SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 6-K REPORT OF FOREIGN PRIVATE ISSUER PURSUANT TO RULE 13a-16 OR 15d-16 OF THE SECURITIES EXCHANGE ACT OF 1934 For the month of November, 2004 CHINA SOUTHERN AIRLINES COMPANY LIMITED (Translation of registrant's name into English) Baiyun International Airport Guangzhou, People's Republic of China (Address of principal executive offices) (Indicate by check mark whether the registrant files or will file annual reports under cover Form 20-F or Form 40-F.) Form 20-F. [X] Form 40-F. [ ] (Indicate by check mark whether the registrant by furnishing the information contained in this Form is also thereby furnishing the information to the Commission pursuant to Rule 12g3-2(b) under the Securities Exchange Act of 1934.) Yes. [ ] No. [X] (If "Yes" is marked, indicate below the file number assigned to the registrant in connection with Rule 12g3-2(b):82-________.) China Southern Airlines Company Limited (the "Company") on November 15, 2004 distributed its Circular regarding a very substantial acquisition and connected transactions of the Company, in English and Chinese to its shareholders. A copy of each of the documents is included in this Form 6-K of the Company. THIS CIRCULAR IS IMPORTANT AND REQUIRES YOUR IMMEDIATE ATTENTION IF YOU ARE IN ANY DOUBT as to any aspect of this circular, you should consult a stockbroker or other registered dealer in securities, bank manager, solicitor, professional accountant or other professional adviser. IF YOU HAVE SOLD OR TRANSFERRED all your shares of China Southern Airlines Company Limited, you should at once hand this circular to the purchaser or transferee or to the bank, stockbroker or other agent through whom the sale was effected for transmission to the purchaser or the transferee. The Stock Exchange of Hong Kong Limited takes no responsibility for the contents of this circular, makes no representation as to its accuracy or completeness and expressly disclaims any liability whatsoever for any loss however arising from or in reliance upon the whole or any part of the contents of this circular. [LOGO] [CHINESE CHARACTERS] CHINA SOUTHERN AIRLINES COMPANY LIMITED (a joint stock limited company incorporated in the People's Republic of China with limited liability) (STOCK CODE: 1055) VERY SUBSTANTIAL ACQUISITION AND CONNECTED TRANSACTIONS FINANCIAL ADVISER [JPMORGAN LOGO] INDEPENDENT FINANCIAL ADVISER TO THE INDEPENDENT BOARD COMMITTEE AND THE INDEPENDENT SHAREHOLDERS [ICEA LOGO] --------------------- A subsidiary of ICBC A letter from the Independent Board Committee containing its advice to the Independent Shareholders in respect of the terms of the Sale and Purchase Agreement and the Financial Services Agreement is set out on pages 27 to 28 of this circular. A letter from ICEA containing its advice to the Independent Board Committee and the Independent Shareholders in respect of the terms of the Sale and Purchase Agreement and the Financial Services Agreement is set out on pages 29 to 48 of this circular. A notice convening an extraordinary general meeting of the Company to be held at the headquarters of the Company at No. 278, Ji Chang Road, Guangzhou, Guangdong Province, the PRC on 31 December, 2004 at 9:00 am is set out on pages 353 to 355 of this circular. If you are not able to attend and/or vote at the EGM, you are strongly urged to complete the accompanying form of proxy in accordance with the instructions printed thereon and return it to the Company's branch share registrar in Hong Kong, Hong Kong Registrars Limited, at 46th Floor, Hopewell Centre, 183 Queen's Road East, Hong Kong as soon as possible and in any event not later than 24 hours before the time appointed for the holding of the EGM or any adjournment thereof. Completion and return of the form of proxy will not preclude you from attending and voting at the meeting or any adjourned meeting should you so wish. 12 November, 2004 CONTENTS Page DEFINITIONS......................................................................... 1 GLOSSARY............................................................................ 6 LETTER FROM THE BOARD 1. Introduction............................................................. 7 2. The Sale and Purchase Agreement.......................................... 8 3. Reasons for and benefits of the Acquisition.............................. 10 4. Financial effect of the Acquisition...................................... 14 5. Implications under the Listing Rules..................................... 15 6. Prospective financial information........................................ 15 7. On-going Connected Transactions.......................................... 16 8. Financial Services Agreement............................................. 22 9. Recommendation........................................................... 25 10. EGM...................................................................... 25 11. Additional information................................................... 26 LETTER FROM THE INDEPENDENT BOARD COMMITTEE......................................... 27 LETTER FROM ICEA.................................................................... 29 APPENDIX I - INFORMATION REGARDING THE AIRLINE OPERATIONS OF NORTHERN AIRLINES GROUP AND XINJIANG AIRLINES GROUP.......................... 49 APPENDIX II - ACCOUNTANTS' REPORT ON FINANCIAL INFORMATION OF THE AIRLINE OPERATIONS OF NORTHERN AIRLINES GROUP................... 65 APPENDIX III - ACCOUNTANTS' REPORT ON FINANCIAL INFORMATION OF THE AIRLINE OPERATIONS OF XINJIANG AIRLINES GROUP................... 112 APPENDIX IV - FINANCIAL INFORMATION OF THE LISTED GROUP........................... 156 APPENDIX V - FINANCIAL INFORMATION OF THE COMBINED GROUP......................... 236 APPENDIX VI - PROFIT FORECAST..................................................... 245 APPENDIX VII - ADDITIONAL INFORMATION TO SHAREHOLDERS.............................. 249 APPENDIX VIII - PROPERTY VALUATION.................................................. 270 APPENDIX IX - GENERAL INFORMATION................................................. 347 NOTICE OF THE EGM................................................................... 353 -i- DEFINITIONS In this circular, the following expressions have the following meanings, unless the context requires otherwise: "Acquisition" the acquisition of the Business and Assets by the Company pursuant to the Sale and Purchase Agreement and all transactions contemplated thereunder "Airline Operations" the airlines and airlines-related operations "Board" the board of Directors "Business and Assets" certain Airline Operations, assets and properties of Northern Airlines Group and Xinjiang Airlines Group to be acquired by the Company from the Vendors pursuant to the Sale and Purchase Agreement, including aircraft, engines, spare parts, aviation equipment and facilities, properties, office facilities, and other fixed, current and intangible assets "CAAC" Civil Aviation Administration of China "Cap" the maximum aggregate annual value for each of the continuing connected transactions under the Listing Rules "Catering Agreement" the catering agreement dated 12 November, 2004 between the Company and the Catering Company "Catering Company" China Southern Airlines Group Air Catering Company Limited, a company incorporated in the PRC with limited liability "CEIC" CEIC Data Co., Ltd. "Chesterton" Chesterton Petty Limited, a chartered surveyor and independent property valuer incorporated in Hong Kong "Combined Group" the Listed Group together with the Airline Operations of Northern Airlines Group and the Airline Operations of Xinjiang Airlines Group "Company" China Southern Airlines Company Limited, a joint stock company incorporated in the PRC with limited liability -1- DEFINITIONS "CSAHC" China Southern Air Holding Company, a state-owned enterprise established under the laws of the PRC and the controlling shareholder of the Company "Debts" the debts and liabilities to be assumed by the Company from the Vendors pursuant to the Sale and Purchase Agreement "Directors" directors of the Company "Effective Date" the date when the Independent Shareholders approve the Sale and Purchase Agreement and the Acquisition "EGM" an extraordinary general meeting of the Company to be held to approve, amongst other things, the Sale and Purchase Agreement, the Financial Services Agreement, the resignation of a director of the Company and the election of a new director of the Company "EIU" Economist Intelligence Unit "Finance Company" Southern Airlines Group Finance Company Limited, a company incorporated in the PRC with limited liability "Financial Services Agreement" the financial services agreement dated 12 November, 2004 between the Company and the Finance Company "ICEA" ICEA Capital Limited, a deemed licensed corporation carrying out Type 1 (dealing in securities), Type 4 (advising on securities), Type 6 (advising on corporate finance) and Type 9 (asset management) regulated activities under SFO, which has been appointed as the independent financial adviser to the Independent Board Committee in respect of the Sale and Purchase Agreement, the Financial Services Agreement and the transactions contemplated thereunder "IFRS" International Financial Reporting Standards promulgated by the International Accounting Standards Board "ILFC" International Lease Finance Corporation, an independent third party which is not connected to the Company -2- DEFINITIONS "Independent Board Committee" the independent committee of the Board, the members of which consist of Simon To, Peter Lok, Wei Ming Hai, Wang Zhi and Sui Guang Jun, who are the independent non-executive Directors of the Company, formed to advise the Independent Shareholders with respect to the Sale and Purchase Agreement, the Financial Services Agreement and the transactions contemplated thereunder "Independent Shareholders" shareholders of the Company other than CSAHC and its associates "JPMorgan" J.P. Morgan Securities (Asia Pacific) Limited, which is licensed by the Securities and Futures Commission for Types 1, 4, 6 and 7 regulated activities under the Securities and Futures Ordinance, being the financial adviser to the Company in respect of the Acquisition "KPMG" KPMG, Certified Public Accountants registered in Hong Kong "KPMG Huazhen" KPMG Huazhen, Certified Public Accountants registered in the PRC "Latest Practicable Date" 5 November, 2004, being the latest practicable date prior to the printing for ascertaining certain information contained herein "Lease Agreement 1" the lease agreement dated 12 November, 2004 between the Company, CSAHC and Northern Airlines "Lease Agreement 2" the lease agreement dated 12 November, 2004 between the Company, CSAHC and Xinjiang Airlines "Lease Agreement 3" the lease agreement dated 12 November, 2004 between the Company and CSAHC "Lease Agreements" Lease Agreement 1, Lease Agreement 2 and Lease Agreement 3 "Listed Group" the Company and its subsidiaries "Listing Rules" the Rules Governing the Listing of Securities on the Stock Exchange -3- DEFINITIONS "Northern Airlines" China Northern Airlines Company, a company incorporated in the PRC with limited liability "Northern Airlines Group" Northern Airlines and its subsidiaries "On-going Connected the Lease Agreements and the Catering Agreement which Transactions" will be entered into between the Company and connected persons of the Company within the meaning of the Listing Rules, which will constitute continuing connected transactions of the Company under the Listing Rules upon completion of the Acquisition, details of which are set out in paragraph 7 headed "On-going Connected Transactions" under the section headed "Letter from the Board" of this circular "Parties" the Company and the Vendors "PBOC" the People's Bank of China, the central bank of the PRC "PRC" or "China" the People's Republic of China (excluding, for the purpose of this circular only, Hong Kong, Macau and Taiwan) "Provision of Deposit Service" the provision of deposit of money service by the Finance Company to the Company pursuant to the Financial Services Agreement "Sale and Purchase Agreement" the sale and purchase agreement dated 12 November, 2004 between the Company, CSAHC, Northern Airlines and Xinjiang Airlines pursuant to which the Company agreed to acquire and CSAHC, Northern Airlines and Xinjiang Airlines agreed to sell the Business and Assets "SASAC" State-owned Assets Supervision and Administration Commission of the State Council "SFO" Securities and Futures Ordinance (Chapter 571 of the laws of Hong Kong) "Stock Exchange" The Stock Exchange of Hong Kong Limited "Target Group" Northern Airlines Group and Xinjiang Airlines Group "Vendors" CSAHC, Northern Airlines and Xinjiang Airlines -4- DEFINITIONS "Xinjiang Airlines" Xinjiang Airlines Company, a company incorporated in the PRC with limited liabilities "Xinjiang Airlines Group" Xinjiang Airlines and its subsidiaries "Zhong Qi Hua Valuation the Valuation Report on the Transfer of Business and Reports" Assets of Northern Airlines as of 31 December, 2003 (Zhongqihuapingbaozi (2004) Report No. 149-1) and the Valuation Report on the Transfer of Business and Assets of Xinjiang Airlines as of 31 December, 2003 (Zhongqihuapingbaozi (2004) Report No. 149-2) prepared by China Enterprise Appraisal Co., Ltd., independent qualified valuers jointly appointed by CSAHC and the Company, and approved by the SASAC on 14 October, 2004 For the purpose of this circular, unless otherwise indicated, Renminbi amounts have been translated into Hong Kong dollars using the rate of HK$1:RMB1.06. -5- GLOSSARY In this circular, the following terms shall have the meanings indicated, unless the context otherwise requires: CAPACITY MEASUREMENTS "available seat kilometres" the number of seats made available for sale multiplied by or "ASKs" the kilometres flown "available tonne kilometres" the tonnes of capacity available for the transportation of or "ATKs" revenue load (passengers and cargo) multiplied by the kilometres flown TRAFFIC MEASUREMENTS "revenue passenger kilometres" the number of passengers carried multiplied by the or "RPKs" kilometres flown "revenue freight tonne the load of cargo in tonnes multiplied by the kilometres kilometres" or "RFTKs" flown "revenue tonne kilometres" the load (passengers and cargo) in tonnes multiplied by or "RTKs" the kilometres flown YIELD MEASUREMENTS "passenger yield" revenue from passenger operations divided by RPKs "cargo yield" revenue from cargo operations divided by cargo tonne kilometres "average yield" revenue from airline operations (passenger and cargo) divided by RTKs "tonne" a metric ton, equivalent to 2,204.6 pounds LOAD FACTORS "passenger load factor" RPKs expressed as a percentage of ASKs "overall load factor" RTKs expressed as a percentage of ATKs UTILISATION "utilisation rates" the actual number of flight and taxi hours per aircraft per operating day -6- LETTER FROM THE BOARD [LOGO] [CHINESE CHARACTERS] CHINA SOUTHERN AIRLINES COMPANY LIMITED (a joint stock limited company incorporated in the People's Republic of China with limited liability) DIRECTORS: REGISTERED ADDRESS: Guangzhou Economic and Executive Directors: Technology Development Zone Yan Zhi Qing (Director) Guangdong Province Liu Ming Qi (Vice Chairman of PRC the Board of Directors) Wang Chang Shun (Vice Chairman of PRINCIPAL PLACE OF BUSINESS the Board of Directors, President) IN HONG KONG: Peng An Fa (Director) Unit B1, 9th Floor Wang Quan Hua (Director) United Centre Zhao Liu An (Director) 95 Queensway Zhou Yong Qian (Director) Hong Kong Zhou Yong Jin (Director) Xu Jie Bo (Director, Chief Financial Officer) Wu Rong Nan (Director) Independent Non-Executive Directors: Simon To Peter Lok Wei Ming Hai Wang Zhi Sui Guang Jun Supervisors: Sun Xiao Yi (Chairman of the Supervisory Committee) Yang Guang Hua (Supervisor) Yan Yi Hua (Supervisor) 12 November, 2004 To the Shareholders Dear Sir or Madam, VERY SUBSTANTIAL ACQUISITION AND CONNECTED TRANSACTIONS 1. INTRODUCTION On 12 November, 2004, the Board announced that the Sale and Purchase Agreement was entered into by the Company as the purchaser and CSAHC, Northern Airlines and Xinjiang Airlines as the vendors, whereby the Company will acquire the Business and Assets and assume the Debts from the Vendors. -7- LETTER FROM THE BOARD The Independent Board Committee, comprising the independent non-executive Directors, namely Simon To, Peter Lok, Wei Ming Hai, Wang Zhi and Sui Guang Jun, has been formed to advise the Independent Shareholders with respect to the Sale and Purchase Agreement, the Financial Services Agreement and the transactions contemplated thereunder. ICEA has been appointed as the independent financial adviser to advise the Independent Board Committee and the Independent Shareholders in respect of the Sale and Purchase Agreement, the Financial Services Agreement and the transactions contemplated thereunder. The purpose of this circular is (i) to give you further information regarding the Acquisition, the On-going Connected Transactions which will constitute continuing connected transactions of the Company after completion of the Sale and Purchase Agreement, and the Financial Services Agreement; (ii) to set out the recommendations from the Independent Board Committee to the Independent Shareholders and the advice from ICEA to the Independent Board Committee and the Independent Shareholders in respect of the Sale and Purchase Agreement, the Financial Services Agreement and the transactions contemplated thereunder; and (iii) to give you the notice of the EGM and other information required under the Listing Rules. 2. THE SALE AND PURCHASE AGREEMENT (1) DATE 12 November, 2004 (2) PARTIES (a) The Company, as the purchaser. The principal business activity of the Company is that of civil aviation. (b) CSAHC, the controlling shareholder of the Company holding approximately 50.30% equity interest in the Company as of the Latest Practicable Date. The principal business activity of CSAHC, based on its business licence, is that of operating and managing, on behalf of the PRC government, certain state-owned assets, including properties, and state-owned shareholdings in various PRC companies. (c) Northern Airlines, a wholly owned subsidiary of CSAHC, as the vendor. The principal business activity of Northern Airlines is that of civil aviation. (d) Xinjiang Airlines, a wholly owned subsidiary of CSAHC, as the vendor. The principal business activity of Xinjiang Airlines is that of civil aviation. (3) THE BUSINESS AND ASSETS TO BE ACQUIRED AND THE DEBTS TO BE ASSUMED (a) The Business and Assets to be acquired consist of certain Airline Operations, assets and properties of Northern Airlines Group and Xinjiang Airlines Group, including aircraft, engines, spare parts, aviation equipment and facilities, properties, office facilities, and other fixed, current and intangible assets. -8- LETTER FROM THE BOARD (b) The Debts to be assumed consist of all indebtedness in the aggregate sum of RMB15,090,109,000 owed by Xinjiang Airlines Group or Northern Airlines Group in connection with their civil aviation business. (4) CONDITIONS PRECEDENT The Sale and Purchase Agreement is subject to the following conditions precedent: (a) the Vendors obtaining all approvals of the Sale and Purchase Agreement by the working meeting of the president of CSAHC and the SASAC; and (b) the Independent Shareholders approving the Sale and Purchase Agreement and the transactions contemplated thereunder. (5) CONSIDERATION AND PAYMENT TERMS The provisional amount of the consideration of the Acquisition, and of the Debts to be assumed under the Sale and Purchase Agreement are set at RMB16,912,244,600 and RMB15,090,109,000 respectively. These amounts are arrived at after arm's length negotiations between the Vendors and the Company, with reference to the valuation of the Business and Assets, and Debts set out in the Zhong Qi Hua Valuation Reports. The Zhong Qi Hua Valuation Reports value the Business and Assets, Debts and net asset value of the Target Group at RMB16,912,244,600, RMB15,090,109,000 and RMB1,822,135,600 respectively as of 31 December, 2003. The provisional amount of the consideration of the Acquisition, and of the Debts to be assumed by the Company will be subject to adjustment and finalisation based on the book value of the Business and Assets, and of the Debts as of the Effective Date, as determined in the financial statements of the Business and Assets of the Target Group prepared under the PRC Accounting Rules and Regulations and audited by KPMG Huazhen. A portion of the final adjusted consideration of the Acquisition will be settled by way of assumption of the final adjusted Debts, with the remaining balance to be payable by the Company to the bank account designated by the Vendors in cash. On the assumption that the Acquisition had taken place on 30 June, 2004, and based on the financial statements of the Business and Assets of the Target Group prepared under the PRC Accounting Rules and Regulations and audited by KPMG Huazhen on the same date, the remaining balance payable by the Company in cash to the bank account designated by the Vendors on that date would have been RMB1,897 million. The Company shall make repayments of the Debts directly to the creditors of such Debts in accordance with the terms and conditions of the relevant agreements between the Vendors and the creditors in relation to the Debts. (6) FUNDING The Company will finance the Acquisition and the assumption of the Debts through its internal resources, and short term U.S. dollar commercial loans from commercial -9- LETTER FROM THE BOARD banks amounting to RMB1,000 million. Such commercial banks are not and will not be connected persons (as defined in the Listing Rules) of the Company. The Company will make use of its unutilised banking facilities to draw down the required commercial loans. (7) TRANSITION PERIOD The terms of the Sale and Purchase Agreement provide for a transition period commencing from 31 December, 2003 and ending on the Effective Date, during which if a material change occurs such that any of the Business and Assets is damaged, lost, or the ownership of which no longer belongs to the Vendors, the Vendors shall give notice to the Company immediately. The Vendors must obtain the prior consent of the Company before disposing of any Business and Assets during the transition period. All profits and losses arising from the Business and Assets during the transition period belong to the Vendors. All profits and losses from the Effective Date thereon shall belong to the Company. (8) DELIVERY TERMS AND OWNERSHIP The Vendors shall deliver all the Business and Assets, together with all documents evidencing or constituting ownership of such Business and Assets, to the Company within five days of the Effective Date. 3. REASONS FOR AND BENEFITS OF THE ACQUISITION The Directors believe that the Acquisition represents an attractive opportunity for the Company to consolidate its strong market position and improve its financial performance. Both Northern Airlines and Xinjiang Airlines are leading airlines in their respective operating regions. The Acquisition will bring various commercial benefits to the Company in terms of broadening its flight service network, increasing its fleet size and transportation capacity, reducing costs and boosting its overall efficiency, ultimately strengthening the Listed Group's position as one of China's largest airlines and enhancing its value for its investors. (1) BROADEN FLIGHT NETWORK (a) The Listed Group is headquartered in Guangzhou with 12 operational bases in central and Southern China, offering regular flights on 248 domestic routes to over 69 cities in China, 18 routes to Hong Kong, and 45 international routes to 24 cities in East and Southeast Asia, Australia, North America and Europe, as of 30 June, 2004. However, due to the lack of operational bases, the Company is only capable of offering very limited flight services in Northern China and Northwestern China. (b) Northern Airlines Group is headquartered in Shenyang with operational bases in Dalian, Changchun and Harbin. Northern Airlines Group's operating region is predominantly in Northeastern China. It is also the dominant Chinese airline serving flight routes to Korea and Japan due to the proximity of its operating region to those countries. -10- LETTER FROM THE BOARD (c) Xinjiang Airlines Group is headquartered in Urumqi, with operational bases and operating region in the Xinjiang autonomous region. It also commands a strong market position on domestic routes between Xinjiang and other parts of China, and on international routes to Russia, the Middle East and West Asia. As the flight networks of the Listed Group, Northern Airlines Group and Xinjiang Airlines Group are disparate and complementary to each other, the Acquisition will significantly broaden the Company's flight network. After the Acquisition, the Company will have a strong presence in additional key markets in the Western and Northeastern part of China, enabling it to provide more comprehensive civil aviation service to customers. The Directors believe that the Acquisition provides significant growth potential for the Listed Group, particularly in light of the "Go West" and "Redevelop the Northeast" campaigns initiated by the PRC government. The Directors also believe that the huge investment made by the PRC government in Western and Northeastern China will lead to rapid economic growth in those regions over the next decade or more, which, in turn, will result in rapid increase in air traffic volume to and from those regions. In addition, the Acquisition will also significantly enhance the Company's international air transportation business. The Company will be able to offer flight services between its bases in Southern, Northeastern and Northwestern China and other international cities in North America, Southeast Asia, North Asia, the Middle East as well as Europe. The table below illustrates the Company's domestic base network before and after the Acquisition: BASE NETWORK BEFORE AND AFTER THE ACQUISITION [BASE NETWORK MAP] Pre-transaction [BASE NETWORK MAP] Post-transaction (2) INCREASE FLEET SIZE AND TRANSPORTATION CAPACITY The Acquisition will substantially increase the fleet size of the Listed Group. As of 30 June, 2004, the Listed Group owned and operated a fleet of 139 medium and large size -11- LETTER FROM THE BOARD commercial passenger and cargo aircraft. The Acquisition will bring in 75 commercial passenger and cargo aircraft from Northern Airlines Group and Xinjiang Airlines Group thereby increasing the Listed Group's fleet size by 54% to 214 commercial aircraft. The increased economies of scale will contribute to greater transportation capacity, higher operating efficiency, lower operating and maintenance cost, more flexible flight scheduling, greater bargaining power in aircraft acquisitions, better financing terms for purchases and improved aircraft allocation for the flight routes. The tables below set out fleet and selected operating data of the Target Group and the Listed Group individually, and on a combined basis, for the year 2003 and the first half of 2004: FIRST SIX MONTHS OF 2004 NORTHERN XINJIANG LISTED AIRLINES AIRLINES GROUP GROUP GROUP COMBINED ------ ----- -------- -------- Number of aircraft(1) 139 55 20 214 Passenger capacity (ASK) (million) 25,928 7,693 3,722 37,343 Passenger traffic (RPK) (million) 17,242 5,190 2,416 24,848 Passenger volume (thousand) 13,315 3,621 1,264 18,200 Cargo and mail carried (thousand tonne) 267 55 12 334 (1) As of 30 June, 2004 including owned and leased (on both finance and operating lease basis) aircraft. 2003 NORTHERN XINJIANG LISTED AIRLINES AIRLINES GROUP GROUP GROUP COMBINED ------ -------- -------- -------- Number of aircraft(1) 132 50 20 202 Passenger capacity (ASK) (million) 40,867 13,940 6,297 61,104 Passenger traffic (RPK) (million) 26,387 9,147 4,092 39,626 Passenger volume (thousand) 20,470 6,474 2,148 29,092 Cargo and mail carried (thousand tonne) 464 111 21 596 (1) As of 31 December, 2003 including owned and leased (on both finance and operating lease basis) aircraft. -12- LETTER FROM THE BOARD (3) MINIMIZE ROUTE OVERLAP AND OPTIMIZE FLIGHT SCHEDULES The Directors believe that the Acquisition will yield significant benefits to the Listed Group through optimization of flight routes and schedules. Most of the major flight routes in the PRC are served by more than one airline, and therefore the competition on most major flight routes is intense. Although offering discounts on air ticket prices is still regulated by the CAAC, many PRC airlines rely heavily on such measures to attract passengers. As a result, the Listed Group faces significant pressure on air ticket prices. Prior to the Acquisition, the routes that the Listed Group shares with Northern Airlines Group and Xinjiang Airlines Group account for approximately 8.2% of the Listed Group's total routes. After the Acquisition, the Listed Group will become the sole or main operator on many of such shared flight routes. This reduction in route and slot overlap will allow the Listed Group to gain advantageous air ticket pricing power and improve its financial performance. Moreover, the Listed Group could reduce the number of flights on those shared routes without sacrificing sufficient coverage and service quality. The Listed Group will then have additional capacity to support other more profitable flight routes and thus generate additional revenue. (4) ENHANCE AIR TICKET SALES NETWORK AND REDUCE OVERHEAD Northern Airlines Group, Xinjiang Airlines Group and the Listed Group each maintains an extensive air ticket sales network in major cities and large ground services teams at major airports in China. The Listed Group can achieve significant cost savings by rationalizing the sales network and consolidating the ground service operations of the three airlines. After the Acquisition, the Company plans to close a total of 14 geographically overlapping domestic air ticket sales offices (eight belong to Northern Airlines Group, four belong to Xinjiang Airlines Group and two to the Company) and four overseas air ticket sales offices (all belong to Northern Airlines Group). (5) IMPROVE ALLOCATION OF AIRCRAFT, ENGINES, SPARE PARTS AND CREWS The Directors believe the expanded fleet will provide the Listed Group greater flexibility in allocating aircraft between the combined routes of the Listed Group, Northern Airlines Group and Xinjiang Airlines Group. For each of the three airlines, there is excess capacity in low seasons, but limited or inadequate capacity during peak seasons. As most of the flight routes served by them are different, each of the Listed Group, Northern Airlines Group and Xinjiang Airlines Group has relatively staggered peak and low seasons. After the Acquisition, the Company will be able to re-deploy an enlarged team of aircraft, pilots and flight personnel to the highest traffic routes and better ensure a balance of demand and supply for capacity throughout the year. -13- LETTER FROM THE BOARD Furthermore, since the Listed Group has already been operating Boeing 737, 757 and Airbus 319, 320 aircraft that Xinjiang Airlines Group and Northern Airlines Group are either currently operating or will be acquiring according to their aircraft replacement schedules, the Listed Group will be able to improve the internal allocation of engines and high-value aircraft spare parts. For instance, the Directors believe that after the Acquisition, the Listed Group may be able to purchase fewer aircraft engines and spare parts and reduce inventory level of them. Through redeployment of aircraft, pilots and crew, and better allocation of spare parts, the Directors believe the Listed Group can improve its operating efficiency and reduce operating costs and capital expenditures. (6) REDUCE MAINTENANCE COSTS The Directors believe significant reduction in maintenance cost can be achieved through more centralized maintenance functions and sharing of maintenance personnel and equipment. The Company plans to centralize fleet maintenance functions at five national maintenance bases which are Guangzhou, Shenyang, Urumqi, Zhengzhou (or Wuhan) and Xiamen in the next few years. These maintenance bases will be responsible for major overhauls on all aircraft while the local bases will be responsible for minor maintenance tasks on their own aircraft. The Directors believe that this initiative will significantly improve efficiency and reduce the costs of fleet maintenance. (7) STRENGTHEN MARKETING EFFORTS Since its listing on the Stock Exchange, the Company has implemented many changes to its remuneration policies in order to improve the effectiveness of marketing efforts by its business units. Under the Company's current performance credit policy, its branch office located in the city that a particular flight originates from (including both non-stop and connecting flights) receives performance credit for the flights to the immediate next destination. Previously, all performance credit earned by a particular aircraft was given to the office in which that aircraft was based in, which did not provide incentive for the offices in intermediate cities to market the air ticket of that particular flight. After the Acquisition, the Company plans to implement this remuneration policy to the marketing units newly acquired from the Target Group. The Directors believe that this will lead to a more effective and concerted marketing effort by all the offices, and therefore resulting in higher sales revenue. 4. FINANCIAL EFFECT OF THE ACQUISITION Based on the pro forma financial information of the Combined Group outlined in Appendix V of this circular, assuming that the Acquisition had taken place on 30 June, 2004, there would not be any impact on the net assets of the Listed Group following the Acquisition as of 30 June, 2004. On the same basis, the total assets of the Listed Group would increase by 35%, or RMB15,179 million, which would be offset by an increase of RMB15,083 million in liabilities and RMB96 million in minority interest. -14- LETTER FROM THE BOARD Based on the pro forma financial information of the Combined Group outlined in Appendix V of this circular, assuming that the Acquisition had taken place on 1 January, 2004, for the first six months ended 30 June, 2004, net profit of the Listed Group would increase by 36%, or RMB95 million to RMB361 million following the Acquisition. On the same basis, basic earnings per share would increase from RMB0.06 to RMB0.08, representing an accretion of 36%. 5. IMPLICATIONS UNDER THE LISTING RULES The Acquisition exceeds 100% of the relevant percentage ratios under Rule 14.07 of the Listing Rules and therefore constitutes a very substantial acquisition of the Company under the Listing Rules. Since CSAHC is the direct controlling shareholder of the Company, the Acquisition also constitutes a connected transaction for the Company under the Listing Rules and is therefore subject to the approval by the Independent Shareholders at the EGM. The Board, including the independent non-executive Directors, believes that the terms of the Sale and Purchase Agreement and the Acquisition are fair and reasonable and are in the interests of the Listed Group and its shareholders as a whole. An Independent Board Committee has been formed to advise the Independent Shareholders in respect of the Sale and Purchase Agreement and the Acquisition. ICEA has been appointed as the independent financial adviser to advise the Independent Board Committee and the Independent Shareholders in respect of the Sale and Purchase Agreement and the Acquisition. CSAHC and its associates are required to abstain from voting in respect of the proposed resolution to approve the Sale and Purchase Agreement and the Acquisition which will be conducted by poll. 6. PROSPECTIVE FINANCIAL INFORMATION The Target Group has prepared certain prospective financial information in respect of the Airline Operations of Northern Airlines Group and the Airline Operations of Xinjiang Airlines Group for the year ending 31 December, 2004 in compliance with Rule 14A.56(8) and Rule 14.62 of the Listing Rules. For further details, please see Appendix VI. Neither the Target Group nor the Company intends to update this information during the remainder of the year or to update such information in future years, although the Directors are aware of the requirements of Rule 13.09 notes 9 and 10 of the Listing Rules. This information is necessarily based upon a number of assumptions (see Appendix VI) that, while presented with numerical specificity and considered reasonable by the Target Group, are inherently subject to significant business, economic and competitive uncertainties and contingencies, many of which are beyond the control of the Company or the Target Group, and upon assumptions with respect to future business decisions which are subject to change. Accordingly, there can be no assurance that these results will be realized. The prospective financial information presented may vary from actual results, and these variations may be material. The Company and the Target Group believe that, on the bases and the assumptions discussed in Appendix VI and in the absence of unforeseen circumstances, the Target Group's -15- LETTER FROM THE BOARD forecast combined profit after taxation and minority interests but before the extraordinary items for the year ending 31 December, 2004 under IFRS is unlikely to be less than RMB148 million. Such forecast has been prepared based on the principal assumptions set out in Appendix VI to this circular. In the event that such forecast is not met, the Company will make further announcement to explain the reasons. The texts of the letters from KPMG and JPMorgan in respect of the profit forecast are set out in Appendix VI to this circular. 7. ON-GOING CONNECTED TRANSACTIONS The Lease Agreements and the Catering Agreement will be entered into between the Company and connected persons of the Company within the meaning of the Listing Rules, which will constitute On-going Connected Transactions of the Company under the Listing Rules upon completion of the Acquisition. (A) LEASE AGREEMENTS (1) LEASE AGREEMENT 1 Date 12 November, 2004 Parties (a) CSAHC, as the lessor. (b) Northern Airlines, as the lessor. (c) The Company, as the lessee. The property to be leased CSAHC and Northern Airlines lease to the Company certain buildings, facilities and other infrastructure related to the civil aviation businesses of Northern Airlines situated at various locations in Shenyang, Dalian, Jilin, Harbin, Chaoyang and Russia. Term of Lease Agreement 1 Lease Agreement 1 is for a fixed term of three years, commencing from the date of the lease, and is renewable, subject to compliance with the relevant requirements of the Listing Rules by the Company, by an application in writing by the Company to the lessors three months before the end of the fixed term. -16- LETTER FROM THE BOARD Consideration and payment terms The consideration for Lease Agreement 1 is RMB41,993,318.44 per year, payable in arrear by cheque, in cash or by bank transfer on or before the 10th day of each calendar month, and is determined after arm's length negotiation between the parties. Chesterton, an independent qualified valuer in Hong Kong, has given its opinion that the consideration for Lease Agreement 1 is not higher than the current market prices of comparable properties. The consideration will be funded wholly by the Company's internal resources. The Cap As the consideration has been determined after arm's length negotiation between the parties and with regard to the current market prices, the Cap for the Lease Agreement 1 is set at RMB41,993,318.44 per year. Reasons and benefits of the Lease Agreement 1 Following the Acquisition, the Company will expand its civil aviation business to locations where the buildings, facilities and infrastructure under the Lease Agreement 1 are situated at. The purchase of such buildings, facilities and infrastructure by the Company will involve the more time-consuming and costly process of transferring to the Company the relevant titles, ownership or land use rights relating thereto; whereas the entering into of the Lease Agreement 1 allows the Company to use those buildings, facilities and infrastructure to operate its expanded civil aviation business from the commencement date of the Lease Agreement 1 at rents not higher than the market rates for similar buildings, facilities and infrastructure. (2) LEASE AGREEMENT 2 Date 12 November, 2004 Parties (a) CSAHC, as the lessor. (b) Xinjiang Airlines, as the lessor. (c) The Company, as the lessee. The property to be leased CSAHC and Xinjiang Airlines lease to the Company certain buildings, facilities and other infrastructure related to the civil aviation businesses of Xinjiang Airlines situated in Xinjiang and Russia. -17- LETTER FROM THE BOARD Term of Lease Agreement 2 Lease Agreement 2 is for a fixed term of three years, commencing from the effective date of the lease, and is renewable, subject to compliance with the relevant requirements of the Listing Rules by the Company, by an application in writing by the Company to the lessor three months before the end of the fixed term. Consideration and payment terms The consideration for Lease Agreement 2 is RMB5,797,908.61 per year, payable in arrear by cheque, in cash or by bank transfer on or before the 10th day of each calendar month, and is determined after arm's length negotiation between the parties. Chesterton, an independent qualified valuer in Hong Kong, has given its opinion that the consideration for Lease Agreement 2 is not higher than the current market prices of comparable properties. The consideration will be funded wholly by the Company's internal resources. The Cap As the consideration has been determined after arm's length negotiation between the parties and with regard to the current market prices, the Cap for the Lease Agreement 2 is set at RMB5,797,908.61 per year. Reasons and benefits of the Lease Agreement 2 Following the Acquisition, the Company will expand its civil aviation business to locations where the buildings, facilities and infrastructure under the Lease Agreement 2 are situated at. The purchase of such buildings, facilities and infrastructure by the Company will involve the more time-consuming and costly process of transferring to the Company the relevant titles, ownership or land use rights relating thereto; whereas the entering into of the Lease Agreement 2 allows the Company to use those buildings, facilities and infrastructure to operate its expanded civil aviation business from the commencement date of Lease Agreement 2 at rents not higher than the market rates for similar buildings, facilities and infrastructure. (3) LEASE AGREEMENT 3 Date 12 November, 2004 Parties (a) CSAHC, as the lessor. (b) The Company, as the lessee. -18- LETTER FROM THE BOARD The property to be leased CSAHC leases to the Company certain lands by leasing the land use rights of such lands to the Company. These lands had been administratively allocated to Xinjiang Airlines and Northern Airlines for the purposes of their civil aviation and related businesses. Subsequently, CSAHC was authorised to deal with the land use rights of such lands, including leasing, but not transferring, such land use rights. Total area of the lands leased is 1,182,297 square metres, and the locations of such lands are in Urumqi, Shenyang, Dalian and Harbin. Term of Lease Agreement 3 Lease Agreement 3 is for a fixed term of three years, commencing from the effective date of the lease, and is renewable, subject to compliance with the relevant requirements of the Listing Rules by the Company, by an application in writing by the Company to the lessor three months before the end of the fixed term. Consideration and payment terms The rent for the land use rights of the designed lands under Lease Agreement 3 is RMB22,298,033 per year, payable in arrear by cheque, in cash or by bank transfer on or before the 10th day of each calendar month, and is determined after arm's length negotiation between the parties. Chesterton, an independent qualified valuer in Hong Kong, has given its opinion that the consideration for Lease Agreement 3 is not higher than the current market prices of comparable properties. The consideration will be funded wholly by the Company's internal resources. The Cap As the consideration has been determined after arm's length negotiation between the parties and with regard to the current market prices, the Cap for the Lease Agreement 3 is set at RMB22,298,033 per year. Benefits of the Lease Agreement 3 Following the Acquisition, the Company will expand its civil aviation business to locations where the lands under the Lease Agreement 3 are situated at. As CSAHC is prohibited from transferring the land use rights of such lands to the Company, the Company could only lease the land use rights of such lands from CSAHC. The Lease Agreement 3 allows the Company to use those lands to operate its expanded civil aviation business at rent not higher than the market rates for similar lands. -19- LETTER FROM THE BOARD (B) CATERING AGREEMENT DATE 12 November, 2004 PARTIES (a) The Company. (b) The Catering Company, which is wholly owned by CSAHC. The principal business activity of the Catering Company is the provision of in-flight meals to airlines. CATERING SERVICE The Catering Company will supply (1) in-flight meals in accordance with the menus of in-flight meals agreed with the Company from time to time, and in such quantity as the Company shall advise the Catering Company in advance; and (2) catering services for different flights of the Company (including normal, additional, chartered and temporary flights) originating or stopping at the domestic airports, mainly in Northern China and the Xinjiang regions where the Catering Company provides catering services. The Combined Group will also obtain catering services and in-flight meals from other catering companies. TERM OF THE CATERING AGREEMENT The Catering Agreement is for a fixed term of three years from the date of the Catering Agreement. CONSIDERATION AND PAYMENT TERMS The parties have agreed, after arm's length negotiation, on the price of each type of in-flight meals and the service charges for each type of aircraft. The prices of in-flight meals and the service charges are not higher than the market rate of comparable in-flight meals and service charges. The Catering Company will issue an invoice listing out the quantity of in-flight meals supplied, the agreed unit price and the total price payable for each of the Company flight it provides service. The invoice shall be verified and signed by the captain flight attendant of that flight. At the end of each month, the Catering Company shall deliver to the Company for its verification all the invoices issued during that month. The Company will make payment to the Catering Company within 60 days of the receipt of the invoices. -20- LETTER FROM THE BOARD THE CAP There are no historical figures available for the Catering Agreement as it will only be entered into on 12 November, 2004. The Cap for the Catering Agreement is set at RMB220 million per year. As discussed above, the flight network of the Company will broaden following the Acquisition. The Cap for the Catering Agreement is therefore determined on the basis of the estimated number of passengers to be carried and the number of flights per year mainly under the enlarged flight network in Northern China and the Xinjiang regions of the Company during the term of the Catering Agreement, the prices of the in-flight meals and the service charges of the catering services under the Catering Agreement. REASONS AND BENEFITS OF THE CATERING AGREEMENT The Company can secure in-flight meals and catering services at prices no higher than the market price for its flights originating or stopping at domestic airports mainly in Northern China and the Xinjiang regions where the Catering Company provides catering services. The Company is not precluded from procuring in-flight meals and catering services from other catering companies where the terms and conditions are favourable. (C) IMPLICATIONS UNDER THE LISTING RULES As each of CSAHC, Xinjiang Airlines, Northern Airlines and the Catering Company is a connected person of the Company under the Listing Rules, each of the Lease Agreements and Catering Agreement constitutes a continuing connected transaction for the Company under the Listing Rules. The Board, including the independent non-executive Directors, considers the On-going Connected Transactions to be on normal commercial terms, in the ordinary and usual course of business, fair and reasonable and in the interests of the Listed Group and its shareholders as a whole. Pursuant to the Listing Rules, each percentage ratio (other than the profits ratio) for (i) the Lease Agreements, and (ii) the Catering Agreement is on an annual basis less than 2.5%. Therefore, each of (i) the Lease Agreements, and (ii) the Catering Agreement falls under Rule 14A.34 and is only subject to the reporting and announcement requirements set out in Rules 14A.45 to 14A.47 and is exempt from the Independent Shareholders' approval requirements. The Company undertakes to comply with the rules in relation to annual review of continuing connected transactions set out in Rule 14A.37 to Rule 14A.41 of the Listing Rules. Pursuant to the relevant rules and regulations of the PRC, each of Lease Agreement 1, Lease Agreement 2, Lease Agreement 3 and Catering Agreement is conditional upon approval by the Independent Shareholders. In accordance with the relevant rules and regulations of Shanghai Stock Exchange, China Galaxy Securities Co., Limited has been appointed by the Company as the independent financial adviser in China to prepare an independent financial report in relation to each of Lease Agreement 1, Lease Agreement 2, Lease Agreement 3 and Catering Agreement which is required to be published in the newspaper in the PRC. -21- LETTER FROM THE BOARD 8. FINANCIAL SERVICES AGREEMENT The first financial services agreement between the Company and the Finance Company was entered into on 22 May, 1997 for a term of three years. The Stock Exchange had, in a letter dated 24 April, 1998, granted the Company waiver from strict compliance with Chapter 14 under the then applicable Listing Rules in relation to, among other transactions, the first financial services agreement and the transactions contemplated thereunder. The first financial services agreement was extended in 2000 for six years to 22 May, 2006. The Stock Exchange is looking into the matter of whether the Company had complied with the requirements of the Listing Rules during the extended term of the first financial services agreement and the Company will publish further announcement in this respect. In order to comply with the new requirements under the Listing Rules, the Company and the Finance Company are now entering into the Financial Services Agreement so that the Finance Company could continue to provide deposit of money service and, subject to the execution of separate agreements with the Company and further compliance with the Listing Rules, other financial services to the Company. The Provision of Deposit Service constitutes a discloseable and non-exempt continuing connected transaction, and is conditional upon approval by the Independent Shareholders. DATE 12 November, 2004 PARTIES (a) The Company. (b) The Finance Company, a subsidiary of CSAHC which is owned as to 42% by CSAHC, 32% by the Company and 26% in aggregate by five subsidiaries of the Company, namely 8% by Xiamen Airlines Company Limited, 8% by Southern Airlines Group Shantou Airlines Company Limited, 4% by Guangxi Airlines Company Limited, 4% by Zhuhai Airlines Company Limited and 2% by Guangzhou Nanland Air Catering Company Limited. The principal business activity of the Finance Company is that of providing various financial services, which it is authorised to carry out under the applicable rules and regulations of the PRC. FINANCIAL SERVICES The Finance Company agrees to provide to the Company the following financial services: (1) Accept deposit of money from the Company at interest rates not lower than those set by the PBOC for the same term of deposit. The Finance Company will in turn deposit the whole of such sums of money with certain banks including Bank of Agriculture, Bank of Communications, China Construction Bank and Industrial and Commercial Bank of China. -22- LETTER FROM THE BOARD (2) Make loans to the Company subject to the entering into of separate loan agreements, which will set out the Cap, terms and conditions of the loans, upon application by the Company during the term of the Financial Services Agreement. The Company will comply with the Listing Rules when entering into such separate written agreements. The Finance Company shall not charge interest rates higher than those set by the PBOC for similar loans. The total amount of outstanding loans extended by the Finance Company to the Company must not exceed the sum of the Finance Company's shareholders' equity, capital reserves and money deposit received from other parties (except the Company). (3) Provide credit facilities, financial guarantees, credit references, and other financial services subject to the entering into of separate agreements, which will set out the Cap, terms and conditions of such services, upon request by the Company during the term of the Financial Services Agreement. The Company will comply with the Listing Rules when entering into such separate written agreements. TERM OF THE FINANCIAL SERVICES AGREEMENT The Financial Services Agreement is for a fixed term of 3 years, commencing from the date of the agreement, and is renewable, subject to compliance with the requirements of the relevant Listing Rules by the Company, by an application in writing by the Company not less than 30 days before the end of the fixed term. CONSIDERATION AND PAYMENT TERMS The Company is not subject to any extra charges for depositing money with the Finance Company. For the other financial services provided by the Finance Company under the Financial Services Agreement, the Company is liable to pay the Finance Company the standard charging rates set by the PBOC. The PRC commercial banks also charge similar charging rates set by the PBOC. The Company will make payment for such interest, fees and commissions in accordance with the payment terms of the separate agreements for the provision of loans or other financial services as might be entered into between the Company and the Finance Company. THE CAP The Cap for the Provision of Deposit Service under the Financial Services Agreement is set at RMB1 billion per year, based on the past figures on deposit of money with the Finance Company, and on the estimated amount of money to be deposited with -23- LETTER FROM THE BOARD the Finance Company by the Company each year for the term of the Financial Services Agreement. The Company's deposit of money with the Finance Company was of the amount of RMB1,316,709,000, RMB877,499,000 and RMB346,357,000 as of 31 December, 2001, 31 December, 2002 and 31 December, 2003 respectively. The Company believes that the demand for air transportation will continue to increase following the growth trend in the aviation transportation market, thus the Company expects that it will substantially increase its deposits with the Finance Company for the next three years, as compared to the year ended 31 December, 2003 when the business of the Company was badly affected by the outbreak of severe acute respiratory syndrome. Taking into account the historical amount of the deposit of money with the Finance Company by the Company, the proposed Cap will sufficiently cover the proposed amount of the deposit of money with the Finance Company by the Company. REASONS AND BENEFITS OF THE FINANCIAL SERVICES AGREEMENT The Finance Company is a non-bank finance company established under the direction of the PBOC with the main business scope of providing various financial services, including deposit and loan facilities, credit facilities, guarantee, remittance of money and credit references, to CSAHC and its subsidiaries. The first financial services agreement between the Company and the Finance Company was entered into on 22 May, 1997. As the transactions under the first financial services agreement constituted connected transactions of the Company, details of which had been disclosed in the annual reports of the Company. In order to comply with the new requirements under the Listing Rules, the Company and the Finance Company are now entering into the Financial Services Agreement so that the Finance Company could continue to provide deposit of money service and, subject to the execution of separate agreements with the Company and further compliance with the Listing Rules, other financial services to the Company. The Company usually receives interest on its money deposited with the Finance Company at rates which are more favourable than the benchmark interest rates set by the PBOC, usually in the range between the benchmark interest rates set by the PBOC and the inter-bank offer rates of interest. This arrangement allows the Company to achieve a more efficient use of its current capital, since the Company can enjoy better interest rates on depositing its current capital with the Finance Company than the benchmark rates of interest set by the PBOC that the PRC commercial banks can offer to the Company. Subject to the entering into of further separate agreements, the Company can borrow from the Finance Company at interest rates not higher than those set by the PBOC for similar loans. In addition, the Company is not precluded under the Financial Services Agreement to borrow money from other PRC commercial banks where the terms and conditions are favourable. The Company can also enjoy the convenience of other financial services at the rates of fees and commissions set by the PBOC, which are comparable to the rates charged by PRC commercial banks for similar services. -24- LETTER FROM THE BOARD IMPLICATIONS UNDER THE LISTING RULES As the Finance Company is a connected person of the Company under the Listing Rules, the Provision of Deposit Service constitutes a discloseable and non-exempt continuing connected transaction under Rule 14A.35 of the Listing Rules and requires the Company to comply with the reporting and announcement requirement and the independent shareholders' approval requirement under Rule 14A.48 of the Listing Rules. The Board, including the independent non-executive Directors, believes that the terms of the Financial Services Agreement and the Provision of Deposit Service to be on normal commercial terms, in the ordinary and usual course of business, fair and reasonable and in the interests of the Listed Group and its shareholders as a whole. An Independent Board Committee has been formed to advise the Independent Shareholders in respect of the Financial Services Agreement and the Provision of Deposit Service. ICEA has been appointed as the independent financial adviser to advise the Independent Board Committee and the Independent Shareholders in respect of the Financial Services Agreement and the Provision of Deposit Service. CSAHC and its associates are required to abstain from voting in respect of the proposed resolution to approve the Financial Services Agreement and the Provision of Deposit Service which will be conducted by poll. The Company will comply with the Listing Rules when it enters into further separate agreements with the Finance Company in connection with the provision of loan facilities and other financial services by the Finance Company. 9. RECOMMENDATIONS ICEA has been appointed to advise the Independent Board Committee and the Independent Shareholders on the Sale and Purchase Agreement, the Financial Services Agreement and the transactions contemplated thereunder. The Independent Board Committee, having taken into account the advice of ICEA, considers that the terms of the Sale and Purchase Agreement, the Financial Services Agreement and the transactions contemplated thereunder are fair and reasonable and are in the interests of the Listed Group and its shareholders as a whole. The Independent Board Committee also considers the On-going Connected Transactions to be in the ordinary course of business, on normal commercial terms and the respective maximum aggregate annual values to be fair and reasonable. That being the case, the Independent Board Committee recommends the Independent Shareholders to vote in favour of the ordinary resolution to be proposed at the EGM in respect of the Sale and Purchase Agreement, the Financial Services Agreement and the transactions contemplated thereunder. 10. EGM Set out on pages 353 to 355 is a notice convening the EGM to be held at the headquarters of the Company at No. 278, Ji Chang Road, Guangzhou, Guangdong Province, the PRC on 31 December, 2004 at 9:00 am. If you are not able to attend and/or vote at the meeting, you are -25- LETTER FROM THE BOARD strongly urged to complete the accompanying form of proxy in accordance with the instructions printed thereon and return it to the Company's branch share registrar in Hong Kong, Hong Kong Registrars Limited, at 46th Floor, Hopewell Centre, 183 Queen's Road East, Hong Kong as soon as possible and in any event not later than 24 hours before the time appointed for the holding of the meeting or any adjournment thereof. Completion and return of the form of proxy will not preclude you from attending and voting at the meeting or any adjourned meeting should you so wish. 11. ADDITIONAL INFORMATION Your attention is drawn to the letter from the Independent Board Committee to the Independent Shareholders set out on pages 27 to 28 of this circular, the letter from ICEA to the Independent Board Committee and the Independent Shareholders in respect of the terms of the Acquisition and the information set out in the appendices to this circular. The text of the letters and the valuation certificates issued by Chesterton in connection with its valuation are set out in Appendix VIII "Property Valuation". Since the parcels of lands and the number of buildings are too numerous, the Company has applied to the Stock Exchange for a waiver from strict compliance with Rule 5.06 of the Listing Rules regarding the form of presentation in this circular of the valuation report on the following conditions: (1) the full valuation reports (which will be prepared in Chinese language only) in compliance with the requirements of Chapter 5 and Practice Note 12 of the Listing Rules will be available for public inspection; and (2) summary valuation reports prepared on the basis of the full valuation reports which (i) set out separately the interests in land and buildings according to the following groups, namely "Properties to be acquired by the Company from CSAHC", "Properties under construction to be acquired by the Company from CSAHC", "Properties to be rented by the Company from CSAHC", "Properties held by the Group in the PRC", "Properties held by the Group in Western Australia", "Properties held by the Group in the Netherlands", "Properties held under construction by the Group in the PRC", and "Properties rented by the Group"; (ii) for each of the above groups (except for "Properties to be rented by the Company from CSAHC" and "Properties rented by the Group") set out separately interests in land and buildings on the basis of the subsidiary or branch of CSAHC or the Listed Group at different locations where the buildings and lands are held. By Order of the Board YAN ZHI QING Director -26- LETTER FROM THE INDEPENDENT BOARD COMMITTEE [LOGO] [CHINESE CHARACTERS] CHINA SOUTHERN AIRLINES COMPANY LIMITED (a joint stock limited company incorporated in the People's Republic of China with limited liability) 12 November, 2004 To the Independent Shareholders Dear Sirs or Madams, VERY SUBSTANTIAL ACQUISITION AND CONNECTED TRANSACTIONS We refer to the circular issued by the Company to its shareholders dated 12 November, 2004 (the "Circular"), of which this letter forms part. Terms defined in the Circular shall have the same meanings in this letter unless the context otherwise requires. The purpose of the Independent Board Committee is to advise you as to whether, in our opinion, the terms of the Sale and Purchase Agreement, Financial Services Agreement and the transactions contemplated thereunder are fair and reasonable so far as the Independent Shareholders are concerned and in the interest of the Company and its shareholders as a whole. ICEA has been appointed as the independent financial adviser to advise the Independent Board Committee and the Independent Shareholders in relation to the fairness and reasonableness of the terms of the Sale and Purchase Agreement, Financial Services Agreement and the transactions contemplated thereunder from a financial perspective. Details of ICEA's conclusion and advice, together with the principal factors and reasons considered in arriving at such conclusion and advice, are set out in its letter on pages 29 to 48 of the Circular. We urge you to read that letter carefully. As your Independent Board Committee, we have discussed with the management of the Company for the reasons for the Sale and Purchase Agreement, Financial Services Agreement and the transactions contemplated thereunder, and the basis upon which their terms have been determined. We have also taken into account the principal factors and reasons considered by ICEA regarding the Sale and Purchase Agreement, Financial Services Agreement and the transactions contemplated thereunder, and its conclusion and advice. The Independent Board Committee concurs with the view of ICEA that the terms of the Sale and Purchase Agreement, Financial Services Agreement and the transactions contemplated thereunder are fair and reasonable so far as the Independent Shareholders are concerned and in the interests of the Company and the shareholders as a whole. The Independent Board Committee also considers the Financial Services Agreement and the transactions contemplated thereunder to be in the ordinary course of business, on normal commercial terms and the -27- LETTER FROM THE INDEPENDENT BOARD COMMITTEE respective maximum aggregate annual values to be fair and reasonable. That being the case, we advise the Independent Shareholders to vote in favour of the ordinary resolutions to approve the Sale and Purchase Agreement, the Financial Services Agreement and the transactions contemplated thereunder at the EGM. Yours faithfully, THE INDEPENDENT BOARD COMMITTEE SIMON TO PETER LOK WEI MING HAI WANG ZHI SUI GUANG JUN Independent non-executive Directors -28- LETTER FROM ICEA The following is the text of the letter of advice to the Independent Board Committee and the Independent Shareholders from ICEA regarding the Acquisition and the Provision of Deposit Service for the purpose of incorporation in this circular. [ICEA LOGO] ICEA CAPITAL LIMITED [CHINESE CHARACTERS] A Subsidiary 42nd Floor, Jardine House, [CHINESE CHARACTERS] of ICBC 1 Connaught Place, Central, Hong Kong [CHINESE CHARACTERS] [CHINESE CHARACTERS] Tel:(852) 2231 8000 [CHINESE CHARACTERS]:(852) 2231 8000 Fax:(852) 2525 0967 [CHINESE CHARACTERS]:(852) 2525 0967 12 November, 2004 To the Independent Board Committee of China Southern Airlines Company Limited Dear Sirs, VERY SUBSTANTIAL ACQUISITION AND CONNECTED TRANSACTION AND DISCLOSEABLE AND CONTINUING CONNECTED TRANSACTION INTRODUCTION We refer to our engagement as independent financial adviser to advise the Independent Board Committee and the Independent Shareholders with respect to the Acquisition and the Provision of Deposit Service. This letter has been prepared for inclusion in the circular dated 12 November, 2004 (the "Circular") issued to the Shareholders and capitalised terms used in this letter shall have the same meanings as defined in the Circular unless the context otherwise requires. The Company entered into the Sale and Purchase Agreement with CSAHC, Northern Airlines and Xinjiang Airlines on 12 November, 2004 and entered into the Financial Services Agreement with the Finance Company on 12 November, 2004. As at the Latest Practicable Date, CSAHC was interested in approximately 50.30% of the existing issued share capital of the Company. Accordingly, CSAHC is a controlling shareholder of the Company under the Listing Rules, and it and its associates (as defined in the Listing Rules) are regarded as connected persons of the Company under the Listing Rules. The Finance Company is owned as to 42% by CSAHC and is therefore regarded as a connected person of the Company under the Listing Rules. For details, please refer to the letter from the Board (the "Letter from the Board") set out in the Circular. Pursuant to the Listing Rules, the Acquisition constitutes both a very substantial acquisition and a connected transaction for the Company, which will be subject to, inter alia, the Independent Shareholders' approval at the EGM to be taken by poll. The Provision of Deposit Service constitutes a discloseable and non-exempt continuing connected transaction under the Listing Rules and requires compliance with the reporting and announcement requirement and the independent shareholders' approval requirement under the -29- LETTER FROM ICEA Listing Rules. CSAHC, the controlling shareholder of the Company and its associates will abstain from voting at the EGM to be convened to approve the Sale and Purchase Agreement, the Financial Services Agreement and the transactions contemplated thereunder which will be conducted by poll. The Independent Board Committee has been formed to advise the Independent Shareholders on whether the terms and conditions of the Sale and Purchase Agreement and the Financial Services Agreement and the transactions contemplated thereunder are fair and reasonable and in the interests of the Company and the Shareholders as a whole. We, ICEA Capital Limited, have been retained as the independent financial adviser to advise the Independent Board Committee and the Independent Shareholders as to whether the terms of the Sale and Purchase Agreement and the Financial Services Agreement and the transactions contemplated thereunder, from a financial perspective, are fair and reasonable and in the interest of the Company as a whole so far as the Independent Shareholders are concerned. In formulating our opinion with regard to the Acquisition and the Provision of Deposit Service, we have reviewed, amongst other things, the Circular, the Sale and Purchase Agreement, the financial projections and the financial statements of the Airline Operations of Northern Airlines Group and the Airline Operations of Xinjiang Airlines Group, the Zhong Qi Hua Valuation Reports and the Financial Services Agreement. We considered information, given in writing and orally, by the Directors, the Company's financial adviser, and the management of the Company and the Target Group. We also reviewed such research studies and publicly available information as we deemed necessary. We have relied, without assuming any responsibility for independent verification, on the information and facts about the Acquisition and the Provision of Deposit Service supplied to us by the Company and have assumed that any information and representations made to us are true, accurate and complete in all material respects as at the date hereof and that they may be relied upon. We have also assumed that all information, representations and opinions contained or referred to in the Circular are true, accurate, and complete in all material respects as of the date hereof and have relied upon them. We also assumed that all statements of intention of the Company's management or its Directors, as set forth in the Circular, will be implemented. With respect to any historical costs and financial statements, financial forecasts, estimates, working capital statements and projections relating to the Airline Operations of Northern Airlines Group and the Airline Operations of Xinjiang Airlines Group and the Provision of Deposit Service, we have assumed that each was prepared on bases reflecting the best currently available information, views, and judgments of the historical and future financial revenues and expenses involved in the Business and Assets and the Provision of Deposit Service and may be relied upon by us in formulating our opinion. We have also assumed that each of the Sale and Purchase Agreement and the Financial Services Agreement, is enforceable against each of the parties thereto in accordance with its terms and that each of the parties will perform, and will be able to perform, its obligations thereunder, and as otherwise described in the Circular, in full when due. We have been advised by the Board that no material facts have been omitted and we are not aware of any facts or circumstances which would render the information provided and the representations made to us untrue, inaccurate or misleading. We have no reason to doubt the truth, accuracy and completeness of the information and representations provided to us by the -30- LETTER FROM ICEA Board. The Directors have collectively and individually accepted full responsibility for the accuracy of the information contained in the Circular and have confirmed, having made all reasonable enquiries, that to the best of their knowledge and belief, there are no other facts the omission of which would make any statement in the Circular misleading. We consider that we have reviewed sufficient information to reach an informed view in order to provide a reasonable basis for our advice. We have not, however, carried out any independent verification of the information provided to us nor have we conducted any form of independent in-depth investigation into the commercial viability or the future prospects of the Acquisition or the financial condition or future prospects of the Business and Assets or the Provision of Deposit Service or the Company. We have further assumed that all material governmental, regulatory, or other consents and approvals necessary for the effectiveness and implementation of the Acquisition and the Provision of Deposit Service have been or will be obtained without any adverse effect on the Business and Assets, the Company or the contemplated benefits to the Company. This letter is for the information of the Independent Board Committee and the Independent Shareholders solely in connection with their consideration of the Acquisition and the Provision of Deposit Service and, except for its inclusion in the Circular, is not to be quoted or referred to, in whole or in part, nor shall this letter be used for any other purpose, without our prior written consent. ICEA is a deemed licensed corporation to carry out regulated activities of dealing in securities, advising on securities and corporate finance and asset management under the SFO. ICEA and its affiliates, whose ordinary business involves the trading of, dealing in and the holding of securities, may be involved in the trading of, dealing in, and the holding of the securities of the Company for client accounts. PRINCIPAL FACTORS CONSIDERED 1. THE ACQUISITION In arriving at our opinion, we have taken into consideration the following principal factors and reasons. Our conclusions are based on the results of all the analyses taken as a whole. (a) PRINCIPAL BUSINESS OF THE LISTED GROUP The Listed Group is one of the largest airlines in the PRC and is headquartered in Guangzhou with 12 operational bases in central and Southern China, offering regular flights on 248 domestic routes to over 69 cities in China, 18 routes to Hong Kong, and 45 international routes to 24 cities in East and Southeast Asia, Australia, North American and Europe, as of 30 June, 2004. However, due to the lack of operational bases, the Company is only capable of offering very limited flight services in Northern China and Northwestern China. -31- LETTER FROM ICEA (b) CONSOLIDATION AND RESTRUCTURING TREND OF GLOBAL AVIATION INDUSTRY In recent years, the global aviation industry has experienced a period of consolidation and restructuring characterised by mergers and acquisitions of airlines within and across the regions. The principal rationale and objective of such wave of global consolidation and restructuring is to achieve economies of scale by merging the operations of different airlines, to reduce redundancies, and thus to enhance operating efficiencies of the airlines. (c) CONSOLIDATION AND RESTRUCTURING OF AVIATION INDUSTRY IN THE PRC In the second half of 2000, the CAAC introduced a policy with the principle of restructuring of the PRC aviation industry on a voluntary basis under government directives and taking advantage of economies of scale. Under the policy, domestic airlines are encouraged to consolidate, centering around CSAHC, Air China Group and Eastern Air Group. On 27 April, 2001, the CAAC announced such consolidation and restructuring plan of the PRC aviation industry in details. On the same date, CSAHC informed the Company that in order to take advantage of economies of scale, the CSAHC voluntarily participates in the consolidation and restructuring plan of the PRC aviation industry under the government proposals. On 11 October, 2002, the consolidation and restructuring proposal of the PRC aviation industry was approved in principle by the State Council of the PRC. As a result, all the equity interest of Northern Airlines and Xinjiang Airlines were transferred to CSAHC. The Listed Group and CSAHC since then have been preparing for the injection of the Business and Assets into the Listed Group in order to achieve economies of scale and enhance the competitiveness of the core business of the Listed Group. (d) REASONS FOR AND BENEFITS OF THE ACQUISITION We have considered the reasons for and benefits of the Acquisition as highlighted in the Letter from the Board and we have noted the following: - the Acquisition is in line with the global trend of consolidation and restructuring of the aviation industry; - the Acquisition is in line with the consolidation and restructuring strategy adopted by the Listed Group in light of the proposed consolidation and restructuring plans of the PRC aviation industry and the CSAHC; We concur with the Board's view that: - the Acquisition represents an attractive opportunity for the Listed Group to consolidate its strong market position as both Northern Airlines and Xinjiang Airlines are leading airlines in their respective operating regions; -32- LETTER FROM ICEA - the Acquisition will bring various benefits to the Listed Group, including broadening its flight network, enhancing its international air transportation business, increasing its fleet size and transportation capacity, enhancing its air ticket sales network; strengthening its marketing efforts; reducing its operating costs and boosting its overall efficiency; and - the Acquisition is in line with the non-competition undertaking granted by the CSAHC to the Company when the Company was listed on the Stock Exchange in 1997. (e) PACKAGED DEAL We notice that the Business and Assets to be acquired consist of certain Airline Operations, assets and properties of Northern Airlines Group and Xinjiang Airlines Group, including aircraft, engines, spare parts, aviation equipment and facilities, properties, office facilities, and other fixed, current and intangible assets. As the Acquisition is a packaged deal, the Business and Assets cannot be divided up and the Company can only acquire the Business and Assets as a whole. (f) BUSINESS AND ASSETS TO BE ACQUIRED AND THE DEBTS TO BE ASSUMED (a) The Business and Assets to be acquired consist of certain Airline Operations, assets and properties of Northern Airlines Group and Xinjiang Airlines Group, including aircraft, engines, spare parts, aviation equipment and facilities, properties, office facilities, and other fixed, current and intangible assets. (b) The Debts to be assumed consist of all indebtedness in the aggregate sum of RMB15,090,109,000 (equivalent to approximately HK$14,235,952,000) owed by Xinjiang Airlines Group or Northern Airlines Group in connection with their civil aviation business. Both Northern Airlines and Xinjiang Airlines are leading airlines in their respective operating regions offering passenger and cargo air transportation and other related services. Northern Airlines Group is headquartered in Shenyang with operational bases in Dalian, Changchun and Harbin. Northern Airlines Group's operating region is predominantly in Northeastern China. It is also the dominant Chinese airline serving flight routes to Korea and Japan due to the proximity of its operating region to those countries. Xinjiang Airlines Group is headquartered in Urumqi, with operational bases and operating region in the Xinjiang autonomous region. It also commands a strong market position on domestic routes between Xinjiang and other parts of China, and on international routes to Russia, the Middle East and West Asia. -33- LETTER FROM ICEA We summarise below the operating revenue, operating profit before interest, taxation, depreciation, amortization and rental under operating leases ("EBITDAR"), the operating profit/loss, and the net profit/loss of (i) the Airline Operations of Northern Airlines Group; and (ii) the Airline Operations of Xinjiang Airlines Group for each of the years in the three-year period ended 31 December, 2003 and the six-month period ended 30 June, 2004. (i) The Airline Operations of Northern Airlines Group FOR THE SIX-MONTH PERIOD ENDED FOR THE YEARS ENDED 31 DECEMBER, 30 JUNE, ----------------------------------------- -------- 2001 2002 2003 2004 (RMB (RMB (RMB (RMB million) million) million) million) Operating revenue 5,203 5,244 5,929 3,465 EBITDAR 588 403 635 863 Operating (loss)/profit (126) (308) (61) 369 Net (loss)/profit (502) (1,141) (1,234) 135 (ii) The Airline Operations of Xinjiang Airlines Group FOR THE SIX-MONTH PERIOD ENDED FOR THE YEARS ENDED 31 DECEMBER, 30 JUNE, ----------------------------------------- -------- 2001 2002 2003 2004 (RMB (RMB (RMB (RMB million) million) million) million) Operating revenue 2,174 2,353 2,152 1,215 EBITDAR 778 821 568 303 Operating profit/(loss) 269 197 (39) (0.2) Net profit/(loss) 41 3 (299) (44) The Airline Operations of Northern Airlines Group Operating revenue For the year ended 31 December, 2002, the operating revenue of the Airline Operations of Northern Airlines Group was approximately RMB5,244 million -34- LETTER FROM ICEA (equivalent to approximately HK$4,947 million), an increase of approximately RMB41 million (equivalent to approximately HK$39 million) from 2001. The increase was primarily due to the increase in cargo and mail revenue driven by the increase in overall yield per RFTK resulting from the suspension of certain routes with low yield in the year. For the year ended 31 December, 2003, the operating revenue of the Airline Operations of Northern Airlines Group was approximately RMB5,929 million (equivalent to approximately HK$5,593 million), an increase of approximately RMB685 million (equivalent to approximately HK$646 million) from 2002. The increase was primarily due to the increase in passenger revenue resulting from increase in traffic volume and passenger yield in the year. The increase in traffic volume was the result of rescheduling of certain major routes in October 2002 while the increase in passenger yield was mainly due to the exemption of the CAAC infrastructure fund and sales tax during the period from 1 May, 2003 to 31 December, 2003. For the six-month period ended 30 June, 2004, the operating revenue of the Airline Operations of Northern Airlines Group was approximately RMB3,465 million (equivalent to approximately HK$3,269 million). EBITDAR For the year ended 31 December, 2002, the EBITDAR of the Airline Operations of Northern Airlines Group was approximately RMB403 million (equivalent to approximately HK$380 million), a decrease of approximately RMB185 million (equivalent to approximately HK$175 million) from 2001. The decrease was primarily due to the increase in operating expenses resulting from increase in landing and navigation fees and repair and maintenance. For the year ended 31 December, 2003, the EBITDAR of the Airline Operations of Northern Airlines Group was approximately RMB635 million (equivalent to approximately HK$599 million), an increase of approximately RMB232 million (equivalent to approximately HK$219 million) from 2002. The increase was mainly due to the increase in operating revenue outweighing the operating expenses in the year. For the six-month period ended 30 June, 2004, the EBITDAR of the Airline Operations of Northern Airlines Group was approximately RMB863 million (equivalent to approximately HK$814 million). Operating profit/loss As there were no significant changes in the depreciation and amortisation expenses, as a result of the reasons mentioned in the analysis of operating revenue and EBITDAR above, for each of the years in the three-year period ended 31 -35- LETTER FROM ICEA December, 2003, the operating loss of the Airline Operations of Northern Airlines Group were approximately RMB126 million (equivalent to approximately HK$119 million), approximately RMB308 million (equivalent to approximately HK$291 million) and approximately RMB61 million (equivalent to approximately HK$58 million) respectively. For the six-month period ended 30 June, 2004, the Airline Operations of Northern Airlines Group had an operating profit of approximately RMB369 million (equivalent to approximately HK$348 million). The Airline Operations of Xinjiang Airlines Group Operating revenue For the year ended 31 December, 2002, the operating revenue of the Airline Operations of Xinjiang Airlines Group was approximately RMB2,353 million (equivalent to approximately HK$2,220 million), an increase of approximately RMB179 million (equivalent to approximately HK$169 million) from 2001. The increase was mainly due to the increase in passenger revenue driven by an increase in traffic volume. For the year ended 31 December, 2003, the operating revenue of the Airline Operations of Xinjiang Airlines Group was approximately RMB2,152 million (equivalent to approximately HK$2,030 million), a decrease of approximately RMB201 million (equivalent to approximately HK$190 million). The decrease was primarily due to the decrease in passenger revenue resulting from a decrease in passenger yield. For the six-month period ended 30 June, 2004, the operating revenue of the Airline Operations of Xinjiang Airlines Group was approximately RMB1,215 million (equivalent to approximately HK$1,146 million). EBITDAR For the year ended 31 December, 2002, the EBITDAR of the Airline Operations of Xinjiang Airlines Group was approximately RMB821 million (equivalent to approximately HK$775 million), an increase of approximately RMB43 million (equivalent to approximately HK$41 million) from 2001. The increase was mainly due to the increase in operating revenue outweighing the increase in operating expenses. For the year ended 31 December, 2003, the EBITDAR of the Airline Operations of Xinjiang Airlines Group was approximately RMB568 million (equivalent to approximately HK$536 million), a decrease of approximately RMB253 million (equivalent to approximately HK$239 million) from 2002. The -36- LETTER FROM ICEA decrease was primarily due to increase in maintenance expenses resulting from increase in utilisation rates of aircraft and increase in aircraft and traffic servicing expenses as a result of increase in the charge rate for domestic landing and navigation fees effective September 2002. For the six-month period ended 30 June, 2004, the EBITDAR of the Airline Operations of Xinjiang Airlines Group was approximately RMB303 million (equivalent to approximately HK$286 million). Operating profit/loss For the year ended 31 December, 2002, the operating profit of the Airline Operations of Xinjiang Airlines Group was approximately RMB197 million (equivalent to approximately HK$186 million), a decrease of approximately RMB72 million (equivalent to approximately HK$68 million) from 2001. The decrease was mainly due to the increase of depreciation and amortisation expenses as a result of addition of one Boeing 757-200 aircraft and two 757-200 jet engines during 2002 and the impairment loss recognised on aircraft and other flight equipment. As there was no significant changes in the depreciation and amortisation expenses for the year ended 31 December, 2003, as a result of the reasons mentioned in the analysis of EBITDAR above, for the year ended 31 December, 2003, the operating loss of the Airline Operations of Xinjiang Airlines Group was approximately RMB39 million (equivalent to approximately HK$37 million) as oppose to operating profit of approximately RMB197 million (equivalent to approximately HK$186 million) in 2002. For the six-month period ended 30 June, 2004, the operating loss of the Airline Operations of Xinjiang Airlines Group was approximately RMB0.20 million (equivalent to approximately HK$0.19 million). In addition, certain prospective financial information in respect of the Airline Operations of Northern Airlines Group and the Airline Operations of Xinjiang Airlines Group for the year ending 31 December, 2004 has been prepared by the Target Group. Based on the assumptions set out in Appendix VI to the Circular and in the absence of unforeseen circumstances, the Board believes that the combined profit after taxation and minority interests but before the extraordinary items for the year ending 31 December, 2004 under IFRS is unlikely to be less than RMB148 million (equivalent to approximately HK$140 million). The Company and the Target Group are not currently aware of any extraordinary items which have arisen or are likely to arise in respect of the year ending 31 December, 2004 which would affect the prospective financial information prepared. -37- LETTER FROM ICEA (g) FINANCIAL POSITION OF THE AIRLINE OPERATIONS OF THE TARGET GROUP The table below sets forth the financial position of the Airline Operations of Northern Airlines Group and the Airline Operations of Xinjiang Airlines Group for the year ended 31 December, 2003 and the six-month period ended 30 June, 2004: NORTHERN AIRLINES GROUP XINJIANG AIRLINES GROUP ----------------------- ----------------------- FOR THE SIX- FOR THE SIX- FOR THE YEAR MONTH PERIOD FOR THE YEAR MONTH PERIOD ENDED ENDED 30 ENDED ENDED 30 31 DECEMBER, JUNE, 31 DECEMBER, JUNE, 2003 2004 2003 2004 (RMB million) (RMB million) (RMB million) (RMB million) Net current liabilities 1,442 1,631 1,072 1,251 Net assets 821 956 929 885 Net cash flow from operating activities 540 222 296 70 As revealed from the table above, both the Airline Operations of Northern Airlines Group and the Airline Operations of Xinjiang Airlines Group had net current liabilities position but positive net assets value as at 30 June, 2004. We note that due to the capital intensive nature of aviation industry, it is not unusual for aviation companies to have net current liabilities position. We have also reviewed the working capital statements of the Airline Operations of Northern Airlines Group and the Airline Operations of Xinjiang Airlines Group for the eighteen months ending 31 December, 2005 which have been prepared by the Company. We concur with the Board's view that the Airline Operations of the Target Group would have sufficient operating cash flow to support its operations. (h) BASIS OF THE CONSIDERATION The Sale and Purchase Agreement was entered into after arm's length negotiations between the Company and the Vendors, and the provisional amount of the consideration of the Acquisition, and of the Debts to be assumed under the Sale and Purchase Agreement are set at RMB16,912,244,600 (equivalent to approximately HK$15,954,948,000) and RMB15,090,109,000 (equivalent to approximately HK$14,235,952,000) respectively. The amounts are arrived at after arm's length negotiations between the Company and the Vendors, with reference to the valuation of the Business and Assets, and the Debts set out in the Zhong Qi Hua Valuation Reports. The Zhong Qi Hua Valuation Reports value the Business and Assets at RMB16,912,244,600 (equivalent to approximately HK$15,954,948,000), and the Debts at RMB15,090,109,000 (equivalent to approximately HK$14,235,952,000) respectively, as at 31 December, 2003 which is equivalent to the provisional amount of the consideration of the Acquisition, and of the Debt to be assumed under the Sale and Purchase Agreement respectively. -38- LETTER FROM ICEA We have reviewed the Zhong Qi Hua Valuation Reports, we consider the valuation methodologies used in appraising the Business and Assets, and the Debts are fair and reasonable. The provisional amount of the consideration of the Acquisition, and of the Debts to be assumed by the Company will be subject to adjustment and finalisation based on the book value of the Business and Assets, and of the Debts as of the Effective Date, as determined in the financial statements on the Business and Assets of the Target Group prepared in accordance with the PRC Accounting Rules and Regulations and audited by KPMG Huazhen. A portion of the final adjusted consideration of the Acquisition will be settled by way of assumption of the final adjusted Debts, with the remaining balance to be payable by the Company to the bank account designated by the Vendors in cash. (i) FINANCING OF THE ACQUISITION Under the Sale and Purchase Agreement, the provisional amount of the consideration of the Acquisition, and of the Debts to be assumed under the Sale and Purchase Agreement are set at RMB16,912,244,600 (equivalent to approximately HK$15,954,948,000) and RMB15,090,109,000 (equivalent to approximately HK$14,235,952,000) respectively. The remaining balance of approximately RMB1,822,135,600 (equivalent to approximately HK$1,718,996,000), subject to adjustment, is to be payable by the Company to the Vendors in cash. We understand from the Company that in determining the payment method, the major portion of the consideration to be satisfied through the assumption of Debts with the remaining to be settled in cash, it took into consideration the current and future cash requirements of the Listed Group and the Target Group. The Board believes that such arrangement should not cause material negative impact to the Group's business operations. The Company confirmed that it has sufficient internal resources to fund the cash payment for the Acquisition without a material negative impact on its ongoing operations and capital expenditure requirements. As at 30 June, 2004, the Listed Group had cash and cash equivalents of approximately RMB2,932 million (equivalent to approximately HK$2,766 million). The Company further confirmed that it has sufficient internal and external financial resources for its ongoing operations and capital expenditure requirements. Based on the above, we consider that the terms for the financing of the Acquisition are fair and reasonable from a financial point of view, insofar as the Independent Shareholders are concerned. (j) VALUATION OF THE BUSINESS AND ASSETS For aviation companies, due to the heavy capital investment in aircraft, their profitability will, to a large extent be distorted by the policy and the amount of depreciation and amortization of aircraft. Further, the methods and terms of financing for aircraft will also significantly affect the operating performance of an aviation company. Due to the specific nature of aviation industry, in order to fairly compare the operating profitability (without being distorted by depreciation, amortization and financing terms) of the Target Group with those of other comparable aviation companies in the market, in -39- LETTER FROM ICEA addition to price/earning ratio ("PER") analysis, we have made reference to another commonly used market valuation benchmark for aviation companies, the EV/EBITDAR factor, being the quotient of the enterprise value ("EV") divided by the operating profit before interest, taxation, depreciation, amortization and rental under the operating leases ("EBITDAR") in assessing the valuation of the Target Group. EV is defined as the sum of the equity value of a company plus its total debt minus its cash balances. The total amount of consideration for the Acquisition of RMB16,912,244,600 (equivalent to approximately HK$15,954,948,000) implies an EV for the Target Group of approximately RMB16,390,513,600) (equivalent to approximately HK$15,462,833,000) being the total amount of consideration for the Acquisition minus the combined cash and cash equivalents of the Target Group of approximately RMB521,731,000 (equivalent to approximately HK$492,115,000). Set out below is the summary of the PER as well as the EV/EBITDAR factor of 15 listed aviation comparables in the Asia Pacific region (the "Aviation Comparables") (including five listed aviation comparables in the PRC (the "PRC Aviation Comparables")) and the Target Group: NAME OF AVIATION COMPARABLE ESTIMATE PER(1) EV/EBITDAR(2) --------------------------- --------------- ------------- Air New Zealand Limited 9.24 2.00 All Nippon Airways Co., Ltd. 35.79 9.50 Cathay Pacific Airways Ltd. 11.90 9.98 China Airlines 15.60 11.38 China Eastern Airlines Corporation Limited(4) 11.88 10.68 China National Aviation Company Limited(4) 17.29 22.71 China Southern Airlines Company Limited(4) 20.27 8.43 Hainan Airlines Company Limited(4) 23.86 22.65 Japan Airlines Corporation 23.61 27.01 Korean Air Lines Co. Ltd. 14.53 5.41 Malaysian Airline System Berhad 15.76 5.45 Qantas Airways Limited 8.75 5.22 Shanghai Airlines Co., Ltd.