20-F 1 d478859d20f.htm FORM 20-F Form 20-F
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION,

WASHINGTON, D.C. 20549

 

 

FORM 20-F

 

 

 

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

OR

 

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

For the fiscal year ended December 31, 2017

OR

 

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

For the transition period from                      to                     

OR

 

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

Date of event requiring this shell company report                     

Commission file number 1-14660

 

 

 

 

(Exact name of Registrant as specified in its charter)

 

 

CHINA SOUTHERN AIRLINES COMPANY LIMITED

(Translation of Registrant’s name into English)

THE PEOPLE’S REPUBLIC OF CHINA

(Jurisdiction of incorporation or organization)

278 JI CHANG ROAD

GUANGZHOU, 510405

PEOPLE’S REPUBLIC OF CHINA

(Address of principal executive offices)

Mr. Xie Bing

Telephone: +86 20 86124462

E-mail: ir@csair.com

Fax: +86 20 86659040

Address: 278 JI CHANG ROAD

GUANGZHOU, 510405

PEOPLE’S REPUBLIC OF CHINA

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

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

 

Title of each class

 

Name of each exchange on which registered

Ordinary H Shares of par value
RMB1.00 per share
represented by American
Depositary Receipts
  New York Stock Exchange

Securities registered or to be registered pursuant to Section 12(g) of the Act:

None

Securities for which there is a reporting obligation pursuant to Section 15(d) of the Act.

None

 

 

Indicate the number of outstanding shares of each of the issuer’s classes of capital or common stock as of the close of the period covered by the annual report: 7,022,650,000 A Shares of par value RMB1.00 per share and 3,065,523,272 H Shares of par value RMB1.00 per share.

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    ☐  Yes    ☒  No

If this report is an annual or transition report, indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.    ☐  Yes    ☒  No

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    ☒  Yes    ☐  No

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    ☒  Yes    ☐  No

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer        Accelerated filer  
Non-accelerated filer        Emerging growth company  

If an emerging growth company that prepares its financial statements in accordance with U.S. GAAP, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards† provided pursuant to Section 13(a) of the Exchange Act.  ☐

 

The term “new or revised financial accounting standard” refers to any update issued by the Financial Accounting Standards Board to its Accounting Standards Codification after April 5, 2012.

Indicate by check mark which basis of accounting the registrant has used to prepare the financial statements included in this filing:

 

U.S. GAAP  ☐

    

International Financial Reporting Standards as issued

by the International Accounting Standards Board  ☒

   Other  ☐

If “Other” has been checked in response to the previous question, indicate by check mark which financial statement Item the registrant has elected to follow.    ☐ Item  17    ☐ Item  18

If this is an annual report, indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    ☐  Yes    ☒  No

 

 

 


Table of Contents

TABLE OF CONTENTS

 

FORWARD-LOOKING STATEMENTS      1  
INTRODUCTORY NOTE      2  
GLOSSARY OF AIRLINE INDUSTRY TERMS      3  
PART I      5  
ITEM 1. IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS      5  
ITEM 2. OFFER STATISTICS AND EXPECTED TIMETABLE      5  
ITEM 3. KEY INFORMATION      5  

A.  Selected financial data.

     5  

B.  Capitalization and Indebtedness

     7  

C.  Reasons for the Offer and Use of Proceeds

     7  

D.  Risk Factors

     7  
ITEM 4. INFORMATION ON THE COMPANY      16  

A.  History and Development of our Company

     16  

B.  Business Overview

     20  

C.  Organizational Structure

     43  

D.  Property, Plant and equipment

     44  
ITEM 4A. UNRESOLVED STAFF COMMENTS      45  
ITEM 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS      45  

A.  Operating Results

     49  

B.  Liquidity and Capital Resources

     55  

C.  Research and Development, Patents and Licenses, etc.

     56  

D.  Trend information

     57  

E.   Off-Balance Sheet Arrangements

     57  

F.   Tabular Disclosure of Contractual Obligations

     57  
ITEM 6. DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES      58  

A.  Directors, Senior Management and Employees

     58  

B.  Compensation

     65  

C.  Board Practices

     66  

D.  Employees

     67  

E.   Share Ownership

     68  
ITEM 7. MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS      68  

A.  Major Shareholders

     68  

B.  Related Party Transactions

     69  

C.  Interests of Experts and Counsel

     79  
ITEM 8. FINANCIAL INFORMATION      80  

A.  Consolidated Statements and Other Financial Information

     80  

B.  Significant Changes

     80  

 

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ITEM 9. THE OFFER AND LISTING      81  

A.  Offer and listing details

     81  

B.  Plan of Distibution

     81  

C   Markets

     81  

D.  Selling Shareholders

     81  

E.  Dilution

     82  

F.   Expenses of the Issue

     82  
ITEM 10. ADDITIONAL INFORMATION      82  

A.  Share Capital

     82  

B.  Memorandum and Articles of Association

     82  

C    Material Contracts

     86  

D.  Exchange Controls

     86  

E.   Taxation

     87  

F.   Dividends and Paying Agents

     91  

G.  Statement By Experts

     91  

H.  Documents on Display

     91  

I.    Subsidiary Information

     92  
ITEM 11. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK      92  
ITEM 12. DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES      93  
ITEM 13. DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES      95  
ITEM 14. MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF PROCEEDS      95  
ITEM 15. CONTROLS AND PROCEDURES      95  
ITEM 16A. AUDIT AND RISK MANAGEMENT COMMITTEE FINANCIAL EXPERT      98  
ITEM 16B. CODE OF ETHICS      98  
ITEM 16C. PRINCIPAL ACCOUNTANT FEES AND SERVICES      98  
ITEM 16D. EXEMPTIONS FROM THE LISTING STANDARDS FOR AUDIT AND RISK MANAGEMENT COMMITTEE      98  
ITEM 16E. PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED PURCHASERS      98  
ITEM 16F. CHANGES IN REGISTRANT’S CERTIFYING ACCOUNTANT      99  
ITEM 16G. CORPORATE GOVERNANCE      100  
ITEM 16. MINE SAFETY DISCLOSURE      102  
ITEM 17. FINANCIAL STATEMENTS      103  
ITEM 18. FINANCIAL STATEMENTS      103  
ITEM 19. EXHIBITS      103  

 

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FORWARD-LOOKING STATEMENTS

This Annual Report contains forward-looking statements. These statements appear in a number of different places in this Annual Report. A forward-looking statement is usually identified by the use in this Annual Report of certain terminology such as “estimate”, “project”, “expect”, “intend”, “believe”, “plan”, “anticipate”, “may”, or their negatives or other comparable words. Also look for discussions of strategy that involve risks and uncertainties. Forward-looking statements include statements regarding the outlook for our future operations, forecasts of future costs and expenditures, evaluation of market conditions, the outcome of legal proceedings (if any), the adequacy of reserves, or other business plans. You are cautioned that such forward-looking statements are not guarantees and involve risks, assumptions and uncertainties. Our actual results may differ materially from those in the forward-looking statements due to risks facing our Company or due to actual facts differing from the assumptions underlying those forward-looking statements.

Some of these risks and assumptions, in addition to those identified under Item 3, “Key Information - Risk Factors,” include:

 

    general economic and business conditions in markets where our Company operates, including changes in interest rates;

 

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

 

    natural phenomena;

 

    the impact of unusual events on our business and operations;

 

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

 

    our relationship with China Southern Air Holding Limited Company (“CSAH”);

 

    uncertainties associated with legal proceedings;

 

    technological development;

 

    our ability to attract key personnel and attract new talent;

 

    future decisions by management in response to changing conditions;

 

    the Company’s ability to execute prospective business plans;

 

    the availability of qualified flight personnel and airport facilities; and

 

    misjudgments in the course of preparing forward-looking statements.

Our Company advises you that these cautionary remarks expressly qualify in their entirety all forward-looking statements attributable to our Company, our Group and persons acting on their behalf.

 

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INTRODUCTORY NOTE

In this Annual Report, unless the context indicates otherwise, the “Company”, “we”, “us” and “our” means China Southern Airlines Company Limited, a joint stock company incorporated in China on March 25, 1995, our “Group” means our Company and our consolidated subsidiaries, and “CSAH” means China Southern Air Holding Limited Company, our Company’s parent company which directly and indirectly holds a 50.65% interest in our Company as of April 26, 2018.

References to “China” or the “PRC” are to the People’s Republic of China, excluding Hong Kong, Macau and Taiwan. References to “Renminbi” or “RMB” are to the currency of China, references to “U.S. dollars”, “$” or “US$” are to the currency of the United States of America (the “U.S.” or “United States”), and reference to “HK$” is to the currency of Hong Kong. Reference to the “Chinese government” is to the national government of China. References to “Hong Kong” or “Hong Kong SAR” are to the Hong Kong Special Administrative Region of the PRC. References to “Macau” or “Macau SAR” are to the Macau Special Administrative Region of the PRC.

Our Company presents our consolidated financial statements in Renminbi. The consolidated financial statements of our Company have been prepared in accordance with all applicable International Financial Reporting Standards (“IFRSs”), which collective term includes all applicable individual IFRSs, International Accounting Standards (“IASs”) and Interpretations issued by the International Accounting Standards Board (the “IASB”).

Solely for the convenience of the readers, this Annual Report contains translations of certain Renminbi amounts into U.S. dollars at the rate of US$1.00 = RMB6.5342, which is the average of the buying and selling rates as quoted by the People’s Bank of China at the close of business on December 29, 2017. No representation is made that the Renminbi amounts or U.S. dollar amounts included in this Annual Report could have been or could be converted into U.S. dollars or Renminbi, as the case may be, at any particular rate or at all. Any discrepancies in the tables included herein between the amounts listed and the totals are due to rounding.

 

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GLOSSARY OF AIRLINE INDUSTRY TERMS

In this Annual Report, unless the context indicates otherwise, the following terms have the respective meanings set forth below.

 

Capacity   
“available seat kilometers” or “ASK”    the number of seats made available for sale multiplied by the kilometers flown
“available ton kilometers” or “ATK”    the tons of capacity available for the transportation of revenue load (passengers and cargo) multiplied by the kilometers flown
Traffic   
“revenue passenger kilometers” or “RPK”    i.e. passenger traffic volume, the number of passengers carried multiplied by the kilometers flown
“revenue ton kilometers” or “RTK”    i.e. total traffic volume, the load (passenger and cargo) in tons multiplied by the kilometers flown
“revenue ton kilometers-cargo” or “RFTK”    i.e. cargo and mail traffic volume or revenue ton kilometers for cargo, the load (cargo) in tons multiplied by the kilometers flown
“revenue ton kilometers-passenger”    the load (passenger) in tons multiplied by the kilometers flown
“ton”    a metric ton, equivalent to 2,204.6 pounds
Yield   
“yield per RPK”    revenue from passenger operations divided by RPK
“yield per RFTK”    revenue from cargo operations divided by RFTK
“yield per RTK”    revenue from airline operations (passenger and cargo) divided by RTK
Cost   
“operating cost per ATK”    operating expenses divided by ATK
Load Factors   
“overall load factor”    RTK expressed as a percentage of ATK
“passenger load factor”    RPK expressed as a percentage of ASK
Utilization   
“utilization rates”    flight hours that aircraft can service during specified time
Equipment   
“expendables”    aircraft parts that are ordinarily used up and replaced with new parts
“rotables”    aircraft parts that are ordinarily repaired and reused
Others   
“ADR”    American Depositary Receipt
“A Shares”    Shares issued by our Company to investors in the PRC for subscription in RMB, with par value of RMB1.00 each
“CSAH”    China Southern Air Holding Limited Company, formerly known as China Southern Air Holding Company
“CAAC”    Civil Aviation Administration of China
“CAOSC”    China Aviation Oil Supplies Company

 

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“CSRC”    China Securities Regulatory Commission
“H Shares”    Shares issued by our Company, listed on The Stock Exchange of Hong Kong Limited and subscribed for and traded in Hong Kong dollars, with par value of RMB1.00 each
“Nan Lung”    Nan Lung Holding Limited (a wholly-owned subsidiary of CSAH)
“NDRC”    National Development and Reform Commission of China
“SA Finance”    Southern Airlines Group Finance Company Limited
“SAFE”    State Administration of Foreign Exchange of China
“SEC”    United States Securities and Exchange Commission
“SPVs”    China Southern Airlines No. 1 Lease (Tianjin); China Southern Airlines No. 2 Lease (Tianjin); China Southern Airlines No. 3 Lease (Tianjin); China Southern Airlines No. 4 Lease (Guangzhou); China Southern Airlines No. 5 Lease (Tianjin); China Southern Airlines No. 6 Lease (Tianjin); China Southern Airlines No. 7 Lease (Tianjin); China Southern Airlines No. 8 Lease (Tianjin); China Southern Airlines No. 9 Lease (Guangzhou); China Southern Airlines No. 12 Lease (Tianjin); China Southern Airlines No. 13 Lease (Tianjin); and China Southern Airlines No. 14 Lease (Tianjin)

 

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PART I

 

ITEM 1. IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS

Not applicable.

 

ITEM 2. OFFER STATISTICS AND EXPECTED TIMETABLE

Not applicable.

 

ITEM 3. KEY INFORMATION

 

A. SELECTED FINANCIAL DATA.

The following tables present selected financial data for the five-year period ended December 31, 2017. The selected consolidated income statement data (other than ADR data) for the three-year period ended December 31, 2015, 2016 and 2017 and selected consolidated statement of financial position data as of December 31, 2016 and 2017 are derived from the audited consolidated financial statements of our Company, included elsewhere in this Annual Report. The selected consolidated income statement data (other than ADR data) for the years ended December 31, 2013 and 2014 and selected consolidated statement of financial position data as of December 31, 2013, 2014 and 2015 are derived from our Company’s audited consolidated financial statements that are not included in this Annual Report.

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

 

     Year ended 31,  
    

2017

US$

    2017
RMB
    2016
RMB
    2015
RMB
    2014
RMB
    2013
RMB
 
     (in million, except per share and per ADR data)  

Consolidated Income Statement Data

            

Operating revenue

     19,560       127,806       114,981       111,652       108,584       98,547  

Operating expenses

     (18,839     (123,098     (106,204     (101,492     (106,026     (98,280

Operating profit

     1,401       9,156       12,612       13,438       4,748       1,510  

Profit before income tax

     1,358       8,874       7,661       6,118       3,066       3,484  

Profit for the year

     1,056       6,898       5,898       4,818       2,398       2,750  

Profit attributable to:

            

Equity shareholders of our Company

     912       5,961       5,044       3,736       1,777       1,986  

Non-controlling interests

     143       937       854       1,082       621       764  

Basic and diluted earnings per share

     0.09       0.60       0.51       0.38       0.18       0.20  

Basic and diluted earnings per ADR(1)

     4.59       30.03       25.69       19.03       9.05       10.11  

Other Financial Data

            

Cash dividends declared per share

     0.02       0.10       0.10       0.08       0.04       0.04  

 

(1) Basic and diluted earnings per share have been computed by dividing profit attributable to equity shareholders of our Company by the weighted average number of shares in issue. Basic and diluted earnings per ADR have been computed as if all of our issued or potential ordinary shares, including domestic shares and H shares, are represented by ADRs during each of the years presented. Each ADR represents 50 shares.

 

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     Year ended 31,  
     2017
US$
     2017
RMB
     2016
RMB
     2015
RMB
     2014
RMB
     2013
RMB
 
     (in million, except per share and per ADR data)  

Consolidated Statement of Financial Position Data:

                 

Cash and cash equivalents

     1,045        6,826        4,152        4,560        15,414        11,748  

Total current assets, excluding cash and cash equivalents

     1,692        11,058        9,612        9,553        12,127        8,825  

Property, plant and equipment, net

     24,322        158,926        146,746        142,870        134,453        119,777  

Total assets

     33,473        218,718        200,442        185,989        189,688        165,207  

Current borrowings

     4,219        27,568        26,746        30,002        20,979        20,242  

Current portion of obligations under finance leases

     1,277        8,341        8,695        6,416        5,992        3,636  

Non-current borrowings

     3,171        20,719        18,758        15,884        42,066        37,246  

Obligations under finance leases, excluding current portion

     9,119        59,583        53,527        49,408        43,919        31,373  

Total equity

     9,572        62,543        54,976        49,624        44,493        42,451  

Number of shares (in million)

     10,088        10,088        9,818        9,818        9,818        9,818  

Selected Operating Data    

The operating data and the profit analysis and comparison below is calculated and disclosed in accordance with the statistical standards, which have been implemented by our Group since January 1, 2001. See “Glossary of Airline Industry Terms” at the front of this Annual Report for definitions of certain terms used herein.

 

     Year ended December 31,  
     2017      2016      2015      2014      2013  

Capacity

              

ASK (million)

     280,646        255,992        235,616        209,807        186,800  

ATK (million)

     38,332        34,980        32,205        28,454        24,952  

Kilometers flown (thousand)

     1,623,014        1,504,310        1,408,500        1,275,570        1,147,070  

Hours flown (thousand)

     2,567        2,375        2,238        2,026        1,829  

Number of landing and take-offs

     1,010,460        959,110        936,750        884,070        809,870  

Traffic

              

RPK (million)

     230,697        206,106        189,588        166,629        148,417  

RTK (million)

     27,321        24,387        22,388        19,780        17,469  

Passengers carried (thousand)

     126,299        114,619        109,422        100,919        91,791  

Cargo and mail carried (tons)

     1,672,162        1,612,550        1,511,550        1,433,250        1,276,350  

Load Factors

              

Passenger load factor (RPK/ASK) (%)

     82.2        80.5        80.5        79.4        79.4  

Overall load factor (RTK/ATK) (%)

     71.3        69.7        69.5        69.5        70.0  

Yield

              

Yield per RPK (RMB)

     0.49        0.50        0.53        0.58        0.59  

Yield per RFTK (RMB)

     1.30        1.16        1.21        1.42        1.48  

Yield per RTK (RMB)

     4.46        4.50        4.78        5.27        5.42  

Fleet

              

- Boeing

     407        372        351        311        282  

- Airbus

     321        304        290        276        253  

- Others

     26        26        26        25        26  

Total aircraft in service at period end

     754        702        667        612        561  

Average daily utilization rate (hours per day)

     9.79        9.53        9.6        9.6        9.6  

 

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Exchange Rate Information

The following table sets forth certain information concerning exchange rates, based on the noon buying rates in New York City for cable transfers in foreign currencies, as certified for customs purposes by the Federal Reserve Bank of New York (the “Noon Buying Rate”), between Renminbi and U.S. dollars for the five most recent financial years.

 

     Renminbi per U.S. Exchange Rate (1)  

Period

   Average(2)      Low      High      Period—end  

Exchange Rate

           

2013

     6.1412        6.0537        6.2213        6.0537  

2014

     6.1704        6.0402        6.2591        6.2046  

2015

     6.2869        6.1870        6.4896        6.4778  

2016

     6.6400        6.4480        6.9580        6.9430  

2017

     6.7569        6.4773        6.9575        6.5063  

October

     6.6254        6.5712        6.6533        6.6328  

November

     6.6200        6.5967        6.6385        6.6090  

December

     6.5932        6.5063        6.6210        6.5063  

2018

           

January

     6.4233        6.8360        6.9575        6.2841  

February

     6.3183        6.2649        6.3471        6.3280  

March

     6.3174        6.2685        6.3565        6.2726  

April (through April 25, 2018)

     6.2912        6.2655        6.3229        6.3066  

 

(1) Source: The source of the exchange rate is the H.10 statistical release of the Federal Reserve Board.
(2) The source of annual averages is the G.5A statistical release of the Federal Reserve Board. The source of monthly averages is the G.5 statistical release of the Federal Reserve Board.

 

B. CAPITALIZATION AND INDEBTEDNESS

Not applicable.

 

C. REASONS FOR THE OFFER AND USE OF PROCEEDS

Not applicable.

 

D. RISK FACTORS

Risks Relating to our Business

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

Major Chinese airlines are wholly- or majority-owned either by the Chinese government or by provincial or municipal governments in China. CSAH, an entity wholly-owned by the Chinese government, directly and indirectly holds and exercises the rights of ownership of 50.65% of the equity of our Company. The interests of the Chinese government in our Company and in other Chinese airlines may conflict with the interests of the holders of the ADRs, H Shares and A Shares. The public policy considerations of the Chinese government in regulating the Chinese commercial aviation industry may also conflict with its indirect ownership interest in our Company. In addition, our Company may accept further capital injection from CSAH through non-public subscriptions, which may have dilutive impact for other holders of ADRs, H Shares and A Shares.

 

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Due to high degree of operating leverage and high fixed costs, a decrease in revenue of our Group could result in a disproportionately higher decrease in our profit for the year. The results of our operations are also significantly exposed to fluctuations in foreign exchange rates.

The airline industry is generally characterized by a high degree of operating leverage. In addition, due to high fixed costs, the expenses relating to the operation of any flight do not vary proportionately with the number of passengers carried, while revenues generated from a flight are directly related to the number of passengers carried and the fare structure of such flight. Accordingly, a decrease in revenues could result in a disproportionately higher decrease in our profit for the year. Moreover, as we have substantial obligations denominated in foreign currencies, our results of operations are significantly affected by fluctuations in foreign exchange rates, particularly by fluctuations in the Renminbi-U.S. dollar exchange rate. Our net exchange loss of RMB3,276 million and net exchange gain of RMB1,801 million was recorded in 2016 and 2017, respectively, primarily due to the translation of balances of borrowings and obligations under finance lease which are denominated in USD.

We have significant committed capital expenditures in the next three years, and may face challenges and difficulties as it seeks to maintain liquidity.

We have a substantial amount of debt, lease and other obligations, and will continue to have a substantial amount of debt, lease and other obligations in the future. As of December 31, 2017, our current liabilities exceeded our current assets by RMB 51,693 million. We generated net cash inflow from operating activities of RMB23,764 million and RMB17,732 million for the years ended December 31, 2016 and 2017, respectively. However, our substantial indebtedness and other obligations may in the future negatively impact our liquidity. In addition, we have significant committed capital expenditures in the next three years, due to aircraft acquisitions. In 2017 and thereafter, the liquidity of our Group is primarily dependent on our ability to maintain adequate cash inflow from operations to meet our debt obligations as they fall due, and our ability to obtain adequate external financing to meet our committed future capital expenditures. If our operating cash flow is materially and adversely affected by factors such as increased competition, a significant decrease in demand for our services, or a significant increase in jet fuel prices, our liquidity would be materially and adversely affected. Moreover, we may not be able to meet our debt obligations as they fall due and commit future capital expenditures if certain assumptions about the availability of external financing on acceptable terms are inaccurate. If we are unable to obtain adequate financing for our capital requirements, our liquidity and operations would be materially and adversely affected.

As of December 31, 2017, we had banking facilities with several PRC commercial banks for providing loan finance up to approximately RMB181,922 million, of which approximately RMB142,239 million was unutilized. Our directors believe that sufficient financing will be available to our Group in 2018. However there can be no assurance that such loan financing will be available on terms acceptable to our Group or at all.

CSAH will continue to be our controlling shareholder, and our interests may conflict with those of our Group. CSAH and certain of its affiliates will continue to provide certain important services to our Group. Any disruption of the provision of services by CSAH or its affiliates could affect our operations and financial conditions.

CSAH will continue to be the controlling shareholder of our Company. CSAH and certain of its affiliates will continue to provide certain important services to our Group, including advertising services, provision of air ticket selling services, property management services, leasing of properties and financial services, and repair, overhaul and maintenance services on jet engines. The interests of CSAH may conflict with those of our Group. In addition, any disruption of the provision of services by CSAH’s affiliates or a default by CSAH of its obligations owed to our Group could affect our operations and financial conditions. In particular, as part of our cash management system, our Group periodically places certain amount of demand deposits after independent shareholders’ approval with SA Finance, a PRC authorized financial institution controlled by CSAH and an associate of our Company. We have taken certain measures to monitor the fund flows between us and SA Finance and the placement of funds by SA Finance. Such monitoring measures may help to enhance the safety of our deposits with SA Finance. In addition, we have received a letter of undertakings from CSAH dated March 31, 2009, in which, among other things, CSAH warranted that our deposits and loans with SA Finance were secure and that SA Finance would continue to operate in strict compliance with the relevant rules and regulations. However, the deposits may be exposed to risks associated with the business of SA Finance over which our Group does not have control. As of December 31, 2016 and 2017, we had deposits of RMB3,759 million and RMB6,095 million, respectively, with SA Finance.

 

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

As a result of the discretionary nature of air travel, the airline industry has been cyclical and particularly sensitive to changes in economic conditions. During periods of unfavorable or volatile economic conditions in the global economy or when global or regional economic conditions are affected by political events, such as the United Kingdom’s exit from the European Union (“EU”) and the trade policies between China and the U.S., demand for air travel can be impacted as business and leisure travelers choose not to travel, seek alternative forms of transportation for short trips or conduct business through videoconferencing. If unfavorable economic conditions occur, particularly for an extended period, our business, financial condition and results of operations may be adversely affected.

Following a referendum in June 2016 in which voters in the U.K. approved an exit from the EU, the U.K. government has initiated a process to leave the EU (often referred to as Brexit) and begun negotiating the terms of the U.K.’s future relationship with the EU. The airline industry faces substantial uncertainty regarding the impact of the exit of the U.K. from the EU. Adverse consequences such as deterioration in economic conditions, volatility in currency exchange rates or adverse changes in regulation of the airline industry or bilateral agreements governing air travel could have a negative impact on our operations, financial condition and results of operations.

On March 8, 2018, the U.S. President Donald Trump proposed a further 25% tariffs, the equivalent of $50 billion on Chinese goods. In response, on April 4, 2018, China released a tariff list of 25% on $50 billion’s US imports, including soybeans, automobiles and aeroplanes. On April 6, 2018, Trump reiterated that by considering adding a further $100 billion in tariffs on goods imported from China, and the Chinese Ministry of Commerce and the Foreign Affairs indicated that they would also adopt new measures. There is no guarantee that more measures will be introduced, and if these trade policies come into force and the scope of them is further expanded, the volume of China-U.S. import and export trade would drop significantly, which will lead to deterioration in economic conditions of both countries and decrease of business and official activities between both countries. Demand for air travel as well as cargo and mail volume can be impacted.

Chinese macroeconomic controls, such as financing adjustments, credit adjustments, taxation policies, price controls and exchange rate policies would also present unexpected changes to the aviation industry. As a result, the changing economic situation and Chinese macroeconomic controls may cause volatility to our business and results of our operations.

We could be adversely affected by an outbreak of a disease or large scale natural disasters that affect travel behavior.

The outbreak of the H1N1 swine flu in March 2009 has had an adverse impact on the aviation industry globally (including our Group). The spread of the swine flu adversely affected our international routes operations in 2009. A future outbreak of an infectious disease or any other serious public health concerns in Asia and elsewhere could have a material adverse effect on our business, financial condition and results of operations.

In 2011, a number of large-scale natural disasters occurred globally, such as the nuclear meltdown in Japan caused by earthquakes and subsequent tsunami, the hurricane on the East Coast of the United States, the flooding in Thailand and the typhoon in the Philippines. Disasters such as these can affect the aviation industry and our Group by reducing revenues and impacting travel behavior.

Lack of adequate documentation for land use rights and ownership of buildings subjects us to challenges and claims by third parties with respect to our Company’s use of such land and buildings.

Although systems for registration and transfer of land use rights and related real property interests in China have been implemented, such systems do not yet comprehensively account for all land and related property interests. We leased certain properties and buildings from CSAH which are located in Guangzhou, Haikou and other PRC cities. However, CSAH lacks adequate documentation evidencing CSAH’s rights to such land and buildings, and, as a result, the lease agreements between CSAH and our Company for such land has not been registered with the relevant authorities. As a result, such lease agreements may not be enforceable. Lack of adequate documentation for land use rights and ownership of buildings subjects our Company to challenges and claims by third parties with respect to our Company’s use of such land and buildings.

As of the date of this Annual Report, we had been occupying all of the land and buildings described above without challenge or claim by third parties. However, if any challenges to the property ownership or other claims are successful, our operation and business may be materially adversely affected. CSAH has agreed to indemnify us against any loss or damage caused by or arising from any challenge of, or interference with, our Company’s right to use certain land and buildings.

 

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Any discontinuity or disruption in the direct flight arrangement between Taiwan and Mainland China may negatively affect our results.

The policy restraint on direct flights between Taiwan and Mainland China has been further loosened in the past few years but there has been no further negotiation on the expansion of such arrangement between Taiwan and Mainland China since mid-2016. As of April 26, 2018, there were 78 cross-Strait direct passenger flights per week. Our Company was the first Chinese carrier to operate non-stop flights from Mainland China to Taiwan and as a result has benefited from the operation of such flights. However, given the cross-Strait flight arrangement is subject to the political relationship between Taiwan and Mainland China, any deterioration in such political relationship may cause the discontinuity or disruption in the flight arrangement, and therefore may have a material adverse impact on our results.

Terrorist attacks or the fear of such attacks, even if not made directly on the airline industry, could adversely affect our Company and the airline industry as a whole. The travel industry continues to face on-going security concerns and cost burdens.

The aviation industry as a whole has been beset with high-profile terrorist attacks, most notably the attack on September 11, 2001 in the United States. Terrorist attacks could also affect the aviation industry in China. Airlines in China have experienced several incidents of terrorist attacks or threats recently. For example, on March 7, 2008, on a China Southern Airlines flight boarding in Urumqi, crew members discovered a terrorist suspect. On July 14, 2010, a passenger jet en route from Urumqi to Guangzhou was forced to make an emergency landing after receiving an anonymous call claiming there was a bomb on the aircraft. On June 29, 2012, there was an attempted hijacking on a passenger flight operated by Tianjin Airlines between Hotan and Urumqi in China’s Xinjiang region. CAAC has enhanced security measures, but the effectiveness of such measures cannot be ascertained. Additional terrorist attacks, even if not made directly on the airline industry, or the fear of or the precautions taken in anticipation of such attacks (including elevated threat warnings or selective cancellation or redirection of flights) could materially and adversely affect our Company and the aviation industry. Potential impacts that terrorist attacks could have on our Company include substantial flight disruption costs caused by grounding of fleet, significant increase in security costs and associated passenger inconvenience, increased insurance costs, substantially higher ticket refunds and significant decrease in traffic measured in revenue passenger kilometers. Additionally, increasingly strict security measures make air travel a hassle in the eyes of some consumers. These factors can have an uncertain impact on the development of the aviation industry.

We may suffer losses in the event of an accident involving our aircraft or the aircraft of any other airline.

An accident involving one of our aircraft could require repair or replacement of a damaged aircraft, and result in our consequential temporary or permanent loss from service and/or significant liability to injured passengers and others. Although we believe that we currently maintain liability insurance in amounts and of the types generally consistent with industry practice, the amounts of such coverage may not be adequate to fully cover the costs related to the accident or incident, which could result in harm to our results of operations and financial condition. In addition, any aircraft accident, even if fully insured, could cause a public perception that we are not as safe or reliable as other airlines, which would harm our competitive position and result in a decrease in our operating revenues. Moreover, a major accident involving the aircraft of any of our competitors may cause demand for air travel to decrease in general, which would adversely affect our results of operations and financial condition.

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

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

 

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We may lose investor confidence in the reliability of our financial statements if we fail to achieve and maintain effective internal control over financial reporting, which in turn could harm our business and negatively impact the trading prices of our ADRs, H Shares or A Shares.

The United States Securities and Exchange Commission, or the SEC, as required by Section 404 of the Sarbanes-Oxley Act of 2002, adopted rules requiring every public company in the United States to include a management report on such company’s internal control over financial reporting in its annual report, which contains management’s assessment of the effectiveness of the company’s internal control over financial reporting. In addition, our Company’s independent registered public accounting firm is required to report on the effectiveness of our Company’s internal control over financial reporting.

Since 2011, pursuant to the Basic Standard for Enterprise Internal Control jointly issued by the Ministry of Finance, China Securities Regulatory Commission (“CSRC”) and other three PRC authorities on May 22, 2008, and its application guidelines and other relevant regulations issued subsequently (collectively, “PRC internal control requirements”) , our Company has carried out a self-assessment of the effectiveness of its internal control and issue a self-assessment report annually in accordance with the PRC internal control requirements, and our Company’s auditor for our PRC GAAP financial statements (the “PRC Auditor”) is required to report on the effectiveness of our Company’s internal control over financial reporting.

However, our independent registered public accounting firm or PRC Auditor may not be satisfied with our internal controls, the level at which our controls are documented, designed, operated and reviewed. Our independent registered public accounting firm or PRC Auditor may also interpret the requirements, rules and regulations differently, and reach a different conclusion regarding the effectiveness of our internal control over financial reporting. Although our management have concluded that our internal control over financial reporting as of December 31, 2017 was effective, we may discover deficiencies in the course of our future evaluation of our internal control over financial reporting and may be unable to remediate such deficiencies in a timely manner. If we fail to maintain the adequacy of our internal control over financial reporting, we may not be able to conclude that we have effective internal control over financial reporting on an ongoing basis, as required under the above mentioned rules and regulations. Moreover, effective internal control is necessary for us to produce reliable financial reports and is important to prevent fraud. As a result, our failure to achieve and maintain effective internal control over financial reporting could result in the loss of investor confidence in the reliability of our financial statements, which in turn could harm our business and negatively impact the trading prices of our ADRs, H Shares or A Shares.

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

Depending upon the relative values of our passive assets and income as compared to our total assets and income each taxable year, we could be classified as a passive foreign investment company, or PFIC, by the United States Internal Revenue Service, or IRS, for U.S. federal income tax purposes. Our Company believes that we were not a PFIC for the taxable year 2017. However, there can be no assurance that we will not be a PFIC for the taxable year 2018 and/or later taxable years, as PFIC status is re-tested each year and depends on the facts in such year.

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

If we were a PFIC, we would generally be subject to additional taxes and interest charges on certain “excess distributions” our Company makes regardless of whether we continue to be a PFIC in the year in which you receive an “excess distribution”. An “excess distribution” would be either (1) the excess amount of a distribution with respect to ADRs during a taxable year in which distributions to you exceed 125% of the average annual distributions to you over the preceding three taxable years or, if shorter, your holding period for the ADRs, or (2) 100% of the gain from the disposition of ADRs. For more information on the United States federal income tax consequences to you that would result from our classification as a PFIC, please see Item 10, “Taxation - United States Federal Income Taxation - U.S. Holders - Passive Foreign Investment Company”.

 

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We may be unable to retain key management personnel.

We are dependent on the experience and industry knowledge of our key management employees, and there can be no assurance that we will be able to retain them. Any inability to retain our key management employees, or attract and retain additional qualified management employees, could have a negative impact on us.

Risks Relating to the Chinese Commercial Aviation Industry

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

Our ability to implement our business strategy will continue to be affected by regulations and policies issued or implemented by relevant government agencies, particularly CAAC, which encompasses substantially all aspects of the Chinese commercial aviation industry, such as the approval of route allocation, the administration of certain airport operations and air traffic control. Such regulations and policies limit the flexibility of our Group to respond to market conditions, competition or changes in our cost structure. The implementation of specific government policies could from time to time adversely affect our operations.

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

The availability and cost of jet fuel have a significant impact on our results of operations. Our jet fuel cost for 2017 accounted for 50.64% of our flight operations expenses. All of the domestic jet fuel requirements of Chinese airlines (other than at the Shenzhen, Sanya, Haikou, Shanghai Pudong) must be purchased from the exclusive providers, CAOSC and Bluesky Oil Supplies Company, which are supervised by the CAAC. Chinese airlines may also purchase jet fuel at the Shenzhen, Sanya, Haikou, Shanghai Pudong from Sino-foreign joint venture in which CAOSC is a joint venture partner. Jet fuel obtained from the CAOSC’s regional branches is purchased at uniform prices throughout China that are determined and adjusted by the CAOSC from time to time with the approval of the CAAC and the pricing department of the NDRC based on market conditions and other factors. As a result, the costs of transportation and storage of jet fuel in all regions of China are spread among all domestic airlines.

Domestic price for jet fuel has experienced fluctuations in the past few years. Our profit for the year may suffer from an unexpected change in the fuel surcharge collection policies and other factors beyond our control. For more information on the jet fuel prices, please see “Item 4, Information on our Company - Business Overview - Jet Fuel” section below for further discussion.

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

In addition, China has experienced jet fuel shortages. On some rare occasions prior to 1993, our Group had to delay or even cancel flights. Although such shortages have not materially affected our operations since 1993, there can be no assurance that such a shortage will not occur in the future. If such a shortage occurs in the future to the extent that our Group has to delay or cancel flights due to fuel shortage, our operational reputation among passengers as well as our operations may suffer.

In 2017, a reasonable possible increase or decrease of 10% in average jet fuel price with volume of fuel consumed and all other variables held constant, would have increased or decreased our annual fuel costs by approximately RMB3,190 million. Accordingly, even if the jet fuel supply remains stable, increases in jet fuel prices will nevertheless adversely impact our financial results.

Our profit for the year may suffer from an unexpected volatility caused by any fluctuation in the level of fuel surcharges.

The level of fuel surcharges, which is regulated by Chinese government, affects domestic customers’ air travel demand as well as our ability to generate profits. On January 14, 2009, the NDRC and the CAAC jointly announced that the collection of passenger fuel surcharge for domestic routes should be suspended from January 15, 2009 onwards. Subsequently, in response to the increase in international fuel prices, the NDRC and CAAC issued a notice on November 11, 2009 to introduce a new pricing mechanism of fuel surcharge that links it with airlines’ jet fuel costs, which was further adjusted subsequently. On October 14, 2011, the NDRC and the CAAC issued a notice to adjust such pricing mechanism. As a result of this adjustment, the maximum rates for fuel surcharge can be adjusted according to the pricing mechanism of fuel surcharge, if the aggregated change in jet fuel costs exceeds RMB250 per ton. Due to the decrease in the jet fuel cost, the fuel surcharge has been suspended since February 5, 2015. On March 24, 2015, NDRC elected to revise the base price of jet fuel which is used to calculate the maximum rate for fuel surcharge. We cannot guarantee that fuel surcharges would not be adjusted further in the future or adjusted in our favour. If fuel surcharges are not adjusted in correspondence to the increase in jet fuel, our profit for the year may be materially adversely affected.

 

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Our results of operations are subject to seasonality.

Our operating revenue is substantially dependent on the passenger and cargo traffic volume carried, which is subject to seasonal and other changes in traffic patterns, the availability of appropriate time slots for our flights and alternative routes, the degree of competition from other airlines and alternate means of transportation, as well as other factors that may influence passenger travel demand and cargo and mail volume. In particular, our airline revenue is generally higher in the second half of the year than in the first half of the year. As a result, our results may fluctuate from season to season.

