Annual Re P O R T 1 9

a n n u a l r e p o r t 1 9 9 8

IBERIA L.A.E. AND IBERIA GROUP

SOCIEDAD ESTATAL DE PARTICIPACIONES INDUSTRIALES

ANNUAL REPORT 1998 IBERIA, LINEAS AEREAS DE ESPAÑA, S.A. AND IBERIA GROUP LETTER FROM THE CHAIRMAN

EXPANDED EARNINGS AND NEW MARKETS

BY XABIER DE IRALA, PRESIDENT IBERIA AIRLINES

With earnings before tax of 62.8 billion pesetas, four times larger than those of 1997, and a return on equity of 34%, there can be no doubt that 1998 was the best year in Iberia´s 72-year history. For the first time in many years our Company is able to distribute a dividend (40 pesetas/share) to our shareholders, including Iberia employees, who now own more than 6% of our stock. For the Iberia Group as a whole, net earnings before tax came to 65.97 billion pesetas, also a record. These results place Iberia at the top among European airlines in terms of profit ratios, an achievement whose significance was enhanced as our Company underwent privatisation.

No less important than these business results were the sweeping changes made to our airline group last year as we prepared for privatisation by forging new partnerships, adding and improving services, and embarking on a major renewal of our fleet.

In this context, last year brought new destinations, such as Chicago and Johannesburg, as we consolidated our leadership in domestic flights and routes to Latin America, substantially expanding and improving our services, and increasing the number of direct flights to major South American destinations. We also undertook the comprehensive remodelling and upgrading of our Business Class service.

We entered into a new commercial alliance with American Airlines, which is enabling us to expand our coverage of the United States, the world’s largest air travel market, and in which we now reach 23 destinations. In partnership with other leading firms we set up Viva Tours, a tour operator poised to become a leading firm in Europe, while optimising our links with travel agencies through the Serviagencias programme.

These and other commercial innovations, along with the hire of additional aircraft and flight crews, helped to boost our core operating income by 10%, while carrying nearly a million more passengers in the year.

Cost containment measures limited the growth of expenditures to just 7.6%, which was well below the rate of revenue growth, signifying a considerable expansion of our operating margin. Overhead expenses were reduced by 6% in the year, in excess of our 5% target.

p-6 ANNUAL REPORT 1998 IBERIA, LINEAS AEREAS DE ESPAÑA, S.A. AND IBERIA GROUP LETTER FROM THE CHAIRMAN

The year under review also witnessed our careful preparations for the privatisation scheduled to take place in 1999. The reorganisation of our finances and balance sheet was completed, and negotiations proceeded with British Airways and American Airlines, which together took up a 10% stake in Iberia´s equity in 1999. Subsequently, four Spanish companies - BBV, Caja Madrid, Logista, Ahorro Corporación and El Corte Inglés - together acquired a 30% holding. As mentioned above, Iberia employees hold 6% of our equity, and the remainder of the stock will be sold through stock exchanges.

Lastly, in 1998 Iberia became a founding member of oneworld, the world´s largest airline alliance.

Meanwhile, we also completed our fleet renovation plan, calling for the acquisition of 92 new short- and medium-range aircraft and 11 long-distance aircraft, representing a total investment of some 600 billion pesetas. The investment formulas used include outright purchase, financial leasing, and operational leasing, among others, to ensure the maximum economy and flexibility. Our aim is to operate a more homogeneous and more competitive fleet that allows us to reduce fuel consumption and noise emissions, while increasing the number of flights and the productivity of our flight crews.

But it takes more than aircraft to make an airline, and another noteworthy achievement in 1998 was the successful negotiation of three of our four major collective bargaining agreements with union representatives (negotiations with the airline pilots union continued into 1999). In order to maintain our rapid rate of growth, and to gain market share, we have added productivity clauses to our collective bargaining contracts, and more than 200 new pilots will have joined Iberia in the 1998-99 period. The commitment of Iberia employees to our Company´s future was crucial in helping us to emerge from a complicated situation in the early 1990s, and it will remain crucial as we compete for customers, market share, and investors in a crowded market.

Despite these achievements, our business results are limited by aviation and airport infrastructures which do not always manage to keep pace with demand growth. The commissioning of the third runway at Madrid´s Barajas airport brought some relief, but the saturation of European air routes, airports, and traffic control facilities has not only constrained our growth, but also made it hard for airlines to maintain optimum punctuality and regularity. More modern and efficient aviation infrastructures are urgently needed throughout Europe, and especially in Spain, where tourism is the largest industry.

Xabier de Irala

p-7

a n n u a l r e p o r t 1 9 9 8

L E G A L I N F O R M AT I O N

IBERIA, LINEAS AEREAS DE ESPAÑA, S.A.

a n n u a l r e p o r t 1 9 9 8

1998 FI N A N C I A L STAT E M E N T S A N D MA N AG E M E N T RE P O R T BALANCE SHEETS AS OF DECEMBER 31, 1998 AND 1997 S T A T E M E N T S OF INCOME FOR 1998 AND 1997

TR A N S L AT IO N O F A R E P O R T A N D F I N A N C I A L S TAT E M E N TS O R IG I N A L LYIS S U E D I N SPA N IS H A N D P R E PA R E D I N AC C O R DA N C E W I T H G E N E R A L LYAC C E P T E D AC C O U N T I N G P R I N C I P L E S I N SPA I N (S E E NOT E 2 0 ) . I N T H E E V E N T O F A D IS C R E PA N C Y , T H E S P A N IS H - L A N G U A G E V E R S IO N P R E VA I L S .

IBERIA, LINEAS AEREAS DE ESPAÑA, S.A. ANNUAL REPORT 1998 IBERIA, LINEAS AEREAS DE ESPAÑA, S.A. BALANCE SHEETS AS OF DECEMBER 31, 1998 AND 1997

TRANSLATIONOF A REPORTANDFINANCIAL ASSETS M I L L I O N S O F P E S E TA S STATEMENTS ORIGINALLY ISSUEDIN SPANISH

ANDPREPAREDIN ACCORDANCEWITHGENERALL Y

ACCEPTED ACCOUNTINGPRINCIPLESIN SPAIN (SEE NOTE 20). 1998 1997 IN THEEVENTOF A DISCREPANCY, THE SPANISH-LANGUAGEVERSIONPREVAILS . FIXED AND OTHER NONCURRENT ASSETS: STA R T-U P E X P E N S E S ( NOT E 4 -a) 4 6 5 6 4 6 IN TA N G I B L E A S S E T S ( NOT E 5 ) 2 5 , 7 1 2 2 7 , 0 4 5 TA N G I B L E F I X E D A S S E T S ( NOT E 6 ) 2 0 2 , 1 9 4 1 8 1 , 1 5 8 AI R C R A F T: CO S T 3 3 8 , 8 0 9 3 0 9 , 4 0 8 AC C U M U L AT E D D E P R E C I AT IO N A N D P R O V IS IO N S ( 1 9 1 , 7 2 0 ) ( 1 8 3 , 8 0 9 ) 1 4 7 , 0 8 9 1 2 5 , 5 9 9 OT H E R TA N G I B L E F I X E D A S S E TS: CO S T 1 5 7 , 1 3 5 1 5 1 , 6 0 3 AC C U M U L AT E D D E P R E C I AT IO N A N D P R O V IS IO N S ( 1 0 2 , 0 3 0 ) ( 9 6 , 0 4 4 ) 5 5 , 1 0 5 5 5 , 5 5 9 LO N G-T E R M F I N A N C I A L I N V E S T M E N T S 1 3 6 , 0 7 4 8 2 , 9 3 3 HO L D I N G S I N GR O U P A N D A S S O C I AT E D C O M PA N I E S ( NOT E 7 ) 9 3 , 9 4 3 7 6 , 3 5 2 LOA N S TO GR O U P A N D A S S O C I AT E D C O M PA N I E S ( NOT E 7 ) 2 7 , 5 5 3 2 3 , 0 7 6 LO N G-T E R M R E C E I VA B L E S F R O M GR O U P C O M PA N I E S ( NOT E 1 4 ) 5 0 , 1 9 2 4 3 , 2 6 5 IN V E S T M E N T S E C U R I T I E S A N D OT H E R L OA N S 4 , 6 5 9 2 , 7 6 0 PR O V IS IO N S ( NOT E 7 ) ( 4 0 , 2 7 3 ) ( 6 2 , 5 2 0 ) TOTA L F I X E D A N D OT H E R N O N C U R R E N T A S S E T S 3 6 4 , 4 4 5 2 9 1 , 7 8 2

DEFERRED CHARGES (N OTE 5) 5 , 5 7 1 7 , 5 2 4

CURRENT ASSETS: IN V E N TO R I E S 8 , 7 4 4 7 , 4 2 7 RE C E I VA B L E F R O M GR O U P C O M PA N I E S ( NOT E 1 4 ) 1 4 , 3 8 5 1 3 , 0 1 3 AC C O U N T S R E C E I VA B L E ( NOT E 8 ) 5 5 , 4 1 8 6 0 , 9 5 0 SH O R T-T E R M F I N A N C I A L I N V E S T M E N T S ( NOT E 9 ) 7 6 , 5 5 7 7 6 , 9 4 9 CA S H 1 , 9 7 7 1 , 2 6 9 AC C R UA L AC C O U N T S 4 , 9 6 4 4 , 7 6 0 TOTA L C U R R E N T A S S E T S 1 6 2 , 0 4 5 1 6 4 , 3 6 8

TOTAL ASSETS 5 3 2 , 0 6 1 4 6 3 , 6 7 4

p-14 INFORME ANUAL 1998 IBERIA, LINEAS AEREAS DE ESPAÑA, S.A. BALANCE SHEETS AS OF DECEMBER 31, 1998 AND 1997

SHAREHOLDERS’ EQUITY AND LIABILITIES M I L L I O N S O F P E S E TA S TRANSLATIONOF A REPORTANDFINANCIAL STATEMENTS ORIGINALLY ISSUEDIN SPANISH

ANDPREPAREDIN ACCORDANCEWITHGENERALLY

ACCEPTED ACCOUNTINGPRINCIPLESIN SPAIN 1998 1997 (SEE NOTE 20). IN THEEVENTOF A DISCREPANCY, THE SPANISH-LANGUAGEVERSIONPREVAILS . SHAREHOLDERS’ EQUITY ( NOT E 1 0 ) : CA P I TA L S TO C K 1 1 4 , 7 2 7 1 1 4 , 7 2 7 RE VA L UAT I O N R E S E R V E - 1 5 , 4 4 7 PR I O R Y E A R S’ L O S S E S ( 1 5 , 8 0 9 ) ( 4 2 , 2 8 4 ) IN C O M E F O R T H E Y E A R 5 1 , 2 9 1 1 1 , 0 2 8 TOTA L S H A R E H O L D E R S’ E Q U I T Y 1 5 0 , 2 0 9 9 8 , 9 1 8

DEFERRED REVENUES (NOTE 6) 1 , 1 4 7 2 , 3 4 1

P R OVISIONS FOR CONTINGENCIES AND EXPENSES: PROVISIONS FOR PENSIONS (NOTE 4-I) 1 5 , 1 1 7 1 4 , 3 3 3 PR OV I S I O N S F O R O B L I GAT I O N S TO E M P L OY E E S ( NOT E 4 -K) 4 5 , 1 5 6 4 2 , 5 1 6 PR OV I S I O N F O R M A J O R R E PA I R S 1 5 , 7 4 0 1 4 , 2 9 3 PR OV I S I O N F O R T H I R D-PA R T Y L I A B I L I T Y ( NOT E 1 1 ) 6 3 , 9 7 9 6 5 , 2 3 8 TOTA L P R OV I S I O N S F O R C O N T I N G E N C I E S A N D E X P E N S E S 1 3 9 , 9 9 2 136,380

LONG-TERM DEBT: PAYA B L E TO C R E D I T E N T I T I E S ( NOT E 1 2 ) 4 8 , 3 2 2 6 7 , 0 9 3 PAYA B L E TO GR O U P A N D A S S O C I AT E D C O M PA N I E S ( NOT E 1 4 ) 4 , 8 5 1 2 , 3 7 8 UN C A L L E D C A P I TA L PAY M E N T S PAYA B L E 9 9 1 5 0 OT H E R AC C O U N T S PAYA B L E 4 1 0 3 TOTA L L O N G-T E R M D E BT 5 3 , 2 7 6 6 9 , 7 2 4

CURRENT LIABILITIES: PAYA B L E TO C R E D I T E N T I T I E S ( NOT E 1 2 ) 3 5 , 9 1 0 1 2 , 7 5 9 PAYA B L E TO GR O U P A N D A S S O C I AT E D C O M PA N I E S ( NOT E 1 4 ) 1 7 , 6 1 7 7 , 1 3 3 TR A D E AC C O U N T S PAYA B L E 1 0 0 , 4 5 6 9 8 , 3 6 5 CUS TO M E R A D VA N C E S 2 7 , 5 4 7 4 0 , 0 8 0 PAYA B L E S F O R P U R C H A S E S A N D S E R V IC E S 7 2 , 9 0 9 5 8 , 2 8 5 CO M P E N SAT I O N PAYA B L E 1 6 , 2 3 5 1 9 , 5 5 2 OT H E R N O N T R A D E PAYA B L E S (NOTE 15) 1 7 , 1 9 3 1 8 , 4 3 0 AC C R UA L AC C O U N T S 2 6 7 2 TOTA L C U R R E N T L I A B I L I T I E S 1 8 7 , 4 3 7 1 5 6 , 3 1 1

The accompanying Notes 1 to 20 TOTAL SHAREHOLDERS’ EQUITY AND LIABILITIES 5 3 2 , 0 6 1 4 6 3 , 6 7 4 are an integral part of the balance sheet as of December 31, 1998.

p-15 ANNUAL REPORT 1998 IBERIA, LINEAS AEREAS DE ESPAÑA, S.A. STATEMENTS OF INCOME FOR 1998 AND 1997

TRANSLATIONOF A REPORTANDFINANCIAL DEBIT M I L L I O N S O F P E S E TA S STATEMENTS ORIGINALLY ISSUEDIN SPANISH

ANDPREPAREDIN ACCORDANCEWITHGENERALL Y

ACCEPTED ACCOUNTINGPRINCIPLESIN SPAIN (SEE NOTE 20). 1998 1997 IN THEEVENTOF A DISCREPANCY, THE SPANISH-LANGUAGEVERSIONPREVAILS . E X P E N S E S : PU R C H A S E S ( NOT E 1 6 ) 7 4 , 1 8 3 6 9 , 4 9 6 PE R S O N N E L E X P E N S E S ( NOT E 1 6 ) 1 6 6 , 1 6 8 1 5 9 , 5 0 4 PE R IO D D E P R E C I AT IO N A N D A MO R T I Z AT IO N 1 9 , 1 3 7 3 0 , 1 3 1 VA R I AT IO N I N O P E R AT I N G P R O V IS IO N S 2 , 0 2 3 1 , 9 0 2 OT H E R O P E R AT I N G E X P E N S E S ( NOT E 1 6 ) 3 2 2 , 8 5 1 2 2 7 , 9 7 1 5 8 4 , 3 6 2 4 8 9 , 0 0 4 OP E R AT I N G I N C O M E 4 7 , 9 7 9 3 5 , 9 4 9 FI N A N C I A L A N D S I M I L A R E X P E N S E S 7 , 6 6 3 1 0 , 5 5 0 EXC H A N G E L O S S E S 8 , 5 2 9 1 4 , 5 1 5

1 6 , 1 9 2 2 5 , 0 6 5

IN C O M E F R O M O R D I N A R Y AC T I V I T I E S 4 4 , 3 0 4 3 0 , 4 1 1 VA R I AT IO N I N TA N G I B L E F I X E D A S S E T P R O V IS IO N S (NOTE 7) ( 3 8 2 ) 1 , 6 3 3 LO S S E S O N F I X E D A S S E TS 9 5 3 7 2 9 EX T R AO R D I N A R Y E X P E N S E S ( NOT E S 7 a nd 1 6 ) 1 3 , 0 9 2 6 2 , 6 2 1 PR IO R Y E A R S’ E X P E N S E S A N D L O S S E S 3 0 5 4 4 1 1 3 , 9 6 8 6 5 , 4 2 4

EX T R AO R D I N A R Y I N C O M E 1 8 , 4 9 7 -

IN C O M E B E F O R E TA X E S 6 2 , 8 0 1 1 4 , 3 6 0 CO R P O R AT E I N C O M E TA X ( NOT E 1 5 ) 1 1 , 5 1 0 3 , 3 3 2 IN C O M E F O R T H E Y E A R 5 1 , 2 9 1 1 1 , 0 2 8

p-16 ANNUAL REPORT 1998 IBERIA, LINEAS AEREAS DE ESPAÑA, S.A. STATEMENTS OF INCOME FOR 1998 AND 1997

CREDIT M I L L I O N S O F P E S E TA S TRANSLATIONOF A REPORTANDFINANCIAL STATEMENTS ORIGINALLY ISSUEDIN SPANISH

ANDPREPAREDIN ACCORDANCEWITHGENERALLY

ACCEPTED ACCOUNTINGPRINCIPLESIN SPAIN 1998 1997 (SEE NOTE 20). IN THEEVENTOF A DISCREPANCY, R E V E N U E S : THE SPANISH-LANGUAGEVERSIONPREVAILS . NE T R E V E N U E S ( NOT E 1 6 ) 6 0 6 , 9 5 3 4 9 6 , 6 4 1 OT H E R O P E R AT I N G R E V E N U E S ( NOT E 1 6 ) 2 5 , 3 8 8 2 8 , 3 1 2

6 3 2 , 3 4 1 5 2 4 , 9 5 3

RE V E N U E S F R O M S H A R E HO L D I N G S ( NOT E 7 ) 3 1 2 2 5 3 OT H E R I N T E R E S T A N D S I M I L A R R E V E N U E S 5 , 9 1 0 8 , 2 6 9 EXC H A N G E GA I N S 6 , 2 9 5 1 1 , 0 0 5 1 2 , 5 1 7 1 9 , 5 2 7 FI N A N C I A L L O S S 3 , 6 7 5 5 , 5 3 8

GA I N S O N F I X E D A S S E T D IS P O SA L S ( NOT E S 6 a nd 7 ) 7 , 9 7 4 1 7 , 0 7 8 EX T R AO R D I N A R Y R E V E N U E S ( NOT E 1 6 ) 1 0 , 9 4 5 1 3 , 0 5 4 PR IO R Y E A R S’ R E V E N U E S A N D I N C O M E ( NOT E 4 -h) 1 3 , 5 4 6 1 9 , 2 4 1

3 2 , 4 6 5 4 9 , 3 7 3

The accompanying Notes 1 to 20 EX T R AO R D I N A R Y L O S S - 1 6 , 0 5 1 are an integral part of the 1998 statement of income.

p-17

a n n u a l r e p o r t 1 9 9 8

N O T E S TO 1 9 9 8 FI N A N C I A L STAT E M E N T S

TRANSLATION OF A REPORT AND FINANCIAL STATEMENTS ORIGINALLYISSUED IN SPANISH AND PREPARED I N AC C O R DA N C E W I T H G E N E R A L LYAC C E P T E D AC C O U N T I N G P R I N C I P L E S I N SPA I N (S E E NOT E 2 0 ) . I N T H E E V E N T O F A D IS C R E PA N C Y , T H E S PA N IS H -L A N G U A G E V E R S IO N P R E VA I L S .

IBERIA, LINEAS AEREAS DE ESPAÑA, S.A.

ANNUAL REPORT 1998 IBERIA, LINEAS AEREAS DE ESPAÑA, S.A. NOTES TO 1998 FINANCIAL STATEMENTS

[1] COMPANY DESCRIPTION

IBERIA, Líneas Aéreas de España, S.A. engages in the air transport of passengers and TRANSLATIONOF A REPORTANDFINANCIAL cargo and also carries on other activities related to its core business. STATEMENTS ORIGINALLY ISSUEDIN SPANISH ANDPREPAREDIN ACCORDANCEWITHGENERALL Y

ACCEPTED ACCOUNTINGPRINCIPLESIN SPAIN As a carrier of passengers and cargo, the Company operates through a large network (SEE NOTE 20). IN THEEVENTOF A DISCREPANCY, serving three major markets: Spain, Europe and the Americas. As regards international THE SPANISH-LANGUAGEVERSIONPREVAILS . traffic, in countries with which bilateral agreements have been entered into designating a single company as the operator, IBERIA, Líneas Aéreas de España, S.A. is the operator designated by the Spanish party.

As part of the activities related to the core business, mention should be made of the Company’s activities as a handling agent, its maintenance activity and the special positioning of IBERIA, Líneas Aéreas de España, S.A. in distribution systems.

As regards the handling activity, it should be noted that in 1992, after a public call for tende r s, Ente Público de Ae ropuertos Españoles y Navegación Aérea (AENA) -the Spanish public airports and aviation agency- awarded the Company a contract for the provision of handling services as the first operator in Spain from April 1, 1993, to April 1, 2000.

The Company performs a significant portion of its own maintenance work and provides technical assistance to various companies, mainly through its maintenance center in Barajas.

As regards the distribution system, IBERIA, Líneas Aéreas de España, S.A. is a partner of the Amadeus Group, which owns the Amadeus central booking system, on an equal footing with Lufthansa and Air France. This investment enables IBERIA to be present in an industry with huge economic and growth potential, characterized by its significant technological content.

The Company is continuing to implement the Master Plan designed by the current management team, the purpose of which it to consolidate IBERIA, Líneas Aéreas de España, S.A. as a global air transport operator. In 1998 numerous measures were taken aimed at achieving this objective, adding to those already carried out in 1997, including most notably:

1. Optimization of the separate management systems organizational structure for each business (airports, materials, systems and cargo) initiated in 1997. In 1998 the business activities of Aviación y Comercio, S.A., other than its activities as an operator, were integrated into the Company, except for its maintenance activity, which will be integrated in 1999. A wide-reaching reorganization of the cargo business was also performed in 1998.

p-21 ANNUAL REPORT 1998 IBERIA, LINEAS AEREAS DE ESPAÑA, S.A. NOTES TO 1998 FINANCIAL STATEMENTS

initiated in 1997 was maintained, and the Aviación y Comercio, S.A. shares held by Sociedad Estatal de Participaciones Industriales (SEPI) were acquired.

The franchise agreement entered into with Air Nostrum in 1997 remained in force, and in March 1998 an agreement was entered into with Air Europa to operate eleven aircraft on the Company’s routes under a wet lease arrangement.

3. Alliance agreements were entered into with American Airlines, Inc. and British Airways. In 1998 these two companies formalized an agreement for the acquisition of a 10% holding in the Company and also entered into commercial agreements with IBERIA. In February 1999 the Company became a fully fledged member of the Oneworld “megacarrier”, one of the two largest air transport groups in the world, which is led by the two aforementioned companies. This will facilitate globalization of the air transport business.

4. Following the agreement with American Airlines, Inc. and British Airways, SEPI, the Company’s main shareholder, is studying the offers received from Spanish institutional investors with a view to divesting approximately 30% of the Company’s capital stock to subsequently launch a public offering on the stock exchange of the rest of its holding.

[2] BASIS OF PRESENTATION OF THE FINANCIAL STATEMENTS The 1998 financial statements, which were prepared from the Company's accounting records adjusted for the effects of the revaluation made pursuant to Royal Decree-Law 7/1996, are presented in accordance with the Spanish National Chart of Accounts and, accordingly, they give a true and fair view of the Company's net worth, financial position, results of operations and funds obtained and applied in 1998. These financial statements, which were prepared by the Company's directors, will be submitted for approval by the Shareholders' Meeting, and it is considered that they will be approved without any changes.

[3] DISTRIBUTION OF INCOME The Company’s directors propose the following distribution of 1998 income:

DISTRIBUTION OF INCOME MILLIONS OF PESETAS

OF F S E T O F P R IO R Y E A R S’ L O S S E S 1 0 , 2 3 9 TO L E GA L R E S E R V E 5 , 1 2 9 TO V O L U N TA R Y R E S E R V E S 6 2 3 DI V I D E N D S 3 5 , 3 0 0 IN C O M E F O R T H E Y E A R 5 1 , 2 9 1

p-22 ANNUAL REPORT 1998 IBERIA, LINEAS AEREAS DE ESPAÑA, S.A. NOTES TO 1998 FINANCIAL STATEMENTS

[4] VALUATION STANDARDS The main valuation methods applied by the Company in preparing its financial statements for 1998, in accordance with the Spanish National Chart of Accounts, were as follows:

A) START-UP EXPENSES These expenses consist basically of public deed execution and registration expenses relating to capital increases, and are amortized at an annual rate of 20%.

Ptas. 181 million of amortization of start-up expenses were charged to the 1998 statement of income.

B) INTANGIBLE ASSETS Leased assets are recorded as intangible assets at the cost of the related item, excluding interest costs, and are amortized by the same methods as those used to depreciate similar items of property, plant and equipment. The total debt for lease payments plus the amount of the purchase option is recorded as a liability. The difference between the two amounts, which represents the interest expenses on the transaction, is recorded under the “Deferred Charges” caption in the accompanying balance sheet and is allocated to income each year by the interest method.

In prior years the Company modified the net book value of certain of its leased aircraft pursuant to a Ministry of Economy and Finance Order (see Note 4-f). Since no aircraft were leased in 1998 or in any of the four preceding years, no modification pursuant to this Order was made to the net book value of any aircraft in 1998.

Leased assets are amortized by the stra ig ht - l i ne me t ho d, distributing the amortizable cost of the assets among the years of estimated useful life, which are the same as those of similar property, plant and equipment items.

Computer software is being amortized on a straight-line basis over an estimated useful life of five years.

Ptas. 1,942 million of amortization of intangible assets were charged to the 1998 statement of income.

C) PROPERTY, PLANT AND EQUIPMENT The valuation methods applied by the Company are as follows:

1. AIRCRAFT: Aircraft are carried at cost revalued pursuant to the applicable enabling legislation, including Royal Decree-Law 7/1996, except for certain aircraft, the value of which was modified in prior years pursuant to the provisions of a Ministry of Economy and Finance Order (see Note 4-f). Since there were no significant aircraft purchases in 1998 or in any of the four preceding years, no modification pursuant to the aforementioned Order was made to the net book value of any aircraft in 1998.

p-23 ANNUAL REPORT 1998 IBERIA, LINEAS AEREAS DE ESPAÑA, S.A. NOTES TO 1998 FINANCIAL STATEMENTS

2. OTHER TANGIBLE FIXED ASSETS: The tangible fixed assets recorded under the “Other Tangible Fixed Assets” caption in the accompanying balance sheets are carried at cost revalued pursuant to the applicable enabling legislation, including Royal Decree-Law 7/1996.

3. REPAIRS, UPKEEP AND MAINTENANCE: The Company records a provision for the periodic major repairs of the B-747, B-757, DC-10, MD-87, A-300, A-320 and A-340 aircraft with which it operates based on the total estimated cost to be incurred, and allocates this cost to income on a straight-line basis during the period elapsing between two successive major repairs. The balance of this provision is reflected under the “Provision for Major Repairs” caption in the accompanying balance sheet as of December 31, 1998.

The costs of minor repairs to the aforementioned types of aircraft and of all repairs to the B-727 and DC-9 aircraft are expensed currently, since the annual expenses tend to be uniform.

Upkeep and maintenance expenses are expensed currently.

D) DEPRECIATION OF PROPERTY, PLANT AND EQUIPMENT The Company depreciates its property, plant and equipment by the straight-line method at annual rates based on the years of estimated useful life.

The methods applied to calculate depreciation of the main items of property, plant and equipment are as follows:

1. AIRCRAFT: The depreciable cost of the aircraft is equal to their book value less the estimated residual value at the end of their useful lives. The residual value ranges from 10% to 20%, depending on the aircraft.

2. AIRCRAFT SPARE PARTS: Spare parts for aircraft maintenance are depreciated, depending on the type of part, as follows: a) Rotatable parts These parts are depreciated over 18 years from the date of purchase, assuming a residual value of between 10% and 20%, depending on the type of aircraft. b) Repairable parts These are depreciated in a period ranging from 8 to 10 years, depending on the aircraft, from the date of purchase, assuming a residual value of 10% in all cases. The Company also records provisions for diminution in value of spare parts due to obsolescence.

p-24 ANNUAL REPORT 1998 IBERIA, LINEAS AEREAS DE ESPAÑA, S.A. NOTES TO 1998 FINANCIAL STATEMENTS

3. YEARS OF ESTIMATED USEFUL LIFE: The years of estimated useful life of property, plant and equipment items are as follows:

YEARS OF ESTIMATED USEFUL LIFE YEARS

A I R C R A F T 18 B U I L D I N G S A N D O T H E R S T R U C T U R E S 20 - 50 M A C H I N E R Y, I N S TA L L AT IO N S A N D T O O L S 10 – 16 T R A N S P O R T E Q U I P M E N T 7 – 10 F U R N I T U R E A N D F I X T U R E S 10 C O M P U T E R H A R D WA R E 5 – 7 S P A R E PA R T S 8 – 18 F L IG H T S I M U L AT O R S 10 – 14

The buildings and facilities on land owned by the Spanish State, mostly at Spanish airports, with an aggregate net book value of Ptas. 4,043 million as of December 31, 1998, are depreciated over the respective concession periods.

Depreciation is taken on the net amount of tangible fixed asset revaluations from the date they are recorded, using the same useful life periods as for the cost values.

The detail of depreciation of and provisions for property, plant and equipment charged to the statement of income for 1998 is as follows:

1998 MILLIONS OF PESETAS

A I R C R A F T 7 , 9 1 9 O T H E R TA N G I B L E F I X E D A S S E T S 9 , 1 0 0 1 7 , 0 1 9

E) SHAREHOLDINGS AND OTHER FINANCIAL INVESTMENTS

1. HOLDINGS IN GROUP AND ASSOCIATED COMPANIES.

The Company carries its investments in other companies at cost, net, where appropriate, of the required provisions for diminution in value if cost exceeds fair market value at year-end, which in the case of the Amadeus Group and the companies which own the A-340 aircraft, was based on their provisional financial statements as of December 31, 1998.

The effects of consolidating the Company's 1998 financial statements were increases of Ptas. 64,077 million in assets, of Ptas. 1,734 million in income and of Ptas. 6,204 million in reserves.

p-25 ANNUAL REPORT 1998 IBERIA, LINEAS AEREAS DE ESPAÑA, S.A. NOTES TO 1998 FINANCIAL STATEMENTS

2. GOVERNMENT DEBT SECURITIES. Investments in government debt securities are carried at cost. The interest on these securities is credited to income when earned and is charged through maturity to the “Short-Term Financial Investments” caption.

3. TIME DEPOSITS. Time deposits are recorded at the amount delivered. The interest on these deposits is credited to income when earned and is charged to the “Short-Term Financial Investments” caption.

F) TRANSLATION OF FOREIGN CURRENCY BALANCES The balances of accounts denominated in foreign currencies are translated to pesetas at the exchange rates ruling at December 31 of each year. However, following customary airline practice, the balance of the liability for unused traffic documents is reflected in the balance sheet at the exchange rate ruling in the month of the sale, as set by the International Air Transport Association (IATA). The IATA exchange rate for each month is the average exchange rate for the last five days of the preceding month.

Translation differences arising from translation at official year-end exchange rates and from the difference between exchange rates at December 31 of the preceding year and those prevailing at the date of effective collection or payment are recorded under the “Exchange Gains/Losses” captions in the statement of income, except for the net gains or losses relating to the financing obtained for the acquisition of certain aircraft.

However, unrealized exchange gains arising on currencies for which exchange losses have not been allocated to income in prior years or in the current year are recorded under the “Deferred Revenues” caption in the balance sheet.

EXCHANGE DIFFERENCES ARISING FROM AIRCRAFT FINANCING Pursuant to Valuation Rule 14 in Section 5 of the Spanish National Chart of Accounts, on March 23, 1994, the Ministry of Economy and Finance issued, at the proposal of the Accounting and Audit Institute (ICAC), a Ministerial Order on the accounting treatment of certain foreign currency exchange differences.

Under this accounting regulation, from January 1, 1993, the net amount of foreign currency exchange differences arising in each year on debts for financing for the acquisition by the Company and other IBERIA Group companies of aircraft added to the fleet in the current year and in the four immediately preceding years has to be recorded as an increase or decrease in the value of such aircraft.

In 1998 the Company did not record any change to the net book value of the aircraft in this connection.

p-26 ANNUAL REPORT 1998 IBERIA, LINEAS AEREAS DE ESPAÑA, S.A. NOTES TO 1998 FINANCIAL STATEMENTS

G) INVENTORIES Inventories, basically aeronautical supplies, are valued at average purchase cost, and the related provisions for diminution in value are recorded.

H) RECOGNITION OF REVENUES AND EXPENSES Revenues and expenses are recognized on an accrual basis, i.e. when the actual flow of the related goods and services occurs, regardless of when the resulting monetary or financial flow arises.

Ticket sales and the traffic documents for freight and other services are initially credited to “Customer Advances” in the balance sheet. The balances of this caption in the accompanying balance sheets reflect the liability for tickets and traffic documents sold prior to December 31, 1998 and 1997, but not yet used at those dates.

The revenues relating to these items are recognized when the transport or service is performed.

1996 was the first full year in which the new system implemented by Company management was used to control sales and uses of international traffic tickets and determine the balance of the “Customer Advances” caption. In 1997 the Company completed definition of the procedures for controlling transactions relating to the main “Customer Advances” balances and recorded the appropriate adjustments. In 1998 the Company completed implementation of the control procedures for the accounts relating to the “Customer Advances” caption and made an adjustment for a net amount of Ptas. 10,938 million, which was recorded under the “Prior Years’ Revenues and Income” caption in the accompanying 1998 statement of income.

The Company has introduced the “IBERIA Plus” card as an ongoing promotional tool whereby the holder of the card accumulates points for taking certain flights, using certain hotels, renting cars or making credit card purchases with credit cards covered by the program. The points can be exchanged for free tickets or other services offered by the companies included in the program. The accompanying balance sheet as of December 31, 1998, includes a provision of Ptas. 4,464 million in this connection, based on estimates of the value of the points accumulated at that date.

I) PROVISIONS FOR PENSIONS Under the collective labor agreements currently in force, the Company is required to pay full compensation to flight personnel who take early retirement (special leave) and to supplement the social security benefits of ground personnel taking early retirement, in accordance with the conditions specified for each case.

The “Provisions for Pensions” caption in the accompanying balance sheet includes the liabilities incurred in this connection as of December 31, 1998. The provisions

p-27 ANNUAL REPORT 1998 IBERIA, LINEAS AEREAS DE ESPAÑA, S.A. NOTES TO 1998 FINANCIAL STATEMENTS

recorded to cover the discounted value of the liabilities incurred as of December 31, 1998, and the interest allocable to the recorded allowance amount to Ptas. 1,364 million and Ptas. 717 million, respectively, and these amounts are included under the “Personnel Expenses” and “Financial and Similar Expenses” captions, respectively, in the accompanying 1998 statement of income.

The liability incurred as of December 31, 1998, was determined on the basis of actuarial studies conducted by independent actuaries using the unit credit method, and the main assumptions were an annual interest rate of 4%, an expected annual CPI variation of 2% and annual provisions payable in arrears.

J) MONTEPÍO DE PREVISIÓN SOCIAL LORETO T he main purpose of the Mo ntepío de Previsión Social Loreto is to pay re t i re me nt p e ns io ns to its members (who inc l ude the employees of the Company) and othe r w e l fa re benefits in certain circ u ms t a nces (death of spouse, temporary and perma ne nt d i s a b i l i t y, etc. ) .

Under the current collective labor agreements, the Company and its employees make the regulatory contributions to the Montepío, as established in these labor agreements. The Montepío’s bylaws limit the Company’s liability to the payment by it of the regulatory established contributions.

The Company’s contribution of Ptas. 2,642 million in 1998 was recorded under the "Personnel Expenses" caption in the accompanying 1998 statement of income.

K) OBLIGATIONS TO FLIGHT PERSONNEL PLACED ON THE RESERVE Under the collective labor agreements in force, the Company is required to pay full compensation to flight personnel placed on the reserve.

The “Provisions for Obligations to Employees” account in the accompanying balance sheet includes the liabilities incurred in this connection as of December 31, 1998. The provisions recorded to cover the estimated liability incurred in 1998 and the interest allocable to the recorded allowance amount to Ptas. 2,987 million and Ptas. 2,126 million, respectively, and these amounts are included under the “Personnel Expenses” and “Financial and Similar Expenses” captions, respectively, in the accompanying 1998 statement of income.

The liability incurred as of December 31, 1998, was determined on the basis of actuarial studies conducted by independent actuaries using the unit credit method, and the main assumptions were an annual interest rate of 4%, an expected annual CPI variation of 2% and annual provisions payable in arrears.

L) PROVISION FOR THIRD-PARTY LIABILITY The Company records under the “Provision for Third-Party Liability” caption in the balance sheet the estimated amount required for probable or certain third-party liability

p-28 ANNUAL REPORT 1998 IBERIA, LINEAS AEREAS DE ESPAÑA, S.A. NOTES TO 1998 FINANCIAL STATEMENTS arising from legal proceedings and litigation in progress or from outstanding indemnity payments or obligations of undetermined amount, and collateral and other similar guarantees provided by the Company. As described in Note 11, the Company has recorded a provision for the restructuring costs that its directors consider will be incurred in the coming years as a result of the measures contained in the IBERIA Group´s Master Plan.

On April 25, 1997, the Fair Trade Office brought, on an ex officio basis, enforcement proceedings alleging practices in restraint of trade by the Company and other airlines “since they approved an interline agreement which was used to simultaneously increase and standardize rates thereby abusing their collective dominant position”.

The Spanish Anti-Trust Tribunal has not yet taken a decision on the aforementioned proceedings.

The 1998 financial statements do not include any provision in connection with these proceedings since the Company’s directors consider that no material liabilities will arise for the Company from the final decision.

M) CORPORATE INCOME TAX The corporate income tax of each year is calculated on the basis of the book income before taxes, increased or decreased, as appropriate, by the permanent differences from taxable income, net of tax relief and tax credits, excluding tax withholdings and prepayments.

The consolidated taxation system applicable to the Company as part of Sociedad Estatal de Participaciones Industriales is regulated by 1989 Budget Law (Law 37/1988) and Royal Decree Law 5/1995. Consequently, the 1998 corporate income tax will be settled on a consolidated tax return basis.

N) FUTURES AND OTHER SIMILAR INSTRUMENTS The Company uses these instruments in transactions to hedge its asset and liability positions and its future cash flows. It only carries out “nongenuine” hedging transactions (i.e. those arranged between two parties, establishing in each case the contractual terms of the transactions agreed upon between them).

If cash deposits are re q u i red to gua ra ntee the oblig a t io ns inhe re nt to the a fo re me nt io ned tra ns a c t io ns, they are re c o rded under the “Sho r t - Term Fina nc ia l I n v e s t me nts - Short-Term Deposits and Guarantees” caption on the asset side of the balance sheet.

The expenses relating to transactions involving futures and similar instruments are expensed currently.

The price differences arising during the term of futures and similar instruments are recorded as follows:

p-29 ANNUAL REPORT 1998 IBERIA, LINEAS AEREAS DE ESPAÑA, S.A. NOTES TO 1998 FINANCIAL STATEMENTS

1. In the case of transactions arranged to hedge exchange rates relating to asset or liability positions, the related balances are discounted to present value based on the related gains or losses.

2. For the other exchange rate transactions, the pricing differences are recorded in the statement of income when the futures transactions or similar instruments are cancelled or finally settled.