(4) 25.84 0.02 Singapore Airlines Ltd. 12.44 6.18 Thai Airways International Public Company Limited 7.92 3.87 Range for Aviation Comparables(3) 8.75-25.84 2.00-22.71 Average for Aviation Comparables(3) 16.23 9.50 Range for PRC Aviation Comparables(3) 17.29-23.86 8.43-22.65 Average for PRC Aviation Comparables(3) 20.47 13.92 Target Group(5) 12.31 13.63 -40- LETTER FROM ICEA (1) Based on consensus brokers' estimates on the forth coming financial year (source: Bloomberg). (2) Calculated based on the latest audited results announced by Aviation Comparables and their respective closing share prices as at 10 November, 2004. (3) Excluding the highest and lowest valuations. (4) PRC Aviation Comparable. (5) Calculated based on the forecasted combined profit after taxation and minority interests but before the extraordinary items of the Airline Operations of Northern Airlines Group and the Airline Operations of Xinjiang Airlines Group for the year ending 31 December, 2004 under IFRS of RMB148 million. Based on the market comparables statistics, we note that the consideration for the Acquisition is within the range of the valuation of Aviation Comparables and slightly below the average of the valuation of PRC Aviation Comparables. On these bases, we consider the acquisition price is fair and reasonable so far as the Company and the Independent Shareholders are concerned. (k) PRO FORMA EFFECTS TO THE COMPANY We have conducted various analyses on the potential financial effects of the Acquisition on the Listed Group, which were extracted from or prepared based on the accountants' report of the Listed Group and unaudited pro forma financial information of the Listed Group and the Target Group (collectively the "Combined Group") as set out in Appendix V to the Circular. (i) Earnings The pro forma earnings per share of the Combined Group for the six-month period ended 30 June, 2004, would be approximately RMB0.08 (equivalent to approximately HK$0.08), which is approximately 36% higher than the actual earnings per share of the Listed Group for the same period. Based on our discussion with the Directors and certain prospective financial information in respect of the Airline Operations of the Target Group for the year ending 31 December, 2004 prepared by the Company and the Target Group, we understand that the combined profit after taxation and minority interests but before the extraordinary items for the year ending 31 December, 2004 under IFRS is unlikely to be less than RMB148 million (equivalent to approximately HK$140 million). Assuming the consideration of the Acquisition is RMB1,897 million (equivalent to approximately HK$1,790 million) (which represents the aggregate amount of the net assets value of the Airline Operations of Northern Airlines Group and the Airline Operations of Xinjiang Airlines Group as at 30 June, 2004 prepared under PRC Accounting Rules and Regulations) which will be satisfied by short term U.S. dollar bank loans amounting to RMB1,000 million (equivalent to approximately HK$943 million) and cash of RMB897 million (equivalent to -41- LETTER FROM ICEA approximately HK$846 million) and the Acquisition had taken place on 1 January, 2004, the annual interest expense arising from short term U.S. dollar bank loans bearing interest at 2.17% per annum would amount to approximately RMB21,700,000 (equivalent to approximately HK$20,472,000) and the reduction in the annual interest income of the cash consideration of RMB897 million (equivalent to approximately HK$846 million) to be taken from the internal resources depositing in certain PRC banks enjoying 0.72% deposit rate per annum would amount to RMB6,458,000 (equivalent to approximately HK$6,093,000). Taking into account the increase in interest expense and the reduction in interest income as a result of the Acquisition, the earnings of the Listed Group would increase by approximately RMB120 million (equivalent to approximately HK$113 million) for the year ending 31 December, 2004. (ii) Gearing The pro forma total debt (including obligations under finance lease) of the Combined Group would be approximately RMB34,974 million (equivalent to approximately HK$32,995 million) as at 30 June, 2004, representing an increase of approximately 57.97% from the total debt of approximately RMB22,139 million (equivalent to approximately HK$20,886 million) of the Listed Group at the same date. The pro forma net debt (total debt less cash and cash equivalents) of the Combined Group would increase to approximately RMB32,417 million (equivalent to approximately HK$30,582 million) from RMB19,207 (equivalent to approximately HK$18,120 million) for the Listed Group as of 30 June, 2004. The pro forma ratio of the Combined Group's net debt to total shareholders' equity would be approximately 267% as at 30 June, 2004, compared to approximately 158% for the Listed Group as at the same date. On a pro forma basis, the total debt to total capitalisation ratio would increase from 65% for the Listed Group to approximately 74% for the Combined Group. The increase in gearing ratio mainly results from the increase in borrowings following the assumption of Debts by the Company. We consider that the substantial increase in gearing ratio not only will increase the overall financial risk of the Group but also increase the financial burden and future financing costs of the Group. (iii) Working capital It is noted that the provisional amount of the consideration is set at approximately RMB16,912 million (equivalent to approximately HK$15,955 million), of which approximately RMB15,090 million (equivalent to approximately HK$14,236 million) will be settled by way of assumption of debt and the remaining balance of approximately RMB1,822 million (equivalent to approximately HK$1,719 million) will be financed by short term U.S. dollar bank loans amounting to RMB1,000 million, and the internal resources of the Listed Group. We understand from the Directors that having taken into account the existing cash and bank balance position of the Listed Group, the operating cash flow of the Combined Group, the -42- LETTER FROM ICEA estimated capital expenditure of the Listed Group in the near future and the banking facilities available to the Listed Group, the Directors consider that the Acquisition would not have a material adverse impact on the normal operations of the Listed Group. We also note that as at 30 June, 2004, the Listed Group had cash and bank balances of approximately RMB2,932 million (equivalent to approximately HK$2,766 million) and had total available banking facilities of approximately RMB13,300 million (equivalent to approximately HK$12,500 million). We have also reviewed the working capital statements of the Listed Group, Northern Airlines Group and Xinjiang Airlines Group, respectively for the eighteen months ending 31 December, 2005, we concur with the Board's view that the Combined Group would have sufficient cash flow to support its operations and the Acquisition will not have a material adverse impact on the normal operations of the Listed Group. 2. PROVISION OF DEPOSIT SERVICE In arriving at our opinion, we have considered, inter alia, the following principal factors and reasons: (a) FINANCIAL SERVICES AGREEMENT Pursuant to the Financial Services Agreement, the Listed Group will from time to time utilise the financial services available from the Financial Company. Such financial services include: (1) Accept deposit of money from the Company at interest rates not lower than those set by the PBOC for the same term of deposit. The Finance Company will in turn deposit the whole of such sums of money with certain banks including Bank of Agriculture, Bank of Communications, China Construction Bank and Industrial and Commercial Bank of China. (2) Make loans to the Company subject to the entering into of separate loan agreements, which will set out the Cap, terms and conditions of the loans, upon application by the Company during the term of the Financial Services Agreement. The Company will comply with the Listing Rules when entering into such separate written agreements. The Finance Company shall not charge interest rates higher than those set by the PBOC for similar loans. The total amount of outstanding loans extended by the Finance Company to the Company must not exceed the sum of the Finance Company's shareholders' equity, capital reserves and money deposit received from other parties (except the Company). (3) Provide credit facilities, financial guarantees, credit references, and other financial services subject to the entering into of separate agreements, which will set out the Cap, terms and conditions of such services, upon request by the Company during the term of the Financial Services Agreement. The Company will comply with the Listing Rules when entering into such separate written agreements. -43- LETTER FROM ICEA The Financial Services Agreement is for a fixed term of three years, commencing from the date of the agreement, and is renewable, subject to compliance with the requirements of the relevant Listing Rules by the Company, by an application in writing by the Company not less than 30 days before the end of the fixed term. Upon the renewal of the Financial Services Agreement, the Company will comply with all applicable discloseable and connected transactions requirement of the Listing Rules, including the Independent Shareholders' approval requirements under Chapter 14A of the Listing Rules. The Company is not subject to any extra charges for depositing money with the Finance Company. For the other financial services provided by the Finance Company under the Financial Services Agreement, the Company is liable to pay the Finance Company the standard charging rates set by the PBOC. The PRC commercial banks also charge similar charging rates set by the PBOC. The Company will make payment of such interest, fees and commissions in accordance with the payment terms of the separate agreements for the provision of loans or other financial services as might be entered into between the Company and the Finance Company. (b) INFORMATION RELATING TO THE FINANCE COMPANY The Finance Company is a non-bank finance company established under the direction of the PBOC with the main business scope of providing various financial services, including deposit and loan facilities, credit facilities, guarantee, remittance of money and credit references, to CSAHC and its subsidiaries. The operations of the Finance Company are subject to the on-going supervision of the PBOC. The registered capital of the Finance Company is RMB424,329,500. (c) DISCLOSEABLE AND CONTINUING CONNECTED TRANSACTION WITH THE FINANCE COMPANY CSAHC is the controlling shareholder of the Company with a beneficial interest of approximately 50.30% of the existing issued share capital of the Company as at the Latest Practicable Date. The Finance Company, a subsidiary of CSAHC which is owned as to 42% by CSAHC, 32% by the Company and 26% in aggregate by five subsidiaries of the Company, and is a connected person of the Company under the Listing Rules. Accordingly, the transactions with the Finance Company contemplated under the Financial Services Agreement constitute continuing connected transactions under the Listing Rules, and are subject to the approval of the Independent Shareholders. -44- LETTER FROM ICEA (d) REASONS FOR AND BENEFITS OF THE PROVISION OF DEPOSIT SERVICE The pricing policy of the Finance Company and commercial banks in China are subject to guidelines set by the PBOC. Therefore, the charges by the Finance Company for its services to the Company is comparable to those charged by PRC banks for similar services. The Company usually receives interest on its money deposited with the Finance Company at rates which are more favourable than the benchmark interest rates set by the PBOC, usually in the range between the benchmark interest rates set by the PBOC and the inter-bank offer rates of interest. This arrangement allows the Company to achieve a more efficient use of its current capital, since the Company can enjoy better interest rates on depositing its current capital with the Finance Company than the benchmark rates of interest set by the PBOC that the PRC commercial banks can offer to the Company. Subject to the entering into of further separate agreements, the Company can borrow from the Finance Company at interest rates not higher than those set by the PBOC for similar loans. We have reviewed the Financial Services Agreement and we understand that it does not preclude the Company from choosing similar services provided by other commercial banks in the PRC where terms and conditions offered by other commercial banks are more favourable to the Company than those offered by the Finance Company. The Financial Services Agreement also provides that the Finance Company will provide relevant services to the Company on normal commercial terms, and on terms no less favourable than those available to the Company from independent third parties. Based on the above analysis, we are of the view that the terms of the Financial Services Agreement are fair and reasonable. -45- LETTER FROM ICEA (e) CAP FOR THE PROVISION OF DEPOSIT SERVICE Set out below is a summary of the Cap for the deposit of money by the Company with the Finance Company from time to time under the Financial Services Agreement during the term of the Financial Services Agreement and the basis of determination of the Cap: PROVISION OF BASIS OF DETERMINATION DEPOSIT SERVICE CAP OF THE CAP --------------- --- ---------- The Cap for the deposit of RMB1 billion The Cap was determined money with the Finance based on past figures on Company from time to time deposit of money with the during the term of the Finance Company, and on Financial Services Agreement the estimated amount of money to be deposited with the Finance Company by the Company each year for the term of the Financial Services Agreement. As at 31 December, 2001, 2002 and 2003, the Company had deposits placed with the Finance Company amounted to approximately 1.32 billion, approximately 0.88 billion and approximately 0.35 billion. We are given to understand that the low deposit of money by the Company with the Finance Company as at 31 December, 2003 was mainly due to material adverse impact caused by the outbreak of severe acute respiratory syndrome on the business operations of the Company during the first half of 2003. We are of the view that the Cap for the deposit of money by the Company with the Finance Company which is determined based on the past figures on deposit of money with the Finance Company, and on the estimated amount of money to be deposited with the Finance Company by the Company each year for the term of the Financial Services Agreement to be fair and reasonable. SUMMARY Having considered the above principal factors and reasons, we draw your attention to the following key factors in arriving at our opinion: (a) the Acquisition represents an attractive opportunity for the Listed Group to consolidate its strong market position as both Northern Airlines and Xinjiang Airlines are leading airlines in their respective operating regions; -46- LETTER FROM ICEA (b) the Board's representation that the terms of the Sale and Purchase Agreement and the Financial Services Agreement were negotiated on an arm's length basis; (c) the provisional amount of the consideration of the Acquisition was determined based on the valuation of the Business and Assets, and the Debts set out in the Zhong Qi Hua Valuation Reports and will be subject to adjustment and finalisation based on the book value of the Business and Assets, and of the Debts as of the Effective Date; (d) the consideration for the Acquisition is within the range of the valuation of Aviation Comparables and slightly below the average of the valuation of PRC Aviation Comparables; (e) notwithstanding the gearing level of the Listed Group would be increased substantially and the financial burden of the Company would be increased as a result of the Acquisition, the Acquisition will bring various benefits to the Listed Group, including broadening its flight network, enhancing its international air transportation business, increasing its fleet size and transportation capacity, enhancing its air ticket sales network; strengthening its marketing efforts; reducing its operating costs and boosting its overall efficiency, which we consider is beneficial to the Group in the long run; (f) the representations made by the Directors that the Provision of Deposit Service have been and will continue to be conducted in the ordinary and usual course of business, on normal commercial terms, and the terms have been determined after arm's length negotiation between the parties; (g) the waiver from strict compliance with the Listing Rules with respect to the Provision of Deposit Service will be subject to the satisfaction of various conditions, including that: (i) the transactions have been approved by the Independent Shareholders; (ii) the transactions will be entered into in the ordinary and usual course of business and on normal commercial terms that are fair and reasonable in so far as the Independent Shareholders are concerned; (iii) the Company shall disclose in its annual reports sufficient details of the transactions; (iv) the independent non-executive Directors of the Company review the transactions annually; (v) the Company's auditors review the transactions annually; and (vi) the value of Provision of Deposit Service does not exceed RMB1 billion; and (h) the Stock Exchange has indicated that if the value of the Provision of Deposit Service exceeds RMB1 billion or if any of the terms of the Financial Services Agreement, or the nature of the Provision of Deposit Service is altered or if the Company entered into any new agreements with connected persons in the future, the Company will need to comply fully with all the relevant provisions of Chapter 14A of the Listing Rules. -47- LETTER FROM ICEA RECOMMENDATION Having considered the above principal factors and reasons and the terms of the Sale and Purchase Agreement and the Financial Services Agreement, we consider that the terms of the Acquisition and the Provision of Deposit Service, from a financial perspective, to be fair and reasonable so far as the Independent Shareholders are concerned and are in the interests of the Company as a whole. We urge the Independent Shareholders to note that as a result of the Acquisition, the gearing level of the Group would be increased substantially, which could have an adverse impact on the financial position of the Group as well as short term share price performance of the Company. However, as the Acquisition will bring various benefits to the Listed Group as mentioned in the Letter from the Board, we consider the Acquisition is beneficial to the Listed Group in the long run. Accordingly, we advise the Independent Board Committee to recommend the Independent Shareholders to vote in favour of ordinary resolutions numbered 1 and 6 as detailed in the notice of the EGM set out at the end of the Circular. Yours faithfully, For and on behalf of ICEA CAPITAL LIMITED GARY S K SIK Managing Director -48- APPENDIX I INFORMATION REGARDING THE AIRLINE OPERATIONS OF NORTHERN AIRLINES GROUP AND XINJIANG AIRLINES GROUP (1) INDUSTRY BACKGROUND The civil aviation industry in China has experienced rapid growth over the past decade. According to the National Bureau of Statistics of China, annual passenger number grew from 17 million in 1990 to 88 million in 2003, with a compound annual growth rate of approximately 14%. Air cargo volume also grew from 370 thousand tonnes in 1990 to 2 million tonnes in 2003, with a compound annual growth rate of approximately 15%. The total number of China's aviation routes also increased from 437 in 1990 to 1,176 by the end of 2003. PASSENGER AND FREIGHT VOLUME CARRIED BY CHINESE AIRLINES (1990-2003) [BAR CHARTS] Passenger turnover(million) 1990-2003 1990 16.0 1991 21.8 1992 28.9 1993 33.8 1994 40.4 1995 51.2 1996 55.6 1997 56.3 1998 57.6 1999 60.9 2000 67.2 2001 75.2 2002 85.9 2003 87.6 Cargo turnover('000 tonnes) 1990-2003 1990 370 1991 452 1992 575 1993 694 1994 829 1995 1,011 1996 1,150 1997 1,247 1998 1,401 1999 1,700 2000 1,967 2001 1,710 2002 2,021 2003 2,190 Source: China Statistical Yearbook 2003 Despite rapid growth both in the passenger and cargo sectors, China's aviation market remains underdeveloped by global standards. Per capita passenger air trip numbers remain low relative to the more developed international markets. AIR TRANSPORT CAPACITY FOR SELECTED COUNTRIES [BAR CHARTS] ATK (mm tonne km) United States 123,283 Japan 22,469 United Kingdom 20,022 Germany 19,156 China 16,200 France 15,592 Singapore 14,140 South Korea 13,859 Netherlands 11,294 Australia 9,507 ATK (tonne km per capita) Singapore 3,401 Netherlands 702 Australia 484 United States 429 United Kingdom 333 South Korea 291 France 260 Germany 233 Japan 177 China 13 Source: China Statistics for Civil Aviation 2003, EIU -49- APPENDIX I INFORMATION REGARDING THE AIRLINE OPERATIONS OF NORTHERN AIRLINES GROUP AND XINJIANG AIRLINES GROUP Since the early 1990's, the Chinese government has begun to separate its function as regulator of the PRC civil aviation industry from its business management role at the major state-owned PRC airlines. As a result, CAAC ceased its participation in airline operations but still continues to exercise authority as the PRC civil aviation industry regulator. CAAC's regulatory roles include developing rules and regulations for the PRC civil aviation industry, directing the restructuring of the PRC airlines, enforcing flight safety rules and standards, managing air traffic, regulating air ticket prices, and overseeing aviation negotiations with foreign parties. During the restructuring of the PRC airlines in 2002, the airlines previously under the control of CAAC were reorganized under three holding company groups. These three holding company groups were: (i) China National Aviation Holding Company including Air China Limited, China National Aviation Corporation, and China Southwest Airlines with main bases in Beijing, Hangzhou, and Chengdu; (ii) China Eastern Air Holding Company consisting of China Eastern Airlines Corporation Limited, China Eastern Yunnan Airlines, and China Eastern Northwest Airlines with main bases in Shanghai, Kunming, and Xian; and (iii) CSAHC, the largest of the three holding companies, comprising the Company, Northern Airlines, and Xinjiang Airlines, with main bases in Guangzhou, Shenyang, and Urumqi. Despite strong growth during the 1990's, PRC civil aviation industry suffered from the significant negative effects arising from the 911 attacks in 2001 and the outbreak of Severe Acute Respiratory Syndrome in early 2003. These negative effects included lower revenue from reduced passenger and cargo traffic and higher operating costs due to the increased cost of aviation insurance and the heightened security and health precautions. Traffic volumes have been recovering since Severe Acute Respiratory Syndrome was brought under control in July 2003. -50- APPENDIX I INFORMATION REGARDING THE AIRLINE OPERATIONS OF NORTHERN AIRLINES GROUP AND XINJIANG AIRLINES GROUP In the post Severe Acute Respiratory Syndrome period, PRC civil aviation industry demonstrated strong growth on the back of solid economic expansion and a significant increase in commercial and leisure travel activities. On a year-to-August basis, 2004 is the strongest year for China's airlines with record turnover in both passenger and freight transportation. PASSENGER VOLUME (MILLION) PASSENGER VOLUME (MILLION) [LINE GRAPH] [PLOT POINTS TO COME] Source: CEIC REVENUE PASSENGER KILOMETRES (MILLION) REVENUE PASSENGER KILOMETRES (MILLION) [LINE GRAPH] [PLOT POINTS TO COME] Source: CEIC FREIGHT CARRIED (MILLION TONNES) [LINE GRAPH] [PLOT POINTS TO COME] FREIGHT CARRIED (MILLION ) Source: CEIC As shown in the above charts, in the first eight months of 2004, passenger turnover and RPKs (a measurement for distance that passengers travel), reached a record of 80 million and 117 billion respectively compared to the same period of the previous years. In the same period, cargo turnover also surpassed historical levels, reaching 1.74 million tonnes. -51- APPENDIX I INFORMATION REGARDING THE AIRLINE OPERATIONS OF NORTHERN AIRLINES GROUP AND XINJIANG AIRLINES GROUP (2) OVERVIEW OF THE TARGET GROUP Northern Airlines was established on 19 October, 1990 following its separation from the Shenyang Bureau of the CAAC. Xinjiang Airlines, which began operations on 1 January, 1985, was formally separated in 2001 from the Urumqi Regional Bureau of the CAAC. As part of the restructuring initiative of the PRC civil aviation industry in late 2002, Southern Airlines (Group), Northern Airlines and Xinjiang Airlines were restructured and consolidated into CSAHC. Both Northern Airlines Group and Xinjiang Airlines Group are the leading airlines in their respective regions, offering passenger and cargo air transportation and other related services. (a) KEY OPERATING DATA Passenger and cargo air transportation are Northern Airlines Group's principal businesses. However, due to its lack of freight aircraft, Northern Airlines Group relies heavily on its passenger air transportation business. In 2003, revenues generated from passenger air transportation business accounted for approximately 93% of the total revenues while those from cargo services accounted for approximately 7%. Northern Airlines Group also provides aircraft maintenance and repair, and other aviation related services. In the past three and a half years, Northern Airlines Group's passenger air transportation business continued to improve with overall passenger load factor increasing from 60% for 2001 to 67% for the first six months of 2004 and passenger yield per RPK rising from RMB0.58 for 2001 to RMB0.61 for the first six months of 2004. The cargo transportation business also showed material improvement with cargo yield per RFTK increasing 12% from RMB1.90 for year 2001 to RMB2.13 for the first six months of 2004. Key operating benchmarks of Northern Airlines Group from 2001 to the first half of 2004 are summarized as follows: NORTHERN AIRLINES GROUP'S KEY OPERATING BENCHMARKS FIRST SIX MONTHS ENDED 30 JUNE, 2004 2003 2002 2001 --------- ----- ----- ----- PASSENGER TRAFFIC (RPK) (million) Domestic 4,652 8,234 7,800 6,914 International 538 913 986 1,334 ------- ----- ----- ----- Total 5,190 9,147 8,786 8,248 ======= ===== ===== ===== -52- APPENDIX I INFORMATION REGARDING THE AIRLINE OPERATIONS OF NORTHERN AIRLINES GROUP AND XINJIANG AIRLINES GROUP FIRST SIX MONTHS ENDED 30 JUNE, 2004 2003 2002 2001 --------- ------ ------ ------ REVENUE TONNE KILOMETRES (RTK) (million) Domestic 504 904 707 619 International 57 101 90 72 ------- ------ ------ ------ Total 561 1,005 797 691 ======= ====== ====== ====== PASSENGER VOLUME (thousand) Domestic 3,258 5,831 5,501 4,849 International 363 643 652 864 ------- ------ ------ ------ Total 3,621 6,474 6,153 5,713 ======= ====== ====== ====== CARGO AND MAIL CARRIED (thousand tonne) Domestic 47 94 74 62 International 8 17 13 9 ------- ------ ------ ------ Total 55 111 87 71 ======= ====== ====== ====== CARGO TRAFFIC (RFTK) (million) Domestic 87 168 166 162 International 9 19 15 13 ------- ------ ------ ------ Total 96 187 181 175 ======= ====== ====== ====== PASSENGER CAPACITY (ASK) (million) Domestic 6,722 12,226 12,232 11,412 International 971 1,714 1,800 2,334 ------- ------ ------ ------ Total 7,693 13,940 14,032 13,746 ======= ====== ====== ====== -53- APPENDIX I INFORMATION REGARDING THE AIRLINE OPERATIONS OF NORTHERN AIRLINES GROUP AND XINJIANG AIRLINES GROUP FIRST SIX MONTHS ENDED 30 JUNE, 2004 2003 2002 2001 --------- ------ ------ ------ AVAILABLE TONNE KILOMETRES (ATK) (million) Domestic 805 1,451 1,193 1,035 International 115 205 186 131 ------- ------ ------ ------ Total 920 1,656 1,379 1,166 ======= ====== ====== ====== PASSENGER LOAD FACTOR Domestic 69% 67% 64% 61% International 55% 53% 55% 57% Overall 67% 66% 63% 60% ======= ====== ====== ====== OVERALL LOAD FACTOR (RTK/ATK) Domestic 63% 62% 59% 60% International 50% 49% 48% 55% Overall 61% 61% 58% 59% ======= ====== ====== ====== PASSENGER YIELD PER RPK (RMB) Domestic 0.57 0.55 0.50 0.55 International 0.98 0.97 0.87 0.71 Overall 0.61 0.60 0.54 0.58 ======= ====== ====== ====== CARGO YIELD PER RFTK (RMB) Domestic 1.51 1.56 1.59 1.55 International 7.77 7.89 8.25 8.54 Overall 2.13 2.20 2.16 1.90 ======= ====== ====== ====== YIELD PER RTK (RMB) Domestic 5.53 5.33 5.90 6.53 International 10.53 10.27 10.90 14.75 Overall 6.04 5.82 6.47 7.38 ======= ====== ====== ====== FLEET Airbus 17 12 10 8 McDonald Douglas 35 35 36 37 Others 3 3 19 27 ------- ------ ------ ------ Total 55 50 65 72 ======= ====== ====== ====== -54- APPENDIX I INFORMATION REGARDING THE AIRLINE OPERATIONS OF NORTHERN AIRLINES GROUP AND XINJIANG AIRLINES GROUP FIRST SIX MONTHS ENDED 30 JUNE, 2004 2003 2002 2001 --------- ------ ------ ------ OVERALL UTILISATION RATE (hours per day) Airbus 8.8 7.8 8.3 7.5 McDonald Douglas 9.1 7.8 8.2 8.4 Overall 9.0 7.8 8.3 7.8 ======= ====== ====== ====== Passenger and cargo air transportation are Xinjiang Airlines Group's principal businesses. In 2003, passenger air transportation business generated 96% of total revenues with freight transportation business accounting for 4%. Xinjiang Airlines Group has managed to improve its domestic passenger load factor to 66% in the first half of 2004 from 59% in 2001. Passenger traffic as measured by RPK has also increased over the past three years. However, passenger yields suffered in 2003 and first half of 2004 due to increased competition. Key operating benchmarks from 2001 to the first half 2004 are summarized as follows: XINJIANG AIRLINES GROUP'S KEY OPERATING BENCHMARKS FIRST SIX MONTHS ENDED 30 JUNE, 2004 2003 2002 2001 --------- ------ ------ ------ PASSENGER TRAFFIC (RPK) (million) Domestic 2,324 3,941 3,768 3,400 International 92 151 148 148 ------- ------ ------ ------ Total 2,416 4,092 3,916 3,548 ======= ====== ====== ====== REVENUE TONNE KILOMETRES (RTK) (million) Domestic 241 415 417 365 International 9 14 14 13 ------- ------ ------ ------ Total 250 429 431 378 ======= ====== ====== ====== -55- APPENDIX I INFORMATION REGARDING THE AIRLINE OPERATIONS OF NORTHERN AIRLINES GROUP AND XINJIANG AIRLINES GROUP FIRST SIX MONTHS ENDED 30 JUNE, 2004 2003 2002 2001 --------- ------ ------ ------ PASSENGER VOLUME (thousand) Domestic 1,209 2,062 1,753 1,510 International 55 86 75 61 ------- ------ ------ ------ Total 1,264 2,148 1,828 1,571 ======= ====== ====== ====== CARGO AND MAIL CARRIED (thousand tonne) Domestic 12 21 27 20 International - - - - ------- ------ ------ ------ Total 12 21 27 20 ======= ====== ====== ====== CARGO TRAFFIC (RFTK) (million) Domestic 33 62 81 62 International 1 1 1 1 ------- ------ ------ ------ Total 34 63 82 63 ======= ====== ====== ====== PASSENGER CAPACITY (ASK) (million) Domestic 3,527 5,995 6,105 5,771 International 195 302 331 326 ------- ------ ------ ------ Total 3,722 6,297 6,436 6,097 ======= ====== ====== ====== AVAILABLE TONNE KILOMETRES (ATK) (million) Domestic 378 597 674 637 International 20 32 35 33 ------- ------ ------ ------ Total 398 629 709 670 ======= ====== ====== ====== PASSENGER LOAD FACTOR Domestic 66% 66% 62% 59% International 47% 50% 45% 45% Overall 65% 65% 61% 58% ======= ====== ====== ====== -56- APPENDIX I INFORMATION REGARDING THE AIRLINE OPERATIONS OF NORTHERN AIRLINES GROUP AND XINJIANG AIRLINES GROUP FIRST SIX MONTHS ENDED 30 JUNE, 2004 2003 2002 2001 ---------- ---------- ---------- ---------- OVERALL LOAD FACTOR (RTK/ATK) Domestic 64% 70% 62% 57% International 45% 44% 40% 39% Overall 63% 68% 61% 56% ========== ========== ========== ========== PASSENGER YIELD PER RPK (RMB) Domestic 0.46 0.48 0.53 0.55 International 0.72 0.69 0.69 0.60 Overall 0.47 0.48 0.54 0.55 ========== ========== ========== ========== CARGO YIELD PER RFTK (RMB) Domestic 1.44 1.44 1.33 1.49 International 2.09 4.43 5.00 5.00 Overall 1.45 1.48 1.36 1.54 ========== ========== ========== ========== YIELD PER RTK (RMB) Domestic 4.75 4.70 5.51 5.83 International 8.12 7.74 8.25 7.74 Overall 4.87 4.80 5.56 5.86 ========== ========== ========== ========== FLEET Boeing 15 15 15 14 ATR 72 and IL86 5 5 8 8 ---------- ---------- ---------- ---------- Total 20 20 23 22 ========== ========== ========== ========== OVERALL UTILISATION RATE (hours per day) Boeing 10.0 8.8 8.9 10.1 ATR 72 and IL86 7.8 7.4 7.1 8.2 Overall 8.9 8.3 7.7 8.4 ========== ========== ========== ========== (b) OPERATIONAL BASES Shenyang, Dalian, Harbin, and Changchun are the primary bases for Northern Airlines Group. Urumqi is the principal base for Xinjiang Airlines Group. -57- APPENDIX I INFORMATION REGARDING THE AIRLINE OPERATIONS OF NORTHERN AIRLINES GROUP AND XINJIANG AIRLINES GROUP SHENYANG: Taoxian Airport, located 22 kilometers south of Shenyang, was opened on 10 April, 1989. In the first half of 2004, Northern Airlines Group's passenger and cargo turnover at Taoxian Airport accounted for 25% and 28% of its total passenger and cargo turnover respectively. The airport has a 3,200 meter runway, and is equipped with modern communication and navigation systems. Taoxian Airport is owned and operated by Shenyang Taoxian Airport Limited, which estimates that Taoxian Airport handled approximately 31,400 landings, three million passengers and 88,000 tonnes cargo for the year 2003, making it one of the busiest airports in Northeastern China. DALIAN: Dalian Zhoushuizi Airport is located 10 kilometers northwest of Dalian. The airport handled 26% of the passenger turnover and 29% of the cargo turnover of Northern Airlines Group in the first half of 2004. Opened on 6 April, 1973, Zhoushuizi Airport is the busiest airport in Northeastern China. The airport is owned and operated by Dalian Zhoushuizi International Airport Limited. Zhoushuizi Airport has a 3,300 meter runway, and is capable of handling commercial aircraft of all types. According to Dalian Zhoushuizi International Airport Limited, the airport handled 35,248 landings, three million passengers and 74,784 tonnes of cargo in 2003. HARBIN: Harbin Taiping Airport is located 33 kilometers northwest of Harbin. In the first half of 2004, the airport handled 16% of passenger turnover and 15% of cargo turnover of Northern Airlines Group. Opened on 1 September, 1997, Taiping Airport is one of the largest airports in Northeastern China. Taiping Airport has a 3,200 meter runway, and is capable of handling Boeing 767 or equivalent aircraft. According to the airport, it handled 22,093 landings in 2003. Passenger and cargo turnover was two million and 31,300 tonnes respectively for the year. CHANGCHUN: Dafangshen Airport is Northern Airlines Group's operational base in Jilin province. Located 11 kilometers west of Changchun, the airport handled 15% of Northern Airlines Group's passenger turnover and 11% of cargo turnover in the first half of 2004. -58- APPENDIX I INFORMATION REGARDING THE AIRLINE OPERATIONS OF NORTHERN AIRLINES GROUP AND XINJIANG AIRLINES GROUP Dafangshen Airport is the only international airport in Jilin province. It has a 2,600 meter runway and is capable of handling Boeing 737, Boeing 757 or equivalent aircraft. According to the airport, it handled 13,880 landings in 2003. Passenger and cargo turnover was one million and 15,700 tonnes respectively for the year. In light of the rapid growth of passenger and cargo turnover at the Dafangshen Airport, CAAC and Jilin provincial government began construction of Longjiabao Airport in May 2003. The new airport is located 28 kilometers northeast of Changchun. Dafangshen Airport will cease operations when the new airport comes into operations. URUMQI: Urumqi Diwo Airport is located 17 kilometers northwest of Urumqi. In 2003, it handled 82% of Xinjiang Airlines Group's total passenger and cargo turnover. Opened in 1973, Diwo Airport is currently one of the largest airports in Northwestern China. Equipped with a 3,600 meter runway and modern navigation systems, the airport is capable of handling commercial aircraft of all types. According to the airport, it handled 33,440 landings in 2003. Passenger and cargo turnover was three million and 47,900 tonnes respectively for the year. (c) ROUTES NETWORK From the four bases in Northeastern China, Northern Airlines currently offers regular flights on 106 domestic routes to over 46 cities in China and 29 international routes to North Asia and Russia. Headquartered in Urumqi, Xinjiang Airlines is the leading air traffic service provider in Northwestern China. It offers regular flight services on 42 domestic routes. It also offers regular flight services on seven international routes to major cities in the Middle East, Russia and West Asia. TOP 10 ROUTES OF NORTHERN AIRLINES GROUP BY REVENUE FIRST SIX MONTHS ENDED 30 JUNE, 2004 2003 ----------------------- -------------------------- 1. Changchun-Beijing Changchun-Beijing 2. Shenyang-Beijing Harbin-Shenyang-Shenzhen -59- APPENDIX I INFORMATION REGARDING THE AIRLINE OPERATIONS OF NORTHERN AIRLINES GROUP AND XINJIANG AIRLINES GROUP FIRST SIX MONTHS ENDED 30 JUNE, 2004 2003 ----------------------- -------------------------- 3. Dalian-Beijing Harbin-Dalian-Guangzhou 4. Harbin-Beijing Harbin-Beijing 5. Dalian-Shanghai Pudong Dalian-Beijing 6. Harbin-Shenyang-Shenzhen Shenyang-Beijing 7. Harbin-Dalian-Guangzhou Shenyang-Wenzhou-Guangzhou 8. Shenyang-Shanghai Pudong Shenyang-Shanghai Pudong 9. Shenyang-Wenzhou-Guangzhou Dalian-Shanghai Pudong 10. Dalian-Hangzhou-Shenzhen Dalian-Hangzhou-Shenzhen TOP 10 ROUTES OF XINJIANG AIRLINES GROUP BY REVENUE FIRST SIX MONTHS ENDED 30 JUNE, 2004 2003 ----------------------- ------------------------ 1. Urumqi-Beijing Urumqi-Beijing 2. Urumqi-Shanghai Urumqi-Shanghai 3. Urumqi-Changsha-Shenzhen Urumqi-Kashi 4. Urumqi-Chengdu Urumqi-Changsha-Shenzhen 5. Urumqi-Guangzhou Urumqi-Guangzhou 6. Urumqi-Kashi Urumqi-Chengdu 7. Urumqi-Lanzhou-Hangzhou Urumqi-Lanzhou-Hangzhou 8. Urumqi-Zhengzhou-Qingdao Urumqi-Zhengzhou-Qingdao 9. Urumqi-Yili Urumqi-Xian 10. Urumqi-Xian Urumqi-Zhengzhou-Fuzhou -60- APPENDIX I INFORMATION REGARDING THE AIRLINE OPERATIONS OF NORTHERN AIRLINES GROUP AND XINJIANG AIRLINES GROUP (d) FLEET As of 30 June, 2004, Northern Airlines Group owned and operated 55 medium to large size aircraft with an average fleet age of 8.08 years. The table below sets out details of its fleet: NORTHERN AIRLINES GROUP'S FLEET DETAILS (AS OF 30 JUNE, 2004) FINANCING OPERATING SELF-OWNED LEASE LEASE TOTAL ---------- ---------- ---------- ---------- MD82 10 1 11 22 MD90 3 10 - 13 A300 - 6 - 6 A321 4 4 - 8 A319 - - 3 3 Cessna 208B 3 - - 3 ---------- ---------- ---------- ---------- Total 20 21 14 55 ========== ========== ========== ========== Xinjiang Airlines Group has gradually phased out the Soviet-made TU-154 and IL-86 for commercial flights. The airline has recently purchased and leased a large number of Boeing and ATR commercial aircraft. As of 30 June, 2004, the average age of the 20 aircraft owned or operated by Xinjiang Airlines Group was 5.90 years. Details of the fleet are set out in the table below: XINJIANG AIRLINES GROUP'S FLEET DETAILS (AS OF 30 JUNE, 2004) OPERATING SELF-OWNED LEASE TOTAL ---------- ---------- ---------- B757-200 6 3 9 B737-300 2 - 2 B737-700 - 4 4 ATR-72 5 - 5 ---------- ---------- ---------- Total 13 7 20 ========== ========== ========== -61- APPENDIX I INFORMATION REGARDING THE AIRLINE OPERATIONS OF NORTHERN AIRLINES GROUP AND XINJIANG AIRLINES GROUP (e) AIRCRAFT ACQUISITION AND DISPOSAL PROGRAM Northern Airlines entered into an aircraft sale and leaseback agreement on 4 November, 2003 with ILFC. Under the agreement, Northern Airlines agreed to sell the 22 MD82 aircraft owned, or to be owned to ILFC in four phases according to the schedule listed below: MD82 AIRCRAFT TO BE SOLD UNDER THE AIRCRAFT SALE AND LEASEBACK AGREEMENT NUMBER OF PHASE DATE MD82 TO BE SOLD ----- --------------------------------- --------------- I 14 November, 2003 4 II 1 March, 2004 7 III 1 July, 2005 and 1 June, 2006 6 IV 1 June, 2006 and 15 January, 2007 5 Under the same agreement, Northern Airlines Group also agreed to lease back the above-mentioned MD82 aircraft from ILFC immediately after the sale. The average term of the lease back agreements is 15 months. In addition, Northern Airlines Group also agreed to replace each of the 22 MD82 aircraft with one new Airbus 319-100 aircraft or one new Airbus 320-200 aircraft from ILFC upon the termination of the lease back agreements. The table below sets out the replacement schedule: AIRCRAFT REPLACEMENT SCHEDULE AIRCRAFT TYPE SCHEDULED DELIVERY DATE ------------- --------------------------- PHASE I 1. A319-100 May 2004 (delivered) 2. A319-100 May 2004 (delivered) 3. A319-100 June 2004 (delivered) 4. A319-100 September 2004 (delivered) PHASE II 5. A319-100 January 2005 6. A319-100 February 2005 7. A319-100 March 2005 8. A319-100 April 2005 9. A319-100 May 2005 10. A319-100 October 2005 11. A319-100 November 2005 -62- APPENDIX I INFORMATION REGARDING THE AIRLINE OPERATIONS OF NORTHERN AIRLINES GROUP AND XINJIANG AIRLINES GROUP AIRCRAFT TYPE SCHEDULED DELIVERY DATE --------------------- ----------------------- PHASE III 12. A319-100/A320-200 January 2006 13. A319-100/A320-200 June 2006 14. A319-100/A320-200 October 2006 15. A319-100/A320-200 November 2006 16. A319-100/A320-200 November 2006 17. A319-100/A320-200 December 2006 PHASE IV 18. A319-100/A320-200 February 2007 19. A319-100/A320-200 June 2007 20. A319-100/A320-200 October 2007 21. A319-100/A320-200 October 2007 22. A319-100/A320-200 November 2007 In addition to the above agreement, Northern Airlines has also committed to the addition of two more A321s by the end of 2005. (f) SALES AND MARKETING Northern Airlines Group and Xinjiang Airlines Group have historically marketed their services under their own brands. FREQUENT FLYER PROGRAM: Both Northern Airlines Group and Xinjiang Airlines Group operated their respective frequent flyer programs prior to consolidation into CSAHC. Following the consolidation of Northern Airlines Group and Xinjiang Airlines Group into CSAHC, the two frequent flyer programs merged with the Company's frequent flyer program, namely, the China Southern Airlines Sky Pearl Club. TICKET SALES CHANNELS AND RESERVATION SYSTEM: Northern Airlines Group and Xinjiang Airlines Group conduct ticket sales through a variety of sales channels, including the airlines' own network of exclusive sales offices, websites and general sales agents. As of 30 June, 2004, Northern Airlines Group has sales offices in nine cities in China. Xinjiang Airlines Group has sales offices in seven cities in China and six outside China. -63- APPENDIX I INFORMATION REGARDING THE AIRLINE OPERATIONS OF NORTHERN AIRLINES GROUP AND XINJIANG AIRLINES GROUP (g) SAFETY Aircraft safety involves three major operational areas: flight operations, aircraft maintenance and ground operations. Both Northern Airlines Group and Xinjiang Airlines Group place great importance on safety in each of the three areas, and comply with applicable safety and security standards and regulations required by CAAC and other aviation industry regulators in the jurisdictions they serve. Xinjiang Airlines Group has established a reputation for safety. To date, it maintains a record of transport flight safety since its founding and is perceived to be one of the safest airline operators in China. On 7 May, 2002, a MD82 aircraft of the Northern Airlines crashed into the ocean near Dalian, resulting in 112 passenger and crew fatalities. The aircraft was fully insured and compensated under the insurance arrangement. (h) EMPLOYEES The table below sets forth information regarding the employees of Northern Airlines Group and Xinjiang Airlines Group as at the end of 2003: NORTHERN AIRLINES GROUP AND XINJIANG AIRLINES GROUP EMPLOYEE INFORMATION (AS AT 31 DECEMBER, 2003) NORTHERN XINJIANG AIRLINES AIRLINES GROUP GROUP TOTAL -------- -------- -------- Flight personnel 1,864 726 2,590 Ground personnel 4,129 758 4,887 Sales, administration and back office personnel 4,650 1,120 5,770 -------- -------- -------- Total headcount 10,643 2,604 13,247 ======== ======== ======== (i) PROPERTIES Both Northern Airlines Group and Xinjiang Airlines Group own certain buildings and real estate properties, which are used for offices, retail outlets, warehouses, aircraft maintenance workshops, ground services and airport services. -64- APPENDIX II ACCOUNTANTS' REPORT ON FINANCIAL INFORMATION OF THE AIRLINE OPERATIONS OF NORTHERN AIRLINES GROUP The following is the text of a report, prepared for the sole purpose of inclusion in this circular, received from the independent reporting accountants, KPMG, Certified Public Accountants, Hong Kong. As described in the section headed "Documents available for inspection" in Appendix IX, a copy of the following accountants' report is available for inspection. [KPMG LOGO] 8th Floor Prince's Building 10 Chater Road Hong Kong The Directors China Southern Airlines Company Limited Baiyun International Airport Guangzhou People's Republic of China 12 November, 2004 Dear Sirs, INTRODUCTION We set out below our report on the financial information relating to the airline and airline related operations (the "Airline Operations") of China Northern Airlines Company ("Northern Airlines") and its subsidiaries ("Northern Airlines Group"), in Sections I to VII below (the "Financial Information"), including the combined balance sheets as at 31 December, 2001, 2002 and 2003 and 30 June, 2004, the combined statements of operations, the combined statements of changes in owner's fund and the combined statements of cash flows for each of the years in the three-year period ended 31 December, 2003 and the six-month period ended 30 June, 2004 (the "relevant period"), and the notes thereto, for inclusion in the shareholders' circular of China Southern Airlines Company Limited ("the Company") dated 12 November, 2004 (the "Circular"). Northern Airlines was established on 19 October, 1990 in the People's Republic of China (the "PRC") and is a wholly-owned subsidiary of China Southern Air Holding Company ("CSAHC"), the ultimate holding company of the Company. It is principally engaged in the provision of domestic, and international passenger, cargo and mail airline services, with flights operating primarily from Shenyang Tao Xian International Airport which is the main base of Northern Airlines in the PRC. In addition, Northern Airlines Group also engages in other non airline related operations (the "Non Airline Operations") mainly consisting of hotel and property operations which provide social and supporting services to Northern Airlines Group. -65- APPENDIX II ACCOUNTANTS' REPORT ON FINANCIAL INFORMATION OF THE AIRLINE OPERATIONS OF NORTHERN AIRLINES GROUP CSAHC has undergone a reorganisation (the "Reorganisation") in connection with the proposed acquisition of the Airline Operations of Northern Airlines Group by the Company. As part of the Reorganisation, the operations and businesses and the assets and liabilities of Northern Airlines Group were segregated into two operations, namely the Airline Operations and the Non Airline Operations on 31 December, 2003. Pursuant to the Sale and Purchase Agreement, as described more fully in the section headed "The Sale and Purchase Agreement" in the letter from the Board contained in the Circular, the Company will acquire the Airline Operations of Northern Airlines Group together with the related assets and liabilities. However, certain assets and liabilities within the Airline Operations of Northern Airlines Group are not to be acquired by the Company. Northern Airlines Group prepares financial statements in accordance with the relevant accounting rules and regulations in the PRC. The financial statements of the Airline Operations of Northern Airlines Group were not required to be audited by independent auditors during the relevant period. BASIS OF PREPARATION The Financial Information has been prepared by management of the Airline Operations of Northern Airlines Group based on the management accounts of the Airline Operations of Northern Airlines Group and on the bases set out in Section V Notes 2 and 3 to conform with International Financial Reporting Standards ("IFRS") promulgated by the International Accounting Standards Board and the disclosure requirements of the Rules Governing the Listing of Securities on The Stock Exchange of Hong Kong Limited. IFRS includes International Accounting Standards and interpretations. RESPECTIVE RESPONSIBILITIES OF MANAGEMENT AND REPORTING ACCOUNTANTS Management of the Airline Operations of Northern Airlines Group are responsible for the preparation of the Financial Information which gives a true and fair view. In preparing the Financial Information which gives a true and fair view, it is fundamental that appropriate accounting policies are selected and applied consistently, that judgements and estimates are made which are prudent and reasonable and that the reasons for any significant departure from applicable accounting standards are stated. It is our responsibility to form an independent opinion, based on our audit, on the Financial Information. -66- APPENDIX II ACCOUNTANTS' REPORT ON FINANCIAL INFORMATION OF THE AIRLINE OPERATIONS OF NORTHERN AIRLINES GROUP BASIS OF OPINION As a basis for forming an opinion on the Financial Information, for the purpose of this report, we have audited the Financial Information of the Airline Operations of Northern Airlines Group for the relevant period in accordance with Statements of Auditing Standards and Guidelines issued by Hong Kong Institute of Certified Public Accountants ("HKICPA") and we have carried out such additional procedures as we considered necessary in accordance with the Auditing Guideline "Prospectuses and the Reporting Accountant" issued by the HKICPA. We have not audited any financial statements of the Airline Operations of Northern Airlines Group in respect of any period subsequent to 30 June, 2004. An audit includes examination, on a test basis, of evidence relevant to the amounts and disclosures in the Financial Information. It also includes an assessment of the significant estimates and judgements made by management of the Airline Operations of Northern Airlines Group in the preparation of the Financial Information, and of whether the accounting policies are appropriate to the circumstances of the Airline Operations of Northern Airlines Group, consistently applied and adequately disclosed. We planned and performed our audit so as to obtain all the information and explanations which we considered necessary in order to provide us with sufficient evidence to give reasonable assurance as to whether the Financial Information is free from material misstatement. In forming our opinion we also evaluated the overall adequacy of the presentation of Financial Information. We believe that our audit provides a reasonable basis for our opinion. OPINION In our opinion, the Financial Information for the purpose of this report, and on the basis of presentation set out in Section V Notes 2 and 3, gives a true and fair view of the combined state of affairs of the Airline Operations of Northern Airlines Group as at 31 December, 2001, 2002 and 2003 and 30 June, 2004, and the combined results and combined cash flows of the Airline Operations of Northern Airlines Group for each of the years in the three-year period ended 31 December, 2003 and the six-month period ended 30 June, 2004 and has been properly prepared in accordance with IFRS. -67- APPENDIX II ACCOUNTANTS' REPORT ON FINANCIAL INFORMATION OF THE AIRLINE OPERATIONS OF NORTHERN AIRLINES GROUP (I) COMBINED STATEMENTS OF OPERATIONS SIX-MONTH PERIODS YEARS ENDED 31 DECEMBER, ENDED 30 JUNE, ------------------------------------ --------------------- 2001 2002 2003 2003 2004 Note RMB'000 RMB'000 RMB'000 RMB'000 RMB'000 (unaudited) OPERATING REVENUE Traffic revenue 5,105,225 5,156,574 5,856,970 2,128,941 3,391,448 Other operating revenue 98,122 87,343 71,765 37,685 73,232 --------- ----------- ---------- --------- --------- TOTAL OPERATING REVENUE 4 5,203,347 5,243,917 5,928,735 2,166,626 3,464,680 --------- ----------- ---------- --------- --------- OPERATING EXPENSES Flight operations 2,123,890 2,194,336 2,338,641 1,119,920 1,480,465 Maintenance 751,542 993,629 1,039,448 541,618 412,118 Aircraft and traffic servicing 667,950 717,332 759,704 319,939 464,035 Promotion and sales 408,994 415,806 425,466 166,296 219,471 General and administrative 162,719 218,594 225,464 99,245 114,849 Depreciation and amortisation 678,435 662,040 645,506 319,023 404,419 Others 535,321 349,856 555,349 - - --------- ----------- ---------- --------- --------- TOTAL OPERATING EXPENSES 5 5,328,851 5,551,593 5,989,578 2,566,041 3,095,357 --------- ----------- ---------- --------- --------- OPERATING (LOSS)/PROFIT (125,504) (307,676) (60,843) (399,415) 369,323 --------- ----------- ---------- --------- --------- NON-OPERATING INCOME/(EXPENSES) Interest income 59,903 28,583 12,943 6,921 4,257 Interest expense 6 (724,605) (700,752) (627,190) (312,183) (195,027) Exchange gain/(loss), net 232,409 (151,196) (217,539) (1,820) 23,567 Gain/(loss) on disposal of property, plant and equipment 7 14,634 22,873 729 3,224 (439) Deficit on revaluation of property, plant and equipment 10 - - (492,369) - - Others, net 3,589 (42,666) 15,540 13,540 - --------- ----------- ---------- --------- --------- TOTAL NON-OPERATING EXPENSES, NET (414,070) (843,158) (1,307,886) (290,318) (167,642) --------- ----------- ---------- --------- --------- (LOSS)/PROFIT BEFORE INCOME TAX AND MINORITY INTERESTS (539,574) (1,150,834) (1,368,729) (689,733) 201,681 INCOME TAX 8 (572) (451) 117,262 - (67,300) --------- ----------- ---------- --------- --------- (LOSS)/PROFIT BEFORE MINORITY INTERESTS (540,146) (1,151,285) (1,251,467) (689,733) 134,381 MINORITY INTERESTS 38,477 10,228 17,846 4,690 661 --------- ----------- ---------- --------- --------- NET (LOSS)/PROFIT (501,669) (1,141,057) (1,233,621) (685,043) 135,042 ========= =========== ========== ========= ========= -68- APPENDIX II ACCOUNTANTS' REPORT ON FINANCIAL INFORMATION OF THE AIRLINE OPERATIONS OF NORTHERN AIRLINES GROUP (II) COMBINED BALANCE SHEETS 31 DECEMBER, 30 JUNE, ------------------------------------- ---------- 2001 2002 2003 2004 Note RMB'000 RMB'000 RMB'000 RMB'000 NON-CURRENT ASSETS Property, plant and equipment, net 10 8,843,881 8,766,726 8,844,541 9,141,267 Construction in progress 11 210,191 258,505 54,446 38,930 Lease prepayments 13,345 13,060 - - Other investments 12 - 68,209 68,209 68,209 Lease and equipment deposits 778,182 640,286 1,334,818 437,117 Deferred expenditure 13 8,329 7,266 18,001 122,093 Deferred tax assets 23 - - 24,743 20,313 ---------- ---------- ---------- --------- TOTAL NON-CURRENT ASSETS 9,853,928 9,754,052 10,344,758 9,827,929 ---------- ---------- ---------- --------- CURRENT ASSETS Inventories 14 625,704 693,960 534,968 544,093 Trade receivables 15 165,274 240,674 242,543 398,158 Other receivables and prepaid expenses 16 359,587 207,054 141,634 566,110 Cash and cash equivalents 17 1,308,902 755,218 542,046 234,733 ---------- ---------- ---------- --------- TOTAL CURRENT ASSETS 2,459,467 1,896,906 1,461,191 1,743,094 ---------- ---------- ---------- --------- CURRENT LIABILITIES Bank and other loans 18 2,488,875 4,171,785 569,547 767,257 Obligations under finance leases 19 976,593 1,023,660 1,070,169 1,063,047 Other liabilities and accrued expenses 20 1,840,530 1,679,034 1,135,292 1,403,363 Accounts payable 21 255,771 206,659 122,259 140,026 Sales in advance of carriage 49,830 98,066 5,525 - Tax payable 297 33 - - ---------- ---------- ---------- --------- TOTAL CURRENT LIABILITIES 5,611,896 7,179,237 2,902,792 3,373,693 ---------- ---------- ---------- --------- NET CURRENT LIABILITIES (3,152,429) (5,282,331) (1,441,601) 1,630,599) ---------- ---------- ---------- --------- TOTAL ASSETS LESS CURRENT LIABILITIES 6,701,499 4,471,721 8,903,157 8,197,330 ---------- ---------- ---------- --------- -69- APPENDIX II ACCOUNTANTS' REPORT ON FINANCIAL INFORMATION OF THE AIRLINE OPERATIONS OF NORTHERN AIRLINES GROUP (II) COMBINED BALANCE SHEETS (CONTINUED) 31 DECEMBER, 30 JUNE, ----------------------------------- --------- 2001 2002 2003 2004 Note RMB'000 RMB'000 RMB'000 RMB'000 NON-CURRENT LIABILITIES AND DEFERRED ITEMS Bank and other loans 18 2,842,763 1,293,183 2,152,067 1,811,371 Obligations under finance leases 19 6,475,202 6,700,765 5,897,242 5,402,143 Deferred credit 22 47,815 38,989 30,163 25,750 ---------- ---------- --------- --------- TOTAL NON-CURRENT LIABILITIES 9,365,780 8,032,937 8,079,472 7,239,264 ---------- ---------- --------- --------- MINORITY INTERESTS 77,309 67,081 3,033 2,372 ---------- ---------- --------- --------- (2,741,590) (3,628,297) 820,652 955,694 ========== ========== ========= ========= Representing: OWNER'S FUND - (DEFICIT)/SURPLUS (2,741,590) (3,628,297) 820,652 955,694 ========== ========== ========= ========= -70- APPENDIX II ACCOUNTANTS' REPORT ON FINANCIAL INFORMATION OF THE AIRLINE OPERATIONS OF NORTHERN AIRLINES GROUP (III) COMBINED STATEMENTS OF CHANGES IN OWNER'S FUND Note RMB'000 Deficit of owner's fund as at 1 January, 2001 (2,203,560) Net loss for the year (501,669) Distributions to owner (36,361) ---------- DEFICIT OF OWNER'S FUND AS AT 31 DECEMBER, 2001 (2,741,590) ========== Deficit of owner's fund as at 1 January, 2002 (2,741,590) Net loss for the year (1,141,057) Distributions to owner (11,277) Contributions from owner 265,627 ---------- DEFICIT OF OWNER'S FUND AS AT 31 DECEMBER, 2002 (3,628,297) ========== Deficit of owner's fund as at 1 January, 2003 (3,628,297) Net loss for the year (1,233,621) Net liabilities assumed by owner in connection with the Reorganisation and Acquisition 2 4,599,709 Surplus arising from revaluation of property, plant and equipment 10 1,175,668 Elimination of net deferred tax assets 23 (117,550) Recognition of deferred tax assets 23 24,743 ---------- SURPLUS OF OWNER'S FUND AS AT 31 DECEMBER, 2003 820,652 ========== Surplus of owner's fund as at 1 January, 2004 820,652 Net profit for the period 135,042 ---------- SURPLUS OF OWNER'S FUND AS AT 30 JUNE, 2004 955,694 ========== -71- APPENDIX II ACCOUNTANTS' REPORT ON FINANCIAL INFORMATION OF THE AIRLINE OPERATIONS OF NORTHERN AIRLINES GROUP (IV) COMBINED STATEMENTS OF CASH FLOWS SIX-MONTH PERIODS YEARS ENDED 31 DECEMBER, ENDED 30 JUNE, -------------------------------------- --------------------- 2001 2002 2003 2003 2004 Note RMB'000 RMB'000 RMB'000 RMB'000 RMB'000 (unaudited) NET CASH FROM/(USED IN) OPERATING ACTIVITIES 29(i) 390,115 102,830 540,228 (489,653) 221,973 ---------- ---------- ---------- ---------- -------- CASH FLOWS FROM INVESTING ACTIVITIES Proceeds from disposal of property, plant and equipment 163,223 223,375 122,227 8,143 136,846 Increase in deferred expenditure - (183) (27,890) (13,067) - Decrease in long term receivable 28,338 - - - - Net cash proceeds from manufacturers' credit 29(ii) 414,722 547,629 - - - Payment of lease and equipment deposits (239,160) (241,880) (1,904,415) (939,931) (84,961) Refund of lease and equipment deposits 333,811 383,563 1,214,509 1,062,275 158,265 Capital expenditures (332,622) (667,041) (1,411,666) (1,030,723) (117,418) Purchase of long term investments - (68,209) - - - ---------- ---------- ---------- ---------- -------- NET CASH FROM/(USED IN) INVESTING ACTIVITIES 368,312 177,254 (2,007,235) (913,303) 92,732 ---------- ---------- ---------- ---------- -------- CASH FLOWS FROM FINANCING ACTIVITIES Proceeds from bank and other loans 2,709,000 3,363,281 9,409,078 5,801,892 309,490 Repayment of bank and other loans (2,329,796) (3,229,998) (7,069,770) (3,691,226) (452,427) Repayment of principal under finance lease obligations (994,221) (1,221,401) (1,006,097) (500,815) (479,081) Contributions from owner - 265,627 - - - Distributions to owner (36,361) (11,277) - - - Cash distributed to owner upon the Reorganisation 2 - - (79,376) - - ---------- ---------- ---------- ---------- -------- NET CASH (USED IN)/FROM FINANCING ACTIVITIES (651,378) (833,768) 1,253,835 1,609,851 (622,018) ---------- ---------- ---------- ---------- -------- NET INCREASE/(DECREASE) IN CASH AND CASH EQUIVALENTS 107,049 (553,684) (213,172) 206,895 (307,313) CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR/PERIOD 1,201,853 1,308,902 755,218 755,218 542,046 ---------- ---------- ---------- ---------- -------- CASH AND CASH EQUIVALENTS AT END OF YEAR/PERIOD 1,308,902 755,218 542,046 962,113 234,733 ========== ========== ========== ========== ======== -72- APPENDIX II ACCOUNTANTS' REPORT ON FINANCIAL INFORMATION OF THE AIRLINE OPERATIONS OF NORTHERN AIRLINES GROUP (V) NOTES TO THE FINANCIAL INFORMATION 1. PRINCIPAL ACTIVITIES AND REORGANISATION China Northern Airlines Company ("Northern Airlines") was established on 19 October, 1990 in the People's Republic of China (the "PRC") and is a wholly-owned subsidiary of China Southern Air Holding Company ("CSAHC"), the ultimate holding company of China Southern Airlines Company Limited (the "Company"). Northern Airlines together with its subsidiaries ("Northern Airlines Group") is principally engaged in the provision of domestic and international passenger, cargo and mail airline services, with flights operating primarily from Shenyang Tao Xian International Airport which is the main base of Northern Airlines in the PRC. In addition, Northern Airlines Group also engages in other non airline related operations (the "Non Airline Operations") mainly consisting of hotel and property operations which provide social and supporting services to Northern Airlines Group. CSAHC has undergone a reorganisation (the "Reorganisation") in connection with the proposed acquisition of the airline and airline related operations (the "Airline Operations") of Northern Airlines Group by the Company (the "Acquisition"). As part of the Reorganisation, the operations and businesses and the assets and liabilities of Northern Airlines Group were segregated into two operations, namely the Airline Operations and the Non Airline Operations on 31 December, 2003. Pursuant to the Sale and Purchase Agreement, as described more fully in the section headed "The Sale and Purchase Agreement" in the letter from the Board contained in the Circular, the Company will acquire the Airline Operations of Northern Airlines Group together with the related assets and liabilities. However, certain assets and liabilities within the Airline Operations of Northern Airlines Group are not to be acquired by the Company. 2. BASIS OF PRESENTATION The Financial Information for each of the years in the three-year period ended 31 December, 2003 and for the six-month period ended 30 June, 2004 presents the results of the Airline Operations of Northern Airlines Group as if the Reorganisation had taken place and the Airline Operations of Northern Airlines Group had been in operation on a stand alone basis as of the earliest date presented and had been in existence throughout the relevant period. The Financial Information for each of the years in the three-year period ended 31 December, 2003 includes the results related to those assets and liabilities that were not to be acquired by the Company, but were historically associated with the Airline Operations of Northern Airlines Group. As at 31 December, 2003, the assets and liabilities not to be acquired by the Company consisted of the following: RMB'000 ASSETS Property, plant and equipment, net 595,576 Construction in progress 298,198 Trade and other receivables 195,263 Cash and cash equivalents 79,376 Other assets 135,953 ---------- 1,304,366 ---------- LIABILITIES Bank and other loans 5,082,599 Other liabilities and accrued expenses 643,292 Accounts payable 110,422 Other liabilities 17,911 ---------- 5,854,224 ---------- MINORITY INTERESTS 49,851 ---------- NET LIABILITIES ASSUMED BY OWNER (4,599,709) ========== -73- APPENDIX II ACCOUNTANTS' REPORT ON FINANCIAL INFORMATION OF THE AIRLINE OPERATIONS OF NORTHERN AIRLINES GROUP (V) NOTES TO THE FINANCIAL INFORMATION (CONTINUED) 2. BASIS OF PRESENTATION (Continued) The assets and liabilities within the Airline Operations of Northern Airlines Group not to be acquired by the Company on 31 December, 2003 was reflected as net liabilities assumed by owner of Northern Airlines in the combined statements of owner's fund as at 31 December, 2003. As a result of the assumption of the above net liabilities as at 31 December, 2003 by the owner, the Financial Information for the six-month period ended 30 June, 2004 presents the results of the assets and liabilities, revenues and expenses of the Airline Operations of Northern Airlines Group to be acquired by the Company. Notwithstanding the Airline Operations of Northern Airlines Group having net current liabilities as at 30 June, 2004, the Financial Information has been prepared on a going concern basis on the assumption that the Airline Operations of Northern Airlines Group will be able to generate adequate cash flows from operations and to obtain adequate external financing to enable the Airline Operations of Northern Airlines Group to meet its debts as they fall due and to meet its committed future capital expenditure (see Note 26). 3. PRINCIPAL ACCOUNTING POLICIES (a) STATEMENT OF COMPLIANCE The Financial Information has been prepared in accordance with International Financial Reporting Standards ("IFRS") promulgated by the International Accounting Standards Board. IFRS includes International Accounting Standards ("IAS") and interpretations. (b) BASIS OF PREPARATION The Financial Information is prepared on the historical cost basis as modified by the revaluation of property, plant and equipment, as explained in Note 10. The accounting policies described below have been consistently applied during the relevant period. (c) BASIS OF CONSOLIDATION A subsidiary is an enterprise controlled by the Airline Operations of Northern Airlines. Control exists when the Airline Operations of Northern Airlines has the power, directly or indirectly, to govern the financial and operating policies of an enterprise so as to obtain benefits from its activities. The financial results of subsidiaries are included in the Financial Information from the date that control commences until the date that control ceases, and the share attributable to minority interests is deducted from or added to the profit/loss after income tax. All significant intercompany balances and transactions and any unrealised gains/losses arising from intercompany transactions are eliminated on consolidation. The particulars of the subsidiary are set out in Note 28. -74- APPENDIX II ACCOUNTANTS' REPORT ON FINANCIAL INFORMATION OF THE AIRLINE OPERATIONS OF NORTHERN AIRLINES GROUP (V) NOTES TO THE FINANCIAL INFORMATION (CONTINUED) 3. PRINCIPAL ACCOUNTING POLICIES (Continued) (d) PROPERTY, PLANT, EQUIPMENT AND DEPRECIATION (i) Property, plant and equipment are initially stated at cost less accumulated depreciation and impairment losses (see Note (f)). The cost of an asset comprises its purchase price, any directly attributable costs of bringing the asset to working condition and location for its intended use and the cost of borrowed funds used during the period of construction. Expenditure incurred after the asset has been put into operation is capitalised only when it increases the future economic benefits embodied in the item of property, plant and equipment. All other expenditure including the cost of repairs and maintenance, is expensed as it is incurred. (ii) Subsequent to the revaluation carried out as at 31 December, 2003, which was based on depreciated replacement costs (Note 10), property, plant and equipment are carried at revalued amount, being the fair value at the date of the revaluation, less subsequent accumulated depreciation and impairment losses. When an item of property, plant and equipment is revalued, any accumulated depreciation and impairment losses at the date of revaluation is eliminated against the gross carrying amount of the asset and the net asset restated to the revalued amount of the asset. When an item of property, plant and equipment is revalued, the entire class of property, plant and equipment to which the asset belongs is revalued simultaneously. When an asset's carrying amount is increased as a result of a revaluation, the increase is credited directly to owner's fund. However, a revaluation increase is recognised as an income to the extent that it reverses a revaluation decrease of the same asset previously recognised as an expense. When an asset's carrying amount is decreased as a result of a revaluation, the decrease is recognised as an expense in the combined statements of operations. However, a revaluation decrease is charged directly against owner's fund to the extent that the decrease does not exceed the amount previously credited to owner's fund in respect of the same asset. Revaluations are performed with sufficient regularity such that the carrying amount does not differ materially from that which would be determined using fair value at the balance sheet date. (iii) Gains or losses arising from the retirement or disposal of property, plant and equipment are determined as the difference between the net disposal proceeds and the carrying amount of the asset and are recognised as income or expense in the combined statements of operations on the date of retirement or disposal. (iv) Depreciation is calculated to write off the cost, or revalued amount, where appropriate, of property, plant and equipment on a straight line basis over their estimated useful lives, to residual values, using the following depreciation rates: DEPRECIATION RATES ------------------ Buildings 2.43% - 6.17% Owned and finance leased aircraft 4.75% - 9.70% Other flight equipment - Jet engines 4.75% - 9.70% - Others, including rotable spares 9.79% - 12.13% Machinery and equipment 9.70% - 11.40% Vehicles 16.17% -75- APPENDIX II ACCOUNTANTS' REPORT ON FINANCIAL INFORMATION OF THE AIRLINE OPERATIONS OF NORTHERN AIRLINES GROUP (V) NOTES TO THE FINANCIAL INFORMATION (CONTINUED) 3. PRINCIPAL ACCOUNTING POLICIES (Continued) (e) LEASED ASSETS Flight equipment under finance leases is stated at an amount equal to the lower of its fair value and the present value of minimum lease payments at inception of the lease, and is amortised on a straight line basis over the shorter of the lease term or estimated useful life of the asset to residual value. In cases where title to the asset will be acquired by the Airline Operations of Northern Airlines Group at the end of the lease, the asset is amortised on a straight line basis over the estimated useful life of the asset to its residual value. Amounts payable in respect of finance leases are apportioned between charges and reductions of obligations based on the interest rates implicit in the leases. Interest charges are included in the combined statements of operations to provide a constant periodic rate of charge over the lease term. Gains or losses on aircraft 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 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. Operating lease payments are charged to the combined statements of operations on a straight line basis over the terms of the related leases. (f) IMPAIRMENT OF ASSETS The carrying amounts of the assets, other than inventories (see Note (j)), trade and other receivables (see Note (k)) and deferred tax assets (see Note (n)), of the Airline Operations of Northern Airlines Group 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 net selling price and the value in use. In determining the value in use, expected future cash flows generated by the asset are discounted to their present value. The amount of the reduction is recognised as an expense in the combined statements of operations. The Airline Operations of Northern Airlines Group assesses at each balance sheet date whether there is any indication that an impairment loss recognised for an asset in prior years may no longer exist. An impairment loss is reversed if there has been a favourable change in the estimates used to determine the recoverable amount. A subsequent increase in the recoverable amount of an asset, when the circumstances and events that led to the write-down or write-off cease to exist, is recognised as income. The reversal is reduced by the amount that would have been recognised as depreciation had the write-down or write-off not occurred. (g) CONSTRUCTION IN PROGRESS Construction in progress is stated in the combined balance sheets at cost less impairment losses (see Note (f)). Cost comprises direct costs of construction as well as interest expense and exchange differences on related borrowed funds to the extent that they are regarded as an adjustment to interest charge during the periods of construction and installation. Capitalisation of these costs ceases and the construction in progress is transferred to property, plant and equipment when substantially all the activities necessary to prepare the asset for its intended use are completed. No depreciation is provided in respect of construction in progress until it is completed and ready for its intended use. (h) LEASE PREPAYMENTS Lease prepayments represent the purchase costs of land use rights and are amortised on a straight line basis over the period of land use rights. -76- APPENDIX II ACCOUNTANTS' REPORT ON FINANCIAL INFORMATION OF THE AIRLINE OPERATIONS OF NORTHERN AIRLINES GROUP (V) NOTES TO THE FINANCIAL INFORMATION (CONTINUED) 3. PRINCIPAL ACCOUNTING POLICIES (Continued) (i) INVESTMENTS Investments, which represent unquoted available-for-sale equity securities of companies established in the PRC, are stated at cost less impairment losses (see Note (f)). There is no quoted market price for such equity securities and accordingly a reasonable estimate of the fair value could not be made without incurring excessive costs. (j) INVENTORIES Inventories, which consist primarily of expendable spare parts and supplies, are stated at cost less any applicable provision for obsolescence, and are expensed when used in operations. Cost represents the average unit cost. Inventories held for disposal are stated at the lower of cost and net realisable value. Net realisable value represents estimated resale price. (k) TRADE AND OTHER RECEIVABLES Trade and other receivables are stated at cost less provision for doubtful accounts. Provision for doubtful accounts is established based on evaluation of the recoverability of these accounts at the balance sheet date. (l) CASH AND CASH EQUIVALENTS Cash and cash equivalents consist of cash in hand and balance with banks and other financial institutions with an original maturity within three months. Cash equivalents are stated at cost, which approximates fair value. (m) INTEREST-BEARING BORROWINGS Interest-bearing borrowings are recognised at cost. (n) INCOME TAXES Income tax comprises current and deferred tax. Current tax is calculated on the taxable income for the relevant period by applying the applicable tax rates. Deferred tax is provided using the balance sheet liability method, providing for all temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for taxation purposes. The amount of deferred tax provided is based on the expected manner of realisation or settlement of the carrying amount of assets and liabilities, using tax rates enacted or substantially enacted at the balance sheet date. A deferred tax asset is recognised only to the extent that it is probable that future taxable profits will be available against which the asset can be utilised. Deferred tax assets are reduced to the extent that it is no longer probable that the related tax benefit will be realised. (o) DEFERRED CREDIT Cash benefit received under finance lease arrangements is initially deferred and amortised over the terms of the respective leases to reduce the future finance lease charges. -77- APPENDIX II ACCOUNTANTS' REPORT ON FINANCIAL INFORMATION OF THE AIRLINE OPERATIONS OF NORTHERN AIRLINES GROUP (V) NOTES TO THE FINANCIAL INFORMATION (CONTINUED) 3. PRINCIPAL ACCOUNTING POLICIES (Continued) (p) PROVISIONS AND CONTINGENT LIABILITIES Provisions are recognised for liabilities of uncertain timing or amount when the Airline Operations of Northern Airlines 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. (q) REVENUE RECOGNITION (i) Passenger, cargo and mail transportation revenues are recognised when the transportation is provided. Ticket sales for transportation not yet provided are included in current liabilities. Revenues from airline-related business are recognised when services are rendered. Revenue is stated net of sales tax. In addition, revenue for each of the years in the three-year period ended 31 December, 2003 and the three-month period ended 31 March, 2004 was stated net of contributions to the Civil Aviation Administration of China ("CAAC") Infrastructure Development Fund. Effective from 1 April, 2004, contributions to the CAAC Infrastructure Development Fund form part of the flight operations expenses instead of being netted off with revenue. (ii) Interest income is recognised as it accrues unless collectability is in doubt. (iii) Operating lease income is recognised on a straight line basis over the terms of the respective leases. (r) TRAFFIC COMMISSIONS Traffic commissions are expensed when the transportation is provided and the related revenue is recognised. Traffic commissions for transportation not yet provided are recorded in the combined balance sheets as prepaid expense. (s) MAINTENANCE AND OVERHAUL COST Routine maintenance and repairs and overhauls in respect of owned aircraft and aircraft held under finance leases are expensed in the combined statements of operations as and when incurred. In respect of aircraft held under operating leases, a provision is made over the lease term for the estimated cost of overhauls required to be performed on the related aircraft prior to their return to the lessors. (t) TRANSLATION OF FOREIGN CURRENCIES The functional currency of the operations of the Airline Operations of Northern Airlines Group is Renminbi. Foreign currency transactions are translated into Renminbi at the applicable rates of exchange ruling at the transaction dates. Monetary assets and liabilities denominated in foreign currencies are translated into Renminbi at the exchange rates ruling at the balance sheet date. Exchange gains and losses, other than those capitalised as construction in progress (See Note (g)), are recognised in the combined statements of operations. -78- APPENDIX II ACCOUNTANTS' REPORT ON FINANCIAL INFORMATION OF THE AIRLINE OPERATIONS OF NORTHERN AIRLINES GROUP (v) NOTES TO THE FINANCIAL INFORMATION (CONTINUED) 3. PRINCIPAL ACCOUNTING POLICIES (Continued) (u) BORROWING COSTS Borrowing costs are expensed in the combined statements of operations in the period in which they are incurred, except to the extent that they are capitalised as being directly attributable to the acquisition or construction of an asset which necessarily takes a substantial period of time to get ready for its intended use (See Note (g)). (v) RETIREMENT BENEFITS Contributions to defined contribution retirement schemes made by the Airline Operations of Northern Airlines Group are charged to the combined statements of operations as and when incurred (see Note 25). (w) RELATED PARTIES For the purposes of the Financial Information set out below, parties are considered to be related to the Airline Operations of Northern Airlines Group if the Airline Operations of Northern Airlines Group has the ability, directly or indirectly, to control the party or exercise significant influence over the party in making financial and operating decisions, or vice versa, or where the Airline Operations of Northern Airlines Group and the party are subject to common control or common significant influence. Related parties may be individuals or other entities. (x) SEGMENT REPORTING A segment is a distinguishable component of the Airline Operations of Northern Airlines Group that is engaged either in providing products or services (business segment), or in providing products or services within a particular economic environment (geographical segment), which is subject to risks and rewards that are different from those of other segments. The Airline Operations of Northern Airlines Group operates principally as a single business segment for the provision of air transportation services. The analysis of operating revenue by geographical segment is based on the following criteria: (i) Traffic revenue from domestic services within the PRC (excluding Hong Kong) is attributed to the domestic operation. Traffic revenue from inbound/outbound services between the PRC and Hong Kong, and overseas destinations is attributed to the international operation. (ii) Other revenue from ticket selling, general aviation and ground services, air catering and other miscellaneous services are attributed on the basis of where the services are performed. (y) USE OF ESTIMATES The preparation of the Financial Information in accordance with IFRS requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities as at 31 December, 2001, 2002 and 2003 and 30 June, 2004 and the reported amounts of revenues and expenses during the relevant period. Actual results could differ from those estimates. -79- APPENDIX II ACCOUNTANTS' REPORT ON FINANCIAL INFORMATION OF THE AIRLINE OPERATIONS OF NORTHERN AIRLINES GROUP (V) NOTES TO THE FINANCIAL INFORMATION (CONTINUED) 4. OPERATING REVENUE Operating revenue comprises revenues from airline and airline related business and is stated net of sales tax. In addition, the operating revenue for each of the years in the three-year period ended 31 December, 2003 and the three-month period ended 31 March, 2004 was stated net of contributions to the CAAC Infrastructure Development Fund. An analysis of operating revenue is as follows: SIX-MONTH PERIODS YEARS ENDED 31 DECEMBER, ENDED 30 JUNE, ------------------------------- ---------------------- 2001 2002 2003 2003 2004 RMB'000 RMB'000 RMB'000 RMB'000 RMB'000 (unaudited) TRAFFIC REVENUE Passenger 4,773,253 4,764,754 5,446,013 1,962,218 3,186,835 Cargo and mail 331,972 391,820 410,957 166,723 204,613 --------- --------- --------- ---------- --------- 5,105,225 5,156,574 5,856,970 2,128,941 3,391,448 --------- --------- --------- ---------- --------- OTHER OPERATING REVENUE Commission income 25,758 24,379 9,415 7,684 1,811 Maintenance services income 5,041 22,259 29,487 7,542 5,071 Hotel operations income* 6,356 6,903 10,083 4,789 5,783 Ground services income 5,631 6,927 10,092 7,936 7,748 Aircraft lease income 40,884 7,286 - - 49,152 Income on transfer of surplus pilot trainees - 9,555 - - - Others 14,452 10,034 12,688 9,734 3,667 --------- --------- --------- ---------- --------- 98,122 87,343 71,765 37,685 73,232 --------- --------- --------- ---------- --------- 5,203,347 5,243,917 5,928,735 2,166,626 3,464,680 ========= ========= ========= ========== ========= * Hotel operations income arises from the operations associated with the Airline Operations of Northern Airlines Group. Pursuant to various sales tax rules and regulations, the Airline Operations of Northern Airlines Group is required to pay sales tax to national and local tax authorities at the following rates during the relevant period: TYPES OF REVENUE APPLICABLE SALES TAX RATES --------------- -------------------------------------------- Traffic revenue 3% of traffic revenue in respect of domestic flights and international outbound flights during the relevant period, except for the period from 1 May, 2003 to 31 December, 2003, during which passenger revenue was exempted from sales tax. Other operating revenue 3% of commission income, general aviation income and ground services income, and 3% to 5% of other operating revenue. -80- APPENDIX II ACCOUNTANTS' REPORT ON FINANCIAL INFORMATION OF THE AIRLINE OPERATIONS OF NORTHERN AIRLINES GROUP (V) NOTES TO THE FINANCIAL INFORMATION (CONTINUED) 4. OPERATING REVENUE (Continued) The amount of sales tax incurred during the relevant period is as follows: SIX-MONTH PERIODS YEAR ENDED 31 DECEMBER, ENDED 30 JUNE, ------------------------- -------------------- 2001 2002 2003 2003 2004 RMB'000 RMB'000 RMB'000 RMB'000 RMB'000 (unaudited) Sales tax netted off against operating revenue 190,885 181,528 72,544 56,755 108,086 ======= ======= ======= =========== ======= In addition, the Airline Operations of Northern Airlines Group is required to pay contributions to the CAAC Infrastructure Development Fund. Prior to 1 April, 2004, contributions to the CAAC Infrastructure Development Fund were payable at 5% and 2% respectively of the domestic and international traffic revenue of the Airline Operations of Northern Airlines Group, except for the period from 1 May, 2003 to 31 March, 2004 during which the Airline Operations of Northern Airlines Group was exempted from contributions to the CAAC Infrastructure Development Fund. Effective from 1 April, 2004, contributions to the CAAC Infrastructure Development Fund are payable based on the traffic capacity of the Airline Operations of Northern Airlines Group deployed on its routes. The contributions now form part of the flight operations expenses. Contributions made to the CAAC Infrastructure Development Fund during the relevant period are as follows: SIX-MONTH PERIODS YEAR ENDED 31 DECEMBER, ENDED 30 JUNE, ------------------------- ------------------- 2001 2002 2003 2003 2004 RMB'000 RMB'000 RMB'000 RMB'000 RMB'000 (unaudited) Contributions made to the CAAC Infrastructure Development Fund - netted off against traffic revenue 234,929 241,576 86,161 84,737 - - included in flight operations expenses - - - - 36,329 ------- ------- ------- ----------- ------ 234,929 241,576 86,161 84,737 36,329 ======= ======= ======= =========== ====== -81- APPENDIX II ACCOUNTANTS' REPORT ON FINANCIAL INFORMATION OF THE AIRLINE OPERATIONS OF NORTHERN AIRLINES GROUP (V) NOTES TO THE FINANCIAL INFORMATION (CONTINUED) 4. OPERATING REVENUE (Continued) An analysis of the operating revenue of the Airline Operations of Northern Airlines Group by geographical segment is set out as below: DOMESTIC *INTERNATIONAL TOTAL --------- -------------- --------- RMB'000 RMB'000 RMB'000 YEAR ENDED 31 DECEMBER, 2001 Traffic revenue 4,042,914 1,062,311 5,105,225 Other revenue 98,122 - 98,122 --------- -------------- --------- Total operating revenue 4,141,036 1,062,311 5,203,347 ========= ============== ========= YEAR ENDED 31 DECEMBER, 2002 Traffic revenue 4,175,833 980,741 5,156,574 Other revenue 87,343 - 87,343 --------- -------------- --------- Total operating revenue 4,263,176 980,741 5,243,917 ========= ============== ========= YEAR ENDED 31 DECEMBER, 2003 Traffic revenue 4,819,899 1,037,071 5,856,970 Other revenue 71,765 - 71,765 --------- -------------- --------- Total operating revenue 4,891,664 1,037,071 5,928,735 ========= ============== ========= SIX-MONTH PERIOD ENDED 30 JUNE, 2003 (UNAUDITED) Traffic revenue 1,728,202 400,739 2,128,941 Other revenue 37,685 - 37,685 --------- -------------- --------- Total operating revenue 1,765,887 400,739 2,166,626 ========= ============== ========= SIX-MONTH PERIOD ENDED 30 JUNE, 2004 Traffic revenue 2,791,181 600,267 3,391,448 Other revenue 73,232 - 73,232 --------- -------------- --------- Total operating revenue 2,864,413 600,267 3,464,680 ========= ============== ========= * Routes are mainly between the PRC and Hong Kong, Japan, Korea and other Asian countries. The major revenue-earning assets of the Airline Operations of Northern Airlines Group are its aircraft fleet, most of which are registered in the PRC. Since the aircraft of the Airline Operations of Northern Airlines Group are employed flexibly across its route network, there is no suitable basis of allocating such assets to geographic segments. Substantially all of the non-aircraft identifiable assets of the Airline Operations of Northern Airlines Group are located in the PRC. -82- APPENDIX II ACCOUNTANTS' REPORT ON FINANCIAL INFORMATION OF THE AIRLINE OPERATIONS OF NORTHERN AIRLINES GROUP (V) NOTES TO THE FINANCIAL INFORMATION (CONTINUED) 5. OPERATING EXPENSES An analysis of the operating expenses during the relevant period is set out below: SIX-MONTH PERIODS YEARS ENDED 31 DECEMBER, ENDED 30 JUNE, -------------------------------- --------------------- 2001 2002 2003 2003 2004 Note RMB'000 RMB'000 RMB'000 RMB'000 RMB'000 (unaudited) Jet fuel 1,284,917 1,235,717 1,314,282 579,259 815,900 Aircraft maintenance 682,020 921,163 972,324 472,731 373,135 Routes 1,142,689 1,201,567 1,215,101 547,775 690,186 Depreciation and amortisation - owned assets 355,011 362,335 358,016 176,307 231,422 - assets held under finance leases 321,992 298,174 284,805 142,084 172,411 Amortisation of deferred expenditure 1,432 1,531 2,685 632 586 Operating lease charges - aircraft and other flight equipment - - 18,587 - 41,635 - land and buildings 35,475 48,368 31,907 31,993 47,131 Staff costs - salaries, wages and welfare 368,382 449,825 530,600 250,682 305,524 - contributions to defined contribution retirement schemes 42,513 65,282 86,476 36,898 43,815 Office and administration 184,981 213,773 213,593 98,954 104,250 Impairment loss on aircraft and other flight equipment (i) 433,378 346,654 555,349 - - Lump sum housing subsidy to eligible employees (ii) 101,943 3,202 - - - Others 374,118 404,002 405,853 228,726 269,362 --------- --------- --------- ---------- --------- 5,328,851 5,551,593 5,989,578 2,566,041 3,095,357 ========= ========= ========= ========== ========= Note: (i) In light of the gradual opening of the aviation market in the PRC and the rapid change of the market price of aircraft during the relevant period, management reviewed the recoverable amount of its aircraft based on the estimated net cashflows. As a result, impairment losses of approximately RMB433 million and RMB347 million were recorded for the years ended 31 December, 2001 and 2002 respectively to write down the carrying amount of certain aircraft. The impairment losses were recognised in the combined statements of operations. In addition, in November 2003, the Airline Operations of Northern Airlines entered into agreements with an independent third party to dispose of its twenty-three McDonald Douglas 82 aircraft during the years 2003 to 2007 and then immediately lease back the aircraft under operating leases for a period of one to two years. Accordingly, the Airline Operations of Northern Airlines Group recorded an impairment loss for the year ended 31 December, 2003 of approximately RMB555 million, being the excess of the carrying amount of the aircraft over their recoverable amount as determined based on the agreed selling prices of the aircraft and estimated future cash flows from operating the aircraft prior to their disposals. The impairment loss was recognised in the combined statements of operations. -83- APPENDIX II ACCOUNTANTS' REPORT ON FINANCIAL INFORMATION OF THE AIRLINE OPERATIONS OF NORTHERN AIRLINES GROUP (V) NOTES TO THE FINANCIAL INFORMATION (CONTINUED) 5. OPERATING EXPENSES (Continued) (ii) Pursuant to the housing policy executed by the Airline Operations of Northern Airlines Group, the Airline Operations of Northern Airlines Group made payments totalling approximately RMB102 million and RMB3 million to eligible employees in 2001 and 2002 respectively for the purpose of subsidising the employees in purchasing their houses. Management considered that the lump sum payments were one-off in nature and the Airline Operations of Northern Airlines Group has no further obligation in relation to providing lump sum housing subsidies for its employees under PRC regulations. 