100
 
Depreciation and amortisation
    5,746       9.3 %     5,554       10.5 %     3.5  
Others
    257       0.4 %     113       0.2 %  
>100
 
                                         
Total operating expenses
    61,767       100.0 %     52,956       100.0 %     16.6  

Total operating expenses in 2008 amounted to RMB61,767 million, representing an increase of 16.6% or RMB8,811 million over 2007, primarily due to the total effect of increases in jet fuel costs, operating lease charges of aircraft, servicing expenses, maintenance expenses and impairment losses on property, plant and equipment. Total operating expenses as a percentage of total operating revenue increased from 97.3% in 2007 to 111.7% in 2008.

Flight operations expenses, which accounted for 56.6% of total operating expenses, increased by 20.3% from RMB29,082 million in 2007 to RMB34,982 million in 2008, primarily as a result of increases in jet fuel costs and operating lease charges of aircraft. Jet fuel costs, which accounted for 66.0% of flight operations expenses, increased by 26.0% from RMB18,316 million in 2007 to RMB23,086 million in 2008 mainly as a result of increased fuel prices. Operating lease charges of aircraft increased by 11.5% from RMB3,735 million in 2007 to RMB4,166 million in 2008 primarily due to the additional rental payments for new aircraft under operating leases.
 
 
40

 

Maintenance expenses, which accounted for 7.9% of total operating expenses, increased by 5.3% from RMB4,643 million in 2007 to RMB4,890 million in 2008. The increase was mainly due to fleet expansion in recent years.

Aircraft and traffic servicing expenses, which accounted for 13.7% of total operating expenses, increased by 3.9% from RMB8,160 million in 2007 to RMB8,476 million in 2008. The increase primarily resulted from a 1.7% rise in landing and navigation fees from RMB6,030 million in 2007 to RMB6,135 million in 2008, due to an increase in number of flights.
 
Promotional and sales expenses, which accounted for 5.7% of total operating expenses, increased by 2.0% from RMB3,421 million in 2007 to RMB3,491 million in 2008.

General and administrative expenses, which accounted for 3.3% of the total operating expenses, increased by 8.9% from RMB1,874 million in 2007 to RMB2,041 million in 2008.

Impairment on property, plant and equipment, which accounted for 3.1% of the total operating expenses, increased by RMB1,775 million from RMB109 million in 2007 to RMB1,884 million in 2008. The impairment losses recognised in 2008 mainly comprise the following:

-
During the year, in view of the age and operating efficiency of the Group’s fleet of Boeing 777-200A aircraft, Airbus 300 aircraft and McDonnell Douglas 90 aircraft, the Group determined to dispose of these aircraft. The Group has commenced its process of seeking buyers for these aircraft. As a result, the Group assessed the recoverable amounts of these aircraft. Based on this assessment, the carrying amount of the aircraft and the related fleet assets was written down by RMB1,590 million. The estimates of recoverable amounts were based on the aircraft’s fair value less costs to sell, determined by reference to the recent observable market prices for the respective model of aircraft.

-
There has been a decrease in demand of cargo transportation services as a result of the current economic conditions. In addition, the operating efficiency of the Group’s cargo freighters Boeing 747 is not satisfactory due to lack of economy of scale for the existing small fleet of cargo freighters. As such, the Group assessed the recoverable amounts of its cargo freighters and the related fleet assets. Based on this assessment, the carrying amount of the cargo freighters was written down by RMB291 million. The estimates of recoverable amounts were based on the aircraft’s fair value less costs to sell, determined by reference to the recent observable market prices for the cargo freighters.

Depreciation and amortisation, which accounted for 9.3% of total operating expenses, increased by 3.5% from RMB5,554 million in 2007 to RMB5,746 million in 2008, mainly resulting from the additional depreciation charge on aircraft delivered in 2007 and 2008.

Operating (loss)/profit

Operating loss of RMB5,646 million was recorded in 2008 as compared to an operating profit RMB1,881 million in 2007. This was mainly because operating revenue increased by RMB887 million or 1.6% in 2008 while operating expenses increased by RMB8,811 million or 16.6% in the same period.

Other income/(expenses)

Interest expense decreased by 13.3% from RMB2,291 million in 2007 to RMB1,987 million in 2008, mainly due to the decrease in average effective interest rate of bank and other loans and obligations under capital leases. Interest income increased by 41.1% from RMB73 million in 2007 to RMB103 million in 2008, mainly attributable to the increase in average bank deposits balances during 2008.

Net exchange gain decreased by 8.5% from RMB2,832 million in 2007 to RMB2,592 million in 2008. Such amount mainly represented an unrealised translation gain on retranslation of foreign currency denominated liabilities at the year end.

Taxation

Income tax expenses decreased by 92.7% from RMB847 million in 2007 to RMB62 million in 2008. This was mainly attributable to the net effect of the operating loss of the Group and the effect of certain deferred tax assets not recognised.

Liquidity and Capital Resources

Generally, 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 addition, the Company received approximately RMB3 billion proceeds from its non-public offerings of 721,150,000 A shares to CSAHC and 721,150,000 H shares to Nan Lung in August 2009.
 
 
41

 

As of December 31, 2009, the Group had banking facilities with several PRC commercial banks for providing loan finance up to an approximate amount of RMB128,175 million to the Group. As of December 31, 2009, an approximate amount of RMB50,455 million was utilized. As of December 31, 2009 and 2008, the Group’s cash and cash equivalents totaled RMB4,343 million and RMB4,649 million, respectively.

Net cash inflows from operating activities in 2009, 2008 and 2007 were RMB8,959 million, RMB1,155 million and RMB6,869 million, respectively. Operating cash inflows of the Group are primarily derived from the provision of air transportation and related service for customers. The vast majority of tickets are purchased prior to the day on which transportation is provided. Operating cash outflows primarily are related to the recurring operating expenses, including flight operation, maintenance, aircraft and traffic servicing, etc.

Net cash used in investing activities in 2009, 2008 and 2007 was RMB14,478 million, RMB7,790 million and RMB4,844 million, respectively. Cash capital expenditures in 2009, 2008 and 2007 were RMB15,007 million, RMB8,364 million and RMB5,502 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 used in operations.

Financing activities resulted in net cash inflows/(outflows) of RMB5,213 million, RMB7,460 million and RMB(465) million in 2009, 2008 and 2007, respectively. Net cash inflow from new bank loans, short-term financing bills and repayments amounted to RMB3,750 million, RMB9,667 million and RMB2,324 million in 2009, 2008 and 2007, respectively. The additions of bank loan were used for capital expenditures and general working capital. Repayment of capital leases in 2009, 2008 and 2007 was RMB1,750 million, RMB2,335 million and RMB3,021 million, respectively, resulting from the aircraft acquisitions under capital leases.

As of December 31, 2009, the Group’s aggregate long-term bank and other loans and obligations under capital leases (including loans and capital leases obligations due within one year) totaled RMB47,633 million. In 2010, 2011, 2012, 2013 and thereafter, amounts payable under such loans and obligations will be RMB7,871 million, RMB9,718 million, RMB10,859 million, RMB3,046 and RMB16,139 million respectively. Such borrowings were denominated in United States dollars with a significant portion being floating 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 primarily results from its foreign currency liabilities. 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 SAFE, or subject to certain restrictive conditions, entering into forward foreign exchange contracts with authorized banks.

As of December 31, 2009, the Group’s short-term bank loans were RMB11,012 million. The Group’s weighted average interest rate on short-term bank loans was 1.18% per annum as of December 31, 2009. The primary use of the proceeds of the Group’s short-term bank loans is to finance working capital and capital expenditure 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.

As of December 31, 2009, the Group had obligations under operating leases totaling RMB30,366 million, predominately for aircraft. Of such amount, RMB4,028 million, RMB4,103 million, RMB4,122 million, RMB3,596 million, RMB3,286 million, and RMB11,231 million respectively, is due in 2010, 2011, 2012, 2013, 2014 and thereafter.

As of December 31, 2009, the Group had a working capital deficit of RMB28,441 million, as compared to a working capital deficit of RMB32,290 million as of December 31, 2008. Historically, the Group operated in a negative working capital position, relying on cash inflow from operating activities and renewal of short-term bank loans to meet its short-term liquidity and working capital needs. The decrease in the Group’s working capital deficit from 2008 to 2009 was mainly because the Group sought increased long-term bank loans to finance its aircraft acquisitions. In 2010 and thereafter, the liquidity of the Group is primarily dependent on its ability to maintain adequate cash inflows from operations to meet its debt obligations as they fall due, and its ability to obtain adequate external financing to meet its committed future capital expenditure. At December 31, 2009, the Group entered into loan financing agreements with several PRC banks to provide financing up to RMB128,175 million, of which approximately RMB50,455 million was utilized. The directors of the Company believe that the liquidity status of the Group in 2010 will be further enhanced upon completion of the non-public share subscriptions as discussed in Business Overview under Item 4. The directors of the Company believe that sufficient financing will be available to the Group.

As the Group is subject to a high degree of operating leverage, a minor decrease in the Group’s yield and/or load factor could result in a significant decrease in its operating revenue and hence its operating cash flows. 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 in the domestic market, could result in a significant increase in the Group’s operating expenses and hence a significant decrease in its operating cash flows. This could be caused by fluctuations in supply and demand in international oil market. Currently, the Group’s existing loans 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 cash flows could adversely affect its financial health and hence weaken its ability to obtain additional loans and lease facilities and to renew its short-term bank loans facilities as they fall due.

As of December 31, 2009, the Group had capital commitments as follows:

 
42

 

   
2010
   
2011
   
2012
   
2013
   
2014
and
afterwards
   
Total
 
   
(RMB million)
 
Acquisition of aircraft and related equipment
    16,404       17,482       17,421       9,845       4,691       65,843  
Others
    1,068       601       192       -       -       1,861  
Total capital commitments
    17,472       18,083       17,613       9,845       4,691       67,704  

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

As of December 31, 2009, the cash and cash equivalents of the Group totaled RMB4,343 million. Of such balance, 22% was denominated in US Dollars, Hong Kong Dollars, Australian Dollars, Japanese Yen and other foreign currencies. 

In view of the unutilized bank facilities of RMB77,720 million, the anticipated non-public share subscription and cash generated from operations, the Group expects that it will have sufficient funding sources to meet its cash requirements in the foreseeable future.

Contractual Obligations and Commitments

The following table sets forth the Group’s obligations and commitments to make future payments under contracts and under commitments as of December 31, 2009.

         
As of December 31, 2009
Payment due by period
         
As of
December
31, 2008
 
   
Total
   
Less
than
1 year
   
1-3
years
   
3-5
years
   
After 5
years
   
Total
 
                                     
Short-term bank loans (note 1)
   
11,094
     
11,094
     
-
     
-
     
-
     
18,757
 
Long-term bank and other loans (note 1)
   
36,014
     
7,047
     
18,248
     
2,853
     
7,866
     
23,300
 
Short-term financing bills
   
-
     
-
     
-
     
-
     
-
     
2,094
 
Bills payable
   
3,207
     
3,207
     
-
     
-
     
-
     
148
 
Obligations under capital leases
   
15,812
     
1,972
     
3,812
     
3,432
     
6,596
     
16,036
 
Operating lease commitments
   
30,366
     
4,028
     
8,225
     
6,882
     
11,231
     
34,330
 
Aircraft purchase commitments (Note 2)
   
65,843
     
16,404
     
34,903
     
12,491
     
2,045
     
75,639
 
Other capital commitments
   
1,861
     
1,068
     
793
     
-
     
-
     
884
 
Investing commitments
   
-
     
-
     
-
     
-
     
-
     
-
 
Total
   
164,197
     
44,820
     
65,981
     
25,658
     
27,738
     
171,188
 

Note 1 Interest on variable rate loans was estimated based on the current rate in effect at December 31, 2009.

Note 2 Amounts shown are net of previously paid purchase deposits.

ITEM 6. DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES.

Directors, Senior Management and Employees

The following table sets forth certain information concerning directors, senior management and supervisors of the Company in 2009. There were certain changes in the Company’s directors, senior management and supervisors subsequent to December 31, 2009, details of which are set forth below.
 
 
43

 
 
Name
 
Position
 
Gender
 
Age
Si Xian Min (1)
 
Chairman of the Board
 
Male
 
53
Li Wen Xin
 
Director
 
Male
 
60
Wang Quan Hua
 
Director
 
Male
 
56
Liu Bao Heng
 
Director
 
Male
 
60
Tan Wan Geng (2)
 
Director, President
 
Male
 
46
Zhang Zi Fang (3)
 
Director and Executive Vice President
 
Male
 
52
Xu Jie Bo
 
Director, Executive Vice President and Chief Financial Officer
 
Male
 
45
Chen Zhen You
 
Director
 
Male
 
58
Wang Zhi
 
Independent Non-executive Director
 
Male
 
68
Sui Guang Jun
 
Independent Non-executive Director
 
Male
 
49
Gong Hua Zhang
 
Independent Non-executive Director
 
Male
 
64
Lam Kwong Yu
 
Independent Non-executive Director
 
Male
 
66
Sun Xiao Yi
 
Chairman of the Supervisory Committee
 
Male
 
56
Yang Guang Hua (4)
 
Former Supervisor
 
Male
 
57
Li Jia Shi (5)
 
Supervisor
 
Male
 
49
Zhang Wei
 
Supervisor
 
Female
 
44
Yang Yi Hua
 
Supervisor
 
Female
 
50
Liang Zhong Gao
 
Supervisor
 
Male
 
54
Ren Ji Dong (6)
 
Executive Vice President
 
Male
 
45
He Zong Kai
 
Executive Vice President
 
Male
 
59
Liu Qian
 
Executive Vice President
 
Male
 
46
Dong Su Guang
 
Executive Vice President
 
Male
 
56
Chen Gang (7)
 
Executive Vice President
 
Male
 
44
Zhang Zheng Rong
 
Chief pilot
 
Male
 
48
Hu Chen Jie
 
Chief Information Officer
 
Male
 
41
Tang Bing (8)
 
Former Chief Engineer
 
Male
 
43
Su Liang
 
Chief Economist
 
Male
 
48
Zhang He Ping (8)
 
Current Chief Engineer
 
Male
 
57
Chen Wei Hua
 
Chief Legal Adviser
 
Male
 
44
Xie Bing
 
Company Secretary
 
Male
 
37
 
(1) On 12 January 2009, Mr Si Xian Min was appointed at the extraordinary board meeting as the Chairman of the Fifth Session of the Board and his resignation as the President of the Company was also approved at the meeting.

(2) On 13 January 2009, Mr Tan Wan Geng was appointed at the extraordinary board meeting as the President of the Company.

(3) On 30 June 2009, Mr Zhang Zi Fang was appointed at the 2008 annual general meeting as a director of the Fifth Session of the Board.

(4) On 30 June 2009, the resignation of Mr Yang Guang Hua as a supervisor of the Fifth Session of the Supervisory Committee was approved at the 2008 annual general meeting.

(5) On 30 June 2009, Mr Li Jia Shi was appointed at the 2008 annual general meeting as a supervisor of the Fifth Session of the Supervisory Committee.

(6) On May 7, 2009, the Board of the Company approved the appointment of Mr. Ren Ji Dong as an Executive Vice President of the Company.

(7) On August 26, 2009, the Board of the Company approved the appointment of Mr. Chen Gang as an Executive Vice President of the Company.

(8) On June 2, 2009, the Board of the Company approved the cessation of Mr. Tang Bing as the Chief Engineer of the Company, and the appointment of Mr. Zhang He Ping as the Chief Engineer of the Company.

Save as disclosed above, since January 1, 2010 through the date of this Annual Report, there has been no change to the Directors, Senior Management or Supervisors.

BOARD OF DIRECTORS

Mr. Si Xian Min is the Chairman of the Board. Mr. Si graduated with a master degree of Business Administration from School of Economics and Management of Tsinghua University, EMBA Major. Mr. Si is also an expert of political science. 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 and the Secretary of the Disciplinary Committee of the Company and Party Secretary of China Northern Airlines and has been the President of the Company from October 2004 to January 2009. He has been the General Manager and Deputy Party Secretary of CSAHC and the Chairman of the Board of the Company since January 2009.
 
 
44

 

Mr. Li Wen Xin is a Director of the Company. Mr. Li was a graduate majoring in economic management. He is a senior expert of political science. Mr. Li joined the civil aviation industry in 1969. He was the Secretary to the Disciplinary Committee, Deputy Party Secretary and Vice General Manager of China General Aviation Corporation successively between 1991 and 1998. He was appointed as the Party Secretary and Vice General Manager of China Eastern Airlines Company Limited Shanxi branch in February 1998. He became the Deputy Party Secretary and Secretary to the Disciplinary Committee of China Eastern Air Holding Company in June 2000. From September 2002 to September 2006, he was appointed as the Party Secretary and Vice President of China Eastern Air Holding Company. Between June 2000 and September 2006, he was the Chairman of the Supervisory Committee of China Eastern Airlines Company Limited. He has been the Party Secretary and Executive Vice President of CSAHC since September 2006.

Mr. Wang Quan Hua is a Director of the Company. Mr. Wang graduated from the Economic Management Department of the Party School of the Central Committee of CPC, and is an economist. 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 Company., the Director of the Planning and Operation Division of the Company, General Manager of Strategy and Development Department of the Company, Assistant President and the Director of Planning Department of CSAHC. Since September 2009, Mr. Wang has been the Executive Vice President of CSAHC. Mr. Wang currently is also the chairman of SACM and the director of Nan Lung.
 
Mr. Liu Bao Heng is a Director of the Company. He graduated from the Central University of Finance and Economics majoring in accounting and is an auditor. Mr. Liu began his career in 1968. He held the post of deputy director and director of the No. 3 Division of Department of Public Finance Audit of National Audit Office of the People’s Republic of China (CNAO). He was the assistant and deputy commissioner to CNAO’s Xian Office. He became the deputy chief, the department chief and director of the General Office of CNAO. He has been the Chief Accountant of CSAHC since February 2006.

Mr. Tan Wan Geng is a Director and president of the Company. Mr. Tan is an engineer graduated from Economic Geography Department in Sun Yatsen University, with major in regional economy, with qualification of post graduate degree, and a master degree in economics. Mr. Tan has previously served as the Head of the Infrastructure Department and Director of Human Resources Department of the Beijing Aircraft Maintenance and Engineering Corporation from 1990 to 1996, the Deputy Director of Human Resources Division (Personnel and Education Division) of CAAC from 1996 to 2000, and has been the Director General and Party Secretary of CAAC Northeastern Branch from December 2000 to January 2006. He has been Party Secretary of Chinese Communist Party Committee and Executive Vice President of the Company from February 2006 to January 2009, and the President of the Company since January 2009.

Mr. Zhang Zi Fang is a Director, the Party Secretary and an Executive Vice President of the Company. Mr. Zhang graduated with a master degree of Business Administration from School of Economics and Management of Tsinghua University, EMBA Major. Mr. Zhang is a senior expert of political science. Mr. Zhang served as the Deputy Commissar and subsequently the Commissar of the Pilot Corps of China Northern Airlines Company, and later on the Party Secretary of the Jilin Branch. He served as General Manager of Dalian Branch of CSAHC Northern Airlines and Director of Political Department of CSAHC. He also served as the Deputy Party Secretary and Secretary of the Disciplinary Committee of the Company. He has been an Executive Vice President of the Company since December 2007 and has been the Party Secretary of the Company since February 2009. Mr. Zhang is also the Vice President of SACM.

Mr. Xu Jie Bo is a Director, Executive Vice President and Chief Financial Officer of the Company. He graduated from the management department of Tianjin University majoring in infrastructure management, and was subsequently awarded with a master degree in business administration from Hong Kong Baptist University and a master degree of Business Administration from School of Economics and Management of Tsinghua University, EMBA Major. He is also a qualified senior accountant. Mr. Xu started his career in 1986. He had ever taken up the posts of Deputy Director and Director of the Financial Department of Central and Southern China Civil Aviation Administration. He became General Manager of the Financial Department of the Company since July 1998 and Chief Financial Officer of the Company since 2001. He has been Executive Vice President and chief accountant of the Company since August 2003. Mr. Xu is also the Chairman of Guizhou Airlines, the Vice Chairman of Xiamen Airlines, and the Vice Chairman of Sichuan Airlines Corporation Limited (“Sichuan Airlines”), an associate of the Group.

Mr. Chen Zhen You is a Director and Chairman of the Labour Union of the Company. He graduated from Hua Zhong Normal University majoring in English. Mr. Chen, an economist, holds an MBA from Murdoch University in Australia. He worked as the Vice Director of the Office of International Affairs of Guangzhou Civil Aviation Administration, Vice Director of the Office of Overseas Business of the Company and General Manager of the Department of Foreign Affairs. He was the Office Director of CSAHC and the Director of the Planning and Investment Department of CSAHC. He has been the Chairman of the Labour Union of the Company since February 2005. Mr. Chen is also the Chairman of Zhuhai Airlines.

Mr. Wang Zhi has 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 of the First Research Institute of Civil Aviation, the Vice Director and Director of the Planning Bureau 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. Sui Guang Jun has been an independent nonexecutive Director of the Company since May 2003. Mr. Sui graduated from the Economic Department of Jinan University and obtained a doctor degree in the Management of Organizations of Jinan University in 1996. He has successively served as the Vice Director of the Research Institute of Hong Kong and Macao Economies, the Dean of corporate administration department of Jinan University and the Chief of the Post-doc Committee of Applied Economics and the Dean of Management College in Jinan University. Mr. Sui is currently the Chancellor of Guangdong University of Foreign Studies.
 
 
45

 

Mr. Gong Hua Zhang has been an independent Non-Executive Director of the Company since June 2007, used to be the Chief Accountant, vice director and director of the financial bureau of China National Petroleum Corporation, the Chief Accountant of China National Petroleum Corporation and a Director of PetroChina Company Limited. Mr. Gong also acts as a part-time professor in Tsinghua University, Nankai University, Xiamen University and China University of Petroleum, and is a professor in National Accounting Institute (Beijing).

Mr. Lam Kwong Yu has been an independent nonexecutive Director of the Company since June 2007, is an expert in the field of civil aviation. Mr. Lam used to serve as the General Manager of the Hong Kong Airport, the Vice Director and Director of the Civil Aviation Department of Hong Kong, a Director of the Airport Authority Hong Kong and the Chairman of the Aviation Advisory Board of Hong Kong. Mr. Lam is currently a member of the Selection Committee for the Hong Kong Special Administrative Region.

SUPERVISORY COMMITTEE

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

Mr. Sun Xiao Yi, the chairman of the Supervisory Committee of the Company, is head of Discipline Supervision Team of CSAHC. Mr. Sun graduated from the Civil Aviation University of China with a degree in Economics and Administration and is a postgraduate law student of the Party School of the Central Committee of CPC. Mr. Sun is a senior expert of political science and Economics. 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 CSAHC. He has been head of Discipline Supervision Team of CSAHC since September 2002.

Mr. Li Jia Shi, a Supervisor of the Company. He graduated from the Guangdong Institute For Nationalities majoring in economic mathematics and an expert of political science. He started to work since August 1976. He served as the Head of the Organization Division of the Party Committee and the Deputy Secretary of the Disciplinary Committee of the Company from December 2003 to December 2007. He has served as the Secretary of the Disciplinary Committee of the Company since December 2007. Mr. Li currently is also the Chairman of Southern Airlines Ka Yuen (Guangzhou) Aviation Supply Company Limited and Guangzhou Nanland Air Catering Company Limited.

Ms. Zhang Wei, a Supervisor of the Company. She is the Director of the Audit Division of CSAHC. She graduated from Tianjin University majoring in investment skills & economics. She holds a master of science in chemical engineering. Ms. Zhang is a senior accountant. She servedas Vice General Manager of the Finance Department of the Company, and the General Manager of Southern Airlines Group Finance Company Limited, the Vice Director of the Supervisory Bureau and the Director of the Audit Division of CSAHC. She has been the Director of the Audit Division of CSAHC since October 2008. Ms. Zhang currently is also the Chairman of the Supervisory Committee of SA Finance and SACM.

Ms. Yang Yi Hua, a Supervisor of the Company. Ms. Yang is the General Manager of the Audit Department of the Company and a Certified 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. Ms. Yang currently is also the Chairman of the Supervisory Committee of Xiamen Airlines, Guizhou Airlines, Guangzhou Baiyun International Logistic Company Limited (“Baiyun Logistic”) and Nan Lung International Freight Limited and a supervisor of Chongqing Airlines, Beijing Ground Service and SA Finance.

Mr. Liang Zhong Gao, a Supervisor and the Director of the Disciplinary Supervision Department of the Company. He is an expert of political science with university qualification. Mr. Liang once served as the Party Secretary and Deputy General Manager of the Guangzhou Sales Office of the Company, Deputy Party Secretary and Secretary of the Disciplinary Committee of the Passenger Traffic Department of the Company, Party Secretary of the Passenger Traffic Department of the Company and General Manager of the Aviation Service Quality Control Department of the Company.

SENIOR MANAGEMENT

Mr. Ren Ji Dong is the Executive Vice President of the Company. He graduated from the School of Economics and Management of Tsinghua University with a master degree in Business Administration (EMBA), and he is a senior engineer. He served as the Deputy Director of Urumqi Civil Aviation Administration, the Vice President of Xinjiang Airlines, the Party Secretary and the Vice President of the Xinjiang Branch of the Company, the Executive Vice President of the Company from February 2005 to January 2007, and the President of the Xinjiang Branch of the Company from January 2007 to April 2009. He has served as the Executive Vice President of the Company since May 2009.
 
 
46

 

Mr. He Zong Kai is the Executive Vice President of the Company. Mr. He graduated from Beijing Foreign Language Institute majoring in French, and he 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. Mr. He has been an Executive Vice President of the Company since March 2005. Currently, Mr. He is also the Chairman of Chongqing Airlines.

Mr. Liu Qian is currently the Executive Vice President of the Company. Mr. Liu graduated from China Civil Aviation Flying College with majoring inaircraft piloting. Mr. Liu served the CAAC as an assistant researcher of the piloting skills supervision division of the piloting standards department, an assistant researcher of the operation supervision division, an assistant researcher of the piloting standards department, the Deputy Head of the Piloting Standards Division of the Piloting Standards Department, and the Deputy Chief Pilot and Chief Pilot of the Company. He has been an Executive Vice President of the Company since August 2007. Mr. Liu served as the Chairman of Zhuhai Xiang Yi Aviation Technology Company Limited, a jointly-controlled entity of the Company.

Mr. Dong Su Guang is the Executive Vice president of the Company. He graduated from Northwestern Polytechnical University majoring in aircraft design, and he is an engineer. He is an Executive Vice President of the Company. Mr. Dong used to be a Deputy General Manager of Guangzhou Aircraft Maintaining and Engineering Co., Ltd., as well as Chief Engineer and the General Manager of Aircraft Engineering Department of the Company. He has been an Executive Vice President of the Company since December 2007. Mr. Dong is also the Chairman of Shantou Airlines and Guangzhou Aircraft Maintenance and Engineering Co., Ltd. (“GAMECO”, a jointly-controlled entity of the Company).

Mr. Chen Gang, the Executive Vice President of the Company. He graduated from Zhongnan Finance and Economics University majoring in Industrial Enterprise Management and the School of Economics and Management of Tsinghua University with a master degree in Advanced Business Administration (EMBA). He began his career in 1987. He served as the Vice Director of the Enterprise Management Department, the Manager of the Planning Enterprise Management Department, the Manager of Operation Department of Henan Branch of the Company, the Vice General Manager of Henan Branch of the Company, the General Manager of Hubei Branch of the Company, and the Director and Vice Party Secretary of the Marketing Management Committee of the Company from November 2005 to August 2009. He served as the Vice General Manager of the Company since August 2009. Currently, Mr. Chen is also the Chairman of CSN – ETC E-commerce Limited and Baiyun Logistics.

Mr. Zhang Zheng Rong is the Chief Pilot of the Company. He graduated from China Civil Aviation Flying College majoring in aircraft piloting and the School of Economics and Management of Tsinghua University with a master degree in Advanced Business Administration (EMBA). Mr. Zhang used to serve as the Captain of the First Squadron of CAAC, the Deputy General Manager of the Flight Operations Division and the Captain of the First Squadron as well as the General Manager of the Aviation Safety Monitoring Division of the Company. He has been the General Manager and Deputy Party Secretary of the Guangzhou Flight Operations Division of the Company. He has been the Chief Pilot of the Company since August 2007.

Mr. Hu Chen Jie is the Chief Information Officer of the Company and graduated from Beijing University Aeronautics and Astronautics majoring in information management. Mr. Hu used to be a software engineer in the Computer Center of CAAC, a senior software engineer in Wei Hong International Technology Company (Singapore), Deputy Director of the Computer Center of the Company, a senior project manager of SITA INC. (US) and the General Manager of CSN-ETC e-Commerce Limited. He has been the Chief Information Officer of the Company since June 2007.

Mr. Su Liang is the Chief Economist of the Company, and graduated from the University of Cranfield, United Kingdom with a master degree in Air Transport Management Engineering. Mr. Su was in charge of the flight operations, planning and international cargo project of the Company. From July 2000 to November 2007, Mr. Su was the Company Secretary of the Company. He has been the Chief Economist of the Company since December 2007. Mr. Su was the Chairman of China Southern West Australian Flying College Pty Ltd (a subsidiary of the Company) and the Director of Sichuan Airlines (an associate of the Company).

Mr. Zhang He Ping is the Chief Engineer of the Company. Mr. Zhang is an engineer with university qualification. From January 2003 to May 2009, he served as the General Manager and Vice Party Secretary of the Hunan Branch of the Company. He has served as the Chief Engineer and the General Manager of the Aircraft Engineering Department of the Company since June 2009. Mr. Zhang was also the Director of GAMECO (a joint controlled entity of the Company) and the Chairman of Shenyang Northern Aircraft Maintenance Co., Ltd.

Mr. Chen Wei Hua is the Chief Legal Adviser. Mr. Chen graduated from the school of law of Peking University and the School of Economics and Management of Tsinghua University with a master degree in Advanced Business Administration (EMBA). He is a qualified solicitor in the PRC and a qualified corporate legal counsellor. Mr. Chen joined the Civil Aviation Administration of China in 1988. 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 the General Manager of the Legal Department of the Company. Mr. Chen has been the Chief Legal Adviser to the Company since January 2004. Currently, Mr. Chen is also a director of Xiamen Airlines.

Mr. Xie Bing, the Company Secretary of the Company. He graduated from Nanjing University of Aeronautics and Astronautics, majoring in civil aviation management. He subsequently received a master degree of business administration and a master degree of international finance from Jinan University and the University of Birmingham, Britain respectively. Mr. Xie used to work in the Planning and Development Department, Company Secretary Office of the Board of Director of the Company and Office of CSAHC. He has been the Secretary of the Board of Directors and the Company Secretary of the Company since November 2007.

 
47

 
   
Save as disclosed above, none of the above Director or Supervisor or senior management of the Company has any relationship with any Directors, Supervisors, senior management, substantial shareholders of the Company.

Compensation

The aggregate compensation paid to all Directors, Supervisors and Senior Management for 2009 was RMB14,913,000. For the year ended December 31, 2009, the Company paid an aggregate of approximately RMB922,000 on behalf of its executive Directors, Supervisors and 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, 2009 are set out below:

   
Directors’
fees
RMB’000
   
Salaries,
allowances
and benefits
in kind
RMB’000
   
Discretionary
bonus
RMB’000
   
Retirement
scheme
contributions
RMB’000
   
Total
RMB’000
 
Executive directors
                             
                               
Si Xian Min
   
-
     
698
     
-
     
40
     
738
 
                                         
Li Wen Xin
   
-
     
608
     
-
     
40
     
648
 
                                         
Wang Quan Hua
   
-
     
550
     
-
     
40
     
590
 
                                         
Liu Bao Heng
   
-
     
550
     
-
     
40
     
590
 
                                         
Tan Wan Geng
   
-
     
672
     
-
     
38
     
710
 
                                         
Xu Jie Bo
   
-
     
572
     
-
     
38
     
610
 
                                         
Chen Zhen You
   
-
     
572
     
-
     
38
     
610
 
                                         
Zhang Zi Fang
   
-
     
590
     
-
     
38
     
628
 
                                         
Supervisors
                                       
                                         
Sun Xiao Yi
   
-
     
550
     
-
     
40
     
590
 
                                         
Yang Guang Hua
   
-
     
407
             
17
     
424
 
                                         
Zhang Wei
   
-
     
345
     
-
     
40
     
385
 
                                         
Yang Yi Hua
   
-
     
266
     
-
     
38
     
304
 
                                         
Liang Zhong Gao
   
-
     
269
     
-
     
38
     
307
 
                                         
Li Jia Shi
   
-
     
118
     
-
     
19
     
137
 
                                         
Independent non-executive directors
                                       
                                         
Wang Zhi
   
50
     
-
     
-
     
-
     
50
 
                                         
Sui Guang Jun
   
100
     
-
     
-
     
-
     
100
 
                                         
Gong Hua Zhang
   
100
     
-
     
-
     
-
     
100
 
                                         
Lam Kwong Yu
   
88
     
-
     
-
     
-
     
88
 
                                         
Total
   
338
     
6,767
     
-
     
504
     
7,609
 
 
48

  
Board Practices

Each Director’s service contract with the Company or any of its subsidiaries provides 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 2010.  A Director may serve consecutive terms upon re-election.
 