Our operations may be adversely affected by insufficient aviation infrastructure in Chinese commercial aviation industry.

The rapid increase in air traffic volume in China in recent years has put pressure on many components of the Chinese commercial aviation industry, including China’s air traffic control system, the availability of qualified flight personnel and airport facilities. Airlines, such as our Group, which have route networks that emphasize short- to medium-haul routes, are generally more affected by insufficient aviation infrastructure in terms of on-time performance and high operating costs due to fuel inefficiencies resulting from the relatively short segments flown, as well as the relatively high proportion of time on the ground during turnaround. All of these factors may adversely affect the perception of the service provided by an airline and, consequently, the airline’s operating results. In recent years, the CAAC has placed increasing emphasis on the safety of Chinese airline operations and has implemented measures aimed at improving the safety record of the industry. The ability of our Group to increase utilization rates and to provide safe and efficient air transportation in the future will depend in part on factors such as the improvement of national air traffic control and navigation systems and ground control operations at Chinese airports, factors which are beyond the control of our Group.

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

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

We face varying degrees of competition on our regional routes from certain Chinese airlines and Cathay Pacific, Cathay Dragon and Air Macau, and on our international routes, primarily from non-Chinese airlines, most of which have significantly longer operating histories, substantially greater financial and technological resources and greater name recognition than our Group. In addition, the public’s perception of the safety and service records of Chinese airlines could adversely affect our ability to compete against our regional and international competitors. Many of our international competitors have larger sales networks and participate in reservation systems that are more comprehensive and convenient than those of our Group, or engage in promotional activities, which may enhance their ability to attract international passengers.

Furthermore, for short-distance transportation, airplanes, trains and buses are alternatives to each other. Given the recent development of high-speed trains (as discussed below), the construction of nationwide high-speed railway network and the improvement of inter-city expressway network, the commercial aviation sector as a whole faces increasing competition from the alternative means of transportation such as railways and highways.

We expect to face substantial competition from the rapid development of the Chinese rail network.

The PRC government is aggressively implementing the expansion of its high-speed rail network. The mileage of new railway lines put into operation in 2017 reached 3,038 kilometers. In 2017, the Baoji-Lanzhou, Wuhan-Jiujiang, Xi’an-Chengdu and Shijiazhuang-Jinan railways commenced operation. Operation of Shijiazhuang-Jinan railway indicates that the “four horizontal and four vertical” high speed railway corridors have been built ahead of schedule. As of December 31, 2017, China’s railway traffic mileage has reached 127,000 kilometers, among which 25,000 kilometers are covered by high-speed railway. China’s high-speed railway traffic mileage accounts for 66.3% of the world’s total high-speed railway traffic mileage. According to the latest development goal of the China Railway Corporation, China’s railway traffic mileage will reach 175,000 kilometers by 2025, among which 38,000 kilometers are covered by high-speed railway. The operating results of the Company’s air routes which overlap with the high-speed railway corridors (especially air routes with a distance of less than 800 kilometers) will be affected in the future.

 

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Due to limitation on foreign ownership imposed by Chinese government policies, our Company may have limited access to the international equity capital markets.

Chinese government policies limit foreign ownership in Chinese airlines. Under these policies, the percentage ownership of our total outstanding ordinary shares held by investors in Hong Kong and any country outside China (“Foreign Investors”) may not in the aggregate exceed 49%. Currently, we estimate that 30.39% of the total outstanding ordinary shares of our Company are held by Foreign Investors. According to The Provisions on Domestic Investment in Civil Aviation Industry, effective on January 19, 2018, Chinese government has loosen up restrictions on state ownership of our total outstanding ordinary shares, which allows the percentage of state-owned shares to be under 50%. However, for so long as the limitation on foreign ownership is in force, we will have limited access to the international equity capital markets.

The European Emissions Trading Scheme may increase operational cost of our Group.

Starting on January 1, 2012, aviation sector has been included in the European Emissions Trading Scheme (ETS), EU’s mandatory cap-and-trade system for reduction of greenhouse gas emissions. Airline operators in the EU will receive tradable emission permits (aviation allowances) covering a certain level of their CO2 emissions per year for their flights operating to and from EU airports. If an airline fails to obtain free-of-charge emission permits from the EU, it will have to buy around EUR10 million (RMB100 million) worth of CO2 emissions allowances from other greener industries. Pursuant to this policy, the Chinese airlines having flight points in Europe undertake the same carbon emission reductions obligation as the European local airlines, which will result in a significant increase in the operating cost of Chinese airlines in Europe, including our Company, and further have an adverse impact on the results of operations and financial condition. In March 2011, a group representing China’s largest airlines sent a formal notice to the EU expressing strong opposition to non-member-state airlines’ inclusion in the EU’s Emissions Trading Scheme. Also, in early February 2012, CAAC issued instructions to various airlines announcing that without approval from the relevant government authorities, the major airlines are prohibited from joining the ETS and the transport airlines are also prohibited from raising the freight price or increasing fee items by adducing this reason. On November 12, 2012, EU announced to temporarily suspend the implementation of the ETS in the aviation sector in 2013 in order to forge a positive negotiation environment for all parties. In November 2014, CAAC issued a notification on the ETS. The notification provided that CAAC would not prohibit Chinese airlines to take part in the ETS if the relevant flights take off and land between the airports within the EU during 2012 and 2016. We operated few flights between airports within the EU since 2012. We expect we would operate few flights between airports within the EU in the future. Therefore, we submitted emissions report and pay the quota between 2012 and 2016 for our flights between airports within the EU. In April 2015, our Company had completed submission of emissions reports for the years 2012 to 2014 and fulfilled our obligations under the ETS. In 2016, our Company had finished year 2015 compliance cycle. On year 2017-2020 compliance cycle, our Company will be in compliance with the requirements of relevant PRC laws and the ETS. There can be no assurance that the new implementation proposal will not have negative impact on our financial condition and result of operation.

We may utilize fuel hedging arrangements which may result in losses.

While we have not entered into any fuel hedging transactions since the fourth quarter of 2008, we may in the future consider to hedge a portion of our future fuel requirements through various financial derivative instruments linked to certain fuel commodities to lock in fuel costs within a hedged price range. However, these hedging strategies may not always be effective and high fluctuations in aviation fuel prices exceeding the locked-in price ranges may result in losses. Significant declines in fuel prices may substantially increase the costs associated with our fuel hedging arrangements. In addition, where we seek to manage the risk of fuel price increases by using derivative contracts, we cannot assure you that, at any given point in time, our fuel hedging transactions will provide any particular level of protection against increased fuel costs.

Risks Relating to the PRC

We have significant exposure to foreign currency risk as part of our lease obligations and certain bank and other loans are denominated in foreign currencies. Due to rigid foreign exchange control by Chinese government, we may face difficulties in obtaining sufficient foreign exchange to pay dividends or satisfy our foreign exchange liabilities.

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

 

 

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We have significant exposure to foreign currency risk as substantially all of our obligations under leases, certain bank and other loans and operating lease commitment are denominated in foreign currencies, principally U.S. dollars, Euros and Japanese Yen. Depreciation or appreciation of the Renminbi against foreign currencies affects our results significantly because our foreign currency liabilities generally exceed our foreign currency assets. We are not able to hedge our foreign currency exposure effectively other than by retaining our foreign currency denominated earnings and receipts to the extent permitted by SAFE, or subject to certain restrictive conditions, entering into foreign exchange forward option contracts with authorized banks. However, SAFE may limit or eliminate our ability to purchase and retain foreign currencies in the future. In addition, foreign currency transactions under the capital account are still subject to limitations and require approvals from SAFE. This may affect our ability to obtain foreign exchange through debt or equity financing, including by means of loans or capital contributions. No assurance can be given that our Group will be able to obtain sufficient foreign exchange to pay dividends or satisfy our foreign exchange liabilities.

Our operations are subject to immature development of legal system in China. Lack of uniform interpretation and effective enforcement of laws and regulations may cause significant uncertainties to our operations.

Our Company and the major subsidiaries of our Group are organized under the laws of China. The Chinese legal system is based on written statutes and is a system, unlike common law systems, in which decided legal cases have little precedential value. Since 1979, the Chinese government has been developing a comprehensive system of commercial laws and considerable progress has been made in the promulgation of laws and regulations dealing with economic matters, such as corporate organization and governance, foreign investments, commerce, taxation and trade. These laws, regulations and legal requirements are relatively recent, and, like other laws, regulations and legal requirements applicable in China (including with respect to the commercial aviation industry), their interpretation and enforcement involve significant uncertainties.

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

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

Caishui Notice [2014] No. 81 provides that, “for dividends derived by Mainland individual investors from investing in H Shares listed on the Hong Kong Stock Exchange through Shanghai Hong Kong Stock Connect, H-Share companies shall apply to the China Securities Depository and Clearing Corporation Limited (CSDC). CSDC shall provide the list of Mainland individual investors to H-Share companies who shall withhold individual income tax at a tax rate of 20%. For Mainland securities investment funds investing in shares listed on the Hong Kong Stock Exchange through Shanghai Hong Kong Stock Connect, the above rules shall also apply and individual income tax shall be levied on dividends derived therefrom.”

Caishui Notice [2014] No. 81 further provides that, “dividends derived by Mainland enterprise investors from investing in shares listed on the Hong Kong Stock Exchange through Shanghai Hong Kong Stock Connect shall be included in their gross income and subject to enterprise income tax. For dividends derived by Mainland enterprises where the relevant H Shares have been continuously held for no less than 12 months, enterprise income tax may be exempt according to the tax law. H-Share companies listed on the Hong Kong Stock Exchange shall apply to CSDC to obtain the list of Mainland enterprise investors from CSDC. H-Share companies are not required to withhold income tax on dividends to Mainland enterprise investors which shall report the income and make the tax payment by themselvers.”

In addition, to date, relevant tax authorities have not collected capital gains tax on the gains realized upon the sale or other disposition of overseas shares in Chinese enterprise held by foreign individuals. If relevant tax authorities promulgate implementation rules on the taxation of capital gains realized by individuals upon the sale or other disposition of the shares, individual holders of the shares may be required to pay capital gains tax.

Our investors in the U.S. who rely on our auditor’s audit reports currently do not have the benefit of PCAOB oversight.

As a company registered with the U.S. Securities and Exchange Commission, or the SEC, and traded publicly in the United States, our independent registered public accounting firm is required by the laws of the United States to be registered with the Public Company Accounting Oversight Board, or the PCAOB, and undergo regular inspections by the PCAOB to assess its compliance with the laws of the United States and professional standards. The PCAOB, however, is currently unable to inspect a registered public accounting firm’s audit work relating to a company’s operations in China where the documentation of such audit work is located in China. Accordingly, our independent registered public accounting firm’s audit of our operations in China is not subject to the PCAOB inspection.

 

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The PCAOB has conducted inspections of independent registered public accounting firms outside of China and has at times identified deficiencies in the audit procedures and quality control procedures of those accounting firms. Such deficiencies may be addressed in those accounting firms’ future inspection process to improve their audit quality. Due to the lack of PCAOB inspections of audit work undertaken in China, our investors do not have the benefit of the regular evaluation by PCAOB of the audit works, audit procedures and quality control procedures of our independent registered public accounting firm.

If additional remedial measures are imposed against four PRC-based accounting firms, including our independent registered public accounting firm, in administrative proceedings brought by the SEC, it could result in our financial statements being determined to not be in compliance with the requirements of the Securities Exchange Act of 1934.

In December 2012, the SEC instituted administrative proceedings against four PRC-based accounting firms, including our independent registered public accounting firm, alleging that these firms had violated U.S. securities laws and the SEC’s rules and regulations thereunder by failing to provide to the SEC the firms’ work papers related to their audits of certain PRC-based companies that are publicly traded in the United States. On January 22, 2014, an initial administrative law decision was issued, which determined that the four PRC-based accounting firms should be censured and barred from practicing before the SEC for a period of six months. The four PRC-based accounting firms appealed the initial administrative law decision to the SEC. The initial law decision is neither final nor legally effective unless and until it is endorsed by the full SEC. In February 2015, each of the four PRC-based accounting firms agreed to a censure and to pay a fine to the SEC to settle the dispute and avoid suspension of their ability to practice before the SEC. The settlement requires the firms to follow detailed procedures to provide the SEC with access to PRC-based firms’ audit documents via the CSRC.

We were not and are not the subject of any SEC investigations nor are we involved in the proceedings brought by the SEC against the accounting firms. If the firms do not follow these procedures or if there is a failure in the process between the SEC and the CSRC, the SEC could impose penalties such as suspensions or it could restart the administrative proceedings. If the accounting firms including our independent registered public accounting firm were denied, temporarily or permanently, the ability to practice before the SEC, and we are unable to find timely another registered public accounting firm which can audit and issue a report on our financial statements, our financial statements could be determined to not be in compliance with the requirements for financial statements of public companies registered under the Securities Exchange Act of 1934, as amended, or the Exchange Act. Such a determination could ultimately lead to the delisting of our common stock from the NYSE for CSA’s case or deregistration from the SEC, or both, which would substantially reduce or effectively terminate the trading of our common stock in the United States.

 

ITEM 4. INFORMATION ON THE COMPANY

 

A. HISTORY AND DEVELOPMENT OF OUR COMPANY

We were incorporated under PRC laws on March 25, 1995 as a joint stock company with limited liability under the name of China Southern Airlines Company Limited. The address of our principal place of business is 278 Ji Chang Road, Guangzhou, People’s Republic of China 510405. Our telephone number is +86 20 8612 4462 and our website is www.csair.com.

In July 1997, we issued 1,174,178,000 H Shares, par value RMB1.00 per share, and completed the listing of the H Shares on the Stock Exchange of Hong Kong Limited (the “Hong Kong Stock Exchange”) and the ADRs representing our H shares on the New York Stock Exchange.

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

In July 2003, we issued 1,000,000,000 A Shares, par value RMB1.00 per share, and completed the listing of the A shares on the Shanghai Stock Exchange.

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

 

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On May 30, 2007, we, together with an independent third party, established Chongqing Airlines Company Limited (“Chongqing Airlines”). As of December 31, 2012, our Company had transferred four aircraft to Chongqing Airlines as capital contribution. We own a total of 60% equity interest in Chongqing Airlines.

On August 14, 2007, we acquired a 51% equity interest in Nan Lung International Freight Limited beneficially owned by and registered in the name of Nan Lung Travel & Express (Hong Kong) Limited, and a 100% equity interest in China Southern Airlines Group Air Catering Company Limited, both a wholly owned subsidiary of CSAH, for a total consideration of RMB112 million.

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

In June 2009, we acquired a 50% equity interest in Beijing Southern Airlines Ground Services Company Limited (“Beijing Ground Service”) from the other shareholder, and Beijing Ground Service became a wholly-owned subsidiary of our Company.

On September 28, 2009, we entered into an agreement with CSAH to sell our 50% equity interest in MTU Maintenance Zhuhai Co., Ltd (“Zhuhai MTU”), a jointly controlled entity of our Company, to CSAH at a consideration of RMB 1,607,850,000. The transfer was completed in February 2010.

On June 2, 2010, a third party company injected capital to Flying College, which diluted our Company’s interest in Flying College from 91% to 48.12%. Flying College became a jointly controlled entity of our Company since then. The retained non-controlling equity interest in Flying College is re-measured to our fair value at the date when control was lost and a gain on deemed disposal of a subsidiary of RMB17 million was recorded in 2010.

In December 2010, we entered into an agreement with Xiamen Jianfa Group Co., Ltd. and Hebei Aviation Investment Group Corporation Limited (“Hebei Investment”), pursuant to which Hebei Investment agreed to inject a cash capital of RMB1,460 million into Xiamen Airlines Company Limited (“Xiamen Airlines”). In March 2011, the capital injection was received in full and our Company’s equity interest in Xiamen Airlines was diluted from 60% to 51%. Xiamen Airlines remains a subsidiary of our Company.

On June 29, 2012, Xiamen Airlines, a subsidiary of our Company and Southern Airlines Culture and Media Co., Ltd. (“SACM”) entered into an agreement, pursuant to which Xiamen Airlines agreed to sell and SACM agreed to purchase 51% equity interests in Xiamen Airlines Media Co., Ltd.(“XAMC”), at a consideration of approximately RMB43.12 million. Immediate prior to the transaction, XAMC was wholly owned by Xiamen Airlines and primarily engaged in providing advertising, corporate branding, publicity and exhibition services and was responsible for the overall brand building and publicity of Xiamen Airlines.

On September 24, 2012, we entered into a joint venture agreement with Henan Civil Aviation Development and Investment Co., Ltd. (“Henan Aviation Investment”) for the establishment of China Southern Airlines Henan Airlines Company Limited (“Henan Airlines”), a joint venture company with a total registered capital of RMB6 billion, which will be owned as 60% and 40% by our Company and Henan Aviation Investment, respectively. On September 28, 2013, Henan Airlines was established.

On October 13, 2014, Xiamen Airlines and Hebei Airlines Investment Group Company Limited (the “Hebei Airlines Investment”) entered into an agreement, pursuant to which Hebei Airlines Investment agreed to sell and Xiamen Airlines agreed to purchase 95.4% equity interests in Hebei Airlines at the consideration of RMB680 million. The acquisition was completed in December 2014.

On July 14, 2015, we and Xiamen Jianfa entered into an agreement, pursuant to which Xiamen Jianfa agreed to sell and we agreed to purchase 4% equity interests in Xiamen Airlines at the consideration of RMB586,666,670. The acquisition was completed in December 2015.

On February 2, 2016, we and CSAH entered into an agreement, pursuant to which CSAH agreed to sell and we agreed to purchase 100% equity interests in Southern Airlines (Group) Import And Export Trading Co. Ltd. at the consideration of RMB400,570,400. The acquisition was completed in August 2016.

On March 27, 2017, according to the authorisation under the general mandate approved by the 2015 annual general meeting and as approved by the Board, we entered into the Share Subscription Agreement with American Airlines, pursuant to which American Airlines has agreed to subscribe for 270,606,272 new H Shares of the Company (the “Subscription”), at the consideration of HK$1,553.28 million, representing a subscription price of HK$5.74 per share. The closing price of the H Shares as at the date of the Share Subscription Agreement is HK$5.49. The Subscription was completed on 10 August 2017.

 

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On May 18, 2017, we entered into the Joint Venture Agreement regarding Guangzhou Nanland Air Catering Company Limited with Hong Kong Sharpland Investments Ltd., Servair S.A and Hong Kong Ginkgo Group Company Limited, pursuant to which our Company made contribution into Guangzhou Nanland Air Catering Co., Ltd. in cash with an amount of RMB76,206,300 and by contributing the equity interests in a subsidiary with a valuation of RMB513,727,300. After the capital contribution, our Company held 70.5% equity interests in Guangzhou Nanland Air Catering Co., Ltd..

On July 10, 2017, we entered into the Share Transfer Agreement with CAE International Holdings Limited for the acquisition of 49% equity interests in Zhuhai Xiang Yi Aviation Technology Company Limited held by CAE with an amount of US$99.52 million (equivalent to approximately RMB678 million). Upon the completion of this acquisition, Zhuhai Xiang Yi Aviation Technology Company Limited become our wholly-owned subsidiary.

On October 13, 2017, Xiamen Airlines entered into the Share Transfer Agreement with SACM for the acquisition of 51% equity interests in Xiamen Airlines Media Co., Ltd. held by SACM with an amount of RMB47 million. Upon the completion of this acquisition, Xiamen Airlines Media Co., Ltd. become a wholly-owned subsidiary of Xiamen Airlines.

Aircraft Acquisitions

Pursuant to an A320 Series Aircraft Purchase Agreement dated January 20, 2010 between our Company and Airbus SNC, we will acquire 20 Airbus 320 series aircraft from Airbus SNC. According to the information provided by Airbus SNC, the catalogue price of an Airbus 320 aircraft, including airframe and engines, is around US$76.9 million. The aggregate consideration for the acquisition was partly paid in cash and partly through financing arrangements with banking institutions. The Airbus aircraft have been delivered in stages to our Company during the period commencing from 2011 to 2013.

On September 30, 2010, Xiamen Airlines entered into a supplemental agreement with Boeing to purchase additional 10 Boeing B737 series aircraft. The aggregate catalogue price for those aircraft, including airframe and engines, is around US$699 million. According to the information provided by Boeing, the aggregate consideration for the acquisition was partly paid in cash by Xiamen Airlines, and partly through financing arrangements with banking institutions. The Boeing aircraft were delivered in stages to Xiamen Airlines during the period commencing from 2015 to October 2016.

On November 4, 2010, we entered into an A320 series aircraft purchase agreement and an A330-300 aircraft purchase agreement with Airbus S.A.S. to purchase 30 Airbus A320 series aircraft and six Airbus A330 series aircraft. According to the information provided by Airbus S.A.S., the catalogue price of six Airbus A330 series aircraft and 30 Airbus A320 series aircraft, including airframe and engines, is US$1.205 billion and US$2.575 billion, respectively. The aggregate consideration for the acquisition was partly paid by cash and partly by financing arrangements with banking institutions. The six Airbus A330 aircraft were delivered in stages to our Company during the period commencing from 2013 to 2014 and the 30 Airbus A320 series aircraft were delivered in stages to our Company during the period commencing from 2012 to 2015.

On May 31, 2011, we entered into an aircraft acquisition agreement with Boeing to purchase six Boeing B777F freighters. According to the information provided by Boeing, the catalogue price of six Boeing B777F aircraft, including airframe and engines, is US$1,584 million. The aggregate consideration for the Acquisition was partly paid by cash and partly by financing arrangements with banking institutions. The six Boeing B777F freighters were delivered in stages to us during the period commencing from 2013 to 2015.

On May 9, 2011, Xiamen Airlines entered into an aircraft acquisition agreement to purchase six Boeing B787 series aircraft. According to the information provided by Boeing, the aggregate catalogue price, including airframe and engines, for the six Boeing B787 series aircraft is US$1,098 million. The aggregate consideration for the acquisition was partly paid in cash and partly through financing arrangements with banking institutions. The Boeing aircraft were delivered in stages to Xiamen Airlines during the period commencing from 2014 to 2015.

On February 28, 2012, we entered into an agreement with the Boeing Company to purchase 10 Boeing 777-300ER aircraft. According to the information provided by Boeing, the catalogue price of one Boeing B777-300ER aircraft, including airframe and engines, is around US$298 million. The aggregate consideration for the acquisition was partly paid in cash and partly through financing arrangements with banking institutions. The Boeing aircraft were delivered in stages to our Company during the period from 2014 to 2016.

 

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On August 3, 2012, Xiamen Airlines entered into an agreement with Boeing to purchase 40 Boeing B737 series aircraft from Boeing. The aggregate catalogue price of the 40 Boeing B737 series aircraft is US$3.36 billion. The aggregate consideration for the acquisition was partly paid by cash and partly by financing arrangements with banking institutions. The 27 Boeing737 series aircraft were delivered in stages to Xiamen Airlines during the period commencing from 2016 to 2017 and the 13 Boeing737 series aircraft will be delivered in stages to Xiamen Airlines during the period commencing from 2018 to 2019.

On December 5, 2012, we entered into the Airbus aircraft acquisition agreement with Airbus S.A.S. to purchase 10 Airbus A330-300 aircraft. The catalogue price of one Airbus A330-300 aircraft is US$188 million. The aggregate consideration for the acquisition was partly paid by cash and partly by financing arrangements with banking institutions. The Airbus aircraft were delivered in stages to our Company during the period commencing from 2014 to 2016.

On May 16, 2014, we entered into the aircraft acquisition agreement with Airbus S.A.S to purchase 30 Airbus A320 series aircraft and 50 A320 NEO series aircraft. The catalogue price of one Airbus A320 series aircraft is priced differently in the range of US$85.8 million and US$110.1 million and one A320 NEO series aircraft is priced differently in the range of US$94.4 million to US$120.5 million. The aggregate consideration for the acquisition will be funded partly by internal resources of our Company and partly through commercial loans by commercial banks. The 30Airbus320 aircraft were delivered in stages to our Company during the period commencing from 2016 to 2017 and the 50Airbus320 NEO aircraft will be delivered in stages to our Company during the period commencing from 2018 to 2020.

On December 17, 2015, we entered into the aircraft acquisition agreement with Boeing to purchase 30 B737NG series aircraft and 50 B737 MAX series aircraft. The catalogue price of each B737NG series aircraft and B737 MAX series aircraft is priced about US$81.2 million and US$96.1 million, respectively. The aggregate consideration for the acquisition will be funded partly payable by cash and partly by financing arrangements with banking institutions. The 30 Boeing737NG aircraft were delivered in stages to our Company in 2017 and the 50 Boeing737 MAX aircraft will be delivered in stages to our Company during the period commencing from 2018 to 2021.

On December 23, 2015, we entered into the aircraft acquisition agreement with Airbus S.A.S to purchase 10 Airbus A330-300 series aircraft. The catalogue price of one Airbus A330-300 series aircraft is priced about US$227.4 million. The aggregate consideration for the acquisition will be funded partly payable by cash and partly by financing arrangements with banking institutions. The Airbus aircraft will be delivered in stages to our Company during the period commencing from 2017 to 2019. The 3 Airbus A330-300 aircraft were delivered in stages to our Company in 2017 and the 7 Airbus A330-300 aircraft will be delivered in stages to our Company during the period commencing from 2018 to 2019.

On April 26, 2016, Xiamen Airlines entered into the aircraft acquisition agreement with Boeing to purchase 10 B737-800 series aircrafts. The catalogue price of one B737-800 series aircraft is priced about US$85.06 million. The aggregate consideration for the acquisition will be funded partly by internal sources of our Company and partly through commercial loans by commercial banks. The 4 Boeing787-800 series aircraft were delivered in stages to Xiamen Airlines during the period commencing in 2017 and the 6 Boeing787-800 series series aircraft will be delivered in stages to Xiamen Airlines in 2018.

On July 27, 2016, Xiamen Airlines entered into the aircraft acquisition agreement with Boeing to purchase 6 B787-9 series aircraft. The catalogue price of one is priced about US$230 million. The aggregate consideration for the acquisition will be funded partly by internal sources of our Company and partly through commercial loans by commercial banks. The Boeing 787-9 series aircraft were delivered in stages to Xiamen Airlines during the period commencing from 2016 to 2018.

On October 12, 2016, we entered into the aircraft acquisition agreement with Boeing to purchase 12 B787-9 series aircraft. The catalogue price of one is priced about US$271 million. The aggregate consideration for the acquisition will be funded partly by internal sources of our Company and partly through commercial loans by commercial banks. The Boeing aircraft will be delivered in stages to our Company during the period commencing from 2018 to 2020.

On April 26, 2017, we entered into the aircraft acquisition agreement with Airbus S.A.S to purchase 20 A350-900 series aircraft. The catalogue price of one A350 series aircraft is priced about US$299 million. The aggregate consideration for the acquisition will be funded partly by internal sources of our Company and partly through commercial loans by commercial banks. The Airbus aircraft will be delivered in stages to our Company during the period commencing from 2019 to 2022.

 

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On October 20, 2017, we entered into the aircraft acquisition agreement with Boeing to purchase 8 B777-300ER and 30 B737-8 series aircraft. The catalogue price of each B777-300ER series aircraft and B737-8 series aircraft is priced about US$318 million and US$104 million, respectively. The aggregate consideration for the acquisition will be funded partly by internal sources of our Company and partly through commercial loans by commercial banks. The Boeing aircraft will be delivered in stages to our Company during the period commencing from 2019 to 2020.

On March 21, 2018, Xiamen Airlines entered into the Boeing Aircraft Acquisition Agreement with Boeing to purchase the 20 B737-8 aircraft and 10 B737-10 aircraft. The catalogue price of each B737-8 series aircraft and B737-10 series aircraft is priced about US$104 million and US$116 million, respectively. The aggregate consideration for the acquisition will be funded partly by internal sources of our Company and partly through commercial loans by commercial banks. The Boeing aircraft will be delivered in stages to Xiamen Airlines during the period commencing from 2019 to 2022.

Capital Expenditure

We had RMB31,129 million, RMB29,454 million and RMB23,390 million capital expenditures in 2017, 2016 and 2015 respectively. Of such capital expenditures in 2017, RMB17,283 million was financed by capital leases, RMB12,208 million was financed by bank borrowings while the remaining RMB1,638 million was financed by internal resources. The capital expenditures were primarily incurred on the additional investments in aircraft and flight equipment under our fleet expansion plans and, to a small extent, additional investments in other facilities and buildings for operations. As of December 31, 2017, we had total capital commitments for aircraft, engines and related equipment of approximately RMB86,834 million.

 

B. BUSINESS OVERVIEW

General

We provide commercial airline services throughout Mainland China, Hong Kong, Macau and Taiwan regions, Southeast Asia and other parts of the world. Based on the statistics from the CAAC, we are one of the largest Chinese airlines and, as of the year end of 2017, ranked first in terms of number of passengers carried, number of scheduled flights per week, number of hours flown, number of routes and size of aircraft fleet. During the three years ended December 31, 2017, our RPKs increased at a compound annual growth rate of 10.3% from 189,588 million in 2015 to 206,106 million in 2016 and 230,697 million in 2017 while its capacity, measured in terms of ASKs, increased at a compound annual growth rate of 9.1%, from 235,616 million in 2015 to 255,992 million in 2016 and 280,646 million in 2017. In 2017, our Group carried 126 million passengers and had passenger revenue of RMB112,791 million (approximately US$17,262 million).

We conduct a portion of our airline operations through our airline subsidiaries namely Xiamen Airlines, Shantou Airlines Company Limited (“Shantou Airlines”), Zhuhai Airlines Company Limited (“Zhuhai Airlines”), Guizhou Airlines Company Limited (“Guizhou Airlines”), Chongqing Airlines Company Limited (“Chongqing Airlines”) and China Southern Airlines Henan Airlines Company Limited (“Henan Airlines”), (collectively, the “Airline Subsidiaries”). In 2017, the Airline Subsidiaries carried 48.49 million passengers and had passenger revenue of RMB36,477 million (approximately US$5,582 million) and accounted for 38.39% and 32.3% of our passengers carried and passenger revenue, respectively.

We also provide air cargo and mail services. Our cargo and mail revenue increased by 26.30% to RMB9,082 million (approximately US$1,390 million) in 2017 as compared with that of 2016. Our airline operations are fully integrated with our airline-related businesses, including aircraft maintenance, ground services and air catering operations.

As of December 31, 2017, we operated 1,169 routes, of which 905 were domestic, 226 were international and 38 were regional. We operate the most extensive domestic route network among all Chinese airlines. Our route network covers commercial centers and rapidly developing economic regions in Mainland China.

We focused on building the “Guangzhou-Beijing Dual Hub” strategic layout and acceleration of all the preparation work for stationing in Beijing’s new Airport. On October 10, 2017, we held the opening ceremony of the Beijing’s new airport’s base project. This new base will be completed simultaneously with the Beijing’s new airport. Through Beijing’s new airport base, we will spare no effort to make Beijing core hub. By 2025, it is estimated to station 250 aircraft to build the network covering international and domestic destinations.

 

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

In December 2005, we established a branch company in Beijing and have added wide-body airplanes to our operation base in Beijing, with the view to expanding our Beijing aviation business and building another main hub there in addition to our Guangzhou base. The establishment of Guangzhou and Beijing hubs will facilitate strategic refinement and enhancement of our route network operations, putting us in a better position to explore and seize the opportunities in the aviation market.

Our operations primarily focus on the domestic market. In addition, our Group also operates regional routes and international flights. As of December 31, 2017, we had 38 regional routes and 226 international routes. Our regional operations include flights between destinations in Mainland China, Hong Kong, Macau and Taiwan. Our international operations include scheduled services to cities in Australia, Azerbaijan, Bangladesh, Cambodia, Canada, Dutch, France, German, India, Indonesia, Iran, Italy, Japan, Kenya, Kazakhstan, Kyrgyzstan, Malaysia, Maldives, Nepal, New Zealand, Pakistan, Philippines, Russia, Singapore, South Korea, Tajikistan, Thailand, Turkmenistan, United Arab Emirates (UAE), United Kingdom, United States of American (USA), Uzbekistan and Vietnam, Mexico, Laos, Sri Lanka.

After joining Skyteam Alliance, we have established a network reaching over 1,062 destinations globally, connecting 177 countries and regions and covering major cities around the world.

As of December 31, 2017, we had a fleet of 754 aircraft, consisting primarily of Boeing737, 747, 777, 787 series, Airbus 320, 330, 380 series etc. The average age of our registered aircraft was 6.6 years as of December 31, 2017.

Restructuring and Initial Public Offering

As part of China’s economic reforms in the 1980’s, the PRC State Council directed the CAAC to separate its governmental, administrative and regulatory role from the commercial airline operations that were being conducted by the CAAC and its regional administrators. As a result, CSAH was established on January 26, 1991 for the purpose of assuming the airline and airline-related commercial operations of the Guangzhou Civil Aviation Administration, one of the then six regional bureaus of the CAAC. CSAH was one of the 55 large-scale enterprises designated by the Chinese government to play a leading role in their respective industries.

CSAH was restructured in 1994 and 1995 in anticipation of our initial public offering. The restructuring was effective through the establishment of our Company and the execution of the De-merger Agreement on March 25, 1995 by and between CSAH and our Company. Upon the restructuring, our Company assumed substantially the entire airline and airline-related businesses, assets and liabilities of CSAH, and CSAH retained its non-airline-related businesses, assets and liabilities. All interests, rights, duties and obligations of CSAH, whenever created or accrued, were divided between our Company and CSAH based on the businesses, assets and liabilities assumed by each of them under the De-merger Agreement. Under the De-merger Agreement, CSAH agreed not to conduct or participate or hold any interest in, either directly or indirectly, any business, activity or entity in or outside China that competes or is likely to compete with the commercial interests of our Group, although CSAH may continue to hold and control its affiliates existing on the date of the De-merger Agreement and may continue to operate the businesses of such associates. Under the De-merger Agreement, CSAH and our Company also agreed to indemnify each other against any losses, claims, damage, debts or expenses arising out of or in connection with the restructuring. As of the date of this Annual Report, no indemnity has been provided by either CSAH or us.

In July 1997, we completed a private placement of 32,200,000 H Shares to certain limited partnership investment funds affiliated with Goldman Sachs & Co. and an initial public offering of 1,141,978,000 H Shares, par value RMB1.00 per share, and the listing of the H Shares on the Hong Kong Stock Exchange and ADRs on the New York Stock Exchange. Prior to the private placement and the initial public offering, all of our issued and outstanding shares of capital stock, consisting of 2,200,000,000 non-tradable domestic shares (“Domestic Shares”), par value RMB1.00 per share, were owned by CSAH, which owned and exercised, on behalf of the Chinese government and under the supervision of the CAAC, the rights of ownership of such Domestic Shares. After giving effect to the private placement and the initial public offering, CSAH maintained its ownership of the 2,200,000,000 Domestic Shares (representing approximately 65.2% of the total share capital of our Company), and became entitled to elect all the directors of our Company and to control the management and policies of our Group. The Domestic Shares and H Shares are both ordinary shares of our Company.

 

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In July 2003, we issued 1,000,000,000 A Shares, par value of RMB1.00 per share, and listed these shares on the Shanghai Stock Exchange. Subsequent to the issuance of the A Shares, the shareholding of CSAH in our Company was reduced from 65.2% to 50.30%.

Share Reform Scheme

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

Bonus Shares Issue by Conversion of Share Premium

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

Non-Public Subscriptions

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

On March 8, 2010, our board approved the placement of up to 1,766,780,000 new A shares to not more than 10 specific investors including CSAH and the placement of not more than 312,500,000 new H shares to Nan Lung, a wholly-owned subsidiary of CSAH. On the same date, our Company entered into the A shares subscription agreement with CSAH, pursuant to which CSAH conditionally agreed to subscribe and our Company conditionally agreed to allot and issue new A shares of not more than 132,510,000 at the subscription price of not less than RMB5.66 per A share. In addition, our Company and Nan Lung entered into the H shares subscription agreement, pursuant to which Nan Lung conditionally agreed to subscribe and our Company conditionally agreed to allot and issue new H shares of not more than 312,500,000 at the subscription price of not less than HK$2.73 per H share. The above placement and subscription agreements were approved in the extraordinary general meeting and the respective class meetings of shareholders of A and H shares on April 30, 2010. On September 8, 2010, we received the formal approval from CSRC for the proposed non-public issuance of H Shares. On September 15, 2010, we received the formal approval from CSRC for the proposed non-public issue of A Shares. In November 2010, we completed the placements of 1,501,500,000 new A shares and 312,500,000 H shares, among which 123,900,000 new A shares were issued to CSAH at the subscription price of RMB6.66 per share, and 312,500,000 H shares were issued to Nan Lung at the subscription price of HK$2.73 per share.

On June 11, 2012, we entered into an A Shares subscription agreement with CSAH, pursuant to which CSAH conditionally agreed to subscribe and we conditionally agreed to allot and issue up to 487,804,878 A Shares for a consideration of not more than RMB2 billion, equivalent to the subscription price of approximately RMB4.1 per new A Share. The subscription agreement was approved in the extraordinary general meeting on August 10, 2012, which remained effective for a period of twelve months from the date of approval of the resolution at the general meeting. As of August 9, 2013, the relevant work regarding the 2012 Non-public A Share Issue of our Company had not been completed. The proposal for the 2012 Non-public A Share Issue of our Company and A Shares subscription agreement therefore were lapsed automatically due to the expiration of the resolution passed at the general meeting.

 

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On March 27, 2017, we entered into an H Shares subscription agreement as well as a framework agreement with American Airlines, Inc. (“American Airlines”), pursuant to which American Airlines conditionally agreed to subscribe and we conditionally agreed to issue 270,606,272 H Shares for a consideration of HK$1,553.28 million, equivalent to the subscription price of HK$5.74 per new H Share. In July 2017, we received the formal approval from CSRC for the proposed non-public issue of H Shares. The issuance of 270,606,272 new H Shares American Airlines was completed on August 10, 2017. Key principles of the above mentioned framework agreement include: (i) except for certain permitted transfers, American Airlines shall not dispose of any of the subscription shares for a period of three years (the “Lock-up Period”) following the purchase of the subscription shares unless any Lock-up termination event occurs; (ii) after the expiry of Lock-up Period, American Airlines shall have the right to dispose of the subscription shares, and we shall have a right of first refusal to purchase such subscription shares; after the Lock-Up Period, American Airlines shall notify us of its first disposal of subscription shares within three business days following the consummation of such sale, and shall announce any subsequent disposals as and if required by applicable law; (iii) whilst the Framework Agreement is in effect, in the event we or any of our subsidiaries intends to sell or issue, or enter into any agreement to sell or issue, equity or equity linked securities or any such subsidiary to any airline that is then a member of or is participating in an airline alliance as agreed by American Airlines and us (other than a PRC Mainland airline company), or any affiliate of any such airline, American Airlines shall have a right of first refusal to purchase such securities; and (iv) subject to applicable laws (including the Hong Kong Listing Rules), our Board will appoint one person to serve as an observer to our Board at the request of American Airlines (the “Board Observer”), and the Board Observer is allowed to attend all meetings of our Board whether in-person or by telephone or video-conference but will not be entitled to vote as a director; the Board Observer will be subject to the same non-disclosure, insider trading restrictions and conflicts of interest policies and procedures as and to the extent the same apply to the members of our Board from time to time, and the Board Observer will no longer serve as the observer to our Board if any Board Observer termination event occurs.