6. INTEREST EXPENSE An analysis of the interest expense is set out below: SIX-MONTH PERIODS YEARS ENDED 31 DECEMBER, ENDED 30 JUNE, ------------------------------ ---------------------- 2001 2002 2003 2003 2004 RMB'000 RMB'000 RMB'000 RMB'000 RMB'000 (unaudited) Finance charges on obligations under finance leases 436,537 395,361 346,673 178,234 154,369 Interest on bank and other loans wholly repayable within five years 310,272 316,046 202,127 121,712 10,914 Interest on other loans 20,305 26,655 94,090 20,112 34,157 -------- -------- -------- ----------- -------- 767,114 738,062 642,890 320,058 199,440 Less: Borrowing costs capitalised (33,683) (28,484) (6,874) (3,462) - Amortisation of deferred credit (Note 22) (8,826) (8,826) (8,826) (4,413) (4,413) -------- -------- -------- ----------- -------- Net interest expense 724,605 700,752 627,190 312,183 195,027 ======== ======== ======== =========== ======== Borrowing costs have been capitalised at the following rates per annum during the relevant period: SIX-MONTH PERIODS YEARS ENDED 31 DECEMBER, ENDED 30 JUNE, ---------------------------- ---------------------- 2001 2002 2003 2003 2004 (unaudited) Capitalisation rates 6.5% 6.5% 5.9% 5.9% - ====== ====== ====== =========== ====== 7. GAIN/(LOSS) ON DISPOSAL OF PROPERTY, PLANT AND EQUIPMENT On 7 May, 2002, a McDonald Douglas 82 aircraft was crashed and had caused fatalities. Investigations with respect to the accident have been conducted by the CAAC and relevant PRC government departments. However, the results of the investigations have not yet been announced. The aircraft and passenger liabilities were fully insured. The Airline Operations of Northern Airlines Group recognised in the year ended 31 December, 2002 a gain of approximately RMB23 million, being the excess of insurance compensation received from the People's Insurance (Property) Company of China over the aggregate of the carrying amount of the aircraft and certain expenses incurred in connection with the accident. -84- APPENDIX II ACCOUNTANTS' REPORT ON FINANCIAL INFORMATION OF THE AIRLINE OPERATIONS OF NORTHERN AIRLINES GROUP (V) NOTES TO THE FINANCIAL INFORMATION (CONTINUED) 8. INCOME TAX Income tax in the combined statements of operations represents: SIX-MONTH PERIODS YEARS ENDED 31 DECEMBER, ENDED 30 JUNE, -------------------------- -------------------- 2001 2002 2003 2003 2004 RMB'000 RMB'000 RMB'000 RMB'000 RMB'000 (unaudited) PRC income tax 572 451 288 - 62,870 Deferred taxation (Note 23) - - (117,550) - 4,430 ------- ------- -------- ----------- ------- 572 451 (117,262) - 67,300 ======= ======= ======== =========== ======= Pursuant to the income tax rules and regulations of the PRC, the Airline Operations of Northern Airlines Group is liable to PRC income tax at a rate of 33%. In respect of the overseas airline activities, the Airline Operations of Northern Airlines Group has either obtained exemptions from overseas taxation pursuant to the bilateral aviation agreements between the overseas governments and the PRC government, or has sustained tax losses in these overseas jurisdictions. Accordingly, no provision for overseas tax has been made for the relevant period. A reconciliation of the expected tax expense with the actual tax expense is as follows: SIX-MONTH PERIODS YEARS ENDED 31 DECEMBER, ENDED 30 JUNE, ------------------------------- ----------------- 2001 2002 2003 2003 2004 Note RMB'000 RMB'000 RMB'000 RMB'000 RMB'000 (unaudited) (Loss)/profit before income tax and minority interests (539,574) (1,150,834) (1,368,729) (689,733) 201,681 ======== ========== ========== ======== ======= Expected PRC income tax (credit)/expense at 33% (178,059) (379,776) (451,681) (227,612) 66,555 Adjustments: - Non-deductible expenses (i) 79,105 87,000 7,232 2,421 745 - Deferred tax assets not recognised (ii) 226,617 194,027 327,187 225,191 - - Provision for doubtful accounts made on inter-company balances (iii) (101,704) (3,300) - - - - Differences in income and expense recognition for certain inter-company transactions (iv) (25,387) 102,500 - - - -------- ---------- ---------- -------- ------- 572 451 (117,262) - 67,300 ======== ========== ========== ======== ======= Note: (i) Non-deductible expenses mainly represent personnel and other miscellaneous expenses in excess of statutory deductible limits for taxation purpose and non-deductible one-off housing subsidies paid to eligible employees. -85- APPENDIX II ACCOUNTANTS' REPORT ON FINANCIAL INFORMATION OF THE AIRLINE OPERATIONS OF NORTHERN AIRLINES GROUP (V) NOTES TO THE FINANCIAL INFORMATION (CONTINUED) 8. INCOME TAX (Continued) (ii) Amounts mainly represent deferred tax assets in respect of taxable losses, provision for doubtful accounts, and repair charges capitalised which are not recognised. Based on projections for future taxable income, management did not forecast that sufficient taxable profits would arise to utilise these deferred tax assets. (iii) Amounts represent tax effects of provision for doubtful accounts made on inter-company balances, of which the corresponding deferred tax asset was not recognised as described in (ii) above. Such provision for doubtful accounts is eliminated on consolidation. (iv) Amounts represent tax effects of differences in the recognition of income and expenses in respect of certain inter-company transactions. Such differences in recognition of income and expenses are eliminated on consolidation. In accordance with relevant PRC tax regulations, a PRC lessee is liable to pay PRC withholding tax in respect of any lease payments regularly made to an overseas lessor. Depending on the circumstances, this tax is generally imposed at a fixed rate ranging from 10% to 20% of the lease payments, or in certain cases, the interest components of such payments. Pursuant to an approval document from the State Tax Bureau, lease arrangements executed prior to 1 September, 1999 are exempted from PRC withholding tax. During the relevant period, PRC withholding tax payable in respect of the leases executed on or after 1 September, 1999, which has been included as part of the operating lease charges, are as follows: SIX MONTH PERIODS YEARS ENDED 31 DECEMBER, ENDED 30 JUNE, ------------------------- ------------------- 2001 2002 2003 2003 2004 RMB'000 RMB'000 RMB'000 RMB'000 RMB'000 (unaudited) PRC withholding tax - - 214 - 2,295 ======= ======= ======= =========== ======= 9. DIRECTORS' EMOLUMENTS AND INDIVIDUALS WITH HIGHEST EMOLUMENTS (i) DIRECTORS' EMOLUMENTS No board of directors or similar corporate governance body was established by the Airline Operations of Northern Airlines during the relevant period. Accordingly, no directors' emoluments were paid during the relevant period. (ii) INDIVIDUALS WITH HIGHEST EMOLUMENTS Details of emoluments paid to the five highest paid individuals are as follows: SIX-MONTH PERIODS YEARS ENDED 31 DECEMBER, ENDED 30 JUNE, ------------------------- ------------------- 2001 2002 2003 2003 2004 RMB'000 RMB'000 RMB'000 RMB'000 RMB'000 (unaudited) Salaries, allowances and benefits in kind 569 582 1,234 268 340 Retirement benefits 143 146 311 156 81 ------- ------- ------- ----------- ------- 712 728 1,545 424 421 ======= ======= ======= =========== ======= -86- APPENDIX II ACCOUNTANTS' REPORT ON FINANCIAL INFORMATION OF THE AIRLINE OPERATIONS OF NORTHERN AIRLINES GROUP (V) NOTES TO THE FINANCIAL INFORMATION (CONTINUED) 9. DIRECTORS' EMOLUMENTS AND INDIVIDUALS WITH HIGHEST EMOLUMENTS (Continued) (ii) INDIVIDUALS WITH HIGHEST EMOLUMENTS (Continued) An analysis of emoluments paid to the five highest paid individuals by number of individuals and emolument ranges is as follows: SIX-MONTH PERIODS YEARS ENDED 31 DECEMBER, ENDED 30 JUNE, ------------------------ ----------------- 2001 2002 2003 2003 2004 (unaudited) RMB Nil - RMB1,060,000 (HK$1,000,000 equivalent) 5 5 5 5 5 ======== ======== ======== =========== ======== None of these employees received any inducements or compensation for loss of office, or waived any emoluments during the relevant period. 10. PROPERTY, PLANT AND EQUIPMENT, NET OTHER AIRCRAFT FLIGHT --------------------- EQUIPMENT, MACHINERY, HELD UNDER INCLUDING EQUIPMENT FINANCE ROTABLE AND BUILDINGS OWNED LEASES SPARES VEHICLES TOTAL RMB'000 RMB'000 RMB'000 RMB'000 RMB'000 RMB'000 COST: At 1 January, 2001 931,775 2,606,648 8,238,950 1,580,127 727,929 14,085,429 Reclassification on exercise of purchase options - 414,712 (414,712) - - - Additions 7,311 - 744,089 164,153 71,795 987,348 Transferred from construction in progress 107,590 - 17,511 - 5,364 130,465 Disposals (50,884) - - (150,376) (13,356) (214,616) --------- --------- ---------- ---------- ----------- ---------- At 31 December, 2001 995,792 3,021,360 8,585,838 1,593,904 791,732 14,988,626 --------- --------- ---------- ---------- ----------- ---------- ACCUMULATED DEPRECIATION AND IMPAIRMENT LOSSES: At 1 January, 2001 98,237 956,558 2,896,764 742,195 406,637 5,100,391 Reclassification on exercise of purchase options - 232,187 (232,187) - - - Depreciation for the year 25,598 114,287 321,992 142,325 72,801 677,003 Impairment loss for the year - - 433,378 - - 433,378 Written back on disposal (4,551) - - (51,263) (10,213) (66,027) --------- --------- ---------- ---------- ----------- ---------- At 31 December, 2001 119,284 1,303,032 3,419,947 833,257 469,225 6,144,745 --------- --------- ---------- ---------- ----------- ---------- NET BOOK VALUE: At 31 December, 2001 876,508 1,718,328 5,165,891 760,647 322,507 8,843,881 ========= ========= ========== ========== =========== ========== -87- APPENDIX II ACCOUNTANTS' REPORT ON FINANCIAL INFORMATION OF THE AIRLINE OPERATIONS OF NORTHERN AIRLINES GROUP (V) NOTES TO THE FINANCIAL INFORMATION (CONTINUED) 10. PROPERTY, PLANT AND EQUIPMENT, NET (Continued) OTHER AIRCRAFT FLIGHT ----------------------- EQUIPMENT, MACHINERY, HELD UNDER INCLUDING EQUIPMENT FINANCE ROTABLE AND BUILDINGS OWNED LEASES SPARES VEHICLES TOTAL RMB'000 RMB'000 RMB'000 RMB'000 RMB'000 RMB'000 COST: At 1 January, 2002 995,792 3,021,360 8,585,838 1,593,904 791,732 14,988,626 Reclassification on exercise of purchase options - 134,394 (134,394) - - - Additions 9,932 1,805 783,098 131,758 69,778 996,371 Transferred from construction in progress 106,948 - 23,930 - 3,261 134,139 Disposals (132,730) (26,628) (130,233) (14,811) (32,795) (337,197) --------- ---------- ---------- ---------- ----------- ---------- At 31 December, 2002 979,942 3,130,931 9,128,239 1,710,851 831,976 15,781,939 --------- ---------- ---------- ---------- ----------- ---------- ACCUMULATED DEPRECIATION AND IMPAIRMENT LOSSES: At 1 January, 2002 119,284 1,303,032 3,419,947 833,257 469,225 6,144,745 Reclassification on exercise of purchase options - 63,837 (63,837) - - - Depreciation for the year 28,106 131,487 298,174 141,686 61,056 660,509 Impairment loss for the year - 76,075 270,579 - - 346,654 Written back on disposal (13,203) (26,002) (69,078) (13,944) (14,468) (136,695) --------- ---------- ---------- ---------- ----------- ---------- At 31 December, 2002 134,187 1,548,429 3,855,785 960,999 515,813 7,015,213 --------- ---------- ---------- ---------- ----------- ---------- NET BOOK VALUE: At 31 December, 2002 845,755 1,582,502 5,272,454 749,852 316,163 8,766,726 ========= ========== ========== ========== =========== ========== -88- APPENDIX II ACCOUNTANTS' REPORT ON FINANCIAL INFORMATION OF THE AIRLINE OPERATIONS OF NORTHERN AIRLINES GROUP (V) NOTES TO THE FINANCIAL INFORMATION (CONTINUED) 10. PROPERTY, PLANT AND EQUIPMENT, NET (Continued) OTHER AIRCRAFT FLIGHT ----------------------- EQUIPMENT, MACHINERY, HELD UNDER INCLUDING EQUIPMENT FINANCE ROTABLE AND BUILDINGS OWNED LEASES SPARES VEHICLES TOTAL RMB'000 RMB'000 RMB'000 RMB'000 RMB'000 RMB'000 COST OR VALUATION: At 1 January, 2003 979,942 3,130,931 9,128,239 1,710,851 831,976 15,781,939 Transferred to owner upon the Reorganisation (595,923) (188,265) - (45,212) (148,678) (978,078) Reclassification on exercise of purchase options - 316,734 (316,734) - - - Additions 19,777 842,368 - 378,451 31,492 1,272,088 Transferred from construction in progress 21,454 27,289 - - 3,570 52,313 Disposals (9,930) (407,619) - - (66,702) (484,251) Revaluation (59,821) (1,720,993) (3,902,701) (768,623) (347,332) (6,799,470) ---------- ---------- ---------- ---------- ---------- ----------- At 31 December, 2003 355,499 2,000,445 4,908,804 1,275,467 304,326 8,844,541 ---------- ---------- ---------- ---------- ---------- ----------- REPRESENTING: Valuation - 2003 355,499 2,000,445 4,908,804 1,275,467 304,326 8,844,541 ---------- ---------- ---------- ---------- ---------- ----------- ACCUMULATED DEPRECIATION AND IMPAIRMENT LOSSES: At 1 January, 2003 134,187 1,548,429 3,855,785 960,999 515,813 7,015,213 Transferred to owner upon the Reorganisation (75,631) (138,686) - (38,964) (129,221) (382,502) Reclassification on exercise of purchase options - 242,435 (242,435) - - - Depreciation for the year 23,170 143,777 284,805 128,743 62,326 642,821 Impairment loss for the year - 417,598 137,751 - - 555,349 Written back on disposal (7,313) (312,825) - - (27,974) (348,112) Elimination on revaluation (74,413) (1,900,728) (4,035,906) (1,050,778) (420,944) (7,482,769) ---------- ---------- ---------- ---------- ---------- ----------- At 31 December, 2003 - - - - - - ---------- ---------- ---------- ---------- ---------- ----------- NET BOOK VALUE: At 31 December, 2003 355,499 2,000,445 4,908,804 1,275,467 304,326 8,844,541 ========== ========== ========== ========== ========== =========== -89- APPENDIX II ACCOUNTANTS' REPORT ON FINANCIAL INFORMATION OF THE AIRLINE OPERATIONS OF NORTHERN AIRLINES GROUP (V) NOTES TO THE FINANCIAL INFORMATION (CONTINUED) 10. PROPERTY, PLANT AND EQUIPMENT, NET (Continued) OTHER AIRCRAFT FLIGHT ----------------------- EQUIPMENT, MACHINERY, HELD UNDER INCLUDING EQUIPMENT FINANCE ROTABLE AND BUILDINGS OWNED LEASES SPARES VEHICLES TOTAL RMB'000 RMB'000 RMB'000 RMB'000 RMB'000 RMB'000 COST OR VALUATION: At 1 January, 2004 355,499 2,000,445 4,908,804 1,275,467 304,326 8,844,541 Reclassification on exercise of purchase options - 29,299 (29,299) - - - Additions 4,678 824,946 - 68,570 19,304 917,498 Transferred from construction in progress - 32,084 - - 9,295 41,379 Disposals - (265,840) - - (1,799) (267,639) ---------- ---------- ---------- ---------- ---------- ---------- At 30 June, 2004 360,177 2,620,934 4,879,505 1,344,037 331,126 9,535,779 ---------- ---------- ---------- ---------- ---------- ---------- REPRESENTING: Cost 4,678 857,030 - 68,570 28,599 958,877 Valuation - 2003 355,499 1,763,904 4,879,505 1,275,467 302,527 8,576,902 ---------- ---------- ---------- ---------- ---------- ---------- 360,177 2,620,934 4,879,505 1,344,037 331,126 9,535,779 ---------- ---------- ---------- ---------- ---------- ---------- ACCUMULATED DEPRECIATION AND IMPAIRMENT LOSSES: At 1 January, 2004 - - - - - - Reclassification on exercise of purchase options - 3,834 (3,834) - - - Depreciation for the period 8,155 97,982 172,411 82,383 42,902 403,833 Written back on disposal - (7,737) - - (1,584) (9,321) ---------- ---------- ---------- ---------- ---------- ---------- At 30 June, 2004 8,155 94,079 168,577 82,383 41,318 394,512 ---------- ---------- ---------- ---------- ---------- ---------- NET BOOK VALUE: At 30 June, 2004 352,022 2,526,855 4,710,928 1,261,654 289,808 9,141,267 ========== ========== ========== ========== ========== ========== All of the buildings of the Airline Operations of Northern Airlines Group are located in the PRC. As required by the relevant PRC rules and regulations with respect to the Acquisition, the property, plant and equipment of the Airline Operations of Northern Airlines Group as at 31 December, 2003 were revalued for each asset class by China Enterprise Appraisal Co., Ltd. (the "PRC Valuers"), independent valuers registered in the PRC, on a depreciated replacement cost basis. The value of property, plant and equipment of the Airline Operations of Northern Airlines Group as at 31 December, 2003 has been determined at approximately RMB8,845 million. Such amount will serve as the tax base for such assets for future years (see Note 23). Surplus arising from revaluation of certain property, plant and equipment totalling approximately RMB1,176 million has been credited to the owner's fund while deficit arising from the revaluation of certain property, plant and equipment totalling approximately RMB492 million has been charged as an expense for the year ended 31 December, 2003. The net surplus on the revaluation of the property, plant and equipment of approximately RMB684 million has been incorporated in the combined balance sheet of the Airline Operations of Northern Airlines Group as at 31 December, 2003. -90- APPENDIX II ACCOUNTANTS' REPORT ON FINANCIAL INFORMATION OF THE AIRLINE OPERATIONS OF NORTHERN AIRLINES GROUP (V) NOTES TO THE FINANCIAL INFORMATION (CONTINUED) 10. PROPERTY, PLANT AND EQUIPMENT, NET (Continued) The properties of the Airline Operations of Northern Airlines Group were also valued separately by Chesterton, independent qualified valuers in Hong Kong, as at 31 December, 2003. The value arrived at by Chesterton was approximately the same as that arrived at by the PRC valuers. The historical carrying amounts of the property, plant and equipment of the Airline Operations of Northern Airlines Group as at 31 December, 2003 and the revalued amounts of these assets were as follows: HISTORICAL CARRYING REVALUATION REVALUATION REVALUED AMOUNT SURPLUS DEFICIT AMOUNT ----------- ----------- ----------- ----------- RMB'000 RMB'000 RMB'000 RMB'000 Buildings 340,907 47,689 33,097 355,499 Aircraft - owned 1,820,710 247,993 68,258 2,000,445 - held under finance leases 4,775,599 211,730 78,525 4,908,804 Other flight equipment, including rotable spares 993,312 557,299 275,144 1,275,467 Machinery, equipment and vehicles 230,714 110,957 37,345 304,326 ----------- ----------- ----------- ----------- 8,161,242 1,175,668 492,369 8,844,541 =========== =========== =========== =========== The effect of the above revaluation is to increase annual depreciation charges by approximately RMB154 million for year beginning 1 January, 2004. Had the property, plant and equipment been stated at cost less accumulated depreciation and impairment losses, the net book value of the property, plant and equipment of the Airline Operations of Northern Airlines Group as at 30 June, 2004 would have been approximately RMB8,622 million, made up as follows: 30 JUNE, 2004 ---------- RMB'000 Buildings 338,774 Aircraft - owned 2,453,130 - held under finance leases 4,600,945 Other flight equipment, including rotable spares 995,468 Machinery, equipment and vehicles 233,469 ---------- 8,621,786 ========== As at 31 December, 2001, 2002 and 2003 and 30 June, 2004, certain aircraft of the Airline Operations of Northern Airlines Group with an aggregate carrying value of approximately RMB6,044 million, RMB6,396 million, RMB6,475 million and RMB6,941 million respectively, were mortgaged under certain loan and lease agreements (See Notes 18 and 19). -91- APPENDIX II ACCOUNTANTS' REPORT ON FINANCIAL INFORMATION OF THE AIRLINE OPERATIONS OF NORTHERN AIRLINES GROUP (V) NOTES TO THE FINANCIAL INFORMATION (CONTINUED 10. PROPERTY, PLANT AND EQUIPMENT, NET (Continued) During the relevant period, the Airline Operations of Northern Airlines Group entered into certain lease agreements to lease several of its aircraft to other airlines. The terms of such leases generally range from one month to five years. As at 31 December, 2001, 2002 and 2003 and 30 June, 2004, the cost or valuation and accumulated depreciation and impairment losses of the relevant aircraft were set out below: 31 DECEMBER, 30 JUNE, --------------------------------- -------- 2001 2002 2003 2004 RMB'000 RMB'000 RMB'000 RMB'000 Cost or valuation - - - 148,869 Accumulated depreciation and impairment losses - - - (21,156) ---- ---- ---- ------- - - - 127,713 ==== ==== ==== ======= Total future minimum lease payments under non-cancellable operating leases of the Airline Operations of Northern Airlines Group are receivable as follows: 31 DECEMBER, 30 JUNE, -------------------------------- -------- 2001 2002 2003 2004 RMB'000 RMB'000 RMB'000 RMB'000 Within one year - - - 51,395 After one year but within five years - - - 88,405 ---- ---- ---- ------- - - - 139,800 ==== ==== ==== ======= 11. CONSTRUCTION IN PROGRESS SIX-MONTH PERIOD ENDED YEARS ENDED 31 DECEMBER, 30 JUNE, ----------------------------------- ------------ 2001 2002 2003 2004 RMB'000 RMB'000 RMB'000 RMB'000 Balance at 1 January, 217,610 210,191 258,505 54,446 Additions 123,046 182,453 146,452 25,863 Transferred to property, plant and equipment (130,465) (134,139) (52,313) (41,379) Transferred to owner upon the Reorganisation - - (298,198) - -------- -------- -------- ------- Balance at 31 December/30 June, 210,191 258,505 54,446 38,930 ======== ======== ======== ======= - 92 - APPENDIX II ACCOUNTANTS' REPORT ON FINANCIAL INFORMATION OF THE AIRLINE OPERATIONS OF NORTHERN AIRLINES GROUP (V) NOTES TO THE FINANCIAL INFORMATION (CONTINUED) 12. OTHER INVESTMENTS 31 DECEMBER, 30 JUNE, -------------------------------- -------- 2001 2002 2003 2004 RMB'000 RMB'000 RMB'000 RMB'000 Unlisted equity investment, at cost - 68,209 68,209 68,209 === ====== ====== ====== Unlisted equity investment of the Airline Operations of Northern Airlines Group represents an interest in a PRC enterprise which is mainly engaged in the provision of general aviation services. 13. DEFERRED EXPENDITURE 31 DECEMBER, 30 JUNE, -------------------------------- -------- 2001 2002 2003 2004 RMB'000 RMB'000 RMB'000 RMB'000 Losses deferred in connection with aircraft sale and leaseback arrangements (Note) - - 14,641 134,677 Others 10,497 10,725 9,869 9,780 ------ ------ ------ ------- 10,497 10,725 24,510 144,457 Less: Accumulated amortisation (2,168) (3,459) (6,509) (22,364) ------ ------ ------ ------- 8,329 7,266 18,001 122,093 ====== ====== ====== ======= Note: Pursuant to certain sale and leaseback arrangements, the Airline Operations of Northern Airlines Group disposed of its four McDonald Douglas 82 aircraft and seven McDonald Douglas 82 aircraft during the year ended 31 December, 2003 and the six-month period ended 30 June, 2004 respectively to independent third parties and then entered into operating leases with such parties to lease back the aircraft for a period of one to two years. The excess of the aircraft's fair value over the sales proceeds on the date of disposal were initially deferred and amortised over the period the aircraft were expected to be used to increase the future operating lease charges. 14. INVENTORIES 31 DECEMBER, 30 JUNE, ------------------------------- -------- 2001 2002 2003 2004 RMB'000 RMB'000 RMB'000 RMB'000 Expendable spare parts and maintenance materials 588,136 661,456 517,350 534,870 Other supplies 44,224 41,665 23,689 18,046 ------- ------- ------- ------- 632,360 703,121 541,039 552,916 Less: Provision for obsolescence (6,656) (9,161) (6,071) (8,823) ------- ------- ------- ------- 625,704 693,960 534,968 544,093 ======= ======= ======= ======= No significant amount of inventories was carried at net realisable value as at 31 December, 2001, 2002 and 2003 and 30 June, 2004. - 93 - APPENDIX II ACCOUNTANTS' REPORT ON FINANCIAL INFORMATION OF THE AIRLINE OPERATIONS OF NORTHERN AIRLINES GROUP (V) NOTES TO THE FINANCIAL INFORMATION (CONTINUED) 15. TRADE RECEIVABLES Credit terms granted by the Airline Operations of Northern Airlines Group to sales agents and other customers generally range from one to three months. An aging analysis of trade receivables, net of provision for doubtful accounts, is set out below: 31 DECEMBER, 30 JUNE, --------------------------- -------- 2001 2002 2003 2004 RMB'000 RMB'000 RMB'000 RMB'000 Within 1 month 147,399 183,834 219,014 359,003 More than 1 month but less than 3 months 14,257 37,623 18,938 38,375 More than 3 months but less than 12 months 3,618 19,217 4,591 780 ------- ------- ------- ------- 165,274 240,674 242,543 398,158 ======= ======= ======= ======= As at 31 December, 2003 and 30 June, 2004, the Airline Operations of Northern Airlines Group had amount due from a fellow subsidiary of approximately RMB186 million and RMB345 million respectively which was included in trade receivables. 16. OTHER RECEIVABLES AND PREPAID EXPENSES Other receivables and prepaid expenses comprise: 31 DECEMBER, 30 JUNE, ------------------------------- -------- 2001 2002 2003 2004 RMB'000 RMB'000 RMB'000 RMB'000 Prepaid expenses and deposits 25,152 23,502 19,581 36,486 Amount due from CSAHC - - 15,284 426,374 Amounts due from related companies 29,463 2,177 4,408 5,435 Loans receivable 88,928 60,269 - - Manufacturers' credit receivables 77,535 105,215 60,257 78,238 Amount due from insurance company 4,490 38,248 26,111 25,905 Property, plant and equipment and spare part sale receivable 148,503 - - - Other receivables 77,103 68,150 41,977 28,337 ------- ------- ------- ------- 451,174 297,561 167,618 600,775 Less: Provision for doubtful accounts (91,587) (90,507) (25,984) (34,665) ------- ------- ------- ------- 359,587 207,054 141,634 566,110 ======= ======= ======= ======= - 94 - APPENDIX II ACCOUNTANTS' REPORT ON FINANCIAL INFORMATION OF THE AIRLINE OPERATIONS OF NORTHERN AIRLINES GROUP (V) NOTES TO THE FINANCIAL INFORMATION (CONTINUED) 17. CASH AND CASH EQUIVALENTS 31 DECEMBER, 30 JUNE, ----------------------------- -------- 2001 2002 2003 2004 RMB'000 RMB'000 RMB'000 RMB'000 Cash at bank and in hand 1,049,413 589,740 542,046 234,733 Time deposits with maturity within three months 259,489 165,478 - - --------- ------- ------- ------- 1,308,902 755,218 542,046 234,733 ========= ======= ======= ======= 18. BANK AND OTHER LOANS The bank and other loans of the Airline Operations of Northern Airlines Group under current liabilities comprise: 31 DECEMBER, 30 JUNE, ------------------------------- -------- 2001 2002 2003 2004 RMB'000 RMB'000 RMB'000 RMB'000 Short term bank loans 1,377,200 1,226,373 194,502 120,011 Short term loans from CSAHC - 1,750,000 - 309,490 Current portion of long term bank loans 1,111,675 1,195,412 375,045 337,756 --------- --------- ------- ------- 2,488,875 4,171,785 569,547 767,257 ========= ========= ======= ======= The weighted average interest rate on short term bank loans of the Airline Operations of Northern Airlines Group was 6.1%, 5.1%, 1.7% and 3.1% as at 31 December, 2001, 2002 and 2003 and 30 June, 2004 respectively. The short term loans from CSAHC, which bear interest rates ranging from 1.9% to 6.0% per annum, were unsecured. In addition, in 2003, CSAHC made short term advances amounting to approximately RMB500 million to the Airline Operations of Northern Airlines Group. These advances are unsecured, interest free and repayable on demand. These advances were fully repaid during 2003. - 95 - APPENDIX II ACCOUNTANTS' REPORT ON FINANCIAL INFORMATION OF THE AIRLINE OPERATIONS OF NORTHERN AIRLINES GROUP (V) NOTES TO THE FINANCIAL INFORMATION (CONTINUED) 18. BANK AND OTHER LOANS (Continued) The long term bank loans of the Airline Operations of Northern Airlines Group comprise: 31 DECEMBER, 30 JUNE, INTEREST RATES AND -------------------------------- -------- BANK LOANS FINAL MATURITY 2001 2002 2003 2004 RMB'000 RMB'000 RMB'000 RMB'000 Renminbi denominated Floating interest rates as specified by the People's Bank of China ranging from 5.76% to 7.15% per annum as at 30 June, 2004, with maturities through 2014 3,223,228 1,890,657 643,058 381,335 Fixed interest rates ranging from 5.94% to 6.53% per annum, with maturities through 2003 128,400 109,800 - - US dollars denominated Floating interest rate of 6 months LIBOR+0.3% per annum, being 1.72% per annum as at 30 June, 2004, with maturities through 2013 - - 1,613,986 1,531,172 Fixed interest rates ranging from 6.13% to 8.18% per annum, with maturities through 2009 602,810 488,138 270,068 236,620 --------- --------- --------- --------- 3,954,438 2,488,595 2,527,112 2,149,127 Less: loans due within one year classified as current liabilities 1,111,675 1,195,412 375,045 337,756 --------- --------- --------- --------- 2,842,763 1,293,183 2,152,067 1,811,371 ========= ========= ========= ========= The aggregate maturities of the bank and other loans of the Airline Operations of Northern Airlines Group are analysed as follows: 31 DECEMBER, 30 JUNE, ------------------------------------- -------- 2001 2002 2003 2004 RMB'000 RMB'000 RMB'000 RMB'000 BANK AND OTHER LOANS DUE: Within one year 2,488,875 4,171,785 569,547 767,257 In the second year 1,597,315 449,515 420,045 261,209 In the third to fifth year, inclusive 1,161,894 616,064 777,993 709,652 After the fifth year 83,554 227,604 954,029 840,510 ---------- ---------- --------- --------- 5,331,638 5,464,968 2,721,614 2,578,628 Portion classified as current liabilities (2,488,875) (4,171,785) (569,547) (767,257) ---------- ---------- --------- --------- 2,842,763 1,293,183 2,152,067 1,811,371 ========== ========== ========= ========= - 96 - APPENDIX II ACCOUNTANTS' REPORT ON FINANCIAL INFORMATION OF THE AIRLINE OPERATIONS OF NORTHERN AIRLINES GROUP (V) NOTES TO THE FINANCIAL INFORMATION (CONTINUED) 18. BANK AND OTHER LOANS (Continued) As at 31 December, 2001, 2002 and 2003 and 30 June, 2004, bank loans of the Airline Operations of Northern Airlines Group totalling approximately RMB1,074 million, RMB1,259 million, RMB2,527 million and RMB2,149 million respectively were secured by mortgages over certain aircraft (See Note 10). In connection with the Reorganisation, bank loans totalling approximately RMB5,083 million as at 31 December, 2003 were assumed by the owner of Northern Airlines. As at 31 December, 2001, 2002 and 2003 and 30 June, 2004, certain bank loans of the Airline Operations of Northern Airlines Group were guaranteed by the following parties: 31 DECEMBER, 30 JUNE, --------------------------------- --------- 2001 2002 2003 2004 RMB'000 RMB'000 RMB'000 RMB'000 CAAC 550,350 399,800 - - CSAHC 575,000 695,000 1,808,488 1,651,183 China Aviation Supplies Import and Export Corporation 2,090,000 972,773 - - Bank of China 341,907 262,251 81,496 67,606 The Industrial and Commercial Bank of China 260,903 225,887 188,572 169,014 --------- --------- --------- --------- 3,818,160 2,555,711 2,078,556 1,887,803 ========= ========= ========= ========= 19. OBLIGATIONS UNDER FINANCE LEASES The Airline Operations of Northern Airlines Group has commitments under finance lease agreements in respect of aircraft and related equipment expiring through 2012, which are repayable as follows: 31 DECEMBER, 2001 31 DECEMBER, 2002 -------------------------------------- ------------------------------------ PAYMENTS INTEREST OBLIGATIONS PAYMENTS INTEREST OBLIGATIONS RMB'000 RMB'000 RMB'000 RMB'000 RMB'000 RMB'000 BALANCE DUE: Within one year 1,369,844 393,251 976,593 1,354,214 330,554 1,023,660 In the second year 1,286,131 321,344 964,787 1,335,380 274,436 1,060,944 In the third to fifth year, inclusive 4,084,664 663,123 3,421,541 4,400,721 551,095 3,849,626 After the fifth year 2,370,131 281,257 2,088,874 1,958,013 167,818 1,790,195 ---------- ---------- ----------- ---------- ---------- ----------- 9,110,770 1,658,975 7,451,795 9,048,328 1,323,903 7,724,425 ========== ========== ========== ========== Less: Balance due within one year classified as current liabilities (976,593) (1,023,660) ----------- ----------- 6,475,202 6,700,765 =========== =========== -97- APPENDIX II ACCOUNTANTS' REPORT ON FINANCIAL INFORMATION OF THE AIRLINE OPERATIONS OF NORTHERN AIRLINES GROUP (V) NOTES TO THE FINANCIAL INFORMATION (CONTINUED) 19. OBLIGATIONS UNDER FINANCE LEASES (Continued) 31 DECEMBER, 2003 30 JUNE, 2004 ----------------------------------------- --------------------------------------- PAYMENTS INTEREST OBLIGATIONS PAYMENTS INTEREST OBLIGATIONS RMB'000 RMB'000 RMB'000 RMB'000 RMB'000 RMB'000 BALANCE DUE: Within one year 1,335,091 264,922 1,070,169 1,300,241 237,194 1,063,047 In the second year 1,210,381 210,740 999,641 1,213,393 180,150 1,033,243 In the third to fifth year, inclusive 4,266,482 390,900 3,875,582 3,858,697 304,988 3,553,709 After the fifth year 1,078,942 56,923 1,022,019 854,606 39,415 815,191 ----------- ----------- ----------- ----------- ----------- ----------- 7,890,896 923,485 6,967,411 7,226,937 761,747 6,465,190 =========== =========== =========== =========== Less: Balance due within one year classified as current liabilities (1,070,169) (1,063,047) ----------- ----------- 5,897,242 5,402,143 =========== =========== The obligations under finance leases by currency are analysed as follows: 31 DECEMBER, 30 JUNE, ------------------------------------ ---------- 2001 2002 2003 2004 RMB'000 RMB'000 RMB'000 RMB'000 US dollars denominated 5,748,520 5,862,948 4,841,087 4,346,698 Japanese yen denominated 1,703,275 1,861,477 2,126,324 2,118,492 ---------- ---------- ---------- ---------- 7,451,795 7,724,425 6,967,411 6,465,190 ========== ========== ========== ========== Under the terms of the leases, the Airline Operations of Northern Airlines Group has an option to purchase, at or near the end of the lease term, certain aircraft at fair market value and others at either fair market value or a percentage of the respective lessor's defined cost of the aircraft. As at 31 December, 2001, 2002 and 2003 and 30 June, 2004, certain aircraft with carrying amount of approximately RMB5,166 million, RMB5,272 million, RMB4,909 million and RMB4,711 million respectively were mortgaged to secure facilities with financial institutions granted to lessors with outstanding obligations totalling approximately RMB7,452 million, RMB7,724 million, RMB6,967 million and RMB6,465 million respectively. In addition, the relevant insurance policies in respect of the aircraft held under finance leases are assigned to the lessors. -98- APPENDIX II ACCOUNTANTS' REPORT ON FINANCIAL INFORMATION OF THE AIRLINE OPERATIONS OF NORTHERN AIRLINES GROUP (V) NOTES TO THE FINANCIAL INFORMATION (CONTINUED) 20. OTHER LIABILITIES AND ACCRUED EXPENSES Other liabilities and accrued expenses represent: 31 DECEMBER, 30 JUNE, ------------------------------------ ---------- 2001 2002 2003 2004 RMB'000 RMB'000 RMB'000 RMB'000 Accrued expenses 841,095 1,058,025 885,134 1,146,534 CAAC Infrastructure Development Fund payable 512,137 288,722 54,994 38,745 Business and other taxes payable 33,053 26,518 3,457 21,347 Salary and staff welfare payable 26,178 36,535 26,424 31,187 Property, plant and equipment purchase payable 183,382 8,670 8,710 - Other liabilities 244,685 260,564 156,573 165,550 ---------- ---------- ---------- ---------- 1,840,530 1,679,034 1,135,292 1,403,363 ========== ========== ========== ========== 21. ACCOUNTS PAYABLE An ageing analysis of accounts payable is as follows: 31 DECEMBER, 30 JUNE, --------------------------- -------- 2001 2002 2003 2004 RMB'000 RMB'000 RMB'000 RMB'000 Due within 1 month or on demand 56,838 45,924 27,169 31,117 Due after 1 month but within 3 months 85,257 68,887 40,753 46,675 Due after 3 months but within 6 months 113,676 91,848 54,337 62,234 ------- ------- ------- -------- 255,771 206,659 122,259 140,026 ======= ======= ======= ======== 22. DEFERRED CREDIT Deferred credit comprises: SIX-MONTH PERIODS YEARS ENDED 31 DECEMBER, ENDED 30 JUNE, ----------------------------- ------------------ 2001 2002 2003 2003 2004 RMB'000 RMB'000 RMB'000 RMB'000 RMB'000 (unaudited) Balance at 1 January, 56,641 47,815 38,989 38,989 30,163 Amortisation for the year/period (Note 6) (8,826) (8,826) (8,826) (4,413) (4,413) ------- ------- ------- ------- ------- Balance at 31 December/30 June, 47,815 38,989 30,163 34,576 25,750 ======= ======= ======= ======= ======= The Airline Operations of Northern Airlines Group entered into several aircraft finance lease arrangements with certain independent third parties, under which the Airline Operations of Northern Airlines Group received cash benefits of approximately Rmb88 million upon the inception of the respective leases. The benefits are initially deferred and amortised over the terms of the respective leases to reduce the future finance lease charges. -99- APPENDIX II ACCOUNTANTS' REPORT ON FINANCIAL INFORMATION OF THE AIRLINE OPERATIONS OF NORTHERN AIRLINES GROUP (V) NOTES TO THE FINANCIAL INFORMATION (CONTINUED) 23. DEFERRED TAXATION Movements in deferred tax assets are as follows: SIX-MONTH PERIODS YEARS ENDED 31 DECEMBER, ENDED 30 JUNE, ------------------------------ --------------------- 2001 2002 2003 2003 2004 RMB'000 RMB'000 RMB'000 RMB'000 RMB'000 (unaudited) Balance at 1 January, - - - - 24,743 Transferred from/(to) combined statements of operations (Note 8) - - 117,550 - (4,430) Recognised in owner's fund - - 24,743 - - Net deferred tax assets eliminated against owner's fund - - (117,550) - - -------- -------- -------- -------- -------- Balance at 31 December/30 June, - - 24,743 - 20,313 ======== ======== ======== ======== ======== The deferred taxation assets were made up of the following taxation effect: 31 DECEMBER, 30 JUNE, -------------------------------------- ---------- 2001 2002 2003 2004 Note RMB'000 RMB'000 RMB'000 RMB'000 DEFERRED TAX ASSETS: Impairment losses on property, plant and equipment (ii) 473,140 587,536 - - Provision for doubtful accounts 74,544 - - - Repair charges (ii) 438,979 490,550 - - Inventories (iii) - - 24,743 20,313 ---------- ---------- ---------- ---------- TOTAL DEFERRED TAX ASSETS 986,663 1,078,086 24,743 20,313 ---------- ---------- ---------- ---------- DEFERRED TAX LIABILITIES: Tax depreciation in excess of accounting depreciation (ii) (986,663) (1,078,086) - - ---------- ---------- ---------- ---------- TOTAL DEFERRED TAX LIABILITIES (986,663) (1,078,086) - - ---------- ---------- ---------- ---------- - - 24,743 20,313 ========== ========== ========== ========== Note: (i) The balance of tax losses as at 31 December, 2003 will no longer be available to be carried forward to off-set future taxable income of the Airline Operations of Northern Airlines Group upon completion of the Reorganisation and Acquisition. In this connection, deferred tax asset arising from tax losses amounting to approximately RMB118 million as at 31 December, 2003 was eliminated against owner's fund. -100- APPENDIX II ACCOUNTANTS' REPORT ON FINANCIAL INFORMATION OF THE AIRLINE OPERATIONS OF NORTHERN AIRLINES GROUP (V) NOTES TO THE FINANCIAL INFORMATION (CONTINUED) 23. DEFERRED TAXATION (Continued) (ii) As described in Note 10, in connection with the Reorganisation and Acquisition, property, plant and equipment of the Airline Operations of Northern Airlines Group were revalued as at 31 December, 2003. Such revalued amount will serve as the tax base for these assets for future years. As a result, the temporary differences that gave rise to the deferred tax assets and liabilities relating to the items above as at 31 December, 2003 were eliminated against owner's fund. An analysis of the deferred tax assets/(liabilities) which have been eliminated against owner's fund is set out below: RMB'000 DEFERRED TAX ASSETS: Impairment losses on property, plant and equipment 762,115 Repair charges 410,739 ---------- TOTAL DEFERRED TAX ASSETS 1,172,854 ---------- DEFERRED TAX LIABILITIES: Tax depreciation in excess of accounting depreciation (1,172,854) ---------- TOTAL DEFERRED TAX LIABILITIES (1,172,854) ---------- - ========== (iii) In connection with the Reorganisation and Acquisition, inventories of the Airline Operations of Northern Airlines Group, which as at 31 December, 2003 had a carrying amount of approximately RMB534 million, were revalued as required by the relevant PRC rules and regulations. The revalued amount of inventories has been determined at approximately RMB609 million. Such amount will serve as the tax base for future years. The inventories were not revalued for financial reporting purposes and accordingly, a deferred tax asset of approximately RMB25 million was created with a corresponding increase in owner's fund. Based upon projections of future taxable income, management believes it is more likely than not the Airline Operations of Northern Airlines Group will realise the benefits of the deferred tax asset. An analysis of the amount of deductible temporary differences for which no deferred tax asset is recognised in the combined balance sheets is set out below: 31 DECEMBER, 30 JUNE, --------------------------------- --------- 2001 2002 2003 2004 RMB'000 RMB'000 RMB'000 RMB'000 Tax losses 558,506 840,382 - - Provision for doubtful accounts 548,361 795,321 - - Repair charges 64,221 123,345 - - --------- --------- --------- --------- 1,171,088 1,759,048 - - ========= ========= ========= ========= -101- APPENDIX II ACCOUNTANTS' REPORT ON FINANCIAL INFORMATION OF THE AIRLINE OPERATIONS OF NORTHERN AIRLINES GROUP (V) NOTES TO THE FINANCIAL INFORMATION (CONTINUED) 24. RELATED PARTY TRANSACTIONS During the period from 1 January, 2001 to 31 December, 2002, the Airline Operations of Northern Airlines Group was under the direct control of the CAAC and therefore, the transactions conducted with the CAAC and its affiliates during the period from 1 January, 2001 to 31 December, 2002 are presented as related party transactions. However, such control was shifted to CSAHC during late 2002. Consequently, transactions with the CAAC and its affiliates are no longer presented as related party transactions from 1 January, 2003 onward. The principal recurring and non-recurring related party transactions between the Airline Operations of Northern Airlines Group and the CAAC and its affiliates, and CSAHC and its affiliates during the relevant period are summarised as follows: SIX-MONTH PERIODS YEARS ENDED 31 DECEMBER, ENDED 30 JUNE, --------------------------------- --------------------- 2001 2002 2003 2003 2004 Note RMB'000 RMB'000 RMB'000 RMB'000 RMB'000 (unaudited) EXPENSES PAID TO CAAC AND ITS AFFILIATES Handling charges (i) 2,377 2,428 - - - Jet fuel supplies (ii) 1,130,283 1,142,378 - - - Aircraft insurance (iii) 36,136 72,907 - - - Ticket reservation service charges (iv) 62,635 67,133 - - - Passenger departure and cargo handling charges (v) 18,526 19,140 - - - Aircraft and traffic service charges (vi) 456,482 541,488 - - - Commission expense (vii) 22,751 17,726 - - - PAID TO CSAHC AND ITS AFFILIATES Interest expense (viii) - 8,155 - - 185 Rentals for land and buildings (ix) - - - - 32,035 Air catering expenses (x) - - - - 32,105 INCOME RECEIVED FROM CAAC AND ITS AFFILIATES Maintenance service income (xi) 23,740 22,259 - - - Ground service income (xii) 7,428 6,927 - - - Aircraft lease income (xiii) - 7,286 - - - Commission income (xiv) 25,279 19,695 - - - RECEIVED FROM CSAHC AND ITS AFFILIATES Aircraft lease income (xiii) - - - - 49,152 -102- APPENDIX II ACCOUNTANTS' REPORT ON FINANCIAL INFORMATION OF THE AIRLINE OPERATIONS OF NORTHERN AIRLINES GROUP (V) NOTES TO THE FINANCIAL INFORMATION (CONTINUED) 24. RELATED PARTY TRANSACTIONS (Continued) Note: (i) Handling charges represent fees payable to China Aviation Supplies Import and Export Corporation, a corporation controlled by the CAAC, in connection with the procurement of aircraft and flight equipment on behalf of the Airline Operations of Northern Airlines Group. Handling charges are calculated based on a fixed percentage of the purchase value and other charges. (ii) Jet fuel supplies represent purchases of jet fuel at the then prevailing state controlled prices from China Aviation Oil Supply Company, Lan Tian Oil Supply Company and certain other suppliers, which are controlled by the CAAC. (iii) Aircraft insurance represents insurance premiums payable to the CAAC which arranges aviation insurance covering hull, war and passenger liability risk on behalf of the PRC airlines with the People's Insurance (Property) Company of China. Insurance premiums are allocated to individual PRC airlines by the CAAC based on the value of the airlines' aircraft and after taking into account the claims history of the airlines. (iv) Ticket reservation service charges represent fees payable to the CAAC in respect of computer reservation services rendered by the CAAC at charge rates determined based on the utilisation of the computer reservation system. (v) Passenger departure and cargo handling charges are payable to the CAAC for use of the computerised passenger departure and cargo handling systems installed at certain PRC airports. The charges are levied based on the utilisation of these systems. (vi) Aircraft and traffic service charges represent landing and take-off fees payable to various PRC airports in respect of landing and take-off slots allocated to the Airline Operations of Northern Airlines Group and other ancillary services provided. Fees are payable by the Airline Operations of Northern Airlines Group based on the scale rates published by the CAAC. (vii) Commission expense represents commissions payable to CAAC's sales offices and other PRC airlines in connection with services provided in exchange for air tickets sold by them. These commissions are calculated based on a fixed rate ranging from 1.5% to 9% on the ticket value as stipulated by the CAAC. (viii) Interest expense represents the interest incurred on certain unsecured loans from CSAHC. The applicable interest rates are in accordance with the rates published by the People's Bank of China (see Note 18). (ix) Rentals were paid to CSAHC under lease arrangements for certain land and buildings in the PRC. The rentals are determined based on prevailing market rates. (x) Air catering expenses represent purchases of in-flight meals and related services from certain affiliates of CSAHC. Prices charged by these suppliers to the Airline Operations of Northern Airlines Group are similar to those charged to other PRC airlines. (xi) Maintenance service income represents the fees received in connection with the provision of aircraft maintenance services to other airlines controlled by the CAAC. (xii) Ground service income represents the fees receivable from certain airlines controlled by the CAAC in respect of ground services provided by the Airline Operations of Northern Airlines Group in certain PRC airports. (xiii) Aircraft lease income for the years in the two-year period ended 31 December, 2002 represent rentals receivable in respect of short term leasing of aircraft to certain PRC airlines controlled by the CAAC. Aircraft lease income for the six-month period ended 30 June, 2004 represents rentals receivable in respect of short term leasing of aircraft to a CSAHC's affiliate. The rentals are determined based on prevailing market rates. (xiv) Commission income represents commission receivable from certain PRC airlines controlled by the CAAC in connection with air tickets sold by the Airline Operations of Northern Airlines Group for which the carriage was provided by such airlines. Commission is calculated based on a fixed rate ranging from 3% to 9% on the ticket value as stipulated by the CAAC. -103- APPENDIX II ACCOUNTANTS' REPORT ON FINANCIAL INFORMATION OF THE AIRLINE OPERATIONS OF NORTHERN AIRLINES GROUP (V) NOTES TO THE FINANCIAL INFORMATION (CONTINUED) 24. RELATED PARTY TRANSACTIONS (Continued) Details of loans borrowed from and/or guaranteed by CSAHC and loans guaranteed by the CAAC and its affiliates are disclosed in Note 18. Management of the Airline Operations of Northern Airlines Group is of the opinion that the above transactions with related parties were entered into in the normal course of business and on normal commercial terms or in accordance with the relevant government regulations governing such transactions. 25. RETIREMENT BENEFITS Employees of the Airline Operations of Northern Airlines Group participate in several defined contribution retirement schemes organised separately by PRC municipal governments in regions where the major operations of the Airline Operations of Northern Airlines Group are located. The Airline Operations of Northern Airlines Group is required to contribute to these schemes at rates ranging from 14% to 20% of salary costs, including certain allowances. A member of the retirement schemes is entitled to pension benefits equal to a fixed proportion of the salary at the retirement date. The retirement benefit obligations of all existing and future retired staff of the Airline Operations of Northern Airlines Group are assumed by these schemes. Contributions to the retirement schemes made by the Airline Operations of Northern Airlines Group during the relevant period are as follows: SIX-MONTH PERIODS YEARS ENDED 31 DECEMBER, ENDED 30 JUNE, --------------------------- ----------------- 2001 2002 2003 2003 2004 RMB'000 RMB'000 RMB'000 RMB'000 RMB'000 (unaudited) Amounts of contributions 42,513 65,282 86,476 36,898 43,815 ======= ======= ======= ======= ======= 26. COMMITMENTS AND CONTINGENCIES (i) CAPITAL COMMITMENTS The Airline Operations of Northern Airlines Group had capital commitments as follows: 31 DECEMBER, 30 JUNE, --------------------------------- --------- 2001 2002 2003 2004 RMB'000 RMB'000 RMB'000 RMB'000 Commitments in respect of aircraft and related equipment: - authorised and contracted for 3,608,101 2,618,215 917,874 860,435 --------- --------- --------- --------- Other commitments: - authorised and contracted for 2,606 2,109 7,355 2,279 - authorised but not contracted for 29,971 40,076 38,472 46,627 --------- --------- --------- --------- 32,577 42,185 45,827 48,906 --------- --------- --------- --------- 3,640,678 2,660,400 963,701 909,341 ========= ========= ========= ========= -104- APPENDIX II ACCOUNTANTS' REPORT ON FINANCIAL INFORMATION OF THE AIRLINE OPERATIONS OF NORTHERN AIRLINES GROUP (V) NOTES TO THE FINANCIAL INFORMATION (CONTINUED) 26. COMMITMENTS AND CONTINGENCIES (Continued) (i) CAPITAL COMMITMENTS (Continued) As at 30 June, 2004, the Airline Operations of Northern Airlines Group had on order two Airbus 321-200 aircraft and certain flight equipment, scheduled for deliveries in the second half of 2004 and in 2005. Deposits of approximately RMB185 million have been made towards the purchase of these aircraft and related equipment. As at 30 June, 2004, the approximate total future payments, including estimated amounts for price escalation through anticipated delivery dates for these aircraft and related equipment are as follows: RMB'000 Payments due - within one year 112,025 - in the second year 748,410 ------- 860,435 ======= (ii) OPERATING LEASE COMMITMENTS The total future minimum lease payments payable by the Airline Operations of Northern Airlines Group under non-cancellable operating leases in respect of aircraft and flight equipment are payable as follows: 31 DECEMBER, 30 JUNE, --------------------------------- --------- 2001 2002 2003 2004 RMB'000 RMB'000 RMB'000 RMB'000 Payments due - within one year - - 92,130 166,408 - in the second to fifth year, inclusive - - 1,614,070 1,780,561 - after the fifth year - - 3,765,609 3,497,896 --------- --------- --------- --------- - - 5,471,809 5,444,865 ========= ========= ========= ========= Leases for aircraft and flight equipment are generally run for an initial period of between one to ten years. The rental payments for aircraft and flight equipment are fixed during the lease period. None of the leases includes contingent rentals. (iii) CONTINGENT LIABILITIES Pursuant to a purchase agreement dated 6 April, 2000, the Airline Operations of Northern Airlines Group placed a procurement order for certain aircraft with a PRC manufacturer, at a total purchase price of approximately RMB180 million, with deliveries in 2002. In 2002, prior to the deliveries of aircraft, the Airline Operations of Northern Airlines Group decided to terminate the procurement order due to a change of its air fleet requirements. Currently, the Airline Operations of Northern Airlines Group has been working with the manufacturer in getting an appropriate new buyer for the aircraft. In this connection, a provision for termination charge of approximately RMB17 million was recognised in the combined statement of operations for the year ended 31 December, 2002. The provision made was recorded under sub-item "Others, net" under Non-operating income/(expenses) in the combined statement of operations. Such provision has been arrived at by management of the Airline Operations of Northern Airlines Group after taking into account all relevant information available to the Airline Operations of Northern Airlines Group, including the estimated differences between the purchase prices committed by the Airline Operations of Northern Airlines Group and the purchase prices that may be probably agreed by the new buyer. -105- APPENDIX II ACCOUNTANTS' REPORT ON FINANCIAL INFORMATION OF THE AIRLINE OPERATIONS OF NORTHERN AIRLINES GROUP (V) NOTES TO THE FINANCIAL INFORMATION (CONTINUED) 26. COMMITMENTS AND CONTINGENCIES (Continued) (iii) CONTINGENT LIABILITIES (Continued) As part of the Acquisition, CSAHC has agreed to indemnify the Company against any losses caused by the termination of the aircraft procurement order in excess of approximately RMB17 million. 27. CONCENTRATION OF RISKS AND FAIR VALUE OF FINANCIAL INSTRUMENTS LIQUIDITY RISK The liquidity of the Airline Operations of Northern Airlines Group is primarily dependent on its ability to maintain adequate cash inflow from operations to meet its debt obligations as they fall due and to renew/refinance these debt obligations where necessary and, on its ability to obtain adequate external loan finance to meet its committed future capital expenditures. With the support of certain PRC banks and CSAHC, the Airline Operations of Northern Airlines Group was able to renew its short term debts and refinance part of its long term debts during the relevant period. With regards to the twelve-month period ending 30 June, 2005, the Airline Operations of Northern Airlines Group has planned to seek the renewals of short term debts amounting to RMB430 million. The Airline Operations of Northern Airlines Group has planned to finance its committed capital expenditures and other financing requirements through available internal funds. Based on the recent negotiations with the principal bankers of the Airline Operations of Northern Airlines Group, management believes that the planned loan renewals will be available to the Airline Operations of Northern Airlines Group. Management has carried out a detailed review of the cash flow forecast of the Airline Operations of Northern Airlines Group for the twelve-month period ending 30 June, 2005. Based on the results of such review, management has determined that adequate liquidity exists to finance the working capital, debt repayment obligations and capital expenditure requirements of the Airline Operations of Northern Airlines Group during the forecasted period. In preparing the cash flow forecast, management has considered historical cash requirements of the Airline Operations of Northern Airlines Group as well as other key factors, including the availability of the above-mentioned loan renewals which may impact the operations of the Airline Operations of Northern Airlines Group during the next twelve-month period. Management is 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. BUSINESS AND ECONOMIC RISKS The Airline Operations of Northern Airlines Group conducts its principal operations in the PRC and accordingly is subject to special considerations and significant risk not typically associated with investments in equity securities of the United States of America and Western European companies. These include risks associated with, among others, the political, economic and legal environment, influence of the CAAC over many aspects of its operations, and competition in the passenger, cargo and mail airlines services industry. INTEREST RATE RISK The Airline Operations of Northern Airlines Group has significant exposure to interest rate fluctuation as a significant portion of its loans are interest bearing at floating rates. Fluctuation in interest rates affects the results of the Airline Operations of Northern Airlines Group significantly because the Airline Operations of Northern Airlines Group is not able to hedge its interest rate exposure effectively. The interest rates and maturity information of the bank and other loans of the Airline Operations of Northern Airlines Group and the maturity information of the finance lease obligations of the Airline Operations of Northern Airlines Group are disclosed in Notes 18 and 19 respectively. -106- APPENDIX II ACCOUNTANTS' REPORT ON FINANCIAL INFORMATION OF THE AIRLINE OPERATIONS OF NORTHERN AIRLINES GROUP (V) NOTES TO THE FINANCIAL INFORMATION (CONTINUED) 27. CONCENTRATION OF RISKS AND FAIR VALUE OF FINANCIAL INSTRUMENTS (Continued) FOREIGN CURRENCY RISK The Airline Operations of Northern Airlines Group has significant exposure to foreign currency as substantially all of its lease obligations and a significant portion of its bank loans are denominated in foreign currencies, principally US dollars, and to a lesser extent, Japanese yen. Depreciation or appreciation of Renminbi against foreign currencies affects the results of the Airline Operations of Northern Airlines Group significantly because the foreign currency payments of the Airline Operations of Northern Airlines Group significantly exceed its foreign currency receipts. The Airline Operations of Northern Airlines 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, by entering into forward foreign exchange contracts with authorised PRC banks. CREDIT RISKS Substantially all of the cash and cash equivalents of the Airline Operations of Northern Airlines Group are deposited with PRC financial institutions. Prior to 2003, a significant portion of the air tickets of the Airline Operations of Northern Airlines Group were 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. As at 31 December, 2001 and 2002, the balance due from BSP agents amounted to approximately RMB77 million and RMB98 million respectively. Beginning in 2003, a significant portion of the air tickets of the Airline Operations of Northern Airlines Group are sold through the sale network of the Company and flight revenue uplifted by the Airline Operations of Northern Airlines Group is billed and collected from the Company. As at 31 December, 2003 and 30 June, 2004, the receivable due from the Company amounted to approximately RMB186 million and RMB345 million respectively. SELF INSURANCE RISK The Airline Operations of Northern Airlines Group maintains a limited amount of property insurance in respect of certain personal and real property. FAIR VALUE Financial assets of the Airline Operations of Northern Airlines Group include cash and cash equivalents, other investments, trade receivables, and other receivables and prepaid expenses. Financial liabilities of the Airline Operations of Northern Airlines Group include bank and other loans, obligations under finance leases, other liabilities and accrued expenses and accounts payable. The Airline Operations of Northern Airlines Group did not hold nor issue any financial instruments for trading purposes during the relevant period. The Airline Operations of Northern Airlines Group did not have any positions in derivative contracts as at 31 December, 2001, 2002 and 2003 and 30 June, 2004. The following disclosure of the estimated fair value of financial instruments is made in accordance with the requirements of IAS 32 "Financial Instruments: Disclosure and Presentation" and IAS 39 "Financial Instruments: Recognition and Measurement". Fair value estimates, methods and assumptions, set forth below for the financial instruments of the Airline Operations of Northern Airlines Group are made solely to comply with the requirements of IAS 32 and IAS 39, and should be read in conjunction with the Financial Information. The estimated fair value amounts have been determined by the Airline Operations of Northern Airlines Group using market information and valuation methodologies considered appropriate. However, considerable judgement is required to interpret market data to develop the estimates of fair values. Accordingly, the estimates presented herein are not necessarily indicative of the amounts the Airline Operations of Northern Airlines Group could realise in a current market exchange. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts. -107- APPENDIX II ACCOUNTANTS' REPORT ON FINANCIAL INFORMATION OF THE AIRLINE OPERATIONS OF NORTHERN AIRLINES GROUP (V) NOTES TO THE FINANCIAL INFORMATION (CONTINUED) 27. CONCENTRATION OF RISKS AND FAIR VALUE OF FINANCIAL INSTRUMENTS (Continued) FAIR VALUE (Continued) The following summarise the major methods and assumptions used in estimating the fair values of the financial instruments of the Airline Operations of Northern Airlines Group. Long term debts The fair values of the long term debts are estimated by discounting future cash flows using current market interest rates offered to the Airline Operations of Northern Airlines Group for debts with substantially the same characteristics and maturities. As at 31 December, 2001, 2002 and 2003 and 30 June, 2004, the carrying amounts and fair values of the long term debts of the Airline Operations of Northern Airlines Group are as follows: 31 DECEMBER, 30 JUNE, ------------------------------------------------------------------- --------------------- 2001 2002 2003 2004 -------------------- --------------------- --------------------- --------------------- CARRYING FAIR CARRYING FAIR CARRYING FAIR CARRYING FAIR AMOUNT VALUE AMOUNT VALUE AMOUNT VALUE AMOUNT VALUE RMB'000 RMB'000 RMB'000 RMB'000 RMB'000 RMB'000 RMB'000 RMB'000 Long term debts 3,954,438 3,962,240 2,488,595 2,526,135 2,527,112 2,549,524 2,149,127 2,166,144 ========= ========= ========= ========= ========= ========= ========= ========= Other investments Other investments are unlisted equity interests and there are no quoted market prices for such interests in the PRC. Accordingly, a reasonable estimate of fair value could not be made without incurring excessive costs. Finance lease obligations The economic characteristics of the leases of the Airline Operations of Northern Airlines Group 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. Other financial instruments The fair values of all other financial instruments approximate their carrying amounts due to the nature or short term maturity of these instruments. 28. SUBSIDIARY The particulars of the subsidiary of the Airline Operations of Northern Airlines as at 30 June, 2004 are as follows: ATTRIBUTABLE PLACE AND DATE OF EQUITY INTEREST ESTABLISHMENT/ ----------------- ISSUED/REGISTERED NAME OF COMPANY OPERATION DIRECT INDIRECT CAPITAL PRINCIPAL ACTIVITIES % % China Northern Airlines PRC 75 - USD3,800,000 Aircraft repair and Aircraft Maintenance 8 November, 1997 maintenance Co., Ltd. services -108- APPENDIX II ACCOUNTANTS' REPORT ON FINANCIAL INFORMATION OF THE AIRLINE OPERATIONS OF NORTHERN AIRLINES GROUP (V) NOTES TO THE FINANCIAL INFORMATION (CONTINUED) 29. RECONCILIATION AND SUPPLEMENTARY COMBINED STATEMENTS OF CASH FLOWS INFORMATION (i) Reconciliation of (loss)/profit before income tax and minority interests to net cash from/(used in) operating activities is as follows: SIX-MONTH PERIODS YEARS ENDED 31 DECEMBER, ENDED 30 JUNE, ----------------------------------------- -------------------------- 2001 2002 2003 2003 2004 RMB'000 RMB'000 RMB'000 RMB'000 RMB'000 (unaudited) (Loss)/profit before income tax and minority interests (539,574) (1,150,834) (1,368,729) (689,733) 201,681 Depreciation and amortisation 678,435 662,040 647,263 319,023 419,777 Amortisation of deferred credit (8,826) (8,826) (8,826) (4,413) (4,413) Impairment loss on aircraft and other flight equipment 433,378 346,654 555,349 - - Deficit on revaluation of property, plant and equipment - - 492,369 - - (Gain)/loss on disposal of property, plant and equipment (14,634) (22,873) (729) (3,224) 439 Interest income (59,903) (28,583) (12,943) (6,921) (4,257) Interest expense 724,605 700,752 627,190 312,183 195,027 Unrealised exchange (gain)/loss, net (254,610) 161,210 246,001 568 (22,880) (Increase)/decrease in inventories (69,439) (68,256) 118,253 14,508 (9,125) Decrease/(increase) in trade receivables 139,044 (75,400) (49,909) 45,005 (155,615) (Increase)/decrease in other receivables and prepaid expenses (35,626) 152,533 (136,603) (320,635) (487,346) Increase/(decrease) in accounts payable 94,680 (49,112) 26,022 22,408 17,767 (Decrease)/increase in sales in advance of carriage (47,933) 48,236 (92,039) (68,108) (5,525) Increase in other liabilities and accrued expenses 51,849 158,730 144,465 222,361 272,890 ----------- ----------- ----------- ----------- ----------- Cash generated from/(used in) operations 1,091,446 826,271 1,187,134 (156,978) 418,420 Interest received 58,506 26,938 11,337 6,828 3,399 Interest paid (759,523) (749,664) (657,922) (339,503) (199,846) Income tax paid (314) (715) (321) - - ----------- ----------- ----------- ----------- ----------- Net cash from/(used in) operating activities 390,115 102,830 540,228 (489,653) 221,973 =========== =========== =========== =========== =========== -109- APPENDIX II ACCOUNTANTS' REPORT ON FINANCIAL INFORMATION OF THE AIRLINE OPERATIONS OF NORTHERN AIRLINES GROUP (V) NOTES TO THE FINANCIAL INFORMATION (CONTINUED) 29. RECONCILIATION AND SUPPLEMENTARY COMBINED STATEMENTS OF CASH FLOWS INFORMATION (Continued) (ii) DISCLOSURE OF NON-CASH INVESTING AND FINANCING ACTIVITIES (a) Acquisition of aircraft SIX-MONTH PERIODS YEARS ENDED 31 DECEMBER, ENDED 30 JUNE, --------------------------------- --------------------- 2001 2002 2003 2003 2004 RMB'000 RMB'000 RMB'000 RMB'000 RMB'000 (unaudited) Aircraft acquired under finance leases 744,089 783,098 - - - Net cash proceeds from manufacturers' credit 414,722 547,629 - - - --------- --------- --------- --------- --------- Finance lease obligations incurred 1,158,811 1,330,727 - - - ========= ========= ========= ========= ========= (b) Net liabilities assumed by owner of Northern Airlines As disclosed in Note 2, in connection with the Reorganisation and the Acquisition, certain assets and liabilities that were not to be acquired by the Company, but were historically associated with the Airline Operations of Northern Airlines Group, were assumed by owner of Northern Airlines. The net liabilities assumed by owner of Northern Airlines other than cash and cash equivalents amounted to approximately RMB4,679 million. 30. ULTIMATE HOLDING COMPANY Management of the Airline Operations of Northern Airlines consider the ultimate holding company to be CSAHC, a state-owned enterprise established in the PRC. (VI) SUBSEQUENT EVENTS In July 2001, the Airline Operations of Northern Airlines Group filed a claim with a PRC court against a shareholder (the "minority shareholder") of a previous non-wholly owned subsidiary, China Northern Swan Airlines Co. Ltd. ("CNSA") for its failure to contribute capital of approximately RMB62 million to the subsidiary. In 2002, the minority shareholder filed a defence and a counterclaim against the Airline Operations of Northern Airlines Group demanding (i) a monetary compensation of approximately RMB0.3 million plus legal costs; (ii) voidance of certain transactions conducted by CNSA with the Airline Operations of Northern Airlines Group which could result in losses to the Airline Operations of Northern Airlines Group in the estimated sum of approximately RMB50 million; and (iii) restoration of certain operating lease arrangements for eight McDonald Douglas 82 aircraft previously leased by the Airline Operations of Northern Airlines Group to CNSA. -110- APPENDIX II ACCOUNTANTS' REPORT ON FINANCIAL INFORMATION OF THE AIRLINE OPERATIONS OF NORTHERN AIRLINES GROUP (VI) SUBSEQUENT EVENTS (CONTINUED) The Airline Operations of Northern Airlines Group made a provision of approximately RMB32 million in the combined statement of operation for the year ended 31 December, 2002. The provision was recorded under sub-item "Others, net" under Non-operating income/(expenses) in the combined statement of operations. Such provision was arrived at by management of the Airline Operations of Northern Airlines Group after taking into account all relevant information of available to the Airline Operations of Northern Airlines Group. In August 2004, an out-of-court settlement was reached amongst the parties. Pursuant to the out-of-court settlement agreement, the Airline Operations of Northern Airlines Group paid approximately RMB32 million to the minority shareholder and in return the minority shareholder revoked its counterclaim against the Airline Operations of Northern Airlines Group. (VII) SUBSEQUENT FINANCIAL STATEMENTS No audited financial statements have been prepared by the Airline Operations of Northern Airlines Group in respect of any period subsequent to 30 June, 2004. Yours faithfully, KPMG Certified Public Accountants Hong Kong -111- APPENDIX III ACCOUNTANTS' REPORT ON FINANCIAL INFORMATION OF THE AIRLINE OPERATIONS OF XINJIANG AIRLINES GROUP The following is the text of a report, prepared for the sole purpose of inclusion in this circular, received from the independent reporting accountants, KPMG, Certified Public Accountants, Hong Kong. As described in the section headed "Documents available for inspection" in Appendix IX, a copy of the following accountants' report is available for inspection. [KPMG LOGO] 8th Floor Prince's Building 10 Chater Road Hong Kong The Directors China Southern Airlines Company Limited Baiyun International Airport Guangzhou People's Republic of China 12 November, 2004 Dear Sirs, INTRODUCTION We set out below our report on the financial information relating to the airline and airline related operations (the "Airline Operations") of Xinjiang Airlines Company ("Xinjiang Airlines") and its subsidiaries ("Xinjiang Airlines Group"), in Sections I to VI below (the "Financial Information"), including the combined balance sheets as at 31 December, 2001, 2002 and 2003 and 30 June, 2004, the combined statements of operations, the combined statements of changes in owner's fund and the combined statements of cash flows for each of the years in the three-year period ended 31 December, 2003 and the six-month period ended 30 June, 2004 (the "relevant period"), and the notes thereto, for inclusion in the shareholders' circular of China Southern Airlines Company Limited (the "Company") dated 12 November, 2004 (the "Circular"). Xinjiang Airlines was established on 1 January, 1985 in the People's Republic of China (the "PRC") and is a wholly-owned subsidiary of China Southern Air Holding Company ("CSAHC"), the ultimate holding company of the Company. It is principally engaged in the provision of domestic and international passenger, cargo and mail airline services, with flights operating primarily from Urumqi International Airport which is the main base of Xinjiang Airlines in the PRC. In addition, Xinjiang Airlines Group also engages in other non airline related operations (the "Non Airline Operations") mainly consisting of property operations which provide supporting services to Xinjiang Airlines Group. -112- APPENDIX III ACCOUNTANTS' REPORT ON FINANCIAL INFORMATION OF THE AIRLINE OPERATIONS OF XINJIANG AIRLINES GROUP CSAHC has undergone a reorganisation (the "Reorganisation") in connection with the proposed acquisition of the Airline Operations of Xinjiang Airlines Group by the Company. As part of the Reorganisation, the operations and businesses and the assets and liabilities of Xinjiang Airlines Group were segregated into two operations, namely the Airline Operations and the Non Airline Operations on 31 December, 2003. Pursuant to the Sale and Purchase Agreement, as described more fully in the section headed "The Sale and Purchase Agreement" in the letter from the Board contained in the Circular, the Company will acquire the Airline Operations of Xinjiang Airlines Group together with the related assets and liabilities. However, certain assets within the Airline Operations of Xinjiang Airlines Group are not to be acquired by the Company. Xinjiang Airlines Group prepares financial statements in accordance with the relevant accounting rules and regulations in the PRC. The financial statements of the Airline Operations of Xinjiang Airlines Group were not required to be audited by independent auditors during the relevant period. BASIS OF PREPARATION The Financial Information has been prepared by management of the Airline Operations of Xinjiang Airlines Group based on the management accounts of the Airline Operations of Xinjiang Airline Group and on the bases set out in Section V Notes 2 and 3 to conform with International Financial Reporting Standards ("IFRS") promulgated by the International Accounting Standards Board and the disclosure requirements of the Rules Governing the Listing of Securities on The Stock Exchange of Hong Kong Limited. IFRS includes International Accounting Standards and interpretations. RESPECTIVE RESPONSIBILITIES OF MANAGEMENT AND REPORTING ACCOUNTANTS Management of the Airline Operations of Xinjiang Airlines Group are responsible for the preparation of the Financial Information which gives a true and fair view. In preparing the Financial Information which gives a true and fair view, it is fundamental that appropriate accounting policies are selected and applied consistently, that judgements and estimates are made which are prudent and reasonable and that the reasons for any significant departure from applicable accounting standards are stated. It is our responsibility to form an independent opinion, based on our audit, on the Financial Information. -113- APPENDIX III ACCOUNTANTS' REPORT ON FINANCIAL INFORMATION OF THE AIRLINE OPERATIONS OF XINJIANG AIRLINES GROUP BASIS OF OPINION As a basis for forming an opinion on the Financial Information, for the purpose of this report, we have audited the Financial Information of the Airline Operations of Xinjiang Airlines Group for the relevant period in accordance with Statements of Auditing Standards and Guidelines issued by Hong Kong Institute of Certified Public Accountants ("HKICPA") and we have carried out such additional procedures as we considered necessary in accordance with the Auditing Guidelines "Prospectuses and the Reporting Accountant" issued by the HKICPA. We have not audited any financial statements of the Airline Operations of Xinjiang Airlines Group in respect of any period subsequent to 30 June, 2004. An audit includes examination, on a test basis, of evidence relevant to the amounts and disclosures in the Financial Information. It also includes an assessment of the significant estimates and judgements made by management of the Airline Operations of Xinjiang Airlines Group in the preparation of the Financial Information, and of whether the accounting policies are appropriate to the circumstances of the Airline Operations of Xinjiang Airlines Group, consistently applied and adequately disclosed. We planned and performed our audit so as to obtain all the information and explanations which we considered necessary in order to provide us with sufficient evidence to give reasonable assurance as to whether the Financial Information is free from material misstatement. In forming our opinion we also evaluated the overall adequacy of the presentation of Financial Information. We believe that our audit provides a reasonable basis for our opinion. OPINION In our opinion, the Financial Information for the purpose of this report, and on the basis of presentation set out in Section V Notes 2 and 3, gives a true and fair view of the combined state of affairs of the Airline Operations of Xinjiang Airlines Group as at 31 December, 2001, 2002 and 2003 and 30 June, 2004, and of the combined results and combined cash flows of the Airline Operations of Xinjiang Airlines Group for each of the years in the three-year period ended 31 December, 2003 and the six-month period ended 30 June, 2004 and has been properly prepared in accordance with IFRS. -114- APPENDIX III ACCOUNTANTS' REPORT ON FINANCIAL INFORMATION OF THE AIRLINE OPERATIONS OF XINJIANG AIRLINES GROUP (I) COMBINED STATEMENTS OF OPERATIONS SIX-MONTH PERIODS YEARS ENDED 31 DECEMBER, ENDED 30 JUNE, ----------------------------------------- -------------------------- 2001 2002 2003 2003 2004 Note RMB'000 RMB'000 RMB'000 RMB'000 RMB'000 (unaudited) OPERATING REVENUE Traffic revenue 2,048,009 2,215,380 2,075,074 717,310 1,176,300 Other operating revenue 126,231 137,732 76,559 55,840 38,776 ----------- ----------- ----------- ----------- ----------- TOTAL OPERATING REVENUE 4 2,174,240 2,353,112 2,151,633 773,150 1,215,076 ----------- ----------- ----------- ----------- ----------- OPERATING EXPENSES Flight operations 1,001,641 1,036,133 1,061,919 486,999 639,339 Maintenance 200,572 203,311 250,380 108,795 126,536 Aircraft and traffic servicing 201,941 205,208 275,658 111,190 134,088 Promotion and sales 99,966 117,333 137,562 54,577 80,877 General and administrative 86,380 98,247 119,052 51,434 61,279 Depreciation and amortisation 314,991 352,150 346,304 166,247 173,177 Others - 143,717 - - - ----------- ----------- ----------- ----------- ----------- TOTAL OPERATING EXPENSES 5 1,905,491 2,156,099 2,190,875 979,242 1,215,296 ----------- ----------- ----------- ----------- ----------- OPERATING PROFIT/(LOSS) 268,749 197,013 (39,242) (206,092) (220) ----------- ----------- ----------- ----------- ----------- NON-OPERATING INCOME/(EXPENSES) Interest income 2,530 1,347 1,776 347 746 Interest expense 6 (189,165) (184,018) (201,415) (81,352) (69,417) Exchange gain/(loss), net 3,198 (345) 792 534 (64) Loss on disposal of property, plant and equipment (8,581) (2,219) (7,943) (3,893) (800) Deficit on revaluation of property, plant and equipment 9 - - (234,835) - - ----------- ----------- ----------- ----------- ----------- TOTAL NON-OPERATING EXPENSES, NET (192,018) (185,235) (441,625) (84,364) (69,535) ----------- ----------- ----------- ----------- ----------- PROFIT/(LOSS) BEFORE INCOME TAX AND MINORITY INTERESTS 76,731 11,778 (480,867) (290,456) (69,755) Income tax 7 (35,782) (9,492) 155,808 95,258 24,048 ----------- ----------- ----------- ----------- ----------- PROFIT/(LOSS) BEFORE MINORITY INTERESTS 40,949 2,286 (325,059) (195,198) (45,707) Minority interests - 522 25,957 824 1,396 ----------- ----------- ----------- ----------- ----------- NET PROFIT/(LOSS) 40,949 2,808 (299,102) (194,374) (44,311) =========== =========== =========== =========== =========== -115- APPENDIX III ACCOUNTANTS' REPORT ON FINANCIAL INFORMATION OF THE AIRLINE OPERATIONS OF XINJIANG AIRLINES GROUP (II) COMBINED BALANCE SHEETS 31 DECEMBER, 30 JUNE, -------------------------------------- ---------- 2001 2002 2003 2004 Note RMB'000 RMB'000 RMB'000 RMB'000 NON-CURRENT ASSETS Property, plant and equipment, net 9 4,127,530 4,387,744 4,140,976 4,043,708 Construction in progress 10 61,450 66,144 32,223 13,404 Other investments 890 890 - - Lease and equipment deposits 243,256 53,715 53,715 53,620 Deferred tax assets 19 - - - 19,195 ---------- ---------- ---------- ---------- TOTAL NON-CURRENT ASSETS 4,433,126 4,508,493 4,226,914 4,129,927 ---------- ---------- ---------- ---------- CURRENT ASSETS Inventories 11 73,117 60,056 59,231 71,311 Trade receivables 12 162,634 183,623 96,288 125,212 Other receivables and prepaid expenses 13 117,134 168,737 130,234 169,295 Cash and cash equivalents 14 256,685 246,387 376,781 286,998 ---------- ---------- ---------- ---------- TOTAL CURRENT ASSETS 609,570 658,803 662,534 652,816 ---------- ---------- ---------- ---------- CURRENT LIABILITIES Bank and other loans 15 693,027 890,271 932,780 1,056,639 Other liabilities and accrued expenses 16 521,511 637,228 702,481 718,783 Accounts payable 17 71,643 92,603 93,987 128,638 Sales in advance of carriage 36,947 19,488 3,268 - Tax payable 17,267 14,267 1,857 - ---------- ---------- ---------- ---------- TOTAL CURRENT LIABILITIES 1,340,395 1,653,857 1,734,373 1,904,060 ---------- ---------- ---------- ---------- NET CURRENT LIABILITIES (730,825) (995,054) (1,071,839) (1,251,244) ---------- ---------- ---------- ---------- TOTAL ASSETS LESS CURRENT LIABILITIES 3,702,301 3,513,439 3,155,075 2,878,683 ---------- ---------- ---------- ---------- -116- APPENDIX III ACCOUNTANTS' REPORT ON FINANCIAL INFORMATION OF THE AIRLINE OPERATIONS OF XINJIANG AIRLINES GROUP (II) COMBINED BALANCE SHEETS (CONTINUED) 31 DECEMBER, 30 JUNE, --------------------------------- --------- 2001 2002 2003 2004 Note RMB'000 RMB'000 RMB'000 RMB'000 NON-CURRENT LIABILITIES AND DEFERRED ITEMS Bank and other loans 15 2,384,972 2,051,386 1,960,461 1,735,037 Provision for major overhauls 18 150,708 161,594 182,727 182,319 Deferred tax liabilities 19 122,691 132,183 4,853 - --------- --------- --------- --------- TOTAL NON-CURRENT LIABILITIES 2,658,371 2,345,163 2,148,041 1,917,356 --------- --------- --------- --------- MINORITY INTERESTS - 94,735 78,173 76,777 --------- --------- --------- --------- 1,043,930 1,073,541 928,861 884,550 ========= ========= ========= ========= Representing: OWNER'S FUND - SURPLUS 1,043,930 1,073,541 928,861 884,550 ========= ========= ========= ========= -117- APPENDIX III ACCOUNTANTS' REPORT ON FINANCIAL INFORMATION OF THE AIRLINE OPERATIONS OF XINJIANG AIRLINES GROUP (III) COMBINED STATEMENTS OF CHANGES IN OWNER'S FUND Note RMB'000 Surplus of owner's fund as at 1 January, 2001 1,018,312 Net profit for the year 40,949 Distributions to owner (15,331) ----------- SURPLUS OF OWNER'S FUND AS AT 31 DECEMBER, 2001 1,043,930 =========== Surplus of owner's fund as at 1 January, 2002 1,043,930 Net profit for the year 2,808 Contributions from owner 26,803 ----------- SURPLUS OF OWNER'S FUND AS AT 31 DECEMBER, 2002 1,073,541 =========== Surplus of owner's fund as at 1 January, 2003 1,073,541 Net loss for the year (299,102) Assets distributed to owner in connection with the Reorganisation and Acquisition 2 (47,802) Surplus arising from revaluation of property, plant and equipment, net of minority interests' share 9 227,452 Elimination of net deferred tax assets 19 (23,625) Recognition of deferred tax liabilities 19 (4,853) Contributions from owner 3,250 ----------- SURPLUS OF OWNER'S FUND AS AT 31 DECEMBER, 2003 928,861 =========== Surplus of owner's fund as at 1 January, 2004 928,861 Net loss for the period (44,311) ----------- SURPLUS OF OWNER'S FUND AS AT 30 JUNE, 2004 884,550 =========== -118- APPENDIX III ACCOUNTANTS' REPORT ON FINANCIAL INFORMATION OF THE AIRLINE OPERATIONS OF XINJIANG AIRLINES GROUP (IV) COMBINED STATEMENTS OF CASH FLOWS SIX-MONTH PERIODS YEARS ENDED 31 DECEMBER, ENDED 30 JUNE, ------------------------------------ ------------------------ 2001 2002 2003 2003 2004 Note RMB'000 RMB'000 RMB'000 RMB'000 RMB'000 (unaudited) CASH FLOWS FROM OPERATING ACTIVITIES 25(i) 326,210 560,964 295,738 23,699 69,672 ---------- ---------- ---------- ----------- ---------- CASH FLOWS FROM INVESTING ACTIVITIES Proceeds from disposal of property, plant and equipment 21,183 25,119 39,398 16,107 286 Proceeds from disposal of long term investment - - 890 890 - Payment of lease and equipment deposits (22,365) - - - - Refund of lease and equipment deposits 207,984 189,541 - - - Capital expenditures (1,071,705) (697,919) (157,216) (102,804) (58,176) Purchase of long term investments (890) - - - - ---------- ---------- ---------- ----------- ---------- NET CASH USED IN INVESTING ACTIVITIES (865,793) (483,259) (116,928) (85,807) (57,890) ---------- ---------- ---------- ----------- ---------- CASH FLOWS FROM FINANCING ACTIVITIES Proceeds from bank and other loans 1,195,000 1,435,000 1,656,259 645,000 297,770 Repayment of bank and other loans (528,315) (1,568,342) (1,704,675) (563,080) (399,335) Capital contribution received from minority shareholders 92,394 45,339 - - - Repayment of principal under finance lease obligations (129,712) - - - - ---------- ---------- ---------- ----------- ---------- NET CASH FROM/(USED IN) FINANCING ACTIVITIES 629,367 (88,003) (48,416) 81,920 (101,565) ---------- ---------- ---------- ----------- ---------- NET INCREASE/(DECREASE) IN CASH AND CASH EQUIVALENTS 89,784 (10,298) 130,394 19,812 (89,783) CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR/PERIOD 166,901 256,685 246,387 246,387 376,781 ---------- ---------- ---------- ----------- ---------- CASH AND CASH EQUIVALENTS AT END OF YEAR/PERIOD 256,685 246,387 376,781 266,199 286,998 ========== ========== ========== =========== ========== -119- APPENDIX III ACCOUNTANTS' REPORT ON FINANCIAL INFORMATION OF THE AIRLINE OPERATIONS OF XINJIANG AIRLINES GROUP (V) NOTES TO THE FINANCIAL INFORMATION 1. PRINCIPAL ACTIVITIES AND REORGANISATION Xinjiang Airlines Company ("Xinjiang Airlines") was established on 1 January, 1985 in the People's Republic of China (the "PRC") and is a wholly-owned subsidiary of China Southern Air Holding Company ("CSAHC"), the ultimate holding company of China Southern Airlines Company Limited (the "Company"). Xinjiang Airlines together with its subsidiaries ("Xinjiang Airlines Group") is principally engaged in the provision of domestic and international passenger, cargo and mail airline services, with flights operating primarily from Urumqi International Airport which is the main base of Xinjiang Airlines in the PRC. In addition, Xinjiang Airlines Group also engages in other non airline related operations (the "Non Airline Operations") mainly consisting of property operations which provide supporting services to Xinjiang Airlines Group. CSAHC has undergone a reorganisation (the "Reorganisation") in connection with the proposed acquisition of the airline and airline related operations (the "Airline Operations") of Xinjiang Airlines Group by the Company (the "Acquisition"). As part of the Reorganisation, the operations and businesses and the assets and liabilities of Xinjiang Airlines Group were segregated into two operations, namely the Airline Operations and the Non Airline Operations on 31 December, 2003. Pursuant to the Sale and Purchase Agreement, as described more fully in the section headed "The Sale and Purchase Agreement" in the letter from the Board contained in the Circular, the Company will acquire the Airline Operations of Xinjiang Airlines Group together with the related assets and liabilities. However, certain assets within the Airline Operations of Xinjiang Airlines Group are not to be acquired by the Company. 