Audit Committee

The audit committee is appointed by the Board of Directors and consists of three independent non-executive Directors. The current members of the audit committee are Gong Hua Zhang, Wang Zhi and Sui Guang Jun. Gong Hua Zhang is the chairman of the audit committee. The term of office of each member will end in 2010.  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 Audit Committee held ten meetings in 2009, which were attended by all members.

The Audit Committee is required, amongst other things, to oversee the relationship with the external auditors, to review the Group’s interim results and annual financial statements, to monitor compliance with statutory and listing requirements, to review the scope, if necessary, to engage independent legal or other advisers as it determines is necessary and to perform investigations. In addition, the Audit Committee also examines the effectiveness of the Company’s internal controls, which involves regular reviews of the internal controls of various corporate structures and business processes on a continuous basis, and takes into account their respective potential risks and severity, in order to ensure the effectiveness of the Company’s business operations and the realization of its corporate objectives and strategies. The scope of such examinations and reviews includes finance, operations, regulatory compliance and risk management. The Audit Committee also reviews the Company’s internal audit plan, and submits relevant reports and concrete recommendations to the Board on a regular basis.

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.

Remuneration and Assessment Committee

The Remuneration and Assessment Committee is comprised of three members. Currently, the Remuneration and Assessment Committee is chaired by independent non-executive Director Sui Guang Jun with independent non-executive Director Gong Hua Zhang and executive Director Wang Quan Hua as members. The term of office of each member is three years. The term of office of the current members will end in 2010. A member may serve consecutive terms upon re-election. The Remuneration and Assessment Committee held one meeting in 2009, which were attended by all members.

The responsibilities of the Remuneration and Assessment Committee are to make recommendations on the remuneration policy and structure for Directors and senior management of the Company, to establish regular and transparent procedures on remuneration policy development and improvement and submit the Company’s “Administrative Measures on Remuneration of Directors” and “Administrative Measures on Remuneration of Senior Management”. In particular, the Remuneration and Assessment Committee has the duty to ensure that the Directors or any of their associates shall not be involved in the determination of their own remuneration packages.

The Remuneration and Assessment Committee consulted, when appropriate, the Chairman and/or the President about its proposals relating to the remuneration of other executive Directors. The Remuneration and Assessment Committee is provided with sufficient resources to discharge its duties and professional advice is available if necessary. The Remuneration and Assessment Committee is also responsible for assessing performance of executive Directors and approving the terms of executive Directors’ service contracts. The Remuneration and Assessment Committee has performed all its responsibilities under its terms of reference in 2009.

Nomination Committee

The Nomination Committee was established on June 28, 2007. Before that, nomination of directors and other senior management was mainly undertaken by the Board. According to the Articles of Association, the Board has the authority to appoint from time to time any person as director to fill a vacancy or as additional director. In selecting candidate directors, the Board focuses on their qualifications, technical skills, experiences (in particular, the experience in the industry in which the Group operates in case of candidates of executive directors) and expected contributions to the Group.

As at December 31, 2009, the Nomination Committee consists of three members, including Si Xian Min as chairman and Wang Zhi (Independent non-executive director) and Gong Hua Zhang (Independent non-executive director) as members. The responsibilities of the Nomination Committee are to make recommendations to the Board in respect of the size and composition of the Board based on the operational activities, assets and shareholding structure of the Company; study the selection criteria and procedures of Directors and executives and give advice to the Board; identify qualified candidates for Directors and executives; investigate and propose candidates for Directors and managers and other senior management members to the Board.
 
49


In accordance with relevant laws and regulations as well as the provisions of the Articles of Association of the Company, the Nomination Committee shall study and resolve on the selection criteria, procedures and terms of office for directors and managers with reference to the Company’s actual situation. Any resolution made in this regard shall be filed and proposed to the Board for approval and shall be implemented accordingly. The Nomination Committee is provided with sufficient resources to discharge its duties and independently engages intermediate agencies to provide professional advice on its proposals if necessary.

The Nomination Committee held six meeting in 2009, which was attended by all members.

Employees

As of December 31, 2009, the Group had 50,412 employees, including 4,006 pilots, 7,521 flight attendants, 7,324 maintenance personnel, 6,257 sales and marketing personnel, 2,039 ground service personnel, 1,691 flight operation officers, 1,636 financial personnel and 9,860 administrative and 10,078 other personnel. All of the Group’s pilots, flight attendants, maintenance personnel, administrative personnel and sales and marketing personnel are contract employees.

The Company’s employees are members of a trade union organized under the auspices of the All-China 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.

Employee benefits

Employee benefits are all forms of considerations given and other related expenditures incurred in exchange for services rendered by employees. Except for termination benefits, employee benefits are recognized as a liability in the period in which the associated services are rendered by employees, with a corresponding increase in cost of relevant assets or expenses in the current period.

(a) Retirement benefits

Pursuant to the relevant laws and regulations of the PRC, the Group has joined a defined contribution basic retirement scheme for the employees arranged by local Labor and Social Security Bureaus. The Group makes contributions to the retirement scheme at the applicable rates ranging from 10% to 25% (2008: 9% to 24%) as required by the government organization. The contributions are charged to profit or loss on an accrual basis. When employees retire, the local Labor and Social Security Bureaus are responsible for the payment of the basic retirement benefits to the retired employees.

In addition, the Group has established a supplementary defined contribution retirement scheme for the benefit of employees in accordance with relevant regulations in the PRC.  Under such supplementary scheme, the Group is required to make contributions not exceeding one-twelfth of the prior year’s total salaries.

(b) Housing fund and other social insurances

Besides the retirement benefits, pursuant to the relevant laws and regulations of the PRC, the Group has joined defined social security contributions for employees, such as a housing fund, basic medical insurance, unemployment insurance, injury insurance and maternity insurance. The Group makes contributions to the housing fund and other social insurances mentioned above at the applicable rates based on the employees’ salaries. The contributions are recognized as cost of assets or charged to profit or loss on an accrual basis.

(c) Termination benefits

When the Group terminates the employment relationship with employees before the employment contracts have expired, or provides compensation as an offer to encourage employees to accept voluntary redundancy, a provision for the termination benefits provided, is recognized in profit or loss when both of the following conditions have been satisfied:

The Group has a formal plan for the termination of employment or has made an offer to employees for voluntary redundancy, which will be implemented shortly;
 
50

  
The Group is not allowed to withdraw from termination plan or redundancy offer unilaterally.

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 suffer 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

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.

ITEM 7. MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS.

Major Shareholders

Share Capital Structure

As of May 7, 2010 the total share capital of the Company was divided into 8,003,567,000 shares, of which approximately 50.24% (4,021,150,000 A Shares) was directly held by CSAHC, approximately 18.74% (1,500,000,000 A Shares) was held by other domestic shareholders, and approximately 31.02% (2,482,417,000 H Shares) was held by Hong Kong and overseas shareholders (among which, approximately 29.27% (726,500,000 H Shares) was indirectly held by CSAHC). CSAHC owns, directly and indirectly, 59.32% 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 May 7, 2010, the following shareholders had an interest of 5% or more in the Company’s shares:

Name
 
Number of Shares
 
Approximate
Percentage
of the Total
Number of
Shares
 
             
CSAHC
 
4,021,150,000 A Shares
(1)
 
50.24
%
             
HKSCC Nominees Limited
 
1,744,633,398 H Shares
(2)
 
21.80
%
             
Nan Lung
 
721,150,000 H Shares
   
9.01
%

The table below sets forth, as of May 7, 2010, the following entities hold 5% or more of the total number of H Shares issued by the Company.

Name
 
Number of H
Shares
   
Approximate
Percentage of
the Total
Number of H
Shares
 
                 
HKSCC Nominees Limited
   
1,744,633,398
(2)
   
70.27%
 
                 
Nan Lung
   
721,150,000
(2)
   
29.05%
 

A Shares and H Shares have identical voting rights.

(1)
CSAHC has right to acquire not more than 132,510,000 A Shares and through Nan Lung Holding Limited (a wholly-owned subsidiary of CSAHC), to acquire not more than 312,500,000 H Shares, pursuant to the A Shares subscription agreement dated March 8, 2010 entered into between the Company and CSAHC and the H Shares subscription agreement dated March 8, 2010 entered into between the Company and Nan Lung, respectively.  Both of the subscription agreements were approved by the shareholders of the Company.  The above placement and subscription agreements were approved in the Extraordinary General Meeting and the respective Class Meetings of shareholders of A and H shares on April 30, 2010 and are pending approval from the relevant security regulatory authorities.
 
51


(2) 
Among the 1,744,633,398 H Shares held by HKSCC Nominees Limited, CSAHC had an interest in an aggregate of 5,350,000 H Shares through Asia Travel Investment Company Limited, a wholly-owned subsidiary of CSAHC in Hong Kong (representing approximately 0.2% of the then total issued H Shares).

Related Party Transactions

The Company enters into transactions from time to time with CSAHC and its associates. For a description of such transactions, see Note 45 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 associates during the year ended December 31, 2009 and up to the latest practicable date. The Company believes that these arrangements have been entered into by the Company in the ordinary course of business and in accordance with the agreements governing such transactions.

Arrangements with CSAHC

Non-Public Subscriptions

On August 20, 2009 and August 21, 2009, the Company issued 721,150,000 A shares to CSAHC and 721,150,000 H shares to Nan Lung for net cash considerations of RMB2,259 million and RMB721 million, respectively.

On March 8, 2010, the board of the Company approved (i) the placement of not more than 1,766,780,000 new A shares to not more than 10 specific investors (subject to the maximum number as permitted by PRC laws and regulations at the time of the issuance) including CSAHC, at the same subscription price of not less than RMB5.66 per A share; and (ii) the placement of not more than 312,500,000 new H shares to Nan Lung, at the subscription price of not less than HKD2.73 per H share.

On the same date, the Company entered into the A shares subscription agreement with CSAHC, pursuant to which CSAHC conditionally agreed to subscribe and the Company conditionally agreed to allot and issue new A shares of not more than 132,510,000 at the subscription price of not less than RMB5.66 per A share.  In addition, the Company and Nan Lung entered into the H shares subscription agreement, pursuant to which Nan Lung conditionally agreed to subscribe and the Company conditionally agreed to allot and issue new H shares of not more than 312,500,000 at the subscription price of not less than HKD2.73 per H share. The above placement and subscription agreements were approved in the Extraordinary General Meeting and the respective Class Meetings of shareholders of A and H shares on April 30, 2010 and are pending approval from the relevant security regulatory authorities.

Trademark License Agreement

The Company and CSAHC entered into a ten year trademark license agreement dated May 22, 1997 pursuant to which CSAHC acknowledges that the Company has the right to use the name “China Southern” and “China Southern Airlines” in both Chinese and English, and grants the Company a renewable royalty free license to use the kapok logo on a worldwide basis in connection with the Company’s airline and airline-related businesses. As CSAHC did not give a written notice of termination three months before the expiration of the agreement, the agreement is automatically renewed for another ten year term. In May of 2007, the Trademark License Agreement has been renewed by the two parties for another ten-year term till 2017.

Leases

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

(1)
On December 19, 2006, the Company entered into a master lease agreement with CSAHC with a term valid from January 1, 2006 to December 31, 2008 (“Lease Agreement”). The Company renewed the Lease Agreement with CSAHC on December 29, 2008. Pursuant to the Lease Agreement, CSAHC agrees to continue to lease to the Company certain parcels of land, properties, and civil aviation structures and facilities at existing locations in Guangzhou, Haikou, Wuhan, Hengyang, Jingzhou (previously known as “Shashi”) and Nanyang as well as some additional locations in Beijing, Shanghai, Changsha, Shenyang, Dalian, Harbin and Changchun, etc.. The Lease Agreement is valid from January 1, 2009 to December 31, 2011 and the annual rents payable to CSAHC under the Lease Agreement for 2009, 2010 and 2011 are RMB37,148,660, RMB39,006,093 and RMB40,956,397.65 respectively.

 
For the year ended December 31, 2009, the rent incurred by the Group amounted to RMB37,148,660 pursuant to such Lease Agreement.

(2)
The Company and CSAHC 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.
 
52

 
(3)
Due to the expiration on December 31, 2007 of the Land Use Rights Lease Agreement between the Company and CSAHC, the Property Lease Agreement between the Company and CSAHC, and China Northern Airlines, as well as the Property Lease Agreement between the Company and CSAHC and Xinjiang Airlines on November 12, 2004, and in order to ensure normal operation of the Company, the Company, based on the actual leasing conditions of both parties, consolidate the three agreements into two agreements by the type of the leased properties, namely the Land Lease Agreement and the Property Lease Agreement. Those two agreements were entered into between the Company and CSAHC on January 10, 2008 and effective for a period from January 1, 2008 to December 31, 2010. As provided for in the Land Lease Agreement and the Property Lease Agreement, the lease areas of the related lands and properties were changed to 1,104,209.69 square meters and 197,010.37 square meters respectively, and their annual rentals were adjusted to RMB21,817,145.00 and RMB48,474,632.77, or an aggregate of RMB70,291,777.77 for each of the years from 2008 to 2010. The rentals were determined by reference to the market rents of the same district and on the basis that unit rental and payment terms remained unchanged.

For the year ended December 31, 2009, the rents for land lease and property lease incurred by the Group amounted to RMB21,817,145.00 and RMB48,474,632.77 respectively pursuant to such lease agreement.

Arrangements with CSAHC’s Associates

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

On January 10, 2008, the Company entered into an Import and Export Agency Framework Agreement with SAIETC, pursuant to which the parties shall cooperate on the following business domains: import and export, customs clearance, customs declaration and inspection, tendering and agency, etc. The agreement is valid from January 1, 2008 to December 31, 2010, and the annual cap for the commission should not exceed RMB90,000,000.

For the year ended December 31, 2009, the agency fee incurred by the Group to SAIETC in respect of the import and export of above service was RMB67,936,000.

Southern Airlines Culture and Media Co., Ltd. (“SACM”), which is 50% owned by the Company and 50% owned by CSAHC

On April 12, 2007, the Company and SACM entered into an Advertising Agency Framework Agreement for a term of three years commencing from the date of the agreement. Under the agreement, SACM will produce advertisement script, graphic and music for the Company with the copyrights of such products belonging to the Company, subject to compliance with the relevant provisions of the Listing Rules. The parties have determined the various rates for providing advertising services after negotiations on a fair and equitable basis, and SACM has promised that the advertising fees for which they charged the Company were all based on the prevailing market prices for similar business which were accepted by the Company. As set forth in the agreement, the transaction cap for 2007, 2008 and 2009 were RMB16,000,000, RMB20,500,000 and RMB25,500,000, respectively.

As the Advertising Agency Framework Agreement had expired and the transactions contemplated under the Advertising Agency Framework Agreement would continue to be entered into on a recurring basis with an expansion of scope between the parties, the Company has entered into the Media Services Framework Agreement on May 11, 2010 for a term of three years from January 1, 2010 to December 31, 2012. Pusuant to the agreement, SACM will provide the following services to the Group: (1) exclusive advertising agency services, including the design, production, broadcast and agency of international and domestic screen, print, outdoor and other forms of advertisement; (2) the plotting, purchase and production of in-flight TV and movie program agency services; (3) public relations services relating to recruitment of airhostess, including organising and implementation of the promotional recruitment activities, on-site recruitment activities, and production of promotional advertising program; and (4) services relating to the distribution of newspapers and magazines issued by SACM within places of the Company services. As set forth in the agreement, the revised transaction cap for 2010, 2011 and 2012 were RMB40,000,000, RMB48,000,000 and RMB58,000,000, respectively.

For the year ended December 31, 2009, the advertising fees incurred by the Group to SACM for the advertising services amounted to RMB20,868,000.

SA Finance which is 66% controlled by CSAHC, 21% owned by the Company and 13% owned in aggregate by four subsidiaries of the Company

On November 15, 2007, the Company renewed the Financial Services Framework Agreement with SA Finance for a term of three years starting from January 1, 2008 to December 31, 2010.

 
53

 

Under such agreement, SA Finance agrees to provide to the Gruop deposit and loan services. SA Finance shall pay interests to the Company regularly at a rate not lower than the current deposit rates set by the People’s Bank of China. The Group’s deposits placed with SA Finance were re-deposited in a number of banks. SA Finance has agreed that the loans it provided to CSAHC and its subsidiaries other than the Group should not exceed the aggregate of share capital, reserves and total deposits of other companies (excluding the Group). The rates should be determined on an arm’s length basis and based on fair market rate, and should not be higher than those available from independent third parties. The parties agreed that the balance of the Group’s deposits placed with SA Finance (including accrued interests) should not at any time exceed RMB2,600,000,000, nor should the balance of loans borrowed from SA Finance at any time exceed the above-mentioned level. The annual cap of fees payable to SA Finance for the other financial services should not exceed RMB5,000,000.

As of December 31, 2009, the Group’s deposits placed with SA Finance amounted to RMB862,015,000.

Freight Agency Agreement

The Company has entered into Ticket Agency Agreements with several subsidiaries of CSAHC (the “Agents”) for the sale of the Group’s air tickets. The Agents charge commission with reference to the prevailing market rate. Besides, the Company has other air ticket sales agents in China who also charge commission at the same rates. The Agents also act as the ticket sales agents of other airline companies in China, and charge commission at the same rates offered to the Group.

The Company and China Southern Airlines Group Passenger and Cargo Agent Company Limited (“PCACL”), a wholly-owned subsidiary of CSAHC have entered into the Framework Agreement on Expanded Businesses Including the Sale of Air Tickets, the Airfreight Forwarding Services, Chartered Flight and Pallets Agency Services, Delivery Services For the Outside Storage Area and the Relevant Internal Operation Services For the Inside Storage Area of China Southern Airlines Company Limited dated January 10, 2008 (the “Freight Agency Agreement”), which is valid from January 1, 2008 to December 31, 2010. Pursuant to the Freight Agency Agreement, the cooperative scope of both parties thereto mainly comprises extended businesses including air ticket sales agency services, airfreight forwarding sales agency services, chartered flight and pallets agency services, internal operation services for the inside storage area, and delivery services for the outside storage area and chartered flight and pallets sales agency business. The annual transaction cap of the sales value shall not exceed RMB250,000,000.

For the year ended December 31, 2009, the amount of ticket and cargo sales of the Group conducted through the above Agents was RMB182,019,000.

Guangzhou China Southern Airlines Property Management Company Limited (the “GCSAPMC”), which is 100% owned by CSAHC

The Company and GCSAPMC entered into a Framework Agreement for the Engagement of Property Management (“Property Management Framework Agreement”) dated January 1, 2006 to engage GCSAPMC to provide property management and improvement service for a term of three years. Pursuant to the agreement, the Company has appointed GCSAPMC to provide management and maintenance services for the Company’s headquarters in Guangzhou and to provide maintenance and management services for the 110KV transformer substation to ensure the ideal working conditions of the Company’s production and office facilities and physical environment, and the normal operation of equipment. The fee charging schedule (or charge standard) shall be determined on an arm’s length basis between both parties, and shall not be higher than the one charged by any independent third parties in the similar industry. The annual cap for the Property Management Framework Agreement is set at RMB47,010,000. The Company renewed the Property Management Framework Agreement with GCSAPMC on December 29, 2008 for a term of three years from January 1, 2009 to December 31, 2011, and there is no change in the scope of services and the annual caps.

For the year ended December 31, 2009, the property management and maintenance fee incurred by the Group amounted to RMB19,471,000 pursuant to the Property Management Framework Agreement.

Disposal of Equity Interest

A resolution was passed at the board meeting of the Company on September 28, 2009, pursuant to which the Company was approved to transfer its 50% equity interests in MTU to CSAHC by way of agreement. The resolution also authorized the Executive Directors of the Company to execute the relevant equity interest transfer agreement. The Company entered into an equity interest transfer agreement with CSAHC on September 28, 2009. The transfer was considered and approved by the Independent Shareholders of the Company at the second extraordinary general meeting in 2009. Pursuant to the agreement, the Company transferred its 50% equity interests in MTU to CSAHC at a consideration of RMB1,607,850,000.

As at December 31, 2009, the sale was approved by the State Owned Assets Supervision and Administration Commission of the PRC and shareholders of the Company and was pending approval by the Ministry of Commerce of the PRC. The sale was subsequently approved by the Ministry of Commerce of the PRC in January 2010, and the Company received the acquisition consideration from CSAHC in full in February 2010.

Others

On May 7, 2009, the Company entered into the Airline Service Agreement with TravelSky Technology Limited (“TravelSky”) for the period from January 1, 2009 to December 31, 2009.  In December 2009, the Company and TravekSky agreed to extend the term of the Airline Service Agreement for the period from January 1, 2010 to December 31, 2010. Mr. Wang Quan Hua, a director of the Company also serves directorship in TravelSky, which is a provider of information technology solutions for aviation and travel industry.  Pursuant to the agreement, TravelSky agrees to provide to the Company with flight control system services, electronic travel distribution system services, ticket-reservation system extended services and civil aviation and commercial data network services.  In return, the Company pays service fees to TravelSky with reference to the standard rate set by CAAC.  Such transaction has been approved by the Board of the Company and will be submitted for approval at the General Meeting of the Shareholders. The total service fee paid by the Company to TravelSky for 2009 was RMB357 million.
 
54

  
All related party transactions have been approved by Independent Non-executive Directors.

Interests of Experts and Counsel

Not applicable.

ITEM 8. FINANCIAL INFORMATION.

Consolidated Statements and Other Financial Information

Our audited consolidated financial statements are set forth beginning on page F-1, which can be found after Item 19.

Significant Changes

No significant changes have occurred since the date of the financial statements.

Legal Proceedings

A writ of summons was issued on May 30, 2007 by the High People’s Court of Guangdong Province relating to a claim that certain sales agents in Taiwan (the “plaintiffs”) against the Company for the alleged breach of certain terms and conditions of a cooperative agreement (the “cooperative agreement”).  The plaintiffs have made a claim against the Company for a total sum of approximately HKD107 million and an unspecified compensation for early termination of the cooperative agreement.

In May 2008, The High People’s Court of Guangdong Province rejected the claims made by the plaintiffs, and the plaintiffs were ordered to bear all litigation expenses in respect of the first trial. The plaintiffs submitted an appeal to The Supreme People’s Court of the People’s Republic of China.

The directors considered that the claim was without merit and had no material adverse effect on the financial position of the Group, and accordingly no provision in respect of the claims was made in the financial statements.

In May 2009, the Company has received the civil judgment from the Supreme People’s Court of the PRC, pursuant to which the plaintiffs were allowed to withdraw their appeal.  Accordingly, the verdict brought in by the High People’s Court of Guangdong Province became legally effective and such verdict is final and conclusive on the parties.

Dividend Information

No interim dividend was paid during the year ended December 31, 2009. The Board of Directors does not recommend the payment of a final dividend in respect of the year ended December 31, 2009.

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 Company completed its initial public offering of H Shares on July 30, 1997.  The ADRs, each representing 50 H Shares, are evidenced by ADRs issued by the Bank of New York as the depositary. The ADRs have been listed for trading on the New York Stock Exchange since July 31, 1997, under the symbol “ZNH”.

The principal trading market for the Company’s A Shares is the Shanghai Stock Exchange with trading code of “600029”.  On July 25, 2003, the Company completed its initial public offering of A Shares.

Set forth below for the periods indicated are the high and low sales prices of H Shares on the Hong Kong Stock Exchange, ADRs on the New York Stock Exchange and A Shares on the Shanghai Stock Exchange.
 
55

 
   
The Hong Kong
Stock Exchange
Price per H Share
(HK$)
   
The New York
Stock Exchange
Price per ADR
(US$)
   
The Shanghai
Stock Exchange
Price per A Share
(RMB)
 
   
High
   
Low
   
High
   
Low
   
High
   
Low
 
                                     
Annual Market Prices
                                   
                                     
Fiscal Year ended December 31, 2005
   
3.10
     
1.83
     
19.93
     
11.68
     
5.30
     
2.23
 
                                                 
Fiscal Year ended December 31, 2006
   
3.42
     
1.60
     
22.43
     
10.51
     
4.09
     
2.24
 
                                                 
Fiscal Year ended December 31, 2007
   
13.90
     
3.25
     
94.48
     
20.81
     
28.73
     
4.26
 
                                                 
Fiscal Year ended December 31, 2008
   
10.44
     
0.83
     
65.31
     
5.56
     
28.68
     
2.72
 
                                                 
Fiscal Year ended December 31, 2009
   
2.99
     
1.14
     
19.45
     
7.09
     
7.22
     
3.28
 
                                                 
Quarterly Market Prices
                                               
                                                 
Fiscal Year ended December 31, 2008
                                               
                                                 
First Quarter
   
10.44
     
5.13
     
65.31
     
33.96
     
28.68
     
12.98
 
                                                 
Second Quarter
   
6.16
     
3.10
     
41.48
     
19.79
     
16.61
     
6.79
 
                                                 
Third Quarter
   
3.70
     
1.40
     
23.22
     
9.03
     
8.46
     
3.18
 
                                                 
Fourth Quarter
   
1.64
     
0.83
     
10.06
     
5.56
     
4.03
     
2.72
 
                                                 
Fiscal Year ended December 31, 2009
                                               
                                                 
First Quarter
   
1.57
     
1.14
     
10.18
     
7.09
     
5.61
     
3.28
 
                                                 
Second Quarter
   
2.40
     
1.62
     
15.45
     
10.67
     
6.33
     
5.11
 
                                                 
Third Quarter
   
2.99
     
2.02
     
19.45
     
12.75
     
7.22
     
4.96
 
                                                 
Fourth Quarter
   
2.88
     
2.24
     
18.86
     
14.35
     
6.49
     
5.15
 
                                                 
Monthly Market Prices
                                               
                                                 
November 2009
   
2.88
     
2.24
     
18.86
     
14.42
     
6.49
     
5.29
 
                                                 
December 2009
   
2.78
     
2.36
     
18.05
     
15.36
     
6.21
     
5.62
 
                                                 
January 2010
   
2.84
     
2.47
     
18.42
     
15.98
     
6.44
     
5.84
 
                                                 
February 2010
   
2.98
     
2.58
     
18.14
     
16.36
     
6.62
     
6.10
 
                                                 
March 2010
   
3.57
     
2.98
     
22.57
     
20.28
     
7.55
     
6.59
 
                                                 
April 2010
   
4.09
     
3.48
     
26.38
     
22.58
     
9.20
     
7.53
 
                                                 
May 2010 (up to May 7, 2010)
   
4.09
     
3.70
     
25.95
     
23.26
     
8.84
     
7.77
 

 
56

 

Plan of Distribution

Not applicable.

Markets

See “Offer and Listing Details” above.

Selling Shareholders

Not applicable.

Dilution

Not applicable.

Expenses of the Issue

Not applicable.

ITEM 10. ADDITIONAL INFORMATION.

A. 
Share Capital

Not applicable.

B. 
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 most updated Articles of Association for further information, which is filed as an exhibit to this Annual Report.

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.

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.

Other Senior Administrative Officers

Pursuant to the Article 16 of the Articles of Association, other senior administrative officers of the Company refer to executive vice president, chief financial officer, the board secretary, chief economist, chief engineer, chief pilot, and chief legal adviser and chief information officer.

Objects and Purpose

Pursuant to the Article 18 of the Articles of Association, 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; (VI) provision of hotel business; (VII) acting as sale agent for aircraft leasing and aviation accident insurance; (VIII) engaging in other airline or airline-related business, including advertising for such services; and (IX) insurance agency business. (subject to approved of State Administration of Industry and Commerce).

Directors

Pursuant to Article 244 of the Articles of Association, where a 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 of Directors at the earliest opportunity, whether or not the contract, transaction or arrangement or proposal is otherwise subject to the approval of the Board of Directors.

 
57

 

Pursuant to Article 174 of the Articles of Association, where a Director is interested in any resolution proposed at a board meeting, such Director shall not be present and shall not have a right to vote. Such Director shall not be counted in the quorum of the relevant meeting.

Pursuant to Article 252 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 wherein his emoluments are stipulated. The aforesaid emoluments include, emoluments in respect of his service as 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 162(6) of the Articles of Association, the Board of 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.

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

Ordinary Shares

Pursuant to Article 26 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 27 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 and can be used to pay the Company for the share price.

Pursuant to Article 28 of the Articles of Association, Domestic-Invested Shares issued by the Company are called “A Shares”. Overseas-Listed Foreign-Invested Shares issued by the Company and listed in Hong Kong are 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 ADR.

Following the issuance of 721,150,000 new A Shares to CSAHC and 721,150,000 new H Shares to Nan Lung, which were completed on August 20, 2009 and August 21, 2009, respectively, the Company has issued a total of 8,003,567,000 ordinary shares, of which approximately 50.24% (4,021,150,000 A Shares) was directly held by CSAHC, approximately 18.74% (1,500,000,000 A Shares) was held by other domestic shareholders, and approximately 31.02% (2,482,417,000 H Shares) was held by Hong Kong and overseas shareholders (among which, approximately 29.27% (726,500,000 H Shares) was indirectly held by CSAHC).

Pursuant to Article 62 of the Articles of Association, the ordinary shareholders of the Company shall enjoy the following rights:

(1)
the right to attend or appoint a proxy to attend shareholders’ general meetings and to vote thereat;

(2)
the right to dividends and other distributions in proportion to the number of shares held;

(3)
the right of supervisory management over the Company’s business operations, and the right to present proposals or enquiries;

(4)
the right to transfer, donate or pledge his shares in accordance with laws, administrative regulations and provisions of these 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;

 
(ii)
the right to inspect and copy, subject to payment of a reasonable charge;

 
(a)
all parts of the register of shareholders;

 
58

 

 
(b)
personal particulars of each of the Company’s directors, supervisors, president and other senior administrative officers, including:

 
(aa)
present name and alias and any former name or alias;

 
(bb) 
principal address (residence);

 
(cc) 
nationality;

 
(dd) 
primary and all other part-time occupations and duties;

 
(ee) 
identification documents and their relevant numbers;

 
(c)
state of the Company’s share capital;

 
(d)
reports showing the aggregate par value, quantity, highest and lowest price paid in respect of each class of shares repurchased by the Company since the end of last accounting year and the aggregate amount paid by the Company for this purpose;

 
(e)
minutes of shareholders’ general meetings; and

 
(f)
interim and annual reports of the Company.

(7)
in the event of the termination or liquidation of the Company, to participate in the distribution of surplus assets of the Company in accordance with the number of shares held; and

(8)
other rights conferred by laws, administrative regulations and these Articles of Association.

Pursuant to Article 67 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; and

(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 152 of the Articles of Association, shareholders who hold different classes of shares are shareholders of different classes.

The holders of the Domestic Shares and holders of Overseas Listed Foreign Shares are deemed to be shareholders of different classes.

Pursuant to Article 153 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.

Pursuant to Article 155 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 the following matters: (i) to effect an exchange of all or part of the shares of such class into shares of another class or to effect an exchange or create a right of exchange of all or part of the shares of another class into the shares of such class; (ii) to restrict the transfer or ownership of the shares of such class or add to such restriction; (iii) to restructure the Company where the proposed restructuring will result in different classes of shareholders bearing a disproportionate burden of such proposed restructuring; and (iv) to vary or abrogate the provisions of these Articles of Association. However, interested shareholder(s) shall not be entitled to vote at class meetings.

Pursuant to Article 156 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 are entitled to vote at class meetings.

 
59

 

Pursuant to Article 157 of the Articles of Association, written notice of a class meeting shall be given forty-five 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 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 158 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 160 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 percent of each of its existing issued Domestic Shares and Overseas Listed Foreign Shares; and

(2)
where the Company’s plan to issue Domestic Shares and Overseas Listed Foreign Shares at the time of its establishment is carried out within fifteen months from the date of approval of the competent securities authority 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.

There are two types of shareholders’ general meetings: annual general meetings and extraordinary general meetings. Shareholders’ general meetings are convened by the Board of Directors. Annual general meetings are held once every year and within six months from the end of the preceding financial year.

Under any of the following circumstances, the Board of Directors shall convene an extraordinary general meeting within two months:

(1)
when the number of Directors is less than the number of Directors required by the Company Law or two thirds of the number of Directors specified in the Articles of Association;

(2)
when the accumulated losses of the Company amount to one third of the total amount of its share capital;

(3)
when shareholder(s) holding 10 percent 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 of Directors or as requested by the Supervisory Committee;

(5)
More than one half of the independent directors propose to convene the meeting.