On June 26, 2017, our board proposed to put forward to the extraordinary general meeting and the class meetings to approve and authorise our board (i) to issue not more than 1,800,000,000 new A Shares to not more than 10 specific investors including CSAH, and as part of such A Share issuance, to enter into the A Share subscription agreement with CSAH, pursuant to which CSAH will subscribe for no less than 31% of such new A Shares, the consideration of which shall be satisfied by transfer 50% of the Zhuhai MTU shares to our Company and cash; and (ii) to issue no more than 590,000,000 new H Shares to Nan Lung at the subscription price of HK$6.27 per H Share (subject to adjustments) and to enter into the H Share subscription agreement with Nan Lung. The total funds to be raised from the aforesaid A Share issuance and the H Share issuance will be not more than RMB12,737.00 million, which will be utilised in the procurement of aircraft, the project for selection and installation of lightweight seats for A320 series aircraft and the supplemental to the general working capital. The aforesaid A Share issuance and the H Share issuance are inter-conditional upon each other. On September 19, 2017, our board considered and approved that (i) our Company to enter into the supplemental agreement I to the A Share subscription agreement with CSAH, pursuant to which 50% of the Zhuhai MTU shares as partial consideration payable by CSAH for its subscription of new A Shares under the A Share subscription agreement has been adjusted to RMB1,741.08 million according to the final assessment results as filed and approved by the State-owned Assets Supervision and Administration Commission of the State Council (“SASAC”); and (ii) the subscription price and the number of H Shares to be issued pursuant to the H Share subscription agreement shall be adjusted to HK$6.156 and not more than 600,925,925 new H Shares, respectively due to the implementation of the 2016 dividend distribution plan of our Company. On November 8, 2017, the aforesaid A Share issuance and the H Share issuance were approved in the extraordinary general meeting and the respective class meetings of shareholders of A and H shares on November 8, 2017. We have received the approval from CSRC for the aforesaid H Share issuance in March 2018, and the aforesaid A Share issuance is subject to the approval from CSRC.

Issuance of Ultra-short-term and Short-term Financing Bills and Medium-term Notes

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

 

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On May 28, 2008, our board approved the proposed issuance of medium term notes by our Company in the principal amount of up to RMB1.5 billion and the submission of such proposal to the shareholders for their consideration and approval. On June 25, 2008, shareholders of our Company approved such notes issuance at the annual general meeting for the year 2007. Our Company believed that the notes issue would provide a further source of medium to long term funding at an interest rate lower than the best lending rate for loans from commercial banks, lower the finance costs of borrowings for us and improve our debt structure. As of the date of this Annual Report, we have not issued any medium term notes, even though it has been approved by our board and shareholders.

In order to capitalize on opportunities in the market and improve the flexibility and efficiency of financing, on June 25, 2012, our Board resolved to obtain a general and unconditional mandate from shareholders to issue potential debt financing instruments, in one or multiple tranches, within the permissible size for debt issuance in accordance with the provisions of the applicable laws and regulations. On the extraordinary general meeting held on August 10, 2012, shareholders approved the authorization given to our Board, generally and unconditionally, to determine the specific debt financing instruments and issuance plan, and to issue, in one or multiple tranches, debt financing instruments within the permissible size for debt issuance in accordance with the provisions of the applicable laws and regulations. According to the resolution, on October 31, 2012, our Board approved to apply to National Association of Financial Market Institutional Investors for registration to issue, in one or multiple tranches, ultra-short-term financing bills with an aggregate principal amount of to RMB10 billion, according to our capital needs and the market conditions. Our Company has completed the issuance of the first tranche of ultra-short-term financing bills on February 8, 2013. The total issuance amount of the first tranche financing bills was RMB0.5 billion, with a maturity period of 180 days, a par value per unit of RMB100 and a nominal interest rate of 3.9%.

On March 21, 2014, our Company completed the issuance of the first tranche of ultra-short-term financing bills for the year 2014 of China Southern Airlines Company Limited (the “2014 First Tranche Financing Bills”). The total issuance amount of the 2014 First Tranche Financing Bills was RMB3 billion, with a maturity period of 180 days, a par value per unit of RMB100 and a nominal interest rate of 5.1%.

On April 17, 2014, our Company completed the issuance of the second tranche of ultra-short-term financing bills for the year 2014 of China Southern Airlines Company Limited (the “2014 Second Tranche Financing Bills”). The total issuance amount of the 2014 Second Tranche Financing Bills was RMB3 billion, with a maturity period of 270 days, a par value per unit of RMB100 and a nominal interest rate of 5.1%.

On August 14, 2014, our Board approved to make an application to National Association of Financial Market Institutional Investors for the registration and issuance of medium-term notes with an aggregate maximum principal amount of RMB10 billion for the purpose of replenishing the working capital and optimizing the debt structure of our Company. The annual general meeting for the year 2014 of our Company held on June 30, 2015 approved to make an application to the National Association of Financial Market Institutional Investors for the registration of ultra-short-term financing bills with the aggregate maximum principal amount of RMB14 billion (the “Ultra-short-term Financing Bills”), and the Ultra-short-term Financing Bills within the mentioned issuance size will be issued in one tranche or multiple tranches according to the funding needs and the market conditions. As of the date of this Annual Report, we have not issued any medium term notes.

On November 19, 2015, our Company completed the issuance of the first tranche of ultra-short-term financing bills for the year 2015 (the “2015 First Tranche Financing Bills”). The total issuance amount of the 2015 First Tranche Financing Bills was RMB3 billion, with a maturity period of 270 days, a par value per unit of RMB 100 and a nominal interest rate of 3.20%.

On November 24, 2015, our Company completed the issuance of the second tranche of ultra-short-term financing bills for the year 2015 (the “2015 Second Tranche Financing Bills”). The total issuance amount of the 2015 Second Tranche Financing Bills was RMB2 billion, with a maturity period of 180 days, a par value per unit of RMB 100 and a nominal interest rate of 3.04%.

On November 30, 2015, our Company completed the issuance of the third tranche of ultra-short-term financing bills for the year 2015 (the “2015 Third Tranche Financing Bills”). The total issuance amount of the 2015 Third Tranche Financing Bills was RMB3 billion, with a maturity period of 268 days, a par value per unit of RMB 100 and a nominal interest rate of 3.16%.

On March 8, 2016, our Board approved to make an application to National Association of Financial Market Institutional Investors for the registration and issuance of medium-term notes and ultra-short-term financing bills with an aggregate maximum principal amount of RMB5 billion and RMB10 billion respectively and the ultra-short-term financing bills within the mentioned issuance size will be issued in one tranche or multiple tranches according to the funding needs and the market conditions for the purpose of replenishing the working capital and optimizing the debt structure of our Company. The National Association of Financial Market Institutional Investors has approved the registration both the medium-term notes and ultra-short-term financing bills.

 

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On August 15, 2016 and August 16, 2016 Xiamen Airlines issued medium-term notes with aggregate nominal value of RMB1,300 million at an interest rate of 2.97%. The medium-term notes mature in three years.

On October 20, 2016, Xiamen Airlines issued medium-term notes with aggregate nominal value of RMB1,600 million at an interest rate of 3.11%. The medium-term notes mature in five years.

On November 21, 2016, Xiamen Airlines issued medium-term notes with aggregate nominal value of RMB1,800 million at an interest rate of 3.38%. The medium-term notes mature in three years.

On February 16, 2017, our Company completed the issuance of a round of ultra-short-term financing bills for the year 2017 (the “2017 Financing Bills”). The total issuance amount of the 2017 Financing Bills was RMB1 billion, with a interest rate of 3.70%. The end date of transcation is November 17, 2017.

Issuance of Corporate Bonds

On November 13, 2015, our Company was approved by the CSRC to publicly issue corporate bonds (the “Corporate Bonds”) in the amount of not more than RMB19 billion to qualified investors. The issuance of the Corporate Bonds shall be conducted in multiple tranches. The issuance of the first tranche must be completed within 12 months from the date of the approval and the issuance of the remaining tranches must be completed within 24 months from the date of the approval. On November 20, 2015, our Company issued the first tranche of 2015 corporate bonds of RMB3,000 million with an interest rate of 3.63% per annum due 2020. On March 3, 2016, our Company issued the first tranche of 2016 corporate bonds of RMB5,000 million with an interest rate of 2.97% per annum due 2019. On May 25, 2016, our Company issued the second tranche of 2016 corporate bonds of RMB5,000 million with an interest rate of 3.12% per annum due 2021.

Route Network

Overview

We operate the most extensive route network among all Chinese airlines. As of December 31, 2017, we operated 1,169 routes consisting of 905 domestic routes, 38 regional routes and 226 international routes.

We continually evaluate our network of domestic, regional and international routes in light of our operating profitability and efficiency. We seek to coordinate flight schedules with the Airline Subsidiaries on shared routes to maximize load factors and utilization rates. The acquisition of domestic, regional and international routes is subject to approval of the CAAC, and the acquisition of regional and international routes is also subject to the existence and the terms of agreements between the Chinese government and the government of the Hong Kong SAR, the government of the Macau SAR, the government of Taiwan province and the government of the proposed foreign destination.

In order to expand our international route network, we have entered into code-sharing agreements with several international airlines, including Aeroflot-Russian Airlines, Air France, Alitalia-Linee Aeree Italiane, American Airlines, INC., Asiana Airlines, China Airlines, China Eastern Airlines, CSA Czech Airlines, Chongqing Airlines Company Limited, Delta Air Lines, Etihad Airways PJSC, Japan Airlines International, Kenya Airways, KLM Royal Dutch Airline, Korean Air, Mandarin Airlines, Pakistan International Airlines, PT Garuda Indonesia (Persero) Tbk., Qantas Airways Limited, Saudi Arabian Airlines, Sichuan Airlines Co., Ltd., Vietnam Airlines, Virgin America, WestJet and Xiamen Airlines. Under the code-sharing agreements, the Participating Airlines are permitted to sell tickets on certain international routes operated by us to passengers using the Participating Airlines’ codes. Similarly, we are permitted to sell tickets for the other participating airlines using CZ code. The code-sharing agreements help increase the number of our international sales outlets. After joining Skyteam Alliance, we have further established a network reaching 1,062 destinations globally, connecting 177 countries and regions and covering major cities around the world.

 

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

 

     Passenger carried      Cargo and Mail arrived
(tons)
     Total traffic (tons
kilometres)
 

Year

   Total (in
millions)
     Increase
(decrease)
over
previous
year (%)
     Total (in
thousands
     Increase
(decrease)
over
previous
year (%)
     Total (in
millions)
     Increase
(decrease)
over
previous
year (%)
 

2015

     109.42        8.4        1,511        5.4        22,388        13.2  

2016

     114.62        4.8        1,613        6.7        24,387        8.9  

2017

     126.30        10.2        1,672        3.7        27,321        12.03  

Route Bases

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

We believe that our extensive network of route bases enables it to coordinate flights and deploy our aircraft more effectively and to provide more convenient connecting flight schedules and access service and maintenance facilities for our aircraft. We believe that the number and location of these route bases may enhance our ability to obtain the CAAC’s approval of requests by our Group to open new routes and provide additional flights between these bases and other destinations in China. Current regulations of the CAAC generally limit airlines to operations principally conducted from their respective route bases.

Domestic Routes

Our domestic routes network serves substantially all provinces and autonomous regions in China, including Guangdong, Fujian, Hubei, Hunan, Hainan, Guangxi, Guizhou, Henan, Heilongjiang, Jilin, Liaoning and Xinjiang, and serves all four centrally-administered municipalities in China, namely, Beijing, Shanghai, Tianjin, and Chongqing. In 2017, our most profitable domestic routes were between: Shenzhen-Beijing, Shengzhen-Shanghai, Guangzhou-Beijing, Beijing-Shenzhen; Shanghai-Shenzhen; Sanya-Beijing, Guangzhou-Shanghai; Shanghai-Guangzhou, Urumqi-Beijing, Beijing-Urumqi.

Regional Routes

We offer scheduled service between Hong Kong and Beijing, Shenyang, Meixian, Wuhan, Yiwu, Shantou, Xiamen, Wuyishan, Quanzhou; and between Taipei and Guangzhou, Shanghai, Fuzhou, Hangzhou, Xiamen, Shenyang, Changsha, Wuhan, Dalian, Guilin, Harbin, Guiyang, Zhengzhou, Changchun, Zhangjiajie, Nanning, Shantou, Yiwu, Quanzhou, Yanji and Shenzhen. In 2017, the most profitable scheduled regional routes were between: Taipei-Guangzhou; Shenzhen-Taipei; Taipei-Shenzhen; Guangzhou-Taipei; Shanghai-Taipei; Taipei-Shanghai; Taipei-Harbin; Taipei-Changchun; Hong Kong-Taipei.

In 2017, we conducted a total of 18,030 flights on our regional routes, accounting for approximately 22.7% of all passengers carried by Chinese airlines on routes between Hong Kong, Macau or Taiwan and destinations in Mainland China according to CAAC statistics briefing.

Previously, direct flights between Taiwan and Mainland China were only available during certain festivals. Other than that, travellers between Taiwan and Mainland China had to make use of intermediate stops in Hong Kong or elsewhere. Since July 2008, however, the ban on direct flights was further liberalized to allow direct charter flights on weekends. We were the first Chinese carrier to fly nonstop to Taiwan. On November 4, 2008, the Mainland China and Taiwan agreed to have regular direct passenger charter flights across the Taiwan Strait. On August 31, 2009, the Mainland China and Taiwan increased the number of regular cross-Strait direct passenger flights from 108 to 270 a week. Cross-Strait direct passenger flights were further increased in the following years. As of April 26, 2018, there were 78 cross-Strait direct passenger flights a week.

 

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International Routes

We are the principal Chinese airlines serving Southeast Asian destinations and Australasia, including Singapore and major cities in Australia, New Zealand, Bangladesh, Indonesia, Thailand, Malaysia, Philippines, Vietnam, Myanmar and Cambodia.

In addition, we also provide scheduled services to cities in Australia, Azerbaijan, Bangladesh, Cambodia, Canada, Dutch, France, German, India, Indonesia, Iran, Italy, Japan, Kenya, Kazakhstan, Kyrgyzstan, Malaysia, Maldives, Nepal, New Zealand, Pakistan, Philippines, Russia, Singapore, South Korea, Tajikistan, Thailand, Turkmenistan, United Arab Emirates (UAE), United Kingdom, United States of American (USA), Uzbekistan, and Vietnam. Since joining Skyteam Alliance, we have established a network reaching over 1,062 destinations globally, connecting 177 countries and regions and covering major cities around the world.

In 2017, our most profitable international routes were: Beijing-Amsterdam, Seoul-Yanji, Beijing-Guangzhou-Phnom Penh, Seoul-Shenyang, Osaka-Guangzhou, Yanji-Seoul, Guangzhou-Dhaka, Dhaka-Guangzhou, Phnom Penh-Guangzhou-Beijing, Guangzhou-Wuhan- San Francisco.

Aircraft Fleet

Our fleet plan in recent years has emphasized expansion and modernization through the acquisition of new aircraft and the retirement of less efficient and old aircraft. As of December 31, 2017, we operated a fleet of 754 aircraft with an average age of 6.6 years. Most aircraft of our Group are Boeing and Airbus aircraft. We have the largest fleet among Chinese airline companies. Among all the aircraft, 477 aircraft operated by our Group are leased pursuant to various types of leasing arrangements. Please see the table below for an analysis of our aircraft in terms of average age and respective passenger capacity.

 

Model

   Number of
Aircraft
     Passenger Capacity  

Boeing 787-8

     16        228/237  

Boeing 787-9

     4        287  

Boeing 777-300ER

     10        309  

Boeing 777-200

     2        360  

Boeing 757-200

     6        174/180//197  

Boeing 737-800

     317        159/161/164/169/170/172/178/184  

Boeing 737-700

     38        128/134  

Boeing 747-400F

     2        N/A  

Boeing 777-200F

     12        N/A  

Airbus 380-800

     5        506  

Airbus 330-300

     29        259/275/284/286  

Airbus 330-200

     16        218/258/278  

Airbus 321

     98        179/189/195  

Airbus 320

     142        152/160/166/168  

Airbus 319

     31        122/130/138  

EMB190

     26        98  

Total

     754        N/A  

In 2017, we continued to expand and modernize our aircraft fleet. During 2017, we (i) took scheduled delivery of 47 aircraft under purchase agreements, including 5 A320-200, 9 A321-200, 7 A330-300, 7 B737-8, 16 B737-800, 3 B787-9 (all 3 B787-9 aircraft belong to Xiamen Airlines); (ii) took scheduled delivery of 27 B737-800 (including 25 B737-800 aircraft belong to Xiamen Airlines) and 5 A320-200neo under operating leases; (iii) returned 6 A319-100, 3 A320-200, 2 B737-800 and 1 B737-700 (all 2 B737-800 and 1 B737-700 aircraft belong to Xiamen Airlines) under operating leases upon expiry; and (iv) disposed of 3 B737-300, 4 B757-200, 2 B777-200 and 6 B737-700 (all 6 B737-700 aircraft belong to Xiamen Airlines).

During 2017, Xiamen Airlines (i) took scheduled delivery of 25 B737-800 aircraft under operating leases; (ii) took scheduled delivery of 3 B787-9 under financing leases.

On April 26, 2017, we entered into the aircraft acquisition agreement with Airbus S.A.S for the acquisition of 20 A350-900 series aircraft to be delivered from 2019 to 2020. On October 20, 2017, we entered into the aircraft acquisition agreement with Boeing for the acquisition of 8 B777-300ER and 30 B737-8 series aircraft to be delivered from 2019 to 2020.

 

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Aircraft Financing Arrangements

Overview

A significant portion of our aircraft is acquired under long-term capital or operating leases or long-term mortgage loans with remaining terms to maturity mainly ranging from one to eleven years. As of December 31, 2017, of the Group’s 754 aircraft, 213 aircraft were operated under capital leases, 264 were operated under operating leases, 277 were either owned aircraft financed by long-term mortgage loans, or acquired either with cash proceeds or acquired by exercising the purchase options upon expiry of the respective capital leases. Our planned acquisition of aircraft in the foreseeable future will generally be made through acquisition by bank loans and our own funds, and pursuant to operating leases or capital leases. Our determination as to our acquisition strategy depends on our evaluation at the time of our capacity requirements, anticipated deliveries of aircraft, our capital structure and cash flow, prevailing interest rates and other general market conditions.

The following table sets forth, as of December 31, 2017, the number of aircraft operated by our Group pursuant to capital and operating leases and the average remaining terms, of such leases.

 

     Capital Lease      Operating Lease      Average
Remaining
Lease Term
 
Model    Number of Aircraft      Number of Aircraft      Year  

Boeing 787-8

     13        2        7.09  

Boeing 787-9

     4        0        9.24  

Boeing 737-800

     63        146        6.40  

Boeing 737-700

     0        3        0.27  

Boeing 777-200F

     5        0        8.78  

Boeing 777-300ER

     9        0        8.62  

Airbus 380

     2        0        5.66  

Airbus 330-300

     20        8        7.01  

Airbus 330-200

     7        2        4.54  

Airbus 321-200

     42        22        6.15  

Airbus 320-200

     41        37        6.60  

Airbus 319-100

     0        17        2.59  

Airbus 320-220 NEO

     0        7        10.58  

Boeing 737-8 MAX

     7        0        9.95  

EMB190

     0        20        2.30  

Total

     213        264        4.09  

Capital leases

The majority of the capital leases in respect to aircraft and related equipment have terms of 10 to 15 years expiring during the years 2017 to 2030. As of December 31, 2017, our aggregate future minimum lease payments (including future finance charges) required under its capital leases were RMB78,899 million. Our capital leases typically cover a significant portion of the relevant aircraft’s useful life and transfer the benefits and risks of ownership to our Group. Under its capital leases, we generally have an option to purchase the aircraft at or near the end of the lease term. As is customary in the case of capital leases, our obligations are secured by the related aircraft, as well as other collateral.

Operating Leases

As of December 31, 2017, our aggregate future minimum lease payments required under its operating leases were RMB69,465 million. As of the year end of 2017, our operating leases had original terms generally ranging from five to fifthteen years from the date of delivery of the relevant aircraft, and the remaining terms of these leases ranged from one to twelve years. Pursuant to the terms of the operating leases, our Group is obligated to make rental payments based on the lease term, with no termination payment obligations or purchase option, and the lessor bears the economic benefits and risks of ownership. Under our operating leases, our Group has no option to purchase the aircraft and is required to return the aircraft in the agreed condition at the end of the lease term. Although title to the aircraft remains with the lessor, our Group is responsible during the lease term for the maintenance, servicing, insurance, repair and overhaul of the aircraft.

 

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For capital leases or operating leases, we are obligated to indemnify the lessors against any withholding or similar taxes that may be imposed on the lessors by taxing authorities in China with regard to payments made pursuant to such leases. In accordance with relevant PRC tax regulations, a PRC lessee is liable to withhold PRC withholding tax in respect of any lease payments regularly made to an overseas lessor. Depending on the circumstances, this tax is generally imposed at a fixed rate ranging from 6.0% to 10.0% of the lease payments, or in certain cases, the interest components of such payments for capital lease. The PRC withholding tax payable in respect of the lease arrangements amounting RMB234 million, RMB237 million and RMB291 million during 2017, 2016 and 2015, has been included as part of the lease charges.

Aircraft Flight Equipment

The jet engines used in our aircraft fleet are manufactured by General Electric Corporation, Rolls-Royce plc, United Technologies International, Inc., CFM International, Inc. and International Aviation Engines Corporation. We had 94 spare jet engines for our fleet as of the year end of 2017 and 2016, respectively. We determine our requirements for jet engines based on all relevant considerations, including manufacturers’ recommendations, the performance history of the jet engines and the planned utilization of its aircraft. Acquisition of rotables and certain of the expendables for our aircraft are generally handled by Southern Airlines (Group) Import and Export Trading Company Limited (“SAIETC”), a subsidiary we acquired from CSAH in August 2016, in consideration of an agency fee. We arrange the ordering of aircraft, jet engines and other flight equipment for the Airline Subsidiaries and keep an inventory of rotables and expendables for the Airline Subsidiaries.

Aircraft Maintenance

A major part of the maintenance for our fleet other than overhauls of jet engines is performed by Guangzhou Aircraft Maintenance Engineering Company Limited (“GAMECO”), an entity jointly controlled by our Company, Hutchison Whampoa (“Hutchison”) and South China International Aircraft Engineering Company Limited, consistent with our strategy to achieve fully integrated airline operations and to assure continued access to a stable source of high quality maintenance services. The remaining part of the maintenance for our fleet other than overhauls of jet engines is performed by service providers in China and overseas. GAMECO performs all types of maintenance services, ranging from maintenance inspections performed on aircraft (“line maintenance services”) to major overhaul performed at specified intervals. GAMECO was the first of three aircraft maintenance facilities in China having been certified as a repair station by both the CAAC and the Federal Aviation Administration. In March 1998, GAMECO received the Joint Civil Aviation Authorities certificate, which was transferred to European Aviation Safety Agency certification in November 2004, for the repair and maintenance of aircraft and aircraft engines.

We believe that GAMECO performs major maintenance checks on our aircraft within time periods generally consistent with those of large international airline maintenance centers. GAMECO’s repair and maintenance capacity include overhaul of more than 40% of our aircraft. Although rotables for our aircraft are generally imported through SAIETC, a portion of expendables and other maintenance materials are directly imported by GAMECO. Our agreement with GAMECO usually has a term of one year.

Overhauls of jet engines are performed by Zhuhai MTU, a former jointly controlled entity of CSAH and MTU Aero Engines GmbH, and also by domestic qualified service providers in Xiamen (TEXL), Hong Kong (RR) and Taiwan (EGAT), and by overseas qualified service providers in USA, Germany, Korea, Singapore, Nederland and Wales. On September 28, 2009, our Company entered into an agreement with CSAH to sell its 50% equity interest in Zhuhai MTU to CSAH at a consideration of RMB1,607,850,000. The transfer was completed in February 2010.

The amounts incurred by our Group for comprehensive maintenance services provided by GAMECO and Zhuhai MTU were RMB3,925 million, RMB3,897 million and RMB3,028 million for the years ended December 31, 2017, 2016 and 2015, respectively.

 

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Safety

We endeavour to maintain strict compliance with all laws and regulations applicable to flight safety. In addition, we have adopted measures to eliminate or minimize factors that may impair flight safety, including specialized training programs and safety manuals. The Air Safety Management Department of our Company implements safety-related training programs on an on-going basis in all of our operations to raise the safety awareness of all employees. As a result, overall flight safety has gradually improved. For “incidents” which include various events and conditions prescribed by the CAAC which do not involve serious personal injury or material damage to flight equipment, our Group has kept the number consistently below what is prescribed by the CAAC. For example, our Company’s “Air Transportation Incidents Per Ten Thousands Hours Ratio” was 0.01, 0.005 and 0.034 in 2017, 2016 and 2015, respectively. In comparison, CAAC’s published maximum acceptable Air Transportation Incidents Per Ten Thousands Hours Ratio was 0.5, 0.14 and 0.5 in 2017, 2016 and 2015, respectively. This ratio is defined as the number of occurrences of air transportation incident for every 10,000 hours of flight time. In 2013, we strengthened our flight safety management on the internal and external safety requirements. In 2008, we received the “Five-Star Flight Safety Award” from CAAC, being the first in domestic aviation industry to receive such a great honour. Subsequently in 2012, we were awarded the “Safe Flight Diamond Award” by CAAC for our 10,000,000 safety flight hours record, also being the first in domestic aviation industry to receive such a great honour. By December 31, 2017, our Company’s continuous safe flight span totalled to 2.567 million hours.

Jet Fuel

Jet fuel costs typically represent a major component of an airline’s operating expenses. Our jet fuel costs accounted for 25.9%, 22.4% and 25.9% of our operating expenses for the years ended December 31, 2017, 2016 and 2015, respectively. Like all Chinese airlines, we are generally required by the Chinese government to purchase our jet fuel requirements from regional branches of CAOSC and Bluesky Oil Supplies Company, except at the Shenzhen, Sanya, Haikou, Shanghai Pudong where jet fuel is supplied by Sino-foreign joint venture in which CAOSC is a joint venture partner. CAOSC is a State-owned organization controlled and supervised by the CAAC that controls the importation and distribution of jet fuel throughout China.

Jet fuel obtained from CAOSC’s regional branches is purchased at uniform prices throughout China that are determined and adjusted by CAOSC from time to time with the approval of the CAAC and the pricing department of the NDRC based on market conditions and other factors. As a result, the costs of transportation and storage of jet fuel in all regions of China are spread among all domestic airlines. Jet fuel costs in China are influenced by costs at state-owned oil refineries and limitations in the transportation infrastructure, as well as by insufficient storage facilities for jet fuel in certain regions of China.

Prior to 1994, domestic jet fuel prices were generally below international jet fuel prices. The Chinese government had gradually increased domestic jet fuel prices in order to reflect more accurately the costs of supplying jet fuel in China. As a result, domestic jet fuel prices have become higher than those in the international market since the beginning of 1994. In 2007 through the first half of 2008, the crude oil prices in the international market reached historic highs. In response to the pressure imposed by such soaring prices, on November 1, 2007 and June 20, 2008, respectively, NDRC increased the domestic price for jet fuel. Thereafter, in order to reduce fuel cost pressure faced by Chinese airlines, NDRC approved reductions in domestic prices for jet fuel in 2008 and 2009. However, during a period starting from February 2009 to 2013, the crude oil price in the international market continued to increase and maintained at a high level. However, influenced by excessive oil supply, global economic weakness and the strong US$, the international oil prices have been trending downward since 2014. Our jet fuel costs increased from RMB 23,799 million in 2016 to RMB 31,895 million in 2017 as a result of the increase in average jet fuel prices from 2016 to 2017.

In addition to purchases of jet fuel from CAOSC, we are also permitted by the Chinese government to purchase a portion of our jet fuel requirements for our international flights from foreign fuel suppliers located outside China at prevailing international market prices. Jet fuel purchased from such sources outside China accounted for approximately 17.31% and 15.96% of our total jet fuel consumption in 2017 and 2016, respectively.

Fuel Surcharge

Our profit for the year may suffer from an unexpected change in the fuel surcharge collection policies and other factors beyond our control. The level of fuel surcharges, which is regulated by Chinese government, affects domestic customers’ air travel demand as well as our ability to generate profits. On January 14, 2009, the NDRC and the CAAC jointly announced that the collection of passenger fuel surcharge for domestic routes should be suspended from January 15, 2009 onwards. Subsequently, in response to the increase in international fuel prices, the NDRC and CAAC issued a notice on November 11, 2009 to introduce a new pricing mechanism of fuel surcharge that links it with airlines’ jet fuel costs, which was further adjusted subsequently.

 

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From April 1, 2015, The NDRC has adjusted the benchmark oil price to RMB5,000 per ton, for every RMB100 by which the cost of jet fuel exceeds that price, the airlines are allowed to charge RMB0.00002566 per kilometre for the flight distance. Based on that rate, for every RMB100 by which the cost of jet fuel exceeds RMB5,000 per ton, the airlines are allowed to charge RMB 0.0002566 per kilometer for the flight distance. The NDRC has decreased the rate of fuel surcharge from RMB 0.00001614 per kilometer to RMB 0.00002566 per kilometer, starting from April 1, 2017 and ending on March 31, 2018.

Flight Operations

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

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

Training of Pilots and Flight Attendants

We believe that our pilot training program, which was established in cooperation with the CAAC affiliated Beijing University of Aeronautics and Astronautics (the “BUAA”), has significantly improved the quality of the training received by our pilots and has helped maintain the quality of our staff of pilots at a level consistent with the expansion of operations called for by our business strategy.

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

Our pilots are required to be licensed by the CAAC, which requires an annual proficiency check. Our pilots attend courses in simulator training twice annually and in emergency survival training once annually. We also conduct regular advanced training courses for captains and captain candidates. Pilots advance in rank based on number of hours flown, types of aircraft flown and their performance history.

We funded the training of our recruited pilots in previous years and, as a result, incurred significant costs over the years. Recently, there has been a trend in the financing of pilot training worldwide from employer-sponsored to self-sponsored scheme. Such a change will not only cut down our training expenses significantly, but also ensures the long-term dedicated service of the pilots. Starting from 2007, we began to recruit pilots under the self-sponsored training arrangement.

 

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

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

Ground Services

We make arrangements with airport authorities, other airlines or ground services companies for substantially all ground facilities, including runway, ramp, terminal and support services buildings, at each airport that they serve. We pay landing, parking and other fees to such airports, including Guangzhou Baiyun International Airport (the “Guangzhou Baiyun Airport”). At domestic airports, such fees are generally determined by CAAC.

At Guangzhou Baiyun Airport, we operate our own passenger check-in, cargo, mail and baggage handling, aircraft maintenance and cleaning services. We also provide such services to our customer airlines that operate in Guangzhou Baiyun Airport.

Ground services at the airports, such as those in Shenzhen, Changsha, Wuhan, Zhengzhou, Haikou, Zhuhai, Guilin, Jieyang, Guiyang, Shenyang, Harbin, Dalian, Changchun, Sanya, Nanning, Chongqing, Shanghai Hongqiao, Shanghai Pudong and Urumqi, are operated directly by the Group. Ground services at the airport in Beijing have been primarily provided by Beijing China Southern Airlines Ground Services Co., Ltd, which became a wholly-own subsidiary of the Company in June 2009. Ground services at other airports in China are provided to the Group by local airport authorities or local airlines pursuant to various service agreements. Ground services and other services at airports outside China are provided to the Group by foreign services providers pursuant to various service agreements with such parties. All such agreements of the Group are short-term and otherwise on terms that are customary in the industry.

Air Catering

We own a 70.5% equity interest in Guangzhou Nanland Air Catering Company Limited (“Nanland”). Nanland provides in-flight meals, snacks, drinks and related services for all of our flights originating in Guangzhou and substantially all other flights departing from Guangzhou Baiyun Airport. We contract with various air catering suppliers with respect to in-flight catering services for flights originating from other airports, generally on an annual basis and otherwise on terms that are customary in the industry.

In order to optimize assets structure, tighten cost control, reduce the number of connected transactions and enhance the independence of operations in the long-run, our Company acquired a 100% equity interest in China Southern Airlines Group Air Catering Company Limited (“SAG Air Catering”) on August 31, 2007 from CSAH. SAG Air Catering provides in-flight meals for flights of our Group originating or stopping at domestic airports, mainly in northern China and Xinjiang regions.

Cargo and Mail

We also provide air cargo and mail services. A significant portion of these services are combined with passenger flights services. In 2017, we had 2 Boeing 747 freighters and 12 Boeing 777 freighters, mainly servicing 12 international cargo routes, including Guangzhou–Chongqing–Amsterdam–Guangzhou, Guangzhou–Amsterdam–Guangzhou, Guangzhou–London-Frankfurt-Guangzhou, Guangzhou-Frankfurt-Guangzhou, Guangzhou-Anchorage-Los Angeles-Guangzhou, Guangzhou-Hefei-Los Angeles-Hefei-Guangzhou, Guangzhou-Ho Chi Minh City-Hanoi-Guangzhou, Shanghai Pudong-Amsterdam-Chongqing-Shanghai Pudong, Shanghai Pudong-Amsterdam-Shanghai Pudong, Shanghai Pudong–Frankfurt–Shanghai Pudong, Shanghai Pudong–Anchorage–Chicago–Shanghai Pudong, Shanghai Pudong–Los Angeles–Shanghai Pudong. We conduct our cargo business primarily through our cargo hubs in Guangzhou and Shanghai.

 

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Sales, Reservations and Marketing

Passenger Ticket Sales and Reservations

Our ticket sales and reservations are conducted by or through independent sales agents and our own network of exclusive sales offices as well as the CAAC’s sales offices and CSAH’s affiliates. We have sales offices in Guangzhou and our other route bases. In addition, we maintain regional sales offices in other cities in China, including Beijing and Shanghai. We maintain international sales offices in Almaty, Amsterdam, Ashkhabad, Auckland, Baku, Bangkok, Bishkek, Brisbane, Busan, Chicago, Christchurch, Daegu, Daejeon, Delhi, Dhaka, Dubai (Sharjah), Dushanbe, Frankfurt, Fukuoka, Hanoi, Hiroshima, Ho Chi Minh City, Irkutsk, Islamabad, Istanbul, Jakarta, Kathmandu, Khabarovsk, Khudzhand, Kitakyushu, Kuala Lumpur, London, Los Angeles, Manila, Melbourne, Mexico City, Moscow, Nagoga, New York, Niigata, Novosibirsk, Nairobi, Oakland, Osaka, Osh, Paris, Penang, Perth, Phnom Penh, Phuket, Roma, San Francisco, Sapporo, Sendai, Seoul, Siem Reap, Singapore, Sydney, Tashkent, Tehran, Toronto, Tokyo, Toyama, Tbilisi, Vancouver, Vladivostok, Vientiane and Yangon.

We have agency agreements with airlines in the Asia-Pacific region, Europe, the United States and Africa for the processing of ticket sales and reservations on a reciprocal basis. In 2017, over 51.5% of all ticket sales for our scheduled flights were made by our network of sales offices and CSAH’s affiliates. We also sell tickets and accept reservations through an extensive network of non-exclusive independent sales agents. Under the agency agreements with these sales agents, we pay commissions based on the value of tickets sold. In 2017, sales by independent sales agents accounted for less than 48.2% of our ticket sales of our scheduled flights.

Substantially all of our sales offices and agents in China are linked electronically to the TravelSky Technology Limited’s computerized ticketing and reservations system, which is in turn linked to all domestic airlines for flights throughout China. We have also entered into membership agreements with several international reservation systems, including SABRE, AMADEUS, WORLDSPAN, GALILEO, INFINI and AXESS in the world. These systems facilitate reservations and sales of tickets for our international flights. In 2007, we further improved and optimized our online sales network, and launched Tencent sales counters in cooperation with Tencent Technology Limited, thus expanded the consumer sales network of our Group. Meanwhile, our Group upgraded and reconstructed the SMS platform, which provided SMS information services on mileage, flight schedule, flight status and air ticket price, and launched the “95539” services hotlines.

Cargo

Our cargo and mail services are promoted through our own cargo divisions and independent cargo agents both within and outside China that track available space among all airlines. In particular, our Group employs a number of cargo agents in the Pearl River Delta region. In 2017, we generally pay the cargo agents an average commission of 0.33% of the relevant cargo freight rate for domestic and international services, of which the commission of cargo agents in the Pearl River Delta region is 0.79%.

Promotional and Marketing Activities

We engage in regular promotional and marketing activities in an effort to increase our market share. Our promotional and marketing activities for domestic routes emphasize safety, passenger comfort and the frequency of our flights. Our promotional and marketing activities for international and regional passengers emphasize our quality of service, extensive route network in China and greater frequency of flights relative to other Chinese airlines. We were among the first to launch premium economy class of seating. In addition, we also promote and market our regional and international routes on the basis of price competitiveness.

We seek to increase our name recognition by offering new services to passengers. For example, our Group was the first Chinese airline to provide off-airport check-in services. We also offered transfer and baggage “through-handling” services to passengers connecting to other airlines, including passengers connecting in Hong Kong for flights to Taiwan. We widened our use of information technology and introduced new services such as cell phone check-in, SMS platforms and online meal booking. In 2017, our Company reached a strategic cooperation agreement with American Airlines. According to this agreement, American Airlines subscribed our Company’s shares in August 2017 by USD200 million. Our Company and American Airlines also established a code sharing partnership on 18 January 2018 to provide more convenient and diversified trip options for passengers. Our Company fully participate in the global network of SkyTeam and continuously strengthen the cooperation with SkyTeam’s members. Based on the “friend circle” in the existing international and domestic carriers, we expanded the circle according to the market demands. Therefore, we partnered with British Airways, Etihad Airways, South American Airlines and other airlines. At present, our Company has shared codes with 25 international and domestic airlines, such as, France Airlines, KLM Royal Dutch Airlines, Delta Airlines, American Airlines, Qantas Airways, in 585 routes (including trunk routes and beyond routes). This further enlarged our sales channels and flight route network.