[5] INTANGIBLE ASSETS The variations in 1998 in intangible asset accounts and in the related accumulated amortization were as follows:

1998 M I L L I O N S O F P E S E TA S ADDITIONS 01-01-98 AND PROVISIONS RETIREMENTS 12-31-98 RIGHTS ON LEASED ASSETS 34,671) 38) - 34,709) COMPUTER SOFTWARE 5,221) 506) (3,914) 1,813) LEASEHOLD ASSIGNMENT AND OTHER RIGHTS 178) 101) (36) 243) AMORTIZATION (13,025) (1,942) 3,914) (11,053) NET VALUE 27,045 25,712

As of December 31, 1998, the balance of the “Leasehold Assignment and Other Rights” account included Ptas. 158 million of research and development expenses.

In 1998 the Company wrote off the cost and accumulated amortization of computer software relating to the AMADEUS booking system that had been fully amortized.

The main features of the lease contracts (relating mainly to aircraft) in force as of December 31, 1998, some of which have interest rates tied to LIBOR and lease payments denominated in foreign currencies, are as follows:

DECEMBER 31, 1998 MILLIONS OF PESETAS

CASH PRICE OF THE FIXED ASSETS ACQUIRED, ACCORDING TO CONTRACTS 34,515 (a) As of December 31, 1998, these MOUNT OF LEASE PAYMENTS PAID N PRIOR YEARS amounts included Ptas. 5,272 A - I 23,073 million of unincurred interest at N THE CURRENT YEAR that date, the balancing entry for - I 4,489 which is included under the MOUNT OF LEASE PAYMENTS OUTSTANDING AT DECEMBER “Deferred Charges” caption in the A 31 18,640 (a) accompanying balance sheet as of MOUNT OF PURCHASE OPTIONS December 31, 1998. A 19,016 (a)

p-30 ANNUAL REPORT 1998 IBERIA, LINEAS AEREAS DE ESPAÑA, S.A. NOTES TO 1998 FINANCIAL STATEMENTS

The due dates for the lease payments outstanding as of December 31, 1998, including the amount of the purchase options, are as follows:

DECEMBER 31, 1998 DU E I N MI L L I O N S O F PE S E TA S 1999 4,435 2000 4,485 2001 7,815 2002 6,389 2003 5,035 2004 9,497

[6] PROPERTY, PLANT AND EQUIPMENT The variations in 1998 in property, plant and equipment accounts and in the related accumulated depreciation and provisions were as follows:

COST

COST M I L L I O N S O F P E S E TA S

01-01-98 ADDITIONS RETIREMENTS TRANSFERS 12-31-98

AIRCRAFT 298,553 3,565 (494) - 301,624 ADVANCES ON AIRCRAFT 10,855 39,526 (13,196) - 37,185 309,408 43,091 (13,690) - 338,809 OTHER TANGIBLE FIXED ASSETS: LAND 551 - -) -) 551 BUILDINGS AND OTHER STRUCTURES 26,661 - -) -) 26,661 MACH I N E R Y , IN S TA L L AT IO N S AN D TOO L S 57,780 2,950 (1,758) 471) 59,443 TRANSPORT EQUIPMENT 1,947 795 (62) 3) 2,683 FURNITURE AND FIXTURES 3,337 191 (91) -) 3,437 COMPUTER HARDWARE 23,225 1,320 (467) -) 24,078 SPARE PARTS 28,948 10,419 (8,497) -) 30,870 FLIGHT SIMULATORS 7,141 12 -) -) 7,153 CONSTRUCTION IN PROGRESS 2,013 2,933 (2,213) (474) 2,259 151,603 18,620 (13,088) - 157,135

The advances on aircraft relate to advances paid as a result of purchase commitments to manufacturers in accordance with the established schedules.

p-31 ANNUAL REPORT 1998 IBERIA, LINEAS AEREAS DE ESPAÑA, S.A. NOTES TO 1998 FINANCIAL STATEMENTS

On December 31, 1996, the Company revalued its property, plant and equipment pursuant to Royal Decree-Law 7/1996, and paid the single 3% tax. The Company had previously availed itself of other revaluation legislation. The revaluation in 1996 was carried out by applying the maximum coefficients authorized by the Royal Decree-Law, with the 40% reduction for the effect of the Company’s financing up to the limit of the estimated market value of each of the assets. The revaluation surplus and its effect as of December 31, 1998, are as follows:

REVALUATION M I L L I O N S O F P E S E TA S

SURPLUS 1998 AT 12-31-97 PROVISION RETIREMENTS SURPLUS

AIRCRAFT 3,200 (884) -) 2,316 LAND 147 -) -) 147 BUILDINGS AND OTHER STRUCTURES 2,448 (489) -) 1,959 MACHINERY, INSTALLATIONS AND TOOLS 2,443 (801) (120) 1,522 TRANSPORT EQUIPMENT 19 (7) -) 12 FLIGHT SIMULATORS 304 (70) -) 234 8,561 (2,251) (120) 6,190

As of December 31, 1998, the accumulated depreciation on the surplus arising from the revaluation amounted to approximately Ptas. 9,538 million.

T he re v a l ua t ion inc reased the 1998 de p re c ia t ion charge by approx i ma t e l y Ptas. 2,251 million, and will increase the 1999 depreciation charge by approximately Ptas. 1,184 million.

The revaluation surplus, net of the single 3% tax, was credited to the “Revaluation Reserve” caption, with a charge to the appropriate revalued asset accounts, without altering the recorded accumulated depreciation amount.

p-32 ANNUAL REPORT 1998 IBERIA, LINEAS AEREAS DE ESPAÑA, S.A. NOTES TO 1998 FINANCIAL STATEMENTS

DEPRECIATION AND PROVISIONS

DEPRECIATION AND PROVISIONS M I L L I O N S O F P E S E TA S

01-01-98 PROVISIONS RETIREMENTS 12-31-98

AIRCRAFT 183,809 7,919 (8) 191,720 OTHER TANGIBLE FIXED ASSETS: BUILDINGS AND OTHER STRUCTURES 12,873 1,365 -) 14,238 MACHINERY, INSTALLATIONS AND TOOLS 35,513 4,080 (1,255) 38,338 TRANSPORT EQUIPMENT 980 229 (61) 1,148 FURNITURE AND FIXTURES 2,683 191 (78) 2,796 COMPUTER HARDWARE 21,310 646 (465) 21,491 SPARE PARTS 17,775 2,120 (1,255) 18,640 FLIGHT SIMULATORS 4,910 469 -) 5,379 96,044 9,100 (3,114) 102,030

As of December 31, 1998, the cost of the fully depreciated assets which the Company maintains in property, plant and equipment amounted to Ptas. 45,162 million.

TRANSACTIONS INVOLVING THE AIRCRAFT In 1998 the Company formalized the agreements relating to its fleet renewal plan and entered into certain agreements with its suppliers, particularly Airbus Industrie, G.I.E. and The Boeing Company. The main features of these agreements are as follows.

BOEING AIRCRAFT · B-757 In 1994 the Company entered into operating lease contracts with several companies for seven B-757 aircraft. Two of these aircraft were on lease for a period of four years, extended by a further 18 months in 1997 and for a further 12 months in 1998, and the contracts did not provide for a purchase option. The other five B-757 aircraft were on lease for an initial period of approximately five years, at the end of which the Company would have the following three options for each plane: to exercise the purchase option; to extend the lease by up to a further 12 years; or to return the plane to the lessor. In 1998 the option to extend the lease by a further 12 months was exercised for four of these aircraft and the return of the fifth plane to the original lessor is currently being negotiated.

p-33 ANNUAL REPORT 1998 IBERIA, LINEAS AEREAS DE ESPAÑA, S.A. NOTES TO 1998 FINANCIAL STATEMENTS

In accordance with the fleet renewal agreements with the manufacturer, the retirements from advances on aircraft include Ptas. 7,137 million which were adjusted through the use of the provisions recorded prior to 1998 (Ptas. 5,618 million) and in 1998 (Ptas. 1,519 million), which were recorded under the “Provision for Third-Party Liability” caption in the balance sheet.

The Company’s initial B-757 aircraft purchase contract with The Boeing Company (“Boeing”) was still in force as of December 31, 1998, and eight of the planes ordered under this contract had not been delivered at that date. In 1998 the Company and Boeing agreed to amend the existing agreements by changing the delivery dates for the eight aircraft not yet received and including the purchase of a further eight B-757 aircraft and a purchase option on a further 14 planes.

The investment commitment assumed in connection with the 16 B-757 aircraft amounts to approximately US$ 994 million. The delivery schedule for the 16 B-757 aircraft for which the Company has a firm purchase commitment is as follows: eight in 1999 and eight in 2000. Of the aircraft on which there is a purchase option, eleven will be received in 2001 and three in 2002. As of December 31, 1998, the Company had paid advances of Ptas. 9,825 million on these aircraft.

· B-747 and B-727 In 1994 the Company sold to Boeing seven B-727 aircraft and one B-747 aircraft and subsequently entered into operating lease contracts for these planes for a period of one year and three years, respectively, including a purchase option.

In 1997 the Company renegotiated the operating lease contract relating to the B-747 aircraft, extending the contract for a further 29-month period and modifying the purchase option price at the end of this period. Also, the contract addresses the possibility of extending the contract for a further 36 months after expiration of the aforementioned 29-month period.

In 1995 the Company exercised the purchase option on two of the seven leased B-727 aircraft for salvaging and use of spare parts. An amendment to the original contract on the other B-727 aircraft was agreed on in 1995 whereby the contract was extended to December 1998, when these five aircraft were acquired for approximately US$ 500,000 each.

p-34 ANNUAL REPORT 1998 IBERIA, LINEAS AEREAS DE ESPAÑA, S.A. NOTES TO 1998 FINANCIAL STATEMENTS

AIRBUS AIRCRAFT

· A-340 In 1996 the Company reached an agreement with Airbus Industrie, G.I.E. (Airbus) for the delivery dates of eight A-340 aircraft (which have already been received and are operating) and on the delivery schedule for a further four aircraft on which there is a purchase option: one in 1999, one in 2000 and two in 2001.

The eight A-340 aircraft in service were leased under operating lease contracts from the “Iberbus” companies (see Note 7). The Company has 40% holdings in the capital stock of each of these companies. The term of the operating leases for the eight A-340 aircraft is seven years, at the end of which the Company will have the following three options: to exercise the purchase option and pay a predetermined price for the aircraft; to extend the lease for periods of between three and eight years and mandatorily exercise the purchase option; or to return the planes to the lessor.

If the Company opts to return the planes and if the owner of the aircraft does not find a buyer for the aircraft, the Company is obliged to extend the operating lease contract for a further one-year period for the aircraft which came into service in 1996 and for a further two-year period for the aircraft which came into service in 1997 and 1998.

In 1998 the Company entered into an agreement with Airbus for the acquisition of a further six A-340 aircraft and a purchase option on a further five. With this agreement, the Company exercised two of the purchase options acquired under the agreement entered into with Airbus in 1996. Also, the Company has four subordinated options that it can exercise provided that it exercises the purchase option on four of the five aforementioned aircraft.

The delivery schedule for these aircraft would be: one in 1999, three in 2000 and two in 2001 in the case of the aircraft for which there are firm commitments, and one in 2001, three in 2002 and one in 2003 for the aircraft on which IBERIA has a purchase option.

In connection with four of these aircraft that will be received in 1999, 2000 and 2001, the Company has entered into financing agreements that will enable it to operate them under an operating lease similar to that existing for the eight A-340 aircraft that it currently operates. The Company has a minority holding in each of the companies and must make contributions to finance them so that they can purchase the aircraft from the manufacturer. The contributions that the Company will have to make on both these counts for the four aircraft range from a minimum of US$ 28 million to a maximum of US$ 68 million.

p-35 ANNUAL REPORT 1998 IBERIA, LINEAS AEREAS DE ESPAÑA, S.A. NOTES TO 1998 FINANCIAL STATEMENTS

At the end of the initial lease term of seven years, the Company may opt to extend the lease for a further eight years, exercise the purchase option or return the aircraft.

The basic price of the six aircraft is approximately US$ 827 million.

As of December 31, 1998, the Company had made advances totaling Ptas. 3,559 million in connection with these aircraft.

Also, the Company entered into an agreement with Singapore Aircraft Leasing Enterprise Pte. Ltd. (“SALE”) to bring forward the date on which two A-320 aircraft scheduled for delivery in 2002 will come into service to 1999. The Company will operate these two aircraft under an operating lease contract with SALE with an initial term of five years, on expiration of which the Company may renew the lease for a maximum period of seven years.

Also, the Company entered into an additional agreement with Airbus for the firm purchase of two A-320 aircraft which will come into service in 2002 on the same date as that on which the aircraft on which the purchase option has been exchanged with SALE were scheduled to be added to the fleet.

The delivery schedule for these aircraft is as follows:

(a) Relating to aircraft on which DELIVERY SCHEDULE FOR AIRCRAFT there is a purchase option. (b) Including the two aircraft TYPE OF AIRCRAFT 1999 2000 2001 2002 2003 2004 (a)2005 (a)2006 TOTAL the purchase option on which was exchanged with SALE. A-319 ------4 5 9 (c) Including three aircraft on which there is a purchase option. A-320 8 (b) 5 6 10 5 (c) 5 (c) 3 2 44 (d) Including six aircraft on which there is a purchase option. A-321 2 3 2 5 11 (d) 10 (e) - 6 39 (e) Including eight aircraft on which 10 8 8 15 16 15 7 13 92 there is a purchase option.

The basic price of the aircraft involved in this transaction is approximately Ptas. 405,000 million.

As of December 31, 1998, the Company had made advances totaling Ptas. 23,733 million in connection with these aircraft.

p-36 ANNUAL REPORT 1998 IBERIA, LINEAS AEREAS DE ESPAÑA, S.A. NOTES TO 1998 FINANCIAL STATEMENTS

In connection with the A-320 aircraft, on July 17, 1998, the Company entered into a lease contract with International Lease Finance Corporation (“ILFC”) for nine A-319 and seven A-320 aircraft under a dry lease arrangement for an initial period of five years, on expiration of which the Company may extend the contract twice for one- or five-year periods, provided that the two extensions do not total more than six additional years.

The delivery schedule for these aircraft is as follows:

DELIVERY SCHEDULE FOR AIRCRAFT

TYPE OF AIRCRAFT 1999 2000 2001 A- 3 2 0 2 3 2 A - 3 1 9 - 4 5 2 7 7

OTHER AIRCRAFT · DC-8 In 1998 the Company exercised the purchase option on two DC-8 aircraft that it operated under an operating lease with Cargosur, S.A. for Ptas. 247 million each. The Company subsequently sold these two aircraft and entered into an agreement to operate them under a wet lease arrangement.

· A-320 and MD-87 Without prejudice to the foregoing regarding the A-319, A-320 and A-321 aircraft, in 1993 the Company sold six A-320 and five MD-87 aircraft, and subsequently entered into operating lease contracts therefor. The gain of Ptas. 5,361 million on the sale of these aircraft was recorded under the “Deferred Revenues” caption in the balance sheet. Ptas. 1,101 million of this gain were charged in 1998 to the “Other Operating Revenues” caption in the accompanying 1998 statement of income.

In July 1997 the owner of these aircraft sold them to three companies, which entered into new lease contracts with the Company. The lease contracts entered into for the six A-320 aircraft expire in 2001, 2002 and 2003, at which time the Company may extend them for a further five-year period or return the planes. The term of the lease contracts entered into for the five MD-87 aircraft is 96 months at the end of which the Company may exercise the purchase option provided for in the contract or return the planes.

p-37 ANNUAL REPORT 1998 IBERIA, LINEAS AEREAS DE ESPAÑA, S.A. NOTES TO 1998 FINANCIAL STATEMENTS

AIRCRAFT IN SERVICE The Company’s aircraft in service in 1998 are summarized as follows:

AIRCRAFT IN SERVICE - 1998p-

UNDER UNDER WET TYPE OF OWNED BY FINANCIAL OPERATING LEASE AIRCRAFT THE COMPANY LEASE LEASE (a) TOTAL (a) Lease type including aircraft and crew for approximately one year. The main B-727 28 (b) (c) - - - 28 lessors were Air Atlanta U.K. Limited, Air Europa, S.A. and Atlas Air Inc. B-737 - - - 3 3 (b) Including five aircraft acquired in 1998 that were operated under B-747 6 - 1 4 (d) 11 an operating lease until December. B-757 - 1 7 6 14 (c) These figures do not include four B-727 and three DC-10 aircraft that were owne by B-767 - - - 2 2 Venezolana Internacional de Aviación, S.A. received in December 1997 in execution of A-300 6 (e) - - - 6 the mortgages on loans granted by the Company. These aircraft were registered A-320 11 5 6 - 22 in 1998 and are ready for sale. (d) Including two B-747 equipped A-340 - - 8 - 8 for freight transport. (e) Excluding two inactive aircraft. DC-8 - - - 2 (f) 2 (f) These two aircraft were leased DC-9 7 - - - 7 by the Company under an operating lease from its subsidiary DC-10 4 (c) - - - 4 Cargosur, S.A. through November 1998, when the MD-87 17 2 5 - 24 Company purchased and then sold them to subsequently lease 79 8 27 17 131 them under a wet lease arrangement.

One aircraft operated by the Company under a financial lease contract had been mortgaged for a net book value of Ptas. 4,321 million as of December 31, 1998.

WET LEASE In 1998 the Company entered into several wet lease contracts (lease of aircraft with crew).

In March 1998 the Company entered into an agreement with Air Europa, S.A. for the lease of eleven aircraft currently in service (six B-757, three B-737 and two B-767) under a wet lease arrangement. These agreements have an initial term of two years and are renewable annually.

p-38 ANNUAL REPORT 1998 IBERIA, LINEAS AEREAS DE ESPAÑA, S.A. NOTES TO 1998 FINANCIAL STATEMENTS

Also, the Company entered into a wet lease contract with Atlas Air, Inc. to operate two B-747 aircraft (one for only six months) equipped for freight transport. The lease contract has an initial term of four years.

LEASE EXPENSES The operating lease payments paid in 1998 for the operating lease of the aforementioned 32 B-747, B-757, B-727, A-320, A-340 and MD-87 aircraft amounted to Ptas. 17,091 million and this amount is included under the “Other Operating Expenses” caption in the accompanying 1998 statement of income (see Note 16). The detail of the approximate operating lease payments payable for these aircraft and of the due dates is as follows:

LEASE EXPENSES

YE A R MI L L IO N S O F U.S. D O L L A R S 1999 114 2000 89 2001 TO 2005 312 515

INSURANCE COVERAGE The Company has arranged insurance policies for its property, plant and equipment and intangible assets which sufficiently covered their net book value as of December 31, 1998. It has also arranged insurance policies for the aircraft leased from third parties in accordance with the conditions stipulated in the related lease contracts. Most of these policies are with Musini, Sociedad Anónima de Seguros y Reaseguros.

p-39 ANNUAL REPORT 1998 IBERIA, LINEAS AEREAS DE ESPAÑA, S.A. NOTES TO 1998 FINANCIAL STATEMENTS

[7] LONG-TERM FINANCIAL INVESTMENTS

HOLDINGS IN GROUP AND ASSOCIATED COMPANIES The variations in 1998 the balance of the "Holdings in Group and Associated Companies" caption and in the related allowance were as follows:

GROUP AND ASSOCIATED COMPANIES M I L L I O N S O F P E S E TA S COST ALLOWANCE

BA L A N C E AT 01-01-98 76,352 ( 5 6 , 9 5 3 ) AD D I T IO N S O R P R O V IS IO N S 45,892 ( 2 , 2 0 9 ) RE T I R E M E N TS O R A MO U N TSUS E D ( 2 8 , 3 0 1 ) 2 4 , 4 5 7 BA L A N C E AT 1 2 - 3 1 - 9 8 9 3 , 9 4 3 ( 3 4 , 7 0 5 )

The additions in 1998 relate mainly to the acquisition of 67% of the shares of Aviación y Comercio, S.A. from SEPI for Ptas. 38,860 million. The additions also relate to the Company’s contributions to offset losses at Vuelos Internacionales de Vacaciones, S.A. and Binter Mediterráneo, S.A. for Ptas. 2,500 million and Ptas. 248 million, respectively,

DECEMBER 31, 1998

PERCENTAGE OF DIRECT AND INDIRECT GROUP AND ASSOCIATED COMPANIES ADDRESS OWNERSHIP (a) AVIACIÓN Y COMERCIO, S.A. MAUDES, 51; MADRID 99.93 BINTER CANARIAS, S.A. LAS PALMAS AIRPORT 99.99 BINTER MEDITERRÁNEO, S.A. LAS PALMAS AIRPORT 99.99 COMPAÑÍA AUXILIAR AL CARGO EXPRÉS, S.A. CEN T R O DE CAR G A AÉR E A PAR C E L A 2 P.5 NAV E 6; MAD R I D 75.00 CAMPOS VELÁZQUEZ, S.A. VELÁZQUEZ, 134; MADRID 99.99 CARGOSUR, S.A. AVDA. DE LA HISPANIDAD, 13; MADRID 100.00 IBER-SWISS CATERING, S.A. CTRA. DE LA MUÑOZA, S/N; MADRID 70.00 VUE L O S INT E R N AC IO N A L E S DE VACAC IO N E S , S.A. (VIVA) (D)ZURBANO, 41; MADRID 99.47 AMADEUS GROUP SALVADOR DE MADARIAGA, 1; MADRID 29.20 VEN E Z O L A N A INT E R N AC IO N A L DE AVI AC I Ó N , S.A. (VIASA) OSCAR M. ZULOAGA, S/N; CARACAS 45.00 SIST E M A S AUTO M AT I Z A D O S AGE N C I A S DE VIA J E S , S.A. (SAVI A ) VELÁZQUEZ, 130; MADRID 75.83 IBERBUS CONCHA LTD.GEORGE’S DOCK HOUSE, IFSC; DUBLÍN 40.00 IBERBUS ROSALÍA LTD.GEORGE’S DOCK HOUSE, IFSC; DUBLÍN 40.00 IBERBUS CHACEL LTD.GEORGE’S DOCK HOUSE, IFSC; DUBLÍN 40.00 IBERBUS ARENAL LTD.GEORGE’S DOCK HOUSE, IFSC; DUBLÍN 40.00 IBERBUS TERESA LTD.EARLSFORT CENTRE-HATCH ST., DUBLÍN 40.00 IBERBUS EMILIA, LTD.EARLSFORT CENTRE-HATCH ST., DUBLÍN 40.00 IBERBUS AGUSTINA, LTD.EARLSFORT CENTRE-HATCH ST., DUBLÍN 40.00 IBERBUS BEATRIZ, LTD.EARLSFORT CENTRE-HATCH ST., DUBLÍN 40.00 INTERINVEST TUCUMÁN, 141; BUENOS AIRES 10.00 TOTAL

p-40 ANNUAL REPORT 1998 IBERIA, LINEAS AEREAS DE ESPAÑA, S.A. NOTES TO 1998 FINANCIAL STATEMENTS

and the acquisition of a 40% holding in the companies leasing the two A-340 aircraft that came into service in 1998 for a total of Ptas. 855 million.

The additions also include Ptas. 3,428 million relating, on the one hand, to the share exchange whereby the Company transferred to Andes Holding B.V. 20% of the shares of Aerolíneas Argentinas, S.A. valued at Ptas. 3,046 million in exchange for 8.92% of the shares of Interinvest, S.A. and, on the other, to the acquisition of 1.08% of the capital stock of Interinvest, S.A. for Ptas. 382 million. The share exchange gave rise to the retirement of the cost of, and the allowance for, the holding in Aerolíneas Argentinas, S.A. amounting to Ptas. 24,908 million and Ptas. 21,862 million, respectively.

The retirements from cost relate mainly to the dividend of Ptas. 3,325 million paid by Campos Velázquez, S.A. out of prior years’ income and to the sale of 34% of the capital stock of Sistemas Automatizados Agencias de Viajes, S.A.

The information relating to the main Group and associated companies as of December 31, 1998, drawn from their respective audited financial statements or from provisional financial statements in the case of Interinvest, S.A., the Amadeus Group and the Iberbus companies (which have not yet been approved by the respective Shareholders' Meetings), is as follows:

M I L L I O N S O F P E S E TA S (a) The Company’s ownership interests in the Group INCOME (LOSS) and associated companies remained unchanged in BOOK VALUE (b) EXTRAOR- 1998, except in the case of Aviación y Comercio, COST ALLOWANCE CAPITAL RESERVES ORDINARY DINARY S.A., the holding in which was increased by 67% and of Sistemas Automatizados Agencias de Viajes, 42,740 -) 7,400 14,506) 2,414) -) S.A., the holding in which was reduced by 34%. The holding in Aerolíneas Argentinas, S.A. was 5,127 (2,109) 1,387 365) 509) 759) exchanged for a 8.92% holding in Interinvest, S.A., in which an additional stake of 1.08% was acquired. 6,405 (6,405) 250 (1) (268) (129) (b) Including the following amounts relating 111 -) 32 261) 43) 9) to revaluation reserves resulting from the assets revalued in 1996 pursuant to 459 (94) 150 30) 191) -) Royal Decree-Law 7/1996: 1,445 (624) 1,008 (266) 72) 8) M I L L I O N S O F P E S E TA S 594 -) 500 492) 242) 23) 13,093 (9,949) 5,001 (727) (1,301) 187) AVIACIÓN Y COMERCIO, S.A. 4,736 BÍNTER CANARIAS, S.A. 593 2,254 -) 6,071 (14,401) 7,155) -) COMPAÑÍA AUXILIAR AL CARGO EXPRÉS, S.A. 1 14,716 (14,716) (C)(C)(C)(C) CARGOSUR, S.A. 185 132 -) 200 438) 305) (67) IBER-SWISS CATERING, S.A. 232 337 -) 979 (123) (34) -) VUELOS INTERNACIONALES DE VACACIONES, S.A. 498 342 -) 971 (102) (35) -) (c) Venezolana Internacional de Aviación, S.A.´s operations were 379 (3) 1,076 (209) (128) -) discontinued in January 1997 and in March 1997 the company filed for “suspensión de pagos” (Chapter 11-type insolvency 393 (30) 1,100 (280) (184) -) proceedings, hereinafter “suspension of payments”) and the process of liquidation commenced. At the date of preparation 417 (59) 995 (53) (43) -) of these financial statements, it had not been possible to obtain 416 (51) 1,000 (33) (43) -) any recent financial statements relating to this company. (d) The Company has recorded an additional provision of 430 (40) 1,000 -) (22) -) Ptas. 3,145 million under the “Provision for Third-Party Liability” caption in the balance sheet as of December 31, 1998, 425 (25) 1,003 -) (3) -) of which it recorded Ptas. 1,380 million in 1998 with a charge 3,428 (600) 97,132 (51,924) (6,165) (16,377) to the “Extraordinary Expenses” caption in the accompanying 1998 statement of income. These provisions were recorded as 93,643 (34,705) a result of the possible dissolution of Vuelos Internacionales de Vacaciones, S.A.

p-41 ANNUAL REPORT 1998 IBERIA, LINEAS AEREAS DE ESPAÑA, S.A. NOTES TO 1998 FINANCIAL STATEMENTS

In 1998 the Shareholders’ Meetings of the Group and associated companies listed below adopted the following resolutions:

1998 M I L L I O N S O F P E S E TA S (a) Ptas. 3,576 million of this amount relate to dividends paid out of prior years’ D I S T R I B U T I O N C A P I TA L C O N T R I B U T I O N S TO income. The remaining Ptas. 34 million O F D I V I D E N D S relate to an interim dividend paid out R E D U C T I O N O F F S E T LO S S E S of 1998 income. Of the total amount of dividends received, the Company recorded VU E L O S IN T E R N AC IO N A L E S D E VAC AC IO N E S, S.A. - 1 , 6 4 9 2 , 5 0 0 Ptas. 3,325 million as a reduction in the value of the holding and Ptas. BI N T E R ME D I T E R R Á N E O, S.A. - 1 2 4 2 4 8 285 million under the “Revenues from Shareholdings” caption in the accompan - CA M P O S VE L Á Z Q U E Z, S.A. (a) 3 , 6 1 0 -- ying 1998 statement of income.

AEROLÍNEAS ARGENTINAS GROUP AND INTERINVEST, S.A. In 1996 the Company significantly reduced its holding in Aerolíneas Argentinas, S.A. by selling its holding in Interinvest, S.A. (the majority shareholder of Aerolíneas Argentinas, S.A.) to Andes Holding, B.V. (42% owned by SEPI).

US$ 135,000,000 (equal to Ptas. 20,500 million) were pending collection in connection with this transaction as of December 31, 1998. The deadline stipulated in the contract for collection of the amount outstanding is September 1999 (see Note 14). Per information received from the Company, in 1997 Andes Holding B.V. started to sell its holding in Interinvest, S.A. and expects that the proceeds from the sale will enable it to settle a portion of its liabilities. Based on the estimate of the proceeds that Andes Holding, B.V. expected to obtain, as of December 31, 1997, the Company decided to record a provision for Ptas. 11,000 million of the balance outstanding. The provision is recorded under the “Provision for Third-Party Liability” caption in the accompanying balance sheet as of December 31, 1998. The Board of Directors of Sociedad Estatal de Participaciones Industriales recently resolved to acquire from IBERIA, Líneas Aéreas de España, S.A. its account receivable from Andes Holding B.V. for Ptas. US$ 62 million.

On October 23, 1998, the Company assigned to Andes Holding, B.V. its direct holding (20% of the capital stock of Aerolíneas Argentinas, S.A.) in exchange for an 8.92% holding in the capital stock of Interinvest, S.A.

The amount recorded for the Interinvest, S.A. shares received in this transaction was Ptas. 3,046 million, equal to the net book value as of December 31, 1997, of the shares of Aerolíneas Argentinas, S.A. transferred to Andes Holding, B.V. As a result of this transaction, Ptas. 24,908 million of cost and Ptas. 21,862 million of the related provision were retired from the accounting records.

Also, on the same date, the Company acquired a 1.08% holding in Interinvest, S.A. for Ptas. 382 million.

p-42 ANNUAL REPORT 1998 IBERIA, LINEAS AEREAS DE ESPAÑA, S.A. NOTES TO 1998 FINANCIAL STATEMENTS

As of 1998 year-end the Company had rec o r ded with a charge to the “Var ia t i on in Fixed Asset Prov i s io n s” caption in the accompanyi n g 1998 statemen t of inco m e a prov i s i on of Pt a s . 600 million for its share of the losses incu r r ed by Interinvest, S.A. in 1998.

As of December 31, 1998, the Company had provided U.S. dollar guarantees for Aerolíneas Argentinas, S.A. to several entities totaling Ptas. 11,563 million. The Company has covered this risk through a Ptas. 2,336 million provision recorded under the “Provision for Third-Party Liability” caption in the accompanying balance sheet as of December 31, 1998, and through a mortgage guarantee on two B-747 aircraft owned by Aerolíneas Argentinas, S.A.

VENEZOLANA INTERNACIONAL DE AVIACIÓN, S.A. (VIASA) In November 1996 the Company submitted a Viability Plan for VIASA which was not accepted by the employees’representatives. VIASA’s operations were discontinued in January 1997 and, following a resolution adopted by the shareholders, in March 1998 the company filed for suspension of payments and the process of liquidation commenced.

As a result of the liquidation process, as of December 31, 1998, the Company had recorded provisions for all the balances (loans, interest and trading accounts) with VIASA at that date.

In December 1997, after the court-ordered auction which transferred to the Company the ownership of four B-727 and three DC-10 aircraft belonging to VIASA, which were mortgaged as security for the loans granted in the past by the Company, these aircraft were capitalized for a symbolic value. As a result of this capitalization, the Company wrote off the loans granted and the related interest with a charge to provisions. These aircraft were registered in 1998. As of December 31, 1998, the four B-727 aircraft were grounded in Miami and the three DC-10 aircraft were in Madrid. These aircraft are currently awaiting sale.

As of December 31, 1998, IBERIA, Líneas Aéreas de España, S.A.’s balances with VIASA were as follows:

DECEMBER 31, 1998 M I L L I O N S O F P E S E TA S C O S T AL L O WA N C E

H O L D I N G 14,716 (14,716) L O A N S A N D I N T E R E S T 4,263 (4,263) C U R R E N T A C C O U N T 4,850 (4,850) T O T A L 23,829 (23,829)

The Company received guarantees for the balances recorded in connection with the loans and interest consisting of mortgages on buildings and a B-727 aircraft of VIASA.

p-43 ANNUAL REPORT 1998 IBERIA, LINEAS AEREAS DE ESPAÑA, S.A. NOTES TO 1998 FINANCIAL STATEMENTS

AMADEUS GROUP The Amadeus Group consists of Amadeus Global Travel Distribution, S.A., Amadeus Data Processing KG (a German company) and their investee companies.

In 1997 the Company sold its holding in Amadeus Data Processing KG to Amadeus Global Travel Distribution, S.A. for DM 156,494,119 (equal to Ptas. 13,234 million), giving rise to a capital gain of the same amount. This was the first sale involved in an operation to be implemented in 1999 under which all the Amadeus Group shareholders sold their holdings in Amadeus Data Processing KG to Amadeus Global Travel Distribution, S.A., after which capital will be increased at the parent company, which will be subscribed on the stock exchange.

Since there was no change in the Company’s holding in the aforementioned group or in the groupís net worth, until the completion of the transaction the Company opted to record a provision for the amount of the capital gain obtained from the sale under the “Provision for Third-Party Liability” caption in the balance sheet as of December 31, 1997. This provision still existed as of December 31, 1998.

Also, on September 21, 1998, the Company sold 34% of its SAVIA trademarks in Spain and Portugal to Amadeus Global Travel Distribution, S.A. for Ptas. 3,340 million, giving rise to a gain of the same amount which was recorded under the “Gains on Fixed Asset Disposals” caption in the accompanying 1998 statement of income.

The Amadeus Group, whose corporate purpose is the management and operation of a computerized booking system, incurred losses in its first five years of operations since it was at the start-up phase. The Amadeus Group reported income in 1997 and 1998.

SISTEMAS AUTOMATIZADOS AGENCIAS DE VIAJES, S.A. On September 21, 1998, the Company sold to Amadeus Global Travel Distribution, S.A. 34% of the capital stock of Sistemas Automatizados Agencias de Viajes, S.A. for Ptas. 3,566 million, giving rise to a capital gain of Ptas. 3,549 million, which the Company recorded under the “Gains on Fixed Asset Disposals” caption in the accompanying 1998 statement of income.

AVIACIÓN Y COMERCIO, S.A. In accordance with the IBERIA Group’s Master Plan for 1997-1999, in October 1997 the flights of Aviación y Comercio, S.A. and IBERIA, Líneas Aéreas de España, S.A. were scheduled jointly for the first time, with the consequent impacts on common commercial policy and on the management of common resources.

On November 10, 1998, the Company acquired SEPI’s holding in Aviación y Comercio, S.A. for Ptas. 38,860 million. This holding consists of 19,832,000 shares representing 67% of the capital stock of Aviación y Comercio, S.A.

p-44 ANNUAL REPORT 1998 IBERIA, LINEAS AEREAS DE ESPAÑA, S.A. NOTES TO 1998 FINANCIAL STATEMENTS

VUELOS INTERNACIONALES DE VACACIONES, S.A. Because it was not possible to integrate Vuelos Internacionales de Vacaciones, S.A. as an IBERIA Group operator, as required under the Master Plan, and in view of the significant losses incurred by this company in recent years, at the end of 1998 IBERIA Group management decided to discontinue the company’s operations and submitted the related labor force reduction plan, on which an agreement was reached at the end of February 1999. The Company’s directors consider that the effect of this plan on the accompanying financial statements will not be material.

LOANS TO GROUP AND ASSOCIATED COMPANIES The main data on the balance of the “Loans to Group and Associated Companies” caption and the related allowance in the accompanying balance sheet as of December 31, 1998, are as follows:

LOANS

MI L L I O N S DU E O F PE S E TA S DAT E IN T E R E S T RAT E VIASA 4,263 (a) (a) IBERBUS CONCHA LTD. 2,806 02-29-2003 5% IBERBUS ROSALÍA LTD. 2,784 05-10-2003 5% IBERBUS CHACEL LTD. 3,084 09-06-2003 6% IBERBUS ARENAL LTD. 3,155 10-18-2003 6% IBERBUS TERESA LTD. 2,853 10-21-2004 6% IBERBUS EMILIA LTD. 2,865 11-10-2004 6% IBERBUS AGUSTINA 2,867 05-15-2005 6% (a) These credits are instrumented in several IBERBUS BEATRIZ 2,876 06-15-2005 6% loans and promissory notes denominated in U.S. dollars. In May 1997 the Company ceased to TOTAL 27,553 record interest on these loans since they were not recoverable. See information on VIASA in the ALLOWANCE (4,263) “Holdings in Group and Associated Companies” section of this Note.

The loans granted to the Iberbus companies relate to loans to the lessor companies of the A-340 aircraft in service (see Note 6).

p-45 ANNUAL REPORT 1998 IBERIA, LINEAS AEREAS DE ESPAÑA, S.A. NOTES TO 1998 FINANCIAL STATEMENTS

[8] ACCOUNTS RECEIVABLE The breakdown of the "Accounts Receivable" caption in the accompanying balance sheet as of December 31, 1998, is as follows:

ACCOUNTS RECEIVABLE

MILLIONS OF PESETAS

R E C E I VA B L E F R O M P U B L ICA U T HO R I T I E S 1 1 , 5 1 9 RE C E I VA B L E F R O M PA S S E N G E R A N D F R E IG H T AG E N C I E S 2 1 , 5 8 0 RE C E I VA B L E F R O M A I R L I N E S 8 , 9 7 5 RE C E I VA B L E F R O M C US TO M E R S ATS A L E S O F F IC E S 3 , 2 5 9 C R E D I T C A R D R E C E I VA B L E S 1 , 9 4 8 OT H E R C US TO M E R R E C E I VA B L E S F O R SA L E S A N D S E R V IC E S 5 , 4 2 1 S U N D R Y AC C O U N T S R E C E I VA B L E 3 , 3 0 0 DO U BT F U L R E C E I VA B L E S 3 , 9 8 5 PR O V IS IO N S ( 4 , 5 6 9 ) 5 5 , 4 1 8

The balance of the “Receivable from Public Authorities” caption relates basically to accounts receivable from the Spanish Directorate-General of Civil Aviation in connection with the subsidy for residents in the Autonomous Communities of the Canary Islands, the Balearic Islands and Ceuta and Melilla; accounts receivable from several Spanish ministries for maintaining the aircraft of the Royal Family and the Armed Forces; accounts receivable from the Spanish Postal and Telegraph Service and other foreign postal agencies for the transport of mail; and accounts receivable from foreign tax authorities.

[9] SHORT-TERM FINANCIAL INVESTMENTS The detail of the balance of this caption in the accompanying balance sheet as of December 31, 1998, is as follows:

DECEMBER 31, 1998

MILLIONS OF PESETAS

SHO R T-T E R M D E P O S I TS 5 4 , 4 5 9 GO V E R N M E N T D E BT S E C U R I T I E S 1 7 , 2 1 8 SHO R T-T E R M D E P O S I TS A N D G UA R A N T E E S 1 , 6 9 0 UN M AT U R E D I N T E R E S T R E C E I VA B L E 1 , 0 9 4 OT H E R S HO R T-T E R M F I N A N C I A L I N V E S T M E N T 9 4 5 OT H E R 1 , 1 5 1 7 6 , 5 5 7

p-46 ANNUAL REPORT 1998 IBERIA, LINEAS AEREAS DE ESPAÑA, S.A. NOTES TO 1998 FINANCIAL STATEMENTS

The average return on short-term deposits was 4.49% as of December 31, 1998.

