山航Ｂ(200152)2003年年度报告（英文版）

SHANDONG AIRLINES CO., LTD. ANNUAL REPORT 2003 March 2004 Jinan · PRC Contents . Company Profile ----------------------------------------------------------------------------1 . Summary Financial Highlight and Business Highlight -----------------------------2 . Changes in Capital Shares and Particulars about Shareholders ------------------4 . Particulars about Directors, Supervisors, Senior Executives and Employees --6 . Administrative Structure ------------------------------------------------------------------8 . Brief Introduction to the Shareholders’ General Meeting --------------------------9 . Report of the Board of Directors --------------------------------------------------------10 . Report of the Supervisory Committee --------------------------------------------------24 . Significant Events ---------------------------------------------------------------------------26 . Financial Report -----------------------------------------------------------------------------29 . Documents for Reference ------------------------------------------------------------------60 Important Notes: The Board of Directors of Shandong Airlines Co., Ltd. (hereinafter referred to as the Company) and its directors hereby confirm that there are no any important omissions, fictitious statements or serious misleading information carried in this report, and shall take all responsibilities, individual and/or joint, for the reality, accuracy and completion of the whole contents. Director Mr. Zeng Guoqiang was absent from the Board meting and authorized Director Mr. Su Zhongmin to exercise the voting right on his behalf. Deloitte Touche Tohmatsu Certified Public Accountants and Deloitte Touche Tohmatsu Hua Yong Certified Public Accountants Ltd. produced an unqualified Auditors’ Report with interpretative explanation. The Board of Directors and the Supervisory Committee of the Company also has particular explanation on the relevant issues. Welcome the investors to read carefully. The Company’s Chairman of the Board Mr. Li Junhai and Chief Accountant Mr. Li Qing’en hereby confirm that the Financial Report of the Annual Report is true and complete. This report has been prepared in Chinese version and English version respectively. In this event of difference in interpretation between the two versions, the Chinese report shall prevail. Paraphrase: The Company: Shandong Airlines Co., Ltd. SDA: Shandong Aviation Group; the holding shareholder of the Company I. Company Profile 1. Legal Name of the Company In Chinese: 山东航空股份有限公司 In English: SHANDONG AIRLINES CO., LTD. 2. Legal Representative: Li Junhai 3. Secretary of Board of Directors: Zheng Baoan Contact Address: 18/F, SDA Bldg., No. 5746, Er Huan East Road, Jinan, Shandong Tel: (86) 531-5698987 E-mail: zhengba@shandongair.com.cn - - 1 Authorized Representative: Huang Haiming E-mail: huanghm@shandongair.com.cn Tel: (86) 531-5698678 Fax: (86) 531-5698679 4. Registered Address: Yaoqiang International Airport, Jinan, Shandong Office Address: SDA Bldg., No. 5746, Er Huan East Road, Jinan, Shandong Post Code: 250014 Company’s Web Site: http://www.shandongair.com.cn E-mail: zqb@shandongair.com.cn 5. Newspapers for Disclosing the Information Appointed by the Company: Domestic: China Securities and Securities Times Overseas: Ta Kung Pao Internet Web Site for Publishing the Annual Report: http://www.cninfo.com.cn The Place Where the Annual Report is Prepared and Placed: Securities Department of the Company Liaison Tel: (86) 531-5698678 6. Stock Exchange Listed with: Shenzhen Stock Exchange Short Form of the Stock: SHANHANG B Stock Code: 200152 7. Other Relevant Information of the Company Initial registration date: Dec. 13, 1999 Registration date after change: June 30, 2003 Registration address: Shangdong Province Administration Bureau of Industry and Commerce Registered number for enterprise corporation business license: QGLZ Zi No. 003926 Registered number for taxation: 370112720721201 Name and address of certified public accountants engaged by the Company: Domestic: Deloitte Touche Tohmatsu Hua Yong Certified Public Accountants Ltd. Address: 30/F, Waitan Centre, No. 222, Yan’an East Road, Shanghai Overseas: Deloitte Touche Tohmatsu Certified Public Accountants Address: 26/F, Wing On Centre, 111 Connaught Road Central, Hong Kong II. Summary Financial Highlight and Business Highlight (I) Financial Highlights and Related Indexes as of the Report Year (According to the International Financial Reporting Standards (“IFRS”)) Items Unit: RMB’000 Profit before taxation 73,178 Net profit for the year 71,368 Net profit after deducting non-recurring 65,822 gains and losses Profit from operations 209,392 Income (loss) from investments 314 Government grant 4,200 Net cash generated from operating 303,883 activities Net increase in cash and cash 24,505 equivalents - - 2 Unit: RMB'000 Items of non-recurring gains and losses Amount after taxation 1. Multiform government subsidy 4,200 2. Funds impropriated expenses reckoned in 1,154 gains and losses of current period and received from non-financial enterprises 3. Other non-operating income/expenses 192 4 Other - 5,546 There existed differences in the net profit and net assets as calculated according to the Chinese Accounting Standards (“CAS”) and IFRS, which are stated as following with their causes: Profit (loss) for the year Net assets 2003 2003 RMB'000 RMB'000 As reported under PRC GAAP 26,531 551,860 Adjustments to conform with IFRS: Difference in depreciation charges of aircraft and related equipment 38,245 -11,924 Difference in deferred expenditure recognition 7,748 -50,388 Adjustment of provision for overhaul of aircraft and engines - - Deferred tax -1,679 20,563 Pre-operating expense of subsidiaries 523 - As reported under IFRS 71,368 510,111 (II) Major Accounting and Financial Highlights over the Past Three Years at the end of the Report Year (According to IFRS) Statement of Accounting Data and Financial Indexes Unit: RMB'000 Items 2003 2002 2001 Total operating revenue 1,771,806 1,614,271 1,287,982 (RMB’000) Net profit for the year 71,368 -80,384 69,570 (RMB’000) Total assets (RMB’000) 3,952,026 3,242,060 1,960,839 Shareholders’ equity (Excluding 510,111 438,743 543,127 Minority shareholders’ equity) (RMB’000) Diluted Earnings per share 0.18 -0.20 0.17 (RMB) Weighted average earnings per 0.18 -0.20 0.17 share(RMB) Net assets per share (RMB) 1.28 1.10 1.36 - - 3 Net cash flows per share arising 0.76 0.35 0.23 from operating activities (RMB) Diluted net asset-income ratio 13.99 -18.32 12.81 (%) (III) Particulars about Changes in Shareholders’ Equity during the Report Period Statutory Statutory Retained Share Share Capital surplus public earnings reserve welfare capital premium reserve (deficits) Total (note) fund RMB'000 RMB'000 RMB'000 RMB'000 RMB'000 RMB'000 RMB'000 Balance at December 31, 2002 400,000 76,258 -40,886 15,215 7,607 -19,451 438,743 and January 1, 2003 Net profit for the - - - - - 71,368 71,368 year Transfer to statutory - - - 33 - -33 - surplus reserve Transfer to statutory public welfare - - - - 11 -11 - fund Balance at 400,000 76,258 -40,886 15,248 7,618 51,873 510,111 December 31, 2003 III. Changes in Shares Capital and Particulars about the Shareholders (I) Statement of changes in share (Unit: 0000 shares) Increase/decrease in this time (+ , - ) Before the After the Rationed Bonus Capitalization of Additional Others Sub- change change share shares public reserve issuance total I. Unlisted shares 26000 26000 1. Sponsor’s shares 26000 Including: State-owned shares 25980.1 Domestic legal person’s shares 19.9 Foreign legal person’s shares Others 2. Raised legal person’s shares 3. Inner employees’ shares 4. Preference shares or other Total unlisted shares 26000 26000 . Listed shares 14000 1. RMB ordinary shares 2. Domestically listed foreign shares 0 14000 3. Overseas listed foreign shares 4. Other Total listed shares 14000 14000 . Total shares 26000 40000 (II) Particulars about issuance and listing of shares 1. Issuance and listing As approved by China Securities Regulatory Commission with ZJFX Zi [2000] No. 116 document, the Company issued 140 million domestically listed foreign shares with par value RMB 1.00 per share to foreign investors at an issuance price of HKD1.58 per share from Aug. 28 to Sep. 1, 2000. The Company’s 140 million domestically listed foreign shares were listed formally with Shenzhen Stock Exchange for trade on Sep. 12, 2000. - - 4 2. During the report period, there was no changes in the number and structure of the Company’s shares due to bonus share, capital public reserve transferring into share capital, rationed share, additional issuance, combination, convertible company’s bonds transferring shares, disinvestments, listing of inner employees’ shares or company’s employee’s shares, etc.. There exist no inner employees’ shares in the Company. (III) About Shareholders 1. Total shareholders as at the end of the report period At the end of the report period, the Company had totally 23,155 shareholders, including 5 ones of sponsor’s shares (namely Shandong Aviation Group, Luyin Investment Group Co., Ltd., Shandong Hualu Group Co., Ltd., Shandong Fisheries Group Corp. and Langchao Group Corp.) and 23,150 ones of domestically listed foreign shares. Ended Dec. 31, 2003, the top ten shareholders of the Company are as following: No. Increase/ Number of Proportion Type Number of Shareholders’ name decrease in holding (%) shares pledged this year shares (share) or frozen 1 SHANDONG AVIATION GROUP 259204000 64.8 State-owned legal Un-pledged or 0 person’s share un-frozen 2 BAI LING -88000 1077091 0.27 Circulation share Unknown 3 PENG XIU MEI Unknown 950300 0.24 Circulation share Unknown 4 WU HAO YUAN 36400 945700 0.24 Circulation share Unknown 5 JOHN POSS Unknown 937190 0.23 Circulation share Unknown 6 XU ZHAO HUAN 0 608000 0.15 Circulation share Unknown 7 XU QIAN Unknown 500000 0.13 Circulation share Unknown 8 LI WEI GUANG 11000 489985 0.12 Circulation share Unknown 9 GAO QIAO CHENG Unknown 476700 0.12 Circulation share Unknown 10 HE ZHI QIU -16700 450000 0.11 Circulation share Unknown Note 1: Shandong Aviation Group is the Company’s holding shareholder, who holds the shares of the Company on behalf of the State with unlisted shares. Note 2: Among the above the top ten shareholders, there exists no associated relationship between SDA, shareholder of state-owned legal person’s share, and the other shareholders, and it does not belong to the consistent actionist regulated by the Management Regulation of Information Disclosure on Change of Shareholding for Listed Companies with the other shareholders. The Company is not aware of their associated relationship among the other shareholders of circulation share, whether belongs to the consistent actionist regulated by the Management Regulation of Information Disclosure on Change of Shareholding for Listed Companies. 2. The holding shareholder of the Company Name of the holding shareholder: Shandong Aviation Group Legal representative: Jia Fuwen Date of foundation: Feb. 9, 1995 Place of SDA: No. 5746, Er Huan East Road, Lixia District, Jinan, Shandong Business scope: Maintaining of aerostat and surface facilities; handicraft article, souvenir (excluding gold and silver jewelry), sale of general merchandise; accommodation and hotel (Red -crowned Crane Hotel). Registered capital: SDA, the holding shareholder of the Company, changed its registration of industry and commerce dated June 22, 2003, and registered capital was changed from RMB 100,000,000 into RMB 413,375,900. 3. The holding shareholder of SDA and actual controller: Shandong Province Economic Development & Investment Co.. The relevant matters are as follows: Legal Representative: Jiang Yanwei Structure of share equity: the Ministry of Finance of Shandong Province holds 100% equity Date of foundation: Apr. 10, 1992 Business scope: compensated investment in development of science and technology, renovation and circulation of technology; construction of socialize service system between urban and rural area, agriculture comprehensive development and development of education, science, culture and health (excluding socialize fund deposit and loan, finance business and capital construction investment) - - 5 Registered capital: 100,000,000 4. The Company has no shareholders holding over 10% of shares of the Company except for the holding shareholder. 5. Particulars about the top ten shareholders of circulation share No. Name of shareholders Number of shares held at Type of shares held the year-end (share) 1 BAI LING 1077091 B-share 2 PENG XIU MEI 950300 B-share 3 WU HAO YUAN 945700 B-share 4 JOHN POSS 937190 B-share 5 XU ZHAO HUAN 608000 B-share 6 XU QIAN 500000 B-share 7 LI WEI GUANG 489985 B-share 8 GAO QIAO CHENG 476700 B-share 9 HE ZHI QIU 450000 B-share 10 YE NIAN ZHAO 424300 B-share The Company is not aware of their associated relationship among the top ten shareholders of circulation share, whether belongs to the consistent actionist regulated by the Management Regulation of Information Disclosure on Change of Shareholding for Listed Companies. 6. On Feb. 28, 2004, the Board of Directors of the Company received the Notification on SDA Transferred the Partial Equity of Shandong Airlines Co., Ltd. held by SDA from the holding shareholder SDA and Letters on China National Aviation Holding Company Purchased the Equity of SDA and Shandong Airlines Co., Ltd. from China National Aviation Holding Company (hereinafter referred to as CN Air Holding); SDA signed the Agreement on Share Transfer with CN Air Holding dated Feb. 28, 2004, CN Air Holding purchased 22.8% equity of the Company held by SDA, at the same time, Shandong Province Economic Development & Investment Co., the holding shareholder of SDA, signed the Agreement on Equity Transfer with CN Air Holding, CN Air Holding purchased 42% equity of SDA held by Shandong Province Economic Development & Investment Co., and increased investment to hold 48% equity of SDA synchronously. After accomplishment of the above equity transfer, CN Air Holding will become the actual controller of the Company. The aforesaid transfer will become effective after approval by the state relevant department. (The relevant notices were published in China Securities, Securities Times and Ta Kung Pao dated Mar. 2, 2004.) IV. Particulars about Directors, Supervisors, Senior Executives and Employees (I) Directors, Supervisors and Senior Executives Date of Amounts at the Amounts at Name Sex Title Office term Birth year-begin the year-end Dec. 25, 2002 – Li Junhai Male Jan. 1946 Chairman of the Board 0 0 Dec. 24, 2005 Vice Chairman of the Dec. 25, 2002 – Jia Fuwen Male Oct. 1945 0 0 Board Dec. 24, 2005 Zeng Director, General Dec. 25, 2002 – Male Oct. 1953 0 0 Guoqiang Manger Dec. 24, 2005 Director, Standing Su Dec. 25, 2002 – Male Mar. 1954 Deputy General 0 0 Zhongmin Dec. 24, 2005 Manager Director, Deputy Dec. 25, 2002 – Bai Weisan Male Oct. 1957 0 0 General Manager Dec. 24, 2005 Director, Deputy General Manager, Dec. 25, 2002 – Song Yuxia Female Jan. 1956 0 0 General Manager of Dec. 24, 2005 Qingdao Branch Director, Deputy Zheng Dec. 25, 2002 – Male Dec. 1963 General Manager, 0 0 Bao’an Dec. 24, 2005 Secretary of the Board Dec. 25, 2002 – Wang Fuzhu Male Jun. 1953 Director 0 0 Dec. 24, 2005 Wang Zhi Male Nov. 1942 Independent Director Dec. 25, 2002 – 0 0 - - 6 Dec. 24, 2005 Dec. 25, 2002 – Hu Jijian Male May 1942 Independent Director 0 0 Dec. 24, 2005 May 21, 2003 – Li Xiuqin Female May 1963 Independent Director 0 0 Dec. 24, 2005 Wang Convener of the Dec. 25, 2002 – Male Sep. 1953 0 0 Kaixun Supervisory Committee Dec. 24, 2005 Wang Dec. 25, 2002 – Male Mar. 1965 Supervisor 0 0 Wuping Dec. 24, 2005 Supervisor, Team Wang Dec. 25, 2002 – Male Nov. 1965 Leader of the 2nd flying 0 0 Xianlin Dec. 24, 2005 Team Supervisor, Deputy General Manager of Dec. 25, 2002 – Li Jiemin Male Dec. 1956 Beijing Sales 0 0 Dec. 24, 2005 Department, Director of Beijing Station Dec. 25, 2002 – Guo Caisen Male Aug. 1970 Supervisor 0 0 Dec. 24, 2005 Deputy General Mar. 27, 2003 – Yu Haitian Male Sep. 1969 0 0 Manager Dec. 24, 2005 Chief Pilot, Deputy Zhang Dec. 25, 2002 – Male Oct. 1958 General Manager of 0 0 Qingshe Dec. 24, 2005 Qingdao Branch Mar. 27, 2003 – He Guobin Male Jul. 1949 Chief Engineer 0 0 Dec. 24, 2005 Chief Accountant, Dec. 25, 2002 – Li Qing’en Male Aug. 1955 Director of Financing 0 0 Dec. 24, 2005 Dept. Note 1: There was no change in the number of shares held by directors, supervisors and senior executives in the report year. Note 2: Particulars about directors, supervisors holding the post in Shareholding Company Name Name of the Post in the Shareholding Company Draw payment and Shareholding allowance from the Company Shareholding Company (Yes or no) Li Junhai SDA Secretary of Party Committee No Jia Fuwen SDA Chairman of the Board and concurrently Yes President Wang Fuzhu SDA Chief Accountant Yes Wang Kaixun Deputy Secretary of Party Committee, SDA Secretary of Commission for Inspecting Discipline and concurrently Chairman of Yes Labor Union of SDA Wang Wuping SDA Director of the Financing Department Yes (II) Particulars about annual payment The payments of the directors, supervisors and senior executives were determined according to the achievements and results salary system, in which wages is linked with the Company’s benefits. The total payments drew by directors, supervisors and senior executives from the Company were RMB 1,729,800 (including basic wage, reward, welfare, subsidy, housing allowance). The total payments of the top three directors drawing the highest payment were RMB 550,600. The total payments of the top three senior executives drawing the highest payment were RMB 482,400. The allowance of independent directors was RMB 30,000 per year respectively and the independent directors received extra allowance of RMB 400 for every working day. Among directors, supervisors and senior executives drew payment from the Company, 4 enjoy the annual payment over RMB 150,00 respectively, 7 enjoy between RMB 100,000 to RMB 150,000 respectively, and 1 enjoys under RMB 100,000 in the report year. Directors of the Company Mr. Jia Fuwen, Mr. Wang Fuzhu, Convener of the Supervisory Committee Mr. Wang Kaixun, Supervisors of the Company Mr. Wang Wuping and Mr. Guo Caisen received no pay from the Company, however, they drew their payments from SDA, the holding shareholder of the Company. - - 7 (III) Particulars about changes in directors, supervisors and senior executive 1. Director In the report period, due to work change, Director Mr. Gao Zhu submitted the resignation letter to the Board of Directors, which was examined and approved at the 3rd meeting of the 2nd Board of Directors. Mr. Gao Zhu resigned from his post of director. To further perfect the administration structure of the Company, improve the normative operation of the Company and safeguard the interests of vast investors, according to the nomination of holding shareholder SDA, Ms. Li Xiuqin was elected as the independent director of the 2nd Board of Directors at the Shareholder’s General Meeting of the Company dated May 21,2003. (The resume of Ms. Li Xiuqin was published in Securities Times, China Securities and Hong Kong Ta Kong Pao on Apr.19, 2003) 2. Supervisor The Company’s supervisors remained unchanged in the report period. 