When the Company convenes a shareholders’ general meeting, written notice of the meeting is given forty five 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 days before the date of the meeting.

The Company shall, based on the written replies received twenty 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 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.
 
60

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.

Cash dividends policy

Pursuant to Article 268 of the Articles of Association, in the event of distribution of dividend by way of cash, the accumulated payment of dividend by way of cash for the last three years may not be less than 30% of the Company’s average distributable profit for the last three years. Where the Company makes a payment of dividend satisfied by an allotment of new shares or completed conversion of capital common reserve fund into capital, the Company may not distribute dividend by way of cash in the same year.

Merger, acquisition or corporate restructuring

Pursuant to Article 291 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.

C. 
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 7, “Related Party Transactions”, Item 4, “Information on the Company” or elsewhere in this Annual Report on Form 20-F.

(a)
Pursuant to the Aircraft General Terms Agreement dated January 20, 2010 between the Company and Airbus S.A.S.  and A320 Family Aircraft Purchase Agreement dated January 20, 2010 between the Company and Airbus SNC, the Company agreed to purchase 20 Airbus A 320 series aircraft from Airbus SNC in accordance with the terms and conditions thereof. According to the information provided by Airbus SNC, the catalogue price of an Airbus A320 aircraft is US$ 76.9 million. Such catalogue price includes price for airframe and engine. The aggregate consideration for the acquisition will be partly payable by cash and partly by financing arrangements with banking institutions. The Airbus Aircraft will be delivered in stages to the Company during the period commencing from 2011 to 2013.

(b)
Pursuant to a Transfer Agreement dated September 28, 2009 and a Supplemental Transfer Agreement dated December 29, 2009 entered into between the Company and CSAHC, the Company agreed to sell and CSAHC agreed to acquire the 50% equity interest in MTU, a jointly controlled entity of the Company, at a consideration of US$235.47 million. The sale was approved by the Company’s shareholders in an extraordinary general meeting held on November 27, 2009. The sale was approved by the State Owned Assets Supervision and Administration Commission of the PRC and the Ministry of Commerce of the PRC subsequently, and the Company received the acquisition consideration from CSAHC in full in February 2010.

(c)
Pursuant to the Agreement entered into by and among the Company, CSAHC, MTU and MTU Aero Engines GmbH on September 28, 2009, the Company agreed to continue to perform certain existing obligations, in particular, the exclusive maintenance undertaking, under the JV Contract to ensure the continuity and stability of the business of MTU.

D. 
Exchange Controls

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

 
61

 

The Company is generally required by law to sell all its foreign currency revenues to Chinese banks. The Company may purchase foreign currency 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 ADRs is also considered a current account transaction under Chinese law. Therefore, there is no legal restriction on the conversion of Renminbi into foreign currency for the purpose of paying dividends to such holders of H Shares and ADRs. In addition, the Company’s Articles of Association require the Company to pay dividends to holders of the Company’s H Shares and ADRs in foreign currency.

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

E. 
Taxation

Chinese Taxation

The following is a general summary of certain Chinese tax consequences of the acquisition, ownership and disposition of A Shares, H Shares and ADRs. 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 ADRs will be treated as the owners of the H Shares represented by those ADRs, and exchanges of H Shares for ADRs, and ADRs 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 A Shares, H Shares or ADRs, 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 A shares, H Shares or ADRs.
  
As a result of the new corporate income tax law, the statutory corporate income tax rate currently adopted by the Company and its subsidiaries has been changed from 33% to 25% with effect from January 1, 2008.  Pursuant to new corporate income tax law, the corporate income tax rates of entities that previously enjoyed preferential tax rates of 15% have been revised to 18%, 20%, 22%, 24% and 25% for 2008, 2009, 2010, 2011 and 2012 onwards, respectively.

Dividends

The new corporate income tax law and its relevant regulations generally provides for the imposition of a withholding tax on dividends paid by a Chinese company to a non-resident enterprise at a rate of 10%.

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

For individuals, Chinese tax law generally provides that an individual who receives dividends from Chinese companies is subject to a 20% individual income tax. A 50% reduction of taxable income is granted by Chinese tax law for an individual receiving dividends from a listed company on Shanghai Stock Exchange or Shenzhen Stock Exchange.  As a result, the effective tax rate for dividends received by A share individual holder is 10%. Currently, dividend income received by any foreign individual that holds overseas shares in any Chinese domestic enterprise is temporarily exempt from individual income tax. In the event that the exemption is discontinued, such payments will be subject to individual income 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.

Capital Gains from Transfer or Disposition of Shares

The new corporate income tax law and its relevant regulations generally provides that a non-resident enterprise is subject to a 10% capital gains tax for the transfer or disposition of shares of a Chinese company.

 
62

 

For individual shareholders, Chinese tax law generally provide that an individual who transfers or otherwise disposes of a company’s shares of capital stock is subject to a 20% individual income tax on the capital gain, if any. Currently, all individuals are temporarily exempt from individual income tax on transfers of shares of joint stock companies listed on Shanghai Stock Exchange or Shenzhen Stock Exchange, such as the Company. Should such temporary exemption be discontinued, such holders may be subject to a 20% individual income tax on the capital gain, if any, unless reduced by an applicable double-taxation treaty.

United States Federal Income Taxation

This discussion describes general U.S. federal income tax consequences of the purchase, ownership and disposition of the Company’s ADRs. 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 ADRs. This discussion applies to you only if you hold and beneficially own the Company’s ADRs 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 ADRs through any such entities;

·
persons that hold ADRs 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 ADRs) 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 ADRs, you are treated as the owner of the underlying ordinary shares represented by such ADRs.

The discussions and comments included herein are only a general description of the tax aspects and they do not constitute a tax advice or opinion.  Therefore, 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 ADRs, 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 ADRs 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.”

 
63

 

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 ADRs, 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 ADRs

Subject to the PFIC discussion below, if the Company makes distributions and you are a U.S. Holder, the gross amount of any distributions you receive on your ADRs 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 ADRs for a sufficient period of time, dividend distributions on the Company’s ADRs 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 ADRs 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 ADRs, 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 ADRs

Subject to the PFIC discussion below, when you sell or otherwise dispose of the Company’s ADRs, 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 ADRs, both as determined in U.S. dollars. Your adjusted tax basis will generally equal the amount you paid for the ADRs. Any gain or loss you recognize will be long-term capital gain or loss if your holding period in the Company’s ADRs 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 PFIC in any taxable year in which you hold the Company’s ADRs, 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 (the “Asset Test”); or (2) 75% or more of its gross income for the taxable year is passive income (such as certain dividends, interest or royalties)(the “Income Test”). For purposes of the Asset 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. In the case of publicly traded corporations, fair market value must be used for purposes of applying the Asset Test.  In addition, regarding the above two tests, there are complex look-through rules to consider with respect to the assets and activities of related corporations from which the foreign corporation either receives income or in which it holds an interest.  More specifically, certain adjustments are made to exclude certain income received from a related party or include income and assets held by a 25% or more owned subsidiary in determining whether a foreign company qualifies as a PFIC under the two tests.  In particular: 1) passive income received from a related party is excluded if it is properly allocable to the nonpassive income of the related party, and 2) a foreign company that owns directly or indirectly 25% or more of the stock of another corporation is treated as if it owned directly a proportionate share of that corporation’s assets and income.

The Company believes that it was not a PFIC for the taxable year 2009. However, there can be no assurance that the Company will not be a PFIC for the taxable year 2010 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 2009 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 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 ADRs.  An excess distribution would be either (1) a distribution with respect to ADRs that is greater than 125% of the average of such distributions over the preceding three years, or (2) 100% of the gain from the disposition of shares/ADRs.

 
64

 

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 ADRs” 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 “Return by a Shareholder of a Passive Foreign Investment Company or a Qualified Electing Fund.” 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 ADRs.

As described above, 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 ADRs provided the Company’s ADRs are “marketable”. The Company’s ADRs 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 ADRs 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 ADRs 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 ADRs. 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 ADRs.

Non-US Holders

If you beneficially own ADRs and are not a U.S. Holder for U.S. federal income tax purposes (a “Non-US Holder”), you generally will not be subject to U.S. federal income tax or U.S. withholding tax on dividends received from the Company with respect to ADRs 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 ADRs, 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 ADRs, 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 ADRs, such gain is attributable to a permanent establishment that you maintain in the United States; or

·
you are a non-resident 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 ADRs, including dividends and the gain from the disposition of the Company’s ADRs, 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 ADRs and the proceeds received on the sale or other disposition of those ADRs may be subject to information reporting to the IRS and to backup withholding (currently imposed at a rate of 28%). Backup withholding will not apply, however, if you (1) are a corporation or come within certain other exempt categories and, when required, can demonstrate that fact or (2) provide a taxpayer identification number, certify as to no loss of exemption from backup withholding and otherwise comply with the applicable backup withholding rules. To establish your status as an exempt person, you will generally be required to provide certification on IRS Form W-9, W-8BEN or W-8ECI, as applicable. Any amounts withheld from payments to you under the backup withholding rules will be allowed as a refund or a credit against your U.S. federal income tax liability, provided that you furnish the required information to the IRS.

 
65

 

HOLDERS OF THE COMPANY’S ADRS 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 ADRS, INCLUDING THE APPLICABILITY AND EFFECT OF THE TAX LAWS OF ANY STATE, LOCAL OR FOREIGN JURISDICTION AND INCLUDING ESTATE, GIFT, AND INHERITANCE LAWS.

F. 
Dividends and Paying Agents

Not applicable.

G. 
Statement by Experts

Not applicable.

H. 
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. Copies of this material may also be obtained for the Company’s website at http:// www.csair.com.

I. 
Subsidiary Information

Not applicable.

ITEM 11. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

The Group’s earnings are affected by changes in the price and availability of jet fuel. There are currently no effective means available to manage the Group’s exposure to the fluctuations in domestic jet fuel prices. The Group’s results of operations may be significantly affected by fluctuations in fuel prices which is a significant expense for the Group. A reasonable possible increase or decrease of 10% in jet fuel price, with volume of fuel consumed and all other variables held constant, would have increased/decreased the fuel costs by approximately RMB1,639 million. The sensitivity analysis of jet fuel price risk is disclosed in Note 49(e) to the Financial Statements.

The Group is subject to market risks due to fluctuations in interest rates. The majority of the Group’s borrowing is in the form of long-term fixed-rate and variable-rate debts with original maturities ranging from three to twelve 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, 2009. The sensitivity analysis of interest rate risk is disclosed in Note 49(b) to the Financial Statements.

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 bank and other loans used to finance such capital expenditures and its capital commitments. Subject to certain restrictive conditions imposed by the SAFE, the Group may, from time to time, enter into foreign exchange forward option contracts to mitigate its foreign currency exposures. As at December 31, 2009, the Group had two outstanding foreign exchange forward option contracts of notional amount ranging from US$34 million to US$68 million. The contracts are to buy US Dollars by selling Japanese Yen at certain specified rates on monthly settlement dates until the maturity of the contracts in 2011. At December 31, 2009, the fair value of these foreign exchange forward option contracts was liabilities of approximately RMB44 million. The sensitivity analysis of foreign currency risk is disclosed in Note 49(c) to the Financial Statements.

As of December 31, 2009, the Group operated a total of 203 aircraft under operating leases 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 capital leases and operating leases are disclosed in Note 35 and Note 50 to the Financial Statements, respectively.

 
66

 

The following table provides information regarding the Group’s material interest rate sensitive financial instruments as of December 31, 2009 and 2008:

   
As of December 31, 2009
   
As of December 31,
2008
 
   
Expected maturity date
       
   
2010
   
2011
   
2012
   
2013
   
2014
   
Thereafter
   
Total
recorded
amount
   
Fair
value(2)
   
Total
recorded
amount
   
Fair
value(2)
 
Fixed-rate bank and other loans
in US$
   
182
     
79
     
59
     
62
     
65
     
325
     
772
     
795
     
994
     
1,036
 
                                                                                 
Average interest rate
   
4.81
%
   
3.70
%
   
3.70
%
   
3.70
%
   
3.70
%
   
3.70
%
                               
                                                                                 
Variable-rate bank and other loans
in US$
   
15,355
     
4,450
     
8,842
     
1,591
     
875
     
7,286
     
38,399
     
38,399
     
25,352
     
25,352
 
                                                                                 
Average interest rate
   
1.08
%
   
1.18
%
   
1.19
%
   
1.14
%
   
1.07
%
   
1.16
%
                               
                                                                                 
Variable-rate bank and other loans in HKD
   
-
     
-
     
-
     
-
     
-
     
-
     
-
     
-
     
17
     
17
 
                                                                                 
Average interest rate
   
-
     
-
     
-
     
-
     
-
     
-
     
  
     
  
     
  
     
  
 
                                                                                 
Fixed-rate bank and other loans
in RMB
   
-
     
-
     
-
     
-
     
-
     
-
     
-
     
-
     
2,224
     
2,224
 
                                                                                 
Average interest rate
   
-
     
-
     
-
     
-
     
-
     
-
     
     
-
     
-
     
-
 
                                                                                 
Variable-rate bank and other loans
in RMB
   
1,915
     
3,694
     
524
     
20
     
-
     
-
     
6,153
     
6,153
     
11,020
     
11,020
 
                                                                                 
Average interest rate
   
4.77
%
   
4.88
%
   
4.95
%
   
5.00
%
   
-
%
   
-
     
-
     
-
     
-
     
-
 
                                                                                 
Fixed-rate short-term financing bills
in RMB
   
-
     
-
     
-
     
-
     
-
     
-
     
-
     
-
     
2,000
     
2,000
 
                                                                                 
Average interest rate
   
-
     
-
     
-
     
-
     
-
     
-
     
-
     
-
     
-
     
-
 
                                                                                 
Fixed-rate bills payable
in RMB
   
3,202
     
-
     
-
     
-
     
-
     
-
     
3,202
     
3,202
     
148
     
148
 
                                                                                 
Average interest rate
   
2.26
%
   
-
     
-
     
-
     
-
     
-
     
-
     
-
     
-
     
-
 
 
67

(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, 2009 and 2008.

The following table provides information regarding the Group’s material foreign currency sensitive financial instruments and capital commitments as of December 31, 2009 and 2008:

   
As of December 31, 2009
   
As of December 31,
2008
 
   
Expected maturity date
       
   
2010
   
2011
   
2012
   
2013
   
2014
   
Thereafter
   
Total
recorded
amount
   
Fair
value(1)
   
Total
recorded
amount
   
Fair
value(1)
 
                                                             
Fixed-rate bank and other loans In US$
   
182
     
79
     
59
     
62
     
65
     
325
     
772
     
795
     
994
     
1,036
 
                                                                                 
Variable-rate bank and other loans  In US$
   
15,355
     
4,450
     
8,842
     
1,591
     
875
     
7,286
     
38,399
     
38,399
     
25,352
     
25,352
 
                                                                                 
Variable-rate bank and other loans in HKD
   
-
     
-
     
-
     
-
     
-
     
-
     
-
     
-
     
17
     
17
 
                                                                                 
Capital commitment in US$
   
16,404
     
17,482
     
17,421
     
9,845
     
2,646
     
2,045
     
65,843
     
65,843
     
75,639
     
75,639
 
 
(1) 
Fair value of debt instruments was estimated based on the floating interest rates applicable to similar debt instruments as of December 31, 2009 and 2008.

ITEM 12. DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES.

A.
DEBT SECURITIES

Not applicable.

B.
AMERICAN DEPOSITARY SHARES

Not applicable.

C.
OTHER SECURITIES

Not applicable.
 
68

 
D.
AMERICAN DEPOSITARY SHARES

The Bank of New York Mellon collects its fees for delivery and surrender of ADSs directly from investors depositing shares or surrendering ADSs for the purpose of withdrawal or from intermediaries acting for them. The Bank of New York Mellon collects fees for making distributions to investors by deducting those fees from the amounts distributed or by selling a portion of distributable property to pay the fees. The Bank of New York Mellon may collect its annual fee for depositary services by deductions from cash distributions or by directly billing investors or by charging the book-entry system accounts of participants acting for them. The Bank of New York Mellon may generally refuse to provide fee-attracting services until its fees for those services are paid.

Persons depositing or withdrawing shares must pay:
 
For:
$5.00 (or less) per 100 ADSs (or portion of 100 ADSs)
 
• Issuance of ADSs, including issuances resulting from a distribution of shares or rights or other property
• Cancellation of ADSs for the purpose of withdrawal, including if the deposit agreement terminates
     
$.02 (or less) per ADS
 
• Any cash distribution to ADS registered holders
     
A fee equivalent to the fee that would be payable if securities distributed to you had been shares and the shares had been deposited for issuance of ADSs
 
• Distribution of securities distributed to holders of deposited securities which are distributed by the depositary to ADS registered holders
     
$.02 (or less) per ADSs per calendar year
 
• Depositary services
     
Registration or transfer fees
 
• Transfer and registration of shares on our share register to or from the name of the depositary or its agent when you deposit or withdraw shares
     
Expenses of the depositary
 
• Cable, telex and facsimile transmissions (when expressly provided in the deposit agreement)
• Converting foreign currency to U.S. dollars
     
Taxes and other governmental charges the depositary or the custodian have to pay on any ADS or share underlying an ADS, for example, stock transfer taxes, stamp duty or withholding taxes
 
• As necessary
     
Any charges incurred by the depositary orits agents for servicing the deposited securities
 
• As necessary

Fees and Payments from the Depositary to Us

In 2009, the Company received from the depositary a reimbursement of US$103,183.92, net of withholding tax, for continuing annual stock exchange listing fees and expenses incurred by the Company in connection with the administration and maintenance of the depositary receipt facility. 

Indirect payments

As part of its service to the Company, the Bank of New York Mellon wavied a total amout of US$135,351.49 for the standard costs associated with the administration of the ADS program in 2009.
 
69


PART II

ITEM 13. DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES.

None.

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

A.
MATERIAL MODIFICATIONS TO THE INSTRUMENTS DEFINING THE RIGHTS OF SECURITY HOLDERS
 
None.
  
B.
MATERIAL MODIFICATIONS TO THE RIGHTS OF REGISTERED SECURITIES BY ISSUING OR MODIFYING ANY OTHER CLASS OF SECURITIES
 
None.
  
C.
WITHDRAWAL OR SUBSTITUTION OF A MATERIAL AMOUNT OF THE ASSETS SECURING ANY REGISTERED SECURITIES
  
Not applicable.
  
D.
CHANGE OF TRUSTEES OR PAYING AGENTS FOR ANY REGISTERED SECURITIES
  
Not applicable.
  
E. 
Use of Proceeds

Not applicable.

ITEM 15. CONTROLS AND PROCEDURES.

(a)             Disclosure controls and procedures

Our president and chief financial officer have evaluated the effectiveness of our disclosure controls and procedures (as defined in the Exchange Act Rules 13a-15(e) or 15d-15(e)), and concluded that, based on their evaluation, our disclosure controls and procedures are effective as of the end of the period covered by this Annual Report to ensure that information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms.

(b)           Management’s annual report on internal control over financial reporting

Our management is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act.  Internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles and includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of a company’s assets, (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of consolidated financial statements in accordance with generally accepted accounting principles, and that a company’s receipts and expenditures are being made only in accordance with authorizations of a company’s management and directors, and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of a company’s assets that could have a material effect on the consolidated financial statements. Our management has assessed the effectiveness of internal control over financial reporting based on the Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.  Our management has concluded that our internal control over financial reporting was effective as of December 31, 2009.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with policies or procedures may deteriorate.

(c)           Attestation of the Registered Public Accounting Firm
 
70

 
Report of Independent Registered Public Accounting Firm

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

We have audited the internal control over financial reporting of China Southern Airlines Company Limited (the “Company”) as of December 31, 2009, based on criteria established in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control over Financial Reporting.  Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit.
 
We conducted our audit 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 effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

In our opinion, China Southern Airlines Company Limited maintained, in all material respects, effective internal control over financial reporting as of December 31, 2009, based on criteria established in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of The Treadway Commission.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of China Southern Airlines Company Limited and its subsidiaries (collectively, the “Group”) as of December 31, 2009 and 2008, and the related consolidated income statements, consolidated statements of comprehensive income, consolidated statements of changes in equity, and consolidated cash flow statements for each of the years in the three-year period ended December 31, 2009, and our report dated April 12, 2010, except for Note 52(a), which is as of April 30, 2010, expressed an unqualified opinion on those consolidated financial statements and included an explanatory paragraph regarding the Group’s adoption of IFRS 8, Operating segments.

/s/ KPMG

Hong Kong, China
April 12, 2010
 
(d)
Changes in internal control over financial reporting

During the year ended December 31, 2009, there have been no changes in our internal control over financial reporting that have materially affected, or are 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. Gong Hua Zhang qualifies as an audit committee financial expert in accordance with the terms of Item 16A of Form 20-F. Mr. Gong Hua Zhang satisfies as an “independent director” within the meaning of NYSE Manual Section 303A and meets the criteria for independence set forth in Section 10A(m)(3) of the US Securities Exchange Act of 1934, as amended, or the Exchange Act, and Rule 10A-3 under the Exchange Act. See “Item 6 Directors, Senior Management and Employees — Directors and Senior Management”.
 
71

 
ITEM 16B. CODE OF ETHICS.

The Company has adopted a code of ethics that applies to the Company’s principal executive officer, principal financial officer and principal accounting officer. Such code is included in the director service agreements, a form of which is incorporated by reference in this Annual Report in Exhibit 4.1.  Each of the aforementioned senior corporate officers currently serves as a Director and all of our Directors are subject to the director service contracts with the Company.  Pursuant to the director service agreements,  among other things, Directors (i) owe fiduciary duties to the Company and shall perform their duties in compliance with applicable governmental laws, rules and regulations; (ii) shall not engage in any activities in competition with the Company’s business or carry out any activities detrimental to the interests of the Company; and (iii) shall be held liable for any loss or injury incurred to the Company as a result of such Director’s violation of applicable laws and regulations.  

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 2008 and 2009:  
 
   
Audit Fees
   
Audit-Related
Fees
   
Tax Fees
   
Other Fees
 
                         
2008
  RMB 10.8 million     RMB 5.0 million     RMB 0.55 million       -  
                                 
2009
  RMB 11.2 million     RMB 5.0 million     RMB 0.25 million     RMB 0.3 million  
 
Audit-related fees

Review of the Group’s 2008 interim financial report prepared under IFRSs and 2009 interim financial report prepared under IFRSs.

Tax fees

Services provided primarily consist of tax compliance services.

Other fees

Provision of Sarbanes Oxley Act of 2002 advisory services.

Prior to our principal accountant being engaged by the Company or our subsidiaries to render the audit or non audit services, the engagements have been approved by our audit committee.

ITEM 16D. EXEMPTIONS FROM THE LISTING STANDARDS FOR AUDIT COMMITTEE

Not applicable.

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

The Company and its associates have not purchased any issued common shares of the Company during 2009 and up to the date of this Annual Report.

ITEM 16F. CHANGES IN REGISTRANT’S CERTIFYING ACCOUNTANT.

Not applicable.

ITEM 16G. CORPORATE GOVERNANCE.

Set out below is a summary of any significant ways in which the Company’s corporate governance practices differ from those followed by domestic companies under the listing standards of the New York Stock Exchange (“NYSE”):
 
72


NYSE   corporate   governance   rules   
 
The Company’s governance practices 
     
Director Independence
 
A listed company must have a majority of independent directors on its board of directors. No director qualifies as “independent” unless the board of directors affirmatively determines that the director has no material relationship with the listed company (either directly or as a partner, shareholder or officer of an organization that has a relationship with the company).  In addition, a director must meet certain standards to be deemed independent. For example, a director is not independent if the director is, or has been within the last three years, an employee of the listed company, or if the director has received, during any twelve-month period within the last three years, more than US$120,000 in direct compensation from the listed company, other than director and committee fees and pension or other forms of deferred compensation for prior service (provided such compensation is not contingent in any way on continued service).
 
Director Independence
 
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.
 
     
Executive Sessions
 
The non-management directors of each listed company must meet at regularly scheduled executive sessions without management.
 
Executive Sessions
 
No similar requirements.
 
     
Nominating/Corporate Governance Committee
 
Listed companies must have a nominating/corporate governance committee composed entirely of independent directors.
 
The nominating/corporate governance committee must have a written charter that addresses the committee’s purposes and responsibilities which, at minimum, must be to: identify individuals qualified to become board members, consistent with criteria approved by the board, and to select, or to recommend that the board select, the director nominees for the next annual meeting of shareholders; develop and recommend to the board a set of corporate governance guidelines applicable to the corporation; and oversee the evaluation of the board and management, and evaluate the performance of the committee every year.
 
Nominating/Corporate Governance Committee
 
The Company has established a nominating committee.  As at December 31, 2009, the Nomination Committee consists of three members, Messrs Si Xian Min, Wang Zhi (Independent non-executive Director) and Gong Hua Zhang (Independent non-executive Director).   Mr. Si Xian Min was appointed as the chairman of the Nomination Committee on March 11, 2009.   The responsibilities of the Nomination Committee are to make recommendations to the Board in respect of the size and composition of the Board based on the operational activities, assets and shareholding structure of the Company; study the selection criteria and procedures of directors and executives and give advice to the Board; identify qualified candidates for directors and executives; investigate and propose candidates for directors and managers and other senior management members to the Board.
     
Compensation Committee
 
Listed companies must have a compensation committee composed entirely of independent directors.
 
Compensation Committee
 
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 Gong Hua Zhang and executive Director Wang Quan Hua as members.
     
The written charter of the compensation committee must state, at least, the following purposes and responsibilities:
(1) review and approve the corporate goals associated with CEO’s compensation, evaluate the performance of the CEO in fulfilling these goals, and based on such evaluation determine and approve the CEO’s compensation level;
(2) make recommendations to the board with respect to non-CEO executive officer compensation, and incentive-compensation and equity-based plans that are subject to board approval;
(3) produce a committee report on executive compensation as required by the SEC to be included in the annual proxy statement or annual report filed with the SEC.
The charter must also include the requirement for an annual performance evaluation of the compensation committee. 
 
The responsibilities are similar to those stipulated by the NYSE rules, but the committee is not required to produce a report on the executive compensation or make an annual performance evaluation of the committee. The responsibilities of the remuneration committee are to approve the remuneration packages of Directors and senior management of the Group, and the Company’s “preliminary proposals on annual emoluments of the directors and senior management of the Group”. The remuneration committee is also responsible for assessing performance of executive director and approving the terms of executive directors’ service contracts. 
     
Audit Committee
 
Listed companies must have an audit committee that satisfies the requirements of Rule 10A-3 of Exchange Act. It must have a minimum of three members, and all audit committee members must satisfy the requirements for independence set forth in Section 303A.02 of NYSE Corporate Governance Rules as well as the requirements of Rule 10A-3b (1) of the Exchange Act.
 
 
Audit Committee
 
The Board of Directors of the Company has established an audit committee that satisfies relevant domestic requirements and the audit committee has a written charter.
 
 
73

 
The written charter of the audit committee must specify that the purpose of the audit committee is to assist the board oversight of the integrity of financial statements, the company’s compliance with legal and regulatory requirements, qualifications and independence of independent auditors and the performance of the listed company’s internal audit function and independent auditors.
  
The written charter must also require the audit committee to prepare an audit committee report as required by the SEC to be included in the listed company’s annual proxy statement as well as an annual performance evaluation of the audit committee.
 
The responsibilities of the audit committee are similar to those stipulated by the NYSE rules, but according to the domestic practices, the Company is not required to make an annual performance evaluation of the audit committee and the audit committee is not required to prepare an audit report to be included in the Company’s annual proxy statement.
     
Shareholder Approval of Equity Compensation Plans
 
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.
 
 
Shareholder Approval of Equity Compensation Plans
 
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 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
 
Listed companies must adopt and disclose corporate governance guidelines, involving director qualification standards, director responsibilities, director access to management and , as necessary and appropriate, independent advisors, director compensation, director orientation continuing education, management succession and annual performance evaluation of the board of directors, etc. 
 
Corporate Governance Guidelines
 
CSRC has issued the Corporate Governance Rules, with which the Company has complied.
 
     
Certification Requirements
 
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 in writing of any material non-compliance with any applicable provisions of Section 303A.
 
Each listed company must submit an executed Written Affirmation annually to the NYSE. In addition, each listed company must submit an interim Written Affirmation as and when required by the interim Written Affirmation form specified by the NYSE.
 
Certification Requirements
 
There are no similar requirements under the domestic corporate governance rules in China.
 

 
74

 
 
PART III

ITEM 17. FINANCIAL STATEMENTS.

We have elected to provide the financial statements and related information specified in Item 18 in lieu of Item 17.

ITEM 18. FINANCIAL STATEMENTS.

Reference is made to pages F-1 to F-88.

ITEM 19. EXHIBITS. 
Index to Exhibits

Exhibit No.
 
Description of Exhibit
1.1
 
Restated and Amended Articles of Association of China Southern Airlines Company Limited (1) 
     
4.1
 
Form of Director’s Service Agreement (2) 
     
4.2
 
Form of Non-Executive Director’s Service Agreement  (3)  
     
4.3
 
Aircraft General Terms Agreement entered into by and between Airbus S.A.S. and China Southern Airlines Company Limited on January 20, 2010 *
     
4.4
 
A320 Family Aircraft Purchase Agreement entered into by and between the Company and Airbus SNC on January 20, 2010 *
     
4.5
 
A Shares Subscription Agreement entered into by and between the Company and CSAHC on December 10, 2008(4)
     
4.6
 
H Shares Subscription Agreement entered into by and between the Company and Nan Lung Holding Limited on December 10, 2008(5)
     
4.7
 
A Shares Subscription Agreement entered into by and between the Company and CSAHC on March 8, 2010
     
4.8
 
H Shares Subscription Agreement entered into by and between the Company and Nan Lung Holding Limited on March 8, 2010
     
4.9
 
Transfer Agreement entered into by and among the Company, CSAHC, MTU and MTU Aero Engines GmbH on September 28, 2009
     
4.10
 
Transfer Agreement for the 50% Equity Interest in MTU between CSAHC and the Company on September 28, 2009
     
8.1
 
Subsidiaries of China Southern Airlines Company Limited
     
11.1
 
Code of Ethics (included in Exhibit 4.1)
     
12.1
 
Section 302 Certification of President 
     
12.2
 
Section 302 Certification of Chief Financial Officer 
     
13.1
 
Section 906 Certification of President 
     
13.2
 
Section 906 Certification of Chief Financial Officer
*   Portions of this document have been omitted pursuant to a confidential treatment request, and the full, unredacted document has been separately submitted to the Securities and Exchange Commission with a confidential treatment request.

(1) Incorporated by reference to the Exhibit 1.1 to our Form 20-F (File No. 001-14660) for the year ended December 31, 2008 filed with the Securities and Exchange Commission on June 25, 2009

 
75

 

(2) Incorporated by reference to the Exhibit 4.1 to our Form 20-F (File No. 001-14660) for the year ended December 31, 2005 filed with the Securities and Exchange Commission on June 30, 2006

(3) Incorporated by reference to the Exhibit 4.2 to our Form 20-F (File No. 001-14660) for the year ended December 31, 2005 filed with the Securities and Exchange Commission on June 30, 2006

(4) Incorporated by reference to the Exhibit 4.8 to our Form 20-F (File No. 001-14660) for the year ended December 31, 2008 filed with the Securities and Exchange Commission on June 25, 2009

(5) Incorporated by reference to the Exhibit 4.9 to our Form 20-F (File No. 001-14660) for the year ended December 31, 2008 filed with the Securities and Exchange Commission on June 25, 2009

 
76

 

CHINA SOUTHERN AIRLINES COMPANY LIMITED
AND SUBSIDIARIES
 
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

   
Page
     
Report of Independent Registered Public Accounting Firm
 
F-1
Consolidated Income Statements
   
for the years ended December 31, 2009, 2008 and 2007
 
F-2
Consolidated Statements of Comprehensive Income
for the years ended December 31, 2009, 2008 and 2007
 
F-4
Consolidated Balance Sheets at December 31, 2009 and 2008
 
F-5
Consolidated Statements of Changes in Equity
   
for the years ended December 31, 2009, 2008 and 2007
 
F-7
Consolidated Cash Flow Statements
   
for the years ended December 31, 2009, 2008 and 2007
 
F-9
Notes to Consolidated Financial Statements
 
F-11

 
77

 

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 (collectively, the “Group”) as of December 31, 2009 and 2008, and the related consolidated income statements, consolidated statements of comprehensive income, consolidated statements of changes in equity, and consolidated cash flow statements for each of the years in the three-year period ended December 31, 2009.  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 consolidated financial statements are free of material misstatement.  An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements.  An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall consolidated financial statements 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, 2009 and 2008, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2009, in conformity with International Financial Reporting Standards issued by the International Accounting Standards Board.
 
