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 selected income statement data for the years ended December 31, 1999,
2000, 2001, 2002 and 2003 and the selected balance sheet data as of December
31, 1999, 2000, 2001, 2002 and 2003 have been derived from our audited
consolidated financial statements, which have been prepared in accordance with
the International Financial Reporting Standards, or IFRS, and audited by
PricewaterhouseCoopers, Certified Public Accountants, Hong Kong.
PricewaterhouseCoopers’ reports in respect of the income statements for the
years ended December 31, 2001, 2002 and 2003 and the balance sheets as of
December 31, 2002 and 2003 appear on page F-1 of this annual report. You should
read Note 40 to our audited consolidated financial statements for a discussion
of certain differences between IFRS and the generally accepted accounting
principles in the United States, or U.S. GAAP, as they relate to our company,
and a reconciliation to U.S. GAAP of profit attributable to shareholders for
the years ended December 31, 2001, 2002 and 2003, and owners’ equity as of
December 31, 2002 and 2003.
Year Ended December 31,
1999
(1)
2000
(1)
2001
(1)
2002
(1)
2003
2003
RMB
RMB
RMB
RMB
RMB
US$
(millions, except per share or per ADS information)
Income Statement Data:
IFRS
:
Revenues
10,163.27
11,220.06
12,152.81
13,078.99
14,277.16
1,724.98
Other operating income
294.15
223.11
127.61
226.37
2.44
0.30
Operating expenses
(9,252.58
)
(10,444.21
)
(11,283.32
)
(12,241.90
)
(14,058.14
)
(1,698.52
)
Operating profit
1,204.84
998.96
997.10
1,063.47
221.46
26.76
Interest income (expense), net
(965.83
)
(814.49
)
(814.38
)
(731.39
)
(712.46
)
(86.08
)
Profit (loss) before taxation
128.22
304.40
313.58
262.89
(589.83
)
(71.26
)
Profit (loss) attributable to
shareholders
84.29
175.53
541.71
86.37
(949.82
)
(114.76
)
Basic and fully diluted
earnings (loss) per share
(2)
0.02
0.04
0.11
0.02
(0.20
)
(0.02
)
Basic and fully diluted
earnings (loss) per ADS
1.73
3.61
11.13
1.77
(19.52
)
(2.36
)
U.S. GAAP:
Profit (loss) attributable to
shareholders
319.80
734.36
474.47
247.74
(898.25
)
(108.53
)
Basic and fully diluted
earnings (loss) per share
(2)
In 2002, certain income and expenses have been reclassified pursuant to
IFRS. As a result, the numbers for the year ended December 31, 1999, 2000
and 2001 have been adjusted to reflect such reclassification. This
reclassification has no effect on the profit (loss) attributable to
shareholders.
(2)
The calculation of earnings (loss) per share is based on the consolidated
profit (loss) attributable to shareholders and 4,866,950,000 shares in
issue.
1999
2000
2001
2002
2003
2003
RMB
RMB
RMB
RMB
RMB
US$
(millions)
Balance Sheet Data:
IFRS
:
Cash and cash equivalents
1,315.20
1,422.89
1,330.98
1,944.52
1,582.78
191.23
Working capital (deficiency)
(656.82
)
(858.32
)
(3,162.91
)
(7,436.75
)
(9,941.35
)
(1,201.13
)
Non-current assets
24,320.39
24,725.46
25,201.24
28,150.78
33,175.44
4,008.29
Total assets
28,261.00
28,652.00
28,610.95
32,761.58
38,007.11
4,592.06
Long-term loans, including
current portion
4,706.17
4,804.19
5,300.57
6,494.63
11,222.92
1,355.97
Capital lease obligations,
including current portion
11,557.27
11,308.18
9,871.35
8,183.97
7,100.89
857.94
Owner’s equity
7,013.50
6,870.53
7,320.10
7,379.10
6,382.15
771.10
U.S. GAAP
:
Total assets
27,194.50
28,077.50
28,297.00
32,512.00
37,789.47
4,565.77
Owner’s equity
5,923.90
6,658.30
7,040.83
7,157.61
6,209.71
750.27
Exchange Rate Information
The noon buying rate in New York City for cable transfers as certified for
customs purposes by the Federal Reserve Bank of New York was RMB8.2766 =
US$1.00, on June 22, 2004. The following tables set forth certain information
concerning exchange rates between Renminbi and U.S. dollars for the periods
indicated:
Average
(1)
Noon Buying Rate
(2)
(RMB per US$)
Noon Buying Rate (RMB per US$)
Period
Period
High
Low
2003
8.2772
December 2003
8.2772
8.2765
2002
8.2772
January 2004
8.2772
8.2767
2001
8.2772
February 2004
8.2773
8.2769
2000
8.2784
March 2004
8.2774
8.2767
1999
8.2785
April 2004
8.2772
8.2768
May 2004
8.2773
8.2768
(1)
Determined by averaging the rates on the last business day of each month
during the relevant period.