3. Senior executive (1) As approved by the 2nd meeting of the 2nd Board of Directors, the Company decided to engage Mr. Yu Haitian as Deputy General Manager of the Company, no longer took as the Chief Engineer. (2) As approved by the 2nd meeting of the 2nd Board of Directors, the Company decided to engage Mr. He Guobin as Chief Engineer of the Company. (IV) About staff Ended Dec. 31, 2003, the Company had 1290 employees in total, including 17 graduate students (Master degree and Doctor degree) or above, taking 2% of total employees of the Company; 943 persons graduated from 3-years regular college, taking 74% of total employees of the Company. The staff structure is as follows: Type of employee Number Proportion holding total staff Flight personnel 293 22.7% Aircraft crew and maintenance man 227 17.6% Salespeople 333 25.8% Steward and stewardess (safety person) 263 20.4% Accountant 91 7.1% Others 83 6.4% At present, the Company has three retirees. V. Administration Structure of the Company (I) Particulars about Company Administration Strictly according to Securities Law, Company Law and relevant laws and regulations promulgated by CSRC, the Company perfected consistently the Company’s administration structure, operated the Company in a normative way and improved the construction of modern enterprise management system. According to the opinions on the administration of the Company provided by Jinan Securities Administration Office of CSRC during the inspection on the Company from Aug. 5, 2003 to Aug. 12, 2003, the Board of the Company worked out the entire correcting measures, and revised the Articles of Association pursuant to procedure of law strictly according to the Company Law, Guidelines on the Articles of Association of Listed Companies, the Administration Rules of Listed Companies and other laws and regulations. On the basis of revising the Articles of Association, the Company also amended the Rules of Procedure of the Board of Directors. Compared with Administration Rules of Listed Companies, the administration situation of the Company has a disadvantage that the proportion of independent directors in the constitution of the Board of Directors didn’t reach one third. The Company planed to engage one independent director again and further consummated the special committee to normalize the legal person’s administrative structure. (II) Performance of Independent Directors Since the Independent Directors of the Company, Mr. Wang Zhi, Mr. Hu Jijian and Mrs. Li Xiuqin, took their posts, they fulfilled their duties in an honest, diligent responsible way, researched and studies actively the operation, business development and finance of the Company, supervised patiently over and guided the normative operation of the Company, participated actively in the decision-making of the Board of Directors and expressed independent and objective opinions on the nomination, appointing and removing of directors, engagement and disengagement of senior executives, suggestion and engagement - - 8 of certified public accountants and significant related transactions of the Company. (III) Separation of the Company and holding shareholder in business, personal, assets, organization and finance. The Company and the holding shareholder are separated in business, personal, assets, organization and finance. The Company possesses the independent and complete business and operates independently. 1. In respect of business Engaging principally in passenger and cargo aviation transportation, the Company was independent of its holding shareholder in regard to both business and operation. The holding shareholder had no actions interfering with the Company’s decision-making and operation directly exceeding the Shareholders’ General Meeting and was not involved in the same or similar operation, which fulfilled the commitment of non-competition in the same industry with the Company. 2. In respect of personal The Company operated independently in terms of labor, personal and wage management and has independent organizations and management regulations. The holding shareholder recommended directors and supervisors through legal procedure and didn’t interfered with the decision of appointing and removing on personal by the Board of Directors and Shareholders’ General Meeting. 3. In respect of assets The Company has independent aviation system, auxiliary system, auxiliary facilities, houses and land use right and etc. Meanwhile, the Company has independent and complete production and sales system and conducted independently the purchase of principal aviation materials and sales of passenger and cargo transportation. With regard to the unavoidable related transactions interfering with the holding shareholder in operation, the Company implemented legal procedure in fair, just and open principle and there existed no actions harmful of the interest of the small and medium shareholders. When voting in the Shareholders’ General Meeting, the related shareholders implemented the procedure of obviation strictly according to Article of Association. 4. In respect of organization The Company established perfect legal person administration structure according to relevant regulations of Company Law and set up the Shareholders’ General Meeting, the Board of Directors and the Supervisory Committee in a legal way and operated them in a normative way. The holding shareholder didn’t intervene in the establishment of the Company’s organizations. There was no belongingness relationship between the holding shareholder and its functional departments and the Company and its functional departments. The office and production and operation site of the Company are separated from that of the holding shareholder. 5. In respect of finance The Company has independent finance department and accounting personal and set up independent financial settlement system, financing and accounting system. The Company opened an independent account in bank independently, had independent bank accounts. The Company paid tax independently and has independent taxation registration number. The Company is independent from the holding shareholder in terms of finance. (IV) Evaluation and encouragement mechanism of senior executives According to the internal Regulation on the Integrated Evaluation and Management of Executives, the Company conducted the annual comprehensive evaluation on the senior executives yearly and implemented the wage system where payment was linked with achievements. VI. Brief introduction to the Shareholders’ General Meeting In the report period, the Company held two Shareholders’ General Meeting. (I) 2002 Annual Shareholders’ General Meeting 1. Notification, convening and holding of the Shareholders’ General Meeting On May 21, 2003, the Company held its 2002 Annual Shareholders’ General Meeting on 31/F conference room of SDA Bldg.. The Company noticed the shareholders of the meeting by means of Public Notice, the notification of the meeting was published in China Securities, Securities Times and Hong Kong Ta Kung Pao dated Apr. 19, 2003. 5 shareholders and shareholder’s proxies attended the meeting with representing 260,000,000 shares, taking 65% of total shares of the Company, including 259,801,000 state-owned legal person’s shares, taking 64.95% of total shares of the Company; 199,000 domestic legal - - 9 person’s shares, taking 0.05% of total shares; 0 domestically listed foreign share (B share), taking 0% of total shares of the Company. Chairman of the Board, Mr. Li Junhai presided over the meeting. The directors, supervisors and senior executives of the Company attended the meeting. 2. The resolutions passed by the Shareholders’ General Meeting and the disclosure of public notice on resolutions. Following proposals were examined item-by-item and approved by means of signed vote in the meeting: (1) 2002 Work Report of the Board of Directors of the Company; (2) 2002 Work Report of the Supervisory Committee of the Company; (3) 2002 Financial Settlement Report and 2003 Financial Preplan Report of the Company; (4) 2002 Profit Distribution Plan of the Company; (5) Proposal on Enlarging the Operation Scope of the Company; (6) Proposal on Providing Funds for SDA; (7) Proposal on Leasing four B737-300/700 Airplanes; (8) Proposal in Adjusting the Allowance of the Independent Directors; (9) Proposal on Adjusting Partial Members of the Board of Directors; The resolutions of the meeting were published in China Securities, Securities Times and Ta Kung Pao dated May 22, 2003. 3. Election and changing of Directors and Supervisors The said shareholders’ general meeting elected Ms. Li Xiuqin as independent director of the Company by means of accumulative voting. (II) The 1st Extraordinary Shareholders’ General Meeting 2003 1. Notification, convening and holding of the Shareholders’ General Meeting On Nov. 26, 2003, the Company held its 1st Extraordinary Shareholders’ General Meeting of the year 2003 on 31/F meeting room of SDA Bldg.. The Company noticed the shareholders of the meeting by means of Public Notice, and the notification of the meeting was published in China Securities, Securities Times and Ta Kung Pao dated Oct. 24, 2003. 6 shareholders and shareholder’s proxies attended the meeting with representing 260,322,000 shares, taking 65.08% of total shares of the Company, including 259,801,000 state-owned legal person’s shares, taking 64.95% of total shares; 199,000 domestic legal person’s shares, taking 0.05% of total shares; 322,000 domestically foreign shares (B-share), taking 0.08% of total shares. Chairman of the Board, Mr. Li Junhai presided over the meeting. The directors, supervisors and senior executives of the Company attended the meeting. 2. The resolutions passed by the Shareholders’ General Meeting and the disclosure of public notice on the resolutions. Following proposals were examined item-by-item and approved by means of signed vote in the meeting: (1) Proposal on Dealing with four SAAB Airplanes and Relevant Aviation Materials; (2) Proposal on Adjusting Investment in Jinan International Airport Co., Ltd.; (3) Proposal on Increasing Operation Scope of the Company; (4) Proposal on Reengaging Certified Public Accountants and its Recompense; (5) Supplemental Proposal on Providing Funds for SDA; (6) Proposal on Providing Funds for Rainbow Jet Co., Ltd; (7) Proposal on Revising the Articles of Association of the Company; (8) Proposal on Revising the Rules of Procedure of the Board of Directors; (9) Proposal on Revising the Rules of Procedure of the Supervisory Committee; The resolutions of the meeting were published in China Securities, Securities Times and Ta Kung Pao dated Nov. 27, 2003. VII. Report of the Board of Directors (I) Discussion and analysis to the operation The Company, a civil aviation transport enterprise, belonged to the industry seriously influenced by SARS epidemic. In 2003, facing the complex and changing operating environment with both opportunities and challenges, all staffs of the Company always drew together and struggled with persisting in “Safety and Benefit” as the core, seriously carried out and fulfilled the total guideline for work of “Reinforcing safety, enhancing benefits, implementing adjustment and developing steadily” set - - 10 up at the beginning of the year, strengthened the safety guarantee, enhanced the running efficiency and actively pushed the adjustments to all structures. Facing the market fluctuation caused by sudden SARS epidemic, the Company made quick response and took strong measures, which not only always ensured the normal operation of the Company, but also gained good benefits and realized the objectives of making up the deficits and getting surpluses for the whole year. In the appraisal for top 100 in foreign enterprises in Shandong for 2003, the Company ranked the 13th place. 1. Further reinforcement of safety management level The Company reinforced the training with persons as the base and enhanced the safety consciousness and theoretical technology level of the key personnel. After training, the pass rate of the two English certificates of airmen increased to 99.7% from 77%; aircrew strengthened tackling key technical problems and solved such several technical problems. In the aspect of safety supervision, based on the technical means, the Company made rewards and punishment strict and mobilized the enthusiasm of the production personnel, which effectively guaranteed the safety. In the report period, the Company totally flied 62471 hours in a safe way, guaranteed 40,700 sorties of flights and realized the safe flights for nine years. 2. Further enhancement of operating benefits Facing the sudden influence of SARS epidemic, decrease in price of air tickets, increase in price of oil used for flying and increase in flying-off and landing expenses and all other costs, the Company actively adopted replying measures, changed operating thought, enhanced transport income in unit hour, timely caught the good opportunity in preferential policy for national civil aviation and recovery in market after SARS epidemic and improved the cost control measures through timely starting up all strategies in market sales, which offset the losses and realized profits. In the report period, the Company’s average ordinary shipping rate reached 72.8%, ranking the 1st place in national civil aviation; average ordinary passenger-occupied rate reached 75%, ranking the 2nd place in national civil aviation. 3. Further improvement in service quality In 2003, the Company’s “96777” client service platform with such functions as aviation consultations, sales of air tickets, dynamic consultations in flights and etc. centralized was started up formally, which has enhanced the sales service level greatly. The Company strengthened the construction of frequent passenger club, thus the members holding “Rainbow Card” increased to 231% over the same period of last year. Through establishing demonstration team for refined products, exerting model’s effect by extending from the point to the whole, the Company’s “Rainbow Steward Team” pushed the enhancement of the whole level in passenger cabinet. Their service styles “Criterion, Relative Feeling, Particularity, Precision and Perfection Pursuit” gained recognition from vast passengers and were awarded honorary title “Satisfactory Service Items for National Consumers” by China Association of Quality. In the investigation for service quality sponsored by the Company in 2003, the satisfaction degree of passengers was 84.19%. 4. Further push of structure adjustment In the report period, the Company continued to push the adjustment strategy and gained material progress in the aspect of adjustment to structure of plane team. The Company signed introduction contract for 7 pieces of B737-700 and 800 planes; leased 4 pieces of 737-300 planes for short term, 2 of which was available in the report period, which timely offset the shortage in transport force; conducted lease-back after sales to 4 pieces of SAAB planes and aviation materials; transferred a pieces of CRJ-200 plane to CR Airways. Through a series of adjustment measures, the Company reduced those plane types incurring losses and thus enhanced profitability. 5. Further itemization of internal management In the report period, the Company itemized the management on all links such as operation, established cost control teams, implemented oil saving award, set up the provisions on assessment, rewards and punishment for guaranteeing the punctuality of flights and reinforced the management on such aspects of cost, earnings of flights and punctuality rate etc.. Through normative instruction and system restriction, the Company effectively controlled the productive consumption and oil consumption ton kilometer - - 11 decreased to the lowest level in national civil aviation, which enhanced the operating benefits. (II) Operations in the report period 1. Scope of main operations and their status The Company, is mainly engaged in the business of passenger and cargo aviation transportation within Shandong province and from Shandong province to partial domestic cities as approved by the relevant authority and concurrently is engaged in services and operating projects related to aviation. In the report period, the Company completed total transport turnover volume amounting to 262.03 million ton kilometers, an increase of 4.5% over year 2002 and carried 2,278,000 passengers in a safe way, an increase of 4.9% over the last year. In the report period, the Company realized income from main operations amounting to RMB 1,723,844,877, an increase of 7.97% compared with the corresponding period of the previous year, including revenue from passenger aviation transportation of RMB 1,642,918,044, taking 95.30% of the total income and revenue from cargo and post aviation transportation of RMB 80,088,529, taking 4.65% of the total income. In the report period, the Company also realized an agent income from passenger and cargo aviation transportation of RMB 838,304, taking 0.05% of the total income. According to CAS Graph of Growth in Income from Main Operations 20 17 14 11 8 5 In 2001 In 2002 In 2003 单位:亿元 13.1 16 17.2 Graph of Growth in Total Transport Turnover 30000 25000 20000 15000 10000 5000 In 2001 In 2002 In 2003 万吨公里 18147 25063 26203 2. Operations and achievements of holding and share-holding companies (1) Qingdao International Airlines Logistics Center Co., Ltd. Qingdao International Airlines Logistics Center Co., Ltd. has registered capital amounting to RMB 100 million, where the Company holds its 70% equity. The business scope of this company is: storage and ground distribution of aviation cargo, E-commerce, logistics design and implementation for the third party, consultation and relevant service for logistics business. In the report period, this company realized income from main operations amounting to RMB 42867.17 and net profit amounting to RMB-1775255.11. According to CAS (2) Shandong Airlines Rainbow International Travel Agency Co., Ltd. Shandong Airlines Rainbow International Travel Agency Co., Ltd. has registered capital amounting to RMB 1.60 million, where the Company holds its investment amounting to RMB 784 thousand, taking - - 12 49% of its equity. This company is mainly engaged in the business of in and out border travel and domestic travel. In the report period, this company realized income from main operations after audited amounting to RMB 14,978,187.97 and net profit amounting to RMB 122,269.34. This company conducted distribution according to proportion of 10% with resolutions of Shareholders’ General Meeting. According to CAS (3) Sichuan Airlines Co., Ltd. Sichuan Airlines Co., Ltd. has registered capital amounting to RMB 350 million, where the Company holds its investment amounting to RMB 35 million, taking its 10% equity. This company is mainly engaged in the passenger, freight, mail and luggage transport business and outspread service in domestic, international and local aviation; aviation maintenance and service; manufacture and maintenance in aviation equipments etc.. In the report period, this company realized income from main operations after audited amounting to RMB 1,686,582,300.56 and net profit amounting to RMB 62,096,736.72. According to the