2. BASIS OF PRESENTATION The Financial Information for each of the years in the three-year period ended 31 December, 2003 and for the six-month period ended 30 June, 2004 presents the results of the Airline Operations of Xinjiang Airlines Group as if the Reorganisation had taken place and the Airline Operations of Xinjiang Airlines Group had been in operation on a stand alone basis as of the earliest date presented and had been in existence throughout the relevant period. The Financial Information for each of the years in the three-year period ended 31 December, 2003 includes the results related to those assets that were not to be acquired by the Company, but were historically associated with the Airline Operations of Xinjiang Airlines Group. As at 31 December, 2003, the assets not to be acquired by the Company consisted of the following: RMB'000 Property, plant and equipment, net 46,272 Trade and other receivables 1,530 ------- Assets distributed to owner 47,802 ======= The assets within the Airline Operations of Xinjiang Airlines Group not to be acquired by the Company on 31 December, 2003 were reflected as assets distributed to owner of Xinjiang Airlines in the combined statements of owner's fund as at 31 December, 2003. As a result of the distribution of the above assets as at 31 December, 2003 to the owner, the Financial Information for the six-month period ended 30 June, 2004 presents the results of the assets and liabilities, revenues and expenses of the Airline Operations of Xinjiang Airlines Group to be acquired by the Company. Notwithstanding the Airline Operations of Xinjiang Airlines Group having net current liabilities as at 30 June, 2004, the Financial Information has been prepared on a going concern basis on the assumption that the Airline Operations of Xinjiang Airlines Group will be able to generate adequate cash flows from operations and to obtain adequate external financing to enable the Airline Operations of Xinjiang Airlines Group to meet its debts as they fall due and to meet its committed future capital expenditure (see Note 22). -120- APPENDIX III ACCOUNTANTS' REPORT ON FINANCIAL INFORMATION OF THE AIRLINE OPERATIONS OF XINJIANG AIRLINES GROUP (V) NOTES TO THE FINANCIAL INFORMATION (CONTINUED) 3. PRINCIPAL ACCOUNTING POLICIES (a) STATEMENT OF COMPLIANCE The Financial Information has been prepared in accordance with International Financial Reporting Standards ("IFRS") promulgated by the International Accounting Standards Board. IFRS includes International Accounting Standards ("IAS") and interpretations. (b) BASIS OF PREPARATION The Financial Information is prepared on the historical cost basis as modified by the revaluation of property, plant and equipment, as explained in Note 9. The accounting policies described below have been consistently applied during the relevant period. (c) BASIS OF CONSOLIDATION A subsidiary is an enterprise controlled by the Airline Operations of Xinjiang Airlines. Control exists when the Airline Operations of Xinjiang Airlines has the power, directly or indirectly, to govern the financial and operating policies of an enterprise so as to obtain benefits from its activities. The financial results of subsidiaries are included in the Financial Information from the date that control commences until the date that control ceases, and the share attributable to minority interests is deducted from or added to the profit/loss after income tax. All significant intercompany balances and transactions and any unrealised gains and losses arising from intercompany transactions are eliminated on consolidation. The particulars of the principal subsidiaries are set out in Note 24. (d) PROPERTY, PLANT, EQUIPMENT AND DEPRECIATION (i) Property, plant and equipment are initially stated at cost less accumulated depreciation and impairment losses (see Note (f)). The cost of an asset comprises its purchase price, any directly attributable costs of bringing the asset to working condition and location for its intended use and the cost of borrowed funds used during the period of construction. Expenditure incurred after the asset has been put into operation is capitalised only when it increases the future economic benefits embodied in the item of property, plant and equipment. All other expenditure including the cost of repairs and maintenance, is expensed as it is incurred. (ii) Subsequent to the revaluation carried out as at 31 December, 2003, which was based on depreciated replacement costs (Note 9), property, plant and equipment are carried at revalued amount, being the fair value at the date of the revaluation, less subsequent accumulated depreciation and impairment losses. When an item of property, plant and equipment is revalued, any accumulated depreciation and impairment losses at the date of revaluation is eliminated against the gross carrying amount of the asset and the net asset restated to the revalued amount of the asset. When an item of property, plant and equipment is revalued, the entire class of property, plant and equipment to which the asset belongs is revalued simultaneously. When an asset's carrying amount is increased as a result of a revaluation, the increase is credited directly to owner's fund. However, a revaluation increase is recognised as an income to the extent that it reverses a revaluation decrease of the same asset previously recognised as an expense. When an asset's carrying amount is decreased as a result of a revaluation, the decrease is recognised as an expense in the combined statements of operations. However, a revaluation decrease is charged directly against owner's fund to the extent that the decrease does not exceed the amount previously credited to owner's fund in respect of the same asset. Revaluations are performed with sufficient regularity such that the carrying amount does not differ materially from that which would be determined using fair value at the balance sheet date. -121- APPENDIX III ACCOUNTANTS' REPORT ON FINANCIAL INFORMATION OF THE AIRLINE OPERATIONS OF XINJIANG AIRLINES GROUP (V) NOTES TO THE FINANCIAL INFORMATION (CONTINUED) 3. PRINCIPAL ACCOUNTING POLICIES (Continued) (d) PROPERTY, PLANT, EQUIPMENT AND DEPRECIATION (Continued) (iii) Gains or losses arising from the retirement or disposal of property, plant and equipment are determined as the difference between the net disposal proceeds and the carrying amount of the asset and are recognised as income or expense in the combined statements of operations on the date of retirement or disposal. (iv) Depreciation is calculated to write off the cost, or revalued amount, where appropriate, of property, plant and equipment on a straight line basis over their estimated useful lives, to residual values, using the following depreciation rates: DEPRECIATION RATES ------------------ BUILDINGS 2.43% - 6.17% Owned and finance leased aircraft 4.75% - 12.13% Other flight equipment - Jet engines 4.75% - 12.13% - Others, including rotable spares 9.79% - 12.13% Machinery and equipment 9.70% - 11.40% Vehicles 16.17% (e) LEASED ASSETS Flight equipment under finance leases is stated at an amount equal to the lower of its fair value and the present value of minimum lease payments at inception of the lease, and is amortised on a straight line basis over the shorter of the lease term or estimated useful life of the asset to residual value. In cases where title to the asset will be acquired by the Airline Operations of Xinjiang Airlines Group at the end of the lease, the asset is amortised on a straight line basis over the estimated useful life of the asset to its residual value. Amounts payable in respect of finance leases are apportioned between charges and reductions of obligations based on the interest rates implicit in the leases. Interest charges are included in the combined statements of operations to provide a constant periodic rate of charge over the lease term. Operating lease payments are charged to the combined statements of operations on a straight line basis over the terms of the related leases. (f) IMPAIRMENT OF ASSETS The carrying amounts of the assets, other than inventories (see Note (i)), trade and other receivables (see Note (j)) and deferred tax assets (see Note (m)) of the Airline Operations of Xinjiang Airlines Group, 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 net selling price and the value in use. In determining the value in use, expected future cash flows generated by the asset are discounted to their present value. The amount of the reduction is recognised as an expense in the combined statements of operations. The Airline Operations of Xinjiang Airlines Group assesses at each balance sheet date whether there is any indication that an impairment loss recognised for an asset in prior years may no longer exist. An impairment loss is reversed if there has been a favourable change in the estimates used to determine the recoverable amount. A subsequent increase in the recoverable amount of an asset, when the circumstances and events that led to the write-down or write-off cease to exist, is recognised as income. The reversal is reduced by the amount that would have been recognised as depreciation had the write-down or write-off not occurred. -122- APPENDIX III ACCOUNTANTS' REPORT ON FINANCIAL INFORMATION OF THE AIRLINE OPERATIONS OF XINJIANG AIRLINES GROUP (V) NOTES TO THE FINANCIAL INFORMATION (CONTINUED) 3. PRINCIPAL ACCOUNTING POLICIES (Continued) (g) CONSTRUCTION IN PROGRESS Construction in progress is stated in the combined balance sheets at cost less impairment losses (see Note (f)). Cost comprises direct costs of construction as well as interest expense and exchange differences on related borrowed funds to the extent that they are regarded as an adjustment to interest charge during the periods of construction and installation. Capitalisation of these costs ceases and the construction in progress is transferred to property, plant and equipment when substantially all the activities necessary to prepare the asset for its intended use are completed. No depreciation is provided in respect of construction in progress until it is completed and ready for its intended use. (h) INVESTMENTS Investments, which represent unquoted available-for-sale equity securities of companies established in the PRC, are stated at cost less impairment losses (see Note (f)). There is no quoted market price for such equity securities and accordingly a reasonable estimate of the fair value could not be made without incurring excessive costs. (i) INVENTORIES Inventories, which consist primarily of expendable spare parts and supplies, are stated at cost less any applicable provision for obsolescence, and are expensed when used in operations. Cost represents the average unit cost. Inventories held for disposal are stated at the lower of cost and net realisable value. Net realisable value represents estimated resale price. (j) TRADE AND OTHER RECEIVABLES Trade and other receivables are stated at cost less provision for doubtful accounts. Provision for doubtful accounts is established based on evaluation of the recoverability of these accounts at the balance sheet date. (k) CASH AND CASH EQUIVALENTS Cash and cash equivalents consist of cash in hand and balance with banks and other financial institutions with an original maturity within three months. Cash equivalents are stated at cost, which approximates fair value. (l) INTEREST-BEARING BORROWINGS Interest-bearing borrowings are recognised at cost. (m) INCOME TAXES Income tax comprises current and deferred tax. Current tax is calculated on the taxable income for the relevant period by applying the applicable tax rates. Deferred tax is provided using the balance sheet liability method, providing for all temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for taxation purposes. The amount of deferred tax provided is based on the expected manner of realisation or settlement of the carrying amount of assets and liabilities, using tax rates enacted or substantially enacted at the balance sheet date. A deferred tax asset is recognised only to the extent that it is probable that future taxable profits will be available against which the asset can be utilised. Deferred tax assets are reduced to the extent that it is no longer probable that the related tax benefit will be realised. -123- APPENDIX III ACCOUNTANTS' REPORT ON FINANCIAL INFORMATION OF THE AIRLINE OPERATIONS OF XINJIANG AIRLINES GROUP (V) NOTES TO THE FINANCIAL INFORMATION (CONTINUED) 3. PRINCIPAL ACCOUNTING POLICIES (Continued) (n) PROVISIONS AND CONTINGENT LIABILITIES Provisions are recognised for liabilities of uncertain timing or amount when the Airline Operations of Xinjiang Airlines 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. (o) REVENUE RECOGNITION (i) Passenger, cargo and mail transportation revenues are recognised when the transportation is provided. Ticket sales for transportation not yet provided are included in current liabilities. Revenues from airline-related business are recognised when services are rendered. Revenue is stated net of sales tax. In addition, revenue for each of the years in the three-year period ended 31 December, 2003 and the three-month period ended 31 March, 2004 was stated net of contributions to the Civil Aviation Administration of China ("CAAC") Infrastructure Development Fund. Effective from 1 April, 2004, contributions to the CAAC Infrastructure Development Fund form part of the flight operations expenses instead of being netted off with revenue. (ii) Interest income is recognised as it accrues unless collectability is in doubt. (iii) Operating lease income is recognised on a straight line basis over the terms of the respective leases. (p) TRAFFIC COMMISSIONS Traffic commissions are expensed when the transportation is provided and the related revenue is recognised. Traffic commissions for transportation not yet provided are recorded in the combined balance sheets as prepaid expense. (q) MAINTENANCE AND OVERHAUL COST Routine maintenance and repairs and overhauls in respect of owned aircraft and aircraft held under finance leases are expensed in the combined statements of operations as and when incurred. In respect of aircraft held under operating leases, a provision is made over the lease term for the estimated cost of overhauls required to be performed on the related aircraft prior to their return to the lessors. (r) TRANSLATION OF FOREIGN CURRENCIES The functional currency of the operations of the Airline Operations of Xinjiang Airlines Group is Renminbi. Foreign currency transactions are translated into Renminbi at the applicable rates of exchange ruling at the transaction dates. Monetary assets and liabilities denominated in foreign currencies are translated into Renminbi at the exchange rates ruling at the balance sheet date. Exchange gains and losses, other than those capitalised as construction in progress (See Note (g)), are recognised in the combined statements of operations. (s) BORROWING COSTS Borrowing costs are expensed in the combined statements of operations in the period in which they are incurred, except to the extent that they are capitalised as being directly attributable to the acquisition or construction of an asset which necessarily takes a substantial period of time to get ready for its intended use (See Note (g)). -124- APPENDIX III ACCOUNTANTS' REPORT ON FINANCIAL INFORMATION OF THE AIRLINE OPERATIONS OF XINJIANG AIRLINES GROUP (V) NOTES TO THE FINANCIAL INFORMATION (CONTINUED) 3. PRINCIPAL ACCOUNTING POLICIES (Continued) (t) RETIREMENT BENEFITS Contributions to defined contribution retirement schemes made by the Airline Operations of Xinjiang Airlines Group are charged to the combined statements of operations as and when incurred (see Note 21). (u) RELATED PARTIES For the purposes of the Financial Information set out below, parties are considered to be related to the Airline Operations of Xinjiang Airlines Group if the Airline Operations of Xinjiang Airlines Group has the ability, directly or indirectly, to control the party or exercise significant influence over the party in making financial and operating decisions, or vice versa, or where the Airline Operations of Xinjiang Airlines Group and the party are subject to common control or common significant influence. Related parties may be individuals or other entities. (v) SEGMENT REPORTING A segment is a distinguishable component of the Airline Operations of Xinjiang Airlines Group that is engaged either in providing products or services (business segment), or in providing products or services within a particular economic environment (geographical segment), which is subject to risks and rewards that are different from those of other segments. The Airline Operations of Xinjiang Airlines Group operates principally as a single business segment for the provision of air transportation services. The analysis of operating revenue by geographical segment is based on the following criteria: (i) Traffic revenue from domestic services within the PRC (excluding Hong Kong) is attributed to the domestic operation. Traffic revenue from inbound/outbound services between the PRC and Hong Kong, and overseas destinations is attributed to the international operation. (ii) Other revenue from ticket selling, general aviation and ground services, air catering and other miscellaneous services are attributed on the basis of where the services are performed. (w) USE OF ESTIMATES The preparation of the Financial Information in accordance with IFRS requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities as at 31 December, 2001, 2002 and 2003 and 30 June, 2004 and the reported amounts of revenues and expenses during the relevant period. Actual results could differ from those estimates. -125- APPENDIX III ACCOUNTANTS' REPORT ON FINANCIAL INFORMATION OF THE AIRLINE OPERATIONS OF XINJIANG AIRLINES GROUP (V) NOTES TO THE FINANCIAL INFORMATION (CONTINUED) 4. OPERATING REVENUE Operating revenue comprises revenues from airline and airline related business and is stated net of sales tax. In addition, the operating revenue for each of the years in the three-year period ended 31 December, 2003 and the three-month period ended 31 March, 2004 was stated net of contributions to the CAAC Infrastructure Development Fund. An analysis of operating revenue is as follows: SIX-MONTH PERIODS YEARS ENDED 31 DECEMBER, ENDED 30 JUNE, ------------------------------- ---------------------- 2001 2002 2003 2003 2004 RMB'000 RMB'000 RMB'000 RMB'000 RMB'000 (unaudited) TRAFFIC REVENUE Passenger 1,950,343 2,104,039 1,982,250 675,798 1,126,626 Cargo and mail 97,666 111,341 92,824 41,512 49,674 --------- --------- --------- ----------- --------- 2,048,009 2,215,380 2,075,074 717,310 1,176,300 --------- --------- --------- ----------- --------- OTHER OPERATING REVENUE Commission income 5,209 5,382 7,840 3,459 6,139 Ground services income - 8,784 14,098 4,671 6,589 Aircraft lease income 114,427 112,370 35,729 34,196 7,116 Others 6,595 11,196 18,892 13,514 18,932 --------- --------- --------- ----------- --------- 126,231 137,732 76,559 55,840 38,776 --------- --------- --------- ----------- --------- 2,174,240 2,353,112 2,151,633 773,150 1,215,076 ========= ========= ========= =========== ========= -126- APPENDIX III ACCOUNTANTS' REPORT ON FINANCIAL INFORMATION OF THE AIRLINE OPERATIONS OF XINJIANG AIRLINES GROUP (V) NOTES TO THE FINANCIAL INFORMATION (CONTINUED) 4. OPERATING REVENUE (Continued) Pursuant to various sales tax rules and regulations, the Airline Operations of Xinjiang Airlines Group is required to pay sales tax to national and local tax authorities at the following rates during the relevant period: TYPES OF REVENUE APPLICABLE SALES TAX RATES ---------------- ----------------------------------------------------------------------- Traffic revenue 3% of traffic revenue in respect of domestic flights and international outbound flights during the relevant period, except for the period from 1 May, 2003 to 31 December, 2003, during which passenger revenue was exempted from sales tax. Other operating 3% of commission income, general aviation income and ground services revenue income, and 3% to 5% of other operating revenue. The amount of sales tax incurred during the relevant period is as follows: SIX-MONTH PERIODS YEARS ENDED 31 DECEMBER, ENDED 30 JUNE, ------------------------- -------------------- 2001 2002 2003 2003 2004 RMB'000 RMB'000 RMB'000 RMB'000 RMB'000 (unaudited) Sales tax netted off against operating revenue 68,057 74,528 21,516 17,827 39,550 ======= ======= ======= =========== ======= In addition, the Airline Operations of Xinjiang Airlines Group is required to pay contributions to the CAAC Infrastructure Development Fund. Prior to 1 April, 2004, contributions to the CAAC Infrastructure Development Fund were payable at 5% and 2% respectively of the domestic and international traffic revenue of the Airline Operations of Xinjiang Airlines Group except for the period from 1 May, 2003 to 31 March, 2004 during which the Airline Operations of Xinjiang Airlines Group was exempted from contributions to the CAAC Infrastructure Development Fund. Effective from 1 April, 2004, contributions to the CAAC Infrastructure Development Fund are payable based on the traffic capacity of the Airline Operations of Xinjiang Airlines Group deployed on its routes. The contributions now form part of the flight operations expenses. Contributions made to the CAAC Infrastructure Development Fund during the relevant period are as follows: SIX-MONTH PERIODS YEARS ENDED 31 DECEMBER, ENDED 30 JUNE, ------------------------- -------------------- 2001 2002 2003 2003 2004 RMB'000 RMB'000 RMB'000 RMB'000 RMB'000 (unaudited) Contributions made to the CAAC Infrastructure Development Fund - netted off against traffic revenue 108,283 117,522 28,238 28,238 - - included in flight operations expenses - - - - 18,703 ------- ------- ------- ----------- ------- 108,283 117,522 28,238 28,238 18,703 ======= ======= ======= =========== ======= -127- APPENDIX III ACCOUNTANTS' REPORT ON FINANCIAL INFORMATION OF THE AIRLINE OPERATIONS OF XINJIANG AIRLINES GROUP (V) NOTES TO THE FINANCIAL INFORMATION (CONTINUED) 4. OPERATING REVENUE (Continued) An analysis of the operating revenue of the Airline Operations of Xinjiang Airlines Group by geographical segment is set out as below: DOMESTIC *INTERNATIONAL TOTAL --------- -------------- --------- RMB'000 RMB'000 RMB'000 YEAR ENDED 31 DECEMBER, 2001 Traffic revenue 1,955,009 93,000 2,048,009 Other revenue 126,231 - 126,231 --------- -------------- --------- Total operating revenue 2,081,240 93,000 2,174,240 ========= ============== ========= YEAR ENDED 31 DECEMBER, 2002 Traffic revenue 2,110,380 105,000 2,215,380 Other revenue 137,732 - 137,732 --------- -------------- --------- Total operating revenue 2,248,112 105,000 2,353,112 ========= ============== ========= YEAR ENDED 31 DECEMBER, 2003 Traffic revenue 1,967,212 107,862 2,075,074 Other revenue 76,559 - 76,559 --------- -------------- --------- Total operating revenue 2,043,771 107,862 2,151,633 ========= ============== ========= SIX-MONTH PERIOD ENDED 30 JUNE, 2003 (UNAUDITED) Traffic revenue 679,912 37,398 717,310 Other revenue 55,840 - 55,840 --------- -------------- --------- Total operating revenue 735,752 37,398 773,150 ========= ============== ========= SIX-MONTH PERIOD ENDED 30 JUNE, 2004 Traffic revenue 1,109,261 67,039 1,176,300 Other revenue 38,776 - 38,776 --------- -------------- --------- Total operating revenue 1,148,037 67,039 1,215,076 ========= ============== ========= * Routes are mainly between the PRC and Hong Kong, Pakistan and Russia. The major revenue-earning assets of the Airline Operations of Xinjiang Airlines Group are its aircraft fleet, most of which are registered in the PRC. Since the aircraft of the Airline Operations of Xinjiang Airlines Group are employed flexibly across its route network, there is no suitable basis of allocating such assets to geographic segments. Substantially all of the non-aircraft identifiable assets of the Airline Operations of Xinjiang Airlines Group are located in the PRC. -128- APPENDIX III ACCOUNTANTS' REPORT ON FINANCIAL INFORMATION OF THE AIRLINE OPERATIONS OF XINJIANG AIRLINES GROUP (V) NOTES TO THE FINANCIAL INFORMATION (CONTINUED) 5. OPERATING EXPENSES An analysis of the operating expenses during the relevant period is set out below: SIX-MONTH PERIODS YEARS ENDED 31 DECEMBER, ENDED 30 JUNE, ------------------------------- ---------------------- 2001 2002 2003 2003 2004 RMB'000 RMB'000 RMB'000 RMB'000 RMB'000 (unaudited) Jet fuel 536,466 472,855 481,198 211,472 314,402 Aircraft maintenance 189,487 196,739 245,065 108,682 122,283 Routes 317,150 334,768 406,533 179,463 213,694 Depreciation and amortisation - owned assets 312,814 352,150 346,304 166,247 173,177 - assets held under finance leases 2,177 - - - - Operating lease charges - aircraft and other flight equipment 183,686 263,970 253,621 125,171 125,980 - buildings 10,606 7,857 6,893 4,111 4,565 Staff costs - salaries, wages and welfare 139,999 160,259 230,165 94,081 114,730 - contributions to defined contribution retirement schemes 7,265 7,119 13,972 6,517 16,259 Office and administration 16,709 27,157 93,990 37,010 45,532 Impairment loss on aircraft and other flight equipment (Note) - 131,710 - - - Provision for obsolescence of inventories (Note) - 12,007 - - - Others 189,132 189,508 113,134 46,488 84,674 --------- --------- --------- ----------- --------- 1,905,491 2,156,099 2,190,875 979,242 1,215,296 ========= ========= ========= =========== ========= Note: In accordance with the regulations announced by the CAAC in 2002, IL86 aircraft were not allowed to fly unless they were installed with additional security modules starting from 1 January, 2003. After having evaluated the costs and benefits, management decided to ground the aircraft. Management assessed the recoverable amount of the IL86 aircraft and their related flight equipment and spare parts. Impairment loss and provision for obsolescence of inventories approximately RMB132 million and RMB12 million respectively were provided for to write down the carrying value of the aircraft and their related assets to their estimated net realisable value. -129- APPENDIX III ACCOUNTANTS' REPORT ON FINANCIAL INFORMATION OF THE AIRLINE OPERATIONS OF XINJIANG AIRLINES GROUP (V) NOTES TO THE FINANCIAL INFORMATION (CONTINUED) 6. INTEREST EXPENSE An analysis of the interest expense is set out below: SIX-MONTH PERIODS YEARS ENDED 31 DECEMBER, ENDED 30 JUNE, ------------------------- -------------------- 2001 2002 2003 2003 2004 RMB'000 RMB'000 RMB'000 RMB'000 RMB'000 (unaudited) Finance charges on obligations under finance leases 1,541 - - - - Interest on bank and other loans wholly repayable within five years 38,099 48,809 110,559 33,780 39,523 Interest on other loans 149,525 135,209 90,856 47,572 29,894 ------- ------- ------- ----------- ------- 189,165 184,018 201,415 81,352 69,417 ======= ======= ======= =========== ======= 7. INCOME TAX Income tax in the combined statements of operations represents: SIX-MONTH PERIODS YEARS ENDED 31 DECEMBER, ENDED 30 JUNE, -------------------------- -------------------- 2001 2002 2003 2003 2004 RMB'000 RMB'000 RMB'000 RMB'000 RMB'000 (unaudited) Deferred taxation (Note 19) 35,782 9,492 (155,808) (95,258) (24,048) ======= ======= ======== =========== ======= Pursuant to the income tax rules and regulations of the PRC, the Airline Operations of Xinjiang Airlines Group is liable to PRC income tax at a rate of 33%. In respect of the overseas airline activities, the Airline Operations of Xinjiang Airlines Group has either obtained exemptions from overseas taxation pursuant to the bilateral aviation agreements between the overseas governments and the PRC government, or has sustained tax losses in these overseas jurisdictions. Accordingly, no provision for overseas tax has been made for the relevant period. -130- APPENDIX III ACCOUNTANTS' REPORT ON FINANCIAL INFORMATION OF THE AIRLINE OPERATIONS OF XINJIANG AIRLINES GROUP (V) NOTES TO THE FINANCIAL INFORMATION (CONTINUED) 7. INCOME TAX (Continued) A reconciliation of the expected tax expense with the actual tax expense is as follows: SIX-MONTH PERIODS YEARS ENDED 31 DECEMBER, ENDED 30 JUNE, -------------------------- -------------------- 2001 2002 2003 2003 2004 Note RMB'000 RMB'000 RMB'000 RMB'000 RMB'000 (unaudited) Profit/(loss) before income tax and minority interests 76,731 11,778 (480,867) (290,456) (69,755) ======= ======= ======== ========== ======= Expected PRC income tax expense/(credit) at 33% 25,321 3,887 (158,686) (95,850) (23,019) Adjustments: - Non-deductible expenses (i) 10,461 5,605 2,878 1,205 2,081 - Non-taxable income - - - - (746) - Differences in income and expense recognition for certain inter-company transactions (ii) - - - (613) (2,364) ------- ------- -------- ---------- ------- 35,782 9,492 (155,808) (95,258) (24,048) ======= ======= ======== ========== ======= Notes: (i) Non-deductible expenses mainly represent personnel and other miscellaneous expenses in excess of statutory deductible limits for taxation purpose. (ii) Amounts represent tax effects of differences in the recognition of income and expenses in respect of certain inter-company transactions. Such differences in recognition of income and expenses are eliminated on consolidation. In accordance with relevant PRC tax regulations, a PRC lessee is liable to pay PRC withholding tax in respect of any lease payments regularly made to an overseas lessor. Depending on the circumstances, this tax is generally imposed at a fixed rate ranging from 10% to 20% of the lease payments, or in certain cases, the interest components of such payments. Pursuant to an approval document from the State Tax Bureau, lease arrangements executed prior to 1 September, 1999 are exempted from PRC withholding tax. During the relevant period, PRC withholding tax payable in respect of the leases executed on or after 1 September, 1999, which has been included as part of the operating lease charges, are as follows: SIX-MONTH PERIODS YEARS ENDED 31 DECEMBER, ENDED 30 JUNE, ------------------------- -------------------- 2001 2002 2003 2003 2004 RMB'000 RMB'000 RMB'000 RMB'000 RMB'000 (unaudited) PRC withholding tax 1,818 7,601 7,957 3,824 3,948 ======= ======= ======= =========== ======= -131- APPENDIX III ACCOUNTANTS' REPORT ON FINANCIAL INFORMATION OF THE AIRLINE OPERATIONS OF XINJIANG AIRLINES GROUP (V) NOTES TO THE FINANCIAL INFORMATION (CONTINUED) 8. DIRECTORS' EMOLUMENTS AND INDIVIDUALS WITH HIGHEST EMOLUMENTS (i) DIRECTORS' EMOLUMENTS No board of directors or similar corporate governance body was established by the Airline Operations of Xinjiang Airlines during the relevant period. Accordingly, no directors' emoluments were paid during the relevant period. (ii) INDIVIDUALS WITH HIGHEST EMOLUMENTS Details of emoluments paid to the five highest paid individuals are as follows: SIX-MONTH PERIODS YEARS ENDED 31 DECEMBER, ENDED 30 JUNE, ------------------------- -------------------- 2001 2002 2003 2003 2004 RMB'000 RMB'000 RMB'000 RMB'000 RMB'000 (unaudited) Salaries, allowances and benefits in kind 286 214 420 172 388 Retirement benefits 37 23 62 29 29 ------- ------- ------- ----------- ------- 323 237 482 201 417 ======= ======= ======= =========== ======= An analysis of emoluments paid to the five highest paid individuals by number of individuals and emolument ranges is as follows: SIX-MONTH PERIODS YEARS ENDED 31 DECEMBER, ENDED 30 JUNE, ------------------------- -------------------- 2001 2002 2003 2003 2004 (unaudited) RMB Nil - RMB1,060,000 (HK$1,000,000 equivalent) 5 5 5 5 5 ======= ======= ======= =========== ======= None of these employees received any inducements or compensation for loss of office, or waived any emoluments during the relevant period. -132- APPENDIX III ACCOUNTANTS' REPORT ON FINANCIAL INFORMATION OF THE AIRLINE OPERATIONS OF XINJIANG AIRLINES GROUP (V) NOTES TO THE FINANCIAL INFORMATION (CONTINUED) 9. PROPERTY, PLANT AND EQUIPMENT, NET OTHER AIRCRAFT FLIGHT --------------------------- EQUIPMENT, MACHINERY, HELD UNDER INCLUDING EQUIPMENT FINANCE ROTABLE AND BUILDINGS OWNED LEASES SPARES VEHICLES TOTAL RMB'000 RMB'000 RMB'000 RMB'000 RMB'000 RMB'000 COST: At 1 January, 2001 552,094 2,943,879 289,321 940,429 271,622 4,997,345 Reclassification on exercise of purchase options - 289,321 (289,321) - - - Additions - 948,783 - 50,788 13,537 1,013,108 Transferred from construction in progress - 7,806 - - 13,214 21,020 Disposals (4,064) (246,033) - (155,878) (23,384) (429,359) ------------ ------------ ------------ ------------ ------------ ------------ At 31 December, 2001 548,030 3,943,756 - 835,339 274,989 5,602,114 ACCUMULATED DEPRECIATION AND IMPAIRMENT LOSSES: At 1 January, 2001 51,853 840,805 98,490 470,834 97,206 1,559,188 Reclassification on exercise of purchase options - 100,667 (100,667) - - - Depreciation for the year 17,288 195,539 2,177 73,538 26,449 314,991 Written back on disposal (1,548) (235,050) - (150,286) (12,711) (399,595) ------------ ------------ ------------ ------------ ------------ ------------ At 31 December, 2001 67,593 901,961 - 394,086 110,944 1,474,584 ------------ ------------ ------------ ------------ ------------ ------------ NET BOOK VALUE: At 31 December, 2001 480,437 3,041,795 - 441,253 164,045 4,127,530 ============ ============ ============ ============ ============ ============ -133- APPENDIX III ACCOUNTANTS' REPORT ON FINANCIAL INFORMATION OF THE AIRLINE OPERATIONS OF XINJIANG AIRLINES GROUP (V) NOTES TO THE FINANCIAL INFORMATION (CONTINUED) 9. PROPERTY, PLANT AND EQUIPMENT, NET (Continued) OTHER AIRCRAFT FLIGHT ----------------------- EQUIPMENT, MACHINERY, HELD UNDER INCLUDING EQUIPMENT FINANCE ROTABLE AND BUILDINGS OWNED LEASES SPARES VEHICLES TOTAL RMB'000 RMB'000 RMB'000 RMB'000 RMB'000 RMB'000 COST: At 1 January, 2002 548,030 3,943,756 - 835,339 274,989 5,602,114 Additions 40,810 501,775 - 142,435 20,035 705,055 Transferred from construction in progress 33,920 - - - 32,437 66,357 Disposals (16,961) - - - (29,399) (46,360) --------- --------- ---------- ---------- ---------- --------- At 31 December, 2002 605,799 4,445,531 - 977,774 298,062 6,327,166 --------- --------- ---------- ---------- ---------- --------- ACCUMULATED DEPRECIATION AND IMPAIRMENT LOSSES: At 1 January, 2002 67,593 901,961 - 394,086 110,944 1,474,584 Depreciation for the year 18,678 231,434 - 71,655 30,383 352,150 Impairment loss for the year - 80,074 - 51,636 - 131,710 Written back on disposal (4,846) - - - (14,176) (19,022) --------- --------- ---------- ---------- ---------- --------- At 31 December, 2002 81,425 1,213,469 - 517,377 127,151 1,939,422 --------- --------- ---------- ---------- ---------- --------- NET BOOK VALUE: At 31 December, 2002 524,374 3,232,062 - 460,397 170,911 4,387,744 ========= ========= ========== ========== ========== ========= -134- APPENDIX III ACCOUNTANTS' REPORT ON FINANCIAL INFORMATION OF THE AIRLINE OPERATIONS OF XINJIANG AIRLINES GROUP (V) NOTES TO THE FINANCIAL INFORMATION (CONTINUED) 9. PROPERTY, PLANT AND EQUIPMENT, NET (Continued) OTHER AIRCRAFT FLIGHT ----------------------- EQUIPMENT, MACHINERY, HELD UNDER INCLUDING EQUIPMENT FINANCE ROTABLE AND BUILDINGS OWNED LEASES SPARES VEHICLES TOTAL RMB'000 RMB'000 RMB'000 RMB'000 RMB'000 RMB'000 COST OR VALUATION: At 1 January, 2003 605,799 4,445,531 - 977,774 298,062 6,327,166 Transferred to owner upon the Reorganisation (56,351) - - - (3,776) (60,127) Additions 569 - - 94,841 7,568 102,978 Transferred from construction in progress 47,554 - - - 40,605 88,159 Disposals (2,770) (317,719) - (336,451) (12,998) (669,938) Revaluation (101,385) (1,145,358) - (253,365) (147,154) (1,647,262) --------- ---------- ---------- ---------- ---------- ---------- At 31 December, 2003 493,416 2,982,454 - 482,799 182,307 4,140,976 --------- ---------- ---------- ---------- ---------- ---------- REPRESENTING: Valuation - 2003 493,416 2,982,454 - 482,799 182,307 4,140,976 --------- ---------- ---------- ---------- ---------- ---------- ACCUMULATED DEPRECIATION AND IMPAIRMENT LOSSES: At 1 January, 2003 81,425 1,213,469 - 517,377 127,151 1,939,422 Transferred to owner upon the Reorganisation (11,692) - - - (2,163) (13,855) Depreciation for the year 17,093 222,771 - 58,845 47,595 346,304 Written back on disposal (90) (297,328) - (323,302) (1,877) (622,597) Elimination on revaluation (86,736) (1,138,912) - (252,920) (170,706) (1,649,274) --------- ---------- ---------- ---------- ---------- ---------- At 31 December, 2003 - - - - - - --------- ---------- ---------- ---------- ---------- ---------- NET BOOK VALUE: At 31 December, 2003 493,416 2,982,454 - 482,799 182,307 4,140,976 ========= ========== ========== ========== ========== ========== -135- APPENDIX III ACCOUNTANTS' REPORT ON FINANCIAL INFORMATION OF THE AIRLINE OPERATIONS OF XINJIANG AIRLINES GROUP (V) NOTES TO THE FINANCIAL INFORMATION (CONTINUED) 9. PROPERTY, PLANT AND EQUIPMENT, NET (Continued) OTHER AIRCRAFT FLIGHT ----------------------- EQUIPMENT, MACHINERY, HELD UNDER INCLUDING EQUIPMENT FINANCE ROTABLE AND BUILDINGS OWNED LEASES SPARES VEHICLES TOTAL RMB'000 RMB'000 RMB'000 RMB'000 RMB'000 RMB'000 COST OR VALUATION: At 1 January, 2004 493,416 2,982,454 - 482,799 182,307 4,140,976 Additions 16 - - 39,899 3,349 43,264 Transferred from construction in progress 31,515 - - - 2,216 33,731 Disposals (148) - - - (4,716) (4,864) ---------- ----------- ---------- ---------- ---------- ---------- At 30 June, 2004 524,799 2,982,454 - 522,698 183,156 4,213,107 ---------- ----------- ---------- ---------- ---------- ---------- REPRESENTING: Cost 31,531 - - 39,899 5,565 76,995 Valuation - 2003 493,268 2,982,454 - 482,799 177,591 4,136,112 ---------- ----------- ---------- ---------- ---------- ---------- 524,799 2,982,454 - 522,698 183,156 4,213,107 ---------- ----------- ---------- ---------- ---------- ---------- ACCUMULATED DEPRECIATION AND IMPAIRMENT LOSSES: At 1 January, 2004 - - - - - - Depreciation for the period 11,330 117,652 - 25,233 18,962 173,177 Written back on disposal (8) - - - (3,770) (3,778) ---------- ----------- ---------- ---------- ---------- ---------- At 30 June, 2004 11,322 117,652 - 25,233 15,192 169,399 ---------- ----------- ---------- ---------- ---------- ---------- NET BOOK VALUE: At 30 June, 2004 513,477 2,864,802 - 497,465 167,964 4,043,708 ========== =========== ========== ========== ========== ========== All of the buildings of the Airline Operations of Xinjiang Airlines Group are located in the PRC. As required by the relevant PRC rules and regulations with respect to the Acquisition, the property, plant and equipment of the Airline Operations of Xinjiang Airlines Group as at 31 December, 2003 were revalued for each asset class by China Enterprise Appraisal Co., Ltd. (the "PRC Valuers"), independent valuers registered in the PRC, on a depreciated replacement cost basis. The value of property, plant and equipment of the Airline Operations of Xinjiang Airlines Group as at 31 December, 2003 has been determined at approximately RMB4,141 million. Such amount will serve as the tax base for such assets for future years (see Note 19). Surplus arising from revaluation of certain property, plant and equipment totalled approximately RMB237 million. The amount of approximately RMB227 million, net of minority interests' share of approximately RMB10 million, has been credited to the owner's fund. Deficit arising from the revaluation of certain property, plant and equipment totalling approximately RMB235 million has been charged as an expense for the year ended 31 December, 2003. The net surplus on the revaluation of the property, plant and equipment of approximately RMB2 million has been incorporated in the combined balance sheet of the Airline Operations of Xinjiang Airlines Group as at 31 December, 2003. The properties of the Airline Operations of Xinjiang Airlines Group were also valued separately by Chesterton, independent qualified valuers in Hong Kong, as at 31 December, 2003. The value arrived at by Chesterton was approximately the same as that arrived at by the PRC valuers. -136- APPENDIX III ACCOUNTANTS' REPORT ON FINANCIAL INFORMATION OF THE AIRLINE OPERATIONS OF XINJIANG AIRLINES GROUP (V) NOTES TO THE FINANCIAL INFORMATION (CONTINUED) 9. PROPERTY, PLANT AND EQUIPMENT, NET (Continued) The historical carrying amounts of the property, plant and equipment of the Airline Operations of Xinjiang Airlines Group as at 31 December, 2003 and the revalued amounts of these assets were as follows: HISTORICAL CARRYING REVALUATION REVALUATION REVALUED AMOUNT SURPLUS DEFICIT AMOUNT ---------- ----------- ----------- --------- RMB'000 RMB'000 RMB'000 RMB'000 Buildings 508,065 47,162 61,811 493,416 Owned aircraft 2,988,900 89,883 96,329 2,982,454 Other flight equipment, including rotable spares 483,244 59,284 59,729 482,799 Machinery, equipment and vehicles 158,755 40,518 16,966 182,307 --------- ------- ------- --------- 4,138,964 236,847 234,835 4,140,976 ========= ======= ======= ========= The effect of the above revaluation is to increase annual depreciation charges by approximately RMB6 million for year beginning 1 January, 2004. Had the property, plant and equipment been stated at cost less accumulated depreciation and impairment losses, the net book value of the property, plant and equipment of the Airline Operations of Xinjiang Airlines Group as at 30 June, 2004 would have been approximately RMB4, 044 million, made up as follows: 30 JUNE, 2004 --------- RMB'000 Buildings 527,872 Owned aircraft 2,879,824 Other flight equipment, including rotable spares 490,944 Machinery, equipment and vehicles 145,802 --------- 4,044,442 ========= As at 31 December, 2001, 2002 and 2003 and 30 June, 2004, certain aircraft of the Airline Operations of Xinjiang Airlines Group with an aggregate carrying value of approximately RMB1,935 million, RMB 1,786 million, RMB 1,772 million and RMB1,689 million respectively, were mortgaged under certain loan agreements (See Note 15). - 137 - APPENDIX III ACCOUNTANTS' REPORT ON FINANCIAL INFORMATION OF THE AIRLINE OPERATIONS OF XINJIANG AIRLINES GROUP (V) NOTES TO THE FINANCIAL INFORMATION (CONTINUED) 9. PROPERTY, PLANT AND EQUIPMENT, NET (Continued) During the relevant period, the Airline Operations of Xinjiang Airlines Group entered into certain lease agreements to lease several of its aircraft to other airlines. The terms of such leases generally range from one to six months. As at 31 December, 2001, 2002 and 2003 and 30 June, 2004, the cost or valuation and accumulated depreciation and impairment losses of the relevant aircraft were set out below: 31 DECEMBER, 30 JUNE, ---------------------------------------------- -------- 2001 2002 2003 2004 RMB'000 RMB'000 RMB'000 RMB'000 Cost or valuation 287,874 436,493 402,190 - Accumulated depreciation and impairment losses (110,786) (95,028) - - -------- ------- ------- -------- 177,088 341,465 402,190 - ======== ======= ======= ======== Total future minimum lease payments under non-cancellable operating leases of the Airline Operations of Xinjiang Airlines Group are receivable as follows: 31 DECEMBER, 30 JUNE, --------------------------------------------- -------- 2001 2002 2003 2004 RMB'000 RMB'000 RMB'000 RMB'000 Within one year 37,802 32,861 3,953 - ======= ======= ======= ======== 10. CONSTRUCTION IN PROGRESS SIX-MONTH PERIOD ENDED YEARS ENDED 31 DECEMBER, 30 JUNE, -------------------------------------------- ------------ 2001 2002 2003 2004 RMB'000 RMB'000 RMB'000 RMB'000 Balance at 1 January, 23,873 61,450 66,144 32,223 Additions 58,597 71,051 54,238 14,912 Transferred to property, plant and equipment (21,020) (66,357) (88,159) (33,731) ------- ------- ------- ------- Balance at 31 December/30 June, 61,450 66,144 32,223 13,404 ======= ======= ======= ======= - 138 - APPENDIX III ACCOUNTANTS' REPORT ON FINANCIAL INFORMATION OF THE AIRLINE OPERATIONS OF XINJIANG AIRLINES GROUP (V) NOTES TO THE FINANCIAL INFORMATION (CONTINUED) 11. INVENTORIES 31 DECEMBER, 30 JUNE, ------------------------------------------ -------- 2001 2002 2003 2004 RMB'000 RMB'000 RMB'000 RMB'000 Expendable spare parts and maintenance materials 66,645 65,611 57,452 69,558 Other supplies 6,472 6,452 1,779 1,753 ------- ------- ------- ------- 73,117 72,063 59,231 71,311 Less: Provision for obsolescence - (12,007) - - ------- ------- ------- ------- 73,117 60,056 59,231 71,311 ======= ======= ======= ======= No significant amount of inventories was carried at net realisable value as at 31 December, 2001, 2002 and 2003 and 30 June, 2004. 12. TRADE RECEIVABLES Credit terms granted by the Airline Operations of Xinjiang Airlines Group to sales agents and other customers generally range from one to three months. An aging analysis of trade receivables, net of provision for doubtful accounts, is set out below: 31 DECEMBER, 30 JUNE, ----------------------------------------- -------- 2001 2002 2003 2004 RMB'000 RMB'000 RMB'000 RMB'000 Within 1 month 142,086 114,605 47,533 19,330 More than 1 month but less than 3 months 12,932 24,521 31,886 34,730 More than 3 months but less than 12 months 7,616 44,497 16,869 71,152 ------- ------- ------- ------- 162,634 183,623 96,288 125,212 ======= ======= ======= ======= As at 31 December, 2003 and 30 June, 2004, the Airline Operations of Xinjiang Airlines Group had amount due from a fellow subsidiary of approximately RMB38 million and RMB1 million respectively which was included in trade receivables. - 139 - APPENDIX III ACCOUNTANTS' REPORT ON FINANCIAL INFORMATION OF THE AIRLINE OPERATIONS OF XINJIANG AIRLINES GROUP (V) NOTES TO THE FINANCIAL INFORMATION (CONTINUED) 13. OTHER RECEIVABLES AND PREPAID EXPENSES Other receivables and prepaid expenses comprise: 31 DECEMBER, 30 JUNE, -------------------------------------------- -------- 2001 2002 2003 2004 RMB'000 RMB'000 RMB'000 RMB'000 Prepaid expenses and deposits 28,248 28,321 27,171 38,046 Amount due from CSAHC - 42,585 67,952 82,545 Amounts due from related companies - - 4,033 7,849 Manufacturers' credit receivables 67,532 61,552 14,420 13,558 Custom duties refundable 14,728 16,104 3,844 1,800 Aircraft lease receivables 3,342 10,002 7,348 10,242 Other receivables 3,284 14,825 10,118 19,907 ------- ------- ------- ------- 117,134 173,389 134,886 173,947 Less: Provision for doubtful accounts - (4,652) (4,652) (4,652) ------- ------- ------- ------- 117,134 168,737 130,234 169,295 ======= ======= ======= ======= 14. CASH AND CASH EQUIVALENTS 31 DECEMBER, 30 JUNE, ----------------------------------------- -------- 2001 2002 2003 2004 RMB'000 RMB'000 RMB'000 RMB'000 Cash at bank and in hand 248,685 246,387 362,779 263,984 Time deposits with maturity within three months 8,000 - 14,002 23,014 ------- ------- ------- ------- 256,685 246,387 376,781 286,998 ======= ======= ======= ======= - 140 - APPENDIX III ACCOUNTANTS' REPORT ON FINANCIAL INFORMATION OF THE AIRLINE OPERATIONS OF XINJIANG AIRLINES GROUP (V) NOTES TO THE FINANCIAL INFORMATION (CONTINUED) 15. BANK AND OTHER LOANS The bank and other loans of the Airline Operations of Xinjiang Airlines Group under current liabilities comprise: 31 DECEMBER, 30 JUNE, --------------------------------------------- --------- 2001 2002 2003 2004 RMB'000 RMB'000 RMB'000 RMB'000 Short term bank loans 400,000 680,000 438,980 611,745 Short term loans from CSAHC - - 345,000 200,000 Current portion of long term bank loans 293,027 210,271 148,800 244,894 ------- ------- ------- --------- 693,027 890,271 932,780 1,056,639 ======= ======= ======= ========= The weighted average interest rate on short term bank loans of the Airline Operations of Xinjiang Airlines Group was 6.0%, 5.0%, 3.7% and 3.6% as at 31 December, 2001, 2002 and 2003 and 30 June, 2004 respectively. The short term loans from CSAHC of approximately RMB345 million as at 31 December, 2003 were unsecured and interest free. The short term loans from CSAHC of approximately RMB200 million as at 30 June, 2004 are unsecured and interest bearing at 4.8% per annum. The long term bank loans of the Airline Operations of Xinjiang Airlines Group comprise: 31 DECEMBER, 30 JUNE, INTEREST RATE AND ------------------------------------- --------- BANK LOANS FINAL MATURITY 2001 2002 2003 2004 RMB'000 RMB'000 RMB'000 RMB'000 Renminbi denominated Floating interest rates as specified by the People's Bank of China ranging from 4.94% to 5.94% per annum as at 30 June, 2004, with maturities through 2011 1,093,450 871,000 910,000 945,000 US dollars denominated Fixed interest rates ranging from 2.38% to 7.63% per annum, with maturities through 2013 1,584,549 1,390,657 1,199,261 1,034,931 --------- --------- --------- --------- 2,677,999 2,261,657 2,109,261 1,979,931 Less: loans due within one year classified as current liabilities (293,027) (210,271) (148,800) (244,894) --------- --------- --------- --------- 2,384,972 2,051,386 1,960,461 1,735,037 ========= ========= ========= ========= - 141 - APPENDIX III ACCOUNTANTS' REPORT ON FINANCIAL INFORMATION OF THE AIRLINE OPERATIONS OF XINJIANG AIRLINES GROUP (V) NOTES TO THE FINANCIAL INFORMATION (CONTINUED) 15. BANK AND OTHER LOANS (Continued) The aggregate maturities of the bank and other loans of the Airline Operations of Xinjiang Airlines Group are analysed as follows: 31 DECEMBER, 30 JUNE, --------------------------------------- ---------- 2001 2002 2003 2004 RMB'000 RMB'000 RMB'000 RMB'000 BANK AND OTHER LOANS DUE: Within one year 693,027 890,271 932,780 1,056,639 In the second year 328,251 224,031 326,098 319,701 In the third to fifth year, inclusive 799,418 943,667 901,177 735,526 After the fifth year 1,257,303 883,688 733,186 679,810 --------- --------- --------- ---------- 3,077,999 2,941,657 2,893,241 2,791,676 Portion classified as current liabilities (693,027) (890,271) (932,780) (1,056,639) --------- --------- --------- ---------- 2,384,972 2,051,386 1,960,461 1,735,037 ========= ========= ========= ========== As at 31 December, 2001, 2002 and 2003 and 30 June, 2004, bank loans of the Airline Operations of Xinjiang Airlines Group totalling approximately RMB1,585 million, RMB1,391 million, RMB1,199 million and RMB1,035 million respectively were secured by mortgages over certain aircraft (See Note 9). As at 31 December, 2001, 2002 and 2003 and 30 June, 2004, certain bank loans of the Airline Operations of Xinjiang Airlines Group were guaranteed by the following parties: 31 DECEMBER, 30 JUNE, ---------------------------------------- -------- 2001 2002 2003 2004 RMB'000 RMB'000 RMB'000 RMB'000 CAAC 303,950 21,000 - - CSAHC - - 60,000 95,000 Export-Import Bank of the United States 797,514 716,159 629,307 583,798 Bank of China 71,017 61,572 - - The Industrial and Commercial Bank of China 716,018 612,926 205,779 178,005 --------- --------- ------- ------- 1,888,499 1,411,657 895,086 856,803 ========= ========= ======= ======= - 142 - APPENDIX III ACCOUNTANTS' REPORT ON FINANCIAL INFORMATION OF THE AIRLINE OPERATIONS OF XINJIANG AIRLINES GROUP (V) NOTES TO THE FINANCIAL INFORMATION (CONTINUED) 16. OTHER LIABILITIES AND ACCRUED EXPENSES Other liabilities and accrued expenses represent: 31 DECEMBER, 30 JUNE, -------------------------------------- -------- 2001 2002 2003 2004 RMB'000 RMB'000 RMB'000 RMB'000 Accrued expenses 242,418 406,949 476,640 500,030 CAAC Infrastructure Development Fund payable 61,086 13,902 20,050 12,697 Business and other taxes payable 57,445 36,565 20,491 11,646 Salary and staff welfare payable 11,204 17,143 71 - Other liabilities 149,358 162,669 185,229 194,410 ------- ------- ------- ------- 521,511 637,228 702,481 718,783 ======= ======= ======= ======= As at 31 December, 2001, 2002 and 2003 and 30 June, 2004, the Airline Operations of Xinjiang Airlines Group had amounts due to related companies of approximately RMB12 million, RMB19 million, RMB22 million and RMB10 million respectively which were included in other liabilities and accrued expenses. These amounts are unsecured, interest free and repayable on demand. 17. ACCOUNTS PAYABLE An ageing analysis of accounts payable is as follows: 31 DECEMBER, 30 JUNE, -------------------------------------- -------- 2001 2002 2003 2004 RMB'000 RMB'000 RMB'000 RMB'000 Due within 1 month or on demand 53,893 68,142 22,916 48,008 Due after 1 month but within 3 months 17,553 24,264 36,002 71,481 Due after 3 months but within 6 months 197 197 35,069 9,149 ------- ------- ------- ------- 71,643 92,603 93,987 128,638 ======= ======= ======= ======= As at 30 June, 2004, the Airline Operations of Xinjiang Airlines Group had amounts due to a fellow subsidiary of approximately RMB9 million which were included in accounts payable. These amounts are unsecured and interest free. - 143 - APPENDIX III ACCOUNTANTS' REPORT ON FINANCIAL INFORMATION OF THE AIRLINE OPERATIONS OF XINJIANG AIRLINES GROUP (V) NOTES TO THE FINANCIAL INFORMATION (CONTINUED) 18. PROVISION FOR MAJOR OVERHAULS Details of provision for major overhauls in respect of aircraft held under operating leases are as follows: SIX-MONTH PERIODS YEARS ENDED 31 DECEMBER, ENDED 30 JUNE, ---------------------------------- ------------------------ 2001 2002 2003 2003 2004 RMB'000 RMB'000 RMB'000 RMB'000 RMB'000 (unaudited) Balance at 1 January, 153,014 159,918 259,889 259,889 356,721 Additional amount provided 79,975 110,846 111,249 58,064 56,939 Amount utilised (73,071) (10,875) (14,417) (6,475) (8,820) ------- ------- ------- --------- -------- Balance at 31 December/ 30 June, 159,918 259,889 356,721 311,478 404,840 Less: Current portion included in other liabilities and accrued expenses (9,210) (98,295) (173,994) (143,095) (222,521) ------- ------- ------- --------- -------- 150,708 161,594 182,727 168,383 182,319 ======= ======= ======= ========= ======== 19. DEFERRED TAXATION Movements in net deferred tax (liabilities)/assets are as follows: SIX-MONTH PERIODS YEARS ENDED 31 DECEMBER, ENDED 30 JUNE, ------------------------------------ ------------------------ 2001 2002 2003 2003 2004 RMB'000 RMB'000 RMB'000 RMB'000 RMB'000 (unaudited) Balance at 1 January, (86,909) (122,691) (132,183) (132,183) (4,853) Transferred from/(to) combined statements of operations (Note 7) (35,782) (9,492) 155,808 95,258 24,048 Recognised in owner's fund - - (4,853) - - Net deferred tax assets eliminated against owner's fund - - (23,625) - - -------- -------- -------- -------- ------- Balance at 31 December/ 30 June, (122,691) (132,183) (4,853) (36,925) 19,195 ======== ======== ======== ======== ======= - 144 - APPENDIX III ACCOUNTANTS' REPORT ON FINANCIAL INFORMATION OF THE AIRLINE OPERATIONS OF XINJIANG AIRLINES GROUP (V) NOTES TO THE FINANCIAL INFORMATION (CONTINUED) 19. DEFERRED TAXATION (Continued) The net deferred taxation (liabilities)/assets were made up of the following taxation effect: 31 DECEMBER, 30 JUNE, ------------------------------------- -------- 2001 2002 2003 2004 Note RMB'000 RMB'000 RMB'000 RMB'000 DEFERRED TAX ASSETS: Tax losses (i) 16,121 40,177 - 22,547 Repair charges (ii) 44,025 60,182 - - Provision for doubtful accounts (ii) 1,689 3,224 - - -------- -------- ------- ------- TOTAL DEFERRED TAX ASSETS 61,835 103,583 - 22,547 -------- -------- ------- ------- DEFERRED TAX LIABILITIES: Tax depreciation in excess of accounting depreciation (ii) (137,819) (186,057) - - Repairs and maintenance accruals (ii) (46,707) (49,709) - - Inventories (iii) - - (4,853) (3,352) -------- -------- ------- ------- TOTAL DEFERRED TAX LIABILITIES (184,526) (235,766) (4,853) (3,352) -------- -------- ------- ------- NET DEFERRED TAX (LIABILITIES)/ASSETS (122,691) (132,183) (4,853) 19,195 ======== ======== ======= ======= Notes: (i) The balance of tax losses as at 31 December, 2003 will no longer be available to be carried forward to off-set future taxable income of the Airline Operations of Xinjiang Airlines Group upon completion of the Reorganisation and Acquisition. In this connection, deferred tax asset arising from tax losses amounting to approximately RMB58 million as at 31 December, 2003 was eliminated against owner's fund. - 145 - APPENDIX III ACCOUNTANTS' REPORT ON FINANCIAL INFORMATION OF THE AIRLINE OPERATIONS OF XINJIANG AIRLINES GROUP (V) NOTES TO THE FINANCIAL INFORMATION (CONTINUED) 19. DEFERRED TAXATION (Continued) (ii) As described in Note 9, in connection with the Reorganisation and Acquisition, property, plant and equipment of the Airline Operations of Xinjiang Airlines Group were revalued as at 31 December, 2003. Such revalued amount will serve as the tax base for these assets for future years. In addition, in connection with the Reorganisation and Acquisition, the tax base of other assets and liabilities of the Airline Operations of Xinjiang Airlines Group that gave rise to the temporary differences above have been adjusted to conform to the related financial reporting carrying amounts. As a result, the temporary differences that gave rise to the deferred tax assets and liabilities relating to the items above as at 31 December, 2003 were eliminated against owner's fund. An analysis of the net deferred tax liabilities which have been eliminated against owner's fund is set out below: RMB'000 DEFERRED TAX ASSETS: Repair charges 74,148 Provision for doubtful accounts 5,363 -------- TOTAL DEFERRED TAX ASSETS 79,511 -------- DEFERRED TAX LIABILITIES: Tax depreciation in excess of accounting depreciation (114,354) -------- TOTAL DEFERRED TAX LIABILITIES (114,354) -------- NET DEFERRED TAX LIABILITIES (34,843) ======== (iii) In connection with the Reorganisation and Acquisition, inventories of the Airline Operations of the Xinjiang Airlines Group, which as at 31 December, 2003 had a carrying amount of approximately RMB59 million, were revalued as required by the relevant PRC rules and regulations. The revalued amount of inventories has been determined at approximately RMB44 million. Such amount will serve as the tax base for future years. The inventories were not revalued for financial reporting purposes and accordingly, a deferred tax liability of approximately RMB5 million was created with a corresponding decrease in owner's fund. - 146 - APPENDIX III ACCOUNTANTS' REPORT ON FINANCIAL INFORMATION OF THE AIRLINE OPERATIONS OF XINJIANG AIRLINES GROUP (V) NOTES TO THE FINANCIAL INFORMATION (CONTINUED) 20. RELATED PARTY TRANSACTIONS During the period from 1 January, 2001 to 31 December, 2002, the Airline Operations of Xinjiang Airlines Group was under the direct control of the CAAC and therefore, the transactions conducted with the CAAC and its affiliates during the period from 1 January, 2001 to 31 December, 2002 are presented as related party transactions. However, such control was shifted to CSAHC during late 2002. Consequently, transactions with the CAAC and its affiliates are no longer presented as related party transactions from 1 January, 2003 onward. The principal recurring and non-recurring related party transactions between the Airline Operations of Xinjiang Airlines Group and the CAAC and its affiliates, and CSAHC and its affiliates during the relevant period are summarised as follows: SIX-MONTH PERIODS YEARS ENDED 31 DECEMBER, ENDED 30 JUNE, ------------------------------- -------------------- 2001 2002 2003 2003 2004 Note RMB'000 RMB'000 RMB'000 RMB'000 RMB'000 (unaudited) EXPENSES PAID TO CAAC AND ITS AFFILIATES Handling charges (i) 1,129 1,988 - - - Jet fuel supplies (ii) 536,466 472,855 - - - Aircraft insurance (iii) 16,531 31,598 - - - Ticket reservation service charges (iv) 8,444 11,314 - - - Passenger departure and cargo handling charges (v) 6,908 9,257 - - - Aircraft and traffic service charges (vi) 170,399 167,166 - - - Commission expense (vii) 53,057 57,951 - - - PAID TO CSAHC AND ITS AFFILIATES Interest expense (viii) - - - - 3,771 Rentals for land and buildings (ix) - - - - 8,989 Air catering expenses (x) - - - - 9,390 Repairing charges (xi) - - 7,971 - 3,680 Flight simulation service charges (xii) - - 3,259 1,208 3,102 INCOME RECEIVED FROM CAAC AND ITS AFFILIATES Ground service income (xiii) - 5,881 - - - Aircraft lease income (xiv) 11,083 55,436 - - - Commission income (xv) 5,209 5,382 - - - RECEIVED FROM CSAHC AND ITS AFFILIATES Aircraft lease income (xvi) - 26,164 35,751 35,751 7,413 -147- APPENDIX III ACCOUNTANTS' REPORT ON FINANCIAL INFORMATION OF THE AIRLINE OPERATIONS OF XINJIANG AIRLINES GROUP (V) NOTES TO THE FINANCIAL INFORMATION (CONTINUED) 20. RELATED PARTY TRANSACTIONS (Continued) Notes: (i) Handling charges represent fees payable to China Aviation Supplies Import and Export Corporation, a corporation controlled by the CAAC, in connection with the procurement of aircraft and flight equipment on behalf of the Airline Operations of Xinjiang Airlines Group. Handling charges are calculated based on a fixed percentage of the purchase value and other charges. (ii) Jet fuel supplies represent purchases of jet fuel at the then prevailing state controlled prices from China Aviation Oil Supply Company, Lan Tian Oil Supply Company and certain other suppliers, which are controlled by the CAAC. (iii) Aircraft insurance represents insurance premiums payable to the CAAC which arranges aviation insurance covering hull, war and passenger liability risk on behalf of the PRC airlines with the People's Insurance (Property) Company of China. Insurance premiums are allocated to individual PRC airlines by the CAAC based on the value of the airlines aircraft and after taking into account the claims history of the airlines. (iv) Ticket reservation service charges represent fees payable to the CAAC in respect of computer reservation services rendered by the CAAC at charge rates determined based on the utilisation of the computer reservation system. (v) Passenger departure and cargo handling charges are payable to the CAAC for use of the computerised passenger departure and cargo handling systems installed at certain PRC airports. The charges are levied based on the utilisation of these systems. (vi) Aircraft and traffic service charges represent landing and take-off fees payable to various PRC airports in respect of landing and take-off slots allocated to the Airline Operations of Xinjiang Airlines Group and other ancillary services provided. Fees are payable by the Airline Operations of Xinjiang Airlines Group based on the scale rates published by the CAAC. (vii) Commission expense represents commissions payable to CAAC's sales offices and other PRC airlines in connection with services provided in exchange for air tickets sold by them. These commissions are calculated based on a fixed rate ranging from 1.5% to 9% on the ticket value as stipulated by the CAAC. (viii) Interest expense represents the interest incurred on certain unsecured loans from CSAHC. The applicable interest rates are in accordance with the rates published by the People's Bank of China (See Note 15). (ix) Rentals were paid to CSAHC under lease arrangements for certain land and buildings in the PRC. The rentals are determined based on prevailing market rates. (x) Air catering expenses represent purchases of in-flight meals and related services from certain affiliates of CSAHC. Prices charged by these suppliers to the Airline Operations of Xinjiang Airlines Group are similar to those charged to other PRC airlines. (xi) Repairing charges represent fees incurred by the Airline Operations of Xinjiang Airlines Group in connection with aircraft repair and maintenance services rendered by Guangzhou Aircraft Maintenance Engineering Company Limited ("GAMECO"). GAMECO is a jointly controlled entity of the Company. (xii) Flight simulation service charges represent fees incurred by the Airline Operations of Xinjiang Airlines Group in connection with flight simulation services provided by Zhuhai Xiang Yi Aviation Technology Company Limited, a jointly controlled entity of the Company. (xiii) Ground service income represents the fees receivable from certain airlines controlled by the CAAC in respect of ground services provided by the Airline Operations of Xinjiang Airlines Group in Xinjiang International Airport. - 148 - APPENDIX III ACCOUNTANTS' REPORT ON FINANCIAL INFORMATION OF THE AIRLINE OPERATIONS OF XINJIANG AIRLINES GROUP (V) NOTES TO THE FINANCIAL INFORMATION (CONTINUED) 20. RELATED PARTY TRANSACTIONS (Continued) (xiv) Aircraft lease income represent rentals receivable in respect of short term leasing of aircraft to certain PRC airlines controlled by the CAAC. (xv) Commission income represents commission receivable from certain PRC airlines controlled by the CAAC in connection with air tickets sold by the Airline Operations of Xinjiang Airlines Group for which the carriage was provided by such airlines. Commission is calculated based on a fixed rate ranging from 3% to 9% on the ticket value as stipulated by the CAAC. (xvi) Aircraft lease income represents rentals receivable from the Company pursuant to a wet lease agreement in respect of a Boeing 757-200 aircraft. The wet lease rental was determined based on prevailing market rates. Details of loans borrowed from and/or guaranteed by CSAHC and loans guaranteed by the CAAC and its affiliates are disclosed in Note 15. Management of the Airline Operations of Xinjiang Airlines Group is of the opinion that the above transactions with related parties were entered into in the normal course of business and on normal commercial terms or in accordance with the relevant government regulations governing such transactions. 21. RETIREMENT BENEFITS Employees of the Airline Operations of Xinjiang Airlines Group participate in several defined contribution retirement schemes organised separately by PRC municipal governments in regions where the major operations of the Airline Operations of Xinjiang Airlines Group are located. The Airline Operations of Xinjiang Airlines Group is required to contribute to these schemes at rates ranging from 14% to 20% of salary costs, including certain allowances. A member of the retirement schemes is entitled to pension benefits equal to a fixed proportion of the salary at the retirement date. The retirement benefit obligations of all existing and future retired staff of the Airline Operations of Xinjiang Airlines Group are assumed by these schemes. Contributions to the retirement schemes made by the Airline Operations of Xinjiang Airlines Group during the relevant period are as follows: SIX-MONTH PERIODS YEARS ENDED 31 DECEMBER, ENDED 30 JUNE, ----------------------------------- ------------------------ 2001 2002 2003 2003 2004 RMB'000 RMB'000 RMB'000 RMB'000 RMB'000 (unaudited) Amounts of contributions 7,265 7,119 13,972 6,517 16,259 ===== ===== ====== ===== ====== - 149 - APPENDIX III ACCOUNTANTS' REPORT ON FINANCIAL INFORMATION OF THE AIRLINE OPERATIONS OF XINJIANG AIRLINES GROUP (V) NOTES TO THE FINANCIAL INFORMATION (CONTINUED) 22. COMMITMENTS (i) CAPITAL COMMITMENTS The Airline Operations of Xinjiang Airlines Group had capital commitments as follows: 31 DECEMBER, 30 JUNE, ------------------------------------ -------- 2001 2002 2003 2004 RMB'000 RMB'000 RMB'000 RMB'000 Commitments in respect of aircraft and related equipment: - authorised and contracted for 310,787 - - - ------- ------- ------- -------- Other commitments: - authorised and contracted for 8,981 10,307 21,050 11,703 - authorised but not contracted for 233,153 164,479 3,467 - ------- ------- ------- -------- 242,134 174,786 24,517 11,703 ------- ------- ------- -------- 552,921 174,786 24,517 11,703 ======= ======= ======= ======== (ii) OPERATING LEASE COMMITMENTS The total future minimum lease payments payable by the Airline Operations of Xinjiang Airlines Group under non-cancellable operating leases in respect of aircraft and flight equipment are payable as follows: 31 DECEMBER, 30 JUNE, -------------------------------------- ------- 2001 2002 2003 2004 RMB'000 RMB'000 RMB'000 RMB'000 Payments due - within one year 220,398 225,424 212,165 156,730 - in the second to fifth year, inclusive 648,616 523,568 390,821 324,699 - after the fifth year 222,599 122,297 41,901 14,898 --------- ------- ------- ------- 1,091,613 871,289 644,887 496,327 ========= ======= ======= ======= Leases for aircraft and flight equipment are generally run for an initial period of between six and eight years. The rental payments for aircraft and flight equipment are fixed during the lease period. None of the leases includes contingent rentals. - 150 - APPENDIX III ACCOUNTANTS' REPORT ON FINANCIAL INFORMATION OF THE AIRLINE OPERATIONS OF XINJIANG AIRLINES GROUP (V) NOTES TO THE FINANCIAL INFORMATION (CONTINUED) 23. CONCENTRATION OF RISKS AND FAIR VALUE OF FINANCIAL INSTRUMENTS LIQUIDITY RISK The liquidity of the Airline Operations of Xinjiang Airlines Group is primarily dependent on its ability to maintain adequate cash inflow from operations to meet its debt obligations as they fall due and to renew/refinance these debt obligations where necessary and, on its ability to obtain adequate external loan finance to meet its committed future capital expenditures. With the support of certain PRC banks and CSAHC, the Airline Operations of Xinjiang Airlines Group was able to renew its short term debts and refinance part of its long term debts during the relevant period. With regards to the twelve-month period ending 30 June, 2005, the Airline Operations of Xinjiang Airlines Group has planned to seek the renewals of short term debts amounting to RMB205 million and refinance part of the long term debts due in 2004 of RMB488 million through loan finance to be obtained from certain PRC banks. Based on the recent negotiations with the principal bankers of the Airline Operations of Xinjiang Airlines Group, management believes that the planned loan renewals and loan refinance will be available to the Airline Operations of Xinjiang Airlines Group. Management has carried out a detailed review of the cash flow forecast of the Airline Operations of Xinjiang Airlines Group for the twelve-month period ending 30 June, 2005. Based on the results of such review, management has determined that adequate liquidity exists to finance the working capital, debt repayment obligations and capital expenditure requirements of the Airline Operations of Xinjiang Airlines Group during the forecasted period. In preparing the cash flow forecast, management has considered historical cash requirements of the Airline Operations of Xinjiang Airlines Group as well as other key factors, including the availability of the above-mentioned loan renewals and refinance which may impact the operations of the Airline Operations of Xinjiang Airlines Group during the next twelve-month period. Management is 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. BUSINESS AND ECONOMIC RISKS The Airline Operations of Xinjiang Airlines Group conducts its principal operations in the PRC and accordingly is subject to special considerations and significant risk not typically associated with investments in equity securities of the United States of America and Western European companies. These include risks associated with, among others, the political, economic and legal environment, influence of the CAAC over many aspects of its operations, and competition, in the passenger, cargo and mail airlines services industry. INTEREST RATE RISK The Airline Operations of Xinjiang Airlines Group has significant exposure to interest rate fluctuation as a significant portion of its loans are interest bearing at floating rates. Fluctuation in interest rates affects the results of the Airline Operations of Xinjiang Airlines Group significantly because the Airline Operations of Xinjiang Airlines Group is not able to hedge its interest rate exposure effectively. The interest rates and maturity information of the bank and other loans of the Airline Operations of Xinjiang Airlines Group are disclosed in Note 15. FOREIGN CURRENCY RISK The Airline Operations of Xinjiang Airlines Group has significant exposure to foreign currency as significant portion of its bank loans are denominated in foreign currencies, principally US dollars. Depreciation or appreciation of the Renminbi against foreign currencies affects the results of the Airline Operations of Xinjiang Airlines significantly because the foreign currency payments of the Airline Operations of Xinjiang Airlines Group significantly exceed its foreign currency receipts. The Airline Operations of Xinjiang Airlines 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, by entering into forward foreign exchange contracts with authorised PRC banks. - 151 - APPENDIX III ACCOUNTANTS' REPORT ON FINANCIAL INFORMATION OF THE AIRLINE OPERATIONS OF XINJIANG AIRLINES GROUP (V) NOTES TO THE FINANCIAL INFORMATION (CONTINUED) 23. CONCENTRATION OF RISKS AND FAIR VALUE OF FINANCIAL INSTRUMENTS (Continued) CREDIT RISKS Substantially all of the cash and cash equivalents of the Airline Operations of Xinjiang Airlines Group are deposited with PRC financial institutions. Prior to 2003, a significant portion of the air tickets of the Airline Operations of Xinjiang Airlines Group were 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. As at 31 December, 2001 and 2002, the balance due from BSP agents amounted to approximately RMB74 million and RMB32 million respectively. Beginning in 2003, a significant portion of the air tickets of the Airline Operations of Xinjiang Airlines Group are sold through the sale network of the Company and flight revenue uplifted by the Airline Operations of Xinjiang Airlines Group is billed and collected from the Company. As at 31 December, 2003 and 30 June, 2004, the receivable due from the Company amounted to approximately RMB38 million and RMB1 million respectively. SELF INSURANCE RISK The Airline Operations of Xinjiang Airlines Group maintains a limited amount of property insurance in respect of certain personal and real property. FAIR VALUE Financial assets of the Airline Operations of Xinjiang Airlines Group include cash and cash equivalents, other investments, trade receivables, and other receivables and prepaid expenses. Financial liabilities of the Airline Operations of Xinjiang Airlines Group include bank and other loans, accounts payable and other payables. The Airline Operations of Xinjiang Airlines Group did not hold nor issue any financial instruments for trading purposes during the relevant period. The Airline Operations of Xinjiang Airlines Group did not have any positions in derivative contracts as at 31 December, 2001, 2002 and 2003 and 30 June, 2004. The following disclosure of the estimated fair value of financial instruments is made in accordance with the requirements of IAS 32 "Financial Instruments: Disclosure and Presentation" and IAS 39 "Financial Instruments: Recognition and Measurement". Fair value estimates, methods and assumptions, set forth below for the financial instruments of the Airline Operations of Xinjiang Airlines Group are made solely to comply with the requirements of IAS 32 and IAS 39, and should be read in conjunction with the Financial Information. The estimated fair value amounts have been determined by the Airline Operations of Xinjiang Airlines Group using market information and valuation methodologies considered appropriate. However, considerable judgement is required to interpret market data to develop the estimates of fair values. Accordingly, the estimates presented herein are not necessarily indicative of the amounts the Airline Operations of Xinjiang Airlines Group could realise in a current market exchange. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts. - 152 - APPENDIX III ACCOUNTANTS' REPORT ON FINANCIAL INFORMATION OF THE AIRLINE OPERATIONS OF XINJIANG AIRLINES GROUP (V) NOTES TO THE FINANCIAL INFORMATION (CONTINUED) 23. CONCENTRATION OF RISKS AND FAIR VALUE OF FINANCIAL INSTRUMENTS (Continued) FAIR VALUE (Continued) The following summarise the major methods and assumptions used in estimating the fair values of the financial instruments of the Airline Operations of Xinjiang Airlines Group. Long term debts The fair values of long term debts are estimated by discounting future cash flows using current market interest rates offered to the Airline Operations of Xinjiang Airlines Group for debts with substantially the same characteristics and maturities. As at 31 December, 2001, 2002 and 2003 and 30 June, 2004, the carrying amounts and fair values of the long term debts of the Airline Operations of Xinjiang Airlines Group are as follows: 31 DECEMBER, 30 JUNE, ---------------------------------------------------------------------- ---------------------- 2001 2002 2003 2004 CARRYING FAIR CARRYING FAIR CARRYING FAIR CARRYING FAIR AMOUNT VALUE AMOUNT VALUE AMOUNT VALUE AMOUNT VALUE RMB'000 RMB'000 RMB'000 RMB'000 RMB'000 RMB'000 RMB'000 RMB'000 Long term debts 2,677,999 2,847,219 2,261,657 2,365,801 2,109,261 2,130,199 1,979,931 1,998,721 ========= ========= ========= ========= ========= ========= ========= ========= Other investments Other investments are unlisted equity interests and there are no quoted market prices for such interests in the PRC. Accordingly, a reasonable estimate of fair value could not be made without incurring excessive costs. Other financial instruments The fair values of all other financial instruments approximate their carrying amounts due to the nature or short term maturity of these instruments. 24. SUBSIDIARIES The particulars of principal subsidiaries of the Airline Operations of Xinjiang Airlines as at 30 June, 2004 are as follows: ATTRIBUTABLE PLACE AND DATE OF EQUITY INTEREST ESTABLISHMENT/ ----------------- ISSUED/REGISTERED PRINCIPAL NAME OF COMPANY OPERATION DIRECT INDIRECT CAPITAL ACTIVITIES % % Xinjiang Aviation Ground PRC 60 - RMB 15,000,000 Ground services Services Co., Ltd. 27 May, 2002 Xinjiang Civil Aviation PRC 51.8 - RMB 185,043,676 Utility services Property Management 12 December, 2002 Limited - 153 - APPENDIX III ACCOUNTANTS' REPORT ON FINANCIAL INFORMATION OF THE AIRLINE OPERATIONS OF XINJIANG AIRLINES GROUP (V) NOTES TO THE FINANCIAL INFORMATION (CONTINUED) 25. RECONCILIATION AND SUPPLEMENTARY COMBINED STATEMENTS OF CASH FLOWS INFORMATION (i) Reconciliation of profit/(loss) before income tax and minority interests to cash flows from operating activities is as follows: SIX-MONTH PERIODS YEARS ENDED 31 DECEMBER, ENDED 30 JUNE, ----------------------------------- ------------------------ 2001 2002 2003 2003 2004 RMB'000 RMB'000 RMB'000 RMB'000 RMB'000 (unaudited) Profit/(loss) before income tax and minority interests 76,731 11,778 (480,867) (290,456) (69,755) Depreciation and amortisation 314,991 352,150 346,304 166,247 173,177 Impairment loss on aircraft and other flight equipment - 131,710 - - - Provision for obsolescence of inventories - 12,007 - - - Deficit on revaluation of property, plant and equipment - - 234,835 - - Loss on disposal of property, plant and equipment 8,581 2,219 7,943 3,893 800 Interest income (2,530) (1,347) (1,776) (347) (746) Interest expense 189,165 184,018 201,415 81,352 69,417 (Increase)/decrease in inventories (14,445) 1,054 825 4,683 (12,080) Decrease/(increase) in trade receivables 60,588 (20,989) 87,335 81,137 (28,924) Decrease/(increase) in other receivables and prepaid expenses 23,318 (51,603) 36,973 25,960 (39,061) Increase in accounts payable 23,372 20,960 1,384 15,188 34,651 Decrease in sales in advance of carriage (5,612) (17,459) (16,220) (13,417) (3,268) (Decrease)/increase in other liabilities and accrued expenses (187,570) 121,537 78,789 24,287 7,968 Increase/(decrease) in provision for major overhauls 61,499 10,886 21,133 8,935 (408) -------- -------- -------- ------- ------- Cash generated from operations 548,088 756,921 518,073 107,462 131,771 Interest received 2,530 1,347 1,776 347 746 Interest paid (185,925) (194,304) (211,701) (83,200) (60,988) Income tax paid (38,483) (3,000) (12,410) (910) (1,857) -------- -------- -------- ------- ------- Cash flows from operating activities 326,210 560,964 295,738 23,699 69,672 ======== ======== ======== ======= ======= - 154 - APPENDIX III ACCOUNTANTS' REPORT ON FINANCIAL INFORMATION OF THE AIRLINE OPERATIONS OF XINJIANG AIRLINES GROUP (V) NOTES TO THE FINANCIAL INFORMATION (CONTINUED) 25. RECONCILIATION AND SUPPLEMENTARY COMBINED STATEMENTS OF CASH FLOWS INFORMATION (Continued) (ii) DISCLOSURE OF NON-CASH INVESTING AND FINANCING ACTIVITIES As disclosed in Note 2, in connection with the Reorganisation and the Acquisition, certain assets that were not to be acquired by the Company but were historically associated with the Airline Operations of Xinjiang Airlines Group, were distributed to the owner of Xinjiang Airlines. The assets distributed to owner of Xinjiang Airlines amounted to approximately RMB48 million. 26. ULTIMATE HOLDING COMPANY Management of the Airline Operations of Xinjiang Airlines consider the ultimate holding company to be CSAHC, a state-owned enterprise established in the PRC. (VI) SUBSEQUENT FINANCIAL STATEMENTS No audited financial statements have been prepared by the Airline Operations of Xinjiang Airlines Group in respect of any period subsequent to 30 June, 2004. Yours faithfully, KPMG Certified Public Accountants Hong Kong - 155 - APPENDIX IV FINANCIAL INFORMATION OF THE LISTED GROUP A. SUMMARY OF FINANCIAL STATEMENTS The following consolidated balance sheets of China Southern Airlines Company Limited ( "the Company") as at 31 December, 2001, 2002 and 2003 and the consolidated statements of operations, consolidated statements of changes in shareholders' equity and consolidated cash flow statements for each of the years in the three-year period ended 31 December, 2003 are derived from the audited financial statements of the Company prepared under IFRS. All such financial information should be read in conjunction with the audited consolidated financial statements and accompanying notes, which are included in the Company's annual reports. The audited financial statements of the Company for the year ended 31 December, 2003, as extracted from the Company's 2003 annual report, are set out in Part B of this Appendix. In addition, the following consolidated balance sheet of the Company as at 30 June, 2004 and the consolidated statements of operations, consolidated statements of changes in shareholders' equity and the condensed consolidated cash flow statements for the six-month periods ended 30 June, 2003 and 2004 are derived from the unaudited interim financial reports of the Listed Group prepared under IFRS. All such financial information should be read in conjunction with the unaudited interim financial reports and accompanying notes, which are included in the Company's interim reports. The unaudited interim financial report of the Company for the six-month period ended 30 June, 2004, as extracted from the Company's 2004 interim report, are set out in Part C of this Appendix. CONSOLIDATED BALANCE SHEETS 31 DECEMBER, 30 JUNE, ------------------------------------------- ---------- 2001 2002 2003 2004 RMB'000 RMB'000 RMB'000 RMB'000 (unaudited) NON-CURRENT ASSETS Fixed assets 22,352,215 26,920,829 28,535,907 29,128,791 Construction in progress 340,063 661,352 1,629,689 2,189,052 Lease prepayments 357,622 201,854 348,652 344,755 Interest in associated companies 531,055 692,026 422,201 443,780 Interest in jointly controlled entities 174,338 461,962 731,323 787,874 Other investments 195,201 201,854 204,971 199,007 Lease and equipment deposits 2,265,003 2,147,038 2,932,591 4,717,553 Deferred expenditure 48,183 283,303 248,853 233,726 Long term receivables 11,091 12,034 6,380 6,648 ---------- ---------- ---------- ---------- TOTAL NON-CURRENT ASSETS 26,274,771 31,582,252 35,060,567 38,051,186 ---------- ---------- ---------- ---------- CURRENT ASSETS Inventories 467,018 545,700 543,777 572,457 Trade receivables 556,542 671,776 833,604 1,210,680 Other receivables 196,751 372,586 296,047 310,365 Prepaid expenses and other assets 340,157 244,690 247,926 323,947 Cash and cash equivalents 2,817,863 3,771,043 2,080,174 2,931,786 ---------- ---------- ---------- ---------- TOTAL CURRENT ASSETS 4,378,331 5,605,795 4,001,528 5,349,235 ---------- ---------- ---------- ---------- - 156 - APPENDIX IV FINANCIAL INFORMATION OF THE LISTED GROUP CONSOLIDATED BALANCE SHEETS (CONTINUED) 31 DECEMBER, 30 JUNE, ------------------------------------------ ----------- 2001 2002 2003 2004 RMB'000 RMB'000 RMB'000 RMB'000 (unaudited) CURRENT LIABILITIES Bank and other loans 2,177,516 5,240,726 7,096,846 9,931,236 Obligations under finance leases 1,451,929 1,566,698 1,297,855 1,138,495 Amounts due to related companies 718,265 525,090 929,003 906,353 Other liabilities 678,133 646,989 1,019,811 1,176,852 Accounts payable 590,700 532,480 928,093 841,409 Bills payable - 1,299,680 438,135 - Sales in advance of carriage 370,546 390,531 466,087 386,255 Accrued expenses 2,013,555 2,341,454 2,527,794 3,217,955 Tax payable 73,464 78,145 89,954 72,954 ---------- ---------- ----------- ----------- TOTAL CURRENT LIABILITIES 8,074,108 12,621,793 14,793,578 17,671,509 ---------- ---------- ----------- ----------- NET CURRENT LIABILITIES (3,695,777) (7,015,998) (10,792,050) (12,322,274) ---------- ---------- ----------- ----------- TOTAL ASSETS LESS CURRENT LIABILITIES 22,578,994 24,566,254 24,268,517 25,728,912 ---------- ---------- ----------- ----------- NON-CURRENT LIABILITIES AND DEFERRED ITEMS Bank and other loans 3,627,594 5,835,434 4,521,735 6,062,819 Obligations under finance leases 7,691,634 6,631,751 5,543,084 5,006,135 Provision for major overhauls 125,661 141,887 189,464 230,525 Deferred credits 15,072 48,095 46,554 44,983 Deferred taxation 519,577 779,234 398,305 456,354 ---------- ---------- ----------- ----------- TOTAL NON-CURRENT LIABILITIES AND DEFERRED ITEMS 11,979,538 13,436,401 10,699,142 11,800,816 ---------- ---------- ----------- ----------- 10,599,456 11,129,853 13,569,375 13,928,096 ========== ========== =========== =========== REPRESENTING: SHARE CAPITAL 3,374,178 3,374,178 4,374,178 4,374,178 RESERVES 5,847,485 6,239,029 7,521,529 7,787,713 ---------- ---------- ----------- ----------- SHAREHOLDERS' EQUITY 9,221,663 9,613,207 11,895,707 12,161,891 MINORITY INTERESTS 1,377,793 1,516,646 1,673,668 1,766,205 ---------- ---------- ----------- ----------- 10,599,456 11,129,853 13,569,375 13,928,096 ========== ========== =========== =========== - 157 - APPENDIX IV FINANCIAL INFORMATION OF THE LISTED GROUP CONSOLIDATED STATEMENTS OF OPERATIONS SIX-MONTH PERIODS YEARS ENDED 31 DECEMBER, ENDED 30 JUNE, ---------------------------------------- ----------------------------- 2001 2002 2003 2003 2004 RMB'000 RMB'000 RMB'000 RMB'000 RMB'000 (unaudited) (unaudited) OPERATING REVENUE Traffic revenue 16,461,532 17,481,892 16,964,800 6,537,679 10,834,278 Other revenue 418,126 536,728 505,323 195,193 259,659 ---------- ---------- ---------- ---------- ---------- TOTAL OPERATING REVENUE 16,879,658 18,018,620 17,470,123 6,732,872 11,093,937 ---------- ---------- ---------- ---------- ---------- OPERATING EXPENSES Flight operations 6,905,628 6,732,543 7,070,031 3,516,885 4,722,442 Maintenance 2,014,579 2,333,419 2,588,613 1,218,488 1,409,841 Aircraft and traffic servicing 2,297,521 2,511,284 2,767,488 1,197,273 1,688,612 Promotion and sales 1,540,780 1,499,587 1,480,168 673,965 874,393 General and administrative 892,233 1,060,010 1,053,319 480,598 551,719 Depreciation and amortisation 1,814,974 1,839,871 2,037,971 1,016,530 1,083,346 Others 13,270 15,829 16,804 3,465 8,244 ---------- ---------- ---------- ---------- ---------- TOTAL OPERATING EXPENSES 15,478,985 15,992,543 17,014,394 8,107,204 10,338,597 ========== ========== ========== ========== ========== OPERATING PROFIT/(LOSS) 1,400,673 2,026,077 455,729 (1,374,332) 755,340 ---------- ---------- ---------- ---------- ---------- NON-OPERATING INCOME/(EXPENSES) Interest income 49,878 52,618 13,061 5,842 8,994 Interest expense (933,717) (959,193) (823,725) (455,456) (343,620) Exchange gain/(loss), net 296,777 (175,451) (164,443) (4,774) 15,397 Share of associated companies' results 53,077 36,988 47,798 2,825 21,156 Share of jointly controlled entities' results (4,034) (3,352) (39,495) (21,654) 4,351 (Loss)/gain on sale of fixed assets (55,889) 170,740 (22,217) (22,679) 2,999 Others, net (11,509) (9,328) 21,682 (287) 4,531 ---------- ---------- ---------- ---------- ---------- TOTAL NET NON-OPERATING EXPENSES (605,417) (886,978) (967,339) (496,183) (286,192) ========== ========== ========== ========== ========== - 158 - APPENDIX IV FINANCIAL INFORMATION OF THE LISTED GROUP CONSOLIDATED STATEMENTS OF OPERATIONS (CONTINUED) SIX-MONTH PERIODS YEARS ENDED 31 DECEMBER, ENDED 30 JUNE, ------------------------------------- ---------------------------- 2001 2002 2003 2003 2004 RMB'000 RMB'000 RMB'000 RMB'000 RMB'000 PROFIT/(LOSS) BEFORE TAXATION AND MINORITY INTERESTS 795,256 1,139,099 (511,610) (1,870,515) 469,148 TAXATION (EXPENSE)/ CREDIT (320,519) (398,227) 324,277 544,992 (94,790) -------- --------- --------- ---------- -------- PROFIT/(LOSS) BEFORE MINORITY INTERESTS 474,737 740,872 (187,333) (1,325,523) 374,358 MINORITY INTERESTS (134,512) (165,111) (170,934) 93,910 (108,174) -------- --------- --------- ---------- -------- PROFIT/(LOSS) ATTRIBUTABLE TO SHAREHOLDERS 340,225 575,761 (358,267) (1,231,613) 266,184 ======== ========= ========= ========== ======== BASIC EARNINGS/(LOSSES) PER SHARE RMB0.10 RMB0.17 RMB(0.09) RMB(0.37) RMB0.06 ======== ========= ========= ========== ======== - 159 - APPENDIX IV FINANCIAL INFORMATION OF THE LISTED GROUP CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY SHARE SHARE OTHER RETAINED CAPITAL PREMIUM RESERVES EARNINGS TOTAL --------- --------- -------- --------- ---------- RMB'000 RMB'000 RMB'000 RMB'000 RMB'000 At 1 January, 2001 3,374,178 3,813,659 664,945 1,028,656 8,881,438 Profit for the year - - - 340,225 340,225 Appropriations to reserves - - 22,229 (22,229) - --------- --------- -------- --------- ---------- At 31 December, 2001 3,374,178 3,813,659 687,174 1,346,652 9,221,663 ========= ========= ======== ========= ========== At 1 January, 2002 3,374,178 3,813,659 687,174 1,346,652 9,221,663 Land use rights adjustment - (129,703) - 12,970 (116,733) Adjustments from adoption of new PRC accounting regulations - - (185,540) 185,540 - Dividends paid - - - (67,484) (67,484) Profit for the year - - - 575,761 575,761 Appropriations to reserves - - 83,738 (83,738) - --------- --------- -------- --------- ---------- At 31 December, 2002 3,374,178 3,683,956 585,372 1,969,701 9,613,207 ========= ========= ======== ========= ========== At 1 January, 2003 3,374,178 3,683,956 585,372 1,969,701 9,613,207 Issue of A shares 1,000,000 1,640,767 - - 2,640,767 Loss for the year - - - (358,267) (358,267) Appropriations to reserves - - 24,969 (24,969) - --------- --------- -------- --------- ---------- At 31 December, 2003 4,374,178 5,324,723 610,341 1,586,465 11,895,707 ========= ========= ======== ========= ========== At 1 January, 2004 4,374,178 5,324,723 610,341 1,586,465 11,895,707 Profit for the period (unaudited) - - - 266,184 266,184 --------- --------- -------- --------- ---------- At 30 June, 2004 (unaudited) 4,374,178 5,324,723 610,341 1,852,649 12,161,891 ========= ========= ======== ========= ========== - 160 - APPENDIX IV FINANCIAL INFORMATION OF THE LISTED GROUP CONSOLIDATED CASH FLOW STATEMENTS YEARS ENDED 31 DECEMBER, --------------------------------------------- 2001 2002 2003 Note RMB'000 RMB'000 RMB'000 ---------- ---------- ---------- NET CASH FROM OPERATING ACTIVITIES (a) 2,223,943 3,697,544 2,128,749 ---------- ---------- ---------- CASH FLOWS FROM INVESTING ACTIVITIES: Proceeds from sale of fixed assets 605,385 825,197 57,077 Proceeds from sale of investments - 68 - Dividends received from associated companies 5,946 3,093 - (Increase)/decrease in long term receivables (345) (943) 5,654 Payment of lease and equipment deposits (2,027,063) (1,999,233) (1,851,726) Refund of lease and equipment deposits 200,029 2,117,386 1,066,086 Capital expenditures (1,492,126) (6,351,030) (4,706,740) Purchase of investments in equity securities (1,241) (6,721) (1,065) Investment in associated company (147,875) (136,500) - Investments in jointly controlled entities (178,372) (295,670) (2,999) Governmental subsidy for safety related capital expenditures - 40,240 - Effect of acquisition of subsidiaries (c) - (90,491) - ---------- ---------- ---------- NET CASH USED IN INVESTING ACTIVITIES (3,035,662) (5,894,604) (5,433,713) ========== ========== ========== NET CASH OUTFLOWS BEFORE FINANCING ACTIVITIES (811,719) (2,197,060) (3,304,964) ---------- ---------- ---------- CASH FLOWS FROM FINANCING ACTIVITIES: Proceeds from A share issue, net of issuance costs - - 2,640,767 Proceeds from bank and other loans 2,123,613 6,996,780 8,913,992 Repayment of bank and other loans (890,228) (2,194,630) (8,371,362) Repayment of principal under finance lease obligations (1,756,098) (1,546,185) (1,555,390) Capital contributions received from minority shareholders 707 10,625 1,050 Dividends paid to shareholders - (67,484) - Dividends paid to minority shareholders (45,867) (48,866) (14,962) ---------- ---------- ---------- NET CASH (OUTFLOWS)/INFLOWS FROM FINANCING ACTIVITIES (567,873) 3,150,240 1,614,095 ========== ========== ========== (DECREASE)/INCREASE IN CASH AND CASH EQUIVALENTS (1,379,592) 953,180 (1,690,869) CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR 4,197,455 2,817,863 3,771,043 ---------- ---------- ---------- CASH AND CASH EQUIVALENTS AT END OF YEAR 2,817,863 3,771,043 2,080,174 ========== ========== ========== - 161 - APPENDIX IV FINANCIAL INFORMATION OF THE LISTED GROUP RECONCILIATION AND SUPPLEMENTARY STATEMENTS OF CASH FLOWS INFORMATION (a) The reconciliation of profit/(loss) before taxation and minority interests to net cash from operations is as follows: YEARS ENDED 31 DECEMBER, ------------------------------------------- 2001 2002 2003 RMB'000 RMB'000 RMB'000 Profit/(loss) before taxation and minority interests 795,256 1,139,099 (511,610) Depreciation and amortisation of fixed assets 1,802,462 1,839,293 1,997,882 Other amortisation 12,512 9,816 40,089 Amortisation of deferred credits (18,483) (7,217) (1,541) Share of associated companies' results (53,077) (36,988) (47,798) Share of jointly controlled entities' results 4,034 3,352 39,495 Loss/(gain) on sale of fixed assets 55,889 (170,740) 22,217 Interest income (49,878) (52,618) (13,061) Interest expense 933,717 959,193 823,725 Unrealised exchange (gain)/loss, net (292,630) 174,978 177,356 (Increase)/decrease in inventories (2,033) (76,472) 1,923 Decrease/(increase) in trade receivables 232,228 (110,749) (161,828) Decrease/(increase) in other receivables 42,938 (166,004) 76,539 (Increase)/decrease in prepaid expenses and other assets (136,600) 123,924 (6,045) Increase/(decrease) in amounts due to related companies 98,040 (193,175) 403,913 (Decrease)/increase in accounts payable (167,599) (61,843) 395,613 Increase/(decrease) in bills payable - 1,299,680 (861,545) Increase in sales in advance of carriage 31,036 19,985 75,556 (Decrease)/increase in accrued expenses (132,121) 86,215 203,439 Increase/(decrease) in other liabilities 70,254 (33,032) 372,822 (Decrease)/increase in provision for major overhauls (40,422) 16,226 47,577 --------- ---------- --------- Cash generated from operations 3,185,523 4,762,923 3,074,718 Interest received 49,878 52,618 13,061 Interest paid (970,734) (1,051,027) (923,901) Income tax paid (40,724) (66,970) (35,129) --------- ---------- --------- Net cash from operating activities 2,223,943 3,697,544 2,128,749 ========= ========== ========= (b) DISCLOSURE OF NON-CASH INVESTING AND FINANCING ACTIVITIES During 2002, the Listed Group assumed from Zhongyuan Airlines debts totalling RMB964,736,000 in partial satisfaction of the consideration payable for acquisition of five Boeing 737-300/37K aircraft and other assets from Zhongyuan Airlines. - 162 - APPENDIX IV FINANCIAL INFORMATION OF THE LISTED GROUP (c) EFFECT OF ACQUISITION OF SUBSIDIARIES YEARS ENDED 31 DECEMBER, ------------------------------------------- 2001 2002 2003 RMB'000 RMB'000 RMB'000 Net assets acquired: Fixed assets - 96,636 - Cash and cash equivalents - 17,355 - Trade receivables and other current assets - 20,681 - ------- ------- ------- - 134,672 - ------- ------- ------- Accounts payable - 3,623 - Accrued expenses and other liabilities - 11,220 - ------- ------- ------- - 14,843 - ------- ------- ------- Net assets value - 119,829 - ======= ======= ======= Consideration paid - 107,846 - Cash and cash equivalents acquired - 17,355 - ------- ------- ------- Net cash outflow from acquisition of subsidiaries - 90,491 - ======= ======= ======= - 163 - APPENDIX IV FINANCIAL INFORMATION OF THE LISTED GROUP CONDENSED CONSOLIDATED CASH FLOW STATEMENTS SIX-MONTH PERIODS ENDED 30 JUNE, ----------------------------- 2003 2004 RMB'000 RMB'000 (unaudited) (unaudited) Net cash from operating activities 1,199,731 1,217,840 Net cash used in investing activities (1,886,023) (4,050,525) ---------- ---------- Net cash outflows before financing activities (686,292) (2,832,685) Net cash (outflows)/inflows from financing activities (803,404) 3,684,297 ---------- ---------- (Decrease)/increase in cash and cash equivalents (1,489,696) 851,612 Cash and cash equivalents as at 1 January, 3,771,043 2,080,174 ---------- ---------- Cash and cash equivalents as at 30 June, 2,281,347 2,931,786 ========== ========== - 164 - APPENDIX IV FINANCIAL INFORMATION OF THE LISTED GROUP B. FINANCIAL STATEMENTS OF THE COMPANY FOR THE YEAR ENDED 31 DECEMBER, 2003 CONSOLIDATED PROFIT AND LOSS ACCOUNT For the year ended 31 December, 2003 (Prepared under International Financial Reporting Standards) (Expressed in Renminbi) 2003 2002 Note RMB'000 RMB'000 ---- ---------- ---------- Operating revenue: Traffic revenue 16,964,800 17,481,892 Other revenue 505,323 536,728 ---------- ---------- Total operating revenue 3 17,470,123 18,018,620 ---------- ---------- Operating expenses: Flight operations 7,070,031 6,732,543 Maintenance 2,588,613 2,333,419 Aircraft and traffic servicing 2,767,488 2,511,284 Promotion and sales 1,480,168 1,499,587 General and administrative 1,053,319 1,060,010 Depreciation and amortisation 2,037,971 1,839,871 Other 16,804 15,829 ---------- ---------- Total operating expenses 4 17,014,394 15,992,543 ---------- ---------- Operating profit 455,729 2,026,077 ---------- ---------- Non-operating income/(expenses): Share of associated companies' results 47,798 36,988 Share of jointly controlled entities' results 14 (39,495) (3,352) (Loss)/gain on sale of fixed assets 5 (22,217) 170,740 Interest income 13,061 52,618 Interest expense 4 (823,725) (959,193) Exchange loss, net (164,443) (175,451) Other, net 21,682 (9,328) ---------- ---------- Total net non-operating expenses (967,339) (886,978) ---------- ---------- (Loss)/profit before taxation and minority interests 4 (511,610) 1,139,099 Taxation credit/(expense) 7 324,277 (398,227) ---------- ---------- (Loss)/profit before minority interests (187,333) 740,872 Minority interests (170,934) (165,111) ---------- ---------- (Loss)/profit attributable to shareholders (358,267) 575,761 ========== ========== Basic (loss)/earnings per share 9 RMB(0.09) RMB0.17 ========== ========== The notes on pages 172 to 223 form part of these financial statements. - 165 - APPENDIX IV FINANCIAL INFORMATION OF THE LISTED GROUP CONSOLIDATED BALANCE SHEET As at 31 December, 2003 (Prepared under International Financial Reporting Standards) (Expressed in Renminbi) 2003 2002 Note RMB'000 RMB'000 ---- ----------- ---------- NON-CURRENT ASSETS Fixed assets 10 28,535,907 26,920,829 Construction in progress 11 1,629,689 661,352 Lease prepayments 348,652 201,854 Interest in associated companies 13 422,201 692,026 Interest in jointly controlled companies 14 731,323 461,962 Other investments 204,971 201,854 Lease and equipment deposits 2,932,591 2,147,038 Deferred expenditure 15 248,853 283,303 Long-term receivables 6,380 12,034 ----------- ---------- 35,060,567 31,582,252 ----------- ---------- CURRENT ASSETS Inventories 17 543,777 545,700 Trade receivables 18 833,604 671,776 Other receivables 296,047 372,586 Prepaid expenses and other assets 247,926 244,690 Cash and cash equivalents 20 2,080,174 3,771,043 ----------- ---------- 4,001,528 5,605,795 ----------- ---------- CURRENT LIABILITIES Bank and other loans 21 7,096,846 5,240,726 Obligations under finance leases 22 1,297,855 1,566,698 Amounts due to related companies 19 929,003 525,090 Other liabilities 1,019,811 646,989 Accounts payable 23 928,093 532,480 Bills payable 438,135 1,299,680 Sales in advance of carriage 466,087 390,531 Accrued expenses 2,527,794 2,341,454 Taxes payable 89,954 78,145 ----------- ---------- 14,793,578 12,621,793 ----------- ---------- NET CURRENT LIABILITIES (10,792,050) (7,015,998) ----------- ---------- TOTAL ASSETS LESS CURRENT LIABILITIES 24,268,517 24,566,254 ----------- ---------- The notes on pages 172 to 223 form part of these financial statements. - 166 - APPENDIX IV FINANCIAL INFORMATION OF THE LISTED GROUP CONSOLIDATED BALANCE SHEET (Cont'd) As at 31 December, 2003 (Prepared under International Financial Reporting Standards) (Expressed in Renminbi) 2003 2002 Note RMB'000 RMB'000 ---- ---------- ----------- LONG TERM LIABILITIES AND DEFERRED ITEMS Bank and other loans 21 4,521,735 5,835,434 Obligations under finance leases 22 5,543,084 6,631,751 Provision for major overhauls 24 189,464 141,887 Deferred credits 46,554 48,095 Deferred taxation 16 398,305 779,234 ---------- ---------- 10,699,142 13,436,401 ---------- ---------- 13,569,375 11,129,853 ========== ========== REPRESENTING: SHARE CAPITAL 25 4,374,178 3,374,178 RESERVES 26 7,521,529 6,239,029 ---------- ---------- SHAREHOLDERS' EQUITY 11,895,707 9,613,207 MINORITY INTERESTS 1,673,668 1,516,646 ---------- ---------- 13,569,375 11,129,853 ========== ========== Approved and authorised for issue by the board of directors on 23 April, 2004 YAN ZHI QING WANG CHANG SHUN XU JIE BO Director Director Director The notes on pages 172 to 223 form part of these financial statements. - 167 - APPENDIX IV FINANCIAL INFORMATION OF THE LISTED GROUP BALANCE SHEET As at 31 December, 2003 (Prepared under International Financial Reporting Standards) (Expressed in Renminbi) 2003 2002 Note RMB'000 RMB'000 ---- ---------- ----------- NON-CURRENT ASSETS Fixed assets 10 22,610,251 19,530,908 Construction in progress 11 1,532,462 615,511 Lease prepayments 116,276 15,502 Interest in subsidiaries 12 1,445,831 1,406,010 Interest in associated companies 13 287,235 367,573 Interest in jointly controlled entities 14 563,736 474,042 Other investments 106,548 106,009 Lease and equipment deposits 2,228,754 2,065,192 Deferred expenditure 15 240,514 272,636 ---------- ----------- 29,131,607 24,853,383 ---------- ----------- CURRENT ASSETS Inventories 17 213,219 118,134 Trade receivables 18 683,206 464,930 Other receivables 222,438 239,601 Prepaid expenses and other assets 181,856 141,591 Cash and cash equivalents 20 1,404,874 2,960,337 ---------- ----------- 2,705,593 3,924,593 ---------- ----------- CURRENT LIABILITIES Bank and other loans 21 5,958,968 3,479,322 Obligations under finance leases 22 1,297,855 1,566,698 Amounts due to related companies 19 870,682 358,077 Other liabilities 854,057 411,218 Accounts payable 23 745,888 296,989 Bills payable 438,135 1,299,680 Sales in advance of carriage 405,851 340,457 Accrued expenses 1,628,072 1,049,806 Tax payable 48,142 48,143 ---------- ----------- 12,247,650 8,850,390 ---------- ----------- NET CURRENT LIABILITIES (9,542,057) (4,925,797) ---------- ----------- TOTAL ASSETS LESS CURRENT LIABILITIES 19,589,550 19,927,586 ---------- ----------- The notes on pages 172 to 223 form part of these financial statements. - 168 - APPENDIX IV FINANCIAL INFORMATION OF THE LISTED GROUP BALANCE SHEET (Cont'd) As at 31 December, 2003 (Prepared under International Financial Reporting Standards) (Expressed in Renminbi) 2003 2002 Note RMB'000 RMB'000 ---- ---------- ----------- NON-CURRENT LIABILITIES AND DEFERRED ITEMS Bank and other loans 21 3,670,499 4,628,372 Obligations under finance leases 22 5,543,084 6,631,751 Provision for major overhauls 24 130,992 63,389 Deferred credits 6,317 7,855 Deferred taxation 16 89,708 507,077 ---------- ---------- 9,440,600 11,838,444 ---------- ---------- NET ASSETS 10,148,950 8,089,142 ========== ========== REPRESENTING: SHARE CAPITAL 25 4,374,178 3,374,178 RESERVES 26 5,774,772 4,714,964 ---------- ---------- SHAREHOLDERS' EQUITY 10,148,950 8,089,142 ========== ========== Approved and authorised for issue by the board of directors on 23 April, 2004 YAN ZHI QING WANG CHANG SHUN XU JIE BO Director Director Director The notes on pages 172 to 223 form part of these financial statements. - 169 - APPENDIX IV FINANCIAL INFORMATION OF THE LISTED GROUP CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY For the year ended 31 December, 2003 (Prepared under International Financial Reporting Standards) (Expressed in Renminbi) SHARE SHARE OTHER RETAINED CAPITAL PREMIUM RESERVES EARNINGS TOTAL RMB'000 RMB'000 RMB'000 RMB'000 RMB'000 --------- --------- -------- --------- ---------- At 1 January, 2002 3,374,178 3,813,659 687,174 1,346,652 9,221,663 Land use rights adjustment (Note 26 (f)) - (129,703) - 12,970 (116,733) Adjustments from adoption of new PRC accounting regulations (Note 26 (c)) - - (185,540) 185,540 - Dividend paid (Note 8) (67,484) (67,484) Profit for the year - - - 575,761 575,761 Appropriations to reserves - - 83,738 (83,738) - --------- --------- -------- --------- ---------- At 31 December, 2002 3,374,178 3,683,956 585,372 1,969,701 9,613,207 ========= ========= ======== ========= ========== At 1 January, 2003 3,374,178 3,683,956 585,372 1,969,701 9,613,207 Issue of A shares (Note 25) 1,000,000 1,640,767 - - 2,640,767 Loss for the year - - - (358,267) (358,267) Appropriations to reserves - - 24,969 (24,969) - --------- --------- -------- --------- ---------- At 31 December, 2003 4,374,178 5,324,723 610,341 1,586,465 11,895,707 ========= ========= ======== ========= ========== The notes on pages 172 to 223 form part of these financial statements. - 170 - APPENDIX IV FINANCIAL INFORMATION OF THE LISTED GROUP CONSOLIDATED CASH FLOW STATEMENT FOR THE YEAR ENDED 31 DECEMBER, 2003 (PREPARED UNDER INTERNATIONAL FINANCIAL REPORTING STANDARDS) (EXPRESSED IN RENMINBI) 2003 2002 Note RMB'000 RMB'000 ------ ---------- ---------- Cash inflows from operations 33 (a) 3,074,718 4,762,923 Interest received 13,061 52,618 Interest paid (923,901) (1,051,027) Income tax paid (35,129) (66,970) ---------- ---------- Net cash inflows from operating activities 2,128,749 3,697,544 ---------- ---------- Investing activities: Proceeds from sale of fixed assets 57,077 825,197 Proceeds from sale of investments - 68 Dividends received from associated companies - 3,093 Decrease/(increase) in long term receivables 5,654 (943) Payment of lease and equipment deposits (1,851,726) (1,999,233) Refund of lease and equipment deposits 1,066,086 2,117,386 Capital expenditures (4,706,740) (6,351,030) Purchase of investments in equity securities (1,065) (6,721) Investment in associated company - (136,500) Investments in jointly controlled entities (2,999) (295,670) Governmental subsidy for safety related capital expenditures - 40,240 Effect of acquisition of subsidiaries 33 (c) - (90,491) ---------- ---------- Net cash used in investing activities (5,433,713) (5,894,604) ---------- ---------- Net cash outflows before financing activities (3,304,964) (2,197,060) ---------- ---------- Financing activities: Proceeds from A share issue, net of issuance costs 2,640,767 - Proceeds from bank and other loans 8,913,992 6,996,780 Repayment of bank and other loans (8,371,362) (2,194,630) Repayment of principal under finance lease obligations (1,555,390) (1,546,185) Capital contribution received from minority shareholders 1,050 10,625 Dividends paid to shareholders - (67,484) Dividends paid to minority shareholders (14,962) (48,866) ---------- ---------- Net cash inflows from financing activities 1,614,095 3,150,240 ---------- ---------- (Decrease)/Increase in cash and cash equivalents (1,690,869) 953,180 Cash and cash equivalents at beginning of year 3,771,043 2,817,863 ---------- ---------- Cash and cash equivalents at end of year 2,080,174 3,771,043 ========== ========== The notes on pages 172 to 223 form part of these financial statements. - 171 - APPENDIX IV FINANCIAL INFORMATION OF THE LISTED GROUP NOTES TO THE FINANCIAL STATEMENTS (PREPARED UNDER INTERNATIONAL FINANCIAL REPORTING STANDARDS) (EXPRESSED IN RENMINBI) 1 BACKGROUND OF THE COMPANY China Southern Airlines Company Limited (the "Company") and its subsidiary companies (collectively the "Group") are principally engaged in the provision of domestic, Hong Kong regional and international passenger, cargo and mail airline services, with flights operating primarily from the Guangzhou Baiyun International Airport, which is both the main hub of the Group's route network and the location of its corporate headquarters. The Company was established in the People's Republic of China (the "PRC", "China" or the "State") on 25 March, 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 Shares ("ADS") (each ADS representing 50 H Shares) are 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. 