(2)
Noon Buying Rate in New York City for cable transfers payable in foreign
currencies as certified for customs purpose by the Federal Reserve Bank of
New York.
Selected Operating Data
The following table sets forth certain operating data of our company for
the five years ended December 31, 2003, which have been derived from financial
information prepared in accordance with IFRS and other data provided by us and
are not audited. All references in this annual report to our cargo operations,
cargo statistics or cargo revenues include figures for cargo and mail.
Average yield (passenger and cargo revenue/
tonne-kilometers)
5.21
4.97
4.92
4.71
4.62
Unit cost (operating expenses/ATK)
2.73
2.87
2.69
2.87
2.94
B. Capitalization and Indebtedness
Not applicable.
C. Reasons for the Offer and Use of Proceeds
Not applicable.
D. Risk Factors
An investment in our ADSs or H shares involves a number of risks. An
investment in our company also involves special concerns and significant risks
not usually involved with an investment in the equity securities of a United
States company. You should carefully consider the following information about
these risks, together with the other information in this annual report.
Government regulation
The Chinese civil aviation industry is subject to a high degree of
regulation by the CAAC. Regulatory policies issued or implemented by the CAAC
encompass virtually every aspect of airline operations, including, among
others:
•
route allocation;
•
domestic airfare;
•
the administration of air traffic control systems and certain airports; and
•
aircraft registration and aircraft airworthiness certification.
As a result, we may face significant constraints on our flexibility and
ability to expand our business operations or to maximize our profitability.
Most of the airline companies in China are currently 100% or majority
owned either by the central government of China or by provincial or municipal
governments in China. CEA Holding currently holds approximately 61.64% of our
company’s equity interest on behalf of the Chinese government. As a result, CEA
Holding will be able to elect our entire board of directors and otherwise be
able to control us. CEA Holding will also have sufficient voting control to
effect transactions without the concurrence of our minority shareholders. The
interests of the Chinese government as the ultimate controlling person of our
company and other Chinese airlines could conflict with the interests of our
minority shareholders. Although the CAAC currently has a policy of equal
treatment for all Chinese airlines, we cannot assure you that the CAAC will not
favor other Chinese airlines.
Competition
We face intense competition in each of the domestic, Hong Kong regional
and international markets we serve. As a result, we may have to lower our
airfare in order to maintain passenger traffic and compete with certain smaller
domestic airline companies that operate with costs lower than our company or
pursue a strategy of offering lower fares. In addition, many of our competitors
have significantly longer operating history, greater name recognition, more
resources and larger sales networks than our company or participate in
reservation systems that are more convenient than ours. The public’s perception
of the safety records of Chinese airlines also adversely affects our ability to
compete against our international competitors. Increased competition may have a
material adverse effect on our financial condition and results of operations.
Insurance coverage and cost
As a result of the September 11, 2001 events, aviation insurers have
significantly reduced the maximum amount of insurance coverage available to
commercial air carriers for liability to persons other than employees or
passengers for claims resulting from acts of terrorism, war or similar events,
or war-risk coverage. At the same time, they significantly increased the
premiums for such coverage as well as for aviation insurance in general. Our
company has extended our insurance coverage purchased prior to the September 11
events to November 31, 2004. However, if the insurance carriers reduce further
the amount of insurance coverage available or increase the premium for such
coverage when we renew our insurance coverage, our financial condition and
results of operations will be adversely affected.
Direct air link between China’s mainland and Taiwan
Currently, our operations on the Hong Kong regional routes benefit from
traffic between Hong Kong and mainland China ultimately originating in Taiwan.
During the Lunar Chinese New Year peak travel season in 2003, from late-January
to mid-February, the Chinese government allowed special chartered flights
between Shanghai and Taiwan for the first time. There was no such direct
chartered flights in 2004 so far. Although regular direct flights between
Taiwan and mainland China are still not permitted, our Hong Kong regional
routes may be adversely affected if such direct flights are permitted in the
future. We cannot assure you that we will obtain sufficient Taiwan-mainland
China routes, or that the yields on these routes will be adequate, to offset
any adverse effect on our revenues derived from our Hong Kong regional routes.