resolutions of the Shareholders’ General Meeting of this company held on Mar. 2, 2004, this company conducted distribution according to proportion of 5%. According to CAS (4) China Civil Aviation Information Network Co., Ltd. China Civil Aviation Information Network Co., Ltd. has registered capital amounting to RMB 888.16 million, where the Company holds its investment amounting to RMB 6690 thousand, taking 0.49% of its registered capital. The business scope of this company is contract of engineering projects for software and hardware of computers; research and manufacture, development, production, sales and lease of computer software, hardware, outside equipments and network products and technology consultation and technology service related to the said businesses; commercial information; consultation in tour information. As proclaimed by this company, in the report period, this company realized income from main operations amounting to RMB 893.6 million and net profit amounting to RMB 242.5 million. According to IFRS (5) Shenzhen Hengchi Freight Co., Ltd. The former Shenzhen SDA SEG Freight Co., Ltd. invested by the Company held the meeting of the Board on Feb. 22, 2003. Shenzhen Aosaike Industrial Development Co., Ltd., the investment party, transferred all its 50% equity, 25% of which was accepted by the Company and the rest of which was transferred to Shenzhen Hengjia Investment Development Co., Ltd.. The relevant equity transfer has been completed. The registered capital of this company was RMB 1,800 thousand, where the Company held its investment amounting to RMB 1,766,465, taking its 75% equity. This company was changed formally into Shenzhen Hengchi Freight Co., Ltd.. Ended Dec. 31, 2003, the total assets of this company amounted to RMB 2,809,574.86. In the report period, this company realized income from main operations amounting to RMB 1,178,204.78 and net profit amounting to RMB 241,994.34 . According to CAS (6) Shandong TAECO Aircraft Engineering Co., Ltd. Shandong TAECO Aircraft Engineering Co., Ltd. had registered capital amounting to RMB 41 million, where the Company held its investment amounting to RMB 8.5 million, taking its 12% equity. The business scope of this company was maintenance, examination and repair (depending on service certificate) of civil planes and relevant service. In the report period, this company realized income from main operations and net profit amounting to RMB 52,224,302.9 and RMB 5,316,336.33 respectively after audited. According to CAS (7) Shandong Airlines United Express Co., Ltd. Shandong Airlines United Express Co., Ltd. had registered capital amounting to RMB 1,000 thousand, where the Company held its investment amounting to RMB 650 thousand, taking 65% of its equity. This company is mainly engaged in road transport of ordinary goods and development and sales of computer software. In the report period, this company realized income from main operations and net profit amounting to RMB 282,263.55 and RMB 128,447.00 respectively. According to CAS - - 13 (8) Shandong Airlines Rainbow Jet Co., Ltd. Shandong Airlines Rainbow Jet Co., Ltd. had registered capital amounting to RMB 50 million, where the Company invested with cash amounting to RMB 22.5 million, taking its 45% equity. This company is mainly engaged in the universal aviation business, aviation photography, aerial aviation and official flight in domestic and adjacent countries and areas etc.. In the report period, this company realized income from main operations and net profit amounting to RMB 34,959,981.24 and RMB-48,386,145.61 respectively after audited. According to CAS (9) Jinan International Airport Co., Ltd. According to the resolutions of the 1st Temporary Shareholders’ General Meeting of the Company for 2003, the Company adjusted the investment to Jinan International Airport Co., Ltd. from original investment not more than RMB 100 million to investment with cash amounting to RMB 30 million. In the report period, the said investment was fully funded. Jinan International Airport Co., Ltd. had registered capital amounting to RMB 216 million, where the Company held its 13.89% equity. This company is mainly engaged in the management and service business of passenger airport (For those stipulated by the State laws and regulations in the said operating items, operating depending on licenses); consultation of aviation information; property management and lease of houses, grounds and counters. Ended the end of the report period, its total assets amounted to RMB 541.14 million. According to CAS (10) Guangdong Luhang Trade Co., Ltd. According to Proposal on Writing Off Guangdong Luhang Trade Co., Ltd. considered and passed by the 15th Meeting of the 1st Board of Directors of the Company, the Company has accomplished the issues relevant to writing-off and clearing in the report period. The Company had no any investment earning with influence on net profit by over 10% from individual holding and share-holding companies. 3.Particulars about major suppliers and customers The total amount of purchase of the top five suppliers of the Company took 19.56% of the total annual amount of purchase (mainly is purchase of aviation oil, aviation materials and plane supply products) and the total amount of sales of the top five customers took 13.64% of the total annual amount of sales of the Company 4. Problems and difficulties from operations and their solutions (1) Inconsequence in structure of plane teams Ended the end of the report period, the Company totally operated 24 pieces of planes, including 9 pieces of B737-300, 2 pieces of CRJ-700, 9 pieces of CRJ-200 and 4 pieces of SAAB. The complexity of plane type made the Company’s pressure in safety increase. Moreover, the relatively high proportion in the lateral planes made the Company’s running cost increase. Solution: The Company sped up to push the adjustment to structure of plane teams, exchanged partial lateral planes through such ways as lease transfer, lease-back after sales and etc. and enhanced and introduced B737 series planes with reliable safety and good economic quality. (2) High running cost The tariff for introducing lateral planes was rather high, which increased the original running cost of the Company; introducing planes needed large quantities of capital support, while the simple channels for financing of the Company (majority of capital was from bank loans) made the Company’s financial expenses rank in a high level; in the report period, the price of domestic oil used for aviation climbed up continuously and the airport charges also increased by a relatively large margin over the previous report year, which made the Company’s cost expenditure increase. Solution: While actively adjusting the structure of plane teams, in order to reduce the running cost and enhance the profitability capability, in the aspect of cost control, the Company implemented warning feedback control to daily controllable expenses through reinforcing controllable projects and implementing ordinary management in the course and effectively strengthened the planning and control - - 14 to outlay use. Through learning and tracking to the whole course of flying, aircraft, running, finance and sales of passenger and goods, the cost control teams established practical improvement measures and carried out such controls as aviation materials, aviation oils and expenses controls to all departments, which decreased the running cost. (3) Not gaining expected earnings from part of external investments Qingdao International Airlines Logistics Center Co., Ltd. and Jet Company, invested by the Company, incurred losses in the report period. Moreover, Shandong Airlines Rainbow International Travel Agency Co., Ltd. gained fewer earnings over the last year. Solution: Through strengthening the administration of subsidiaries, the Company enhanced their scientific and reasonable decision-making, strengthened the running management efficiency and financial supervision and pushed the increase of their benefits. At the same time, the Company would continue to adjust the investment structure gradually according to the legal procedures based on the full adjustment and demonstration, in compliance with the changes in the market. (II) Investment 1.Investment of proceeds raised through share offering In the report period, there was no application of proceeds raised through share offering or application of proceeds raised through previous share offering continued to the report period in the Company. 2. Investment of proceeds not raised through share offering In the report period, the Company did not increase any new investment project by carrying out the principle of controlling external investments established at the beginning of the year. (IV) Financial position of the Company 1. Financial position and reasons of changes(According to IFRS) Increased Increase Items 2003 2002 amount proportion RMB’000 RMB’000 (+/-)RMB’000 (+/-,%) Total assets 3,952,026 3,242,060 709,966 21.90 Property, plant and equipment 2,696,747 2,432,213 264,534 10.88 Bank loans - due within one 1,977,146 1,220,219 756,927 62.03 year Finance costs 136,539 125,513 11,026 8.78 General and administration 59,937 38,639 21,298 55.12 Shareholders’ equity 510,111 438,743 71,368 16.27 Profit from operations 209,392 62,736 146,656 233.77 Net profit for the year 71,368 -80,384 151,752 -188.78 Obligations under finance 555,564 681,136 -125,572 -18.44 leases - due after one year Net increase in cash and cash 24,505 164,382 -139,877 -85.09 equivalents Main reason of change Items Cause of the changes Total assets Purchase of planes and relevant equipments Property, plant and equipment Purchase of planes and relevant equipments Bank loans increased for supplementing the Bank loans - due within one year circulating funds ,purchase and investments. Finance costs Increase in bank loans General and administration Enlargement of operating scale - - 15 Shareholders’ equity Profitability in the period Profit from operations Decrease in operating cost, increase in flight earnings and tax exemption during the period of SARS epidemic Net profit for the year Decrease in operating cost, increase in flight earnings and tax exemption during the period of SARS epidemic Obligations under finance leases - due after one year Payment of rent for financing lease Net increase in cash and cash equivalents Increase in cash outflow for investing activities 2. Changes in accounting policies and accounting estimate and their influences In the report period, there were not changes in accounting policies and accounting estimate according to the International Financial Reporting Standards (“IFRS”). (V) Influence of changes in productive and operative environment, macro-policies and regulations on the Company 1. In the first half of year 2003, SARS epidemic brought serious strike on the domestic market of aviation transport, thus the Company lost many clients and was forced to reduce the flights. During April to June, the number of passengers carried by the Company was only 55.8% over the same period of last year and the income decreased by a large margin, for instance, the income from main operations decreased by RMB 146 million just between May to June. In order to reduce the losses caused by SARS epidemic to the minimum, the Company timely adopted the decisive measures: Firstly, to reinforce the safety prevention, which ensured the safety flying and the Company’s normal operating order; Secondly, to leave no stone unturned to increase the earnings by “Supplementing passengers with goods” under the situation that the passenger sources were reduced and to strengthen the development in freight business, which made the freight business increase by 9.2% during April to May over the same period of last year; Thirdly, to centralize the staff to study and to be trained in order to enhance the business quality of flight personnel and aircrew, enhance the maintenance quality of planes and reduce the failure rate, which made the Company’s punctuality rate of flights increase by 10% over the same period of last year; Fourthly, to catch the opportunity to improve the line layout. Through efforts of various parties, the Company pioneered the bases for staying over in Dalian and Hongqiao, Shanghai, which pushed the CRJ type to be permitted for entering into Guangzhou Baiyun Airport; gained operating rights in international lines and passed international operating certification of general aviation carriers, beneficial for expanding the operating fields and improving the line network, which made the Company timely catch the good opportunity of market rebound after SARS epidemic, recovery the production quickly and gain good earnings. In order to reduce the losses caused by SARS epidemic on aviation transport enterprises, Ministry of Finance of the P.R.C. released the preferential policy of exempting the funds of civil aviation and the Company strived for tax preferential and discount loan preference of exempting the passenger transport business operating tax from Shandong Provincial Government since May 1. The said policy played an active role to the Company’s reducing losses. 2. In the report period, the general bureau’s restricting the by-staying flights of non-base aviation companies in 15 key cities influenced on the Company’s line layout, thus difficulties in market sales increased. In order to develop market resources as much as possible, on the one hand, the Company strengthened the market promotion, expanded the network of direct distribution and consolidated and enhanced the market share in Shandong; on the other hand, the Company adjusted the line layout in a reasonable way, planned the line network in a reasonable and flexible way with all bases as the core, has opened the line from Qingdao to Macao combining the examination and approval of international operating right and prepared to open such international and local lines as from Qingdao to Qingzhou, from Qingdao to Fushan and from Qingdao to Hong Kong etc.. The Company also reinforced in developing freight market through developing various business cooperation, improved the flight earnings management and enhanced the passenger-occupied rate and earnings level. - - 16 3. In the report period, the three large aviation groups have finished combined reorganization basically and have realized optimization and integration of all resources. At the same time, the reform project of price for tickets in civil aviation would also be released after continuous amendment and improvement for over one year. Along with more competition mechanism’s introducing into the market, the competition in civil aviation market would be more abundant. The Board of Directors of the Company fully understood that the reinforcement of the comprehensive strength and the enhancement of market competitive force was the only way for the Company to gain living and development in the intense competition and thus established the development planning and detailed business plan (For details, please refer to Clause VIII in this section). The Board of the Company would diligently perform its duties in order to ensure the said plan to be implemented effectively. (VI) Explanation of the Board on interpretative explanation paragraph in the auditors’ report In 2003, Deloitte Touche Tohmatsu Certified Public Accountants (HK)presented auditors’ report with interpretative explanation paragraph with details as follows: “Without qualifying our opinion we draw attention to note 2 to the financial statements which explains that the Group is dependent upon the support of its bankers and in particular on the renewal of existing, and the obtaining of new, bank loan facilities within the next twelve months. Provided that the bankers continue to support the Group, the directors are satisfied that the Group will have sufficient financial resources to meet in full its financial obligations as they fall due for the foreseeable future. Accordingly, the financial statements have been prepared on a going concern basis.” The Board thinks the interpretative explanation from Deloitte Touche Tohmatsu Certified Public Accountants Ltd. in an objective way. However, the Board of the Company has predicted the Company’s profitability and cash flow in the next year, ensuring the Company has enough running capital for sustainable operation and pays the capital commitments signed; the Board of the Company shall improve the cash flow status through such means as adjusting the plane teams;the main loaning banks have promised to support the Company continually;SDA Group, the Company’s controlling shareholder, has committed to refund all arrearages to the Company with the payment gained from the equity transfer before June 30, 2004. To sum up, the Board thinks the Company’s status of cash flow shall be improved greatly in 2004, which shall not impact on the Company’s operation. (VII) Business plan for year 2004 The Board of the Company predicted along with the steady growth in national economy in 2004 and upgrading of the consumption structure of citizens, the civil aviation market was hopeful to keep stable growth, while under the market environment that the three large aviation groups have finished resources integration, the market competition faced by the Company would also be more brutal. In order to keep the Company’s complete, coordinate and sustainable development, the Board would develop by making safety technology contents high, service quality excellent, economic benefits good and human resources fully exerted with reform as the drive, with improving modern enterprise system as the good chance and with resources optimization and structure adjustment as the means and established detailed measures for implementation. 1. To push the legal, standardized and scientific safety management with persons as bases. Firstly, base on improving the flight quality supervision and control system, aircraft MES system and internet preparation system, the Company developed the information system construction completely; Secondly, the Company continued to promote tackling key problems with science and technology, enhanced the level in flight and maintenance and reinforced the implementation and supervision of criterion and regulations combining the improvement in ISO 9001 quality system, which guaranteed the safety and realized the safety flying for 10 years. 2. To continue implementing adjustment strategy and firmly push the adjustment in structure of plane teams. According to the line network layout with the trunk as the core and trunk and lateral as the combination constructed by the Company, the reasonable structure of plane teams which could meet short, middle and long lines and adapt to various market demand was gradually formed, which enhanced the - - 17 general planning of the Company’s core competitive force. The Company planned to lease 4 to 6 pieces of B737-300 in short term to increase transport force before 7 pieces of B737-700/800 being fully funded in 2005. To continue to seek for cooperation parties and lease or sell CRJ planes. Moreover, according to the authorization, the Company actively helped the owners of SAAB planes to sell four pieces of SAAB so as to further optimize the structure of plane teams and reduce the operating costs. 