 

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

To enhance relationships with our passengers, we have launched two major frequent flyer programs, namely the “China Southern Airlines Sky Pearl Club” and the “Xiamen Airlines’ Egret Card Frequent Flyer Program”. By the end of 2017, we had approximately 34.52 million members (including those of Xiamen Airlines) under these programs.

Regulation

The Chinese commercial aviation industry is subject to a high degree of regulation and oversight by the CAAC. Regulations and policies issued or implemented by the CAAC encompass substantially all aspects of airline operations, including route allocation, pricing of domestic airfare, the administration of air traffic control systems and certain airports, air carrier certifications and air operator certification and aircraft, registration and aircraft airworthiness certification. The Civil Aviation Law, which became effective in March 1996, provides a framework for regulation of many of these aspects of commercial aviation activities. Although China’s airlines operate under the supervision and regulation of the CAAC, they are accorded an increasingly significant degree of operational autonomy, including with respect to the application for domestic, regional and international routes, the allocation of aircraft among routes, the purchase of flight equipment, the pricing of air fares within a certain range, the training and supervision of personnel and their day-to-day operations.

As an airline providing services on international routes, we are also subject to a variety of bilateral civil air transport agreements that provide for the exchange of air traffic rights between China and various other countries. In addition, China is a contracting state, as well as a permanent member, of the International Civil Aviation Organization (the “ICAO”), an agency of the United Nations established in 1947 to assist in the planning and development of international air transport, and is a party to many other international aviation conventions. The ICAO establishes technical standards for the international aviation industry. We believe that we, in all material respects, comply with all such technical standards.

Route Rights

Domestic Routes. The right of any Chinese airline to carry passengers or cargo on any domestic route must be obtained from the CAAC. Non-Chinese airlines are not permitted to provide domestic air service between destinations in China. The CAAC’s policy is to assign a domestic route to the Chinese airline that is best suited to serve the route based, in part, on the location of the airline’s main or regional base at the point of origin. Under current regulations, airlines are generally expected to operate mainly from their route bases, and flights within a particular region are expected to be served by airlines based in that region. We believe that these regulatory parameters benefit airlines, such as our Group, that have a large number of regional route bases. The CAAC also considers other factors that may make a particular airline suitable to operate a domestic route, including the applicant’s general operating authority, compliance with pricing regulations and regulations applicable to safety and service quality, market demand, the ability of the applicant in terms of its existing routes, airport facilities and related support services.

The CAAC considers market conditions for a domestic route in determining whether the route should be allocated to one or more airlines. Generally, the CAAC requires the passenger load factor on certain route should be above the average rate of the whole market in the last flight season before additional flights and participants may be put on that route.

Regional Routes. Hong Kong and Macau routes and landing rights are derived from agreements between the Chinese government and the government of the Hong Kong SAR, and between the Chinese government and the government of Macau SAR. The rights to fly between Beijing and Hong Kong, Beijing and Macau, Shanghai and Hong Kong and Shanghai and Macau are allocated by the CAAC among the four Chinese airlines. We understand that the criteria for determining whether a Hong Kong and Macau route will be allocated to a particular airline include market demand, the ability of the airline to service the route and the appropriateness of the airline’s aircraft for such route.

 

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Previously, direct flights between Taiwan and Mainland China were only available during certain festivals. Since July 4, 2008, however, the ban on direct flights has been further liberalized to allow direct charter flights on weekends. On November 4, 2008, the Mainland China and Taiwan agreed to regular direct passenger charter flights across the Taiwan Strait. On August 31, 2009, the Mainland China and Taiwan extended the number of regular cross-Strait direct passenger flights from 108 to 270 a week. Cross-Strait direct passenger flights were further increased in the following years. As of April 26, 2018, there were 78 cross-Strait direct passenger flights a week.

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

Air Fare Pricing Policy

In recent years, there were a series of air fare reform to deregulate the control on the air fare pricing policy step by step. Pursuant to “Pricing Reform of Domestic Civil Aviation” as approved by the State Council of the PRC effective on April 20, 2004, prices on domestic routes now fluctuate freely within a predetermined range. Instead of direct supervision by setting prices of air tickets through a local price bureau, the government now provides guidance on domestic flights and domestic civil aviation is controlled by the government indirectly. Market-oriented pricing policy was introduced and pricing system has been adjusted as a result of the above pricing reform. The CAAC and NDRC issued a notice on April 13, 2010, pursuant to which, effective on June 1, 2010, airlines may set first-class and business-class airfares freely in accordance with market prices, subject to relevant PRC laws. The economy-class airfares remain to be subject to the predetermined range. The CAAC and NDRC further issued a notice, pursuant to which, effective on October 20, 2013, airlines are free to set domestic flights airfares not exceeding up to 25% above the bench mark prices where governmental pricing guidance is applicable; and to freely determine the airfares for domestic routes with the market-oriented pricing policy based on the market demand and supply situation. On September 29, 2016, the CAAC and NDRC further issued the Notice on Deepening the Pricing Reform of Demotic Civil Aviation to further expand the scope of the routes with the market-oriented pricing policy: airfares for the routes below 800 kilometers or the routes above 800 kilometers and in the competing relationship with the high-speed rail EMU trains can be freely determined by airlines. Airlines may raise the non-discounted announced airfares for a certain amount of routes with the market-oriented pricing policy. In principle, such amount shall be no more than 10 per flight season, and the accumulative increase rate of airfares shall be no more than 10 percent per route per flight season. On December 17, 2017, the CAAC further issued the Notice on Further Deepening the Pricing Reform of Demotic Civil Aviation, pursuant to which the airlines will be allowed to decide their own prices on domestic routes that have at least five carriers competing. Price increases of no more than 10 percent would be also allowed for each travel season.

On December 17, 2017, the CAAC further issued the Notice on Further Deepening the Pricing Reform of Demotic Civil Aviation, pursuant to which the airlines will be allowed to decide their own prices on domestic routes that have at least five carriers competing. For each airline, the total number of the routes which the airline can decide itself shall be no less than 10 but shall generally not exceed 15 percent of the total number of the market-oriented routes operated by such airline in one flight season. On April 13, 2018, CAAC issued the Notice on Distributing the Catalog of Domestic Routes adopting Market Regulation Price. The catalog of domestic routes is published together with such notice.

Published air fares of Chinese airlines for the Hong Kong and Taiwan routes are determined by the CAAC and the relevant civil aviation authorities in Hong Kong or Taiwan. Airlines may offer discounts on flights on their Hong Kong and Taiwan regional routes.

 

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Published air fares of Chinese airlines for international routes (except for Japan) are determined by Chinese airlines at their own discretion, taking into account the international air fare standards established through the International Air Transport Association. For Japan routes, air fares must be approved by the relevant civil aviation authorities in Japan, and discounting of published international air fares is permitted.

Acquisition of Aircraft and Flight Equipment

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

Jet Fuel Supply and Pricing

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

Safety

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

Every pilot is required to pass CAAC-administered examinations before obtaining a pilot license and is subject to an annual recertification examination.

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

Security

The CAAC establishes and supervises the implementation of security standards and regulations for the Chinese commercial aviation industry. Such standards and regulations are based on Chinese laws, as well as standards developed by international commercial aviation organizations. Each airline and airport in China is required to submit to the CAAC an aviation security handbook describing specific security procedures established by such airline or airport for the day-to-day operations of commercial aviation and procedures for staff training on security. Such security procedures must be based on relevant CAAC regulations and international commercial aviation treaties. Chinese airports and airlines that operate international routes must also adopt security measures in accordance with the requirements of the relevant international agreements.

 

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Noise and Environmental Regulation

All airlines in China must comply with the noise and environmental regulations of the PRC State Environmental Protection Agency. Applicable regulations of the CAAC permit Chinese airports to refuse to grant take-off and landing rights to any aircraft that does not comply with noise regulations.

Chinese Airport Policy

The CAAC supervises and regulates all civilian airports in China. The local government of the PRC manages the administration of most civilian airports in China. Airports in China are also subject to regulation and ongoing review by the CAAC, which determines take-off and landing charges, as well as charges for the use of airports and airport services.

Competition

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

In the Chinese aviation industry, the three dominant airlines are our Group, Air China Limited (the “Air China”) and China Eastern Airlines Corporation Limited (the “China Eastern Airlines”). In 2017, these three airlines together controlled approximately 60.9% of the commercial aviation market in China as measured by passengers carried.

Most major Chinese airlines have in recent years significantly expanded their fleets, while at the same time passenger traffic may not increase proportionately. In some years, this has resulted in a reduction in our passenger load factors. As a result, we are required to be more competitive with respect to, for example, quality of service, including ticketing and reservations, in-flight services, flight scheduling and timeliness.

In the next few years, the target customers of high-speed railway and airline will gradually differenciate, so passengers of airline will not be massively redirected to high-speed railway. However, the positive changes in the high-speed railway will continue to erode the aviation market. First of all, the “eight horizontal and eight vertical” high-speed railway corridors are gradually being perfected. The advantages of scale are becoming obvious. Secondly, in the future, the railway system will gradually release its own pricing, adopt flexible pricing and market pricing. Passengers can get discount on more routes. Hence, the competition that aviation industry faces will become more intense. Thirdly, one-third of high-speed railway will speed-up which will have the following impacts: (i) the advantages of high-speed railway will increase. The competition on passengers whose trip distance are from 750 kilometers to 1000 kilometers was intense. Following the increase of speed, high-speed railway may attract passengers who travel longer than 1000 kilometers; (ii) the operational efficiency of high-speed railways and train capacity have increased.

 

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We believe that it possesses certain competitive advantages as compared to other Chinese airlines. We have the most extensive route network and the largest number of regional route bases among Chinese airlines, which our Group believes places it in a favorable position in the route allocation process. We also have the largest aircraft fleet among all Chinese airlines, which, together with our planned aircraft acquisitions, will permit our Group to expand our operations and to improve the deployment of the aircraft in our fleet. We also believe that our dominant presence in the populous and economically developed southern and central regions of China provides it with a competitive advantage in attracting new customers and that our fully integrated flight training, aircraft and engine maintenance and air catering operations enable it to achieve and maintain high quality service to our customers. In light of increasing competition from high-speed trains, we intend to place more flight fleet to the international routes, where we will make an effort for a stronger market position. We also believe that our optimized route network, increased operational efficiency and improved service quality will attract more customers. The proposed cooperation between our Company and the high speed trains operators will also enable us to render a seamless air-ground service to customers which will bring a win-win situation for both our Group and the high speed trains operators.

According to CAAC statistics briefing, the following table sets forth our market share of passengers carried, cargo and mail carried and total traffic of Chinese airlines for the years indicated.

 

     Passengar Carried      Cargo and Mail Carried
(tons)
     Total Traffic (tons
kilometres)
 

Year

   Industry
Total (in
millions)
     Group’s
Share (%
of total)
     Industry
Total (in
millions)
     Group’s
Share (%
of total)
     Industry
Total (in
millions)
     Group’s
Share (%
of total)
 

2013

     354.0        25.9        5,613        22.7        67.2        26.0  

2014

     391.7        25.8        5,933        24.2        74.9        26.4  

2015

     435.6        25.1        6,253        24.2        85.0        26.3  

2016

     487.8        23.5        6,669        22.7        96.1        25.4  

2017

     551.6        25.2        7,058        23.7        108.3        22.9  

Domestic Routes

We compete against our domestic competitors primarily on the basis of flight schedule, route network, quality of service, safety, type and age of aircraft and, to a lesser extent, price. We compete against other major Chinese airlines in our various domestic route markets. Of these competitors, the largest are two airlines owned or controlled by the Chinese government, and the remaining airlines are operated by or under the control of various Chinese provincial or municipal governments.

The following table sets forth our market share in terms of passengers carried, cargo and mail carried on departing flights and total departing flights at the 10 busiest airports in China in 2017 according to passenger volume data from CAAC statistics briefing.

 

Airport

   Passenger Carried
(% of total)
     Cargo and Mail
Carried
(% of total)
     Departing Flight
(% of total)
 

Beijing

     16.4        9.4        16.7  

Shanghai Pudong

     9.3        6.8        10.0  

Guangzhou

     47.9        33.5        49.7  

Chengdu

     11.3        12.0        10.5  

Shenzhen

     27.5        15.3        25.7  

Kunming

     10.7        14.3        10.3  

Shanghai Hongqiao

     13.5        24.4        13.6  

Xi’an

     13.4        11.7        13.7  

Chongqing

     22.4        19.8        23.7  

Hangzhou

     24.9        13.5        25.2  

 

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The following table sets forth our market share in terms of passengers carried, cargo and mail carried on departing flights and total departing flights at 8 busiest airports in southern and central China (excluding Guangzhou and Shenzhen, which are included in the table above) in 2017 according to passenger volume data from CAAC statistics briefing.

 

Airport

   Passenger Carried
(% of total)
     Cargo and Mail
Carried
(% of total)
     Departing Flight
(% of total)
 

Changsha

     30.2        36.4        31.2  

Wuhan

     35.0        32.4        35.6  

Zhengzhou

     28.4        9.8        29.2  

Haikou

     22.4        30.1        21.6  

Sanya

     24.1        35.6        25.0  

Nanning

     20.1        24.9        21.2  

Guilin

     19.0        23.5        20.7  

Zhuhai

     29.6        45.1        28.5  

Regional Routes

In 2017, we conducted a total of 18,030 flights on our regional routes, accounting for approximately 22.7% of all passengers carried by Chinese airlines on routes between Hong Kong, Macau or Taiwan and destinations in China. We face less competition on regional routes than that on domestic and international, and earns higher operating margin. Air China, China Eastern Airlines, Air Macau, Cathay Dragon, Cathay Pacific, China Airlines and Eva Airways compete with our Group in the regional traffic markets.

International Routes

We compete with Air China, China Eastern Airlines and many well-established foreign airlines on our international routes. Most of these international competitors have significantly longer operating histories, substantially greater financial and technological resources and greater name recognition than our Group. In addition, the public’s perception of the safety and service records of Chinese airlines may adversely affect our ability to compete against our regional and international competitors. Many of our international competitors have larger sales networks and participate in reservation systems that are more comprehensive and convenient than those of our Group, or engage in promotional activities that may enhance their ability to attract international passengers.

In Southeast Asian routes, our competitors mainly include Thai Airways International, Singapore Airlines, Malaysian Airlines System, Vietnam Airlines, Garuda Indonesia, Philippine Airlines, Air China and China Eastern Airlines. In European routes, our competitors mainly include Air China, China Eastern Airlines, Cathay Pacific and Lufthansa German Airlines. In the United States routes, our competitors mainly include Air China, China Eastern Airlines, Cathay Pacific and United Airlines. In Australian routes, our competitors include Air China, China Eastern Airlines, Cathay Pacific and Qantas Airways. We compete in the international market primarily on the basis of safety, price, timeliness and convenience of scheduling.

 

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Airline Subsidiaries

Our Airline Subsidiaries are joint ventures established by our Company and local companies in the provinces or special economic zones where our Airline Subsidiaries are based and are engaged in providing airline and related services. As of December 31, 2017, our Company owns a 55% or 60% equity interest in each of our Airline Subsidiaries.

As of December 31, 2017, Xiamen Airlines operated under the “MF” code with a fleet of 186 aircraft. In 2017, Xiamen Airlines carried a total of about 31.76 million passengers, or approximately 25.15% of the passengers carried by our Group in that year, and had RMB24,907 million in traffic revenue.

As of December 31, 2017, Shantou Airlines operated under “CZ” code with a fleet of 15 aircraft. In 2017, under the centralized allocation of flight routes of our Group, Shantou Airlines carried a total of about 3.14 million passengers, or 2.48% of the passengers carried by our Group in that year. Total traffic revenue of Shantou Airlines for the year ended December 31, 2017 was RMB2,194 million.

As of December 31, 2017, Chongqing Airlines operated under the “OQ” code with a fleet of 19 aircraft. In 2017, under the centralized allocation of flight routes of our Group, Chongqing Airlines carried a total of about 3.13 million passengers, or 2.48% of the total number of passengers carried by our Group in that year. Total traffic revenue of Chongqing Airlines for the year ended December 31, 2017 was RMB2,255 million.

As of December 31, 2017, Zhuhai Airlines operated under the “CZ” code with a fleet of 11 aircraft. In 2017, under the centralized allocation of flight routes of our Group, Zhuhai Airlines carried a total of about 1.93 million passengers, or approximately 1.53% of the total number of passengers carried by our Group in that year. Total traffic revenue of Zhuhai Airlines for the year ended December 31, 2017 was RMB1,506 million.

As of December 31, 2017, Guizhou Airlines operated under the “CZ” code with a fleet of 20 aircraft. In 2017, under the centralized allocation of flight routes of our Group, Guizhou Airlines carried a total of about 3.33 million passengers, or approximately 2.64% of the total number of passengers carried by our Group in that year. Total traffic revenue of Guizhou Airlines was approximately RMB2,697 million for the year ended December 31, 2017.

As of December 31, 2017, Henan Airlines operated under the “CZ” code with a fleet of 31 aircraft. In 2017, under the centralized allocation of flight routes of our Group, Henan Airlines carried a total of about 5.19 million passengers, or approximately 4.11% of the total number of passengers carried by our Group in that year. Total traffic revenue of Henan Airlines was approximately RMB3,851 million for the year ended December 31, 2017.

Insurance

The CAAC maintains fleet and legal liability insurance on behalf of our Group and all other Chinese airlines with PICC Property and Casualty Company Limited, or PICCP&C, and China Pacific Property Insurance Company Ltd., Ping An Property and Casualty Insurance Company of China, Ltd. under the PICCP&C master policy. We maintain aviation hull all risks, spares and airline liability insurance, aircraft hull all risks and spare engines deductible insurance, aviation hull war and allied perils policy of the type and in the amount customary in the Chinese aviation industry.

Under the relevant PRC laws, civil liability of Chinese airlines for death or injuries suffered by passengers on domestic flights is limited to RMB400,000 (approximately US$61,216) per passenger. As of July 31, 2006, the Convention for the Unification of Certain Rules for International Carriage by Air of 1999, or Montreal Convention, became effective in China. Under the Montreal Convention, carriers of international flights are strictly liable for proven damages up to 100,000 Special Drawing Rights and beyond that, carriers are only able to exclude liability if they can prove that the damage was not due to negligence or other wrongful act of the carrier (and its agents), or the damage arose solely from the negligence or other wrongful act of a third party. We believe that our Group maintains adequate insurance coverage for the civil liability that can be imposed in respect of death or injuries to passengers under Chinese law, the Montreal Convention and any agreement which our Group is subject to.

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

 

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Intellectual Property

Our businesses and operations, other than the businesses and operations of Xiamen Airlines and Chongqing Airlines, are conducted under the names “China Southern” and “China Southern Airlines” in both English and Chinese. We use as our logo a stylized rendition of a kapok plant. Xiamen Airlines conducts its businesses and operations under the name of “Xiamen Airlines” in English and Chinese and uses its own logo depicting a stylized rendition of an egret. Chongqing Airlines conducts its business and operations under the name of “Chongqing Airlines” in English and Chinese and uses its own logo depicting a cross of two rivers.

We own various trademarks and trade names related to our business. The names “China Southern” and “China Southern Airlines” contain Chinese words of common usage and are therefore not eligible for registration as trade names under current Chinese law. The kapok logo is a trademark registered in China and recorded with the International Air Transport Association (“IATA”), the rights to which are owned by CSAH. Our Company and CSAH have entered into a trademark license agreement (the “Trademark License Agreement”), pursuant to which CSAH has licensed to our Group the right to use the names “China Southern” and “China Southern Airlines” in both English and Chinese and granted our Company a ten-year renewable license from 1997 to use the kapok logo on a world-wide basis. CSAH has retained the right to use the kapok logo in connection with its non-airline related businesses conducted as of the date of the Trademark License Agreement and to permit its affiliates that do not compete, directly or indirectly, with our Group to use the kapok logo. Unless CSAH gives a written notice of termination three months before the expiration of the agreement, the agreement will be automatically renewed for another ten-year term. In May of 2017, the Trademark License Agreement has been automatically renewed by the two parties for another ten-year term ending 2027. Xiamen Airlines owns all rights to its egret logo, which is a trademark registered in China, and recorded with the IATA. Chongqing Airlines also owns all rights to its logo, which is a trademark registered in China, and recorded with the IATA.

 

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Iran Sanctions Disclosure

Pursuant to Section 13(r) of the Securities Exchange Act of 1934, or the Exchange Act, if during 2017, our Company or any of our affiliates have engaged in certain transactions with Iran or with persons or entities designated under certain executive orders, our Company would be required to disclose information regarding such transactions in our Annual Report as required under Section 219 of the Iran Threat Reduction and Syria Human Rights Act of 2012, or ITRA. During 2017, our Company operated air services to and from Iran through the specifically designated route of “Beijing - Urumqi - Tehran - Urumqi - Beijing” (the “Iran Route”) and engages in international traffic in passengers, cargo and mail.

In order to provide our aviation service in Iran, our Company has entered into certain grounding service agreement with Iran Air whereby Iran Air provides our Company with grounding service, maintenance and other support services in return for certain service fees to be paid by our Company in accordance with the agreement. Our Company does not provide, nor has it ever provided any equipment, component, or technology to Iran. The service rendered by our Company to Iran is limited to the provision of international traffic in passengers, cargo and mail and those services provided by our local offices and agents to customers. Our Company does not operate flights within Iran.

Our Company’s international route rights, as well as the corresponding landing rights, are derived from air services agreements negotiated between the Chinese government, through the CAAC, and the governments of the relevant foreign countries. With respect to the Iran Route, our Company’s international route rights associated thereto are derived from and based on the bilateral air transport agreement (the “Bilateral Agreement”) entered into by and between the Chinese government and the Iranian government. Both parties are contracting parties to the Convention on International Civil Aviation, opened for signature at Chicago on December 7, 1944, and entered into the Bilateral Agreement with an aim to establish and operate scheduled air services between and beyond the two countries’ respective territories. The Bilateral Agreement, which has been registered with the International Civil Aviation Organization, sets forth general principles and specific rules governing our Company’s aviation services in Iran.

Our Company understands that Iran Air is Iran’s national airline carrier and is designated by the U.S. Department of the Treasury pursuant to Executive Order No. 13382. However, Executive Order No. 13382 only “prohibits all transactions between the designees and any U.S. person.” Our Company is incorporated in the People’s Republic of China and is a foreign issuer in the United States. As our Company is not a U.S. person, our transactions with Iran Air are not prohibited by Executive Order No. 13382. Our Company further understands that it has an obligation to disclose our transactions with Iran Air as described above under Exchange Act Section 13(r)(1)(D)(iii). Iran Air is Iran’s national airline carrier and is controlled or owned by the Government of Iran. Our Company believes that Iran Air can be identified as the Government of Iran under Section 560.304 of title 31, Code of Federal Registration (relating to the definition of the Government of Iran). Our Company has not obtained any specific authorization of a Federal department or agency of the United States concerning our transactions with Iran Air.

Our Company does not anticipate any significant change in our service to Iran, either by way of increasing significantly the size of or altering the nature of our operations in the territory. For the year ended December 31, 2017, the asset of Iran office and revenue generated from the air services to Iran amounted to US$7,948.48 and US$3.89 million, representing only 0.00002% and 0.0199% of the total asset and total revenue generated by our Group for the year ended December 31, 2017, respectively. Therefore, our Company believes that our operations in Iran for the year ended December 31, 2017 are inconsequential and quantitatively immaterial to our business, financial condition and results of operations.

 

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C. ORGANIZATIONAL STRUCTURE

The following chart illustrates the corporate structure of our Group as of December 31, 2017 and the aggregate effective equity interest of our Company in each of our principal subsidiaries, associates and jointly controlled entities.

 

 

LOGO

The particulars of our principal subsidiaries as of December 31, 2017 are as follows:

 

Name of Company

 

Place and Date of
Establishment/Operation

   Proportion
of
Ownership
Interest
Held by our
Company
 

Shantou Airlines Company Limited

  PRC July 20, 1993      60

Zhuhai Airlines Company Limited

  PRC May 8, 1995      60

Xiamen Airlines Company Limited

  PRC August 11, 1984      55

Guizhou Airlines Company Limited

  PRC June 17, 1998      60

Chongqing Airlines Company Limited

  PRC May 30, 2007      60

Guangzhou Nanland Air Catering Company Limited

  PRC November 21, 1989      70.5

Guangzhou Baiyun International Logistic Company Limited

  PRC July 23, 2002      61

Zhuhai Xiang Yi Aviation Technology Company Limited

  PRC July 10, 2002      100

Nan Lung International Freight Limited

  Hong Kong October 1, 1996      51

Beijing Southern Airlines Ground Services Company Limited

  PRC April 1, 2004      100

China Southern Airlines Henan Airlines Company Limited

  PRC September 28, 2013      60

Southern Airlines Group Import and Export Trading Company

  PRC June 8, 1993      100

Southern Airlines General Aviation Company Limited

  PRC November 17, 2014      100

 

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The particulars of our principal associates and joint ventures as of December 31, 2017 are as follows:

 

            Proportion of Ownership Interest Held
by
 

Name of Company

   Place and Date of
Establishment/Operation
     Group
Effective
Interest
    Our
Company
    Subsidiaries  

Guangzhou Aircraft Maintenance Engineering Co., Ltd.

     PRC October 28, 1989        50     50     —    

Southern Airlines Group Finance Company Limited

     PRC June 28, 1995        33.98     25.28     8.70

Sichuan Airlines Co., Ltd.

     PRC August 28, 2002        39     39     —    

Southern Airlines Culture and Media Co., Ltd.

     PRC May 13, 2004        40     40     —    

China Southern West Australian Flying College Pty Limited

     Australia October 1,1993        48.12     48.12     —    

Guangzhou China Southern Zhongmian Dutyfree Store Co., Limited

     PRC March 1, 2001        50     50     —    

Xinjiang Civil Aviation Property Management Limited

     PRC December 12, 2002        42.80     42.80     —    

 

D. PROPERTY, PLANT AND EQUIPMENT

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

Our headquarters in Guangzhou occupy an area of approximately 1,261,460 square meters of land and a total gross floor area of approximately 738,895 square meters. We lease from CSAH the land in Guangzhou on which our headquarters and other facilities are located. We also lease from CSAH certain buildings mainly at the Haikou, Wuhan, Nanyang, Shenyang, Dalian, Jilin, Harbin, Xinjiang and other PRC cities.

Our principal properties are located at our headquarters site and at our route bases. The following table sets forth certain information with respect to our properties at our headquarters in Guangzhou and certain route bases as of the date hereof.

 

     Land (in square meters)      Building (in square meters)  
     Owned      Leased      Owned      Leased  

Guangzhou

     1,172,531        88,929        691,355        47,540  

Shenzhen

     256,280        —          101,502        5,730  

Zhuhai

     179,415        30,000        61,973        3,047  

Changsha

     255,422        45,568        86,092        12,836  

Haikou

     332,961        12,497        65,231        1,288  

Wuhan

     16,712        38,082        36,429        35,406  

Nanyang

     —          3,800,994        12,156        24,323  

Sanya

     106,680        —          38,513        5,421  

Shenyang

     142,199        70,808        29,078        62,330  

Dalian

     —          —          64,226        16,869  

Jilin

     134,488        65,076        78,536        7,767  

Harbin

     5,381        267,872        40,599        39,693  

Xinjiang

     2,143        540,493        137,932        2,758  

Guangxi

     112,246        —          61,093        2,892  

Beijing

     85,453        —          91,124        26,924  

Shanghai

     42,292        —          35,512        7,253  

Chengdu

     —          —          1,964        209  

Sydney

     —          —          1,151        2,449  

Xi’an

     —          —          4,367        1,707  

 

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

 

     Land (in square meters)      Building (in square meters)  
     Owned      Leased      Owned      Leased  

Xiamen Airlines

     1,534,087        —          723,851        51,290  

Shantou Airlines

     260,639        1,605        73,499        3,544  

Zhuhai Airlines

     99,306        —          52,793        1,252  

Guizhou Airlines

     259,879        —          20,783        15,371  

Chongqing Airlines

     82,449        —          8,943        12,343  

Henan Airlines

     388,209        —          217,253        —    

As systems for registration and transfer of land use rights and related real property interests in China have been implemented relatively recently, such systems do not yet comprehensively account for all land and related property interests. The land in Guangzhou on which our headquarters and other facilities are located and the buildings that our Company uses at our route bases in Wuhan and Haikou are leased by our Company from CSAH. However, CSAH lacks adequate documentation evidencing CSAH’s rights to such land and buildings, and, as a consequence, the lease agreements between CSAH and our Company for such land may not be registered with the relevant authorities. Lack of registration may affect the validity of such lease agreements. There are certain other parcels of land and buildings owned or used by us that lack adequate documentation. Lack of adequate documentation for land use rights and ownership of buildings may impair our ability to dispose of or mortgage such land use rights and buildings. As of February 2018, the Group was in the process of applying for the land use right certificates and property title certificates in respect of the properties located in Guangzhou (including Guangzhou Baiyun International Airport), Guangxi, Guizhou, Chengdu, Xiamen, Heilongjiang, Jilin, Dalian, Hunan, Beijing, Zhuhai, Shenyang, Shenzhen, Henan, Shantou, Xinjiang, Hainan, Shanghai, Hubei, Chongqing and Hangzhou, in which the Group has interests and for which such certificates have not been granted. Our directors are of the opinion that the use of and the conduct of operating activities at the properties referred to above are not affected by the fact that we have not yet obtained the relevant land use right certificates and property title certificates.

 

ITEM 4A. UNRESOLVED STAFF COMMENTS

Not applicable.

 

ITEM 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS

The following discussion and analysis should be read in conjunction with our consolidated financial statements, which have been prepared in accordance with IFRSs, included elsewhere in this Annual Report.

Critical Accounting Policies

The preparation of the consolidated financial statements requires our Group to make estimates and judgments that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the end of each reporting period, and the reported revenues and expenses during each reporting period. Actual results may differ from these estimates under different assumptions or conditions.

Critical accounting policies are defined as those that are reflective of significant judgments and uncertainties, and potentially result in materially different results under different assumptions and conditions. Our principal accounting policies are set forth in Note 3 to the consolidated financial statements. We believe that the following critical accounting policies involve the key accounting judgments and estimates used in the preparation of our financial statements.

 

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Impairment of long-lived assets (other than goodwill)

If circumstances indicate that the carrying amount of a long-lived asset may not be recoverable, the asset may be considered “impaired”, and an impairment loss may be recognised in accordance with IAS 36, Impairment of Assets. The carrying amounts of long-lived assets are reviewed periodically in order to assess whether the recoverable amounts have declined below the carrying amounts. These assets are tested for impairment whenever events or changes in circumstances indicate that their recorded carrying amounts may not be recoverable. When such a decline has occurred, the carrying amount is reduced to the recoverable amount. The recoverable amount is the higher of the fair value less costs of disposal and value in use. In particular, in determining the value in use of the Group’s aircraft fleet, expected future cash flows to be generated by the asset are discounted to their present value, which requires significant judgement relating to forecast traffic revenue, forecast operating costs and discount rate applied. The Group uses all readily available information in determining an amount that is a reasonable approximation of recoverable amount, including estimates based on reasonable and supportable assumptions for projections of traffic revenue and operating costs and application of discount rate.

Provision for major overhauls

Provision for the cost of major overhauls to fulfil the lease return conditions for airframes and engines held under operating leases are accrued and charged to the income statement over the estimated overhaul period. This requires estimation of the expected overhaul cycles and overhaul costs, which are based on the historical experience of actual costs incurred for overhauls of airframes and engines of the same or similar types and current economic and airline-related developments. Different estimates could significantly affect the estimated provision and the results of operations.

Frequent flyer revenue

The amount of revenue attributable to the mileage earned by the members of the Group’s frequent flyer award programmes is estimated based on the fair value of the mileage awarded and the expected redemption rate. The fair value of mileage awarded is estimated by reference to external sales. The expected redemption rate is estimated based on historical experience, anticipated redemption patterns and the frequent flyer programmes’ design. Different estimates could significantly affect the estimated deferred revenue and the results of operations.

Depreciation

Property, plant and equipment are depreciated on a straight-line basis over the estimated useful lives, after taking into account the estimated residual value. The Group reviews the estimated useful lives of assets annually in order to determine the amount of depreciation expense to be recorded during any financial year. The useful lives are based on the Group’s historical experience with similar assets and take into account anticipated technological changes. The depreciation expense for future periods is adjusted if there are significant changes from previous estimates.

Provision for consumable spare parts and maintenance materials

Provision for consumable spare parts and maintenance materials is made based on the difference between the carrying amount and the net realisable value. The net realisable value is estimated based on current market condition, historical experience and the Group’s future operation plan for the consumable spare parts and maintenance materials. The net realisable value may be adjusted due to the change of market condition and the future plan for the consumable spare parts and maintenance materials.

Income tax

There are certain transactions and calculations for which the ultimate tax determination is uncertain during the ordinary course of business. The Group recognises liabilities for anticipated tax audit issues based on estimates of whether additional tax will be due. Where the final tax outcome of these matters is different from the amounts that were initially recorded, such differences will impact the current and deferred income tax assets and liabilities in the year in which such determination is made.

Impairment of trade receivables

When there is objective evidence that the Group will not be able to collect all amounts due according to the original terms of the receivables, a provision for impairment of trade receivables is established based on the difference between the receivable’s carrying amount and the present value of estimated future cash flows, discounted at the original effective interest rate.

 

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Retirement benefits

According to IAS 19, Employee Benefits, an entity shall account not only for its legal obligation under the formal terms of a defined benefit plan, but also for any constructive obligation that arises from the entity’s informal practices where the entity has no realistic alternative but to pay the employee benefits. The Company believes the payments of welfare subsidy to those retirees who retired before the establishment of Pension Scheme (as defined in Note 51(a)) are discretionary and have not created a legal or constructive obligation. Such payments are made according to the Group’s business performance, and can be suspended at any time (note 14).

Recently Pronounced International Financial Reporting Standards

Information relating to the recently pronounced IFRSs is presented in Note 58 to the consolidated financial statements.

Business Overview

General

Because we finance our aircraft acquisitions mainly through capital leases or bank loans in U.S. dollars, and there are a substantial amount of transactions and obligations denominated in U.S. dollars in relation to our global purchases of jet fuel, lease and purchase of aviation equipment as well as major repairs, in addition to the landing fees of our international flights in the airports of other countries, our business was affected by the Renminbi depreciation. Renminbi depreciation has brought exchange loss to our Group and increased our operating costs which are denominated in foreign currencies.

A number of other external variables, including political and economic conditions in China, tend to have a major impact on our performance. Our financial performance is also significantly affected by factors arising from operating in a regulated industry. As substantially all aspects of our airline operations are regulated by the PRC government, our operating revenues and expenses are directly affected by the PRC government’s policies with respect to domestic air fares, jet fuel prices and landing and navigation fees, among others. The nature and extent of airline competition and the ability of Chinese airlines to expand are also affected by CAAC’s control over route allocations. Any changes in the PRC government’s regulatory policies or any implementation of such policies could have a significant impact on our future operations and our ability to implement our operating strategy.

In addition, our operating revenue is substantially dependent on the passenger and cargo traffic volume carried, which is subject to seasonal and other changes in traffic patterns, the availability of appropriate time slots for our flights and alternative routes, the degree of competition from other airlines and alternate means of transportation, as well as other factors that may influence passenger travel demand and cargo and mail volume. In particular, our airline revenue is generally higher in the second half of the year than in the first half of the year.

Like most airlines, we are subject to a high degree of financial and operating leverage. A significant percentage of our operating expenses are fixed costs that do not vary proportionally based on our yields or the load factors. These fixed costs include depreciation expense, jet fuel costs, landing and navigation fees, financing costs, operating lease payments, aircraft maintenance costs and labor for flight crew, cabin crew and ground personnel. Thus, a minor change in our yields or load factors would have a material effect on our results of operations. In addition, certain of these expenses, primarily financing costs and operating lease payments, labor costs and depreciation do not vary based on the number of flights flown. Thus, our operating results can also be substantially affected by minor changes in aircraft utilization rates. We are and will continue to be highly leveraged with substantial obligations denominated in foreign currencies and, accordingly, the results of our operations are significantly affected by fluctuations in foreign exchange rates, particularly for the U.S. dollar. Our net exchange gain of RMB1,801 million was recorded in 2017 mainly due to Renminbi appreciated significantly against U.S. dollar in 2017.

 

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Table of Contents

Certain Financial Information and Operating Data by Geographic Region

The following table sets forth certain financial information and operating data by geographic region for the years ended December 31, 2017, 2016 and 2015.