The government debt securities relate mainly to government debentures and Treasury bills which earned average interest of 3.89% as of December 31, 1998.

[1 0 ]SHAREHOLDERS’EQUITY

CAPITAL STOCK As of December 31, 1998, the Company’s capital stock consisted of 882,512,019 fully subscribed and paid registered shares of Ptas. 130 par value each.

As of December 31, 1998, SEPI was the Company’s majority shareholder, with a 93.86% holding.

REVALUATION RESERVE On January 22, 1998, the tax authorities reviewed and approved the balance of the “Revaluation Reserve” caption and, accordingly, as permitted by current legislation, on June 27, 1998, the Shareholders’ Meeting resolved to use the balance of this reserve to offset prior years’ losses.

DISTRIBUTION OF 1997 INCOME On June 27, 1998, the Company’s Shareholders’ Meeting resolved to allocate the income for 1997 a to partially offset the balance of the “Prior Years’ Losses” caption.

[1 1 ]PROVISION FOR THIRD-PARTY LIABILITY The variations in 1998 in the balance of this caption in the accompanying balance sheet were as follows:

PROVISION FOR THIRD-PARTY LIABILITY MI L L I O N S O F P E S E TA S

BA L A N C E AT 0 1 - 0 1 - 9 8 6 5 , 2 3 8 PE R IO D P R O V IS IO N 1 3 , 7 2 7 AMO U N TSUS E D I N 1 9 9 8 ( 1 4 , 9 8 6 ) BA L A N C E AT 1 2 - 3 1 - 9 8 6 3 , 9 7 9

p-47 ANNUAL REPORT 1998 IBERIA, LINEAS AEREAS DE ESPAÑA, S.A. NOTES TO 1998 FINANCIAL STATEMENTS

The period provision recorded in 1998 includes Ptas. 10,000 million to make up an allowance of Ptas. 20,000 million relating to restructuring costs that the Company’s directors consider will be incurred in the coming years as a result of the measures contained in the IBERIA Group’s Master Plan.

T he afo re me nt io ned period pro v i s ion was re c o rded with a charge to the “Extraordinary Expenses” caption in the accompanying 1998 statement of income.

The amounts used in 1998 include Ptas. 6,550 million recorded as extraordinary revenues for the year as a result of the disappearance of the risk for which the related provisions were recorded in prior years, and the remaining Ptas. 8,436 million relate mainly to provisions used for the purpose for which they were recorded.

[1 2 ]PAYABLE TO CREDIT ENTITIES The breakdown, by maturity, of the Company’s payables to credit entities as of December 31, 1998, is as follows:

DECEMBER 31, 1998 M I L L I O N S O F P E S E TA S

D UE I N : SU B S E Q U E N T CU R R E N C Y 1999 2000 2001 2002 YE A R S D E BT : PESETA LOANS 9,699 903 903 968 4,982 FOREIGN CURRENCY LOANS: U.S. DOLLAR 24,481 1,962 13,241 4,306 2,496 YEN 376 468 3,542 1,502 1,736 DEUTSCHE MARKS 1,354 1,153 1,158 1,188 7,814 35,910 4,486 18,844 7,964 17,028

The weighted average annual interest rates on the foregoing loans in 1998 were 7,52% for peseta loans and 6,63% for foreign currency loans, and some of the rates were tied to MIBOR or LIBOR, respectively.

[1 3 ]FUTURES TRANSACTIONS The Company’s policy is to actively manage the risks arising from fluctuations in exchange and interest rates and in fuel prices.

Hedging transactions are arranged to minimize the impact of these variables on the consolidated statement of income.

The breakdown, by hedging derivative, of the notional values held by the Company as of December 31, 1998, is as follows:

p-48 ANNUAL REPORT 1998 IBERIA, LINEAS AEREAS DE ESPAÑA, S.A. NOTES TO 1998 FINANCIAL STATEMENTS

DECEMBER 31, 1998

MILLIONS OF PESETAS HE D G I N G O F A S S E T A N D L I A B I L I T Y P O S I T I O N S: EXC H A N G E R I S K H E D G I N G T R A N SAC T I O N S CR O S S C U R R E N C Y S WA P S 1 3 , 3 6 5 IN T E R E S T R AT E R I S K H E D G I N G T R A N SAC T I O N S IN T E R E S T R AT E S WA P S I R S ’S 7 , 5 7 3

HE D G I N G O F F U T U R E C A S H F L OW S: EXC H A N G E A N D I N T E R E S T R AT E R I S K H E D G I N G T R A N SAC T I O N S (a) CR O S S C U R R E N C Y I N T E R E S T A N D E XC H A N G E R AT E S WA P S 2 8 , 3 2 4 EXC H A N G E R I S K H E D G I N G T R A N SAC T I O N S (a) (a) Swaps of returns on operating lease CR O S S C U R R E N C Y S WA P S 7 3 , 0 6 2 contracts in U.S. dollars to surplus currencies (pounds sterling and Swiss francs) for an OT H E R H E D G I N G T R A N SAC T I O N S average period of four years. (b) In 1998 the Company lengthened the term FU E L P R IC E H E D G I N G T R A N SAC T IO N S (b) 78,684 of its aircraft fuel price hedging transactions to three years.

[1 4 ]BALANCES AND TRANSACTIONS WITH GROUP AND ASSOCIATED COMPANIES The detail of the receivables from and payables to SEPI Group and associated companies as of December 31, 1998, is as follows:

1998 M I L L I O N S O F P E S E TA S

RE C E I VA B L E PAYA B L E LONG SHORT LONG SHORT COMPANY TERM TERM TERM TERM SEPI, TAXES (NOTE 15) 29,692 6,457 3,034 13,501 SEPI, OTHER - - 133 129 VUELOS INTERNACIONALES DE VACACIONES, S.A. - 700 - - CAMPOS VELÁZQUEZ, S.A. - - - 63 COMPAÑÍA AUXILIAR AL CARGO EXPRÉS, S.A. - 306 - 94 IBER-SWISS CATERING, S.A. - 32 - 556 IBERIA TECNOLOGÍA, S.A. - 58 - 18 SAVIA - 1,626 - - AVIACIÓN Y COMERCIO, S.A. - - - 464 CARGOSUR, S.A. - - - 929 AEROLÍNEAS ARGENTINAS, S.A. - 2,981 (a) - 61 AMADEUS GROUP - 321 - - BÍNTER FINANCE B.V. - 1,744 - - ANDES HOLDING B.V. (NOTE 7) 20,500 - - - BÍNTER CANARIAS, S.A. - - - 556 BÍNTER MEDITERRÁNEO, S.A. - - - 200 MUSINI - 39 1,684 341 CONSTRUCCIONES AERONÁUTICAS, S.A. - 115 - 2 VENEZOLANA INTERNACIONAL DE AVIACIÓN, S.A. - - - 388 THER O - 6 - 315 (a) Including Ptas. 317 million 50,192 14,385 4,851 17,617 relating to Austral Líneas Aéreas - Cielos del Sur, S.A.

p-49 ANNUAL REPORT 1998 IBERIA, LINEAS AEREAS DE ESPAÑA, S.A. NOTES TO 1998 FINANCIAL STATEMENTS

T he Company has re c o rded a short-term account receivable of Ptas. 4,850 million from Venezolana Internacional de Aviación, S.A. for which a provision has been recorded in full.

The Company’s main transactions with SEPI Group and associated companies in 1998 were as follows:

1998 M I L L I O N S O F P E S E TA S

SERVICES FINANCIAL SERVICES FINANCIAL COMPANY RENDERED REVENUES RECEIVED EXPENSES SEPI - 5 - 4 VUELOS INTERNACIONALES DE VACACIONES, S.A. 1,083 - 676 - CAMPOS VELÁZQUEZ, S.A. 2 285 179 - COMPAÑÍA AUXILIAR AL CARGO EXPRÉS, S.A. 1,620 - 392 - IBER-SWISS CATERING, S.A. 86 - 6,438 - SAVIA 4,267 - 638 - AVIACIÓN Y COMERCIO, S.A. 5,378 12 40,151 - CARGOSUR, S.A. - - 101 - AEROLÍNEAS ARGENTINAS, S.A. 7,821 - 281 - VENEZOLANA INTERNACIONAL DE AVIACIÓN, S.A. - - 251 - AMADEUS GROUP 4,981 - 13,068 - BINTER FINANCE, B.V. - 59 - 10 BINTER CANARIAS, S.A. 2,870 2 - - BINTER MEDITERRÁNEO, S.A. 416 - - - IBERBUS COMPANIES 1,270 - 8,335 - MUSINI - - - 183

The services rendered to Aviación y Comercio, S.A., Aerolíneas Argentinas, S.A. and Binter Canarias, S.A. consist basically of aircraft maintenance, passenger service, handling services for aircraft on stopovers, commissions on ticket sales and aircraft leasing.

The services rendered to the Company by Iber-Swiss Catering, S.A. relate to catering services and materials. The Amadeus Group bills the Company for ticket reservations made through its system and the Company receives a commission for each ticket issued through that system.

As of December 31, 1998, the Company had provided guarantees to third parties for its subsidiary Binter Mediterráneo, S.A. totaling Ptas. 2,300 million.

p-50 ANNUAL REPORT 1998 IBERIA, LINEAS AEREAS DE ESPAÑA, S.A. NOTES TO 1998 FINANCIAL STATEMENTS

[1 5 ]TAX MATTERS T he “Ac c o u nts Receivable” and “Other No nt ra de Payables” captio ns in the accompanying balance sheet as of December 31, 1998, include the accounts receivable from and payable to, respectively, public authorities, the detail being as follows:

DECEMBER 31, 1998

MI L L I O N S O F PE S E TA S R E C E I VA B L E : RECEIVABLE FROM FOREIGN TAX AUTHORITIES 475 475 P AY A B L E : VAT 598 PERSONAL INCOME TAX WITHHOLDINGS 3,397 AIRPORT TAKEOFF AND SAFETY LEVIES 1,489 PAYABLE TO FOREIGN TAX AUTHORITIES 2,867 ACCRUED SOCIAL SECURITY TAXES 5,188 OTHER PAYABLES TO PUBLIC AUTHORITIES 9 13,548

Corporate income tax is calculated on the basis of the income per books, which does not necessarily coincide with the taxable income for corporate income tax purposes.

The reconciliation of the income per books for 1998 to the taxable income for corporate income tax purposes is as follows:

1998 M I L L I O N S O F P E S E TA S

IN C R E A S E DE C R E A S E AM O U N T

INCOME BEFORE TAXES - - 62,801) PERMANENT DIFFERENCES 87 (231) (a) (144) TI M I N G D I F F E R E N C E S :

ARISING IN THE YEAR 25,123 (b) (6,889) 18,234) (a) This amount relates mainly to the adjustment for the effect of inflation on ARISING IN PRIOR YEARS - (12,011) (C) (12,011) the gains obtained by the Company on fixed asset disposals. TAXABLE INCOME (BEFORE CONSOLIDATION ADJUSTMENTS) 68,880 (b) This amount relates basically to TA X C O N S O L I DAT I O N A D J U S T M E N T S: the provisions for pensions, for projected restructuring costs, for contingencies PERMANENT DIFFERENCES 1,430 (1,897) (467) related to subsidiaries and for bad debts. (c) This amount relates basically to TAXABLE INCOME 68,413 provisions for pensions, obligations to employees and provisions for aircraft.

p-51 ANNUAL REPORT 1998 IBERIA, LINEAS AEREAS DE ESPAÑA, S.A. NOTES TO 1998 FINANCIAL STATEMENTS

T he detail of the balance of the “Corporate Inc o me Tax” caption in the accompanying 1998 statement of income is as follows:

1998

MI L L I O N S O F PE S E TA S AP P L IC AT IO N O F T H E 35% TA X R AT E TO I N C O M E P E R B O O KS A D J US T E D BY T H E P E R M A N E N T D I F F E R E N C E S 2 1 , 7 6 6 AD D / (LE S S) : 7% O F T H E P R IO R Y E A R S’ TA X L O S S E S O F F S E T I N 1 9 9 8 (3,975) DO U B L E TA X AT IO N A N D I N V E S T M E N T TA X C R E D I TS (1,602) RE V E R SA L O F P R O V IS IO N S F O R P R E PA I D TA X E S R E C O R D E D I N P R IO R Y E A R S (4,375) OT H E R (304) C O R P O R AT E I N C O M E TA X 11,510

The 7% of prior years’ tax losses offset in 1998 relates to the difference between the corporate income tax rate (35%) and the rate of 28% that the Company obtained from SEPI by contributing its tax losses in consolidation for tax purposes.

The tax assets and liabilities were recorded, on the basis of the recovery date, under the “Receivable from Group Companies”, “Long-Term Receivables from Group Companies” and “Payable to Group and Associated Companies” captions in the accompanying balance sheet as of December 31, 1998, the detail being as follows:

DECEMBER 31, 1998 M I L L I O N S O F P E S E TA S

PAYA B L E TO GR O U P RE C E I VA B L E F R O M GR O U P CO M PA N I E S A N D AS S O C I AT E D CO M PA N I E S S H O R T L O N G S H O R T L O N G TE R M TE R M TOTA L TE R M TE R M TOTA L TAXABLE INCOME FOR 1998 - - - 13,501 - 13,501 TIMING DIFFERENCES ARISING IN THE YEAR 5,673 3,425 9,098 - 2,411 2,411 UNALLOCATED TIMING DIFFERENCES ARISING IN PRIOR YEARS 784 26,267 27,051 - 623 623 TOTAL 6,457 29,692 36,149 13,501 3,034 16,535

The estimated years for use of the long-term tax assets as of December 31, 1998, are as follows:

p-52 ANNUAL REPORT 1998 IBERIA, LINEAS AEREAS DE ESPAÑA, S.A. NOTES TO 1998 FINANCIAL STATEMENTS

YEAR OF RECOVERY MILLIONS OF PESETA S 2 0 0 0 5 , 2 5 8 2 0 0 1 5 , 1 0 0 2002 A N D S U B S E Q U E N T Y E A R S 1 9 , 3 3 4 2 9 , 6 9 2

The Company’s directors consider that all these assets will be recovered in not more than ten years.

Current Spanish corporate income tax legislation provided various tax incentives to encourage new investments through 1996 and, through April 1992, job creation. The Company availed itself of the tax benefits envisaged in this legislation and earned tax credits of Ptas. 64 million in 1998 in this connection. As of December 31, 1998, the Company used Ptas. 1,519 million of tax credits earned in prior years and in 1998. As of December 31, 1998, the Company did not have any unused tax credits.

REINVESTMENT EXEMPTION In 1998 and 1997 the Company availed itself of the tax regime for the reinvestment of extraordinary income and deducted Ptas. 6,889 million and Ptas. 915 million, respectively, of tax.

The Company opted to include the income deferred in 1998 and 1997 by the method established in Article 34.1 a) of the Corporate Income Tax Regulations.

REINVESTMENT EXEMPTION M I L L I O N S O F P E S E TA S 1 9 9 8 1 9 9 7

I N C O M E Q UA L I F Y I N G F O R R E I N V E S T M E N T E X E M P T IO N A N D NOT I N C L U D E D I N T A X A B L E I N C O M E 6 , 8 8 9 9 1 5 R E I N V E S T M E N T C O M M I T M E N T 6 , 9 0 6 2 , 8 4 8

In 1998 the Company reinvested the amounts shown below as follows:

REINVESTED IN 1998 M I L L I O N S O F P E S E TA S 1998 GAIN 1997 GAIN

R E I N V E S T E D I N 1 9 9 8 : PR O P E R T Y, P L A N T A N D E Q U I P M E N T A I R C R A F T 3 , 5 6 6 - MA C H I N E R Y 8 3 9 - A I R P O R T E Q U I P M E N T 1 , 5 0 6 2 8 6 IN S TA L L AT IO N S - 1 , 4 0 5 C O M P U T E R H A R D WA R E 9 9 5 1 , 1 5 7 TOTA L 6 , 9 0 6 2 , 8 4 8

p-53 ANNUAL REPORT 1998 IBERIA, LINEAS AEREAS DE ESPAÑA, S.A. NOTES TO 1998 FINANCIAL STATEMENTS

The Company has no outstanding reinvestment commitments for future years.

In January 1997 the tax authorities commenced an audit of 1992 to 1995 for all the taxes applicable to the Company. Although in the tax audit of corporate income tax provisional assessments were issued with no deficiency confirming the figures reported by the Company, as a result of the review tax assessments were issued for nonmaterial amounts and accepted and other tax assessments were issued and not accepted. The Company’s directors do not expect any liabilities to arise in this connection additional to those recorded as of December 31, 1998.

[1 6 ] REVENUES AND EXPENSES

NET SALES The breakdown of the Company’s net sales in 1998 and 1997, by type of activity, is as follows:

BY TYPE OF ACTIVITY M I L L I O N S O F P E S E TA S 1 9 9 8 1 9 9 7

PA S S E N G E R T IC K E T R E V E N U E S 4 8 1 , 6 1 8 3 7 3 , 4 6 0 FR E IG H T R E V E N U E S 3 7 , 1 0 7 3 7 , 4 9 9 OT H E R PA S S E N G E R T IC K E T A N D F R E IG H T R E V E N U E S 1 5 , 2 4 7 8 , 8 9 6 HA N D L I N G (A I R C R A F T D IS PATC H I N G A N D A I R P O R T S E R V IC E S) 4 0 , 2 0 0 4 7 , 8 0 6 TE C H N IC A L A S S IS TA N C E TO A I R L I N E S 2 2 , 6 0 3 1 8 , 9 7 8 OT H E R R E V E N U E S 1 0 , 1 7 8 1 0 , 0 0 2 6 0 6 , 9 5 3 4 9 6 , 6 4 1

The geographical breakdown of passenger ticket revenues in 1998 and 1997, by network, is as follows:

NETWORK M I L L I O N S O F P E S E TA S 1 9 9 8 1 9 9 7

S PA I N A N D E U R O P E 3 4 0 , 9 2 7 2 4 2 , 9 7 6 AT L A N T I C 1 2 1 , 0 1 5 1 1 0 , 7 0 8 FA R E A S T 9 , 2 5 2 1 2 , . 5 1 4 AF R IC A 1 0 , 4 2 4 7 , 2 6 2 4 8 1 , 6 1 8 3 7 3 , 4 6 0

TECHNICAL ASSISTANCE TO AIRLINES This caption includes revenues from aircraft maintenance services rendered to other airlines, including the Group companies.

p-54 ANNUAL REPORT 1998 IBERIA, LINEAS AEREAS DE ESPAÑA, S.A. NOTES TO 1998 FINANCIAL STATEMENTS

B) OTHER OPERATING REVENUES The detail of the balances of this caption in the accompanying 1998 and 1997 statements of income is as follows:

OTHER OPERATING REVENUES M I L L I O N S O F P E S E TA S 1 9 9 8 1 9 9 7

CO M M IS S IO N S 1 0 , 9 6 2 1 3 , 1 4 7 ROYA LT I E S 3 , 1 5 3 3 , 8 4 8 R E N T 1 , 8 1 7 1 , 7 1 1 RE C O G N I T IO N O F D E F E R R E D R E V E N U E S 1 , 3 2 9 1 , 4 4 0 OT H E R S U N D R Y R E V E N U E S 8 , 1 2 7 8 , 1 6 6 2 5 , 3 8 8 2 8 , 3 1 2

C) EXTRAORDINARY REVENUES The detail of the balance of the “Extra o rd i nary Revenues” caption in the accompanying 1998 statement of income is as follows:

1998 MI L L I O N S O F P E S E TA S

1997 D E BT O F A E N A 2 , 3 8 4 RE C O V E R Y O F P R O V IS IO N S F O R T H I R D-PA R T Y L I A B I L I T Y 6 , 5 5 0 RE C O V E R Y O F C O N T I N G E N C Y-R E L AT E D O P E R AT I N G P R O V IS IO N S 1 , 4 3 3 OT H E R 5 7 8 1 0 , 9 4 5

AENA The Company’s claims against AENA, amounting to Ptas. 6,366 million are still pending decision by the courts. To date all the decisions have been in favor of the Company, there being no claim by AENA against the Company.

D) PURCHASES The detail of the “Purchases” caption in the accompanying 1998 and 1997 statements of income is as follows:

PURCHASES M I L L I O N S O F P E S E TA S 1 9 9 8 1 9 9 7

AIRCRAFT FUEL 49,902 49,944 AIRCRAFT SPARE PARTS 15,920 12,190 CATERING MATERIALS 5,467 4,623 OTHER PURCHASES 2,894 2,739 74,183 69,496

p-55 ANNUAL REPORT 1998 IBERIA, LINEAS AEREAS DE ESPAÑA, S.A. NOTES TO 1998 FINANCIAL STATEMENTS

E) HEADCOUNT AND PERSONNEL EXPENSES The detail of the “Personnel Expenses” caption in the accompanying 1998 and 1997 statements of income is as follows:

PERSONNEL EXPENSES M I L L I O N S O F P E S E TA S 1 9 9 8 1 9 9 7 WAG E S , SA L A R I E S, E TC . 1 2 7 , 0 0 9 1 2 3 , 2 5 3 E M P L OY E E W E L FA R E E X P E N S E S 3 9 , 1 5 9 3 6 , 2 5 1 1 6 6 , 1 6 8 1 5 9 , 5 0 4

The average number of employees, by professional category, in 1998 and 1997 was as follows:

EMPLOYEES 1 9 9 8 1 9 9 7 GR O U N D P E R S O N N E L : SE N IO R M A N AG E R S A N D T E C H N IC I A N S 1 , 1 7 2 1 , 1 4 8 CL E R IC A L S TA F F 6 , 0 3 9 5 , 6 4 6 OT H E R 1 0 , 3 2 9 1 0 , 2 9 5 1 7 , 5 4 0 1 7 , 0 8 9 F L I G H T P E R S O N N E L : PI L OTS 1 , 2 3 9 1 , 2 0 1 F L IG H T E N G I N E E R S 2 2 9 2 4 1 C A B I N C R E W 3 , 0 5 6 2 , 9 6 7 4 , 5 2 4 4 , 4 0 9 2 2 , 0 6 4 2 1 , 4 9 8

F) OTHER OPERATING EXPENSES The detail of the balances of this caption in the accompanying 1998 and 1997 statements of income is as follows:

OTHER OPERATING EXPENSES M I L L I O N S O F P E S E TA S 1 9 9 8 1 9 9 7 COMMERCIAL EXPENSES 67,377 57,917 AIR TRAFFIC LEVIES AND CHARGES 36,631 34,134 AIRCRAFT LEASE PAYMENTS AND PAYMENTS TO OPERATORS (NOTE 6) (a) (C) 80,565 27,549 MAINTENANCE (b) 23,571 18,336 NAVIGATION AIDS 25,532 19,022 (a) Including the cost of the wet lease contracts amounting to IN-FLIGHT SERVICES 13,895 11,894 Ptas. 16,773 million in 1998 and to Ptas. 5,268 million in 1997. RESERVATION SYSTEM EXPENSES 16,220 10,288 (b) Including maintenance expenses SUNDRY RENT 8,798 8,222 and provisions for major repairs. (c) Including the payments to the OTHER 50,262 40,609 operator AVIACO amounting to 322,851 227,971 Ptas. 38,174 million.

G) EXTRAORDINARY EXPENSES The detail of the balance of the “Extraordinary Expenses” caption in the accompanying 1998 statement of income is as follows:

p-56 ANNUAL REPORT 1998 IBERIA, LINEAS AEREAS DE ESPAÑA, S.A. NOTES TO 1998 FINANCIAL STATEMENTS

EXTRAORDINARY EXPENSES MI L L I O N S O F P E S E TA S PR O V IS IO N S F O R T H I R D-PA R T Y L I A B I L I T Y 1 1 , 7 8 0 OT H E R E X T R AO R D I N A R Y E X P E N S E S 1 , 3 1 2 1 3 , 0 9 2

[17]“YEAR 2000 ISSUE” The effect of the Year 2000 issue presents a particularly significant problem for aviation because of its implications for the efficient and normal operation of international air transport.

Since the first half of 1997 the Company has been adopting the measures required to tackle the Year 2000 Issue, and has implemented a plan for assessing all systems and remedying possible problems.

Also, the international air transport coordinating organizations such as IATA ( I nt e r na t io nal Air Tra nsport As s o c ia t ion) and IC AO (Int e r na t io nal Civil Av ia t io n Organization) have drawn up standard international regulations for Y2K compliance. Specifically, IATA has designed standard methodology for assessing Year 2000 compliance and identifying problem areas at air traffic service suppliers. IATA and Airports Council International (ACI) have worked together on developing standard methodology for assessing the functioning of airports. The findings of the two studies were shared with the IATA member airlines, and the Company is a member of this association.

As regards aircraft safety, the related suppliers, such as The Boeing Company, Airbus Industrie and Honeywell, among others, have implemented Year 2000 projects that will obviate all threats to the safe functioning of aircraft in Y2K.

For the other information systems involved in the air transport business (both internal and external), the Company is implementing the plan designed and, accordingly, no significant problems are expected to arise as a result of the arrival of the Year 2000. In 1997 the Company recorded a provision of Ptas. 1,000 million for the costs involved in these processes. In 1998 the Company used Ptas. 433 million of this provision, and at year-end it estimated that further costs of Ptas. 4,000 million will be incurred in this connection. This amount was recorded with a charge to the “Other Operating Expenses” caption in the accompanying 1998 statement of income, and the related provision was recorded under the “Payable for Purchases and Services” caption in the accompanying balance sheet as of December 31, 1998.

[18 ]DIRECTORS’REMUNERATION AND OTHER BENEFITS The remuneration of all types earned by the Company’s directors amounted to Ptas. 122 million in 1998.

In 1998 no advances or loans were granted to the directors and there were no pension commitments to them.

p-57 ANNUAL REPORT 1998 IBERIA, LINEAS AEREAS DE ESPAÑA, S.A. NOTES TO 1998 FINANCIAL STATEMENTS

[1 9 ] 1998 AND 1997 STATEMENTS OF CHANGES IN FINANCIAL POSITION Following are the Company’s statements of changes in financial position for 1998 and 1997:

APPLICATION OF FUNDS M I L L I O N S O F P E S E TA S

1998 1997

FIXED ASSET ADDITIONS: INTANGIBLE ASSETS 645 142 TANGIBLE FIXED ASSETS 54,732 13,870 LONG-TERM FINANCIAL INVESTMENTS IN GROUP AND ASSOCIATED COMPANIES 48,978 7,112 OTHER LONG-TERM FINANCIAL INVESTMENTS 2,916 220 OTHER DEFERRED REVENUES 182 - REPAYMENT OR TRANSFER TO SHORT-TERM OF LONG-TERM DEBT: DEBT SECURITIES AND OTHER SIMILAR ISSUES 34,096 31,212 GROUP AND ASSOCIATED COMPANIES 129 1,147 OTHER DEBT 97 60 PROVISIONS FOR MAJOR REPAIRS 1,016 1,054 PROVISIONS FOR PENSIONS 2,245 2,113 PROVISIONS FOR OBLIGATIONS TO EMPLOYEES 1,524 1,482 PROVISION FOR THIRD-PARTY LIABILITY 1,074 17,757 TOTAL FUNDS APPLIED 147,634 76,169 FUNDS OBTAINED IN EXCESS OF FUNDS APPLIED (INCREASE IN WORKING CAPITAL) - 42,545

p-58 ANNUAL REPORT 1998 IBERIA, LINEAS AEREAS DE ESPAÑA, S.A. NOTES TO 1998 FINANCIAL STATEMENTS

SOURCE OF FUNDS M I L L I O N S O F P E S E TA S

1998 1997

FUNDS OBTAINED FROM OPERATIONS 77,599 85,255 LONG-TERM DEBT: GROUP COMPANIES 2,602 240 OTHER COMPANIES 16,109 3 DISPOSALS OF TANGIBLE FIXED ASSETS AND INTANGIBLE ASSETS 10,019 7,372 DISPOSALS OF LONG-TERM FINANCIAL INVESTMENTS 3,566 19,824 DIVIDENDS RECEIVED 3,325 - EARLY AMORTIZATION OR TRANSFER TO SHORT-TERM OF LONG-TERM FINANCIAL INVESTMENTS: GROUP COMPANIES 147 5,080 OTHER FINANCIAL INVESTMENTS 583 173 DEFERRED REVENUES 235 767

TOTAL FUNDS OBTAINED 114,185 118,714 FUNDS APPLIED IN EXCESS OF FUNDS OBTAINED (DECREASE IN WORKING CAPITAL) 33,449 -

VARIATION IN WORKING CAPITAL M I L L I O N S O F P E S E TA S 1 9 9 8 1 9 9 7 IN C R E A S E DE C R E A S E IN C R E A S E DE C R E A S E

INVENTORIES 1,317 - 554 - ACCOUNTS RECEIVABLE - 4,160 - 4,490 CURRENT LIABILITIES - 31,126 13,849 - SHORT-TERM FINANCIAL INVESTMENTS - 392 32,830 - CASH 708 - - 785 ASSET ACCRUAL ACCOUNTS 204 - 587 - TOTAL 2,229 35,678 47,820 5,275 VARIATION IN WORKING CAPITAL - 33,449 42,545 -

p-59 ANNUAL REPORT 1998 IBERIA, LINEAS AEREAS DE ESPAÑA, S.A. NOTES TO 1998 FINANCIAL STATEMENTS

The reconciliation of the income per books to the funds obtained from operations is as follows:

RECONCILIATION M I L L I O N S O F P E S E TA S 1 9 9 8 1 9 9 7

IN C O M E P E R B O O KS 51,291) 11,028) AD D / (LE S S) : PERIOD DEPRECIATION AND AMORTIZATION AND FIXED ASSET PROVISIONS 21,356) 33,960) PROVISION FOR CONTINGENCIES AND EXPENSES 25,974) 67,586) DEFERRED INTEREST EXPENSES AND DEFERRED CHARGES 2,071) 2,200) TAX ASSET RECOVERABLE AT LONG-TERM (6,927) (2,012) NET EXCHANGE DIFFERENCES ON LONG-TERM DEBT 3,297) (2,986) NET EXCHANGE DIFFERENCES ON FIXED ASSET REVALUATIONS -) (69) DEFERRED INTEREST REVENUES (1,430) (1,571) NET LOSSES ON FIXED ASSET DISPOSALS (7,022) (16,207) RECOVERY OF OVERSTATED PROVISIONS AND DEPRECIATION AND AMORTIZATION (11,736) (7,090) CANCELLATION OF CAPITALIZED INTEREST 725) 416) 77,599 85,255

[20]EXPLANATION ADDED FOR TRANSLATON TO ENGLISH These financial statements are presented on the basis of accounting principles generally accepted in Spain. Certain accounting practices applied by the Company that conform with generally accepted accounting principles in Spain may not conform with generally accepted accounting principles in other countries.

p-60 a n n u a l r e p o r t 1 9 9 8

M A N A G E M E N T R E P O R T

D U E TO I T S L E N GT H , T H IS P U B L IC AT IO N I N C L U D E S O N LYA S U M M A R Y O F T H E M A N AG E M E N T R E P O R T. T H E C O M P L E T E T E X T H A S B E E N D E P O S I T E D W I T H T H E M A D R I D M E R C A N T I L E R E G IS T E R . TRA N S L AT IO N OF A RE P O R T OR IG I N A L L YISS U E D IN SPAN IS H . IN TH E EV E N T OF A DIS C R E PA N C Y , TH E SPAN IS H -LA N G U AGE VE R S IO N PR E VA I L S .

IBERIA, LINEAS AEREAS DE ESPAÑA, S.A.

ANNUAL REPORT 1998 IBERIA, LINEAS AEREAS DE ESPAÑA, S.A. MANAGEMENT REPORT

[1] 1998 HIGHLIGHTS 1998, prior to IBERIA’s privatization, saw a significant step forward towards achieving the strategic objectives set in the Master Plan, despite the obstacles to growth caused by the restrictions placed on the use of resources and infrastructures.

IBERIA’s pre-tax income amounted to Ptas. 62,801 million in 1998, four times higher than in 1997, enabling it to report a return on equity of 34%, considerably above the target set in the Master Plan. The IBERIA Group reported income before taxes of Ptas. 65,967 million.

The privatization process will be the most significant event for the Company in early 1999. The first phase, consisting of the sale of 10% of the Company’s capital stock to industrial partners (American Airlines and British Airways), will be formalized in February 1999. As regards the second phase, consisting of the sale of 30% of the Company’s shares to institutional partners (banks, construction companies, etc.), Sociedad Estatal de Participaciones Industriales (SEPI) is currently selecting partners that will guarantee sh a re ho l d er stability. The process will culminate in the admi s s i on to listing of the rema i n i n g 54% of the capital stock in the last four months of 1999, since 6% of the shares are owned by Company employees.

In a favorable market context, IBERIA’s operations in 1998 were hindered by certain restrictions placed on production, since despite the integration of the Group’s commercial policy and joint scheduling, both of which were introduced in 1997 in accordance with the Master Plan, which aimed to optimize the use of resources, IBERIA was unable to increase its volume of business using in-house resources because of the difficulties in improving the productivity of technical crews caused by the negotiations relating to the collective labor agreement that concluded in October. Thu s , IBERIA’s prod uct i on in 1998 was 6% lower than in 1997. Avi aco incr eased its block hours by nearly 4%. The combinat io n of these two factors forced the Company to acquire more aircraft from non-Group companies under wet lease arrangements than in 1997 and, specifically, to enter into an agreement with Air Europa in March for the long-term lease of eleven aircraft (two long-haul and nine short- and medium-haul aircraft) with their technical crews.

In 1998 agreements were signed with certain groups of IBERIA employees. The year started with the signature of the ground personnel agreement, in force through 1999, and in October 1998 the IBERIA-SEPLA agreement on the sixth collective labor agreement, in force through 2000, which provides for the maintenance of current productivity levels and the adoption of new features, such as the inclusion of the relief co-pilot, for an increase in maximum flying hours and working days, and for the hiring in 1998 and 1999 of 220 new pilots, thereby removing the restrictions encountered by IBERIA in 1998. Production is therefore expected to reach 324,000 block hours in 1999, and to exceed 360,000 block hours in 2000. Negotiation of the collective labor agreement for cabin crew is currently in progress.

p-63 ANNUAL REPORT 1998 IBERIA, LINEAS AEREAS DE ESPAÑA, S.A. MANAGEMENT REPORT

The most ambitious plan for new aircraft in the Company’s history, amounting to over Ptas. 600,000 million, was signed in early 1998. This is a clear indication of IBERIA’s commitment to future expansion, particularly in the market in which it aims to strengthen its leadership, namely the European-Latin American market. This plan envisages significant aircraft modernization work and will lead to operating and training cost savings as a result of the standardization of most of the Airbus-type aircraft, leading to reduced expenses relating to maintenance, spare parts and aircraft fuel, with the concomitant environmental benefits and pilot and cabin crew training cost savings. The ability of crews to switch from one type of aircraft to another will also boost productivity.

The plan envisages the addition of 92 short- and medium-haul aircraft (52 purchased outright and 40 leased with purchase option), and 11 aircraft for long-haul routes (6 purchased outright and 5 leased with purchase option). The aircraft will be acquired outright or acquired under financial lease or operating lease agreements or other forms of financing.

The new labor agreements and the availability of new aircraft will enable IBERIA to set about meeting the strategic objectives set for 1999, with the advantage that the flexibility arising from the signature of the wet lease agreements and the purchase options included in the established plan for new aircraft will enable decisions to be taken regarding the maintenance or modification of commercial plans on the basis of unforeseen market demand fluctuations thanks to the lower fixed cost burden.

The growth potential of Madrid-Barajas airport, whose third runway came into service in November 1998 and at which refurbishment and expansion work continued throughout the year (and for which a fourth and fifth runway are planned), will facilitate its development as a hub airport. A new passenger terminal (T4) will be opened for exclusive use by IBERIA and its strategic allies. However, the situation at Barajas airport in 1998 made it impossible to provide the quality demanded by our customers in terms of punctuality and ground comforts. One of our main targets for 1999 is to overcome the difficulties that these problems represent for our services and which reduced the Company’s earnings in 1998.

In 1998 IBERIA inaugurated new routes to destinations such as Helsinki, Turin, Johannesburg, Chicago, Porto and Venice, and started to offer non-stop flights to Latin American destinations such as Santiago de Chile, Lima and San José de Costa Rica. However, in order not to lose its share of this target market, and due to the aforementioned limitations on supply in 1998, IBERIA had to reschedule certain flights, and ceased to operate the route to Tokyo in December in order to assign its human and material resources to the Mid and South-Atlantic market.

The daily flight to Chicago is a result of the strategic commercial alliance with American Airlines: the flight is operated under a shared code and opens up 23 new North American destinations for IBERIA.

p-64 ANNUAL REPORT 1998 IBERIA, LINEAS AEREAS DE ESPAÑA, S.A. MANAGEMENT REPORT

In 1998 the Group’s Commercial Management completed the implementation of certain of the programs envisaged in the Master Plan, including the creation of Serviagencias, a centralized service for travel agencies in Spain and the introduction of a new, more competitive travel agency incentive system, Valor 98. 1998 also saw the formation of Viva Tours, which, targeted at Spanish tourists, will optimize the marketing and retailing of excess supply, both of the Group’s services, i.e. high-season plane tickets, and of hotel and car rental services and other tourism products.

As regards its end customers, in 1998 IBERIA relaunched the IBERIA Plus customer loyalty program and redesigned service standards for higher-priced classes, bringing them into line with the best practices in the market for European and intercontinental travelers. Serviberia was also introduced to provide information, make bookings and sell and deliver tickets to customers who require these services.

A salient event in 1998 in connection with the product offered by IBERIA was the initiation of a significant investment drive aimed at improving the business classes on long-haul flights, a measure which forms part of the strategic objective of increasing the Company’s presence in this higher-yield market segment. The investment will be completed on all the aircraft in 1999.

The production of the material management area amounted to 3.18 million hours in 1998, almost three million hours of which were worked by Company employees, an increase with respect to 1997. Production work for third parties was also up on 1997, to the detriment of in-house production work. The work carried out in the year included most notably maintenance by IBERIA of the aircraft operated under wet lease arrangements by Air Europa, the refurbishment of the cabins of long-haul aircraft and the installation of new electronic radionavigation systems in the aircraft.

The loaning of staff to second operators continued at airports and, pursuant to the Master Plan, Aviaco’s handling activity was incorporated at airports where this airline holds the related license, except for Mahón, which will be incorporated in 1999. As a result of the measures taken to protect market share, the impact of competition was ultimately not as harmful as expected, enabling IBERIA to attain a market share of 69% and higher-than budgeted WPH revenues.

The Systems area continued to operate the systems that enable the Company to carry on its normal operations, while at the same time continuing with its work aimed at addressing two key projects for IBERIA, namely the Year 2000 and Euro Projects. This work will guarantee the safe functioning of the Company’s systems and their adaptation to the new economic and technological environment.

p-65 ANNUAL REPORT 1998 IBERIA, LINEAS AEREAS DE ESPAÑA, S.A. MANAGEMENT REPORT

aircraft at the end of the year gave rise to a significant capital gain, and the aircraft were su b s e q u e n tly leased under a wet lease arran geme n t. One B-747 freig h t plane was operat e d under a wet lease agreement with Kalitta in the first quarter of the year and subsequently with Atlas.