3. To fully dig potential advantages and enhance the market competitive force. The Company has established five strategies for market development including base layout, line network, earnings management, direct distribution of customers and competitive cooperation, namely, in the aspect of base layout, to consolidate Jinan, reinforce Qingdao, develop Yantai and construct the base layout with regional advantage in Shandong; in the aspect of line network layout, to consolidate the old brands with trunk as the core and lateral as the supplement, create new brands, expand international business and strive for opening 1 to 2 international and local lines again in 2004; in the aspect of earnings management, do the market prospect well, reinforce the marginal earnings and do the berth management well; in the aspect of customer direct distribution, create 96777 customer service platform, reinforce the network construction of direct distribution and develop the business of ordinary passengers; in the aspect of competitive cooperation, while push the equity transfer between SDA and CATIC Group, the Company would develop a serious business cooperation with CATIC Group and realize resources share. Through such ways as code share and share of sales network etc., to enlarge the Company’s market share and increase the income of flights. 4. To establish the service marketing concept and create the Company’s service brands. In the aspect of cabin service, the Company studied and learned the experiences from excellent companies, researched and analyzed the customers’ demand, pushed the individualized and diversified service and reinforced the brand image of “Rainbow Aircraft Team”; in the aspect of commercial sales, the Company continued to improve 96777 passenger service telephones and rainbow ordinary passenger club business; in the aspect of ground guarantee, the Company strictly implemented Provisions on Guaranteeing Normal Flights and Provisions of Rewards and Punishment on Enhancing the Punctuality Rate of Flights, tried its best to enhance the punctuality rate of flights, strived for making the Company’s punctuality rate reach the leading level in civil aviation industry and established the excellent service brand image of “Safety, Punctuality and Meticulosity” of SDA. The Board would really carry out all work measures with “Making SDA rich and strong” and go all out to strive for the Company’s general benefits improving again based on year 2003 in 2004. (VIII) Routine work of the Board of Directors 1.The Board of Directors of the Company totally held six meetings in 2003 (1) On Mar. 27, 2003, the Company held the 2nd Meeting of the 2nd Board of Directors. 11 Directors should be present while actually 9 attended the Meeting. Directors Mr. Gao Zhu and Mr. Su Zhongmin were not present and respectively authorized Directors Mr. Li Junhai and Mr. Zheng Bao’an as their representatives. All Supervisors and other Senior Executives of the Company attended the Meeting as nonvoting delegates. The meeting was presided by Chairman of the Board Mr. Li Junhai. The following resolutions were examined and approved in the Meeting: a) Annual Report 2002 and its Summary; b) Work Report 2002 of the Board of Directors; c) Work Report 2002 of General Manager; d) Financial Settlement Report 2002 and Financial Budget Report 2003; e) Profit Distribution Preplan 2002; f) Proposal on Financing to Shandong Airlines Group Co., Ltd.; g) Proposal on Expanding Business Scope of the Company; h) Proposal on Leasing four B737-300/700 Airplanes; i) Proposal on Altering the Lease Object of a CRJ-200 Airplane; j) Proposal on Adjusting Allowance of Independent Directors; k) Proposal on Adjusting Part of Senior Executives. The public notice of the resolutions of the meeting was published on China Securities, Securities Times - - 18 and Hong Kong Ta Kung Pao dated Mar. 28, 2003. (2) On Apr. 17, 2003, the Company held the 3rd Meeting of the 2nd Board of Directors. 11 Directors should be present while actually 9 attended the Meeting. Directors Mr. Gao Zhu and Ms. Song Yuxia were not present for some business reasons and respectively authorized Directors Mr. Jia Fuwen and Mr. Zheng Bao’an as their representatives. Supervisors and other Senior Executives of the Company attended the Meeting as nonvoting delegates. The meeting was presided by Chairman of the Board Mr. Li Junhai. The following resolutions were examined and approved in the Meeting: a) 1st Quarterly Report in 2003; b) Proposal on Adjusting Partial Members of the Board of Directors; c) Proposal on Holding Annual Shareholders’ General Meeting 2002 of Shandong Airlines Co., Ltd. (3) On Jun. 20, 2003, the Company held the 4th Meeting of the 2nd Board of Directors. 11 Directors should be present while actually 10 attended the Meeting. Director Mr. Su Zhongmin was not present for some reasons and authorized Director Mr. Zheng Bao’an to act as his representative. Supervisors and other Senior Executives of the Company attended the Meeting as nonvoting delegates. The meeting was presided by Chairman of the Board Mr. Li Junhai. The following resolutions were examined and approved in the Meeting: a) Proposal on Disposing Four SAAB Airplanes and Relevant Aviation Material; b) Proposal on Adjusting Investment to Jinan International Airport Co., Ltd.; c) Proposal on Abandoning Preferential Purchase Right of the Investment of Qingdao International Airlines Logistics Center Co., Ltd.; d) Proposal on Expanding the Company’s Business Scope; e) Proposal on Establishing Part of Ticket Offices. The public notice of the resolutions of the meeting was published on China Securities, Securities Times and Hong Kong Ta Kung Pao dated Jun. 21, 2003. (4) On Aug.13, 2003, the Company held the 5th Meeting of the 2nd Board of Directors. 11 Directors should be present while actually 10 attended the Meeting. Independent Director Mr. Wang Zhi was not present for some reasons and authorized another Independent Director Mr. Hu Jijian to act as his representative. Supervisors and other Senior Executives of the Company attended the Meeting as nonvoting delegates. The meeting was presided by Chairman of the Board Mr. Li Junhai. The following resolutions were examined and approved in the Meeting: a) Semi-annual Report 2003 of Shandong Airlines Co., Ltd.; b) Proposal on Altering Principals of the Company’s Sales Department and Ticket Offices; The public notice of the resolutions of the meeting was published on China Securities, Securities Times and Hong Kong Ta Kung Pao dated Aug.14, 2003. (5) On Sep.11, 2003, the Company held the 6th Meeting of the 2nd Board of Directors. 11 Directors should be present while actually 9 attended the Meeting. Chairman of the Board Mr. Li Junhai went abroad for some business reasons and authorized Vice Chairman of the Board Mr. Jia Fuwen to preside the meeting instead. Director Mr. Su Zhongmin was out for some business reason and authorized Director Mr. Zheng Bao’an as his representative. Supervisors and other Senior Executives of the Company attended the Meeting as nonvoting delegates. The following resolutions were examined and approved in the Meeting: a) Correction Report of Circuit Check of Shandong Airlines Co., Ltd.; b) Proposal on Further Adjusting Structure of Airplane Team and Preparing to Import ARJ21 Branch Airplanes. The public notice of the resolutions of the meeting was published on China Securities, Securities Times and Hong Kong Ta Kung Pao dated Sep.11, 2003. (6) On Oct.22, 2003, the Company held the 7th Meeting of the 2nd Board of Directors. 11 Directors should be present while actually 10 attended the Meeting. Director Mr. Su Zhongmin was not present for some business reasons and authorized Director Mr. Zheng Bao’an to act as his representative. Supervisors and other Senior Executives of the Company attended the Meeting as nonvoting delegates. The following - - 19 resolutions were examined and approved in the Meeting: The meeting was presided by Chairman of the Board Mr. Li Junhai. The following resolutions were examined and approved in the Meeting: a) Proposal on Reengage Certified Public Accountants and their reward; b) Proposal on Amending the Articles of Association of the Company; c) Proposal on Amending Discussion Rules of the Board of Directors; d) Self-check Report on Current Capital between the Company and its Related Parties and the Company’s External Guarantee and the Correction Plan; e) Proposal on Purchasing aviation material Storage of Shandong TAECO Aircraft Engineering Co., Ltd.; f) Proposal on Financing to Shandong Airlines Group Co., Ltd.; g) Proposal on Converting the Fund Occupied by Related Parties to Investment of Shandong Aviation Rainbow Official Airplane Co., Ltd.; h) Proposal on Financing to Shandong Aviation Rainbow Official Airplane Co., Ltd.; i) Proposal on Holding the 1st Provisional Shareholders’ General Meeting in 2003; The public notice of the resolutions of the meeting was published on China Securities, Securities Times and Hong Kong Ta Kung Pao dated Oct.23, 2003. 2.The implementation of the resolutions of Shareholders’ General Meeting by the Board of Directors In the report period, as per the requirements of the relevant laws and regulations of Company Law, Securities Law and Articles of Association, the Board of Directors of the Company earnestly implemented all resolutions approved by Shareholders’ General Meeting strictly in compliance with the resolutions and authorization of Shareholders’ General Meeting. (1) The implementation of profit distribution of the Company of 2002 According to Profit Distribution Preplan 2002 approved by Annual Shareholders’ General Meeting 2002 held on May 21, 2003, the Company planned not to implement share distribution and convert public reserve into share capital in 2002. (2) The Board of Directors strictly implemented other resolutions approved by the Shareholders’ General Meeting. (IX) Profit distribution preplan or preplan on converting capital public reserve into share capital Audited by Deloitte Touche Tohmatsu Certified Public Accountants as per International Accounting Standards and Deloitte Touche Tohmatsu Certified Public Accountants Ltd. as per Chinese Accounting Standards, the Company realized a net profit of 71,368 thousand RMB and 26,531 thousand RMB respectively. As the Company realized a loss of 45,584 thousand RMB in Year 2002,it was not withdrew as statutory public reserve and statutory welfare fund.based on The Articles of Association. Considering the actual situation of the Company’s cash flow, the Board would neither distribute profits nor convert reserve into share capital in 2003 so as to keep the sustainable, stable and healthy development of the Company. This profit distribution preplan should be submitted to Annual Shareholders’ General Meeting 2003 for examination and approval before its implementation. (X) Special explanation of CPA on the capital occupied by the Company’s controlling shareholder and other related parties To the Board of Shandong Airlines Co., Ltd.: We has audited the balance sheet as of Dec. 31, 2003 and income statement and cash flow statement for the year then ended of Shandong Airlines Co., Ltd. (hereinafter referred to as the Company) according to Independent Auditing Standards of Chinese CPA and presented auditors’ report without reservation with DTTR(A) No. P0 document in Mar. 2004. According to the requirements in Circular on Standardizing Listed Companies’ Capital Current with Related Parties, External Guarantees and Other Several Problems released by CSRC and State-owned Assets Supervision and Administration Commission of the State Council, the Company has prepared Investigation Form of Capital Occupation of the Company (hereinafter referred to as Investigation Form) ended Dec. 31, 2003 listed in the appendix of the Letter. The Company is responsible for truly preparing for and disclosing Investigation Form out and is also liable for ensuring its truthfulness, legality and - - 20 completeness. We have checked the materials carried in the Investigation Form and the accounting materials rechecked in the financial report of the Company in 2003 audited by us and contents related to the financial report after audited and have found no difference in all material aspects. Except for implementing the auditing procedures relevant to the related transactions implemented in the audit of accounting statements for 2003 to the Company, we do not implement extra auditing procedures to the materials carried in the Investigation Form. The Letter is only used by the Company for submitting particulars about capital occupied by the controlling shareholder and other related parties in 2003 to CSRC and can not be used for any other purposes without written agreement from us. Appendix: Investigation Form of Capital Occupation of Shandong Airlines Co., Ltd. Appendix: Investigation Form of Capital Occupation of Shandong Airlines Co., Ltd. (Ended Dec. 31, 2003) Capital occupied Related Names of related parties Relationships Amount Accounting Ending-balan Remarks transactio subjects ce at the year ns Borrowing capital Borrowing Shandong Airlines Group Controlling 132,543,002 Other 79,771,947 With capital Co., Ltd. shareholder receivables compensation/rec eiving capital occupation fee amounting to RMB 1,154,185 at 1.98% (annual interest rate) Entrusted loan Naught Entrusting related Naught parties to invest Opening trade Naught acceptance without true trade Refunding Naught liabilities for other companies Others (such as Advance paying expenses in paying for others in expenses advance) Shandong Airlines Group Controlling 35,549 Other 58,771,947 With Co., Ltd. shareholder receivables compensation/rec eiving capital occupation fee amounting to RMB 1,154,185 at 1.98% (annual interest rate) Shandong TAECO Subsidiary 102,790 Other Aircraft Engineering Co., belonging to receivables Ltd. the same controlling shareholder Shandong Airlines Subsidiary 231,262,580 Other 1,962,484 Volunteer Rainbow Jet Co., Ltd. belonging to receivables the same controlling shareholder Shandong International Subsidiary 2,967,070 Other 451,651 Volunteer Aviation Training Co., belonging to receivables Ltd. the same controlling shareholder - - 21 Shandong Airlines Subsidiary Other Volunteer Qingdao Foods Co., Ltd. belonging to - receivables 5,390 the same controlling shareholder Shandong Aviation Subsidiary Other Volunteer Building Administration belonging to 371,524 receivables 233,341 Co., Ltd. the same controlling shareholder Shandong Xiangyu Subsidiary Other Volunteer Aviation Technology belonging to - receivables 37,242 Service Co., Ltd. the same controlling shareholder Qingdao Feisheng Subsidiary Other Volunteer International Aviation belonging to 913,421 receivables 1,084,104 Technology Training Co., the same Ltd. controlling shareholder Shandong Aviation Associated Other Volunteer Rainbow International company 34,665 receivables 2,160 Travel Agency Co., Ltd. Accepting service Shandong TAECO Subsidiary Other Maintenan Aircraft Engineering Co., belonging to 31,541,547 payables 6,725,932 ce expense Ltd. the same of controlling airplanes shareholder Flight Shandong Jinping Subsidiary Other pantry Aviation Foods Co., Ltd. belonging to 10,762,606 payables 2,088,948 the same controlling shareholder Flight Shandong Airlines Subsidiary Other pantry Qingdao Foods Co., Ltd. belonging to 6,006,719 receivables the same controlling shareholder Rent of Shandong Airlines Group Controlling Other office Co., Ltd. shareholder 1,576,733 receivables buildings Shandong Airlines Group Controlling Other Comprehe Co., Ltd. shareholder 3,124,867 receivables nsive service expense Lease of Shandong Airlines Group Controlling Other airplanes Co., Ltd. shareholder 1,002,200- receivables and engines Daily Shandong Airlines Group Controlling Other accommod Co., Ltd. shareholder 2,280,657 receivables ation expense Daily Shandong Aviation Subsidiary Other accommod Building Administration belonging to 1,673,735 receivables ation Co., Ltd. the same expense controlling shareholder Agency Shandong Aviation Associated Accounts expenses Rainbow International company 150,000 payable 150,000 Travel Agency Co., Ltd. Training Qingdao Feisheng Subsidiary Other expenses International Aviation belonging to 9,429,459 payables - Technology Training Co., the same Ltd. controlling shareholder - - 22 Training Shandong International Subsidiary Other expenses Aviation Training Co., belonging to 8,823,839 payables - Ltd. the same controlling shareholder Purchasing assets Purchasing Shandong Airlines Group Controlling Other fixed Co., Ltd. shareholder 2,320,000 payables - assets Shandong TAECO Subsidiary Other Purchasing Aircraft Engineering Co., belonging to 2,556,737 payables - fixed Ltd. the same assets controlling shareholder Providing service Income Shandong International Subsidiary Other from lease Aviation Training Co., belonging to - receivables - of Ltd. the same airplanes controlling shareholder Income Shandong International Subsidiary Other from lease Aviation Training Co., belonging to - receivables - of fixed Ltd. the same assets controlling shareholder Capital Shandong Airlines Group Controlling Other use Co., Ltd. shareholder 1,154,185 receivables expense Rent of Shandong Airlines Group Controlling 841,296 Other office Co., Ltd. shareholder receivables buildings Income Shandong Airlines Subsidiary Other from air Rainbow International belonging to 5,263,072 receivables - tickets Travel Agency Co., Ltd. the same controlling shareholder Lease Shandong Airlines Subsidiary Other transfer of Rainbow Jet Co., Ltd. belonging to 47,365,777 receivables - airplanes the same and controlling relevant shareholder aviation materials (XI) Special explanations and independent opinions of independent directors on the Company’s accumulated and current external guarantees and relevant particulars about the Company’s implementing Circular on Standardizing Listed Companies’ Capital Current with Related Parties, External Guarantees and Other Several Problems The Company’s independent directors Mr. Wang Zhi, Mr. Hu Jijian and Ms. Li Xiuqin signed Explanations and Independent Opinions on Relevant Conditions of the Company’s Implementing Circular on Standardizing Listed Companies’ Capital Current with Related Parties, External Guarantees and Other Several Problems with whole text as follows: The independent directors of Shandong Airlines Co., Ltd. now explain the condition relevant to the Company’s implementing Circular on Standardizing Listed Companies’ Capital Current with Related Parties, External Guarantees and Other Several Problems as follows: 1. Capital current of the related parties (1) Ended Dec. 31, 2003, Shandong Airlines Group Co., Ltd., the controlling shareholder of the Company, still owed RMB 80,771,900 to the Company. SDA Group presented Refundment Plan and Commitment on Dec. 15, 2003 and committed to refund all arrearages to the Company with the payments gained from - - 23 the transfer of partial equity of the Company held by it. We expressed opinions on Feb. 29, 2004 and considered that “The plan made by SDA Group on Dec. 15, 2003 that it would repay all its arrearage to the Company before June 30, 2004 is practical and workable, which can ensure the Company shall receive relevant arrearages as scheduled, not harming the interests of the Company.” According to the materials provided by the Company, SDA Group refunded RMB 10 million to the Company on Mar. 9, 2004 after receiving the 1st payment for equity transfer. (2)The Company has started to strictly control the payment of capital in advance for the controlling shareholder and related parties in accordance with relevant provisions. (3) Shandong Airlines Rainbow Jet Co., Ltd., a related party of the Company, refunded all its arrearages to the Company in Nov. 2003; At the same time, we have examined Auditors’ Report 2003 of the Company, where the Company should receive RMB 1,962,500 from Jet Co., Ltd. ended the end of the report period, which was the normal current account between the both parties. 