As discussed in Note 3 to the consolidated financial statements, the Group has changed its presentation of segment information with retrospective effect due to the adoption of IFRS 8, Operating segments.
 
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company’s internal control over financial reporting as of December 31, 2009, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated April 12, 2010 expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.
 
/s/ KPMG
 
Hong Kong, China
April 12, 2010, except for Note 52(a), which is as of April 30, 2010

 
F-1

 

Consolidated Income Statements for the years ended December 31, 2009, 2008 and 2007
(Prepared in accordance with International Financial Reporting Standards)
(Expressed in Renminbi)

   
Note
 
2009
   
2008
   
2007
 
       
RMB million
   
RMB million
   
RMB million
 
Operating revenue
                     
Traffic revenue
 
4
    52,967       53,913       53,196  
Other operating revenue
 
5
    1,835       1,375       1,205  
Total operating revenue
        54,802       55,288       54,401  
                             
Operating expenses
                           
Flight operations
 
6
    29,296       34,982       29,082  
Maintenance
 
7
    4,446       4,890       4,643  
Aircraft and traffic servicing
 
8
    9,169       8,476       8,160  
Promotion and sales
 
9
    4,170       3,491       3,421  
General and administrative
 
10
    1,844       2,041       1,874  
Impairment on property, plant and equipment
 
20(g)
    26       1,884       109  
Depreciation and amortisation
 
11
    5,971       5,746       5,554  
Others
        429       257       113  
Total operating expenses
        55,351       61,767       52,956  
Other net income
 
15
    1,989       833       436  
                             
Operating profit/(loss)
        1,440       (5,646 )     1,881  
Interest income
        68       103       73  
Interest expense
 
13
    (1,497 )     (1,987 )     (2,291 )
Share of associates’ results
 
22
    69       (12 )     57  
Share of jointly controlled
                           
entities’ results
 
23
    214       170       123  
Gain/(loss) on derivative
                           
financial instruments, net
        45       (124 )     90  
Exchange gain, net
        93       2,592       2,832  
Gain on sale of other investments in equity securities
        -       -       107  
Gain on sale of a jointly controlled entity
        -       143       -  
Gain on sale of equity interest in subsidiaries
        -       37       7  
                             
Profit/(loss) before taxation
        432       (4,724 )     2,879  
Income tax credit/(expense)
 
16
    95       (62 )     (847 )
Profit/(loss) for the year
        527       (4,786 )     2,032  

 
F-2

 

Consolidated Income Statements for the years ended December 31, 2009, 2008 and 2007 (continued)
(Prepared in accordance with International Financial Reporting Standards)
(Expressed in Renminbi)

   
Note
 
2009
   
2008
   
2007
 
       
RMB million
   
RMB million
   
RMB million
 
Attributable to:
                     
Equity shareholders of the
                     
Company
        330       (4,823 )     1,839  
Minority interests
        197       37       193  
                             
Profit/(loss) for the year
        527       (4,786 )     2,032  
                             
Earnings/(loss) per share
 
19
                       
Basic and diluted
     
RMB
0.05
   
RMB 
(0.74
 
RMB
0.28
 

The notes on pages F-11 to F-88 form part of these consolidated financial statements.

 
F-3

 

Consolidated Statements of Comprehensive Income for the years ended December 31, 2009, 2008 and 2007
(Prepared in accordance with International Financial Reporting Standards)
(Expressed in Renminbi)

   
Note
   
2009
   
2008
   
2007
 
         
RMB million
   
RMB million
   
RMB million
 
                         
Profit/(loss) for the year
          527       (4,786 )     2,032  
                               
Other comprehensive income
                             
for the year (after tax and
                             
reclassification adjustments):
                             
                               
Available-for-sale securities:
                             
net movement in the fair value
                             
reserve
 
17
      30       (192 )     218  
                                 
Total comprehensive income
                               
for the year
            557       (4,978 )     2,250  
                                 
Attributable to:
                               
Equity shareholders of the
                               
Company
            349       (4,988 )     2,022  
Minority interests
            208       10       228  
                                 
Total comprehensive income
                               
for the year
            557       (4,978 )     2,250  

The notes on pages F-11 to F-88 form part of these financial statements.

 
F-4

 

Consolidated Balance Sheets at December 31, 2009 and 2008
(Prepared in accordance with International Financial Reporting Standards)
(Expressed in Renminbi)

   
Note
 
2009
   
2008
 
       
RMB million
   
RMB million
 
Non-current assets
               
Property, plant and equipment, net
 
20
    63,673       53,237  
Construction in progress
 
21
    18,059       17,321  
Lease prepayments
        516       531  
Interest in associates
 
22
    257       235  
Interest in jointly controlled entities
 
23
    728       1,048  
Other investments in equity securities
 
24
    166       166  
Lease deposits
        564       563  
Available-for-sale equity securities
 
25
    93       114  
Deferred tax assets
 
26
    479       167  
Other assets
 
27
    558       412  
          85,093       73,794  
                     
Current assets
                   
Inventories
 
29
    1,256       1,229  
Trade receivables
 
30
    1,359       1,317  
Other receivables
        1,408       1,371  
Prepaid expenses and other current assets
        711       620  
Amounts due from related companies
 
38
    51       11  
Pledged bank deposits
 
33(j)
    -       51  
Cash and cash equivalents
 
31
    4,343       4,649  
          9,128       9,248  
Asset classified as held for sale
 
32
    529       -  
          9,657       9,248  
                     
Current liabilities
                   
Financial liabilities
 
28
    44       116  
Bank and other loans
 
33
    17,452       22,178  
Short-term financing bills
 
34
    -       2,000  
Obligations under finance leases
 
35
    1,431       1,781  
Trade and bills payables
 
36
    4,992       1,353  
Sales in advance of carriage
        2,196       2,244  
Deferred revenue
 
37
    316       261  
Income tax payable
        44       120  
Amounts due to related companies
 
38
    94       102  
Accrued expenses
 
39
    8,153       8,420  
Other liabilities
 
40
    3,376       2,963  
          38,098       41,538  
                     
Net current liabilities
 
49
    (28,441 )     (32,290 )
                     
Total assets less current liabilities
        56,652       41,504  

 
F-5

 

Consolidated Balance Sheets as at December 31, 2009 and 2008 (continued)
(Prepared in accordance with International Financial Reporting Standards)
(Expressed in Renminbi)

   
Note
 
2009
   
2008
 
       
RMB million
   
RMB million
 
Non-current liabilities and deferred items
               
Bank and other loans
 
33
    27,875       17,429  
Obligations under finance leases
 
35
    11,887       11,157  
Deferred revenue
 
37
    594       445  
Provision for major overhauls
 
41
    953       945  
Provision for early retirement benefits
 
42
    148       179  
Deferred benefits and gains
          1,080       1,109  
Deferred tax liabilities
 
26
    853       761  
          43,390       32,025  
                     
Net assets
        13,262       9,479  
                     
Capital and reserves
                   
Share capital
 
43
    8,003       6,561  
Reserves
 
44
    2,348       460  
Total equity attributable to equity
                   
shareholders of the Company
        10,351       7,021  
Minority interests
        2,911       2,458  
Total equity
        13,262       9,479  

The notes on pages F-11 to F-88 form part of these consolidated financial statements.

 
F-6

 

Consolidated Statements of Changes in Equity for the years ended December 31, 2009, 2008 and 2007
(Prepared in accordance with International Financial Reporting Standards)
(Expressed in Renminbi)
 
   
Attributable to equity shareholders of the Company
             
                           
(Accumulated
                   
                     
Other
   
losses) /
                   
   
Share
   
Share
   
Fair value
   
reserves
   
retained
         
Minority
   
Total
 
   
capital
   
premium
   
reserves
   
RMB
   
earnings
   
Total
   
interests
   
equity
 
   
RMB
   
RMB
   
RMB
   
million
   
RMB
   
RMB
   
RMB
   
RMB
 
   
million
   
million
   
million
   
(Note (a))
   
million
   
million
   
million
   
million
 
                                                 
Balance at January 1, 2007
    4,374       5,325       -       603       (465 )     9,837       1,915       11,752  
Changes in equity for 2007:
                                                               
Paid in capital from minority
                                                               
equity holders of a subsidiary
    -       -       -       -       -       -       240       240  
Acquisition of Nan Lung
                                                               
Freight and Air Catering
                                                               
(Note 48(b))
    -       -       -       -       -       -       80       80  
Disposal of equity interest in
                                                               
a subsidiary to minority
                                                               
shareholders
                                                               
(Note 48(c))
    -       -       -       -       -       -       (8 )     (8 )
Distributions to minority
                                                               
shareholders
    -       -       -       -       -       -       (8 )     (8 )
Share of an associate’s
                                                               
reserves movement
    -       -       -       4       -       4       -       4  
Total comprehensive income
                                                               
for the year
    -       -       183       -       1,839       2,022       228       2,250  
                                                                 
Balance at December 31,
                                                               
2007 and January 1, 2008
    4,374       5,325       183       607       1,374       11,863       2,447       14,310  
                                                                 
Changes in equity for 2008:
                                                               
Bonus share issue (Note 43(a))
    2,187       (2,187 )     -       -       -       -       -       -  
Acquisition of China Southern
                                                               
West Australian Flying
                                                               
College Pty Limited
                                                               
(Note 45(c)(xv))
    -       -       -       (5 )     -       (5 )     -       (5 )
Disposal of partial equity interest in
                                                               
a subsidiary to minority
                                                               
shareholders
    -       -       -       -       -       -       24       24  
Distributions to minority
                                                               
shareholders
    -       -       -       -       -       -       (28 )     (28 )
Government contributions
                                                               
(Note 44(d))
    -       -       -       151       -       151       5       156  
Total comprehensive income
                                                               
for the year
    -       -       (165 )     -       (4,823 )     (4,988 )     10       (4,978 )
                                                                 
Balance at December 31, 2008
                                                               
and January 1, 2009
    6,561       3,138       18       753       (3,449 )     7,021       2,458       9,479  
                                                                 
Changes in equity for 2009:
                                                               
Issuance of shares (Note 43(a))
    1,442       1,538       -       -       -       2,980       -       2,980  
Paid in capital from minority
                                                               
equity holders of subsidiaries
                                                               
(Note (b))
    -       -       -       -       -       -       261       261  
Liquidation of subsidiaries
    -       -       -       -       -       -       (6 )     (6 )
Distributions to minority
                                                               
shareholders
    -       -       -       -       -       -       (10 )     (10 )
Government contributions
                                                               
(Note 44(d))
    -       -       -       1       -       1       -       1  
Total comprehensive income
                                                               
for the year
    -       -       19       -       330       349       208       557  
Balance at December 31, 2009
    8,003       4,676       37       754       (3,119 )     10,351       2,911       13,262  

 
F-7

 

Consolidated Statements of Changes in Equity for the years ended December 31, 2009, 2008 and 2007 (continued)
(Prepared in accordance with International Financial Reporting Standards)
(Expressed in Renminbi)

Note (a):
 
Other reserves represent statutory surplus reserve, discretionary surplus reserve and others.  Details are set out in Note 44.
     
Note (b):
 
In 2009, the minority equity holders of certain subsidiaries of the Company injected cash of RMB242 million and assets of RMB19 million in respect of their shares of the registered capital in these subsidiaries.

The notes on pages F-11 to F-88 form part of these consolidated financial statements.

 
F-8

 

Consolidated Cash Flow Statements for the years ended December 31, 2009, 2008 and 2007
(Prepared in accordance with International Financial Reporting Standards)
(Expressed in Renminbi)

   
Note
 
2009
   
2008
   
2007
 
       
RMB million
   
RMB million
   
RMB million
 
Operating activities
                     
Cash generated from operations
 
31(b)
    11,232       4,256       9,698  
Interest received
        68       103       73  
Interest paid
        (2,131 )     (2,805 )     (2,814 )
Income tax paid
        (210 )     (399 )     (88 )
Net cash generated from
                           
operating activities
        8,959       1,155       6,869  
                             
Investing activities
                           
Proceeds from disposal of
                           
property, plant and
                           
equipment
        320       312       288  
Proceeds from sale of available-
                           
for-sale equity securities
        138       -       -  
Proceeds from sale of a jointly
                           
controlled entity
        -       210       -  
Proceeds from sale of equity
                           
interest in subsidiaries
        -       61       -  
Proceeds from sale of other
                           
investments in equity
                           
securities
        -       -       127  
Net cash settlement of derivative
                           
financial instruments
        (27 )     (11 )     67  
Dividends received from
                           
associates
        47       -       -  
Dividends received from jointly
                           
controlled entities
        -       14       79  
Dividends received from other
                           
investments
        14       14       12  
Payment of lease deposits
        (10 )     -       (86 )
Refund of lease deposits
        8       54       165  
Capital expenditures
        (15,007 )     (8,364 )     (5,502 )
Decrease/(increase) in pledged
                           
bank deposits
        51       (51 )     -  
Payment for the investment in
                           
an associate, jointly control
                           
entities, a subsidiary and other
                           
investments
        (6 )     (29 )     (10 )
Payment for acquisition of
                           
Nan Lung Freight and Air
                           
Caterting
 
48(b)
    -       -       (58 )
Liquidation of subsidiaries
        (6 )     -       74  
Net cash used in investing
                           
  activities
        (14,478 )     (7,790 )     (4,844 )
 
 
F-9

 

Consolidated Cash Flow Statements for the years ended December 31, 2009, 2008 and 2007 (continued)
(Prepared in accordance with International Financial Reporting Standards)
(Expressed in Renminbi)

   
Note
 
2009
   
2008
   
2007
 
       
RMB million
   
RMB million
   
RMB million
 
Financing activities
                     
Proceeds from issue of shares
 
43(a)
    2,980       -       -  
Proceeds from bank and other
                           
loans
        37,146       41,450       30,984  
Repayment of bank and other
                           
loans
        (31,396 )     (33,783 )     (28,660 )
Proceeds from issue of short-
                           
term financing bills
        -       2,000       -  
Repayment of short-term
                           
financing bills
        (2,000 )     -       -  
Repayment of principal under
                           
finance lease obligations
        (1,750 )     (2,335 )     (3,021 )
Capital contributions received
                           
from government
 
44(d)
    1       156       -  
Paid in capital from minority
                           
equity holders of subsidiaries
        242       -       240  
Dividends paid to minority
                           
shareholders
        (10 )     (28 )     (8 )
Net cash generated from/(used in)
                           
financing activities
        5,213       7,460       (465 )
                             
Net (decrease)/increase in cash
                           
and cash equivalents
        (306 )     825       1,560  
Cash and cash equivalents at
                           
January 1
        4,649       3,824       2,264  
Cash and cash equivalents at
                           
December 31
        4,343       4,649       3,824  

The notes on pages F-11 to F-88 form part of these consolidated financial statements.

 
F-10

 

Notes to the Consolidated Financial Statements
(Prepared in accordance with International Financial Reporting Standards)
(Expressed in Renminbi)
 
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, Macau and Taiwan and international passenger, cargo and mail airline services.
 
The Company was established in the People’s Republic of China (the “PRC” or “China”) on March 25, 1995 as a joint stock limited company as part of the reorganisation (the “Reorganisation”) of the Company’s holding company, China Southern Air Holding Company (“CSAHC”).  CSAHC is a state-owned enterprise under the supervision of the PRC central government.
 
The Company’s H Shares and American Depositary Receipts (“ADR”) (each ADR 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 which are listed on the Shanghai Stock Exchange.
 
The 2007 bonus share issue of 2,187,089,000 shares, by the conversion of share premium to share capital, was implemented in August 2008.
 
On August 20, 2009 and August 21, 2009, the Company issued 721,150,000 A shares to CSAHC and 721,150,000 H shares to Nan Lung Holdings Ltd. (“Nan Lung”), a wholly-owned subsidiary of CSAHC, respectively.
 
Principal accounting policies
 
(a) 
Statement of compliance
 
These consolidated financial statements have been prepared in accordance with all applicable International Financial Reporting Standards (“IFRSs”), which collective term includes all applicable individual International Financial Reporting Standards, International Accounting Standards (“IASs”) and interpretations issued by the International Accounting Standards Board (the “IASB”).
 
Note 3 provides information on the impact of the new and revised IFRSs and interpretations that are first effective for the current accounting period and the changes in accounting policies for the current and prior accounting periods reflected in these consolidated financial statements.
 
(b) 
Basis of preparation of the consolidated financial statements
 
At December 31, 2009, the Group’s current liabilities exceeded its current assets by RMB28,441 million, which includes bank and other loans repayable within one year of RMB17,452 million.  In preparing the 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 a basis that the Group will be able to continue as a going concern.  Further details are set out in Note 49(a).
 
The consolidated financial statements for the year ended December 31, 2009 comprise the Company and its subsidiaries and the Group’s interest in associates and jointly controlled entities.
 
The measurement basis used in the preparation of the consolidated financial statements is the historical cost basis except that the following assets and liabilities are stated at their fair value as explained in the accounting policies set out below:
 
Derivative financial instruments (Note 2(g)); and
 
Available-for-sale equity securities (Note 2(f)).

 
F-11

 
 
Principal accounting policies (continued)
 
(b) 
Basis of preparation of the consolidated financial statements (continued)
 
Non-current assets held for sale are stated at the lower of carrying amount and fair value less costs to sell (Note 2(cc)).
 
The preparation of consolidated financial statements in conformity with 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 recognised 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.
 
Judgements made by management in the application of IFRSs that have significant effect on the financial statements and major sources of estimation uncertainty are discussed in Note 54.
 
(c) 
Subsidiaries and minority interests
 
Subsidiaries are entities controlled by the Group.  Control exists when the Group has the power 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 are taken into account.
 
An investment in a subsidiary is consolidated into the consolidated financial statements from the date that control commences until the date that control ceases.  Intra-group balances and transactions and any unrealised profits arising from intra-group transactions are eliminated in full in preparing the consolidated financial statements.  Unrealised losses resulting from intra-group transactions are eliminated in the same way as unrealised gains but only to the extent that there is no evidence of impairment.
 
Minority interests represent the portion of the net assets of subsidiaries attributable to interests that are not owned by the Company, whether directly or indirectly through subsidiaries, and in respect of which the Group has not agreed any additional terms with the holders of those interests which would result in the Group as a whole having a contractual obligation in respect of those interests that meets the definition of a financial liability.  Minority interests are presented in the consolidated balance sheet within equity, separately from equity attributable to the equity shareholders of the Company.  Minority interests in the results of the Group are presented on the face of the consolidated income statements and the consolidated statements of comprehensive income as an allocation of the total profit or loss and total comprehensive income for the year between minority interests and the equity shareholders of the Company.
 
Where losses applicable to the minority exceed the minority’s interest in the equity of a subsidiary, the excess, and any further losses applicable to the minority, are charged against the Group’s interest except to the extent that the minority has a binding obligation to, and is able to, make additional investment to cover the losses.  If the subsidiary subsequently reports profits, the Group’s interest is allocated all such profits until the minority’s share of losses previously absorbed by the Group has been recovered.
 
Loans from holders of minority interests and other contractual obligations towards these holders are presented as financial liabilities in the consolidated balance sheet in accordance with Notes 2(o) or (p) depending on the nature of the liability.

 
F-12

 
 
Principal accounting policies (continued)
 
(d) 
Associates and jointly controlled entities
 
An associate is an entity in which the Group or the Company has significant influence, but not control or joint control, over its management, including participation in the financial and operating policy decisions.
 
A jointly controlled entity is an entity which operates under a contractual arrangement between the Group or the Company and other parties, where the contractual arrangement establishes that the Group or the Company and one or more of the other parties share joint control over the economic activities of the entity.
 
An investment in an associate or a jointly controlled entity is accounted for in the consolidated financial statements under the equity method, unless it is classified as held for sale (or included in a disposal group that is classified as held for sale) (Note 2(cc)). Under the equity method, the investment is initially recorded at cost and adjusted thereafter for the post acquisition change in the Group’s share of the investee’s net assets and any impairment loss relating to the investment (Note 2(l)).  The Group’s share of the post-acquisition, post-tax results of the investees and any impairment losses for the year are recognised in the consolidated income statements, whereas the Group’s share of the post-acquisition post-tax items of the investees’ other comprehensive income is recognised in the consolidated statements of comprehensive income.
 
When the Group’s share of losses exceeds its interest in the associate or the jointly controlled entity, the Group’s interest is reduced to nil and recognition of further losses is discontinued except to the extent that the Group has incurred legal or constructive obligations or made payments on behalf of the investee.  For this purpose, the Group’s interest is the carrying amount of the investment under the equity method together with the Group’s long-term interests that in substance form part of the Group’s net investment in the associate or the jointly controlled entity.
 
Unrealised profits and losses arising from transactions between the Group and its associates and jointly controlled entities are eliminated to the extent of the Group’s interest in the investee, except where unrealised losses provide evidence of an impairment of the asset transferred, in which case they are recognised immediately in profit or loss.
 
(e) 
Goodwill
 
Goodwill represents the excess of the cost of a business combination or an investment in an associate 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 arising on a business combination is allocated to each cash-generating unit, or groups of cash generating units, that is expected to benefit from the synergies of the combination and is tested annually for impairment (Note 2(l)).  In respect of associates or jointly controlled entities, the carrying amount of goodwill is included in the carrying amount of the interest in the associate or jointly controlled entity and the investment as a whole is tested for impairment whenever there is objective evidence of impairment (Note 2(l)).
 
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 associate or a jointly controlled entity is recognised immediately in profit or loss.
 
On disposal of a cash generating unit, an associate or a jointly controlled entity during the year, any attributable amount of purchased goodwill is included in the calculation of the profit or loss on disposal.

 
F-13

 
 
Principal accounting policies (continued)
 
(f) 
Other investments in equity securities
 
The Group’s policies for investments in equity securities, other than investments in subsidiaries, associates and jointly controlled entities, are as follows:
 
Investments in equity securities are initially stated at fair value, which is their transaction price unless fair value can be more reliably estimated using valuation techniques whose variables include only data from observable markets.  Cost includes attributable transaction costs, except where indicated otherwise below.  These investments are subsequently accounted for as follows, depending on their classification:
 
Available-for-sale equity securities are those non-derivative financial assets that are designated as available for sale.  At each balance sheet date the fair value is remeasured, with any resultant gain or loss being recognised in other comprehensive income and accumulated separately in equity in the fair value reserve, except foreign exchange gains and losses resulting from changes in the amortised cost of monetary items which are recognised directly in profit or loss.  Dividend income from these investments is recognised in profit or loss in accordance with the policy set out in Note 2(v)(iv).  When these investments are derecognised or impaired (Note 2(l)), the cumulative gain or loss is reclassified from equity to profit or loss.
 
The Group’s other investments in equity securities represent unlisted equity securities of companies established in the PRC.  They do not have a quoted market price in an active market and whose fair value cannot be reliably measured. Accordingly, they are recognised in the consolidated balance sheet at cost less impairment losses (Note 2(l)).
 
Investments are recognised/derecognised on the date the Group commits to purchase/sell the investments or they expire.
 
(g) 
Derivative financial instruments
 
Derivative financial instruments are recognised initially at fair value.  At each balance sheet date the fair value is remeasured.  The gain or loss on remeasurement to fair value is recognised immediately in profit or loss.
 
(h) 
Property, plant and equipment
 
(i) 
Investment property
 
Investment properties are land and/or buildings which are owned or held under a leasehold interest (Note 2(j)) to earn rental income and/or for capital appreciation.
 
Investment properties are stated in the consolidated balance sheet at cost, less accumulated depreciation and impairment losses (Note 2(l)). Depreciation is calculated to write off the cost of items of investment property, less their estimated residual value, if any, using the straight line method over their estimated useful lives. Rental income from investment properties is accounted for as described in Note 2(v)(iii).

 
F-14

 
 
Principal accounting policies (continued)
 
(h) 
Property, plant and equipment (continued)
 
(ii) 
Other property, plant and equipment
 
Property, plant and equipment are stated in the consolidated balance sheet at cost less accumulated depreciation and impairment losses (Note 2(l)).
 
The cost of self-constructed items of property, plant and equipment includes the cost of materials, the initial estimate, where relevant, of the costs of dismantling and removing the items and restoring the site on which they are located, and an appropriate proportion of production overheads and borrowing costs (Note 2(y)).
 
Gains or losses arising from the retirement or disposal of an item of property, plant and equipment are determined as the difference between the net disposal proceeds and the carrying amount of the item and are recognised in profit or loss on the date of retirement or disposal.
 
Depreciation is calculated to write off the cost of items of property, plant and equipment, less their estimated residual value, if any, using the straight line method over their estimated useful lives as follows:

Buildings
30 to 35 years
Owned and leased aircraft
15 to 20 years
Other flight equipment
 
- Jet engines
15 to 20 years
- Others, including rotable spares
3 to 15 years
Machinery and equipment
4 to 10 years
Vehicles
6 to 8 years
   
Where parts of an item of property, plant and equipment have different useful lives, the cost 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.
 
(i) 
Construction in progress
 
Construction in progress represents office buildings, various infrastructure projects under construction and equipment pending installation, and is stated at cost less impairment losses (Note 2(l)).  Capitalisation of these costs ceases and the construction in progress is transferred to property, plant and equipment when the asset is substantially ready for its intended use, notwithstanding any delay in the issue of the relevant commissioning certificates by the relevant PRC authorities.
 
No depreciation is provided in respect of construction in progress.
 
(j) 
Leased assets
 
An arrangement, comprising a transaction or a series of transactions, is or contains a lease if the Group determines that the arrangement conveys a right to use a specific asset or assets for an agreed period of time in return for a payment or a series of payments.  Such a determination is made based on an evaluation of the substance of the arrangement and is regardless of whether the arrangement takes the legal form of a lease.

 
F-15

 
 
Principal accounting policies (continued)
 
(j) 
Leased assets (continued)
 
(i) 
Classification of assets leased to the Group
 
Assets that are held by the Group under leases which transfer to the Group substantially all the risks and rewards of ownership are classified as being held under finance leases.  Leases which do not transfer substantially all the risks and rewards of ownership to the Group are classified as operating leases, except for land held for own use under an operating lease, the fair value of which cannot be measured separately from the fair value of a building situated thereon at the inception of the lease, is accounted for as being under a finance lease, unless the building is also clearly held under an operating lease.  For these purposes, the inception of the lease is the time that the lease was first entered into by the Group, or taken over from the previous lessee.
 
(ii) 
Assets acquired under finance leases
 
Where the Group acquires the use of assets under finance leases, the amounts representing the fair value of the leased asset, or, if lower, the present value of the minimum lease payments, of such assets are included in property, plant and equipment and the corresponding liabilities, net of finance charges, are recorded as obligations under finance leases.  Depreciation is provided at rates which write off the cost or valuation of the assets over the term of the relevant lease or, where it is likely the Group will obtain ownership of the asset, the life of the asset, as set out in Note 2(h)(ii).  Impairment losses are accounted for in accordance with the accounting policy as set out in Note 2(l).  Finance charges implicit in the lease payments are charged to profit or loss over the period of the leases so as to produce an approximately constant periodic rate of charge on the remaining balance of the obligations for each accounting period.  Contingent rentals are charged to profit or loss in the accounting period in which they are incurred.
 
(iii) 
Operating lease charges
 
Where the Group has the use of assets held under operating leases, payments made under the leases are charged to profit or loss in equal installments 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 recognised in profit or loss as an integral part of the aggregate net lease payments made.
 
The cost of acquiring land held under an operating lease is amortised on a straight-line basis over the respective periods of lease terms which ranged from 30 to 70 years.

 
F-16

 
 
Principal accounting policies (continued)
 
(j) 
Leased assets (continued)
 
(iv) 
Sale and leaseback transactions
 
Gains or losses on sale and leaseback transactions which result in finance leases are deferred and amortised over the terms of the related leases.  Gains or losses on other aircraft sale and leaseback transactions which result in operating leases are recognised immediately if the transactions are established at fair value.  Any difference between the sales price and the fair value is deferred and amortised over the period the assets are expected to be used.
 
(k) 
Deferred expenditure
 
Lump sum housing benefits payable to employees of the Group are deferred and amortised on a straight-line basis over a period of 10 years, which represents the benefit vesting period of the employees.
 
Deferred expenditure is stated at cost less impairment losses (Note 2(l)).
 
(l) 
Impairment of assets
 
(i)
Impairment of investments in equity securities and other receivables
 
Investments in equity securities (other than investments in subsidiaries: see (Note 2(l)(ii)) and other current and non-current receivables that are stated at cost or amortised cost or are classified as available-for-sale equity securities are reviewed at each balance sheet date to determine whether there is objective evidence of impairment.  Objective evidence of impairment includes observable data that comes to the attention of the Group about one or more of the following loss events:
 
-
significant financial difficulty of the debtor;
 
-
a breach of contract, such as a default or delinquency in interest or principal payments;
 
-
it becoming probable that the debtor will enter bankruptcy or other financial reorganisation;
 
-
significant changes in the technological, market, economic or legal environment that have an adverse effect on the debtor; and
 
-
a significant or prolonged declined in the fair value of an investment in an equity instrument below its cost.
 
If any such evidence exists, any impairment loss is determined and recognised as follows:
 
-
For investments in associates and jointly controlled entities recognised using the equity method (Note 2(d)), the impairment loss is measured by comparing the recoverable amount of the investment as a whole with its carrying amount in accordance with Note 2(l)(ii).  The impairment loss is reversed if there has been a favourable change in the estimates used to determine the recoverable amount in accordance with Note 2(l)(ii).
 
-
For unquoted equity securities carried at cost, the impairment loss is measured as the difference between the carrying amount of the financial asset and the estimated future cash flows, discounted at the current market rate of return for a similar financial asset where the effect of discounting is material.  Impairment losses for equity securities carried at cost are not reversed.

 
F-17

 
 
2
Principal accounting policies (continued)
 
(l)
Impairment of assets (continued)
 
(i)
Impairment of investments in equity securities and other receivables (continued)
 
-
For trade and other current receivables and other financial assets carried at amortised cost, the impairment loss is measured as the difference between the asset’s carrying amount and the present value of estimated future cash flows, discounted at the financial asset’s original effective interest rate (i.e. the effective interest rate computed at initial recognition of these assets), where the effect of discounting is material.  This assessment is made collectively where financial assets carried at amortised cost share similar risk characteristics, such as similar past due status, and have not been individually assessed as impaired.  Future cash flows for financial assets which are assessed for impairment collectively are based on historical loss experience for assets with credit risk characteristics similar to the collective group.
 
 
If in a subsequent period the amount of an impairment loss decreases and the decrease can be linked objectively to an event occurring after the impairment loss was recognised, the impairment loss is reversed through profit or loss.  A reversal of an impairment loss shall not result in the asset’s carrying amount exceeding that which would have been determined had no impairment loss been recognised in prior years.
 
-
For available-for-sale equity securities, the cumulative loss that has been recognised in the fair value reserve is reclassified to profit or loss.  The amount of the cumulative loss that is recognised in profit or loss is the difference between the acquisition cost (net of any principal repayment and amortisation) and current fair value, less any impairment loss on that asset previously recognised in profit or loss.
 
Impairment losses recognised in profit or loss in respect of available-for-sale equity securities are not reversed through profit or loss.  Any subsequent increase in the fair value of such assets is recognised directly in other comprehensive income.
 
Impairment losses are written off against the corresponding asset directly, except for impairment losses recognised in respect of trade and other receivables, whose recovery is considered doubtful but not remote.  In this case, the impairment losses for doubtful debts are recorded using an allowance account.  When the Group is satisfied that recovery is remote, the amount considered irrecoverable is written off against trade and other receivables directly and any amounts held in the allowance account relating to that debt are reversed.  Subsequent recoveries of amounts previously charged to the allowance account are reversed against the allowance account.  Other changes in the allowance account and subsequent recoveries of amounts previously written off directly are recognised in profit or loss.

 
F-18

 
 
Principal accounting policies (continued)
 
(l) 
Impairment of assets (continued)
 
(ii) 
Impairment of other assets
 
Internal and external sources of information are reviewed at each balance sheet date to identify indications that the following assets may be impaired or, except in the case of goodwill, an impairment loss previously recognised no longer exists or may have decreased:
 
-
Property, plant and equipment;
 
-
Construction in progress;
 
-
Lease deposits;
 
-
Lease prepayments;
 
-
Deferred expenditure;
 
-
Investments in subsidiaries; and
 
-
Goodwill.
 
If any such indication exists, the asset’s recoverable amount is estimated.  For goodwill, the recoverable amount is estimated annually whether or not there is any indication of impairment.
 