 

     Year ended December 31,      2017 vs.
2016%
increase
    2016 vs.
2015%
increase
 
Traffic    2017      2016      2015      (decrease)     (decrease)  

RPK (million)

             

Domestic

     160,427.72        144,979.57        138,769.05        10.66       4.48  

Regional

     2,934.65        3,083.71        3,526.99        (4.83     (12.57

International

     67,334.50        58,042.36        47,291.67        16.01       22.73  

Total

     230,696.87        206,105.64        189,587.71        11.93       8.71  

RTK (million)

             

Domestic

     15,833.96        14,551.20        13,916.26        8.82       4.56  

Regional

     282.52        292.46        331.50        (3.40     (11.78

International

     11,204.15        9,542.90        8,140.24        17.41       17.23  

Total

     27,320.63        24,386.56        22,388.00        12.03       8.93  

Passengers carried (thousand)

             

Domestic

     108,616.65        98,463.43        95,121.91        10.31       3.51  

Regional

     2,329.80        2,340.68        2,571.15        (0.46     (8.96

International

     15,352.29        13,814.52        11,728.96        11.13       17.78  

Total

     126,298.75        114,618.63        109,422.02        10.19       4.75  

Cargo and mail carried (thousand tons)

             

Domestic

     1,048.18        1,083.68        1,030.10        (3.28     5.20  

Regional

     22.01        19.73        19.18        11.56       2.87  

International

     601.97        509.14        462.27        18.23       10.14  

Total

     1,672.16        1,612.55        1,511.55        3.70       6.68  

Capacity

             

ASK (million)

             

Domestic

     194,354.34        179,655.46        172,104.99        8.18       4.39  

Regional

     3,843.89        4,193.19        4,762.25        (8.33     (11.95

International

     82,447.49        72,143.29        58,749.02        14.28       22.80  

Total

     280,645.72        255,991.94        235,616.26        9.63       8.65  

ATK (million)

             

Domestic

     22,168.17        20,740.93        20,055.09        6.88       3.42  

Regional

     446.80        491.23        562.65        (9.04     (12.69

International

     15,717.21        13,748.02        11,586.92        14.32       18.65  

Total

     38,332.18        34,980.18        32,204.66        9.58       8.62  

Load Factors

             

Passenger load factor (RPK/ASK) (%)

             

Domestic

     82.5        80.7        80.6        1.84       0.12  

Regional

     76.4        73.5        74.1        2.81       (0.81

International

     81.7        80.5        80.5        1.22       /  

Overall

     82.2        80.5        80.5        1.69       /  

Overall load factor (RTK/ATK) (%)

             

Domestic

     71.4        70.2        69.4        1.27       1.15  

Regional

     63.2        59.5        58.9        3.69       1.02  

International

     71.3        69.4        70.3        1.88       (1.28

Overall

     71.3        69.7        69.5        1.55       0.29  

Yield

             

Yield per RPK (RMB)

             

Domestic

     0.53        0.53        0.55        /       (3.64

Regional

     0.78        0.72        0.71        8.33       1.41  

International

     0.37        0.40        0.45        (7.50     (11.11

Overall

     0.49        0.50        0.53        (2.00     (5.66

Yield per RTK (RMB)

             

Domestic

     5.52        5.45        5.65        1.28       (3.54

Regional

     8.45        7.92        7.89        6.69       0.38  

International

     2.87        2.94        3.18        (2.38     (7.55

Overall

     4.46        4.50        4.78        (0.89     (5.86

Financial

             

Passenger revenue (RMB million)

             

Domestic

     85,392        77,257        76,570        10.53       0.90  

Regional

     2,281        2,230        2,517        2.29       (11.40

International

     25,118        23,015        21,151        9.14       8.81  

Total

     112,791        102,502        100,238        10.04       2.26  

Cargo and mail revenue (RMB million)

     9,082        7,191        6,861        26.30       4.81  

 

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Table of Contents
A. OPERATING RESULTS

The historical results of operations discussed below may not be indicative of our future operating performance. In addition to the factors discussed under “Overview” above, our future operations will be affected by, among other things, changes in the aviation market, the cost of jet fuel, aircraft acquisition and leasing costs, aircraft maintenance expenses, take-off and landing charges, wages, salaries and benefits and other operating expenses, foreign exchange rates and the rates of income taxes paid.

2017 compared with 2016

The profit attributable to equity shareholders of our Company of RMB5,961 million was recorded in 2017 as compared to the profit attributable to equity shareholders of our Company of RMB5,044 million in 2016. Our operating revenue increased by RMB12,825 million or 11.15% from RMB114,981 million in 2016 to RMB127,806 million in 2017. Passenger load factor was 82.2% in 2017 and 80.51% in 2016. Passenger yield (in passenger revenue per RPK) decreased by 2.00% from RMB0.50 in 2016 to RMB0.49 in 2017. Average yield (in traffic revenue per RTK) decreased by 0.89% from RMB4.50 in 2016 to RMB4.46 in 2017. Operating expenses increased by RMB16,894 million or 15.91% from RMB106,204 million in 2016 to RMB123,098 million in 2017. Operating profit of RMB9,156 million was recorded in 2017 as compared to operating profit of RMB12,612 million in 2016, decreased by RMB3,456 million.

Operating Revenue

 

     2017      2016         
     Operating
revenue
RMB
million
    Percentage
%
     Operating
revenue
RMB
million
    Percentage
%
     Change
in
revenue
%
 

Traffic revenue

     121,873       95.36        109,693       95.40        11.10  

Including: Passenger revenue

     112,791          102,502          10.04  

– Domestic

     85,392          77,257          10.53  

– Hong Kong, Macau and Taiwan

     2,281          2,230          2.29  

– International

     25,118          23,015          9.14  

Cargo and mail revenue

     9,082          7,191          26.30  

Other operating revenue

     5,933       4.64        5,288       4.60        12.20  

Mainly including:

            

Commission income

     2,781          2,518          10.44  

Hotel and tour operation income

     547          625          (12.48

General aviation income

     467          461          1.30  

Ground services income

     429          384          11.72  

Expired sales in advance of carriage

     396          376          5.32  

Total operating revenue

     127,806       100.00        114,981       100.00        11.15  

Less: fuel surcharges income

     (5,355        (5,798        (7.64

Total operating revenue excluding fuel surcharges

     122,451          109,183          12.15  
     2017      2016         
     Traffic
revenu
RMB
million
    Percentage
%
     Traffic
revenu
RMB
million
    Percentage
%
     Change
in traffic
revenue

%
 

Passenger Revenue

     112,791       92.55        102,502       93.44        10.04  

Cargo and Mail Revenue

     9,082       7.45        7,191       6.56        26.30  

Traffic revenue

     121,873       100.00        109,693       100.00        11.10  
     2017      2016         
     Passenger
revenu
RMB
million
    Percentage
%
     Passenger
revenu
RMB
million
    Percentage
%
     Change in
passenger
revenue
%
 

Domestic

     85,392       75.71        77,257       75.37        10.53  

Hong Kong, Macau and Taiwan

     2,281       2.02        2,230       2.18        2.29  

International

     25,118       22.27        23,015       22.45        9.14  

Passenger revenue

     112,791       100.00        102,502       100.00        10.04  

 

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Table of Contents

Substantially all of our operating revenue is attributable to airlines transport operations. Traffic revenue accounted for 95.36% and 95.4% of total operating revenue in 2017 and 2016 respectively. Passenger revenue and cargo and mail revenue accounted for 92.55% and 7.45% respectively of the total traffic revenue in 2017. During the reporting period, our total traffic revenue was RMB121,873 million, representing an increase of RMB12,180 million or 11.10% from prior year, mainly due to the increase in traffic capacity and traffic volume. The other operating revenue is mainly derived from commission income, hotel and tour operation income, general aviation income, ground services income and expired sales in advance of carriage.

The increase in operating revenue was primarily due to a 10.04% increase in passenger revenue from RMB102,502 million in 2016 to RMB112,791 million in 2017. The total number of passengers carried increased by 10.19% to 126.3 million passengers in 2017. RPKs increased by 11.93% from 206,106 million in 2016 to 230,697 million in 2017, primarily as a result of the increase in number of passengers carried. Passenger yield per RPK decreased from RMB0.50 in 2016 to RMB0.49 in 2017, which is mainly due to the drop of average ticket price.

Domestic passenger revenue, which accounted for 75.71% of the total passenger revenue in 2017, increased by 10.53% from RMB77,257 million in 2016 to RMB85,392 million in 2017. Domestic capacity in ASKs increased by 8.18%, while passenger traffic in RPKs increased by 10.66%, resulting in an increase in passenger load factor by 1.84 percentage points from 80.70% in 2016 to 82.54% in 2017. Domestic passenger yield per RPK was RMB0.53 in 2017 which is consistent with the same in 2016.

Hong Kong, Macau and Taiwan passenger revenue, which accounted for 2.02% of total passenger revenue, increased by 2.29% from RMB2,230 million in 2016 to RMB2,281 million in 2017. For Hong Kong, Macau and Taiwan flights, passenger traffic in RPKs decreased by 4.83%, while passenger capacity in ASKs decreased by 8.33%, resulting in an increase in passenger load factor by 2.81 percentage points from 73.54% in 2016 to 76.35% in 2017. Passenger yield per RPK increased from RMB0.72 in 2016 to RMB0.78 in 2017.

International passenger revenue, which accounted for 22.27% of total passenger revenue, increased by 9.14% from RMB23,015 million in 2016 to RMB25,118 million in 2017. For international flights, passenger traffic in RPKs increased by 16.01%, while passenger capacity in ASKs increased by 14.28% resulting in 1.22 percentage points increase in passenger load factor from 80.45% in 2016 to 81.67% in 2017. Passenger yield per RPK decreased from RMB0.40 in 2016 to RMB0.37 in 2017.

Cargo and mail revenue, which accounted for 7.45% of the Group’s total traffic revenue and 7.11% of total operating revenue, increased by 26.30% from RMB7,191 million in 2016 to RMB9,082 million in 2017. The increase was attributable to the increase in cargo and mail carried.

Other operating revenue increased by 12.20% from RMB5,288 million in 2016 to RMB5,933 million in 2017. The increase was primarily due to the increase of commission income.

 

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Table of Contents

Operating Expenses

Total operating expenses in 2017 amounted to RMB123,098 million, representing an increase of RMB16,894 million or 15.91% over 2016, primarily due to the increase in staff cost, fuel cost and aircraft and transportation service expense. Total operating expenses as a percentage of total operating revenue was 96.32% in 2017 and 92.37% in 2016.

 

     2017      2016         
     Operating
expense
RMB
million
     Percentage
%
     Operating
expense
RMB
million
     Percentage
%
     Change
in
Operating
expenses
%
 

Flight operation expenses

     62,978        51.16        51,461        48.45        22.38  

Mainly including:

              

Jet fuel costs

     31,895           23,799           34.02  

Aircraft operating lease charges

     8,022           7,330           9.44  

Flight personnel payroll and welfare

     10,574           9,215           14.75  

Maintenance expenses

     11,877        9.65        11,318        10.66        4.94  

Aircraft and transportation service expenses

     22,935        18.63        20,215        19.03        13.46  

Promotion and selling expenses

     6,881        5.59        6,304        5.94        9.15  

General and administrative expenses

     3,391        2.75        2,815        2.65        20.46  

Depreciation and amortization

     13,162        10.69        12,619        11.88        4.30  

Impairment on property, plant and equipment

     324        0.26        71        0.07        356.34  

Others

     1,550        1.27        1,401        1.32        10.64  

Total operating expenses

     123,098        100.00        106,204        100.00        15.91  

Flight operations expenses, which accounted for 51.16% of total operating expenses, increased by 22.38% from RMB51,461 million in 2016 to RMB62,978 million in 2017, primarily as a result of increase in RTK due to the increase of capacity and the increase in jet fuel costs because of increase in average fuel prices. Jet fuel costs, which accounted for 50.64% of flight operations expenses in 2017, increased by 34.02% from RMB23,799 million in 2016 to RMB31,895 million in 2017.

Maintenance expenses, which accounted for 9.65% of total operating expenses, increased by 4.94% from RMB11,318 million in 2016 to RMB11,877 million in 2017. The increase was mainly due to fleet expansion.

Aircraft and transportation service expenses, which accounted for 18.63% of total operating expenses, increase by 13.46% from RMB20,215 million in 2016 to RMB22,935 million in 2017. The increase was primarily due to a 13.74% rise in landing and navigation fees from RMB13,109 million in 2016 to RMB 14,910 million in 2017, resulted from the increase in the number of take-off and landings for international flights.

Promotion and selling expenses, which accounted for 5.59% of total operating expenses, increased by 9.15% from RMB6,304 million in 2016 to RMB6,881 million in 2017, mainly due to the decrease in ticket office expenses.

General and administrative expenses, which accounted for 2.75% of the total operating expenses, increased by 20.46% from RMB2,815 million in 2016 to RMB3,391 million in 2017, mainly due to the increase in general corporate expenses.

Depreciation and amortization, which accounted for 10.69% of total operating expenses, increased by 4.30% from RMB12,619 million in 2016 to RMB13,162 million in 2017, mainly due to fleet expansion.

Operating Profit

Operating profit of RMB9,156 million was recorded in 2017 (2016: RMB12,612 million). The decrease in operating profit was mainly due to the net effect of increase in operating revenue by RMB12,825 million or 11.15% and increase in operating expenses by RMB16,894 million or 15.91% compared with 2016.

 

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Table of Contents

Other Income or Expenses

Other net income increased by RMB613 million from RMB3,835 million in 2016 to RMB4,448 million in 2017, mainly due to the increase in gain on transfer of aircraft purchase quota.

Interest expense increased by RMB282 million from RMB2,465 million in 2016 to RMB2,747 million in 2017 was mainly due to the increase in the interest rate and the weighted average balance of obligations under finance leases during the year. Net exchange gain of RMB1,801 million was recorded in 2017, compared with net exchange loss of RMB3,276 million in 2016, mainly due to the translation of balances of borrowings and obligations under finance lease which are denominated in USD and the appreciation of RMB againt USD.

Income Tax

Income tax expense of RMB1,976 million was recorded in 2017, increased by RMB213 million from RMB1,763 million in 2016, mainly due to the increase of profit before income tax in the reporting period.

2016 compared with 2015

The profit attributable to equity shareholders of our Company of RMB5,044 million was recorded in 2016 as compared to the profit attributable to equity shareholders of our Company of RMB3,736 million in 2015. Our operating revenue increased by RMB3,329 million or 3.0% from RMB111,652 million in 2015 to RMB114,981 million in 2016. Passenger load factor was 80.5% in 2016 and 2015. Passenger yield (in passenger revenue per RPK) decreased by 5.66% from RMB0.53 in 2015 to RMB0.50 in 2016. Average yield (in traffic revenue per RTK) decreased by 5.86% from RMB4.78 in 2015 to RMB4.50 in 2016. Operating expenses increased by RMB4,712 million or 4.6% from RMB101,492 million in 2015 to RMB106,204 million in 2016. Operating profit of RMB12,612 million was recorded in 2016 as compared to operating profit of RMB13,438 million in 2015, decreased by RMB826 million.

Operating Revenue

 

     2016      2015         
     Operating
revenue
RMB
million
    Percentage
%
     Operating
revenue
RMB
million
    Percentage
%
     Change
in
revenue
%
 

Traffic revenue

     109,693       95.4        107,099       95.9        2.4  

Including: Passenger revenue

     102,502          100,238          2.3  

– Domestic

     77,257          76,570          0.9  

– Hong Kong, Macau and Taiwan

     2,230          2,517          (11.4

– International

     23,015          21,151          8.8  

Cargo and mail revenue

     7,191          6,861          4.8  

Other operating revenue

     5,288       4.6        4,553       4.1        16.1  

Mainly including:

            

Commission income

     2,518          1,545          63.0  

Hotel and tour operation income

     625          621          0.6  

General aviation income

     461          490          (5.9

Ground services income

     384          345          11.3  

Expired sales in advance of carriage

     376          459          (18.1

Total operating revenue

     114,981       100.0        111,652       100.0        3.0  

Less: fuel surcharges income

     (5,798        (6,300        (8.0

Total operating revenue

excluding fuel surcharges

     109,183          105,352          3.6  

 

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Table of Contents

Traffic revenue composition

 

     2016     

 

     2015  
     Traffic
revenue
RMB
million
     Percentage
%
     Traffic
revenue
RMB
million
     Percentage
%
     Change
in
traffic
revenue
%
 

Passenger Revenue

     102,502        93.4        100,238        93.6        2.3  

Cargo and Mail Revenue

     7,191        6.6        6,861        6.4        4.8  

Traffic revenue

     109,693        100.0        107,099        100.0        2.4  

Passenger revenue composition

 

     2016     

 

     2015  
     Passenger
revenue
RMB
million
     Percentage
%
     Passenger
revenue
RMB
million
     Percentage
%
     Change in
passenger
revenue
%
 

Domestic

     77,257        75.4        76,570        76.4        0.9  

Hong Kong, Macao and Taiwan

     2,230        2.2        2,517        2.5        (11.4

International

     23,015        22.4        21,151        21.1        8.8  

Passenger revenue

     102,502        100.0        100,238        100.0        2.3  

Substantially all of our operating revenue is attributable to airline and airline-related operations. Traffic revenue accounted for 95.4% and 95.9% of total operating revenue in 2016 and 2015 respectively. Passenger revenue and cargo and mail revenue accounted for 93.4% and 6.6% respectively of the total traffic revenue in 2016. During the reporting period, our total traffic revenues was RM109,693 million, representing an increase of RMB2,594 million or 2.4% from prior year, mainly due to the increase in traffic capacity and traffic volume. The other operating revenue is mainly derived from commission income, expired sales in advance of carriage hotel and tour operation income, general aviation income, ground services income and expired sales in advanced carriage.

The increase in operating revenue was primarily due to a 2.3% increase in passenger revenue from RMB100,238 million in 2015 to RMB102,502 million in 2016. The total number of passengers carried increased by 4.75% to 114.62 million passengers in 2016. RPKs increased by 8.71% from 189,588 million in 2015 to 206,106 million in 2016, primarily as a result of the increase in number of passengers carried. Passenger yield per RPK decreased from RMB0.53 in 2015 to RMB0.50 in 2016, which is mainly due to the drop of average ticket price.

Domestic passenger revenue, which accounted for 75.4% of the total passenger revenue in 2016, increased by 0.9% from RMB76,570 million in 2015 to RMB77,257 million in 2016. Domestic capacity in ASKs increased by 4.39%, while passenger traffic in RPKs increased by 4.48%, resulting in an increase in passenger load factor by 0.1 percentage points from 80.6% in 2015 to 80.7% in 2016. Domestic passenger yield per RPK decreased from RMB0.55 in 2015 to RMB0.53 in 2016.

Hong Kong, Macau and Taiwan passenger revenue, which accounted for 2.2% of total passenger revenue, decreased by 11.4% from RMB2,517 million in 2015 to RMB2,230 million in 2016. For Hong Kong, Macau and Taiwan flights, passenger traffic in RPKs decreased by 12.57%, while passenger capacity in ASKs decreased by 11.95%, resulting in an decrease in passenger load factor by 0.6 percentage points from 74.1% in 2015 to 73.5% in 2016. Passenger yield per RPK increased from RMB0.71 in 2015 to RMB0.72 in 2016.

International passenger revenue, which accounted for 22.4% of total passenger revenue, increased by 8.8% from RMB21,151 million in 2015 to RMB23,015 million in 2016. For international flights, passenger traffic in RPKs increased by 22.73%, while passenger capacity in ASKs increased by 22.80%. Passenger load factor was 80.5% in 2015 and 2016. Passenger yield per RPK decreased from RMB0.45 in 2015 to RMB0.40 in 2016.

Cargo and mail revenue, which accounted for 6.6% of our total traffic revenue and 6.3% of total operating revenue, increased by 4.8% from RMB6,861 million in 2015 to RMB7,191 million in 2016. The increase was attributable to the increase in cargo and mail carried.

 

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Other operating revenue increased by 16.1% from RMB4,553 million in 2015 to RMB5,288 million in 2016. The increase was primarily due to the increase of commission income.

Operating Expenses

Total operating expenses in 2016 amounted to RMB106,204 million, representing a increase of RMB4,712 million or 4.6% over 2015, primarily due to the increase in payroll, landing and navigation fees, depreciation and amortization and aircraft operating lease charges partially offset by the decrease in jet fuel costs. Total operating expenses as a percentage of total operating revenue was 92.4% in 2016 and 90.9% in 2015.

 

     2016      2015         
     Operating
expense
RMB
million
     Percentage
%
     Operating
expense
RMB
million
     Percentage
%
     Change in
Operating
expenses

%
 

Flight operation expenses

     51,461        48.4        50,412        49.7        2.1  

Mainly including:

              

Jet fuel costs

     23,799           26,274           (9.4

Aircraft operating

lease charges

     7,330           6,153           19.1  

Flight personnel

payroll and welfare

     9,215           8,070           14.2  

Maintenance expenses

     11,318        10.7        10,407        10.3        8.8  

Aircraft and transportation service expenses

     20,215        19.0        17,908        17.6        12.9  

Promotion and selling expenses

     6,304        5.9        6,976        6.9        (9.6

General and administrative expenses

     2,815        2.7        2,464        2.4        14.2  

Depreciation and amortization

     12,619        11.9        11,845        11.7        6.5  

Impairment on property, plant and equipment

     71        0.1        90        0.1        (21.1

Others

     1,401        1.3        1,390        1.4        0.8  

Total operating expenses

     106,204        100.0        101,492        100.0        4.6  

Flight operations expenses, which accounted for 48.4% of total operating expenses, increased by 2.1% from RMB50,412 million in 2015 to RMB51,461 million in 2016, primarily as a result of increase in RTK due to the increase of capacity netted off by the decrease in jet fuel costs because of decrease in average fuel prices. Jet fuel costs, which accounted for 46.2% of flight operations expenses in 2016, decreased by 9.42% from RMB26,274 million in 2015 to RMB23,799 million in 2016.

Maintenance expenses, which accounted for 10.7% of total operating expenses, increased by 8.8% from RMB10,407 million in 2015 to RMB11,318 million in 2016. The increase was mainly due to fleet expansion.

Aircraft and transportation service expenses, which accounted for 19.0% of total operating expenses, increase by 12.9% from RMB17,908 million in 2015 to RMB20,215 million in 2016. The increase was primarily due to a 13.9% rise in landing and navigation fees from RMB11,510 million in 2015 to RMB13,109 million in 2016, resulted from the increase in the number of take-off and landings for international flights.

Promotion and selling expenses, which accounted for 5.9% of total operating expenses, decreased by 9.6% from RMB6,976 million in 2015 to RMB6,304 million in 2016, mainly due to the decrease in sales commissions expenses.

General and administrative expenses, which accounted for 2.7% of the total operating expenses, increased by 14.2% from RMB2,464 million in 2015 to RMB2,815 million in 2016, mainly due to the increase in general corporate expenses.

Depreciation and amortization, which accounted for 11.9% of total operating expenses, increased by 6.5% from RMB11,845 million in 2015 to RMB12,619 million in 2016, mainly due to fleet expansion.

 

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Operating Profit

Operating profit of RMB12,612 million was recorded in 2016 (2015: RMB13,438 million). The decrease in operating profit was mainly due to the net effect of increase in operating revenue by RMB3,329 million or 3.0% and increase in operating expenses by RMB4,712 million or 4.6% compared with 2015.

Other Income or Expenses

Other net income increased by RMB557 million from RMB3,278 million in 2015 to RMB3,835 million in 2016, mainly due to the increase of government grants.

Interest expense increased by RMB277 million from RMB2,188 million in 2015 to RMB2,465 million in 2016 was mainly due to the increase in the interest rate and the weighted average balance of obligations under finance leases during the year.

Net exchange loss of RMB3,276 million was recorded in 2016, a decrease of RMB2,677 million from RMB5,953 million in 2015, mainly due to the decrease in USD dominated borrowings during the reporting period.

Income Tax

Income tax expense of RMB1,763 million was recorded in 2016, increased by RMB463 million from RMB1,300 million in 2015, mainly due to the increase of profit before income tax in the reporting period.

 

B. LIQUIDITY AND CAPITAL RESOURCES

Generally, we meet our working capital and capital expenditure requirements through cash from our operations, the proceeds of certain long-term and short-term bank loans, capital lease financing and rebates available under certain of our aircraft leases.

As of December 31, 2017, we had banking facilities with several PRC commercial banks for providing loan finance up to an approximate amount of RMB181,922 million to our Group. As of December 31, 2017, an approximate amount of RMB142,239 million was unutilized. As of December 31, 2017 and 2016, our cash and cash equivalents totaled RMB6,826 million and RMB4,152 million, respectively.

Net cash generated from operating activities in 2017, 2016 and 2015 were RMB17,732 million, RMB23,764 million and RMB23,734 million, respectively. Our operating cash inflows are primarily derived from the provision of air transportation and related service for customers. The decrease of operating cash inflows of our Group was mainly due to the increase of jet fuel cost. The vast majority of tickets are purchased prior to the day on which transportation is provided. Operating cash outflows primarily are related to the recurring operating expenses, including flight operation, maintenance, aircraft and transportation service, etc.

Net cash used in investing activities in 2017, 2016 and 2015 were RMB8,236 million, RMB15,750 million and RMB6,931 million, respectively. Cash capital expenditures in 2017, 2016 and 2015 were RMB13,846 million, RMB18,967 million and RMB12,139 million, respectively, reflecting predominantly additional investments in aircraft and flight equipment under our fleet expansion plans and additional investments in other facilities and buildings used in operations.

Net cash used in financing activities were RMB6,796 million, RMB8,459 million and RMB27,695 million in 2017, 2016 and 2015, respectively. Net cash inflow/(outflows) from borrowings and repayments of borrowings amounted to RMB2,557 million, RMB(481) million and RMB(20,042) million in 2017, 2016 and 2015, respectively. The borrowings were used for capital expenditures and general working capital. Repayment of capital leases in 2017, 2016 and 2015 were RMB9,835 million, RMB6,994 million, RMB8,209 million, respectively, resulting from the increase of aircraft acquisitions under capital leases.

 

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As of December 31, 2017, our aggregate long-term borrowings and obligations under capital leases (including borrowings and capital leases obligations due within one year) totaled RMB95,585 million. In 2018, 2019, 2020, 2021 and thereafter, amounts payable under such loans and obligations will be RMB15,283 million, RMB14,174 million, RMB16,060 million, RMB13,862 million and RMB36,206 million respectively. Such borrowings and obligations were mainly denominated in U.S. dollars, Euro and Japanese Yen. In the normal course of business, we are exposed to fluctuations in foreign currencies. Our exposure to foreign currencies primarily results from our foreign currency liabilities. Depreciation or appreciation of the Renminbi against foreign currencies affects our results significantly because our foreign currency liabilities generally exceed our foreign currency assets. We are not able to hedge our foreign currency exposure effectively other than by retaining our foreign currency denominated earnings and receipts to the extent permitted by the SAFE, or subject to certain restrictive conditions, entering into forward foreign exchange contracts with authorized banks.

As of December 31, 2017, our short-term bank loans were RMB20,626 million. Our weighted average interest rate on short-term bank loans was 3.76% per annum as of December 31, 2017. As at December 31, 2017, our outstanding ultra-short-term financing bills was nil. The primary use of the proceeds of our short-term bank loans and ultra-short-term financing bills is to finance working capital and capital expenditure needs. We have generally been able to arrange short-term borrowings with domestic banks in China as necessary and believes it can continue to obtain them based on our well-established relationships with various lenders.

As of December 31, 2017, we had obligations under operating leases totaling RMB69,465 million, predominately for aircraft. Of such amount, RMB8,283 million, RMB8,776 million, RMB8,172 million, RMB7,256 million, RMB6,971 million and RMB30,007 million, respectively, is due in 2018, 2019, 2020, 2021 and 2022 and thereafter.

As of December 31, 2017, we had a working capital deficit of RMB51,693 million, as compared to a working capital deficit of RMB54,168 million as of December 31, 2016. Historically, we operated in a negative working capital position, relying on cash inflow from operating activities and renewal of short-term bank loans to meet our short-term liquidity and working capital needs. In 2018 and thereafter, our liquidity is primarily dependent on our ability to maintain adequate cash inflows from operations to meet our debt obligations as they fall due, and our ability to obtain adequate external financing to meet our committed future capital expenditure. As of December 31, 2017, we had banking facilities with several PRC commercial banks for providing loan finance up to approximately RMB181,922 million (2016: RMB139,274 million), of which approximately RMB142,239 million (2016: RMB110,199 million) was unutilized.

As we are subject to a high degree of operating leverage, a minor decrease in our yield and/or load factor could result in a significant decrease in our operating revenue and hence our operating cash flows. This could arise in such circumstances as where competition between Chinese airlines increases or where PRC aviation demand decreases. Similarly, a minor increase in the jet fuel prices, particularly in the domestic market, could result in a significant increase in our operating expenses and hence a significant decrease in our operating cash flows. This could be caused by fluctuations in supply and demand in international oil market. We currently complied with the financial covenants attached to certain of our borrowings. Nevertheless, as we are subject to a high degree of financial leverage, an adverse change in our operating cash flows could adversely affect our financial health and hence weaken our ability to obtain additional loans and lease facilities and to renew our short-term bank loans facilities as they fall due.

As of December 31, 2017, we had capital commitments as follows:

 

     2018      2019      2020      2021      2022 and
afterwards
     Total  
     (RMB million)  

Acquisition of aircraft and related equipment

     28,125        28,370        22,686        4,808        2,845        86,834  

Others

     9,462        9,359        1,098        1,095        1,008        22,022  

Total capital commitments

     37,587        37,729        23,784        5,903        3,853        108,856  

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

As of December 31, 2017, our cash and cash equivalents totaled RMB6,826 million. Of such balance, 35.88% was denominated in U.S. Dollars, Hong Kong Dollars, Euro, Japanese Yen and other foreign currencies.

In view of the unutilized bank facilities of RMB142,239 million, we expect that we will have sufficient funding sources to meet our cash requirements in the foreseeable future.

 

C. RESEARCH AND DEVELOPMENT, PATENTS AND LICENSES, ETC.

None.

 

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D. TREND INFORMATION

Other than as disclosed in the foregoing disclosures and elsewhere in this Annual Report, we are not aware of any trends, uncertainties, demands, commitments or events for the period from January 1, 2018 to December 31, 2018 that are reasonably likely to have a material adverse effect on our net revenues, income, profitability, liquidity or capital resources, or that would cause our disclosed financial information to be not necessarily indicative of future operating results or financial conditions.

 

E. OFF-BALANCE SHEET ARRANGEMENTS

We have not entered into any off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition that is material to investors. In particular, we (i) have not entered into any financial guarantees or other commitments to guarantee the payment obligations of any unconsolidated entity; (ii) have not entered into any derivative contracts that are both indexed to our own stock and classified in stockholders’ equity, or not reflected in our statement of financial position; and (iii) do not have any retained or contingent interest in assets transferred to an unconsolidated entity that serves as credit, liquidity or market risk support to such entity.

 

F. TABULAR DISCLOSURE OF CONTRACTUAL OBLIGATIONS

The following table sets forth our obligations and commitments to make future payments under contracts and under commitments (excluding share of commitments of a joint venture) as of December 31, 2017.

 

     As of December 31, 2017
Payment due by period
            As of
December
31, 2016
 
     Total      Less
than 1
year
     1 - 3
years
     3 - 5
years
     After 5
years
     Total  

Short-term bank loans and ultra-short-term bills (Note 1)

     20,953        20,953        —          —          —          26,467  

Long-term bank and other loans (Note 1)

     29,502        7,823        14,808        6,843        28        21,411  

Obligations under capital leases

     78,899        10,764        20,194        19,690        28,251        71,388  

Operating lease commitments

     69,465        8,283        16,948        14,227        30,007        61,215  

Aircraft purchase commitments (Note 2)

     86,834        28,125        51,056        7,653        —          83,532  

Other capital commitments

     22,022        9,462        10,457        2,103        —          21,609  

Investment commitments

     —          —          —          —          —          170  

Total

     307,675        85,410        113,463        50,516        58,286        285,792  

Note 1 Interest on variable rate loans was estimated based on the current rate in effect at December 31, 2017.

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

 

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ITEM 6. DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES

 

A. DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES

The following table sets forth certain information concerning directors, senior management and supervisors of our Company. There were certain changes in our Company’s directors, senior management and supervisors as of April 26, 2018, details of which are set forth below.

 

Name

  

Position

  

    Gender    

  

    Age    

Wang Chang Shun

   Executive Director, Chairman of our Board    Male    60

Tan Wan Geng

   Executive Director, Vice Chairman of our Board and President    Male    53

Zhang Zi Fang

   Executive Director and Executive Vice President    Male    59

Zheng Fan

   Independent Non-executive Director    Male    62

Gu Hui Zhong

   Independent Non-executive Director    Male    61

Tan Jin Song

   Independent Non-executive Director    Male    53

Jiao Shu Ge

   Independent Non-executive Director    Male    52

Pan Fu

   Chairman of the Supervisory Committee    Male    55

Li Jia Shi

   Supervisor    Male    56

Mao Juan

   Supervisor    Female    44

Han Wen Sheng

   Executive Vice President    Male    50

Xiao Li Xin

   Executive Vice President, Chief Accountant and Chief Financial Officer    Male    51

Ren Ji Dong

   Executive Vice President    Male    53

Wang Zhi Xue

   Executive Vice President    Male    56

Li Tong Bin

   Executive Vice President and Chief Engineer    Male    56

Zhang Zheng Rong

   Chief Operation Officer    Male    55

Su Liang

   Chief Economist    Male    55

Chen Wei Hua

   Chief Legal Adviser    Male    51

Guo Zhi Qiang

   Chief Marketing Officer    Male    54

Xie Bing

   Company Secretary to our Board    Male    44

Feng Hua Nan

   COO Flight Safety    Male    55

Luo Ming Hao

   Chief Pilot    Male    55

Guo Jian Ye

   Chief Customer Officer    Male    55

Directors

Wang Chang Shun, male, aged 60, Ph.D. degree, graduated from University of Science and Technology of China majoring in management science and engineering and is a member of Communist Party of China (“CPC”). He began his career in February 1976. He has acted as Vice Director and Director of aeronautical meteorology supervision department of CAAC Urumqi Administration, Vice President and a member of standing committee of Xinjiang Airlines (Vice Chairman of CAAC Urumqi Administration) and then as Party Secretary and Vice President of Xinjiang Airlines (Vice Chairman of CAAC Urumqi Administration). In November 2000, he acted as General Manager and Deputy Party Secretary of the Company. In April 2001, he also acted as the Vice Chairman of the Company; in September 2002, he acted as Vice President and Party member of CSAH and also as Vice Chairman, General Manager and Deputy Party Secretary of the Company. In August 2004, he served as Deputy Director and Party member of Civil Aviation Administration of China. In March 2008, he acted as Deputy Director and Party member of Civil Aviation Administration of China. In October 2011, he was appointed as General Manager and Deputy Party Secretary of CSAH and in January 2012, he also was appointed as the Chairman of Air China International Corporation. He was appointed as Vice Minister and Party Leadership Group Member of Ministry of Transport and Secretary of Communist Party Committee of the direct department in January 2014, General Manager and Deputy Party Secretary of CSAH from February 2016 to May 2016, General Manager and Deputy Party Secretary of CSAH and Chairman of the Company from May 2016 to December 2016. From December 2016 to November 2017, he has been Chairman, Party Secretary of CSAH and Chairman of the Company. Since November 2017, he has been Chairman, Party Secretary of CSAH and Chairman and Party Secretary of the Company. He is also a deputy to the 12th National People’s Congress. He is the representative of the 19th Communist Party of China National Congress, standing committee member of the 13th National Committee of the Chinese People’s Political Consultative Conference and a member of the 12th CPC Guangdong Provincial Committee.

 

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Tan Wan Geng, male, aged 53, graduated from Sun Yat-sen University, majoring in regional geography, with qualification of a Master’s degree. He is an economist and a member of CPC. Mr. Tan began his career in August 1990 and served as the head of the Infrastructure Department and Director of Human Resources and Administration Department of the Beijing Aircraft Maintenance and Engineering Corporation from 1992 to 1996. He served as the Deputy Director General of Human Resources Division of the CAAC from May 1996 to September 1998. Mr. Tan served as the Deputy Director General of Personnel and Education Division of the CAAC from September 1998 to December 2000. He had been the Director General and Party Secretary of the CAAC Northeast Regional Administration from December 2000 to January 2006, and became the Party Secretary and Executive Vice President of the Company from January 2006 to February 2007. He has been the Director of the Company since June 2006. He had been the Party Member of CSAH and the Party Secretary and Executive Vice President and Director of the Company from February 2007 to January 2009. He had been the Party Member of CSAH and the President, the Party Secretary and the Director of the Company from January 2009 to February 2009. He had been the Party Member of CSAH and the President, the Deputy Party Secretary and the Director of the Company from February 2009 to May 2011. He had been the Party Secretary of CSAH and General Manager, the Deputy Party Secretary and the Director of the Company from May 2011 to January 2013. He was the Party Secretary of CSAH and General Manager, the Deputy Party Secretary and the Vice Chairman of the Board from January 2013 to December 2016. Since December 2016 to date, Mr. Tan has been the President, Director and Deputy Party Secretary of CSAH and General Manager, the Deputy Party Secretary and the Vice Chairman of the Board. Mr. Tan has been a member of the 11th CPC Guangdong Provincial Committee.

Zhang Zi Fang, male, aged 59, graduated with a college degree from foundation science profession for Party administrative cadres of Liaoning University. While Mr. Zhang was at work, he obtained an Executive Master of Business Administration (EMBA) degree from Tsinghua University and is a senior expert of political science. Mr. Zhang is a CPC member and began his career in February 1976. He served as Deputy Commissioner of the China Northern Airlines Company as well as the Deputy Commissioner of the Office, Deputy Commissioner of Shenyang Flight Team from 1993 to 2000. He served as the Party Secretary of the Jilin Branch of China Northern Airlines Company and the General Manager of Dalian Branch from 2000 to 2003. He had been the Director of Political Works Department of CSAH from October 2003 to February 2005. Subsequently, Mr. Zhang was appointed as the Deputy Party Secretary and Secretary of the Commission for Discipline of the Company from February 2005 to December 2007. He had been Executive Vice President and the Deputy Party Secretary of the Company from December 2007 to February 2009. He was the Party Secretary and Executive Vice President of the Company from February 2009 to August 2011. Mr. Zhang has been the Director of the Company since June 2009. He had been the Party member of CSAH and the Party Secretary, Executive Vice President and the Director of the Company from August 2011 to April 2016. He had acted as the Party Member of the CSAH and the Director, Party Secretary, Executive Vice President of the Company as well as the Director and Chairman of China Southern Henan Airlines Company Limited from April 2016 to August 2016. Mr. Zhang has been Deputy Party Secretary, Executive Vice President of CSAH and Director, Party Secretary, Executive Vice President of the Company as well as the Director and Chairman of China Southern Henan Airlines Company Limited since August 2016. Since November 2017, he has been Deputy Party Secretary and Executive Vice President of CSAH, Director, Deputy Party Secretary and Executive Vice President of China Southern Airlines Company Limited, Chairman of China Southern Airlines Henan Airlines Company Limited. He has been a member of Standing Committee of 12th Guangdong Provincial Committee of the Chinese People’s Political Consultative Conference since January 2018 to date.