2. External guarantees of the Company After being audited, the Company did not conduct any guarantee for others. 3. Independent opinions Based on the said condition, we considered the Company has implemented Circular on Standardizing Listed Companies’ Capital Current with Related Parties, External Guarantees and Other Several Problems and the capital current between the Company and its controlling shareholder and its related parties is oriented to be standardized gradually, which is beneficial for safeguarding the interests of the Company and all shareholders. VIII. Report of the Supervisory Committee (I) Particulars about work of Supervisory Committee In 2003, the Supervisory Committee exerted the duties authorized by Company Law of the P.R.C. and the Articles of Association of the Company according to laws, dutifully implemented supervision functions on the Company’s operation in the period and seriously safeguarded the rights and interests of the shareholders. The Supervisory Committee attended all shareholders’ general meetings and meetings of the Board as nonvoting delegates in 2003. The Supervisory Meeting held 4 meetings in the report period and the average attending rate of the supervisors reached 90%. It considered such issues as the Company’s financial budget and settlement report, quarterly report, plan on production and operation, amending rules of procedure of the Supervisory Committee and etc. and formed resolutions. For the related transactions between the Company and its controlling shareholders and subsidiaries, the Supervisory Committee especially requested the Board to pay attention to them and made special resolutions. Implementation Opinion on Reinforcing the Normative Operation of the Supervisory Committee was passed so as to further standard the operation of the Supervisory Committee, who dispatched its members to participate the annual auditing of the Company so as to further strengthen the supervision. In 2003, the Supervisory Committee totally held four meetings 1.On Mar. 27, 2003, the 2nd meeting of the 2nd Supervisory Committee was held in the meeting room of SDA Building. The meeting was presided by the Supervisory Committee caller Mr. Wang Kaixun. 5 supervisors should be present and actually 4 were present. The meeting examined and approved Supervisory Committee Work Report 2002 and Financial Settlement Report 2002 and Budge Report 2003. (The public notice of the resolutions was published on China Securities, Securities Times and Hong Kong Ta Kung Pao dated Mar.28, 2003). 2.On Aug. 13, 2003, the 3rd meeting of the 2nd Supervisory Committee was held in the meeting room of SDA Building. The meeting was presided by the Supervisory Committee caller Mr. Wang Kaixun. 5 supervisors should be present and actually 4 were present. The meeting examined and approved Shandong Airlines Co., Ltd. Semi-annual Report in 2003. The Supervisory Committee asked the Board of Directors of the Company to pay attention to such problems as the fund of the Company occupied by that Shanghang Group and other accounts receivable of Shandong Aviation Rainbow Official Airplane Co., Ltd. (The public notice of the resolutions were published on China Securities, Securities Times and - - 24 Hong Kong Ta Kung Pao dated Aug.14, 2003). 3.On Oct.22, 2003, the 4th meeting of the 2nd Supervisory Committee was held in the meeting room of SDA Building. The meeting was presided by the Supervisory Committee caller Mr. Wang Kaixun. 5 supervisors should be present and actually 5 were present. Independent Directors attended as nonvoting delegates. The meeting examined and approved Proposal on Amending Discussion Rules of the Supervisory Committee (The public notice of the resolutions were published on China Securities, Securities Times and Hong Kong Ta Kung Pao dated Oct.23, 2003). 4.On Nov.26, 2003, the 5th meeting of the 2nd Supervisory Committee was held in the meeting room of SDA Building. The meeting was presided by the Supervisory Committee caller Mr. Wang Kaixun. 5 supervisors should be present and actually 5 were present. The contents of the meeting are as follows: (1) Organized to study the relevant training files of the Supervisory Committee of listed companies in the ruling area of Jinan Collection and Management Office of CSRC, the Supervisory Committee of the Company decided to strengthen Supervisory Committee Institutional Construction, increase its normative operation and strengthen its supervisory function according to the Guide Opinions on Strengthen the Normative Operation of Supervisory Committee of Listed Companies in the Ruling Area in Jinan Collection and Management Office. (2) The meeting examined and approved Implementation Opinions on Strengthen Normative Operation of Supervisory Committee of Shandong Airplanes Co., Ltd.. (3) The meeting approved Supervisor Mr. Guo Caisen as the secretary of the Supervisory Committee of the Company and in charge of recording the meeting of the Supervisory Committee, keeping the files of Supervisory Committee and collecting files of the Company, etc.. (II) Independent Opinions of the Supervisory Committee on relevant events in 2003 The Supervisory Committee conducted serious inspection and supervision on such conditions as the Company’s finance, implementing resolutions of shareholders’ general meeting, operating decision-making, operation according to laws, operating behaviors of directors, managers and senior executives and related transactions etc.. 1.Operation according to laws In the report period, the Company conducted regulated operation complying to Company Law, Securities Law, Articles of Association of the Company, and Rules for Shares Listed with Shenzhen Stock Exchange and other national relevant policies and regulations. It implemented effective internally control system in the inside of the Company. Following the regulations and laws and being honest with faith and diligence, directors and senior executives of the Company carefully implemented every resolutions approved by shareholders’ general meeting with a view to protecting the shareholders’ interests. There was no such situation that directors or senior executives broke the laws, regulations, or Articles of Association or harmed the interests of the Company in their office term. 2.Inspection of finance The Supervisory Committee examined patiently and meticulously the financing situation of the Company. In opinion of the Supervisory Committee, 2003 Financial Report of the Company reflected the financing situation and operation result of the Company. The accountant materials as accountant vouchers, books and statements were genuine and standard. Deloitte Touche Tohmatsu Certified Public Accountants and Deloitte Touche Tohmatsu Certified Public Accountants Ltd. audited 2003 financial report of the Company respectively according to international and domestic accounting standards and issued auditor’s non-reservation opinion with explanation. The Supervisory Committee thought that the Company’s financing situation and operation result truly, objectively and accurately. 3.Purchase and sale of assets The trading prices for purchase or sales of assets of the Company were reasonable. Neither inside trading has been found, nor there occurred damage of the interests and rights of some shareholders or loss of the Company’s assets. - - 25 4.Related transactions The Company conducted related transactions strictly according to market principle in fair and juristic way. The price of the transactions was reasonable. The informationg disclosure was in-time and effective,and disclosing-information was true,accurate and complete.The Company vindicated the interest of the shareholders and listed company. 5. Opinions of the Company’s Board of Directors on relevant events in the auditing report with non-reservation opinions with explanation issued by Deloitte Touche Tohmatsu Certified Public Accountants and Deloitte Touche Tohmatsu Certified Public Accountants Ltd. The Board of Directors of the Company has explained on the issues involved in the auditors’ report with interpretative explanations presented by Deloitte Touche Tohmatsu Certified Public Accountants Ltd. and the Supervisory Committee has examined the said explanation. The Supervisory Committee considered the relevant explanations of the Board on the issues involved in the auditors’ report with interpretative explanations presented by Deloitte Touche Tohmatsu Certified Public Accountants Ltd. were true and reasonable and the project of the Management on solutions in keeping the Company’s sustainable development involved in the explanation was workable and proper, which could improve the Company’s financial status and safeguard the interest of the Company and the interests of vast shareholders, not disobeying laws and regulations and the Articles of Association of the Company and harming the interests of the Company and its shareholders. The Supervisory Committee requested the Board to push SDA Group, its controlling shareholder, to implement the commitment that it shall repay the arrearages to the Company on time. The Supervisory Committee specially requested the Board to pay attention to the problem of the Company’s sustainable operation presented by CPA and to settle it down with planned measures. IX. Significant Events (I) The Company has no significant lawsuits and arbitrations in the report period. (II) Purchase, sale, consolidation and merge of assets in the report period 1. On July 4, 2003, Shandong Airlines Co., Ltd. (hereinafter referred to as the Company) and Shenzhen Financial Leasing Co., Ltd. (hereinafter referred to as Shen Jin Zu) signed Trade Agreement of Four SAAB340B Airplanes and Leasing Agreement of Four SAAB340B Airplanes and the Company would sell four SAAB340B airplanes and associated aviation equipments to Shen Jin Zu as the sale price of RMB 180,000,000. The Company would lease back the airplanes in the way of operation leasing after the sale. This transaction does not belong to related transaction. (The related public notice was published in China Securities, Securities Times and Ta Kung Pao dated July 11, 2003.) 2. According to Proposal on Structure Adjustment of Airplane Team examined and approved by the 1st meeting of the 2nd Board of Directors of the Company, being authorized by National Development & Reform Commission (FGJY[2003]NO. 1562), the Company will introduce into seven B737-700/800 airplanes. (The related public notice was published in China Securities, Securities Times and Ta Kung Pao dated Nov. 8, 2003). The aforesaid purchase, sale, consolidation and merge of assets had no influence on the consistence of business and stability of managers of the Company. (III) Material related transaction At present, there exist related transactions between the Company and control shareholders and its auxiliary companies in some degree that are necessary for the Company and belong to unavoidable related transactions. The Company made full consideration of quality, price and efficiency of the service and product provided by the transaction party and analyzed and compared the market environment before conducting the transactions. The independent directors, independent financing consultant expressed opinions respectively on the related transaction and considered that the Company and related party are in conformity with the principle of publicity, fairness and honesty, the trading price was fair and there existed no actions harmful of the interest of issuer and other shareholders. 1. The Company and its control shareholder invested together To grasp the huge commercial chance from China’s successfully joining in WTO and applying for - - 26 Olympics and improve business enlargement and continuous and health development of Jet Company, according to Proposal on Jointly Reorganizing Shandong Airlines Rainbow Jet Co., Ltd. examined and approved by the 1st meeting of the 2nd Board of Directors of the Company, the Company and its control shareholder-SDA and Hong Kong Zhongfu Airlines Co., Ltd. have finished the reorganization of Jet Company together. The Company invested RMB 22.5 million in cash, taking by 45% of the registered capital; Hong Kong Zhongfu Airlines Co., Ltd. invested RMB 24.5 million in cash, taking by 49% of the registered capital; SDA invested RMB 3 million in intangible assets, taking by 6% of the registered capital. The independent director of the Company, Mr. Hu Jijian, expressed independent opinions on this related transaction. (The related public notice was published in China Securities, Securities Times and Ta Kung Pao dated Mar. 12. 2003). 2. Credits and liabilities between the Company and its control shareholder According to related promise that Shandong Province Finance Bureau and SDA took place to pay civil aviation base construction fund, the 1st Provisional Shareholders’ General Meeting of the Company in 2003 examined and approved the average balance at the month-end of the funds financed to SDA would not exceed RMB 85 million and according to the agreement, the Company would receive some capital usage expense based on related regulation. (The related public notice was published in China Securities, Securities Times and Ta Kung Pao dated Oct. 24, 2003 and Nov. 27, 2003). SDA promised to repay the amount owed to the Company in funds from equity transfer. 3. Credits and liabilities between the Company and its subsidiaries Because the Company introduced into airplanes for Jet Company in place of it and the Company transferred two 604 jets to Jet Company for use and received rent from it as the expense of financial leasing paid for others, it objectively caused the Company’s financing to Jet Company. Being examined and approved by the 1st Provisional Shareholders’ General Meeting of the Company in 2003, the Company agreed to continuously finance to Jet Company according to the need. The transaction is related transaction. (The related public notice was published in China Securities, Securities Times and Ta Kung Pao dated Oct. 24, 2003). Jet Company has repaid the amount owed to the Company in Nov. 2003. (IV) Significant contracts and implementation 1. Assets entrustment, contract and rent (1) On Apr. 2, 2003, the Company and Hong Kong Zhongfu Airlines Co., Ltd. signed the contract of subleasing a CRJ-200LR airplane and the term of subleasing was one year. The item has been replied and agreed by the plain telegram dated June 6, 2003 of Civil Aviation Administration of China. (2) On June 7, 2003, according to Reply on Shandong Airlines Co., Ltd.’s Short-term Financial Leasing of Four B737-300/700 Airplanes of Civil Aviation Administration of China (MHGH [2003] No. 108), the Company and Ireland BELLEVUE Airplanes Leasing Co., Ltd. signed the agreement of short-term leasing of two B737-300 airplanes and the leasing term was not less than 28 months. The two planes have been received on July 22. (3) In July 2003, the two B737-300QC planes the Company leased from AIRPLANES HOLDINGS LIMITED were threw a lease due to expiration of leasing. (4) According to Reply on Introducing into Two CRJ700 Airplanes for Exchanging Two Challenger 604 Jets by Shandong Airlines Co., Ltd. (JJC[2002] No. 1274) of National Development and Planning Commission, the Company signed the agreement of purchasing two CRJ700 airplanes with BOMBARDIER Company of Canada and the two airplanes has been received on Nov. 5, 2003. 2. Significant guarantee. The Company has not provided guarantee for others. 3. In the report period, the Company has not entrusted financing. 4. Other significant contracts Ended the report period, the accumulated amount of long-term and short-term borrowings of the Company was RMB 2,366,761,911. The Company had no other significant contracts not disclosed. (V) The Company has not entrusted anyone to manage its cash assets in the report period. (VI) Commitment Events On Dec. 15, 2003. SDA send Repay Plan and Commitment to the Company and promised to repay the amount owed to the Company in payment from equity transfer before June 30, 2004. In the report period, the Company or shareholders holding over 5% equity has no significant commitment events necessary to be disclosed. - - 27 (VII) Engagement of Certified Public Accountants According to the resolution of the 1st Provisional Shareholders’ General Meeting of the Company for 2003 on Nov. 26, 2003, in the report period, the Company continued to engage Deloitte Touche Tohmatsu Certified Public Accountants Ltd. and Deloitte Touche Tohmatsu Certified Public Accountants as the Company’s auditor agents. The Company paid audit expense of RMB 0.8 million to Deloitte Touche Tohmatsu Certified Public Accountants Ltd. and Deloitte Touche Tohmatsu Certified Public Accountants in the report year. Up to now, the Certified Public Accountants has provided service for the Company for continuous five years. (VIII) No punishment was imposed on the Company, its directors or senior executives by the supervisory authorities in the report period. (IX) Rectifying and reforming progress of opinion of the circling check CSRC Jinan Office issued for the Company From Aug. 5, 2003 to Aug. 12, 2003, CSRC Jinan Office made circling check for the Company and issued Rectifying and Reforming Notification (JZGSZ [2003] No. 50). The Board of the Company established measures of rectifying and reforming according to requirement and formed Report of Rectifying and Reforming (The related public notice was published in China Securities, Securities Times and Ta Kung Pao dated Sep. 24, 2003). Ended the report period, the Company has finished rectifying and reforming on partial problems. Now there exist the following problems: 1. Separation of assets and finance Because the houses in Jinan Base locate in the united layout district of Jinan Airport, they can not be conducted related procedures of land and property at present. The Board of Directors planned to cancel the above related transaction under the negotiation with SDA. 2. Operation of three committees Concerning the problem that the number of independent directors has not come to standard, the Company has communicated with related shareholders and would adopt to increase one independent director or decrease the number of the directors of the Board, formed the adjustment proposal and submitted it to the Shareholders’ General Meeting for examining and approving and then will implement it. 3. Related parties’ occupying capital In the report period, SDA has sent Repayment Plan and Commitment to the Company and promised to repay the amount owed to the Company in payment from equity transfer before June 30, 2004. (IX) The Company experienced neither material events as stated in Article 62 of Securities Law and Article 17 of Detailed Rules for Information Disclosure of Company Publicly Issuing Shares (Draft) nor material events decided by the Board to disclose. (X) Other Material Events The Company had no other significant events necessary to be disclosed. - - 28 X. Financial Report AUDITORS' REPORT TO THE SHAREHOLDERS OF SHANDONG AIRLINES CO., LTD. 