2 PRINCIPAL ACCOUNTING POLICIES (a) STATEMENT OF COMPLIANCE The financial statements of the Group and the Company have been prepared in accordance with International Financial Reporting Standards ("IFRS") promulgated by the International Accounting Standards Board and the disclosure requirements of the Hong Kong Companies Ordinance. IFRS includes International Accounting Standards ("IAS") and related interpretations. (b) BASIS OF PREPARATION The financial statements of the Group and the Company are prepared on the historical cost basis as modified by the revaluation of certain fixed assets. The accounting policies have been consistently applied by the Group and the Company and are consistent with those used in the previous year. (c) BASIS OF CONSOLIDATION The consolidated financial statements of the Group include the financial statements of the Company and all of its subsidiaries made up to 31 December each year. Subsidiaries are those enterprises controlled by the Group. Control exists when the Group has the power, directly or indirectly, to govern the financial and operating policies of an enterprise so as to obtain benefits from its activities. The financial statements of subsidiaries are included in the consolidated financial statements from the date that control effectively commences until the date that control effectively ceases. - 172 - APPENDIX IV FINANCIAL INFORMATION OF THE LISTED GROUP NOTES TO THE FINANCIAL STATEMENTS (Cont'd) (PREPARED UNDER INTERNATIONAL FINANCIAL REPORTING STANDARDS) (EXPRESSED IN RENMINBI) 2 PRINCIPAL ACCOUNTING POLICIES (cont'd) (c) BASIS OF CONSOLIDATION (cont'd) The results of subsidiaries are included in the consolidated profit and loss account and the share attributable to minority shareholders is deducted from or added to the consolidated profit after taxation. Losses attributable to minority shareholders of partly owned subsidiaries are accounted for based on the respective equity owned by the minority shareholders up to the amount of the capital contribution and reserves attributable to the minority shareholders. Thereafter, all further losses are assumed by the Company. All significant intercompany balances and transactions have been eliminated on consolidation. (d) INTEREST-BEARING BORROWINGS Interest-bearing borrowings are recognised initially at cost, less attributable transaction costs. Subsequent to initial recognition, interest-bearing borrowings are stated at amortised cost with any difference between cost and redemption value being recognised in the profit and loss account over the period of the borrowings on an effective interest basis. (e) INVESTMENTS (i) Investments in subsidiaries Investments in subsidiaries in the Company's balance sheet are stated at cost less impairment losses (refer to accounting policy n). (ii) Investments in associated companies and jointly controlled entities An associated company is an entity in which the Group or the Company has significant influence, but not control or joint control, over its management, including participating in the financial and operating policy decisions. A jointly controlled entity is an entity which operates under a contractual agreement between the Group or the Company and other parties, where the contractual agreement establishes the Group or the Company and one or more of the other parties share joint control over the economic activity of the entity. The consolidated profit and loss account includes the Group's share of the results of its associated companies and jointly controlled entities for the year. In the consolidated balance sheet, the investments in associated companies and jointly controlled entities are stated at the Group's attributable share of net assets. When the Group's share of losses exceeds the carrying amount of the associated company or jointly controlled entity, the carrying amount is reduced to nil and recognition of further losses is discontinued except to the extent that the Group has incurred obligations in respect of the associated company or jointly controlled entity. - 173 - APPENDIX IV FINANCIAL INFORMATION OF THE LISTED GROUP NOTES TO THE FINANCIAL STATEMENTS (Cont'd) (PREPARED UNDER INTERNATIONAL FINANCIAL REPORTING STANDARDS) (EXPRESSED IN RENMINBI) 2 PRINCIPAL ACCOUNTING POLICIES (cont'd) (e) INVESTMENTS (cont'd) The results of associated companies and jointly controlled entities are included in the Company's profit and loss account to the extent of dividends received and receivable, providing such dividends are in respect of a period ending on or before that of the Company and the Company's right to receive the dividend is established before 31 December each year. In the Company's balance sheet, investments in associated companies and jointly controlled entities are stated at cost, less impairment losses (refer to accounting policy n). (iii) Other investments Other investments are stated at cost less impairment losses (refer to accounting policy n). Other investments represent unquoted available-for-sale equity securities of companies established in the PRC. There is no quoted market price for such equity securities and accordingly a reasonable estimate of the fair value could not be made without incurring excessive costs. (f) FIXED ASSETS AND DEPRECIATION Fixed assets are stated at cost or revalued amount less accumulated depreciation and impairment losses (refer to accounting policy n). Revaluations are performed periodically to ensure that the carrying amount does not differ materially from that which would be determined using fair value at the balance sheet date. Depreciation is provided to write off the cost, or revalued amount where appropriate, of the fixed assets over their estimated useful lives on a straight line basis, after taking into account their estimated residual values, as follows: DEPRECIABLE LIFE RESIDUAL VALUE Buildings 15 to 40 years Nil Owned & leased aircraft 8 to 15 years 28.75% Other flight equipment - Jet engines 8 to 15 years 3% - Others, including rotable spares 8 to 15 years Nil Machinery and equipment 5 to 10 years 3% Vehicles 6 years 3% No depreciation is provided in respect of construction in progress. - 174 - APPENDIX IV FINANCIAL INFORMATION OF THE LISTED GROUP NOTES TO THE FINANCIAL STATEMENTS (Cont'd) (PREPARED UNDER INTERNATIONAL FINANCIAL REPORTING STANDARDS) (EXPRESSED IN RENMINBI) 2 PRINCIPAL ACCOUNTING POLICIES (cont'd) (g) LEASED ASSETS Flight equipment under finance leases is stated at an amount equal to lower of its fair value and the present value of minimum lease payments at inception of the lease, and is amortised on a straight line basis over the shorter of the lease term or estimated useful life of the asset to residual value. In cases where title to the asset will be acquired by the Group at the end of the lease, the asset is amortised on a straight line basis over the estimated useful life of the asset to its residual value. Amounts payable in respect of finance leases are apportioned between interest charges and reductions of obligations based on the interest rates implicit in the leases. Interest charges are included in the profit and loss account to provide a constant periodic rate of charge over the lease term. Gains on aircraft sale and leaseback transactions which result in finance leases are deferred and amortised over the terms of the related leases. Gains on other aircraft sale and leaseback transactions are recognised as income immediately if the transactions are established at fair value. Any excess of the sales price over fair value is deferred and amortised over the period the assets are expected to be used. Operating lease payments are charged to the profit and loss account on a straight line basis over the terms of the related leases. (h) CONSTRUCTION IN PROGRESS Construction in progress represents office buildings, various infrastructure projects under construction and equipment pending installation, and is stated at cost. Cost comprises direct costs of construction as well as interest charges during the periods of construction and installation. Capitalisation of these costs ceases and the construction in progress is transferred to fixed assets when the asset is substantially ready for its intended use, notwithstanding any delays in the issue of the relevant commissioning certificates by the relevant PRC authorities. (i) LEASE PREPAYMENTS Lease prepayments represent the purchase costs of land use rights and are amortised on a straight line basis over the period of land use rights (Note 26). (j) INVENTORIES Inventories, which consist primarily of expendable spare parts and supplies, are stated at cost less any applicable provision for obsolescence, and are expensed when used in operations. Cost represents the average unit cost. Inventories held for disposal is stated at the lower of cost and net realisable value. Net realisable value represents estimated resale price. - 175 - APPENDIX IV FINANCIAL INFORMATION OF THE LISTED GROUP NOTES TO THE FINANCIAL STATEMENTS (Cont'd) (PREPARED UNDER INTERNATIONAL FINANCIAL REPORTING STANDARDS) (EXPRESSED IN RENMINBI) 2 PRINCIPAL ACCOUNTING POLICIES (cont'd) (k) TRADE AND OTHER RECEIVABLES Trade and other receivables are stated at cost less impairment losses. Impairment losses are established based on evaluation of the recoverability of these accounts at the balance sheet date. (l) DEFERRED EXPENDITURE Custom duties and other direct costs in relation to modifying, introducing and certifying certain operating leased aircraft are deferred and amortised over the terms of the related leases. 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. (m) CASH AND CASH EQUIVALENTS Cash and cash equivalents consist of cash in hand and balances with banks and other financial institutions with an original maturity within three months. For the purpose of the consolidated cash flow statement, cash and cash equivalents are presented net of bank overdrafts, if any. (n) IMPAIRMENT LOSS The carrying amounts of the Group's and the Company's assets, other than inventories (refer to accounting policy j) and deferred tax assets (refer to accounting policy u) 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 net selling price and the value in use. In determining the value in use, expected future cash flows generated by the asset are discounted to their present value. The amount of the reduction is recognised as an expense in the profit and loss account. The Group and the Company assess at each balance sheet date whether there is any indication that an impairment loss recognised for an asset in prior years may no longer exist. An impairment loss is reversed if there has been a favourable change in the estimates used to determine the recoverable amount. A subsequent increase in the recoverable amount of an asset, when the circumstances and events that led to the write-down or write-off cease to exist, is recognised as income. The reversal is reduced by the amount that would have been recognised as depreciation had the write-down or write-off not occurred. - 176 - APPENDIX IV FINANCIAL INFORMATION OF THE LISTED GROUP NOTES TO THE FINANCIAL STATEMENTS (Cont'd) (PREPARED UNDER INTERNATIONAL FINANCIAL REPORTING STANDARDS) (EXPRESSED IN RENMINBI) 2 PRINCIPAL ACCOUNTING POLICIES (cont'd) (o) DEFERRED CREDITS In connection with the acquisition or operating lease of certain aircraft and engines, the Group receives various credits. Such credits are deferred until the aircraft and engines are delivered, at which time they are either applied as a reduction of the cost of acquiring the aircraft and engines, resulting in a reduction of future depreciation, or amortised as a reduction of rental expense for aircraft and engines under operating leases. (p) REVENUE RECOGNITION Passenger, cargo and mail revenues are recognised 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 and contributions to the CAAC Infrastructure Development Fund. Interest income is recognised as it accrues unless collectability is in doubt. Dividend income is recognised when the Group's right to receive the dividend is established. Operating lease income is recognised on a straight line basis over the terms of the respective leases. (q) TRAFFIC COMMISSIONS Traffic commissions are expensed 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. (r) MAINTENANCE AND OVERHAUL COSTS Routine maintenance and repairs and overhauls in respect of owned aircraft and aircraft held under finance leases are expensed in the profit and loss account as and when incurred. In respect of aircraft held under operating leases, a provision is made over the lease term for the estimated cost of scheduled overhauls required to be performed on the related aircraft prior to their return to the lessors. (s) TRANSLATION OF FOREIGN CURRENCIES Foreign currency transactions during the year are translated into Renminbi at the applicable rates of exchange prevailing on the transaction dates. Foreign currency monetary balances at the balance sheet date are translated into Renminbi at the exchange rates quoted by the People's Bank of China ruling at that date. Exchange differences are dealt with in the profit and loss account. - 177 - APPENDIX IV FINANCIAL INFORMATION OF THE LISTED GROUP NOTES TO THE FINANCIAL STATEMENTS (Cont'd) (PREPARED UNDER INTERNATIONAL FINANCIAL REPORTING STANDARDS) (EXPRESSED IN RENMINBI) 2 PRINCIPAL ACCOUNTING POLICIES (cont'd) (t) BORROWING COSTS Borrowing costs are expensed in the profit and loss account as and when incurred, except to the extent that they are capitalised as being directly attributable to the acquisition or construction of an asset which necessarily takes a substantial period of time to get ready for its intended use. (u) DEFERRED TAXATION Deferred tax is provided using the balance sheet liability method on all temporary differences between the carrying amounts for financial reporting purposes and the amounts used for taxation purposes, except differences relating to the initial recognition of assets or liabilities which affect neither accounting nor taxable profit/loss. The tax value of losses expected to be available for utilisation against future taxable income is recognised as a deferred tax asset and offset against the deferred tax liability attributable to the same legal tax unit and jurisdiction. Net deferred tax assets are reduced to the extent that it is no longer probable that the related tax benefit will be realised. (v) RETIREMENT BENEFITS Contributions to retirement schemes and additional retirement benefits paid to retired employees are charged to the profit and loss account as and when incurred. (w) FREQUENT FLYER AWARD PROGRAMMES The Group maintains two frequent flyer award programmes, namely, the China Southern Airlines Sky Pearl Club and the Egret Mileage Plus, which provide travel awards to members based on accumulated mileage. The estimated incremental cost to provide free travel is recognised as an expense and accrued as a current liability as members accumulate mileage. As members redeem awards or their entitlements expire, the incremental cost liability is reduced accordingly to reflect the acquittal of the outstanding obligations. Revenue from mileage sales to third parties under the frequent flyer award programmes is recognised when the related transportation services are provided. (x) PROVISIONS A provision is recognised in the balance sheet when the Group has a legal or constructive obligation as a result of a past event, and it is probable that an outflow of economic benefits will be required to settle the obligations. If the effect is material, provisions are determined by discounting the expected future cash flows at a pre-tax rate that reflects current market assessments of the time value of money and, where appropriate, the risks specific to the liability. - 178 - APPENDIX IV FINANCIAL INFORMATION OF THE LISTED GROUP NOTES TO THE FINANCIAL STATEMENTS (Cont'd) (PREPARED UNDER INTERNATIONAL FINANCIAL REPORTING STANDARDS) (EXPRESSED IN RENMINBI) 2 PRINCIPAL ACCOUNTING POLICIES (cont'd) (y) RELATED PARTIES For the purposes of these financial statements, parties are considered to be related to the Group if the Group has the ability, directly or indirectly, to control the party or exercise significant influence over the party in making financial and operating decisions, or vice versa, or where the Group and the party are subject to common control or common significant influence. Related parties may be individuals or entities. (z) SEGMENTAL REPORTING The Group operates principally as a single business segment for the provision of air transportation services. The analysis of turnover and operating profit by geographical segment is based on the following criteria: (i) Traffic revenue from domestic services within the PRC (excluding Hong Kong) is attributed to the domestic operation. Traffic revenue from inbound / outbound services between the PRC and Hong Kong, and the PRC and overseas destinations is attributed to the Hong Kong regional operation and international operation respectively. (ii) Other revenue from ticket selling, general aviation and ground services, air catering and other miscellaneous services is attributed on the basis of where the services are performed. (aa) USE OF ESTIMATES The preparation of the financial statements of the Group and the Company in accordance with IFRS requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. - 179 - APPENDIX IV FINANCIAL INFORMATION OF THE LISTED GROUP NOTES TO THE FINANCIAL STATEMENTS (Cont'd) (PREPARED UNDER INTERNATIONAL FINANCIAL REPORTING STANDARDS) (EXPRESSED IN RENMINBI) 3 TURNOVER Turnover comprises revenues from airline and airline-related business and is stated net of sales tax and contributions to the CAAC Infrastructure Development Fund. An analysis of turnover is as follows: 2003 2002 RMB'000 RMB'000 ---------- ---------- Traffic revenue Passenger 15,009,885 15,695,622 Cargo and mail 1,954,915 1,786,270 ---------- ---------- 16,964,800 17,481,892 ---------- ---------- Other operating revenue Commission income 140,180 137,928 General aviation income 40,309 68,225 Ground services income 99,130 78,616 Air catering income 30,756 38,077 Net income from lease arrangements (Note 10) 69,121 51,682 Rental income 40,307 - Aircraft lease income - 46,640 Other 85,520 115,560 ---------- ---------- 505,323 536,728 ---------- ---------- 17,470,123 18,018,620 ========== ========== Pursuant to various sales tax rules and regulations, the Group is required to pay sales tax to national and local tax authorities at the following rates: TYPES OF REVENUE APPLICABLE SALES TAX RATES Traffic revenue 3% (2002: 3%) of traffic revenue, except for the period from 1 May, 2003 to 31 December, 2003 during which passenger revenue was exempted from sales tax. All inbound international and Hong Kong regional flights are exempted from sales tax. Other operating revenue 3% (2002: 3%) of commission income, general aviation income and ground services income, and 3% to 5% (2002: 3% to 5%) of other operating revenue. - 180 - APPENDIX IV FINANCIAL INFORMATION OF THE LISTED GROUP NOTES TO THE FINANCIAL STATEMENTS (Cont'd) (PREPARED UNDER INTERNATIONAL FINANCIAL REPORTING STANDARDS) (EXPRESSED IN RENMINBI) 3 TURNOVER (cont'd) Sales tax incurred during the year ended 31 December, 2003, netted off against revenue, amounted to RMB205,925,000 (2002: RMB557,784,000). In addition, the Group is required to pay contributions to the CAAC Infrastructure Development Fund which are calculated at the rates of 5% and 2%, respectively (2002: 5% and 2%, respectively) of the domestic and international/Hong Kong regional traffic revenue, except for the period from 1 May, 2003 to 31 December, 2003 during which the Group was exempted from paying the contributions. Contributions to the CAAC Infrastructure Development Fund payable by the Group for the year ended 31 December, 2003 totalled RMB250,802,000 (2002: RMB798,386,000). Pursuant to approval documents issued by the CAAC, the Group imposes a fuel surcharge on passengers carried by its domestic and Hong Kong regional flights at certain prescribed rates on ticket fares. The fuel surcharge forms part of the traffic revenue of the Group. For the year ended 31 December, 2003, the fuel surcharge revenue of the Group totalled approximately RMB740 million (2002: RMB554 million). - 181 - APPENDIX IV FINANCIAL INFORMATION OF THE LISTED GROUP NOTES TO THE FINANCIAL STATEMENTS (Cont'd) (PREPARED UNDER INTERNATIONAL FINANCIAL REPORTING STANDARDS) (EXPRESSED IN RENMINBI) 4 (LOSS)/PROFIT BEFORE TAXATION AND MINORITY INTERESTS 2003 2002 RMB'000 RMB'000 ---------- ---------- (Loss)/profit before taxation and minority interests is arrived at after charging: Operating expenses Jet fuel 3,866,932 3,519,005 Aircraft maintenance 2,376,635 2,134,705 Routes 4,363,277 4,297,767 Depreciation - owned assets 1,502,013 1,301,601 - assets held under finance leases 495,869 537,692 Amortisation of deferred expenditure 40,089 578 Operating lease charges - aircraft and other flight equipment 1,536,466 1,416,524 - buildings 135,528 129,982 Staff costs - salaries, wages and welfare 1,496,191 1,538,617 - contributions to retirement schemes 150,447 131,622 Office and administration 470,565 452,432 Auditors' remuneration 8,200 8,200 Other 572,182 523,818 ---------- ---------- 17,014,394 15,992,543 ---------- ---------- Interest expense Interest on bank and other loans wholly repayable within five years 288,293 335,953 Interest on other loans 176,026 142,679 Finance charges on obligations under finance leases 442,483 544,747 Less: borrowing costs capitalised (Note) (83,077) (64,186) ---------- ---------- Net interest expense 823,725 959,193 ---------- ---------- and after crediting: Amortisation of gains on sale and leaseback transactions - 2,579 Dividend income from unlisted investments 17,220 7,116 ========== ========== Note: The borrowing costs have been capitalised at rates ranging 1.62% to 5.46% per annum (2002: 5.70%). - 182 - APPENDIX IV FINANCIAL INFORMATION OF THE LISTED GROUP NOTES TO THE FINANCIAL STATEMENTS (Cont'd) (PREPARED UNDER INTERNATIONAL FINANCIAL REPORTING STANDARDS) (EXPRESSED IN RENMINBI) 4 (LOSS)/PROFIT BEFORE TAXATION AND MINORITY INTERESTS (cont'd) The (loss)/profit attributable to shareholders for the year ended 31 December, 2003 includes a loss of RMB580,959,000 (2002: profit of RMB 381,305,000) which has been dealt with in the financial statements of the Company. 5 (LOSS)/GAIN ON SALE OF FIXED ASSETS (Loss)/gain on sale of fixed assets represents: 2003 2002 RMB'000 RMB'000 ------- ------- Aircraft (Note) (20,405) 199,394 Staff quarters (Note 28) - (17,624) Flight equipment and other fixed assets (1,812) (11,030) ------- ------- (22,217) 170,740 ======= ======= Note: During 2003, the Group incurred a loss of RMB20,405,000 on early retirement of two old Boeing 737-200 aircraft. Pursuant to certain sale and leaseback arrangements, the Group sold four Boeing 757-200 aircraft during 2002 to independent third parties and then entered into operating leases with such parties to lease back the aircraft for a period of eight to nine years. For the year ended 31 December, 2002, the Group recognised a profit of RMB199,394,000, being the excess of the sale proceeds which approximated the aircraft's fair value on the date of disposal, over the aircraft's net book value and related disposal costs. 6 EMOLUMENTS OF DIRECTORS, SUPERVISORS AND SENIOR MANAGEMENT (a) DIRECTORS' AND SUPERVISORS' EMOLUMENTS 2003 2002 RMB'000 RMB'000 ------- ------- Fees 203 103 Salaries, allowances and benefits in kind 1,244 970 Retirement benefits 98 67 Bonuses 943 264 ----- ----- 2,488 1,404 ===== ===== Included in the above were fees of RMB203,000 (2002: RMB103,000) paid to non-executive independent directors during the year. - 183 - APPENDIX IV FINANCIAL INFORMATION OF THE LISTED GROUP NOTES TO THE FINANCIAL STATEMENTS (Cont'd) (PREPARED UNDER INTERNATIONAL FINANCIAL REPORTING STANDARDS) (EXPRESSED IN RENMINBI) 6 EMOLUMENTS OF DIRECTORS, SUPERVISORS AND SENIOR MANAGEMENT (cont'd) (a) DIRECTORS' AND SUPERVISORS' EMOLUMENTS (cont'd) An analysis of directors' and supervisors' emoluments by number of individuals and emolument ranges is as follows: 2003 2002 NUMBER Number ------ ------ Nil to HK$1,000,000 (RMB1,066,000 equivalent) 18 14 === === (b) SENIOR MANAGEMENT'S EMOLUMENTS Details of emoluments paid to the five highest paid individuals (including directors and supervisors) of the Group during the year are as follows: 2003 2002 RMB'000 RMB'000 ------- ------- Salaries, allowances and benefits in kind 1,701 1,496 Retirement benefits 25 24 ----- ----- 1,726 1,520 ===== ===== An analysis of emoluments paid to the five highest paid individuals (including directors and supervisors) by number of individuals and emolument ranges is as follows: 2003 2002 NUMBER Number ------ ------ Directors and supervisors - 1 Employees 5 4 --- --- 5 5 === === Nil to HK$1,000,000 (RMB1,066,000 equivalent) 5 5 === === - 184 - APPENDIX IV FINANCIAL INFORMATION OF THE LISTED GROUP NOTES TO THE FINANCIAL STATEMENTS (Cont'd) (PREPARED UNDER INTERNATIONAL FINANCIAL REPORTING STANDARDS) (EXPRESSED IN RENMINBI) 7 TAXATION (CREDIT)/EXPENSE Taxation (credit)/expense in the consolidated profit and loss account comprises: 2003 2002 RMB'000 RMB'000 -------- ------- PRC income tax 46,938 71,651 Share of taxation of associated companies 3,342 9,424 Share of taxation of jointly controlled entities 6,372 - -------- ------- 56,652 81,075 Deferred taxation (Note 16) - current year 11,208 317,152 - adjustment for change in income tax rate (392,137) - -------- ------- Taxation (credit)/expense (324,277) 398,227 ======== ======= On 17 October, 2003, the Company's registered address was moved to Guangzhou Economic & Technology Development Zone. In accordance with the Rules and Regulations for Implementation of Income Tax for Foreign Investment Enterprises and Foreign Enterprises of the PRC and a taxation approval document "Guangzhou Municipal State Tax Bureau Suo De Shui Zi Que 020043", the Company is entitled to enjoy the preferential tax policy implemented in the Guangzhou Economic & Technology Development Zone effective 1 October, 2003. As a result, the Company's income tax rate has been changed to 15% from 33% beginning from that date. As a result of the reduction in income tax rate, the Company's net deferred taxation liability balance brought forward from 31 December, 2002 of RMB507,077,000 was reduced by RMB392,137,000 and a net deferred tax credit of RMB392,137,000 was recognised for such reduction in income tax rate in the consolidated profit and loss account for the year ended 31 December, 2003. In respect of the Group's overseas airline activities, the Group has either obtained exemptions from overseas taxation pursuant to the bilateral aviation agreements between the overseas governments and PRC government, or has sustained tax losses in these overseas jurisdictions. Accordingly, no provision for overseas tax has been made for the year (2002: nil). - 185 - APPENDIX IV FINANCIAL INFORMATION OF THE LISTED GROUP NOTES TO THE FINANCIAL STATEMENTS (Cont'd) (PREPARED UNDER INTERNATIONAL FINANCIAL REPORTING STANDARDS) (EXPRESSED IN RENMINBI) 7 TAXATION (CREDIT)/EXPENSE (cont'd) Actual taxation amount in the consolidated profit and loss account differed from the amount computed by applying the PRC income tax rate of 15% to consolidated (loss)/profit before taxation and minority interests as a result of the following: 2003 2002 RMB'000 RMB'000 -------- --------- Consolidated (loss)/profit before taxation and minority interests (511,610) 1,139,099 ======== ========= Expected PRC income tax (credit)/expense at 15% (2002: 33%) (76,742) 375,903 Adjustments: Gains on sale and leaseback transactions and their amortisation - (851) Effect of change in income tax rate (392,137) - Rate differential on subsidiaries - (60,530) Non-deductible expenses 79,907 61,454 Other, net 64,695 22,251 --------- ------- (324,277) 398,227 ========= ======= In accordance with relevant PRC tax regulations, a PRC lessee is liable to pay PRC withholding tax in respect of any lease payments regularly made to an overseas lessor. Depending on the circumstances, this tax is generally imposed at a fixed rate ranging from 10% to 20% of the lease payments, or in certain cases, the interest components of such payments. Pursuant to an approval document from the State Tax Bureau, lease arrangements executed prior to 1 September, 1999 are exempted from PRC withholding tax. For the year ended 31 December, 2003, the PRC withholding tax payable by the Group in respect of the leases executed on or after 1 September, 1999 of RMB7,706,000 (2002: RMB14,305,000) has been included as part of the operating lease charges for the year. 8 DIVIDENDS No interim dividend was paid during the year ended 31 December, 2003 (2002: Nil). The board of directors of the Company does not recommend the payment of a final dividend in respect of the year ended 31 December, 2003. A final dividend of RMB0.02 per share totalling RMB67,484,000 in respect of the year ended 31 December, 2001 was approved and paid during 2002. 9 BASIC (LOSS)/EARNINGS PER SHARE The calculation of basic (loss)/earnings per share is based on the consolidated loss attributable to shareholders of RMB358,267,000 (2002: profit of RMB575,761,000) and the weighted average number of shares in issue during the year of 3,831,712,000 (2002: 3,374,178,000). The amount of diluted (loss)/earnings per share is not presented as there were no dilutive potential ordinary shares in existence for both years. - 186 - APPENDIX IV FINANCIAL INFORMATION OF THE LISTED GROUP NOTES TO THE FINANCIAL STATEMENTS (Cont'd) (PREPARED UNDER INTERNATIONAL FINANCIAL REPORTING STANDARDS) (EXPRESSED IN RENMINBI) 10 FIXED ASSETS OTHER AIRCRAFT FLIGHT ----------------------- EQUIPMENT, MACHINERY, HELD UNDER INCLUDING EQUIPMENT FINANCE ROTABLE AND BUILDINGS OWNED LEASES SPARES VEHICLES TOTAL RMB'000 RMB'000 RMB'000 RMB'000 RMB'000 RMB'000 ------------------------------------------------------------------------------------------------------------ (a) THE GROUP Cost or valuation: At 1 January, 2003 3,160,073 13,510,717 11,459,978 6,283,470 1,782,400 36,196,638 Exchange adjustments 16,572 - - - 36,851 53,423 Reclassification on exercise of purchase options - 997,403 (997,403) - - - Additions 11,382 2,818,475 - 558,594 137,307 3,525,758 Transferred from construction in progress 133,839 - - - 12,255 146,094 Disposals (34,273) (104,235) - - (38,540) (177,048) --------- ---------- ---------- ---------- ---------- ---------- At 31 December, 2003 3,287,593 17,222,360 10,462,575 6,842,064 1,930,273 39,744,865 --------- ---------- ---------- ---------- ---------- ---------- Representing: Cost 2,932,399 10,993,419 6,123,034 4,667,887 1,446,235 26,162,974 Valuation - 1996 355,194 6,228,941 4,339,541 2,174,177 484,038 13,581,891 --------- ---------- ---------- ---------- ---------- ---------- 3,287,593 17,222,360 10,462,575 6,842,064 1,930,273 39,744,865 --------- ---------- ---------- ---------- ---------- ---------- Accumulated depreciation: At 1 January, 2003 476,867 2,145,849 2,499,495 3,177,253 976,345 9,275,809 Exchange adjustments 2,892 - - - 30,129 33,021 Reclassification on exercise of purchase options - 389,958 (389,958) - - - Charge for the year 128,776 710,509 495,869 467,202 195,526 1,997,882 Written back on disposal (14,740) (54,555) - - (28,459) (97,754) --------- ---------- ---------- ---------- ---------- ---------- At 31 December, 2003 593,795 3,191,761 2,605,406 3,644,455 1,173,541 11,208,958 --------- ---------- ---------- ---------- ---------- ---------- Net book value: At 31 December, 2003 2,693,798 14,030,599 7,857,169 3,197,609 756,732 28,535,907 ========= ========== ========== ========== ========== ========== At 31 December, 2002 2,683,206 11,364,868 8,960,483 3,106,217 806,055 26,920,829 ========= ========== ========== ========== ========== ========== -187- APPENDIX IV FINANCIAL INFORMATION OF THE LISTED GROUP NOTES TO THE FINANCIAL STATEMENTS (Cont'd) (PREPARED UNDER INTERNATIONAL FINANCIAL REPORTING STANDARDS) (EXPRESSED IN RENMINBI) 10 FIXED ASSETS (Cont'd) OTHER AIRCRAFT FLIGHT ----------------------- EQUIPMENT, MACHINERY, HELD UNDER INCLUDING EQUIPMENT FINANCE ROTABLE AND BUILDINGS OWNED LEASES SPARES VEHICLES TOTAL RMB'000 RMB'000 RMB'000 RMB'000 RMB'000 RMB'000 ------------------------------------------------------------------------------------------------------------ (b) THE COMPANY Cost or valuation: At 1 January, 2003 1,036,612 9,053,359 11,459,978 3,941,880 895,562 26,387,391 Reclassification on exercise of purchase options - 997,403 (997,403) - - - Additions 2,228 2,818,475 - 455,763 87,555 3,364,021 Additions through transfer of fixed assets upon dissolution of subsidiary 514,197 - - 998,215 217,272 1,729,684 Transferred from construction in progress 91,018 - - - 8,228 99,246 Disposals (347) - - - (20,178) (20,525) --------- ---------- ---------- ---------- ---------- ---------- At 31 December, 2003 1,643,708 12,869,237 10,462,575 5,395,858 1,188,439 31,559,817 --------- ---------- ---------- ---------- ---------- ---------- Representing: Cost 1,449,476 8,255,920 6,123,034 3,570,949 924,558 20,323,937 Valuation - 1996 194,232 4,613,317 4,339,541 1,824,909 263,881 11,235,880 --------- ---------- ---------- ---------- ---------- ---------- 1,643,708 12,869,237 10,462,575 5,395,858 1,188,439 31,559,817 --------- ---------- ---------- ---------- ---------- ---------- Accumulated depreciation: At 1 January, 2003 176,841 1,327,363 2,499,495 2,387,634 465,150 6,856,483 Reclassification on exercise of purchase options - 389,958 (389,958) - - - Charge for the year 72,980 514,000 495,869 373,896 116,207 1,572,952 Additions through transfer of fixed assets upon dissolution of subsidiary 73,772 - - 311,097 153,358 538,227 Written back on disposal (23) - - - (18,073) (18,096) --------- ---------- ---------- ---------- ---------- ---------- At 31 December, 2003 323,570 2,231,321 2,605,406 3,072,627 716,642 8,949,566 --------- ---------- ---------- ---------- ---------- ---------- Net book value: At 31 December, 2003 1,320,138 10,637,916 7,857,169 2,323,231 471,797 22,610,251 ========= ========== ========== ========== ========== ========== At 31 December, 2002 859,771 7,725,996 8,960,483 1,554,246 430,412 19,530,908 ========= ========== ========== ========== ========== ========== -188- APPENDIX IV FINANCIAL INFORMATION OF THE LISTED GROUP NOTES TO THE FINANCIAL STATEMENTS (Cont'd) (PREPARED UNDER INTERNATIONAL FINANCIAL REPORTING STANDARDS) (EXPRESSED IN RENMINBI) 10 FIXED ASSETS (Cont'd) Substantially all of the Group's buildings are located in the PRC. The Group was formally granted the rights to use the twenty one parcels of land in Guangzhou, Shenzhen, Zhuhai, Beihai, Changsha, Shantou, Haikou, Zhengzhou, Guiyang and Wuhan by the relevant PRC authorities for a period of 30 to 70 years, which expire between 2020 and 2068. For other land in the PRC on which the Group's buildings are erected, the Group was formally granted the rights to use such land for periods of one to five years commencing in the second quarter of 1997 pursuant to various lease agreements between the Company and CSAHC. The leases with initial one-year term are automatically renewable for another one-year period unless the Group gives appropriate notice of termination. In this connection, rental payments totalling RMB15,224,000 (2002: RMB15,224,000) were paid to CSAHC during 2003 in respect of these leases. During the year, the Company entered into operating lease arrangements to lease certain flight training facilities and buildings to Zhuhai Xiang Yi Aviation Technology Company Limited ("Zhuhai Xiang Yi"), a jointly controlled entity of the Company. The leases with initial one-year term are automatically renewable for another one year unless either party gives appropriate notice of termination. In this connection, rental income totalling RMB34,175,000 was received by the Company during 2003 in respect of the leases. As at 31 December, 2003, the cost and accumulated depreciation of the relevant fixed assets totalled RMB787,432,000 and RMB462,281,000 respectively. As at 31 December, 2003, the Company's rental receivable in respect of the leases due in 2004 amounted to RMB34,175,000. In compliance with the PRC rules and regulations governing initial public offering of shares by PRC joint stock limited companies, the fixed assets of the Group as at 31 December, 1996 were revalued. This revaluation was conducted by Guangzhou Assets Appraisal Corp. ("GAAC"), a firm of independent valuers registered in the PRC, on a depreciated replacement cost basis, and approved by the China State-owned Assets Administration Bureau. In accordance with IAS 16 "Property, plant and equipment", subsequent to the 1996 revaluation, which was based on replacement costs, the fixed assets of the Group are carried at revalued amount, being the fair value at the date of the revaluation less any subsequent accumulated depreciation and impairment losses. Revaluation is performed periodically to ensure that the carrying amount does not differ materially from that which would be determined using fair value at the balance sheet date. In accordance with the revaluation performed by the directors in respect of fixed assets held by the Group as at 31 December, 2000, the carrying amounts of fixed assets did not differ materially from their respective fair value. -189- APPENDIX IV FINANCIAL INFORMATION OF THE LISTED GROUP NOTES TO THE FINANCIAL STATEMENTS (Cont'd) (PREPARED UNDER INTERNATIONAL FINANCIAL REPORTING STANDARDS) (EXPRESSED IN RENMINBI) 10 FIXED ASSETS (Cont'd) The effect of the above revaluation was to increase future annual depreciation charges of the Group by approximately RMB33,000,000 (2002: RMB33,000,000). Had the fixed assets of the Group and the Company been stated at cost, that is, the effect of the revaluation was excluded, the net book values of fixed assets of the Group and the Company as at 31 December, 2003 would have been approximately RMB28,522,787,000 and RMB22,793,781,000 respectively (2002: RMB26,874,709,000 and RMB19,440,211,000 respectively), made up as follows: THE GROUP THE COMPANY 2003 2002 2003 2002 RMB'000 RMB'000 RMB'000 RMB'000 ---------------------------------------------------------------------------------------------- Buildings 3,109,988 2,982,468 1,610,075 1,002,979 Aircraft - owned 18,344,930 14,694,256 13,657,746 9,841,868 - held under finance leases 10,942,131 11,939,534 10,942,131 11,939,534 Flight equipment and others 9,634,146 8,927,679 6,910,210 5,163,355 ---------- ---------- ---------- ---------- 42,031,195 38,543,937 33,120,162 27,947,736 Less: Accumulated depreciation 13,508,408 11,669,228 10,326,381 8,507,525 ---------- ---------- ---------- ---------- 28,522,787 26,874,709 22,793,781 19,440,211 ========== ========== ========== ========== As at 31 December, 2003, certain aircraft of the Group and the Company with an aggregate carrying value of approximately RMB14,575,906,000 and RMB12,795,867,000 respectively (2002: RMB14,782,559,000 and RMB12,893,592,000, respectively) were mortgaged under certain loan and lease agreements (see Notes 21 and 22). 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. As agreed, the lease payment obligations, with pre-determined net present value, are to be satisfied solely out of the sale proceeds and such amount has been placed irrevocably by the Company in form of deposits and debt securities in favour of the lessors. The Company has an option to purchase the aircraft at a pre-determined date and an agreed purchase price to be satisfied by the balances of the deposits and debt securities outstanding at that date. In the event that the lease agreement is early terminated by the Company, the Company is liable to pay a pre-determined penalty to the lessor. As long as 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 incident to ownership of the aircraft and enjoys substantially the same rights to their use as before the Arrangements, no adjustment has been made to the fixed assets. As at 31 December, 2003, the net present value of the lease commitments and the corresponding defeased deposits and debt securities amounted to RMB2,409,252,000 (2002: RMB1,322,843,000). As a result of the Arrangements, the Company received net cash benefits of RMB51,682,000 and RMB69,121,000 in 2002 and 2003 respectively which have been recognised as income for the respective years. -190- APPENDIX IV FINANCIAL INFORMATION OF THE LISTED GROUP NOTES TO THE FINANCIAL STATEMENTS (Cont'd) (PREPARED UNDER INTERNATIONAL FINANCIAL REPORTING STANDARDS) (EXPRESSED IN RENMINBI) 11 CONSTRUCTION IN PROGRESS Construction in progress comprises expenditure incurred on the construction of buildings and other operating facilities not yet substantially completed at 31 December, 2003, details as follows: 2003 2002 RMB'000 RMB'000 --------- --------- THE COMPANY Guangzhou new airport base 1,378,063 432,580 Hubei catering building 27,911 23,407 Zhengzhou ticket selling office 22,016 21,988 Material and engineering system 21,066 21,063 Henan office building 13,986 3,717 Guangzhou ticket selling office - 45,988 Other 69,420 66,768 --------- --------- 1,532,462 615,511 --------- --------- SUBSIDIARIES Guangzhou new cargo centre 67,697 - Fuzhou Chang Le airport facilities 14,244 14,839 Other 15,286 31,002 --------- --------- 97,227 45,841 --------- --------- 1,629,689 661,352 ========= ========= 12 INTEREST IN SUBSIDIARIES THE COMPANY 2003 2002 RMB'000 RMB'000 --------- --------- Unlisted shares/capital contributions, at cost 977,540 1,086,793 Amounts due from subsidiaries 468,291 319,217 --------- --------- 1,445,831 1,406,010 ========= ========= -191- APPENDIX IV FINANCIAL INFORMATION OF THE LISTED GROUP NOTES TO THE FINANCIAL STATEMENTS (Cont'd) (PREPARED UNDER INTERNATIONAL FINANCIAL REPORTING STANDARDS) (EXPRESSED IN RENMINBI) 12 INTEREST IN SUBSIDIARIES (Cont'd) In March 2003, China Southern Airlines (Group) Shenzhen Co., a wholly owned subsidiary of the Company was dissolved in March 2003. Its operation and respective assets and liabilities were transferred to the Company since then. No material gains or losses were incurred by the Group on dissolution of the subsidiary. Details of the Company's subsidiaries are set out in Note 36. 13 INTEREST IN ASSOCIATED COMPANIES THE GROUP THE COMPANY 2003 2002 2003 2002 RMB'000 RMB'000 RMB'000 RMB'000 -------- -------- -------- -------- Share of attributable net assets other than goodwill 422,201 692,026 - - Unlisted capital contributions, at cost - - 348,502 428,840 Impairment loss for investment in associated company - - (61,267) (61,267) -------- -------- -------- -------- 422,201 692,026 287,235 367,573 ======== ======== ======== ======== Details of the Group's associated companies are set out in Note 37. 14 INTEREST IN JOINTLY CONTROLLED ENTITIES THE GROUP THE COMPANY 2003 2002 2003 2002 RMB'000 RMB'000 RMB'000 RMB'000 -------- -------- -------- -------- Share of attributable net assets other than goodwill 731,323 461,962 - - Unlisted capital contributions, at cost - - 563,736 474,042 -------- -------- -------- -------- 731,323 461,962 563,736 474,042 ======== ======== ======== ======== Details of the Company's jointly controlled entities are set out in Note 37. -192- APPENDIX IV FINANCIAL INFORMATION OF THE LISTED GROUP NOTES TO THE FINANCIAL STATEMENTS (Cont'd) (PREPARED UNDER INTERNATIONAL FINANCIAL REPORTING STANDARDS) (EXPRESSED IN RENMINBI) 14 INTEREST IN JOINTLY CONTROLLED ENTITIES (Cont'd) An analysis of the Group's attributable share of assets, liabilities, revenues and expenses of the jointly controlled entities is set out below: 2003 2002 RMB'000 RMB'000 -------- -------- Non-current assets 606,185 290,088 Current assets 618,799 326,712 Non-current liabilities (235,718) - Current liabilities (257,943) (154,838) -------- -------- Net assets 731,323 461,962 ======== ======== Income 486,049 - Expenses (525,544) (3,352) -------- -------- Net loss (39,495) (3,352) ======== ======== 15 DEFERRED EXPENDITURE Deferred expenditure mainly comprises custom duties and other direct costs incurred in respect of the Group's operating leased aircraft upon the inception of the respective leases, and lump sum housing benefits provided to eligible employees of the Group: THE GROUP THE COMPANY 2003 2002 2003 2002 RMB'000 RMB'000 RMB'000 RMB'000 -------- -------- -------- -------- Custom duties and other direct costs 60,135 257,509 36,551 168,265 Lump sum housing benefits (Note 28) 260,000 260,000 260,000 260,000 -------- -------- -------- -------- 320,135 517,509 296,551 428,265 Less: Accumulated amortisation 71,282 234,206 56,037 155,629 -------- -------- -------- -------- 248,853 283,303 240,514 272,636 ======== ======== ======== ======== -193- APPENDIX IV FINANCIAL INFORMATION OF THE LISTED GROUP NOTES TO THE FINANCIAL STATEMENTS (Cont'd) (PREPARED UNDER INTERNATIONAL FINANCIAL REPORTING STANDARDS) (EXPRESSED IN RENMINBI) 16 DEFERRED TAXATION Movements in net deferred tax liabilities are as follows: THE GROUP THE COMPANY --------------------- ------------------ 2003 2002 2003 2002 RMB'000 RMB'000 RMB'000 RMB'000 -------- -------- ------- -------- Balance at 1 January, (779,234) (519,577) (507,077) (293,991) Land use rights adjustment (Note 26 (f)) - 57,495 - 57,495 Transferred from profit and loss account (Note 7) - current year (11,208) (317,152) 25,232 (270,581) - adjustment for change in income tax rate 392,137 - 392,137 - -------- -------- ------- -------- Balance at 31 December, (398,305) (779,234) (89,708) (507,077) ======== ======== ======= ======== The net deferred tax liabilities at 31 December, 2003 were made up of the following taxation effects: THE GROUP THE COMPANY -------------------- ----------------------- 2003 2002 2003 2002 RMB'000 RMB'000 RMB'000 RMB'000 -------- --------- ------- --------- Deferred tax assets: Tax losses 222,936 149,338 222,936 149,338 Repairs and maintenance accruals 87,608 63,896 93,097 69,385 Repair charges capitalised 261,312 319,697 199,292 259,147 Accrued expenses 18,883 311,893 18,883 311,893 Other 8,989 129,423 10,829 144,463 -------- --------- ------- --------- Total deferred tax assets 599,728 974,247 545,037 934,226 -------- --------- ------- --------- Deferred tax liabilities: Undistributed profits of subsidiaries - 254,210 - 254,210 Repairs and maintenance accruals 80,545 78,083 - - Depreciation of fixed assets 847,781 1,403,278 590,543 1,187,093 Other 69,707 17,910 44,202 - -------- --------- ------- --------- Total deferred tax liabilities 998,033 1,753,481 634,745 1,441,303 -------- --------- ------- --------- Net deferred tax liabilities (398,305) (779,234) (89,708) (507,077) ======== ========= ======= ========= - 194 - APPENDIX IV FINANCIAL INFORMATION OF THE LISTED GROUP NOTES TO THE FINANCIAL STATEMENTS (Cont'd) (PREPARED UNDER INTERNATIONAL FINANCIAL REPORTING STANDARDS) (EXPRESSED IN RENMINBI) 17 INVENTORIES THE GROUP THE COMPANY ------------------- ----------------- 2003 2002 2003 2002 RMB'000 RMB'000 RMB'000 RMB'000 ------- ------- ------- ------- Expendable spare parts and maintenance materials 486,290 489,554 182,742 106,376 Other supplies 57,487 56,146 30,477 11,758 ------- ------- ------- ------- 543,777 545,700 213,219 118,134 ======= ======= ======= ======= No significant amount of inventories was carried at net realisable value at 31 December, 2002 and 2003. 18 TRADE RECEIVABLES Credit terms granted by the Group to sales agents and other customers generally range from one to three months. An ageing analysis of trade receivables, net of impairment losses, is set out below: THE GROUP THE COMPANY ------------------- ----------------- 2003 2002 2003 2002 RMB'000 RMB'000 RMB'000 RMB'000 ------- ------- ------- ------- Within 1 month 589,080 576,789 445,980 394,744 More than 1 month but less than 3 months 235,828 88,133 228,530 62,536 More than 3 months but less than 12 months 8,696 6,854 8,696 7,650 ------- ------- ------- ------- 833,604 671,776 683,206 464,930 ======= ======= ======= ======= As at 31 December, 2003, the Group and the Company had an amount due from a fellow subsidiary of RMB54,161,000 (2002: RMB89,550,000) which was included in trade receivables. All of the trade receivables are expected to be recovered within one year. 19 AMOUNTS DUE TO RELATED COMPANIES Amounts due to related companies, which represent balances with CSAHC and its affiliates, and the Group's associated companies and jointly controlled entities, are unsecured, interest free and repayable within one year. The balance at 31 December, 2002 also included balances with the CAAC and its affiliates. - 195 - APPENDIX IV FINANCIAL INFORMATION OF THE LISTED GROUP NOTES TO THE FINANCIAL STATEMENTS (Cont'd) (PREPARED UNDER INTERNATIONAL FINANCIAL REPORTING STANDARDS) (EXPRESSED IN RENMINBI) 20 CASH AND CASH EQUIVALENTS Cash and cash equivalents comprise cash at bank and in hand and deposits with Southern Airlines Group Finance Company Limited ("SA Finance"), a PRC authorised financial institution controlled by CSAHC and an associated company of the Group. In accordance with the financial agreement dated 22 May, 1997 between the Company and SA Finance, all the Group's deposits accepted by SA Finance at 31 December, 2003 were simultaneously placed with several designated major PRC banks by SA Finance. As at 31 December, 2003, the Group's and the Company's deposits with SA Finance amounted to RMB365,906,000 and RMB346,357,000 respectively (2002: RMB 900,979,000 and RMB877,449,000 respectively). 21 BANK AND OTHER LOANS THE GROUP THE COMPANY -------------------------- --------------------------- 2003 2002 2003 2002 RMB'000 RMB'000 RMB'000 RMB'000 ---------- ---------- ---------- ---------- Bank loans due: Within one year 7,096,846 5,240,726 5,958,968 3,479,322 In the second year 646,492 839,036 401,466 522,482 In the third to fifth year, inclusive 1,223,710 3,730,849 826,417 3,143,413 After the fifth year 2,648,533 1,262,549 2,442,616 962,477 ---------- ---------- ---------- ---------- 11,615,581 11,073,160 9,629,467 8,107,694 Other loans due: In the second year 3,000 3,000 - - ---------- ---------- ---------- ---------- 11,618,581 11,076,160 9,629,467 8,107,694 Portion classified as current liabilities (7,096,846) (5,240,726) (5,958,968) (3,479,322) ---------- ---------- ---------- ---------- 4,521,735 5,835,434 3,670,499 4,628,372 ========== ========== ========== ========== As at 31 December, 2003, bank loans of the Group and the Company totalling RMB4,902,118,000 and RMB3,822,826,000 respectively (2002: RMB 4,117,778,000 and RMB2,783,418,000 respectively) were secured by mortgages over certain of the Group's and the Company's aircraft. - 196 - APPENDIX IV FINANCIAL INFORMATION OF THE LISTED GROUP NOTES TO THE FINANCIAL STATEMENTS (Cont'd) (PREPARED UNDER INTERNATIONAL FINANCIAL REPORTING STANDARDS) (EXPRESSED IN RENMINBI) 21 BANK AND OTHER LOANS (cont'd) As at 31 December, 2003, certain bank loans were guaranteed by the following parties: THE GROUP THE COMPANY ------------------------ ----------------------- 2003 2002 2003 2002 RMB'000 RMB'000 RMB'000 RMB'000 --------- --------- --------- --------- Export-Import Bank of the United States 2,207,393 2,680,801 1,236,160 1,536,835 Bank of China 357,193 604,010 262,231 433,706 China Construction Bank - 76,134 - 76,134 CSAHC 359,300 3,340,118 228,800 2,280,118 Guangzhou Baiyun International Airport Company Limited 63,000 - - - Shenzhen Yingshun Investment Development Company Limited 21,000 - - - SA Finance 10,052 561,531 - 550,000 --------- --------- --------- --------- 3,017,938 7,262,594 1,727,191 4,876,793 ========= ========= ========= ========= - 197 - APPENDIX IV FINANCIAL INFORMATION OF THE LISTED GROUP NOTES TO THE FINANCIAL STATEMENTS (Cont'd) (PREPARED UNDER INTERNATIONAL FINANCIAL REPORTING STANDARDS) (EXPRESSED IN RENMINBI) 21 BANK AND OTHER LOANS (cont'd) Details of bank and other loans with original maturity over one year are as follows: THE GROUP THE COMPANY ------------------------- ------------------------- 2003 2002 2003 2002 INTEREST RATE AND FINAL MATURITY RMB'000 RMB'000 RMB'000 RMB'000 ----------------------------------- --------- --------- --------- --------- RMB denominated loans: Loans for construction Floating interest rates projects ranging from 4.94% to 5.25% per annum as at 31 December, 2003, with maturities through 2009 12,357 893,838 - 850,000 Non-interest bearing loan from a municipal government authority, repayable in 2005 3,000 3,000 - - Loans for purchase of aircraft Floating interest rate of 5.49% per annum as at 31 December, 2003, with maturities through 2004 63,500 2,310,268 - 2,231,768 U.S. dollar denominated loans: Loans for purchase of Fixed interest rates ranging aircraft from 5.00% to 8.33% per annum as at 31 December, 2003, with maturities through 2011 2,612,687 3,426,038 1,546,492 2,111,768 Floating interest rates ranging from 1.48% to 1.50% per annum as at 31 December, 2003, with maturities through 2013 2,505,134 - 2,505,134 - Loan for purchase Fixed interest rate of 8.35% per of flight equipment annum as at 31 December, 2003, with maturity in 2004 13,097 20,090 - - --------- --------- --------- --------- 5,209,775 6,653,234 4,051,626 5,193,536 Less: Loans due within one year classified as current liabilities (688,040) (817,800) (381,127) (565,164) --------- --------- --------- --------- 4,521,735 5,835,434 3,670,499 4,628,372 ========= ========= ========= ========= - 198 - APPENDIX IV FINANCIAL INFORMATION OF THE LISTED GROUP NOTES TO THE FINANCIAL STATEMENTS (Cont'd) (PREPARED UNDER INTERNATIONAL FINANCIAL REPORTING STANDARDS) (EXPRESSED IN RENMINBI) 21 BANK AND OTHER LOANS (cont'd) As at 31 December, 2003, bank and other loans of the Group and the Company included short-term bank loans totalling RMB6,408,806,000 and RMB5,577,841,000 respectively (2002: RMB4,422,926,000 and RMB 2,914,158,000 respectively). On such date, the Group's and the Company's weighted average interest rate on short-term borrowings were 1.76% and 1.65% respectively (2002: 3.11% and 2.66% respectively). As at 31 December, 2003, the Group had banking facilities with several PRC commercial banks for providing loan finance up to an approximate amount of RMB9,860 million (2002: RMB12,360 million). As at 31 December, 2003, an approximate amount of RMB4,412 million (2002: RMB7,258 million) was utilised. 22 OBLIGATIONS UNDER FINANCE LEASES The Group and the Company have commitments under finance lease agreements in respect of aircraft and related equipment expiring during the years 2004 to 2009. As at 31 December, 2003, future payments under these finance leases, which were 74% and 26% respectively (2002: 78% and 22% respectively) denominated in United States dollars and Japanese yen, are as follows: 2003 2002 ----------------------------------- ------------------------------------ PAYMENTS INTEREST OBLIGATIONS Payments Interest Obligations RMB'000 RMB'000 RMB'000 RMB'000 RMB'000 RMB'000 --------- --------- ----------- --------- --------- ----------- THE GROUP AND THE COMPANY Balance due: Within one year 1,648,141 350,286 1,297,855 2,006,392 439,694 1,566,698 In the second year 1,356,614 290,163 1,066,451 1,624,381 351,237 1,273,144 In the third to fifth year, inclusive 4,348,235 439,418 3,908,817 4,153,235 647,988 3,505,247 After the fifth year 608,124 40,308 567,816 1,960,607 107,247 1,853,360 --------- --------- --------- --------- --------- --------- 7,961,114 1,120,175 6,840,939 9,744,615 1,546,166 8,198,449 --------- --------- --------- --------- --------- --------- Less: Balance due within one year classified as current liabilities (1,297,855) (1,566,698) --------- --------- 5,543,084 6,631,751 ========= ========= Certain lease financing arrangements comprised finance leases between the Company and certain of its subsidiaries, and corresponding borrowings between such subsidiaries and banks. The Company has guaranteed the subsidiaries' obligations under the bank borrowings and accordingly, the relevant leased assets and obligations are recorded in the balance sheet to reflect the substance of the transactions. The future payments under these leases have therefore been presented by the Company and the Group in amounts that reflect the payments under the bank borrowings between the subsidiaries and banks. - 199 - APPENDIX IV FINANCIAL INFORMATION OF THE LISTED GROUP NOTES TO THE FINANCIAL STATEMENTS (Cont'd) (PREPARED UNDER INTERNATIONAL FINANCIAL REPORTING STANDARDS) (EXPRESSED IN RENMINBI) 22 OBLIGATIONS UNDER FINANCE LEASES (cont'd) Under the terms of the leases, the Group has an option to purchase, at or near the end of the lease term, certain aircraft at fair market value and others at either fair market value or a percentage of the respective lessor's defined cost of the aircraft. Security, including charges over the assets concerned and relevant insurance policies, is provided to the lessors. As at 31 December, 2003, certain of the Group's and the Company's aircraft with carrying amount of RMB7,857,169,000 (2002: RMB8,960,483,000) were mortgaged to secure facilities with financial institutions granted to lessors totalling RMB6,840,939,000 (2002: RMB8,198,449,000). 23 ACCOUNTS PAYABLE An ageing analysis of accounts payable is set out below: THE GROUP THE COMPANY 2003 2002 2003 2002 RMB'000 RMB'000 RMB'000 RMB'000 ------- ------- ------- ------- Due within 1 month or on demand 279,165 164,442 206,620 88,645 Due after 1 month but within 3 months 278,113 157,731 231,115 89,290 Due after 3 months but within 6 months 370,815 210,307 308,153 119,054 ------- ------- ------- ------- 928,093 532,480 745,888 296,989 ======= ======= ======= ======= As at 31 December, 2003, the Group and the Company had an amount due to a fellow subsidiary of RMB693,345,000 (2002: RMB267,468,000) which was included in accounts payable. All of the accounts payable are expected to be settled within one year. - 200 - APPENDIX IV FINANCIAL INFORMATION OF THE LISTED GROUP NOTES TO THE FINANCIAL STATEMENTS (Cont'd) (PREPARED UNDER INTERNATIONAL FINANCIAL REPORTING STANDARDS) (EXPRESSED IN RENMINBI) 24 PROVISION FOR MAJOR OVERHAULS Details of provision for major overhauls in respect of aircraft held under operating leases are as follows: THE GROUP THE COMPANY -------------------- ------------------ 2003 2002 2003 2002 RMB'000 RMB'000 RMB'000 RMB'000 ------- ------- ------- -------- Balance at 1 January, 193,887 187,125 63,389 48,154 Additional amount provided 68,620 49,051 67,603 33,460 Amount utilised (62,326) (42,289) - (18,225) ------- ------- ------- ------- Balance at 31 December, 200,181 193,887 130,992 63,389 Less: Current portion included in accrued expenses 10,717 52,000 - ------- ------- ------- ------- 189,464 141,887 130,992 63,389 ======= ======= ======= ======= 25 SHARE CAPITAL 2003 2002 RMB'000 RMB'000 --------- --------- Registered capital: 2,200,000,000 domestic shares of RMB 1.00 each 2,200,000 2,200,000 1,174,178,000 H shares of RMB 1.00 each 1,174,178 1,174,178 1,000,000,000 A shares of RMB 1.00 each 1,000,000 - --------- --------- 4,374,178 3,374,178 ========= ========= Issued and paid up capital: 2,200,000,000 domestic shares of RMB 1.00 each 2,200,000 2,200,000 1,174,178,000 H shares of RMB 1.00 each 1,174,178 1,174,178 1,000,000,000 A shares of RMB 1.00 each 1,000,000 - --------- --------- 4,374,178 3,374,178 ========= ========= In July 2003, the Company issued 1,000,000,000 A shares with a par value of RMB1.00 each at issue price of RMB2.70 by way of a public offering to natural persons and institutional investors in the PRC. The share premium received by the Company, net of the issuance costs of RMB59,233,000, amounted to RMB1,640,767,000 and was credited to share premium account. All the domestic, H and A shares rank pari passu in all material respects. - 201 - APPENDIX IV FINANCIAL INFORMATION OF THE LISTED GROUP NOTES TO THE FINANCIAL STATEMENTS (Cont'd) (PREPARED UNDER INTERNATIONAL FINANCIAL REPORTING STANDARDS) (EXPRESSED IN RENMINBI) 26 RESERVES Movements on reserves during the year comprise: THE GROUP THE COMPANY ------------------------ --------------------------- 2003 2002 2003 2002 Notes RMB'000 RMB'000 RMB'000 RMB'000 ----- --------- --------- --------- --------- Share premium Balance at 1 January, 3,683,956 3,813,659 3,683,956 3,813,659 Land use rights adjustment (f) - (129,703) - (129,703) Share premium from issuance of shares, net of related issuance costs 1,640,767 - 1,640,767 - --------- --------- --------- --------- Balance at 31 December, 5,324,723 3,683,956 5,324,723 3,683,956 --------- --------- --------- --------- Statutory surplus reserve (a) Balance at 1 January, 337,195 391,867 337,195 121,943 Adjustments from adoption of new PRC accounting regulations (c) - (106,007) - 163,917 Transfer from profit and loss account 23,856 51,335 1,449 51,335 --------- --------- --------- --------- Balance at 31 December, 361,051 337,195 338,644 337,195 --------- --------- --------- --------- Statutory public welfare fund (b) Balance at 1 January, 171,574 225,440 171,574 114,558 Adjustments from adoption of new PRC accounting regulations (c) - (79,533) - 31,349 Transfer from profit and loss account 1,113 25,667 724 25,667 --------- --------- --------- --------- Balance at 31 December, 172,687 171,574 172,298 171,574 --------- --------- --------- --------- Discretionary surplus reserve (d) Balance at 1 January, 76,603 69,867 76,603 - Adjustments from adoption of new PRC accounting regulations (c) - - - 69,867 Transfer from profit and loss account - 6,736 - 6,736 --------- --------- --------- --------- Balance at 31 December, 76,603 76,603 76,603 76,603 --------- --------- --------- --------- Retained earnings/(Accumulated losses) Balance at 1 January, 1,969,701 1,346,652 445,636 467,716 Adjustments from adoption of new PRC accounting regulations (c) - 185,540 - (265,133) Land use rights adjustment (f) - 12,970 - 12,970 (Loss)/profit for the year (358,267) 575,761 (580,959) 381,305 Appropriations to reserves (24,969) (83,738) (2,173) (83,738) Dividends paid - (67,484) - (67,484) --------- --------- --------- --------- Balance at 31 December, 1,586,465 1,969,701 (137,496) 445,636 --------- --------- --------- --------- Total 7,521,529 6,239,029 5,774,772 4,714,964 ========= ========= ========= ========= - 202 - APPENDIX IV FINANCIAL INFORMATION OF THE LISTED GROUP NOTES TO THE FINANCIAL STATEMENTS (Cont'd) (PREPARED UNDER INTERNATIONAL FINANCIAL REPORTING STANDARDS) (EXPRESSED IN RENMINBI) 26 RESERVES (cont'd) Notes: (a) According to the PRC Company Law and the Articles of Association of the Company and certain of its subsidiaries, the Company and the relevant subsidiaries are required to transfer 10% of their annual net profits after taxation, as determined under relevant PRC accounting regulations, to a statutory surplus reserve until the reserve balance reaches 50% of the registered capital. The transfer to this reserve must be made before distribution of a dividend to shareholders. Statutory surplus reserve can be used to offset prior years' losses, if any, and may be converted into share capital by the issue of new shares to shareholders in proportion to their existing shareholding or by increasing the par value of the shares currently held by them, provided that the balance after such issue is not less than 25% of the registered capital. (b) According to the PRC Company Law and the Articles of Association of the Company and certain of its subsidiaries, the Company and the relevant subsidiaries are required to transfer between 5% to 10% of their annual net profits after taxation, as determined under PRC accounting regulations, to the statutory public welfare fund. This fund can only be utilised on capital items for the collective benefits of the Company's and the relevant subsidiaries' employees such as the construction of dormitories, canteen and other staff welfare facilities. This fund is non-distributable other than in liquidation. The transfer to this reserve must be made before distribution of a dividend to shareholders. (c) During 2002, the Group and the Company adopted certain new PRC accounting regulations which resulted in adjustments to the amounts of the Group's and Company's profits determined under PRC accounting regulations in respect of prior years and corresponding adjustments to amounts appropriated to the statutory surplus reserve, statutory public welfare fund and discretionary surplus reserve for the prior years. (d) The usage of this reserve is similar to that of statutory surplus reserve. (e) Under PRC Company Law and the Company's Articles of Association, the net profit after taxation as reported in the PRC statutory financial statements of the Company can only be distributed as dividends after allowances have been made for: (i) making up cumulative prior years' losses, if any; (ii) allocations to the statutory surplus reserve of at least 10% of after-tax profit, until the fund aggregates to 50% of the Company's registered capital; (iii) allocations of 5% to 10% of after-tax profit to the Company's statutory public welfare fund; and (iv) allocations to the discretionary surplus reserve, if approved by the shareholders. 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 principles and financial regulations and (ii) the net profit determined in accordance with IFRS; or if the financial statements of the Company are not prepared in accordance with IFRS, the accounting standards of one of the countries in which its shares are listed. As at 31 December, 2003, the Company did not have any distributable reserves (2002: RMB445,636,000). - 203 - APPENDIX IV FINANCIAL INFORMATION OF THE LISTED GROUP NOTES TO THE FINANCIAL STATEMENTS (Cont'd) (PREPARED UNDER INTERNATIONAL FINANCIAL REPORTING STANDARDS) (EXPRESSED IN RENMINBI) 26 RESERVES (cont'd) Notes: (cont'd) (f) The Group adopted IAS 40 "Investment Property" in 2002. According to IAS 40, the land use rights which were previously included in fixed assets at revaluation base are now presented as lease prepayments and carried at historical cost base with effect from 1 January, 2002. Accordingly, the unamortised surplus on previous revaluations of the land use rights, net of related deferred tax asset, are reversed to the share premium and retained profits accounts. The IAS 40 was adopted prospectively in 2002 as the effect of this change did not have a material impact on the Group's financial condition and results of operations in the periods prior to the change. 27 RELATED PARTY TRANSACTIONS The Group obtained various operational and financial services provided by CSAHC and its affiliates, and the Group's associated companies and jointly controlled entities during the normal course of its business. In the past, CSAHC was under the direct control of the CAAC. However, such control has been shifted to the State Assets Administration Committee since early 2003. Consequently, transactions with the CAAC and its affiliates are no longer presented as related party transactions of the Group. - 204 - APPENDIX IV FINANCIAL INFORMATION OF THE LISTED GROUP NOTES TO THE FINANCIAL STATEMENTS (Cont'd) (PREPARED UNDER INTERNATIONAL FINANCIAL REPORTING STANDARDS) (EXPRESSED IN RENMINBI) 27 RELATED PARTY TRANSACTIONS (cont'd) The following is a summary of significant transactions carried out in the normal course of business between the Group, CSAHC and its affiliates, and the Group's associated companies and jointly controlled entities during the year: 2003 2002 Notes RMB'000 RMB'000 ----- ------- ------- EXPENSES PAID TO CSAHC AND OTHER RELATED PARTIES Handling charges (a) 27,051 36,306 Wet lease rentals (b) 35,751 26,164 Advertising expenses (c) - 3,275 Sundry aviation supplies (d) 42,849 101,350 Commission expense (e) 4,896 16,725 Air catering expense (f) 28,199 29,058 Repairing charges (g) 693,303 592,311 Housing benefits (h) 85,000 85,000 Lease charges for land and buildings (i) 15,224 15,224 Flight simulation service charges (j) 101,355 - PAID TO CAAC AND ITS AFFILIATES Jet fuel supplies - 2,373,956 Aircraft insurance - 256,238 Guarantee fees - 1,025 Ticket reservation service charges - 107,234 Passenger departure and cargo handling charges - 62,111 Aircraft and traffic servicing charges - 1,667,706 Commission expense - 464,721 INCOME RECEIVED FROM CSAHC AND OTHER RELATED PARTIES Rental income (j) 34,175 - Wet lease rentals (k) - 27,599 Interest income (l) 3,100 10,530 RECEIVED FROM CAAC AND ITS AFFILIATES Ground services income - 39,735 Commission income - 81,931 OTHERS Short term advances from CSAHC (m) 165,995 - Refund of medical benefit payments (n) 58,120 - Acquisition of aircraft and related spare parts and vehicles (o) - 946,866 Acquisition of subsidiaries (p) - 107,846 ======= ========= - 205 - APPENDIX IV FINANCIAL INFORMATION OF THE LISTED GROUP NOTES TO THE FINANCIAL STATEMENTS (Cont'd) (PREPARED UNDER INTERNATIONAL FINANCIAL REPORTING STANDARDS) (EXPRESSED IN RENMINBI) 27 RELATED PARTY TRANSACTIONS (cont'd) Notes: (a) Handling charges represent fees payable to Southern Airlines (Group) Import and Export Trading Company, a wholly owned subsidiary of CSAHC, in connection with the procurement of aircraft and flight equipment on the Group's behalf. Handling charges are calculated based on a fixed percentage of the purchase value and other charges. (b) Wet lease rentals represented rentals payable to Xinjiang Airlines Company, a subsidiary of CSAHC, pursuant to a wet lease agreement in respect of a Boeing 757-200 aircraft effective October 2002. The wet lease agreement was terminated in April 2003. (c) Advertising expenses represent expense reimbursements to Southern Airlines Advertising Company ("SAAC") for promotional services rendered to the Group. SAAC was a subsidiary of CSAHC up to July 2002. In August 2002, the Company acquired 90% equity interest in SAAC from CSAHC. (d) Sundry aviation supplies represent purchases of aviation supplies from Southern Airlines (Group) Economic Development Company, a subsidiary of CSAHC. Prices charged by this supplier to the Group are similar to those charged to other PRC airlines. (e) Commission expense represents commissions payable to certain subsidiaries of CSAHC in connection with services provided in exchange for air tickets sold by them. These commissions are calculated based on a fixed rate ranging from 1.5% to 12% on the ticket value. (f) Air catering expense represents purchases of inflight meals and related services from Shenzhen Air Catering Company Limited, a cooperative joint venture established in the PRC, in respect of which CSAHC is entitled to 33% of its profits after tax. (g) Repairing charges represent fees incurred by the Group in connection with aircraft repair and maintenance services rendered by Guangzhou Aircraft Maintenance Engineering Company Limited ("GAMECO") and MTU Maintenance Zhuhai Co., Ltd. ("MTU Zhuhai"). GAMECO and MTU Zhuhai are jointly controlled entities of the Company. (h) Housing benefits represent a fixed annual fee payable to CSAHC in respect of the provision of quarters to the eligible employees of the Group. (Note 28). (i) Charges were paid to CSAHC under certain lease agreements in respect of certain land and buildings in the PRC (Note 10). (j) Flight simulation service charges represent fees incurred by the Group in connection with flight simulation services provided by Zhuhai Xiang Yi, a jointly controlled entity of the Company. In addition, the Company entered into operating lease agreements to lease certain flight training facilities and buildings to Zhuhai Xiang Yi. Rental income earned by the Company amounted to RMB34,175,000 during 2003 (Note 10). (k) During the period from August to October 2002, the Company received wet lease rentals totalling RMB27,599,000 from wet leasing of an Airbus 320-200 aircraft to Sichuan Airlines Corporation Limited, an associated company of the Company. (l) Interest income represents interest received from deposits placed with SA Finance. The applicable interest rate is determined in accordance with the deposit rate published by the People's Bank of China (see Note 20). - 206 - APPENDIX IV FINANCIAL INFORMATION OF THE LISTED GROUP NOTES TO THE FINANCIAL STATEMENTS (Cont'd) (PREPARED UNDER INTERNATIONAL FINANCIAL REPORTING STANDARDS) (EXPRESSED IN RENMINBI) 27 RELATED PARTY TRANSACTIONS (cont'd) Notes: (cont'd) (m) During the year, CSAHC made short term advances to the Group. These advances are unsecured, interest free and repayable on demand. As at 31 December, 2003, the advances amounted to RMB165,995,000. (n) Prior to 1 January, 2002, the Group paid a fixed annual fee to CSAHC in return for CSAHC providing medical benefit, transportation subsidies and other welfare facilities to the retirees of the Group. Such arrangement was terminated on 1 January, 2002. During 2003, CSAHC refunded to the Group the difference between the aggregate fixed annual fees received from the Group and the aggregate cost of services incurred by CSAHC under the above arrangement. (o) During 2002, the Group acquired five Boeing 737-300/37K aircraft and related spare parts and certain vehicles from Zhongyuan Airlines, a subsidiary of CSAHC, at a consideration of approximately RMB1,096,866,000. The consideration was satisfied by cash of approximately RMB132,130,000 together with an assumption by the Group of Zhongyuan Airlines' debts of approximately RMB964,736,000. In addition, the Group received reimbursements of wet lease rentals totalling RMB150,000,000. (p) In August 2002, the Company acquired 90% equity interest in each of Guangzhou Aviation Hotel, Southern Airlines Advertising Company and South China International Aviation & Travel Services Company from CSAHC at an aggregate cash consideration of approximately RMB107,846,000. Such consideration is determined by reference to the valuation reports prepared by Guangzhou Zhongtian Valuation Company Limited, a firm of independent valuers registered in the PRC. In addition to the above, certain business undertakings of CSAHC also provided hotel and other services to the Group during the year. The total amount involved is not material to the results of the Group for the year. The directors of the Company are of the opinion that the above transactions with related parties were entered into in the normal course of business and on normal commercial terms or in accordance with the agreements governing such transactions. 28 RETIREMENT AND HOUSING BENEFITS Employees of the Group participate in several defined contribution retirement schemes organised separately by PRC municipal governments in regions where the major operations of the Group are located. The Group is required to contribute to these schemes at the rates ranging from 14% to 19% (2002: 14% to 19%) of salary costs including certain allowances. A member of the retirement schemes is entitled to pension benefits equal to a fixed proportion of the salary at the retirement date. The retirement benefit obligations of all existing and future retired staff of the Group are assumed by these schemes. In addition, the Group was selected as one of the pilot enterprises to establish a supplementary defined contribution retirement scheme for the benefit of employees. In this connection, employees of the Group participate in a supplementary defined contribution retirement scheme whereby the Group is required to make defined contributions at a rate of 4.5% of total salaries. The Group has no obligation for the payment of pension benefits beyond the contributions described above. Contributions to the retirement schemes are charged to the profit and loss account as and when incurred. - 207 - APPENDIX IV FINANCIAL INFORMATION OF THE LISTED GROUP NOTES TO THE FINANCIAL STATEMENTS (Cont'd) (PREPARED UNDER INTERNATIONAL FINANCIAL REPORTING STANDARDS) (EXPRESSED IN RENMINBI) 28 RETIREMENT AND HOUSING BENEFITS (cont'd) Furthermore, pursuant to the comprehensive services agreement (the "Services Agreement") dated 22 May, 1997 between the Company and CSAHC, CSAHC agrees to provide adequate quarters to eligible employees of the Group as and when required. In return, the Group agrees to pay a fixed annual fee of RMB85,000,000 to CSAHC for a ten-year period effective 1 January, 1995. During 2002, the Group provided additional quarters at its own expense to certain employees who are not eligible for quarters pursuant to the Services Agreement. These quarters were provided to the respective employees in accordance with the relevant PRC housing reform policy. The excess of the cost of these additional quarters over the considerations received by the Group from the employees of RMB17,624,000 were charged to expenses in 2002. Pursuant to an additional staff housing benefit scheme effective September 2002, the Group agreed to pay lump sum housing allowances to certain employees who have not received quarters from CSAHC or the Group according to the relevant PRC housing reform policy, for subsidising their purchases of housing. Such expenditure has been deferred and amortised on a straight line basis over a period of 10 years, which represents the vesting benefit period of the employees. 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 remained. The Group has the right to effect a charge on the employee's house and to enforce repayment through selling the house in the event of default in repayment. Any shortfall in repayment would be charged against profit and loss account. As at 31 December, 2003, the Group already made payments totalling RMB130,479,000 (2002: RMB46,325,000) under the scheme and recorded its remaining contractual liabilities totalling RMB129,521,000 (2002: RMB213,675,000) as accrued liabilities on its balance sheet. - 208 - APPENDIX IV FINANCIAL INFORMATION OF THE LISTED GROUP NOTES TO THE FINANCIAL STATEMENTS (Cont'd) (PREPARED UNDER INTERNATIONAL FINANCIAL REPORTING STANDARDS) (EXPRESSED IN RENMINBI) 29 COMMITMENTS (a) CAPITAL COMMITMENTS As at 31 December, 2003, the Group and the Company had capital commitments as follows: THE GROUP THE COMPANY --------------------- ----------------------- 2003 2002 2003 2002 RMB'000 RMB'000 RMB'000 RMB'000 ---------- --------- ---------- --------- Commitments in respect of aircraft and related equipment (Note) - authorised and contracted for 10,615,079 5,875,996 7,739,290 5,875,996 ---------- --------- ---------- --------- Commitments in respect of investments in the Guangzhou new airport - authorised and contracted for 617,277 525,700 617,277 525,700 - authorised but not contracted for 1,454,661 2,601,720 1,454,661 2,601,720 ---------- --------- ---------- --------- 2,071,938 3,127,420 2,071,938 3,127,420 ---------- --------- ---------- --------- Other commitments - authorised and contracted for 232,570 43,887 29,628 42,968 - authorised but not contracted for 708,099 500,545 229,302 245,440 ---------- --------- ---------- --------- 940,669 544,432 258,930 288,408 ---------- --------- ---------- --------- 13,627,686 9,547,848 10,070,158 9,291,824 ========== ========= ========== ========= - 209 - APPENDIX IV FINANCIAL INFORMATION OF THE LISTED GROUP NOTES TO THE FINANCIAL STATEMENTS (Cont'd) (PREPARED UNDER INTERNATIONAL FINANCIAL REPORTING STANDARDS) (EXPRESSED IN RENMINBI) 29 COMMITMENTS (cont'd) (a) CAPITAL COMMITMENTS (cont'd) Note: As at 31 December, 2003, the Group had on order 2 Boeing 757-200 aircraft, 13 Boeing 737-700 aircraft, 4 Airbus 330-200 aircraft, 6 Embraer ERJ-145 aircraft and certain flight equipment, scheduled for deliveries in 2004 to 2005. Deposits of RMB2,494,853,000 have been made towards the purchase of these aircraft and related equipment. At 31 December, 2003, the approximate total future payments, including estimated amounts for price escalation through anticipated delivery dates for these aircraft and related equipment are as follows: THE GROUP THE COMPANY ---------------------- -------------------- 2003 2002 2003 2002 RMB'000 RMB'000 RMB'000 RMB'000 ---------- --------- --------- --------- Year ending 31 December, 2003 - 2,801,451 - 2,801,451 2004 4,584,823 2,343,978 3,248,674 2,343,978 2005 6,030,256 730,567 4,490,616 730,567 ---------- --------- --------- --------- 10,615,079 5,875,996 7,739,290 5,875,996 ========== ========= ========= ========= The Group has taken steps towards the purchase of the airline business of China Northern Airlines Company and Xinjiang Airlines Company. No contractual obligations existed as at 31 December, 2003 and up to the date of approval of these financial statements. The purchase price has not yet been determined. As at 31 December, 2003, the Group's and the Company's attributable share of the capital commitments of jointly controlled entities was as follows: THE GROUP AND THE COMPANY ------------------------- 2003 2002 RMB'000 RMB'000 ------- ------- Authorised and contracted for 24,137 63,723 Authorised but not contracted for 283,761 518,000 ------- ------- 307,898 581,723 ======= ======= - 210 - APPENDIX IV FINANCIAL INFORMATION OF THE LISTED GROUP NOTES TO THE FINANCIAL STATEMENTS (Cont'd) (PREPARED UNDER INTERNATIONAL FINANCIAL REPORTING STANDARDS) (EXPRESSED IN RENMINBI) 29 COMMITMENTS (cont'd) (b) OPERATING LEASE COMMITMENTS As at 31 December, 2003, commitments under non-cancellable aircraft and flight equipment operating leases were as follows: THE GROUP THE COMPANY -------------------- ------------------------ 2003 2002 2003 2002 RMB'000 RMB'000 RMB'000 RMB'000 --------- --------- --------- --------- Payments due Within one year 1,482,888 1,280,060 1,193,892 1,044,720 In the second to fifth year, inclusive 4,248,095 4,358,474 3,578,618 3,772,227 After the fifth year 2,388,874 2,898,104 2,278,463 2,893,237 --------- --------- --------- --------- 8,119,857 8,536,638 7,050,973 7,710,184 ========= ========= ========= ========= (c) INVESTING COMMITMENTS As at 31 December, 2003, the Company was committed to make a capital contribution of approximately RMB446 million and RMB Nil respectively (2002: RMB60 million and RMB201 million respectively) to its jointly controlled entities and associated companies. 