Chinese aviation infrastructure limitations and safety
The rapid increase in air traffic volume in China in recent years has put
pressure on many components of the Chinese airline industry, including air
traffic control systems, the availability of
qualified flight personnel and airport facilities. Our ability to provide
safe air transportation depends on the availability of qualified and
experienced pilots in China and the improvement of maintenance services,
national air traffic control and navigational systems and ground control
operations at Chinese airports. If any of these is not available or is
inadequate, our ability to provide safe air transportation will be compromised
and our financial condition and results of operations will be materially
adversely affected.
Fuel supply and costs
The availability and cost of the aviation fuel has a significant impact on
our financial condition and results of operations. In the past, jet fuel
shortages have occurred in China and, on limited occasions, required us to
delay or cancel flights. Although jet fuel shortages have not occurred since
the end of 1993, we cannot assure you that jet fuel shortages will not occur in
the future. As of May 31, 2004, the official domestic fuel price increased
16.6% compared to the price as of May 31, 2003. The international and domestic
fuel prices may continue to increase in the future, in part due to the domestic
turmoil in Iraq and other oil producing regions. The fuel costs accounted for
approximately 21.7% of our operating expenses in 2003. In 2003, our fuel
expenses increased 18.8% as a result of increased weighted average domestic and
international fuel prices and the expansion of our fleet. In particular, the
weighted average domestic and international fuel prices paid by our company in
2003 increased by approximately 10.6% and 3.6%, respectively. Due to the highly
competitive nature of the airline industry, we may be unable to pass on to our
customers any increased fuel costs we may encounter in the future. Any jet fuel
shortages or any increase in domestic or international jet fuel price may
materially adversely affect our financial condition and results of operations.
Operating leverage
The airline industry is characterized by a high degree of operating
leverage. Due to high fixed costs, including payments made in connection with
aircraft leases, the expenses relating to the operation of any given flight do
not vary proportionately with the number of passengers carried, while revenues
generated from a particular flight are directly related to the number of
passengers carried and the fare structure of the flight. Accordingly, a
decrease in revenues may result in a proportionately higher decrease in
profits.
Future financing requirements
We require significant amounts of external financing to meet our capital
commitments for additions of and upgrades on the aircraft and flight equipment
and other business expansion needs. In the past, we have obtained, sometimes
with the assistance of the CAAC, guarantees from Bank of China and other
Chinese banks in respect of payments under our foreign loan and capital lease
obligations. However, we cannot assure you that we will be able to continue to
obtain bank guarantees in the future. The unavailability of Bank of China or
other acceptable bank guarantees or the increased cost of such guarantees may
adversely affect our ability to borrow internationally or enter into
international aircraft lease financings on acceptable terms. The ability of our
company to obtain financing may also be affected by our financial position and
leverage as well as by prevailing economic conditions and the cost of financing
generally. If we were unable to obtain financing for a significant portion of
our capital requirements, our ability to acquire new aircraft or to expand our
operations may be impaired. We have and in the future will likely continue to
have substantial debts. As a result, the interest cost associated with these
debts might impair our future profitability and cause our earnings to be
subject to a higher degree of volatility.
Related party transactions; conflict of interests
We have engaged from time to time and will continue to engage in a variety
of transactions with CEA Holding and various members of CEA Holding, which
provide a number of services to us, including
in-flight catering and import of aircraft, flight equipment and flight
equipment spare parts. Our transactions with CEA Holding and members of CEA
Holding are conducted pursuant to a number of service and other contracts
between CEA Holding and us, the terms of which were negotiated on an arm’s
length basis. Since CEA Holding is our controlling shareholder and the
interests of CEA Holding may conflict with our company’s own interests, CEA
Holding or any member of CEA Holding may take actions that favor the interests
of other members of CEA Holding over our company’s interests.
Limitation on foreign ownership
The current CAAC policies limit foreign ownership in Chinese airlines.
Under these limits, non-Chinese residents and Hong Kong, Macau or Taiwan
residents cannot hold majority equity interest in a Chinese airline company. At
present, approximately 32.2% of our total outstanding shares are held by
non-Chinese residents and Hong Kong, Macau or Taiwan residents. As a result,
our access to international equity capital markets may be limited. This
restriction may also limit the opportunities available to our company to obtain
funding or other benefits through the creation of equity-based strategic
alliances with foreign carriers. We cannot assure you that the CAAC will
increase these limits in the near future or at all.
Adverse impact of unusual events
On March 19, 2003, the United States commenced its military campaign
against Iraq. The number of passengers for some of our company’s international
routes, in particular, the U.S. route of our company, decreased after the
commencement of the war in Iraq. The demand on our international routes may
continue to decrease due in part to fears of terrorism that ensued the Iraqi
war, which may materially adversely affect our financial condition and results
of operations.