山东航空股份有限公司 (Established in the People's Republic of China) We have audited the accompanying balance sheet of Shandong Airlines Co., Ltd. as of December 31, 2003 and the related statements of income, cash flows and changes in equity for the year then ended. These financial statements are the responsibility of the Group's management. Our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit in accordance with International Standards on Auditing. Those Standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by the management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion. In our opinion, the financial statements present fairly, in all material respects, the financial position of the Group as of December 31, 2003 and the results of its operations and its cash flows for the year then ended, in accordance with International Financial Reporting Standards. Without qualifying our opinion we draw attention to note 2 to the financial statements which explains that the Group is dependent upon the support of its bankers and in particular on the renewal of existing, and the obtaining of new, bank loan facilities within the next twelve months. Provided that the bankers continue to support the Group, the directors are satisfied that the Group will have sufficient financial resources to meet in full its financial obligations as they fall due for the foreseeable future. Accordingly, the financial statements have been prepared on a going concern basis. Deloitte Touche Tohmatsu Certified Public Accountants Hong Kong, March 26, 2004 - - 29 CONSOLIDATED INCOME STATEMENT FOR THE YEAR ENDED DECEMBER 31, 2003 NOTES 2003 2002 RMB'000 RMB'000 OPERATING REVENUE 4 Passenger 1,626,941 1,458,361 Cargo and mail 78,982 88,987 Interest income 3,261 13,325 Leasing income 47,366 29,284 Government grant 6 4,200 13,740 Others 11,056 10,574 _________ __________ TOTAL OPERATING REVENUE 1,771,806 1,614,271 OPERATING EXPENSES Depreciation and amortisation 184,495 176,694 Take-off and landing charges 200,163 179,536 Personnel 87,619 88,886 Fuel 348,285 335,379 Maintenance and overhaul 148,942 161,001 Catering 63,606 68,140 Rental 245,601 274,686 Insurance 25,960 26,525 Promotion and sales 108,122 116,929 General and administration 59,937 38,639 Others 89,684 85,120 _________ __________ TOTAL OPERATING EXPENSES 1,562,414 1,551,535 PROFIT FROM OPERATIONS 7 209,392 62,736 FINANCE COSTS 8 (136,539) (125,513) SHARE OF RESULTS OF ASSOCIATES 11 188 INCOME (LOSS) FROM INVESTMENTS 9 314 (21,200) _________ __________ PROFIT (LOSS) BEFORE TAX 73,178 (83,789) INCOME TAX (EXPENSE) CREDIT 10 (1,728) 3,029 _________ __________ PROFIT (LOSS) AFTER TAX 71,450 (80,760) MINORITY INTERESTS (82) 376 _________ __________ NET PROFIT (LOSS) FOR THE YEAR 71,368 (80,384) RMB RMB Basic earnings (loss) per share 12 17.8 cents (20.1 cents) 30 CONSOLIDATED BALANCE SHEET AT DECEMBER 31, 2003 NOTES 2003 2002 RMB'000 RMB'000 ASSETS Non-current assets Property, plant and equipment 13 2,696,747 2,432,213 Negative goodwill 14 - - Intangible assets 15 51,565 44,192 Land use rights 16 15,453 - Interests in associates 18 1,082 831 Advances on aircraft and related equipment 289,463 81,724 Unlisted investments 19 80,190 45,940 Non-current prepayments 20 - 20,000 Deferred tax assets 29 20,563 22,242 _________ _________ 3,155,063 2,647,142 _________ _________ Current assets Flight equipment spare parts and other inventories 21 22,267 35,886 Trade and other receivables 318,731 195,616 Amount due from holding company 22 80,772 936 Amounts due from related parties 23 4,169 14,577 Tax recoverable - 1,384 Bank balances and cash 371,024 346,519 _________ _________ 796,963 594,918 _________ _________ TOTAL ASSETS 3,952,026 3,242,060 _________ _________ 31 CONSOLIDATED BALANCE SHEET AT DECEMBER 31, 2003 NOTES 2003 2002 RMB'000 RMB'000 LIABILITIES AND SHAREHOLDERS' EQUITY Shareholders' equity Share capital 24 400,000 400,000 Reserves 25 110,111 38,743 _________ _________ 510,111 438,743 _________ _________ MINORITY INTERESTS 10,848 6,986 _________ _________ Non-current liabilities Bank loans - due after one year 26 389,616 465,977 Obligations under finance leases - due after one year 27 555,564 681,136 _________ _________ 945,180 1,147,113 _________ _________ Current liabilities Trade and other payables 361,184 264,217 Sales in advance of carriage 16,887 9,873 Amounts due to related parties 28 8,965 8,881 Tax liabilities 139 - Bank loans - due within one year 26 1,977,146 1,220,219 Obligations under finance leases - due within one year 27 121,566 146,028 _________ _________ 2,485,887 1,649,218 _________ _________ TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY 3,952,026 3,242,060 _________ _________ The financial statements on pages 2 to 34 were approved by the board of directors and authorised for issue on March 26, 2004 and are signed on its behalf by: _________Li Junhai______________ ____Zheng Bao’an________ DIRECTOR DIRECTOR 32 CONSOLIDATED STATEMENT OF CHANGES IN EQUITY FOR THE YEAR ENDED DECEMBER 31, 2003 Statutory Statutory Retained Share Share Capital surplus public earnings capital premium reserve (note) reserve welfare fund (deficits) Total RMB'000 RMB'000 RMB'000 RMB'000 RMB'000 RMB'000 RMB'000 Balance at January 1, 2002 400,000 76,258 (40,886) 15,202 7,601 84,952 543,127 Net loss for the year - - - - - (80,384) (80,384) Transfer to statutory surplus reserve - - - 13 - (13) - Transfer to statutory public welfare fund - - - 6 (6) - Dividends - - - - - (24,000) (24,000) _______ _______ _______ _______ _______ _______ _______ Balance at December 31, 2002 and January 1, 2003 400,000 76,258 (40,886) 15,215 7,607 (19,451) 438,743 Net profit for the year - - - - - 71,368 71,368 Transfer to statutory surplus reserve - - - 33 - (33) - Transfer to statutory public welfare fund - - - - 11 (11) - _______ _______ _______ _______ _______ _______ _______ Balance at December 31, 2003 400,000 76,258 (40,886) 15,248 7,618 51,873 510,111 _______ _______ _______ _______ _______ _______ _______ Note: Capital reserve arose from the reorganisation, in which the Company took over the air transportation service business from the holding company, Shandong Aviation Group 山东航空集团有限公司(formerly Shandong Airlines Limited. 山东航空集团有限公司), by issuing the Company's shares to the holding company. The transfer of the Company's assets under the reorganisation was calculated based on the financial statements prepared in accordance with accounting standards and regulations applicable to enterprises in the People's Republic of China. 33 CONSOLIDATED CASH FLOW STATEMENT FOR THE YEAR ENDED DECEMBER 31, 2003 2003 2002 RMB'000 RMB'000 OPERATING ACTIVITIES Profit (loss) before tax 73,178 (83,789) Adjustments for: Depreciation and amortisation 184,495 176,694 Loss on disposal of property, plant and equipment 388 130 Interest expenses 136,539 125,513 Interest income (3,261) (13,325) Impairment loss (reversed) recognised on property, plant and equipment (6,900) 6,900 Impairment loss on investments in associates/ non-current prepayments 500 22,000 Dividend from unlisted investments (835) (800) Share of results of associates (11) (188) Negative goodwill released to income (183) (74) _________ _________ Operating cash flows before movements in working capital 383,910 233,061 Decrease (increase) in flight equipment spare parts and other inventories 13,619 (8,113) Increase in trade and other receivables (74,775) (44,944) Decrease (increase) in amounts due from related parties 10,408 (12,429) Increase in trade and other payables 97,063 93,863 Increase (decrease) in sales in advance of carriage 7,014 (539) Increase in amounts due to related parties 84 4,189 _________ _________ Net cash generated from operations 437,323 265,088 Interest paid (138,175) (128,998) Income tax paid 1,474 (10,071) Interest received 3,261 13,325 _________ _________ Net cash generated from operating activities 303,883 139,344 _________ _________ 34 NOTES 2003 2002 RMB'000 RMB'000 INVESTING ACTIVITIES Purchase of aircraft and related equipment (560,732) (73,264) Increase in advances on aircraft and related equipment (207,739) (18,698) Advance to holding company (79,836) (223,581) Purchase of property, plant and equipment other than aircraft and related equipment (31,323) (131,162) Purchase of land use rights (1,680) - Acquisition of unlisted investments (14,250) (39,250) Additions of intangible asset (9,996) (19,557) Additional interest in an associate (500) - Acquisition of investment in an associate (740) - Deregistration of a subsidiar 30 (180) - Prepayment for non-current prepayments - (42,000) Proceeds from disposal of property, plant and equipment 91,442 33,218 Dividends received from unlisted investments 835 800 Acquisition of subsidiaries 31 - 1,695 Decrease in bank deposits - 106,700 Decrease in advances on land and buildings - 39,000 Dividend received from an associate - 141 _________ _________ Net cash used in investing activities (814,699) (365,958) FINANCING ACTIVITIES New bank loans obtained 2,035,769 1,635,017 Capital contribution from minority shareholders 4,937 5,729 Repayment of bank loans (1,355,203) (1,137,657) Repayment of obligations under finance leases (150,034) (54,987) Repayment of other loans - (33,106) Dividend paid to minority shareholder (148) - Dividend paid - (24,000) _________ _________ Net cash generated from financing activities 535,321 390,996 _________ _________ NET INCREASE IN CASH AND CASH EQUIVALENTS 24,505 164,382 CASH AND CASH EQUIVALENTS AT BEGINNING OF THE YEAR 346,519 182,137 _________ _________ CASH AND CASH EQUIVALENTS A END OF THE YEAR 371,024 346,519 __________ __________ 35 NOTES TO THE FINANCIAL STATEMENTS FOR THE YEAR ENDED DECEMBER 31, 2003 1.GENERAL Shandong Airlines Co., Ltd. (the "Company") was established in the People's Republic of China ("PRC") on December 13, 1999 and is responsible for its own operations, subject to the supervision and regulation of the Civil Aviation Administration of China ("CAAC"), a regulatory authority of the civil aviation industry in the PRC. Its B shares are listed on the Shenzhen Stock Exchange (the "Stock Exchange") with effect from September 12, 2000. Its holding company is Shandong Aviation Group 山东航空集团有限公司 (formerly Shandong Airlines Limited 山东航空集团有限公司), a company also established in the PRC. The Company maintains its accounting records and prepares its statutory financial statements in Renminbi, in which the majority of the Company's transactions are denominated. The statutory financial statements are prepared in accordance with accounting standards and regulations applicable to enterprises in the PRC ("PRC GAAP"). However, these financial statements have been prepared in accordance with International Financial Reporting Standards ("IFRS") for the shareholders of the Company's B shares listed on the Stock Exchange. Differences between IFRS and PRC GAAP are stated in note 38. The Company is engaged in the provision of domestic passenger and cargo air transportation services. The principal activities of subsidiaries and associates are set out in notes 17 and 18, respectively. The Company and its subsidiaries are hereinafter collectively referred to as "the Group". 2.BASIS OF PREPARATION In preparing the financial statements the directors have given careful consideration to the future liquidity of the Group. The Group is dependent upon the support of its bankers and in particular on the renewal of existing, and the obtaining of new, bank loan facilities within the next twelve months. Provided that the bankers continue to support the Group, the directors are satisfied that the Group will be able to meet in full its financial obligations as they fall due for the foreseeable future. Accordingly the financial statements have been prepared on a going concern basis. 3.SIGNIFICANT ACCOUNTING POLICIES The financial statements have been prepared under the historical cost convention and in accordance with IFRS. The principal accounting policies adopted are set out below: Basis of consolidation The consolidated financial statements incorporate the financial statements of the Company and enterprises controlled by the Company ("its subsidiaries") made up to 31 December each year. Control is achieved where the Company has the power to govern the financial and operating policies of an investee enterprise so as to obtain benefits from its activities. On acquisition, the assets and liabilities of a subsidiary are measured at their fair values at the date of acquisition. Any excess (deficiency) of the cost of acquisition over (below) the fair values of the identifiable net assets acquired is recognised as goodwill (negative goodwill). The interest of minority shareholders is stated at the minority's proportion of the fair values of the assets and liabilities recognised. The results of subsidiaries acquired or disposed of during the year are included in the consolidated income statement from the effective date of acquisition or up to the effective date of disposal, as appropriate. 36 Where necessary, adjustments are made to the financial statements of subsidiaries to bring the accounting policies used into line with those used by other members of the Group. All significant intercompany transactions and balances between group enterprises are eliminated on consolidation. Interests in associates An associate is an enterprise over which the Group is in a position to exercise significant influence, but not control, through participation in the financial and operating policy decisions of the investee. The results and assets and liabilities of associates are incorporated in these financial statements using the equity method of accounting. Investments in associates are carried in the balance sheet at cost as adjusted by post-acquisition changes in the Group's share of the net assets of the associate, less any impairment in the value of individual investments. Any excess (deficiency) of the cost of acquisition over (below) the Group's share of the fair values of the identifiable net assets of the associate at the date of acquisition is recognised as goodwill (negative goodwill). Where a group enterprise transacts with an associate of the Group, unrealised profits and losses are eliminated to the extent of the Group's interest in the relevant associate, except to the extent that unrealised losses provide evidence of an impairment of the asset transferred. Goodwill Goodwill arising on consolidation represents the excess of the cost of acquisition over the Group's interest in the fair value of the identifiable assets and liabilities of a subsidiary or associate at the date of acquisition. Goodwill is recognised as an asset and amortised on a straight-line basis over its estimated useful life. Goodwill arising on the acquisition of an associate is included within the carrying amount of the associate. Goodwill arising on the acquisition of subsidiaries is presented separately in the balance sheet. On disposal of a subsidiary or associate, the attributable amount of unamortised goodwill is included in the determination of the profit or loss on disposal. Negative goodwill Negative goodwill represents the excess of the Group's interest in the fair value of the identifiable assets and liabilities of a subsidiary and associate at the date of acquisition over the cost of acquisition. Negative goodwill is released to income based on an analysis of the circumstances from which the balance resulted. To the extent that the negative goodwill is attributable to losses or expenses anticipated at the date of acquisition, it is released to income in the period in which those losses or expenses arise. The remaining negative goodwill is recognised as income on a straight-line basis over the remaining average useful life of the identifiable acquired depreciable assets. To the extent that such negative goodwill exceeds the aggregate fair value of the acquired identifiable non-monetary assets, it is recognised as income immediately. Negative goodwill arising on the acquisition of an associate is deducted from the carrying amount of that associate. Negative goodwill arising on the acquisition of subsidiaries is presented separately in the balance sheet as a deduction from assets. 37 Revenue recognition Passenger and cargo sales are recognised as operating revenue when the transportation service is provided rather than when a ticket is sold. Such revenue is reported net of sales tax and business tax. The value of unflown passenger and cargo sales is recorded as a current liability in the sales in advance of carriage account. Interest income is accrued on a time basis, by reference to the principal outstanding and at the effective interest rate applicable. Dividend income from investments is recognised when the shareholder's rights to receive payment have been established. Rental income from operating leases is recognised on a straight-line basis over the terms of the relevant leases. Leasing Leases are classified as finance leases whenever the terms of the lease transfer substantially all the risks and rewards of ownership to the lessee. All other leases are classified as operating leases. The Group as lessor Rental income from operating leases is recognised on a straight-line basis over the term of the relevant lease. The Group as lessee Assets held under finance leases are recognised as assets of the Group at their fair value at the date of acquisition or, if lower, at the present value of the minimum lease payments. The corresponding liability to the lessor is included in the balance sheet as a finance lease obligation. Lease payments are apportioned between finance charges and reduction of the lease obligation so as to achieve a constant rate of interest on the remaining balance of the liability. Finance charges are charged directly against income, unless they are directly attributable to qualifying assets, in which case they are capitalised in accordance with the Group's general policy on borrowing costs (see below). Rentals payable under operating leases are charged to income on a straight-line basis over the tem of the relevant lease. Foreign currencies Transactions in currencies other than Renminbi are initially recorded at the rates of exchange prevailing on the dates of the transactions. Monetary assets and liabilities denominated in such currencies are retranslated at the rates prevailing on the balance sheet date. Profits and losses arising on exchange are included in net profit or loss for the period. Capitalisation of borrowing costs Interest on advances made in connection with the acquisition of aircraft is capitalised as an additional cost of the aircraft. Interest is capitalised at the weighted average interest rate on the total borrowings or, where applicable, the actual interest rate applicable to the specific borrowings. Capitalisation of interest ceases when the aircraft is placed into revenue earning service. All other borrowing costs are recognised in net profit or loss in the period in which they are incurred. 