Despite the obstacles created by limited in-house resources, a problem resolved by the agreements now in force, and by external factors (operating restrictions arising from airport infrastructure problems), 1998 was a good year since, even though average supply in terms of ASKs and block hours were 4.4% and 4.2%, respectively, lower than expected, the IBERIA Group’s operating income amounted to Ptas. 52,461 million (Ptas. 47,979 mi l l i on at IBERIA, L.A.E.), up 31% on 1997. The incr ease of 9.1% in the Group’s operat i n g revenues was higher than the 7.6% increase in operating expenses.

As reg a r ds the Group’s operat i n g rev e nu e s , not e w o r t h y was the 10% rise in passenger revenues in comparable terms with respect to 1997, largely due to the positive evolution of the yield, which was almost 3.2% higher than in 1997, basically on short- and medium- haul routes, and to a lesser extent on long-haul routes (1%). This increase in the yield is a fruit of the Group’s commercial policy, one of the main pillars of which is protection of passenger revenues. Accordingly, 80% of the aforementioned increase in the yield was due to improved prices (the policy of tailoring prices to markets is key to this), and the other 20% to the favorable parity of the peseta, particularly with respect to the U.S. dollar, in the first part of the year.

The evolution of freight revenues, however, was not quite so positive, with a reduction of 4% from 1997, due to factors nearly all of which are nonrecurring: on the one hand, the barriers to growth put up by unstable scheduling, which penalized freight disproportionately as a result of its being considered to be a marginal activity with respect to passenger transport and, on the other, the inauguration of the new terminal with the multiple problems that this entailed, leading to a significant reduction in the volume of freight passing through Barajas in the middle of the year. In addition, the elimination of the route to Japan hit freight revenues and earnings hard, since this route contributed almost 10% of total freight revenues. The replacement of this line by other markets is one of the challenges facing the freight unit in 1999.

Despite the drop in handling revenues obtained from third parties with respect to 1997, this area performed well in 1998. In contrast to forecasts pointing to a sharp reduction in the third-party handling market share to 66% (a percentage considered very difficult to achieve in the face of the foreseeable consolidation of the second operators at Barajas and Barcelona airports), the market share was actually maintained at 69% and, more importantly with a view to the future stabilization of margins in this business area, without a significant fall in yield (the decrease with respect to 1997 was only 4%), signifying that the cumulative fall in the yield since the second operators commenced operations is slightly below 20%, in contrast to the much more negative forecasts which placed this percentage at 35% at 1999 year-end.

p-66 ANNUAL REPORT 1998 IBERIA, LINEAS AEREAS DE ESPAÑA, S.A. MANAGEMENT REPORT

Noteworthy as regards operating expenses was the significant growth (69%) in ai rc r aft lease exp e ns e s , largely due to wet lease trans a c t io n s, which were used in 1998 for the two aircr aft of Air Atl a n ta (initially one B-747 and one L1011, and since May two B-747s) and the long-term wet lease from March of Air Europa aircraft (initially two B-767s, five B-737s and four B-757s. The number of Air Atlanta and Air Europa aircraft operated under wet lease arrangements will vary in the coming months, although the number of short- and medium-haul aircraft thus leased will be maintained at nine, and in navigation levies, which increased by 18% with respect to 1997 as a result of the introduction by AENA on January 1, 1998, of the new approach charge, giving rise to an increased expense of over Ptas. 2,000 million in 1998. The effect of the new charge is expected to amount to Ptas. 4,500 million in 1999 and to almost Ptas. 7,000 million in 2000.

Per s o n n el exp e n ses incr eased by 3.5% in 1998, mainly due to the pay rises established in the agreements signed with the employees which, combined with promotions and the increase in social security costs, accounted for three percentage points of the aforementioned increase at the various Group companies. The remainder of the rise was due to the increase in cabin crew (3% of equivalent full-time employees mainly to cover the wet lease arrangement with Air Europa), in technical crew (2% at IBERIA) and in ground employee numbers in the Spanish handling (2%) and maintenance (3%) areas.

The most positive aspect of 1998 with regard to expenses was the sharp drop in fuel prices, which not only offset the increase in the value of the peseta with respect to the U.S. dollar, but also gave rise to significant savings in amounts billed to the Company in pesetas. Also, aircraft fuel costs were almost 3% lower than in 1997, despite the increase of almost 6% in block hours.

Also positive was the decrease in period depreciation and amortization of almost 30% as a result of significant increase (around Ptas. 8,000 million) in the depreciation charge arising from the asset revaluation made at 1996 year-end. The effect of the revaluation was lower in 1998 (a little under Ptas. 3,000 million) and will even out at around Ptas. 2,000 million in the next five years.

Ap p l ic a t i on conti n ued in 1998 of the gene r al exp e n se red uct i on mea s u r es established in the Master Plan. The decrease in general expenses with respect to the reductions for ecasted in the Master Plan was almost 6%, high er than the annual 5% target established for 1997-1999.

As regards unit cost and operating margin ratios at IBERIA and Aviaco, the cost per ASK was Ptas. 12.73, only 1% higher than in 1997, despite the significant increase in certain cost items described above (aircraft lease and personnel expenses, levies and charges, commercial expenses), placing the operating revenue per ASK at Ptas. 13.87, up 2.4% on 1997. Thus, the unit operating margin increased from Ptas. 0.96/ASK in 1997 to Ptas. 1.14/ASK in 1998.

p-67 ANNUAL REPORT 1998 IBERIA, LINEAS AEREAS DE ESPAÑA, S.A. MANAGEMENT REPORT

However, this positive evolution in operating margins contrasts with the negative trend in aircraft productivity. IBERIA is ranked among the last airlines in terms of aircraft productivity, a matter to which the Company must pay particular attention, since it has a highly negative impact on the cost of its resources, and represents an opportunity to improve the Company’s earnings and net worth.

A noteworthy event in the latter part of the year was the decision to dissolve VIVA. The impossibility of integrating it into the Group’s scheduled operations ruled out its continuity in the charter market, in which it had accumulated losses of almost Ptas. 7,000 million since 1996. Even the most optimistic projections forecast that this company would continue to incur annual losses of Ptas. 1,000 million. In these circumstances, Group management was forced to close down the company. The labor force reduction plan prior to the cessation of operations was submitted at the end of January 1999, and it is hoped to reach a negotiated agreement in the first quarter of 1999.

Also noteworthy was the recovery of certain VIASA aircraft that were mortgaged as security for the loans granted to this company in the period from 1994 to 1996. In August 1998 IBERIA recovered and registered three DC-10s and four B-727s, thus cushioning the cost of the investment made in the past.

1998 saw the implementation of various major projects, including most notably because of its impact on the employees the so-called “CREANDO FUTURO” (BUILDING A FUTURE) plan. The aim of this plan is to foster a cultural change which, with the commitment and participation of all, will place the Company and the Group in a position of leadership, thus meeting the expectations of our customers, in order to guarantee profitability and growth, motivating all the employees, sharing the effects of the need for changes, reducing the barriers that separate different seniority levels and improving processes by means of measures that can be quickly brought into effect. 18 processes with the participation of almost 1,000 people were carried out in the plan’s first year.

The “Year 2000” issue made it necessary to design within the Group a special project that, through the presence of experts in all areas, will identify needs and establish the required action plans, including possible contingency plans. This project has been up and running in the information systems area since mid-1997, and is expected to conclude in the first half of 1999. The other, non-IT actions have been implemented since the second half of 1998 and are expected to finish before the end of 1999.

In 1998 the Company designed in-house methodology to tackle the EURO project for the adoption on the euro. This project was implemented in 1998 and will run for the next two years (1999 and 2000).

p-68 ANNUAL REPORT 1998 IBERIA, LINEAS AEREAS DE ESPAÑA, S.A. MANAGEMENT REPORT

In 1999 IBERIA will be privatized. A change in business culture will be essential, the objective being to create value for the shareholder, who will oversee the decision-making process. These targets will not be met unless the parameters defining our service quality do not substantially improve. 1999 will be key to securing the success of our aim to achieve profitable growth. Significant work lies ahead in improving quality parameters, and we must ensure above all that these improvements are clearly perceived by our passengers.

[2] GROUP PRODUCTION (BY NETWORK)

SUPPLY In terms of ASKs, IBERIA’s production, largely characterized in 1998 by the consolidation of the joint scheduling with Aviaco initiated in the last quarter of 1997, increased by 7.8% with respect to 1997, the largest increase being on long-haul routes.

This important growth did not, however, reach the levels projected at the beginning of the year (3.4% lower) as a result of the limitations involving slots at Madrid and Barcelona airports and of the fact that agreements were not met with the aircraft technical employees until October. The Company addressed this problem by using aircraft under wet leases and, in January, an important agreement was entered into with Air Europa. Under this agreement, which has been in force since mid-March, 26,606 block hours have been flown by B-767, B-757 and B-737 aircraft.

The breakdown of supply is as follows: AVAILABLE SEATS KILOMETRE

SOUTHERN AFRICA FAR EAST 0.92 % 3.02 % S U P P LY M I L L I O N A S K S SPAIN 26.84 % 1 9 9 8 1 9 9 7 VAR I AT I O N 98 / 9 7 % VAR I AT I O N S PAIN 12,218 1 1 , 9 0 5 3 1 3) 2 . 6) EUROPE 1 1 , 8 6 9 1 0 , 9 3 3 9 3 6) 8 . 6) A M E R IC A S 1 9 , 6 3 8 1 7 , 7 6 5 1 , 8 7 3) 1 0 . 5) AMERICAS 43.14 % EUROPE SOUTHERN AFRIC A 4 1 8 0 4 1 8) -) 26.07 % 1998 FAR EAST 1 , 3 7 5 1 , 6 1 4 ( 2 3 9 ) ( 1 4 . 8 ) IBERIA, L.A.E. + AVIACO IBERIA, L.A.E. + AV I ACO 4 5 , 5 1 8 4 2 , 2 1 7 3 , 3 0 1 7 . 8 45,518

p-69 ANNUAL REPORT 1998 IBERIA, LINEAS AEREAS DE ESPAÑA, S.A. MANAGEMENT REPORT

Average production in terms of block hours was up 5.7% on 1997, slightly lower (0.4%) than projected. Despite the restrictions on the use of in-house resources, it was possible to maintain this level by arranging more wet lease transactions.

The variations in 1998 were as follows:

BLOCK HOURS AV E R AGE PRODUCTION B L O C K H O U R S 1 9 9 8 1 9 9 7 VAR I AT I O N 98 / 9 7 % VAR I AT I O N 1998 1997 IBERIA 2 7 9 , 8 2 9 2 9 3 , 3 7 2 ( 1 3 , 5 4 3 ) ( 4 . 6 ) W E T-LEASE 3 7 , 5 7 6 7 , 6 3 7 2 9 , 9 3 9) 3 9 2 . 0) AV I AC O 8 3 , 5 4 7 7 8 , 2 1 0 5 , 3 3 7) 6 . 8) IBERIA, L.A.E. + AV I ACO 4 0 0 , 9 5 2 3 7 9 , 2 1 9 2 1 , 7 3 3 5 . 7

2.2. DEMAND

IBERIA WET-LEASE AVIACO IBERIA, L.A.E. IBERIA carried almost 22 million passengers in 1998, 5.4% more than in 1997. OPERATIONS OPERATIONS + AVIACO Noteworthy were the increases in the European network as a whole and on the Madrid- Barcelona shuttle, which carried a total of almost 1.8 million passengers.

In the Americas market, the increase in supply made it possible to carry 7.2% more passengers than in 1997, thanks to the new directly operated destinations (Lima, Santiago de Chile and San José de Costa Rica), with 153,000 passengers. However, there was a sharp drop in the number of passengers carried to Brazil and the Dominican Republic, as a result in both cases of the split of certain networks of flights passing through these countries.

The breakdown of passengers carried is as follows:

PASSENGERS CARRIED DEMAND T H O U SA N D S O F P A S S E N G E R S

SOUTHERN AFRICA AR I AT I O N AR I AT I O N FAR EAST 1 9 9 8 1 9 9 7 V 98 / 9 7 % V 0.17 % 0.46 % AMERICAS 9.03 % S PAIN 1 3 , 1 9 9 1 2 , 7 9 5 4 0 4) 3 . 2) SPAIN 60.67 % EUROPE 6 , 4 5 3 5 , 8 9 6 5 5 7) 9 . 4) A M E R IC A S 1 , 9 6 4 1 , 8 3 2 1 3 2) 7 . 2) SOUTHERN AFRIC A 3 7 0 3 7) -) EUROPE FAR EAST 1 0 0 1 2 5 ( 2 5 ) ( 2 0 . 0 ) 29.66 % IBERIA, L.A.E. + AV I ACO 2 1 , 7 5 3 2 0 , 6 4 8 1 , 1 0 5 5 . 4

1998 IBERIA, L.A.E. + AVIACO 21,753

p-70 ANNUAL REPORT 1998 IBERIA, LINEAS AEREAS DE ESPAÑA, S.A. MANAGEMENT REPORT

The trend in RPKs was the same as that in passenger numbers, with scant variations on average hauls, with an overall increase of 1.3%

The breakdown of RPK, by network, is as follows (million RPKs):

BY NETWORK M I L L I O N R P K S REVENUE PASSENGERS KILOMETRE 1 9 9 8 1 9 9 7 VAR I AT I O N 98 / 9 7 % VAR I AT I O N SOUTHERN AFRICA FAR EAST 0.91 % 2.80 % S PAIN 8 , 6 1 5 8 , 2 2 5 3 9 0) 4 . 7) AMERICAS SPAIN EUROPE 8 , 0 6 0 7 , 4 1 9 6 4 1) 8 . 6) 45 % 26.49 % A M E R IC A S 1 4 , 6 3 6 1 3 , 6 8 3 9 5 3) 7 . 0) SOUTHERN AFRIC A 2 9 6 0 2 9 6) -) FAR EAST 9 1 3 1 , 1 6 4 ( 2 5 1 ) ( 2 1 . 6 )

IBERIA, L.A.E. + AV I ACO 3 2 , 5 2 0 3 0 , 4 9 1 2 , 0 2 9 6 . 7 EUROPE 24.78 %

1998 2.3. PASSENGER LOAD FACTOR IBERIA, L.A.E. + AVIACO 32,520 The load factor of 71.4% in 1998 was 0.8 percentage points lower than in 1997. This result can be viewed as satisfactory in view of the increase in supply and the inauguration in the year of new destinations (Johannesburg and Chicago), which have lower load factors than they will foreseeably have in the future.

The breakdown of the passenger load factor, by network, is as follows:

PASSENGER LOAD FAC TOR L O A D F A C TO R % PASSENGER LOAD FAC TO R (in %) 1 9 9 8 1 9 9 7 VAR I AT I O N 98 / 9 7 % VAR I AT I O N 1998 1997 S PAIN 7 0 . 5 6 9 . 1 1 . 4) 2 . 1) EUROPE 6 7 . 9 6 7 . 9 0 . 0) 0 . 1) A M E R IC A S 7 4 . 5 7 7 . 0 ( 2 . 5 ) ( 3 . 2 ) SOUTHERN AFRIC A 7 0 . 8 --) -) FAR EAST 6 6 . 4 7 2 . 1 ( 5 . 7 ) ( 7 . 9 ) IBERIA, L.A.E. + AV I ACO 7 1 . 4 7 2 . 2 ( 0 . 8 ) ( 1 . 1 )

The joint scheduling of IBERIA and Aviaco, together with the operation of a fran- SPAIN EUROPE AMERICAS SOUTHERN FAR EAST IBERIA, L.A.E. chise with Air Nostrum, enabled the load factor in the European network to match that of AFRICA + AVIACO 1997 and that on Spanish routes to increase from 69% in 1997 to the very high 70.5% in 1998, with increases in supply of 8.5% and 2.4%, respectively.

p-71 ANNUAL REPORT 1998 IBERIA, LINEAS AEREAS DE ESPAÑA, S.A. MANAGEMENT REPORT

The greatest variation was in the Americas network, with a drop of 2.5 percentage points to 74.5%, similar to 1997, despite the significant increase in supply. Worthy of mention, however, were the decreases in Mexico, the Dominican Republic and Brazil, the only destinations where supply was not increased, whose load factors decreased by 3%, 2% and 7%, respectively, due mainly to the continuous changes in supply and aircraft types as a result of the resource utilization difficulties, which led to considerable scheduling instability.

2.4. AVERAGE YIELD The detail of the variations in the average yield, by area, in 1998, and of the comparable figures for 1997 is as follows:

AV E R AGE YIELD AV E R AGE YIELD P T S . / R P K (in Pts. / R P K ) 1998 1997 1 9 9 8 1 9 9 7 VAR I AT I O N 98 / 9 7 % VAR I AT I O N S PA I N 2 0 . 9 1 9 . 8 1 . 1) 5 . 6) EUROPE 2 0 . 9 2 0 . 3 0 . 7) 3 . 2) A M E R IC A S 8 . 3 8 . 1 0 . 2) 2 . 2) SOUTHERN AFRIC A 5 . 9 --) -) FAR EAST 1 0 . 3 1 0 . 7 ( 0 . 4 ) ( 3 . 6 ) IBERIA, L.A.E. + AV I ACO 1 4 . 8 1 4 . 3 0 . 5 3 . 3

SPAIN EUROPE AMERICAS SOUTHERN FAR EAST IBERIA, L.A.E. AFRICA + AVIACO The significant increase of over 3% in the average yield, which was partially (20%) due to the increase in the value of the peseta with respect to the U.S. dollar, was mainly due to the new fares for different markets in response to the higher demand, to the implementation of marketing improvements (revenue management tools, the creation of agency services, etc.) and to the greater attention paid to business classes, with the retention of the Business II class in Europe and the commencement of the redesign of higher-priced classes on long-haul flights.

Noteworthy in this area was the increase in the proportion of business-class travelers to total passengers to 11% in 1998, as compared with 10.7% in 1997.

p-72 ANNUAL REPORT 1998 IBERIA, LINEAS AEREAS DE ESPAÑA, S.A. MANAGEMENT REPORT

2.5. PASSENGER REVENUES The passenger revenues earned by IBERIA + Aviaco amounted to Ptas. 481,026 million in 1998, the detail being as follows:

PASSENGERS REVENUES M I L L I O N S O F P E S E TA S PASSENGERS REVENUES

SOUTHERN AFRICA 1 9 9 8 1 9 9 7 VAR I AT I O N 98 / 9 7 % VAR I AT I O N FAR EAST 1.95 % 0.36 % S PAIN 1 8 0 , 3 2 2 1 6 2 , 9 8 6 1 7 , 3 3 6) 1 0 . 6) AMERICAS 25.15 % SPAIN EUROPE 1 6 8 , 5 3 5 1 5 0 , 2 8 6 1 8 , 2 4 9) 1 2 . 1) 37.48 % A M E R IC A S 1 2 1 , 0 1 9 1 1 0 , 6 9 7 1 0 , 3 2 2) 9 . 3) SOUTHERN AFRIC A 1 , 7 4 7 - 1 , 7 4 7) -) FAR EAST 9 , 4 0 3 1 2 , 4 4 1 ( 3 , 0 3 8 ) ( 2 4 . 4 )

IBERIA, L.A.E. + AV I ACO 4 8 1 , 0 2 6 4 3 6 , 4 1 0 4 4 , 6 1 6 1 0 . 2 EUROPE 35 %

1998 IBERIA, L.A.E. + AVIACO The significant improvement in revenues, mainly due to the increases in demand, was 481,026 evident in all markets, except for the Far East, where revenues dropped by Ptas. 3,038 million, reflecting the crisis in Asia and the poor performance of the yen. This, plus the fact that this market is not considered to be strategic for the Group, led to the elimination in October of the route to Japan, thus freeing up resources to cover growth requirements in strategic destinations for the development of IBERIA.

[3] ACTIVITIES OF IBERIA, L.A.E.

3.1. IBERIA MARKETING, NETWORK AND SCHEDULING Work continued in 1998 on restructuring the flight network, concentrating more production on the Company’s two hubs, Madrid and Barcelona. This process affected the short- and medium-haul network (European and domestic flights). The variations in flights to European and domestic destinations other that Madrid and Barcelona were as follows:

EVOLUTION IN FLIGHTS NOT OPERATED VIA MADRID NOR BARCELONA 1996 1997 1998

D O M E S T I C 1 6 . 5 % 1 4 . 2 % 7 . 6 % E U R O P E 1 9 . 4 % 1 7 . 0 % 1 2 . 7 %

p-73 ANNUAL REPORT 1998 IBERIA, LINEAS AEREAS DE ESPAÑA, S.A. MANAGEMENT REPORT

In 1998 alone the reduction in loss-making routes which in addition did not contribute traffic to the rest of the network was 51% on domestic routes and 28% on European routes. This was possible because 1998 was the first complete year of full integration of Aviaco in the single IBERIA network and of operation of the franchise with Air Nostrum. Both operations enabled resources to be channeled to supply at the hubs. The replacement of IBERIA by Air Nostrum on these routes maintained the presence of the IBERIA brand in these markets while not losing flights to these regional destinations.

Noteworthy with respect to the development of the long-haul network was the inauguration of two routes that added two new destinations, Chicago and Johannesburg in the network. The service to Chicago is just one of the opportunities provided by the shared-code agreements with American Airlines that came into force in June and which enabled 23 U.S. destinations to be served with IBERIA codes, and permitted American Airlines’ commercial strength to be harnessed on IBERIA’s routes to Miami, New York and San Juan de Puerto Rico.

Non-stop flights commenced to three destinations formerly served by stopover flights: Lima, Santiago de Chile and San José de Costa Rica, as part of the Company’s strategy of attracting European network traffic to Latin America, thereby significantly improving the product offered.

Shared-code operations between IBERIA and Aerolíneas Argentinas commenced on routes to Argentina and Brazil, and a similar agreement was reached with Finnair for the new non-stop Madrid-Helsinki route.

It was not possible for the major growth in IBERIA’s strategic markets to be matched by an increase in our network because of the pilot resource limitations, leading to a loss of market share.

As regards marketing, implementation was completed in 1998 of various projects envisaged in the Master Plan.

The Valor 98 program was introduced in June 1998, leading to a radical change in IBERIA’s remuneration and monitoring systems relating to Spanish travel agencies. The aim of this program is to build travel agency loyalty by replacing the current fixed commission with a system which, provides an incentive for growth in the gross revenues generated by travel agencies on routes flown on IBERIA, Aviaco and Air Nostrum flights.

p-74 ANNUAL REPORT 1998 IBERIA, LINEAS AEREAS DE ESPAÑA, S.A. MANAGEMENT REPORT

From April 1 for the Balearic and Canary Islands and from September 15 for the rest of Spain, the Group Management unit was set up to centralize in Madrid this service in Spain. Among the organizational changes in the branch office sales area, 1998 also saw the centralization of the management of corporate (large) accounts.

The Serviagencias service came into operation at the end of October, under which services to travel agencies (provided until then by the branch offices) were centralized in Madrid.

The Serviberia project, initiated in July 1997, enabled the number of sales to be doubled in 1998. In 1998, under the customer loyalty-building program, IB Plus, the platinum IB Plus card was launched, joint scheduling commenced in May under the a l l ia nce with Ame r ican Airline s, and in-flig ht sales and Aldeasa’s network were i nc o r p o rated into the system.

Work also continued in 1998 on other programs envisaged in the Master Plan, such as the price management and space management programs. 3.2. FREIGHT In 1998 there was a significant strategic change in IBERIA’s freight operations. The freight program based on passenger aircraft cargo holds and freight planes operated under a wet lease arrangement (aircraft leased with crew and maintenance) was defined and planned to reduce costs and enable freight crews to work in the passenger area.

In March, the contract for the leased DC-8 was cancelled, and in November Cargosur DC-8s were sold, to be rented under wetlease, as B-747 from April.

Cargo program has been changed along the year, as follows: - Non-stop flights to Chile, with limited hold disposability. - For East Market enjoyed, firstly, a modified configuration from B-747 combi to B-747 passenger configuration. Finally, in December the closing of the route was decided, with a reduction of the hold availability of 43% respect to 1998, and a decreasing in cargo revenue of Ptas. 1,100 million. - South Africa started operation from May, with an impact in revenaues of Ptas. 491 million. - The cargo hold revenues in IBERIA accounted Ptas. 9,827 million, a decreasing of 10% respect to prior year, mainly due to the new distributor of fligh ts in long haul net w o r k .

p-75 ANNUAL REPORT 1998 IBERIA, LINEAS AEREAS DE ESPAÑA, S.A. MANAGEMENT REPORT

This unit’s main parameters in 1998 and 1997 were as follows:

F R E I G H T 1 9 9 8 1 9 9 7 VAR I AT I O N 98 / 9 7 % VAR I AT I O N

MI L L IO N AT KS 1 , 2 1 1 1 , 1 2 6 8 5) 7 . 6) INHO L D S 7 7 9 8 4 7 ( 6 8 ) ( 8 . 1 ) IN F R E IG H T A I R C R A F T 4 3 2 2 7 9 1 5 3) 5 4 . 8) MI L L IO N S R T KS 8 1 3 829 ( 1 6 ) ( 2 . 0 ) INHO L D S 5 8 5 6 4 5 ( 6 0 ) ( 9 . 2 ) IN F R E IG H T A I R C R A F T 2 2 8 1 8 5 4 3) 2 3 . 5) LOA D FAC TO R ( % ) 6 7 . 2 7 3 . 7 ( 6 . 5 ) ( 8 . 9 ) INHO L D S 7 5 . 1 7 6 . 1 ( 1 . 0 ) ( 1 . 3 ) IN F R E IG H T A I R C R A F T 5 2 . 8 6 6 . 4 ( 1 3 . 6 ) ( 2 0 . 5 ) AV E R AG E Y I E L D ( PTA S. / R T KS) 4 3 . 5 4 3 . 3 0 , 2) 0 . 4) TOTAL FREIGHT REVENUES (M IL L IO N S OF PTAS .) 3 5 , 3 4 0 3 5 , 8 8 8 ( 5 4 8 ) ( 1 . 5 )

3.3. HANDLING The process of deregulating handling services at Spanish airports which commenced in 1994 continued in 1998 as initially scheduled. Accordingly, the activity of third parties (excluding Air Nostrum) decreased by 3.7% with respect to 1997.

However, the volume of business of these companies was 3.9% than forecast, with a slight drop in the case of Spanish companies and a 5.1% increase in that of foreign companies. Air Nostrum’s operations in 1998 were 31% higher than forecast.

In 1998 the Aviaco personnel at Madrid and Bilbao airports, together with those discharging operating duties at Barcelona, Palma de Mallorca and Las Palmas airports, were included in IBERIA’s Handling Department. The employees at airports at which Aviaco carried out handling activities exclusively for the Group and third parties were also incorporated, except for those at Mahón, who will be included in November 1999.

p-76 ANNUAL REPORT 1998 IBERIA, LINEAS AEREAS DE ESPAÑA, S.A. MANAGEMENT REPORT

The variations in the main parameters in 1998 and 1997 were as follows:

H A N D L I N G

1 9 9 8 1 9 9 7 VAR I AT I O N 98 / 9 7 % VAR I AT I O N

WEIGHTED PLANES HANDLED 401,972 398,336 3,636) 0.9) IBERIA AND IBERIA GROUP 231,596 231,099 497) 0.2) FRANCHISEES 19,609 10,697 8,912) 83.3) THIRD PARTIES 150,767 156,540 (5,773) (3.7) EQUIVALENT FULL-TIME EMPLOYEES 7,382 7,181 * 201) 2.8) THIRD-PARTIE REVENUES (MILLIONS OF PTAS) 39,809 47,520 (7,711) (16.2) OPERATING REVENUES (MILLIONS OF PTAS) 73,549 72,939 * 610) 0.8) OPERATING EXPENSES (MILLIONS OF PTAS) 61,696 57,790 * 3,906) 6.8) OPERATING INCOME (MILLIONS OF PTAS) 11,853 15,149 * (3,296) (21.8) OPERATING REVENUES/WAA (M IL L . OF PTAS ) 182,970 183,109 * (139) (0.1) * Uniform data, eliminating foreign stopovers which in 1997 formed part OPERATING EXPENSES/WAA (M IL L . OF PTAS ) 153,483 145,079 * 8,404) 5.8) of the Iberia Handling organization and which in 1998 were transferred HOURS/WAA 31.64 31.04 0.6) 1.9) to Iberia Marketing, Network and Scheduling.

3.4. MAINTENANCE Based on the decisions contained in the Master Plan, marketing efforts focused on the services with the best technological prospects, such as airframe, engine and component maintenance for the A-320, MD-87 and B-757 aircraft. Maintenance work was also performed in 1998 by IBERIA on Air Europe aircraft leased under wet lease arrangements.

The main customers in 1998 were as follows: LUFTHANSA, ALITALIA, AIR LIBERTE, AEROLINEAS ARGENTINAS, OLYMPIC AIRWAYS, AIR EUROPA, AUSTRAL, MINISTRY OF DEFENSE and ADRIA.

In addition to implementation of the aircraft brake workshop automation research and development project, new products and services were developed, including most notably: - Modification of the cabins of long-haul aircraft - Inclusion of RNAV and GPS in IBERIA’s fleet - Overhaul of the hot area of the CFM56-5C4 (A-340) engine - A-340 aircraft parts - “C” overhauls of A-340 aircraft

Billings to non-Group companies increased by 7% with respect to 1997 as a result of the repair of a greater number of engines of third parties, while billings to IBERIA rose slightly, despite the fact that the latter’s production was lower than projected. This decrease in activity was offset by the work performed on modifying the cabins of long-haul aircraft, enabling the unit to reallocate its projected production capacity.

p-77 ANNUAL REPORT 1998 IBERIA, LINEAS AEREAS DE ESPAÑA, S.A. MANAGEMENT REPORT

As regards expenses, materials and outsourcing expenses both increased as a result of the greater use of spare parts for engines of both IBERIA and third parties, of the purchase of equipment for modifying cabins and the incorporation of GPS, and of the outsourced maintenance work on the B-767/B-737 aircraft leased from Air Europe and on standard JT8D engines.

The variations in the main operating aggregates were as follows:

VA R I ATION IN PA R A M E T E R S 1 9 9 8 1 9 9 7 VAR I AT I O N 98 / 9 7 % VAR I AT I O N

NU M B E R O F O V E R H AU L S 223 256 (33) (12.9) THOU SAN D SO F PR O D U C T IO N HOU R SO F IN HO US E PE R S O N N E L 2,982 2,887 95) 3.3) IN D I R E C T/ DI R E C T L A B O R 0.55 0.60 (0.05) (8.0) TH I R D-PA R T Y R E V E N U E S (MILLIONS OF PTAS.) 22,929 19,054 3,875) 20.3) OP E R AT I N G I N C O M E (MILLIONS OF PTAS.) 1,920 1,434 486) 33.9) EQ U I VA L E N T F U L L-T I M E E M P L OY E E S (NUMBER) 3,929 3,824 105) 2.7)

3.5. SYSTEMS MANAGEMENT In 1998 the capacity of the Company’s mainframe computers was increased to cater for the need to make its software Year 2000 compliant. The capacity of the processors supporting management systems was increased by 58% to 165 MIPS (millions of instruc- tions per second).

The policy to develop products using open systems also started to be implemented with the acquisition of new hardware to process new software in the Commercial, Control and Administration areas and for Aircraft Maintenance.

As reg a r ds activity in the operat io n s area, the RENOVE plan came to an end rep l a c i n g the Company’s management PCs.

Noteworthy with respect to the telecommunications network were the agreements entered into with Telefónica and SITA for the conversion of the whole network to TCP/IP to cater for the growing demands of modern technologies. Other salient events were the full installation of an Extended Area Network at all offices in Madrid, and the extension and general integration of the corporate e-mail and fax service in the worldwide web.

The variations in the main operating aggregates were as follows:

S Y S T E M S 1 9 9 8 1 9 9 7 VAR I AT I O N 98 / 9 7 % VAR I AT I O N

OP E R AT I N G R E V E N U E S (MILLIONS OF PTAS.) 1 0 , 0 4 5 1 1 , 2 0 2 ( 1 , 1 5 7 ) ( 1 0 . 3 ) OP E R AT I N G E X P E N S E S (MILLIONS OF PTAS.) 9 , 8 6 3 1 0 , 5 4 1 ( 6 7 8 ) (6.4) OP E R AT I N G I N C O M E (MILLIONS OF PTAS.) 1 8 3 6 6 2 ( 4 7 9 ) ( 7 2 . 4 ) EQ U I VA L E N T F U L L-T I M E E M P L OY E E S (NUMBER) 5 6 7 5 2 7 4 0) 7 . 6)

p-78 ANNUAL REPORT 1998 IBERIA, LINEAS AEREAS DE ESPAÑA, S.A. MANAGEMENT REPORT

3.6. OPERATIONS MANAGEMENT 3.6.1. FLIGHT OPERATIONS DEPARTMENT The training work in this area was intense in 1998 due to the hiring of 53 new pilots. 11,205 employees were trained and leadership training courses were given to 71 future commanders during the year.

In 1998 66,943 and 3,993 hours of training were given to technical crews and cabin crews, respectively.

In the crew planning area among other measures taken to improve productivity, in 1998 the schedules of the crew members on all IBERIA aircraft were prepared, assessing the optimization of commercial programs with provision, where appropriate, for temporary transfers, assessing the various productivity enhancement measures for their possible inclusion in the collective labor agreement for technical crew and planning training courses for technical crew members, to a degree that will contribute to cushioning staff shortages over several years.

The CARMEN computer system was acquired in 1998 for the generation of schedules and the assignation of crew members with a view to optimizing existing resources.

The JAR-OPS 1 published in 1995 established a period of three years through April 1, 1998, for their implementation. One of the points provided for under these regulations was the development and implementation of a quality system based on international ISO 9001 standards, under which the operator must establish a quality system and appoint a Quality Manager to take responsibility for verifying the compliance and suitability of the processes required to guarantee the safe operation of aircraft and their airworthiness.

The international company was engaged to assess and certify the quality system under the ISO 9001 standard. The external audits performed on December 1 and 3, 1998, were successfully passed, and certification under the ISO 9001 international standard was obtained. IBERIA is one of the first airlines to have obtained ISO 9001 certification in the flight operations area.

In network control area significant improvements were made to the ACARS system, and the Mercurio project commenced. Year 2000 compliance trials were also performed on IBERIA’s OPS automated systems.

Work was also performed to adapt the new computer systems to the new Eurocontrol procedure for calculating distances for billing rates to third parties (navigation aids), based on the route actually flown as opposed to the old system based on the busiest routes.

In the technical area and flight support the exVIASA and ETOPS DC-10 manuals were prepared, together with a technical and operating proposal for the submission of the ETOPS operating application for IBERIA to the Directorate-General of Civil Aviation.

Also, the take-off weight restriction tables were recalculated for all the Company’s aircraft-types, taking into account, as required by JAR OPS 1, the loss of take-off distance due to runway positioning.

p-79 ANNUAL REPORT 1998 IBERIA, LINEAS AEREAS DE ESPAÑA, S.A. MANAGEMENT REPORT

3.6.2. IN-FLIGHT SERVICES DEPARTMENT The actions taken include most notably: - Participation in the design of new cabin layouts on long-haul aircraft - Design of the new supervisor report automation system - Participation in the definition of the needs of the computer system for monthly crew member scheduling and assignment - Supply of articles and equipme nt to the Air Europe airc raft inc l uded in IBERIA’s fleet - Inclusion of in-flight sales on intercontinental flights under the IB Plus program - Design of the computer system for portable in-flight sale terminals - Definition of the service procedures and rules for the Air Europa aircraft operating for IBERIA

3,646 alumns has been trained, with a total of 74,895 hours given on the 325 courses organized in 1998.

[4] RESOURCES

4.1. FLEET Th e detail of the aircr aft operated by the Group as of December 31, 1998, is as fol l o w s :

F L E E T AI R C R A F T BI N T E R BI N T E R TOTA L TY P E IB E R I A AV I AC O VI VA CA N A R.ME D I T.OW N E D W E T B - 7 2 7 25 - - - - 2 5 - B-737 - - 9 - - 93 B-747 7 - - - - 7 2 B-757 8 - - - - 86 B - 7 6 7 ------2

A- 3 0 0 6 - - - - 6 - A-320 22 - - - - 2 2 - A-340 8 - - - - 8-

DC-9 6 19 - - - 2 5 - DC-10 4 - - - - 4- OT H E R ------1 D C - 8 ------2

- ExViasa recovered fleet is not included MD-87 24 - - - - 2 4 - - There are also two inactive MD-88 - 13 - - - 13 - A-300 aircraft. - There is one inactive Binter Canarias CN-234 aircraft. CN-235 - - - - 3 3- - In addition to those shown above, there are two CN-235 leased to Austral. ATR-72 - - - 9 - 9- - One Iberia DC-10 has been TOTAL 110 32 9 9 3 163 16 inactive since November.

p-80 ANNUAL REPORT 1998 IBERIA, LINEAS AEREAS DE ESPAÑA, S.A. MANAGEMENT REPORT

These numbers are the result of the following changes in 1998:

ADDITIONS - Two A-340 aircraft under operating leases were brought into service in the IBERIA network. - One additional B-747 aircraft leased by the Freight Division is being operated (leased initially from Kalitta and subsequently from Atlas).

RETIREMENTS - Three B-727s were retired. - The lease of one DC-8/71 was terminated, and the other two DC-8 aircraft operated by Cargosur are now leased from Gestair under wet lease agreements. - Four more B-757 aircraft are operated under a wet lease agreement with Air Europe. - The L1011 under a wet lease in 1997 is no longer operated. 4.2. PERSONNEL In performing a comparative analysis of the headcount, it should be taken into account that, pursuant to the management system defined in the Master Plan, from the beginning of 1998 the figures reflect the decentralization of functions in the personnel, administration, economic control and procurement areas from the Central Services to the Maintenance, Handling, Systems and Freight Divisions and, in addition, that in 1998 Aviaco employees were transferred to IBERIA’s Commercial, Revenue Management, Systems and Handling Departments (except at Mahón airport).

T he detail of the avera ge and year-end he a dc o u nt in 1998 and 1997 is as fo l l o w s :

AV E R AGE ANNUAL HEADCOUNT AV E R AGE ANNUAL HEADCOUNT MARKETING, NETWORK G R O U N D F L I G H T T OT A L CENTRAL SERVICES 5.56 % AND SCHEDULING 12.33 % 1 9 9 71 9 9 811 9 9 71 9 9 8 1 9 9 7 1 9 9 8 1 9 9 7 OPERATIONS 20.40 % FREIGHT 4.89 % MARKETING, NETWORK AND SCHED. 2,722 2,203 2,722 2,203 FREIGHT 1,081 1,022 1,081 1,022 HANDLING 7,382 7,530 7,382 7,530

MAINTENANCE 3,921 3,790 3,921 3,790 SYSTEMS HANDLING 2.55 % 33.45 % SYSTEMS 564 527 564 527 MAINTENANCE 17.77 % OPERATIONS 641 637 4,525 4,424 5,165 5,061 1998 IBERIA, L.A.E.: 22,065 IBERIA, L.A.E. + AVIACO: 23,784 CENTRAL SERVICES 1,229 1,391 1,229 1,391 IBERIA, L.A.E. 17,540 17,100 4,525 4,424 22,065 21,525 IBERIA, L.A.E. + AV I AC O 18,376 18,136 5,408 5,276 23,784 23,413

p-81 ANNUAL REPORT 1998 IBERIA, LINEAS AEREAS DE ESPAÑA, S.A. MANAGEMENT REPORT

YEAR-END HEADCOUNT

G R O U N D F L I G H T T OT A L 1 9 9 71 9 9 811 9 9 71 9 9 8 1 9 9 7 1 9 9 8 1 9 9 7

MARKETING, NETWORK AND SCHED. 2,854 2,315 2,854 2,315 FREIGHT 1,121 1,072 1,121 1,072 HANDLING 8,654 8,345 8,654 8,345 MAINTENANCE 3,998 3,777 3,998 3,777 SYSTEMS 573 512 573 512 OPERATIONS 674 621 4,827 4,449 5,501 5,070 CENTRAL SERVICES 1,265 1,381 1,265 1,381 IBERIA, L.A.E. 19,139 18,023 4,827 4,449 23,966 22,472 IBERIA, L.A.E. + AV I AC O 19,704 18,988 5,703 5,329 25,407 24,317

To make the 1998 and 1997 figures comparable, “Iberia+Aviaco” consolidated level information is provided, as a result of the transfer of handling, systems, commercial and administration employees from the subsidiary to the Controlling Company in 1998 when Aviaco became merely an operator.