30 CONTINGENT LIABILITIES (a) The Company has been advised by its PRC lawyers that, except for liabilities constituting or arising out of or relating to the businesses assumed by the Company in the Reorganisation, no other liabilities were assumed by the Company, and the Company is not jointly and severally liable for other debts and obligations incurred by CSAHC prior to the Reorganisation. There are not, however, any definitive PRC regulations or other pronouncements confirming such conclusion. (b) The Group leases from CSAHC certain land in Guangzhou and certain land and buildings in Wuhan, Haikou and Zhengzhou. The Group has a significant investment in buildings and other leasehold improvements located on such land. However, such land in Guangzhou and such land and buildings in Wuhan, Haikou and Zhengzhou lack adequate documentation evidencing CSAHC's rights thereto. - 211 - APPENDIX IV FINANCIAL INFORMATION OF THE LISTED GROUP NOTES TO THE FINANCIAL STATEMENTS (Cont'd) (PREPARED UNDER INTERNATIONAL FINANCIAL REPORTING STANDARDS) (EXPRESSED IN RENMINBI) 30 CONTINGENT LIABILITIES (cont'd) With respect to the facilities in Guangzhou, CSAHC has received written assurance from the CAAC to the effect that CSAHC is entitled to continued use and occupancy of the land in Guangzhou. The Company understands that the CAAC is basing its conclusion on an agreement among certain government authorities relating to such land. Such assurance does not constitute formal evidence of CSAHC's right to transfer, mortgage or lease such real property interests. The Group cannot predict the magnitude of the effect on its financial condition or results of operations to the extent that its use of one or more of these parcels of land or the related facilities were successfully challenged. CSAHC has agreed to indemnify the Group against any loss or damage caused by any challenge or interference with the Group's use of any of its land and buildings. (c) The Company is currently involved in a civil litigation (Hong Kong High Court Action No. 515 of 2001) ("Litigation"). According to the writ of summons for the Litigation, New Link Consultants Limited, the plaintiff, claimed against the Group (as one of the defendants to the Litigation) on the basis of certain evidence proving that United Aero-Supplies System of China, Limited ("UASSC") entered into an agreement with the defendants for exclusive purchase of aviation equipment consigned to UASSC for sale and, that as the defendants failed to perform the agreement, UASSC has the right to compensation. Since UASSC is in the course of its winding up proceedings, all the rights and benefits of UASSC in connection with the claim have been transferred to the plaintiff. The Company, as one of the defendants to the Litigation, has been claimed for unspecified damages for breach of the agreement. Given that the Litigation is still at its preliminary stage, it is pre-matured to predict the result of the court judgment. Based on the opinion given by its instructing solicitors, the Company's directors consider that the Company has a reasonable chance of success in its defence to the claim. At present, the Company has filed an objection in respect of the jurisdiction of the court, and has requested the court to transfer the case of Mainland China for trial. Accordingly, the Company's directors consider that a provision for such claim and/or the associated legal costs is not required. 31 FAIR VALUE OF FINANCIAL INSTRUMENTS AND CONCENTRATION OF RISK Financial assets of the Group include cash and cash equivalents, investments, trade receivables and other receivables. Financial liabilities of the Group include bank and other loans, amounts due to related companies, other liabilities, accounts payable, bills payable, sales in advance of carriage, accrual expenses and obligations under finance leases. LIQUIDITY RISK As at 31 December, 2003, the Group's net current liabilities amounted to RMB10,792 million (2002: RMB7,016 million). For the year ended 31 December, 2003, the Group recorded a net cash inflow from operating activities of RMB2,129 million (2002: RMB3,698 million), a net cash outflow from investing activities and financing activities of RMB3,820 million (2002: RMB2,745 million) and a decrease in cash and cash equivalents of RMB1,691 million (2002: increase of RMB953 million). With regard to 2004 and thereafter, the liquidity of the Group is primarily dependent on its ability to maintain adequate cash inflow from operations to meet its debt obligations as they fall due, and on its ability to obtain adequate external finance to meet its committed future capital expenditures. With regard to its short-term bank loans outstanding at 31 December, 2003, the Group has obtained firm commitments from its principal bankers to renew the relevant loans as they fall due during 2004. With regard to its future capital commitments and other financing requirements, the Group has already entered into loan financing agreements with several PRC banks to provide loan finance up to an approximate amount of RMB8,450 million during 2004 and thereafter. The directors of the Company believe that such financing will be available to the Group. - 212 - APPENDIX IV FINANCIAL INFORMATION OF THE LISTED GROUP NOTES TO THE FINANCIAL STATEMENTS (Cont'd) (PREPARED UNDER INTERNATIONAL FINANCIAL REPORTING STANDARDS) (EXPRESSED IN RENMINBI) 31 FAIR VALUE OF FINANCIAL INSTRUMENTS AND CONCENTRATION OF RISK (cont'd) LIQUIDITY RISK (cont'd) The directors of the Company have carried out a detailed review of the cash flow forecast of the Group for the twelve months ending 31 December, 2004. 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. BUSINESS RISK The Group conducts its principal operations in the PRC and accordingly is subject to special considerations and significant risks not typically associated with investments in equity securities of the United States of America and Western European companies. These include risks associated with, among others, the political, economic and legal environment, influence of the CAAC over many aspects of its operations, and competition, in the passenger, cargo and mail airlines services industry. INTEREST RATE RISK The interest rates and maturity information of the Group's bank and other loans, and the maturity information of the Group's finance lease obligations are disclosed in Notes 21 and 22 respectively. FOREIGN CURRENCY RISK The Group has significant exposure to foreign currency as substantially all of the Group's lease obligations and bank loans are denominated in foreign currencies, principally US dollars, and to a lesser extent, Japanese Yen. Depreciation or appreciation of the Renminbi against foreign currencies affects the Group's results significantly because the Group's foreign currency payments generally exceed its foreign currency receipts. The Group is not able to hedge its foreign currency exposure effectively other than by retaining its foreign currency denominated earnings and receipts to the extent permitted by the State Administration of Foreign Exchange, or subject to certain restrictive conditions, entering into forward foreign exchange contracts with authorised PRC banks. - 213 - APPENDIX IV FINANCIAL INFORMATION OF THE LISTED GROUP NOTES TO THE FINANCIAL STATEMENTS (Cont'd) (PREPARED UNDER INTERNATIONAL FINANCIAL REPORTING STANDARDS) (EXPRESSED IN RENMINBI) 31 FAIR VALUE OF FINANCIAL INSTRUMENTS AND CONCENTRATION OF RISK (cont'd) CREDIT RISKS Substantially all of the Group's cash and cash equivalents are deposited with PRC financial institutions. 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. As of 31 December, 2003, the balance due from BSP agents amounted to RMB446,399,000 (2002: RMB353,246,000). SELF INSURANCE RISK The Group maintains a limited amount of property insurance in respect of certain personal and real property. FAIR VALUE The carrying amounts and estimated fair values of significant financial assets and liabilities at 31 December, 2002 and 2003 are set out below: 2003 2002 CARRYING FAIR Carrying Fair AMOUNT VALUE amount value RMB'000 RMB'000 RMB'000 RMB'000 --------- --------- --------- --------- THE GROUP Cash and cash equivalents 2,080,174 2,080,174 3,771,043 3,771,043 Trade receivables 833,604 833,604 671,776 671,776 Other receivables 296,047 296,047 372,586 372,586 Bank and other loans, current portion 7,096,846 7,164,216 5,240,726 5,326,511 Amounts due to related companies 929,003 929,003 525,090 525,090 Other liabilities 1,019,811 1,019,811 646,989 646,989 Accounts payable 928,093 928,093 532,480 532,480 Bills payable 438,135 438,135 1,299,680 1,299,680 Sales in advance of carriage 466,087 466,087 390,531 390,531 Accrued expenses 2,527,794 2,527,794 2,341,454 2,341,454 Bank and other loans, non-current portion 4,521,735 4,743,128 5,835,434 6,111,052 --------- --------- --------- --------- - 214 - APPENDIX IV FINANCIAL INFORMATION OF THE LISTED GROUP NOTES TO THE FINANCIAL STATEMENTS (Cont'd) (PREPARED UNDER INTERNATIONAL FINANCIAL REPORTING STANDARDS) (EXPRESSED IN RENMINBI) 31 FAIR VALUE OF FINANCIAL INSTRUMENTS AND CONCENTRATION OF RISK (cont'd) FAIR VALUE (cont'd) 2003 2002 CARRYING FAIR Carrying Fair AMOUNT VALUE amount value RMB'000 RMB'000 RMB'000 RMB'000 --------- --------- --------- --------- THE COMPANY Cash and cash equivalents 1,404,874 1,404,874 2,960,337 2,960,337 Trade receivables 683,206 683,206 464,930 464,930 Other receivables 222,438 222,438 239,601 239,601 Bank and other loans, current portion 5,958,968 6,010,222 3,479,322 3,546,409 Amounts due to related companies 870,682 870,682 358,077 358,077 Other liabilities 854,057 854,057 411,218 411,218 Accounts payable 745,888 745,888 296,989 296,989 Bills payable 438,135 438,135 1,299,680 1,299,680 Sales in advance of carriage 405,851 405,851 340,457 340,457 Accrued expenses 1,628,072 1,628,072 1,049,806 1,049,806 Bank and other loans, non-current portion 3,670,499 3,827,220 4,628,372 4,811,961 --------- --------- --------- --------- The following methods and assumptions were used to estimate the fair value for each class of financial instrument: (i) Cash and cash equivalents, trade receivables, other receivables, amounts due to related companies, other liabilities, accounts payable, bills payable, sales in advance of carriage and accrued expenses The carrying values approximate fair value because of the short maturities of these instruments. (ii) Bank and other loans The fair value has been estimated by applying a discounted cash flow approach using interest rates available to the Group for similar indebtedness. - 215 - APPENDIX IV FINANCIAL INFORMATION OF THE LISTED GROUP NOTES TO THE FINANCIAL STATEMENTS (Cont'd) (PREPARED UNDER INTERNATIONAL FINANCIAL REPORTING STANDARDS) (EXPRESSED IN RENMINBI) 31 FAIR VALUE OF FINANCIAL INSTRUMENTS AND CONCENTRATION OF RISK (cont'd) The economic characteristics of the Group's 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. Other investments represent unquoted available-for-sale equity securities of companies established in the PRC. There is no quoted market price for such equity securities and accordingly a reasonable estimate of the fair value could not be made without incurring excessive costs. Fair value estimates are made at a specific point in time and are based on relevant market information about the financial instruments. These estimates are subjective in nature and involve uncertainties and matters of significant judgement and therefore cannot be determined with precision. Changes in assumptions could significantly affect the estimates. 32 SEGMENTAL INFORMATION Geographic information about the Group's turnover and operating profit/(loss) are as follows: HONG KONG DOMESTIC REGIONAL *INTERNATIONAL TOTAL RMB'000 RMB'000 RMB'000 RMB'000 ---------- --------- -------------- ---------- 2003 Traffic revenue 13,086,939 807,677 3,070,184 16,964,800 Other revenue 436,122 - 69,201 505,323 ---------- --------- --------- ---------- 13,523,061 807,677 3,139,385 17,470,123 ========== ========= ========= ========== Operating profit/(loss) 440,158 (29,210) 44,781 455,729 ========== ========= ========= ========== 2002 Traffic revenue 13,197,589 1,118,695 3,165,608 17,481,892 Other revenue 485,046 - 51,682 536,728 ---------- --------- --------- ---------- 13,682,635 1,118,695 3,217,290 18,018,620 ========== ========= ========= ========== Operating profit 1,614,975 193,440 217,662 2,026,077 ========== ========= ========= ========== * Mainly routes between the PRC and Asian countries, the United States of America, the Netherlands, Belgium and Australia. The major revenue-earning assets of the Group are its aircraft fleet, most of which are registered in the PRC. Since the Group's aircraft fleet is employed flexibly across its route network, there is no suitable basis of allocating such assets to geographic segments. Substantially all of the Group's non-aircraft identifiable assets are located in the PRC. - 216 - APPENDIX IV FINANCIAL INFORMATION OF THE LISTED GROUP NOTES TO THE FINANCIAL STATEMENTS (Cont'd) (PREPARED UNDER INTERNATIONAL FINANCIAL REPORTING STANDARDS) (EXPRESSED IN RENMINBI) 33 RECONCILIATION AND SUPPLEMENTARY STATEMENT OF CASH FLOW INFORMATION (a) THE RECONCILIATION OF (LOSS)/PROFIT BEFORE TAXATION AND MINORITY INTERESTS TO CASH INFLOWS FROM OPERATIONS IS AS FOLLOWS: 2003 2002 RMB'000 RMB'000 --------- --------- (Loss)/profit before taxation and minority interests (511,610) 1,139,099 Depreciation and amortisation of fixed assets 1,997,882 1,839,293 Other amortisation 40,089 9,816 Amortisation of deferred credits (1,541) (7,217) Share of associated companies' results (47,798) (36,988) Share of jointly controlled entities' results 39,495 3,352 Loss/(gain) on sale of fixed assets 22,217 (170,740) Interest income (13,061) (52,618) Interest expense 823,725 959,193 Unrealised exchange loss, net 177,356 174,978 Decrease/(increase) in inventories 1,923 (76,472) Increase in trade receivables (161,828) (110,749) Decrease/(increase) in other receivables 76,539 (166,004) (Increase)/decrease in prepaid expenses and other assets (6,045) 123,924 Increase/(decrease) in amounts due to related companies 403,913 (193,175) Increase/(decrease) in accounts payable 395,613 (61,843) (Decrease)/increase in bills payable (861,545) 1,299,680 Increase in sales in advance of carriage 75,556 19,985 Increase in accrued expenses 203,439 86,215 Increase/(decrease) in other liabilities 372,822 (33,032) Increase in provision for major overhauls 47,577 16,226 --------- --------- Cash inflows from operations 3,074,718 4,762,923 ========= ========= (b) DISCLOSURE OF NON-CASH INVESTING AND FINANCING ACTIVITIES During 2002, the Group assumed from Zhongyuan Airlines debts totalling RMB964,736,000 in partial satisfaction of the consideration payable for acquisition of five Boeing 737-300/37K aircraft and other assets from Zhongyuan Airlines (Note 27(o)). - 217 - APPENDIX IV FINANCIAL INFORMATION OF THE LISTED GROUP NOTES TO THE FINANCIAL STATEMENTS (Cont'd) (PREPARED UNDER INTERNATIONAL FINANCIAL REPORTING STANDARDS) (EXPRESSED IN RENMINBI) 33 RECONCILIATION AND SUPPLEMENTARY STATEMENT OF CASH FLOW INFORMATION (cont'd) (c) EFFECT OF ACQUISITION OF SUBSIDIARIES 2003 2002 RMB'000 RMB'000 ------- ------- Net assets acquired: Fixed assets - 96,636 Cash and cash equivalents - 17,355 Trade receivables and other current assets - 20,681 ------- ------- - 134,672 ------- ------- Accounts payable - 3,623 Accrued expenses and other liabilities - 11,220 ------- ------- - 14,843 ------- ------- Net assets value - 119,829 ======= ======= Consideration paid - 107,846 Cash and cash equivalents acquired - 17,355 ------- ------- Net cash outflow from acquisition of subsidiaries - 90,491 ======= ======= 34 ULTIMATE HOLDING COMPANY The directors of the Company consider the ultimate holding company to be CSAHC, a state-owned enterprise established in the PRC. 35 SUBSEQUENT EVENTS In April 2004, the Company entered into a purchase agreement with Airbus SNC for the acquisition of fifteen Airbus 320-200 aircraft and six Airbus 319-100 aircraft, scheduled for deliveries in 2005 and 2006. - 218 - APPENDIX IV FINANCIAL INFORMATION OF THE LISTED GROUP NOTES TO THE FINANCIAL STATEMENTS (Cont'd) (PREPARED UNDER INTERNATIONAL FINANCIAL REPORTING STANDARDS) (EXPRESSED IN RENMINBI) 36 SUBSIDIARIES The particulars of the Company's principal subsidiaries at 31 December, 2003 are as follows: ATTRIBUTABLE PLACE AND EQUITY INTEREST DATE OF ----------------- ISSUED/ ESTABLISHMENT/ DIRECT INDIRECT REGISTERED PRINCIPAL NAME OF COMPANY OPERATION % % CAPITAL# ACTIVITIES China Southern Airlines PRC 100 - 100,000,000 Helicopter (Group) Zhuhai Helicopter 31 August, 1993 transportation Company Limited (a) Guangxi Airlines PRC 60 - 170,900,000 Airline Company Limited (a) 28 April, 1994 Southern Airlines Group PRC 60 - 280,000,000 Airline Shantou Airlines 20 July, 1993 Company Limited (a) Zhuhai Airlines PRC 60 - 250,000,000 Airline Company Limited (a) 8 May, 1995 Xiamen Airlines PRC 60 - 588,434,000 Airline Company Limited (a) 11 August, 1984 Guizhou Airlines PRC 60 - 80,000,000 Airline Company Limited (a) 12 November, 1991 Guangzhou Nanland Air PRC 51 - 55,980,000 Air catering Catering Company 21 November, 1989 Limited (b) China Southern West Australia 65 - A$100,000 Pilot training Australian Flying 26 January, 1971 services College Pty Ltd Guangzhou Baiyun International PRC 61 - 20,000,000 Logistics Logistic Company Ltd 23 July, 2002 operations Guangzhou Aviation Hotel PRC 90 - 63,290,000 Hotel operation 8 January, 1997 - 219 - APPENDIX IV FINANCIAL INFORMATION OF THE LISTED GROUP NOTES TO THE FINANCIAL STATEMENTS (Cont'd) (PREPARED UNDER INTERNATIONAL FINANCIAL REPORTING STANDARDS) (EXPRESSED IN RENMINBI) 36 SUBSIDIARIES (cont'd) ATTRIBUTABLE PLACE AND EQUITY INTEREST DATE OF ----------------- ISSUED/ ESTABLISHMENT/ DIRECT INDIRECT REGISTERED PRINCIPAL NAME OF COMPANY OPERATION % % CAPITAL# ACTIVITIES Southern Airlines Advertising PRC 90 - 2,000,000 Aviation Company Ltd 3 March, 1994 advertising South China International PRC 90 - 2,100,000 Travel services Aviation & Travel Services 11 May, 1992 Company CZ Flamingo Limited Cayman Islands 100 - US$1,000 Aircraft leasing 8 December, 1993 CZ Skylark Limited Cayman Islands 100 - US$1,000 Aircraft leasing 17 November, 1993 CZ Kapok Limited Cayman Islands 100 - US$1,000 Aircraft leasing 26 October, 1993 CSA-I Limited Cayman Islands 100 - US$1,000 Aircraft leasing 1 September, 1993 CZ93B Limited Cayman Islands 100 - US$1,000 Aircraft leasing 11 May, 1993 CZ97A Limited Cayman Islands 100 - US$1,000 Aircraft leasing 2 January, 1997 Zhong Yuan 99A Limited Cayman Islands 100 - US$1,000 Aircraft leasing 15 February, 1999 CXA92A Limited Cayman Islands - 60 US$1,000 Aircraft leasing 3 August, 1992 CXA93A Limited Cayman Islands - 60 US$1,000 Aircraft leasing 1 July, 1993 CXA95B Limited Cayman Islands - 60 US$1,000 Aircraft leasing 7 July, 1995 - 220 - APPENDIX IV FINANCIAL INFORMATION OF THE LISTED GROUP NOTES TO THE FINANCIAL STATEMENTS (Cont'd) (PREPARED UNDER INTERNATIONAL FINANCIAL REPORTING STANDARDS) (EXPRESSED IN RENMINBI) 36 SUBSIDIARIES (cont'd) ATTRIBUTABLE PLACE AND EQUITY INTEREST DATE OF ----------------- ISSUED/ ESTABLISHMENT/ DIRECT INDIRECT REGISTERED PRINCIPAL NAME OF COMPANY OPERATION % % CAPITAL# ACTIVITIES CXA95C Limited Cayman Islands - 60 US$1,000 Aircraft leasing 16 October, 1995 CXA98A Limited Cayman Islands - 60 US$1,000 Aircraft leasing 20 March, 1998 Xiamen Aviation PRC - 60 5,000,000 Property Property Development 22 June, 1993 development Company (a) Xiamen Aviation PRC - 60 620,218 Aviation Advertising Company 17 December, 1992 advertising Limited (a) Xiamen Aviation PRC - 60 8,560,000 Aviation supplies Supplies Limited (a) 30 July, 1997 Xiamen Aviation PRC - 54 5,000,000 Hotel Development 18 February, 1998 management Company Limited (a) Bai Lu Finance Limited Hong Kong - 54 HK$10,000,000 Investment 22 February, 1996 holding Xiamen Air Holidays Hong Kong - 54 HK$3,000,000 Travel Limited 28 April, 1994 servicing Xiamen Macau Macau - 27.5 MOP1,000,000 Travel Holidays Limited 11 May, 1995 servicing Shantou Hua Kang Air PRC - 42 10,000,000 Air catering Catering Company Ltd (a) 22 June, 1994 # Expressed in RMB, unless otherwise stated (a) These subsidiaries are PRC limited companies. (b) These subsidiaries are Sino-foreign equity joint venture companies - 221 - APPENDIX IV FINANCIAL INFORMATION OF THE LISTED GROUP NOTES TO THE FINANCIAL STATEMENTS (Cont'd) (PREPARED UNDER INTERNATIONAL FINANCIAL REPORTING STANDARDS) (EXPRESSED IN RENMINBI) 37 ASSOCIATED COMPANIES AND JOINTLY CONTROLLED ENTITIES The particulars of the Group's principal associated companies and jointly controlled entities as at 31 December, 2003 are as follows: ATTRIBUTABLE PLACE AND EQUITY INTEREST DATE OF ----------------- ISSUED/ ESTABLISHMENT/ DIRECT INDIRECT REGISTERED PRINCIPAL NAME OF COMPANY OPERATION % % CAPITAL# ACTIVITIES Guangzhou Aircraft PRC 50 - US$27,500,000 Provision of Maintenance 28 October, 1989 aircraft repair Engineering and Company Limited* (Note) maintenance services Southern Airlines PRC 32 15.42 424,330,000 Provision of Group Finance 28 June, 1995 financial Company Limited services Hainan Phoenix PRC 45 - US$16,360,000 Provision of Information 12 March, 1994 ticket System Limited reservation system services Hong Kong Business Hong Kong 20 - HKD1,000,000 Provision of Aviation Centre 7 January, 1998 private Company Limited flight logistic services Sichuan Airlines PRC 39 - 350,000,000 Airline Corporation Limited 28 August, 2002 MTU Maintenance PRC 50 - US$63,100,000 Provision of Zhuhai Co. Ltd.* 6 April, 2001 engine repair and maintenance services China Postal Airlines PRC 49 - 306,000,000 Airline Limited* 25 November, 1996 - 222 - APPENDIX IV FINANCIAL INFORMATION OF THE LISTED GROUP NOTES TO THE FINANCIAL STATEMENTS (Cont'd) (PREPARED UNDER INTERNATIONAL FINANCIAL REPORTING STANDARDS) (EXPRESSED IN RENMINBI) 37 ASSOCIATED COMPANIES AND JOINTLY CONTROLLED ENTITIES (cont'd) ATTRIBUTABLE PLACE AND EQUITY INTEREST DATE OF ----------------- ISSUED/ ESTABLISHMENT/ DIRECT INDIRECT REGISTERED PRINCIPAL NAME OF COMPANY OPERATION % % CAPITAL# ACTIVITIES Zhuhai Xiang Yi PRC 51 - US$29,800,000 Provision of Aviation Technology 10 July, 2002 flight Company Limited* simulation services CSN-ETC e-commerce PRC 51 - 5,880,000 Provision of Limited* 10 February, 2003 internet services # Expressed in RMB, unless otherwise stated * These are jointly controlled entities Note: Guangzhou Aircraft Maintenance Engineering Company Limited has been reclassified from an associated company to a jointly controlled entity since 2003 due to a change in the composition of its shareholders in 2003. - 223 - APPENDIX IV FINANCIAL INFORMATION OF THE LISTED GROUP C. UNAUDITED INTERIM FINANCIAL REPORT OF THE COMPANY FOR THE SIX-MONTH PERIOD ENDED 30 JUNE, 2004 PREPARED IN ACCORDANCE WITH INTERNATIONAL FINANCIAL REPORTING STANDARDS ("IFRS") CONSOLIDATED PROFIT AND LOSS ACCOUNT (UNAUDITED) 2004 vs 2003 FOR THE SIX MONTHS ENDED 30 JUNE, Increase/ 2004 2003 2004 2004 (Decrease) Note RMB'000 RMB'000 HK$'000 US$'000 (%) ---- ---------- --------- --------- --------- ---------- Operating revenue Traffic revenue: Passenger 9,776,002 5,615,796 9,214,819 1,181,162 74.1 Cargo and mail 1,058,276 921,883 997,527 127,864 14.8 ---------- --------- ---------- --------- 10,834,278 6,537,679 10,212,346 1,309,026 65.7 Other revenue 259,659 195,193 244,754 31,372 33.0 ---------- --------- ---------- --------- Total operating revenue 2 11,093,937 6,732,872 10,457,100 1,340,398 64.8 ---------- --------- ---------- --------- Operating expenses: Flight operations 4,722,442 3,516,885 4,451,355 570,578 34.3 Maintenance 1,409,841 1,218,488 1,328,910 170,341 15.7 Aircraft and traffic servicing 1,688,612 1,197,273 1,591,679 204,022 41.0 Promotion and sales 874,393 673,965 824,199 105,646 29.7 General and administrative 551,719 480,598 520,048 66,660 14.8 Depreciation and amortisation 1,083,346 1,016,530 1,021,158 130,893 6.6 Other 8,244 3,465 7,771 996 137.9 ---------- --------- ---------- --------- Total operating expenses 10,338,597 8,107,204 9,745,120 1,249,136 27.5 ---------- --------- ---------- --------- Operating profit/(loss) 755,340 (1,374,332) 711,980 91,262 155.0 ---------- --------- ---------- --------- Non-operating income/(expenses): Share of associated companies' results 21,156 2,825 19,942 2,556 648.9 Share of jointly controlled entities' results 4,351 (21,654) 4,101 526 120.1 Profit/(loss) on sale of fixed assets 2,999 (22,679) 2,827 362 113.2 Interest income 8,994 5,842 8,478 1,087 54.0 Interest expense 3 (343,620) (455,456) (323,895) (41,517) (24.6) Exchange gain/(loss), net 15,397 (4,774) 14,513 1,860 422.5 Other, net 4,531 (287) 4,271 548 1,678.7 ---------- --------- ---------- --------- Total net non-operating expenses (286,192) (496,183) (269,763) (34,578) (42.3) ---------- --------- ---------- --------- Profit/(loss) before taxation and minority interests 3 469,148 (1,870,515) 442,217 56,684 125.1 Taxation (expense)/credit 4 (94,790) 544,992 (89,349) (11,453) (117.4) ---------- --------- ---------- --------- Profit/(loss) before minority interests 374,358 (1,325,523) 352,868 45,231 128.2 Minority interests (108,174) 93,910 (101,964) (13,070) 215.2 ---------- --------- ---------- --------- Profit/(loss) attributable to shareholders 266,184 (1,231,613) 250,904 32,161 121.6 ========== ========= ========== ========= Basic earnings/(loss) per share 5 RMB0.06 RMB(0.37) HK$0.06 US$0.007 116.7 ========== ========= ========== ========= The notes on pages 229 to 235 form part of this interim financial report. -224- APPENDIX IV FINANCIAL INFORMATION OF THE LISTED GROUP CONSOLIDATED BALANCE SHEET (UNAUDITED) As at 30 June, 2004 (Expressed in Renminbi) AS AT As at 30 JUNE, 31 December, 2004 2003 Note RMB'000 RMB'000 ---- ---------- ------------ NON-CURRENT ASSETS Fixed assets 29,128,791 28,535,907 Construction in progress 2,189,052 1,629,689 Lease prepayments 344,755 348,652 Interest in associated companies 443,780 422,201 Interest in jointly controlled entities 787,874 731,323 Other investments 199,007 204,971 Lease and equipment deposits 4,717,553 2,932,591 Deferred expenditure 233,726 248,853 Long-term receivables 6,648 6,380 ---------- ---------- 38,051,186 35,060,567 ---------- ----------- CURRENT ASSETS Inventories 572,457 543,777 Trade receivables 7 1,210,680 833,604 Other receivables 310,365 296,047 Prepaid expenses and other assets 323,947 247,926 Cash and cash equivalents 2,931,786 2,080,174 ---------- ----------- 5,349,235 4,001,528 ---------- ----------- CURRENT LIABILITIES Bank and other loans 9,931,236 7,096,846 Obligations under finance leases 1,138,495 1,297,855 Amounts due to related companies 906,353 929,003 Other liabilities 1,176,852 1,019,811 Accounts payable 8 841,409 928,093 Bills payable - 438,135 Sales in advance of carriage 386,255 466,087 Accrued expenses 3,217,955 2,527,794 Taxes payable 72,954 89,954 ---------- ----------- 17,671,509 14,793,578 ---------- ----------- NET CURRENT LIABILITIES (12,322,274) (10,792,050) ---------- ----------- TOTAL ASSETS LESS CURRENT LIABILITIES 25,728,912 24,268,517 ---------- ----------- LONG-TERM LIABILITIES AND DEFERRED ITEMS Bank and other loans 6,062,819 4,521,735 Obligations under finance leases 5,006,135 5,543,084 Provision for major overhauls 230,525 189,464 Deferred credits 44,983 46,554 Deferred taxation 456,354 398,305 ---------- ----------- 11,800,816 10,699,142 ---------- ----------- 13,928,096 13,569,375 ========== =========== The notes on pages 229 to 235 form part of this interim financial report. -225- APPENDIX IV FINANCIAL INFORMATION OF THE LISTED GROUP CONSOLIDATED BALANCE SHEET (UNAUDITED)(Continued) As at 30 June, 2004 (Expressed in Renminbi) AS AT As at 30 JUNE, 31 December, 2004 2003 Note RMB'000 RMB'000 ---- ---------- ------------ REPRESENTING: SHARE CAPITAL 4,374,178 4,374,178 RESERVES 9 7,787,713 7,521,529 ---------- ----------- SHAREHOLDERS' EQUITY 12,161,891 11,895,707 MINORITY INTERESTS 1,766,205 1,673,668 ---------- ----------- 13,928,096 13,569,375 ========== =========== Approved and authorised for issue by the board of directors on 26 August, 2004. YAN ZHI QING WANG CHANG SHUN XU JIE BO Director Director Director The notes on pages 229 to 235 form part of this interim financial report. -226- APPENDIX IV FINANCIAL INFORMATION OF THE LISTED GROUP CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY (UNAUDITED) For the six months ended 30 June, 2004 (Expressed in Renminbi) SHARE SHARE OTHER RETAINED CAPITAL PREMIUM RESERVES EARNINGS TOTAL RMB'000 RMB'000 RMB'000 RMB'000 RMB'000 --------- --------- -------- --------- ---------- At 1 January, 2003 3,374,178 3,683,956 585,372 1,969,701 9,613,207 Loss for the period - - - (1,231,613) (1,231,613) --------- --------- ------- --------- ---------- At 30 June, 2003 3,374,178 3,683,956 585,372 738,088 8,381,594 ========= ========= ======= ========= ========== At 1 January, 2004 4,374,178 5,324,723 610,341 1,586,465 11,895,707 Profit for the period - - - 266,184 266,184 --------- --------- ------- --------- ---------- AT 30 JUNE, 2004 4,374,178 5,324,723 610,341 1,852,649 12,161,891 ========= ========= ======= ========= ========== The notes on pages 229 to 235 form part of this interim financial report. -227- APPENDIX IV FINANCIAL INFORMATION OF THE LISTED GROUP CONDENSED CONSOLIDATED CASH FLOW STATEMENT (UNAUDITED) For the six months ended 30 June, 2004 (Expressed in Renminbi) FOR THE SIX MONTHS ENDED 30 JUNE, 2004 2003 RMB'000 RMB'000 ---------- ---------- Net cash inflows from operating activities 1,217,840 1,199,731 Net cash used in investing activities (4,050,525) (1,886,023) ---------- ---------- Net cash outflows before financing activities (2,832,685) (686,292) Net cash inflows/(outflows) from financing activities 3,684,297 (803,404) ---------- ---------- Increase/(decrease) in cash and cash equivalents 851,612 (1,489,696) Cash and cash equivalents as at 1 January, 2,080,174 3,771,043 ---------- ---------- Cash and cash equivalents as at 30 June, 2,931,786 2,281,347 ========== ========== The notes on pages 229 to 235 form part of this interim financial report. -228- APPENDIX IV FINANCIAL INFORMATION OF THE LISTED GROUP NOTES: 1 BASIS OF PREPARATION This interim financial report of China Southern Airlines Company Limited (the "Company") and its subsidiaries (the "Group") is unaudited, but has been reviewed by KPMG in accordance with Statement of Auditing Standards 700 "Engagements to review interim financial reports", issued by the Hong Kong Society of Accountants. KPMG's independent review report to the Board of Directors is included on page 25. The interim financial report has been prepared in accordance with the requirements of the Main Board Listing Rules of The Stock Exchange of Hong Kong Limited, including compliance with International Accounting Standard 34 "Interim Financial Reporting" adopted by the International Accounting Standards Board. The financial information relating to the financial year ended 31 December, 2003 included in the interim financial report does not constitute the Group's annual financial statements prepared under International Financial Reporting Standards for that financial year but is derived from those financial statements. The Group's annual financial statements for the year ended 31 December, 2003 are available at the Company's registered office. The auditors have expressed an unqualified opinion on those financial statements in their report dated 23 April, 2004. The accounting policies have been consistently applied by the Group and are consistent with those adopted in the 2003 annual financial statements. The notes on the unaudited interim financial report include an explanation of events and transactions that are significant to an understanding of the changes in financial position and performance of the Group since the 2003 annual financial statements. 2 TURNOVER The Group is principally engaged in the provision of domestic, Hong Kong regional and international passenger, cargo and mail airline services, with flights operating primarily from the Guangzhou Baiyun International Airport in the People's Republic of China ("PRC"), which is both the main hub of the Group's route network and the location of its corporate headquarters. Turnover comprises revenues from airline and airline-related businesses and is stated net of sales tax. The turnover for the six months ended 30 June, 2003, was stated net of sales tax and contributions to the CAAC Infrastructure Development Fund. Sales tax is payable at 3% (2003: 3%) of the Group's traffic revenue in respect of domestic flights and international/Hong Kong regional outbound flights. During the six months ended 30 June, 2003, the Group's passenger revenue for May and June 2003 was exempted from sales tax. Prior to 1 April, 2004, contributions to the CAAC Infrastructure Development Fund were payable at 5% and 2%, respectively of the Group's domestic and international/Hong Kong regional traffic revenue, except for the period from 1 May, 2003 to 31 March, 2004 during which the Group was exempted from contributions to the CAAC Infrastructure Development Fund. Effective from 1 April, 2004, contributions to the CAAC Infrastructure Development Fund are payable based on the Group's traffic capacity deployed on its routes. The contributions now form part of the flight operations expenses. - 229 - APPENDIX IV FINANCIAL INFORMATION OF THE LISTED GROUP 2 TURNOVER (Continued) The Group's turnover and operating profit/(loss) by geographic region are as follows: FOR THE SIX MONTHS ENDED 30 JUNE, HONG KONG DOMESTIC REGIONAL INTERNATIONAL TOTAL RMB'000 RMB'000 RMB'000 RMB'000 ------- ------- ------- ------- 2004 Traffic revenue 8,341,352 568,609 1,924,317 10,834,278 Other revenue 259,659 - - 259,659 --------- ------- --------- ---------- Turnover 8,601,011 568,609 1,924,317 11,093,937 ========= ======= ========= ========== Operating profit 604,728 38,852 111,760 755,340 ========= ======= ========= ========== 2003 Traffic revenue 4,896,421 321,912 1,319,346 6,537,679 Other revenue 195,193 - - 195,193 --------- ------- --------- ---------- Turnover 5,091,614 321,912 1,319,346 6,732,872 ========= ======= ========= ========== Operating (loss) (1,198,810) (80,384) (95,138) (1,374,332) ========= ======= ========= ========== 3 PROFIT/(LOSS) BEFORE TAXATION AND MINORITY INTERESTS FOR THE SIX MONTHS ENDED 30 JUNE, 2004 2003 RMB'000 RMB'000 ------- ------- Profit/(loss) before taxation and minority interests is arrived at after charging: Depreciation - owned assets 815,604 768,595 - assets held under finance leases 254,742 247,935 Staff costs 1,061,144 847,623 Operating lease charges in respect of aircraft 827,665 820,491 Amortisation of deferred expenditure 13,000 13,348 --------- ------- Interest on bank and other loans 174,232 273,841 Finance charges on obligations under finance leases 186,147 231,371 Less: borrowing costs capitalised (16,759) (49,756) --------- ------- Net interest expense 343,620 455,456 ========= ======= - 230 - APPENDIX IV FINANCIAL INFORMATION OF THE LISTED GROUP 4 TAXATION EXPENSE/(CREDIT) FOR THE SIX MONTHS ENDED 30 JUNE, 2004 2003 RMB'000 RMB'000 ------- ------- PRC income tax 27,953 2,859 Share of taxation of associated companies 3,738 3,791 Share of taxation of jointly controlled entities 5,050 - ------ -------- 36,741 6,650 Deferred taxation 58,049 (551,642) ------ -------- 94,790 (544,992) ====== ======== On 17 October, 2003, the Company's registered address was moved to Guangzhou Economic & Technology Development Zone. In accordance with the Rules and Regulations for Implementation of Income Tax for Foreign Investment Enterprises and Foreign Enterprises of the PRC and a taxation approval document from Guangzhou Municipal State Tax Bureau, the Company is entitled to enjoy the preferential tax policy implemented in the Guangzhou Economic & Technology Development Zone effective 1 October, 2003. As a result, the Company's income tax rate has been changed to 15% from 33% beginning from that date. 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 and PRC governments, or has sustained tax losses in these overseas jurisdictions. Accordingly, no provision for overseas tax has been made for the periods presented. 5 BASIC EARNINGS/(LOSS) PER SHARE The calculation of basic earnings/(loss) per share is based on the consolidated profit attributable to shareholders of RMB266,184,000 (2003: loss of RMB1,231,613,000) and the weighted average number of shares in issue during the period of 4,374,178,000 (2003: 3,374,178,000). There were no dilutive potential shares in existence during the six months ended 30 June, 2003 and 2004. 6 DIVIDENDS The Board of Directors of the Company does not recommend the payment of an interim dividend for the six months ended 30 June, 2004 (2003: Nil). - 231 - APPENDIX IV FINANCIAL INFORMATION OF THE LISTED GROUP 7 TRADE RECEIVABLES Credit terms granted by the Group to sales agents and other customers generally range from one to three months. An ageing analysis of trade receivables, net of impairment losses, is set out below: AS AT As at 30 JUNE, 31 December, 2004 2003 RMB'000 RMB'000 ------- ------- Within 1 month 919,687 589,080 More than 1 month but less than 3 months 288,093 235,828 More than 3 months but less than 12 months 2,900 8,696 --------- ------- 1,210,680 833,604 ========= ======= 8 ACCOUNTS PAYABLE An ageing analysis of accounts payable is as follows: AS AT As at 30 JUNE, 31 December, 2004 2003 RMB'000 RMB'000 ------- ------- Due within 1 month or on demand 275,060 279,165 Due after 1 month but within 3 months 242,721 278,113 Due after 3 months but within 6 months 323,628 370,815 ------- ------- 841,409 928,093 ======= ======= 9 RESERVES No transfer to statutory surplus reserve, statutory public welfare fund and discretionary surplus reserve has been made during the period and the corresponding period of 2003. According to the Articles of Association of the Company and certain of its subsidiaries and the PRC Company Law, any such transfer shall be proposed by the respective board of directors and approved by shareholders in the annual general meeting. - 232 - APPENDIX IV FINANCIAL INFORMATION OF THE LISTED GROUP 10 COMMITMENTS (a) CAPITAL COMMITMENTS As at 30 June, 2004, the Group had capital commitments as follows: AS AT As at 30 JUNE, 31 December, 2004 2003 RMB'000 RMB'000 ------- ------- Commitments in respect of aircraft and related equipment - authorised and contracted for 14,155,601 10,615,079 ---------- ---------- Commitments in respect of investments in the Guangzhou new airport - authorised and contracted for 387,185 617,277 - authorised but not contracted for 1,252,906 1,454,661 ---------- ---------- 1,640,091 2,071,938 ---------- ---------- Other commitments - authorised and contracted for 134,201 232,570 - authorised but not contracted for 656,971 708,099 ---------- ---------- 791,172 940,669 ---------- ---------- 16,586,864 13,627,686 ========== ========== The Group has taken steps towards the purchase of the airline business of China Northern Airlines Company and Xinjiang Airlines Company. No contractual obligations existed as at 30 June, 2004 and up to the date of approval of this interim financial report. The purchase price has not yet been determined. (b) INVESTING COMMITMENTS As at 30 June, 2004, the Company was committed to make a capital contribution of approximately RMB382 million (as at 31 December, 2003: approximately RMB446 million) to its jointly controlled entities. - 233 - APPENDIX IV FINANCIAL INFORMATION OF THE LISTED GROUP 11 RELATED PARTY TRANSACTIONS The Group obtained various operating and financial services provided by China Southern Air Holding Company ("CSAHC"), the ultimate holding company and its affiliates, and the Group's associated companies and jointly controlled entities during the normal course of its business. The following is a summary of significant transactions carried out in the normal course of business between the Group, CSAHC and its affiliates, and the Group's associated companies and jointly controlled entities during the period: FOR THE SIX MONTHS ENDED 30 JUNE, 2004 2003 RMB'000 RMB'000 ------- ------- EXPENSES Paid to CSAHC and its affiliates Handling charges 18,552 14,277 Wet lease rentals - 27,800 Sundry aviation supplies 25,596 25,982 Air catering expenses 18,865 11,986 Housing benefits 42,500 42,500 Lease charges for land and buildings 7,612 7,612 Paid to associated companies and jointly controlled entities Repairing charges 431,340 277,579 Flight simulation service charges 46,426 50,151 INCOME Received from associated companies and jointly controlled entities Rental income 15,288 15,288 Interest income 1,025 1,178 In addition to the above, certain business undertakings of CSAHC also provided hotel and other services to the Group during the period. The total amount involved is not material to the results of the Group for the period. As at 30 June, 2004, the Group had cash and cash equivalents placed with Southern Airlines Group Finance Company Limited, a PRC authorised financial institution controlled by CSAHC and an associated company of the Group amounting to RMB677,835,000 (as at 31 December, 2003: RMB365,906,000). The applicable interest rates are determined in accordance with the rates published by the People's Bank of China. - 234 - APPENDIX IV FINANCIAL INFORMATION OF THE LISTED GROUP 11 RELATED PARTY TRANSACTIONS (Continued) As at 31 December, 2003, the Group had advances from CSAHC amounting to RMB165,995,000, which was interest free and repayable on demand. The advances were repaid by the Group during the period. The Directors of the Company are of the opinion that the above transactions were conducted in the normal course of business and on normal commercial terms or in accordance with the agreements governing such transactions. 12 CONTINGENT LIABILITIES There have been no material adverse changes in contingent liabilities of the Group subsequent to 31 December, 2003, details of which are disclosed in its 2003 annual financial statements. 13 CONVENIENCE TRANSLATION The unaudited consolidated profit and loss account has been prepared in Renminbi ("RMB"), the national currency of the PRC. Translations of amounts from RMB into Hong Kong dollars ("HK$") and United States dollars ("US$") solely for the convenience of readers have been made at the rates of HK$1.00 to RMB1.0609 and US$1.00 to RMB8.2766, being the average of the buying and selling rates as quoted by the People's Bank of China at the close of business on 30 June, 2004. No representation is made that the RMB amounts could have been or could be converted into HK$ or US$ at these rates or at any other certain rates on 30 June, 2004 or on any other date. - 235 - APPENDIX V FINANCIAL INFORMATION OF THE COMBINED GROUP (A) UNAUDITED PRO FORMA FINANCIAL INFORMATION OF THE COMBINED GROUP The following is the text of a report, prepared for the sole purpose of inclusion in this circular, received from the independent reporting accountants, KPMG, Certified Public Accountants, Hong Kong. As described in the section headed "Documents available for inspection" in Appendix IX, a copy of the following report is available for inspection. [KPMG LOGO] 8th Floor Prince's Building 10 Chater Road Hong Kong 12 November, 2004 The Directors China Southern Airlines Company Limited Baiyun International Airport Guangzhou People's Republic of China Dear Sirs, We report on the unaudited pro forma financial information of the Combined Group (the Listed Group (as defined herein) together with the Airline Operations (as defined herein) of Northern Airlines Group (as defined herein) and the Airline Operations of Xinjiang Airlines Group (as defined herein)) (the "Pro Forma Financial Information") set out on pages 239 to 243 in Section A of Appendix V to the shareholders' circular of China Southern Airlines Company Limited (the "Company", and together with its subsidiaries are referred to as the "Listed Group") dated 12 November, 2004, which has been prepared by the Company solely for illustrative purposes to provide information about how the proposed acquisition of the airline and airline related operations (the "Airline Operations") of each of China Northern Airlines Company and its subsidiaries ("Northern Airlines Group") and Xinjiang Airlines Company and its subsidiaries ("Xinjiang Airlines Group") by the Company (the "Acquisition") as described in the accompanying introduction to the unaudited pro forma financial information of the Combined Group might have affected the historical amounts in the accompanying unaudited pro forma balance sheet of the Combined Group as at 30 June, 2004, and the unaudited pro forma statement of income and unaudited pro forma condensed statement of cash flows of the Combined Group for the six-month period ended 30 June, 2004. The historical financial information is derived from the unaudited historical financial information of the Listed Group as set out in Appendix IV and the audited historical financial information of the Airline Operations of Northern Airlines Group and the Airline Operations of Xinjiang Airlines Group appearing as set out in Appendices II and III respectively. The basis of preparation of the Pro Forma Financial Information is set out in the accompanying introduction and notes to the unaudited pro forma financial information of the Combined Group. - 236 - APPENDIX V FINANCIAL INFORMATION OF THE COMBINED GROUP RESPONSIBILITIES It is the responsibility solely of the directors of the Company to prepare the Pro Forma Financial Information in accordance with Paragraph 29 of Chapter 4 of the Rules Governing the Listing of Securities on the Stock Exchange of Hong Kong Limited (the "Listing Rules"). It is our responsibility to form an opinion, as required by the Listing Rules, on the Pro Forma Financial Information and to report our opinion to you. We do not accept any responsibility for any reports previously given by us on any financial information used in the compilation of the Pro Forma Financial Information beyond that owed to those to whom those reports were addressed by us at the dates of their issue. BASIS OF OPINION We conducted our work in accordance with the Statements of Investment Circular Reporting Standards and Bulletin 1998/8 "Reporting on pro forma financial information pursuant to the Listing Rules" issued by the Auditing Practices Board in the United Kingdom, where applicable. Our work consisted primarily of comparing the unadjusted financial information with the source documents, considering the evidence supporting the adjustments and discussing the Pro Forma Financial Information with the directors of the Company. Our work did not constitute an audit or review made in accordance with the Statements of Auditing Standards issued by the Hong Kong Institute of Certified Public Accountants, and accordingly, we do not express any such audit or review assurance on the Pro Forma Financial Information. The Pro Forma Financial Information is for illustrative purposes only, based on the directors' judgements and assumptions, and because of its nature, it does not provide any assurance or indication that any event will take place in the future and may not be indicative of the financial position or result of: - the Combined Group had the Acquisition actually completed as at the dates indicated therein; or - the Combined Group at any future date or for any future periods. - 237 - APPENDIX V FINANCIAL INFORMATION OF THE COMBINED GROUP OPINION In our opinion: (a) the accompanying unaudited Pro Forma Financial Information has been properly compiled on the basis stated; (b) such basis is consistent with the accounting policies of the Company; and (c) the adjustments are appropriate for the purposes of the Pro Forma Financial Information as disclosed pursuant to Paragraph 29(1) of Chapter 4 of the Listing Rules. Yours faithfully, KPMG Certified Public Accountants Hong Kong - 238 - APPENDIX V FINANCIAL INFORMATION OF THE COMBINED GROUP INTRODUCTION TO THE UNAUDITED PRO FORMA FINANCIAL INFORMATION OF THE COMBINED GROUP The accompanying unaudited pro forma financial information of the Combined Group (the Listed Group (as defined herein) together with the Airline Operations (as defined herein) of Northern Airlines Group (as defined herein) and the Airline Operations of Xinjiang Airlines Group (as defined herein)) has been prepared to illustrate the effect of the proposed acquisition of the airline and airline related operations (the "Airline Operations") of each of China Northern Airlines Company and its subsidiaries ("Northern Airlines Group") and Xinjiang Airlines Company and its subsidiaries ("Xinjiang Airlines Group") by China Southern Airlines Company Limited (the "Company", and together with its subsidiaries are referred to as the "Listed Group") (the "Acquisition"). The consideration is assumed to be approximately RMB1,897 million, which represents the aggregate amount of the net assets value of the Airline Operations of Northern Airlines Group and the Airline Operations of Xinjiang Airlines Group as at 30 June, 2004 prepared under PRC Accounting Rules and Regulations. The consideration will be satisfied by short term U.S. dollar bank loans amounting to RMB1,000 million and cash of RMB897 million. The accompanying unaudited pro forma statement of income and unaudited pro forma condensed statement of cash flows of the Combined Group for the six-month period ended 30 June, 2004 gives effect to the Acquisition as if the Acquisition had been completed on 1 January, 2004. The accompanying unaudited pro forma balance sheet of the Combined Group as at 30 June, 2004 gives effect to the Acquisition as if the Acquisition had been completed on 30 June, 2004. The accompanying unaudited pro forma financial information of the Combined Group is prepared based upon the audited historical financial information of the Airline Operations of Northern Airlines Group and Xinjiang Airlines Group as set out in Appendices II and III respectively and the unaudited historical financial information of the Listed Group as set out in Appendix IV after giving effect to the pro forma adjustments described in the accompanying notes. A narrative description of the pro forma adjustments of the Acquisition that are (i) directly attributable to the transactions; (ii) expected to have a continuing impact on the Combined Group; and (iii) factually supportable, are summarised in the accompanying notes. The unaudited pro forma financial information of the Combined Group should be read in conjunction with the financial information of the Airline Operations of Northern Airlines Group and Xinjiang Airlines Group as set out in Appendices II and III respectively, the financial information of the Listed Group as set out in Appendix IV and other financial information included elsewhere in this circular. - 239 - APPENDIX V FINANCIAL INFORMATION OF THE COMBINED GROUP UNAUDITED PRO FORMA STATEMENT OF INCOME OF THE COMBINED GROUP For the six-month period ended 30 June, 2004 NORTHERN XINJIANG THE LISTED AIRLINES AIRLINES PRO FORMA GROUP GROUP GROUP PRO FORMA COMBINED HISTORICAL HISTORICAL HISTORICAL ADJUSTMENTS Note GROUP ------------- ---------- ---------- ----------- ---- ------------- RMB'000 RMB'000 RMB'000 RMB'000 RMB'000 OPERATING REVENUE Traffic revenue 10,834,278 3,391,448 1,176,300 15,402,026 Other operating revenue 259,659 73,232 38,776 371,667 ------------- ---------- ---------- ---------- ------------- TOTAL OPERATING REVENUE 11,093,937 3,464,680 1,215,076 - 15,773,693 ------------- ---------- ---------- ---------- ------------- OPERATING EXPENSES Flight operations 4,722,442 1,480,465 639,339 6,842,246 Maintenance 1,409,841 412,118 126,536 8,881 3 1,957,376 Aircraft and traffic servicing 1,688,612 464,035 134,088 2,286,735 Promotion and sales 874,393 219,471 80,877 1,174,741 General and administrative 551,719 114,849 61,279 727,847 Depreciation and 1,083,346 404,419 173,177 1,660,942 amortisation Others 8,244 - - 8,244 ------------- ---------- ---------- ---------- ------------- TOTAL OPERATING EXPENSES 10,338,597 3,095,357 1,215,296 8,881 14,658,131 ------------- ---------- ---------- ---------- ------------- OPERATING PROFIT/(LOSS) 755,340 369,323 (220) (8,881) 1,115,562 ------------- ---------- ---------- ---------- ------------- NON-OPERATING INCOME/(EXPENSES) Interest income 8,994 4,257 746 (3,228) 2 10,769 Interest expense (343,620) (195,027) (69,417) (10,850) 1 (618,914) Exchange gain/(loss), net 15,397 23,567 (64) 38,900 Share of associated companies' results 21,156 - - 21,156 Share of jointly controlled entities' results 4,351 - - 4,351 Gain/(loss) on disposal of property, plant and equipment 2,999 (439) (800) 1,760 Others, net 4,531 - - 4,531 ------------- ---------- ---------- ---------- ------------- TOTAL NON-OPERATING EXPENSES, NET (286,192) (167,642) (69,535) (14,078) (537,447) ------------- ---------- ---------- ---------- ------------- PROFIT/(LOSS) BEFORE INCOME TAX AND MINORITY INTERESTS 469,148 201,681 (69,755) (22,959) 578,115 INCOME TAX (94,790) (67,300) 24,048 3,444 4 (111,006) 23,592 5 ------------- ---------- ---------- ---------- ------------- PROFIT/(LOSS) BEFORE MINORITY INTERESTS 374,358 134,381 (45,707) 4,077 467,109 MINORITY INTERESTS (108,174) 661 1,396 (106,117) ------------- ---------- ---------- ---------- ------------- NET PROFIT/(LOSS) 266,184 135,042 (44,311) 4,077 360,992 ============= ========== ========== ========== ============= BASIC EARNINGS PER SHARE (IN RMB) 0.06 0.08 WEIGHTED AVERAGE NUMBER OF SHARES 4,374,178,000 4,374,178,000 ============= ============= - 240 - APPENDIX V FINANCIAL INFORMATION OF THE COMBINED GROUP UNAUDITED PRO FORMA BALANCE SHEET OF THE COMBINED GROUP As at 30 June, 2004 NORTHERN XINJIANG THE LISTED AIRLINES AIRLINES PRO FORMA GROUP GROUP GROUP PRO FORMA COMBINED HISTORICAL HISTORICAL HISTORICAL ADJUSTMENTS Note GROUP ----------- ---------- ---------- ----------- ---- ----------- RMB'000 RMB'000 RMB'000 RMB'000 RMB'000 NON-CURRENT ASSETS Property, plant and equipment, net 29,128,791 9,141,267 4,043,708 42,313,766 Construction in progress 2,189,052 38,930 13,404 2,241,386 Lease prepayments 344,755 - - 55,683 8 400,438 Interest in associated companies 443,780 - - 443,780 Interest in jointly controlled entities 787,874 - - 787,874 Other investments 199,007 68,209 - 267,216 Lease and equipment deposits 4,717,553 437,117 53,620 5,208,290 Deferred expenditure 233,726 122,093 - 355,819 Long term receivables 6,648 - - 6,648 ----------- ---------- ---------- ---------- ----------- TOTAL NON-CURRENT ASSETS 38,051,186 9,807,616 4,110,732 55,683 52,025,217 ----------- ---------- ---------- ---------- ----------- CURRENT ASSETS Inventories 572,457 544,093 71,311 51,395 7 1,239,256 Trade receivables 1,210,680 398,158 125,212 (345,442) 9 1,388,608 Other receivables and prepaid expenses 634,312 566,110 169,295 1,369,717 Cash and cash equivalents 2,931,786 234,733 286,998 (896,642) 6 2,556,875 ----------- ---------- ---------- ---------- ----------- TOTAL CURRENT ASSETS 5,349,235 1,743,094 652,816 (1,190,689) 6,554,456 ----------- ---------- ---------- ---------- ----------- CURRENT LIABILITIES Bank and other loans 9,931,236 767,257 1,056,639 1,000,000 6 12,755,132 Obligations under finance leases 1,138,495 1,063,047 - 2,201,542 Amounts due to related companies 906,353 - - (675,300) 9 231,053 Other liabilities and accrued expenses 4,394,807 1,403,363 718,783 6,516,953 Accounts payable 841,409 140,026 128,638 (9,012) 9 1,101,061 Sales in advance of carriage 386,255 - - 338,870 9 725,125 Tax payable 72,954 - - 72,954 ----------- ---------- ---------- ---------- ----------- TOTAL CURRENT LIABILITIES 17,671,509 3,373,693 1,904,060 654,558 23,603,820 ----------- ---------- ---------- ---------- ----------- NET CURRENT LIABILITIES (12,322,274) (1,630,599) (1,251,244) (1,845,247) (17,049,364) ----------- ---------- ---------- ---------- ----------- TOTAL ASSETS LESS CURRENT LIABILITIES 25,728,912 8,177,017 2,859,488 (1,789,564) 34,975,853 ----------- ---------- ---------- ---------- ----------- NON-CURRENT LIABILITIES AND DEFERRED ITEMS Bank and other loans 6,062,819 1,811,371 1,735,037 9,609,227 Obligations under finance leases 5,006,135 5,402,143 - 10,408,278 Provision for major overhauls 230,525 - 182,319 412,844 Deferred credits 44,983 25,750 - 70,733 Deferred taxation 456,354 (20,313) (19,195) 16,961 7 450,643 16,836 8 ----------- ---------- ---------- ---------- ----------- NON-CURRENT LIABILITIES AND DEFERRED ITEMS 11,800,816 7,218,951 1,898,161 33,797 20,951,725 ----------- ---------- ---------- ---------- ----------- MINORITY INTERESTS 1,766,205 2,372 76,777 16,883 8 1,862,237 ----------- ---------- ---------- ---------- ----------- 12,161,891 955,694 884,550 (1,840,244) 12,161,891 =========== ========== ========== ========== =========== CAPITAL AND RESERVES 12,161,891 955,694 884,550 (1,840,244) 12,161,891 =========== ========== ========== ========== =========== - 241 - APPENDIX V FINANCIAL INFORMATION OF THE COMBINED GROUP UNAUDITED PRO FORMA CONDENSED STATEMENT OF CASH FLOWS OF THE COMBINED GROUP For the six-month period ended 30 June, 2004 NORTHERN XINJIANG THE LISTED AIRLINES AIRLINES PRO FORMA GROUP GROUP GROUP PRO FORMA COMBINED HISTORICAL HISTORICAL HISTORICAL ADJUSTMENTS Note GROUP ---------- ---------- ---------- ----------- ---- --------- RMB'000 RMB'000 RMB'000 RMB'000 RMB'000 Net cash from operating activities 1,217,840 221,973 69,672 (10,850) 1 1,495,407 (3,228) 2 Net cash (used in)/generated from investing activities (4,050,525) 92,732 (57,890) (977,815) 10 (4,993,498) ---------- -------- -------- --- --------- Net cash (outflows)/inflows before financing activities (2,832,685) 314,705 11,782 (3,498,091) Net cash inflows/(outflows) from financing activities 3,684,297 (622,018) (101,565) 1,000,000 6 3,960,714 ---------- -------- -------- --- --------- Increase/(decrease) in cash and cash equivalents 851,612 (307,313) (89,783) 462,623 Cash and cash equivalents at 1 January, 2004 2,080,174 542,046 376,781 (918,827) 10 2,080,174 ---------- -------- -------- --- --------- Cash and cash equivalents at 30 June, 2004 2,931,786 234,733 286,998 2,542,797 ========== ======== ======== ========= - 242 - APPENDIX V FINANCIAL INFORMATION OF THE COMBINED GROUP NOTES TO UNAUDITED PRO FORMA FINANCIAL INFORMATION OF THE COMBINED GROUP (1) To record the additional interest expense arising from short term U.S. dollar bank loans bearing interest at 2.17% per annum amounting to RMB1,000 million borrowed to partially satisfy the consideration as if the Acquisition had taken place on 1 January, 2004. (2) To adjust for reduction in the interest income for the cash consideration of RMB897 million to be taken from the internal resources depositing in certain PRC banks enjoying saving rate of 0.72% per annum of the Listed Group as if the Acquisition had taken place on 1 January, 2004. (3) To record the additional costs of inventories charged to the combined statement of income as a result of adjusting the carrying value of inventories to fair value under purchase method as if the Acquisition had taken place on 1 January, 2004. (4) To record the tax effect of the pro forma statement of income adjustments described in notes 1 to 3 above using the Company's applicable income tax rate of 15%. (5) To adjust for the reduction in taxation because of different applicable income tax rates on the Company and the Airline Operations of Northern Airlines Group and the Airline Operations of Xinjiang Airlines Group as if the Acquisition had taken place on 1 January, 2004. The Company's applicable income tax rate is 15% while the applicable income tax rate of the Airline Operations of Northern Airlines Group and the Airline Operations of Xinjiang Airlines Group is 33%. The Airline Operations of Northern Airlines Group and the Airline Operations of Xinjiang Airlines Group will become branches of the Company subsequent to the Acquisition and will be subject to the Company's income tax rate of 15% according to the current relevant PRC tax regulations. (6) To record the payment of consideration of RMB1,897 million satisfied by short term U.S. dollar bank loans amounting to RMB1,000 million and cash of RMB897 million as if the Acquisition had taken place on 30 June, 2004. (7) To adjust the carrying value of inventories to fair value under purchase method and to reverse the corresponding deferred tax asset recognised as if the Acquisition had taken place on 30 June, 2004. (8) To adjust the carrying value of land use rights to fair value under purchase method, the related deferred tax liability and the corresponding minority shareholders' share as if the Acquisition had taken place on 30 June, 2004. (9) Elimination of the inter-company balances among the Airline Operations of Northern Airlines Group, the Airline Operations of Xinjiang Airlines Group and the Listed Group on combined basis. (10) To record the pro forma cash flow effect of the Acquisition, being the payment of consideration of RMB1,897 million, net of the cash and cash equivalents acquired amounting to RMB919 million as if the Acquisition had taken place on 1 January, 2004 (B) INDEBTEDNESS As at the close of business on 30 September, 2004, being the latest practicable date for the purpose of this indebtedness statement prior to the printing of this circular, the Combined Group had bank and other loans of approximately RMB22,031,716,000 and finance lease obligations of approximately RMB11,966,164,000. As at 30 September, 2004, certain bank loans of the Combined Group were secured by certain aircraft with an aggregate carrying amount of RMB10,529,085,000. Finance lease obligations were secured by the related aircraft under finance lease with an aggregate carrying amount of RMB11,886,637,000. In addition, bank loans of RMB3,071,227,000 were also guaranteed by certain banks. - 243 - APPENDIX V FINANCIAL INFORMATION OF THE COMBINED GROUP Save as aforesaid or as otherwise disclosed herein, the Combined Group did not have, at the close of business on 30 September, 2004, outstanding liabilities or any mortgages, charges, debentures, loan capital, bank overdrafts, loans, liabilities under acceptance or other similar indebtedness, hire purchase or finance lease obligations or any guarantees or other material contingent liabilities. (C) WORKING CAPITAL The Directors of the Company are of the opinion that the Combined Group will, following the completion of the Acquisition, have sufficient working capital for its present requirements. - 244 - APPENDIX VI PROFIT FORECAST The forecast combined profit after taxation and minority interests but before extraordinary items of the Airline Operations of Northern Airlines Group and the Airline Operations of Xinjiang Airlines Group for the year ending 31 December, 2004 is set out in the section headed "Prospective Financial Information" in the Letter from the Board. (A) BASES AND ASSUMPTIONS The management of the Company, the Airline Operations of Northern Airlines Group and the Airline Operations of Xinjiang Airlines Group have prepared the forecast combined profit after taxation and minority interests but before extraordinary items of the Airline Operations of Northern Airlines Group and the Airline Operations of Xinjiang Airlines Group for the year ending 31 December, 2004. The management of the Company, Airline Operations of Northern Airlines Group and the Airline Operations of Xinjiang Airlines Group are not currently aware of any extraordinary items which have arisen or are likely to arise in respect of the year ending 31 December, 2004. The forecast has been prepared on a basis consistent in all material respects with the accounting policies currently adopted by the Airline Operations of Northern Airlines Group and the Airline Operations of Xinjiang Airlines Group as summarised in Appendices II and III respectively and on the following principal assumptions: (1) there will be no material changes in existing government policies or political, legal, including changes in legislations or rules, regulatory, fiscal, economic or market conditions in the PRC or any of the countries in which the Airline Operations of Northern Airlines Group and the Airline Operations of Xinjiang Airlines Group carry out business; (2) the Airline Operations of Northern Airlines Group and the Airline Operations of Xinjiang Airlines Group will continue to be authorised to operate services to other countries and cities of which their current scheduled services are covered pursuant to the bilateral aviation agreements between the PRC and overseas governments; (3) the Airline Operations of Northern Airlines Group and the Airline Operations of Xinjiang Airlines Group will be able to maintain all of their certificates and licenses required from the CAAC to enable them to operate their forecast services; (4) there will be no material changes in the bases or rates of taxation or duties in the PRC or any of the countries in which the Airline Operations of Northern Airlines Group and the Airline Operations of Xinjiang Airlines Group operate; (5) there will be no material changes in inflation, interest rates or foreign currency exchange rates from those currently prevailing; and (6) the Airline Operations of Northern Airlines Group and the Airline Operations of Xinjiang Airlines Group will not be severely interrupted by any force majeure events or unforeseeable factors of any unforeseeable reasons that are beyond the control of the Company, the Airline Operations of Northern Airlines Group and the Airline Operations of Xinjiang Airlines Group, including but not limited to, the occurrence of natural disasters or catastrophes, epidemics or serious accidents. - 245 - APPENDIX VI PROFIT FORECAST (B) LETTERS Set out below are the text of the letters received from KPMG, and from the Company's Financial Advisers in connection with the profit forecast and prepared for the sole purpose of inclusion in this circular. [KPMG LOGO] 8th Floor Prince's Building 10 Chater Road Hong Kong 12 November, 2004 The Directors China Southern Airlines Company Limited J.P. Morgan Securities (Asia Pacific) Limited ICEA Capital Limited Dear Sirs, We have reviewed the accounting policies and calculations adopted in arriving at the forecast (the "Forecast") of the combined profit after taxation and minority interests but before extraordinary items of the airline and airline related operations (the "Airline Operations") of China Northern Airlines Company and its subsidiaries (collectively referred to as "Northern Airlines Group") for the year ending 31 December, 2004, for which the directors (the "Directors") of China Southern Airlines Company Limited (the "Company") and management of the Airline Operations of Northern Airlines Group ("Management") are solely responsible, as set out in the circular dated 12 November, 2004 issued by the Company (the "Circular"). In our opinion, so far as the accounting policies and calculations are concerned, the Forecast has been properly compiled on the bases and assumptions made by the Directors and Management as set out in Part A of Appendix VI to the Circular and is presented on a basis consistent in all material respects with the accounting policies adopted by the Airline Operations of Northern Airlines Group as set out in our Accountants' Report on Financial Information of the Airline Operations of Northern Airlines Group dated 12 November, 2004, the text of which is set out in Appendix II to the circular. Yours faithfully, KPMG Certified Public Accountants Hong Kong - 246 - APPENDIX VI PROFIT FORECAST [KPMG LOGO] 8th Floor Prince's Building 10 Chater Road Hong Kong 12 November, 2004 The Directors China Southern Airlines Company Limited J.P. Morgan Securities (Asia Pacific) Limited ICEA Capital Limited Dear Sirs, We have reviewed the accounting policies and calculations adopted in arriving at the forecast (the "Forecast") of the combined profit after taxation and minority interests but before extraordinary items of the airline and airline related operations (the "Airline Operations") of Xinjiang Airlines Company and its subsidiaries (collectively referred to as "Xinjiang Airlines Group") for the year ending 31 December, 2004, for which the directors (the "Directors") of China Southern Airlines Company Limited (the "'Company") and management of the Airline Operation of Xinjiang Airlines Group ("Management") are solely responsible, as set out in the circular dated 12 November, 2004 issued by the Company (the "Circular"). In our opinion, so far as the accounting policies and calculations are concerned, the Forecast has been properly compiled on the bases and assumptions made by the Directors and Management as set out in Part A of Appendix VI to the Circular and is presented on a basis consistent in all material respects with the accounting policies adopted by the Airline Operations of Xinjiang Airlines Group as set out in our Accountants' Report on Financial Information of the Airline Operations of Xinjiang Airlines Group dated 12 November, 2004, the text of which is set out in Appendix III to the circular. Yours faithfully, KPMG Certified Public Accountants Hong Kong - 247 - APPENDIX VI PROFIT FORECAST [JPMORGAN LOGO] J.P. MORGAN SECURITIES (ASIA PACIFIC) LIMITED 28th Floor Chater House 8 Connaught Road Central Hong Kong 12 November, 2004 The Directors China Southern Airlines Company Limited Baiyun International Airport Guangzhou 510405 PRC Dear Sirs, We refer to the forecast of the combined profit after taxation and minority interests but before extraordinary items of the Airline Operations of Northern Airlines Group and the Airline Operations of Xinjiang Airlines Group as defined in this circular, for the year ending 31 December, 2004, as set out in the section headed "Letter from the Board - Prospective Financial Information" of the circular dated 12 November, 2004 issued by the Company. We have discussed with you the assumptions upon which the profit forecast has been made. We have also considered the letter dated 12 November, 2004 addressed to you and us from KPMG regarding the accounting policies and calculations upon which the forecast has been made. On the basis of the assumptions solely made by the management of the Company, the Airline Operations of Northern Airlines Group and the Airline Operations of Xinjiang Airlines Group, respectively, and on the basis of the accounting policies and calculations reviewed by KPMG, we are of the opinion that the profit forecast, for which the management of the Company, the Airline Operations of Northern Airlines Group and the Airline Operations of Xinjiang Airlines Group are solely responsible, has been made after due and careful enquiry. Yours faithfully, For and on behalf of J.P. MORGAN SECURITIES (ASIA PACIFIC) LIMITED TODD R. MARIN Managing Director - 248 - APPENDIX VII ADDITIONAL INFORMATION TO SHAREHOLDERS The following information should be read in conjunction with the financial information as set out in Appendix I headed "Information regarding the Airline Operations of Northern Airlines Group and Xinjiang Airlines Group" and the Accountants' Reports on Financial Information of the Airline Operations of Northern Airlines Group and the Airline Operations of Xinjiang Airlines Group as set out in Appendices II and III respectively. OVERVIEW The Listed Group provides commercial airlines services throughout China, Southeast Asia and other parts of the world. The Listed Group conducts a portion of its airline operations through its 60% owned subsidiaries, namely Xiamen Airlines Company Limited, Southern Airlines Group Shantou Airlines Company Limited, Guangxi Airlines Company Limited, Zhuhai Airlines Company Limited and Guizhou Airlines Company Limited. The Listed Group also provides air cargo and mail services. Currently, the Listed Group has two Boeing 747-400 freighters servicing three international cargo routes. The Listed Group's airline operations are fully integrated with its airline-related businesses, including flight training, aircraft maintenance and air catering operations. Please refer to the annual reports of the Company for each of the years in the three-year period ended 31 December, 2003 and the interim report of the Company for the six-month period ended 30 June, 2004 for a detailed management discussion and analysis of the financial performance of the Listed Group during the respective periods. Northern Airlines Group is principally engaged in the provision of domestic and international passenger, cargo and mail airline services, with flights operating primarily from Shenyang Tao Xian International Airport which is the main base of Northern Airlines Group in the PRC. Northern Airlines Group has three branches in Dalian (Liaoning Province), Changchun (Jilin Province) and Harbin (Heilongjiang Province). Xinjiang Airlines Group is also principally engaged in the provision of domestic and international passenger, cargo and mail airline services, with flights operating primarily from Urumqi International Airport which is the main base of Xinjiang Airlines Group in the PRC. - 249 - APPENDIX VII ADDITIONAL INFORMATION TO SHAREHOLDERS CERTAIN FINANCIAL INFORMATION AND OPERATING DATA BY GEOGRAPHIC REGION The following table sets forth certain financial information and operating data of the Airline Operations of Northern Airlines Group by geographic region for each of the years in the three-year period ended 31 December, 2003 and the six-month periods ended 30 June, 2003 and 2004: SIX-MONTH PERIODS ENDED 30 JUNE, YEARS ENDED 31 DECEMBER, ----------------- ------------------------------ 2004 2003 2003 2002 2001 Traffic Revenue passenger kilometres (RPK) (million) - Domestic 4,652 2,846 8,234 7,800 6,914 - International 538 396 913 986 1,334 ----- ----- ------ ------ ------ Total 5,190 3,242 9,147 8,786 8,248 ===== ===== ====== ====== ====== Passengers carried (thousand) - Domestic 3,258 1,943 5,831 5,501 4,849 - International 363 262 643 652 864 ----- ----- ------ ------ ------ Total 3,621 2,205 6,474 6,153 5,713 ===== ===== ====== ====== ====== Cargo tonne kilometres (RFTK) (million) - Domestic 87 73 168 166 162 - International 9 8 19 15 13 ----- ----- ------ ------ ------ Total 96 81 187 181 175 ===== ===== ====== ====== ====== Capacity Available seat kilometres (ASK) (million) - Domestic 6,722 4,697 12,226 12,232 11,412 - International 971 814 1,714 1,800 2,334 ----- ----- ------ ------ ------ Total 7,693 5,511 13,940 14,032 13,746 ===== ===== ====== ====== ====== - 250 - APPENDIX VII ADDITIONAL INFORMATION TO SHAREHOLDERS SIX-MONTH PERIODS ENDED 30 JUNE, YEARS ENDED 31 DECEMBER, ----------------- ------------------------- 2004 2003 2003 2002 2001 Load Factors Passenger load factor (RPK/ASK) - Domestic 69% 61% 67% 64% 61% - International 55% 49% 53% 55% 57% Overall 67% 59% 66% 63% 60% ==== ==== ==== ==== ==== Yield Yield per RPK (RMB) - Domestic 0.57 0.57 0.55 0.50 0.55 - International 0.98 0.87 0.97 0.87 0.71 Overall 0.61 0.61 0.60 0.54 0.58 ==== ==== ==== ==== ==== Fleet Total number of aircraft in service at year end/ period end - McDonald Douglas 35 35 35 36 37 - Airbus 17 12 12 10 8 - Others 3 6 3 19 27 ---- ---- ---- ---- ---- Total 55 53 50 65 72 ==== ==== ==== ==== ==== Overall utilisation rate (hours per day) - Airbus 8.8 7.0 7.8 8.3 7.5 - McDonald Douglas 9.1 7.0 7.8 8.2 8.4 Overall 9.0 7.0 7.8 8.3 7.8 ==== ==== ==== ==== ==== - 251 - APPENDIX VII ADDITIONAL INFORMATION TO SHAREHOLDERS The following table sets forth certain financial information and operating data of the Airline Operations of Xinjiang Airlines Group by geographic region for each of the years in the three-year period ended 31 December, 2003 and the six-month periods ended 30 June, 2003 and 2004: SIX-MONTH PERIODS ENDED 30 JUNE, YEARS ENDED 31 DECEMBER, ----------------- -------------------------- 2004 2003 2003 2002 2001 Traffic Revenue passenger kilometres (RPK) (million) - Domestic 2,324 1,435 3,941 3,768 3,400 - International 92 54 151 148 148 ----- ----- ----- ----- ----- Total 2,416 1,489 4,092 3,916 3,548 ===== ===== ===== ===== ===== Passengers carried (thousand) - Domestic 1,209 721 2,062 1,753 1,510 - International 55 31 86 75 61 ----- ----- ----- ----- ----- Total 1,264 752 2,148 1,828 1,571 ===== ===== ===== ===== ===== Cargo tonne kilometres (RFTK) (million) - Domestic 33 28 62 81 62 - International 1 - 1 1 1 ----- ----- ----- ----- ----- Total 34 28 63 82 63 ===== ===== ===== ===== ===== Capacity Available seat kilometres (ASK) (million) - Domestic 3,527 2,480 5,995 6,105 5,771 - International 195 121 302 331 326 ----- ----- ----- ----- ----- Total 3,722 2,601 6,297 6,436 6,097 ===== ===== ===== ===== ===== - 252 - APPENDIX VII ADDITIONAL INFORMATION TO SHAREHOLDERS SIX-MONTH PERIODS ENDED 30 JUNE, YEARS ENDED 31 DECEMBER, ----------------- ------------------------ 2004 2003 2003 2002 2001 Load Factors Passenger load factor (RPK/ASK) - Domestic 66% 58% 66% 62% 59% - International 47% 45% 50% 45% 45% Overall 65% 57% 65% 61% 58% ==== ==== ==== ==== ==== Yield Yield per RPK (RMB) - Domestic 0.46 0.45 0.48 0.53 0.55 - International 0.72 0.65 0.69 0.69 0.60 Overall 0.47 0.95 0.48 0.54 0.55 ==== ==== ==== ==== ==== Fleet Total number of aircraft in service at year end/ period end - Boeing 15 15 15 15 14 - ATR 72 and IL 86 5 5 5 8 8 ---- ---- ---- ---- ---- Total 20 20 20 23 22 ==== ==== ==== ==== ==== Overall utilisation rate (hours per day) - Boeing 10.0 7.9 8.8 8.9 10.1 - ATR 72 and IL86 7.8 6.3 7.4 7.1 8.2 Overall 8.9 7.4 8.3 7.7 8.4 ==== ==== ==== ==== ==== OPERATING RESULTS INTERIM PERIOD FOR THE SIX-MONTH PERIOD ENDED 30 JUNE, 2004 COMPARED TO INTERIM PERIOD FOR THE SIX-MONTH PERIOD ENDED 30 JUNE, 2003 THE AIRLINE OPERATIONS OF NORTHERN AIRLINES GROUP Operating revenue For the first half of 2004, the total traffic revenue was RMB3,391 million, an increase of RMB1,262 million or 59.3% from the same period last year. The increase was primarily due to a 62.4% increase in passenger revenue. The number of passengers carried increased by 64.2% to 3.6 million. Passenger traffic in terms of RPKs increased by 60.1% to 5,190 million. - 253 - APPENDIX VII ADDITIONAL INFORMATION TO SHAREHOLDERS Passenger revenue was RMB3,187 million, up 62.4% from the same period last year, representing 94.0% of total traffic revenue. The increase was mainly due to increases in traffic volume of 60.1%. Domestic passenger revenue was RMB2,659 million, up 63.5% from the same period last year. Domestic passenger revenue accounted for 83.4% of overall passenger revenue. The increase in domestic passenger revenue was mainly due to the increases in traffic volume of 63.5% to 4,652 million. The increase in traffic volume was mainly due to the combined effect of the absence of Severe Acute Respiratory Syndrome impact during the first half of 2004 and the PRC government's policies and efforts to attract more investment in the Northeastern part of the PRC, including Shenyang. International passenger revenue was RMB528 million, an increase of 47.5% from the same period last year. International passenger revenue accounted for 16.6% of overall passenger revenue. The increase in international passenger was mainly due to the increases in traffic volume of 35.9% to 538 million and passenger yield of 12.6% to RMB0.98. The increase in traffic volume was mainly because of the absence of Severe Acute Respiratory Syndrome impact during the first half of 2004. The increase in passenger yield was mainly the result of the recording of the contributions to the CAAC infrastructure fund as an operating expense instead of being netted off with traffic revenue and an upward adjustment of fare resulting from increased traffic demand with effect from 1 April, 2004. Cargo and mail revenue was RMB204 million in the first half of 2004, an increase of 22.7% from the same period last year. Cargo and mail revenue accounted for 6.0% of total traffic revenue in the first half of 2004. The increase in cargo and mail revenue was mainly due to increases in traffic volume of 18.5% to 96 million RFTKs and overall yield per RFTK of 7.0% to RMB2.13. The increase in traffic volume was mainly due to the absence of Severe Acute Respiratory Syndrome impact during the first half of 2004. The increase in overall yield per RFTK was mainly due to an increase in fares resulting from increased traffic demand. Other operating revenue increased by 94.3% to RMB73 million in the first half of 2004. The increase was mainly due to a rise in the aircraft lease income of RMB49 million from leasing certain aircraft to a related party. Operating expenses Total operating expenses increased by 20.6% to RMB3,095 million from the same period last year, representing an increase of RMB529 million. The increase was mainly due to increases in fuel costs, landing and navigation fees and commission expenses resulting from increased traffic volume during the first half of 2004. Flight operations expenses, which accounted for 47.8% of total operating expenses in the first half of 2004, increased by 32.2% to RMB1,481 million. Of these expenses, fuel cost was RMB816 million, up 40.9%, mainly as a result of increases in fuel consumption and fuel prices. Air catering expenses increased by 57.6% to RMB104 million, primarily as a result of an increase in number of passengers carried during the first half of 2004. Labour costs increased by 54.2% to RMB222 million, largely due to an increase in flying hours. - 254 - APPENDIX VII ADDITIONAL INFORMATION TO SHAREHOLDERS Maintenance expenses which accounted for 13.3% of total operating expenses in the first half of 2004, decreased by 23.9% to RMB412 million. The decrease was mainly due to year 2003 being a peak time for aircraft engine major repairs. Aircraft and traffic servicing expenses, which accounted for 15.0% of the total operating expenses in the first half of 2004, increased by 45.0% to RMB464 million, reflecting primarily the rise in the number of landing and takeoffs resulting from increased traffic volume during the first half of 2004. Promotional and sales expenses, which accounted for 7.1% of total operating expenses in the first half of 2004, increased by 32.0% to RMB219 million. The increase was the result of an increase in traffic revenue. General and administrative expenses, which accounted for 3.7% of the total operating expenses in the first half of 2004, increased by 15.7% to RMB115 million. The increase was mainly due to an increase in the scale of operations during the first half of 2004. Depreciation and amortization expenses, which accounted for 13.1% of the total operating expenses in the first half of 2004, increased by 26.8% to RMB404 million. The increase was mainly due to the additional depreciation arising from the net revaluation surplus as a result of the revaluation of property, plant and equipment as at 31 December, 2003. Non-operating income/(expenses) Interest expense decreased by 37.5% to RMB195 million during the first half of 2004, primarily reflecting the interest saving resulting from the assumption of RMB5,083 million bank loans by CSAHC as at 31 December, 2003. A net exchange gain of RMB24 million was recorded in the first half of 2004 as compared to a net exchange loss of RMB2 million in the same period last year, mainly due to its Japanese yen denominated borrowings as a result of the depreciation of Japanese yen during the first half of 2004. Taxation The taxation amount for the first half of 2003 was nil because the Airline Operations of Northern Airlines Group did not recognise any deferred tax assets in respect of its taxable losses as the Airline Operations of Northern Airlines Group did not forecast any future taxable income to utilise the taxable losses. As a result of the aforementioned reasons, the Airline Operations of Northern Airlines Group earned a net profit of RMB135 million for the first half of 2004 as compared to a net loss of RMB685 million for the same period last year. - 255 - APPENDIX VII ADDITIONAL INFORMATION TO SHAREHOLDERS THE AIRLINE OPERATIONS OF XINJIANG AIRLINES GROUP Operating revenue For the first half of 2004, the total traffic revenue was RMB1,176 million, an increase of RMB459 million or 64.0% from the same period last year. The increase was primarily due to a 66.7% increase in passenger revenue. The number of passengers carried increased by 68.1% to 1.3 million. Passenger traffic in terms of RPKs increased by 62.3% to 2,416 million. Passenger revenue was RMB1,126 million, up 66.7% from the same period last year, representing 95.8% of total traffic revenue. The increase was mainly due to an increase in traffic volume of 62.3%. Domestic passenger revenue was RMB1,059 million, up 65.2% from the same period last year. Domestic passenger revenue accounted for 94.0% of overall passenger revenue. The increase in domestic passenger was mainly due to the increases in traffic volume of 62.0% to 2,324 million and passenger yield of 2.2% to RMB0.46. The increase in traffic volume was mainly due to the combined effect of the absence of Severe Acute Respiratory Syndrome impact during the first half of 2004. The increase in passenger yield was mainly as a result of recording the contributions to the CAAC infrastructure fund as an operating expense instead of being netted off with traffic revenue with effect from 1 April, 2004. International passenger revenue was RMB67 million, an increase of 91.4% from the same period last year. International passenger revenue accounted for 6.0% of overall passenger revenue. The increase in international passenger was mainly due to the increases in traffic volume of 70.4% to 92 million and passenger yield of 10.8% to RMB0.72. The increase in traffic volume was mainly because of the absence of Severe Acute Respiratory Syndrome impact during the first half of 2004. The increase in passenger yield was mainly the result of the recording of the contributions to the CAAC infrastructure fund as an operating expense instead of being netted off with traffic revenue and an upward adjustment of fare resulting from increased traffic demand with effect from 1 April, 2004. Cargo and mail revenue was RMB50 million in the first half of 2004, an increase of 19.7% from the same period last year. Cargo and mail revenue accounted for 4.2% of total traffic revenue in the first half of 2004. The increase in cargo and mail revenue was mainly due to the net effect of an increase in traffic volume of 21.4% to 34 million RFTKs and a decrease in overall yield per RFTK of 4.0% to RMB1.45. The increase in traffic volume was mainly due to the absence of Severe Acute Respiratory Syndrome impact during the first half of 2004. The decrease in overall yield per RFTK was mainly due to the decrease in fares resulting from intensified competition from other airlines and other modes of transportation. Other operating revenue decreased by 30.6% to RMB39 million in the first half of 2004. The decrease was primarily due to the decrease in aircraft lease income. - 256 - APPENDIX VII ADDITIONAL INFORMATION TO SHAREHOLDERS Operating expenses Total operating expenses increased by 24.1% to RMB1,215 million from the same period last year, representing an increase of RMB236 million. The increase was mainly due to increases in fuel costs, maintenance, landing and navigation fees and commission expenses resulting from increased traffic volume during the first half of 2004. Flight operations expenses, which accounted for 52.6% of total operating expenses in the first half of 2004, increased by 31.3% to RMB639 million. Of these expenses, fuel cost was RMB314 million, up 48.7%, mainly as a result of increases in fuel consumption and fuel prices. Air catering expenses increased by 21.5% to RMB36 million, primarily as a result of an increase in number of passengers carried during the first half of 2004. Labour costs increased by 22.6% to RMB79 million, largely due to an increase in flying hours. Maintenance expenses which accounted for 10.5% of total operating expenses in the first half of 2004, increased by 16.3% to RMB127 million. The increase was primarily attributable to increases in aircraft overhaul charges and routine maintenance costs resulting from increased flying hours. Aircraft and traffic servicing expenses, which accounted for 11.0% of the total operating expenses in the first half of 2004, increased by 20.6% to RMB134 million, reflecting primarily the rise in the number of landing and takeoffs resulting from increased traffic volume during the first half of 2004. Promotional and sales expenses, which accounted for 6.7% of total operating expenses in the first half of 2004, increased by 48.2% to RMB81 million. The increase was the result of an increase in traffic revenue. General and administrative expenses, which accounted for 5.0% of the total operating expenses in the first half of 2004, increased by 19.1% to RMB61 million. The increase was mainly due to an increase in the scale of operations during the first half of 2004. Depreciation and amortization expenses, which accounted for 14.2% of the total operating expenses in the first half of 2004, increased by 4.2% to RMB173 million. The increase was mainly due to the additional depreciation arising from the net revaluation surplus as a result of the revaluation of property, plant and equipment as at 31 December, 2003 and new purchases during the first half of 2004. Non-operating income/(expenses) Interest expense decreased by 14.7% to RMB69 million during the first half of 2004, primarily reflecting the interest saving resulting from the replacement of higher interest bearing foreign U.S. dollar bank loans with lower interest bearing domestic U.S. dollar bank loans during 2003. - 257 - APPENDIX VII ADDITIONAL INFORMATION TO SHAREHOLDERS Taxation The income tax credit for the first half of 2004 was RMB24 million as compared to RMB95 million for the same period of last year. The decrease was mainly due to better performance during the first half of 2004. The Airline Operations of Xinjiang Airlines Group incurred a loss before income tax of RMB70 million for the first half of 2004 as compared to a loss before income tax of RMB290 million for the same period last year. As a result of the aforementioned reasons, the Airline Operations of Xinjiang Airlines Group incurred a net loss of RMB44 million for the first half of 2004 as compared to a net loss of RMB194 million for the same period last year. YEAR ENDED 31 DECEMBER, 2003 COMPARED TO YEAR ENDED 31 DECEMBER, 2002 THE AIRLINE OPERATIONS OF NORTHERN AIRLINES GROUP Operating revenue The total traffic revenue was RMB5,857 million in 2003, an increase of RMB700 million or 13.6% from 2002. The increase was primarily due to a 14.3% increase in passenger revenue. The number of passengers carried increased by 5.2% to 6.5 million. Passenger traffic in terms of RPKs increased by 4.1% to 9,147 million. Passenger revenue was RMB5,446 million, up 14.3% from 2002, representing 93.0% of total traffic revenue. The increase was mainly due to increases in traffic volume of 4.1% and passenger yield of 10.0%. Domestic passenger revenue was RMB4,559 million, up 16.7% from 2002. Domestic passenger revenue accounted for 83.7% of overall passenger revenue. The increase in domestic passenger revenue was mainly due to increases in traffic volume of 5.6% to 8,234 million and passenger yield of 10.0% to RMB0.55. The increase in traffic volume was the result of rescheduling of certain major routes in October 2002. Some low yield and load factor routes were suspended and the traffic capacity were allocated to those routes with high yield and load factor. The increase in passenger yield was due mainly to the exemption of the CAAC infrastructure fund and sales tax during the period from 1 May, 2003 to 31 December, 2003. International passenger revenue was RMB887 million, an increase of 3.5% from 2002. International passenger revenue accounted for 16.3% of overall passenger revenue. The increase in international passenger revenue was mainly due to the net effect of a decrease in traffic volume of 7.4% to 913 million and an increase in passenger yield of 11.5% to RMB0.97. The decrease in traffic volume was the result of suspension of routes to Hong Kong during the period of 1 April, 2003 to 31 December, 2003 because of the outbreak of Severe Acute Respiratory Syndrome and persistently low load factor and yield. The increase in passenger yield per RPK was due mainly to the exemption of the CAAC infrastructure fund and sales tax during the period from 1 May, 2003 to 31 December, 2003. - 258 - APPENDIX VII ADDITIONAL INFORMATION TO SHAREHOLDERS Cargo and mail revenue was RMB411 million, an increase of 4.9% from 2002. Cargo and mail revenue accounted for 7.0% of total traffic revenue in 2003. The increase in cargo and mail revenue was mainly due to an increase in traffic volume resulting from the introduction of new routes to Japan in October 2002. Other operating revenue decreased by 