Zheng Fan, male, aged 62, graduated with a bachelor’s degree from Beijing Normal University majoring in School Education and is a senior expert of political science. Mr. Zheng is a CPC member and began his career in 1974. He served as a teacher of Faculty of Education at Beijing Normal University from February 1982. He worked as a cadre at public relationship department of the Chinese Communist Party Central Committee and was a deputy Director level investigator from January 1986, deputy Director-general (temporary post) of public relationship department of CBRC Shenzhen Municipality Luohu District Committee and deputy Director general (temporary post) of public relationship department of Shenzhen Committee of Communist Party of China from March 1988, deputy Director of public relationship department of CBRC Shenzhen Municipality Futian District Committee and office Director of working committee under the CBRC Shenzhen Municipality Committee from March 1991. Since August 1994, he has been appointed as general manager of general administration office of Overseas Chinese Town Economic Development Company, general manager’s assistant of OCT Group and managing Director of Overseas Chinese Town (HK) Company Limited since December 1997, deputy secretary of the Party Committee, secretary of Discipline Inspection Commission and Chief Cultural Officer of Overseas Chinese Group Company since August 2000, secretary of the Party Committee and vice-president of Overseas Chinese Group Company since March 2008, secretary of the Party Committee and vice-chairman of Overseas Chinese Town Company Limited since January 2010, chief supervisor since December 2014 and Professional External Director for Central State-owned Enterprises since February 2016. He acted as Council Member of China Overseas Exchange Association, Director of relation of the Two Shores Across the Strait Association, vice president of Guangdong’s Association For Promotion of Cooperation between Guangdong, Hong Kong and Macao and vice-chairman of Guangdong Province Association of Entrepreneurs. He was also a Congressman of the 4th term and 5th term of the People’s Congress for Shenzhen Municipality and a member of the 11th session of Guangdong Provincial Committee of Political Consultative Conference. Mr. Zheng has been independent non-executive Director of the company since 20 December 2017.

 

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Gu Hui Zhong, male, aged 61, graduated with a master degree from Beihang University majoring in International Finance and is a senior accountant with professor level. Mr. Gu is a CPC member and began his career in 1974. He served as deputy chief and chief of the General Office of Financial Division of Aviation Industry Department, Director of International Affairs Financial Division of Aviation Industry Corporation of China, general manager of Zhongzhen Accounting Consultative Corporation, vice Director general of Financial Department of Aviation Industry Corporation of China and deputy Directorgeneral of Financial Department of State Commission of Science, Technology and Industry for National Defence. From June 1999 to February 2005, he acted as a member of the Communist Party and vice president of Aviation Industry Corporation of China I. From February 2005 to August 2008, he acted as a member of Party Leadership Group, vice president and chief accountant of Aviation Industry Corporation of China I. From August 2008 to January 2017, he acted as a member of Party Leadership Group, vice president and chief accountant of Aviation Industry Corporation of China. He previously served as chairman of AVIC I International Leasing Co., Ltd., chairman of AVIC I Financial Co., Ltd., chairman of CATIC International Holdings Limited, chairman of AVIC Capital Co., Ltd and chairman of AVIC International Vanke Company Limited. He is currently served as supervisors of the Bank of Communications, is a chairman of the Expert Committee of government authorities in the PRC and vice chairman of the Accounting Society of China. Since 20 December 2017, Mr. Gu has been independent non-executive Director of the Company.

Tan Jin Song, male, aged 53, graduated from Renmin University of China with an on-job doctor degree in Accounting. Mr. Tan is a Chinese Certified Public Accountant and a CPC member. Mr. Tan began his career in 1985 and was a teacher in Shaoyang School of Finance and Accounting of Hunan Province and the Deputy Dean of the School of Management of Sun Yat-sen University. Mr. Tan is currently a professor and a doctorate-tutor of the School of Management of Sun Yat-sen University. He is also a member of the MPAcc Education Instruction Committee, a member of China Institute of Internal Audit, Vice President of Guangdong Institute of Certified Public Accountants and a member of China Audit Society. Currently, Mr. Tan also serves as the independent Director of Poly Real Estate Company Limited, Guangzhou Hengyun Enterprises Holdings Limited, Shanghai RAAS Blood Products Co., Ltd. and Zhuhai Huafa Industrial Company Limited. Mr. Tan has been the independent non-executive Director of the Company since 26 December 2013.

Jiao Shu Ge, male, aged 52, with a master degree, first graduated from the Control Theory Faculty of the Department of Mathematics of Shandong University with a bachelor degree, and then graduated from the Systems Engineering Faculty of No. 2 Research Institute of the Ministry of Aerospace Industry with a Master’s degree in Engineering. Mr. Jiao has extensive experience in funds management and equity management. Currently, Mr. Jiao is the Director and President of CDH China Management Company Limited (“CDH Investments”) and is the founder of CDH Investments. He was a computer researcher of 710 Research Institute of the former Ministry of Aerospace Industry of China, the Deputy General Manager of Direct Investment Department of China International Capital Corporation Ltd. (“CICC”). Mr. Jiao was the non-executive Director of China Yurun Food Group Limited and China Shanshui Cement Group Limited. Currently, he is also the Director of the associated companies of CDH Investments, the independent non-executive Director of China Mengniu Dairy Company Limited, the non-executive Director and Vice Chairman of WH Group Limited, the Director of Joyoung Co., Ltd., the Vice President of Henan Shuanghui Investment & Development Co.,Ltd. and the Director of a number of companies including Beijing Taiyang Pharmaceutical Industry Company Limited, Chery Automobile Co., Ltd., Inner Mongolia Hetao Spirit Group Co., Ltd., Fujian Nanping Nanfu Battery Co.,Ltd. and Shanghai Qingchen Real Estate Development Co., Ltd. Mr Jiao has been the independent non-executive Director of the Company since 30 June 2015.

Supervisors

Pan Fu, male, aged 55, graduated with a master degree from Chongqing University majoring in Power Systems and Automation, and is a senior engineer. Mr. Pan is a CPC member and began his career in July 1986, and served successively as the Deputy Head of the Planning Department of Electric Power Industry Bureau of Yunnan Province, the Deputy Director of the Planning & Development Department of Yunnan Electric Power Group Co., Ltd., the Deputy Director and Director of Kunming Power Plant, the Deputy Chief Engineer and chief engineer of Yunnan Electric Power Corporation from 1994 to 2003. He served as the deputy Director (work as chair) and Director of the Department of Security Supervision of China Southern Power Grid Company Ltd. from February 2003 to April 2004, he served as the Director of the China Southern Power Grid Technology and Research Center from April 2004 to January 2005, and served as the General Manager (legal representative) and Deputy Party Secretary of the Guizhou Power Grid Corporation from January 2005 to November 2007. Mr. Pan served as the Director of the Planning Development Department of China Southern Power Grid Company Ltd. from November 2007 to November 2010. Mr. Pan has been the party member and team leader of the Discipline Inspection Commission of CSAH since November 2010 and the supervisor and chairman of the Supervisory Committee of the Company since December 2010.

 

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Li Jia Shi, male, aged 56, graduated from Guangdong Polytechnic Normal University majoring in Economics and Mathematics, and obtained an Economic Administration bachelor degree from Correspondence School under the Party School of the CPC Central Committee and an Executive Master of Business Administration (EMBA) degree from Tsinghua University and is an expert of political science. Mr. Li is a CPC member and began his career in August 1976. He served as the Deputy Head of the Organization Division of the Party Committee of the China Southern Airlines (Group) Company, the party secretary of Guangzhou Nanland Air Catering Company Limited and the Deputy Head (work as chair) of the Organization Division of the Party Committee of the China Southern Airlines (Group) Company from 1994 to 1999. Mr. Li served as the head of the Organization Division of the Party Committee of CSAH from December 1999 to December 2003; and served as the Deputy Secretary of the Disciplinary Committee and the Director of the Disciplinary Committee Office of the Company from December 2003 to December 2007. Mr. Li served as a member of the Standing Committee of the CPC, the Secretary of the Disciplinary Committee and the Director of the Disciplinary Committee Office of the Company from December 2007 to February 2012. Mr. Li has been the supervisor of the Company since June 2009. He has been the team deputy leader of the Discipline Inspection Commission of CSAH, and member of the Standing Committee of the CPC, Secretary of the Disciplinary Committee of the Company from February 2012 to November 2017. He has acted as the Chairman of the Labour Union of CSAH and the Standing Member of Party Committee and Chairman of the Labour Union of China Southern Airlines Company Limited since November 2017.

Mao Juan, female, aged 44, with a bachelor’s degree, graduated from Operation and Management Department in Civil Aviation College of China majoring in civil aviation program and finance, and obtained an on-job bachelor degree in Auditing from the School of Adult Education, Harbin University of Science and Technology. Ms. Mao is a CPC member and began her career in July 1993. She served as Deputy General Manager of Hainan Branch Comprehensive Trading Company of the Company, Deputy Manager of Finance Department in Hainan Branch of the Company and Manager of Audit and System Office of Finance Department in the Company. From August 2011 to May 2016, she acted as Deputy General Manager of Audit Department in the Company. She has served various positions in the Company, such as general manager of Audit Department, from June 2016 to May 2017. She has been the deputy general manager of Audit Department in the Company from May 2017 to November 2017. She has served as the General Manager of the Company’s Audit Department since December 2017. She currently serve as the general manager of audit department of CSAH, the Chairman of the Supervisory Committee of Guangzhou Nanland Air Catering Company Limited and Nan Lung Freight Company Limited, as well as the supervisor of Southern Airlines Group Finance Company Limited, Xiamen Airlines Company Limited, Chongqing Airlines Company Limited, Guizhou Airlines Company Limited, Zhuhai Airlines Company Limited, China Southern Airlines Henan Airlines Company Limited, and Guangzhou Baiyun International Logistic Company Limited, etc.

Senior Management

Han Wen Sheng, male, aged 50, graduated from Management Department of Tianjin University, majoring in engineering management, with qualification of a Master’s degree. He is a member of CPC and began his career in August 1987.From September 1999 to June 2001, he acted as Deputy Director General of Cadre Training Center of the Company. He served as Director of The Research Bureau of the Company from June 2001 to January 2002. From January 2002 to November 2005, he acted as general manager of Labour Department and Secretary of CPC General Committee of the Company. From November 2005 to June 2007, he served as a member of Party Committee and the Deputy Director of the Commercial Steering Committee and general manager as well as Deputy Party Secretary of the sales and marketing department of the Company. From June 2007 to December 2009, he served as general manager of Shanghai base and Deputy Party Secretary of the Company. He acted as Deputy Party Secretary and Deputy Director of the Marketing Management Committee of the Company from December 2009 to October 2011. From October 2011 to October 2016, he was Party Secretary and Deputy Director of the Marketing Management Committee of the Company. From October 2016 to November 2017, he has been the Party member and Deputy General Manager of China Southern Air Holding Limited Company. He served as the Party member and Deputy General Manager of China Southern Air Holding Limited Company and Deputy General Manager of the Company since November 2017. For now, he also acts as Vice Chairman of Sichuan Airlines Corporation Limited and Vice Director General of China Air Transport Association.

 

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Xiao Li Xin, male, aged 51, graduated from Guangdong Academy of Social Sciences with a master degree in Economics and then obtained an on-job Executive Master of Business Administration (EMBA) degree from Tsinghua University. He is a qualified senior accountant and a certified public accountant. Mr. Xiao is a CPC member and began his career in July 1991. From June 1999 to March 2001, he acted as the General Manager Assistant of the Finance Department of the China Southern Airlines (Group) Company and served as the Deputy General Manager of the Finance Department of the Company from March 2001 to January 2002. He served as the General Manager and Deputy Secretary of the General Party Branch of the Finance Department of the Company from January 2002 to February 2007. Mr. Xiao served as the deputy chief accountant and general manager of the Finance Department of the Company from February 2007 to October 2007, and served as the General Manager and Secretary of the General Party Branch of Southern Airlines Group Finance Company Limited from October 2007 to February 2008. He served as the General Manager and Party Secretary of Southern Airlines Group Finance Company Limited from February 2008 to April 2015. Mr. Xiao has been the Chief Accountant and Chief Financial Officer of the Company since April 2015 to October 2016. From October 2016 to November 2017, he has served as Party member and Chief Accountant of CSAH and Chief Accountant and Chief Financial Officer of the Company. From December 2017 till now, he has served as Party member and Chief Accountant of CSAH and Executive Vice President, Chief Accountant and Chief Financial Officer of the Company. For now, he also serves as chairman of Guizhou Airlines Company Limited, Chairman of Shantou Airlines Company Limited, Chairman of Xiamen Airlines as well as Director of China Southern Airlines Overseas (Hong Kong) Co. Ltd.

Ren Ji Dong, male, aged 53, graduated from Nanjing University of Aeronautics and Astronautics, majoring in Aircraft Engine Design and obtained an Executive Master of Business Administration (EMBA) degree from Tsinghua University, and he is a senior engineer. Mr. Ren is a CPC member and began his career in August 1986. Mr. Ren served as the No. 2 Workshop Manager, Deputy Plant Manager and Deputy General Manager of Engineering Department of the aircraft maintenance factory of Urumqi Civil Aviation Administration (Xinjiang Airlines) from 1995 to 2000. He served as the Deputy Director (deputy general manager) and a member of the Standing Committee of the CPC of Urumqi Civil Aviation Administration (Xinjiang Airlines) from January 2000 to December 2001, and a member of the party committee and the Deputy General Manager of Xinjiang Airlines from December 2001 to June 2004, and the Party Secretary and Deputy General Manager of CSAH Xinjiang Company from June 2004 to December 2004, the Party Secretary and Deputy General Manager of Xinjiang Branch of the Company from January 2005 to February 2015, a member of the Standing Committee of the CPC and the Executive Vice President of the Company from March 2005 to February 2007; a member of the Standing Committee of the CPC of the Company and the General Manager and Deputy Party Secretary of Xinjiang Branch from January 2007 to April 2009.Mr. Ren has been a member of the Standing Committee of the CPC of the Company and the Executive Vice President of the Company since May 2009.

Wang Zhi Xue, male, aged 56, has a college degree from Civil Aviation Flight University of China majoring in Aircraft Piloting, and obtained an on-job university degree from Civil Aviation Flight University of China majoring in Wingmanship, and is a command pilot. Mr. Wang is a CPC member, and began his career in February 1981. Mr. Wang successively served as the Deputy General Manager and Manager of the Flight Safety Technology Division of Zhuhai Airlines Company Limited, the Senior Flight Instructor of Model B737, Deputy Chief Pilot and Director of the Flight Safety Technology Division as well as the Deputy Chief Pilot and Manager of the Flight Safety Technology Management Division from 1995 to 2002 of Shantou Airlines Company Limited of CSAH. He also acted as the Deputy General Manager of Shantou Airlines Company Limited from June 2002 to October 2004, and the General Manager of the Flight Management Division of the Company from October 2004 to February 2009, and the General Manager and Deputy Party Secretary of Guangzhou Flight Division of the Company from February 2009 to July 2012. Mr. Wang has been a member of the Standing Committee of the CPC, Executive Vice President and chief pilot of the Company from August 2012 to December 2016. He has been a member of the Standing Committee of the CPC and Executive Vice President of the Company from December 2016 until now. For now, he also serves as Chairman of Zhuhai Airlines Company Limited.

 

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Li Tong Bin, male, aged 56, has college qualification and graduated from Civil Aviation Institute of China majoring in Maintenance of Aircraft Electrical Equipment. He obtained on-job Master of Business Administration (MBA) from Hainan University and Executive Master of Business Administration (EMBA) form Tsinghua University, and is a senior engineer. Mr. Li is a CPC member and began his career in August 1983, and successively served as the Deputy Head of Technical Division of Aircraft Maintenance Plant, the head of Maintenance Plant and the deputy Director of Aircraft Engineering Department (aircraft maintenance base), the Director of Aircraft Engineering Department (aircraft maintenance base) of China Northern Airlines Company, the General Manager of Jilin branch of China Northern Airlines Company from 1994 to 2003. He also acted as the Deputy General Manager and Deputy Party Secretary of Zhuhai Airlines Company Limited from September 2004 to January 2005, the General Manager and Deputy Party Secretary of Zhuhai Airlines Company Limited from January 2005 to April 2012, and the party secretary and Deputy General Manager of Northern Branch of the Company from April 2012 to April 2014. Mr. Li was the Chief Engineer, General Manager and Deputy Party Secretary of Aircraft Engineering Department of the Company from April 2014 to August 2015. Mr. Li has been a member of the Standing Committee of the CPC, Executive Vice President and Chief Manager, as well as General Manager and Deputy Party Secretary of Aircraft Engineering Department of the Company since September 2015 to December 2016. From December 2016 till now, he has been a member of the Standing Committee of the CPC, Executive Vice President and Chief Manager. For now, Mr. Li also serves as Chairman of Shenyang Northern Aircraft Maintenance Co., Ltd., Southern Airlines Group Import and Export Trading Company and Guangzhou Aircraft Maintenance Engineering Co., Ltd.

Zhang Zheng Rong, male, aged 55, has a college degree from Civil Aviation Flight University of China majoring in Aircraft Piloting, and obtained an on-job Executive Master of Business Administration (EMBA) degree from Tsinghua University. He is a CPC member and began his career in February 1982. He served as Vice Captain of the Fifth Sub- Flight Corps under Sixth Flight Corps of Civil Aviation Administration, Sub-Captain, Vice Captain and Captain of China Southern Airlines Flight Corps, Vice President of Flight Corps of the Company, General Manager of Department of Security Supervision of the Company, as well as General Manager and Deputy Party Secretary of Guangzhou Flight Division of the Company. In August 2007, he was appointed as Chief Pilot of the Company and General Manager and Deputy Party Secretary of Guangzhou Flight Division of the Company. Since April 2012, he served as the Chief Pilot and Director of Aviation Security Department of CSAH and in July 2012, he served as the chief pilot and Aviation Security Minister of China Southern Airlines (Group) Company. Since April 2014, he has acted as Chief Pilot, Chief Safety Officer and Director of Aviation Security Department of CSAH. He has served as COO of the Company since January 2017. Since November 2017, he has been the General Manager Assistant of CSAH and COO of the Company.

Su Liang, male, aged 55, graduated from the University of Cranfield, United Kingdom with a master degree majoring in Air Transport Management, and is an engineer. Mr. Su is a CPC member and began his career in December 1981. From 1998 to 2000, he successively served as Deputy General Manager of the Flight Operations Division, Deputy General Manager and Manager of Planning and Management Division of CSAH Shenzhen Company. Mr. Su was the Secretary to the Board from July 2000 to December 2003, the Secretary to the Board and Director of Board Secretariat of the Company from December 2003 to November 2005, the Secretary to the Board and Vice Director of Commercial Steering Committee of the Company from November 2005 to February 2006, the Company Secretary and Director of Company Secretary Office and Vice Director of Commercial Steering Committee of the Company from February 2006 to January 2007, and the Secretary to the Board and Director of Company Secretary Office from January 2007 to November 2007. Mr. Su has been the Chief Economist of the Company since December 2007. For now, he also serves as Director of Sichuan Airlines Company Limited, chairman of Southern Airlines Culture and Media Co., Ltd. and chairman of China Southern West Australian Flying College Pty Ltd..

Chen Wei Hua, male, aged 51, graduated from the School of Law of Peking University with a bachelor degree, who is an economist, a qualified lawyer in the PRC and a qualified corporate legal counselor. Mr. Chen is a CPC member and joined the aviation industry in July 1988. He successively served as Deputy Director of China Southern Airlines (Group) Corporation, Deputy Director of the Office (Director of the Legal Department) of the Company and China Southern Airlines (Group) Corporation from 1997 to 2004. Mr. Chen was the Chief Legal Adviser of the Company and Director of the Legal Department of the Company from June 2004 to October 2008. Mr. Chen has been the General Counsel and General Manager of the Legal Department of the Company since October 2008. He has served as Chief Legal Adviser of the Company since April 2017. For now, he also acts as Director of Xiamen Airlines Company Limited.

 

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Guo Zhi Qiang, male, aged 54, is an economist who graduated with a master degree from Party School of Xinjiang Uyghur Autonomous Region majoring in Business Administration. Mr. Guo is a CPC member and began his career in January 1981. He successively served as the Xi’an Office manager, Beijing Office manager and General Manager of Transportation Department of Xinjiang Airlines; the Deputy General Manager of Xinjiang Airlines; the Beijing Office Director of CSAH, the General Manager and the Party Secretary of China Southern Airlines Beijing Office from 1995 to 2004. He served as a member of the Standing Committee of the CPC and the Deputy General Manager of CSAH Xinjiang Branch from June 2004 to December 2004, a member of the Standing Committee of the CPC and the Deputy General Manager of China Southern Airlines Xinjiang Branch from January 2005 to December 2005. Mr. Guo served as a member of Party Committee and the Deputy General Manager of the Shenzhen Branch of the Company from December 2005 to February 2008 and the President and Chief Executive Officer as well as Deputy Party Secretary of Chongqing Airlines Company Limited from February 2008 to May 2009. He served as a member of Party Committee and the Deputy Director of the Commercial Steering Committee of the Company from May 2009 to September 2009, the Director and Deputy Party Secretary of the Commercial Steering Committee of the Company from September 2009 to September 2012. Mr. Guo acted as the COO Marketing and Sales of the Company, the Director and the Deputy Party Secretary of the Commercial Steering Committee of the Company from September 2012 to July 2014. Mr. Guo has been the COO Marketing and Sales of the Company since July 2014. For now, he also serves as Chairman of China Southern Jia Yuan (Guangzhou) Air Products Co., Ltd., Guangzhou Nanland Air Catering Co., Ltd., Guangzhou China Southern PRC Zhongmian Dutyfree Store Co., Limited., China Southern Airlines General Aviation Limited and Shenzhen Air Catering Company Limited.

Xie Bing, male, aged 44, with a university degree, graduated from Nanjing University of Aeronautics and Astronautics, majoring in Civil Aviation Management. He subsequently received a master degree of business administration, a master degree of business administration (international banking and finance) and an Executive Master of Business Administration (EMBA) degree from Jinan University, the University of Birmingham, Britain and Tsinghua University, respectively. Mr. Xie is a Senior Economist, fellow member of The Hong Kong Institute of Chartered Secretaries, and has the qualification for Company Secretary of companies listed on Shanghai Stock Exchange and also has the qualification for Company Secretary of companies listed on Stock Exchange. Mr. Xie is a CPC member and began his career in July 1995. He successively served as the Assistant of Company Secretary of the Company, and the Executive Secretary of the General Office of CSAH from 2003 to 2007. Mr. Xie has been the Company Secretary and Deputy Director of the Company Secretary Office from November 2007 to December 2009. Mr. Xie has been the Company Secretary and Director of the Company Secretary Office from December 2009 to May 2017. Form May 2017 till now, he has been the Company Secretary and Director of the Company Secretary Bureau of the company. For now, he also acts as Chairman of China Southern Airlines Group Capital Holding Limited and CSA International Finance Leasing Co., Ltd..

Feng Hua Nan, male, aged 55, graduated with a college degree from China Civil Aviation Flying College, majoring in Aircraft Piloting, and obtained an on-job master degree in Aeronautical Engineering from Beijing University of Aeronautics and Astronautics and an Executive Master of Business Administration (EMBA) from the School of Economics and Management of Tsinghua University. He is a commanding pilot. Mr. Feng is a CPC member and began his career in January 1983. He successively served as the Director of Zhuhai Flight Training Centre of China Southern Airlines (Group) Company and the Deputy General Manager of Flight Operation Division of the Company from 1994 to 1999. He was the General Manager of Flight Safety Technology Department from December 1999 to October 2002, and the General Manager of Flight Technology Management Department of the Company from November 2002 to September 2004. Mr. Feng also served as the Party Secretary and Deputy General Manager of Guizhou Airlines Company Limited from September 2004 to February 2006, and then served as the General Manager and Deputy Party Secretary of Guizhou Airlines Company Limited from February 2006 to July 2014. He has been the COO Flight Safety of the Company since August 2014. For now, he also serves as President of Zhuhai Xiang Yi Aviation Technology Co., Ltd..

Luo Ming Hao, male, aged 55, Mr. Luo obtained a college diploma in aircraft aviation from the China Civil Aviation Flight College, a postgraduate degree in economics (in-service) from Hunan Provincial Party Committee College and an executive master degree in business administration (EMBA) from School of Economics and Management of Tsinghua University. Mr. Luo is a member of the Communist Party of China. Mr. Luo began his career in July 1982. From May 1996 to October 1997, he served as the deputy manager of Aviation Department of China Southern Airlines (Group) Hunan Company; from October 1997 to June 1998, he served as the deputy manager of Beihai Operation Branch of China Southern Airlines Hunan Company; from June 1998 to May 2002, he served as the manager of Beihai Operation Branch of China Southern Airlines Hunan Company; from May 2002 to December 2006, he served as the deputy general manager of Hunan Branch of China Southern Airlines Company Limited; from December 2006 to December 2010, he served as the general manager and the deputy secretary of the Party of Cabin Department of China Southern Airlines Company Limited; from December 2010 to July 2012, he served as the member of the Party Committee, the general manager and the deputy secretary of the Party of Dalian Branch of China Southern Airlines Company Limited; from July 2012 to March 2018, he served as the member of the Party Committee, the general manager and the deputy secretary of the Party of Guangzhou Flight Department of China Southern Airlines Company Limited.

 

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Guo Jian Ye, male, aged 55, graduated with a master degree from Party School of Civil Aviation Flight University of China majoring in Aircraft Piloting. He got the on-job university degree from South China Normal University majoring in Political Education in Education Management Department. He also obtained a master’s degree from the Party School of the Central Committee of CPC majoring in economics and management. He is a CPC member and began his career in May 1980. He was appointed as Committee Secretary, Director of Advertising and Promotion Department of CAAC Central and Southern Regional Administration, Director of Air Transportation Administration Political Office of CAAC Central and Southern Regional Administration, Vice Director of Air Transportation Administration under CAAC Central and Southern Regional Administration and General Manager, Vice Director of Guangdong CAAC Central and Southern Industrial Co., Ltd., Head of CAAC Henan Safety Supervision Office, Director of Safety Supervision Administration, Secretary of standing committee and the member of standing committee of CAAC Central and Southern Regional Administration, as well as the Vice Director. In July 2012, he served as a member of standing committee, General Manager and Deputy Party Secretary of Heilongjiang Branch of the Company. From July 2014 to January 2017, he acted as a Party member, Director and Deputy Party Secretary of marketing management committee of the Company. Since January 2017, he has been the Chief Customer Officer of the Company.

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

 

B. COMPENSATION

The aggregate compensation paid to all Directors, Supervisors and Senior Management for 2017 was RMB14.74 million. For the year ended December 31, 2017, we paid an aggregate of approximately RMB1.84 million on behalf of our executive Directors, Supervisors and Senior Management pursuant to the pension scheme and the retirement plans operated by various municipal and provincial governments in which we participate.

Details of the remuneration of Directors’ and Supervisors’ remuneration for the year ended December 31, 2017 are set out below:

 

     Directors’
fees
RMB’000
     Salaries,
allowancs
and benefits
in kind
RMB’000
     Retirement
scheme
contributions
RMB’000
     Total
RMB’000
 

Non-executive Directors

           

Yuan Xin An

     —          —          —          —    

Yang Li Hua

     —          —          —          —    

Executive Directors

           

Wang Chang Shun

     —          —          —          —    

Tan Wan Geng

     —          —          —          —    

Zhang Zi Fang

     —          —          —          —    

Li Shao Bin

     —          812        123        935  

Independent Non-executive Directors

           

Tan Jin Song

     150        —          —          150  

Zheng Fan

     —          —          —          —    

Jiao Shu Ge

     150        —          —          150  

Gu Hui Zhong

     —          —          —          —    

Ning Xiang Dong

     150        —          —          150  

Liu Chang Le

     150        —          —          150  

Guo Wei

     150        —          —          150  

Supervisors

           

Pan Fu

     —          —          —          —    

Li Jia Shi

     —          901        126        1,027  

Mao Juan

     —          324        120        444  

Zhang Wei

     —          —          —          —    

Yang Yi Hua

     —          —          —          —    

Wu De Ming

     —          419        127        546  

Total

     750        2,456        496        3,702  

 

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C. BOARD PRACTICES

Each director’s service contract with our Company or any of its subsidiaries provides prorated monthly salary upon termination of employment in accordance with his contract. The director is entitled to paid leave under his contract. The term of office of a director is three years. The terms of the eighth session of our board of directors will expire on December 20, 2020. A director may serve consecutive terms upon re-election.

Strategic and Investment Committee

The Strategic and Investment Committee comprises three members and is chaired by Mr. Wang Chang Shun. The other two members are Mr. Gu Hui Zhong as independent non-executive Director and Mr. Jiao Shu Ge as independent non-executive Director.

Audit and Risk Management Committee

The Audit and Risk Management Committee is appointed by our board of Directors and consists of three independent non-executive directors. The current members of the Audit and risk management committee are Tan Jin Song, Gu Hui Zhong and Jiao Shu Ge. Tan Jin Song is the Chairman of the Audit and Risk Management Committee. A member may serve consecutive terms upon re-election. At least once a year, the committee is required to meet with our Company’s external auditors without any executive members of our board in attendance. The quorum necessary for the transaction of any business is two committee members. The Audit and Risk Management Committee held 18 meetings in 2017, which were attended by all members.

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

Our Company has an internal audit department which reviews procedures in all major financial and operational activities. This department is led by the head of internal audit.

Remuneration and Evaluation Committees

The Remuneration and Evaluation Committees is comprised of three members. Currently, the Remuneration and Evaluation Committees is chaired by independent non-executive director Gu Hui Zhong with independent non-executive director Zhang Zi Fang and non-executive director Zheng Fan An as members. The term of office of each member is three years. A member may serve consecutive terms upon re-election. The Remuneration and Evaluation Committees held 3 meeting in 2017, which were attended by all members.

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

The Remuneration and Evaluation Committees consulted, when appropriate, the Chairman and/or the President about its proposals relating to the remuneration of other executive directors. The Remuneration and Evaluation Committees is provided with sufficient resources to discharge its duties and professional advice is available if necessary. The Remuneration and Evaluation Committees is also responsible for assessing performance of executive directors and approving the terms of executive directors’ service contracts. The Remuneration and Evaluation Committees has performed all its responsibilities under its terms of reference in 2017.

 

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Nomination Committee

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

As of December 31, 2017, the Nomination Committee consists of three members, including Zheng Fan as Chairman and Wang Chang Shun (independent non-executive director) and Jiao Shu Ge (independent non-executive director) as members. The responsibilities of the Nomination Committee are to make recommendations to our board in respect of the size and composition of our board based on the operational activities, assets and shareholding structure of our Company; study the selection criteria and procedures of directors and executives and give advice to our board; identify qualified candidates for Directors and executives; investigate and propose candidates for directors and managers and other senior management members to our board.

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

The Nomination Committee held 3 meetings in 2017, which was attended by all members.

Aviation Safety Committee

The Aviation Safety Committee comprises three members and is chaired by Mr. Tan Wan Geng as non-executive Director. The other two members are Mr. Zheng Fan as independent non-executive Director and Mr. Tan Jin Song as independent non-executive Director.

 

D. EMPLOYEES

As of December 31, 2017, we had 96,234 employees, including 8,957 pilots, 19,632 flight attendants, 16,031 maintenance personnel, 9,409 passenger transportation personnel, 6,791 cargo transportation personnel, 10,340 ground service personnel, 2,519 flight operation officers, 2,301 flight security guards, 1,474 information system personnel, 2,485 financial personnel, and 16,295 other personnel. All of our pilots, flight attendants, maintenance personnel, administrative personnel and sales and marketing personnel are contract employees.

Our employees are members of a trade union organized under the auspices of the All-China Federation of Trade Unions, which is established in accordance with the Trade Union Law of China. One representative of our Company labor union currently serve on the Supervisory Committee of our Company. Each of our subsidiaries has its own trade union. We have not experienced any strikes, slowdowns or labor disputes that have interfered with our operations, and we believe that our relations with our employees are good.

All employees of our Group receive cash remuneration and certain non-cash benefits. Cash remuneration consists of salaries, bonuses and cash subsidies provided by our Group. Salaries are determined in accordance with the national basic wage standards. The total amount of wages payable by our Group to our employees is subject to a maximum limit based on the profitability of our Group and other factors. Bonuses are based on the profitability of our Group. Cash subsidies are intended as a form of cost-of-living adjustment. In addition to cash compensation, our contract employees receive certain non-cash benefits, including housing, education and health services, and our temporary employees also receive certain health services, housing fund and education.

Employee benefits

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

 

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Retirement benefits

Our employees participate in several defined contribution retirement schemes organized separately by the PRC municipal and provincial governments in regions where our major operations are located. We are required to contribute to these schemes at rates ranging from 13% to 20% (2016: 13% to 20%) of salary costs including certain allowances. A member of the retirement schemes is entitled to pension benefits from the Local Labour and Social Security Bureau upon his/her retirement. The retirement benefit obligations of all retired staff of our Group are assumed by these schemes. We, at our sole discretion, had made certain welfare subsidy payments to these retirees.

In 2014, our Company and our major subsidiaries joined a new defined contribution retirement scheme that was implemented by CSAH. The annual contribution to the Pension Scheme is based on a fixed specified percentage of prior year’s annual wage. There will be no further obligation beyond the annual contribution according to the Pension Scheme. The total contribution into the Pension Scheme in 2017 was approximately RMB546 million.

Housing fund and other social insurances

We contribute on a monthly basis to housing funds organized by municipal and provincial governments based on certain percentages of the salaries of employees. Our liability in respect of these funds is limited to the contributions payable in each year.

We also pay cash housing subsidies on a monthly basis to eligible employees. The monthly cash housing subsidies are reflected in the consolidated income statement.

Termination benefits

When we terminate the employment relationship with employees before the employment contracts expire, or provides compensation as an offer to encourage employees to accept voluntary redundancy, a provision for the termination benefits provided is recognized in the consolidated income statement when both of the following conditions are satisfied:

 

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

 

    We are not allowed to withdraw from termination plan or redundancy offer unilaterally.

Workers’ Compensation

There is no workers’ compensation or other similar compensation scheme under the Chinese labor and employment system. As required by Chinese law, however, we, subject to certain conditions and limitations, pay for the medical expenses of any contract employee who suffer a work-related illness, injury or disability, and continues to pay the full salary of, and provides all standard cash subsidies to, such employee during the term of such illness, injury or disability. We also pay for certain medical expenses of our temporary employees.

 

E. SHARE OWNERSHIP

None of our directors and senior management owns any shares or options in our Group as of April 26, 2018.

 

ITEM 7. MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS

 

A. MAJOR SHAREHOLDERS

The table below sets forth information regarding the ownership of our share capital as of April 26, 2018 by all persons who are known to us to be the beneficial owners of 5.0% or more of each class of our voting securities.

 

Title of Shares    Identity of Person or Group    Beneficially
Owned(1)
     Percentage
of the
Respective
Class of
Shares (2)
    Percentage
of Total
Shares
 

A shares

   CSAH      4,039,228,665        57.52     40.04

H shares

   HKSCC Nominees Limited      1,749,711,988        57.08     17.34

H shares

   CSAH(3)      1,070,362,000        34.92     10.61

H shares

   Nan Lung Holding Limited      1,039,212,000        33.90     10.30

 

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(1) Beneficial ownership is determined in accordance with the rules of the SEC.
(2) Percentage of A Shares and percentage of H Shares is based on 7,022,650,000 A Shares and 3,065,523,272 H Shares, respectively, issued as of April 26, 2018. Percentage of total shares is based on 10,088,173,272 shares issued as of April 26, 2018.
(3) CSAH was deemed to be interested in an aggregate of 1,070,362,000 H Shares through its direct and indirect wholly-owned subsidiaries in Hong Kong, of which 31,150,000 H Shares were directly held by Yazhou Travel Investment Company Limited (representing approximately 1.02% of its then total issued H Shares) and 1,039,212,000 H Shares were directly held by Nan Lung (representing approximately 33.90% of its then total issued H Shares). As Yazhou Travel Investment Company Limited is also an indirect wholly-owned subsidiary of Nan Lung, Nan Lung was also deemed to be interested in the 31,150,000 H Shares held by Yazhou Travel Investment Company Limited.

Shareholders of H Shares and A Shares enjoy the same voting rights with respect to each share. None of our major shareholders has voting rights that differ from the voting rights of other shareholders. We are not aware of any arrangement which may at a subsequent date result in a change of control of our Company.

As of December 31, 2017, there were 46 registered holders of 1,760,568 American Depositary Shares in the U.S., consisting of 2.87% of our outstanding H shares. Since certain of the ADSs are held by nominees, the above number may not be representative of the actual number of U.S. beneficial holders of ADSs or the number of ADSs beneficially held by U.S. persons.

Our Company is currently a majority-owned subsidiary of CSAH, which is an entity wholly-owned by the Chinese government.

 

B. RELATED PARTY TRANSACTIONS

For a detailed description of our related party transactions, please see Note 50 to the consolidated financial statements. In particular, the following arrangements, which our Company believes are material to our operations, have been made between our Company and CSAH and its affiliates during the year ended December 31, 2017 and up to the latest practicable date. Our Company believes that these arrangements have been entered into by our Company in the ordinary course of business and in accordance with the agreements governing such transactions.

Arrangements with CSAH

De-merger Agreement

The De-merger Agreement dated March 25, 1995 (such agreement was amended by the Amendment Agreement No.1 dated May 22, 1997) was entered into between CSAH and our Company for the purpose of defining and allocating the assets and liabilities between CSAH and our Company. Under the De-merger Agreement, CSAH and our Company have agreed to indemnify the other party against claims, liabilities and expenses incurred by such other party relating to the businesses, assets and liabilities held or assumed by CSAH or our Company pursuant to the De-merger Agreement.

Neither our Company nor CSAH has made any payments in respect of such indemnification obligations from the date of the De-merger Agreement up to the date of this Annual Report.

Trademark License Agreement

Our Company and CSAH entered into a ten-year trademark license agreement dated May 22, 1997. Pursuant to which CSAH acknowledges that our Company has the right to use the name “China Southern” and “China Southern Airlines” in both Chinese and English, and grants our Company a renewable and royalty free license to use the kapok logo on a worldwide basis in connection with our Company’s airline and airline-related businesses. Unless CSAH gives a written notice of termination three months before the expiration of the agreement, the agreement will be automatically renewed for another ten-year term. In May 2007, the trademark license agreement entered into by our Company and CSAH was automatically renewed for ten years.

 

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Leases

We (as lessee) and CSAH or its subsidiaries (as lessor) entered into lease agreements as follows:

 

  (1) Our Company and CSAH entered into the Asset Lease Agreement (the “Asset Lease Agreement”) on September 25, 2012 to renew the leases transactions for a term of three years from January 1, 2012 to December 31, 2014. Pursuant to the Asset Lease Agreement, CSAH agrees to continue to lease to our Company certain parcels of land, properties, and civil aviation structures and facilities at existing locations in Guangzhou, Haikou, Wuhan, Hengyang, Jingzhou (previously known as “Shashi”), Zhanjiang and Changsha. The annual rents payable to CSAH under the Asset Lease Agreement is RMB36 million for the three years ending December 31, 2014.