[5] OPERATING INCOME AT IBERIA

5.1. OPERATING INCOME BY MANAGEMENT AREA Total operating income for 1998 amounted to Ptas. 47,979 million, the detail by management area being as follows (in millions of pesetas):

O P E R ATING INCOME BY MANAGEMENT AREA M I L I L O N S O F P E S E TA S 1 9 9 8 1 9 9 7 MARKETING, NETWORK, SCHEDULING AND OPERAT IO N S 3 7 , 1 0 3) 1 6 , 9 8 8) F R E IG H T 2 , 6 9 9) 6 , 6 3 5) H A N D L I N G 1 1 , 8 5 3) 1 5 , 1 4 8) M A I N T E N A N C E 1 , 9 2 0) 1 , 4 3 5) SY S T E MS 1 8 2) 6 6 2) CENTRAL SERVIC E S ( 5 , 7 7 8 ) ( 4 , 9 1 8 ) IBERIA, L.A.E. 4 7 , 9 7 9 3 5 , 9 5 0

p-82 ANNUAL REPORT 1998 IBERIA, LINEAS AEREAS DE ESPAÑA, S.A. MANAGEMENT REPORT

The summarized detail of IBERIA, L.A.E.’s operating account for management accounting purposes, which differs from the statement of income in the Company’s financial statements because the revenue and expense items are aggregated using management accounting criteria, is as follows (in millions of pesetas):

O P E R ATING ACCOUNT M I L L I O N S O F P E S E TA S 1 9 9 8 1 9 9 7 % VA R. O P E R ATING REVENUES PA S S E N G E R 4 9 6 , 0 8 9 3 7 3 , 4 5 3 3 2 . 8) FR E IG H T A N D E XC E S S BAG GAG E 3 7 , 1 0 7 3 7 , 4 9 9 ( 1 . 0 ) HA N D L I N G 4 0 , 2 0 0 4 7 , 8 0 6 ( 1 5 . 9 ) MA I N T E N A N C E 2 2 , 6 0 3 1 8 , 9 7 8 1 9 . 1) SA L E S C O M M IS S IO N S 1 0 , 9 6 2 1 3 , 1 4 7 ( 1 6 . 6 ) CAT E R I N G SA L E S 3 , 6 6 6 3 , 4 2 0 7 . 2) OT H E R O P E R AT I N G R E V E N U E S 2 1 , 7 1 4 3 0 , 6 5 2 ( 2 9 . 2 ) 6 3 2 , 3 4 1 5 2 4 , 9 5 4 2 0 . 5 O P E R ATING EXPENSES FU E L 4 9 , 9 0 2 4 9 , 9 4 4 ( 1 8 . 1 ) PE R S O N N E L E X P E N S E S 1 6 6 , 1 6 8 1 5 9 , 5 0 4 4 . 2) TR A F F IC S E R V IC E S 5 1 , 7 2 4 4 1 , 9 5 6 2 3 . 3) IN-F L IG H T S E R V IC E S 1 3 , 8 9 5 1 1 , 8 9 4 1 6 . 8) CO M M IS S IO N S 7 3 , 2 8 7 6 2 , 7 5 7 1 6 . 8) NAV IGAT IO N A I D S 2 5 , 5 3 2 1 9 , 0 2 3 3 4 . 2) AI R C R A F T M A I N T E N A N C E 3 5 , 5 3 8 2 7 , 0 1 9 3 1 . 5) AI R C R A F T L E A S E E X P E N S E S 4 2 , 3 9 2 2 5 , 5 0 3 6 6 . 2) PE R IO D D E P R E C I AT IO N A N D A MO R T I Z AT IO N 1 9 , 1 3 7 3 0 , 1 3 1 ( 3 6 . 5 ) BO O K I N G SY S T E M 1 6 , 2 2 8 1 0 , 3 3 8 5 7 . 0) ROYA LT I E S 2 , 3 9 9 5 , 5 3 1 ( 5 6 . 6 ) AV I AC O T R A N SAC T IO N 3 8 , 1 7 4 2 , 3 7 0 1 6 1 . 1) OT H E R O P E R AT I N G E X P E N S E S 4 9 , 9 8 6 4 3 , 0 3 4 1 6 . 1) 5 8 4 , 3 6 2 4 8 9 , 0 0 4 1 9 . 5 O P E R ATING INCOME 4 7 , 9 7 9 3 5 , 9 5 0 3 3 . 5

p-83 ANNUAL REPORT 1998 IBERIA, LINEAS AEREAS DE ESPAÑA, S.A. MANAGEMENT REPORT

The main comments on the operating account are as follows:

A) IBERIA, L.A.E. OPERATING REVENUES Operating revenues increased by 20.5% with respect to 1997, due mainly to the incorporation of Aviaco’s operations. The main variations were as follows: -Passenger revenues The difference between the passenger revenue figure shown above and that shown in the activity tables is due to the fact that the latter relates directly to the actual production for each year and does not reflect accounting adjustments and revaluations. The Ptas. 122,636 million increase in passenger revenues was due mainly to the inclusion of Aviaco’s production in IBERIA’s figures, signifying that the passenger revenues formally generated by Aviaco are now generated by IBERIA.

The breakdown of the variations is as follows:

PASSENGER REVENUES M I L L I O N S O F P E S E TA S

VA R. I N OP. R E A S O N F O R V A R I AT I O N VA R. I N RE V. * The “Other” column reflects the RE V E N U E S P E R B O O K S variation in the difference between 9 8 / 9 7 PR I C E VO L U M E PA R I T Y OT H E R * 9 8 / 9 7 revenues per books and revenues by network, caused by passenger ticket DOMESTIC 17,336 9,128) 7,920 288 - - revenues not allocable to airlines, charter revenues, IB Plus point revenues and EU 15,211 3,571) 10,260 1,371 - - the recovery of Ptas. 14,470 million of revenues from the “Unused Tickets” NON-EU 3,038 6) 2,854 178 - - account included in 1998 in passenger revenues, as compared with the Ptas. LONG-HAUL 9,031 (585) 8,286 1,330 - - 9,000 million recorded in 1997 under the IBERIA, L.A.E. + AVIACO 44,616 12,120 29,329 3,167 14,742 59,356 “Other Operating Revenues” account.

In order to make the 1998 and 1997 revenues figures comparable, the consolidated aggregates of IBERIA plus Aviaco are included. Accordingly, the difference in volume is due to the sharp increase in demand of 6.7% in terms of RPK. The price variation was the result of several factors affecting the yield, such as the fare mix, with sales of higher-class fares increasing by 4.6% with respect to those of economy-class fares, and commercial yield enhancement policies, (redesigned fares, revenue management computer tools, etc.).

Lastly, the parity effect was due mainly to the fluctuations in the price of the U.S. dollar and the pound sterling of approximately 3.7% and 4.8%, respectively, with respect to their average 1997 price.

p-84 ANNUAL REPORT 1998 IBERIA, LINEAS AEREAS DE ESPAÑA, S.A. MANAGEMENT REPORT

-Freight revenues The Ptas. 392 million drop in freight revenues was due mainly to the 1.9% reduction in IBERIA’s demand, which was not offset by the slight increase (0.9%) in the yield, largely as a result of a decrease of 0.3% in the average haul and to the parity effect (yen).

- Handling revenues Handling revenues continued to fall with a decrease of Ptas. 7,606 million in 1998 as a result of the fall in billings to third parties due to the entry into the market of the second operators with the consequent loss of market share for IBERIA and price cuts. However, it should be noted that the loss of market share recorded in 1998 was significantly lower than expected, and that the decrease in the yield was smaller than initially feared.

- Maintenance Aircraft maintenance revenues increased by Ptas. 3,625 million in 1998, due mainly to the implementation of the measures envisaged in the Master Plan, under which work for third parties should focus on products with the greatest value added.

- Sales commissions The variation in sales commissions was due mainly to the Ptas. 2,185 million reduction in sales to companies by IBERIA Comercialización.

- Other operating revenues The main reason for the Ptas. 8,938 million drop in other operating revenues was that in 1997 this caption included the approximately Ptas. 9,000 million of revenues recovered from the balance of the “Unused Tickets” account.

B) OPERATING EXPENSES The 19.5% (Ptas. 95,357 million) increase in operating expenses was lower than the increase in operating revenues. This figure, which in 1998 included an increase in operating expenses as a result of the absorption of Aviaco’s operations under the joint scheduling policy, is the result of an increase in aircraft lease expenses arising from wet leases, an increase in maintenance costs, which was partially offset by the increase in billings to third parties, the cost of the approach charge and the increase in personnel expenses, due to implementation of the collective labor agreements and the rise in flight and ground (handling and maintenance) employee numbers.

p-85 ANNUAL REPORT 1998 IBERIA, LINEAS AEREAS DE ESPAÑA, S.A. MANAGEMENT REPORT

The variations in the main expense items were as follows: - Fuel Total fuel expenses in 1998 were practically the same as in 1997, since the increase in production was offset by the drop in fuel prices, despite the 3.7% rise in the value of the U.S. dollar, and by the use of new aircraft, which consume less fuel. - Personnel expenses Per s o n n el exp e n ses incr ease by 4.2% with respect to 1997, due mainly to the fol l o w i ng : · Wage rise of variation in CPI for 1997 and 1998 under the collective labor agreement for pilots · Wage rise for 1998 under the collective labor agreement for ground personnel · Increases in the flight personnel (cabin crews 3.0%; technical crews 1.8%) and ground personnel (2.6%) headcounts. · Long-service, promotions, etc. and 1% increase in social security costs There was a decrease in earnings-related bonus expenses due to the lower provision required as a result of lower-than-expected earnings. - Traffic service expenses Following up on the cost saving measures envisaged in the PREGA program, contracts relating to expenses controllable by the Company, such as aircraft cleaning and handling on international stopovers, continue to be renegotiated. This, however, contrasts with the significant increase in expense items subject to official prices, such as landing rights or approach charges or with expenses subject to regulatory prices, such as aircraft handling expenses, which are difficult to negotiate because they depend on handling operators (which at certain airports are protected from competition). The main variations arose in the case of landing rights (an average increase of 4%), crew hotel expenses and costs arising from interrupted journeys, due to the drop in the quality of certain aspects of the operations. - Commercial expenses (commissions, overcommissions and advertising) The increase in net passenger and freight revenues lay behind the rise in commercial expenses; commercial costs as a percentage of operating revenues increased by 6.8%, due mainly to the increased expenses triggered by IBERIA’s sales drive, which increased advertising and publicity expenses by Ptas. 1,071 million with respect to 1997. In 1998, as in prior years, commissions as a percentage of passenger revenues decreased, due to greater use of the TNM (net market price) method and the drop in overcommissions, particularly in Japan. This decrease is being achieved through the introduction of new direct sales and sales information systems such as telephone sales, distribution on the Internet and the introduction of ticketless flights. Under the Master Plan, the Valor 98 plan is being implemented for Spanish travel agencies, enabling commercial costs to be reduced by means of commercial management by the Spanish agencies that focuses much more on providing incentives.

p-86 ANNUAL REPORT 1998 IBERIA, LINEAS AEREAS DE ESPAÑA, S.A. MANAGEMENT REPORT

- Navigation aids The 34.2% (Ptas. 6,510 million) increase in air traffic control expenses was due to the inclusion of Aviaco’s operations, whose expenses are now borne by IBERIA. In comparative terms, there was an increase in the unit cost as a result of the increase in prices charged by Eurocontrol and the introduction in January of the approach charge (totaling a little over Ptas. 2,000 million) at Spanish airports. - Aircraft maintenance In 1998 aircraft maintenance expenses rose by Ptas. 8,519 million with respect to 1997 due, inter alia, to the performance of additional work on aircraft in compliance with air safety regulations and, above all, to the outsourcing of engine maintenance work. Also, the costs of maintaining the Air Europe planes operated led to an increase of almost Ptas. 3,000 million in the balance of this caption with respect to 1997. - Aircraft lease expenses The significant increase of Ptas. 16,889 million in aircraft lease expenses was due mainly to: · A higher amount incurred in operating A-340 aircraft under operating lease agreements as a result of the new additions (Ptas. 4,143 million), although the lease exp e n ses fell by Ptas. 1,433 million, for the A-320, B-727, B-757, MD-87 and B-747 aircra f t . · The higher cost (Ptas. 2,560 million) incurred in wet lease transactions with Air Atlanta, BCM and Challengair, but mainly due to Air Europa’s B-737, B-757 and B-767 contract amounting to Ptas. 10,623 million, as compared with Ptas. 693 million in 1997. · The increase of Ptas. 2,438 million in the price of the freight aircraft and hold lease contracts entered into in 1998. - Period depreciation and amortization There was a significant drop of almost Ptas. 11,000 million in the depreciation charge for 1998 as a result of the reduced impact (Ptas. 5,000 million) of the asset revaluation made in 1996 and the nonrecurring effect (Ptas. 3,500 million) in 1998 of the depreciation of the B-727 aircraft in 1997 in addition to the effect of the assets which were fully depreciated by 1997 year-end or the first few months of 1998. - Other operating expenses The breakdown by major items is as follows: a) Reservation system distribution expenses rose by Ptas. 5,889 million, due largely to the inclusion of the marketing by IBERIA of all Aviaco’s production and the growth in activity (5.4% in terms of passenger numbers). b) Royalties decreased by Ptas. 3,132 million due to the change in the method used to record the increase in operating levies from May 1997 (with the same effect on revenues).

p-87 ANNUAL REPORT 1998 IBERIA, LINEAS AEREAS DE ESPAÑA, S.A. MANAGEMENT REPORT

5.2. IBERIA, L.A.E. STATEMENTS OF INCOME

IBERIA, L.A.E. STATEMENTS OF INCOME M I L L I O N S O F P E S E TA S 1 9 9 8 1 9 9 7 O P E R ATING INCOME 4 7 , 9 7 9 3 5 , 9 5 0 FI N A N C I A L R E V E N U E S 6 , 2 2 2) 9 , 6 5 4) FI N A N C I A L E X P E N S E S ( 4 , 8 2 1 ) ( 9 , 8 1 6 ) PR O V IS IO N TO P E N S IO N A L L O WA N C E ( 2 , 8 4 3 ) ( 3 , 7 5 2 ) EXC H A N G E GA I N S 6 , 2 9 6) 1 1 , 4 4 8) EXC H A N G E L O S S E S ( 8 , 5 2 9 ) ( 1 5 , 4 6 4 ) FINANCIAL LOSS ( 3 , 6 7 5 ) ( 7 , 9 3 0 ) GAIN (LOSS) ON SECURITIES PORTFOLIO 3 8 6 ( 3 , 3 7 2 ) E X T R AORDINARY INCOME (LOSS) 1 8 , 1 1 1 ( 1 2 , 6 7 9 ) NET INCOME BEFORE TA X E S 6 2 , 8 0 1 1 4 , 3 6 1 TA X E S 1 1 , 5 1 0 ( 3 , 3 3 3 ) NET INCOME AFTER TAXES 51,291 1 1 , 0 2 8

p-88 a n n u a l r e p o r t 1 9 9 8

G O V E R N I N G B O D I E S

IBERIA GROUP ANNUAL REPORT 1998 IBERIA L.A.E. AND IBERIA GROUP GOVERNING BODIES

BOARD OF IBERIA, L.A.E.

CHAIRMAN Xabier de Irala Estévez

BOARD MEMBERS Juan José Arroyo Riego Joaquín Clotet Garriga José de Carvajal Salido Marino Díaz Guerra José Manuel Fernández Norniella Juan Gurbindo Gutiérrez Fermín López Covarrubias García María Angeles Monjas Revilla Miquel Nadal Segalá Cecilio Pérez Velasco Francisco Javier Salas Collantes José Manuel Serra Peris

SECRETARY OF THE BOARD Ignacio Pinilla Rodríguez

p-90 ANNUAL REPORT 1998 IBERIA L.A.E. AND IBERIA GROUP GOVERNING BODIES

MANAGEMENT TEAM

CHAIRMAN AND C.E.O. Xabier de Irala Estévez

MEMBERS Angel Mullor Parrondo MANAGING DIRECTOR

Javier Arraiza Martínez-Marina OPERATIONS DIRECTOR

Martín Cuesta Vivar ORGANIZATION AND HUMAN RESOURCES DIRECTOR

Luis Díaz Güell COMMUNICATION DIRECTOR

Enrique Donaire Rodríguez COMERCIAL DIRECTOR

Enrique Dupuy de Lôme Chávarri FINANCIAL DIRECTOR

José Mª Fariza Batanero CONTROL AND ADMINISTRATION DIRECTOR

Luis Fernández Turanzas IN-FLIGHT SERVICES DIRECTOR

Manuel López Colmenarejo NETWORK DEVELOPMENT AND PROGRAMMING DIRECTOR

Juan Losa Montañés GENERAL DIRECTOR AVIACO

Salvador Magalló Martínez BUSINESS DIRECTOR

Ignacio Pinilla Rodríguez GENERAL COUNCIL - SECRETARY OF THE BOARD

Guillermo Serrano Entrambasaguas S.V.P. CORPORATE AFFAIRS

Sergio Turrión Barbado INDUSTRIAL RELATIONS DIRECTOR

Vicente Aguilera Ribota TECHNICAL SECRETARY

p-91

ANNUAL REPORT 1998 IBERIA L.A.E. AND IBERIA GROUP A G E N D A

A G E N D A

[1] Approval of the Annual Accounts (Balance Sheet, Profit and Loss Statement and Annual Report) and Management Report for the Iberia Parent Company and Group in1998.

[2] Agreement on the application of 1998 Company earnings.

[3] Approval of the performance of the Board in 1998.

[4] Proposal to increase capital through the issue of 30,395,137 shares of Class A common stock, with a par value of 130 pesetas each, and an issue premium of 528 pesetas/share, for a total increase, including par and issue premium value of 20,000,000,146 pesetas. Under Article 159 of the revised text of the Corporations Act, subscription of this capital increase is reserved for the Sociedad Estatal de Participaciones Industriales (SEPI), and preferential subscription rights will not be extended to other shareholders. This capital increase will be subject to compliance with European Union regulations. Li ke w i s e , and in accordan ce with Article 152.1 b of the revised text of the Corporat io n s Act , Co m p a n y Officers will be delegated to des ig n ate the date on which this capital incre a s e will be carried out and all others details of the operation not specified by decision of the General Shareholders Meeting, and also to effect the pertinent modifications of Company Bylaws referring to equity once the increase in approved and completed.

[5] Ratification and re-election of Board Members.

[6] Re-election of Accounts Auditors for the Parent Company and Group.

[7] Delegation of powers.

p-93 a n n u a l r e p o r t 1 9 9 8

L E G A L I N F O R M AT I O N

IBERIA GROUP

a n n u a l r e p o r t 1 9 9 8

CO N S O L I DAT E D F I N A N C I A L S TA T E M E N T S C O N S O L I DATED BALANCE SHEETS AS OF DECEMBER 31, 1998 AND 1997 C O N S O L I D AT ED S TAT E M E N TS OF INCOME FOR 1998 AND 1997

TR A N S L AT IO N O F A R E P O R T A N D C O N S O L I DAT E D F I N A N C I A L S TAT E M E N TS O R IG I N A L LYIS S U E D I N SPA N IS H A N D P R E PA R E D I N AC C O R DA N C E W I T H G E N E R A L LYAC C E P T E D AC C O U N T I N G P R I N C I P L E S I N SPA I N (S E E NOT E 2 2 ) . I N T H E E V E N T O F A D IS C R E PA N C Y , T H E S P A N IS H - L A N G U A G E V E R S IO N P R E VA I L S .

IBERIA GROUP ANNUAL REPORT 1998 IBERIA GROUP CONSOLIDATED BALANCE SHEETS AS OF DECEMBER 31, 1998 AND 1997

TRANSLATIONOF A REPORTANDCONSOLID ATED ASSETS M I L L I O N S O F P E S E TA S FINANCIALSTATEMENTS ORIGINALLY ISSUED

IN SPANISHANDPREPAREDIN ACCORDANCEWITH

GENERALLY ACCEPTED ACCOUNTINGPRINCIPLES IN SPAIN (SEE NOTE 22). 1998 1997 IN THEEVENTOF A DISCREPANCY, THE SPANISH-LANGUAGEVERSIONPREVAILS . FIXED AND OTHER NONCURRENT ASSETS: STA R T-U P E X P E N S E S ( NOT E 6 -D) 4 8 3) 6 9 5) IN TA N G I B L E A S S E T S ( NOT E 7 ) 3 1 , 8 2 0) 3 3 , 7 7 2) PR O P E R T Y, P L A N T A N D E Q U I P M E N T ( NOT E 8 ) 2 5 3 , 8 8 2) 2 3 7 , 4 3 6) AI R C R A F T: CO S T 4 2 7 , 2 9 9) 4 0 2 , 0 9 7) AC C U M U L AT E D D E P R E C I AT IO N A N D P R O V IS IO N S ( 2 3 6 , 1 3 6 ) ( 2 2 7 , 2 4 1 ) 1 9 1 , 1 6 3 1 7 4 , 8 5 6 OT H E R TA N G I B L E F I X E D A S S E TS: CO S T 1 7 5 , 3 3 0) 1 6 8 , 4 9 8) AC C U M U L AT E D D E P R E C I AT IO N A N D P R O V IS IO N S ( 1 1 2 , 6 1 1 ) ( 1 0 5 , 9 1 8 ) 6 2 , 7 1 9 6 2 , 5 8 0 LO N G-T E R M F I N A N C I A L I N V E S T M E N T S 8 9 , 4 6 9) 7 3 , 6 5 9) HO L D I N G S I N C O M PA N I E S C A R R I E D BY T H E E Q U I T Y M E T HO D ( NOT E 9 ) 2 , 7 2 4) 2 , 2 3 0) LOA N S TO C O M PA N I E S C A R R I E D BY T H E E Q U I T Y M E T HO D ( NOT E 9 ) 2 7 , 5 5 3) 2 2 , 9 2 9) LO N G-T E R M I N V E S T M E N T S E C U R I T I E S ( NOT E S 3 a nd 9 ) 4 , 4 6 4) 2 5 , 4 0 2) OT H E R L O N G-T E R M R E C E I VA B L E S ( NOT E S 3 a nd 1 7 ) 6 0 , 8 9 6) 5 0 , 5 2 5) PR O V IS IO N S ( 6 , 1 6 8 ) ( 2 7 , 4 2 7 ) SH A R E S O F T H E CO N T R O L L I N G CO M PA N Y 3) 7) TOTA L F I X E D A N D OT H E R N O N C U R R E N T A S S E T S 3 7 5 , 6 5 7 3 4 5 , 5 6 9

GOODWILL IN CONSOLIDATION ( NOT E 1 0 ) 2 1 , 8 2 4 -

DEFERRED C H A R G E S (NOTE 7) 6,965 9,549

CURRENT ASSETS: IN V E N TO R I E S 1 0 , 8 7 4) 9 , 7 9 8) AC C O U N T S R E C E I VA B L E 7 1 , 9 8 6) 7 8 , 8 3 5) SH O R T-T E R M F I N A N C I A L I N V E S T M E N T S ( NOT E 1 1 ) 9 9 , 7 2 9) 9 9 , 3 4 4) CA S H 3 , 5 9 1) 3 , 2 3 2) AC C R UA L AC C O U N T S 5 , 5 1 2) 5 , 2 8 9) TOTA L C U R R E N T A S S E T S 1 9 1 , 6 9 2 1 9 6 , 4 9 8

TOTAL ASSETS 5 9 6 , 1 3 8 5 5 1 , 6 1 6

p-100 ANNUAL REPORT 1998 IBERIA GROUP CONSOLIDATED BALANCE SHEETS AS OF DECEMBER 31, 1998 AND 1997

SHAREHOLDERS’ EQUITY AND LIABILITIES M I L L I O N S O F P E S E TA S TRANSLATIONOF A REPORTANDCONSOLID ATED FINANCIALSTATEMENTS ORIGINALLY ISSUED

IN SPANISHANDPREPAREDIN ACCORDANCEWITH

GENERALLY ACCEPTED ACCOUNTINGPRINCIPLES 1998 1997 IN SPAIN (SEE NOTE 22). IN THEEVENTOF A DISCREPANCY, THE SPANISH-LANGUAGEVERSIONPREVAILS . SHAREHOLDERS’ EQUITY ( NOT E 1 2 ): CA P I TA L S TO C K 1 1 4 , 7 2 7) 1 1 4 , 7 2 7) RE S E R V E S O F T H E CO N T R O L L I N G CO M PA N Y ( 1 5 , 8 0 9 ) ( 2 6 , 8 3 7 ) RE VA L UAT IO N R E S E R V E -) 1 5 , 4 4 7) PR IO R Y E A R S’ L O S S E S ( 1 5 , 8 0 9 ) ( 4 2 , 2 8 4 ) RES E R V E S AT CO M PA N I E S CO N S O L I D ATE D BY TH E GL O BA L IN T E G R AT I O N ME T H O D 5 , 0 4 7) 3 , 7 1 8) RE S E R V E S AT C O M PA N I E S C A R R I E D BY T H E E Q U I T Y M E T H O D 1 , 0 4 3) ( 1 , 5 0 4 ) TR A N S L AT I O N D I F F E R E N C E S 1 1 4) ( 2 3 2 ) INC O M E ATT R I B U TA B L E TO TH E CON T R O L L I N G COM PA N Y (N OTE 19 ) 53,025) 14,904) CO N S O L I DAT E D I N C O M E F O R T H E Y E A R 53,171) 17,110) INCOME ATTRIBUTED TO MINORITY INTERESTS (NOTES 13 AND 19) ( 1 4 6 ) ( 2 , 2 0 6 ) TOTA L S H A R E H O L D E R S’ E Q U I T Y 1 5 8 , 1 4 7 1 0 4 , 7 7 6

MINORITY INTERESTS ( NOT E 1 3 ) 6 9 8 1 7 , 2 5 1

DEFERRED REVENUES (N OTE 8) 1,979 3,440

PR O VISIONS FOR CONTINGENCIES AND EXPENSES (N OTE 14 ) 1 6 0 , 3 3 0 1 5 5 , 1 3 3 LONG-TERM DEBT: PAYA B L E TO C R E D I T E N T I T I E S ( NOT E 1 5 ) 6 7 , 3 3 3) 8 8 , 6 5 9) OT H E R AC C O U N T S PAYA B L E 4 , 9 0 4) 2 , 8 2 0) TOTA L L O N G-T E R M D E BT 7 2 , 2 3 7 9 1 , 4 7 9

CURRENT LIABILITIES: PAYA B L E TO C R E D I T E N T I T I E S ( NOT E 1 5 ) 4 0 , 5 5 0) 1 9 , 7 8 4) PAYA B L E TO C O M PA N I E S C A R R I E D BY T H E E Q U I T Y M E T H O D -) 9 5 1) CU S TO M E R A DVA N C E S 2 7 , 6 8 3) 4 0 , 7 4 1) PAYA B L E S F O R P U R C H A S E S A N D S E R V I C E S 8 3 , 1 9 2) 7 1 , 6 9 2) OT H E R N O N T R A D E PAYA B L E S ( NOT E 1 7 ) 3 2 , 6 3 5) 2 5 , 1 7 7) CO M P E N SAT I O N PAYA B L E 1 8 , 4 9 9) 2 0 , 9 7 2) AC C R UA L AC C O U N T S 1 8 8 2 2 0) TOTA L C U R R E N T L I A B I L I T I E S 2 0 2 , 7 4 7 1 7 9 , 5 3 7

TOTAL SHAREHOLDERS’ EQUITY AND LIABILITIES 5 9 6 , 1 3 8 5 5 1 , 6 1 6 The accompanying Notes 1 to 22 are an integral part of the consolidated balance sheet as of December 31, 1998.

p-101 ANNUAL REPORT 1998 IBERIA GROUP NOTES TO 1998 - CONSOLIDATED FINANCIAL STATEMENTS

TRANSLATIONOF A REPORTANDCONSOLID ATED DEBIT M I L L I O N S O F P E S E TA S FINANCIALSTATEMENTS ORIGINALLY ISSUED

IN SPANISHANDPREPAREDIN ACCORDANCEWITH

GENERALLY ACCEPTED ACCOUNTINGPRINCIPLES

IN SPAIN (SEE NOTE 22). 1998 1997 IN THEEVENTOF A DISCREPANCY, THE SPANISH-LANGUAGEVERSIONPREVAILS . E X P E N S E S : PU R C H A S E S ( NOT E 1 8 ) 8 8 , 2 1 6 8 4 , 7 6 7 PE R S O N N E L E X P E N S E S ( NOT E 1 8 ) 1 9 7 , 0 4 3 1 9 0 , 4 5 2 PE R IO D D E P R E C I AT IO N A N D A MO R T I Z AT IO N 2 6 , 3 2 7 3 7 , 5 7 8 VA R I AT IO N I N O P E R AT I N G P R O V IS IO N S 2 , 2 6 6 2 , 0 8 0 OT H E R O P E R AT I N G E X P E N S E S ( NOT E 1 8 ) 2 9 9 , 0 2 1 2 5 4 , 6 5 3 6 1 2 , 8 7 3 5 6 9 , 5 3 0 OP E R AT I N G I N C O M E 5 2 , 4 6 1 4 0 , 0 4 8 FI N A N C I A L A N D S I M I L A R E X P E N S E S 1 0 , 0 5 3 1 3 , 5 6 9 VA R I AT IO N I N F I N A N C I A L I N V E S T M E N T P R O V IS IO N S 2 - EXC H A N G E L O S S E S 8 , 8 5 1 1 5 , 4 6 4 1 8 , 9 0 6 2 9 , 0 3 3

SHARE IN LOSSES OF COMPANIES CARRIED BY THE EQUITY METHOD 1 7 6 3 5 5 AMO R T I Z AT IO N O F G O O D W I L L I N C O N S O L I DAT IO N 1 8 4 - IN C O M E F R O M O R D I N A R Y AC T I V I T I E S 4 9 , 6 9 6 3 7 , 2 3 6 LO S S E S O N F I X E D A S S E TS 9 7 7 7 4 2 VA R I AT IO N I N F I X E D A S S E T P R O V IS IO N S 7 1 3 2 6 EX T R AO R D I N A R Y E X P E N S E S ( NOT E 1 8 ) 1 3 , 1 6 0 4 9 , 4 2 9 PR IO R Y E A R S’ E X P E N S E S A N D L O S S E S 4 9 7 6 1 0 1 5 , 3 4 7 5 0 , 8 0 7 EX T R AO R D I N A R Y I N C O M E 1 6 , 2 7 1 -

CO N S O L I DAT E D I N C O M E B E F O R E TA X E S 6 5 , 9 6 7 2 0 , 7 8 2 CO R P O R AT E I N C O M E TA X ( NOT E 1 7 ) 1 2 , 7 9 6 3 , 6 7 2 CO N S O L I DAT E D I N C O M E F O R T H E Y E A R 5 3 , 1 7 1 1 7 , 1 1 0 IN C O M E AT T R I B U T E D TO M I NO R I T Y I N T E R E S TS ( NOT E 1 3 ) 1 4 6 2 , 2 0 6 INCOME FOR THE YEAR ATTRIBUTED TO THE CONTROLLING COMPANY 5 3 , 0 2 5 1 4 , 9 0 4

p-102 ANNUAL REPORT 1998 IBERIA GROUP CONSOLIDATED STATEMENTS OF INCOME FOR 1998 AND 1997

CREDIT M I L L I O N S O F P E S E TA S TRANSLATIONOF A REPORTANDCONSOLID ATED FINANCIALSTATEMENTS ORIGINALLY ISSUED

IN SPANISHANDPREPAREDIN ACCORDANCEWITH

GENERALLY ACCEPTED ACCOUNTINGPRINCIPLES

1998 1997 IN SPAIN (SEE NOTE 22). IN THEEVENTOF A DISCREPANCY, THE SPANISH-LANGUAGEVERSIONPREVAILS . R E V E N U E S : NE T SA L E S ( NOT E 1 8 ) 6 4 4 , 9 6 0 5 9 1 , 9 3 7 OT H E R O P E R AT I N G R E V E N U E S ( NOT E 1 8 ) 2 0 , 3 7 4 1 7 , 6 4 1

6 6 5 , 3 3 4 6 0 9 , 5 7 8

RE V E N U E S F R O M S H A R E HO L D I N G S 2 7 4 OT H E R I N T E R E S T A N D S I M I L A R R E V E N U E S 7 , 3 1 5 9 , 6 5 0 EXC H A N G E GA I N S 6 , 5 7 2 1 1 , 4 4 8 1 3 , 9 1 4 2 1 , 1 0 2 FI N A N C I A L L O S S 4 , 9 9 2 7 , 9 3 1 SHARE IN INCOME OF COMPANIES CARRIED BY THE EQUITY METHOD 2 , 5 8 7 5 , 4 7 4

LO S S O N O R D I N A R Y AC T I V I T I E S -- GA I N S O N F I X E D A S S E T D IS P O SA L S ( NOT E S 2 a nd 9 ) 6 , 5 4 8 4 , 4 5 5 EX T R AO R D I N A R Y R E V E N U E S ( NOT E 1 8 ) 1 1 , 0 4 6 1 0 , 2 4 5 PR IO R Y E A R S’ R E V E N U E S A N D I N C O M E ( NOT E 6 -I) 1 4 , 0 2 4 1 9 , 6 5 3

3 1 , 6 1 8 3 4 , 3 5 3 EX T R AO R D I N A R Y L O S S - 1 6 , 4 5 4

The accompanying Notes 1 to 22 are integral part of the 1998 consolidated statement of income.

p-103

a n n u a l r e p o r t 1 9 9 8

N O T E S TO 1 9 9 8 CO N S O L I DAT E D FI N A N C I A L S TA T E M E N T S

IBERIA GROUP

ANNUAL REPORT 1998 IBERIA GROUP NOTES TO 1998 - CONSOLIDATED FINANCIAL STATEMENTS

[1] DESCRIPTION OF THE CONTROLLING COMPANY AND THE GROUP

IBERIA, Líneas Aéreas de España, S.A. (“IBERIA”) engages in the air transport of TRANSLATIONOF A REPORTANDCONSOLID ATED passengers and cargo and also carries on other activities related to its core business. FINANCIALSTATEMENTS ORIGINALLY ISSUED IN SPANISHANDPREPAREDIN ACCORDANCEWITH

GENERALLY ACCEPTED ACCOUNTINGPRINCIPLES As a carrier of passengers and cargo, the Company operates through a large network IN SPAIN (SEE NOTE 22). IN THEEVENTOF A DISCREPANCY, serving three major markets: Spain, Europe and the Americas. As regards international THE SPANISH-LANGUAGEVERSIONPREVAILS . traffic, in countries with which bilateral agreements have been entered into designating a single company as the Operator, IBERIA is the operator designated by the Spanish party.

As part of the activities related to the core business, mention should be made of IBERIA’s activities as a handling agent, its maintenance activity and its special positioning in distribution systems.

As regards the handling activity, it should be noted that in 1992, after a public call for tenders, Ente Público de Aeropuertos Españoles y Navegación Aérea (AENA) -the Spanish public airports and aviation agency- awarded IBERIA a contract for the provision of handling services as the first operator in Spain from April 1, 1993, to April 1, 2000.

IBERIA performs a significant portion of its own maintenance work and provides technical assistance to various companies, mainly through its maintenance center in Barajas.

As regards the distribution system, IBERIA is a partner of the Amadeus Group, which owns the Amadeus central bookings system, on an equal footing with Lufthansa and Air France. This investment enables IBERIA to be present in an industry with huge economic and growth potential, characterized by its significant technological content.

The Group is currently in the process of implementing the Master Plan designed by IBERIA’s current management team, the purpose of which it is to consolidate IBERIA and its Subsidiaries as a global air transport operating group. In 1998 numerous measures were taken aimed at achieving this objective, adding to those already carried out in 1997, including most notably:

1. Optimization of the separate management systems organizational structure for each business (airports, materials, systems and cargo) initiated in 1997. In 1998 the business activities of Aviación y Comercio, S.A., other than its activities as an operator, were integrated into IBERIA, Líneas Aéreas de España, S.A., except for its maintenance activity, which will be integrated in 1999. A wide-reaching reorganization of the cargo business was also performed in 1998.

2. Strengthening of the “group” concept by consolidating the operating management system, performed through various operators, which is completely separate from the global commercial management activities carried out by a single Commercial Department. In this connection, the joint scheduling of IBERIA, Líneas Aéreas de España, S.A. and Aviación y Comercio, S.A. initiated in 1998 was maintained, and the Aviación y Comercio, S.A. shares held by Sociedad Estatal de Participaciones Industriales (SEPI) were acquired.

p-107 ANNUAL REPORT 1998 IBERIA GROUP NOTES TO 1998 - CONSOLIDATED FINANCIAL STATEMENTS

The franchise agreement entered into with Air Nostrum in 1997 remained in force, and in March 1998 an agreement was entered into with Air Europa to operate eleven aircraft on IBERIA routes under a wet lease arrangement.

3. Alliance agreements were entered into with American Airlines, Inc. and British Airways. These two companies formalized an agreement in 1998 for the acquisition of a 10% holding in IBERIA and commercial agreements were also entered into by these companies with IBERIA. In February 1999 IBERIA became a fully fledged member of the Oneworld “megacarrier”, one of the two largest air transport groups in the world, which is led by the two aforementioned companies. This will facilitate globalization of the air transport business.

4. Following the agreement with British Airways and American Airlines, Sociedad Estatal de Participaciones Industriales (SEPI), IBERIA’s main shareholder, is studying the offers received from Spanish institutional investors with a view to divesting approximately 30% of IBERIA’s capital stock to subsequently launch a public offering on the stock exchange of the rest of its holding.