38 Government grants Government grants are recognised as income over the periods necessary to match them with the related costs. Retirement scheme The Group participates in a defined contribution retirement scheme organised by the municipal government of the province in which it operates. The contributions to the scheme are charged to operating expenses as they fall due. Taxation Income tax expense represents the sum of the tax currently payable and deferred tax. The tax currently payable is based on the taxable profit for the year. Taxable profit differs from net profit as reported in the income statement because it excludes items of income or expense that are taxable or deductible in other years and it further excludes items that are never taxable or deductible. The Group's liability for current tax is calculated using tax rates that have been enacted or substantively enacted by the balance sheet date. Deferred tax is the tax expected to be payable or recoverable on differences between the carrying amount of assets and liabilities in the financial statements and the corresponding tax basis used in the computation of taxable profit, and is accounted for using the balance sheet liability method. Deferred tax liabilities are generally recognised for all taxable temporary differences and deferred tax assets are recognised to the extent that it is probable that taxable profit will be available against which deductible temporary differences can be utilised. Such assets and liabilities are not recognised if the temporary difference arises from goodwill (or negative goodwill) or from the initial recognition (other than in a business combination) of other assets and liabilities in a transaction which affects neither the tax profit nor the accounting profit. Deferred tax liabilities are recognised for taxable temporary differences arising on investments in subsidiaries and associates, except where the Group is able to control the reversal of the temporary difference and it is probable that the temporary difference will not reverse in the foreseeable future. The carrying amount of deferred tax assets is reviewed at each balance sheet date and reduced to the extent that it is no longer probable that sufficient taxable profit will be available to allow all or part of the asset to be recovered. Deferred tax is calculated at the tax rates that are expected to apply to the period when the asset is realised or the liability is settled. Deferred tax is charged or credited in the income statement, except when it relates to items credited or charged directly to equity, in which case the deferred tax is also dealt with in equity. Property, plant and equipment Property, plant and equipment are stated at cost less accumulated depreciation or amortisation and any recognised impairment loss. Depreciation and amortisation are charged so as to write down the cost of property, plant and 39 equipment to their estimated residual values over their estimated useful lives. Useful lives and residual values are reviewed annually in the light of experience and changing circumstances. Property, plant and equipment - continued (i) Aircraft and related equipment Aircraft are depreciated, using the straight-line method, over their estimated useful lives of 12 to 20 years with a residual value of 5% of the original cost. Related equipment is depreciated, using the straight-line method, over 12 to 18 years. (ii) Buildings Buildings are depreciated, using the straight-line method, over their estimated useful lives of 27 to 33 years with a residual value of 5% on the original cost. (iii) Other equipment Other equipment are depreciated, using the straight-line method, over their estimated useful lives of 5 to 10 years with a residual value of 5% on the cost of the property, plant and equipment. Assets held under finance leases are depreciated over their expected useful lives on the same basis as owned assets or, where shorter, the terms of the relevant leases. The gain or loss arising on the disposal or retirement of an asset is determined as the difference between the sales proceeds and the carrying amount of the asset and is recognised in net profit or loss in the period. Construction in progress Construction in progress, being equipment under construction and equipment pending installation in the aircraft, is carried at cost less any identified impairment loss. Cost comprises the direct cost of construction, the cost of equipment as well as finance charges from borrowings used to finance these assets during the construction or installation period. No depreciation is provided on construction in progress until the asset is completed and put into use. Intangible assets Intangible assets are measured initially at purchase cost and amortised on a straight-line basis over their estimated useful lives. Land use rights Land use rights are measured initially at purchase cost and amortised on a straight-line basis over their lease term. Impairment At each balance sheet date, the Group reviews the carrying amounts of its tangible and intangible assets to determine whether there is any indication that those assets have suffered an impairment loss. If any such indication exists, the recoverable amount of the asset is estimated in order to determine the 40 extent of the impairment loss (if any). Where it is not possible to estimate the recoverable amount of an individual asset, the Group estimates the recoverable amount of the cash-generating unit to which the asset belongs. Recoverable amount is the greater of net selling price and value in use. In assessing value in use, the estimated future cash flows are discounted to their present value using a pre-tax discount rate that reflects current market assessments of the time value of money and the risks specific to the asset. If the recoverable amount of an asset is estimated to be less than its carrying amount, the carrying amount of the asset is reduced to its recoverable amount. An impairment loss is recognised as an expense immediately. Where an impairment loss subsequently reverses, the carrying amount of the asset is increased to the revised estimate of it recoverable amount, but so that the increased carrying amount does not exceed the carrying amount that would have been determined had no impairment loss been recognised for the asset in prior years. A reversal of an impairment loss is recognised as income immediately. Flight equipment spare parts and other inventories Flight equipment spare parts and other inventories are stated at the lower of cost and net realisable value. Cost is calculated using the weighted average method. Manufacturers' credits In connection with the acquisition of certain aircraft and related equipment, various credits are received from the manufacturers. These credits are applied as a reduction of the acquisition costs of the related aircraft and related equipment. Aircraft maintenance and overhaul costs Costs for routine maintenance and overhaul of aircraft and related equipment are charged to operating expenses when incurred. Financial instruments Financial assets and financial liabilities are recognised on the Group's balance sheet when the Group becomes a party to the contractual provisions of the instrument. Trade and other receivables, amount due from holding company and amounts due from related parties are stated at their nominal value as reduced by appropriate allowances for estimated irrecoverable amounts. Financial instruments - continued Investments are recognised on a trade-date basis and are measured at cost, including transaction costs less any identified impairment losses. Trade and other payables and amounts due to related parties are stated at their nominal value. Interest-bearing bank loans and other loans are recorded at the proceeds received, net of direct issue costs. Finance charges, including premiums payable on settlement or redemption, are accounted for on an accrual basis and are added to the carrying amount of the instrument to the extent that they are not settled in the period in which they arise. 4. OPERATING REVENUE Operating revenue represents revenue earned principally from the carriage of passengers, cargo and 41 mail. Operating revenue from other services represents services provided to third parties as well as commission income earned on tickets sold by the Group for which the carriage is provided by other airlines. Operating revenue is net of sales tax which are calculated at the following rates: Tax Applicable rates on revenues Sales tax 3% traffic revenue from domestic flights Sales tax 5% on other revenue, except for interest income The Group enjoyed a business tax exemption from May 2003 to December 2003 as a result of the Severe Acute Respiratory Syndrome attack during the year. 5.BUSINESS AND GEOGRAPHICAL SEGMENTS The Group is mainly engaged in the provision of domestic passenger, cargo and mail air transportation services and it contributes over 90% of the Group's operations, and identifiable assets, sales revenue and profit for the year. The operations of the Group are all located in PRC. 6.GOVERNMENT GRANT The government grant represented interest subsidy to specific loans advanced to the Group for relief of the financial impact as a result of the Severe Acute Respiratory Syndrome attack during the year. In 2002, the grant was obtained specifically for the maintenance of the aviation security system. Both were recognised as income when, and only when, the government grant became receivable and the required conditions were met. 7. PROFIT FROM OPERATIONS 2003 2002 RMB'000 RMB'000 Profit from operations has been arrived at after charging (crediting): Rental expenses under operating leases Aircraft and related equipment 245,601 274,686 Land and buildings 5,251 6,936 Impairment loss (reversed) recognised on property, plant and equipment (included in operating expenses - others) (6,900) 6,900 Retirement scheme contributions (note 35) 13,568 9,331 Loss on disposal of property, plant and equipment 388 130 Net foreign exchange loss 114 92 Release of negative goodwill to income (included in operating revenue - others) (183) (74) _______ _______ 8.FINANCE COSTS Finance costs comprise the following: 2003 2002 RMB'000 RMB'000 Interest on bank loans 92,361 77,250 42 Interest on obligations under finance leases 45,814 48,263 Interest on other loans - 3,485 _______ _______ 138,175 128,998 Less: Amounts included in the cost of qualifying assets (1,636) (3,485) _______ _______ 136,539 125,513 _______ _______ Finance costs included in the cost of qualifying assets during the year arose on bank loans utilised in financing the acquisition of aircraft and related equipment by applying a capitalisation rate of 2.35% per annum. 9.INCOME (LOSS) FROM INVESTMENTS 2003 2002 RMB'000 RMB'000 Loss on deregistration of a subsidiary (21) - Dividends from unlisted investments 835 800 Impairment loss on non-current prepayments (note 20) (500) (22,000) _______ _______ 314 (21,200) _______ _______ 10.INCOME TAX (EXPENSE) CREDIT 2003 2002 RMB'000 RMB'000 The (charge) credit comprises: PRC income tax - the Group (49) (60) Over-provision of PRC income tax in prior years - 3,089 Deferred tax credit (note 29) (1,679) - _______ _______ (1,728) 3,029 _______ _______ Provision for PRC income tax is calculated at 33% of the estimated assessable income for the year. The charge (credit) for the year can be reconciled to the net profit (loss) before tax as follows: 2003 2002 RMB'000 % RMB'000 % Net profit (loss) before tax 73,178 (83,789) _______ _______ Tax at the PRC tax rate of 33% 24,149 33.0 (27,650) (33.0) Tax effect on PRC allowable tax loss not recognised as an asset - - 16,760 20.0 43 Tax effect of income not taxable for tax purpose (163) (0.2) - - Tax effect of expenses that are not deductible for tax purpose 10,339 14.1 10,950 13.1 Tax effect of utilisation of tax losses not previously recognised (18,931) (25.8) - - Tax effect of utilisation of deferred tax asset not previously recognised (13,666) (18.7) - Over-provision for PRC income tax in prior years - - (3,089) (3.7) _______ _______ _______ _______ Tax expense (credit) and effective tax rate for the year 1,728 2.4 (3,029) (3.6) _______ _______ _______ _______ 11.DIVIDENDS The directors do not recommend the payment of a dividend and propose that the net profit for the year be retained. 12.BASIC EARNINGS (LOSS) PER SHARE The calculation of the basic earnings (loss) per share is based on the net profit for the year of RMB 71,368,000 (2002: net loss of RMB80, 384,000) and on the 400,000,000 shares (2002: 400,000,000 shares) in issue during the year. No diluted earnings per share has been presented as there were no potential ordinary shares in issue in either 2003 or 2002. 13.PROPERTY, PLANT AND EQUIPMENT Aircraft and related Other Motor Construction Buildings equipment equipment vehicles in progress Total RMB'000 RMB'000 RMB'000 RMB'000 RMB'000 RMB'000 COST At January 1, 2003 89,211 2,600,669 36,119 28,309 47,656 2,801,964 Additions 14,710 563,786 7,936 3,856 4,821 595,109 Reclassifications 25,351 - - - (25,351) Transfer out to land use right - - - (14,129) (14,129) Disposals - (306,589) (819) (217) - (307,625) _______ _________ _______ _______ _______ _________ At December 31, 2003 129,272 2,857,866 43,236 31,948 12,997 3,075,319 _______ _________ _______ _______ _______ _________ DEPRECIATION AND AMORTISATION At January 1, 2003 1,296 346,753 9,522 12,180 - 369,751 Provided for the year 2,391 172,097 4,229 2,799 - 181,516 Impairment loss reversed - (6,900) - - - (6,900) 44 Eliminated on disposals - (165,103) (541) (151) - (165,795) _______ _________ _______ _______ _______ _________ At December 31, 2003 3,687 346,847 13,210 14,828 - 378,572 _______ _________ _______ _______ _______ _________ NET BOOK VALUES At December 31, 2003 125,585 2,511,019 30,026 17,120 12,997 2,696,747 _______ _________ _______ _______ _______ _________ At December 31, 2002 87,915 2,253,916 26,597 16,129 47,656 2,432,213 _______ _________ _______ _______ _______ _________ The net book value of aircraft and related equipment held under finance leases at December 31, 2003 amounted to approximately RMB 978,669,000 (2002: 1,047,813,000). During the year, impairment loss of RMB6,900,000 (2002: Nil) was reversed due to the net selling price of those assets. 14.NEGATIVE GOODWILL 2003 RMB'000 GROSS AMOUNT Arising on acquisition of additional interest in a subsidiary and balance at December 31, 2003 183 RELEASED TO INCOME Release in the year and balance at December 31, 2003 183 _______ CARRYING AMOUNT At December 31,2003 _______ At December 31,2002 _______ 15.INTANGIBLE ASSETS RMB'000 AT COST At January 1, 2003 47,472 Additions 9,996 _______ At December 31, 2003 57,468 _______ AMORTISATION At January 1, 2003 3,280 Charge for the year 2,623 _______ At December 31, 2003 5,903 _______ 45 CARRYING AMOUNT At December 31, 2003 51,565 _______ At December 31, 2002 44,192 _______ Intangible assets represent recruitment and initial training costs incurred for pilots, which are measured at purchase cost and amortised on a straight-line basis over the average years of services of the pilots of 20 years. 16.LAND USE RIGHT RMB'000 AT COST Transfer from construction in progress 14,129 Additions 1,680 _______ Balance at December 31, 2003 15,809 AMORTISATION Charge for the year and balance at December 31, 2003 356 _______ CARRYING AMOUNT At December 31, 2003 15,453 _______ At December 31, 2002 _______ Land use rights are measured initially at purchase cost and amortised on a straight-line basis over 50 years. 17.SUBSIDIARIES Details of the Company's subsidiaries at December 31, 2003 are as follows: Place of incorporation Proportion Proportion (or registration) of ownership of voting Name of subsidiary and operation interest power held Principal activity % % Qingdao Int'l Aviation Logisitics Center Co., Ltd. 青岛国际航空物流中心有限公司 PRC 70 70 Transportation agency 46 Union Express Service Shandong Airlines Co., Ltd. 山东航空联合快运有限公司 PRC 65 65 Cargo agency SDA-Hangchi Cargo Co., Ltd. 深圳市山航恒驰航空货运有限公司 (Formerly SDA-SEG Cargo Co., Ltd. 深圳市山航赛格航空货运有限公司) ("SDA-Hangchi") PRC 75 75 Cargo agency 18.INTERESTS IN ASSOCIATES 2003 2002 RMB'000 RMB'000 Share of net assets 1,082 831 _______ _______ Details of the Group's associates at December 31, 2003 are as follows: Place of Proportion Proportion incorporation of ownership of voting Name of associate and operation interest powerheld Principal activity % % Shandong Aviation Rainbow PRC 49 49 Inbound and International Travel Service local tours Co., Ltd. 山东航空彩虹国际旅行社有限公司 ("SARITS") (Note) Shanghai Airlines Rainbow - Jet Co., Ltd. 山东航空彩虹公务机有限公司 ("SARJ") PRC 45 45 Business jet Qingdao SDA Union Express Co., Ltd. PRC 24 24 Cargo agency 青岛山航联合快运有限公司 Note: The remaining 51% interest in SARITS is held by Shandong Aviation Group. 19.UNLISTED INVESTMENTS 2003 2002 RMB'000 RMB'000 Legal person share, at cost (Note i) 6,690 6,690 Unlisted shares, at cost (Note ii) 73,500 39,250 _______ _______ 80,190 45,940 _______ _______ Note: 47 (i) In the opinion of the directors, the investment held by the Group is in the form of legal person share in PRC, which is not freely transferable in the market. Accordingly, it is not practical to determine the fair value and thus the investment is stated at cost. (ii) In the opinion of the directors, the fair value of the investments are not materially different from their costs. 20.NON-CURRENT PREPAYMENTS 2003 2002 RMB'000 RMB'000 At cost - 42,000 Less: impairment loss recognised - (22,000) _______ _______ - 20,000 _______ _______ The non-current prepayments in 2002 of RMB20,000,000 and RMB22,000,000 were paid for the purpose of obtaining the interest in Shandong Jinan International Airport Co., Ltd. ("SJIA") and SARJ, respectively. An impairment loss of RMB500,000 (2002: RMB22,000,000) was recognised during the year in respect of the cost prepaid for SARJ as the investment is unlikely to generate future benefits to the Group. The prepayments of RMB20,000,000 and RMB22,500,000 were transferred to unlisted investments and interests in associate, respectively, upon the completion of the relevant procedures during the year. 21.FLIGHT EQUIPMENT SPARE PARTS AND OTHER INVENTORIES 2003 2002 RMB'000 RMB'000 Flight equipment spare parts 21,578 32,556 Other inventories 689 3,330 _______ _______ 22,267 35,886 _______ _______ Included above are flight equipment spare parts of approximately RMB21,578,000 (2002: RMB23,866,000), which are carried at net realisable value. 22.AMOUNT DUE FROM HOLDING COMPANY The amount due from Shandong Aviation Group is unsecured, bears interest at 1.98% per annum and repayable on demand. 48 23.AMOUNTS DUE FROM RELATED PARTIES 2003 2002 RMB'000 RMB'000 Shandong International Aviation Training Co., Ltd. 山东国际航空培训有限公司 ("SIATC") 452 6,308 SARITS 3 425 山东航空大厦管理有限公司 233 27 山东翔宇航空技术服务有限公司 37 410 SARJ 1,962 7,036 青岛飞圣国际航空技术培训有限公司 1,084 171 山东航空青岛食品有限公司 398 200 _______ _______ 4,169 14,577 _______ _______ All the above-mentioned companies are subsidiaries of Shandong Aviation Group while SARITS and SARJ are associates of the Company. The amounts are unsecured, non-interest bearing and repayable on demand. 