-
Calculation of recoverable amount
 
The recoverable amount of an asset is the greater of its fair value less costs to sell and value in use.  In assessing value in use, the estimated future cash flows are discounted to their present value using a pre-tax discount rate that reflects current market assessments of the 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 recognised in profit or loss if the carrying amount of an asset, or the cash-generating unit to which it belongs, exceeds its recoverable amount.  Impairment losses recognised in respect of cash-generating units are allocated first to reduce the carrying amount of any goodwill allocated to the cash-generating unit (or group of units) and then, to reduce the carrying amount of the other assets in the unit (or group of units) on a pro-rata basis, except that the carrying value of an asset will not be reduced below its individual fair value less costs to sell, or value in use, if determinable.

 
F-19

 
 
Principal accounting policies (continued)
 
(l) 
Impairment of assets (continued)
 
(ii) 
Impairment of other assets (continued)
 
Reversals of impairment losses
 
In respect of assets other than goodwill, an impairment loss is reversed if there has been a favourable change in the estimates used to determine the recoverable amount.  An impairment loss in respect of goodwill is not reversed.
 
A reversal of an impairment loss is limited to the asset’s carrying amount that would have been determined had no impairment loss been recognised in prior years.  Reversals of impairment losses are credited to profit or loss in the year in which the reversals are recognised.
 
 (iii) 
Interim financial reporting and impairment
 
Impairment losses recognised in an interim period in respect of goodwill, available-for-sale equity securities and unquoted equity securities carried at cost are not reversed in a subsequent period.  This is the case even if no loss, or a smaller loss, would have been recognised had the impairment been assessed only at the end of the financial year to which the interim period relates.  Consequently, if the fair value of an available-for-sale equity security increases in the remainder of the annual period, or in any other period subsequently, the increase is recognised in other comprehensive income and not profit or loss.
 
(m) 
Inventories
 
Inventories, which consist primarily of expendable spare parts and supplies, are stated at cost less any applicable provision for obsolescence, and are charged to profit or loss when used in operations. Cost represents the average unit cost.
 
Inventories held for disposal are carried at the lower of cost and net realisable value.  Net realisable value is the estimated selling price in the ordinary course of business less the estimated costs of completion and the estimated costs necessary to make the sale.
 
(n) 
Trade and other receivables
 
Trade and other receivables are initially recognised at fair value and thereafter stated at amortised cost less allowance for impairment of 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 allowance for impairment of bad and doubtful debts.
 
(o) 
Interest-bearing borrowings
 
Interest-bearing borrowings are recognised initially at fair value less attributable transaction costs.  Subsequent to initial recognition, interest-bearing borrowings are stated at amortised cost with any difference between the amount initially recognised and redemption value being recognised in profit or loss over the period of the borrowings, together with any interest and fees payable, using the effective interest method.

 
F-20

 
 
Principal accounting policies (continued)
 
(p) 
Trade and other payables
 
Trade and other payables are initially recognised at fair value.  Except for financial guarantee liabilities measured in accordance with Note 2(r)(i), trade and other payables are subsequently stated at amortised cost unless the effect of discounting would be immaterial, in which case they are stated at cost.
 
(q) 
Cash and cash equivalents
 
Cash and cash equivalents comprise cash at bank and on hand, demand deposits with banks and other financial institutions having been within three months of maturity at acquisition.  Bank overdrafts that are repayable on demand and form an integral part of the Group’s cash management are also included as a component of cash and cash equivalents for the purpose of the consolidated cash flow statements.
 
(r) 
Financial guarantees issued, provisions and contingent liabilities
 
(i) 
Financial guarantees issued
 
Financial guarantees are contracts that require the issuer (i.e. the guarantor) to make specified payments to reimburse the beneficiary of the guarantee (the “holder”) for a loss the holder incurs because a specified debtor fails to make payment when due in accordance with the terms of a debt instrument.
 
Where the Group issues a financial guarantee, the fair value of the guarantee (being the transaction price, unless the fair value can otherwise be reliably estimated) is initially recognised as deferred income within trade and other payables.  Where consideration is received or receivable for the issuance of the guarantee, the consideration is recognised in accordance with the Group’s policies applicable to that category of asset.  Where no such consideration is received or receivable, an immediate expense is recognised in profit or loss on initial recognition of any deferred income.
 
The amount of the guarantee initially recognised as deferred income is amortised in profit or loss over the term of the guarantee as income from financial guarantees issued.  In addition, provisions are recognised in accordance with Note 2(r)(ii) if and when (i) it becomes probable that the holder of the guarantee will call upon the Group under the guarantee, and (ii) the amount of that claim on the Group is expected to exceed the amount currently carried in trade and other payables in respect of that guarantee i.e. the amount initially recognised, less accumulated amortisation.
 
(ii) 
Provisions and contingent liabilities
 
Provisions are recognised for other liabilities of uncertain timing or amount when the Group has a legal or constructive obligation arising as a result of a past event, it is probable that an outflow of economic benefits will be required to settle the obligation and a reliable estimate can be made.  Where the time value of money is material, provisions are stated at the present value of the expenditures expected to settle the obligation.
 
Where it is not probable that an outflow of economic benefits will be required, or the amount cannot be estimated reliably, the obligation is disclosed as a contingent liability, unless the probability of outflow of economic benefits is remote.  Possible obligations, whose existence will only be confirmed by the occurrence or non-occurrence of one or more future events are also disclosed as contingent liabilities unless the probability of outflow of economic benefits is remote.

 
F-21

 
 
Principal accounting policies (continued)
 
(s) 
Defeasance of long-term liabilities
 
Where long-term liabilities have been defeased by the placement of security deposits, those liabilities and deposits (and income and charge arising therefrom) are netted off in order to reflect the overall commercial effect of the arrangements. Such netting off has been effected where a right is held by the Group to insist on net settlement of the liability and deposit including in all situations of default and where that right is assured beyond doubt.
 
(t) 
Deferred benefits and gains
 
In connection with the acquisitions or operating leases 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 amortised as a reduction of rental expense for aircraft and engines under operating leases.
 
(u) 
Income tax
 
Income tax for the year comprises current tax and movements in deferred tax assets and liabilities.  Current tax and movements in deferred tax assets and liabilities are recognised in profit or loss except to the extent that they relate to items recognised in other comprehensive income or directly in equity, in which case the relevant amounts of tax are recognised in other comprehensive income or directly in equity, respectively.
 
Current tax is the expected tax payable on the taxable income for the year, using tax rates enacted or substantively enacted at the balance sheet date, and any adjustment to tax payable in respect of previous years.
 
Deferred tax assets and liabilities arise from deductible and taxable temporary differences respectively, being the differences between the carrying amounts of assets and liabilities for financial reporting purposes and their tax bases.  Deferred tax assets also arise from unused tax losses and unused tax credits.
 
Apart from certain limited exceptions, all deferred tax liabilities, and all deferred tax assets to the extent that it is probable that future taxable profits will be available against which the asset can be utilised, are recognised.  Future taxable profits 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 utilised.
 
The limited exception to the recognition of deferred tax assets and liabilities are those temporary differences arising from goodwill not deductible for tax purposes, the initial recognition of assets or liabilities that affect neither accounting nor taxable profit (provided they are not part of a business combination), and temporary differences relating to investments in subsidiaries to the extent that, in the case of taxable differences, the Group controls the timing of the reversal and it is probable that the differences will not reverse in the foreseeable future, or in the case of deductible differences, unless it is probable that they will reverse in the future.

 
F-22

 
 
Principal accounting policies (continued)
 
(u) 
Income tax (continued)
 
The amount of deferred tax recognised is measured based on the expected manner of realisation or settlement of the carrying amount of the assets and liabilities, using tax rates enacted or substantively enacted at the balance sheet date. Deferred tax assets and liabilities are not discounted.
 
The carrying amount of a deferred tax asset is reviewed at each balance sheet date and is reduced to the extent that it is no longer probable that sufficient taxable profits will be available to allow the related tax benefit to be utilised.  Any such reduction is reversed to the extent that it becomes probable that sufficient taxable profits will be available.
 
Current tax balances and deferred tax balances, and movements therein, are presented separately from each other and are not offset.  Current tax assets are offset against current tax liabilities, and deferred tax assets against deferred tax liabilities, if the 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 realise 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 realise the current tax assets and settle the current tax liabilities on a net basis or realise and settle simultaneously.
 
(v) 
Revenue recognition
 
Revenue is measured at the fair value of the consideration received or receivable.  Provided it is probable that the economic benefits will flow to the Group and the revenue and costs, if applicable, can be measured reliably, revenue is recognised in profit or loss as follows:
 
(i)
Passenger, cargo and mail revenues
 
 
Passenger, cargo and mail revenues are recognised at the fair value of the consideration received 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 recognised when services are rendered.  Revenue is stated net of sales tax.
 
(ii)
Frequent flyer revenue
 
 
The Group maintains two frequent flyer award programmes, namely, the China Southern Airlines Sky Pearl Club and the Egrets Mileage Plus, which provide travel and other awards to members based on accumulated mileages.
 
 
Revenue received in relation to mileage earning flights is allocated, based on fair value, between the flight and mileages earned by members of the Group’s frequent flyer award programmes. The value attributed to the awarded mileages is deferred as a liability, within deferred revenue, until the mileages are ultimately utilised.
 
 
Revenue received from third parties for the issue of mileages under the frequent flyer award programmes is also deferred as a liability, within deferred revenue.

 
F-23

 
 
Principal accounting policies (continued)
 
(v) 
Revenue recognition (continued)
 
(ii)
Frequent flyer revenue (continued)
 
 
As members of the frequent flyer award programmes redeem mileages for an award, revenue is recorded in profit or loss. Revenue in relation to flight awards is recognised when the transportation is provided. Revenue is recognised at the point of redemption where non-flight rewards are selected.
 
 
The value attributed to mileages that are expected to expire is recognised as revenue, based on the number of mileages that have been redeemed relative to the total number expected to be redeemed.
 
(iii)
Rental income receivable under operating leases is recognised in profit or loss in equal instalments over the periods covered by the lease term, except where an alternative basis is more representative of the pattern of benefits to be derived from the use of the leased asset.  Lease incentives granted are recognised in profit or loss as an integral part of the aggregate net lease payments receivables.
 
(iv)
Dividend income is recognised when the shareholder’s right to receive payment is established.
 
(v)
Government grants are recognised in the balance sheet initially when there is reasonable assurance that they will be received and that the Group will comply with the conditions attaching to them.  Grants that compensate the Group for expenses incurred are recognised as revenue in profit or loss on a systematic basis in the same periods in which the expenses are incurred.  Grants that compensate the Group for the cost of an asset are deducted from the carrying amount of the asset and consequently are effectively recognised in profit or loss over the useful life of the asset by way of reduced depreciation expense.
 
(vi)
Interest income is recognised as it accrues using the effective interest method.
 
(w) 
Traffic commissions
 
Traffic commissions are expensed in profit or loss when the transportation is provided and the related revenue is recognised.  Traffic commissions for transportation not yet provided are recorded on the balance sheet as a prepaid expense.

 
F-24

 
 
Principal accounting policies (continued)
 
(x) 
Maintenance and overhaul costs
 
Routine maintenance, repairs and overhauls are charged to profit or loss as and when incurred.
 
In respect of owned and finance 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 recognised 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 derecognised and charged to profit or loss.
 
In respect of aircraft held under operating leases, the Group has responsibility to fulfil certain return conditions under relevant lease agreements.  In order to fulfil these return conditions, major overhauls are required to be conducted on a regular basis.  Accordingly, estimated costs of major overhauls are accrued and charged to profit or loss over the estimated period between overhauls.  After the aircraft has completed its last overhaul cycle prior to being returned, expected cost of overhaul to be incurred at the end of the lease is estimated and accrued over the remaining period of the lease. Differences between the estimated costs and the actual costs of overhauls are charged to profit or loss in the period when the overhaul is performed.
 
(y) 
Borrowing costs
 
Borrowing costs that are directly attributable to the acquisition, construction or production of an asset which necessarily takes a substantial period of time to get ready for its intended use or sale are capitalised as part of the cost of that asset.  Other borrowing costs are expensed in the period in which they are incurred.
 
The capitalisation of borrowing costs as part of the cost of a qualifying asset commences when expenditure for the asset is being incurred, borrowing costs are being incurred and activities that are necessary to prepare the asset for its intended use are in progress.  Capitalisation of borrowing costs is suspended or ceases when substantially all the activities necessary to prepare the qualifying asset for its intended use are interrupted or complete.
 
(z) 
Short term employee benefits and contributions to defined contribution retirement schemes
 
Salaries, annual bonuses and contributions to defined contribution retirement schemes are accrued in the year in which the associated services are rendered by employees.  Where payment or settlement is deferred and the effect would be material, these amounts are stated at their present values.
 
(aa) 
Termination benefits
 
Termination benefits are recognised when, and only when, the Group demonstrably commits itself to terminate employment or to provide benefits as a result of voluntary redundancy by having a detailed formal plan which is without realistic possibility of withdrawal.
 
(bb) 
Translation of foreign currencies
 
Foreign currencies transactions during the year are translated into Renminbi at the applicable rates of exchange quoted by the People’s Bank of China (“PBOC”) prevailing at the transaction dates.  Monetary assets and liabilities denominated in foreign currencies are translated into Renminbi at the PBOC exchange rates prevailing at the balance sheet date.  Exchange gains and losses are recognised in profit or loss.

 
F-25

 
 
2
Principal accounting policies (continued)
 
(bb)
Translation of foreign currencies (continued)
 
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 at the transaction dates.  Non-monetary assets and liabilities denominated in foreign currencies that are stated at fair value are translated into Renminbi at the PBOC exchange rates prevailing at the dates the fair value was determined.
 
(cc)
Non-current assets held for sale
 
A non-current asset is classified as held for sale if it is highly probable that its carrying amount will be recovered through a sale transaction rather than through continuing use and the asset is available-for-sale in its present condition.
 
Immediately before classification as held for sale, the measurement of the non-current assets is brought up-to-date in accordance with the accounting policies before the classification. Then, on initial classification as held for sale and until disposal, the non-current assets (except for certain assets as explained below), are recognised at the lower of their carrying amount and fair value less costs to sell.  The principal exceptions to this measurement policy so far as the consolidated financial statements of the Group are concerned are deferred tax assets, financial assets (other than investments in subsidiaries, associates and jointly controlled entities) and investment properties.  These assets, even if held for sale, would continue to be measured in accordance with the policies set out elsewhere in Note 2.
 
Impairment losses on initial classification as held for sale, and on subsequent remeasurement while held for sale, are recognised in profit or loss.  As long as a non-current asset is classified as held for sale, the non-current asset is not depreciated or amortised.
 
(dd)
Related parties
 
For the purposes of these financial statements, a party is considered to be related to the Group if:
 
(i)
the party has the ability, directly or indirectly through one or more intermediaries, to control the Group or exercise significant influence over the Group in making financial and operating policy decisions, or has joint control over the Group;
 
(ii)
the Group and the party are subject to common control;
 
(iii)
the party is an associate of the Group or a joint venture in which the Group is a venturer;
 
(iv)
the party is a member of key management personnel of the Group or the Group’s parent, or a close family member of such an individual, or is an entity under the control, joint control or significant influence of such individuals;
 
(v)
the party is a close family member of a party referred in (i) or is an entity under the control, joint control or significant influence of such individuals; or
 
(vi)
the party is a post-employment benefit plan which is for the benefit of employees of the Group or of any entity that is a related party of the Group.
 
Close family members of an individual are those family members who may be expected to influence, or be influenced by, that individual in their dealings with the entity.

 
F-26

 
 
2
Principal accounting policies (continued)
 
(ee)
Segmental reporting
 
Operating segments, and the amounts of each segment item reported in the consolidated financial statements, are identified from the financial information provided regularly to the Group’s most senior executive management for the purposes of allocating resources to, and assessing the performance of, the Group’s various lines of business and geographical locations.
 
Individually material operating segments are not aggregated for financial reporting purposes unless the segments have similar economic characteristics and are similar in respect of the nature of products and services, the nature of production processes, the type or class of customers, the methods used to distribute the products or provide the services, and the nature of the regulatory environment.  Operating segments which are not individually material may be aggregated if they share a majority of these criteria.

 
F-27

 
 
3
Changes in accounting policies
 
(a)
Standards, amendment and interpretations effective in 2009
 
The IASB has issued certain new and revised IFRSs and interpretations that are first effective for the current accounting period of the Group. Of these, the following developments are relevant to the Group’s financial statements:
 
IFRS 8, Operating segments
 
IAS 1 (revised 2007), Presentation of financial statements
 
Amendments to IFRS 7, Financial instruments: Disclosures – improving disclosures about financial instruments
 
Improvements to IFRSs (2008)
 
IAS 23, Borrowing costs
 
IAS 27, Consolidated and separate financial statements – cost of an investment in a subsidiary, jointly controlled entity or associate
 
IFRIC 13, Customer loyalty programmes
 
The amendments to Improvements to IFRSs (2008) and IAS 23 have had no material impact on the Group’s financial statements as the amendments and interpretations were consistent with policies already adopted by the Group.  The impact of the remainder of these developments is as follows:
 
IFRS 8 requires segment disclosure to be based on the way that the Group’s chief operating decision maker regards and manages the Group, with the amounts reported for each reportable segment being the measures reported to the Group’s chief operating decision maker for the purposes of assessing segment performance and making decisions about operating matters. This contrasts with the presentation of segment information in prior years which was based on a disaggregation of the Group’s financial statements into segments based on related services and on geographical areas. The adoption of IFRS 8 has resulted in the presentation of segment information in a manner that is more consistent with internal reporting provided to the Group’s chief operating decision maker. Corresponding amounts have been provided on a basis consistent with the revised segment information.
 
As a result of the adoption of IAS 1 (revised 2007), details of changes in equity during the year arising from transactions with equity shareholders in their capacity as such have been presented separately from all other income and expenses in a revised consolidated statement of changes in equity.  All other items of income and expense are presented in the consolidated income statement, if they are recognised as part of profit or loss for the year, or otherwise in a new primary statement, the consolidated statement of comprehensive income.  Corresponding amounts have been restated to conform to the new presentation.  This change in presentation has no effect on reported profit or loss, total income and expense or net assets for any period presented.
 
As a result of the adoption of the amendments to IFRS 7, the consolidated financial statements include expanded disclosures in Note 49(f) about the fair value measurement of the Group’s financial instruments, categorising these fair value measurements into a three-level fair value hierarchy according to the extent to which they are based on observable market data.  The Group has taken advantage of the transitional provisions set out in the amendments to IFRS 7, under which comparative information for the newly required disclosures about the fair value measurements of financial instruments has not been provided.

 
F-28

 
 
3
Changes in accounting policies (continued)
 
(a)
Standards, amendment and interpretations effective in 2009 (continued)
 
The amendments to IAS 27 have removed the requirement that dividends out of pre-acquisition profits should be recognised as a reduction in the carrying amount of the investment in the investee, rather than as income. As a result, as from January 1, 2009 all dividends receivable from subsidiaries, associates and jointly controlled entities, whether out of pre- or post-acquisition profits, will be recognised in the Company’s profit or loss and the carrying amount of the investment in the investee will not be reduced unless that carrying amount is assessed to be impaired as a result of the investee declaring the dividend. In such cases, in addition to recognising dividend income in profit or loss, the Company would recognise an impairment loss. In accordance with the transitional provisions in the amendment, this new policy will be applied prospectively to any dividends receivable in the current or future periods and previous periods have not been restated.
 
During the year ended December 31, 2008, the Group early adopted IFRIC 13, Customer loyalty programmes, which is effective for accounting periods beginning on or after July 1, 2008. The impact of the adoption of IFRIC 13 on the 2008 consolidated financial statements was disclosed in Note 3 to the Group’s financial statements for the year ended December 31, 2008.  Further details of the accounting policy are set out in Note 2(v)(ii).
 
(b) 
Change in accounting policy for property, plant and equipment
 
Under IFRSs, the Group has the option to use the revaluation model or historical cost model to account for its property, plant and equipment (“PP&E”).  Previously, the Group adopted the revaluation model in accordance with IAS 16.  In 2009, the Group changed its IFRS accounting policy in respect of PP&E from the revaluation model to the historical cost model to increase the relevance of financial data to the users of the consolidated financial statements for the following factors:
 
The alignment of the Group’s accounting policy with industry peers - management considers that the historical cost model will improve comparability of certain financial performance data and results of operations of the Group with other airlines.  The valuation model is not commonly used by leading global airlines and the valuation data is generally not relevant to the operation of airlines except upon disposal of aircraft or assessment of impairment of aircraft.
 
Increased comparability between finance and operating leased aircraft – under the old policy the depreciation cost of a finance leased aircraft was based on the revalued amount whereas operating lease payments are based on cost as aircraft held under operating leases are not recognised as assets subject to valuation.  Management therefore considers that the change to the cost model increases the level of consistency in accounting for aircraft which are not distinguished from an operational perspective.
 
The high degree of subjectivity and risk of cyclical volatility associated with external valuation and second hand aircraft fair values – the market value of second hand aircraft can be volatile and is influenced by transactions in global markets that may have little relevance to the operating environment in China. Management does not believe that financial statements that reflect, often subjective, movements in second hand values provide meaningful information to investors.

 
F-29

 
 
3
Changes in accounting policies (continued)
 
(b)
Change in accounting policy for property, plant and equipment (continued)
 
This change in accounting policy has been accounted for retrospectively, and the comparative financial information has also been restated.  This change in accounting policy has no effect on reported profit or loss, total income and expenses or net assets for the years ended December 31, 2007, 2008 and 2009.  The change in accounting policy only resulted in changes in the cost and accumulated depreciation of the PP&E of the same amount with no profit or loss effect as shown in Note 20.  As the effect of change in accounting policy was not material to the consolidated financial statements, no comparative balance sheet as at January 1, 2008 is presented.
 
4
Traffic revenue

   
2009
   
2008
   
2007
 
   
RMB million
   
RMB million
   
RMB million
 
                   
Passenger
    48,488       42,808       44,589  
Cargo and mail
    2,493       2,908       3,248  
Fuel surcharge income
    1,986       8,197       5,359  
      52,967       53,913       53,196  
 
Pursuant to various sales tax rules and regulations, the Group is required to pay sales tax (including business tax and other surcharges) to national and local tax authorities at the rate of approximately 3% of the traffic revenue in respect of domestic flights and international, Hong Kong, Macau and Taiwan flights.  Pursuant to the “Notice of exemption of business tax on fuel surcharge for airline companies” issued jointly by the PRC Ministry of Finance and the State Administration of Taxation, the Group is exempted from business tax on fuel surcharge income received during the period from January 1, 2008 to December 31, 2010.  Sales tax incurred by the Group during the year ended December 31, 2009, netted off against revenue, amounted to RMB1,532 million (2008: RMB1,337 million; 2007: RMB1,574 million). Traffic revenue is stated net of sales tax.
 
5
Other operating revenue

   
2009
   
2008
   
2007
 
   
RMB million
   
RMB million
   
RMB million
 
                   
Commission income
    342       317       281  
General aviation income
    197       133       108  
Ground services income
    320       250       241  
Air catering income
    112       107       81  
Rental income
    116       120       119  
Expired sales in advance of carriage
    350       276       273  
Aircraft lease income
    83       -       -  
Others
    315       172       102  
      1,835       1,375       1,205  

 
F-30

 
 
6
Flight operations expenses

   
2009
   
2008
   
2007
 
   
RMB million
   
RMB million
   
RMB million
 
                   
Jet fuel costs
    16,390       23,086       18,316  
Operating lease charges
                       
 - Aircraft and flight equipment
    4,740       4,166       3,735  
 - Land and buildings
    383       361       320  
Air catering expenses
    1,392       1,363       1,350  
Aircraft insurance
    188       174       207  
Flight personnel payroll and welfare
    2,622       2,490       2,226  
Training expenses
    556       577       517  
Civil Aviation Administration of China
                       
(”CAAC”) Infrastructure Development
                       
Fund contributions
    1,418       1,289       1,250  
Others
    1,607       1,476       1,161  
      29,296       34,982       29,082  
 
7
Maintenance expenses

   
2009
   
2008
   
2007
 
   
RMB million
   
RMB million
   
RMB million
 
                   
Repair and maintenance charges
    3,903       4,406       4,111  
Maintenance materials
    543       484       532  
      4,446       4,890       4,643  
 
8
Aircraft and traffic servicing expenses

   
2009
   
2008
   
2007
 
   
RMB million
   
RMB million
   
RMB million
 
                   
Landing and navigation fees
    6,772       6,135       6,030  
Ground service and other charges
    2,397       2,341       2,130  
      9,169       8,476       8,160  

 
F-31

 
 
9
Promotion and sales expenses

   
2009
   
2008
   
2007
 
   
RMB million
   
RMB million
   
RMB million
 
                   
Sales commissions
    2,539       1,853       1,789  
Ticket office expenses
    1,055       1,055       1,016  
Computer reservation services
    327       331       385  
Advertising and promotion
    52       52       51  
Others
    197       200       180  
      4,170       3,491       3,421  
 
10
General and administrative expenses

   
2009
   
2008
   
2007
 
   
RMB million
   
RMB million
   
RMB million
 
                   
General corporate expenses
    1,760       1,973       1,811  
Auditors’ remuneration
    16       16       16  
Other taxes and levies
    68       52       47  
      1,844       2,041       1,874  
 
11
Depreciation and amortisation

   
2009
   
2008
   
2007
 
   
RMB million
   
RMB million
   
RMB million
 
Depreciation
                 
 - Owned assets
    4,702       4,199       4,232  
 - Assets acquired under finance leases
    1,260       1,560       1,365  
Amortisation of deferred benefits and gains
    (71 )     (71 )     (71 )
Other amortisation
    80       58       28  
      5,971       5,746       5,554  
 
12
Staff costs

   
2009
   
2008
   
2007
 
   
RMB million
   
RMB million
   
RMB million
 
                   
Salaries, wages and welfare
    5,887       5,591       5,130  
Retirement scheme contributions
    567       686       614  
Early retirement benefits (Note 42)
    6       10       12  
      6,460       6,287       5,756  
 
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 6 to 10 above.

 
F-32

 
 
13
Interest expense

   
2009
   
2008
   
2007
 
   
RMB million
   
RMB million
   
RMB million
 
                   
Interest on bank and other loans wholly
                 
repayable within five years
    1,333       1,934       1,986  
Interest on other loans
    120       30       105  
Finance charges on obligations
                       
under finance leases
    471       678       743  
Other interest expense (Note 42)
    14       19       15  
Less:  borrowing costs capitalised
    (441 )     (674 )     (558 )
      1,497       1,987       2,291  
 
The borrowing costs have been capitalised at rates ranging from 1.55% to 3.30% per annum in 2009 (2008: 5.17% to 5.28% per annum; 2007: 5.30% to 5.84% per annum).
 
14
Emoluments of directors, supervisors and senior management
 
Details of directors’ and supervisors’ emoluments for the year ended December 31, 2009 are set out below:

         
Salaries,
                   
         
allowances
                   
         
and
         
Retirement
       
   
Directors’
   
benefits
   
Discretionary
   
scheme
       
Name
 
fees
   
in kind
   
bonuses
   
contributions
   
Total
 
   
RMB’000
   
RMB’000
   
RMB’000
   
RMB’000
   
RMB’000
 
Executive directors
                             
Si Xian Min
    -       698       -       40       738  
Li Wen Xin
    -       608       -       40       648  
Wang Quan Hua
    -       550       -       40       590  
Liu Bao Heng
    -       550       -       40       590  
Tan Wan Geng
    -       672       -       38       710  
Xu Jie Bo
    -       572       -       38       610  
Chen Zhen You
    -       572       -       38       610  
Zhang Zi Fang (Note (ii))
    -       590       -       38       628  
                                         
Supervisors
                                       
Sun Xiao Yi
    -       550       -       40       590  
Yang Guang Hua (Note (iii))
    -       407       -       17       424  
Zhang Wei
    -       345       -       40       385  
Yang Yi Hua
    -       266       -       38       304  
Liang Zhong Gao
    -       269       -       38       307  
Li Jia Shi (Note (iv))
    -       118       -       19       137  
                                         
Independent
                                       
non-executive directors
                                       
Wang Zhi
    50       -       -       -       50  
Sui Guang Jun
    100       -       -       -       100  
Gong Hua Zhang
    100       -       -       -       100  
Lam Kwong Yu
    88       -       -       -       88  
      338       6,767       -       504       7,609  

 
F-33

 
 
14
Emoluments of directors, supervisors and senior management (continued)
 
Details of directors’ and supervisors’ emoluments for the year ended December 31, 2008 are set out below:

         
Salaries,
                   
         
allowances
                   
         
and
         
Retirement
       
   
Directors’
   
benefits
   
Discretionary
   
scheme
       
Name
 
fees
   
in kind
   
bonuses
   
contributions
   
Total
 
   
RMB’000
   
RMB’000
   
RMB’000
   
RMB’000
   
RMB’000
 
Executive directors
                             
Si Xian Min
    -       857       -       60       917  
Li Wen Xin
    -       596       -       80       676  
Wang Quan Hua
    -       535       -       61       596  
Liu Bao Heng (Note (v))
    -       -       -       -       -  
Tan Wan Geng
    -       854       -       59       913  
Xu Jie Bo
    -       711       -       57       768  
Chen Zhen You
    -       711       -       55       766  
Liu Shao Yong (Notes (i) and (vi))
    -       597       -       79       676  
Zhao Liu An (Notes (i) and (vii))
    -       442       -       61       503  
                                         
Supervisors
                                       
Sun Xiao Yi
    -       535       -       61       596  
Yang Guang Hua
    -       712       -       28       740  
Yang Yi Hua
    -       292       -       53       345  
Liang Zhong Gao
    -       296       -       54       350  
Zhang Wei (Note (viii))
    -       282       -       61       343  
                                         
Independent
                                       
non-executive directors
                                       
Wang Zhi
    100       -       -       -       100  
Sui Guang Jun
    100       -       -       -       100  
Gong Hua Zhang
    100       -       -       -       100  
Lam Kwong Yu
    89       -       -       -       89  
      389       7,420       -       769       8,578  

 
F-34

 
 
14
Emoluments of directors, supervisors and senior management (continued)
 
Details of directors’ and supervisors’ emoluments for the year ended December 31, 2007 are set out below:

         
Salaries,
                   
         
allowances
                   
         
and
         
Retirement
       
   
Directors’
   
benefits
   
Discretionary
   
scheme
       
Name
 
fees
   
in kind
   
bonuses
   
contributions
   
Total
 
   
RMB’000
   
RMB’000
   
RMB’000
   
RMB’000
   
RMB’000
 
Executive directors
                             
Si Xian Min
    -       670       -       13       683  
Li Wen Xin
    -       329       -       14       343  
Wang Quan Hua
    -       597       -       14       611  
Tan Wan Geng
    -       542       -       13       555  
Xu Jie Bo
    -       529       -       13       542  
Chen Zhen You
    -       513       -       16       529  
Liu Shao Yong (Notes (i) and (vi))
    -       737       -       14       751  
Zhao Liu An (Notes (i) and (vii))
    -       576       -       14       590  
                                         
Supervisors
                                       
Sun Xiao Yi
    -       597       -       14       611  
Yang Guang Hua
    -       565       -       8       573  
Yang Yi Hua
    -       209       -       16       225  
Liang Zhong Gao (Note (xi))
    -       232       -       12       244  
Liu Biao (Note (ix) and (xi))
    -       134       -       2       136  
                                         
Independent
                                       
non-executive directors
                                       
Peter Lok (Note (x))
    49       -       -       -       49  
Wei Ming Hai (Note (x))
    50       -       -       -       50  
Gong Hua Zhang (Note (xi))
    50       -       -       -       50  
Wang Zhi
    100       -       -       -       100  
Sui Guang Jun
    100       -       -       -       100  
Lam Kwong Yu (Note (xi))
    48       -       -       -       48  
      397       6,230       -       163       6,790  
 
Notes:
 
(i)
The above amounts included salaries paid to these directors as pilots of the Company.
 
(ii)
Appointed on June 30, 2009.
 
(iii)
Resigned on June 30, 2009.
 
(iv)
Appointed on June 30, 2009.
 
(v)
Appointed on December 29, 2008.
 
(vi)
Resigned on December 12, 2008.
 
(vii)
Resigned on September 19, 2008.
 
(viii)
Appointed on June 25, 2008.
 
(ix)
Resigned on January 18, 2008
 
(x)
Retired on June 28, 2007.
 
(xi)
Appointed on June 28, 2007

 
F-35

 
 
15
Other net income
 
   
2009
   
2008
   
2007
 
   
RMB million
   
RMB million
   
RMB million
 
                   
Refund of CAAC infrastructure
                 
development fund
    1,328       -       -  
Government subsidies
    541       901       329  
Gain on sale of available-for-sale equity
                       
securities (Note 17(b))
    78       -       -  
Gain/(loss) on sale of property, plant
                       
and equipment, net
                       
- Aircraft and spare engines
    14       (20 )     106  
- Other property, plant and equipment
    17       (39 )     24  
Others
    11       (9 )     (23 )
      1,989       833       436  
 
Pursuant to the “Notice of refund of CAAC infrastructure development fund” jointly issued by CAAC and the Ministry of Finance of the PRC in 2009, RMB1,328 million of CAAC infrastructure development fund paid for the period from July 1, 2008 to June 30, 2009 was refunded during the year.
 