[2] DEPENDENT COMPANIES The data on the dependent companies is as follows:

DEPENDENT COMPANIES P E R C E N T A G E O F O W N E R S H I P B Y I B E R I A , L Í N E A S A É R E A S D E E S PA Ñ A , S . A . C O M PA N Y R E G I S T E R E D O F F I C E L I N E O F BU S I N E S S %

AV I AC I Ó N Y CO M E R C IO, S.A. MAU D E S, 51 AI R T R A N S P O R T O F ( AV I ACO) MA D R I D PA S S E N G E R S A N D C A R G O 9 9 . 9 3

VU E L O S IN T E R N AC IO N A L E S D E ZU R BA NO, 41 - MA D R I D AI R T R A N S P O R T O F VAC AC IO N E S, S.A. (VIVA) PA S S E N G E R S A N D C A R G O 9 9 . 4 7

CA M P O S VE L Á Z Q U E Z, S.A. VE L Á Z Q U E Z, 134 - MA D R I D AC Q U IS I T IO N A N D HO L D I N G O F U R BA N P R O P E R T I E S 9 9 . 9 9

BÍ N T E R CA N A R I A S, S.A. LA S PA L M A S A I R P O R T AI R T R A N S P O R T O F PA S S E N G E R S A N D C A R G O I N T H E CA N A R Y IS L A N D S 9 9 . 9 9

BÍ N T E R ME D I T E R R Á N E O, S.A. LA S PA L M A S A I R P O R T AI R T R A N S P O R T O F PA S S E N G E R S A N D C A R G O 9 9 . 9 9

CA R G O S U R, S.A. AV DA. D E L A HIS PA N I DA D, 13 AI R T R A N S P O R T MA D R I D O F C A R G O 1 0 0 . 0 0

IB E R– SW IS S CAT E R I N G, S.A. CT R A. D E L A MU Ñ OZ A, S/N PR E PA R AT IO N A N D MA D R I D M A R K E T I N G O F F O O D A N D OT H E R S E R V IC E S F O R A I R C R A F T 7 0 . 0 0

SIS T E M A S AU TO M AT I Z A D O S VE L Á Z Q U E Z, 130 CO M P U T E R S E R V IC E S AG E N C I A S D E VI A J E, S.A. MA D R I D A P P L IC A B L E TO T H E T R AV E L ( SAVIA) A N D TO U R IS M I N D US T R I E S 7 5 . 8 3 (a)

(a) Including the 65.90% owned directly CO M PA Ñ Í A AU X I L I A R A L CA R G O CE N T R O D E CA R GA AÉ R E A TR A N S P O R T O F C A R G O 7 5 . 0 0 by Iberia and the 9.93% owned indirectly EX P R E S, S.A. (CAC E SA) PA R C E L A 2 P.5 NAV E 6 MA D R I D through the Amadeus Group.

p-108 ANNUAL REPORT 1998 IBERIA GROUP NOTES TO 1998 - CONSOLIDATED FINANCIAL STATEMENTS

All the foregoing companies were consolidated by the global integration method in 1998 and their fiscal years end on December 31.

AVIACIÓN Y COMERCIO, S.A. In accordance with the IBERIA Group’s Master Plan for 1997-1999, in October 1997 the flights of Aviación y Comercio, S.A. and IBERIA, Líneas Aéreas de España, S.A. were scheduled jointly for the first time, with the consequent impacts on the common commercial policy and on the management of common resources.

On November 10, 1998, IBERIA, Líneas Aéreas de España, S.A. acquired Sociedad Estatal de Participaciones Industriales (SEPI)’s holding in Aviación y Comercio, S.A. for Ptas. 38,860 million. This holding consists of 19,832,000 shares representing 67% of the capital stock of Aviación y Comercio, S.A. The financial statements as of December 31, 1997, were used for the acquisition and, accordingly, the income statement balances of Aviación y Comercio, S.A. with the new percentage of ownership were integrated in full in consolidation.

The increase in the ownership interest in Aviación y Comercio, S.A. did not give rise to any change in the scope of consolidation.

SISTEMAS AUTOMATIZADOS AGENCIAS DE VIAJE, S.A. On September 21, 1998, IBERIA, Líneas Aéreas de España, S.A. sold to Amadeus Global Travel Distribution, S.A., the parent company of the Amadeus Group, 34% of the capital stock of Sistemas Automatizados Agencias de Viajes, S.A. for Ptas. 3,566 million.

Based on IBERIA’s holding of 29.2% in the Amadeus Group, the IBERIA Group actually reduced its ownership interest in Sistemas Automatizados Agencias de Viajes, S.A. by 24.07%, and the gain of Ptas. 2,542 million obtained on the sale was recorded under the “Gains on Fixed Asset Disposals” caption in the accompanying 1998 consolidated statement of income.

VUELOS INTERNACIONALES DE VACACIONES, S.A. Because it was not possible to integrate Vuelos Internacionales de Vacaciones, S.A. as a Group operator, as required under the Master Plan, and in view of the significant losses incurred by this company in recent years, at the end of 1998 Group management decided to discontinue the companyís operations and submitted the related labor force reduction plan, on which an agreement was reached at the end of February 1999. The directors of IBERIA consider that the effect of this plan on the accompanying consolidated financial statements will not be material.

p-109 ANNUAL REPORT 1998 IBERIA GROUP NOTES TO 1998 - CONSOLIDATED FINANCIAL STATEMENTS

[3] ASSOCIATED COMPANIES The fiscal years of the associated companies consolidated in the IBERIA Group in 1998 end on December 31. The data on these companies, all of which are carried by the equity method, are as follows:

ASSOCIATED COMPANIES P E R C E N T A G E O F O W N E R S H I P B Y I B E R I A , L Í N E A S A É R E A S D E E S PA Ñ A , S . A .

C O M PA N Y R E G I S T E R E D O F F I C E L I N E O F B U S I N E S S %

VENEZOLANA INTERNACIONAL OSCAR M. ZULOAGA, S/N AIR TRANSPORT OF 45.00 DE AVIACIÓN, S.A. CARACAS, VENEZUELA PASSENGERS AND CARGO (VIASA)

AMADEUS GROUP SALVADOR DE MADARIAGA, 1 MANAGEMENT AND 29.20 MADRID OPERATION OF A COMPUTERIZED BOOKING SYSTEM

IBERBUS CONCHA LTD.GEORGE’S DOCK HOUSE,LEASE 40.00 IFSC; DUBLÍN OF AIRCRAFT

IBERBUS ROSALÍA LTD.GEORGE’S DOCK HOUSE,LEASE 40.00 IFSC; DUBLÍN OF AIRCRAFT

IBERBUS CHACEL LTD.GEORGE’S DOCK HOUSE,LEASE 40.00 IFSC; DUBLÍN OF AIRCRAFT

IBERBUS ARENAL LTD.GEORGE’S DOCK HOUSE,LEASE 40.00 IFSC; DUBLÍN OF AIRCRAFT

IBERBUS TERESA LTD.EARLSFORT LEASE 40.00 CENTRE-HATCH ST.;DUBLÍN OF AIRCRAFT

IBERBUS EMILIA LTD.EARLSFORT LEASE 40.00 CENTRE-HATCH ST.; DUBLÍN OF AIRCRAFT

IBERBUS AGUSTINA LTD.EARLSFORT LEASE 40.00 CENTRE-HATCH ST.; DUBLÍN OF AIRCRAFT

IBERBUS BEATRIZ LTD.EARLSFORT LEASE 40.00 CENTRE-HATCH ST.; DUBLÍN OF AIRCRAFT

The net worth data of the Amadeus Group and of each of the Iberbus companies used in consolidation were drawn from their respective provisional financial statements as of December 31, 1998, before receipt of the related auditors’ reports.

Venezolana Internacional de Aviación, S.A.’s operations were discontinued in January 1997 and in March 1997 the company filed for “suspensión de pagos” (Chapter 11-type insolvency proceedings, hereinafter “suspension of payments”) and the process of liquidation commenced. At the date of preparation of these consolidated financial statements, it had not been possible to obtain any recent financial statements relating to this company.

p-110 ANNUAL REPORT 1998 IBERIA GROUP NOTES TO 1998 - CONSOLIDATED FINANCIAL STATEMENTS

AEROLÍNEAS ARGENTINAS GROUP AND INTERINVEST, S.A. In 1996 IBERIA significantly reduced its holding in Aerolíneas Argentinas, S.A. by se l l i n g its hol d i n g in Interinvest, S.A. (the majority shareho l d er of Aero l í n eas Argent i na s , S.A.) to Andes Holding, B.V. (42% owned by SEPI).

US$ 135,000,000 (equal to Ptas. 20,500 million) were pending collection in connection with this transaction as of December 31, 1998, and was recorded under the “Other long-term Receivables” caption in the accompanying consolidated balance sheet as of december 31, 1998. The deadline stipulated in the contract for collection of the amount outstanding is September 1999.

Per information received from IBERIA, in 1997 Andes Holding, B.V. started to sell its holding in Interinvest, S.A. and expects that the proceeds from the sale will enable it to settle a portion of its liabilities. Based on the estimate of the proceeds that Andes Holding, B.V. expects to obtain, as of December 31, 1997, IBERIA decided to record a provision for Ptas. 11,000 million of the balance outstanding, under the “Provisions for Contingencies and Expenses” caption in the accompanying consolidated balance sheet as of December 31, 1998. The Board of Directors of Sociedad Estatal de Participaciones Industriales recently resolved to acquire from IBERIA, Líneas Aéreas de España, S.A. its account receivable from Andes Holding B.V. for Ptas. US$ 62 million.

On October 23, 1998, IBERIA assigned to Andes Holding, B.V. its direct holding (20% of the capital stock of Aerolíneas Argentinas, S.A.) in exchange for an 8.92% holding in the capital stock of Interinvest, S.A.

Also, on the same date, IBERIA acquired a 1.08% holding in Interinvest, S.A. for Ptas. 382 million.

Accordingly, as of December 31, 1998, IBERIA had a holding of 10% in Interinvest, S.A. and, therefore, this company was not consolidated in 1998, and the value of its shares is recorded under the “Long-Term Investment Securities” caption in the accompanying consolidated balance sheet as of December 31, 1998.

[4] BASIS OF PRESENTATION OF THE CONSOLIDATED FINANCIAL STATEMENTS

A) TRUE AND FAIR VIEW The 1998 consolidated financial statements were prepared from the accounting records of IBERIA and of its subsidiaries (as detailed in Notes 2 and 3) which include, in the case of certain companies, the effects of the revaluation made pursuant to Royal Decree-Law 7/1996.

The financial statements of the Spanish subsidiaries were prepared by each company’s directors in accordance with the Spanish National Chart of Accounts.

p-111 ANNUAL REPORT 1998 IBERIA GROUP NOTES TO 1998 - CONSOLIDATED FINANCIAL STATEMENTS

The Amadeus Group was consolidated on the basis of its provisional consolidated financial statements as of December 31, 1998, before receipt of the related auditors’ report.

Iberbus Concha, Ltd., Iberbus Rosalía, Ltd., Iberbus Chacel, Ltd., Iberbus Arenal, Ltd., Iberbus Teresa, Ltd., Iberbus Emilia, Ltd., Iberbus Agustina, Ltd. and Iberbus Beatriz, Ltd. were consolidated in 1998 using their provisional financial statements as of December 31, 1998, before receipt of the related auditorsí reports.

As a result of the situation of Venezolana Internacional de Aviación, S.A. (see Note 9) and because recent financial statements were not available, this company was consolidated on the basis of its latest available provisional financial statements.

The 1998 consolidated financial statements, which were prepared by IBERIA’s di re c t o r s , will be submitted for approval by the Shareho l d ers’ Mee t i n g, and it is consi dere d that they will be approved without any changes.

B) CONSOLIDATION PRINCIPLES The companies over which there is effective control were consolidated by the global integration method. The Controlling Company and the companies consolidated by the global integration method constitute the "consolidable Group". The associated companies in which the Controlling Company has a significant influence on management but does not have majority voting rights and does not manage them jointly with third parties are carried by the equity method. The companies comprising the consolidable Group and those carried by the equity method constitute the IBERIA Group. The equity of minority shareholders in the net worth and results of the consolidated subsidiaries is reflected under the "Minority Interests " caption on the liability side of the consolidated balance sheet. Also, the equity of minority shareholders in the results of the aforementioned subsidiaries is reflected under the “Income Attributed to Minority Interests” caption in the consolidated statement of income.

All material accounts and transactions between companies consolidated by the global integration method were eliminated in consolidation.

[5] DISTRIBUTION OF THE CONTROLLING COMPANY’S INCOME IBERIA’s directors propose the following distribution of 1998 income:

DISTRIBUTION OF THE CONTROLLING COMPANY’S INCOME MILLIONS OF PESETAS

p-112 ANNUAL REPORT 1998 IBERIA GROUP NOTES TO 1998 - CONSOLIDATED FINANCIAL STATEMENTS

[6] VALUATION STANDARDS The main valuation methods applied in preparing the consolidated financial statements for 1998 were as follows:

A) GOODWILL IN CONSOLIDATION Goodwill was calculated as the positive difference between the additional investment made in Aviación y Comercio, S.A. by IBERIA in 1998 and the underlying book value of the holding per the balance sheet used as the basis for the acquisition.

The balance of the “Goodwill in Consolidation” caption in the accompanying consolidated balance sheet as of December 31, 1998, relates in full to securities that cannot be assigned to assets and is being amortized on a straight-line basis over 20 years (see Note 10). IBERIA’s directors set this amortization period in accordance with Law 37/1998 amending Article 194 of the Corporations Law because they consider that this is the period in which the goodwill will contribute to the obtainment of income by the Group.

B) UNIFORMITY OF PRESENTATION The main valuation principles and standards used by IBERIA were applied to all the companies consolidated and to the associated companies so as to ensure uniform presentation of the items composing the consolidated financial statements.

C) TRANSLATION METHODS The 1998 provisional financial statements of the Iberbus companies, which are denominated in U.S. dollars, were translated to pesetas at the year-end exchange rates, except for: 1. Capital and reserves, which were translated at historical exchange rates. 2. Inc o m e statement s , which were tran slated at the averag e exch a n ge rates for the year.

The exchange differences arising from application of these translation methods are included under the “Shareholders’ Equity - Translation Differences” caption in the accompanying consolidated balance sheet as of December 31, 1998.

D) START-UP EXPENSES These expenses consist basically of public deed execution and registration expenses relating to capital increases, and are amortized at an annual rate of 20%.

Ptas. 200 million of amortization of start-up expenses were charged to the 1998 consolidated statement of income.

E) INTANGIBLE ASSETS Leased assets are recorded as intangible assets at the cost of the related item, excluding interest cost, and are amortized by the same methods as those used to depreciate similar items of property, plant and equipment. The total debt for lease payments plus the amount of the purchase option is recorded as a liability. The difference between the two amounts, which represents the interest expenses on the transaction, is recorded under the “Deferred Expenses” caption in the accompanying consolidated balance sheet and is allocated to income each year by the interest method.

p-113 ANNUAL REPORT 1998 IBERIA GROUP NOTES TO 1998 - CONSOLIDATED FINANCIAL STATEMENTS

In prior years IBERIA, Líneas Aéreas de España, S.A., and Vuelos Internacionales de Vacaciones, S.A. modified the net book value of certain of their leased aircraft pursuant to a Ministry of Economy and Finance Order (see Note 6-j). Since these companies did not lease any aircraft in 1998 or in any of the four preceding years, no modification pursuant to this Order was made to the net book value of any aircraft in 1998.

Leased assets are amortized by the straig ht - l i n e met ho d , distributing the amor t i z a b l e cost of the assets among the years of estimated useful life, which are the same as those of similar property, plant and equipment items.

Computer software is being amortized on a straight-line basis over an estimated useful life of five years.

Ptas. 2,440 million of amortization of intangible assets were charged to the 1998 consolidated statement of income.

F) PROPERTY, PLANT AND EQUIPMENT The valuation methods applied by the consolidable Group are basically as follows:

1. AIRCRAFT: Spanish companies’ aircraft are carried at cost revalued pursuant to the applicable enabling legislation, including Royal Decree-Law 7/1996, except for certain aircraft, the value of which was modified pursuant to the provisions of a Ministry of Economy and Finance Order (see Note 6-j).

2. OTHER TANGIBLE FIXED ASSETS: The tangible fixed assets recorded under the “Other Tangible Fixed Assets” caption in the accompanying consolidated balance sheets are carried at cost revalued pursuant to Royal Decree-Law 7/1996.

3. REPAIRS, UPKEEP AND MAINTENANCE: The companies in the consolidable Group record a provision for the periodic major repairs of their aircraft (basically B-737, B-747, B-757, DC-10, Aviación y Comercio, S.A.’s DC-9, A-300, A-320, A-340, MD-87 and MD-88 aircraft) based on the total estimated cost to be incurred, and allocate this cost to income on a straight-line basis during the period elapsing between two successive major repairs. The balance of this provision is reflected under the “Provisions for Contingencies and Expenses - Provision for Major Repairs” caption in the accompany i ng cons o l idated balance sheet as of December 31, 1998.

The costs of minor repairs to the aforementioned types of aircraft and of all repairs to the B-727 and DC-9 aircraft of IBERIA, Líneas Aéreas de España, S.A. are expensed currently, since the annual expenses tend to be uniform.

Upkeep and maintenance expenses are expensed currently.

p-114 ANNUAL REPORT 1998 IBERIA GROUP NOTES TO 1998 - CONSOLIDATED FINANCIAL STATEMENTS

G) DEPRECIATION OF PROPERTY, PLANT AND EQUIPMENT The consolidable Group companies depreciate their property, plant and equipment by the straight-line method at annual rates based on the years of estimated useful life.

The methods applied to calculate depreciation of the main items of property, plant and equipment are as follows:

2. AIRCRAFT SPARE PARTS: Spare parts for aircraft maintenance are depreciated, depending on the type of part, as follows: a. Rotatable parts These are depreciated in a period ranging from 10 to 18 years from the date of purchase, assuming a residual value of between 10% and 20%, depending on the type of aircraft. b. Repairable parts These are depreciated in a period ranging from 8 to 10 years, depending on the aircraft, from the date of purchase, assuming a residual value of 10% in all cases. The Companies also record provisions for depreciation of spare parts based on obsolescence.

3. YEARS OF ESTIMATED USEFUL LIFE: The years of estimated useful life of property, plant and equipment items are as follows:

YEARS OF ESTIMATED USEFUL LIFE YEARS

A I R C R A F T 18 (a) B U I L D I N G S A N D O T H E R S T R U C T U R E S 20 - 50 M A C H I N E R Y, I N S TA L L AT IO N S A N D T O O L S 10 – 16 T R A N S P O R T E Q U I P M E N T 7 – 10 F U R N I T U R E A N D F I X T U R E S 10 C O M P U T E R H A R D WA R E 4 – 7 S P A R E PA R T S 8 – 18 (a) The used aircraft acquired by the Group are depreciated over a period F L IG H T S I M U L AT O R S 10 – 14 shorter than their estimated useful life for accounting purposes.

p-115 ANNUAL REPORT 1998 IBERIA GROUP NOTES TO 1998 - CONSOLIDATED FINANCIAL STATEMENTS

The buildings and facilities of IBERIA, Líneas Aéreas de España, S.A. and of Aviación y Comercio, S.A. on land owned by the Spanish State, mostly at Spanish airports, with an aggregate net book value of Ptas. 4,159 million per the two companies’ balance sheets as of December 31, 1998, are depreciated over the respective concession periods.

Depreciation is taken on the net amount of tangible fixed asset revaluations from the date they are recorded, using the same useful life periods as for the cost values.

The detail of depreciation of and provisions for property, plant and equipment charged to the consolidated statement of income for 1998 is as follows:

1998 MILLIONS OF PESETAS

A I R C R A F T 1 3 , 1 1 9 O T H E R TA N G I B L E F I X E D A S S E T S 1 0 , 6 8 2 2 3 , 8 0 1

H) SHAREHOLDINGS AND OTHER FINANCIAL INVESTMENTS I n v e s t me nts in no nc o ns o l idated companies are carried at cost net, whe re appropriate, of the required provisions for diminution in value (cost higher than fair value at year-end).

Investments in government debt securities are carried at cost. The interest on these securities is credited to income when earned and is charged through maturity to the “Short-Term Financial Investments” caption.

Time deposits are recorded at the amount delivered. The interest on these deposits is credited to income when earned and is charged to the “Short-Term Financial Investments” caption.

I) TRANSLATION OF FOREIGN CURRENCY BALANCES The balances of accounts denominated in foreign currencies are translated to pesetas at the exchange rates ruling at December 31 of each year. However, following customary airline practice, the balance of the liability for unused traffic documents is reflected in the accompanying consolidated balance sheets at the exchange rate ruling in the month of the sale, as set by the International Air Transport Association (I.A.T.A.). The I.A.T.A. exchange rate for each month is the average exchange rate for the last five days of the preceding month.

p-116 ANNUAL REPORT 1998 IBERIA GROUP NOTES TO 1998 - CONSOLIDATED FINANCIAL STATEMENTS the “Exchange Gains/Losses” captions in the consolidated statements of income, except for the net gains or losses relating to the financing obtained for the acquisition of certain aircraft.

J) EXCHANGE DIFFERENCES ARISING FROM AIRCRAFT FINANCING Pursuant to Valuation Rule 14 in Section 5 of the Spanish National Chart of Accounts, on March 23, 1994, the Ministry of Economy and Finance issued, at the proposal of the Accounting and Audit Institute (ICAC), a Ministerial Order on the accounting treatment of certain foreign currency exchange differences.

Under this accounting regulation, from January 1, 1993, the net amount of foreign currency exchange differences arising in each year on debts for financing for the acquisition by IBERIA, Líneas Aéreas de España, S.A., Aviación y Comercio, S.A. and Vuelos Internacionales de Vacaciones, S.A. of aircraft added to the fleet in the current year and in the four immediately preceding years has to be recorded as an increase or decrease in the value of such aircraft.

In accordance with this regulation, the value of the aircraft was reduced by a net amount of Ptas. 268 million.

K) INVENTORIES Inventories, basically aeronautical supplies, are valued at average purchase cost, and the related provisions for depreciation are recorded.

L) RECOGNITION OF REVENUES AND EXPENSES Revenues and expenses are recognized on an accrual basis, i.e. when the actual flow of the related goods and services occurs, regardless of when the resulting monetary or financial flow arises.

Ticket sales and the traffic documents for freight and other services are initially credited to “Customer Advances” in the consolidated balance sheet. The balances of this caption in the accompanying consolidated balance sheets reflect the liability for tickets and traffic documents sold prior to December 31, 1998 and 1997, but not yet used at those dates.

The revenues relating to these items are recognized when the transport or service is performed.

1996 was the first full year in which the new system implemented by IBERIA management was used to control sales and uses of international traffic tickets and determine the balance of the “Customer Advances” caption. In 1997 IBERIA completed

p-117 ANNUAL REPORT 1998 IBERIA GROUP NOTES TO 1998 - CONSOLIDATED FINANCIAL STATEMENTS

definition of the procedures for controlling transactions relating to the main “Customer Advances” balances and recorded the appropriate adjustments. In 1998 IBERIA completed implementation of the control procedures for the accounts relating to the “Customer Advances” caption and made an adjustment for a net amount of Ptas. 10,938 million, w h ich is re c o rded under the “Prior Years’ Revenues and Inc o me” caption in the accompanying 1998 consolidated statement of income.

IBERIA and its commercial air subsidiaries have introduced the “IBERIA Plus” card as an ongoing promotional tool whereby the holder of the card accumulates points for taking certain flights, using certain hotels, renting cars or making credit card purchases with credit cards covered by the program. The points can be exchanged for free tickets or other se r v i ces off e r ed by the companies incl u ded in the prog r am. The accompanyi n g conso l i dat e d balance sheet as of December 31, 1998, includes provisions of Ptas. 4,464 million in this connection, based on estimates of the value of the points accumulated at those dates.

M) PENSION PROVISIONS Under the collective labor agreements currently in force, IBERIA, Líneas Aéreas de España, S.A. and Aviación y Comercio, S.A. are required to pay full compensation to flight personnel who take early retirement (special leave) and to supplement the social security benefits of ground personnel taking early retirement, in accordance with the conditions specified for each case.

The “Provisions for Contingencies and Expenses- Pension Provisions” account in the accompanying consolidated balance sheet includes the liabilities incurred in this connection as of December 31, 1998. The provisions recorded to cover the discounted value of the liabilities incurred as of December 31, 1998, and the interest allocable to the recorded allowance amount to Ptas. 1,557 million and Ptas. 870 million, respectively, and these amounts are included under the “Personnel Expenses” and “Financial and Similar Expenses” captio ns, re s p e c t i v e l y, in the accompany i ng 1998 cons o l ida t e d statement of income.

The liability incurred as of December 31, 1998, was determined on the basis of actuarial studies conducted by independent actuaries using the unit credit method, and the main assumptions were an annual interest rate of 4%, an expected annual CPI variation of 2% and annual provisions payable in arrears.

N) MONTEPÍO DE PREVISIÓN SOCIAL LORETO The main purpose of the Montepío de Previsión Social Loreto is to pay retirement pensions to its members (who include the employees of IBERIA, Líneas Aéreas de España, S.A. and of its subsidiaries Aviación y Comercio, S.A. and Sistemas Automatizados Agencias de Viajes, S.A.) and other welfare benefits in certain circumstances (death of spouse, temporary and permanent disability, etc.).

Under the current collective labor agreements, the aforementioned companies and their employees make the regulatory contributions to the Montepío, as established in these labor agreements. The Montepío’s bylaws limit these companiesí liability to the payment by them of the regulatory established contributions.

p-118 ANNUAL REPORT 1998 IBERIA GROUP NOTES TO 1998 - CONSOLIDATED FINANCIAL STATEMENTS

The consolidable Group’s contribution of Ptas. 3,254 million in 1998 was recorded under the "Personnel Expenses" caption in the accompanying 1998 consolidated statement of income.

O) OBLIGATIONS TO FLIGHT PERSONNEL PLACED ON THE RESERVE Under the collective labor agreements in force, IBERIA, Líneas Aéreas de España, S.A. and Aviación y Comercio, S.A. are required to pay full compensation to flight personnel placed on the reserve.

The “Provisions for Contingencies and Expenses - Provisions for Obligations to Employees” account in the accompanying consolidated balance sheet includes the liabilities incurred in this connection as of December 31, 1998. The provisions recorded to cover the estimated liability incurred in 1998 and the interest allocable to the recorded allowance amount to Ptas. 3,500 million and Ptas. 2,584 million, respectively, and these amounts are included under the “Personnel Expenses” and “Financial and Similar Expenses” captions, respectively, in the accompanying 1998 consolidated statement of income.

T he liability inc u r red as of December 31, 1998, was de t e r m i ned on the basis of a c t ua r ial stud ies conducted by inde p e nde nt actua r ies using the unit credit me t ho d, a nd the main assumptio ns were an annual int e rest rate of 4%, an expected annua l CPI varia t ion of 2% and annual pro v i s io ns payable in arre a r s.

P) PROVISION FOR THIRD-PARTY LIABILITY The consolidated companies record in the “Provisions for Contingencies and Expenses - Provision for Third-Party Liability” caption in the accompanying consolidated balance sheet the estimated amount required for probable or certain third-party liability arising from legal proceedings and litigation in progress or from outstanding indemnity payments or obligations of undetermined amount, and collateral and other similar guarantees provided by the consolidated companies. As described in Note 14, IBERIA has recorded a provision for the restructuring costs that the directors consider will be incurred in the coming years as a result of the measures contained in the IBERIA Groupís Master Plan.

On April 25, 1997, the Fair Trade Office brought, on an ex officio basis, enforcement proceedings alleging practices in restraint of trade by IBERIA and other airlines “since they approved an interline agreement which was used to simultaneously increase and standardize rates thereby abusing their collective dominant position”. On June 17, 1997, the Fair Trade Office brought supplementary enforcement proceedings against Aviación y Comercio, S.A. (AVIACO) and Bínter Canarias, S.A. for their involvement in the aforementioned practices.

The Spanish Anti-Trust Tribunal has not yet taken a decision on the aforementioned proceedings.

T he 1998 cons o l idated fina nc ial stateme nts do not inc l ude any pro v i s ion in connection with these proceedings since the directors of the companies consider that no material liabilities will arise from the final decision.

p-119 ANNUAL REPORT 1998 IBERIA GROUP NOTES TO 1998 - CONSOLIDATED FINANCIAL STATEMENTS

Q) CORPORATE INCOME TAX The corporate income tax of each year for each consolidated company is calculated on the basis of the book income before taxes, increased or decreased, as appropriate, by the permanent differences from taxable income, net of tax relief and tax credits, excluding tax withholdings and prepayments.

T he Cont ro l l i ng Company and its de p e nde nt companies are taxed under the consolidated taxation system as part of Sociedad Estatal de Participaciones Industriales. This system is regulated by the 1989 Budget Law (Law 37/1988) and Royal Decree Law 5/1995. Consequently, the 1998 corporate income tax will be settled on a consolidated tax return basis.

R) FUTURES AND OTHER SIMILAR INSTRUMENTS IBERIA uses these instruments in transactions to hedge its asset and liability positions and its future cash flows. It only carries out “nongenuine” hedging transactions (i.e. those arranged between two parties, establishing in each case the contractual terms of the transactions agreed upon between them).

If cash deposits are required to guarantee the obligations inherent to the a fo re me nt io ned tra ns a c t io ns, they are re c o rded under the “Sho r t - Term Fina nc ia l Investments - Short-Term Deposits and Guarantees” caption on the asset side of the consolidated balance sheet.

The expenses relating to transactions involving futures and similar instruments are expensed currently.

The price differences arising during the term of futures and similar instruments are recorded as follows: 1. In the case of transactions arranged to hedge exchange rates relating to asset or liability positions, the related balances are discounted to present value based on the related gains or losses. 2. For the other exchange rate transactions, the pricing differences are recorded in the statement of income when the futures transactions or similar instruments are cancelled or finally settled, until which date they are recorded in balance sheet accounts.

[7] INTANGIBLE ASSETS The variations in 1998 in intangible asset accounts and in the related accumulated amortization were as follows:

p-120 ANNUAL REPORT 1998 IBERIA GROUP NOTES TO 1998 - CONSOLIDATED FINANCIAL STATEMENTS

1998 M I L L I O N S O F P E S E TA S AD D I T IO N S 01-01-98 AND PROVISIONS RETIREMENTS TR A N S F E R S 12-31-98 RIGHTS ON LEASED ASSETS 43,285) 59) (383) -) 42,961) COMPUTER SOFTWARE 6,084) 659) (3,918) (4) 2,821) RESEARCH AND DEVELOPMENT EXPENSES 94) 100) (36) -) 158) INTELLECTUAL PROPERTY AND LEASEHOLD ASSIGNMENT RIGHTS 105) -) (1) -) 104) AMORTIZATION (15,796) (2,440) 4,012) -) (14,224) NET VALUE 33,772 31,820

In 1998 IBERIA wrote off the cost and accumulated amortization of computer software relating to the AMADEUS booking system that had been fully amortized.

The main features of the lease contracts (relating mainly to aircraft) in force as of December 31, 1998, some of which have floating interest rates and lease payments denominated in foreign currencies, are as follows:

DECEMBER 31, 1998 MILLIONS OF PESETAS

CASH PRICE OF THE FIXED ASSETS ACQUIRED, ACCORDING TO CONTRACTS 4 1 , 1 2 8 AMOUNT OF LEASE PAYMENTS PAID: IN PRIOR YEARS 2 9 , 9 7 5 (a) As of December 31, 1998, these IN THE CURRENT YEAR 5 , 5 6 6 amounts included Ptas. 6,662 million of unincurred interest at that date, AMOUNT OF LEASE PAYMENTS OUTSTANDING AT DECEMBER 31 2 5 , 3 8 1 (a) the balancing entry for which is included under the “Deferred Charges” caption AMOUNT OF PURCHASE OPTIONS 1 9 , 3 7 8 (a) in the accompanying consolidated balance sheet as of December 31, 1998.

The due dates for the lease payments outstanding as of December 31, 1998, including the amount of the purchase options, are as follows:

DECEMBER 31, 1998 DU E I N MI L L I O N S O F PE S E TA S 1999 5,477 2000 5,460 2001 8,787 2002 7,359 2003 6,003 2004 11,673

p-121 ANNUAL REPORT 1998 IBERIA GROUP NOTES TO 1998 - CONSOLIDATED FINANCIAL STATEMENTS

[8] PROPERTY, PLANT AND EQUIPMENT The variations in 1998 in property, plant and equipment accounts and in the related accumulated depreciation and provisions were as follows:

COST

COST M I L L I O N S O F P E S E TA S

01-01-98 ADDITIONS RETIREMENTS TRANSFERS 12-31-98

AIRCRAFT 391,242 3,614 (5,698) 956 390,114 ADVANCES ON AIRCRAFT 10,855 39,526 (13,196) -) 37,185 402,097 43,140 (18,894) 956 427,299 OTHER TANGIBLE FIXED ASSETS: LAND 552 - -) -) 552 BUILDINGS AND OTHER STRUCTURES 28,519 7 (90) 73) 28,509 MACHINERY, INSTALLATIONS AND TOOLS 60,603 3,027 (2,109) 471) 61,992 TRANSPORT EQUIPMENT 2,876 962 (86) 3) 3,755 FURNITURE AND FIXTURES 3,910 210 (153) -) 3,967 COMPUTER HARDWARE 27,258 1,947 (1,039) 5) 28,171 SPARE PARTS 33,909 10,803 (8,621) -) 36,091 FLIGHT SIMULATORS 7,141 12 -) -) 7,153 OTHER TANGIBLE FIXED ASSETS 1,067 116 (81) -) 1,102 CONSTRUCTION IN PROGRESS 2,663 5,091 (2,213) (1,503) 4,038 168,498 22,175 (14,392) (951) 175,330

The advances on aircraft relate to advances paid as a result of aircraft purchase commitments to manufacturers in accordance with the established schedules.

On December 31, 1996, IBERIA and certain of its dependent companies revalued their property, plant and equipment pursuant to Royal Decree-Law 7/1996, and paid the single 3% tax. These companies had previously availed themselves of other revaluation legislation. The revaluation in 1996 was carried out by applying the maximum coefficients authorized by the Royal Decree-Law, with the 40% reduction for the effect of the financing of these companies (except for Aviación y Comercio, S.A.) up to the limit of the estimated market value of each of the assets. The revaluation surplus and effect as of December 31, 1998, is as follows:

p-122 ANNUAL REPORT 1998 IBERIA GROUP NOTES TO 1998 - CONSOLIDATED FINANCIAL STATEMENTS

REVALUATION M I L L I O N S O F P E S E TA S

SURPLUS 1998 AT 12-31-97 PROVISION RETIREMENTS SURPLUS

AIRCRAFT 8,587 (1,379) (38) 7,170 LAND 147 -) -) 147 BUILDINGS AND OTHER STRUCTURES 2,703 (514) -) 2,189 MACHINERY, INSTALLATIONS AND TOOLS 2,496 (831) (120) 1,545 TRANSPORT EQUIPMENT 21 (8) -) 13 FLIGHT SIMULATORS 304 (70) -) 234 14,258 (2,802) (158) 11,298

As of December 31, 1998, the accumulated depreciation on the surplus arising from the revaluation amounted to approximately Ptas. 10,831 million.

T he re v a l ua t ion inc reased the 1998 de p re c ia t ion charge by approx i ma t e l y Ptas. 2,802 million, and will increase the 1999 depreciation charge by approximately Ptas. 1,726 million.

The revaluation surplus, net of the single 3% tax, was credited to the “Revaluation Reserve” caption at each company, with a charge to the appropriate revalued asset accounts, without altering the recorded accumulated depreciation amount.

DEPRECIATION AND PROVISIONS

DEPRECIATION AND PROVISIONS M I L L I O N S O F P E S E TA S

01-01-98 ADDITIONS RETIREMENTS TRANSFERS 12-31-98

AIRCRAFT 227,241 13,119 (4,224) - 236,136 OTHER TANGIBLE FIXED ASSETS: BUILDINGS AND OTHER STRUCTURES 13,627 1,450 (64) - 15,013 MACHINERY, INSTALLATIONS AND TOOLS 37,139 4,368 (1,410) - 40,097 TRANSPORT EQUIPMENT 1,684 318 (84) - 1,918 FURNITURE AND FIXTURES 3,086 232 (122) - 3,196 COMPUTER HARDWARE 23,836 1,148 (967) 1 24,018 SPARE PARTS 20,928 2,584 (1,313) - 22,199 FLIGHT SIMULATORS 4,911 469 -) - 5,380 OTHER TANGIBLE FIXED ASSETS 707 113 (30) - 790 105,918 10,682 (3,990) 1 112,611

As of December 31, 1998, the cost of fully depreciated assets and of obsolete or unused items for which full provisions had been recorded and which the IBERIA G roup ma i nt a i ns in pro p e r t y, plant and equipme nt amo u nted to approx i ma t e l y Ptas. 54,792 million.

p-123 ANNUAL REPORT 1998 IBERIA GROUP NOTES TO 1998 - CONSOLIDATED FINANCIAL STATEMENTS

TRANSACTIONS INVOLVING THE AIRCRAFT In 1998 IBERIA formalized the agreements relating to its fleet renewal plan and entered into certain agreements with its suppliers, particularly Airbus Industrie, G.I.E. and The Boeing Company. The main features of these agreements are as follows.

BOEING AIRCRAFT · B-757 In 1994 IBERIA entered into operating lease contracts with several companies for seven B-757 aircraft. Two of these aircraft were on lease for a period of four years, extended by a further 18 months in 1997 and for a further 12 months in 1998, and the contracts did not provide for a purchase option. The other five B-757 aircraft were on lease for an initial period of approximately five years, at the end of which IBERIA would have the following three options for each plane: to exercise the purchase option; to extend the lease by up to a further 12 years; or to return the plane to the lessor. In 1998 the option to extend the lease by a further 12 months was exercised for four of these aircraft and the return of the fifth plane to the original lessor is currently being negotiated. In accordance with the fleet renewal agreements with the manufacturer, the retirements from advances on aircraft include Ptas. 7,137 million which were adjusted through the use of the provisions recorded prior to 1998 (Ptas. 5,618 million) and in 1998 (Ptas. 1,519 million), which were recorded under the “Provisions for Contingencies and Expenses” caption in the consolidated balance sheet. I B E R I A’s initial B-757 airc raft purchase cont ract with The Boeing Company (“Boeing”) was still in force as of December 31, 1998, and eight of the planes ordered under this contract had not been delivered at that date. In 1998 IBERIA and Boeing agreed to amend the existing agreements by changing the delivery dates for the eight aircraft not yet received and including the purchase of a further eight B-757 aircraft and a purchase option on a further 14 planes. The investment commitment assumed in connection with the 16 B-757 aircraft amounts to approximately US$ 994 million. The delivery schedule for the 16 B-757 aircraft for which IBERIA has a firm purchase commitment is as follows: eight in 1999 and eight in 2000. Of the aircraft on which there is a purchase option, eleven will be received in 2001 and three in 2002. As of December 31, 1998, IBERIA had paid advances of Ptas. 9,825 million on these aircraft.

· B-747 and B-727 In 1994 IBERIA sold to Boeing seven B-727 aircraft and one B-747 aircraft and subsequently entered into operating lease contracts for these planes for periods of one year and three years, respectively, including a purchase option. In 1997 IBERIA renegotiated the operating lease contract relating to the B-747 aircraft, extending the contract for a further 29-month period and modifying the purchase option price at the end of this period. Also, the contract addresses the possibility of extending the contract for a further 36 months after expiration of the aforementioned 29-month period.

p-124 ANNUAL REPORT 1998 IBERIA GROUP NOTES TO 1998 - CONSOLIDATED FINANCIAL STATEMENTS

In 1995 IBERIA exercised the purchase option on two of the seven leased B-727 aircraft for salvaging and use of spare parts. An amendment to the original contract on the other B-727 aircraft was agreed on in 1995 whereby the contract was extended to December 1998, when these five aircraft were acquired for approximately US$ 500,000 each.