Our Company further entered into the 2013 Nanyang Asset Lease Agreement (the “2013 Nanyang Asset Lease Agreement”) with CSAH on April 19, 2013, pursuant to which CSAH agreed to lease to our Company certain lands, properties, facilities and structures at Nanyang Jiangying Airport for a term of two years, commencing from January 1, 2013 to December 31, 2014. The rent payable under the Nanyang Asset Lease Agreement was RMB30 million for the year ended December 31, 2014.

For the year ended December 31, 2014, the rent incurred by our Group amounted to approximately RMB66 million pursuant to the Asset Lease Agreement and Nanyang Asset Lease Agreement.

As the lease transactions contemplated under the Asset Lease Agreement and the 2013 Nanyang Asset Lease Agreement would continue to be entered into on a recurring basis, our Company and CSAH entered into the new Asset Lease Agreement (the “New Asset Lease Agreement”) on December 29, 2014 for a term of three years from January 1, 2015 to December 31, 2017 to renew lease transactions originally covered under the Asset Lease Agreement and the 2013 Nanyang Asset Lease Agreement. The annual rents payable to CSAH under the New Asset Lease Agreement is RMB86,268,700 for the three years ending December 31, 2017.

For the years ended December 31, 2015, 2016 and 2017, the rent incurred by our Group amounted to RMB86 million pursuant to the New Asset Lease Agreement, respectively.

Our Company and CSAH entered into a new Asset Lease Agreement on January 26, 2018 for a term of three years from January 1, 2018 to December 31, 2020 to renew lease transactions originally covered under the Asset Lease Agreement and the 2013 Nanyang Asset Lease Agreement. The annual cap for rent payable to CSAH under such new New Asset Lease Agreement is RMB116,198,000 for the three years ending December 31, 2020.

 

  (2) Our Company and CSAH entered into an indemnification agreement dated May 22, 1997 in which CSAH has agreed to indemnify our Company against any loss or damage caused by or arising from any challenge of, or interference with, our Company’s right to use certain lands and buildings.

 

  (3) On January 9, 2014, our Company and CSAH have entered into two new lease agreements (the “Lease Agreements”), namely, the property lease agreement (the “Property Lease Agreement”) and the land lease agreement (the “Land Lease Agreement”) to renew the land and property leases transactions contemplated thereunder for the period from January 1, 2014 to December 31, 2016. Pursuant to the Property Lease Agreement, CSAH agreed to lease certain properties, facilities and other infrastructure located in various cities such as Guangzhou, Shenyang, Dalian, Harbin, Xinjiang, Changchun, Beijing and Shanghai held by CSAH or its subsidiaries to our Company for office use related to the civil aviation business development. Pursuant to the Land Lease Agreement, CSAH agreed to lease certain lands located in Xinjiang, Harbin, Changchun, Dalian and Shenyang by leasing the land use rights of such lands to our Company for the purposes of civil aviation and related businesses of our Company. The annual rental is determined after arm’s length negotiation between the parties and adjusted with reference to the rental assessment report prepared by Guangdong Yangcheng Land and Property Appraisal Co., Ltd. taking into account the prevailing market rental for properties located at similar locations and historical figures. The maximum annual aggregate amount of rent payable by our Company to CSAH under the Property Lease Agreement and the Land Lease Agreement for each of the three years ending December 31, 2016 shall not exceed RMB40,114,700 and RMB63,582,200, respectively, and such payment shall be made quarterly. On August 13, 2015, our Company and CSAH entered into a supplemental agreement to the Property Lease Agreement, pursuant to which our Company and CSAH agreed that the maximum annual aggregate amount of rent payable by our Company to CSAH under the Property Lease Agreement for the two years ending December 31, 2016 shall be slightly adjusted to not more than RMB40,270,700 (original cap of RMB 40,114,700) and RMB40,348,700 (original cap of RMB 40,114,700), respectively. Save as the said revision, all other terms of the Property Lease Agreement shall remain unchanged.

 

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On December16, 2016, our Company and CSAH have entered into the new Property Lease Agreement and Land Lease Agreement to renew the land and property leases transactions contemplated thereunder for the period from January 1, 2017 to December 31, 2019. Pursuant to this new Property Lease Agreement and Land Lease Agreement, CSAH further agreed to lease the property and land in Shenyang, Chaoyang, Dalian, Changchun, Harbin, Xinjiang, Beijing, Shanghai and foreign offices to our Company. The maximum annual aggregate amount of rent payable by our Company to CSAH under the Property Lease Agreement and the Land Lease Agreement for each of the three years ending December 31, 2019 shall not exceed RMB130 million. Pursuant to this new Property Lease Agreement and Land Lease Agreement, our Company and CSAH shall further discuss and agree on the scope and details of specific leasing and sign separate contracts.

For the year ended December 31, 2015, the rents for property lease and land lease incurred by our Group amounted to RMB40 million and RMB64 million, respectively pursuant to the Lease Agreements.

For the year ended December 31, 2016, the rents for property lease and land lease incurred by our Group amounted to RMB40 million and RMB64 million, respectively pursuant to the Lease Agreements.

For the year ended December 31, 2017, the rents for property lease and land lease incurred by our Group amounted to RMB32 million and RMB68 million, respectively pursuant to the Lease Agreements.

Share Issuance

On June 26, 2017, our Company and CSAH have entered into the A Share Subscription, pursuant to which, our Company will issue not more than 1,800,000,000 new A Shares (including 1,800,000,000 A Shares) and CSAH will subscribe for no less than 31% of new A Shares, the consideration of which shall be satisfied by transfer of 50% shares of Zhuhai MTU to our Company and cash. The subscription price for new A Shares under the A Shares Subscription Agreement shall not be lower than a price determined as the higher of (i) the 90% of the average trading price of the A Shares as quoted on the Shanghai Stock Exchange in the 20 trading days immediately prior to the Price Benchmark Date, and (ii) the most recent net assets value per share of the Company.

On 19 September 2017, the Company and CSAH entered into the A Share Subscription Supplemental Agreement, pursuant to which 50% shares of Zhuhai MTU as partial consideration payable by CSAH for its subscription of new A Shares under the A Share Subscription Agreement has been adjusted to RMB1,741.08 million, according to the final assessment results of RMB1,838.93 million as stated in the Zhuhai MTU Filed Valuation after the adjustment made due to the dividend distribution of MTU for 2016. Save as amended by the A Share Subscription Supplemental Agreement, all other terms and conditions of the A Share Subscription Agreement as described in the Announcement remain unchanged.

The completion of the A Shares Subscription Agreement will take place when the Shanghai Securities Depository and Clearing Corporation Limited confirms that the new A Shares to be subscribed by CSAH have been fully subscribed by CSAH.

SAIETC, a former wholly-owned subsidiary of CSAH

On January 9, 2014, our Company and SAIETC entered into a new import and export agency framework agreement (the “Import and Export Agency Framework Agreement”) to renew the continuing connected transactions contemplated therein for a fixed term of three years commencing from January 1, 2014 to December 31, 2016. Pursuant to the Import and Export Agency Framework Agreement, SAIETC agreed to provide import and export services and the relevant lease services, customs clearance services, customs declaration and inspection services, and the relevant storage, transportation and insurance agency services, and tendering and agency services to our Group. In relation to the service fee charged for import and export services, both parties agreed that such fee shall not be higher than the prevailing market rate charged by several trading companies of certain airlines companies in the PRC for similar services. In relation to the service fee charged for custom clearing, custom declaration and inspection, and the relevant storage, transportation and insurance services, both parties agreed that such fee charged shall not be higher than the prevailing market rate charged for similar services provided by independent third party service providers in the flight equipment logistics transportation market in the PRC. In relation to the service fee charged for the tendering and agency services, it is required to be determined in accordance with the fee standard prescribed by the State for this kind of tendering and agency services from time to time. During the period of the Import and Export Agency Framework Agreement, the annual cap are set at RMB160 million per annum.

For the year ended December 31, 2015, the agency fee incurred by our Group in respect of the above import and export services was RMB114 million.

 

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SAIETC was a former wholly-owned subsidiary of CSAH. In August 2016, since SAIETC has become a wholly-owned subsidiary of our Company, the transactions between our Company and SAIETC under Import and Export Agency Framework Agreement are not considered as the connected transactions of our Company. Prior to that, the agency fee incurred by our Group in respect of the above import and export services was RMB60 million in 2016.

Southern Airlines Culture and Media Co., Ltd. (“SACM”), which is 40% owned by our Company and 60% owned by CSAH

On April 19, 2013, our Company entered into a new Media Services Framework Agreement with SACM to renew the annual cap, expand the services scope and extend the term for an additional term of three years, commencing from January 1, 2013 to December 31, 2015. Pursuant to the agreement, our Company has appointed SACM to provide advertising agency services, plotting, purchase and production of in-flight TV and movie program agency services, channel publicity and production services, public relations services relating to recruitments of airhostess, and services relating to the distribution of newspapers and magazines. The service fees for the media services to be provided to members of our Group by SACM and its subsidiaries (the “SACM Group”) are determined, among others, the prevailing market price. Pricing are based on prevailing market price and agreed upon between the parties for each transaction on arm’s length negotiations in accordance with the following pricing mechanism: (a) if there are prevailing market prices for same or similar types of services in the same or similar locations of the services being provided, the pricing of the services shall follow such prevailing market price; or (b) if there are no such prevailing market price in the same or similar locations, the services to be provided by SACM Group shall be on terms which are no less favourable than the terms which can be obtained by our Group from independent third parties within the PRC market.The annual cap under the agreement for each year is RMB98 million, RMB105 million and RMB113 million for each of years ended December 31, 2013, 2014 and 2015, respectively.

Our Company and SACM entered into the Supplemental Agreement to the Media Services Framework Agreement on 29 December 2014 to revise the annual cap for services provided by the SACM Group for the period from January 1, 2015 to December 31, 2015 from RMB113 million to RMB118.5 million. In addition, the following revisions to the Media Services Framework Agreement were also made and set out in the Supplemental Agreement to the Media Services Framework Agreement as follows: (a) to clarify the parties referred in the Media Services Framework Agreement shall include itself and its wholly-owned or controlled subsidiaries; and (b) to clarify the rights and obligations of the SACM Group, i.e. clarifying the SACM Group will have full discretion for the whole process of the selection of media or media agent, negotiation, purchase, execution and supervision, and the SACM Group should take the responsibility to monitor the advertisement, submit the monitoring report and strengthen the supervision on the advertising effect. Save as the aforesaid revision, all other terms of the Media Services Framework Agreement remain unchanged.

On December 30, 2015, our Company entered into a new Media Services Framework Agreement with SACM to renew the media services transaction and extend for an additional term of three years, commencing from January 1, 2016 to December 31, 2018. The annual cap under the new agreement will remain unchanged at RMB118.5 million.

For the years ended December 31, 2015, 2016, 2017, the media fees incurred by our Group for the media services amounted to RMB67 million, RMB71 million and RMB74 million, respectively.

Southern Airlines Group Finance Company Limited (“SA Finance”), which is 66.02% owned by CSAH, 25.28% owned by our Company and 8.70% owned in aggregate by four subsidiaries of our Company

(1)    On November 8, 2013, our Company renewed the financial services framework agreement (the “Financial Services Framework Agreement”) with the SA Finance for a term of three years starting from January 1, 2014 to December 31, 2016. Under such agreement, the SA Finance agrees to provide to our Company deposit (the “Provision of Deposit Services”) and loan services (the “Provision of Loan Services”). The SA Finance shall pay interests to our Company regularly at a rate not lower than the current deposit rates set by the People’s Bank of China. The Group’s deposits placed with the SA Finance were re-deposited in a number of banks. The SA Finance has agreed that the loans it provided to CSAH and its subsidiaries other than our Group should not exceed the sum of the SA Finance’s shareholders’ equity, capital reserves and total deposits received from other companies (excluding our Group). The rates should be determined on an arm’s length basis and based on fair market rate, and should not be higher than those available from independent third parties. Each of the maximum daily balance of deposits (including the corresponding interests accrued thereon) placed by our Company as well as the maximum amount of the outstanding loan provided by the SA Finance to our Company (including the corresponding interests payable accrued thereon) at any time during the term of the Financial Services Framework Agreement shall not exceed the Cap which is set at RMB6 billion on any given day. The annual cap of fees payable to the SA Finance by our Group for the other financial services should not exceed RMB5 million. On 26 December 2013, the second extraordinary general meeting of 2013 considered and approved the Financial Services Framework Agreement.

 

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Our Company and the SA Finance entered into the Supplemental Agreement to the Financial Services Framework Agreement on May 4, 2015 to revise each of the annual cap in relation to the Provision of Deposit Services and the Provision of the Loan Services for the period from the effective date of Supplemental Agreement to December 31, 2016 from RMB6 billion to RMB8 billion. On June 30, 2015, 2014 annual general meeting of our Company considered and approved the Supplemental Agreement to the Financial Services Framework Agreement.

On August 29, 2016, our Company and SA Finance entered into the new Financial Services Framework Agreement for a term of three years starting from January 1, 2017 to December 31, 2019 to renew the provision of the financial services contemplated under the Financial Services Framework Agreement. The annual caps for the insurance business platform services arrangement under the new Financial Services Framework Agreement for any given day is RMB8 billion. On 16 December 2016, the first extraordinary general meeting of 2016 considered and approved the Financial Services Framework Agreement.

As of December 31, 2015, our deposits placed with SA Fiance amounted to RMB2,934 million.

As of December 31, 2016, our deposits placed with SA Fiance amounted to RMB3,759 million.

As of December 31, 2017, our deposits placed with SA Fiance amounted to RMB6,095 million.

(2)    On November 21, 2014, the Board approved Guangdong CSA E-commerce Co., Ltd. (the “E-commerce Company”, a wholly-owned subsidiary of our Company), to enter into the four electronic aviation passenger comprehensive insurance four parties cooperation agreements (the “Cooperation Agreements”) with the SA Finance, Insurance Brokers (Beijing) Co., Ltd. (the “Air Union”) and each of the four insurance companies, respectively, for a period of three years commencing from June 12, 2014 to May 31, 2017.

Pursuant to the Cooperation Agreements, the E-commerce Company agreed to authorize other parties to use the B2C website, the mobile terminal air tickets sale platform and VOS sale system of our Company for sales of online insurances in consideration for a fixed service fees for each policy sold through its electronic platform.

Our Group will charge a fixed service fee of RMB5 for each insurance policy sold through its electronic platforms. There has not been any comparative market prices due to the specific nature of such transaction and the above pricing model has been agreed on an arm’s length basis among the parties and has been adopted since the commencement of cooperation in 2008.

The annual caps in relation to the service fees to be charged by our Group are RMB14.24 million, RMB30.27 million, RMB42.38 million and RMB24.72 million for the seven months ended December 31, 2014, for the two years ended December 31, 2016 and the five months ending May 31, 2017.

As a result of the increase in aviation insurance purchase demand from travellers and the various cooperation between our Company and the SA Finance on the sale of aviation insurance, on November 19, 2015, our Company and the SA Finance entered into the cooperation framework agreement (the “Cooperation Framework Agreement”) for two years commencing from January 1, 2015 to December 31, 2016.

Pursuant to the insurance business platform cooperation arrangements under the Cooperation Framework Agreement, our Company as the platform service provider, agreed to cooperate with the SA Finance, and authorize SA Finance to use the various platforms of our Group including online channels and ground service counter channels as the sales platforms for sale of various insurances relating to aviation transportation including baggage insurance and aviation passenger accident insurance. The scope of the Cooperation Framework Agreement shall also cover the electronic platform as contemplated under the Cooperation Agreements. In addition, our Company agreed to further authorize the SA Finance to use our Group’s ground service counter channels as the sales platform for sale of baggage insurance and aviation passenger accident insurance.

For the sale of insurance policies through our Group’s ground service counter channels and its electronic platforms, our Group is currently charging a fixed ratio of the insurance premium of each of the different kinds of insurance policies. The pricing model has been agreed on an arm’s length basis by our Company and the SA Finance with reference to the determination basis as set out in a table disclosed in the announcement of our Company dated November 19, 2015.

The annual caps in relation to the service fees to be charged by our Group under the Cooperation Framework Agreement are RMB40 million and RMB60 million for the two years ended December 31, 2016, respectively.

 

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On August 29, 2016, our Company and SA Fiance entered into the new Insurance Business Platform Services Agreement under the new Financial Services Framework Agreement for a term of three years starting from January 1, 2017 to December 31, 2019 to renew the provision of the services contemplated under the Insurance Business Platform Services Agreement. The annual caps for the insurance business platform services arrangement under the new Financial Services Framework Agreement for each year are RMB68.60 million, RMB79.35 million and RMB91.67 million respectively. Pursuant to the new Financial Services Framework Agreement, our Company shall be only liable for providing insurance sales platforms and shall not be liable for any disputes arising among the insurers, insurance agents, policy holders, the insured and other parties. SA Fiance shall ensure that it has the agency authority to sell the insurance in the place where the insurance is sold while our Company shall not bear any obligations or liabilities arising therefrom.

For the year ended December 31, 2015 and 2016, the service fee charged by our Group were RMB16 million and RMB26 million, respectively.

For the year ended December 31, 2017, the service fee charged by our Group was RMB26 million.

China Southern Air Holding Ground Services Company Limited (“GSC”), a wholly-owned subsidiary of CSAH

On November 8, 2013, our Company and GSC renewed the Passenger and Cargo Sales Agency Services Framework Agreement (the “Passenger and Cargo Sales Agency Services Framework Agreement”) to renew the continuing connected transactions contemplated therein for a fixed term of three years commencing from January 1, 2014 to December 31, 2016. Pursuant to the New Passenger and Cargo Sales Agency Services Framework Agreement, GSC agrees to provide the following services to our Group: domestic and international air ticket sales agency services; domestic and international airfreight forwarding sales agency services; chartered flight and pallets sales agency services; internal operation services for the inside storage area (these services include the areas in Guangzhou, Beijing and Shanghai, etc); and delivery services for the outside storage area. The agency fee for sales agency services is determined by reference to the agency ratio paid to the agency companies by the airlines companies of the same types of the industry in the same regions; the service fee for internal operation services is determined by the fee standard prescribed by the local government. The annual cap shall maintain RMB250 million per annum for the entire term of the New Passenger and Cargo Sales Agency Services Framework Agreement.

In view of the sudden increase of the sales agency services as a result of the peak season market demand for our Group exceeds the original projection, the annual cap under the Passenger and Cargo Sales Agency Services Framework Agreement in respect of the year ended December 31, 2016 would become insufficient. Accordingly, on December 16, 2016, our Company and GSC entered into the Supplemental Agreement to revise the annual cap under Passenger and Cargo Sales Agency Services Framework Agreement from RMB250 million to RMB260 for the year ended December 31, 2016.

For the year ended December 31, 2015, the commission expense and goods handling fee paid to GSC were RMB98 million and RMB109 million, respectively, and the income relating to other services was RMB20million.

For the year ended December 31, 2016, the commission expense and goods handling fee paid to GSC were RMB99 million and RMB117 million, respectively, and the income relating to other services was RMB6 million.

For the year ended December 31, 2017, the commission expense and goods handling fee paid to GSC were RMB44 million and RMB112 million, respectively, and the income relating to other services was RMB3 million.

 

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On December 16, 2016, our Company entered into a new Passenger and Cargo Sales and Ground Services Framework Agreement (the “Passenger and Cargo Sales and Ground Services Framework Agreement”) for a term of three years starting from January 1, 2017 to December 31, 2019. Under Passenger and Cargo Sales and Ground Services Framework Agreement, GSC agreed to provide certain services and charge agent service fees while our Company agreed to lease certain assets including transportation tools and equipment and workplace and charge rental thereon. GSC agrees to provide the following services to our Group: (i) domestic and international air ticket sales agency services; (ii) domestic and international airfreight forwarding sales agency services; (iii) chartered flight and pallets sales agency services; (iv) Import and export port and transfer services related to cargo operations; (v) ground services, including aircraft maintenance, cabin cleaning, cleaning, collecting and issuing of towels, entertaining equipment maintenance within aircraft, surface cleaning of aircraft and comprehensive ground services; and (vi) support to sales and services oriented to major direct customers of our Company. In respect of the services provided by GSC to our Group, the agency fee for sales agency services is determined by reference to the agency ratio paid to the agency companies by the airlines companies of the same types of the industry in the same regions (including domestic and foreign market). The service fee for internal operation services is determined by the fee standard prescribed by the local government. The service fee for other maintenance and ground services is mainly determined based on related costs (mainly including labor costs, operation costs, management costs and taxes) in addition to 10% profit ratio. With respect to the rentals to be received by our Company, rentals are determined with reference to the valuation prepared by valuation agency (independent third party). Our Company expect the annual fees payable to our Company under Passenger and Cargo Sales and Ground Services Framework Agreement will not exceed RMB10 million. Under Passenger and Cargo Sales and Ground Services Framework Agreement, the annual caps for the services provided to our Group by GCS for each of the three years ending December 31, 2019 will be RMB270 million, RMB330 million and RMB400 million, respectively.

China Southern Airlines Group Property Management Company Limited (the “CSAGPMC”), a wholly-owned subsidiary of CSAH

Our Company has entered into a New Framework Agreement for Engagement of Property Management (the “New Property Management Framework Agreement”) on December 28, 2012 to renew the property management transactions for a term of three years from January 1, 2012 to December 31, 2014. Pursuant to the New Property Management Framework Agreement, our Company has renewed the appointment of CSAPMC for provision of property management and maintenance services for our Company’s leased properties in the airport terminal, the base and the 110KV transformer substation at the new Baiyun International Airport (other than certain properties in our Company’s headquarter located in the old Baiyun Airport which were covered in the existing Property Management Framework Agreement) to ensure the ideal working conditions of our Company’s production and office facilities and physical environment, and the normal operation of equipment.

Our Company has further entered into the airport property management framework agreement (the “Airport Property Management Framework Agreement”) on January 11, 2013 to renew the property management at the old Baiyun Airport for a term of three years from January 1, 2012 to December 31, 2014. Pursuant to the Airport Property Management Framework Agreement, our Company has renewed the appointment of CSAPMC for the provision of property management and maintenance services for our Company’s properties at the old Baiyun Airport and surrounding in Guangzhou.

The fee charging schedule (or charge standard) under the New Property Management Framework Agreement and the Airport Property Management Framework Agreement shall be determined on an arm’s length basis between both parties, and shall not be higher than the one charged by any independent third parties in the similar industry. The annual cap for the New Property Management Framework Agreement and the Airport Property Management Framework Agreement are set at RMB32,750,000 and RMB22,250,000, respectively.

On December 31, 2013, our Company further entered into an agreement supplemental to the New Property Management Framework Agreement (the “New Property Management Supplemental Agreement”) and an agreement supplemental to the Airport Property Management Framework Agreement (the “Airport Property Management Supplemental Agreement”). Pursuant to the New Property Management Supplemental Agreement, the parties have agreed to revise the services fee in relation to the provision of property management and maintenance services by CSAPMC for our Company’s leased properties at the airport terminal, the base and the 110KV transformer substation at the new Baiyun International Airport from RMB32,750,000 per annum to RMB42,700,000 per annum for the year ended December 31, 2014. Pursuant to the Airport Property Management Supplemental Agreement, the parties have agreed to revise the services fee in relation to provision of property management and maintenance services by CSAPMC for our Company’s several properties at the old Baiyun Airport and surrounding in Guangzhou from RMB22,250,000 per annum to RMB27,300,000 per annum for the year ended December 31, 2014.

 

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As the transactions contemplated under the New Property Management Framework Agreement and the Airport Property Management Framework Agreement will continue to be entered into on a recurring basis, our Company entered into the new Property Management Framework Agreement (the “Property Management Framework Agreement”) with the services fee in relation to the provision of property management and maintenance services by CSAPMC on December 29, 2014 to renew the property management transactions originally covered under the New Property Management Framework Agreement and the Airport Property Management Framework Agreement for a term of three years from January 1, 2015 to December 31, 2017. In addition, CSAGPMC has also been appointed for the provision of the property management and maintenance services for the power transformation and distribution equipment at Guangzhou cargo terminal, and the provision of the electricity charge agency services to our Group, which are newly added services to be provided by CSAGPMC to our Group. The annual cap for the Property Management Framework Agreement is set at RMB90 million, RMB92 million and RMB96 million for the three years ending December 31, 2015, 2016 and 2017, respectively.

For the years ended December 31, 2015, 2016 and 2017, the property management and maintenance fee incurred by our Group respectively amounted to RMB73 million, RMB70 million and RMB70 million pursuant to the New Property Management Framework Agreement, the Airport Property Management Framework Agreement and the Property Management Framework Agreement.

On December 19, 2017, our Company further entered into an Property management Framework Agreement to renew the property management transactions originally covered under the Property Management Framework Agreement for a term of three years from January 1, 2018 to December 31, 2020. The annual cap for the Property Management Framework Agreement is set at 155 million for the three years ending December 31, 2020, respectively.

Guangzhou Nansha CSA Tianru Leasing Co., Ltd. (the “CSA Leasing Company”), which is wholly owned by CSA International Finance Leasing Co., Ltd. (the “CSA International”), which is wholly owned by CSAH

Our Company entered into the A321 Finance Lease agreement and A330 Finance Lease Agreement with CSA Leasing Company on April 27, 2017, pursuant to which CSA Leasing Company agreed to provide finance leasing to our Company in relation to one Airbus A321 aircraft and one Airbus A330-300 aircraft.

CSA International, which is wholly owned by CSAH

Our Company entered into an Aircraft Finance Lease Framework Agreement with CSA International on May 26, 2017, pursuant to which CSA International agreed to provide finance leasing to our Company in relation to the Leased Aircraft.

Our Company entered into the 2018-2019 Finance and Lease Service Framework Agreement with CSA International on October 17, 2017, pursuant to which CSA International agreed to provide finance leasing service to the Company in relation to the Leased Aircraft, Leased Aircraft Related Assets and Leased Aviation Related Equipment, as well as the operating lease service to the Company in relation to certain aircraft and engines.

Shenzhen Air Catering Co., Ltd. (the “SACC”), which is 50.1% owned by CSAH

Our Company entered into a Catering Services Framework Agreement with SACC, a non-wholly-owned subsidiary of CSAH on April 19, 2013 for a term of three years, commencing from January 1, 2013 to December 31, 2015, pursuant to which SACC agrees to provide the in-flight lunch box, and order, supply, allot, recycle, store and install the in-flight supply with their respective services for the arrival and departure flights designated by our Group at the airport where SACC located at. The maximum annual aggregate amount of the services fee payable by our Company to SACC shall not exceed RMB100 million, RMB115 million and RMB132.5 million for each of the years ended December 31, 2013, 2014 and 2015, respectively.

Our Company entered into a new Catering Services Framework Agreement with SACC on December 30, 2015 for an additional term of three years, commencing from January 1, 2016 to December 31, 2018. The annual cap under the new agreement is set at RMB152 million, RMB175 million and RMB201 million for each of the years ending December 31, 2016, 2017 and 2018, respectively.

For the years ended December 31, 2015, 2016 and 2017 the services fee incurred by our Group for the catering services amounted to RMB100 million, RMB124 million and RMB125 million, respectively.

 

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Zhuhai MTU, which is 50% owned by CSAH

Our Company entered into an agreement relating to continuing connected transactions with CSAH, MTU Aero Engines GmbH (“MTU GmbH”) and Zhuhai MTU on September 28, 2009, by which Zhuhai MTU shall continue to provide our Company with engine repair and maintenance services subject to the international competitiveness and at the net most favorable terms, while our Company shall make relevant payment to Zhuhai MTU according to related charging standard. The agreement is effective from its date to April 5, 2031.

For the year ended December 31, 2015, 2016 and 2017, our engine repair and maintenance service fees incurred under the agreement amounted to RMB1,324 million, RMB1,877 million and RMB1,537 million, respectively.

Nan Lung, which is wholly owned by CSAH

Our Company entered into the H Share Subscription Agreement with Nan Lung on June 26, 2017, pursuant to which, Nan Lung will, at the subscription price of HK$6.27 per H Share, subscribe in cash for no more than 590,000,000 new H Shares (including 590,000,000 H Shares), raising gross proceeds of no more than HK$3,699.30 million (including HK$3,699.30 million). The subscription price and the number of the new H Shares will be adjusted in case of ex-right or ex-dividend events including distribution of dividend according to the H Share Subscription Agreement. On September 19, 2017, our board considered and approved that the subscription price and the number of H Shares to be issued pursuant to the H Share subscription agreement shall be adjusted to HK$6.156 and not more than 600,925,925 new H Shares, respectively due to the implementation of the 2016 dividend distribution plan of our Company.

Guangzhou Southern Airlines Construction Company Limited (the “GSAC”, which is wholly owned by CSAH)

Our Company entered into the CSA Building Asset Lease Agreement with GSAC on January 19, 2018, pursuant to which GSAC agreed to lease to (i) certain offices at floors 1-10, 12 and 17-36 in CSA Building located at West Side of Yuncheng East Road, Baiyun Xincheng, Baiyun District, Guangzhou with an aggregate gross floor area of not exceeding 88,396 square meters at an annual rental of not exceeding RMB159,112,800; and (ii) 550 parking lots in CSA Building at an annual rental of not exceeding RMB5,520,000 for a term of three years commencing from 19 January 2018 to 18 January 2021. CSA Building is developed by GSAC for office and business purpose. The annual rental will be payable on a quarterly basis and will be funded by the internal resources of our Company.

Guangzhou Nansha CSA Tianshui Leasing Co., Ltd(the Guangzhou “Tianshui”), which is indirect wholly-owned by CSAH

Our Company entered into the Aircraft Sale and Leaseback Agreement with Guangzhou Tianshui on March 16, 2018, pursuant to which our Company agreed to sell 14 A320 aircrafts to Guangzhou Tianshui. The consideration for such aircrafts of RMB371 million is determined after arm’s length negotiations between our Company and Guangzhou Tianshui with reference to the actual conditions of such aircrafts and the valuation of such aircrafts prepared by China United Assets Appraisal Group Co., Ltd..

Acquisition of 95.4% Equity Interests in Hebei Airlines by Xiamen Airlines

On October 13, 2014, Xiamen Airlines (a subsidiary of our Company) and Hebei Airlines Investment Group Company Limited (“Hebei Airlines Investment”) entered into the equity transfer agreement, pursuant to which Xiamen Airlines agreed to purchase and Hebei Airlines Investment agreed to sell the 95.40% equity interests in Hebei Airlines at the consideration of RMB680 million (the “Acquisition”). The consideration of RMB680 million is determined after an arm’s length negotiation between the parties in accordance with prevailing market conditions and after taking into account, inter alia, the net asset value of Hebei Airlines and the appraisal value of the 95.40% equity interests in Hebei Airlines as of April 30, 2014.

Our Company believes that the Acquisition can help our Group to further develop the aviation market in Hebei, facilitate the integration of the North China market by Xiamen Airlines and improve its domestic route network. The Acquisition will also achieve the synergies of Xiamen Airlines and Hebei Airlines to strengthen their market positions, so as to further enhance the competitiveness of the Company, Xiamen Airlines and Hebei Airlines as a whole.

The Acquisition was completed in December 2014.

 

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Acquisition of 4% Equity Interests in Xiamen Airlines from Xiamen Jianfa

On July 14, 2015, our board announced that our Company and Xiamen Jianfa entered into an agreement (the “Share Transfer Agreement”), pursuant to which Xiamen Jianfa agreed to sell and our Company agreed to purchase 4% equity interests (the “Targeted Equity Interests”) in Xiamen Airlines at the consideration of RMB586,666,670 (the “Acquisition”). Our Company believes that the increase of 4% equity interests in Xiamen Airlines held by our Company can help our Group to further enhance our control over the Xiamen Airlines, help the Xiamen Airlines to maintain a stable shareholding structure, further improve the strategic synergy effect of our Company and Xiamen Airlines and improve the overall operating results of our Company.

On December 8, 2015, our Company and Xiamen Jianfa entered into a supplemental agreement to the Share Transfer Agreement, pursuant to which the parties agreed to adjust the consideration from RMB586,666,667 to RMB626,666,667 so as to reflect the profit attribution arrangement. The acquisition was completed in December 2015.

Acquisition of 100% equity interests in SAIETC

On 2 February 2016, our Company and CSAH entered into the share transfer agreement (the “Share Transfer Agreement”), pursuant to which our Company agreed to purchase and CSAH agreed to sell 100% equity interests in SAIETC at the consideration of RMB400,570,400. The consideration of RMB400,570,400 is determined after an arm’s length negotiation between the parties in accordance with prevailing market conditions and after taking into account, inter alia, the net asset value of SAIETC and the appraisal value of 100% equity interests in SAIETC as of June 30, 2015, net of decrease of net asset resulting from events after balance sheet date (including profit distribution and long-term equity investment).

Our Company believes that the acquisition can assist our Group to strengthen procurement management of aircraft, flight equipment and other airlines-related facilities, lower management risk; assist our Company to streamline its relationship with trading companies so as to reduce connected transactions. With SAIETC’s experience in tendering and agency services, SAIETC will be developed into a centralised platform for procurement activities of our Group, that enhances concentration and efficiency of procurement activities.

Capital Increase Agreement

On December 23, 2016, our Company entered into the Capital Increase Agreement (the “Capital Increase Agreement”) with CSAH, Xiamen Airlines, Shantou Airlines, Zhuhai Airlines and Guangzhou Nanland Air Catering Company Limited (“Nanland Company”), under which each party agreed that each of our Company and CSAH can increase the capital of SA Finance, up to RMB500 million in total. RMB348,597,550 of such capital increase will be used to increase the registered capital from RMB724,329,500 to RMB1,072,927,050, while RMB151,402,450 will be used to increase the capital reserve of SA Finance. Xiamen Airlines, Shantou Airlines, Zhuhai Airlines and Nanland Company (non-wholly owned subsidiary of our Company) agreed to waive their rights to make capital contributions. The amounts of capital increase to the SA Finance were determined by each party through fair negotiation with reference to (among other things) the net assets of SA Finance on May 31, 2016 and current shareholding ratio of each party in SA Finance.

Upon the completion of capital increase, the equity interest held by CSAH in the SA Finance would remain at 66.022% while the equity interest held by our Company in the SA Finance would increase from 21.089% to 25.277%.

Our Company considers that the entering into the Capital Increase Agreement and the capital increase will enhance the finance conditions and therefore the development of the SA Finance and allow the SA Finance to further expand its business. Our Company would also be able to share the benefit from the SA Finance’s profits by holding 25.277% equity interest directly, and 8.701% equity interest indirectly through its four subsidiaries, in the SA Finance. All related party transactions have been approved by independent non-executive directors.

Acquisition of Property in the PRC

On December 15, 2016, Hainan Branch of our Company (as the purchaser) entered into the Sale and Purchase Agreement with China Southern Air Sanya Property Development Co., Ltd (the “Vendor”), under which our Company agreed to purchase a property at the total consideration of RMB56,089,800 (equivalent to HK$64,953,591). The property includes whole 4th floor of China Southern Air Sanya Headquarter Building located at No.360-2 Yingbin Road, Kedong District, Sanya, Hainan Province, the PRC with a gross floor area of approximately 2,123.5 square meters (the “Property”).

 

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The consideration for the Property acquisition was determined after arm’s length negotiations between our Company and the Vendor, with reference to (i) the prevailing selling prices of other presale units of the development in which the Property forms part of, in the open market of Sanya; (ii) the similar types (for office purpose) of properties located in the same areas in Sanya; and (iii) the agreed 15% discount provided by the Vendor to our Company. The consideration also included the taxes and renovation costs.

The Vendor is a wholly-owned subsidiary of CITIC China Southern Air Construction Development Co., Ltd. which is owned as to 49% by CSAH. CSAH is the controlling shareholder of our Company and therefore the Vendor is a connected person of our Company under the Listing Rules.

Since the Property is situated at the city centre of Sanya and a new commercial business district established by the Sanya municipal government, our Company believes that acquiring the Property with such geographical advantages as its office can not only meet the needs of future production development, but also realign its office premises with our Company’s brand and image. The Property Acquisition will also strengthen our Company’s strategic cooperation with the Sanya municipal government.

On 7 December 2017, Zhuhai Airlines, as purchaser (“Purchaser”), entered into the Sale and Purchase Agreements with Zhuhai China Southern Air Real Property Development Co., Ltd., as vendor (“Vendor”), pursuant to which the Purchaser agreed to acquire the whole 7th to 11th floor and one shop of China Southern Air Zhuhai Area Headquarter Building located at No. 52 Haibin South Road, Xiangzhou District, Zhuhai City, the PRC with a gross floor area of approximately 8,183.27 square meters (“Property”) at a total consideration of RMB159,990,100 for office and marketing purposes.

The consideration for the Property Acquisition was determined after arm’s length negotiations between our Company and the Vendor, with reference to (i) the price of similar types (for office purpose) of properties located in the same areas in Zhuhai, which ranges from RMB25,900 per square meter to RMB31,300 per square meter; (ii) the price of street shops in the open market of Zhuhai, which is approximately RMB80,000 per square meter; (iii) the prevailing selling prices of other shops of the development in which the Property forms part of, in the open market of Zhuhai; and (iv) the agreed discount of approximately 22.58% on the price offered to public which is RMB206,654,700, provided by the Vendor to the Company. The consideration also includes taxes and renovation costs. Our Company intends to satisfy the consideration by its internal resources.

The vendor is a wholly-owned subsidiary of Zhonghai China Southern Air Construction Development Co., Ltd., which is owned as to 49%, 30% and 21% equity interests by CSAH, CITIC Real Estate Group Co., Ltd. and Guangdong Zhonghai Real Estate Co., Ltd. respectively. As CSAH is a controlling shareholder of our Company, the vendor is a connected person of our Company under the Listing Rules.

The Property Acquisition will strengthen the Company’s cooperation with the Zhuhai municipal government as the development of the Property was approved by Zhuhai municipal government with a view to provide support to the business development of our Company. The Property Acquisition will also address Zhuhai Airline’s needs for improvement on infrastructure to support the growth of Zhuhai Airline in the civil aviation market. Since the Property is situated at the commercial business district in Zhuhai City, our Company believes that acquiring the Property with such geographical advantages as its office can not only meet the needs of future business development, but also realign its office premises with our Company’s brand and image.

All the above related party transactions have been approved by independent non-executive directors.

Provision of Guarantees to SPV established by our Company

In order to reduce aircraft leasing costs, the Board of the Company convened the extraordinary meeting on 29 December 2015, 7 April 2017, 25 April 2017, 21 August 2017, 29 November 2017, respectively, and considered the guarantees provided for SPVs established by the Company. By the end of the reporting period, the Company provided the SPV with total guarantee of US1.164 billion.

 

C. INTERESTS OF EXPERTS AND COUNSEL

Not applicable.