17.8% to RMB72 million in 2003. The decrease was primarily due to a drop in the commission income of RMB15 million resulting from the use of the Company's tickets for the flights of the Airline Operations of Northern Airlines Group since 1 January, 2003 under a ticket sale agreement. Operating expenses Total operating expenses increased by 7.9% to RMB5,989 million from 2002, representing an increase of RMB438 million. The increase was mainly due to increases in fuel costs, landing and navigation fees, repair and maintenance resulting from increased traffic volume during 2003. Flight operations expenses, which accounted for 39.0% of total operating expenses in 2003, increased by 6.6% to RMB2,338 million. Of these expenses, fuel cost was RMB1,314 million, up 6.4%, mainly as a result of an increase in fuel prices caused by the outbreak of Iraq war. Air catering expenses decreased by 15.1% to RMB174 million during 2003 primarily as a result of stricter cost control. Labour costs increased by 16.8% to RMB376 million largely due to an increase of headcount and the introduction of double pay during 2003. Maintenance expenses which accounted for 17.4% of total operating expenses in 2003, increased by 4.6% to RMB1,039 million. The increase was mainly due to year 2003 being a peak time for aircraft engine major repairs. Aircraft and traffic servicing expenses, which accounted for 12.7% of the total operating expenses in 2003, increased by 5.9% to RMB760 million, reflecting primarily an increase in the charge rate for domestic landing and navigation fees effective September 2002. Promotional and sales expenses, which accounted for 7.1% of total operating expenses in 2003, increased by 2.3% to RMB425 million. The increase was the result of an increase in traffic revenue. General and administrative expenses, which accounted for 3.8% of the total operating expenses in 2003, increased by 3.1% to RMB226 million. The increase was mainly due to an increase in labour costs resulting from the introduction of double pay during 2003. Depreciation and amortization expenses, which accounted for 10.8% of the total operating expenses in 2003, decreased by 2.5% to RMB646 million. The decrease was mainly due to the reduction associated with fully depreciated property, plant and equipment which outweighed the additional depreciation on those property, plant and equipment purchased during 2003. - 259 - APPENDIX VII ADDITIONAL INFORMATION TO SHAREHOLDERS Others which represented impairment losses on aircraft and accounted for 9.2% of the total operating expenses, increased by 58.7% to RMB555 million in 2003. During 2003, the Airline Operations of Northern Airlines entered into agreements with an independent third party to dispose of its twenty-three McDonald Douglas 82 aircraft during the years 2003 to 2007 and then immediately lease back the aircraft under operating leases for a period of one to two years. Accordingly, the Airline Operations of Northern Airlines Group recorded an impairment loss for the year ended 31 December 2003 of approximately RMB555 million, being the excess of the carrying amount of the aircraft over their recoverable amount as determined based on the agreed selling prices of the aircraft and estimated future cash flows from operating the aircraft prior to their disposals. Non-operating income/(expenses) Interest income decreased by 54.7% to RMB13 million in 2003. This is mainly due to the combined effect of decreases in average cash balances and bank deposit interest rates. Interest expense decreased by 10.5% to RMB627 million in 2003, primarily reflecting the combined effect of scheduled debt repayments and the replacement of certain Renminbi denominated bank loans with US$ denominated bank loans with lower interest rates. During 2003, the Airline Operations of Northern Airlines Group recorded a net exchange loss of RMB218 million predominantly due to its Japanese Yen denominated borrowings as a result of the Japanese Yen appreciation. Such amount comprised mostly unrealized translation gain. In connection with the Acquisition, the property, plant and equipment of the Airline Operations of Northern Airlines Group as at 31 December, 2003 were revalued on a replacement cost basis as required by the relevant PRC rules and regulations. As a result of the revaluation, a deficit on revaluation of RMB492 million was resulted during 2003. Taxation The income tax for 2003 was RMB117 million as compared to nil for 2002. This was because the Airline Operations of Northern Airlines Group did not recognise any deferred tax assets in respect of its taxable losses in 2002 as the Airline Operations of Northern Airlines Group did not forecast any future taxable income to utilise the taxable losses. As a result of the aforementioned reasons, the Airline Operations of Northern Airlines Group incurred a net loss of RMB1,234 million for 2003 as compared to a net loss of RMB1,141 million for 2002. - 260 - APPENDIX VII ADDITIONAL INFORMATION TO SHAREHOLDERS THE AIRLINE OPERATIONS OF XINJIANG AIRLINES GROUP The total traffic revenue was RMB2,075 million in 2003, a decrease of RMB140 million or 6.3% from 2002. This decrease was primarily due to a 5.8% decrease in passenger revenue. Passenger revenue was RMB1,982 million, down 5.8% from 2002, representing 95.5% of total traffic revenue. The decrease was mainly due to the net effect of an increase in traffic volume of 4.5% and a decrease in passenger yield of 11.1%. Domestic passenger revenue was RMB1,878 million, down 6.2% from 2002. Domestic passenger revenue accounted for 94.8% of overall passenger revenue. The decrease in domestic passenger revenue was mainly due to the net effect of an increase in traffic volume of 4.6% to 3,941 million and a decrease in passenger yield of 9.4% to RMB0.48. The increase in traffic volume was the result of a quick and strong recovery of aviation market during the second half year of 2003 subsequent to the recovery from Severe Acute Respiratory Syndrome. The decrease in passenger yield was due mainly to the entry of other airlines which induced the price competition. International passenger revenue was RMB104 million, an increase of 2.0% from 2002. International passenger revenue accounted for 5.2% of overall passenger revenue. The increase in international passenger revenue was mainly due to the net effect of an increase in traffic volume of 2.0% to 151 million. The passenger yield remained at RMB0.69. Cargo and mail revenue was RMB93 million, a decrease of 16.6% from 2002. Cargo and mail revenue accounted for 4.5% of total traffic revenue in 2003. The decrease in cargo and mail revenue was mainly due to a decrease in traffic volume resulting from the disposal of three IL86 aircraft during 2003. The overall yield per RFTK increased by 8.8% to RMB1.48 because of an upward adjustment of fare on certain routes to Russia as a result of increased demand. Other operating revenue decreased by 44.4% to RMB77 million in 2003. The decrease was due to decrease in the aircraft lease income resulting from the disposal of three IL86 aircraft. Operating expenses Total operating expenses increased by 1.6% to RMB2,191 million from 2002, representing an increase of RMB35 million. The increase was mainly due to increases in fuel costs, landing and navigation fees, repair and maintenance resulting from increased traffic volume during 2003. Flight operations expenses, which accounted for 48.5% of total operating expenses in 2003, increased by 2.5% to RMB1,062 million. Of these expenses, fuel cost was RMB481 million, up 1.8%, mainly as a result of an increase in fuel prices caused by the outbreak of Iraq war. Air catering expenses decreased by 7.9% to RMB70 million during 2003 primarily as a result of stricter cost control. Labour costs increased by 45.0% to RMB134 million largely due to increases in headcount and salary level by 20% in late 2002. - 261 - APPENDIX VII ADDITIONAL INFORMATION TO SHAREHOLDERS Maintenance expenses which accounted for 11.4% of total operating expenses in 2003, increased by 23.2% to RMB250 million. The increase was primarily attributable to an increase in utilization rates of the aircraft. Aircraft and traffic servicing expenses, which accounted for 12.6% of the total operating expenses in 2003, increased by 34.3% to RMB276 million, reflecting primarily an increase in the charge rate for domestic landing and navigation fees effective September 2002. Promotional and sales expenses, which accounted for 6.3% of total operating expenses in 2003, increased by 17.2% to RMB138 million. The increase was mainly the result of an increase in commission and bonus paid to sales agents due to intensified competition. General and administrative expenses, which accounted for 5.4% of the total operating expenses in 2003, increased by 21.2% to RMB119 million. The increase was mainly due to an increase in staff cost resulting from increases in headcount and salary level by 20% in late 2002. Depreciation and amortization expenses, which accounted for 15.8% of the total operating expenses in 2003, decreased by 1.7% to RMB346 million. The decrease was mainly due to the reduction associated with fully depreciated property, plant and equipment which outweighed the additional depreciation on those property, plant and equipment purchased during 2003. Non-operating income/(expenses) Interest expense increased by 9.5% to RMB201 million in 2003, primarily reflecting a termination charge paid for early repayment of certain overseas U.S. dollar loans amounting to RMB43 million, the effect of which was partly offset by interest saving from scheduled debt repayments. In connection with the Acquisition, the property, plant and equipment of the Airline Operations of Xinjiang Airlines Group as at 31 December, 2003 were revalued on a replacement cost basis as required by the relevant PRC rules and regulations. As a result of the revaluation, a deficit on revaluation of RMB235 million was resulted during 2003. Taxation The income tax credit for 2003 was RMB156 million as compared to a taxation expense of RMB9 million for 2002. This was mainly because the Airline Operations of Xinjiang Airlines Group incurred a loss before income tax of RMB481 million for 2003 as compared to a profit before income tax of RMB12 million for 2002. As a result of the aforementioned reasons, the Airline Operations of Xinjiang Airlines Group incurred a net loss of RMB299 million for 2003 as compared to a net profit of RMB3 million for 2002. - 262 - APPENDIX VII ADDITIONAL INFORMATION TO SHAREHOLDERS YEAR ENDED 31 DECEMBER 2002 COMPARED TO YEAR ENDED 31 DECEMBER 2001 THE AIRLINE OPERATIONS OF NORTHERN AIRLINES GROUP Operating revenue The total traffic revenue was RMB5,157 million in 2002, an increase of RMB51 million or 1.0% from 2001. This increase was primarily due to 18.0% or RMB60 million increase in cargo and mail revenue. Passenger revenue was RMB4,765 million, down slightly by 0.2% from 2001, representing 92.4% of total traffic revenue. The decrease was mainly due to the decrease in passenger yield of 6.9% to RMB0.54. Domestic passenger revenue was RMB3,908 million, up slightly by 2.2% from 2001. Domestic passenger revenue accounted for 82.0% of total passenger revenue. The increase in domestic passenger revenue was mainly due to the net effect of an increase in traffic volume of 12.8% to 7,800 million and a decrease in passenger yield of 9.1% to RMB0.50. The increase in traffic volume was the result of the continued PRC government's effort in stimulating domestic consumption which increased traffic demand. The decrease in passenger yield was mainly as a result of increased competition among the PRC airlines. International passenger revenue was RMB857 million, down 9.9% from 2001. International passenger revenue accounted for 18.0% of overall passenger revenue. The decrease in international passenger revenue was mainly due to the net effect of a decrease in traffic volume of 26.1% to 986 million and an increase in passenger yield of 22.5% to RMB0.87. In January 2002, the Airline Operations of Northern Airlines Group suspended certain low yield and load factor international routes. This accounted for a decrease in traffic volume but an increase in passenger yield. Cargo and mail revenue was RMB392 million, an increase of 18.0% from 2001. Cargo and mail revenue accounted for 7.6% of total traffic revenue in 2002. The increase in cargo and mail revenue was mainly to an increase in overall yield per RFTK of 14.3% to RMB2.16 resulting from the suspension of certain routes with low yield as mentioned above. Other operating revenue decreased by 11.0% to RMB87 million in 2002. The decrease was primarily due to the net effect of a drop in aircraft wet lease income of RMB34 million and an increase in maintenance service income of RMB17 million. Operating expenses Total operating expenses increased by 4.2% to RMB5,552 million from 2002, representing an increase of RMB223 million. The increase was mainly due to the net effect of increases in landing and navigation fees and repair and maintenance, and a decrease in impairment loss on aircraft. - 263 - APPENDIX VII ADDITIONAL INFORMATION TO SHAREHOLDERS Flight operations expenses, which accounted for 39.6% of total operating expenses in 2002, increased by 3.3% to RMB2,194 million. Of these expenses, fuel cost was RMB1,236 million, down 3.8%, mainly as a result of a decrease in fuel prices. Air catering expenses increased by 9.6% to RMB205 million during 2002 primarily as a result of an increase in passenger carried. Labour costs increased by 15.8% to RMB322 million largely due to an increase of flying hours. Maintenance expenses which accounted for 17.9% of total operating expenses in 2002, increased by 32.2% to RMB994 million. The increase was mainly due to year 2002 being a peak time for aircraft engine major repairs. Aircraft and traffic servicing expenses, which accounted for 12.9% of the total operating expenses in 2002, increased by 7.4% to RMB717 million, reflecting primarily an increase in the charge rate for domestic landing and navigation fees effective September 2002. Promotional and sales expenses, which accounted for 7.5% of total operating expenses in 2002, increased by 1.7% to RMB416 million. The increase was the result of an increase in operation scale. General and administrative expenses, which accounted for 3.9% of the total operating expenses in 2002, increased by 34.3% to RMB219 million. The increase was mainly due to an increase in labour costs resulting from salary increment. Depreciation and amortization expenses, which accounted for 11.9% of the total operating expenses in 2002, decreased by 2.4% to RMB662 million. The decrease was mainly due to the reduction associated with fully depreciated property, plant and equipment which outweighed the additional depreciation on those property, plant and equipment purchased during 2002. Others which mainly represented impairment losses on aircraft and accounted for 6.3% of the total operating expenses, decreased by 34.7% to RMB350 million. The decrease was mainly due the absence of lump sum housing subsidy to eligible employees during 2002. Pursuant to the housing policy executed by the Airline Operations of Northern Airlines Group, the Airline Operations of Northern Airlines Group made payments totalling approximately RMB102 million to eligible employees in 2001 for the purpose of subsidising the employees in purchasing their houses. Non-operating income/(expenses) Interest income decreased by 52.3% to RMB29 million in 2002. This was mainly due to the combined effect of decreases in average cash balances and bank deposit interest rates. Interest expense decreased by 3.3% to RMB701 million in 2002, primarily reflecting the combined effect of scheduled debt repayments and the decrease in interest rates on certain floating rates obligation as market interest rates dropped. - 264 - APPENDIX VII ADDITIONAL INFORMATION TO SHAREHOLDERS During 2002, the Airline Operations of Northern Airlines Group recorded a net exchange loss of RMB151 million as compared to a net exchange gain of RMB232 million in 2001. The net exchange loss in 2002 was predominantly due to its Japanese Yen denominated borrowings as a result of the Japanese Yen appreciation. Such amount comprised mostly unrealized translation gain. Taxation The taxation amount was small for both 2002 and 2001. This was because the Airline Operations of Northern Airlines Group did not recognise any deferred tax assets in respect of its taxable losses in both years as the Airline Operations of Northern Airlines Group did not forecast any future taxable income to utilise the taxable losses. As a result of the aforementioned reasons, the Airline Operations of Northern Airlines Group incurred a net loss of RMB1,141 million for 2002 as compared to a net loss of RMB502 million for 2001. THE AIRLINE OPERATIONS OF XINJIANG AIRLINES GROUP Operating revenue The total traffic revenue was RMB2,215 million in 2002, an increase of RMB167 million or 8.2% from 2001. This increase was primarily due to the 7.9% or RMB154 million increase in passenger revenue. Passenger revenue was RMB2,104 million, up by 7.9% from 2001, representing 95.0% of total traffic revenue. The increase was mainly due to an increase in traffic volume of 10.4%. Domestic passenger revenue was RMB2,002 million, increased by 7.6% from 2001. Domestic passenger revenue accounted for 95.2% of overall passenger revenue. The increase in domestic passenger revenue was mainly due to the net effect of an increase of traffic volume of 10.8% to 3,768 million and a decrease in passenger yield of 3.6% to RMB0.53. The increase in traffic volume was the result of the continued PRC government's effort in stimulating domestic consumption which increased traffic demand. The decrease in passenger yield was mainly as a result of increased competition among the PRC airlines. International passenger revenue was RMB102 million, up 14.6% from 2001. International passenger revenue accounted for 4.8% of overall passenger revenue. The increase in international passenger revenue was mainly due to an increase in passenger yield of 15.0% to RMB0.69 because of increased traffic demand. Cargo and mail revenue was RMB111 million, an increase of 14.0% from 2001. Cargo and mail revenue accounted for 5.0% of total traffic revenue in 2002. The increase in cargo and mail revenue was mainly due to the net effect of an increase in traffic volume of 30.2% to 82 million and a decrease in overall yield per RFTK of 11.7% to RMB1.36 resulting from the intensified competition from other airlines. - 265 - APPENDIX VII ADDITIONAL INFORMATION TO SHAREHOLDERS Other operating revenue increased by 9.1% to RMB138 million in 2002. The increase was primarily due to an increase in ground services income subsequent to the introduction of ground services in 2002. Operating expenses Total operating expenses increased by 13.2% to RMB2,156 million from 2001, representing an increase of RMB251 million. The increase was mainly due to the impairment loss recognised on aircraft and other flight equipment of RMB132 million. Flight operations expenses, which accounted for 48.1% of total operating expenses in 2002, increased by 3.4% to RMB1,036 million. Of these expenses, fuel cost was RMB473 million, down 11.9%, mainly as a result of a decrease in fuel prices. Air catering expenses increased by 10.1% to RMB76 million during 2002 primarily as a result of an increase in passenger carried. Labour costs increased by 8.2% to RMB92 million largely due to an increase of flying hours. Maintenance expenses which accounted for 9.4% of total operating expenses in 2002, increased by 1.4% to RMB203 million. The increase was primarily attributable to an increase in flight hours. Aircraft and traffic servicing expenses, which accounted for 9.5% of the total operating expenses in 2002, increased by 1.6% to RMB205 million, reflecting primarily an increase in the charge rate for domestic landing and navigation fees effective September 2002. Promotional and sales expenses, which accounted for 5.4% of total operating expenses in 2002, increased by 17.4% to RMB117 million. The increase was the result of an increase in revenue. General and administrative expenses, which accounted for 4.6% of the total operating expenses in 2002, increased by 13.7% to RMB98 million. The increase was mainly due to an increase in labour costs resulting from salary increment. Depreciation and amortization expenses, which accounted for 16.3% of the total operating expenses in 2002, increased by 11.8% to RMB352 million. This increase was primarily as a result of addition of one Boeing 757-200 aircraft and two 757-200 jet engines during 2002. Others which mainly represented the impairment loss on aircraft accounted for 6.7% of the total operating expenses in 2002. In accordance with certain regulations announced by the CAAC in 2002, IL86 aircraft were not allowed to fly unless they were installed with additional security modules starting from 1 January, 2003. After having evaluated the costs and benefits, management decided to ground the aircraft. Management assessed the recoverable amount of the three IL86 aircraft and their related flight equipment and spare parts. Impairment loss of approximately RMB132 million was provided for to write down the carrying value of the aircraft to their estimated net realisable value during 2002. - 266 - APPENDIX VII ADDITIONAL INFORMATION TO SHAREHOLDERS Non-operating income/(expenses) Interest expense decreased by 2.7% to RMB184 million in 2002, primarily reflecting the effect of scheduled debt repayments. Taxation The income tax for 2002 was RMB9 million as compared to RMB36 million for 2001. The decrease was mainly due to a decrease in profit before income tax. As a result of the aforementioned reasons, the Airline Operations of Xinjiang Airlines Group had a net profit of RMB3 million for 2002 as compared to a net profit of RMB41 million for 2001. LIQUIDITY THE AIRLINE OPERATIONS OF NORTHERN AIRLINES GROUP As of 30 June 2004, the Airline Operations of Northern Airlines Group's borrowings totalled RMB9,044 million. The majority of such borrowings were denominated in United States dollars and, to a smaller extent, in Japanese yen and Renminbi, with a significant portion being fixed interest rate borrowings ranging from 5.94% to 8.18%. Of such borrowings, RMB1,830 million, RMB1,294 million, RMB2,310 million, RMB1,279 million and RMB2,331 million will be repayable in 2005, 2006, 2007, 2008, 2009 and thereafter respectively. THE AIRLINE OPERATIONS OF XINJIANG AIRLINES GROUP As of 30 June 2004, the Airline Operations of Xinjiang Airlines Group's borrowings totalled RMB2,792 million. The majority of such borrowings were denominated in United States dollars and Renminbi, with a significant portion being fixed interest rate borrowings ranging from 5.77% to 7.63%. Of such borrowings, RMB1,057 million, RMB320 million, RMB314 million, RMB222 million and RMB879 million will be repayable in 2005, 2006, 2007, 2008, 2009 and thereafter respectively. FINANCIAL RISK MANAGEMENT POLICY In the normal course of business, each of the Airline Operations of Northern Airlines Group and the Airline Operations of Xinjiang Airlines Group is exposed to fluctuations in foreign currencies and jet fuel prices. Their exposure to foreign currencies is mainly attributable to their debts denominated in foreign currencies. Depreciation or appreciation of the Renminbi against foreign currencies could affect results and financial position of the Airline Operations of Northern Airlines Group and the Airline Operations of Xinjiang Airlines Group significantly, as their foreign currency payments generally exceed its foreign currency receipts. Both the Airline Operations of Northern Airlines Group and the Airline Operations of Xinjiang Airlines Group are not able to hedge their foreign currency exposure effectively other - 267 - APPENDIX VII ADDITIONAL INFORMATION TO SHAREHOLDERS than by retaining their foreign currency denominated earnings and receipts to the extent permitted by the State Administration of Foreign Exchange, or subject to certain restrictive conditions, by entering into forward foreign exchange contracts with authorized PRC banks. Both the Airline Operations of Northern Airlines Group and the Airline Operations of Xinjiang Airlines Group are required to procure a majority of its jet fuel domestically at PRC spot market prices. There are currently no effective means available to either the Airline Operations of Northern Airlines Group or the Airline Operations of Xinjiang Airlines Group for managing their exposure associated with the fluctuations in domestic jet fuel prices. CHARGES ON ASSETS THE AIRLINE OPERATIONS OF NORTHERN AIRLINES GROUP As of 30 June 2004, certain aircraft of the Airline Operations of Northern Airlines Group with an aggregate carrying value of approximately RMB6,941 million were mortgaged under certain loan and finance leases. THE AIRLINE OPERATIONS OF XINJIANG AIRLINES GROUP As of 30 June 2004, certain aircraft of the Airline Operations of Xinjiang Airlines Group with an aggregate carrying value of approximately RMB1,689 million were mortgaged under certain loan agreements. COMMITMENTS AND CONTINGENCIES THE AIRLINE OPERATIONS OF NORTHERN AIRLINES GROUP As of 30 June 2004, the Airline Operations of Northern Airlines Group had capital commitments of approximately RMB909 million. Of such amounts, RMB860 million was related to the acquisition of aircraft and related flight equipment. The remaining amount of RMB49 million was related to the Airline Operations of Northern Airlines Group's office facilities and equipment, overhaul and maintenance bases and training facilities. The details of the contingencies of the Airline Operations of Northern Airlines Group was set out on page 105 of the Circular. THE AIRLINE OPERATIONS OF XINJIANG AIRLINES GROUP As of 30 June 2004, the Airline Operations of Xinjiang Airlines Group had capital commitments of approximately RMB12 million. They were related to the Airline Operations of Xinjiang Airlines Group's office facilities and equipment, overhaul and maintenance bases and training facilities. As at 30 June, 2004, the Airline Operations of Xinjiang Airlines Group was not subject to any major contingent liabilities. - 268 - APPENDIX VII ADDITIONAL INFORMATION TO SHAREHOLDERS OPERATING RESULTS OUTLOOK The Directors view the Acquisition as a significant driver to improving its operating efficiency and competitiveness. Via a successful integration, the Directors aim to achieve the following improvement in the Company's operating results: 2005 2004 2003 BENCHMARK (PRO FORMA)(1) (PRO FORMA)(1) (ACTUAL)(2) --------------------------------- -------------- -------------- ----------- Total RTK (million) 7,300 6,550 3,561 Total passenger carried (million) 45 40 26 Total RFTK (million) 0.76 0.69 0.59 Average daily utilization (hours) 9.3 9.2 8.45 Overall load factor (%) 63.2 62.8 60.1 Passenger load factor (%) 70 69.3 64.6 (1) Refers to pro forma combination of the Listed Group, the Airline Operations of Northern Airlines Group and the Airline Operations of Xinjiang Airlines Group. (2) Refers to the Listed Group's actual 2003 result. - 269 - APPENDIX VIII PROPERTY VALUATION The following is the text of the letter, summary of values and valuation certificate received from Chesterton, an independent property valuer, prepared for the purpose of incorporation in this Circular, in connection with their valuation of the property interests held and to be acquired by the Group as at 31 August, 2004. [CHESTERTON PETTY LOGO] International Property Consultants Chesterton Petty Limited 16/F CITIC Tower 1 Tim Mel Avenue Central Hong Kong Tel 2840 1177 Fax 2840 0600 12 November, 2004 The Directors China Southern Airlines Company Limited Baiyun International Airport Guangzhou City Guangdong Province The People's Republic of China Dear Sirs, In accordance with your instructions to us to value the property interests to be acquired by China Southern Airlines Company Limited (hereinafter referred to as the "Company") from China Southern Air Holding Company ("CSAHC") which are originally held by China Northern Airlines Company and Xinjiang Airlines Company and those property interests held by the Company and its principal subsidiaries and associated company (hereinafter together referred to as the "Group"), we confirm that we have carried out inspections, made relevant enquiries and obtained such further information as we consider necessary for the purpose of providing you with our opinion of the open market values of the property interests as at 31 August, 2004. Our valuation is our opinion of the open market value which we would define as intended to mean "the best price at which the sale of an interest in a property would have been completed unconditionally for cash consideration on the date of valuation assuming: (a) a willing seller; (b) that, prior to the date of valuation, there had been a reasonable period (having regard to the nature of the property and the state of the market) for the proper marketing of the interest, for the agreement of price and terms and for the completion of the sale; (c) that the state of the market, level of values and other circumstances were, on any earlier assumed date of exchange of contracts, the same as on the date of valuation; - 270 - APPENDIX VIII PROPERTY VALUATION (d) that no account is taken of any additional bid by a prospective purchaser with a special interest; and (e) that both parties to the transaction had acted knowledgeably, prudently and without compulsion". Our valuation has been made on the assumption that the owner sells the property interest in the open market without the benefit of a deferred term contract, leaseback, joint venture, management agreement or any similar arrangement which would serve to increase the values of the property interests. In addition, no account has been taken of any option or right of pre-emption concerning or affecting the sale of the property interest and no forced sale situation in any manner is assumed in our valuation. In valuing the property interests, we have assumed that, unless otherwise stated, CSAHC and its subsidiaries and the Company have an enforceable title to each of the property interests to be acquired and those held by the Group, respectively, and have free and uninterrupted rights to use, occupy or assign the property interests for the whole of the respective unexpired terms as granted. In the course of our valuation to the properties held by the Group in the PRC, we have also assumed that, unless otherwise stated, transferable land use rights in respect of the properties for their respective specific terms at nominal annual land use fees have been granted and that any premium payable has already been fully paid. We have relied on the advice given by the Group and its PRC legal advisers, Z & T Law Firm, on the PRC laws regarding the title to the properties. Due to the specific purposes for which most of the buildings and structures to be acquired in Group I and those held by the Group in Groups IV and V have been constructed, there are no readily identifiable market comparables available, thus the buildings and structures cannot be valued on the basis of direct comparison. They have therefore been valued on the basis of their depreciated replacement cost. We would define depreciated replacement cost to be our opinion of the land value in its existing use together with an estimate of the new replacement costs of the buildings and structures, including fees and finance charges, from which deductions are then made to allow for age, condition and functional obsolescence. The depreciated replacement cost approach generally provides the most reliable indication of value for property in the absence of a known market based on comparable sales. We have valued the property interest in Group VI by using "Direct Comparison Approach" with the benefit of vacant possession and by reference to comparable sales evidence as available in the market. Property interests under construction in Groups II and VII have been valued on the basis of their prevailing costs level and status of construction as at the date of valuation. We have assumed that all consents, approvals and licences from the relevant government authorities for such constructions and related development proposals have been granted without any onerous conditions or undue delay which might affect their values. The properties in Group III which are to be rented by the Company and those in Groups VIII which are rented by the Group in the PRC and overseas have been assigned no commercial value due to the short term nature or the prohibition against assignment or sub-letting, or lack of substantial profit rent. - 271 - APPENDIX VIII PROPERTY VALUATION In valuing the property interests, we have complied with the requirements contained within the relevant provisions as stipulated in Chapter 5 and Practice Note 12 to the Rules Governing the Listing of Securities on The Stock Exchange of Hong Kong Limited, except to those in respect of which waiver in respect of Rule 5.06 of the Listing Rules has been applied for due to the large number of land and buildings involved in the Acquisition. We have been provided with copies of extracts of title documents relating to the property interests. However, we have not inspected the original documents to verify the ownership or to verify any amendments which may not appear on the copies handed to us. We have relied to a considerable extent on information given by the Group and the legal opinion of the Group's PRC legal advisers and have accepted advice given to us on such matters as planning approvals or statutory notices, easements, tenure, particulars of occupancy, identification of the property, development proposals, completion dates of buildings, floor and site areas, construction costs incurred, attributable interests and all other relevant information. Dimensions, measurements and areas included in the valuation certificate are based on information contained in the documents provided to us and are therefore only approximations. We have not been able to carry out on-site measurements to verify the correctness of the site and floor areas of the properties and we have assumed that the site and floor areas shown on the documents handed to us are correct. We have inspected the exteriors and, where possible, the interiors of the properties. However, we have not carried out any site investigations to determine the suitability of the ground conditions and the services etc, for any future development. Our valuation is prepared on the assumption that these aspects are satisfactory and that no extraordinary expenses or delays will be incurred during the construction period. Moreover, no structural survey has been made, but in the course of our inspection, we did not note any serious defects. We are not, however, able to report that the properties are free of rot, infestation, or any other structural defects. No test has been carried out to any of the services. No allowance has been made in our valuation for any charges, mortgages or amounts owing on any property or for any expenses or taxation which may be incurred in effecting a sale. Unless otherwise stated, it is assumed that the properties are free from encumbrances, restrictions and outgoings of an onerous nature which could affect their values. Unless otherwise stated, all money amounts are stated in Renminbi. The exchange rates used in calculating the values of the property interests in Groups IV and V into Renminbi, being AUD1=RMB5.849 and Euro1=RMB10.086 and they have no significant fluctuation between the date of valuation and the date of this letter. We enclose herewith a summary of values and valuation certificate. Yours faithfully For and on behalf of CHESTERTON PETTY LIMITED CHARLES C K CHAN Chartered Estate Surveyor MSc FRICS FHKIS MCIArb RPS(GP) Executive Director Note: Charles C K Chan, MSc, FRICS, FHKIS, MCIArb, RPS (GP), has been a qualified valuer with Chesterton since June 1987 and has about 19 years' experience in the valuation of properties in Hong Kong and extensive experience in the valuation of properties in the People's Republic of China and the Asia Pacific regions. - 272 - APPENDIX VIII PROPERTY VALUATION SUMMARY OF VALUES OPEN MARKET CAPITAL VALUE VALUE IN EXISTING ATTRIBUTABLE TO STATE AS AT INTEREST THE GROUP AS AT 31 AUGUST, 2004 ATTRIBUTABLE 31 AUGUST, 2004 PROPERTY RMB TO THE GROUP RMB GROUP I - PROPERTIES TO BE ACQUIRED BY THE COMPANY FROM CSAHC 1. Various properties to be 132,250,000 100% 132,250,000 acquired by the Company from China Northern Airlines Company in Shenyang 2. Various properties to be 138,270,000 100% 138,270,000 acquired by the Company from China Northern Airlines Company in Harbin 3. Various properties to be 39,850,000 100% 39,850,000 acquired by the Company from China Northern Airlines Company in Dalian 4. Various properties to be 47,440,000 100% 47,440,000 acquired by the Company from China Northern Airlines Company in Changchun 5. Various properties to be 5,120,000 100% 5,120,000 acquired by the Company from China Northern Airlines Company in Chaoyang 6. Various properties to be No commercial 51.8% No commercial acquired by the Company value value from Xinjiang Civil Aviation Property Management Ltd in Urumqi 7. Various properties to be 406,370,000 100% 406,370,000 acquired by the Company from Xinjiang Airlines Company in Urumqi ------------- ------------- SUB-TOTAL: 769,300,000 769,300,000 ------------- ------------- - 273 - APPENDIX VIII PROPERTY VALUATION OPEN MARKET CAPITAL VALUE VALUE IN EXISTING ATTRIBUTABLE TO STATE AS AT INTEREST THE GROUP AS AT 31 AUGUST, 2004 ATTRIBUTABLE 31 AUGUST, 2004 PROPERTY RMB TO THE GROUP RMB GROUP II - PROPERTIES UNDER CONSTRUCTION TO BE ACQUIRED BY THE COMPANY FROM CSAHC 8. Various properties to be No commercial 51.8% No commercial acquired by the Company value value from Xinjiang Civil Aviation Property Management Ltd in Urumqi 9. Various properties to be 263,000 100% 263,000 acquired by the Company from Xinjiang Airlines Company in Urumqi ------------- ------------- SUB-TOTAL: 263,000 263,000 ------------- ------------- GROUP III - PROPERTIES TO BE RENTED BY THE COMPANY FROM CSAHC 10. Various properties to be No commercial 100% No commercial rented by the Company value value from CSAHC ------------- ------------- SUB-TOTAL: NIL NIL ------------- ------------- GROUP IV - PROPERTIES HELD BY THE GROUP IN THE PRC 11. Various properties held by 383,290,000 100% 383,290,000 China Southern Airlines Company Limited Guangzhou Headquarters 12. Various properties held by 110,210,000 100% 110,210,000 China Southern Airlines Company Limited in Henan 13. Various properties held by 54,060,000 100% 54,060,000 China Southern Airlines Company Limited in Hubei - 274 - APPENDIX VIII PROPERTY VALUATION OPEN MARKET CAPITAL VALUE VALUE IN EXISTING ATTRIBUTABLE TO STATE AS AT INTEREST THE GROUP AS AT 31 AUGUST, 2004 ATTRIBUTABLE 31 AUGUST, 2004 PROPERTY RMB TO THE GROUP RMB 14. Various properties held by 169,480,000 100% 169,480,000 China Southern Airlines Company Limited in Hunan 15. Various properties held by 74,640,000 100% 74,640,000 China Southern Airlines Company Limited in Shenzhen 16. Various properties held by 48,211,000 100% 48,211,000 China Southern Airlines Company Limited in Hainan 17. Various properties held by 2,110,000 100% 2,110,000 China Southern Airlines (Group) Zhuhai Helicopter Company Limited 18. Various properties held by 126,880,000 60% 76,128,000 Xiamen Airlines Company Limited (Xiamen Airlines) 19. Various properties held by 115,870,000 60% 69,520,000 Southern Airlines (Group) Shantou Airlines Company Limited 20. Various properties held by 24,140,000 60% 14,484,000 Guangxi Airlines Company Limited 21. Various properties held by 67,530,000 60% 40,520,000 Zhuhai Airlines Company Limited 22. Various properties held by No commercial 60% No commercial Guizhou Airlines Company value value Limited 23. Various properties held by No commercial 51% No commercial Guangzhou Nanland Air value value Catering Company Limited - 275 - APPENDIX VIII PROPERTY VALUATION OPEN MARKET CAPITAL VALUE VALUE IN EXISTING ATTRIBUTABLE TO STATE AS AT INTEREST THE GROUP AS AT 31 AUGUST, 2004 ATTRIBUTABLE 31 AUGUST, 2004 PROPERTY RMB TO THE GROUP RMB 24. A property held by 57,670,000 90% 51,900,000 Guangzhou Aviation Hotel 25. Various properties held by 16,030,000 100% 16,030,000 China Southern Airlines Company Limited Operation Department 26. Various properties held by 156,070,000 100% 156,070,000 China Southern Airlines Company Limited Zhuhai Flight Simulator Training Centre ------------- ------------- SUB-TOTAL: 1,406,191,000 1,266,653,000 ------------- ------------- GROUP V - PROPERTIES HELD BY THE GROUP IN WESTERN AUSTRALIA 27. Various properties held by 12,120,000 65% 7,878,000 China Southern West Australian Flying College Pty Ltd. ------------- ------------- SUB-TOTAL: 12,120,000 7,878,000 ------------- ------------- GROUP VI - PROPERTIES HELD BY THE GROUP IN THE NETHERLANDS 28. Five residential units held 13,210,000 100% 13,210,000 by the Company in Amestelveen, Noord-Holland, The Netherlands ------------- ------------- SUB-TOTAL: 13,210,000 13,210,000 ------------- ------------- - 276 - APPENDIX VIII PROPERTY VALUATION OPEN MARKET CAPITAL VALUE VALUE IN EXISTING INTEREST ATTRIBUTABLE TO STATE AS AT ATTRIBUTABLE THE GROUP AS AT PROPERTY 31 AUGUST, 2004 TO THE GROUP 31 AUGUST, 2004 RMB RMB GROUP VII - PROPERTIES HELD UNDER CONSTRUCTION BY THE GROUP IN THE PRC 29. Various properties held 1,559,830,000 100% 1,559,830,000 under construction by China Southern Airlines Company Limited Guangzhou Headquarters 30. Various properties held No commercial 60% No commercial under construction by value value Xiamen Airlines 31. A property held under 4,810,000 60% 2,890,000 construction by Southern Airlines (Group) Shantou Airlines Company Limited 32. A parcel of land held under 7,200,000 60% 4,320,000 construction by Zhuhai Airlines Company Limited 33. Various properties held No commercial 60% No commercial under construction by value value Guizhou Airlines Company Limited 34. Various properties held No commercial 61% No commercial under construction by value value Guangzhou Baiyun International Logistic Company Ltd. ---------------- -------------- SUB-TOTAL: 1,571,840,000 1,567,040,000 ---------------- -------------- -277- APPENDIX VIII PROPERTY VALUATION OPEN MARKET CAPITAL VALUE VALUE IN EXISTING INTEREST ATTRIBUTABLE TO STATE AS AT ATTRIBUTABLE THE GROUP AS AT PROPERTY 31 AUGUST, 2004 TO THE GROUP 31 AUGUST, 2004 RMB RMB GROUP VIII - PROPERTIES RENTED BY THE GROUP 35. Various properties rented by No commercial 100% No commercial China Southern Airlines value value Company Limited Guangzhou Headquarters 36. Various properties rented by No commercial 100% No commercial China Southern Airlines value value Company Limited in Henan 37. Various properties rented by No commercial 100% No commercial China Southern Airlines value value Company Limited in Hubei 38. Various properties rented by No commercial 100% No commercial China Southern Airlines value value Company Limited in Shenzhen 39. Various properties rented by No commercial 100% No commercial China Southern Airlines value value (Group) Zhuhai Helicopter Company Limited 40. Various properties rented by No commercial 60% No commercial Xiamen Airlines value value 41. Various properties rented by No commercial 60% No commercial Southern Airlines (Group) value value Shantou Airlines Company Limited 42. Various properties rented by No commercial 60% No commercial Guangxi Airlines Company value value Limited 43. Various properties rented by No commercial 60% No commercial Zhuhai Airlines Company value value Limited 44. Various properties rented by No commercial 60% No commercial Guizhou Airlines Company value value Limited -278- APPENDIX VIII PROPERTY VALUATION OPEN MARKET CAPITAL VALUE VALUE IN EXISTING INTEREST ATTRIBUTABLE TO STATE AS AT ATTRIBUTABLE THE GROUP AS AT PROPERTY 31 AUGUST, 2004 TO THE GROUP 31 AUGUST, 2004 RMB RMB 45. A property rented by No commercial 90% No commercial Southern Chinab value value International Aviation & Travel Services Company 46. Various properties rented by No commercial 100% No commercial China Southern Airlines value value Company Limited Overseas Offices 47. Various properties rented by No commercial 100% No commercial China Southern Airlines value value Operation Department ------------- ------------- SUB-TOTAL: NIL NIL ------------- ------------- TOTAL: 3,772,924,000 3,624,344,000 ============= ============= -279- APPENDIX VIII PROPERTY VALUATION VALUATION CERTIFICATE GROUP I - PROPERTIES TO BE ACQUIRED BY THE COMPANY FROM CSAHC OPEN MARKET VALUE IN EXISTING STATE AS AT PARTICULARS 31 AUGUST, 2004 PROPERTIES DESCRIPTION AND TENURE OF OCCUPANCY RMB 1. Various properties The property comprises 27 The properties are 132,250,000 to be acquired by various operational and ancillary occupied by China the Company from buildings and various structures Northern Airlines China Northern completed in various stages Company as Airlines Company between 1989 and 2000 with a headquarters purposes. in Shenyang total gross floor area of approximately 80,778.39 sq.m. (869,499 sq.ft.). Details of gross floor areas of the properties are listed as follows: APPROXIMATE USE GROSS FLOOR AREA sq.m. sq.ft. Office 19,757.70 212,672 Warehouses 25,556.30 275,088 Ancillary buildings and structures 35,464.39 381,739 --------- ------- Total: 80,778.39 869,499 ========= ======= The land upon which the properties currently erected comprises 9 parcels of land with a total area of 134,356.36 sq.m. (1,446,212 sq.ft.). The land use rights of the properties are held for a term of 49 years from 26 August, 2004 to 1 January, 2053. Notes: (1) Pursuant to the land use rights leasing agreement entered into between the Company and CSAHC on 12 November, 2004 (the "Lease Agreement") CSAHC agreed to lease 22 parcels of land with a total area of approximately 633,740.93 sq.m. to the Company at an annual rental of RMB10,340,449 for a term of three years with an option to renew for further terms (subsequent annual rents will remain unchanged) where the entire lease term is either not less than the term specified in the corresponding Building Ownership Certificates of the buildings erected on the lands or the corresponding residual useful life of buildings determined in valuations when the Company purchases the buildings, whichever is longer. (2) We have been provided with a copy of the legal opinion on the title to the properties prepared by Z & T Law Firm, the Company's PRC legal adviser, which contains, inter alia, the following information: (i) CSAHC has obtained the authorized land use rights of 9 parcels of land with a total area of approximately 134,356.36 sq.m. (ii) China Northern Airlines has obtained the Building Ownership Certificates for 27 buildings. -280- APPENDIX VIII PROPERTY VALUATION (iii) The Lease Agreement is legally valid. During the lease term, the Company has the right to occupy and use the leased lands; (iv) CSAHC has agreed to bear all liabilities, losses and costs arising from disputes on the land use rights of the leased lands and to indemnify the Company in respect of losses to the buildings and structures erected on the leased lands; (v) CSAHC and China Northern Airlines Company have agreed to indemnify the Company in respect of disputes on the title and the incorrectness to the buildings and structures of the properties; and (vi) The transfer of buildings and structures of the properties to the Company has no legal impediment. After the acquisition, the Company will have the ownership to the buildings and structures of the properties and can use, mortgage, lease and sell the buildings and structures of the properties. However, if the Company sells the buildings and structures of the properties to third parties (other than CSAHC, its subholdings, subsidiaries and associates), the Company shall obtain an approval from relevant State-owned Land Resources Administration Bureaus and pay relevant land grant fees. While the sale, CSAHC has agreed to assist the Company in proceeding the relevant procedures for conversion the lands to granted lands but not to bear any procedural costs. (3) We have assigned no commercial value to the land portions of the properties due to its non-transferability in the open market. According to the Group's PRC legal adviser opinion, the Company will obtain the ownership of the buildings and structures of the property without any legal obstacles. Also, CSAHC has agreed to assist the Company to transfer the properties and process the land grant process. We have, relied on the aforesaid, assigned open market values to the buildings and structures of the properties but excluding the land portion. -281- APPENDIX VIII PROPERTY VALUATION OPEN MARKET VALUE IN EXISTING STATE AS AT PARTICULARS 31 AUGUST, 2004 PROPERTIES DESCRIPTION AND TENURE OF OCCUPANCY RMB 2. Various properties The property comprises 6 various The properties are 138,270,000 to be acquired by operational and ancillary occupied by China the Company from buildings and various structures Northern Airlines China Northern completed in various stages Company for airport Airlines Company between 1989 and 1999 with a services, aircraft in Harbin total gross floor area of maintenance works approximately 36,925.40 sq.m. and offices purposes. (397,465 sq.ft.). Details of gross floor areas of the properties are listed as follows: APPROXIMATE USE GROSS FLOOR AREA --- ---------------- sq.m. sq.ft. Office 27,132.35 292,053 Ancillary buildings and structures 9,793.05 105,412 --------- ------- Total: 36,925.40 397,465 ========= ======= The land upon which the properties currently erected comprises 8 parcels of land with a total area of 289,647.90 sq.m. (3,117,770 sq.ft.). The land use rights of the properties are held for terms of 49 years from 26 August, 2004 to 1 January, 2053 and 39 years expiring on 1 January, 2043. Notes: (1) Pursuant to the land use rights leasing agreement entered into between the Company and CSAHC on 12 November, 2004 (the "Lease Agreement") CSAHC agreed to lease 22 parcels of land with a total area of approximately 633,740.93 sq.m. to the Company at an annual rental of RMB10,340,449 for a term of three years with an option to renew for further terms (subsequent annual rents will remain unchanged) where the entire lease term is either not less than the term specified in the corresponding Building Ownership Certificates of the buildings erected on the lands or the corresponding residual useful life of buildings determined in valuations when the Company purchases the buildings, whichever is longer. (2) We have been provided with a copy of the legal opinion on the title to the properties prepared by Z & T Law Firm, the Company's PRC legal adviser, which contains, inter alia, the following information: (i) CSAHC has obtained the authorized land use rights of 8 parcels of land with a total area of approximately 289,647.90 sq.m. (ii) China Northern Airlines has obtained the Building Ownership Certificates for 6 buildings. (iii) The Lease Agreement is legally valid. During the lease term, the Company has the right to occupy and use the leased lands; -282- APPENDIX VIII PROPERTY VALUATION (iv) CSAHC has agreed to bear all liabilities, losses and costs arising from disputes on the land use rights of the leased lands and to indemnify the Company in respect of losses to the buildings and structures erected on the leased lands; (v) CSAHC and China Northern Airlines Company have agreed to indemnify the Company in respect of disputes on the title and the incorrectness to the buildings and structures of the properties; and (vi) The transfer of buildings and structures of the properties to the Company has no legal impediment. After the acquisition, the Company will have the ownership to the buildings and structures of the properties and can use, mortgage, lease and sell the buildings and structures of the properties. However, if the Company sells the buildings and structures of the properties to third parties (other than CSAHC, its subholdings, subsidiaries and associates), the Company shall obtain an approval from relevant State-owned Land Resources Administration Bureaus and pay relevant land grant fees. While the sale, CSAHC has agreed to assist the Company in proceeding the relevant procedures for conversion the lands to granted lands but not to bear any procedural costs. (3) We have assigned no commercial value to the land portions of the properties due to its non-transferability in the open market. According to the Group's PRC legal adviser opinion, the Company will obtain the ownership of the buildings and structures of the property without any legal obstacles. Also, CSAHC has agreed to assist the Company to transfer the properties and process the land grant process. We have, relied on the aforesaid, assigned open market values to the buildings and structures of the properties but excluding the land portion. -283- APPENDIX VIII PROPERTY VALUATION OPEN MARKET VALUE IN EXISTING STATE AS AT PARTICULARS 31 AUGUST, 2004 PROPERTIES DESCRIPTION AND TENURE OF OCCUPANCY RMB 3. Various properties The property comprises 2 various The properties are 39,850,000 to be acquired by operational and ancillary occupied by China the Company from buildings and various structures Northern Airlines China Northern completed in various stages Company for office Airlines Company between 1995 and 1997 with a and guest house in Dalian total gross floor area of purposes. approximately 16,488.34 sq.m. (177,480 sq.ft.). Details of gross floor areas of the properties are listed as follows: APPROXIMATE USE GROSS FLOOR AREA sq.m. sq.ft. Office 16,488.34 177,480 --------- ------- Total: 16,488.34 177,480 ========= ======= The land upon which the properties currently erected comprises 1 parcels of land with a total area of 14403.40 sq.m. (155,038 sq.ft.). The land use rights of the properties are held for a term of 39 years commencing 26 August, 2004. Notes: (1) Pursuant to the land use rights leasing agreement entered into between the Company and CSAHC on 12 November, 2004 (the "Lease Agreement") CSAHC agreed to lease 22 parcels of land with a total area of approximately 633,740.93 sq.m. to the Company at an annual rental of RMB10,340,449 for a term of three years with an option to renew for further terms (subsequent annual rents will remain unchanged) where the entire lease term is either not less than the term specified in the corresponding Building Ownership Certificates of the buildings erected on the lands or the corresponding residual useful life of buildings determined in valuations when the Company purchases the buildings, whichever is longer. (2) We have been provided with a copy of the legal opinion on the title to the properties prepared by Z & T Law Firm, the Company's PRC legal adviser, which contains, inter alia, the following information: (i) CSAHC has obtained the authorized land use rights of 1 parcel of land with a total area of approximately 14,403.40 sq.m. (ii) China Northern Airlines has obtained the Building Ownership Certificates for 2 buildings. (iii) The Lease Agreement is legally valid. During the lease term, the Company has the right to occupy and use the leased lands; (iv) CSAHC has agreed to bear all liabilities, losses and costs arising from disputes on the land use rights of the leased lands and to indemnify the Company in respect of losses to the buildings and structures erected on the leased lands; -284- APPENDIX VIII PROPERTY VALUATION (v) CSAHC and China Northern Airlines Company have agreed to indemnify the Company in respect of disputes on the title and the incorrectness to the buildings and structures of the properties; and (vi) The transfer of buildings and structures of the properties to the Company has no legal impediment. After the acquisition, the Company will have the ownership to the buildings and structures of the properties and can use, mortgage, lease and sell the buildings and structures of the properties. However, if the Company sells the buildings and structures of the properties to third parties (other than CSAHC, its subholdings, subsidiaries and associates), the Company shall obtain an approval from relevant State-owned Land Resources Administration Bureaus and pay relevant land grant fees. While the sale, CSAHC has agreed to assist the Company in proceeding the relevant procedures for conversion the lands to granted lands but not to bear any procedural costs. (3) We have assigned no commercial value to the land portions of the properties due to its non-transferability in the open market. According to the Group's PRC legal adviser opinion, the Company will obtain the ownership of the buildings and structures of the property without any legal obstacles. Also, CSAHC has agreed to assist the Company to transfer the properties and process the land grant process. We have, relied on the aforesaid, assigned open market values to the buildings and structures of the properties but excluding the land portion. -285- APPENDIX VIII PROPERTY VALUATION OPEN MARKET VALUE PARTICULARS IN EXISTING STATE AS PROPERTIES DESCRIPTION AND TENURE OF OCCUPANCY AT 31 AUGUST, 2004 RMB 4. Various properties to be The property comprises 16 various The properties are occupied by 47,440,000 acquired by the Company from operational and ancillary buildings and China Northern Airlines Company China Northern Airlines various structures completed in various for offices, and warehouses Company in Changchun stages between 1975 and 2002 with a purposes. total gross floor area of approximately 33,656.96 sq.m. (362,284 sq.ft.). Details of gross floor areas of the properties are listed as follows: APPROXIMATE USE GROSS FLOOR AREA --- ---------------- sq.m. sq.ft. Office 21,145.94 227,615 Warehouses 7,359.41 79,217 Ancillary buildings and structures 5,151.61 55,452 --------- ------- Total: 33,656.96 362,284 ========= ======= The land upon which the properties currently erected comprises 3 parcels of land with a total area of 160,106.30 sq.m. (1,723,384 sq.ft.). The land use rights of the properties are held for terms of 49 years from 26 August, 2004 to 1 January, 2053 and 37 years expiring on 1 January, 2053. Notes: (1) Pursuant to the land use rights leasing agreement entered into the Company and CSAHC on 12 November, 2004 (the "Lease Agreement") CSAHC agreed to lease 22 parcels of land with a total area of approximately 633,740.93 sq.m. to the Company at an annual rental of RMB10,340,449 for a term of three years with an option to renew for further terms (subsequent annual rents will remain unchanged) where the entire lease term is either not less than the term specified in the corresponding Building Ownership Certificates of the buildings erected on the lands or the corresponding residual useful life of buildings determined in valuations when the Company purchases the buildings, whichever is longer. (2) We have been provided with a copy of the legal opinion on the title to the properties prepared by Z & T Law Firm, the Company's PRC legal adviser, which contains, inter alia, the following information: (i) CSAHC has obtained the granted or authorized land use rights of 3 parcels of land with a total area of approximately 160,160.30 sq.m. (ii) China Northern Airlines has obtained the Building Ownership Certificates for 16 buildings. (iii) The Lease Agreement is legally valid. During the lease term, the Company has the right to occupy and use the leased lands; - 286 - APPENDIX VIII PROPERTY VALUATION (iv) CSAHC has agreed to bear all liabilities, losses and costs arising from disputes on the land use rights of the leased lands and to indemnify the Company in respect of losses to the buildings and structures erected on the leased lands; (v) CSAHC and China Northern Airlines Company have agreed to indemnify the Company in respect of disputes on the title and the incorrectness to the buildings and structures of the properties; and (vi) The transfer of buildings and structures of the properties to the Company has no legal impediment. After the acquisition, the Company will have the ownership to the buildings and structures of the properties and can use, mortgage, lease and sell the buildings and structures of the properties. However, if the Company sells the buildings and structures of the properties to third parties (other than CSAHC, its subholdings, subsidiaries and associates), the Company shall obtain an approval from relevant State-owned Land Resources Administration Bureaus and pay relevant land grant fees. While the sale, CSAHC has agreed to assist the Company in proceeding the relevant procedures for conversion the lands to granted lands but not to bear any procedural costs. (3) We have assigned no commercial value to the land portions of the properties due to its non-transferability in the open market. According to the Group's PRC legal adviser opinion, the Company will obtain the ownership of the buildings and structures of the property without any legal obstacles. Also, CSAHC has agreed to assist the Company to transfer the properties and process the land grant process. We have, relied on the aforesaid, assigned open market values to the buildings and structures of the properties but excluding the land portion. - 287 - APPENDIX VIII PROPERTY VALUATION OPEN MARKET VALUE PARTICULARS IN EXISTING STATE AS PROPERTIES DESCRIPTION AND TENURE OF OCCUPANCY AT 31 AUGUST, 2004 RMB 5. Various properties to be The property comprises 9 various The properties are occupied by 5,120,000 acquired by the Company from operational and ancillary buildings China Northern Airlines Company China Northern Airlines and various structures completed in for office and training Company in Chaoyang various stages between 1966 and purposes. 1992 with a total gross floor area of approximately 7,831.45 sq.m. (84,298 sq.ft.). Details of gross floor areas of the properties are listed as follows: APPROXIMATE USE GROSS FLOOR AREA --- ---------------- sq.m. sq.ft. Office 4,046.99 43,562 Ancillary buildings and structures 3,784.46 40,736 -------- ------ Total: 7,831.45 84,298 ======== ====== The land upon which the properties currently erected comprises 1 parcel of land with a total area of 31,226.67 sq.m. (336,123.88 sq.ft.). The land use rights of the properties are held for a term of 49 years from 26 August, 2004 to 1 January, 2053. Notes: (1) Pursuant to the land use rights leasing agreement entered into the Company and CSAHC on 12 November, 2004 (the "Lease Agreement") CSAHC agreed to lease 22 parcels of land with a total area of approximately 633,740.93 sq.m. to the Company at an annual rental of RMB10,340,449 for a term of three years with an option to renew for further terms (subsequent annual rents will remain unchanged) where the entire lease term is either not less than the term specified in the corresponding Building Ownership Certificates of the buildings erected on the lands or the corresponding residual useful life of buildings determined in valuations when the Company purchases the buildings, whichever is longer. (2) We have been provided with a copy of the legal opinion on the title to the properties prepared by Z & T Law Firm, the Company's PRC legal adviser, which contains, inter alia, the following information: (i) CSAHC has obtained the authorized land use rights of 1 parcel of land with a total area of approximately 31,226.67 sq.m. (ii) China Northern Airlines has obtained the Building Ownership Certificates for 9 buildings. (iii) The Lease Agreement is legally valid. During the lease term, the Company has the right to occupy and use the leased lands; (iv) CSAHC has agreed to bear all liabilities, losses and costs arising from disputes on the land use rights of the leased lands and to indemnify the Company in respect of losses to the buildings and structures erected on the leased lands; - 288 - APPENDIX VIII PROPERTY VALUATION (v) CSAHC and China Northern Airlines Company have agreed to indemnify the Company in respect of disputes on the title and the incorrectness to the buildings and structures of the properties; and (vi) The transfer of buildings and structures of the properties to the Company has no legal impediment. After the acquisition, the Company will have the ownership to the buildings and structures of the properties and can use, mortgage, lease and sell the buildings and structures of the properties. However, if the Company sells the buildings and structures of the properties to third parties (other than CSAHC, its subholdings, subsidiaries and associates), the Company shall obtain an approval from relevant State-owned Land Resources Administration Bureaus and pay relevant land grant fees. While the sale, CSAHC has agreed to assist the Company in proceeding the relevant procedures for conversion the lands to granted lands but not to bear any procedural costs. (3) We have assigned no commercial value to the land portions of the properties due to its non-transferability in the open market. According to the Group's PRC legal adviser opinion, the Company will obtain the ownership of the buildings and structures of the property without any legal obstacles. Also, CSAHC has agreed to assist the Company to transfer the properties and process the land grant process. We have, relied on the aforesaid, assigned open market values to the buildings and structures of the properties but excluding the land portion. - 289 - APPENDIX VIII PROPERTY VALUATION OPEN MARKET VALUE PARTICULARS IN EXISTING STATE AS PROPERTIES DESCRIPTION AND TENURE OF OCCUPANCY AT 31 AUGUST, 2004 RMB 6. Various properties to be The property comprises 59 various The properties are occupied by No commercial value acquired by the Company from operational and ancillary buildings Xinjiang Civil Aviation Property (please see note 1) Xinjiang Civil Aviation and various structures completed in Management Ltd for offices, Property Management Ltd in various stages between 1975 and carparks and warehouses purposes. Urumqi 2004 with a total gross floor area of approximately 65,424.44 sq.m. (704,229 sq.ft.). Details of gross floor areas of the properties are listed as follows: APPROXIMATE USE GROSS FLOOR AREA --- ---------------- sq.m. sq.ft. Office 4,289.67 46,174 Warehouses 10,387.28 111,809 Ancillary buildings and structures 50,747.49 546,246 --------- ------- Total: 65,424.44 704,229 ========= ======= The land upon which the properties currently erected comprises 18 parcels of land with a total area of 310,059.85 sq.m. (3,337,484 sq.ft.). The land use rights of the properties are allocated to Xinjiang Civil Aviation Property Management Ltd. Notes: (1) According to the information provided, the land portions of the properties are allocated which are non-transferable in the open market. We have thus attributed no commercial value to the properties due to its non-transferability in the open market. However, further to your specific term of instructions, we have calculated the depreciated replacement cost of the properties for indication purposes. The depreciated replacement costs of the buildings and structures with a total gross floor area of approximately 65,424.44 sq.m. is RMB150,960,000 as at the date of valuation. (2) We have been provided with a copy of the legal opinion on the title to the properties prepared by Z & T Law Firm, the Company's PRC legal adviser, which contains, inter alia, the following information: (i) The land use rights of the 18 parcels of land with a total area of 310,059.85 sq.m. is allocated to Xinjiang Civil Aviation Property Management Ltd; and (ii) Xinjiang Civil Aviation Property Management Ltd obtained the ownership of the 59 buildings and structures of the properties. (3) In the course of our valuation, we have assigned no commercial value to the properties due to its non-transferability in the market. - 290 - APPENDIX VIII PROPERTY VALUATION OPEN MARKET VALUE PARTICULARS IN EXISTING STATE AS PROPERTIES DESCRIPTION AND TENURE OF OCCUPANCY AT 31 AUGUST, 2004 RMB 7. Various properties to be The property comprises 60 various The properties are occupied by 406,370,000 acquired by the Company from operational and ancillary buildings Xinjiang Airlines Company for Xinjiang Airlines Company in and various structures completed in offices, training centre, Urumqi various stages between 1975 and carparks and warehouses 2004 with a total gross floor area purposes. of approximately 116,292.37 sq.m. (1,251,771 sq.ft.). Details of gross floor areas of the properties are listed as follows: APPROXIMATE USE GROSS FLOOR AREA --- ---------------- sq.m. sq.ft. Office 100,167.71 1,078,205 Warehouses 6,577.96 70,805 Ancillary buildings and structures 9,546.70 102,761 ---------- --------- Total: 116,292.37 1,251,771 ========== ========= The land upon which the properties currently erected comprises 13 parcels of land with a total area of 548,556.07 sq.m. (5,904,658 sq.ft.). The land use rights of the properties is held for a term of 49 years from 26 August, 2004 to 1 January, 2053. Notes: (1) Pursuant to the land use rights leasing agreement entered into the Company and CSAHC on 12 November, 2004 (the "Lease Agreement") CSAHC agreed to lease 22 parcels of land with a total area of approximately 633,740.93 sq.m. to the Company at an annual rental of RMB10,340,449 for a term of three years with an option to renew for further terms (subsequent annual rents will remain unchanged) where the entire lease term is either not less than the term specified in the corresponding Building Ownership Certificates of the buildings erected on the lands or the corresponding residual useful life of buildings determined in valuations when the Company purchases the buildings, whichever is longer. (2) We have been provided with a copy of the legal opinion on the title to the properties prepared by Z & T Law Firm, the Company's PRC legal adviser, which contains, inter alia, the following information: (i) The Lease Agreement is legally valid. During the lease term, the Company has the right to occupy and use the leased lands; (ii) CSAHC has agreed to bear all liabilities, losses and costs arising from disputes on the land use rights of the leased lands and to indemnify the Company in respect of losses to the buildings and structures erected on the leased lands; (iii) CSAHC and Xinjiang Airlines Company have agreed to indemnify the Company in respect of disputes on the title and the incorrectness to the buildings and structures of the properties; and - 291 - APPENDIX VIII PROPERTY VALUATION (iv) The transfer of buildings and structures of the properties to the Company has no legal impediment. After the acquisition, the Company will have the ownership to the buildings and structures of the properties and can use, mortgage, lease and sell the buildings and structures of the properties. However, if the Company sells the buildings and structures of the properties to third parties (other than CSAHC, its subholdings, subsidiaries and associates), the Company shall obtain an approval from relevant State-owned Land Resources Administration Bureaus and pay relevant land grant fees. While the sale, CSAHC has agreed to assist the Company in proceeding the relevant procedures for conversion the lands to granted lands but not to bear any procedural costs. (3) We have assigned no commercial value to the land portions of the properties due to its non-transferability in the open market. According to the Group's PRC legal adviser opinion, the Company will obtain the ownership of the buildings and structures of the property without any legal obstacles. Also, CSAHC has agreed to assist the Company to transfer the properties and process the land grant process. We have, relied on the aforesaid, assigned open market values to the buildings and structures of the properties but excluding the land portion. - 292 - APPENDIX VIII PROPERTY VALUATION GROUP II - PROPERTIES UNDER CONSTRUCTION TO BE ACQUIRED BY THE COMPANY FROM CSAHC OPEN MARKET VALUE PARTICULARS IN EXISTING STATE AS PROPERTIES DESCRIPTION AND TENURE OF OCCUPANCY AT 31 AUGUST, 2004 RMB 8. Various properties to be The property comprises 3 ancillary The properties are under No commercial value acquired by the Company from buildings and various structures construction. (please see note 1) Xinjiang Civil Aviation scheduled to be completed in late 2004. Property Management Ltd in Upon completion, the total gross floor Urumqi area of the properties will be approximately 193,809.28 sq.m. (2,086,163 sq.ft.). Details of gross floor areas of the properties are listed as follows: APPROXIMATE USE GROSS FLOOR AREA --- ---------------- sq.m. sq.ft. Office 7,652.90 82,375 Warehouses 186,156.38 2,003,787 ---------- --------- Total: 193,809.28 2,086,163 ========== ========= The land upon which the properties currently erected comprises 2 parcels of land with a total area of approximately 134,163.90 sq.m. (1,444,140 sq.ft.). The land use rights of the properties are allocated to Xinjiang Airlines Property. Notes: (1) According to the information provided, the land portions of the properties are allocated which are non-transferable in the open market. We have thus attributed no commercial value to the properties due to its non-transferability in the open market. However, further to your specific term of instructions, we have calculated the depreciated replacement cost of the properties for indication purposes. The depreciated replacement costs of the buildings and structures with a total gross floor area of approximately 65,424.44 sq.m. is RMB40,850,000 as at the date of valuation. (2) We have been provided with a copy of the legal opinion on the title to the properties prepared by Z & T Law Firm, the Company's PRC legal adviser, which contains, inter alia, the following information: (i) The land use rights of the 2 parcels of land with a total area of 134,163.90 sq.m. is allocated to Xinjiang Civil Aviation Property Management Ltd; and (ii) The buildings with a total gross floor area of 193,909.28 sq.m. is under construction. Application for Building Ownership Certificates is incapable to conduct at this moment. (3) In the course of our valuation, we have assigned no commercial value to the properties due to its non-transferability in the market. - 293 - APPENDIX VIII PROPERTY VALUATION OPEN MARKET VALUE PARTICULARS IN EXISTING STATE AS PROPERTIES DESCRIPTION AND TENURE OF OCCUPANCY AT 31 AUGUST, 2004 RMB 9. Various properties to be The property comprises an ancillary The property is under 263,000 acquired by the Company from structure scheduled to be completed in construction. Xinjiang Airlines Company in late 2004 with a total gross floor area Urumqi of approximately 780 sq.m. (8,396 sq.ft.). The land upon which the properties currently erected on comprises a parcel of land with a total area of 72,534.82 sq.m. (780,765 sq.ft.). The land use rights of the property is held for a term of 49 years from 26 August, 2004 to 1 January, 2053. Notes: (1) We have been provided with a copy of the legal opinion on the title to the properties prepared by Z & T Law Firm, the Company's PRC legal adviser, which contains, inter alia, the following information: (i) The Lease Agreement is legally valid. During the lease term, the Company has the right to occupy and use the leased lands; (ii) CSAHC has agreed to bear all liabilities, losses and costs arising from disputes on the land use rights of the leased lands and to indemnify the Company in respect of losses to the buildings and structures erected on the leased lands; (iii) CSAHC and Xinjiang Airlines Company have agreed to indemnify the Company in respect of disputes on the title and the incorrectness to the buildings and structures of the properties; and (iv) The transfer of buildings and structures of the properties to the Company has no legal impediment. After the acquisition, the Company will have the ownership to the buildings and structures of the properties and can use, mortgage, lease and sell the buildings and structures of the properties. However, if the Company sells the buildings and structures of the properties to third parties (other than CSAHC, its subholdings, subsidiaries and associates), the Company shall obtain an approval from relevant State-owned Land Resources Administration Bureaus and pay relevant land grant fees. While the sale, CSAHC has agreed to assist the Company in proceeding the relevant procedures for conversion the lands to granted lands but not to bear any procedural costs. (2) We have assigned no commercial value to the land portions of the properties due to its non-transferability in the open market. According to the Group's PRC legal adviser opinion, the Company will obtain the ownership of the buildings and structures of the property without any legal obstacles. Also, CSAHC has agreed to assist the Company to transfer the properties and process the land grant process. We have, relied on the aforesaid, assigned open market values to the buildings and structures of the properties but excluding the land portion. - 294 - APPENDIX VIII PROPERTY VALUATION GROUP III - PROPERTY INTERESTS TO BE RENTED BY THE COMPANY FROM CSAHC OPEN MARKET VALUE PARTICULARS IN EXISTING STATE AS PROPERTIES DESCRIPTION AND TENURE OF OCCUPANCY AT 31 AUGUST, 2004 RMB 10. Various properties to be The properties comprise 35 parcels of The properties are currently No commercial value rented by the Company from land with a total area of approximately occupied by China Northern CSAHC 1,182,297.00 sq.m. (12,726,245 sq.ft.), Airlines Company for office, together with 186 various operational warehouse, carparks, ancillary and ancillary buildings and various buildings and staff quarters for structures completed in various stages operating and ancillary purposes. between 1964 and 2000 with a total gross floor area of approximately 220,152.51 sq.m. (2,369,722 sq.ft.). Details of the gross floor areas of the properties are listed as follows: APPROXIMATE USE GROSS FLOOR AREA --- ---------------- sq.m. sq.ft. Offices 103,850.04 1,117,842 Warehouses 37,195.81 400,376 Ancillary buildings 79,106.66 851,504 ---------- --------- Total: 220,152.51 2,369,722 ========== ========= The buildings and structures will be leased by the Company from CSAHC, China Northern Airlines Company Limited and Xinjiang Airlines Company under 2 lease agreements for a term of 3 years at an aggregate annual rental of RMB47,791,227.05. The land use rights of the properties will be leased to the Company from CSAHC at an aggregate annual rental of approximately RMB1,850,000 (please see note (3) for details). Notes: (1) Pursuant to the premises leasing agreement entered into between CSAHC and China Northern Airlines Company and the Company on 12 November, 2004 ("Lease Agreement 1"), 156 buildings and various structures will be rented by Company for a term of 3 years commencing from the effective date of this agreement at an annual rental of RMB41,993,318.44. (2) Pursuant to the premises leasing agreement entered into between CSAHC and Xinjiang Airlines Company and the Company on 12 November, 2004 ("Lease Agreement 2"), 30 buildings and various structures will be rented by Company for a term of 3 years commencing from the effective date of this agreement at an annual rental of RMB5,797,908.61. - 295 - APPENDIX VIII PROPERTY VALUATION (3) Pursuant to a land lease agreement entered into between CSAHC and the Company dated ("Lease Agreement 3"), 35 parcels of land with a total area of approximately 1,182,297.00 sq.m. will be rented to the Company at an aggregate annual rental of RMB1,850,000 for a term of three years with an option to renew for further terms (subsequent annual rents will remain unchanged) where the entire lease term is either not less than the term specified in the corresponding Building Ownership Certificates of the buildings erected on the lands or the corresponding residual useful life of buildings determined in valuations when the Company purchases the buildings, whichever is longer. (4) We have been provided with a legal opinion on the legality of the lease agreements prepared by Z & T Law Firm, the Company's PRC legal adviser, which contains, inter alia, the following information: (i) The Lease Agreement is legally valid. During the lease term, the Company has the right to occupy and use the leased lands; (ii) CSAHC has agreed to bear all liabilities, losses and costs arising from disputes on the land use rights of the leased lands to indemnify the Company in respect of losses to the buildings and structures erected on the leased lands; (iii) CSAHC and China Northern Airlines Company have agreed to indemnify the Company in respect of disputes on the title and the incorrectness to the buildings and structures of the properties; and (iv) The transfer of buildings and structures of the properties to the Company has no legal impediment. After the acquisition, the Company will have the ownership to the buildings and structures of the properties and can use, mortgage, lease and sell the buildings and structures of the properties. However, if the Company sells the buildings and structures of the properties to third parties (other than CSAHC, its subholdings, subsidiaries and associates), the Company shall obtain an approval from relevant State-owned Land Resources Administration Bureaus and pay relevant land grant fees. With the sale, CSAHC has agreed to assist the Company in proceeding the relevant procedures for conversion of the lands to granted lands but not to bear any procedural costs. - 296 - APPENDIX VIII PROPERTY VALUATION GROUP IV - PROPERTY INTERESTS HELD BY THE GROUP IN THE PRC OPEN MARKET VALUE PARTICULARS OF IN EXISTING STATE AS PROPERTIES DESCRIPTION AND TENURE OCCUPANCY AT 31 AUGUST, 2004 RMB 11. Various properties held by The properties comprise 50 various The property is occupied by the 383,290,000 China Southern Airlines operational and ancillary buildings and Group as offices, warehouses and (100% interest Company Limited Guangzhou various structures completed in various staff quarters for operating and attributable to the Headquarters stages between 1957 and 2003 with a ancillary purposes. Group: 383,290,000) total gross floor area of approximately 158,202.26 sq.m. (1,702,889 sq.ft.). Details of the gross floor areas of the properties are listed as follows: APPROXIMATE USE GROSS FLOOR AREA --- ---------------- sq.m. sq.ft. Offices 97,476.24 1,049,234 Warehouses 15,303.09 164,722 Ancillary buildings 45,422.93 488,932 ---------- --------- Total: 158,202.26 1,702,889 ========== ========= The lands upon which the properties currently erected comprise 3 parcels of land with a total area of approximately 1,659,136.21 sq.m. (17,858,942 sq.ft.). Notes: (1) We have been provided with a copy of the legal opinion on the title to the properties prepared by Z & T Law Firm, the Company's PRC legal adviser, which contains, inter alia, the following information: (i) Pursuant to an approval for construction land, the land of approximately 676 sq.m. is vested in CSAHC. However, there is a dispute on the land use right of the land so that the Group cannot obtain the relevant land use right certificate and transfer the land. Nevertheless, the Group can use the land in its existing state. In addition, the building with gross floor area of approximately 7,606 sq.m. erected on the aforesaid land also cannot be transferred due to the land dispute, but the Group can use the building; (ii) In respect of a parcel of granted land of approximately 248,461.62 sq.m., the Group has signed the relevant land use right grant contract but has not yet fully paid the land grant fee and thus has not obtained the land use right certificate; - 297 - APPENDIX VIII PROPERTY VALUATION (iii) The Group has legal rights to the buildings of the properties and has no legal impediment in obtaining the relevant title documents. The Group has the ownership to the buildings and can use, mortgage, lease and sell the buildings. However, if the Group sells the buildings of the properties to third parties (other than CSAHC and its subsidiaries, associated companies and shareholding companies), the Group shall obtain an approval from relevant State-owned Land Administration Bureaus and pay relevant land grant fees. (iv) The total land area of Bai Yun Airport is approximately 14,394,652.27 sq.m., which is an allocated land, and a portion which is occupied by the Group. When the Group transfers the portion of the land, the Group needs to obtain an approval from State-owned Land Administration Bureau and to pay a land grant fee. (2) In the course of our valuation, we have assumed that the granted land can be transferable in the market. In respect of the land of approximately 676 sq.m. and the corresponding building erected thereon with gross floor area of approximately 7,606 sq.m. where there is land dispute, and a portion of the allocated land with site area of approximately 1,409,988.59 sq.m., as advised by the Group, we have assigned no commercial value to the lands and the building. - 298 - APPENDIX VIII PROPERTY VALUATION OPEN MARKET VALUE PARTICULARS OF IN EXISTING STATE AS PROPERTIES DESCRIPTION AND TENURE OCCUPANCY AT 31 AUGUST, 2004 RMB 12. Various properties held The properties comprise 20 various The properties are occupied by 110,210,000 (100% by China Southern operational and ancillary buildings and the Group as offices and staff interest Airlines Company various structures completed in various quarters for operating and attributable to the Limited in Henan stages between 1997 and 2002 with a ancillary purposes. Group: 110,210,000) total gross floor area of approximately 36,805 sq.m. (396,166 sq.ft.). Details of the gross floor areas of the properties are listed as follows: APPROXIMATE USE GROSS FLOOR AREA --- ---------------- sq.m. sq.ft. Offices 19,783.35 212,948 Ancillary buildings 17,021.35 183,218 --------- ------- Total: 36,804.70 396,166 ========= ======= The lands upon which the properties currently erected comprise 4 parcels of land with a total area of approximately 295,661.32 sq.m. (3,182,498 sq.ft.). The land use rights of the properties have been granted for 50 years (except the allocated land). Notes: (1) According to 4 Land Use Rights Certificates and 20 Building Ownership Certificates, the land use rights of 4 parcels of land with a total area of approximately 295,661.32 sq.m. and the building ownership rights of 20 buildings with a total gross floor area of approximately 36,804.70 sq.m. are held by China Southern Airlines Company Limited Henan Branch, which is 100% owned by the Group. (2) We have been provided with a copy of the legal opinion on the title to the properties prepared by Z & T Law Firm, the Company's PRC legal adviser, which contains, inter alia, the following information: (i) The Group has obtained three Land Use Right Certificates for the three granted lands with a total area of approximately 289,909.65 sq.m. and the Group has owned the land use rights and has the rights to use, lease, mortgage and transfer the lands; (ii) The Group has obtained a Land Use Right Certificate for the allocated land with an area of approximately 5,751.67 sq.m.. The Group has owned the land use rights and has the rights to use, mortgage and sell the land. While the land is transferred, the Group shall obtain an approval from the relevant State-owned Land Administration Bureaus and pay relevant land grant fees; and -299- APPENDIX VIII PROPERTY VALUATION (iii) The Group has obtained 16 Building Ownership Certificates for 16 buildings of the properties and has legally acquired 4 buildings of the properties where the Group needs to apply for change of ownership of the buildings. The Group has the ownership to all the buildings and can use, mortgage, lease and sell the buildings. (3) In the course of our valuation, since the allocated land cannot be freely transferable in the market, we have assigned no commercial value to the land. -300- APPENDIX VIII PROPERTY VALUATION OPEN MARKET VALUE PARTICULARS OF IN EXISTING STATE AS PROPERTIES DESCRIPTION AND TENURE OCCUPANCY AT 31 AUGUST, 2004 RMB 13. Various properties held The properties comprise 6 various The properties are occupied by 54,060,0000 (100% by China Southern operational and ancillary buildings and the Group as offices and staff interest Airlines Company various structures completed in various quarters for operating and attributable to the Limited in Hubei stages between 1994 and 1999 with a ancillary purposes. Group: 54,060,000) total gross floor area of approximately 55,065.33 sq.m. (592,723 sq.ft.). Details of the gross floor areas of the properties are listed as follows: APPROXIMATE USE GROSS FLOOR AREA --- ---------------- sq.m. sq.ft. Offices 44,178.39 475,536 Ancillary buildings 10,886.94 117,187 --------- ------- Total: 55,065.33 592,723 ========= ======= The lands upon which the properties currently erected comprise 7 parcels of land with a total area of approximately 119,320.47 sq.m. (1,284,366 sq.ft.) (excluding the site with uncertain area). The land use rights of the properties have been granted for various terms ranging from 42 to 50 years. Notes: (1) According to 3 Land Use Rights Certificates and 3 Building Ownership Certificates, the land use rights of 3 parcels of land with a total area of approximately 14,884.97 sq.m. and the building ownership rights of 2 buildings with a total gross floor area of approximately 28,693.09 sq.m. are held by China Southern Airlines Company Limited Hubei Branch, which is 100% owned by the Group. (2) We have been provided with a copy of the legal opinion on the title to the properties prepared by Z & T Law Firm, the Company's PRC legal adviser, which contains, inter alia, the following information: (i) The Group has obtained three Land Use Right Certificates for the three granted lands with a total area of approximately 14,884.97 sq.m. and the Group has owned the land use rights and has the rights to use, lease, mortgage and transfer the lands; (ii) The Group has obtained three Land Use Right Certificates for the three allocated lands with a total area of approximately 104,435.50 sq.m.. The Group has owned the land use rights and has the rights to use, mortgage and sell the lands. While the lands are transferred, the Group shall obtain an approval from the relevant State-owned Land Administration Bureaus and pay relevant land grant fees; (iii) A parcel of land with undetermined site area has not been obtained the relevant Land Use Right Certificate; -301- APPENDIX VIII PROPERTY VALUATION (iv) The Group has obtained 3 title documents for 3 buildings of the properties with a total gross floor area of approximately 44,178.39 sq.m.. Since one of the buildings of approximately 15,485.30 sq.m. is erected on the allocated land, a land grant fee shall be paid while transfer. The remaining two buildings can be leased, mortgaged and transferred; and (v) There are two buildings with a total gross floor area of approximately 5,486.94 sq.m. not yet obtained the relevant title documents. (3) In the course of our valuation, since the allocated lands and the corresponding buildings erected thereon as well as the buildings and the parcel of land having no title documents cannot be freely transferable in the market, we have assigned no commercial value to them. -302- APPENDIX VIII PROPERTY VALUATION OPEN MARKET VALUE PARTICULARS OF IN EXISTING STATE AS PROPERTIES DESCRIPTION AND TENURE OCCUPANCY AT 31 AUGUST, 2004 RMB 14. Various properties held The properties comprise 35 various The property is occupied by the 169,480,000 (100% by China Southern operational and ancillary buildings and Group as office and warehouse interest Airlines Company various structures completed in various for operating purposes. attributable to the Limited Hunan Branch stages between 1989 and 2002 with a Group: 169,480,000) total gross floor area of approximately 69,057.36 sq.m. (743,333 sq.ft.). Details of the gross floor areas of the properties are listed as follows: APPROXIMATE USE GROSS FLOOR AREA sq.m. sq.ft. Offices 26,861.53 289,138 Warehouses 9,444.89 101,665 Ancillary buildings 32,750.94 352,531 --------- ------- Total: 69,057.36 743,333 ========= ======= The land upon which the properties currently erected comprise 8 parcels of land with a total area of approximately 174,138.34 sq.m. (1,874,425 sq.ft.) (excluding the site with uncertain area). The land use rights of the properties have been granted for various terms ranging from 38 to 61 years. Notes: (1) According to 7 Land Use Rights Certificates and 36 Building Ownership Certificates, the land use rights of 7 parcels of land with a total area of approximately 174,138.34 sq.m. and the building ownership rights of 35 buildings with a total gross floor area of approximately 51,391.62 sq.m. are held by China Southern Airlines Company Limited Hunan Branch, which is 100% owned by the Group. (2) We have been provided with a copy of the legal opinion on the title to the properties prepared by Z & T Law Firm, the Company's PRC legal adviser, which contains, inter alia, the following information: (i) The Group has obtained 7 Land Use Right Certificates for the 7 granted lands with a total area of approximately 174,138.34 sq.m. and the Group has owned the land use rights and has the rights to use, lease, mortgage and transfer the lands; (ii) A parcel of land with undetermined site area has not been obtained the relevant Land Use Right Certificate for which the Group is applying; -303- APPENDIX VIII PROPERTY VALUATION (iii) The Group has possessed proper title to the buildings of the properties with a total gross floor area of approximately 51,391.62 sq.m., which can be used, leased, mortgaged and transferred by the Group. (3) In the course of our valuation, since the parcel of land with undetermined site area and the buildings with total gross floor area of approximately 18,116.48 sq.m. have no proper title, we have assigned no commercial value to them. -304- APPENDIX VIII PROPERTY VALUATION OPEN MARKET VALUE PARTICULARS OF IN EXISTING STATE AS PROPERTIES DESCRIPTION AND TENURE OCCUPANCY AT 31 AUGUST, 2004 RMB 15. Various properties held The properties comprise 269 various The properties are currently 74,640,000 (100% by China Southern operational and ancillary buildings and occupied by the Group for interest Airlines Company Limited commodity properties completed in office, warehouse and staff attributable to the in Shenzhen various stages between 1991 and 1994 quarters for operating and Group: 74,640,000) with a total gross floor area of ancillary purposes. approximately 31,937.22 sq.m. (343,772 sq.ft.). Details of gross floor areas of the properties are listed as follows: APPROXIMATE USE GROSS FLOOR AREA --- ---------------- sq.m. sq.ft. Offices 7,931.92 85,379 Warehouses 1,665.60 17,929 Ancillary buildings 22,339.70 240,465 --------- ------- Total: 31,937.22 343,772 ========= ======= The lands upon which the properties (excluding stratified properties) currently erected comprise 3 parcels of land with a total area of approximately 205,045.40 sq.m. (2,207,109 sq.ft.). The land use rights of portions of the properties have been granted for various terms ranging from 30 years to 70 years, and the remaining lands are allocated lands. Notes: (1) We have been provided with a copy of the legal opinion on the title to the properties prepared by Z & T Law Firm, the Company's PRC legal adviser, which contains, inter alia, the following information: (i) The Company has the land use right of the site with an area of approximately 199,285.60 sq.m. and is entitled to occupy, use and dispose the land within the land use right term. There is no legal impediment for the Company to obtain Real Estate Title Certificate and settlement of land premium is not necessary. (ii) The Company is entitled to use, rent, mortgage and transfer the land use right of the land which 248 buildings with a gross floor area of approximately 20,852.01 sq.m. erecting upon. (iii) According to 253 Real Estate Title Certificates registered under the name of China Southern Airlines Company Limited in Shenzhen, 248 buildings and commodity properties with a total gross floor area of approximately 20,852.01 sq.m. are held by China Southern Airlines Company Limited in Shenzhen, which is 100% owned by the Group. -305- APPENDIX VIII PROPERTY VALUATION (iv) According to 5 Real Estate Title Certificates registered under the name of Shenzhen City Southern Aviation Instrument Company Limited, 5 commodity properties with a total gross floor area of approximately 465.50 sq.m. are not owned by the Group. (v) Since 14 buildings with total gross floor area of 10,623.69 sq.m. and 2 buildings with undetermined floor area do not have any land use right title certificate, the Group cannot obtain the real estate with certificates. (2) In the course of our valuation, we have assigned no commercial value to the 21 properties to which the Group has no title. However, for indication purpose, the total value of the 21 properties is RMB99,120,000 as at the date of valuation. -306- APPENDIX VIII PROPERTY VALUATION OPEN MARKET VALUE PARTICULARS OF IN EXISTING STATE AS PROPERTIES DESCRIPTION AND TENURE OCCUPANCY AT 31 AUGUST, 2004 RMB 16. Various properties held by The properties comprise 29 various The properties are currently 48,211,000 (100% China Southern Airlines operational and ancillary buildings and occupied by the Group for interest Company Limited in Hainan various structures completed in various office, warehouse and staff attributable to the stages between 1997 and 2002 with a quarters for operating and Group: 48,211,000 ) total gross floor area of approximately ancillary purposes. 