24.SHARE CAPITAL 2003 & 2002 RMB'000 Registered, issued and fully paid 260,000,000 shares of domestic shares of RMB 1 each 260,000 140,000,000 shares of B shares of RMB 1 each 140,000 _______ 400,000 _______ 25.RESERVES Statutory surplus reserve and statutory public welfare fund, which consist of appropriations from the profit after tax, form part of the shareholders' equity. Statutory surplus reserve In accordance with the PRC Company Law and the Company's Articles of Association, the Company is required to appropriate 10% of its profit after tax as reported in its PRC statutory financial statements to the statutory surplus reserve. The appropriation to statutory surplus reserve may cease to apply if the balance of the statutory surplus reserve has reached an amount equal to 50% of the Company's registered capital. Surplus reserves can be used to offset prior year accumulated losses, to expand the Company's operations or for conversion into share capital. The Company may, upon the approval by a resolution at the Annual General Meeting, convert its surplus reserve into share capital and issue new shares to existing shareholders in proportion to their original shareholdings to increase the nominal value of each share. When converting the Company's statutory surplus reserves into share capital, the amount of such reserves remaining unconverted must not be less than 25% of the registered capital. 49 Statutory public welfare fund In accordance with the PRC Company Law and the Company's Articles of Association, the Company is required to appropriate 5% to 10% of the profit after tax as reported in its PRC statutory financial statements to the statutory public welfare fund. The appropriation in the current year to the statutory public welfare fund is made at 5%. The statutory public welfare fund shall only be applied to collective welfare of staff and workers and welfare facilities remain as property of the Company. Profits available for distribution The profit of the Company available for appropriations will be the lesser of the profit reported in its financial statements prepared under PRC GAAP or under IFRS. The retained profits available for future distribution at December 31, 2003, based on the IFRS financial statements, amounted to approximately RMB51,873,000 (2002: RMB19,451,000). 26.BANK LOANS 2003 2002 RMB'000 RMB'000 The bank loans are repayable as follows: Within one year 1,977,146 1,220,219 In the second year 76,376 76,430 In the third to fifth year, inclusive 175,240 217,547 After five years 138,000 172,000 _________ _________ 2,366,762 1,686,196 Less: Amounts due within one year shown under current liabilities (1,977,146) (1,220,219) _________ _________ Amounts due after one year 389,616 465,977 _________ _________ Secured 465,992 542,407 Unsecured 1,900,770 1,143,789 _________ _________ 2,366,762 1,686,196 _________ _________ The terms of secured bank loans are summarised as follows: 2003 2002 RMB'000 RMB'000 Denominated in RMB Fixed interest rate at 5.76% per for the acquisition of aircraft annum, repayable in 10 years and related equipment with final maturity in 2012 308,000 342,000 50 Denominated in USD Interest at market rate, for the acquisition of aircraft repayable in 5 years with and related equipment final maturity in 2007 157,992 200,407 _______ _______ 465,992 542,407 Less: Amounts due within one year shown under current liabilities (76,376) (76,430) _______ _______ Amounts due after one year 389,616 465,977 _______ _______ Of the unsecured bank loans, RMB 1,202,833, 000 (2002: RMB229,663,000) is guaranteed by Shandong Aviation Group, RMB157,937,000 (2002: RMB437,937,000) is guaranteed by a shareholder of the Shandong Aviation Group and RMB540,000,000 (2002: RMB476,189,000) is guaranteed by two other unrelated companies. Bank loans bear interest rates ranging from 2.24 % to 5.76% per annum. 27.OBLIGATIONS UNDER FINANCE LEASES Present value Minimum of minimum lease payments lease payment 2003 2002 2003 2002 RMB'000 RMB'000 RMB'000 RMB'000 Amounts payable under finance leases: Within one year 162,353 195,840 121,566 146,028 In the second to fifth years inclusive 526,058 583,814 459,795 468,079 Over five years 104,172 208,776 95,769 213,057 _______ _______ _______ _______ 792,583 988,430 677,130 827,164 Less: future finance charges (115,453) (161,266) N/A N/A _______ _______ _______ _______ Present value of lease obligations 677,130 827,164 677,130 827,164 _______ _______ _______ _______ Less: Amount due for settlement within twelve months (shown under current liabilities) (121,566) (146,028) _______ _______ Amount due for settlement after twelve months 555,564 681,136 The Group leased five Boeing 737 aircraft under finance leases. The average lease term is 6 - 8 years. For the year ended December 31, 2003, the average effective borrowing rate was 6.48%. Interest rates are fixed at the contract date. All leases are on a fixed repayment basis and no arrangements have been entered into for contingent rental payments. All lease obligations are denominated in United States Dollars. 51 The fair value of the Group's lease obligations approximates their carrying amount. The Group's obligations under finance leases are secured by the lessor's charge over the leased assets. 28.AMOUNTS DUE TO RELATED PARTIES 2003 2002 RMB'000 RMB'000 Shandong Taeco Aircraft Engineering Co., Ltd. 山东太古飞机工程有限公司 ("SDTAE") 6,726 7,648 Shandong Shengping Catering Co., Ltd. 山东金平航空食品有限公司 ("SDSCC") 2,089 1,233 SARITS 150 - _______ _______ 8,965 8,881 _______ _______ The above companies are subsidiaries of Shandong Aviation Group. The amounts are unsecured, non-interest bearing and repayable on demand. 29.DEFERRED TAX ASSETS 2003 2002 RMB'000 RMB'000 At January 1 22,242 22,242 Credit for the year (note 10) (1,679) - _______ _______ At December 31 20,563 22,242 _______ _______ Deferred tax assets (liabilities) recognised are made up of the tax effect of: Depreciation Major of aircraft overhaul and related Deferred provision equipment expenditure for aircraft Total RMB'000 RMB'000 RMB'000 RMB'000 (note i) (note ii) (note iii) At January 1, 2002, December 31, 2002 and January 1, 2003 8,991 20,353 (7,102) 22,242 52 Credit (charge) for the year (5,056) (3,725) 7,102 (1,679) _______ _______ _______ _______ At December 31, 2003 3,935 16,628 - 20,563 _______ _______ _______ _______ (i) The amount represents the tax effect of temporary differences attributable to the excess of depreciation charges over depreciation allowances. (ii) The amount represents the tax effect on training costs where under PRC GAAP, which is the basis for the PRC tax computation, the training costs are capitalised and amortised, while under IFRS, such costs are charged to the income statement when incurred before 2000. (iii) The amount represents the tax effect of major overhaul provision for aircraft which is provided for under PRC GAAP and allowed for tax purposes, but can only be recognised when there is a present obligation as a result of a past event under IFRS. At December 31, 2003, the Company has unused tax losses of approximately RMB64,942,000 (2002: RMB 122,308,000) available for offset against future profits. No deferred tax asset has been recognised in respect of the tax losses due to the unpredictability of future profit streams. The tax losses will expire in 2007. 30.DEREGISTRATION OF A SUBSIDIARY On February 27, 2003 the Group deregistered a subsidiary, Guangdong Lumao Trading Co., Ltd. 广东鲁航贸易有限公司 ("Lumao"). The net assets of "Lumao" as at the date of deregistration are as follows: RMB'000 Trade and other receivables 242 Bank balances and cash 464 Trade and other payables (96) Minority interest (305) _______ 305 Loss on deregistration (21) _______ Net cash received 284 _______ Net cash inflow arising on disposal: Net cash received 284 Bank balances and cash disposed of (464) _______ (180) 53 31.ACQUISITION OF SUBSIDIARIES On March 31, 2002, the Group acquired a 50% interest in SDA-Hengchi and Guangdong Lumao Trading Co., Ltd. 广东鲁航贸易有限公司 for a cash consideration of approximately RMB1.6 million from Shandong Aviation Group. This transaction has been accounted for by the purchase method of accounting. 2003 2002 RMB'000 RMB'000 Net assets acquired: Property, plant and equipment - 428 Trade and other receivables - 988 Bank balances and cash - 3,254 Trade and other payable - (1,404) Minority interests - (1,633) _______ _______ - 1,633 Goodwill - (74) _______ _______ Total consideration - 1,559 _______ _______ Satisfied by cash - 1,559 _______ _______ Net cash inflow arising on acquisition: Cash consideration - (1,559) Bank balances and cash acquired - 3,254 _______ _______ - 1,695 _______ _______ 32.MAJOR NON-CASH TRANSACTIONS During the year, purchase of aircraft and related equipment amounting to RMB1,418,000 (2002: RMB16,554,000) were settled by manufacturers' credits. 33.CONTINGENT LIABILITIES In accordance with the regulations of the Ministry of Finance and CAAC, the Group was required to pay domestic aviation infrastructure levies to CAAC, calculated at the rate of 5% on the traffic revenue. The Finance Department of Shandong Province agreed on August 30, 1999 that it would make every endeavour to settle the payment of domestic aviation infrastructure levies on behalf of the Group. At the same time, Shandong Aviation Group has also undertaken to compensate the Group for any payment of such levies. Under such an arrangement, in the opinion of the 54 directors, the Group has been released from the requirement to pay domestic aviation infrastructure levies to CAAC. No accruals has been made in the financial statements accordingly. 34.COMMITMENTS The Group had the following commitments at the balance sheet date: (i) Capital commitments 2003 2002 RMB'000 RMB'000 Aircraft and related equipment 3,493,082 414,904 Land and buildings 2,854 8,070 Unlisted investments - 4,250 Capitalised training costs 5,583 7,636 _________ _______ 3,501,519 434,860 _________ _______ Apart from the above, the Group has committed to place refundable deposits to manufacturers for intended purchases of aircrafts. (ii) Lease commitments At the balance sheet date, the Group had outstanding commitments under non-cancellable operating leases which fall due as follows: 2003 2002 RMB'000 RMB'000 Aircraft and related equipment Within one year 217,206 187,182 In the second to fifth year inclusive 674,165 622,409 Over five years 109,433 202,440 _________ _________ 1,000,804 1,012,031 _________ _________ Land and buildings Within one year 4,755 4,920 In the second to fifth year inclusive 4,340 6,140 Over five years 480 - _________ _________ 9,575 11,060 _________ _________ 55 The outstanding commitments under operating leases are entered into with independent third parties. Leases are negotiated for an average term of 1 to 8 years for aircraft and related equipment and 1 to 5 years for land and buildings, respectively. The rentals are fixed throughout the lease periods, except that an annual increment of 6% has been imposed on one of the lease arrangements in respect of land and buildings. 35.RETIREMENT SCHEME CONTRIBUTIONS The Group participates in a defined contribution retirement scheme organised by the municipal government of Shandong Province. All qualifying employees of the Group are participants of the scheme. Under this scheme, the Group is required to make contributions to the scheme at 23% of the employee salaries, and the employees are required to contribute at 4% of their salaries. The average number of employees for the year is 1,309 (2002: 1,168). 36.RELATED PARTY TRANSACTIONS In addition to the disclosure set out in notes 22, 23, 26, 28 and 33, during the year, the Group entered into the following transactions with related parties: Name of related party Nature of transaction 2003 2002 RMB'000 RMB'000 Shandong Aviation Group Operating lease charges in respect of aircraft and related equipment 1,002 17,161 General service charges 3,125 1,110 Rental charges in respect of land and buildings 1,577 476 Room and restaurant service charges 4,523 2,281 Interest income 1,154 11,888 Rental income in respect of buildings 841 421 Purchase of property, plant and equipment 2,320 70,861 Transfer of finance leasing rights - 223,283 Purchase of unlisted investments in SDTAE 4,250 [4,250] Payments for investment in SARJ 500 22,000 SDTAE Repairs and maintenance charges 31,542 35,665 Purchase of property, plant and equipment 2,557 - SDSCC Air catering services and purchase of other supplies 10,762 17,945 SIATC Rental income in respect of aircraft - 1,410 56 SARITS Sales of airtickets 5,263 8,846 SARJ Rental income in respect of aircraft 47,366 27,874 Disposal of aircraft and related equipment - 33,198 山东航空大厦管理有限公司 Rental charges in respect of buildings 1,674 852 Room and restaurant service charges - 240 山东航空青岛食品有限公司 Air catering services and purchase 6,007 - of other supplies 山东国际航空培训有限公司 Training fee 8,824 青岛飞圣国际航空技术 培训有限公司 Training fee 9,430 5,014 _______ _______ In the opinion of the directors, all the above transactions were carried out in the Company's ordinary course of business and with reference to the market rates. Shandong Aviation Group is the holding company of the Group while SARITS and SARJ or associates of the Company. The other companies are subsidiaries of Shandong Aviation Group. During the year, the Group made numerous advances to Shandong Aviation Group and the monthly average outstanding balance amounted to approximately RMB80,730,000. 37.PLEDGE OF ASSETS Aircraft and related equipment of the Group with a net book value of approximately RMB1,820,627,000 (2002: RMB1,954,300,000) have been pledged to banks to secure bank loans granted to the Group. 38.SUMMARY OF DIFFERENCES BETWEEN IFRS AND PRC GAAP These financial statements are prepared in conformity with IFRS, which differ from the Company's statutory financial statements prepared in accordance with the PRC GAAP. The statutory financial statements for the year ended December 31, 2003 reported profit for the year of RMB26,531,000 (2002: loss of RMB 45,584,000) and net assets of RMB551,860,000 (2002: RMB525,329,000). A reconciliation between profit (loss) for the year and net assets reported under PRC GAAP and those reported under IFRS are as follows: Profit (loss) for the year Net assets 2003 2002 2003 2002 57 RMB'000 RMB'000 RMB'000 RMB'000 As reported under PRC GAAP 26,531 (45,584) 551,860 525,329 Adjustments to conform with IFRS: Difference in depreciation charges of aircraft and related equipment 38,245 (22,925) (11,924) (50,169) Difference in deferred expenditure recognition 7,748 3,538 (50,388) (58,136) Adjustment of provision for overhaul of aircraft and engines - (21,521) - - Deferred tax (1,679) - 20,563 22,242 Pre-operating expense of subsidiaries 523 (523) - (523) Interest income from holding company - 6,631 - - _______ _______ _______ _______ As reported under IFRS 71,368 (80,384) 510,111 438,743 _______ _______ _______ _______ 39.SUBSEQUENT EVENT On February 18, 2004, Shandong Aviation Group pledged 129,600,000 shares of the Company to China Minsheng Bank Corp., Ltd. for the Company to apply for a short-term loan of RMB3,500,000,000. The pledged period was from February 18, 2004 to June 30, 2004. Related pledge procedure has been processed in the Shengzhen Branch of China Securities Depository & Clearing Corporation Limited. On February 28, 2004, Shandong Aviation Group signed an agreement with China National Aviation Holding Company to transfer 91,200,000 shares, representing 22.8% of the total issued shares in the Company to China National Aviation Holding Company. Meanwhile, China National Aviation Holding Company will purchase 42% shareholding in Shandong Aviation Group. Shandong Aviation Group will then issue shares to China National Aviation Holding Company and China National Aviation Holding Company will hold 48% shareholding in Shandong Aviation Group. 40.FAIR VALUE OF FINANCIAL INSTRUMENTS AND CONCENTRATION OF RISK Financial assets of the Group include bank balance and cash, trade and other receivables, amount due from holding company and amounts due from related parties. Financial liabilities of the Group include bank loans, other loan, trade and other payables and amounts due to related companies. Business risk The Group conducts its principal operations in the PRC and accordingly is subject to special considerations and significant risks not typically associated with companies in the United States of America and Western European companies. These include risks associated with, among others, the 58 political, economic and legal environment, competition in the passenger and cargo air transportation services, and influence of CAAC on pricing of air tickets, take-off and landing charges at certain PRC airports, commission rates and the adjustment on fuel prices. Interest rate risk The interest rates and terms of repayment of the borrowings made to the Group are disclosed in note 26 and 27. Foreign currency risk Certain of the Group's bank loans and other loan are denominated in United States dollars but the group's revenue is denominated in Renminbi. The Group is exposed to foreign currency risk. Credit risks (i) Bank balances and cash Substantially all of the Company's bank balance and cash are deposited with PRC financial institutions. (ii) Trade receivables These are mainly ticket sale receivables from sale agents and receivables related to uplifts by the Group on behalf of other carriers. These receivables are spread among numerous parties. (iii) Other receivables The amounts mainly comprise outstanding balances due from third parties which is non-interest bearing. The carrying amount of financial assets best represent their maximum credit risk exposure at the balance sheet date. Other financial liabilities Trade and other payables The amounts principally comprise amounts outstanding for trade purchases and ongoing costs. Fair value The fair value of bank balances and cash, trade and other receivables, amount due from holding company, amount due from related companies, bank loans, other loan, obligations under finance lease, trade and other payables and amounts due to related parties are not materially different from their carrying amounts. 59 Fair value estimates are made at specific point in time and are based on relevant market information. The estimate is subjective in nature and involved uncertainties and matters of significant judgement and therefore cannot be determined with precision. 41.LANGUAGE The English text of the financial statements is a translated version for reference only. The Chinese text of the financial statements will prevail over the English text. XI. Documents Available for Reference 1. Financial statements carried with the personal signatures and seals of Chairman of the Board, general accountants and accounting departments; 2. Original of Auditors’ Report carried with the seal of Certified Public Accountants as well as personal signatures and seals of certified public accountants; 3. Originals of all documents and notices publicly disclosed on newspapers designated by CSRC in the report period; The Company will offer above documents for reference timely provided that CSRC or Stock Exchange demands or shareholders requires according to the regulations and Articles of Association. Chairman of the Board: Li Junhai Shandong Airlines Co., Ltd. March 31, 2004 60