16
Income tax (credit)/expense
 
(a)
Income tax (credit)/expense in the consolidated income statements

   
2009
   
2008
   
2007
 
   
RMB million
   
RMB million
   
RMB million
 
PRC income tax
                 
Provision for the year
    90       25       408  
Over-provision in prior year
    -       (6 )     (58 )
      90       19       350  
Deferred tax (Note 26)
                       
Origination and reversal of
                       
temporary differences
    327       232       301  
Utilisation of unused tax losses and
                       
deductible temporary differences
                       
not recognised in prior year
                       
(Note 16(b))
    (512 )     -       -  
Effect on deferred tax balances
                       
resulting from a change in tax rate
    -       (189 )     196  
      (185 )     43       497  
Income tax (credit)/expense
    (95 )     62       847  
 
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 both the current and prior years.

 
F-36

 
 
16
Income tax (credit)/expense (continued)
 
(a)
Income tax expense in the consolidated income statements (continued)
 
The Corporate Income Tax Law of the PRC (“new tax law”) took effect on January 1, 2008 and the statutory income tax rate adopted by the Company and its subsidiaries has been changed from 33% to 25% with effect from January 1, 2008.
 
Pursuant to the new tax law, the income tax rates of entities that previously enjoyed preferential tax rates of 15% and 18% have been revised to 18%, 20%, 22%, 24% and 25% for 2008, 2009, 2010, 2011 and 2012 onwards respectively.
 
(b)          Reconciliation between actual tax (credit)/expense and calculated tax based on accounting profit/(loss) at applicable tax rates

   
2009
   
2008
   
2007
 
   
RMB million
   
RMB million
   
RMB million
 
                   
Profit/(loss) before taxation
    432       (4,724 )     2,879  
                         
Notional tax on profit/(loss) before taxation,
                       
calculated at the rates applicable to
                       
profit/(loss) in the tax jurisdictions
                       
concerned (Note (i))
    87       (913 )     474  
Adjustments for tax effect of:
                       
Non-deductible expenses
    63       64       250  
Non-taxable income
                       
  - Share of results of associates
                       
    and jointly controlled entities
    (76 )     (38 )     (36 )
  - Others
    (20 )     -       -  
Recognition of taxable temporary
                       
difference on asset classified as held
                       
for sale
    67       -       -  
Unused tax losses not recognised
    216       566       28  
Deductible temporary differences
                       
not recognised
    -       577       -  
Utilisation of unused tax losses and
                       
deductible temporary differences not
                       
recognised in prior year (Note 16(a)/Note (ii))
    (512 )     -       -  
Difference in tax rates (Note (ii))
    81       -       -  
Effect of change in tax rate (Note (iii))
    -       (189 )     196  
Over provision in prior years
    -       (6 )     (58 )
Others
    (1 )     1       (7 )
Actual tax (credit)/expense
    (95 )     62       847  

Notes:
 
(i)
The headquarters of the Company and its branches are taxed at rates ranging from 20% to 25% (2008: 18% to 25%; 2007: 15% to 33%).  The subsidiaries of the Group are taxed at rates ranging from 15% to 25% (2008: 15% to 25%; 2007: 7.5% to 33%).

 
F-37

 
 
16
Income tax (credit)/expense (continued)
 
(b)          Reconciliation between actual tax (credit)/expense and calculated tax based on accounting profit/(loss) at applicable tax rates (continued)
 
 (ii)
The Company increased its retained earnings under PRC Accounting Standards for Business Enterprises (“PRC GAAP”) as a result of changes in accounting policies in 2003 and 2007.  As at December 31, 2008, the Company recognised deferred tax liabilities of RMB498 million and an income tax payable of RMB112 million in respect of the increase in retained earnings of RMB3,320 million in 2003 and RMB627 million in 2007, respectively in the financial statements prepared under IFRSs.  In 2009, the Company agreed with the local tax authority that the above deferred tax liabilities and income tax payable would be settled from 2009 to 2011.
 
 (iii)
The deferred tax assets and liabilities as at December 31, 2008 and 2007 have been remeasured for the change in applicable tax rates as a result of enactment of regulations governing administration of income tax among headquarters and branches in 2008, and the new tax law and certain detailed implementation rules in 2007, respectively.
 
17
Other comprehensive income
 
(a)
Tax effects relating to each component of other comprehensive income
 
   
2009
   
2008
   
2007
 
   
Before-tax
   
Tax
   
Net-of-tax
   
Before-tax
   
Tax
   
Net-of-tax
   
Before-tax
   
Tax
   
Net-of-tax
 
   
amount
   
expense
   
amount
   
amount
   
benefit
   
amount
   
amount
   
expense
   
amount
 
   
RMB
   
RMB
   
RMB
   
RMB
   
RMB
   
RMB
   
RMB
   
RMB
   
RMB
 
   
million
   
million
   
million
   
million
   
million
   
million
   
million
   
million
   
million
 
Available-for-sales securities:
                                                     
net movement in fair value reserve
    39       (9 )     30       (248 )     56       (192 )     282       (64 )     218  
 
(b)
Reclassification adjustments relating to components of other comprehensive income
 
   
2009
   
2008
   
2007
 
   
RMB million
   
RMB million
   
RMB million
 
                   
Available-for-sale securities:
                 
Changes in fair value recognised
                 
during the year
    117       (248 )     282  
Reclassification adjustment for amount
                       
transferred to profit or loss:
                       
- gain on disposal (Note 15)
    (78 )     -          
Net deferred tax (debited)/credited to
                       
other comprehensive income
                       
(Note 26(a))
 
(9
    56       (64 )
Net movement in the fair value reserve
                       
during the year recognised in other
                       
comprehensive income
    30       (192 )     218  
 
18
Dividends
 
The board of directors of the Company does not recommend the payment of a dividend in respect of the year ended December 31, 2009.
 
No dividend was paid in respect of the year ended December 31, 2008 and 2007.

 
F-38

 
 
Earnings/(loss) per share
 
The calculation of basic earnings/(loss) per share for the year ended December 31, 2009 is based on the profit attributable to equity shareholders of the Company of RMB330 million (2008 loss of RMB4,823 million; 2007 profit of RMB1,839 million) and the weighted average number of 7,084,842,000 shares in issue during the year (2008 and 2007: 6,561,267,000 shares).

   
2009
   
2008
   
2007
 
   
Million shares
   
Million shares
   
Million shares
 
                   
Issued ordinary shares at January 1
    6,561       4,374       4,374  
Effect of bonus share issue (Note 43)
    -       2,187       2,187  
Effect of issuance of A shares (Note 43)
    263       -       -  
Effect of issuance of H shares (Note 43)
    261       -       -  
Weighted average number of
                       
ordinary shares at December 31
    7,085       6,561       6,561  
 
The amounts of diluted earnings per share are the same as basic earnings per share as there were no dilutive potential ordinary shares in existence for both the current and prior years.

 
F-39

 
 
20
Property, plant and equipment, net

               
Aircraft
   
Other
             
                     
Acquired
   
flight
   
Machinery,
       
                     
under
   
equipment,
   
equipment
       
   
Investment
               
finance
   
including
   
and
       
   
properties
   
Buildings
   
Owned
   
leases
   
rotables
   
vehicles
   
Total
 
   
RMB
   
RMB
   
RMB
   
RMB
   
RMB
   
RMB
   
RMB
 
   
million
   
million
   
million
   
million
   
million
   
million
   
million
 
Cost:
                                         
                                           
At January 1, 2008
                                         
-as previously reported
    266       6,792       37,389       25,783       10,689       3,448       84,367  
-prior period adjustment
    -       (223 )     1,243       -       -       -       1,020  
-as restated (Note 3(b))
    266       6,569       38,632       25,783       10,689       3,448       85,387  
Additions
    -       36       683       288       739       307       2,053  
Transfer from construction
                                                       
in progress (Note 21)
    -       180       56       101       152       22       511  
Reclassification on exercise
                                                       
of purchase options
    -       -       4,784       (4,784 )     -       -       -  
Reclassification in respect
                                                       
of sale and lease back
                                                       
(finance lease)
    -       -       (640 )     640       -       -       -  
Reclassification from
                                                       
lease prepayments
    98       -       -       -       -       -       98  
Disposals
    -       (45 )     (828 )     (96 )     (271 )     (193 )     (1,433 )
Other reclassifications
    412       (555 )     -       190       (190 )     143       -  
At December 31, 2008
                                                       
(Restated, Note 3(b))
    776       6,185       42,687       22,122       11,119       3,727       86,616  
                                                         
At January 1, 2009
                                                       
(Restated, Note 3(b))
    776       6,185       42,687       22,122       11,119       3,727       86,616  
Additions
    -       67       4,490       2,326       1,067       402       8,352  
Transfer from construction
                                                       
in progress (Note 21)
    -       356       7,603       102       150       104       8,315  
Reclassification on exercise
                                                       
of purchase options
    -       -       2,586       (2,586 )     -       -       -  
Reclassification to
                                                       
lease prepayments
    (12 )     -       -       -       -       -       (12 )
Disposals
    -       (36 )     (1,209 )     (37 )     (480 )     (109 )     (1,871 )
Other reclassifications
    (181 )     179       (77 )     -       77       2       -  
At December 31, 2009
    583       6,751       56,080       21,927       11,933       4,126       101,400  

 
F-40

 

20
Property, plant and equipment, net (continued)

               
Aircraft
   
Other
             
                     
Acquired
   
flight
   
Machinery,
       
                     
under
   
equipment,
   
equipment
       
   
Investment
               
finance
   
including
   
and
       
   
properties
   
Buildings
   
Owned
   
leases
   
rotables
   
vehicles
   
Total
 
   
RMB
   
RMB
   
RMB
   
RMB
   
RMB
   
RMB
   
RMB
 
   
million
   
million
   
million
   
million
   
million
   
million
   
million
 
Accumulated
                                         
  depreciation and
                                         
  impairment losses:
                                         
                                           
At January 1, 2008
                                         
-as previously reported
    69       1,257       11,567       4,509       6,289       2,235       25,926  
-prior period adjustment
    -       (223 )     1,243       -       -       -       1,020  
-as restated (Note 3(b))
    69       1,034       12,810       4,509       6,289       2,235       26,946  
Charge for the year
    14       232       2,752       1,560       835       366       5,759  
Reclassification on exercise
                                                       
of purchase options
    -       -       2,050       (2,050 )     -       -       -  
Reclassification in respect
                                                       
of sale and lease back
                                                       
(finance lease)
    -       -       (15 )     15       -       -       -  
Reclassification from
                                                       
lease prepayments
    6       -       -       -       -       -       6  
Disposals
    -       (14 )     (732 )     (65 )     (240 )     (165 )     (1,216 )
Other reclassifications
    47       (62 )     -       50       (50 )     15       -  
Impairment losses (Note (g))
    -       3       1,741       50       90       -       1,884  
At December 31, 2008
                                                       
(Restated, Note 3(b))
    136       1,193       18,606       4,069       6,924       2,451       33,379  
                                                         
At January 1, 2009
                                                       
(Restated, Note 3(b))
    136       1,193       18,606       4,069       6,924       2,451       33,379  
Charge for the year
    19       234       3,260       1,260       844       345       5,962  
Reclassification on exercise
                                                       
of purchase options
    -       -       1,354       (1,354 )     -       -       -  
Reclassification to
                                                       
lease prepayments
    (1 )     -       -       -       -       -       (1 )
Disposals
    -       (11 )     (970 )     (37 )     (428 )     (93 )     (1,539 )
Other reclassifications
    (32 )     31       (66 )     -       66       1       -  
Impairment losses (Note (g))
    -       -       -       -       26       -       26  
Impairment written off
                                                       
on disposal
    -       -       (97 )     -       (3 )     -       (100 )
At December 31, 2009
    122       1,447       22,087       3,938       7,429       2,704       37,727  
                                                         
Net book value:
                                                       
At December 31, 2009
    461       5,304       33,993       17,989       4,504       1,422       63,673  
At December 31, 2008
    640       4,992       24,081       18,053       4,195       1,276       53,237  
 
(a)           Most of the Group’s buildings are located in the PRC.  The Group was formally granted the rights to use the thirty-two parcels of land in Guangzhou, Shenzhen, Zhuhai, Beihai, Changsha, Shantou, Haikou, Zhengzhou, Jilin, Guiyang and Wuhan, etc. by the relevant PRC authorities for periods of 30 to 70 years, which expire between 2020 and 2073.  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 three years pursuant to various lease agreements between the Company and CSAHC.  In this connection, rental payments in respect of land use rights totalling RMB22 million were paid to CSAHC during 2009 (2008 and 2007: RMB22 million) in respect of these leases.

 
F-41

 
 
20
Property, plant and equipment, net (continued)
 
(b)           As at December 31, 2009, certain aircraft, land use rights and investment properties of the Group with an aggregate carrying value of approximately RMB34,384  million (2008: RMB29,321 million) were mortgaged under certain loan and lease agreements (Notes 33 and 35).
 
(c)           The Group leased out investment properties and certain flight training facilities under operating leases.  The leases typically run for an initial period of five to fifteen years, with an option to renew the lease after that date at which time all terms are renegotiated.  None of the leases includes contingent rentals.  In this connection, rental income totalling RMB62 million (2008: RMB54 million; 2007: RMB49 million) was received by the Group during the year in respect of the leases.
 
All properties held under operating leases that would otherwise meet the definition of investment property are classified as investment property.
 
The Group’s total future minimum lease payments under non-cancellable operating leases are receivable as follows:

   
2009
   
2008
 
   
RMB million
   
RMB million
 
             
Within 1 year
    56       64  
After 1 year but within 5 years
    182       203  
After 5 years
    111       154  
      349       421  
 
As at December 31, 2009, the net book value of the aircraft and flight training facilities leased out by the Group under operating leases amounted to RMB52 (2008: RMB63 million).
 
(d)           The investment properties are located in the PRC, where comparable market transactions are infrequent.  In the absence of the current or recent prices in an active market and alternative reliable estimates of fair value (for example, discounted cash flow projection) are not available, the Group could not reliably determine the fair value of the investment properties.
 
(e)           The Company entered into two separate arrangements (the “Arrangements”) with certain independent third parties during each of 2002 and 2003.  Under each of the Arrangements, the Company sold an aircraft and then immediately leased back the aircraft for an agreed period.  The Company has an option to purchase the aircraft at a pre-determined date.  In the event that the lease agreement is early terminated by the Company, the Company is liable to pay a pre-determined penalty to the lessor.  Provided that the Company complies with the lease agreements, the Company is entitled to the continued possession and operation of the aircraft.  Since the Company retains substantially all risks and rewards incidental 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.
 
(f)           As at December 31, 2009 and up to the date of approval of these 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 Guangzhou (including Guangzhou Baiyun International Airport), Xiamen, Heilongjiang, Hainan, Jilin, Dalian, Hunan, Xinjiang, Henan and Shenzhen, in which the Group has interests and for which such certificates have not been granted.  As at December 31, 2009, carrying value of such properties of the Group amounted to RMB2,638 million (2008: RMB2,331 million).  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.

 
F-42

 
 
20
Property, plant and equipment, net (continued)
 
(g)           During the year, in view of the age of the Group’s fleet of ATR72 aircraft, the Group determined to dispose of these aircraft and commenced its process of seeking buyers for these aircraft. As a result, the Group assessed the recoverable amounts of these aircraft and related fleet assets. The carrying amount of the related fleet assets was written down by RMB26 million. The estimates of recoverable amounts were based on the assets’ fair value less costs to sell, determined by reference to the recent observable market prices for the aircraft fleet and related fleet assets.
 
In 2008, in view of the age and operating efficiency of the Group’s fleet of Boeing 777-200A aircraft, Airbus 300 aircraft and McDonnell Douglas 90 aircraft, the Group determined to dispose and commenced its process of seeking buyers for these aircraft.  As a result, the Group assessed the recoverable amounts of these aircraft and the related fleet assets.  The carrying amount of the aircraft and the related fleet assets was written down by RMB1,590 million.  The estimates of recoverable amounts were based on the aircraft’s fair value less costs to sell, determined by reference to observable market prices for the respective model of aircraft.  In addition, in 2008, there had been a decrease in demand of cargo transportation services as a result of the economic conditions, and that the operating efficiency of the Group’s cargo freighters Boeing 747 was not satisfactory due to lack of economy of scale for the existing small fleet of cargo freighters.  The Group assessed the recoverable amounts of its cargo freighters and the related fleet assets, the carrying amount of the cargo freighters was written down by RMB291 million.  The estimates of recoverable amounts were based on the aircraft’s fair value less costs to sell, determined by reference to the observable market prices for the cargo freighters.
 
In 2007, in view of the age of the Group’s fleet of MD82 aircraft, the Group disposed of 11 MD82 aircraft and assessed the recoverable amounts of the remaining 12 MD82 aircraft.  Based on this assessment, the carrying amount of the aircraft was written down by RMB109 million and recognised as an impairment loss during the year ended December 31, 2007.  The estimates of recoverable amount were based on the aircraft’s fair value less costs to sell, determined by reference to observable market prices for MD82 aircraft.
 
21
Construction in progress

   
2009
   
2008
 
   
RMB million
   
RMB million
 
             
At January 1
    17,321       11,385  
Additions
    9,070       10,711  
Transferred to property, plant
               
and equipment (Note 20)
    (8,315 )     (511 )
Transferred to other assets upon
               
completion of development
    (17 )     (112 )
Transferred out in respect of sales and
               
lease back of aircraft
    -       (4,135 )
Other decrease
    -       (17 )
At December 31
    18,059       17,321  

 
F-43

 
 
21
Construction in progress (continued)
 
The construction in progress as at December 31, 2009 mainly related to advance payments for acquisition of aircraft and flight equipment and progress payments for other construction projects at the Guangzhou, Hainan, Shenzhen and Fuzhou airports, Shanghai Pudong Airport Base, Shanghai Hongqiao Airport Base and Beijing Branch.
 
As at December 31, 2009, advance payments for acquisition of aircraft of the Group of approximately RMB7,601million (2008: RMB6,337 million) were mortgaged under certain loan agreements (Note 33).
 
In 2008, the Company entered into agreements with certain third party lessors to sell 14 aircraft to the lessors prior to the deliveries of these aircraft and then lease back the aircraft from the lessors in the form of operating leases.  Upon delivery of aircraft, the advance payments paid to aircraft manufacturers and the related interest costs capitalised in respect of the aircraft included in construction in progress were transferred out to calculate the gain or loss on sales and lease back.
 
22
Interest in associates
 
   
2009
   
2008
 
   
RMB million
   
RMB million
 
             
Share of net assets
    257       235  
 
The details of the Group’s principal associates are set out in Note 58, all of which are unlisted corporate entities.
 
Summary of financial information on associates:

   
100 Percent
   
Group’s effective interest
 
   
2009
   
2008
   
2007
   
2009
   
2008
   
2007
 
   
RMB
   
RMB
   
RMB
   
RMB
   
RMB
   
RMB
 
   
million
   
million
   
million
   
million
   
million
   
million
 
                                     
Non-current assets
    11,190       9,587             4,210       3,546        
Current assets
    3,597       5,524             986       1,158        
Non-current liabilities
    (7,347 )     (6,314 )           (2,861 )     (2,460 )      
Current liabilities
    (6,837 )     (8,213 )           (2,229 )     (2,135 )      
Net assets
    603       584             106       109        
Net liabilities not
                                           
shared by the Group
                          151       126        
                                             
                            257       235        
                                             
Revenue
    7,123       5,761       5,635       2,750       2,234       2,184  
Expenses
    (7,009 )     (6,071 )     (5,471 )     (2,715 )     (2,312 )     (2,127 )
Profit/(loss) for the year
    114       (310 )     164       35       (78 )     57  
Net loss not
                                               
shared by the Group
                            34       66       -  
The Group’s share of associates’ results
                            69       (12 )     57  
 
During the year, an associate of the Group was in a net liability position.  The Group only shared its losses up to the Group’s investment cost in the associate.

 
F-44

 

23
Interest in jointly controlled entities

   
2009
   
2008
 
   
RMB million
   
RMB million
 
             
Share of net assets
    728       1,048  
 
The details of the Group’s principal jointly controlled entities are set out in Note 58, all of which are unlisted corporate entities.  Major changes in investments in jointly controlled entities during the year are summarised below:
 
·
During the year, the Company acquired 50% equity interest in a jointly controlled entity of the Company, Beijing Southern Airlines Ground Services Company Limited (“Beijing Ground Services”) from the other venturer, which has become a wholly-owned subsidiary of the Company. The carrying amount of Beijing Ground Services was RMB18 million as at December 31, 2009.
 
·
During the year, the Company entered into an agreement with CSAHC to dispose of its entire equity interest in MTU Maintenance Zhuhai Co., Ltd. (“MTU”) with carrying amount of RMB529 million to CSAHC.  As at December 31, 2009, the investment in MTU was classified as asset held for sale.  Please refer to Note 32 for more details
 
Summary of financial information on jointly controlled entities:

   
Group’s effective interest
 
   
2009
   
2008
   
2007
 
   
RMB million
   
RMB million
   
RMB million
 
                   
Non-current assets
    812       986        
Current assets
    547       1,226        
Non-current liabilities
    (231 )     (291 )      
Current liabilities
    (400 )     (873 )      
Net assets
    728       1,048        
                       
Revenue
    1,973       2,382       1,885  
Expenses
    (1,759 )     (2,212 )     (1,762 )
Profit for the year
    214       170       123  
 
24
Other investments in equity securities
 
   
2009
   
2008
 
   
RMB million
   
RMB million
 
             
Unlisted equity securities, at cost
    166       166  
 
Dividend income from unlisted securities of the Group amounted to RMB10 million during the year ended December 31, 2009 (2008: RMB13 million; 2007: RMB10 million).

 
F-45

 
 
25
Available-for-sale equity securities
 
   
2009
   
2008
 
   
RMB million
   
RMB million
 
Available-for-sale securities
           
- Listed in the PRC
    93       114  
                 
Market value of listed securities
    93       114  
 
During the year, the Group disposed of certain equity securities with carrying amount of RMB138 million and recorded a gain on disposal of RMB78 million.
 
Dividend income from listed securities of the Group amounted to RMB2 million during the year ended December 31, 2009 (2008: RMB1 million; 2007: RMB2 million).
 
26
Deferred tax assets/(liabilities)
 
(a)
Movements of net deferred tax assets/(liabilities) are as follows:

   
2009
   
2008
 
   
RMB million
   
RMB million
 
             
At January 1
    (594 )     (607 )
Credited/(charged) to profit or loss (Note (16(a))
    185       (43 )
(Charged)/credited to other comprehensive
               
income (Note (17(b))
    (9 )     56  
Transfer to income tax payable
    44       -  
At December 31
    (374 )     (594 )

 
F-46

 
 
26
Deferred tax assets/(liabilities) (continued)
 
(b)
The components of deferred tax assets/(liabilities) recognised are analysed as follows:
 
   
2009
   
2008
 
   
RMB million
   
RMB million
 
Deferred tax assets:
           
Accrued expenses
    599       574  
Deferred revenue
    118       136  
Others
    52       53  
Total deferred tax assets
    769       763  
                 
Deferred tax liabilities:
               
Accrued expenses
    (334 )     (278 )
Depreciation allowances in excess of the
               
related depreciation
    (672 )     (1,071 )
Change in fair value of available-for-sale
               
equity securities
    (17 )     (8 )
Asset classified as held for sale
    (67 )     -  
Others
    (53 )     -  
Total deferred tax liabilities
    (1,143 )     (1,357 )
Net deferred tax liabilities
    (374 )     (594 )

   
2009
   
2008
 
   
RMB million
   
RMB million
 
Net deferred tax asset recognised on
           
the consolidated balance sheet
    479       167  
Net deferred tax liability recognised
               
on the consolidated balance sheet
    (853 )     (761 )
      (374 )     (594 )

 
F-47

 
 
26
Deferred tax assets/(liabilities) (continued)
 
(c)
Deferred tax assets not recognised
 
At December 31, 2009, deferred tax assets were not recognised in relation to certain unused tax losses and other deductible temporary differences. The unrecognised unused tax losses and deductible temporary differences are analysed as follows:

   
2009
   
2008
 
   
RMB
   
RMB
 
   
million
   
million
 
             
Tax losses
    1,720       3,251  
Other deductible temporary differences:
               
- Accrued expenses
    499       637  
- Provision for impairment losses
    1,916       1,990  
      2,415       2,627  
      4,135       5,878  
 
At December 31, 2009, the Group’s deductible temporary differences amounting to RMB2,415 million (2008: RMB2,627 million) have not been recognised as deferred tax assets as it was determined by management that it is not probable that future taxable profits will be available for these deductible temporary differences to reverse in the foreseeable future.
 
Tax losses in the PRC are available for carry forward to set off future assessable incomes for a maximum period of five years.  The Group’s unused tax losses of RMB1,720 million (2008: RMB3,251 million) have not been recognised as deferred tax assets, as it was determined by management that it is not probable that future taxable profits against which the losses can be utilised will be available before they expire.  The expiry dates of unrecognised unused tax losses are analysed as follows:

   
2009
   
2008
 
   
RMB million
   
RMB million
 
Expiring in:
           
             
2011
    309       309  
2012
    92       92  
2013
    373       2,850  
2014
    946       -  
      1,720       3,251  

 
F-48

 
 
27
Other assets
 
Other assets of the Group mainly include lump sum housing benefits (Note 46(b)(ii)), computer software used for airline operation and prepayment for exclusive use right of an airport terminal.
 
Movements of lump sum housing benefits, computer software and prepayment for exclusive use of right of an airport terminal are as follows:
               
Prepayment
 
               
for exclusive
 
   
Lump sum
         
use right of
 
   
housing
   
Computer
   
an airport
 
   
benefits
   
software
   
terminal
 
   
RMB million
   
RMB million
   
RMB million
 
                   
At January 1, 2008
    119       149       150  
Additions
    -       1       -  
Amortisation for the year
    (26 )     (41 )     -  
At December 31, 2008
    93       109       150  
                         
At January 1, 2009
    93       109       150  
Additions
    -       32       150  
Amortisation for the year
    (26 )     (45 )     -  
At December 31, 2009
    67       96       300  
 
28
Financial liabilities
 
   
2009
   
2008
 
   
RMB million
   
RMB million
 
             
Foreign exchange forward option
    44       116  
 
Further disclosure of the financial derivative instruments are set out in Note 49(c) and (f).
 
29
Inventories
 
   
2009
   
2008
 
   
RMB million
   
RMB million
 
             
Expendable spare parts and maintenance materials
    1,112       1,094  
Other supplies
    144       135  
      1,256       1,229  
 
The analysis of the amount of inventories recognised as an expense and included in profit or loss is as follows:

   
2009
   
2008
   
2007
 
   
RMB million
   
RMB million
   
RMB million
 
                   
Consumption
    887       828       836  
Write-down of inventories
    30       189       101  
      917       1,017       937  
 
Inventories have been written down as a result of fleet adjustments during the current and prior years.

 
F-49

 
 
30
Trade receivables
 
   
2009
   
2008
 
   
RMB million
   
RMB million
 
             
Trade receivables
    1,389       1,348  
Allowance for doubtful debts
    (30 )     (31 )
      1,359       1,317  
 
(a)
Ageing analysis
 
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 allowance for doubtful debts, is set out below:
   
2009
   
2008
 
   
RMB million
   
RMB million
 
             
Within 1 month
    1,191       1,123  
More than 1 month but less than 3 months
    147       182  
More than 3 months but less than 12 months
    21       11  
More than 12 months
    -       1  
      1,359       1,317  
 
All of the trade receivables are expected to be recovered within one year.
 
(b)
Impairment of trade receivables
 
Impairment loss in respect of trade receivables is recorded using an allowance account unless the Group is satisfied that recovery of the amount is remote, in which case the impairment loss is written off against trade receivables directly.
 
The movements in the allowance for doubtful debts during the year are as follows:

   
2009
   
2008
 
   
RMB million
   
RMB million
 
             
At January 1
    31       33  
Impairment loss recognised
    14       -  
Impairment loss written back
    (13 )     -  
Uncollectible amounts written off
    (2 )     (2 )
At December 31
    30       31  
 
(c)
Trade receivables that are not impaired
 
The ageing analysis of trade receivables that is neither individually nor collectively considered to be impaired is as follows:

   
2009
   
2008
 
   
RMB million
   
RMB million
 
             
Neither past due nor impaired
    1,338       1,305  
 
Trade receivables that were neither past due nor impaired relate to customers for whom there was no recent history of default.

 
F-50

 
 
31
Cash and cash equivalents
 
(a)
Cash and cash equivalents comprise:

   
2009
   
2008
 
   
RMB million
   
RMB million
 
             
Deposits with banks
    1,116       1,998  
Cash at bank and in hand
    3,227       2,651  
Cash and cash equivalents in the consolidated balance sheet
    4,343       4,649  
 
Southern Airlines Group Finance Company Limited (“SA Finance”) is a PRC authorised financial institution controlled by CSAHC and is an associate of the Group.  In accordance with the financial agreement dated May 22, 1997, as revised subsequently on December 31, 2004 and November 15, 2007 between the Company and SA Finance, all of the Group’s deposits accepted by SA Finance would be simultaneously placed with several designated major PRC banks by SA Finance.  As at December 31, 2009, the Group’s deposits with SA Finance amounted to RMB862 million (2008: RMB1,139 million) (Note 45(d)).

 
F-51

 
 
31
Cash and cash equivalents (continued)

(b) Reconciliation of profit/(loss) before taxation to cash generated from operations:

         
2009
   
2008
   
2007
 
   
Note
   
RMB million
   
RMB million
   
RMB million
 
                         
Profit/(loss) before taxation
          432       (4,724 )     2,879  
Depreciation of property, plant and equipment
 
20
      5,962       5,759       5,597  
Other amortisation
 
11
      80       58       28  
Amortisation of deferred benefits and gains
 
11
      (71 )     (71 )     (71 )
Impairment loss on property, plant and equipment
 
  
      26       1,884       109  
Share of associates’ results
 
22
      (69 )     12       (57 )
Share of jointly controlled entities’ results
 
23
      (214 )     (170 )     (123 )
(Gain)/loss on sale of property, plant and equipment, net
 
15
      (31 )     59       (130 )
Gain on sale of available-for-sale equity securities
 
15
      (78 )     -       -  
Gain on sale of other investment in equitiy securities
          -       -       (107 )
Gain on sale of a jointly controlled entity
          -       (143 )     -  
Gain on sale of equity interest in subsidiaries
          -       (37 )     (7 )
Interest income
          (68 )     (103 )     (73 )
Interest expense
 
13
      1,497       1,987       2,291  
(Gain)/Loss on derivative financial instruments, net
          (45 )     124       (90 )
Dividend income from other investments in equity securities
          (14 )     (14 )     (12 )
Unrealised exchange gain, net
          (70 )     (2,649 )     (2,832 )
(Increase)/decrease in inventories
          (27 )     (16 )     108  
(Increase)/decrease in trade receivables
          (42 )     649       (349 )
(Increase)/decrease in other receivables
          (15 )     203       156  
Increase in prepaid expenses and other current assets
          (91 )     (28 )     (8 )
(Decrease)/increase in net amounts due to related companies
          (48 )     15       (50 )
Increase/(decrease) in trade and bills payables
          3,639       (491 )     (95 )
(Decrease) /increase in sales in advance of carriage
          (48 )     353       451  
(Decrease)/increase in accrued expenses
          (49 )     1,274       1,790  
Increase/(decrease) in other liabilities
          353       (36 )     245  
Increase in deferred revenue
          204       116       98  
Increase/(decrease) in provision for major overhauls
          8       262       (122 )
Decrease in provision for early retirement benefits
          (31 )     (51 )     (76 )
Increase in deferred benefits and gains
          42       34       148  
Cash generated from operations
          11,232       4,256       9,698  

 
F-52

 
 
32
Asset classified as held for sale
 
   
2009
   
2008
 
   
RMB million
   
RMB million
 
             
Share of net assets
    529       -  
 
In accordance with a Transfer Agreement dated September 28, 2009 and a Supplemental Transfer Agreement dated December 29, 2009, entered into between the Company and CSAHC, the Company agreed to sell and CSAHC agreed to acquire the 50% equity interest in MTU, a jointly controlled entity of the Company.  As at December 31, 2009, the sale was approved by the State Owned Assets Supervision and Administration Commission of the PRC and shareholders of Company and was pending approval by the Ministry of Commerce of the PRC.  The sales was subsequently approved by the Ministry of Commerce of the PRC in January 2010, and the Company received the acquisition consideration from CSAHC in full in February 2010.
 