54,567.19 sq.m. (587,361 sq.ft.). Details of the gross floor areas of the properties are listed as follows: APPROXIMATE USE GROSS FLOOR AREA --- ---------------- sq.m. sq.ft. Offices 23,310.75 250,917 Warehouses 2,051 22,077 Ancillary buildings 29,205.44 314,367 --------- ------- Total: 54,567.19 587,361 ========= ======= The lands upon which the properties currently erected comprise 5 parcels of land with a total area of approximately 330,532.71 sq.m. (3,557,854 sq.ft.). The land use rights of the properties with an area of 4,739.21 sq.m. and 19,329.9 sq.m. have been granted for terms expiring on 17 February, 2070 and July 2063 respectively. The remaining lands are allocated lands. Notes: (1) Since the land of 23 buildings is allocated land and/or the buildings have not obtained the Real Estate Title Certificates, we have attributed no commercial value to the properties. However, for indication purposes, the depreciated replacement costs of the 23 buildings with a total gross floor areas of approximately 41,515.30 sq.m. is RMB107,209,307 as at the date of valuation. (2) According to 2 Land Use Rights Certificates and 6 Building Ownership Certificates given to us, the land use rights of 2 parcels of land with a total area of approximately 24,069.11 sq.m. and the building ownership rights of 6 buildings with a total gross floor area of approximately 13,051.89 sq.m. are held by China Southern Airlines Company Limited Hainan Branch, which is 100% owned by the Group. -307- APPENDIX VIII PROPERTY VALUATION (3) We have been provided with a copy of the legal opinion on the title to the properties prepared by Z & T Law Firm, the Company's PRC legal adviser, which contains, inter alia, the following information: (1) The Company has the land use right of the lands with an area of approximately 4,739.21 sq.m. and 19,329.9 sq.m. and is entitled to occupy, use and dispose the land within their respective land use right term. (ii) The Company has legally obtained the Building Ownership Certificates with an area of approximately 269.45 sq.m. and the land of Room 1308, Block E of World Trade Building and Room 1005 of Jiang Nan Hua Yuan (Unit Yi) and there is no legal impediment in applying for relevant title certificate. However, as the policy of the different government departments varies, the time for successful application cannot be confirmed. (iii) The Real Estate Title Certificate of 6 buildings has been obtained and the titles to the properties are legally vested in the Company. The Company is entitled to use, rent, mortgage and transfer the properties. -308- APPENDIX VIII PROPERTY VALUATION OPEN MARKET VALUE PARTICULARS OF IN EXISTING STATE AS PROPERTIES DESCRIPTION AND TENURE OCCUPANCY AT 31 AUGUST, 2004 RMB 17. Various properties held The properties comprise 46 various The properties are currently 2,110,000 (100% by China Southern operational and ancillary buildings and occupied by the Group for interest Airlines (Group) Zhuhai various structures completed in various office and staff quarters for attributable to the Helicopter Company Limited stages between 1989 and 2004 with a operating and ancillary Group: 2,110,000) total gross floor area of approximately purposes. 16,350.29 sq.m. (175,995 sq.ft.). Details of the gross floor areas of the properties are listed as follows: APPROXIMATE USE GROSS FLOOR AREA --- ---------------- sq.m. sq.ft. Offices 2,977.56 32,050.46 Ancillary buildings 13,372.73 143,944.07 --------- ---------- Total: 16,350.29 175,994.52 ========= ========== The lands upon which the properties currently erected comprise 6 parcels of land with a total area of approximately 150,524.18 sq.m. (1,620,242.27 sq.ft.). The land use rights of the properties have been granted for various terms ranging from 50 to 50 years. Notes: (1) Since the land of 28 buildings is allocated land and/or the buildings have not obtained the Real Estate Title Certificates, we have attributed no commercial value to the properties. However, for indication purposes, the depreciated replacement costs of the 28 buildings with a total gross floor areas of approximately 16,350.29 sq.m. is RMB25,610,000 as at the date of valuation. (2) According to a Land Use Rights Certificate and 14 Real Estate Title Certificates given to us, the land use rights of 1 parcel of granted land with a total area of approximately 10,046.60 sq.m. and the building ownership rights of 14 buildings with a total gross floor area of approximately 8,249.90 sq.m. are held by China Southern Airlines (Group) Zhuhai Helicopter Company Limited, which is 100% owned by the Group. (3) We have been provided with a copy of the legal opinion on the title to the properties prepared by Z & T Law Firm, the Company's PRC legal adviser, which contains, inter alia, the following information: (i) The Company has legally obtained the land use right of the land with an area of approximately 140,120.3 sq.m.. There is no legal impediment for change of "land origin" registration and settlement of land premium for the registration is not necessary. However, as the policy of the different government departments varies, the time for successful change of registration cannot be confirmed. -309- APPENDIX VIII PROPERTY VALUATION (ii) The land with an area of approximately 257.28 sq.m. is allocated land. The Company held the land use right and is entitled to occupy, use and dispose the land. Since the land is allocated, the Company has to settle the land premium and get prior approval from relevant government authorities when disposing the land. (iii) The Company has the land use right of the land with an area of approximately 10,046.6 sq.m. and is entitled to use, rent, mortgage and transfer the land use right. (iv) The Real Estate Certificate of 14 buildings with a total gross floor area of approximately 8,249.9 sq.m. has been obtained. However, the property rights owner of the aforesaid certificate is in the old name of China Southern Airlines Company Limited Zhuhai Branch. There is no legal impediment in applying for change of name. (v) The 5 buildings with a total gross floor area of approximately 2,521.44 sq.m. is erected upon allocated land. The Company has to settle the land premium whenever it transfers the property right. (vi) The Company can use the 5 buildings with a total gross floor area of approximately 4,460 sq.m. but it has to settle the land premium whenever it transfers the property right. (vii) The Company has the right to use, rent, mortgage and transfer the building with a gross floor area of approximately 165.27 sq.m.. Since the building is erected upon allocated land, the Company has to settle the land premium whenever it transfers the property right. -310- APPENDIX VIII PROPERTY VALUATION OPEN MARKET VALUE PARTICULARS OF IN EXISTING STATE AS PROPERTIES DESCRIPTION AND TENURE OCCUPANCY AT 31 AUGUST, 2004 RMB 18. Various properties held The properties comprise 114 various The property is occupied by the 126,880,000 (60% by Xiamen Airlines Company operational and ancillary buildings and Group as office and warehouse interest Limited (Xiamen Airlines) various structures completed in various for operating purposes. attributable to the stages between 1979 and 2003 with a Group: 76,128,000) total gross floor area of approximately 267,287.34 sq.m. (2,877,081 sq.ft.). Details of the gross floor areas of the properties are listed as follows: APPROXIMATE USE GROSS FLOOR AREA --- ---------------- sq.m. sq.ft. Offices 217,198.34 2,337,923 Warehouses 8,554 92,075 Ancillary buildings 41,535.02 447,083 ---------- --------- Total: 267,287.36 2,877,081 ========== ========= The lands upon which the properties (excluding stratified properties) currently erected comprise 22 parcels of land with a total area of approximately 400,753.28 sq.m. (4,313,708 sq.ft.). The land use rights of the properties have been granted for various terms ranging from 40 to 70 years. Notes: (1) According to 52 Land Use Rights Certificates and 83 Building Ownership Certificates, the land use rights of land with a total area of approximately 400,925.83 sq.m. and the building ownership rights of buildings with a total gross floor area of approximately 183,966.37 sq.m. are held by Xiamen Airlines Company Limited, which is 60% owned by the Group. (2) We have been provided with a copy of the legal opinion on the title to the properties prepared by Z & T Law Firm, the Company's PRC legal adviser, which contains, inter alia, the following information: (i) The Group has obtained 16 Land Use Right Certificates for a granted land with total area of approximately 31,298.42 sq.m. and 34 allocated lands with a total area of approximately 369,627.41 sq.m., respectively. The Group owned the land use rights of the two lands and has the rights to use, lease, mortgage and transfer the lands where the allocated land is subject to obtaining an approval from the relevant State-owned Land Administration Bureaus and pay relevant land grant fees; (ii) The Group has the land use rights of 39 buildings, which have not yet obtained the relevant Land Use Right Certificates. The lands cannot be transferred separately but shall be transferred with the buildings erected on. In addition, the use of a land for "Zhai Ji Di" with an area of approximately 152.90 sq.m. which the Group has the land use right is inconsistent with the laws; -311- APPENDIX VIII PROPERTY VALUATION (iii) The Group has obtained Building Ownership Certificates for 83 buildings of which approximately 25,359.02 sq.m. of buildings the Group has the right to use, lease, mortgage and transfer, approximately 144,892.04 sq.m. of buildings the Group has the building ownership but land grant fee shall be payable upon transfer, approximately 13,715.31 sq.m. of buildings the Group has the right to use, lease, mortgage and transfer but the corresponding land use right certificates have not yet obtained where while the buildings are transferred, the corresponding land use right shall be transferred altogether; (3) In the course of our valuation, we have assigned no commercial value to the allocated land, the lands without Land Use Right Certificates and the "Zhai Ji Di" with a total land area of approximately 229,863.85 sq.m. and the buildings with a total gross floor area of approximately 241,928.32 sq.m. because they cannot be freely transferred in the market. -312- APPENDIX VIII PROPERTY VALUATION OPEN MARKET VALUE IN EXISTING STATE AS AT PARTICULARS OF 31 AUGUST, 2004 PROPERTIES DESCRIPTION AND TENURE OCCUPANCY RMB 19. Various properties The properties comprise 88 The properties are 115,870,000 held by various operational and currently occupied by (60% interest Southern Airlines ancillary buildings and various the Group for office, attributable to (Group) Shantou structures completed in various operating and the Group: Airlines Company stages between 1993 and 2002 ancillary purposes. 69,520,000) Limited with a total gross floor area of approximately 40,624.35 sq.m. (437,281 sq.ft.). Details of the gross floor areas of the properties are listed as follows: APPROXIMATE USE GROSS FLOOR AREA --- ---------------- sq.m. sq.ft. Offices 31,333.59 337,275 Ancillary buildings 9,290.76 100,006 --------- ------- Total: 40,624.35 437,281 ========= ======= The lands upon which the properties currently erected comprise 5 parcels of land with a total area of approximately 32,094.13 sq.m. (345,461 sq.ft.). The land use rights of the properties have been granted for various terms ranging from 50 to 70 years. Notes: (1) Since the land of 11 buildings is allocated land and/or the buildings have not obtained the Building Ownership Certificates/Reality Title Certificates, we have attributed no commercial value to the properties. However, for indication purposes, the depreciated replacement costs of the 11 buildings with a total gross floor areas of approximately 9,185.85 sq.m. is RMB29,540,000 as at the date of valuation. (2) According to 4 Land Use Rights Certificates and 77 Reality Title Certificates given to us, the land use rights of 4 parcels of land with a total area of approximately 32,094.13 sq.m. and the building ownership rights of 77 buildings with a total gross floor area of approximately 31,438.50 sq.m. are held by Southern Airlines (Group) Shantou Airlines Company Limited, which is 60% owned by the Group. (3) We have been provided with a copy of the legal opinion on the title to the properties prepared by Z & T Law Firm, the Company's PRC legal adviser, which contains, inter alia, the following information: (i) Southern Airlines (Group) Shantou Airlines Company Limited has obtained the granted land use rights of the 4 parcels of land with a total area of approximately 32,094.00 sq.m. and can use, lease, mortgage and transfer the land. - 313 - APPENDIX VIII PROPERTY VALUATION (ii) Southern Airlines (Group) Shantou Airlines Company Limited has obtained the reality title certificates for 77 buildings and can use, mortgage, lease and sell the buildings. However, as 20 of the buildings has been mortgaged, consent has been obtained for the transfer of the aforesaid 20 buildings according to the law in the PRC. (iii) For the 11 buildings which have not obtained the reality title certificates, 9 buildings with a total floor area of approximately 7,830.85 sq.m. are erected on leased land and the ownership will be given to the lessor of the land. Southern Airlines (Group) Shantou Airlines Company Limited has the right to use the 9 buildings during the lease period. The remaining 2 buildings with a total gross floor area of approximately 1,355 sq.m. are erected on granted land and there is no impediment for obtaining the reality title certificate. (4) We have assigned no commercial value to the land in which the reality title certificate has not been obtained. - 314 - APPENDIX VIII PROPERTY VALUATION OPEN MARKET VALUE IN EXISTING STATE AS AT PARTICULARS OF 31 AUGUST, 2004 PROPERTIES DESCRIPTION AND TENURE OCCUPANCY RMB 20. Various properties The properties comprise 29 The property is 24,140,000 held by various operational and occupied by the (60% interest Guangxi Airlines ancillary buildings and various Group as office, attributable to Company Limited structures completed in various warehouse and staff the Group: stages between 1996 and 2002 quarters for operating 14,484,000) with a total gross floor area of and ancillary approximately 55,765.21 sq.m. purposes. (600,257 sq.ft.). Details of the gross floor areas of the properties are listed as follows: APPROXIMATE USE GROSS FLOOR AREA --- ---------------- sq.m. sq.ft. Offices 38,615.41 415,656 Warehouses 2,256 24,284 Ancillary buildings 14,893.81 160,317 --------- ------- Total: 55,765.22 600,257 ========= ======= The lands upon which the properties currently erected comprise 5 parcels of land with a total area of approximately 54,837.55 sq.m. (590,271 sq.ft.). The land use rights of the properties have been granted for various terms of 70 years. Notes: (1) Since 25 buildings are erected on allocated land and/or have not obtained the Building Ownership Certificates, we have attributed no commercial value to the properties. However, for indication purposes, the depreciated replacement costs of the 25 buildings with a total gross floor areas of approximately 50,097.28 sq.m. is RMB101,450,000 as at the date of valuation. (2) According to 2 Land Use Rights Certificates and 12 Building Ownership Certificates given to us, the land use rights of 1 parcel of granted land with an area of approximately 8,490.85 sq.m. and 1 parcel of allocated land with an area of approximately 46,346.7 sq.m. and the building ownership rights of 4 buildings erected on granted land with a total gross floor area of approximately 5,667.93 sq.m. and 8 buildings erected on allocated land with total gross floor area of approximately 27,481.53 sq.m. are held by Guangxi Airlines Company Limited, which is 60% owned by the Group. (3) We have been provided with a copy of the legal opinion on the title to the properties prepared by Z & T Law Firm, the Company's PRC legal adviser, which contains, inter alia, the following information: (i) Guangxi Airlines Company Limited has obtained the granted land use right of a parcel of land with an area of approximately 8,590.85 sq.m. and can use, lease, mortgage and transfer the land and has obtained the allocated land use right of a parcel of land with an area approximately 46,346.70 sq.m. and can use, lease, mortgage and transfer the land with approval of the State Land Bureau and payment of the land premium. - 315 - APPENDIX VIII PROPERTY VALUATION (ii) Guangxi Airlines Company Limited has obtained the building ownership certificates for 10 buildings. 4 buildings with a total area of approximately 5,576.93 sq.m., which are erected on granted land, are legally owned and can be used; leased, mortgaged and transferred by Guangxi Airlines Company Limited. As the other 6 buildings with a total area of approximately 27,481.53 sq.m. are erected on allocated land or land with unclear title, there is legal impediment for the transfer of the buildings and or land premium has to be paid. (iii) Guangxi Airlines Company Limited has the land use right for the remaining 19 buildings with a total gross floor area of approximately 22,615.75 sq.m. Since they are erected on granted land, there is no legal impediment for Guangxi Airlines Company Limited to obtain the building ownership certificates. (4) For the remaining 3 parcels of land in which the reality title certificates have not been obtained, the areas of the land cannot be determined. - 316 - APPENDIX VIII PROPERTY VALUATION OPEN MARKET VALUE IN EXISTING STATE AS AT PARTICULARS OF 31 AUGUST, 2004 PROPERTIES DESCRIPTION AND TENURE OCCUPANCY RMB 21. Various properties The properties comprise 52 The property is 67,530,000 held by various operational and occupied by the (60% interest Zhuhai Airlines ancillary buildings and various Group as office, attributable to Company Limited structures completed in various warehouse and staff the Group: stages between 1993 and 2002 quarters for operating 40,520,000) with a total gross floor area of and ancillary approximately 54,471.53 sq.m. purposes. (586,331 sq.ft.). Details of the gross floor areas of the properties are listed as follows: APPROXIMATE USE GROSS FLOOR AREA --- ---------------- sq.m. sq.ft. Offices 8,735.22 94,026 Ancillary buildings 45,736.31 492,306 --------- ------- Total: 54,471.53 586,332 ========= ======= The lands upon which the properties (excluding stratified properties) currently erected comprise 5 parcels of land with a total area of approximately 65,255.50 sq.m. (702,410 sq.ft.) (See Notes (2)(ii)). The land use rights of the properties have been granted for various terms ranging from 48 to 65 years. Notes: (1) According to 48 Land Use Rights Certificates and 46 Building Ownership Certificates, the land use rights and the building ownership rights of 46 buildings with a total gross floor area of approximately 44,432.19 sq.m. are held by Zhuhai Airlines Company Limited, which is 60% owned by the Group. (2) We have been provided with a copy of the legal opinion on the title to the properties prepared by Z & T Law Firm, the Company's PRC legal adviser, which contains, inter alia, the following information: (i) The Group has obtained two Land Use Right Certificates for a granted land with area of approximately 59,999.90 sq.m. and an allocated land with area of approximately 5,255.60 sq.m., respectively. The Group has owned the land use rights of the two lands and has the rights to use, lease, mortgage and transfer the lands where the allocated land is subject to obtaining an approval from the relevant State-owned Land Administration Bureaus and pay relevant land grant fees; (ii) The Group has three lands together with buildings (6,706 sq.m.) without having any title documents where the land areas cannot be determined. Thus, the ownership of the Group in the three lands and buildings cannot be confirmed; - 317 - APPENDIX VIII PROPERTY VALUATION (iii) The Group has obtained 46 Building Ownership Certificates for 46 buildings with total gross floor area of approximately 44,432.19 sq.m. of which 43 buildings with total gross floor area of approximately 43,922.79 sq.m. can be used, leased, mortgaged and transferred by the Group whilst 3 buildings with total gross floor area of approximately 509.40 sq.m. are erected on allocated lands that need to pay land grant fee before a transfer; and (iv) The Group has the right to use two buildings with total gross floor area of approximately 3,033.34 sq.m. There is no legal impediment in applying for relevant Building Ownership Certificates. (3) In the course of our valuation, we have assigned no commercial value to the allocated land (5,255.60 sq.m.) and the three lands together with buildings (6,706 sq.m.) because they cannot be freely transferred in the market. - 318 - APPENDIX VIII PROPERTY VALUATION OPEN MARKET VALUE IN EXISTING STATE AS AT PARTICULARS OF 31 AUGUST, 2004 PROPERTIES DESCRIPTION AND TENURE OCCUPANCY RMB 22. Various properties The properties comprise 11 The properties are No commercial value held by Guizhou various operational and ancillary currently occupied by Airlines Company buildings and various structures the Group for office Limited completed in various stages and staff quarters for between 1991 and 2000 with a operating and total gross floor area of ancillary purposes. approximately 4,087.81 sq.m. (44,001 sq.ft.). Details of the gross floor areas of the properties are listed as follows: APPROXIMATE USE GROSS FLOOR AREA --- ---------------- sq.m. sq.ft. Offices 1,667 17,944 Ancillary buildings 2,420.81 26,058 -------- ------ Total: 4,087.81 44,001 ======== ====== The lands upon which the properties currently erected comprise 2 parcels of land with area unknown. The lands are allocated lands. Notes: (1) Since the land is allocated land and/or the buildings have not obtained the Real Estate Title Certificates, we have attributed no commercial value to the properties. However, for indication purposes, the depreciated replacement costs of the 11 buildings with a total gross floor areas of approximately 4,087.81 sq.m. is RMB30,000,000 as at the date of valuation. (2) We have been provided with a copy of the legal opinion on the title to the properties prepared by Z & T Law Firm, the Company's PRC legal adviser, which contains, inter alia, the following information: (i) The Company can legally use the land in Guiyang Leizhuang Airport for aviation transport purpose but it has to get approval from relevant government authorities and settle land premium prior to transfer of land use right. (ii) There is no legal impediment in obtaining relevant title certificate for the land in Changli Commercial/Residential Building since it is commodity housing. (iii) The Company has the right to use the property in Changli Commercial/Residential Building and there is no legal impediment in obtaining relevant title certificate for the land since it is commodity housing. (iv) The Company has the right to use the property in Guiyang Leizhuang Airport and there is no legal impediment in obtaining relevant title certificate. - 319 - APPENDIX VIII PROPERTY VALUATION OPEN MARKET VALUE IN EXISTING STATE AS AT PARTICULARS OF 31 AUGUST, 2004 PROPERTIES DESCRIPTION AND TENURE OCCUPANCY RMB 23. Various properties The properties comprise 3 The property is No commercial value held by various operational and ancillary occupied by the Guangzhou buildings and various structures Group as office, Nanland Air completed in various stages warehouse and staff Catering Company between 1985 and 1991 with a quarters for operating Limited total gross floor area of and ancillary approximately 12,464 sq.m. purposes. (134,163 sq.ft.). Details of the gross floor areas of the properties are listed as follows: APPROXIMATE USE GROSS FLOOR AREA --- ---------------- sq.m. sq.ft. Food processing building 11,300 121,633 Warehouses 664 7,147 Ancillary buildings 500 5,382 ------ ------- Total: 12,464 134,162 ====== ======= The land upon which the properties currently erected comprises a parcel of land with an area of approximately 15,333.41 sq.m. (165,049 sq.ft.). The land use rights of the properties have been authorized for operation to CSAHC. Notes: (1) Since the land is authorized for operation to CSAHC and the buildings have not obtained Reality Title Certificates, we have attributed no commercial value to the properties. However, for indication purposes, the depreciated replacement costs of the 3 buildings with a total gross floor areas of approximately 12,464.00 sq.m. is RMB24,850,000 as at the date of valuation. (2) We have been provided with a copy of the legal opinion on the title to the properties prepared by Z & T Law Firm, the Company's PRC legal adviser, which contains, inter alia, the following information: (i) The land use rights of the property is authorized to CSAHC which is currently used by Nanland Air Catering Company Limited. (ii) The buildings erected on the land are owned by Guangzhou Nanland Air Catering Company Limited, however, as the State-owned land use right certificate and building ownership certificate are combined as the reality title certificate in Guangzhou, it is impossible for Nanland Air Catering Company Limited to obtain the reality title certificate for the buildings. - 320 - APPENDIX VIII PROPERTY VALUATION OPEN MARKET VALUE IN EXISTING STATE AS AT PARTICULARS OF 31 AUGUST, 2004 PROPERTIES DESCRIPTION AND TENURE OCCUPANCY RMB 24. A property held by The property comprises a hotel The property is 57,670,000 Guangzhou building completed in 1998 with currently occupied by (90% interest Aviation Hotel a total gross floor area of the Group as an attributable to approximately 11,485.40 sq.m. operating hotel. the Group: (123,629 sq.ft.). 51,900,000) The land upon which the property currently erected comprises 1 parcel of land with a total area of approximately 1,250.46 sq.m. (13,460 sq.ft.). Notes : (1) According to 1 Land Use Rights Certificate and 1 Building Ownership Certificate given to us, the land use rights of 1 parcel of land with a total area of approximately 1,250.46 sq.m. and the building ownership rights of 1 building with a total gross floor area of approximately 11,485.40 sq.m. are held by Guangzhou Aviation Hotel, which is 90% owned by the Group. (2) We have been provided with a copy of the legal opinion on the title to the property prepared by Z & T Law Firm, the Company's PRC legal adviser, which contains, inter alia, the following information: (i) Pursuant to the Real Estate Title Certificate Hui Fang Di Zheng Zi No. 0423921, the land portion of the property of granted land nature with an area of approximately 1,250.46 sq.m. is held by CSAHC. (ii) The Guangzhou Aviation Hotel has obtained the land use rights of the property and can occupy, use, handle the land use rights within the land use right terms. The Group should change the land use rights of the property under its name and there is no legal obstacle to process such changes of ownership. (iii) Pursuant to the Real Estate Title Certificate Hui Fang Di Zheng Zi No. 0423921, the building portion of the property with a gross floor area of approximately 11,485.40 sq.m. is held by CSAHC. (iv) Guangzhou Aviation Hotel has obtained the building ownership of the property and can use, let, mortgage and transfer the property. The Group should change the land use rights of the property under its name and there is no legal obstacle to process such changes of ownership. - 321 - APPENDIX VIII PROPERTY VALUATION OPEN MARKET VALUE IN EXISTING STATE AS AT PARTICULARS OF 31 AUGUST, 2004 PROPERTIES DESCRIPTION AND TENURE OCCUPANCY RMB 25. Various properties The properties comprise 14 The properties are 16,030,000 held by China various operational and ancillary currently occupied by (100% interest Southern Airlines buildings and various structures the Group for office attributable to Company Limited completed in various stages and staff quarters for the Group: Operation between 1985 and 2002 with a operating and 16,030,000) Department total gross floor area of ancillary purposes. approximately 19,375.49 sq.m. (280,558 sq.ft.). Details of the gross floor areas of the properties are listed as follows: APPROXIMATE USE GROSS FLOOR AREA --- ---------------- sq.m. sq.ft. Offices 16,901.44 181,927 Ancillary buildings 2,474.05 26,631 --------- ------- Total: 19,375.49 280,558 ========= ======= The lands upon which the properties currently erected comprise 13 parcels of land with a total area of approximately 31,505.99 sq.m. (339,130 sq.ft.). The land use rights of the properties have been granted for various terms ranging from 40 to 70 years. Notes: (1) Since the 5 buildings with a total gross floor area of approximately 1,881.99 sq.m. are erected on allocated land and/or the buildings have not obtained the Real Estate Title Certificates, we have attributed no commercial value to the properties. However, for indication purposes, the depreciated replacement costs of the 5 buildings with a total gross floor areas of 1,881.99 sq.m. is RMB158,880,000 as at the date of valuation. (2) According to 7 Land Use Rights Certificates and 10 Real Estate Title Certificates given to us, the land use rights of 6 parcels of land with a total area of approximately 5,834.66 sq.m. and the building ownership rights of 6 buildings with a total gross floor area of approximately 2,518.44 sq.m. are held by China Southern Airlines Company Limited Operation Department, which is 100% owned by the Group. (3) We have been provided with a copy of the legal opinion on the title to the properties prepared by Z & T Law Firm, the Company's PRC legal adviser, which contains, inter alia, the following information: (i) The land used by the operation departments in Beijing, Shanghai, Kunming, Chengdu (Friendship Building), Jinan and Xian cannot obtain relevant land use right certificate as the application for construction inspection by developer has not been carried out. (ii) The Land Use Right Certificate of the land used by the operation departments in Chengdu (Ao Shen Hua Yuan), Xiamen and Nanjing has been obtained and the Company has the land use right of the land. Whenever the Company transfers the land use right, it has to transfer together with the buildings erected upon. - 322 - APPENDIX VIII PROPERTY VALUATION (iii) The Beijing Nan Hang Hotel and property used by Shanghai operation department has no real estate certificate and the Company has the right to use it. (iv) The Real Estate Title Certificates of the buildings used by the operation departments of Kunming and Chengdu (Ao Shen Hua Yuan) has been obtained and the Company can use, rent, mortgage and transfer the property right. (v) The Company has the right to use the buildings of the operation departments of Jinan and Chengdu (Friendship Building) and there is no legal impediment for the Company to obtain Real Estate Title Certificates upon settlement of the property price. (vi) The Company has the right to use, rent, mortgage and transfer the property right of the National Development Bank Building and property used by Xiamen operation department. - 323 - APPENDIX VIII PROPERTY VALUATION OPEN MARKET VALUE IN EXISTING STATE AS AT PARTICULARS OF 31 AUGUST, 2004 PROPERTIES DESCRIPTION AND TENURE OCCUPANCY RMB 26. Various properties The properties comprise 4 The properties are 156,070,000 held by China various operational and ancillary currently occupied by (100% interest Southern Airlines buildings completed in various the Group for and attributable to Company Limited stages between 1992 and 2001 Zhuhai Xiang Yi the Group: Zhuhai Flight with a total gross floor area of Aviation Technology 156,070,000) Simulator Training approximately 38,720.00 sq.m. Company Limited for Centre (416,782 sq.ft.). office, training centre, student quarters and Details of the gross floor areas canteen purposes. of the properties are listed as follows: APPROXIMATE USE GROSS FLOOR AREA --- ---------------- sq.m. sq.ft. Offices 21,095.00 227,066 Ancillary buildings 17,625.00 189,716 --------- ------- Total: 38,720.00 416,782 ========= ======= The lands upon which the properties currently erected comprise 2 parcels of land with a total area of approximately 29,941.60 sq.m. (322,291.38 sq.ft.). The land use rights of the properties have been granted for 50 years commencing from 7 February, 1991 and 1 August, 1994 respectively. Notes: (1) According to 2 Land Use Rights Certificates given to us, the land use rights of 2 parcels of land with a total area of approximately 29,416.60 sq.m. are held by China Southern Airlines Company Limited Zhuhai Flight Simulator Training Centre, which is 100% owned by the Group. (2) We have been provided with a copy of the legal opinion on the title to the properties prepared by Z & T Law Firm, the Company's PRC legal adviser, which contains, inter alia, the following information: (i) The Company is entitled to use, rent, mortgage and transfer the land use right with an area of approximately 16,954 sq.m. There is no legal impediment for change of "land origin" registration and settlement of land premium for the registration is not necessary. (ii) The Land Use Right Certificate of the land use right with an area of approximately 12,987.6 sq.m. has been obtained. The Company is entitled to use, rent, mortgage and transfer the land use right for a term of 50 years commencing from August 1994 and expiring on August 2004. However, the land use rights owner of the aforesaid certificate is in the old name of Zhuhai Flight Simulator Training Centre. There is no legal impediment in applying for change of name. (iii) The Company held the ownership rights of the 4 buildings with a total gross floor area of approximately 38,720 sq.m. and there is no legal impediment for the Company to obtain relevant title certificates. - 324 - APPENDIX VIII PROPERTY VALUATION GROUP V - PROPERTIES HELD BY THE GROUP IN WESTERN AUSTRALIA OPEN MARKET VALUE IN EXISTING STATE AS AT PARTICULARS OF 31 AUGUST, 2004 PROPERTIES DESCRIPTION AND TENURE OCCUPANCY RMB 27. Various properties The properties comprise 38 The properties are 12,120,000 held by various operational and ancillary currently occupied by (65% interest China Southern buildings and various structures the Group for staff, attributable to West Australian completed in various stages student accommodation, the Group: Flying College Pty between 1960 and 2000 with a administration and 7,878,000) Ltd. in Australia total gross floor area of flying school purposes. approximately 11,580 sq.m. (124,647 sq.ft.). Details of the gross floor areas of the properties held under freehold land are listed as follows: APPROXIMATE USE GROSS FLOOR AREA --- ---------------- sq.m. sq.ft. 13 Residences 2,250 23,940 5 Transportables 300 3,229 Dining/Ancillary 250 2,691 Operations 390 4,197 Briefing 390 4,197 Tower/Facilities 150 1,614 Hangar Workshop 1,000 10,764 Residences 1,040 11,194 Other 150 1,614 --------- ------- Total 5,920 63,723 ========= ======= Details of the gross flow areas of the properties held under leasehold land are listed as follows: APPROXIMATE USE GROSS FLOOR AREA --- ---------------- sq.m. sq.ft. Hangar/Workshop 1,485 15,984 Ground School 377 4,058 Ancillary Storage 98 1,054 Engine Workshop 700 7,534 Dormitory Accom. 3,000 32,393 --------- ------- Total: 5,660 60,924 ========= ======= The lands upon which the properties currently erected comprise 31 parcels of freehold lands with a total area of approximately 1,121,639 sq.m. (12,073,322 sq.ft.) and 3 parcels of leasehold lands with a total area of approximately 16,122sq.m. (173,537sq.ft.). Note : (1) The registered owner of the property is China Southern West Australian Flying College Pty Ltd.. The lands of the property with an area of approximately 16,122 sq.m. are leasehold lands, and we thus have attributed no commercial value to those leasehold lands and the buildings erecting thereon. However, for indication purposes, the depreciated replacement costs of the buildings with a total gross floor area of approximately 5,660 sq.m. is RMB19,773,000 as at the date of valuation. - 325 - APPENDIX VIII PROPERTY VALUATION GROUP VI - PROPERTIES HELD BY THE GROUP IN THE NETHERLANDS OPEN MARKET VALUE IN EXISTING STATE AS AT PARTICULARS OF 31 AUGUST, 2004 PROPERTIES DESCRIPTION AND TENURE OCCUPANCY RMB 28. Five residential The property comprises five The property is 13,210,000 units held by the residential units completed in currently occupied by (100% interest Company in various stages between late the Group for staff attributable to Amstelveen 1980s and mid 1990s with a total quarters purposes. the Group: Noord-Holland gross floor area of approximately 13,210,000) The Netherlands 432.00 sq.m. (4,650 sq.ft.). Note: The registered owner of the property is China Southern Airlines Company Limited. - 326 - APPENDIX VIII PROPERTY VALUATION GROUP VII - PROPERTIES HELD UNDER CONSTRUCTION BY THE GROUP IN THE PRC OPEN MARKET VALUE IN EXISTING STATE AS AT PARTICULARS OF 31 AUGUST, 2004 PROPERTIES DESCRIPTION AND TENURE OCCUPANCY RMB 29. Various properties The properties under The properties are 1,559,830,000 held under development are planned to currently under (100% interest construction by comprise 16 buildings and 3 construction. attributable to China Southern structures. Upon completion, the the Group: Airlines Company proposed development will have 1,559,830,000) Limited a total gross floor area of Guangzhou approximately 346,235.89 sq.m. Headquarters (3,726,883 sq.ft.). The lands upon which the properties currently erected comprise a parcel of land with a total area of approximately 80,909 sq.m. (870,904 sq.ft.). Notes : (1) We have been provided with a copy of the legal opinion on the title to the properties prepared by Z & T Law Firm, the Company's PRC legal adviser, which contains, inter alia, the following information: (i) The application for properties under construction has been legally obtained and the properties under construction are vested in the Group. After the constructions have been completed and have obtained the completion certificates, the Group may apply for the relevant title documents; (ii) The properties under construction are erected on a leased with a site area of 80,909 sq.m. land where the Group has the right to use but cannot sub-lease the land. (2) We have assigned no commercial value to the land portions of the properties due to its non-transferability and non-subletting nature in the open market. According to the Group's PRC legal adviser opinion, the Company could apply the ownership of the buildings and structures of the property upon completion. Also, CSAHC has agreed to assist the Company to transfer the properties and process the land grant process whenever the Company dispose of the properties. We have, relied on the aforesaid, assigned open market values to the un-completed buildings and structures of the properties but excluding the land portion. - 327 - APPENDIX VIII PROPERTY VALUATION OPEN MARKET VALUE IN EXISTING STATE AS AT PARTICULARS OF 31 AUGUST, 2004 PROPERTIES DESCRIPTION AND TENURE OCCUPANCY RMB 30. Various properties The properties under The properties are No commercial value held under development are planned to currently under construction by comprise 4 buildings and construction. Xiamen Airlines structures. Upon completion, the proposed development will have a total gross floor area of approximately 2,122 sq.m. (22,841 sq.ft.). The lands upon which the properties currently erected comprise 2 parcels of land with a total area of approximately 151,347.20 sq.m. (1,629,101 sq.ft.). Notes : (1) We have been provided with a copy of the legal opinion on the title to the properties prepared by Z & T Law Firm, the Company's PRC legal adviser, which contains, inter alia, the following information: 4 buildings are held under construction by Xiamen Airlines. One of the buildings is an aircraft repairing warehouse with a gross floor area of approximately 2,122 sq.m. For the remaining 3 buildings, there is no information regarding their gross floor area. (2) Since no land use rights certificates have been obtained for the 2 subject lands of the property and the buildings of the property which are under construction have not obtained any construction approval documents from relevant governmental departments, we have attributed no commercial value to the properties. However, for indication purposes, the depreciated replacement costs of the 4 buildings with a total gross floor areas of approximately 2,122 sq.m. is RMB1,250,000 as at the date of valuation. - 328 - APPENDIX VIII PROPERTY VALUATION OPEN MARKET VALUE IN EXISTING STATE AS AT PARTICULARS OF 31 AUGUST, 2004 PROPERTIES DESCRIPTION AND TENURE OCCUPANCY RMB 31. A property held The property under development The property is 4,810,000 under construction is planned to comprise a currently under (60% interest by Southern warehouse. Upon completion, the construction. attributable to Airlines (Group) proposed development will have the Group: Shantou Airlines a total gross floor area of 2,890,000) Company Limited approximately 2,058.00 sq.m. (22,152 sq.ft.). The land upon which the property currently erected comprises 1 parcel of land with an area of approximately 3,563.50 sq.m. (38,357.51 sq.ft.). The land use right of the property has been granted for a term of 50 years commencing from 25 May, 1994. Note: We have been provided with a copy of the legal opinion on the title to the property prepared by Z & T Law Firm, the Company's PRC legal adviser, which contains, inter alia, the following information: Southern Airlines (Group) Shantou Airlines Company Limited has obtained the granted land use rights of a parcel of land with an area of approximately 3,563.50 sq.m. and can use, lease, mortgage and transfer the land. - 329 - APPENDIX VIII PROPERTY VALUATION OPEN MARKET VALUE IN EXISTING STATE AS AT PARTICULARS OF 31 AUGUST, 2004 PROPERTIES DESCRIPTION AND TENURE OCCUPANCY RMB 32. A parcel of land The property comprise 1 parcel The property is 7,200,000 held under of land with an area of currently under (60% interest construction by approximately 60,006.35 sq.m. construction. attributable to Zhuhai Airlines (645,908.35 sq.ft.). the Group: Company Limited 4,320,000) The land use right of the property has been granted for a term of 50 years. Note : We have been provided with a copy of the legal opinion on the title to the property prepared by Z & T Law Firm, the Company's PRC legal adviser, which contains, inter alia, the following information: The Company has obtained the Land Use Right Certificate and it has the right to occupy, use and dispose of the land use right within the land use term. - 330 - APPENDIX VIII PROPERTY VALUATION OPEN MARKET VALUE IN EXISTING STATE AS AT PARTICULARS OF 31 AUGUST, 2004 PROPERTIES DESCRIPTION AND TENURE OCCUPANCY RMB 33. Various properties The properties under The properties are No commercial value held under development are planned to currently under construction by comprise 20 buildings and construction. Guizhou Airlines structures. Upon completion, the Company Limited proposed development will have a total gross floor area of approximately 26,434.82 sq.m. (284,544 sq.ft.). The lands upon which the properties currently erected comprise 2 parcels of land with a total area of approximately 259,878.60 sq.m. (2,797,333.25 sq.ft.). The lands are allocated lands. Notes : (1) Since the land of 20 buildings is allocated land and/or the buildings have not obtained the Real Estate Title Certificates, we have attributed no commercial value to the properties. However, for indication purposes, the depreciated replacement costs of the 20 buildings with a total gross floor areas of approximately 26,434.82 sq.m. is RMB22,600,000 as at the date of valuation. (2) We have been provided with a copy of the legal opinion on the title to the properties prepared by Z & T Law Firm, the Company's PRC legal adviser, which contains, inter alia, the following information: (i) The 2 parcels of lands with a total area of 259,878.6 sq.m. are allocated lands and the land use right certificates have been obtained. (ii) The properties with a gross floor area of approximately 26,434.82 sq.m. have legally obtained the approval of construction and no third parties is involved in the dispute of the title. The Group will have the ownership right of the properties and there is no legal impediment in obtaining real estate title certificates after the construction has obtained a completion certificate. - 331 - APPENDIX VIII PROPERTY VALUATION OPEN MARKET VALUE IN EXISTING STATE AS AT PARTICULARS OF 31 AUGUST, 2004 PROPERTIES DESCRIPTION AND TENURE OCCUPANCY RMB 34. Various properties The properties under The properties are No commercial value held under development are planned to currently under construction by comprise 10 buildings and construction. Guangzhou Baiyun structures. Upon completion, the International proposed development will have Logistic Company a total gross floor area of Ltd. approximately 123,928 sq.m. (1,333,961 sq.ft.). The land upon which the properties currently erected comprises 1 parcel of land with an area of approximately 653,333.3 sq.m. (7,032,480 sq.ft.). Notes: (1) We have been provided with a copy of the legal opinion on the title to the properties prepared by Z & T Law Firm, the Company's PRC legal adviser, which contains, inter alia, the following information: (i) Ten buildings under construction with a total gross floor area of approximately 123,928 sq.m. have obtained approvals of construction and there is no third parties dispute on the title. The Group may apply for Building Ownership Certificates after the construction has obtained a completion certificate. (ii) The Group has possessed a parcel of land with an area of approximately 653,333 sq.m., which has no Land Use Right Certificate. (2) Since the land has no title document, we have attributed no commercial value to the properties. However, for indication purposes, the depreciated replacement costs of the 10 buildings with a total gross floor area of approximately 123,928 sq.m. is RMB213,617,983 as at the date of valuation. - 332 - APPENDIX VIII PROPERTY VALUATION OPEN MARKET VALUE IN EXISTING STATE AS AT PARTICULARS OF 31 AUGUST, 2004 PROPERTIES DESCRIPTION AND TENURE OCCUPANCY RMB 35. Various properties The properties comprise 12 The property is No commercial value rented by various operational and ancillary occupied by the China Southern buildings and various structures Group as office, Airlines Company completed in various stages warehouse and staff Limited between 1986 and 1996 with a quarters for operating Guangzhou total gross floor area of and ancillary Headquarters approximately 93,854.35 sq.m. purposes. (1,010,248 sq.ft.) and a parcel of land with an area of approximately 80,909 sq.m. (870,904 sq.ft.). Details of the gross floor areas of the properties are listed as follows: APPROXIMATE USE GROSS FLOOR AREA --- ---------------- sq.m. sq.ft. Offices 33,827.88 364,123 Warehouses 41,405 445,683 Ancillary buildings 18,621.47 200,442 --------- --------- Total: 93,854.35 1,010,248 ========= ========= 7 buildings of the property are rented from independent third parties under tenancy agreements for various terms with the latest expiry date in 2002 at a total annual rental of RMB15,997,315.56. The remaining 5 buildings and the parcel of land together with other structures having an aggregate gross floor area of 52,449.62 sq.m. and site area of approximately 80,909 sq.m. are rented from 1995 at an aggregate annual rental of RMB20,027,523.83. - 333 - APPENDIX VIII PROPERTY VALUATION Note: We have been provided with a copy of the legal opinion on the legality of the use to the properties prepared by Z & T Law Firm, the Company's PRC legal adviser, which contains, inter alia, the following information: (i) CSAHC has obtained the rights to use the above-mentioned parcel of land with an area of approximately 80,909 sq.m. and under the condition of not changing the use of the land, CSAHC can continue to use the land. According to the Permit No. 460 dated 17 November, 2003, CSAHC has obtained the authorization to conduct its trade of business upon the said land and is being entitled to lease the land to its subsidiaries. The Group has obtained the rights to use the land according to the lease agreement and has not acquired the right of handling the property. The property cannot be sub-let, mortgaged or transferred by the Group. (ii) For the remaining portion of property, according to the lease agreement entered into between the Group and the lessor or CSAHC, the Group has obtained the rights to use the property and has not acquired the ownership of the property. - 334 - APPENDIX VIII PROPERTY VALUATION OPEN MARKET VALUE IN EXISTING STATE AS AT PARTICULARS OF 31 AUGUST, 2004 PROPERTIES DESCRIPTION AND TENURE OCCUPANCY RMB 36. Various properties The properties comprise 7 The properties are No commercial value rented by various operational and ancillary occupied by the China Southern buildings and various structures Group as offices for Airlines Company completed in various stages operating purposes. Limited Henan between 1989 and 1993 with a Branch total gross floor area of approximately 917.26 sq.m. (9,873 sq.ft.). Details of the gross floor areas of the properties are listed as follows: APPROXIMATE USE GROSS FLOOR AREA --- ---------------- sq.m. sq.ft. Offices 917.26 9,873 ------ ----- Total: 917.26 9,873 ====== ===== The properties are subject to tenancy agreements for various terms with the latest expiry date in 2010 at a total annual rental of RMB978,416. Note: We have been provided with a copy of the legal opinion on the legality of the use to the properties prepared by Z & T Law Firm, the Company's PRC legal adviser, which contains, inter alia, the following information: According to the lease agreements entered into between the Group and the lessors, the Group has obtained the rights to use the properties and has not acquired the ownership of the properties. - 335 - APPENDIX VIII PROPERTY VALUATION OPEN MARKET VALUE IN EXISTING STATE AS AT PARTICULARS OF 31 AUGUST, 2004 PROPERTIES DESCRIPTION AND TENURE OCCUPANCY RMB 37. Various properties The properties comprise 4 The properties are No commercial value rented by various operational and ancillary occupied by the China Southern buildings and various structures Group as offices for Airlines Company completed in various stages operating purposes. Limited Hubei between 1990 and 1995 with a Branch total gross floor area of approximately 1,112.70 sq.m. (11,977 sq.ft.). Details of the gross floor areas of the properties are listed as follows: APPROXIMATE USE GROSS FLOOR AREA --- ---------------- sq.m. sq.ft. Offices 1,112.70 11,977 -------- ------ Total: 1,112.70 11,977 ======== ====== The properties are subject to tenancy agreements for various terms with the latest expiry date in 2005 at a total annual rental of RMB1,328,840. Note : We have been provided with a copy of the legal opinion on the legality of the use to the properties prepared by Z & T Law Firm, the Company's PRC legal adviser, which contains, inter alia, the following information: According to the lease agreements entered into between the Group and the lessors, the Group has obtained the rights to use the properties and has not acquired the ownership of the properties. - 336 - APPENDIX VIII PROPERTY VALUATION OPEN MARKET VALUE IN EXISTING STATE AS AT PARTICULARS OF 31 AUGUST, 2004 PROPERTIES DESCRIPTION AND TENURE OCCUPANCY RMB 38. Various properties The properties comprise 17 The properties are No commercial value rented by various operational and ancillary occupied by the China Southern buildings and various structures Group as offices and Airlines Company completed in various stages warehouses for Limited Shenzhen between 1991 and 1997 with a operating purposes. Branch total gross floor area of approximately 2,231.5 sq.m. (24,020 sq.ft.). Details of the gross floor areas of the properties are listed as follows: APPROXIMATE USE GROSS FLOOR AREA --- ---------------- sq.m. sq.ft. Offices 2,131.5 2,943 Warehouses 100 1,076 ------- ------ Total: 2,231.5 24,019 ======= ====== The properties are subject to tenancy agreements for various terms with the latest expiry date in 2012 at a total annual rental of RMB261,771.78. Note : We have been provided with a copy of the legal opinion on the legality of the use to the properties prepared by Z & T Law Firm, the Company's PRC legal adviser, which contains, inter alia, the following information: According to the lease agreements entered into between the Group and the lessors, the Group has obtained the rights to use the properties and has not acquired the ownership of the properties. - 337 - APPENDIX VIII PROPERTY VALUATION OPEN MARKET VALUE IN EXISTING STATE AS AT PARTICULARS OF 31 AUGUST, 2004 PROPERTIES DESCRIPTION AND TENURE OCCUPANCY RMB 39. A parcel of land The property comprises a parcel The property is No commercial value rented by of land with an area of currently occupied by China Southern approximately 33,333.50 sq.m. the Group for aircraft Airlines Company (358,802 sq.ft.). runway purposes. Limited Zhuhai Branch The property is rented from an independent third party under a tenancy agreement for a term expiring in 2019 at a total yearly rental of RMB27,500. Note : We have been provided with a copy of the legal opinion on the legality of the use to the property prepared by Z & T Law Firm, the Company's PRC legal adviser, which contains, inter alia, the following information: According to the lease agreement entered into between the Group and the lessor, the Group has obtained the rights to use the property and has not acquired the ownership of the property. - 338 - APPENDIX VIII PROPERTY VALUATION OPEN MARKET VALUE IN EXISTING STATE AS AT PARTICULARS OF 31 AUGUST, 2004 PROPERTIES DESCRIPTION AND TENURE OCCUPANCY RMB 40. Various properties The properties comprise 102 The properties are No commercial value rented by Xiamen various operational and ancillary occupied by the Airlines buildings and various structures Group as offices and with a total gross floor area of staff quarters for approximately 37,543.03 sq.m. operating and (404,113 sq.ft.). ancillary purposes. Details of the gross floor areas of the properties are listed as follows: APPROXIMATE USE GROSS FLOOR AREA --- ---------------- sq.m. sq.ft. Offices 36,730.34 395,365 Ancillary buildings 812.7 8,748 --------- ------- Total: 37,543.04 404,113 ========= ======= The properties are rented from independent third parties under tenancy agreements for various terms with the latest expiry date in 2013 at a total annual rental of RMB13,485,851.48. Note: We have been provided with a copy of the legal opinion on the legality of the use to the property prepared by Z & T Law Firm, the Company's PRC legal adviser, which contains, inter alia, the following information: According to the lease agreements entered into between the Group and the lessors, the Group has obtained the rights to use the properties and has not acquired the ownership of the properties. - 339 - APPENDIX VIII PROPERTY VALUATION OPEN MARKET VALUE IN EXISTING STATE AS AT PARTICULARS OF 31 AUGUST, 2004 PROPERTIES DESCRIPTION AND TENURE OCCUPANCY RMB 41. Various properties The properties comprise 4 The properties are No commercial value rented by Southern various operational and ancillary occupied by the Airlines (Group) buildings and various structures Group as offices and Shantou Airlines completed in various stages with warehouses for Company Limited a total gross floor area of operating and approximately 55,773 sq.m. ancillary purposes. (600,341 sq.ft.) and a parcel of land with a site area of approximately 53,000.00 sq.m. Details of the gross floor areas of the properties are listed as follows: APPROXIMATE USE GROSS FLOOR AREA --- ---------------- sq.m. sq.ft. Offices 366 3,940 Warehouses 2,407 25,909 ----- ------ Total: 2,773 29,849 ===== ====== The properties are rented from independent third parties under tenancy agreements for various terms with the latest expiry date in 2043 at a total annual rental of RMB13,628,783.5. Note: We have been provided with a copy of the legal opinion on the legality of the use to the properties prepared by Z & T Law Firm, the Company's PRC legal adviser, which contains, inter alia, the following information: (i) According to the lease agreements entered into between the Group and the lessors, the Group has obtained the rights to use the properties and has not acquired the ownership of the properties. (ii) Pursuant to the lease agreement of the aforesaid parcel of land with an area of approximately 53,000 sq.m., the buildings erected thereon will be surrendered to the lessor upon expiry of the lease term of 12 years from 1 January, 1997. - 340 - APPENDIX VIII PROPERTY VALUATION OPEN MARKET VALUE IN EXISTING STATE AS AT PARTICULARS OF 31 AUGUST, 2004 PROPERTIES DESCRIPTION AND TENURE OCCUPANCY RMB 42. Various properties The properties comprise 3 The properties are No commercial value rented by Guangxi various operational and ancillary occupied by the Airlines Company buildings and various structures Group as offices for Limited operating purposes. completed in various stages between 1998 and 1999 with a total gross floor area of approximately 250.84 sq.m. (2,700 sq.ft.). Details of the gross floor areas of the properties are listed as follows: APPROXIMATE USE GROSS FLOOR AREA --- ---------------- sq.m. sq.ft. Offices 250.84 2,700 ------ ------ Total: 250.84 2,700 ====== ====== The properties are rented from independent third parties under tenancy agreements for various terms with the latest expiry date in 2006 at a total annual rental of RMB373,508. Note : We have been provided with a copy of the legal opinion on the legality of the use to the properties prepared by Z & T Law Firm, the Company's PRC legal adviser, which contains, inter alia, the following information: According to the lease agreements entered into between the Group and the lessors, the Group has obtained the rights to use the properties and has not acquired the ownership of the properties. - 341 - APPENDIX VIII PROPERTY VALUATION OPEN MARKET VALUE IN EXISTING STATE AS AT PARTICULARS OF 31 AUGUST, 2004 PROPERTIES DESCRIPTION AND TENURE OCCUPANCY RMB 43. Various properties The properties comprise 6 The properties are No commercial value rented by Zhuhai various operational and ancillary occupied by the Airlines Company buildings and various structures Group as offices Limited completed in various stages with for operating a total gross floor area of purposes. approximately 2,135.20 sq.m. (22,983 sq.ft.). Details of the gross floor areas of the properties are listed as follows: APPROXIMATE USE GROSS FLOOR AREA ------ ----------------- sq.m. sq.ft. Offices 2,135.20 22,983 -------- ------ Total: 2,135.20 22,983 ======== ====== The properties are rented from independent third parties under tenancy agreements for various terms with the latest expiry date in 2008 at a total annual rental of RMB604,584. Note: We have been provided with a copy of the legal opinion on the legality of the use to the properties prepared by Z & T Law Firm, the Company's PRC legal adviser, which contains, inter alia, the following information: According to the lease agreements entered into between the Group and the lessors, the Group has obtained the rights to use the properties and has not acquired the ownership of the properties. - 342 - APPENDIX VIII PROPERTY VALUATION OPEN MARKET VALUE IN EXISTING STATE AS AT PARTICULARS OF 31 AUGUST, 2004 PROPERTIES DESCRIPTION AND TENURE OCCUPANCY RMB 44. Various properties The properties comprise 14 various The properties are No commercial value rented by Guizhou operational and ancillary buildings and occupied by the Airlines Company various structures completed in various Group as offices Limited stages between 1988 and 1996 with a and staff quarters total gross floor area of approximately for operating and 2,090.06 sq.m. (22,497 sq.ft.). ancillary purposes. Details of the gross floor areas of the properties are listed as follows: APPROXIMATE USE GROSS FLOOR AREA --- ---------------- sq.m. sq.ft. Offices 1,892.06 20,366 Ancillary buildings 198 2,131 -------- ------ Total: 2,090.06 22,497 ======== ====== The properties are rented from independent third parties under tenancy agreements for various terms with the latest expiry date in 2018 at a total annual rental of RMB3,535,832.15. Note : We have been provided with a copy of the legal opinion on the legality of the use to the properties prepared by Z & T Law Firm, the Company's PRC legal adviser, which contains, inter alia, the following information: According to the lease agreements entered into between the Group and the lessors, the Group has obtained the rights to use the properties and has not acquired the ownership of the properties. - 343 - APPENDIX VIII PROPERTY VALUATION OPEN MARKET VALUE IN EXISTING STATE AS AT PARTICULARS OF 31 AUGUST, 2004 PROPERTIES DESCRIPTION AND TENURE OCCUPANCY RMB 45. A property rented by The property comprise 1 operational and The property is No commercial value Southern China ancillary building with a gross floor occupied by the International area of approximately 90 sq.m. (969 Group as office for Aviation & Travel sq.ft.). operating purposes. Services Company Details of the gross floor area of the property is listed as follows: APPROXIMATE USE GROSS FLOOR AREA --- ---------------- sq.m. sq.ft. Office 90 969 -- --- Total: 90 969 == === The property is rented from an independent third party under a tenancy agreement for a term expiring in 2010 at an annual rental of RMB189,504. Note: We have been provided with a copy of the legal opinion on the legality of the use to the property prepared by Z & T Law Firm, the Company's PRC legal adviser, which contains, inter alia, the following information: According to the lease agreement entered into between the Group and the lessors, the Group has obtained the rights to use the property and has not acquired the ownership of the property. - 344 - APPENDIX VIII PROPERTY VALUATION OPEN MARKET VALUE IN EXISTING STATE AS AT PARTICULARS OF 31 AUGUST, 2004 PROPERTIES DESCRIPTION AND TENURE OCCUPANCY RMB 46. Various properties The properties comprise 99 various The properties are No commercial value rented by China operational and ancillary buildings and occupied by the Southern Airlines various structures completed in various Group for sales Company Limited stages between 1950's and 2000's with office, dormitory Overseas Offices a total gross floor area of and carport purposes. approximately 10,333.19 sq.m. (111,226 sq.ft.) in Japan, Malaysia, Korea, Sharjah U.A.E., Singapore, Australia, Vietnam, The Netherlands, Indonesia, France and USA. According to the information provided by the Group, the properties are rented under tenancy agreements for various terms with the latest expiry date in March 2013 at a total annual rental of RMB21,030,673.18. Note: We have been provided with a copy of the legal opinion on the legality of the use to the properties prepared by Z & T Law Firm, the Company's PRC legal adviser, which contains, inter alia, the following information: According to the lease agreements entered into between the Group and the lessors, the Group has obtained the rights to use the properties and has not acquired the ownership of the properties. - 345 - APPENDIX VIII PROPERTY VALUATION OPEN MARKET VALUE IN EXISTING STATE AS AT PARTICULARS OF 31 AUGUST, 2004 PROPERTIES DESCRIPTION AND TENURE OCCUPANCY RMB 47. Various properties The properties comprise 67 various The properties are No commercial value rented by China operational and ancillary buildings and occupied by the Southern Airlines various structures completed in various Group as offices, Operation Department stages between 1982 and 2003 with a warehouses and total gross floor area of approximately staff quarters for 6,804.85 sq.m. (73,247 sq.ft.). operating and ancillary purposes. Details of the gross floor areas of the properties are listed as follows: APPROXIMATE USE GROSS FLOOR AREA --- ---------------- sq.m. sq.ft. Offices 5,864.85 63,129 Warehouses 580 6,243 Ancillary buildings 360 3,875 -------- ------ Total: 6,804.85 73,247 ======== ====== The properties are rented from independent third parties under tenancy agreements for various terms with the latest expiry date in 2009 at a total annual rental of RMB8,185,479.12. Note: We have been provided with a copy of the legal opinion on the legality of the use to the properties prepared by Z & T Law Firm, the Company's PRC legal adviser, which contains, inter alia, the following information: According to the lease agreements entered into between the Group and the lessors, the Group has obtained the rights to use the properties and has not acquired the ownership of the properties. - 346 - APPENDIX IX GENERAL INFORMATION 1. RESPONSIBILITY STATEMENT This circular includes particulars given in compliance with the Listing Rules for the purpose of giving information with regard to the Listed Group. The Directors collectively and individually accept full responsibility for the accuracy of the information contained in this circular and confirm, having made all reasonable inquiries, that to the best of their knowledge and belief there are no other facts the omission of which would make any statement herein misleading. 2. DISCLOSURE OF INTERESTS OF DIRECTORS AND SUPERVISORS As at the Latest Practicable Date, the interests and short positions of the Directors, chief executive and supervisors of the Company in the shares, underlying shares and debentures (as the case may be) of the Company or its associated corporations (within the meaning of Part XV of the SFO) which were notified to the Company and the Stock Exchange pursuant to SFO (including interests or short positions which are taken or deemed to have under such provisions of the SFO), or recorded in the register maintained by the Company pursuant to Section 352 of the SFO or which were notified to the Company and the Stock Exchange pursuant to the Model Code for Securities Transactions by Directors of the Listed Companies in Schedule 10 of the Listing Rules are as follows: % TO THE % TO THE TOTAL TOTAL % TO THE ISSUED ISSUED TOTAL THE SHARE DOMESTIC ISSUED H COMPANY/ NUMBER OF CAPITAL SHARES SHARES ASSOCIATED TYPE OF TYPE OF SHARES OF THE OF THE OF THE SHORT NAME CORPORATION INTEREST SHARES HELD COMPANY COMPANY COMPANY POSITION -------- ------------ ----------- -------- --------- -------- -------- -------- -------- Simon To the Company Interest of H shares 100,000 0.002% - 0.009% - spouse (Note 1) Note 1. The spouse of Mr. Simon To is the owner of these 100,000 H Shares of the Company and accordingly, Mr. Simon To, is taken to be interested in these 100,000 H Shares by virtue of the SFO. Save as disclosed above, as at the Latest Practicable Date, none of the Directors, chief executive or supervisors of the Company has interests or short positions in the shares, underlying shares and/or debentures (as the case may be) of the Company or its associated corporations (within the meaning of Part XV of the SFO) which were notified to the Company and the Stock Exchange pursuant to SFO (including interests or short positions which he is taken or deemed to have under such provisions of the SFO), or recorded in the register maintained by the Company pursuant to Section 352 of the SFO or which were notified to the Company and the Stock Exchange pursuant to the Model Code for Securities Transactions by Directors of the Listed Companies. None of the Directors, chief executive or supervisors of the Company and their respective associates (as defined in the Listing Rules) has any competing interests which would be required to be disclosed under Rule 8.10 of the Listing Rules if each of them were a controlling shareholder. - 347 - APPENDIX IX GENERAL INFORMATION 3. SUBSTANTIAL SHAREHOLDERS As at the Latest Practicable Date, to the knowledge of the Directors, chief executive and supervisors of the Company, the interests and short positions of the following persons other than the Directors, chief executives or supervisors in the shares and underlying shares of the Company as recorded in the register of the Company required to be kept under Section 336 of the SFO or otherwise persons who are, directly or indirectly, interested in 10% or more of the nominal value of any class of share capital carrying rights to vote in all circumstances at general meetings of any members of the Listed Group are as follows: THE COMPANY % OF THE % OF THE % OF THE TOTAL ISSUED TOTAL ISSUED TOTAL ISSUED SHARES DOMESTIC H SHARES CAPITAL SHARES NAME OF TYPE OF TYPE OF NUMBER OF OF THE OF THE OF THE SHORT SHAREHOLDER SHAREHOLDING SHARES SHARES HELD COMPANY COMPANY COMPANY POSITION ----------- -------------- ----------- ------------ ------------ ------------ ------------ -------- CSAHC Direct holding State-owned 2,200,000,000 - 50.30% 68.75% - shares HKSCC Nominees Direct holding H shares 1,151,389,998 98.6% 26.32% - - Limited Note: Based on the information available to the Directors, chief executive and supervisors of the Company (including such information as was available on the website of the Stock Exchange) and so far as the Directors, chief executive and supervisors are aware, as at the Latest Practicable Date: Among the 1,151,389,998 H Shares held by HKSCC Nominees Limited, JPMorgan Chase & Co. had an interest in an aggregate of 154,610,800 H Shares of the Company (representing approximately 13.17% of its then total issued H Shares). Out of the 154,610,800 H Shares, JPMorgan Chase & Co. had an interest in a lending pool comprising 69,960,000 H Shares of the Company (representing approximately 5.96% of its then total issued H Shares). According to the information as disclosed in the website of the Stock Exchange and so far as the Directors, chief executive and supervisors are aware, JPMorgan Chase & Co. held its interest in the Company in the following manners: (a) 69,960,000 H Shares in a lending pool, representing approximately 5.96% of the Company's then total issued H Shares, were held by JPMorgan Chase Bank, which was 100% held by JPMorgan Chase & Co.; (b) 1,030,800 H Shares, representing approximately 0.09% of the Company's then total issued H Shares, were held in the capacity as beneficial owner by JPMorgan Whitefriars Inc., which was ultimately 100% held by JPMorgan Chase & Co.; (c) 81,978,000 H Shares, representing approximately 6.98% of the Company's then total issued H Shares, were held in the capacity as investment manager by JF Asset Management Limited, which was approximately 99.99% held by JPMorgan Fleming Asset Management (Asia) Inc., which was ultimately 100% held by JPMorgan Chase & Co.; and (d) 1,642,000 H Shares, representing approximately 0.14% of the Company's then total issued H Shares, were held in the capacity as investment manager by JF International Management Inc., which was 100% held by JPMorgan Fleming Asset Management (Asia) Inc., which was ultimately 100% held by JPMorgan Chase & Co. - 348 - APPENDIX IX GENERAL INFORMATION Save as disclosed above, as at the Latest Practicable Date, to the knowledge of the Directors, chief executive and supervisors of the Company, no other person (other than the Directors, chief executives or supervisors) had an interest or short positions in the shares or underlying shares of the Company as recorded in the register of the Company required to be kept under section 336 of the SFO or otherwise had an interest of 10% or more of the nominal value of any class of share capital carrying rights to vote in all circumstances at general meetings of any members of the Group. 4. MATERIAL CONTRACTS No material contract has been entered into by the Listed Group within the two years immediately preceding the date of this circular. 5. LITIGATION As at the Latest Practicable Date, there was no litigation or claims of material importance pending or threatened against any member of the Listed Group. 6. PROCEDURES FOR DEMANDING A POLL BY SHAREHOLDERS Pursuant to Article 77 of the Articles of Association of the Company, at any general meeting of shareholders of the Company, a resolution shall be decided on a show of hands unless a poll is (before or after any vote by show of hands) demanded: i. by the chairman of the meeting; ii. by at least two shareholders entitled to vote present in person or by proxy; or iii. by one or more shareholders present in person or by proxy and representing 10 per cent or more of all shares carrying the right to vote at the meeting. The demand for a poll may be withdrawn by the person who makes such demand. 7. DIRECTORS' AND SUPERVISORS' INTERESTS (a) None of the Directors or supervisors of the Company, or any professional advisers named in paragraph 11 of this Appendix has any direct or indirect interest in any assets which have been, since 31 December, 2003, the date to which the latest published audited accounts of the Listed Group were made up, acquired or disposed of by or leased to, or which are proposed to be acquired or disposed of by, or leased to, to any member of the Listed Group. (b) None of the Directors or supervisors of the Company is materially interested in any contract or arrangement subsisting at the date of this circular and which is significant in relation to the business of the Listed Group. - 349 - APPENDIX IX GENERAL INFORMATION 8. SERVICE CONTRACTS None of the Directors has any existing or proposed service contract with any member of the Listed Group which is not expiring or terminable by the Listed Group within one year without payment of compensation (other than statutory compensation). 9. MATERIAL ADVERSE CHANGE The Directors are not aware of any material adverse change in the financial or trading position of the Listed Group since 31 December, 2003, being the date of the latest published audited financial statements of the Company. 10. CONSENTS JPMorgan, ICEA, KPMG and Chesterton have given and have not withdrawn their respective written consents to the issue of this circular with the inclusion of their reports and letters (if any), as the case may be, and references to their names in the form and context in which they respectively appear. 11. QUALIFICATIONS OF EXPERTS The following are the qualifications of the professional advisers who have given opinions or advice contained in this circular. NAMES QUALIFICATIONS ----- -------------- JPMorgan Licensed by the Securities and Futures Commission for Types 1, 4, 6 and 7 regulated activities under SFO ICEA Deemed licensed by the Securities and Futures Commission for Types 1, 4, 6 and 9 regulated activities under SFO KPMG Certified Public Accountants registered in Hong Kong Chesterton Chartered Surveyor - 350 - APPENDIX IX GENERAL INFORMATION 12. EXPERTS' INTERESTS IN ASSETS As at the Latest Practicable Date, each of JPMorgan, ICEA, KPMG and Chesterton: (a) was not interested, directly or indirectly in any assets which have been acquired or disposed of by or leased to the Company since 31 December, 2003, being the date to which the latest published audited financial statements of the Company were made up; and (b) did not have any shareholding interest in any member of the Listed Group or any right (whether legally enforceable or not) to subscribe for or to nominate persons to subscribe for securities in any member of the Listed Group. 13. MISCELLANEOUS (a) The secretary of the Company is Su Liang. (b) The Company has not currently appointed an individual who will satisfy all the requirements of a qualified accountant for the purposes of Rule 3.24 of the Listing Rules, pursuant to which the Company has published an announcement on 5 November, 2004. (c) The registered address of the Company is at Guangzhou Economic and Technology Development Zone, Guangdong Province, PRC and the principal place of business of the Company in Hong Kong is at Unit B1, 9th Floor, United Centre, 95 Queensway, Hong Kong. (d) The Hong Kong branch share registrar and transfer office of the Company is Hong Kong Registrars Limited, 46th Floor, Hopewell Centre, 183 Queen's Road East, Hong Kong. (e) The English text of this circular and the form of proxy shall prevail over the Chinese text in the case of inconsistency. 14. DOCUMENTS AVAILABLE FOR INSPECTION Copies of the following documents are available for inspection during normal business hours at the principal place of business of the Company in Hong Kong at Unit B1, 9th Floor, United Centre, 95 Queensway, Hong Kong up to and including 3 December, 2004: (a) Sale and Purchase Agreement; (b) Lease Agreement 1, Lease Agreement 2 and Lease Agreement 3; - 351 - APPENDIX IX GENERAL INFORMATION (c) Catering Agreement; (d) Financial Services Agreement; (e) the accountants' reports of the Airline Operations of Northern Airlines Group and the Airline Operations of Xinjiang Airlines Group for each of the years in the three-year period ended 31 December, 2003 and the six-month period ended 30 June, 2004, the text of which is set out in Appendices II and III to this circular respectively; (f) the audited financial statements of the Company for each of the three financial years immediately preceding the issue of this circular; (g) the interim financial reports of the Company for the six-month periods ended 30 June, 2003 and 2004; (h) the letters of consent referred to in paragraph 10 of this Appendix; (i) the report from KPMG on the unaudited pro forma financial information of the Combined Group dated 12 November, 2004 the text of which is set out in Appendix V to this circular; (j) the letter from ICEA dated 12 November, 2004 the text of which is set out on pages 29 to 48 of this circular; (k) the letter from the Independent Board Committee to the Independent Shareholders dated 12 November, 2004, the text of which is set out on pages 27 to 28 of this circular; (l) the letters relating to the profit forecast, the text of which is set out in Appendix VI of this circular; (m) the letter dated 12 November, 2004, summary of values and valuation certificate prepared by Chesterton, the texts of which are set out in Appendix VIII to this circular, and the full valuation report (in the Chinese language only) prepared by Chesterton referred to in Appendix VIII; (n) the Zhong Qi Hua Valuation Reports; (o) articles of association of the Company; and (p) the major transaction circular of the Company dated 21 May, 2004 in relation to the acquisition of certain aircraft from Airbus SNC. - 352 - NOTICE OF THE EGM [CHINESE CHARACTER] [LOGO] CHINA SOUTHERN AIRLINES COMPANY LIMITED (A JOINT STOCK LIMITED COMPANY INCORPORATED IN THE PEOPLE'S REPUBLIC OF CHINA WITH LIMITED LIABILITY) (STOCK CODE: 1055) NOTICE OF THE SECOND EXTRAORDINARY GENERAL MEETING IN 2004 NOTICE IS HEREBY GIVEN that an extraordinary general meeting (the "EGM") of China Southern Airlines Company Limited (the "Company") will be held at No. 278, Ji Chang Road, Guangzhou, Guangdong Province, the PRC on 31 December, 2004 at 9:00 a.m. for the purpose of considering and passing the following resolutions as ordinary resolutions: ORDINARY RESOLUTIONS (1) "THAT the entering into of the sale and purchase agreement dated 12 November, 2004, copy of which has been produced to this meeting marked "A" and initialed by the Chairman of this meeting for the purpose of identification, between China Southern Air Holding Company ("CSAHC"), China Northern Airlines Company ("Northern Airlines") and Xinjiang Airlines Company ("Xinjiang Airlines") as vendors and the Company as purchaser and the transactions contemplated thereunder, upon the terms and subject to the conditions therein contained, be and are hereby unconditionally approved." (2) "THAT the entering into of the lease agreement dated 12 November, 2004, copy of which has been produced to this meeting marked "B" and initialed by the Chairman of this meeting for the purpose of identification, between the Company, CSAHC and Northern Airlines, and the transactions contemplated thereunder, upon the terms and subject to the conditions therein contained, be and are hereby unconditionally approved." (3) "THAT the entering into of the lease agreement dated 12 November, 2004, copy of which has been produced to this meeting marked "C" and initialed by the Chairman of this meeting for the purpose of identification, between the Company, CSAHC and Xinjiang Airlines, and the transactions contemplated thereunder, upon the terms and subject to the conditions therein contained, be and are hereby unconditionally approved." (4) "THAT the entering into of the lease agreement dated 12 November, 2004, copy of which has been produced to this meeting marked "D" and initialed by the Chairman of this meeting for the purpose of identification, between the Company and CSAHC, and the transactions contemplated thereunder, upon the terms and subject to the conditions therein contained, be and are hereby unconditionally approved." (5) "THAT the entering into of the catering agreement dated 12 November, 2004, copy of which has been produced to this meeting marked "E" and initialed by the Chairman of this meeting for the purpose of identification, between the Company and China Southern Airlines Group Air Catering Company Limited, and the transactions contemplated thereunder, upon the terms and subject to the conditions therein contained, be and are hereby unconditionally approved." - 353 - NOTICE OF THE EGM (6) "THAT the entering into of the financial services agreement dated 12 November, 2004, copy of which has been produced to this meeting marked "F" and initialed by the Chairman of this meeting for the purpose of identification, between the Company and Southern Airlines Group Finance Company Limited, and the transactions contemplated thereunder, upon the terms and subject to the conditions therein contained, be and are hereby unconditionally approved." (7) "THAT the proposed resignation of Mr. Wang Chang Shun as a director of the Company be and is hereby approved." (8) "THAT the proposed election of Mr. Si Xian Min, as nominated by China Southern Air Holding Company in accordance with the Articles of Association of the Company, as a director of the fourth session of the Board of the Company (the biography of Mr. Si Xian Min is set out below) be and is hereby approved." By Order of the Board SU LIANG Company Secretary Guangzhou, the People's Republic of China 12 November, 2004 As at the date of this notice, the Directors of the Company include Yan Zhi Qing, Liu Ming Qi, Wang Chang Shun, Peng An Fa, Wang Quan Hua, Zhao Liu An, Zhou Yong Qian, Zhou Yong Jin, Xu Jie Bo and Wu Rong Nan as executive Directors; and Simon To, Peter Lok, Wei Ming Hai, Wang Zhi and Sui Guang Jun as independent non-executive Directors. Notes: 1. PERSONS WHO ARE ENTITLED TO ATTEND THE EGM a. Holders of H shares of the Company who are registered with Hong Kong Registrars Limited, the registrar of H shares of the Company, at the close of trading in the afternoon of Tuesday, 30 November, 2004 ("Eligible Shareholders") or their representatives are entitled to attend the EGM after completion of the required registration procedures in accordance with Note 2 "Registration procedures for attending the EGM". Holders of A shares of the Company shall receive a notice separately. b. The directors, supervisors and senior management of the Company. c. Representatives of the professional advisers hired by the Company and special guests invited by the board of directors of the Company. 2. REGISTRATION PROCEDURES FOR ATTENDING THE EGM a. Eligible Shareholders who intend to attend the EGM either in person or by proxy must deliver to the Company on or before Friday, 10 December, 2004, in person or by post at the registration address of the Company, or by fax at (+86) 20-8665 9040, the reply slip, which is attached to the notice of the EGM as Attachment A. b. When attending the EGM, individual Eligible Shareholder or his/her proxy shall bring along his/her identity card. The legal representative of a corporate Eligible Shareholder attending the EGM shall bring along his/her identity card, together with a notarized copy of the resolution or power of attorney issued by the board of directors or other governing body of the corporate Eligible Shareholder to appoint such legal representative to attend the meeting. c. Holders of H shares of the Company who intend to attend the EGM must deliver their instruments of transfer together with the relevant share certificates to Hong Kong Registrars Limited, the registrar of H Shares of the Company, at Shops 1712-1716, 17th Floor, Hopewell Centre, 183 Queen's Road East, Hong Kong, at or before 4:00 p.m. on Tuesday, 30 November, 2004. - 354 - NOTICE OF THE EGM d. The register of H shares of the Company will be closed from Wednesday, 1 December, 2004 to Thursday, 30 December, 2004 (both days inclusive), during which period no transfer of H shares will be registered. 3. PROXIES a. An Eligible Shareholder has the right to appoint one or more proxies to attend the EGM and vote on his/her behalf. A proxy does not need to be a shareholder of the Company. b. A proxy must be appointed by an Eligible Shareholder or his/her attorney by way of a form of proxy for extraordinary general meeting, which is attached to the notice of EGM as Attachment B. If the proxy is appointed by the attorney of an Eligible Shareholder, the power of attorney or other authorization document(s) authorizing such attorney to appoint the proxy must be notarized. c. To be valid, the notarized power of attorney or other authorization document(s), together with the completed form of proxy for the EGM, must be lodged with Hong Kong Registrars Limited at 46th Floor, Hopewell Centre, 183 Queen's Road East, Hong Kong, not less than 24 hours before the time designated for the holding of the EGM. 4. MISCELLANEOUS a. The EGM is expected to last for approximately one day. Eligible Shareholders who attend shall bear their own traveling and accommodation expenses. b. The address of the headquarters of the Company is: 1st Floor, No. 278 Ji Chang Road Guangzhou 510405, Guangdong Province People's Republic of China Telephone No.: (+86) 20-8612 4737 Facsimile No.: (+86) 20-8665 9040 Website: www.cs-air.com Contact persons: Su Liang and Lei Bin c. Pursuant to the Article 77 of the Articles of Association of the Company, at any general meeting of shareholders of the Company, a resolution shall be decided on a show of hands unless a poll is (before or after any vote by show of hands) demanded: i. by the chairman of the meeting; ii. by at least two shareholders entitled to vote present in person or by proxy; or iii. by one or more shareholders present in person or by proxy and representing 10 per cent or more of all shares carrying the right to vote at the meeting. The demand for a poll may be withdrawn by the person who makes such demand. 5. BRIEF BIOGRAPHY OF MR. SI XIAN MIN Mr. Si Xian Min, born in November 1957, graduated from No. 14 Aviation College as an aircraft piloting major with an associate's degree. A professional political tutor, he began his career in civil aviation in 1975. He has held positions as Deputy Director and Director of the political division of China Southern Airlines Henan Branch in 1992-1998 and Party Secretary and Vice president of Guizhou Airlines in 1998-2000. From 2000 to July 2003, Mr. Si served as Deputy Party Secretary of China Southern Airlines Company Limited. From 2002 to July 2003, he served concurrently as Secretary of the Disciplinary Department of China Southern Airlines Company Limited. He has been Party Secretary of China Northern Airlines since 2003. Mr. Si Xian Min has no interests or short positions in the shares, underlying shares or debentures of the Company or its associated corporations (within the meaning of Part XV of the Securities and Futures Ordinance) which is notifiable to the Company and The Stock Exchange of Hong Kong Limited pursuant to the Securities and Futures Ordinance (including interests or short positions which are taken or deemed to have under such provisions of the Securities and Futures Ordinance) or required to be recorded in the register maintained by the Company pursuant to Section 352 of the Securities and Futures Ordinance or which is notifiable to the Company and The Stock Exchange of Hong Kong Limited pursuant to the "Model Code for Securities Transactions by Directors of the Listed Companies" in Schedule 10 of the Rules Governing the Listing of Securities on The Stock Exchange of Hong Kong Limited. Further, save as disclosed, Mr. Si Xian Min is not connected with any directors, senior management, substantial shareholders or controlling shareholders of the Company. - 355 - SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. CHINA SOUTHERN AIRLINES COMPANY LIMITED By /s/ Su Liang ------------------------------------- Name: Su Liang Title: Company Secretary Date: November 29, 2004