AIRBUS AIRCRAFT · A-340 In 1996 IBERIA, Líneas Aéreas de España, S.A. agreed with Airbus Industrie, G.I.E. (Airbus) on the delivery dates of eight A-340 aircraft (which have already been received and are operating) and on the delivery schedule for a further four aircraft on which there is a purchase option: one in 1999, one in 2000 and two in 2001. The eight A-340 aircraft in service were leased under operating lease contracts from the “Iberbus” companies (see Note 3). IBERIA has 40% holdings in the capital stock of each of these companies. The term of the operating leases for the eight A-340 aircraft is seven years, at the end of which IBERIA will have the following three options: to exercise the purchase option and pay a predetermined price for the aircraft; to extend the lease for periods of between three and eight years and mandatorily exercise the purchase option; or to return the planes to the lessor. If IBERIA opts to return the planes and if the owner of the aircraft does not find a buyer for the aircraft, IBERIA is obliged to extend the operating lease contract for a further one-year period for the aircraft which came into service in 1996 and for a further two-year period for the aircraft which came into service in 1997 and 1998. In 1998 IBERIA entered into an agreement with Airbus for the acquisition of a further six A-340 aircraft and a purchase option on a further five. With this agreement, IBERIA exercised two of the purchase options acquired under the agreement entered into with Airbus in 1996. Also, IBERIA has four subordinated options that it can exercise provided that it exercises the purchase option on four of the five aforementioned aircraft. The delivery schedule for these aircraft would be: one in 1999, three in 2000 and two in 2001 in the case of the aircraft for which there are firm commitments, and one in 2001, three in 2002 and one in 2003 for the aircraft on which IBERIA has a purchase option. In connection with four of these aircraft that will be received in 1999, 2000 and 2001, IBERIA has entered into financing agreements that will enable it to operate them under an operating lease similar to that existing for the eight A-340 aircraft that it currently operates. IBERIA has a minority holding in each of the companies and must make contributions to finance them so that they can purchase the aircraft from the manufacturer. The contributions that IBERIA will have to make on both these counts for the four aircraft range from a minimum of US$ 28 million to a maximum of US$ 68 million. At the end of the initial lease term of seven years, IBERIA may opt to extend the lease for a further eight years, exercise the purchase option or return the aircraft.

p-125 ANNUAL REPORT 1998 IBERIA GROUP NOTES TO 1998 - CONSOLIDATED FINANCIAL STATEMENTS

The basic price of the six aircraft is approximately US$ 827 million. As of December 31, 1998, IBERIA had made advances totaling Ptas. 3,559 million in connection with these aircraft.

· A-319, A-320 and A-321 On June 19, 1998, IBERIA, Líneas Aéreas de España, S.A. and Airbus Industrie, G.I.E. entered into an agreement for the firm purchase of 50 A-320 aircraft, with the option of acquiring a further 26 aircraft of this type and an additional purchase option on 14 aircraft. Also, IBERIA, Líneas Aéreas de España, S.A. entered into an agreement with Singapore Aircraft Leasing Enterprise Pte. Ltd. (“SALE”) to bring forward the date on which two A-320 scheduled for delivery in 2002 will come into service to 1999. IBERIA will operate these two aircraft under an operating lease contract with SALE with an initial term of five years, on expiration of which IBERIA may renew the lease for a maximum period of seven years. Also, IBERIA entered into an additional agreement with Airbus for the firm purchase of two A-320 aircraft which will come into service in 2002 on the same date as that on which the aircraft on which the purchase option has been exchanged with SALE were scheduled to come into service.

The delivery schedule for these aircraft is as follows:

DELIVERY SCHEDULE FOR AIRCRAFT (a) Relating to aircraft on which there is a purchase option. TYP E OF AIR C R A F T 1999 2000 2001 2002 2003 2004 (a)2005 (a)2006 TOTAL (b) Including two aircraft the purchase option on which was exchanged with SALE. A-319 ------4 5 9 (c) Including three aircraft on which there is a purchase option. A-320 8 (b) 5 6 10 5 (c) 5 (c) 3 2 44 (d) Including six aircraft on which there is a purchase option A-321 2 3 2 5 11 (d) 10 (e) - 6 39 (e) Including eight aircraft on which 10 8 8 15 16 15 7 13 92 there is a purchase option.

The basic price of the aircraft involved in this transaction is approximately Ptas. 405,000 million. As of December 31, 1998, IBERIA had made advances totaling Ptas. 23,733 million in connection with these aircraft.

p-126 ANNUAL REPORT 1998 IBERIA GROUP NOTES TO 1998 - CONSOLIDATED FINANCIAL STATEMENTS

In connection with the A-320 aircraft, on July 17, 1998, IBERIA entered into a lease contract with International Lease Finance Corporation (“ILFC”) for nine A-319 and seven A-320 aircraft under a dry lease arrangement for an initial period of five years, on expiration of which IBERIA may extend the contract twice for one- or five-year periods, provided that the two extensions do not total more than six additional years. The delivery schedule for these aircraft is as follows:

DELIVERY SCHEDULE FOR AIRCRAFT

TYPE OF AIRCRAFT 1999 2000 2001 A - 3 2 0 2 3 2 A - 3 1 9 - 4 5 2 7 7

OTHER AIRCRAFT · DC-8 In 1998 IBERIA exercised the purchase option on two DC-8 aircraft that it operated under an operating lease with Cargosur, S.A. for Ptas. 247 million each. IBERIA subsequently sold these two aircraft and entered into an agreement to operate them under a wet lease arrangement.

· A-320 and MD-87 Without prejudice to the foregoing regarding the A-319, A-320 and A-321 aircraft, in 1993 IBERIA sold six A-320 and five MD-87 aircraft, and subsequently entered into operating lease contracts thereon. The gain of Ptas. 5,361 million on the sale of these aircraft was recorded under the “Deferred Revenues” caption in the consolidated balance sheet. Ptas. 1,101 million of this gain were charged in 1998 to the “Other Operating Revenues” caption in the accompanying 1998 consolidated statement of income. In July 1997 the owner of these aircraft sold them to three companies, which entered into new lease contracts with IBERIA. The lease contracts entered into for the six A-320 aircraft expire in 2001, 2002 and 2003, at which time IBERIA may extend them for a further five-year period or return the planes. The term of the lease contracts entered into for the five MD-87 aircraft is 96 months at the end of which IBERIA may exercise the purchase option provided for in the contract or return the planes.

p-127 ANNUAL REPORT 1998 IBERIA GROUP NOTES TO 1998 - CONSOLIDATED FINANCIAL STATEMENTS

AIRCRAFT IN SERVICE The aircraft in service of the companies consolidated by the global integration method in 1998 are summarized as follows:

AIRCRAFT IN SERVICE

UNDER UNDER WET TYPE OF OWNED BY THE FINANCIAL OPERATING LEASE AIRCRAFT COMPANIES LEASE LEASE (a) TOTAL B-727 28 (b) (c) - - - 28 B-737 2 2 5 3 12 B-747 6 - 1 4 (d) 11 (a) Lease type including aircraft and crew for approximately one year. The lessors were B-757 - 1 7 6 14 Air Atlanta UK Limited, Air Europa, S.A. and Atlas Air, Inc. B-767 - - - 2 2 (b) Including five aircraft acquired in 1998 that were operated under an operating A-300 6 (e) - - - 6 lease until December. (c) These figures do not include four B-727 and A-320 11 5 6 - 22 three DC-10 aircraft owned by Venezolana Internacional de Aviación, S.A. (VIASA) received A-340 - - 8 - 8 in December 1997 in execution of the mortgages on the loans granted by IBERIA, Líneas Aéreas DC-8 - - - 2 (f) 2 de España, S.A. These aircraft were registered in 1998 and are ready for sale. DC-9 26 - - - 26 (d) Including two B-747 equipped DC-10 4 (c) - - - 4 for freight transport. (e) Excluding two inactive aircraft of Iberia. MD-87 17 2 5 - 24 (f) These two aircraft were leased by Iberia under an operating lease from its subsidiary MD-88 13 - - - 13 Cargosur, S.A. through November 1998, when Iberia purchased and then sold them ATR 6 - 3 - 9 to subsequently lease them under a wet lease arrangement. CN-235 4 (g) - 1 - 5 (g) Including a Bínter Canarias, S.A. aircraft 123 10 36 17 186 leased from Bínter Mediterráneo, S.A.

One aircraft operated by IBERIA under a financial lease contract had been mortgaged for a net book value of Ptas. 4,321 million as of December 31, 1998.

Wet Lease In 1998 IBERIA entered into several wet lease contracts (lease of aircraft with crew).

In March 1998 IBERIA entered into an agreement with Air Europa, S.A. for the lease of eleven aircraft (six B-757, three B-737 and two B-767) under a wet lease arrangement. These agreements have an initial term of two years and are renewable annually.

Also, IBERIA entered into a wet lease contract with Atlas Air, Inc. to operate two B-747 aircraft (one for only six months) equipped for freight transport. The lease contract has an initial term of four years.

p-128 ANNUAL REPORT 1998 IBERIA GROUP NOTES TO 1998 - CONSOLIDATED FINANCIAL STATEMENTS

Lease expenses The operating lease payments paid by IBERIA in 1998 for the operating lease of the aforementioned 32 B-747, B-757, B-727, A-320, A-340 and MD-87 aircraft amounted to Ptas. 17,091 million, and this amount is included under the “Other Operating Expenses” caption in the accompanying 1998 consolidated statement of income. The detail of the approximate operating lease payments payable for these aircraft and of the due dates is as follows:

LEASE EXPENSES

YE A R M I L L IO N S O F U.S. D O L L A R S 1999 114 2000 89 2001 TO 2005 312 515

Insurance coverage The Controlling Company and its dependent companies have arranged insurance policies for their property, plant and equipment and intangible assets which sufficiently covered their net book value as of December 31, 1998. They have also arranged insurance policies for the aircraft leased from third parties in accordance with the conditions stipulated in the related lease contracts. Most of these policies are with Musini, Sociedad Anónima de Seguros y Reaseguros.

[9] LONG-TERM FINANCIAL INVESTMENTS

HOLDINGS IN COMPANIES CARRIED BY THE EQUITY METHOD The variation in 1998 in the balance of the “Holdings in Companies Carried by the Equity Method” caption in the consolidated balance sheet relates to the effect of recording, one the one hand, the share in the results of the Iberbus companies existing in 1997 and the effect of the related exchange differences and, on the other, the recording of IBERIA’s equity in the net worth of the two new Iberbus companies formed in 1998.

HOLDINGS IN COMPANIES CARRIED BY THE EQUITY METHOD

MILLIONS OF PESETAS

BA L A N C E AT JA N UA R Y 1, 1998 2 , 2 3 0) HO L D I N G S I N N E W C O M PA N I E S 8 5 5) SH A R E I N L O S S E S ( 1 7 5 ) EXC H A N G E D I F F E R E N C E S ( 1 8 6 ) BA L A N C E AT D E C E M B E R 31, 1998 2 , 7 2 4

p-129 ANNUAL REPORT 1998 IBERIA GROUP NOTES TO 1998 - CONSOLIDATED FINANCIAL STATEMENTS

AEROLÍNEAS ARGENTINAS GROUP AND INTERINVEST, S.A. As indicated in Note 3, IBERIA assigned to Andes Holding B.V. its 20% direct holding in Aerolíneas Argentinas, S.A., in exchange for an 8.92% holding in the capital stock of Interinvest, S.A. Also, on the same date IBERIA acquired 1.08% of the capital stock of Interinvest, S.A. The net book value of the 10% ownership interest in Interinvest, S.A. amounts to Ptas. 2,828 million and relates to the net amount of a cost of Ptas. 3,428 million recorded under the “Long-Term Investment Securities” caption and a provision of Ptas. 600 million recorded under the “Provisions” caption in the accompanying consolidated balance sheet as of December 31, 1998. As of December 31, 1998, IBERIA had provided U.S. dollar guarantees for Aerolíneas Argentinas, S.A. to several entities totaling Ptas. 11,563 million. The IBERIA Group has covered this risk through a Ptas. 2,336 million provision recorded under the “Provision for Contingencies and Expenses” caption in the accompanying consolidated balance sheet as of December 31, 1998, and through a mortgage guarantee on two B-747 aircraft owned by Aerolíneas Argentinas, S.A.

VENEZOLANA INTERNACIONAL DE AVIACIÓN, S.A. (VIASA) In November 1996 IBERIA submitted a Viability Plan for VIASA which was not accepted by the employees’ representatives. VIASA’s operations were discontinued in January 1997 and, following a resolution adopted by the shareholders, in March 1998 the company filed for suspension of payments and the process of liquidation commenced. As a result of the liquidation process, as of December 31, 1998, the IBERIA Group had recorded provisions for all the balances (loans, interest and trading accounts) with VIASA at that date. In December 1997, after the court-ordered auction which transferred to IBERIA ownership of four B-727 and three DC-10 aircraft belonging to VIASA, which were mortgaged as security for the loans granted in the past by IBERIA, these aircraft were capitalized for a symbolic value. As a result of this capitalization, IBERIA wrote off the loans granted and the related interest with a charge to provisions. These aircraft were registered in 1998. As of December 31, 1998, the four B-727 aircraft were grounded in Miami and the three DC-10 aircraft were in Madrid. These aircraft are currently awaiting sale.

p-130 ANNUAL REPORT 1998 IBERIA GROUP NOTES TO 1998 - CONSOLIDATED FINANCIAL STATEMENTS

As of December 31, 1998, the IBERIA Group’s balances with VIASA, in addition to the value of the holding, were as follows:

DECEMBER 31, 1998 M I L L I O N S O F P E S E TA S COST ALLOWANCE

LOA N S A N D I N T E R E S T 4,263 ( 4 , 2 6 3 ) CU R R E N T AC C O U N T 4,850 ( 4 , 8 5 0 ) TOTA L 9,113 ( 9 , 1 1 3 )

IBERIA received guarantees for the balances recorded in connection with the loans and interest consisting of mortgages on buildings and a B-727 aircraft of VIASA.

AMADEUS GROUP The value of the Controlling Company’s holding in the negative net worth of the Amadeus Group for approximately Ptas. 10,248 million, is recorded under the “Provisions for Contingencies and Expenses - Provisions for Third-Party Liability” caption in the accompanying consolidated balance sheet as of December 31, 1998. The Amadeus Group consists of Amadeus Global Travel Distribution, S.A., Amadeus Data Processing KG (a German company) and their investee companies. In 1997 IBERIA, Líneas Aéreas de España, S.A. sold its holding in Amadeus Data Processing KG to Amadeus Global Travel Distribution, S.A. for DM 156,494,119 (equal to Ptas. 13,234 million). This transaction did not have any effect at the IBERIA Group because IBERIA had recorded the related provision. This was the first sale involved in an operation to be implemented in 1999 under which all the Amadeus Group shareholders will sell their holdings in Amadeus Data Processing KG to Amadeus Global Travel Distribution, S.A., after which capital will be increased at the parent company and the new shares offered on the stock market. Also, on September 21, 1998, IBERIA sold 34% of its SAVIA trademarks in Spain and Portugal to Amadeus Global Travel Distribution, S.A. for Ptas. 3,340 million, giving rise to a gain of Ptas. 2,365 million which was recorded under the “Gains on Fixed Asset Disposals” caption in the accompanying 1998 consolidated statement of income. This gain relates to the sale effectively made by the IBERIA Group, namely 24.07% of its SAVIA trademarks in Spain and Portugal. The Amadeus Group, whose corporate purpose is the management and operation of a computerized booking system, has incurred losses in its first five years of operations since it was at the start-up phase. As in 1997, the Amadeus Group reported income in 1998.

p-131 ANNUAL REPORT 1998 IBERIA GROUP NOTES TO 1998 - CONSOLIDATED FINANCIAL STATEMENTS

LOANS TO COMPANIES CARRIED BY THE EQUITY METHOD The main data on the balance of the loans granted by IBERIA included under the “Loans to Companies Carried by the Equity Method” caption in the accompanying consolidated balance sheet as of December 31, 1998, are as follows:

LOANS

MI L L I O N S O F PE S E TA S DU E DAT E IN T E R E S T RAT E VIASA 4,263 (a) (a) IBERBUS ROSALÍA LTD. 2,806 02-29-2003 5% IBERBUS CONCHA LTD. 2,784 05-10-2003 5% IBERBUS CHACEL LTD. 3,084 09-06-2003 6% IBERBUS ARENAL LTD. 3,155 10-18-2003 6% IBERBUS TERESA LTD. 2,853 10-21-2004 6% IBERBUS EMILIA LTD. 2,865 11-10-2004 6% IBERBUS AGUSTINA LTD. 2,867 05-15-2005 6% (a) These credits are instrumented IBERBUS BEATRIZ LTD. 2,876 06-15-2005 6% in several loans and promissory notes denominated in U.S. dollars. TOTAL 27,553 In May 1997 Iberia ceased to record interest on these loans since ALLOWANCE (4,263) they were not recoverable.

The loans granted by IBERIA to the Iberbus companies relate to loans to the A-340 aircraft lessor companies (see Notes 3 and 8).

[10 ]GOODWILL IN CONSOLIDATION The variations in 1998 in the balance of this caption in the consolidated balance sheet were as follows:

1998 MILLIONS OF PESETAS

BA L A N C E AT JA N UA R Y 1, 1998 -) AD D I T IO N S 2 2 , 0 0 8) AC C U M U L AT E D A MO R T I Z AT IO N ( 1 8 4 ) BA L A N C E AT D E C E M B E R 31, 1998 2 1 , 8 2 4

As indicated in Note 6-a, the additions relate to the positive difference between the amount paid by IBERIA to acquire a 67% holding in Aviación y Comercio, S.A. and the underlying book value of the holding as of December 31, 1997.

As permitted by Law 37/1998 amending Article 194 of the Corporations Law, IBERIA’s directors opted to amortize this goodwill on a straight-line basis over 20 years (see Note 6-a) from the acquisition date (November 10, 1998).

p-132 ANNUAL REPORT 1998 IBERIA GROUP NOTES TO 1998 - CONSOLIDATED FINANCIAL STATEMENTS

The directors of IBERIA, Líneas Aéreas de España, S.A. estimate that the flow of future income that Aviación y Comercio, S.A. will obtain over the next 20 years is as follows:

ESTIMATE FLOW OF FUTURE INCOME OF AVIACION Y COMERCIO, S.A.

YE A R M I L L IO N S O F P E S E TA S 1999 2,377 2000 2,496 2001 2,621 2002 2,752 2003 2,889

From 2004 onwards the estimates are along the same lines.

[11 ] SHORT-TERM FINANCIAL INVESTMENTS The detail of the balance of this caption in the accompanying consolidated balance sheet as of December 31, 1998, is as follows:

SHORT-TERM FINANCIAL INVESTMENTS

MILLIONS OF PESETAS

SHO R T-T E R M D E P O S I TS 7 1 , 2 1 2) GO V E R N M E N T D E BT S E C U R I T I E S 1 9 , 3 2 2) SHO R T-T E R M D E P O S I TS A N D G UA R A N T E E S 1 , 8 8 8) UN M AT U R E D I N T E R E S T R E C E I VA B L E 1 , 3 6 3) OT H E R S HO R T-T E R M F I N A N C I A L I N V E S T M E N TS 4 , 7 9 3) OT H E R 1 , 1 5 1) 9 9 , 7 2 9

The average return on short-term deposits was 4.35% as of December 31, 1998.

The government debt securities relate to government debentures and Treasury bills which earned average interest of 4.49% as of December 31, 1998.

[12 ]SHAREHOLDERS’EQUITY As of December 31, 1998, the capital stock of IBERIA, Líneas Aéreas de España, S.A. consisted of 882,512,019 fully subscribed and paid registered shares of Ptas. 130 par value each.

As of December 31, 1998, Sociedad Estatal de Participaciones Industriales was the majority shareholder IBERIA, Líneas Aéreas de España, S.A., with a 93,86% holding.

p-133 ANNUAL REPORT 1998 IBERIA GROUP NOTES TO 1998 - CONSOLIDATED FINANCIAL STATEMENTS

The variations in consolidated equity accounts in 1998 were as follows:

SHAREHOLDERS’ EQUITY

CAPITAL REVALUATION PRIOR YEARS’ STOCK RESERVE LOSSES

BALANCES AT JANUARY 1, 1998 114,727 15,447) (42,284)

DISTRIBUTION OF 1997 CONSOLIDATED INCOME - - 11,028)

REVALUATION RESERVE USED - (15,447) 15,447)

1998 INCOME, PER ACCOMPANYING CONSOLIDATED STATEMENT OF INCOME ---

OTHER VARIATIONS ---

BALANCES AT DECEMBER 31, 1998 114,727 - (15,809)

REVALUATION RESERVE On January 22, 1998, the tax authorities reviewed and approved the balance relating to IBERIA of the “Revaluation Reserve” caption in the accompanying consolidated balance sheet as of December 31, 1998, and, accordingly, as permitted by current legislation, on June 27, 1998, the Shareholders’ Meeting resolved to use the balance of this reserve to offset prior years’ losses.

OTHER MATTERS On June 27, 1998, IBERIA’s Shareholders’ Meeting resolved to allocate the income for 1997 to partially offset the balance of the “Prior Years’ Losses” caption.

p-134 ANNUAL REPORT 1998 IBERIA GROUP NOTES TO 1998 - CONSOLIDATED FINANCIAL STATEMENTS

M I L L I O N S O F P E S E TA S

(LOSS) RESERVES AT INCOME COMPANIES RESERVES AT FOR THE YEAR CONSOLIDATED COMPANIES ATTRIBUTABLE TO BY THE GLOBAL CARRIED BY THE TRANSLATION THE CONTROLLING INTEGRATION METHOD EQUITY METHOD DIFFERENCES COMPANY TOTAL

3,718 (1,504) (232) 14,904) 104,776

1,329 2,547) - (14,904) -

-----

- - - 53,025) 53,025

- - 346) - 346

(a) Including shares of Iberia 5,047 (a) 1,043 114 53,025 158,147 amounting to Ptas. 7 million which constitute restricted reserves.

RES E R V E S AT CO M P AN I E S CO N S O L I D ATE D BY TH E GL O B AL IN T E G R A TI O N ME T H O D AN D CA R R I E D BY TH E EQ U I T Y ME T H O D The detail of the balance of the "Reserves at Companies Consolidated by the Global Integration Method" caption in the accompanying consolidated balance sheet as of December 31, 1998, is as follows:

DECEMBER 31, 1998

C O M PA N Y MILLIONS OF PESETAS AV I AC I Ó N Y C O M E R C IO, S.A . 4 , 4 0 4) BÍ N T E R CA N A R I A S, S.A. ( 3 , 3 7 7 ) BÍ N T E R ME D I T E R R Á N E O, S.A. ( 6 , 1 5 5 ) CO M PA Ñ Í A AU X I L I A R A L CA R G O EX P R É S, S.A. 1 0 9) CA M P O S VE L Á Z Q U E Z, S.A. 8 3 1) CA R G O S U R, S.A. ( 7 0 3 ) IB E R– SW IS S CAT E R I N G, S.A. 1 0 0) VU E L O S IN T E R N AC IO N A L E S D E VAC AC IO N E S, S.A. ( 8 , 8 2 8 ) SIS T E M A S AU TO M AT I Z A D O S AG E N C I A S D E VI A J E S, S.A. 4 3 8) TOTA L ( 1 3 , 1 8 1 ) CO N S O L I DAT IO N A D J US T M E N TS 1 8 , 2 2 8) TOTA L 5 , 0 4 7

p-135 ANNUAL REPORT 1998 IBERIA GROUP NOTES TO 1998 - CONSOLIDATED FINANCIAL STATEMENTS

The breakdown of the consolidation adjustments is as follows:

DECEMBER 31, 1998 MILLIONS OF PESETAS

RE V E R SA L O F P R O V IS IO N S F O R L O N G-T E R M F I N A N C I A L I N V E S T M E N TS I N IBERIA M A D E BY D E P E N D E N T C O M PA N I E S I N P R IO R Y E A R S 1 9 , 0 8 9 CA N C E L L AT IO N O F D I V I D E N D S R E C E I V E D I N P R IO R Y E A R S ( 8 6 1 ) TOTA L 1 8 , 2 2 8

The detail of the balance of the "Reserves at Companies Carried by the Equity Method" caption in the accompanying consolidated balance sheet as of December 31, 1998, is as follows:

DECEMBER 31, 1998

CO M PA N Y MILLIONS OF PESETAS

VE N E Z O L A N A IN T E R N AC IO N A L D E AV I AC I Ó N, S.A. ( 1 5 , 5 4 7 ) AM A D E US GR O U P ( 1 1 3 ) IB E R B US C O M PA N I E S ( 3 5 5 ) TOTA L ( 1 6 , 0 1 5 ) CO N S O L I DAT IO N A D J US T M E N TS 1 7 , 0 5 8) TOTA L 1 , 0 4 3

The breakdown of the consolidation adjustments is as follows:

DECEMBER 31, 1998 MILLIONS OF PESETAS

RE V E R SA L O F P R O V IS IO N S F O R L O N G-T E R M F I N A N C I A L I N V E S T M E N TS I N IBERIA M A D E BY D E P E N D E N T C O M PA N I E S I N P R IO R Y E A R S 1 7 , 0 5 8

OTHER MATTERS The restricted reserves at the consolidable Group companies amounted to Ptas. 7,859 million as of December 31, 1998 (Ptas. 6,239 million of revaluation reserves and Ptas. 1,620 million of legal reserves). The balances of the revaluation reserves of the consolidable Group companies, except for IBERIA, have not been reviewed and approved by the tax authorities and, accordingly, these reserves are restricted until the tax authorities have reviewed and approved their balances or the three-year period for review has elapsed.

p-136 ANNUAL REPORT 1998 IBERIA GROUP NOTES TO 1998 - CONSOLIDATED FINANCIAL STATEMENTS

As of December 31, 1998, the accumulated losses of Interinvest, S.A. and Bínter Mediterráneo, S.A. had reduced their net worth to less than one-half of their respective capital stock amounts. These companies are presently evaluating various measures to restore their net worth equilibrium within the periods stipulated in the relevant legislation. Also, as of December 31, 1998, the accumulated losses of Vuelos Internacionales de Vacaciones, S.A. had reduced its net worth to less than two-thirds of capital stock. However, as indicated in Note 2, Group management decided to discontinue the operations of this company and submitted the appropriate labor force reduction plan. The companies with holdings of 10% or more in the capital stock of the dependent companies as of December 31, 1998, were as follows:

DECEMBER 31, 1998 P E R C E N TAG E O F C O M PA N Y O W N E R S H I P I N V E S T E E MA R Í T I M A S RE U N I DA S, S.A. 25.00 COMPAÑÍA AUXILIAR AL CARGO EXPRÉS, S.A. AM A D E US GL O BA L TR AV E L 3 4 . 0 0 SISTEMAS AUTOMATIZADOS DISTRIBUTION, S.A. AGENCIAS DE VIAJE, S.A. SW IS S– AI R GR O U P 30.00 IBER-SWISS CATERING, S.A. AI R FR A N C E 29.20 AMADEUS GROUP LU F T H A N SA 29.20 AMADEUS GROUP SY S T E M ON E 12.40 AMADEUS GROUP FO N D O D E IN V E R S I Ó N VE N E Z O L A NO 40.00 VENEZOLANA INTERNACIONAL DE AVIACIÓN, S.A. BA N C O PR O V I N C I A L 15.00 VENEZOLANA INTERNACIONAL DE AVIACIÓN, S.A. AI R B US IN D US T R I E, FI N A N C I A L SERVICES 60.00 IBERBUS CONCHA LTD. AI R B US IN D US T R I E, FI N A N C I A L SERVICES 60.00 IBERBUS ROSALÍA LTD. AI R B US IN D US T R I E, FI N A N C I A L SERVICES 60.00 IBERBUS CHACEL LTD. AI R B US IN D US T R I E, FI N A N C I A L SERVICES 60.00 IBERBUS ARENAL LTD. AI R B US IN D US T R I E, FI N A N C I A L SERVICES 60.00 IBERBUS TERESA LTD. AI R B US IN D US T R I E, FI N A N C I A L SERVICES 60.00 IBERBUS EMILIA LTD. AI R B US IN D US T R I E, FI N A N C I A L SERVICES 60.00 IBERBUS AGUSTINA LTD. AI R B US IN D US T R I E, FI N A N C I A L SERVICES 60.00 IBERBUS BEATRIZ LTD. ANDES HOLDING, B.V. 80.00 INTERINVEST

p-137 ANNUAL REPORT 1998 IBERIA GROUP NOTES TO 1998 - CONSOLIDATED FINANCIAL STATEMENTS

[13]MINORITY INTERESTS The variations, by dependent company, in the balance of the “Minority Interests” caption in the accompanying consolidated balance sheet as of December 31, 1998, were as follows:

DECEMBER 31, 1998 M I L L I O N S O F P E S E TA S VU E L O S SI S T E M A S IN T E R N A- CO M PA Ñ Í A AU TO M A- C I O N A L E S AV I AC I Ó N IB E R- AU X I L I A R T I Z A D O S D E VAC A- Y SW I S S A L CA R G O AG E N C I A S C I O N E S, CO M E R C I O, CAT E R I N G, EX P R É S, D E VI A J E, S . A . S . A . S . A . S . A . S . A . TOTA L

BALANCE AT JANUARY 1, 1998 9) 16,869) 298 74 1 17,251) PURCHASE OF HOLDINGS -) (16,852) - - - (16,852) SALE OF HOLDINGS -) -) - - 153 153) SHARE IN 1998 INCOME (6) 2) 80 13 57 146) BAL A N C E AT DE C E M B E R 31, 1998 3 19 378 87 211 698

The breakdown of the balance of the “Minority Interests” caption as of December 31, 1998, is as follows:

DECEMBER 31, 1998 M I L L I O N S O F P E S E TA S

CA P I TA L RE VA L UAT I O N SH A R E I N STO C K RE S E R V E S RE S E R V E S IN C O M E TOTA L

VUELOS INTERNACIONALES DE VACACIONES, S.A. 13 (a) (7) 3 (6) 3 AVIACIÓN Y COMERCIO, S.A. 5 9) 3 2) 19 IBER-SWISS CATERING, S.A. 150 78) 70 80) 378 COMPAÑÍA AUXILIAR (a) In 1998 Iberia made a contribution AL CARGO-EXPRÉS, S.A. 8 66) - 13) 87 of Ptas. 2,500 million to offset losses. Since the minority shareholders did not SISTEMAS AUTOMATIZADOS make any contribution, this amount AGENCIAS DE VIAJE, S.A. 48 106) - 57) 211 was not included in calculating the balance of the 224 252 76 146 698 “Minority Interests” caption.

p-138 ANNUAL REPORT 1998 IBERIA GROUP NOTES TO 1998 - CONSOLIDATED FINANCIAL STATEMENTS

[14 ]PROVISIONS FOR CONTINGENCIES AND EXPENSES The detail of the balance of this caption in the accompanying consolidated balance sheets as of December 31, 1998, is as follows:

PROVISIONS FOR CONTINGENCIES AND EXPENSES

MILLIONS OF PESETAS

PE N S IO N P R O V IS IO N S ( NOT E 6 -M) 1 8 , 5 5 8 PR O V IS IO N S F O R O B L IGAT IO N S TO E M P L OY E E S ( NOT E 6 -O) 5 3 , 8 3 1 PR O V IS IO N F O R M A J O R R E PA I R S ( NOT E 6 -F) 2 3 , 7 0 5 PR O V IS IO N F O R T H I R D-PA R T Y L I A B I L I T Y ( NOT E 6 -P) 6 4 , 2 3 6 T OTA L 1 6 0 , 3 3 0

PROVISION FOR THIRD-PARTY LIABILITY The variations in 1998 in the “Provisions for Contingencies and Expenses - Provisions for Third-Party Liability” caption in the accompanying consolidated balance sheet were as follows:

PROVISION FOR THIRD-PARTY LIABILITY

MILLIONS OF PESETAS

BA L A N C E AT 0 1 - 0 1 - 9 8 6 6 , 1 6 3) PE R IO D P R O V IS IO N S 1 4 , 0 0 2) AMO U N TSUS E D I N 1 9 9 8 ( 1 6 , 5 8 2 ) TR A N S F E R S 6 5 3) B A L A N C E AT 1 2 - 3 1 - 9 8 6 4 , 2 3 6

The period provisions includes Ptas. 10,000 million to make up an allowance of Ptas. 20,000 million relating to restructuring costs that the directors of IBERIA consider will be incurred in the coming years as a result of the measures contained in the IBERIA Group’s Master Plan. T he afo re me nt io ned period pro v i s ion was re c o rded with a charge to the “Extraordinary Expenses” caption in the accompanying 1998 consolidated statement of income. The amounts used in 1998 include Ptas. 6,550 million recorded as extraordinary revenues for the year as a result of the disappearance of the risk for which the related provisions were recorded in prior years, and the remaining Ptas. 10,032 million relate mainly to provisions used for the purpose for which they were recorded.

p-139 ANNUAL REPORT 1998 IBERIA GROUP NOTES TO 1998 - CONSOLIDATED FINANCIAL STATEMENTS

[15 ]PAYABLE TO CREDIT ENTITIES The breakdown, by maturity, of the debts to credit entities as of December 31, 1998, is as follows:

DECEMBER 31, 1998 M I L L I O N S O F P E S E TA S

D UE I N SU B S E Q U E N T 1999 2000 2001 2002 2003 YE A R S DE BT : PESETA LOANS 12,546 2,084 2,381 1,717 2,898 3,671 FOREIGN CURRENCY LOANS: YEN 376 468 3,542 1,502 1,736 - E.C.U. 816 816 816 816 816 4,691 U.S. DOLLAR 25,458 2,937 14,213 5,276 2,544 3,096 DEUTSCHE MARK 1,354 1,153 1,158 1,188 1,219 6,595 40,550 7,458 22,110 10,499 9,213 18,053

The weighted average annual interest rates on the foregoing loans in 1998 were 7.52% for peseta loans and 6.63% for foreign currency loans, and certain of the rates were tied to MIBOR or LIBOR, respectively.

[16]FUTURES TRANSACTIONS IBERIA’s policy is to actively manage the risks arising from fluctuations in exchange and interest rates and in fuel prices.

Hedging transactions are arranged to minimize the impact of these variables on the consolidated statement of income. The breakdown, by hedging derivative, of the notional values held by IBERIA as of December 31, 1998, is as follows:

DECEMBER 31, 1998 MILLIONS OF PESETAS HEDGING OF ASSET AND LIABILITY POSITIONS EXC H A N G E R I S K H E D G I N G T R A N SAC T I O N S CR O S S CU R R E N C Y S WA P S 1 3 , 3 6 5 IN T E R E S T R AT E R I S K H E D G I N G T R A N SAC T I O N S IN T E R E S T R AT E S WA P S ( I R S ’S) 7 , 5 7 3

HEDGING OF FUTURE CASH FLOW S EXC H A N G E A N D I N T E R E S T R AT E R I S K H E D G I N G T R A N SAC T I O N S (a) CR O S S CU R R E N C Y I N T E R E S T A N D E XC H A N G E R AT E S WA P S 2 8 , 3 2 4

(a) Swaps of returns on operating EXC H A N G E R I S K H E D G I N G T R A N SAC T I O N S (a) lease contracts in U.S. dollars to surplus currencies (pounds sterling and Swiss francs) CR O S S CU R R E N C Y S WA P S 7 3 , 0 6 2 for an average period of four years. OT H E R H E D G I N G T R A N SAC T I O N S (b) In 1998 Iberia lengthened the term of its aircraft fuel price hedging FU E L P R IC E H E D G I N G T R A N SAC T IO N S (b) 7 8 , 6 8 4 transactions to three years.

p-140 ANNUAL REPORT 1998 IBERIA GROUP NOTES TO 1998 - CONSOLIDATED FINANCIAL STATEMENTS

[17]TAX MATTERS The corporate income tax of each of the companies consolidated by the global integration method is calculated on the basis of the result per books, which does not necessarily coincide with the taxable income for corporate income tax purposes.

The reconciliation of the consolidated income per books for 1998 of the companies composing the consolidated taxation group to the taxable income for corporate income tax purposes is as follows:

1998 M I L L I O N S O F P E S E TA S

IN C R E A S E D E C R E A S E AM O U N T

INCOME FOR THE YEAR PER BOOKS (BEFORE TAXES) - - 65,822) PERMANENT DIFFERENCES 88 (285) (197) TIMING DIFFERENCES: ARISING IN THE YEAR 29,057 (a) (6,889) 22,168) ARISING IN PRIOR YEARS 63 (14,526) (b) (14,463) TAXABLE INCOME (BEFORE CONSOLIDATION ADJUSTMENTS) 73,330) (a) This amount relates basically to the provisions for pensions, for projected CONSOLIDATION ADJUSTMENTS: restructuring costs, for contingencies related to investee companies and for bad debts. PERMANENT DIFFERENCES 2,315 (1,520) 795) (b) This amount relates basically to provisions TAXABLE INCOME 74,125 recorded in prior years for pensions and other commitments to employees and for aircraft.

The corporate income tax expense recorded in 1998, amounting to Ptas. 12,796 million, relates to the sum of the corporate income tax expenses recorded by each company consolidated by the global integration method, the detail being as follows:

1998

MI L L I O N S O F PE S E TA S AP P L IC AT IO N O F T H E 35% TA X R AT E TO I N C O M E P E R B O O KS A D J US T E D BY T H E P E R M A N E N T D I F F E R E N C E S 2 3 , 2 4 7) AD D / (LE S S) : 7% O F T H E P R IO R Y E A R S’ TA X L O S S E S O F F S E T I N 1 9 9 8 (3,870) DO U B L E TA X AT IO N A N D I N V E S T M E N T TA X C R E D I TS (2,005) RE S E R VA L O F P R O V IS IO N S F O R P R E PA I D TA X E S R E C O R D E D I N P R IO R Y E A R S (4,272) OT H E R (304) C O R P O R AT E I N C O M E TA X 12,796

The 7% of prior years’ tax losses offset in 1998 relates mainly to the difference between the corporate income tax rate (35%) and the rate of 28% that the consolidated companies obtained from SEPI by contributing their tax losses in consolidation for tax purposes.

p-141 ANNUAL REPORT 1998 IBERIA GROUP NOTES TO 1998 - CONSOLIDATED FINANCIAL STATEMENTS

The tax assets and liabilities were recorded, on the basis of the recovery date, under the “Accounts Receivable”, “Other Long-Term Receivables”, “Other Nontrade Payables” and “Long-Term Debt - Other Accounts Payable” captions in the accompanying consolidated balance sheet as of December 31, 1998, the detail being as follows:

DECEMBER 31, 1998 M I L L I O N S O F P E S E TA S CURRENT LONG-TERM ASSETS OTHER TOTAL DEB T / OTH E R OTHER TOTAL ACCOUNTS LONG-TERM ACCOUNTS ACCOUNTS NONTRADE ACCOUNTS RECEIVABLE RECEIVABLES RECEIVABLE PAYABLE PAYABLES PAYABLE

TAXABLE INCOME FOR 1998 550 - 550 - 15,094 15,094 PRIOR YEARS’ TAX LOSSES, AVAILABLE FOR CARRYFORWARD ------TIMING DIFFERENCES ARISING IN THE YEAR 5,673 4,802 10,475 2,535 - 2,535 UNALLOCATED TIMING DIFFERENCES ARISING IN PRIOR YEARS 2,163 30,134 32,297 538 - 538 TOTAL 8,386 34,936 43,322 3,073 15,094 18,167

The estimated years for use of the long-term tax assets as of December 31, 1998, are as follows:

YEAR OF RECOVERY MILLIONS OF PESETA S 2 0 0 0 5 , 2 5 8 2 0 0 1 5 , 1 0 0 2002 A N D S U B S E Q U E N T Y E A R S 2 4 , 5 7 8 3 4 , 9 3 6

The directors of the companies in the consolidated taxation group consider that all these assets will be recovered in not more than ten years.