33
Bank and other loans
 
(a)
At December 31, 2009, bank and other loans were repayable as follows:

   
2009
   
2008
 
   
RMB million
   
RMB million
 
             
Within 1 year or on demand
    17,452       22,178  
                 
After 1 year but within 2 years
    8,223       6,104  
After 2 years but within 5 years
    12,038       10,343  
After 5 years
    7,614       982  
      27,875       17,429  
      45,327       39,607  
 
(b)
At December 31, 2009, bank and other loans are analysed as follows:

   
2009
   
2008
 
   
RMB million
   
RMB million
 
             
Short-term bank loans
    11,012       18,232  
Long-term bank and other loans due within
               
one year (classified as current liabilities)
    6,440       3,946  
      17,452       22,178  
Long-term bank and other loans due after one
               
year (classified as non-current liabilities)
    27,875       17,429  
      45,327       39,607  
                 
Representing:
               
Bank loans
    45,324       39,604  
Other loans
    3       3  
      45,327       39,607  

 
F-53

 
 
33
Bank and other loans (continued)
 
(c)          As at December 31, 2009, the Group’s weighted average interest rates on short-term borrowings were 1.18% per annum (2008: 4.48% per annum).
 
(d)
Details of bank and other loans with original maturity over one year are as follows:

   
2009
   
2008
 
   
RMB million
   
RMB million
 
Renminbi denominated loans
           
Non-interest bearing loan from a
           
municipal government authority
    3       3  
                 
Floating interest rates ranging from 90% to 91% of
               
benchmark interest rate (stipulated by PBOC) as
               
at December 31, 2009, with maturities through 2013
    5,660       7,647  
                 
United States Dollars denominated loans
               
Fixed interest rates ranging from 3.26% to 7.20%
               
per annum as at December 31, 2009, with
               
maturities through 2015
    772       994  
                 
Floating interest rates ranging from 1-month
               
LIBOR + 0.50% to 1.20% per annum as at
               
December 31, 2009, with maturities through 2019
    4,681       -  
                 
Floating interest rates ranging from 3-month
               
LIBOR + 0.45% to 1.20% per annum as at
               
December 31, 2009, with maturities through 2019
    13,937       1,343  
                 
Floating interest rates ranging from 6-month
               
LIBOR + 0.30% to 2.30% per annum as at
               
December 31, 2009, with maturities through 2019
    9,262       11,388  
      34,315       21,375  
Less:  loans due within one year classified
               
as current liabilities
    (6,440 )     (3,946 )
      27,875       17,429  

 
F-54

 
 
33
Bank and other loans (continued)
 
(e)          The remaining contractual maturities at the balance sheet date of the Group’s bank and other loans, which are based on contractual undiscounted cash flows (including interest payments computed using contractual rates, or if floating, based on rates current at the balance sheet date) and the earliest date the Group can be required to pay, are as follows:

   
2009
   
2008
 
   
RMB million
   
RMB million
 
Contractual undiscounted cash flows
           
             
Within 1 year
    18,141       23,478  
After 1 year but within 2 years
    8,640       6,752  
After 2 years but within 5 years
    12,461       10,792  
After 5 years
    7,866       1,035  
      47,108       42,057  
                 
Consolidated balance sheet carrying amounts
    45,327       39,607  
 
(f)          As at December 31, 2009, bank and other loans of the Group totalling RMB17,677 million (2008: RMB9,188 million) were secured by mortgages over certain of the Group’s aircraft, advance payments for aircraft, lease prepayments of land use right and investment properties with aggregate carrying amount of RMB23,996 million (2008: RMB17,652million).
 
(g)          As at December 31, 2009, certain bank and other loans were guaranteed by the following parties:

   
2009
   
2008
 
   
RMB million
   
RMB million
 
Guarantors
           
Industrial and Commercial Bank of China Ltd.
    -       15  
Export-Import Bank of the United States
    149       304  
CSAHC (Note 45(e))
    512       783  
Shenzhen Yingshun Investment & Development Co., Ltd.
    -       22  
SA Finance (Note 45(e))
    -       1  
Bank of Communications Co., Ltd.
    -       438  
China Minsheng Banking Corp., Ltd.
    -       629  
      661       2,192  
 
(h)          As at December 31, 2009, loans to the Group from SA Finance amounted to RMB819 million (2008: RMB2,539 million) (Note 45(d)).
 
(i)           The Group has significant bank and other loans balances as well as obligations under finance leases (Note 35) which are denominated in US dollars as at December 31, 2009. The net exchange gain of RMB93 million (2008: RMB2,592 million; 2007: RMB2,832 million) recorded by the Group was mainly attributable to the exchange gain arising from retranslation and settlement of bank and other loans balances and finance lease obligations denominated in US dollars and Japanese Yen.  The foreign currency risk is further discussed in Note 49(c).
 
(j)           As at December 31, 2008, short-term bank loans of the Group amounting to RMB37 million were secured by pledged bank deposits of RMB51 million.

 
F-55

 
 
33
Bank and other loans (continued)
 
(k)          As at December 31, 2009, a long-term loan of RMB10 million (2008: RMB10 million) was granted by SA Finance to a subsidiary of the Company.  The loan was secured by the trade receivables of the subsidiary due from the Company during the loan period.  As at December 31, 2009, the balance of the trade receivables of the subsidiary due from the Company amounted to RMB21 million (2008: RMB8 million).
 
34
Short-term financing bills
 
   
2009
   
2008
 
   
RMB million
   
RMB million
 
             
Short-term financing bills
    -       2,000  
 
In October 2008, the Group issued short-term financing bills with total value of RMB2,000 million, bearing coupon interest rate at 4.7%, with a maturity period of one year for funding of the business activities of the Company. The short-term financing bills were fully repaid in October 2009.
 
35
Obligations under finance leases
 
The Group have commitments under finance lease agreements in respect of aircraft and related equipment.  The majority of these leases have terms of 10 to 12 years expiring during the years 2011 to 2019.  As at December 31, 2009, future payments under these finance leases are as follows:

   
2009
   
2008
 
   
Present
   
Total
         
Present
   
Total
       
   
value of the
   
minimum
         
value of the
   
minimum
       
   
minimum lease
   
lease
         
minimum lease
   
lease
       
   
payments
   
payments
   
Interest
   
payments
   
payments
   
Interest
 
   
RMB
   
RMB
   
RMB
   
RMB
   
RMB
   
RMB
 
   
million
   
million
   
million
   
million
   
million
   
million
 
                                     
Within 1 year
    1,431       1,972       541       1,781       2,390       609  
After 1 year but
                                               
within 2 years
    1,495       1,970       475       1,215       1,752       537  
After 2 years but
                                               
within 5 years
    4,240       5,274       1,034       3,654       4,845       1,191  
After 5 years
    6,152       6,596       444       6,288       7,049       761  
                                                 
      13,318       15,812       2,494       12,938       16,036       3,098  
                                                 
Less:  balance due within one year classified as current liabilities
    (1,431 )                     (1,781 )                
      11,887                       11,157                  

 
F-56

 
 
35
Obligations under finance leases (continued)
 
Details of obligations under finance leases are as follows:

   
2009
   
2008
 
   
RMB million
   
RMB million
 
United States Dollars
           
denominated obligations
           
Fixed interest rates ranging from
           
4.24% to 6.01% per annum as
           
at December 31, 2009
    7,035       7,949  
                 
Floating interest rates
               
3 month LIBOR + 1% per annum
               
as at December 31, 2009
    2,172       -  
                 
Floating interest rates ranging
               
6 month LIBOR + 0.03%
               
to 1.05% per annum
               
as at December 31, 2009
    4,111       4,515  
                 
Japanese Yen
               
denominated obligations
               
Fixed interest rates ranging from
               
2.20% to 3.51% per annum as
               
at December 31, 2008
    -       474  
      13,318       12,938  
 
Under the terms of the leases, the Group has an option to purchase, at or near the end of the lease term, certain aircraft and related equipment at either fair market value or a percentage of the respective lessor’s defined cost.
 
Security, including charges over the assets concerned and relevant insurance policies, is provided to the lessors.  As at December 31, 2009, certain of the Group’s aircraft with carrying amount of RMB17,989 million (2008: RMB18,054 million) were mortgaged to secure finance lease obligations totalling RMB13,318 million (2008: RMB12,938 million).
 
36
Trade and bills payables

   
2009
   
2008
 
   
RMB million
   
RMB million
 
             
Bills payable
    3,207       148  
Trade payables
    1,785       1,205  
      4,992       1,353  

 
F-57

 
 
36
Trade and bills payables (continued)
 
The following is the ageing analysis of trade and bills payables:

   
2009
   
2008
 
   
RMB million
   
RMB million
 
             
Within 1 month
    1,873       809  
More than 1 month but less than 3 months
    1,545       302  
More than 3 months but less than 6 months
    1,566       239  
More than 6 months but less than 1 year
    8       3  
      4,992       1,353  
 
All of the trade and bills payables are expected to be settled within one year.
 
37
Deferred revenue
 
   
2009
   
2008
 
   
RMB million
   
RMB million
 
             
Current portion
    316       261  
Non-current portion
    594       445  
      910       706  
 
Deferred revenue represents the unredeemed frequent flyer revenue.
 
38
Amounts due from/to related companies
 
(a)
Amounts due from related companies

   
2009
   
2008
 
   
RMB million
   
RMB million
 
             
CSAHC and its affiliates
    6       1  
An associate
    14       1  
Jointly controlled entities
    31       9  
      51       11  
 
The amounts due from related companies are unsecured, interest free and have no fixed terms of repayment.  They are expected to be recovered within one year.
 
(b)
Amounts due to related companies

   
2009
   
2008
 
   
RMB million
   
RMB million
 
             
CSAHC and its affiliates
    43       64  
Jointly controlled entities
    51       38  
      94       102  
 
The amounts due to related companies are unsecured, interest free and have no fixed terms of repayment. They are expected to be settled within one year.

 
F-58

 
 
39
Accrued expenses
 
   
2009
   
2008
 
   
RMB million
   
RMB million
 
             
Jet fuel costs
    1,368       1,320  
Air catering expenses
    115       161  
Salaries and welfare
    1,545       1,452  
Repairs and maintenance
    1,827       1,853  
Provision for major overhauls (Note 41)
    503       409  
Provision for early retirement benefits (Note 42)
    57       68  
Landing and navigation fees
    1,899       2,097  
Computer reservation services
    518       539  
Interest expenses
    146       339  
Others
    175       182  
      8,153       8,420  
 
40
Other liabilities
 
   
2009
   
2008
 
   
RMB million
   
RMB million
 
             
CAAC Infrastructure Development Fund,
           
airport construction surcharge and airport tax payable
    1,052       899  
Construction cost payable
    154       106  
Advance payments on chartered flights
    71       58  
Sales agent deposits
    224       222  
Other taxes payable
    611       591  
Others
    1,264       1,087  
      3,376       2,963  
 
41
Provision for major overhauls
 
Details of provision for major overhauls in respect of aircraft held under operating leases are as follows:

   
2009
   
2008
 
   
RMB million
   
RMB million
 
             
At January 1
    1,354       1,133  
Provision for the year
    398       462  
Provision utilised during the year
    (296 )     (241 )
At December 31
    1,456       1,354  
Less:  current portion included in accrued expenses (Note 39)
    (503 )     (409 )
      953       945  

 
F-59

 
 
42
Provision for early retirement benefits
 
Details of provision for early retirement benefits in respect of obligations to early retired employees are as follows:

   
2009
   
2008
 
   
RMB million
   
RMB million
 
             
At January 1
    247       307  
Provision for the year (Note 12)
    6       10  
Financial costs (Note 13)
    14       19  
Payments made during the year
    (80 )     (108 )
Effect of changes in discount rate
    18       19  
At December 31
    205       247  
Less:  current portion included in accrued expenses (Note 39)
    (57 )     (68 )
      148       179  
 
The Group has implemented an early retirement plan for certain employees.  The benefits of the early retirement plan are calculated based on factors including the remaining number of years of services from the date of early retirement to the normal retirement date and the salary amount on the date of early retirement of the employees.  The present value of the future cash flows expected to be required to settle the obligations is recognised as provision for early retirement benefits.
 
43
Share capital and capital management
 
(a)
Share capital
 
   
2009
   
2008
 
   
RMB million
   
RMB million
 
Registered, issued and paid up capital:
           
4,021,150,000 domestic state-owned
           
shares with selling restrictions of RMB1.00 each
           
(2008: 3,300,000,000 shares of RMB1.00 each)
    4,021       3,300  
2,482,417,000 H shares of RMB1.00 each
               
(2008: 1,761,267,000shares of RMB1.00 each)
    2,482       1,761  
1,500,000,000 A shares of RMB1.00 each
               
(2008: 1,500,000,000 shares of RMB1.00 each)
    1,500       1,500  
      8,003       6,561  
 
A bonus share issue of 1,100,000,000 domestic state-owned shares, 587,089,000 H shares and 500,000,000 A shares, totalling 2,187,089,000 shares, by the conversion of share premium in the amount of RMB2,187,089,000 to share capital of the same amount, was approved by shareholders and relevant government authorities and took effect in November 2008.
 
On August 20, 2009 and August 21, 2009, the Company issued 721,150,000 A shares to CSAHC and 721,150,000 H shares to Nan Lung, a wholly-owned subsidiary of CSAHC, for net cash considerations of RMB2,259 million and RMB721 million, respectively.
 
The 721,150,000 A shares and 721,150,000 H shares issued on August 20, 2009 and August 21, 2009 are subject to a lock-up period to August 20, 2012 and August 21, 2010, respectively.  The remaining 3,300,000,000 domestic state-owned shares would become listed and tradable in August 2010.
 
All the domestic state-owned, H and A shares rank pari passu in all material respects.

 
F-60

 
 
43
Share capital and capital management (continued)
 
(b)
Capital management
 
The Group’s primary objectives in managing capital are to safeguard its ability to continue as a going concern, and to generate sufficient profit to maintain growth and provide returns to its shareholders, by securing access to finance at a reasonable cost.
 
The Group manages the amount of capital in proportion to risk and managing its debt portfolio in conjunction with projected financing requirements.  The Group monitors capital on the basis of the debt to equity ratio, which is calculated on net debt as a percentage of the total equity where net debt is represented by the aggregate of bank and other loans, short-term financing bills, obligations under finance leases, trade and bills payables, sales in advance of carriage, amounts due to related companies, accrued expenses and other liabilities less cash and cash equivalents.
 
There was no change in the Group’s approach to capital management during 2009 as compared with previous years. Neither the Company nor any of its subsidiaries are subject to externally imposed capital requirements.  The Group’s debt to equity ratio remains high at 551% at December 31, 2009 (2008: 685%) because of the acquisitions of aircraft during the current and prior years.

 
F-61

 
 
44
Reserves
 
   
2009
   
2008
 
   
RMB million
   
RMB million
 
Share premium
           
             
At January 1
    3,138       5,325  
Bonus Share Issue (Note 43)
    -       (2,187 )
Issue of shares (Note 43)
    1,538       -  
At December 31
    4,676       3,138  
                 
Fair value reserve
               
At January 1
    18       183  
Change in fair value of available-for-sale equity securities
    19       (165 )
At December 31
    37       18  
                 
Statutory surplus reserve (Note (a))
               
                 
At January 1 and at December 31
    526       526  
                 
Discretionary surplus reserve
               
                 
At January 1 and at December 31
    77       77  
                 
Other reserve
               
                 
At January 1
    150       4  
Acquisition of equity interest in a subsidiary (Note (c))
    -       (5 )
Government contributions (Note (d))
    1       151  
At December 31
    151       150  
                 
Retained earnings/(accumulated losses)
               
                 
At January 1
    (3,449 )     1,374  
Profit/(loss) for the year
    330       (4,823 )
At December 31
    (3,119 )     (3,449 )
Total
    2,348       460  

 
F-62

 
 
44
Reserves (continued)
 
(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 profits after taxation, as determined under the 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 and when there are retained earnings at the financial year end.
 
Statutory surplus reserve can be used to offset prior years’ losses, if any, and may be converted into share capital by the issue of new shares to shareholders in proportion to their existing shareholding or by increasing the par value of the shares currently held by them, provided that the balance after such issue is not less than 25% of the registered capital.
 
(b)          Dividend distributions may be proposed at the discretion of the Company’s board of directors, after consideration of the transfers of reserves referred to above and making up cumulative prior years’ losses. Pursuant to the Articles of Association of the Company, the net profit of the Company for the purpose of profit distribution is deemed to be the lesser of (i) the net profit determined in accordance with the PRC accounting rules and regulations, and (ii) the net profit determined in accordance with IFRSs.  As at December 31, 2009, the Company did not have any distributable reserves (2008: Nil).
 
(c)          The Company acquired certain equity interest in a subsidiary from CSAHC in 2008 (Note 45(c)(xv)).  The balance represents the difference of the consideration paid and the share of net assets of the subsidiary.
 
(d)          Pursuant to the “Notice of approval for funds to be used specifically for the purchase of snow handling equipment” issued by the CAAC, national fund amounting to RMB1 million was contributed during the year ended December 31, 2009 by the PRC government to the Company.  Such fund is to be used specifically for the maintenance of safety condition of airports located at Zhengzhou, Luoyang and Nanyang.
 
During the year ended December 31, 2008, national funds amounting to RMB121 million and RMB35 million were contributed by the PRC government.  Such funds are to be used specifically for the reconstruction after the snowstorm disaster and the maintenance of Urumqi airport parking apron and other projects.
 
Pursuant to the requirements of the relevant notice, the national funds were designated as capital contribution and vested solely by the PRC government. They can be converted to share capital of the entities receiving the funds upon approval by their shareholders and completion of other procedures.

 
F-63

 
 
45
Material related party transactions
 
(a)
Key management personnel remuneration
 
Remuneration for key management personnel of the Group, including amounts paid to the Company’s directors and certain of the highest paid employees as disclosed in Note 14, is as follows:

   
2009
   
2008
   
2007
 
   
RMB’000
   
RMB’000
   
RMB’000
 
                   
Short-term employees benefits
    13,991       14,117       12,226  
Post-employment benefits
    922       1,268       275  
      14,913       15,385       12,501  

   
2009
   
2008
   
2007
 
   
RMB’000
   
RMB’000
   
RMB’000
 
                   
Directors and supervisors (Note 14)
    7,609       8,578       6,790  
Senior management
    7,304       6,807       5,711  
      14,913       15,385       12,501  
 
Total remuneration is included in “staff costs” (Note 12).
 
(b)
Contributions to post-employment benefit plans
 
The Group participates in various defined contribution retirement plans organised by municipal and provincial governments for its staff.  Details of the Group’s employee benefits plan are disclosed in Note 46.

 
F-64

 
 
45 
Material related party transactions (continued)
 
(c)           Transactions with CSAHC and its affiliates (the “CSAHC Group”), and the associates and jointly controlled entities of the Group
 
The Group obtained various operational services provided by the CSAHC Group and the associates and jointly controlled entities of the Group during the normal course of its business.
 
Details of the significant transactions carried out by the Group are as follows:

     
2009
   
2008
   
2007
 
 
Note
 
RMB million
   
RMB million
   
RMB million
 
Expenses paid to the CSAHC Group
                   
                     
Handling charges
(i)
    68       50       46  
Air catering supplies
(ii)
    -       60       157  
Commission expense
(iii)
    6       4       7  
Sundry aviation supplies
(iv)
    -       -       72  
Lease charges for land and buildings
(v)
    107       100       101  
Property management fee
(vi)
    19       31       31  
                           
Expenses paid to jointly controlled entities and an associate
                         
                           
Ground service expenses
(vii)
    36       64       37  
Repairing charges
(viii)
    1,344       1,129       1,047  
Flight simulation service charges
(ix)
    172       150       120  
Advertising expenses
(x)
    21       20       9  
                           
Income received from a jointly controlled entity
                         
                           
Rental income
(ix)
    47       33       31  
                           
Issuance of A shares to CSAHC
(xi)
    2,279       -       -  
                           
Issuance of H shares to Nan Lung
(xi)
    721       -       -  
                           
Acquisition of assets from CSAHC Group
(xii)
    -       -       270  
                           
Disposal of GZ Aviation Hotel to CSAHC Group
(xiii)
    -       -       75  
                           
Transfer of exclusive right to use certain advertising resources to Southern Airlines Culture and Media Co., Ltd.
(xiv)
    -       35       -  
 
                         
Acquisition of 26% equity interest in West Australian Flying College from CSAHC Group
(xv)
    -       5       -  
                           
Disposal of certain buildings to Southern Airlines Culture and Media Co., Ltd.
(xvi)
    -       2       -  

 
F-65

 
 
45 
Material related party transactions (continued)
 
(c)           Transactions with CSAHC and its affiliates (the “CSAHC Group”), and the associates and jointly controlled entities of the Group (continued)
 
(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 and pays handling charges to SAIETC.
 
(ii)
The Group purchases certain in flight meals and related services from Shenzhen Air Catering Company Limited (“SZ Catering”), which was an associate of the CSAHC. SZ Catering ceased to be a related party of the Company in November 2008.
 
(iii)
Commission is earned by certain subsidiaries of CSAHC in connection with the air tickets sold by them on behalf of the Group.  Commission is calculated based on the rates stipulated by the CAAC and International Air Transportation Association.
 
(iv)
Certain sundry aviation supplies were purchased from Southern Airlines (Group) Economic Development Company (“SAGEDC”), a subsidiary of CSAHC in 2007.  No sundry aviation supplies were purchased from SAGEDC during the year and 2008.
 
(v)
The Group leases certain land and buildings in the PRC from CSAHC.  Rental payments for land and buildings were paid or payable to CSAHC.
 
(vi)
Guangzhou China Southern Airlines Property Management Co., Ltd, a subsidiary of CSAHC, provides property management services to the Group.
 
(vii)
Beijing Ground Services, a former jointly controlled entity of the Group, provides airport ground service to the Group. In June 2009, the Company acquired 50% equity interests in Beijing Ground Services from the other venture of Beijing Ground Services and it became a wholly-owned subsidiary of the Company.
 
(viii)
Guangzhou Aircraft Maintenance Engineering Company Limited (“GAMECO”) and MTU, both are jointly controlled entities of the Group, provide comprehensive maintenance services to the Group.
 
(ix)
Zhuhai Xiang Yi Aviation Technology Company Limited (“Zhuhai Xiang Yi”), a jointly controlled entity of the Group, provides flight simulation services to the Group.  In addition, the Group entered into operating lease agreements to lease certain flight training facilities and buildings to Zhuhai Xiang Yi.
 
(x)
Southern Airlines Culture and Media Co., Ltd. an associate of the Group, provides advertising services to the Group.
 
(xi)
On August 20, 2009 and August 21, 2009, the Company issued 721,150,000 A shares to CSAHC and 721,150,000 H shares to Nan Lung, a wholly-owned subsidiary of CSAHC, for cash considerations of RMB2,279 million and RMB721 million, respectively.
 
(xii)
On August 14, 2007, the Company signed an agreement to acquire (1) the entire equity interest in Air Catering; (2) certain assets of Guangzhou Bi Hua Yuan Training Centre including certain properties and office facilities; and (3) certain assets of Nan Lung Travel & Express (Hong Kong) Limited, including certain properties and office facilities and the 51% equity interest in Nan Lung International Freight Limited (“Nan Lung Freight”), from CSAHC for a total consideration of RMB270 million (Note 48(b)).
 
(xiii)
On August 14, 2007, the Company signed an agreement to dispose of its equity interest in GZ Aviation Hotel Co., Ltd. to CSAHC at a consideration of RMB75 million.

 
F-66

 
 
45 
Material related party transactions (continued)
 
(c)           Transactions with CSAHC and its affiliates (the “CSAHC Group”), and the associates and jointly controlled entities of the Group (continued)
 
(xiv)
On November 11, 2008, the Company signed an agreement to transfer the exclusive right to use certain advertising space on the aircraft fleet for a period of 18 years to Southern Airlines Culture and Media Co., Ltd. an associate of the Group, for a total consideration of RMB35 million.
 
(xv)
On December 30, 2008, the Company signed an agreement to acquire 26% equity interest in West Australian Flying College from CSAHC at a consideration of RMB5 million .
 
(xvi)
On November 11, 2008, the Company signed an agreement to transfer certain buildings to Southern Airlines Culture and Media Co., Ltd. an associate of the Group at a consideration of RMB2 million.
 
In addition to the above, certain subsidiaries of CSAHC also provided hotel and other services to the Group during the year.  The total amount involved is not material to the results of the Group for the current and prior years.
 
Details of amounts due from/to the CSAHC Group, and the associates and jointly controlled entities of the Group:

   
2009
   
2008
 
   
RMB million
   
RMB million
 
Receivables:
           
The CSAHC Group
    6       1  
Associates
    14       1  
Jointly controlled entities
    31       9  
      51       11  
                 
Payables:
               
The CSAHC Group
    43       64  
Jointly controlled entities
    51       38  
      94       102  
 
The amounts due from/to the CSAHC Group, the associates and jointly controlled entities of the Group are unsecured, interest free and have no fixed terms of repayment.

 
F-67

 
 
45 
Material related party transactions (continued)
 
(d) 
Loans from and deposits placed with SA Finance
 
(i) 
Loans from SA Finance
 
At December 31, 2009, loans from SA Finance to the Group amounted to RMB819 million (2008: RMB2,539 million).
 
The loans were repayable and secured as follows:

   
2009
   
2008
 
   
RMB million
   
RMB million
 
             
Within 1 year
    400       2,100  
After 2 years but within 5 years
    419       439  
      819       2,539  
                 
Unsecured
    819       2,539  
 
Interest expense paid on such loans amounted to RMB71 million (2008: RMB38 million; 2007: RMB17 million) and the interest rates ranged from 1.25% to 7.56% per annum during the year ended December 31, 2009 (2008: 4.75% to 7.56% per annum; 2007: 5.10% to 6.16% per annum).
 
(ii) 
Deposits placed with SA Finance
 
At December 31, 2009, the Group’s deposits with SA Finance amounted to RMB862 million (2008: RMB1,139 million).  The applicable interest rates are determined in accordance with the rates published by the PBOC.
 
Interest income received on such deposits amounted to RMB11 million (2008: RMB22 million; 2007: RMB20 million) during the year ended December 31, 2009.
 
(e) 
Guarantees from CSAHC and SA Finance
 
Certain bank loans of the Group were guaranteed by the following related parties:

   
2009
   
2008
 
   
RMB million
   
RMB million
 
             
CSAHC
    512       783  
SA Finance
    -       1  
      512       784  

 
F-68

 
 
45 
Material related party transactions (continued)
 
(f) 
Transactions with other state-controlled entities
 
The Company is a state-controlled entity and operates in an economic regime currently dominated by entities directly or indirectly controlled by the PRC government (“state-controlled entities”) through its government authorities, agencies, affiliations and other organisations.
 
Other than those transactions with the CSAHC Group, and the associates and jointly controlled entities of the Group as disclosed in Notes 45(c), (d), and (e) above, the Group conducts transactions with other state-controlled entities which include but are not limited to the following:
 
Transportation services;
 
Leasing arrangements;
 
Purchase of equipment;
 
Purchase of ancillary materials and spare parts;
 
Ancillary and social services; and
 
Financial services arrangement.
 
These transactions are conducted in the ordinary course of the Group’s business on terms comparable to those with other entities that are not state-controlled.  The Group has established its buying, pricing strategy and approval process for purchases and sales of products and services.  Such buying, pricing strategy and approval processes do not depend on whether the counterparties are state-controlled entities or not.
 
Having considered the potential for transactions to be impacted by related party relationships, the Group’s pricing strategy, buying and approval processes, and what information would be necessary for an understanding of the potential effect of the relationship on the financial statements, the directors are of the opinion that the following transactions with other state-controlled entities require disclosure:
 
 (i)
The Group’s transactions with other state-controlled entities, including state-controlled banks in the PRC

   
2009
   
2008
   
2007
 
   
RMB million
   
RMB million
   
RMB million
 
                   
Jet fuel cost
    15,260       21,042       14,814  
Interest income
    56       77       47  
Interest expense
    1,249       1,719       1,751  
 
(ii)
The Group’s balances with other state-controlled entities, including state-controlled banks in the PRC

   
2009
   
2008
 
   
RMB million
   
RMB million
 
             
Cash and deposits at bank
    3,174       3,354  
Short-term bank loans and current portion of long-term bank loans
    16,068       18,675  
Long-term bank loans, less current portion
    26,646       14,773  

 
F-69

 

45 
Material related party transactions (continued)
 
(f) 
Transactions with other state-controlled entities (continued)
 
(iii)
Guarantees from other state-controlled entities, including state-controlled banks in the PRC
 
   
2009
   
2008
 
   
RMB million
   
RMB million
 
             
Guarantees on certain bank loans of the Group
    -       1,082  
 
(iv)
In 2008, the issuance of the short-term financing bills of RMB2,000 million was underwritten by certain state-controlled banks in the PRC.  No issuance of short-term financing bills was made during the year.
 
46 
Retirement and housing benefits
 
(a) 
Retirement benefits
 
Employees of the Group participate in several defined contribution retirement schemes organised separately by the 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 10% to 25% (2008 and 2007: 9% to 24%) of salary costs including certain allowances.  A member of the retirement schemes is entitled to pension benefits from the Local Labour and Social Security Bureau upon his/her retirement.  The retirement benefit obligations of all retired staff of the Group are assumed by these schemes.
 
In addition, the Group has established a supplementary defined contribution retirement scheme for the benefit of employees in accordance with relevant regulations in the PRC.  In this connection, employees of the Group participate in a supplementary defined contribution retirement scheme whereby the Group is required to make contributions not exceeding one-twelfth of the prior year’s total salaries.
 
(b) 
Housing benefits
 
The Group contributes on a monthly basis to housing funds organised by municipal and provincial governments based on certain percentages of the salaries of employees.  The Group’s liability in respect of these funds is limited to the contributions payable in each year.
 
In addition to the housing funds, certain employees of the Group are eligible to one of the following housing benefit schemes:
 
(i)
Pursuant to a staff housing benefit scheme effective on September 2002, the Group agreed to pay lump sum housing allowances to certain employees who have not received quarters from CSAHC or the Group according to the relevant PRC housing reform policy, for subsidising their purchases of houses.  An employee who quits prior to the end of the vesting benefit period is required to pay back a portion of the lump sum housing benefits determined on a pro-rata basis of the vesting benefit period.  The Group has 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 to profit or loss.
 
(ii)
The Group also pays cash housing subsidies on a monthly basis to eligible employees.  The monthly cash housing subsidies are charged to profit or loss.

 
F-70

 
 
47 
Segmental reporting
 
The Group’s network passenger and cargo operations are managed as a single business unit.  The Group’s chief operating decision maker makes resource allocation decisions based on route profitability, which considers aircraft type and route economics.  The objective in making resource allocation decisions is to optimise consolidated financial results.  Therefore, based on the way the Group manages the network passenger and cargo operations, and the manner in which resource allocation decisions are made, the Group has only one reportable operating segment for financial reporting purposes, reported as the “airline business”.
 
Financial results from other operating segments are below the quantitative threshold for determining reportable operating segments and consist primarily of business segments of aviation repair services, aviation training services, ground services, air catering and other miscellaneous services.  These other operating segments are combined and reported as “all other segments”.  Inter-segment sales are based on prices set on an arm’s length basis.
 
For the purposes of assessing segment performance and allocating resources between segments, the Group’s chief operating decision maker monitors the results, assets and liabilities attributable to each reportable segment based on financial results prepared under PRC GAAP. As such, the amount of each material reconciling item from the Group’s reportable segment revenue, profit or loss, assets and liabilities arising from different accounting policies are set out in Note 47(c).

 
F-71

 

47
Segmental reporting (continued)

(a)
Business segments

Information regarding the Group’s reportable segments as provided to the Group’s chief operating decision maker for the purposes of resource allocation and assessment of segment performance for each of the years in the three-year period ended December 31, 2009 is set out below.
 