From November 2002 to June 2003, China and certain other countries and
regions experienced an outbreak of a new and highly contagious form of atypical
pneumonia now known as severe acute respiratory syndrome, or SARS. On July 5,
2003, the World Health Organization declared that the SARS outbreak had been
contained in China. However, new cases of SARS were reported in China since
April 22, 2004. Any future outbreak of SARS or similar contagious epidemic
will, among other things, significantly reduce demand for our services and will
have a material adverse effect on our financial condition and results of
operations.
Changes in the economic policies of the Chinese government
Since the late 1970s, the Chinese government has been reforming the
Chinese economic system. These reforms have resulted in significant economic
growth and social progress. Although we believe that economic reform and
macroeconomic policies and measures adopted by the Chinese government will
continue to have a positive effect on the economic development in China and
that we will continue to benefit from these policies and measures, these
policies and measures may from time to time be modified or revised. Adverse
changes in economic and social conditions in China, in the policies of the
Chinese government or in the laws and regulations in China, if any, may have a
material adverse effect on the overall economic growth of China and investment
in the airline industry in China. These developments, in turn, may materially
adversely affect our business operations, such as an adverse effect on the
demand for our services, and may also materially adversely affect our financial
condition and results of operations.
Convertibility of Renminbi
A significant portion of our revenue and operating expenses are
denominated in Renminbi, while a portion of our revenue, capital expenditures
and debts are denominated in U.S. dollars and other foreign currencies.
Renminbi is currently freely convertible under the current account, which
includes dividends,
trade and service-related foreign currency transactions, but not under the
capital account, which includes foreign direct investment, unless the prior
approval of the State Administration of Foreign Exchange, or SAFE, is obtained.
As a foreign investment enterprise approved by the PRC Ministry of Commerce, or
MOC, we can purchase foreign currency without the approval of SAFE for
settlement of current account transactions, including payment of dividends, by
providing commercial documents evidencing these transactions. We can also
retain foreign exchange in our current accounts, subject to a maximum amount
approved by SAFE, to satisfy foreign currency liabilities or to pay dividends.
However, the relevant Chinese government authorities may limit or eliminate our
ability to purchase and retain foreign currencies in the future. 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. We cannot assure you that we will be able to
obtain sufficient foreign exchange to pay dividends or satisfy our foreign
exchange liabilities.
Fluctuations in exchange rates
The value of Renminbi fluctuates and is subject to significant changes in
China’s political and economic conditions. While the official exchange rate for
the conversion of Renminbi to U.S. dollars has generally been stable in recent
years, any devaluation of Renminbi may adversely affect the value of dividends,
if any, payable on our H shares in foreign currency terms. We use currency
forward contracts to reduce risks of changes in currency exchange rates in
respect of ticket sales and expenses denominated in foreign currencies. These
currency forward contracts will expire between 2004 and 2010. Since we may not
be able to fully hedge against Renminbi devaluations, future movements in the
exchange rate of Renminbi and other currencies may have an adverse effect on
our financial condition and results of operations.
Uncertainties embodied in the Chinese legal system
The Chinese legal system is a civil law system based on written statutes.
Unlike common law systems, it is a system in which decided legal cases have
little precedential value. In 1979, the Chinese government began to promulgate
a comprehensive system of laws and regulations governing economic matters in
general. Legislation over the past 20 years has significantly enhanced the
protection afforded to foreign investment in China. However, the interpretation
and enforcement of some of these laws, regulations and other legal requirements
involve uncertainties that may limit the legal protection available to you.
Item 4. Information on the Company.
History and Development of the Company
Our company was established on April 14, 1995 under the laws of China as a
company limited by shares in connection with the restructuring of our
predecessor and our initial public offering. Our registered office is located
at 66 Airport Street, Pudong International Airport, Shanghai, China, 201202.
Our principal executive office is located at 2550 Hong Qiao Road, Hong Qiao
International Airport, Shanghai, China, 200335. The telephone number of our
principal executive office is (86-21) 6268-6268. We currently do not have an
agent for service of process in the United States. Our predecessor was one of
the six original airlines established in 1988 as part of the decentralization
of the airline industry in China undertaken in connection with China’s overall
economic reform efforts. Prior to 1988, the CAAC was responsible for all
aspects of civil aviation in China, including the regulation and operation of
China’s airlines and airports. In connection with our initial public offering,
our predecessor was restructured into two separate legal entities, our company
and EA Group. According to the restructuring arrangement, by operation of law,
our company succeeded to substantially all of the assets and liabilities
relating to the airline business of our predecessor. EA Group succeeded to our
predecessor’s assets and liabilities that do not directly relate to the airline
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