 

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ITEM 8. FINANCIAL INFORMATION

 

A. CONSOLIDATED STATEMENTS AND OTHER FINANCIAL INFORMATION

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

Legal Proceedings

Not applicable.

Dividend Information

A dividend in respect of the year ended December 31, 2017 of RMB0.1 (inclusive of applicable tax) per share, amounting to a total dividend of RMB1,009 million was proposed by the directors on March 26, 2018. The final dividend proposed after the end of the financial year has not been recognized as a liability at the end of the financial year.

Our Board declares dividends, if any, in Renminbi with respect to H Shares on a per share basis and pays such dividends in Hong Kong dollars. Any final dividend for a fiscal year is subject to shareholders’ approval. Bank of New York Mellon, as depositary, converts the HK dollar dividend payments and distributes them to holders of ADSs in U.S. dollars, less expenses of conversion. Under the Company Law of the PRC and our Articles of Association, all of our shareholders have equal rights to dividends and distributions. The holders of the H Shares share proportionately on a per share basis in all dividends and other distributions declared by our Board, if any, based on the foreign exchange conversion rate published by the People’s Bank of China, or PBOC, on the date of the distribution of the cash dividend.

We believe that our dividend policy strikes a balance between two important goals providing our shareholders with a competitive return on investment and assuring sufficient reinvestment of profits to enable us to achieve our strategic objectives. The declaration of dividends is subject to the discretion of our Board, which takes into account the following factors:

 

    our financial results;

 

    capital requirements;

 

    contractual restrictions on the payment of dividends by us to our shareholders or by our subsidiaries to us;

 

    our shareholders interests;

 

    the effect on our creditworthiness;

 

    general business and economic conditions; and

 

    other factors our Board may deem relevant.

Pursuant to PRC laws and regulations and the Articles of Association of our Company, dividends may only be distributed after allowance has been made for: (i) recovery of losses, if any, and (ii) allocations to the statutory surplus reserve. The allocation to the statutory surplus reserve is 10% of our net profit determined in accordance with PRC GAAP. Our distributable profits for the current fiscal year will be equal to our net profits determined in accordance with IFRSs, less allocations to the statutory surplus reserve.

 

B. SIGNIFICANT CHANGES

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

 

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ITEM 9. THE OFFER AND LISTING

 

A. OFFER AND LISTING DETAILS

The principal trading market for our Company’s H Shares is the Hong Kong Stock Exchange, and our Company’s trading code is “1055”. Our Company completed our initial public offering of H Shares on July 30, 1997. The ADRs, each representing 50 H Shares, have been listed for trading on the New York Stock Exchange since July 31, 1997, under the symbol “ZNH”.

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

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

 

     The Hong Kong
Stock Exchange
Price Per H Share
(HK$)
     The New York
Stock

Exchange Price per
ADR (US$)
     The Shanghai Stock
Exchange Price per
A Share

(RMB)
 
     High      Low      High      Low      High      Low  

Annual Market Prices

                 

Fiscal Year ended December 31, 2013

     4.43        2.61        30.04        17.09        4.30        2.54  

Fiscal Year ended December 31, 2014

     3.90        2.23        25.17        14.53        5.93        2.26  

Fiscal Year ended December 31, 2015

     9.84        3.53        63.29        22.52        15.98        4.48  

Fiscal Year ended December 31, 2016

     5.50        4.00        36.29        25.44        8.62        5.86  

Fiscal Year ended December 31, 2017

     8.18        4.09        54.52        26.21        12.30        7.03  

Quarterly Marker Prices

                 

Fiscal Year ended December 31, 2016

                 

First Quarter

     5.48        4.13        35.23        25.44        8.04        5.86  

Second Quarter

     5.30        4.20        34.18        26.96        7.56        6.06  

Third Quarter

     5.50        4.35        36.29        28.13        8.62        6.97  

Fourth Quarter

     4.59        4.00        29.47        25.71        7.76        6.79  

Fiscal Year ended December 31, 2017

                 

First Quarter

     5.49        4.09        35.68        26.21        8.20        7.03  

Second Quarter

     6.78        5.13        42.20        32.69        9.08        7.66  

Third Quarter

     6.52        5.38        41.81        34.37        9.06        7.90  

Fourth Quarter

     8.18        5.37        54.52        34.66        12.30        8.07  

Monthly Marker Prices

                 

October 2017

     5.86        5.37        37.52        34.66        8.72        8.07  

November 2017

     7.42        5.79        48.00        37.05        11.14        8.91  

December 2017

     8.18        6.85        54.52        43.84        12.30        10.46  

January 2018

     10.20        7.90        64.70        50.54        11.94        10.44  

February 2018

     10.88        8.62        70.52        55.00        12.79        10.82  

March 2018

     10.42        7.86        66.29        50.29        11.83        9.71  

April 2018 (up to April 20, 2018)

     8.57        7.09        53.98        46.50        10.52        9.38  

 

  B. Plan of Distribution

Not applicable.

 

  C Markets

See “Offer and Listing Details” above.

 

  D. Selling Shareholders

Not applicable.

 

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  E. Dilution

NOT applicable.

 

  F. Expenses of the Issue

Not applicable.

 

ITEM 10. ADDITIONAL INFORMATION

 

  A. Share Capital

Not applicable.

 

  B. Memorandum and Articles of Association

The following is a summary of certain provisions of our Articles of Association. As this is a summary, it does not contain all the information that may be important to you. You and your advisors should read the text of our most updated Articles of Association for further information, which is filed as an exhibit to this Annual Report.

General

Our Company is registered with and has obtained a business license from the State Administration Bureau of Industry and Commerce of the People’s Republic of China on March 25, 1995. On March 13, 2003, our Company obtained an approval certificate from the Ministry of Commerce to change to a permanent limited company with foreign investments.

Other Senior Administrative Officers

Pursuant to the Article 17 of the Articles of Association, other senior administrative officers of our Company refer to the Executive Vice President, Chief Financial Officer, Chief Pilot, COO Flight Safety, Chief Information Officer, Chief Economist, Chief Legal Adviser, Chief Engineer, COO Flight Operations, Company Secretary and other senior management appointed by the Board of Directors.

Objects and Purposes

Pursuant to the Article 19 of the Articles of Association, the scope of business of our Company includes: (1) provision of scheduled and non-scheduled domestic, regional and international air transportation services for passengers, cargo, mail and luggage; (2) undertaking general aviation services; (3) provision of aircraft repair and maintenance services; (4) acting as agent for other domestic and international airlines; (5)provision of air catering services; (6) engaging in other airline or airlinerelated business, (limited to insurance agency business personal accident insurance); (7) provision of airline ground services; (8) aviation training; (9) asset leasing services; (10) project management and technical consultancy services; (11) sales of aviation equipment; (12) travel agency business; (13) merchandise retail and wholesale; all subject to approval by company registration authorities.

Directors

Pursuant to Article 175 of the Articles of Association, where a director is interested in any resolution proposed at a board meeting, such director shall abstain from voting and shall not have a right to vote. Such director shall not be counted in the quorum of the relevant meeting. Such directors also shall not vote on behalf of other directors. Board meetings may be convened by more than half of the directors who are not interested in the proposal. Resolutions of board meetings shall be passed by more than half of directors who are not interested in the proposal.

Pursuant to Article 245 of the Articles of Association, where a director of our Company is in any way, directly or indirectly, materially interested in a contract, transaction or arrangement or proposed contract, transaction or arrangement with the Company, (other than his contract of service with the Company), he shall declare the nature and extent of his interests to the Board of Directors at the earliest opportunity, whether or not the contract, transaction or arrangement or proposal therefor is otherwise subject to the approval of the Board of Directors. For the purposes of this Article, a director is deemed to be interested in a contract, transaction or agreement in which an associate of him is interested.

 

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Pursuant to Article 253 of the Articles of Association, our Company shall, with the prior approval of shareholders in shareholders’ general meeting, enter into a contract in writing with a director wherein his emoluments are stipulated. The aforesaid emoluments include, emoluments in respect of his service as director, Supervisor or senior administrative officer of our Company or any subsidiary of our Company, emoluments in respect of the provision of other services in connection with the management of the affairs of our Company and any of its subsidiaries, and payment by way of compensation for loss of office, or as consideration for or in connection with his retirement from office. There is no specific provisions concerning a director’s power, in the absence of an independent quorum, to vote compensation to themselves or any members of their body, other than the above Article 175 with respect to a director’s voting power in matters he is materially interested.

Ordinary Shares

Pursuant to Article 27 of the Articles of Association, subject to the approval of the securities authority of the State Council, our Company may issue and offer shares to domestic investors or foreign investors for subscription. Foreign investors are those investors of foreign countries and regions of Hong Kong, Macau and Taiwan who subscribe for shares issued by our Company. Domestic investors are those investors within the territory of the PRC (excluding investors of the regions referred to in the preceding sentence) who subscribe for shares issued by our Company.

Pursuant to Article 28 of the Articles of Association, shares issued by our Company to domestic investors for subscription in RMB shall be referred to as “Domestic Shares”. Shares issued by our Company to foreign investors for subscription in foreign currencies shall be referred to as “Foreign Shares”. Foreign Shares which are listed overseas are called “Overseas Listed Foreign Shares”. The foreign currencies mean the legal currencies (apart from RMB) of other countries or regions which are recognised by the foreign exchange control authority of the state and can be used to pay our Company for the share price.

Pursuant to Article 29 of the Articles of Association, Domestic Shares issued by our Company shall be called “A Shares”. Overseas Listed Foreign Shares issued by our Company and listed in Hong Kong shall be called “H Shares”. H Shares are shares which have been admitted for listing on the Stock Exchange of Hong Kong Limited, the par value of which is denominated in RMB and which are subscribed for and traded in Hong Kong dollars. H Shares can also be listed on a stock exchange in the United States of America in the form of ADR. Shares issued by our Company, including Domestic Shares and Foreign Shares, are all ordinary shares.

Pursuant to Article 63 of the Articles of Association, the ordinary shareholders of our Company shall enjoy the following rights:

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

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

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

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

(5)    the right of knowledge and decision making power with respect to important matters of the Company in accordance with laws, administrative regulations and these Articles of Association;

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

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

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

(iii)    all parts of the register of shareholders;

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

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

(bb)    principal address (residence);

(cc)    nationality;

 

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

(ee)    identification documents and their relevant numbers;

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

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

(d)minutes of shareholders’ general meetings and accountants’ report; and

(e)interim and annual reports of the Company.

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

(8)    the right to request the company to repurchase their shares as a result of disagreement on the resolutions passed by the shareholders’ general meeting on the merger or division of the Company; and

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

According to Article 270, dividends shall be distributed in accordance with the proportion of shares held by shareholders.

According to Article 38 of the Articles of Association, our Company may repurchase its issued shares under the following circumstances: (1) cancellation of shares for the reduction of its capital; (2) merging with another company that holds shares in our Company; (3) awarding its employees with shares; (4) at the request of the dissenting shareholders; and (5) other circumstances permitted by laws and administrative regulations.

According to Article 42 of the Articles of Association, unless our Company is in the course of liquidation, it must comply with thefollowing provisions in relation to repurchase of its issued shares: (1) where our Company repurchases shares of our Company at par value, payment shall be made out of book surplus distributable profits of our Company or out of proceeds of a fresh issue of shares made for that purpose; (2) where our Company repurchases shares of our Company at a premium to its par value, payment up to the par value may be made out of the book surplus distributable profits of our Company or out of the proceeds of a fresh issue of shares made for that purpose: (i) If the shares being repurchased were issued at par value, payment shall be made out of the book surplus distributable profits of the Company; (ii) If the shares being repurchased were issued at a premium to its par value, payment shall be made out of the book surplus distributable profits of the Company or out of the proceeds of a fresh issue of shares made for that purpose, provided that the amount paid out of the proceeds of the fresh issue shall not exceed the aggregate of premiums received by the Company on the issue of the shares repurchased or the current amount (including the premiums on the fresh issue) of the Company’s premium account (or capital common reserve fund account) at the time of the repurchase; (3) payment by our Company in consideration of the following shall be made out of our Company’s distributable profits: (i) acquisition of rights to repurchase shares of our Company; (ii) variation of any contract to repurchase shares of our Company; and (iii) release of any of our Company’s obligation under any contract to repurchase shares of our Company; and (4) After our Company’s registered capital has been reduced by the total par value of the cancelled shares in accordance with the relevant provisions, the amount deducted from the distributable profits of our Company for paying up the par-value portion of the shares repurchased shall be transferred to our Company’s premium account (or capital common reserve fund account).

According to Article 68 of the Articles of Association, shareholders of our company have the obligation not to withdraw their shares unless required by laws and regulations; shareholders are not liable to make any further contribution to the share capital other than as agreed by the subscriber of the relevant shares on subscription.

According to Article 267 of the Articles of Association, when distributing each year’s after-tax profits, our Company shall set aside 10% of such profits for our Company’s statutory common reserve fund, except where the accumulated balance of the said fund has reached 50% of our Company’s registered capital. After our Company has allocated its after-tax profits to the statutory common reserve fund, we may, with the approval of the shareholders by way of resolution in a shareholders’ general meeting, further allocate its after-tax profits to the discretionary common reserve fund.

The Articles of Association does not have specific provisions discriminating against any existing or prospective holder of such securities as a result of other shareholders owning a substantial number of shares.

 

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Action Necessary to Change Rights of Shareholders

Pursuant to Article 152 of the Articles of Association, shareholders who hold different classes of shares are shareholders of different classes. The holders of the Domestic Shares and holders of Overseas Listed Foreign Shares are deemed to be shareholders of different classes.

Pursuant to Article 153 of the Articles of Association, rights conferred on any class of shareholders in the capacity of shareholders (“class rights”) may not be varied or abrogated unless approved by a special resolution of shareholders in general meeting and by holders of shares of that class at a separate meeting.

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

Pursuant to Article 156 of the Articles of Association, resolutions of a class of shareholders shall be passed by votes representing more than two-thirds of the voting rights of shareholders of that class represented at the relevant meeting who are entitled to vote at class meetings.

Pursuant to Article 157 of the Articles of Association, written notice of a class meeting shall be given forty-five days before the date of the class meeting to notify all of the shareholders in the share register of the class of the matters to be considered, the date and the place of the class meeting. A shareholder who intends to attend the class meeting shall deliver his written reply concerning attendance at the class meeting to our Company twenty days before the date of the class meeting. If the number of shares carrying voting rights at the meeting represented by the shareholders who intend to attend the class meeting reaches more than one half of the voting shares at the class meeting, our Company may hold the class meeting; if not, our Company shall within five (5) days notify the shareholders again by public notice of the matters to be considered, the date and the place for the class meeting. Our Company may then hold the class meeting after such publication of notice.

Pursuant to Article 158 of the Articles of Association, notice of class meetings need only be served on shareholders entitled to vote thereat. Meeting of any class of shareholders shall be conducted in a manner as similar as possible to that of general meetings of shareholders. The provisions of these Articles of Association relating to the manner to conduct any shareholders’ general meeting shall apply to any meeting of a class of shareholders.

Meetings of Shareholders

According to Article 79, shareholders’ general meetings are divided into annual general meetings and extraordinary general meetings. Shareholders’ general meetings shall be convened by our board of directors. Annual general meetings are held once every year and within six months from the end of the preceding financial year.

According to Article 80, under any of the following circumstances, our board of directors shall convene an extraordinary general meeting within two months: (1) the number of directors is less than that is required by the Company Law or two thirds of the number of directors specified in these Articles of Association; (2) the accrued losses of our Company amount to one third of the total amount of its share capital; (3) shareholder(s) individually or jointly holding 10% or more of our Company’s issued and outstanding shares carrying voting rights request(s) in writing the convening of an extraordinary general meeting; (4) it is deemed necessary by the board of directors or requested by the supervisory committee to convene an extraordinary general meeting; (5) more than one half of the independent directors propose to convene the meeting.

According to Article 92 of the Articles of Association, notice of a shareholders’ general meeting shall be given by way of announcement or by any other manner as provided in these Articles of Association (if necessary), not less than forty-five days (including forty-five days) before the date of the meeting to notify all of the shareholders in the share register of the matters to be considered, the date and the place of the meeting.

 

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According to Article 93 of the Articles of Association, our Company shall, based on the written replies received twenty days before the date of the shareholders’ general meeting from the shareholders, calculate the number of voting shares represented by the shareholders who intend to attend the meeting. If the number of voting shares represented by the shareholders who intend to attend the meeting reaches one half or more of our Company’s total voting shares, our Company may hold the meeting; if not, then our Company shall within five days notify the shareholders again by public notice of the matters to be considered, the place and date for, the meeting. Our Company may then hold the meeting after such publication of notice.

Limitation on Right to Own Securities

The Articles of Association does not specifically provide for the limitations on the rights to own securities by certain shareholders, however, the PRC Special Regulations on Overseas Offering and the Listing of Shares by Companies Limited by Share (the “Special Regulations”) and the Mandatory Provisions for Articles of Association of Companies to be Listed Overseas (the “Mandatory Provisions”) provide for different classes of shares to be subscribed for and traded by local and overseas investors respectively. Shares which can be traded by overseas investors must be in registered form and while denominated in Renminbi, they are traded in foreign currency with dividends payable in foreign currency. Local investors are prohibited from dealing in such shares.

Merger, Acquisition or Corporate Restructuring

Pursuant to Article 295 of the Articles of Association, in the event of the merger or division of our Company, a plan shall be presented by our Company’s board of directors and shall be approved in shareholders’ general meeting and the relevant examining and approving formalities shall be processed as required by law. A shareholder who objects to the plan of merger or division shall have the right to demand our Company or the shareholders who consent to the plan of merger or division to acquire that dissenting shareholder’s shareholding at a fair price. The contents of the resolution of merger or division of our Company shall be made into special documents for shareholders’ inspection. Such special documents shall be sent by mail to holders of Overseas-Listed Foreign Shares.

Ownership to Be Disclosed

The Articles of Association do not contain any provisions governing the ownership threshold above which shareholder ownership must be disclosed.

 

C MATERIAL CONTRACTS

Other than such contracts as are described in our disclosure in Item 4 “Information on the Company” and Item 7 “Major Shareholders and Related Party Transactions”, we have not entered into any material contracts outside the ordinary course of our business within the two years preceding the date of this annual report.

 

D. EXCHANGE CONTROLS

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

Our Company is generally required by law to sell all its foreign currency revenues to Chinese banks. Our Company may purchase foreign currency directly from Chinese banks for any current account transactions, such as trade transactions in our usual and normal course of business, including acquisition of aircraft, jet fuel and flight equipment (such acquisition requires approvals from the relevant Chinese government agencies). Payment of dividends by our Company to holders of our Company’s H Shares and ADRs is also considered a current account transaction under Chinese law. Therefore, there is no legal restriction on the conversion of Renminbi into foreign currency for the purpose of paying dividends to such holders of H Shares and ADRs. In addition, our Company’s Articles of Association require our Company to pay dividends to holders of our Company’s H Shares and ADRs in foreign currency.

 

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On July 21, 2005, the PRC government changed its policy of pegging the value of the Renminbi to the U.S. dollar so that the Renminbi is now permitted to fluctuate within a band against a basket of certain foreign currencies. On May 18, 2007, the People’s Bank of China announced that the floating band of Renminbi trading prices against U.S. dollar in the inter-bank spot foreign exchange market would be permitted to rise or fall by as much as 0.5%. The floating band was subsequently expanded to 1% by the People’s Bank of China, effective from April 16, 2012, and further expanded to 2% by the People’s Bank of China, effective from March 15, 2014.

The PRC government has stated publicly that it intends to further liberalize its currency policy, which could result in a further and more significant change in the value of the Renminbi against the U.S. dollar. Any significant revaluation of the Renminbi may have a material adverse effect on our Company’s financial performance, and the value of, and any dividends payable on, our Company’s H Shares and ADRs in foreign currency terms.

Other Limitations

There are no limitations on the right of non-resident or foreign owners to hold or vote H Shares or ADRs imposed by Chinese law or by the Articles of Association or other constituent documents of our Company. However, under current Chinese law, foreign ownership of our Company may not exceed 49%.

 

E. TAXATION

Chinese Taxation

The following is a general summary of certain Chinese tax consequences of the acquisition, ownership and disposition of A Shares, H Shares and ADRs. This summary is based upon tax laws of China as in effect on the date of this Annual Report, including the income tax treaty between the United States and China (the “U.S.-PRC Tax Treaty”), all of which are subject to change or different interpretation.

In general, for Chinese tax purposes, holders of ADRs will be treated as the owners of the H Shares represented by those ADRs, and exchanges of H Shares for ADRs, and ADRs for H Shares, will not be subject to taxation under the laws of China.

This summary does not purport to address all material tax consequences for holders or prospective purchasers of A Shares, H Shares or ADRs, and does not take into account the specific circumstances of such investors. Investors should consult their own tax advisors as to Chinese or other tax consequences of the acquisition, ownership and disposition of A shares, H Shares or ADRs.

As a result of the new corporate income tax law, the statutory corporate income tax rate adopted by our Company and our subsidiaries has been changed from 33% to 25% with effect from January 1, 2008. Pursuant to new corporate income tax law, the corporate income tax rates of entities that previously enjoyed preferential tax rates of 15% have been revised to 18%, 20%, 22%, 24% and 25% for 2008, 2009, 2010, 2011 and 2012 onwards, respectively.

Dividends

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

China currently has double-taxation treaties with a number of countries, such as Australia, Canada, France, Germany, Japan, Malaysia, the Netherlands, Singapore, the United Kingdom and the United States. Under the U.S.-PRC Tax Treaty, China may tax a dividend paid by our Company to a U.S. holder up to a maximum of 10% of the gross amount of such dividend.

For individuals, Chinese tax law generally provides that an individual who receives dividends from Chinese companies is subject to a 20% individual income tax. A 50% reduction of taxable income is granted by Chinese tax law for an individual receiving dividends from a listed company on Shanghai Stock Exchange or Shenzhen Stock Exchange. As a result, the effective tax rate for dividends received by A share individual holder is 10% in 2018. Dividend income received by any foreign individual that holds overseas shares in Chinese enterprise is generally subject to individual income tax at a flat rate of 20%, subject to exemption or reduction by an applicable double-taxation treaty.

 

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Capital Gains from Transfer or Disposition of Shares

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

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

United States Federal Income Taxation

This discussion describes general U.S. federal income tax consequences of the purchase, ownership and disposition of our Company’s ADRs. This discussion does not address any aspect of U.S. federal gift or estate tax, or the state, local or foreign tax consequences of an investment in our Company’s ADRs. This discussion applies to you only if you hold and beneficially own our Company’s ADRs as capital assets for tax purposes. This discussion does not apply to you if you are a member of a class of holders subject to special rules, such as:

 

    dealers in securities or currencies;

 

    traders in securities that elect to use a mark-to-market method of accounting for securities holdings;

 

    banks or other financial institutions;

 

    insurance companies;

 

    tax-exempt organizations, retirement plans, individual retirement accounts or tax deferred accounts;

 

    partnerships or other pass-through entities (including entities treated as partnerships for U.S. federal income tax purposes) or persons holding ADRs through any such entities;

 

    persons that hold ADRs as part of a hedge, straddle, constructive sale, conversion transaction or other integrated investment;

 

    persons whose functional currency for tax purposes is not the U.S. dollar;

 

    persons who are U.S. expatriates;

 

    persons liable for alternative minimum tax; or

 

    persons who directly, indirectly or constructively own 10% or more of the total combined voting power of all classes of our Company’s shares (including ADRs) entitled to vote.

This discussion is based on the U.S. Internal Revenue Code of 1986, as amended, which is referred to in this discussion as the Code, its legislative history, existing and proposed regulations promulgated thereunder, published rulings and court decisions, all as currently in effect. These laws are subject to change, possibly on a retroactive basis. In addition, this discussion relies on the assumptions regarding the value of our Company’s shares and the nature of our business over time. Finally, this discussion is based in part upon the representations of the depositary and the assumption that each obligation in the deposit agreement and any related agreement will be performed in accordance with its terms. For U.S. federal income tax purposes, as a holder of ADRs, you are treated as the owner of the underlying ordinary shares represented by such ADRs.

The discussions and comments included herein are only a general description of the tax aspects and they do not constitute a tax advice or opinion. Therefore, you should consult your own tax advisor concerning the particular U.S. federal income tax consequences to you of the purchase, ownership and disposition of our Company’s ADRs, as well as the consequences to you arising under the laws of any other taxing jurisdiction.

For purposes of the U.S. federal income tax discussion below, you are a “U.S. Holder” if you beneficially own ADRs and are:

 

    a citizen or resident of the United States for U.S. federal income tax purposes;

 

    a corporation, or other entity taxable as a corporation, that was created or organized in or under the laws of the United States or any political subdivision thereof;

 

    an estate the income of which is subject to U.S. federal income tax regardless of its source; or

 

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    a trust if (a) a court within the United States is able to exercise primary supervision over its administration and one or more U.S. persons have the authority to control all substantial decisions of the trust, or (b) the trust has a valid election in effect to be treated as a U.S. person.

If you are not a U.S. person, please refer to the discussion below under “Non-U.S. Holders.”

U.S. Holders

Dividends on ADRs

Subject to the Passive Foreign Investment Company (“PFIC”) discussion below, if our Company makes distributions and you are a U.S. Holder, the gross amount of any distributions you receive on your ADRs will generally be treated as dividend income if the distributions are made from our Company’s current or accumulated earnings and profits, calculated according to U.S. federal income tax principles. Dividends will generally be subject to U.S. federal income tax as ordinary income on the day you actually or constructively receive such income. However, if you are an individual and have held your ADRs for a sufficient period of time, dividend distributions on our Company’s ADRs will generally constitute qualified dividend income taxed at a preferential rate as long as our Company is not treated as a PFIC, our Company’s ADRs continue to be readily tradable on the New York Stock Exchange and certain other conditions apply. You should consult your own tax adviser as to the rate of tax that will apply to you with respect to dividend distributions, if any, you receive from us.

Distributions in excess of current and accumulated earnings and profits, as determined for U.S. federal income tax purposes, will be treated as a non-taxable return of capital to the extent of your adjusted tax basis in the ADRs and thereafter as capital gain. However, our Company does not intend to maintain calculations of our earnings and profits in accordance with U.S. federal income tax principles, so each U.S. Holder should therefore assume that any distribution by our Company with respect to the ADRs will constitute ordinary dividend income. Even if you are a corporation, you will not be entitled to claim a dividends-received deduction with respect to distributions you receive from our Company. Dividends generally will constitute foreign source passive income for U.S. foreign tax credit limitation purposes. You should consult your own tax advisor to determine the foreign tax credit implications of owning ADRs.

Sales and other dispositions of ADRs

Subject to the PFIC discussion below, when you sell or otherwise dispose of our Company’s ADRs, you will generally recognise capital gain or loss in an amount equal to the difference between the amount realized on the sale or other disposition and your adjusted tax basis in the ADRs, both as determined in U.S. dollars. Your adjusted tax basis will generally equal the amount you paid for the ADRs. Any gain or loss you recognise is long-term capital gain or loss if your holding period in our Company’s ADRs is more than one year at the time of disposition. If you are an individual, any such long-term capital gain is eligible for preferential rates. Your ability to deduct capital losses is subject to various limitations.

Passive Foreign Investment Company

If our Company is currently or were to become a PFIC, as a U.S. Holder, you would generally be subject to adverse U.S. tax consequences, in the form of increased tax liabilities and special U.S. tax reporting requirements.

Our Company will be classified as a PFIC in any taxable year if either: (1) the average value during the taxable year of our assets that produce passive income, or are held for the production of passive income, is at least 50% of the average value of our total assets for such taxable year (the “Asset Test”); or (2) 75% or more of our gross income for the taxable year is passive income (such as certain dividends, interest or royalties)(the “Income Test”). For purposes of the Asset Test: (1) any cash, cash equivalents, and cash invested in short-term, interest bearing, debt instruments, or bank deposits that is readily convertible into cash, will generally count as producing passive income or as being held for the production of passive income; and (2) the average values of our Company’s passive and total assets is calculated based on our market capitalization. In the case of publicly traded corporations, fair market value must be used for purposes of applying the Asset Test. In addition, regarding the above two tests, there are complex look-through rules to consider with respect to the assets and activities of related corporations from which our Company either receives income or in which it holds an interest. More specifically, certain adjustments are made to exclude certain income received from a related party or to include income earned and assets held by a 25% or more owned subsidiary in determining whether our Company qualifies as a PFIC under the two tests. In particular: 1) passive income received from a related party is excluded if it is properly allocable to the non-passive income of the related party, and 2) if our Company owns directly or indirectly 25% or more of the stock of another corporation, our Company is treated as if we owned directly a proportionate share of that corporation’s assets and income.

 

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Our Company believes that we were not a PFIC for the taxable year 2017. However, there can be no assurance that our Company will not be a PFIC for the taxable year 2017 and/or later taxable years, as PFIC status is re-tested each year and depends on the facts in such year. For example, our Company would be a PFIC for the taxable year 2017 if the sum of our average market capitalization, which is our share price multiplied by the total amount of our outstanding shares, and our liabilities over that taxable year is not more than twice the value of our cash, cash equivalents, and other assets that are readily converted into cash.

If our Company were a PFIC, you would generally be subject to additional taxes and interest charges on certain “excess distributions” our Company makes regardless of whether our Company continues to be a PFIC in the year in which you receive an “excess distribution”. An “excess distribution” would be either (1) the excess amount of a distribution with respect to ADRs during a taxable year in which distributions to you exceed 125% of the average annual distributions to you over the preceding three taxable years or, if shorter, your holding period for the ADRs, or (2) 100% of the gain from the disposition of ADRs.

To compute the tax on “excess” distributions or any gain, (1) the “excess distribution” would be allocated ratably to each day in your holding period, (2) the amounts allocated to the current year and to any tax year before the first day on which our Company became a PFIC would be taxed as ordinary income in the current year, (3) the amount allocated to other taxable years would be taxable at the highest applicable marginal rate in effect for that year, and (4) an interest charge at the rate for underpayment of U.S. federal income tax for any period described under (3) above would be imposed with respect to any portion of the “excess” distribution that is allocated to such period. In addition, if our Company were a PFIC, no distribution that you receive from our Company would qualify for taxation at the preferential rate discussed in the “Dividends on ADRs” section above.

If our Company were a PFIC in any year, as a U.S. Holder, you would be required to make an annual return on IRS Form 8621 “Information Return by a Shareholder of a Passive Foreign Investment Company or a Qualified Electing Fund.” However, our Company does not intend to generate, or share with you, information that you might need to properly complete IRS Form 8621. You should consult with your own tax adviser regarding reporting requirements with regard to your ADRs.

If our Company were a PFIC in any year, you would generally be able to avoid the “excess” distribution rules described above by making a timely so-called “mark-to-market” election with respect to your ADRs provided our Company’s ADRs are “marketable”. Our Company’s ADRs will be “marketable” as long as they remain regularly traded on a national securities exchange, such as the New York Stock Exchange. If you made this election in a timely fashion, you would generally recognise as ordinary income or ordinary loss the difference between the fair market value of your ADRs on the first day of any taxable year and their value on the last day of that taxable year. Any ordinary income resulting from this election would generally be taxed at ordinary income rates and would not be eligible for the reduced rate of tax applicable to qualified dividend income. Any ordinary losses would be limited to the extent of the net amount of previously included income as a result of the mark-to-market election, if any. Your basis in the ADRs would be adjusted to reflect any such income or loss. Any gains recognised on the sale or other disposition of the ADRs would be treated as ordinary income and any losses would be treated as ordinary losses (but only to the extent of the net amount of previously included income as a result of the mark-to-market election, if any). You should consult with your own tax adviser regarding potential advantages and disadvantages to you of making a “mark-to-market” election with respect to your ADRs.

Separately, if our Company were a PFIC in any year, you would be able to avoid the “excess” distribution rules by making a timely election to treat us as a so-called “Qualified Electing Fund” or “QEF”. You would then generally be required to include in gross income for any taxable year (1) as ordinary income, your pro rata share of our Company’s ordinary earnings for the taxable year, and (2) as long-term capital gain, your pro rata share of our Company’s net capital gain for the taxable year. However, our Company does not intend to provide you with the information you would need to make or maintain a “QEF” election and you will, therefore, not be able to make or maintain such an election with respect to your ADRs.

Medicare Tax

Recently enacted legislation requires certain U.S. Holders who are individuals, estates or trusts to pay up to an additional 3.8% tax on, among other things, dividends and capital gains for tax years beginning after December 12, 2012.

Non-U.S. Holders

If you beneficially own ADRs and are not a U.S. Holder for U.S. federal income tax purposes (a “Non-U.S. Holder”), you generally will not be subject to U.S. federal income tax or U.S. withholding tax on dividends received from our Company with respect to ADRs unless that income is considered effectively connected with your conduct of a U.S. trade or business and, if an applicable income tax treaty so requires as a condition for you to be subject to U.S. federal income tax with respect to income from your ADRs, such dividends are attributable to a permanent establishment that you maintain in the United States.

 

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You generally will not be subject to U.S. federal income tax, including withholding tax, on any gain realized upon the sale or exchange of ADRs, unless:

 

    that gain is effectively connected with the conduct of a U.S. trade or business and, if an applicable income tax treaty so requires as a condition for you to be subject to U.S. federal income tax with respect to income from your ADRs, such gain is attributable to a permanent establishment that you maintain in the United States; or

 

    you are a non-resident alien individual and are present in the United States for at least 183 days in the taxable year of the sale or other disposition and certain other conditions are met.

If you are engaged in a U.S. trade or business, unless an applicable tax treaty provides otherwise, the income from your ADRs, including dividends and the gain from the disposition of our Company’s ADRs, that is effectively connected with the conduct of that trade or business will generally be subject to the rules applicable to U.S. Holders discussed above. In addition, if you are a corporation, you may be subject to an additional branch profits tax at a rate of 30% or any lower rate under an applicable tax treaty.

U.S. information reporting and backup withholding rules

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

HOLDERS OF OUR COMPANY’S ADRS SHOULD CONSULT WITH THEIR OWN TAX ADVISORS REGARDING THE APPLICATION OF THE U.S. FEDERAL INCOME TAX LAWS TO THEIR PARTICULAR SITUATIONS AS WELL AS ANY TAX CONSEQUENCES RESULTING FROM PURCHASING, HOLDING OR DISPOSING OF THE ADRS, INCLUDING THE APPLICABILITY AND EFFECT OF THE TAX LAWS OF ANY STATE, LOCAL OR FOREIGN JURISDICTION AND INCLUDING ESTATE, GIFT, AND INHERITANCE LAWS.

 

F. Dividends and Paying Agents

Not applicable.

 

G. Statement By Experts

Not applicable.

 

H. Documents on Display

Our Company has filed this Annual Report on Form 20-F with the Securities and Exchange Commission under the Securities Exchange Act of 1934, as amended. Statements made in this Annual Report as to the contents of any document referred to are not necessarily complete. With respect to each such document filed as an exhibit to this Annual Report, reference is made to the exhibit for a more complete description of the matter involved, and each such statement shall be deemed qualified in its entirety by such reference.

Our Company is subject to the informational requirements of the Exchange Act and file reports and other information with the Securities and Exchange Commission. Reports and other information which our Company filed with the Securities and Exchange Commission, including this Annual Report on Form 20-F, may be inspected and copied at the public reference room of the Securities and Exchange Commission at 450 Fifth Street N.W. Washington D.C. 20549.

You can also obtain copies of this Annual Report on Form 20-F by mail from the Public Reference Section of the Securities and Exchange Commission, 450 Fifth Street, N.W., Washington D.C. 20549, at prescribed rates. Additionally, copies of this material may be obtained from the Securities and Exchange Commission’s Internet site at http://www.sec.gov. The Commission’s telephone number is 1-800-SEC-0330. Copies of this material may also be obtained for our Company’s website at http:// www.csair.com.

 

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I. Subsidiary Information

Not applicable.

 

ITEM 11. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Fuel Price Fluctuation Risk

Our earnings are affected by changes in the price and availability of jet fuel. There are currently no effective means available to manage our exposure to the fluctuations in jet fuel prices. Our results of operations may be significantly affected by fluctuations in fuel prices which is a significant expense for our Group. A reasonable possible increase or decrease of 10% in jet fuel price, with volume of fuel consumed and all other variables held constant, would have increased or decreased the fuel costs by approximately RMB3,190 million. The sensitivity analysis of jet fuel price risk is disclosed in Note 4(e) to the consolidated financial statements.

Interest Rate Risk

We are subject to market risks due to fluctuations in interest rates. The majority of our borrowings and obligations under capital leases are in the form of long-term fixed-rate and variable-rate. Fluctuations in interest rates can lead to significant fluctuations in the fair value of such debt instruments.

Interest rate swaps, denominated in United States Dollars (“USD”), have been entered into to mitigate our cash flow interest rate risk. The interest rate swaps allow our Company to pay at fixed rate from 1.64% to 1.72% to receive LIBOR. The notional principal of the outstanding interest rate swap contracts as at December 31, 2017 amounted to USD460 million.

Cross currency swaps have been entered into mitigate interest rate risk and foreign currency risk. The cross currency swaps allow our Company to exchange the floating interest rate and principal payments in USD for fixed interest rate rate from 3.58% to 4.04% and principal payments in Renminbi. The notional principal of the outstanding cross currency swaps as at December 31, 2017 amounted to USD920 million.

The sensitivity analysis of interest rate risk is disclosed in Note 4(b) to the consolidated financial statements.

The following table provides information regarding our financial instruments that are sensitive to changes in interest rate as of December 31, 2017 and 2016:

 

     As of December 31, 2017
Expected Maturity Date
     As of December 31,
2016
 
     2018     2019     2020     2021     2022     Thereafter     Total
recorded
amount
    Fair
Vlaue(2)
     Total
Recorded
amount
    Fair
Vlaue(2)
 

Variable rate bank and other loans in US$ Average interest rate

     8,135       66       —         —         —         —         8,201       8,201        208       208  

Average intereset rate

     2.38     4.99     —         —         —         —         2.40        2.75  

Variable rate bank and other loands in Euro

     —         —         —         —         —         —         —         —          —         —    

Average interest rate

     —         —         —         —         —         —         —            —      

Fixed rate bank and other loans in RMB

     3,430       8,100       1       6,600       1       17       18,149       18,149        39,695       39,695  

Average interest rate

     3.67     3.06     1.20     3.12     1.20     1.20     3.20        2.97  

Variable rate bank and other loans in RMB

     16,003       963       4,833       69       63       10       21,941       21,941        5,601       5,601  

Average interest rate

     4.06     4.35     4.38     4.35     4.34     4.41     4.14        4.02