   
Airline business
   
All other segments
   
Elimination
   
Unallocated*
   
Total
 
   
2009
   
2008
   
2007
   
2009
   
2008
   
2007
   
2009
   
2008
   
2007
   
2009
   
2008
   
2007
   
2009
   
2008
   
2007
 
   
RMB
   
RMB
   
RMB
   
RMB
   
RMB
   
RMB
   
RMB
   
RMB
   
RMB
   
RMB
   
RMB
   
RMB
   
RMB
   
RMB
   
RMB
 
   
million
   
million
   
million
   
million
   
million
   
million
   
million
   
million
   
million
   
million
   
million
   
million
   
million
   
million
   
million
 
                                                                                           
Revenue from external customers
    55,708       56,150       55,522       335       277       250       -       -       -       -       -       -       56,043       56,427       55,772  
Inter-segment sales
    -       4       -       674       506       484       (674 )     (510 )     (484 )     -       -       -       -       -       -  
                                                                                                                         
Reportable segment revenue
    55,708       56,154       55,522       1,009       783       734       (674 )     (510 )     (484 )     -       -       -       56,043       56,427       55,772  
                                                                                                                         
Reportable segment profit/(loss) before taxation
    27       (5,031 )     2,532       56       (68 )     11       -       -       -       374       351       306       457       (4,748 )     2,849  
                                                                                                                         
Reportable segment assets
    91,322       79,841               1,776       1,705               (159 )     (131 )             1,797       1,588               94,736       83,003          
Addition to non- current segment assets during the year
    17,558       12,801               66       47               -       -               13       29               17,637       12,877          
                                                                                                                         
Reportable segment liabilities
    80,435       72,519               1,202       1,167               (159 )     (131 )             -       -               81,478       73,555          
                                                                                                                         
Other segment information
                                                                                                                       
                                                                                                                         
Interest income
    65       99       68       3       4       5       -       -       -       -       -       -       68       103       73  
Interest expenses
    1,446       1,923       2,286       51       64       46       -       -       -       -       -       -       1,497       1,987       2,332  
Depreciation and  amortisation for  the year
    5,954       5,724       5,501       85       94       94       -       -       -       -       -       -       6,039       5,818       5,595  
Impairment losses (including impact on PP&E, allowance for doubtful debts and provision for inventories)
    57       2,073       212       -       -       -       -       -       -       -       -       -       57       2,073       212  
 
*Unallocated assets primarily include investments in associates and jointly controlled entities, available-for-sale securities and other investments.  Unallocated results primarily include the share of results of associates and jointly controlled entities and gain on sale of available-for-sale securities.

 
F-72

 
 
47 
Segmental reporting (continued)
 
(b) 
Geographic information

   
2009
   
2008
   
2007
 
   
RMB million
   
RMB million
   
RMB million
 
                   
Domestic
    47,645       45,972       44,785  
Hong Kong, Macau and Taiwan
    1,067       1,051       1,188  
International *
    7,331       9,404       9,799  
      56,043       56,427       55,772  
 
 
Asian market accounted for approximately 74% (2008: 72%; 2007: 68%) of the Group’s total international traffic revenue for the year ended December 31, 2009.  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 the Group are its aircraft fleet which is registered in the PRC and is employed across its worldwide route network.  The chief operating decision maker considers that there is no suitable basis for allocating such assets and related liabilities to geographical locations. Accordingly, geographical segment assets and liabilities are not disclosed.
 
(c)
Reconciliations of reportable segment revenue, profit or loss, assets and liabilities arising from different accounting policies
 
 
Note
 
2009
   
2008
   
2007
 
     
RMB million
   
RMB million
   
RMB million
 
Revenue
                   
                     
Reportable segment revenue
      56,717       56,937       56,256  
Elimination of intersegment revenues
      (674 )     (510 )     (484 )
Reclassification of expired sales in advance of carriage
(i)
    350       276       273  
Reclassification of business tax
(ii)
    (1,591 )     (1,415 )     (1,644 )
Consolidated revenue
      54,802       55,288       54,401  

 
F-73

 
 
47 
Segmental reporting (continued)
 
(c)
Reconciliations of reportable segment revenue, profit or loss, assets and liabilities arising from different accounting policies (continued)
 
 
Note
 
2009
   
2008
   
2007
 
     
RMB million
   
RMB million
   
RMB million
 
Profit
                   
                     
Reportable segment profit/ (loss) before taxation
      83       (5,099 )     2,543  
Unallocated amounts
      374       351       306  
Losses on lump sum housing benefits
(iii)
    (26 )     (26 )     (26 )
Revaluation of land use rights
(iv)
    4       4       4  
Adjustments arising from  business combinations under common control
(v)
    (7 )     (7 )     (6 )
Capitalisation of exchange difference of specific loans
(vi)
    3       51       57  
Government grants
(vii)
    1       2       1  
Consolidated profit/(loss) before taxation
 
   
432
      (4,724     2,879  

     
2009
   
2008
 
 
Note
 
RMB million
   
RMB million
 
               
Assets
             
               
Reportable segment assets
      93,098       81,546  
Elimination of intersegment balances
      (159 )     (131 )
Other unallocated amounts
      1,797       1,588  
Losses on lump sum housing benefits
(iii)
    66       92  
Revaluation of land use rights
(iv)
    (142 )     (146 )
Adjustments arising from business
                 
combinations under common control
(v)
    1       8  
Capitalisation of exchange difference of
                 
specific loans
(vi)
    111       108  
Government grants
(vii)
    (39 )     (40 )
Effect of the above adjustments on taxation
      17       17  
Consolidated total assets
      94,750       83,042  
                   
     
2009
   
2008
 
     
RMB million
   
RMB million
 
Liabilities
                 
                   
Reportable segment liabilities
      81,637       73,686  
Elimination of intersegment balances
      (159 )     (131 )
Effect of the above adjustments on taxation
      10       8  
Consolidated total liabilities
      81,488       73,563  
 
 
F-74

 
 
47 
Segmental information (continued)
 
(c)
Reconciliations of reportable segment revenue, profit or loss, assets and liabilities arising from different accounting policies (continued)
 
Notes:
 
 
(i)
In accordance with the PRC GAAP, expired sales in advance of carriage is recorded under non-operating income. Under IFRSs, such income is recognised as other net income.
 
 
(ii)
In accordance with the PRC GAAP, business tax and surcharge is separately disclosed rather than deducted from revenue under IFRSs.
 
 
(iii)
In accordance with the PRC GAAP , losses on the lump sum housing benefits executed by CSAHC are charged to retained profits as of January 1, 2001 pursuant to the relevant regulations. Under IFRSs, losses on lump sum housing benefits are charged to the consolidated statements of opeartions, which are spread over the vesting benefit periods stipulated by the relevant contracts.
 
 
(iv)
In accordance with the PRC GAAP, land use rights are carried at revalued amounts. Under IFRSs, land use rights are carried at cost with effect from January 1, 2002, and accordingly, the unamortised surplus on revaluation of land use rights was reversed against shareholders’ equity.
 
 
(v)
In accordance with the PRC GAAP, business combinations under common control should be accounted for by applying the pooling-of-interest method. The carrying amount of the assets and liabilities in the books of subsidiaries acquired were used for consolidation. Under IFRSs, purchase accounting is adopted. The assets and liabilities of the subsidiaries are recorded at fair value.
 
 
(vi)
In accordance with the PRC GAAP, exchange difference arising on translation of specific loans and related interest denominated in a foreign currency is capitalised as part of the cost of qualifying assets. Under IFRSs, such exchange difference should be recognised in profit or loss unless the exchange difference represents an adjustment to interest.
 
 
(vii)
In accordance with the PRC GAAP, special funds such as investment grants allocated by the government, if clearly defined in official documents as part of “capital reserve”, are credited to capital reserve, and amortised over the respective useful lives of corresponding assets. Under IFRSs, government grants relating to purchase of fixed assets are deducted from the cost of the related fixed assets.
 
48 
Supplementary information to the consolidated cash flow statements
 
(a) 
Non cash transactions - acquisition of aircraft
 
During the year ended December 31, 2009, aircraft acquired under finance leases amounted to RMB2,171 million (2008: RMB281 million; 2007: RMB4,330 million).

 
F-75

 
 
48 
Supplementary information to the consolidated cash flow statements (continued)
 
(b) 
Effect of the acquisition of Nan Lung Freight and Air Catering
 
The Group acquired a 51% equity interest in Nan Lung Freight and a 100% equity interest in Air Catering on August 31, 2007.  Details are as follows:
   
RMB million
 
Assets acquired:
     
Property, plant and equipment, net
    77  
Inventories
    6  
Trade receivables
    106  
Other receivables
    7  
Cash and cash equivalents
    54  
      250  
Liabilities assumed:
       
Trade payables
    30  
Accrued expenses
    10  
Other liabilities
    18  
      58  
Net identifiable assets before minority interests
    192  
Less: Minority interest
    (80 )
         
Net identifiable assets after minority interest
    112  
         
Satisfied by:
       
Cash
    112  
         
Analysis of the net outflow of cash and cash equivalents in respect of the acquisition:
       
         
Cash consideration paid
    (112 )
Cash and cash equivalents acquired
    54  
Net outflow of cash and cash equivalents in respect of the acquisition
    (58 )
 
In the four months to December 31, 2007, these subsidiaries contributed profit of RMB3 million.

 
F-76

 
    
48 
Supplementary information to the consolidated cash flow statements (continued)
 
(c) 
Effect of the disposal of GZ Aviation Hotel
 
The Group disposed of its 90% equity interest in GZ Aviation Hotel to CSAHC on August 31, 2007.  Details are as follows:
   
RMB million
 
Assets disposed of:
     
Property, plant and equipment, net
    72  
Trade receivables
    1  
Other receivables
    6  
Cash and cash equivalents
    1  
      80  
Liabilities disposed of:
       
Other liabilities
    4  
Minority interest
    8  
         
Net identifiable assets and liabilities
    68  
Gain on disposal
    7  
                      75  
         
Satisfied by:
       
Cash
    75  
         
Analysis of the net inflow of cash and cash equivalents in respect of the disposal:
       
         
Cash consideration received
    75  
Cash and cash equivalents disposed of
    (1 )
Net inflow of cash and cash equivalents in respect of the disposal
    74  
  
 
F-77

 
 
49 
Financial risk management and fair values
 
Exposure to liquidity, interest rate, currency, jet fuel price risk and credit risks arises in the normal course of the Group’s business.  The Group’s exposure to these risks and the financial risk management policies and practices used by the Group to manage these risks are described below:
 
(a) 
Liquidity risk
 
As at December 31, 2009, the Group’s current liabilities exceeded its current assets by RMB28,441  million.  For the year ended December 31, 2009, the Group recorded a net cash inflow from operating activities of RMB8,959 million, a net cash outflow from investing activities of RMB14,478 million and a net cash inflow from financing activities of RMB5,213 million, and resulted in a net decrease  in cash and cash equivalents of RMB306 million.
 
In 2010 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 its ability to obtain adequate external financing to meet its committed future capital expenditures.  As at December 31, 2009, the Group had banking facilities with several PRC commercial banks for providing loan finance up to approximately RMB128,175 million (2008: RMB125,265 million), of which approximately RMB50,455 million (2008: RMB47,125 million ) was utilised.  The directors of the Company believe that sufficient financing will be available to the Group.
 
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, 2010.  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 realised.
 
As at December 31, 2009, the Group’s recognised financial liabilities, bank and other loans, short-term financing bills, finance lease obligations, trade and bills payables and amounts due to related companies as disclosed in Notes 28, 33, 34, 35, 36 and 38 respectively, are not materially different from the amount determined based on contractual undiscounted cash flows (including interest payments computed using contractual rates or, if floating, based on rates current at the balance sheet date).  During the year ended December 31, 2009, the Group had derivatives settled gross in respect of the foreign exchange forward option contracts, of which the outflow amounted to RMB426 million (2008: RMB79 million) and inflow amounted to RMB399 million (2008: RMB25 million).
 
(b) 
Interest rate risk
 
The interest rates and maturity information of the Group’s bank and other loans, short-term financing bills and finance lease obligations are disclosed in Notes 33, 34 and 35 respectively.
 
At December 31, 2009, it is estimated that a general increase/decrease of 100 basis points in interest rates, with all other variables held constant, would have decreased/increased the Group’s profit after tax and would have increased/decreased the Group’s accumulated losses by approximately RMB238 million (2008: would have increased/decreased the Group’s loss after tax and accumulated losses by approximately RMB186 million). Other components of consolidated equity would not be affected (2008: Nil) by the changes in interest rates.

 
F-78

 
 
49 
Financial risk management and fair values (continued)
 
(b) 
Interest rate risk (continued)
 
The sensitivity analysis above indicates the instantaneous change in the Group’s profit after tax (and accumulated losses) and other components of consolidated equity that would arise assuming that the change in interest rates had occurred at the balance sheet date and had been applied to re-measure those financial instruments held by the Group which expose the Group to fair value interest rate risk at the balance sheet date. In respect of the exposure to cash flow interest rate risk arising from floating rate non-derivative instruments held by the Group at the balance sheet date, the impact on the Group’s profit after tax (and accumulated losses) and other components of consolidated equity is estimated as an annualised impact on interest expense or income of such a change in interest rates. The analysis is performed on the same basis for 2008.
 
(c) 
Foreign currency risk
 
The Renminbi is not freely convertible into foreign currencies.  All foreign exchange transactions involving Renminbi must take place either through the PBOC or other institutions authorised to buy and sell foreign exchange or at a swap centre.
 
The Group has significant exposure to foreign currency risk as substantially all of the Group’s obligations under finance leases (Note 35) and bank and other loans (Note 33) are denominated in foreign currencies, principally US dollars.  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 banks.
 
The Group also has exposure to foreign currency risk in respect of net cash inflow denominated in Japanese Yen from ticket sales in overseas branch office after payment of expenses.  As at December 31, 2009, the Group had two outstanding foreign exchange forward option contracts of notional amount ranging from USD34 million to USD68 million (2008: USD64 million to USD128 million).  The contracts are to buy USD1 million and USD1.5 million respectively (or USD2 million and USD3 million respectively if the spot exchange rate at settlement date is below certain specified strike rates) by selling Japanese Yen at certain specified rates on monthly settlement dates until the maturity of the contracts in 2011.  Both contracts have a knock-out clause where the contracts early terminate upon the exchange rate of Japanese Yen to US dollar reaching a certain knock-out level.  For the year ended December 31, 2009, a net gain of approximately RMB72 million (2008: a loss of RMB111 million) arising from changes in the fair value of these foreign exchange forward option contracts has been recognised in profit or loss.  At December 31, 2009, the fair value of these foreign exchange forward option contracts was financial liabilities of approximately RMB44 million (2008: RMB116 million).

 
F-79

 
 
49 
Financial risk management and fair values (continued)
 
(c) 
Foreign currency risk (continued)
 
As at December 31, 2009, it is estimated that  if an appreciation/depreciation of 3.4% in exchange rate of US dollar against Japanese Yen, with all other variables held constant, would have increased/decreased the Group’s profit after tax and decreased/increased the Group’s accumulated losses by approximately RMB15 million/RMB16 million, respectively.
 
The exchange rate of Renminbi to US dollar was set by the PBOC and had fluctuated within a narrow band prior to July 21, 2005.  Since then, a managed floating exchange rate regime based on market supply and demand with reference to a basket of foreign currencies has been used and the US dollar exchange rate has gradually declined against the Renminbi.
 
The following table indicates the instantaneous change in Group’s profit or loss after tax (and accumulated losses) that would arise if foreign exchange rates to which the Group has significant exposure at the balance sheet date had changed at that date, assuming all other risk variables remained constant.

   
2009
   
2008
 
   
Appreciation /
   
Decrease/(increase)
   
Appreciation/
   
Increase/(decrease)
 
   
(depreciation) of
   
on profit after tax and
   
(depreciation) of
   
on loss after tax
 
   
Renminbi against
   
increase/(decrease)
   
Renminbi against
   
and accumulated
 
   
foreign
   
on accumulated losses
   
foreign
   
losses
 
   
currency
   
RMB million
   
currency
   
RMB million
 
                         
United States Dollars
    2 %     (764 )     2 %     (606 )
      (2 )%     764       (2 )%     606  
 
Results of the analysis as presented in the above table represent an aggregation of the instantaneous effects on each of the Group entities’ profit or loss after tax and equity measured in the respective functional currencies, translated into Renminbi at the exchange rate ruling at the balance sheet date for presentation purposes.
 
The sensitivity analysis assumes that the change in foreign exchange rates had been applied to re-measure those financial instruments held by the Group which expose the Group to foreign currency risk at the balance sheet date, including inter-company payables and receivables within the Group which are denominated in a currency other than the functional currencies of the lender or the borrower.  The analysis excludes differences that would result from the translation of the financial statements of foreign operations into the Group’s presentation currency.  The analysis is performed on the same basis for 2008.
 
(d) 
Credit risk
 
The Group’s credit risk is primarily attributable to cash and cash equivalents and trade receivables.
 
Substantially all of the Group’s cash and cash equivalents are deposited with PRC financial institutions, which management believes are of high credit quality.
 
A significant portion of the Group’s air tickets are sold by agents participating in the Billing and Settlement Plan (“BSP”), a clearing scheme between airlines and sales agents organised by International Air Transportation Association which has insignificant credit risk to the Group.  As at December 31, 2009, the balance due from BSP agents amounted to RMB631 million (2008: RMB641 million).  The credit risk exposure to BSP and the remaining trade receivables balance are monitored by the Group on an ongoing basis and the allowance for impairment of doubtful debts is within management’s expectations. Further quantitative disclosures in respect of the Group’s exposure to credit risk arising from trade receivables is set out in Note 30.

 
F-80

 
 
49
Financial risk management and fair values (continued)
 
(e) 
Jet fuel price risk
 
The Group’s results of operations may be significantly affected by fluctuations in fuel prices which is a significant expense for the Group. A reasonable possible increase or decrease of 10% (2008: 40%) in jet fuel price, with volume of fuel consumed and all other variables held constant, would have increased/decreased the fuel costs by approximately RMB1,639 million (2008: RMB9,232 million).  The sensitivity analysis indicates the instantaneous change in the Group’s fuel cost that would arise assuming that the change in fuel price had occurred at the balance sheet date.
 
(f) 
Fair value
 
(i)
Financial instruments carried at fair value.
 
The following table presents the carrying value of financial instruments measured at fair value at the balance sheet date across the three levels of the fair value hierarchy defined in IFRS 7, Financial Instruments: Disclosures, with the fair value of each financial instrument categorised in its entirety based on the lowest level of input that is significant to that fair value measurement.  The levels are defined as follows:
 
-
Level 1 (highest level): fair values measured using quoted prices (unadjusted) in active markets for identical financial instruments
 
-
Level 2: fair values measured using quoted prices in active markets for similar financial instruments, or using valuation techniques in which all significant inputs are directly or indirectly based on observable market data
 
-
Level 3 (Lowest level): fair values measured using valuation techniques in which any significant input is not based on observable market data

2009

   
Level 1
   
Level 2
   
Level 3
   
Total
 
   
RMB
   
RMB
   
RMB
   
RMB
 
   
million
   
million
   
million
   
million
 
Assets
                       
Available-for-sale equity securities:                                
- Listed
    93       -       -       93  
                                 
Liabilities
                               
Derivative financial instruments:                              
 - Forward option  contracts
 
-
      44       -       44  
 
During the year there were no significant transfers between instruments in Level 1 and Level 2.
 
Fair value of available-for-sale securities is based on quoted market prices at the balance sheet date without any deduction for transaction costs.
 
The fair value of forward option contracts is estimated by using Black Scholes Pricing Model, taking into account the terms and conditions of the forward option contracts.  The major inputs used in estimation process include implied volatility, benchmark interest rates and foreign exchange spot and forward rates, which can be obtained from observable markets.
 
(ii)
The economic characteristics of the Group’s finance leases vary from lease to lease.  It is impractical to compare such leases with those prevailing in the market within the constraints of timeliness and cost for the purpose of estimating the fair value of such leases.

 
F-81

 
 
49
Financial risk management and fair values (continued)
 
(f) 
Fair value (continued)
 
(iii)
Other non-current investments represent unlisted equity securities of companies established in the PRC.  There is no quoted market price for such equity securities and accordingly a reasonable estimate of the fair value could not be measured reliably.
 
(iv)
Amounts due from/to related companies are unsecured, interest-free and have no fixed terms of repayment.  Given these terms, it is not meaningful to disclose fair values of these balances.
 
(v)
Loans, trade and other payables, bills payable and short-term financing bills are carried at amounts not materially different from their fair values as at December 31, 2009 and December 31, 2008.
 
50 
Commitments
 
(a) 
Capital commitments
 
Capital commitments outstanding at December 31, 2009 not provided for in the financial statements were as follows:

   
2009
   
2008
 
   
RMB million
   
RMB million
 
Commitments in respect of aircraft
           
and flight equipment
           
- authorised and contracted for
    57,890       75,639  
- authorised but not contracted for
    7,953       -  
      65,843       75,639  
Other commitments
               
- authorised and contracted for
    462       884  
- authorised but not contracted for
    1,399       1,958  
      1,861       2,842  
      67,704       78,481  
 
As at December 31, 2009, the Group had on order 199 aircraft and certain flight equipment, scheduled for deliveries in 2010 to 2015, and deposits of RMB14,792 million have been made towards the purchase of these aircraft and related equipment.  As at December 31, 2009, the approximate total future payments, including estimated amounts for price escalation through anticipated delivery dates for these aircraft and flight equipment are as follows:

   
2009
   
2008
 
   
RMB million
   
RMB million
 
             
2009
    -       15,777  
2010
    16,404       19,167  
2011
    17,482       15,142  
2012
    17,421       13,893  
2013
    9,845       7,170  
2014 and afterwards
    4,691       4,490  
      65,843       75,639  

 
F-82

 
 
50 
Commitments (continued)
 
(a) 
Capital commitments (continued)
 
As at December 31, 2009, the Group’s attributable share of the capital commitments of jointly controlled entities was as follows:

   
2009
   
2008
 
   
RMB million
   
RMB million
 
             
Authorised and contracted for
    2       1  
Authorised but not contracted for
    40       26  
      42       27  
 
(b) 
Operating lease commitments
 
As at December 31, 2009, the total future minimum lease payments under non-cancellable operating leases in respect of properties, aircraft and flight equipment were payable as follows:

   
2009
   
2008
 
   
RMB million
   
RMB million
 
Payments due
           
Within 1 year
    4,028       4,186  
After 1 year but within 5 years
    15,107       15,689  
After 5 years
    11,231       14,455  
      30,366       34,330  
 
51 
Contingent liabilities
 
(a)
The Group leased certain properties and buildings from CSAHC which located in Guangzhou, Wuhan and Haikou, etc.  However, such properties and buildings lack adequate documentation evidencing CSAHC’s rights thereto.
 
Pursuant to an indemnification agreement dated May 22, 1997 between the Group and CSAHC, CSAHC has agreed to indemnify the Group against any loss or damage arising from any challenge of the Group’s right to use the certain properties and buildings.
 
(b)
The Company entered into agreements with its pilot trainees and certain banks to provide guarantees on personal bank loans amounting to RMB292,586,000 (2008: RMB90,858,000) to be granted to its pilot trainees to finance their respective flight training expenses.  As at December 31, 2009, an aggregate of personal bank loans of RMB60 million (2008: RMB13million), under these guarantees, were drawn down from the banks.

 
F-83

 
 
52
Non-adjusting post balance sheet events
 
(a)
On March 8, 2010, the board of the Company approved (i) the placement of not more than 1,766,780,000 new A shares to not more than 10 specific investors (subject to the maximum number as permitted by PRC laws and regulations at the time of the issuance) including CSAHC, at the same subscription price of not less than RMB5.66 per A share; and (ii) the placement of not more than 312,500,000 new H shares to Nan Lung, at the subscription price of not less than HKD2.73 per H share.
 
On the same date, the Company entered into the A shares subscription agreement with CSAHC, pursuant to which CSAHC conditionally agreed to subscribe and the Company conditionally agreed to allot and issue new A shares of not more than 132,510,000 at the subscription price of not less than RMB5.66 per A share.  In addition, the Company and Nan Lung entered into the H shares subscription agreement, pursuant to which Nan Lung conditionally agreed to subscribe and the Company conditionally agreed to allot and issue new H shares of not more than 312,500,000 at the subscription price of not less than HKD2.73 per H share.
 
The above placement and subscription agreements were approved in the Extraordinary General Meeting and the respective Meetings of shareholders of A and H shares on April 30, 2010 and are pending approval from the relevant security regulatory authorities.
 
(b)
On January 20, 2010, the Company entered into an agreement with Airbus SNC to purchase 20 Airbus 320 series aircraft, which were scheduled for delivery from 2011 to 2013.  According to the information provided by Airbus SNC, the catalogue price of an Airbus 320 aircraft is around USD77 million. Such catalogue price includes price for airframe and engines.
 
(c)
In accordance with a Transfer Agreement dated September 28, 2009 and a Supplemental Transfer Agreement dated December 29, 2009 entered into between the Company and CSAHC, the Company agreed to sell and CSAHC agreed to acquire the 50% equity interest in MTU, a jointly controlled entity of the Company.  As at December 31, 2009, the sale was approved by the State Owned Assets Supervision and Administration Commission of the PRC and shareholders of Company and was pending approval by the Ministry of Commerce of the PRC.  The sales was subsequently approved by the Ministry of Commerce of the PRC in January 2010, and the Company received the acquisition consideration from CSAHC in full in February 2010.
 
53 
Immediate and ultimate controlling party
 
As at December 31, 2009, the directors of the Company consider the immediate parent and ultimate controlling party of the Group to be CSAHC, a state-owned enterprise established in the PRC.  CSAHC does not produce financial statements available for public use.

 
F-84

 
 
54
Accounting judgements and estimates
 
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 judgements 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 judgements 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 judgements and estimates used in the preparation of the consolidated financial statements.
 
(a) 
Impairment of long-lived assets
 
If circumstances indicate that the net book value of a long-lived asset may not be recoverable, this asset may be considered “impaired”, and an impairment loss may be recognised 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 the recoverable amount.  The recoverable amount is the greater of the fair value less costs to sell and 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 judgements relating to the level of traffic revenue and the 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 reasonable and supportable assumptions for projections of traffic revenue and amount of operating costs.
 
(b) 
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 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.
 
55 
Comparative figures
 
As a result of the application of IAS1 (revised 2007), Presentation of financial statements, and IFRS 8, Operating segments and the change in accounting policy for property, plant and equipment, certain comparative figures have been adjusted to conform to current year’s presentation and to provide comparative amounts in respect of items disclosed for the first time in 2009. Further details of these developments are disclosed in Note 3.

 
F-85

 
 
56
Possible impact of amendments, new standards and interpretations issued but not yet effective for the year ended December 31, 2009
 
Up to the date of issue of these financial statements, the IASB has issued a number of amendments, new standards and interpretations which are not yet effective for the year ended December 31, 2009 and which have not been adopted in these financial statements.
 
The Group is in the process of making an assessment of what the impact of these amendments, new standards and new interpretations is expected to be in the period of initial application. So far it has concluded that the adoption of them is unlikely to have a significant impact on the Group’s results of operations and financial position.
 
In addition, the following developments are expected to result in amended disclosures in the financial statements, including restatement of comparative amounts in the first period of adoption:

   
Effective for accounting periods
beginning on or after
     
IAS 24 (Revised), Related party disclosures
 
January 1, 2011
IFRS 9, Financial instruments
 
January 1, 2013

 
F-86

 
 
57 
Subsidiaries
 
The particulars of the Group’s principal subsidiaries as of December 31, 2009 are as follows:

Name of company
 
Place of
establishment/
operation
 
Registered capital
 
Proportion of
ownership
interest held
by the
Company
 
Principal
activities
                   
Southern Airlines Shantou Airlines Company Limited (a)
 
PRC
  RMB 
280,000,000
    60
Airline
                     
Chongqing Airlines Company Limited (a)
 
PRC
  RMB 
1,200,000,000
    60 %
Airline
                     
Zhuhai Airlines Company Limited (a)
 
PRC
  RMB 
250,000,000
    60 %
Airline
                     
Xiamen Airlines Company Limited (a)
 
PRC
  RMB 
1,200,000,000
    60 %
Airline
                     
Guizhou Airlines Company Limited (a)
 
PRC
  RMB 
80,000,000
    60 %
Airline
                     
Nan Lung International Freight Limited
 
HK
  HKD 
3,270,000
    51 %
Freight services
                     
Guangzhou Baiyun International Logistic Company Limited (a)
 
PRC
  RMB 
50,000,000
    61 %
Logistics operations
                     
China Southern Airlines Group Air Catering Company Limited (a)
 
PRC
  RMB 
10,200,000
    100 %
Air catering
                     
Guangzhou Nanland Air Catering Company Limited (“Nanland”) (b)
 
PRC
  RMB 
120,000,000
    55 %
Air catering
                     
China Southern West Australian Flying College Pty Limited
 
Australia
  AUD 
100,000
    91 %
Pilot training services
                     
Xinjiang Civil Aviation Property Management Limited (a)
 
PRC
  RMB 
251,332,832
    51.8 %
Property management
                     
Beijing Southern Airlines Ground Services Company Limited (a)
 
PRC
  RMB 
18,000,000
    100 %
Provision of airport ground services
 
(a)
These subsidiaries are PRC limited liability companies.
 
(b)
This subsidiary is 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-87

 
58 
Associates and jointly controlled entities
 
The particulars of the Group’s principal associates and jointly controlled entities as of December 31, 2009 are as follows:

       
Proportion of ownership interest
held by
   
Name of company
 
Place of
establishment/
operation
 
Group’s
effective
interest
   
The
Company
   
Subsidiaries
 
Principal activities
                         
Guangzhou Aircraft Maintenance Engineering Company Limited (a)
 
PRC
    50 %     50 %     -  
Provision of aircraft repair and maintenance services
                               
Southern Airlines Group Finance Company Limited
 
PRC
    34 %     21.1 %     12.9
Provision of financial services
                               
Sichuan Airlines Corporation Limited
 
PRC
    39 %     39 %     -  
Airline
                               
MTU Maintenance Zhuhai Co., Limited (a)
 
PRC
    50 %     50 %     -  
Provision of engine repair and maintenance services
                               
Zhuhai Xiang Yi Aviation Technology Company Limited (a)
 
PRC
    51 %     51 %     -  
Provision of flight simulation services
                               
Guangzhou China Southern Zhongmian Dutyfree Store Co., Limited (a)
 
PRC
    50 %     50 %     -  
Sales of duty free goods in flight
 
(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-92

 

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/ Si Xian Min
 
Name: Si Xian Min
   
 
Title: Chairman of the Board of Directors

Date: May 28, 2010

 

 

Index to Exhibits

Exhibit No.
 
Description of Exhibit
1.1
 
Restated and Amended Articles of Association of China Southern Airlines Company Limited (1) 
     
4.1
 
Form of Director’s Service Agreement (2) 
     
4.2
 
Form of Non-Executive Director’s Service Agreement  (3)  
     
4.3
 
Aircraft General Terms Agreement entered into by and between Airbus S.A.S. and China Southern Airlines Company Limited on January 20, 2010 *
     
4.4
 
A320 Family Aircraft Purchase Agreement entered into by and between the Company and Airbus SNC on January 20, 2010 *
     
4.5
 
A Shares Subscription Agreement entered into by and between the Company and CSAHC on December 10, 2008(4)
     
4.6
 
H Shares Subscription Agreement entered into by and between the Company and Nan Lung Holding Limited on December 10, 2008(5)
     
4.7
 
A Shares Subscription Agreement entered into by and between the Company and CSAHC on March 8, 2010
     
4.8
 
H Shares Subscription Agreement entered into by and between the Company and Nan Lung Holding Limited on March 8, 2010
     
4.9
 
Transfer Agreement entered into by and among the Company, CSAHC, MTU and MTU Aero Engines GmbH on September 28, 2009
     
4.10
 
Transfer Agreement for the 50% Equity Interest in MTU between CSAHC and the Company on September 28, 2009
     
8.1
 
Subsidiaries of China Southern Airlines Company Limited
     
11.1
 
Code of Ethics (included in Exhibit 4.1)
     
12.1
 
Section 302 Certification of President 
     
12.2
 
Section 302 Certification of Chief Financial Officer 
     
13.1
 
Section 906 Certification of President 
     
13.2
 
Section 906 Certification of Chief Financial Officer
*   Portions of this document have been omitted pursuant to a confidential treatment request, and the full, unredacted document has been separately submitted to the Securities and Exchange Commission with a confidential treatment request.

(1) Incorporated by reference to the Exhibit 1.1 to our Form 20-F (File No. 001-14660) for the year ended December 31, 2008 filed with the Securities and Exchange Commission on June 25, 2009

(2) Incorporated by reference to the Exhibit 4.1 to our Form 20-F (File No. 001-14660) for the year ended December 31, 2005 filed with the Securities and Exchange Commission on June 30, 2006

(3) Incorporated by reference to the Exhibit 4.2 to our Form 20-F (File No. 001-14660) for the year ended December 31, 2005 filed with the Securities and Exchange Commission on June 30, 2006

(4) Incorporated by reference to the Exhibit 4.8 to our Form 20-F (File No. 001-14660) for the year ended December 31, 2008 filed with the Securities and Exchange Commission on June 25, 2009

(5) Incorporated by reference to the Exhibit 4.9 to our Form 20-F (File No. 001-14660) for the year ended December 31, 2008 filed with the Securities and Exchange Commission on June 25, 2009