Current Spanish corporate income tax legislation provides various tax incentives to encourage new investments and, through April 1992, job creation. The Spanish consolidated companies availed themselves of the tax benefits envisaged in this legislation and earned tax credits of Ptas. 144 million in 1998 this connection. As of December 31, 1998, the consolidable Group companies used Ptas. 1,922 million of tax credits earned in prior years and in 1998. The unused tax credits as of December 31, 1998, amounted to Ptas. 280 million, and the final years for using them are as follows:

p-142 ANNUAL REPORT 1998 IBERIA GROUP NOTES TO 1998 - CONSOLIDATED FINANCIAL STATEMENTS

FINAL YEARS FOR USING

L A S T Y E A R Y E A R E A R N E D M I L L I O N S O F PE S E TA S F O R U S E 1 9 9 4 2 8 0 1 9 9 9

In January 1997 the tax authorities commenced a review of 1992 through 1995 of all the taxes applicable to IBERIA, Líneas Aéreas de España, S.A. Although in the tax audit of corporate income tax provisional assessments were issued with no deficiency confirming the figures reported by IBERIA, as a result of the review tax assessments were issued for nonmaterial amounts and accepted and other tax assessments were issued and not accepted. The directors of IBERIA do not expect any liabilities to arise in this connection additional to those recorded as of December 31, 1998.

[18]REVENUES AND EXPENSES

A) NET SALES The breakdown of the consolidable Group companies’ net sales in 1998 and 1997, by type of activity, is as follows:

BY TYPE OF ACTIVITY M I L L I O N S O F P E S E TA S 1 9 9 8 1 9 9 7

PA S S E N G E R T IC K E T R E V E N U E S 5 1 3 , 7 2 9 4 6 9 , 2 7 1 FR E IG H T R E V E N U E S 3 7 , 4 3 9 3 9 , 0 9 5 OT H E R PA S S E N G E R T IC K E T A N D F R E IG H T R E V E N U E S 1 5 , 2 4 7 8 , 8 9 6 HA N D L I N G (A I R C R A F T D IS PATC H I N G A N D A I R P O R T S E R V IC E S) 3 6 , 5 6 6 4 0 , 6 1 3 TE C H N IC A L A S S IS TA N C E TO A I R L I N E S 1 7 , 9 0 5 1 4 , 5 3 9 OT H E R R E V E N U E S 2 4 , 0 7 4 1 9 , 5 2 3 TOTA L 6 4 4 , 9 6 0 5 9 1 , 9 3 7

PASSENGER TICKET REVENUES The geographical breakdown of passenger ticket revenues in 1998 and 1997, by network, is as follows:

BY NETWORK M I L L I O N E S O F P E S E TA S 1 9 9 8 1 9 9 7

SPA I N A N D E U R O P E 3 7 2 , 9 1 2 3 3 8 , 2 3 7 AT L A N T IC 1 2 0 , 6 1 8 1 1 0 , 7 0 8 FA R E A S T 1 2 , 0 7 4 1 2 , 5 1 4 AF R IC A A N D M I D D L E E A S T 8 , 1 2 5 7 , 8 1 2 TOTA L 5 1 3 , 7 2 9 4 6 9 , 2 7 1

p-143 ANNUAL REPORT 1998 IBERIA GROUP NOTES TO 1998 - CONSOLIDATED FINANCIAL STATEMENTS

TECHNICAL ASSISTANCE TO AIRLINES This caption includes revenues from aircraft maintenance services rendered to other airlines.

B) OTHER OPERATING REVENUES T he detail of the “Other Opera t i ng Revenues” caption in the accompany i ng consolidated statements of income is as follows:

OTHER OPERATING REVENUES M I L L I O N S O F P E S E TA S 1 9 9 8 1 9 9 7

CO M M IS S IO N S 9 , 6 4 6 8 , 0 6 0 RE N T 6 , 8 6 0 6 , 0 0 8 OT H E R S U N D R Y R E V E N U E S 3 , 8 6 8 3 , 5 7 3 2 0 , 3 7 4 1 7 , 6 4 1

C) EXTRAORDINARY REVENUES This caption in the accompanying 1998 consolidated statement of income includes mainly the following transactions:

EXTRAORDINARY REVENUES MI L L I O N S O F P E S E TA S

1997 D E BT O F A E N A 2 , 3 8 4 RE C O V E R Y O F P O V IS IO N S F O R T H I R D -PA R T Y L I A B I L I T Y 6 , 5 5 0 RE C O V E R Y O F C O N T I N G E N C Y- R E L AT E D O P E R AT I N G P R O V IS IO N S 1 , 4 3 3 OT H E R 6 7 9 TOTA L 1 1 , 0 4 6

AENA IBERIA’s claims against AENA, amounting to Ptas. 6,366 million, are still pending decision by the courts. To date all the decisions have been in favor of IBERIA, there being no claim by AENA against IBERIA.

D) PURCHASES The detail of the “Purchases” caption in the accompanying consolidated statement of income is as follows:

PURCHASES M I L L I O N S O F P E S E TA S 1 9 9 8 1 9 9 7

AI R C R A F T F U E L 5 9 , 2 6 1 6 0 , 2 6 5 AI R C R A F T S PA R E PA R TS 1 7 , 2 1 2 1 2 , 8 7 7 CAT E R I N G M AT E R I A L S 6 , 5 1 7 5 , 2 9 0 OT H E R P U R C H A S E S 5 , 2 2 6 6 , 3 3 5 8 8 , 2 1 6 8 4 , 7 6 7

p-144 ANNUAL REPORT 1998 IBERIA GROUP NOTES TO 1998 - CONSOLIDATED FINANCIAL STATEMENTS

E) HEADCOUNT AND PERSONNEL EXPENSES The breakdown of the balance of the “Personnel Expenses” caption in the accompanying consolidated statements of income is as follows:

PERSONNEL EXPENSES M I L L I O N S O F P E S E TA S 1 9 9 8 1 9 9 7

WAG E S , SA L A R I E S , E TC . 1 5 1 , 3 7 2 1 4 6 , 9 3 8 E M P L OY E E W E L FA R E E X P E N S E S 4 5 , 6 7 1 4 3 , 5 1 4 1 9 7 , 0 4 3 1 9 0 , 4 5 2

The average number of employees at the companies consolidable by the global integration method, by professional category, in 1998 and 1997 was as follows:

EMPLOYEES N U M B E R O F E M P L O Y E E S 1 9 9 8 1 9 9 7

G R O U N D P E R S O N N E L : SE N IO R M A N AG E R S A N D T E C H N IC I A N S 1 , 3 4 6 1 , 4 2 9 CL E R IC A L S TA F F 6 , 9 0 7 6 , 1 5 6 OT H E R 1 1 , 7 9 2 1 2 , 0 6 6 2 0 , 0 4 5 1 9 , 6 5 1 F L I G H T P E R S O N N E L : PI L OTS 1 , 7 3 5 1 , 7 1 3 F L IG H T E N G I N E E R S 2 3 0 2 4 3 C A B I N C R E W 3 , 8 1 6 3 , 6 9 0 5 , 7 8 1 5 , 6 4 6 2 5 , 8 2 6 2 5 , 2 9 7

F) OTHER OPERATING EXPENSES The detail of the balances of this caption in the accompanying consolidated statements of income is as follows:

OTHER OPERATING EXPENSES M I L L I O N S O F P E S E TA S 1 9 9 8 1 9 9 7

COMMERCIAL EXPENSES 72,739 60,169 AIR TRAFFIC LEVIES AND CHARGES 40,753 50,076 MAINTENANCE (a) 28,500 21,910 NAVIGATION AND OTHER COMMUNICATION AIDS 33,127 23,748 AIRCRAFT LEASES (NOTE 8) 45,858 29,473 OTHER 78,044 69,277 (a) Including maintenance 299,021 254,653 expenses and provision for major repairs.

p-145 ANNUAL REPORT 1998 IBERIA GROUP NOTES TO 1998 - CONSOLIDATED FINANCIAL STATEMENTS

G) EXTRAORDINARY EXPENSES The detail of the balance of the “Extraordinary Expenses” caption in the accompanying 1998 consolidated statement of income is as follows:

EXTRAORDINARY EXPENSES MI L L I O N S O F P E S E TA S

PR O V IS IO N S F O R T H I R D-PA R T Y L I A B I L I T Y 1 1 , 7 8 0 OT H E R E X T R AO R D I N A R Y E X P E N S E S 1 , 3 8 0 1 3 , 1 6 0

[19] CONTRIBUTION OF GROUP AND ASSOCIATED COMPANIES TO CONSOLIDATED INCOME T he cont r i b u t ion of Group and associated companies to the 1998 and 1997 consolidated income was as follows:

COMPANY M I L L I O N S O F P E S E TA S IN C O M E / (LO S S) 1 9 9 8 1 9 9 7

IB E R I A, LÍ N E A S AÉ R E A S D E ES PA Ñ A, S.A. 4 7 , 7 6 1) 9 , 8 5 2) AV I AC I Ó N Y CO M E R C IO, S.A. 2 , 4 1 3) 1 , 0 7 0) BI N T E R CA N A R I A S, S.A. 1 , 2 6 8) 3 3 2) BI N T E R ME D I T E R R Á N E O, S.A. (397) ( 3 7 2 ) CO M PA Ñ Í A AU X I L I A R A L CA R G O EX P R É S, S.A. 3 9) 3 5) CA M P O S VE L Á Z Q U E Z, S.A. 1 9 1) 2 5 1) CA R G O S U R, S.A. 8 0) (119) IB E R– SW IS S CAT E R I N G, S.A. 1 8 5) 5 3) VU E L O S IN T E R N AC IO N A L E S D E VAC AC IO N E S, S.A. (1,108) ( 1 , 5 8 6 ) SIS T E M A S AU TO M AT I Z A D O S AG E N C I A S D E VI A J E S, S.A. 1 8 0) 2 6 9) AM A D E US GR O U P (a) 2 , 5 8 7) 5 , 4 7 4) VE N E Z O L A N A IN T E R N AC IO N A L D E AV I AC I Ó N, S.A. (b) -) -) IB E R B US CO N C H A, LT D. 3) (67) IB E R B US RO SA L Í A, LT D. 3) (58) IB E R B US CH AC E L, LT D. ( 3 5 ) (103) IB E R B US AR E N A L, LT D. ( 6 3 ) (127) (a) This group contributed income from B E R B US E R E SA T D operations of Ptas. 2,587 million. I T , L . ( 4 0 ) -) However, the writeoff of certain amounts B E R B US M I L I A T D of goodwill arising at the Amadeus Group I E , L . ( 3 2 ) -) as a result of the transactions described B E R B US G US T I N A T D in Notes 2 and 9 gave rise to additional I A , L . ( 9 ) -) losses reducing he value of the holding. IB E R B US BE AT R I Z LT D. ( 1 ) -) (b) As described in Note 3 it was not possible to obtain any recent financial IN C O M E AT T R I B U T E D TO T H E CO N T R O L L I N G CO M PA N Y 53,025 1 4 , 9 0 4 statements of this company.

p-146 ANNUAL REPORT 1998 IBERIA GROUP NOTES TO 1998 - CONSOLIDATED FINANCIAL STATEMENTS

The detail of the balances of the "Income Attributed to Minority Interests" caption in the accompanying 1998 and 1997 consolidated statements of income is as follows:

COMPANY M I L L I O N S O F P E S E TA S IN C O M E / (LO S S) 1 9 9 8 1 9 9 7

AV I AC I Ó N Y CO M E R C IO, S.A. 2) 2 , 1 7 8) CO M PA Ñ Í A AU X I L I A R A L CA R G O EX P R É S, S.A. 1 3) 1 3) IB E R– SW IS S CAT E R I N G, S.A. 8 0) 2 3) VU E L O S IN T E R N AC IO N A L E S D E VAC AC IO N E S, S.A. (6) ( 9 ) SIS T E M A S AU TO M AT I Z A D O S AG E N C I A S D E VI A J E, S.A. 5 7) 1) IN C O M E AT T R I B U T E D TO M I N O R I T Y I N T E R E S T S 1 4 6 2 , 2 0 6

[20 ]“YEAR 2000 ISSUE” The effect of the Year 2000 issue presents a particularly significant problem for av ia t i on because of its implica t io n s for the efficie n t and nor m al operat i on of inte r na t io na l air transport.

Since the first half of 1997 the IBERIA Group has been adopting the measures required to tackle the Year 2000 Issue, and has implemented a plan for assessing all systems and remedying possible problems.

Also, the international air transport coordinating organizations such as IATA ( I nt e r na t io nal Air Tra nsport As s o c ia t ion) and IC AO (Int e r na t io nal Civil Av ia t io n Organization) have drawn up standard international regulations. Specifically, IATA has designed standard methodology for assessing Year 2000 compliance and identifying problem areas at air traffic service suppliers. IATA and Airports Council International (ACI) have worked together on developing standard methodology for assessing the functioning of airports. The findings of the two studies were shared with the IATA member airlines, and the consolidated companies engaging in the air transport business are members of this association.

As regards aircraft safety, the suppliers related with The Boeing Company, Airbus Industrie and Honeywell, among others, have implemented Year 2000 projects that will obviate all threats to the safe functioning of aircraft in Y2K.

p-147 ANNUAL REPORT 1998 IBERIA GROUP NOTES TO 1998 - CONSOLIDATED FINANCIAL STATEMENTS

For the other information systems involved in the air transport business (both internal and external), the IBERIA Group is implementing the plan designed and, accordingly, no significant problems are expected to arise as a result of the arrival of the Year 2000. In 1997 IBERIA recorded a provision of Ptas. 1,000 million for the costs involved in these processes. In 1998 IBERIA used Ptas. 433 million of this provision, and at year-end it estimated that further costs of Ptas. 4,000 million will be incurred in this connection. This amount was recorded under the “Other Operating Expenses” caption in the accompanying 1998 consolidated statement of income, and the related provision was recorded under the “Payable for Purchases and Services” caption in the accompanying consolidated balance sheet as of December 31, 1998.

[21 ]DIRECTORS’ REMUNERATION AND OTHER BENEFITS The remuneration of all types earned by IBERIA’s directors amounted to Ptas. 122 million in 1998.

In 1998 no advances or loans were granted to the directors of IBERIA and there are no pension commitments to them.

[22 ]EXPLANATION ADDED FOR TRANSLATION TO ENGLISH These consolidated financial statements are presented on the basis of accounting principles generally accepted in Spain. Certain accounting practices applied by the Group that conform with generally accepted accounting principles in Spain may not conform with generally accepted accounting principles in other countries.

p-148 a n n u a l r e p o r t 1 9 9 8

1 99 8 C O N S O L I D AT E D M A N A G E M E N T R E P O R T

D U E TO I T S L E N GT H , T H IS P U B L IC AT IO N I N C L U D E S O N L YA S U M M A R Y O F T H E M A N AG E M E N T R E P O R T. T H E C O M P L E T E T E X T H A S B E E N D E P O S I T E D W I T H T H E M A D R I D M E R C A N T I L E R E G IS T E R .

IBERIA GROUP

ANNUAL REPORT 1998 IBERIA GROUP CONSOLIDATED MANAGEMENT REPORT

[1] 1998 HIGHLIGHTS

1998, prior to IBERIA’s privatization, saw a significant step forward towards TRANSLATIONOF A REPORTORIGINALLY achieving the strategic objectives set in the Master Plan, despite the obstacles to growth ISSUEDIN SPANISH. IN THEEVENTOF A DISCREPANCY, caused by the restrictions placed on the use of resources and infrastructures. THE SPANISH-LANGUAGEVERSIONPREVAILS .

IBERIA’s pre-tax income amounted to Ptas. 62,801 million in 1998, four times higher than in 1997, enabling it to report a return on equity of 34%, considerably above the t a rget set in the Master Plan. The IBERIA Group reported inc o me befo re taxes of Ptas. 65,967 million.

The privatization process will be the most significant event for the Company in early 1999. The first phase, consisting of the sale of 10% of the Company’s capital stock to industrial partners (American Airlines and British Airways), will be formalized in February 1999. As regards the second phase, consisting of the sale of 30% of the Company’s shares to institutional partners (banks, construction companies, etc.), Sociedad Estatal de Participaciones Industriales (SEPI) is currently selecting partners that will guarantee shareholder stability. The process will culminate in the admission to listing of the remaining 54% of the capital stock in the last four months of 1999, since 6% of the shares are owned by Company employees.

In a favorable market context, IBERIA’s operations in 1998 were hindered by certain restrictions placed on production, since despite the integration of the Group’s commercial policy and joint scheduling, both of which were introduced in 1997 in accordance with the Master Plan, which aimed to optimize the use of res o u rc e s , IBERIA was unable to incre a s e its volume of business using in-house resources because of the difficulties in improving the productivity of technical crews caused by the negotiations relating to the collective labor agreement that concluded in October. Thus, IBERIA’s production in 1998 was 6% lower than in 1997. Aviaco increased its block hours by nearly 4%. The combination of these two factors forced the Company to acquire more aircraft from non-Group companies under wet lease arrangements than in 1997 and, specifically, to enter into an agreement with Air Europa in March for the long-term lease of eleven aircraft (two long-haul and nine short- and medium-haul aircraft) with their technical crews.

p-151 ANNUAL REPORT 1998 IBERIA GROUP CONSOLIDATED MANAGEMENT REPORT

The most ambitious plan for new aircraft in the Company’s history, amounting to over Ptas. 600,000 million, was signed in early 1998. This is a clear indication of IBERIA’s co m m i t me n t to future exp a ns i on, particularly in the mar k et in which it aims to streng t he n its leadership, na mely the European-Latin Ame r ican ma r ket. This plan envisage s significant aircraft modernization work and will lead to operating and training cost savings as a result of the standardization of most of the Airbus-type aircraft, leading to reduced expenses relating to maintenance, spare parts and aircraft fuel, with the concomitant environmental benefits and pilot and cabin crew training cost savings. The ability of crews to switch from one type of aircraft to another will also boost productivity.

The plan envisages the addi t i on of 92 short- and medium-haul aircr aft (52 purch a s e d outright and 40 leased with purchase option), and 11 aircraft for long-haul routes (6 purchased outright and 5 leased with purchase option). The aircraft will be acquired outright or acquired under financial lease or operating lease agreements or other forms of financing.

The new labor agreements and the availability of new aircraft will enable IBERIA to set about meeting the strategic objectives set for 1999, with the advantage that the flexibility arising from the signature of the wet lease agreements and the purchase options included in the established plan for new aircraft will enable decisions to be taken regarding the maintenance or modification of commercial plans on the basis of unforeseen market demand fluctuations thanks to the lower fixed cost burden.

p-152 ANNUAL REPORT 1998 IBERIA GROUP CONSOLIDATED MANAGEMENT REPORT

The growth potential of Madrid-Barajas airport, whose third runway came into service in November 1998 and at which refurbishment and expansion work continued throughout the year (and for which a fourth and fifth runway are planned), will facilitate its development as a hub airport. A new passenger terminal (T4) will be opened for exclusive use by IBERIA and its strategic allies. However, the situation at Barajas airport in 1998 made it impossible to provide the quality demanded by our customers in terms of punctuality and ground comforts. One of our main targets for 1999 is to overcome the difficulties that these problems represent for our services and which reduced the Company’s earnings in 1998.

In 1998 IBERIA inaugurated new routes to destinations such as Helsinki, Turin, Johannesburg, Chicago, Porto and Venice, and started to offer non-stop flights to Latin American destinations such as Santiago de Chile, Lima and San José de Costa Rica. How e v e r , in order not to lose its share of this target mar k et, and due to the afore me nt io ne d limitations on supply in 1998, IBERIA had to reschedule certain flights, and ceased to op e r ate the route to Tokyo in December in order to assign its hum an and mat e r i al res o u rc e s to the Mid and South-Atlantic market.

In 1998 the Group’s Commercial Management completed the implementation of certain of the pro g ra ms envisaged in the Master Plan, inc l ud i ng the cre a t io n of Serviagencias, a centralized service for travel agencies in Spain and the introduction of a new, more competitive travel agency incentive system, Valor 98. 1998 also saw the formation of Viva Tours, which, targeted at Spanish tourists, will optimize the marketing and retailing of excess supply, both of the Group’s services, i.e. high-season plane tickets, and of hotel and car rental services and other tourism products.

p-153 ANNUAL REPORT 1998 IBERIA GROUP CONSOLIDATED MANAGEMENT REPORT

The production of the material management area amounted to 3.18 million hours in 1998, almost three million hours of which were worked by Company employees, an increase with respect to 1997. Production work for third parties was also up on 1997, to the detriment of in-house production work. The work carried out in the year included most notably ma i nt e na nce by IBERIA of the airc raft operated under wet lease arrangements by Air Europa, the refurbishment of the cabins of long-haul aircraft and the installation of new electronic radionavigation systems in the aircraft.

IBERIA’s freight business generated revenues of Ptas. 35,340 million in 1998, down 1% from 1997 as a result of the planning of the program based on the volume of business and the use of resources targeted at passenger transport. The sale of the DC-8 freight aircraft at the end of the year gave rise to a significant capital gain, and the aircraft were su b s e q u e n tly leased under a wet lease arran geme n t. One B-747 freig h t plane was operat e d under a wet lease agreement with Kalitta in the first quarter of the year and subsequently with Atlas.

p-154 ANNUAL REPORT 1998 IBERIA GROUP CONSOLIDATED MANAGEMENT REPORT

The evolution of freight revenues, however, was not quite so positive, with a reduction of 4% from 1997, due to factors nearly all of which are nonrecurring: on the one hand, the barriers to growth put up by unstable scheduling, which penalized freight disproportionately as a result of its being considered to be a marginal activity with respect to passenger transport and, on the other, the inauguration of the new terminal with the multiple problems that this entailed, leading to a significant reduction in the volume of freight passing through Barajas in the middle of the year. In addition, the elimination of the route to Japan hit freight revenues and earnings hard, since this route contributed almost 10% of total freight revenues. The replacement of this line by other markets is one of the challenges facing the freight unit in 1999.

p-155 ANNUAL REPORT 1998 IBERIA GROUP CONSOLIDATED MANAGEMENT REPORT

Noteworthy as regards operating expenses was the significant growth (69%) in aircraft lease expenses, largely due to wet lease transactions, which were used in 1998 for the two aircraft of Air Atlanta (initially one B-747 and one L1011, and since May two B-747s) and the long-term wet lease from Mar ch of Air Europa aircr aft (initially two B-767s, five B-737s and four B-757s. The number of Air Atlanta and Air Europa aircraft operated under wet lease arrangements will vary in the coming months, although the number of short- and medium-haul aircraft thus leased will be maintained at nine, and in navigation levies, which increased by 18% with respect to 1997 as a result of the introduction by AENA on January 1, 1998, of the new approach charge, giving rise to an increased expense of over Ptas. 2,000 million in 1998. The effect of the new charge is expected to amount to Ptas. 4,500 million in 1999 and to almost Ptas. 7,000 million in 2000.

p-156 ANNUAL REPORT 1998 IBERIA GROUP CONSOLIDATED MANAGEMENT REPORT

Ap p l ic a t i on conti n ued in 1998 of the gene r al exp e n se red uct i on mea s u r es established in the Master Plan. The decrease in general expenses with respect to the reductions fo recasted in the Master Plan was almost 6%, hig her than the annual 5% targe t e s t a b l i s hed for 1997-1999.

p-157 ANNUAL REPORT 1998 IBERIA GROUP CONSOLIDATED MANAGEMENT REPORT

In 1998 the Company designed in-house methodology to tackle the EURO project for the adoption on the euro. This project was implemented in 1998 and will run for the next two years (1999 and 2000).

[2] GROUP PRODUCTION (BY NETWORK)

2.1. SUPPLY In terms of ASKs, IBERIA Group’s pro duc t ion, largely characterized in 1998 by t he cons o l ida t ion of the joint sche du l i ng between IBERIA and Av iaco initiated in the last quarter of 1997, inc reased by 7.3% with respect to 1997, the largest inc rease being on long-haul routes (10,6%).

In 1998 Viva’s supply increased by 10% in the charter market, in which Aviaco also operates on a marginal basis.

p-158 ANNUAL REPORT 1998 IBERIA GROUP CONSOLIDATED MANAGEMENT REPORT

Binter Canarias reduced its production by 6.2%, adapting to the competition in its market and operating throughout the year under the aircraft fleet plan contained in the Master Plan, and Binter Mediterr·neo maintained 1997 production levels, since its sales increased in the last few months of the year following the disappearance of PauknAir.

S U P P LY M I L L I O N S O F A S K ’ S 1 9 9 8 1 9 9 7 VAR I AT I O N 98 / 9 7 % VAR I AT I O N IBERIA, L.A.E. + AV I AC O 4 5 , 5 1 8 4 2 , 2 1 7 3 , 3 0 1 7 . 8 AV I ACO (CHARTER) 2 3 6 4 3 6 ( 2 0 0 ) ( 4 5 . 9 ) V I VA 2 , 6 7 2 2 , 4 2 7 2 4 5) 1 0 . 1) BINTER CANARIAS 3 7 8 4 0 3 ( 2 5 ) ( 6 . 2 ) BINTER MEDITERRANEO 7 1 7 1 0) 0) S PANISH GROUP 4 8 , 8 7 5 4 5 , 5 5 4 3 , 3 2 1 7 . 3

The breakdown of the Spanish Group’s supply, by network, is as follows:

BY NETWORK M I L L I O N A S K S AVAILABLE SEATS KILOMETRE

AR I AT I O N AR I AT I O N TOTAL OTHER 9.62 % 1 9 9 8 1 9 9 7 V 98 / 9 7 % V TOTAL SPAIN 25.9 % MAD-BCN SHUTTLE 1 , 1 6 6 1 , 0 6 7 9 9) 9 . 3) MAINLAND-CANARIES 4 , 8 8 8 4 , 6 5 6 2 3 2) 5 . 0) CANARY ISLANDS 3 7 3 3 9 3 ( 2 0 ) ( 5 . 1 ) OTHER NAT IO N A L 6 , 2 3 5 6 , 2 5 3 ( 1 8 ) ( 0 . 3 ) TOTAL TOTAL SPA I N 1 2 , 6 6 2 1 2 , 3 6 9 2 9 3 2 . 4 ATLANTIC 40.18 % TOTAL EUROPE A F R ICA AND MIDDLE EAST 8 4 0 7 0 9 1 3 1) 1 8 . 5) 24.28 % E.U. COUNTRIES 1 0 , 1 3 5 9 , 4 8 8 6 4 7) 6 . 8) 1998 SPANISH GROUP: 48,875 NON E.U. COUNTRIES 8 9 4 7 4 0 1 5 4) 2 0 . 8) TOTAL EUROPE 1 1 , 8 6 9 1 0 , 9 3 7 9 3 2 8 . 5 NORTH AT L A N T IC 5 , 5 4 9 5 , 1 2 1 4 2 8) 8 . 4) MID AT L A N T IC 8 , 2 1 2 7 , 2 6 1 9 5 1) 1 3 . 1) SOUTH AT L A N T IC 5 , 8 7 7 5 , 3 8 3 4 9 4) 9 . 2) TOTAL ATLANTIC 1 9 , 6 3 8 1 7 , 7 6 5 1 , 8 7 3 1 0 . 5 SOUTHERN AFRIC A 4 1 8 0 4 1 8) -) FAR EAST 1 , 3 7 5 1 , 6 1 4 ( 2 3 9 ) ( 1 4 . 8 ) C H A R T E R 2 , 9 1 3 2 , 8 6 9 4 4) 1 . 5) S PANISH GROUP 4 8 , 8 7 5 4 5 , 5 5 4 3 , 3 2 1 7 . 3

p-159 ANNUAL REPORT 1998 IBERIA GROUP CONSOLIDATED MANAGEMENT REPORT

Average production in terms of block hours was up 5.6% on 1997, slightly lower (0.4%) than projected. Despite the restrictions on the use of in-house resources, it was possible to maintain this level by arranging more wet lease transactions.

The variations in 1998 were as follows:

AV E R AGE PRODUCTION B L O C K H O U R S 1 9 9 8 1 9 9 7 VAR I AT I O N 98 / 9 7 % VAR I AT I O N IBERIA, L.A.E. + AV I AC O 4 0 0 , 9 5 2 3 7 9 , 2 1 9 2 1 , 7 3 3 5 . 7 AV I ACO (CHARTER) 3 , 1 3 8 5 , 1 2 9 ( 1 , 9 9 1 ) ( 3 8 . 8 ) V I VA 2 9 , 6 5 7 2 6 , 6 4 4 3 , 0 1 3) 1 1 . 3) BINTER CANARIAS 2 0 , 7 6 4 1 8 , 5 8 7 2 , 1 7 7) 1 1 . 7) BINTER MEDITERRANEO 5 , 7 9 3 6 , 2 0 2 ( 4 0 9 ) ( 6 . 6 ) S PANISH GROUP 4 6 0 , 3 0 4 4 3 5 , 7 8 1 2 4 , 5 2 3 5 . 6

2.2. DEMAND The IBERIA Group carried slightly over 25 million passengers in 1998, 5.1% more than in 1997. Noteworthy were the increases in the European network as a whole and on the Madrid-Barcelona shuttle, which carried a total of almost 1.8 million passengers.

The breakdown of passengers carried is as follows:

D E M A N D T H O U SA N D S O F P A S S E N G E R S 1 9 9 8 1 9 9 7 VAR I AT I O N 98 / 9 7 % VAR I AT I O N IBERIA, L.A.E. + AV I AC O 2 1 , 7 5 3 2 0 , 6 4 8 1 , 1 0 5 5 . 4 AV I ACO (CHARTER) 1 2 8 2 3 6 ( 1 0 8 ) ( 4 5 . 8 ) V I VA 1 , 3 4 7 1 , 1 4 2 2 0 5) 1 8 . 0) BINTER CANARIAS 1 , 5 9 0 1 , 5 8 5 5) 0 . 3) BINTER MEDITERRANEO 1 9 2 1 8 0 1 2) 6 . 7) S PANISH GROUP 2 5 , 0 1 0 2 3 , 7 9 1 1 , 2 1 9 5 . 1

p-160 ANNUAL REPORT 1998 IBERIA GROUP CONSOLIDATED MANAGEMENT REPORT

The breakdown, by network, is as follows:

BY NETWORK T H O U SA N D S O F P A S S E N G E R S PASSENGERS CARRIED

1 9 9 8 1 9 9 7 VAR I AT I O N 98 / 9 7 % VAR I AT I O N TOTAL OTHER 6.47 % TOTAL ATLANTIC 7.85 % TOTAL SPAIN MAD-BCN SHUTTLE 1 , 7 9 4 1 , 6 1 6 1 7 8) 1 1 . 0) 59.87 % MAINLAND-CANARIES 2 , 0 6 2 2 , 0 1 9 4 3) 2 . 1) CANARY ISLANDS 1 , 5 8 3 1 , 5 7 2 1 1) 0 . 7) OTHER NAT IO N A L 9 , 5 3 5 9 , 3 3 9 1 9 6) 2 . 1) TOTAL TOTAL SPA I N 1 4 , 9 7 4 1 4 , 5 4 6 4 2 8 2 . 9 EUROPE 25.79 % A F R ICA AND MIDDLE EAST 2 6 0 2 1 9 4 1) 1 8 . 7)

E.U. COUNTRIES 5 , 7 3 8 5 , 2 8 4 4 5 4) 8 . 6) 1998 NON E.U. COUNTRIES 4 5 4 3 9 7 5 7) 1 4 . 4) SPANISH GROUP: 25,010 TOTAL EUROPE 6 , 4 5 2 5 , 9 0 0 5 5 2 9 . 4 NORTH AT L A N T IC 6 6 9 6 4 5 2 4) 3 . 7) MID AT L A N T IC 8 3 7 7 4 3 9 4) 1 2 . 7) SOUTH AT L A N T IC 4 5 8 4 4 4 1 4) 3 . 2) ATLANTIC TOTAL 1 , 9 6 4 1 , 8 3 2 1 3 2 7 . 2 SOUTHERN AFRIC A 3 7 0 3 7) -) FAR EAST 1 0 0 1 2 5 ( 2 5 ) ( 2 0 . 0 ) C H A R T E R 1 , 4 8 3 1 , 3 8 8 9 5) 6 . 8) S PANISH GROUP 2 5 , 0 1 0 2 3 , 7 9 1 1 , 2 1 9 5 . 1

RPKs followed the same trend as ASKs, with minor variations in average hauls, which overall increased by 1.3%.

The detail by company and network is as follows (amounts in million RPKs):

BY COMPANY M I L L I O N R P K S 1 9 9 8 1 9 9 7 VAR I AT I O N 98 / 9 7 % VAR I AT I O N IBERIA, L.A.E. + AV I AC O 3 2 , 5 2 0 3 0 , 4 9 1 2 , 0 2 9 6 . 7 AV I ACO (CHARTER) 1 9 3 3 4 3 ( 1 5 0 ) ( 4 3 . 7 ) V I VA 2 , 1 5 7 1 , 9 0 0 2 5 7) 1 3 . 5) BINTER CANARIAS 2 7 4 2 7 8 ( 4 ) ( 1 . 4 ) BINTER MEDITERRANEO 4 6 4 4 2) 4 . 5) S PANISH GROUP 3 5 , 1 9 0 3 3 , 0 5 6 2 , 1 3 4 6 . 5

p-161 ANNUAL REPORT 1998 IBERIA GROUP CONSOLIDATED MANAGEMENT REPORT

REVENUE PASSENGERS KILOMETRE BY NETWORK M I L L I O N R P K S

TOTAL OTHER 10.12 % 1 9 9 8 1 9 9 7 VAR I AT I O N 98 / 9 7 % VAR I AT I O N TOTAL SPAIN 25.37 % MAD-BCN SHUTTLE 8 6 5 7 7 9 8 6) 1 1 . 0) MAINLAND-CANARIES 3 , 6 3 7 3 , 4 8 6 1 5 1) 4 . 3) CANARY ISLANDS 2 7 0 2 7 1 ( 1 ) ( 0 . 4 )

TOTAL OTHER NAT IO N A L 4 , 1 5 9 4 , 0 0 3 1 5 6) 3 . 9) TOTAL EUROPE ATLANTIC 22.90 % TOTAL SPA I N 8 , 9 3 1 8 , 5 3 9 3 9 2 4 . 6 41.59 % A F R ICA AND MIDDLE EAST 5 3 8 4 6 9 6 9) 1 4 . 7) 1998 SPANISH GROUP: 35,190 E.U. COUNTRIES 6 , 9 4 8 6 , 4 6 1 4 8 7) 7 . 5) NON E.U. COUNTRIES 5 7 5 4 9 2 8 3) 1 6 . 9) EUROPE TOTAL 8 , 0 6 1 7 , 4 2 2 6 3 9 8 . 6 NORTH AT L A N T IC 4 , 1 0 8 3 , 9 2 4 1 8 4) 4 . 7) MID AT L A N T IC 6 , 2 8 9 5 , 6 9 8 5 9 1) 1 0 . 4) SOUTH AT L A N T IC 4 , 2 3 9 4 , 0 6 1 1 7 8) 4 . 4) ATLANTIC TOTA L 1 4 , 6 3 6 1 3 , 6 8 3 9 5 3 7 . 0 SOUTHERN AFRIC A 2 9 6 0 2 9 6) -) FAR EAST 9 1 3 1 , 1 6 4 ( 2 5 1 ) ( 2 1 . 6 ) C H A R T E R 2 , 3 5 3 2 , 2 4 8 1 0 5) 4 . 7) S PANISH GROUP 3 5 , 1 9 0 3 3 , 0 5 6 2 , 1 3 4 6 . 5

2.3. PASSENGER LOAD FACTOR The Spanish Group’s load factor of 72% in 1998 was 0.6 percentage points lower than in 1997. This result can be viewed as satisfactory in view of the increase in supply and the inauguration in the year of new destinations (Johannesburg and Chicago), which PASSENGER LOAD FAC TOR BY COMPA N Y S initially have lower load factors than they will foreseeably have in the future. (in %)

1998 1997 The breakdown, by company and networks, is as follows:

PASSENGER LOAD FAC TOR L O A D F A C TO R % 1 9 9 8 1 9 9 7 VAR I AT I O N 98 / 9 7 % VAR I AT I O N IBERIA, L.A.E. + AV I AC O 7 1 . 4 7 2 . 2 ( 0 . 8 ) ( 1 . 1 ) AV I ACO (CHARTER) 8 1 . 8 7 8 . 7 3 . 1) 4 . 0) V I VA 8 0 . 7 7 8 . 3 2 . 4) 3 . 1) BINTER CANARIAS 7 2 . 5 6 9 . 0 3 . 5) 5 . 1) BINTER MEDITERRANEO 6 4 . 8 6 2 . 0 2 . 8) 4 . 5)

IBERIA, L.A.E. AVI AC O VI V A BI N T E R BI N T E R SPA N IS H S PANISH GROUP 7 2 . 0 7 2 . 6 ( 0 . 6 ) ( 0 . 8 ) + AVI AC O (C H A R T E R ) CA N A R I A S ME D I T E R R A N E O GR O U P

p-162 ANNUAL REPORT 1998 IBERIA GROUP CONSOLIDATED MANAGEMENT REPORT

BY NETWORK L O A D F A C TO R % PASSENGER LOAD FAC TOR BY MARKET (en %) 1 9 9 8 1 9 9 7 VAR I AT I O N 98 / 9 7 % VAR I AT I O N 1998 1997 MAD-BCN SHUTTLE 7 4 . 2 7 3 . 0 1 . 2) 1 . 6) MAINLAND-CANARIES 7 4 . 4 7 4 . 9 ( 0 . 5 ) ( 0 . 6 ) CANARY ISLANDS 7 2 . 4 6 9 . 0 3 . 4) 5 . 0) OTHER NAT IO N A L 6 6 . 7 6 4 . 0 2 . 7) 4 . 2) S PAIN TOTA L 7 0 . 5 6 9 . 0 1 . 5 2 . 2 A F R ICA AND MIDDLE EAST 6 4 . 0 6 6 . 1 ( 2 . 1 ) ( 3 . 2 ) E.U. COUNTRIES 6 8 . 6 6 8 . 1 0 . 5) 0 . 7) NON E.U. COUNTRIES 6 4 . 3 6 6 . 5 ( 2 . 2 ) ( 3 . 3 ) TOTAL TOTAL TOTAL SPANISH EUROPE TOTAL 6 7 . 9 6 7 . 9 0 . 1 0 . 1 SPAIN EUROPE ATLANTIC GROUP NORTH AT L A N T IC 7 4 . 0 7 6 . 6 ( 2 . 6 ) ( 3 . 4 ) MID AT L A N T IC 7 6 . 6 7 8 . 5 ( 1 . 9 ) ( 2 . 4 ) SOUTH AT L A N T IC 7 2 . 1 7 5 . 4 ( 3 . 3 ) ( 4 . 4 ) ATLANTIC TOTAL 7 4 . 5 7 7 . 0 ( 2 . 5 ) ( 3 . 2 ) SOUTHERN AFRIC A 7 0 . 8 --) -) FAR EAST 6 6 . 4 7 2 . 1 ( 5 . 7 ) ( 7 . 9 ) C H A R T E R 8 0 . 8 7 8 . 4 2 . 4) 3 . 1) S PANISH GROUP 7 2 . 0 7 2 . 6 ( 0 . 6 ) ( 0 . 8 )

2.4. AVERAGE YIELD The detail of the variations in the average yield, by area/company, in 1998, and of the comparable figures for 1997 is as follows:

AV E R AGE YIELD P T A S . / R P K AV E R AGE YIELD BY COMPA Ñ Y S (en Pts. / P K T )

1 9 9 8 1 9 9 7 VAR I AT I O N 98 / 9 7 % VAR I AT I O N 1998 1997 IBERIA, L.A.E. + AV I AC O 1 4 . 8 1 4 . 3 0 . 5 3 . 3 AV I ACO (CHARTER) 9 . 3 9 . 1 0 . 2) 2 . 3) V I VA 8 . 7 8 . 5 0 . 2) 2 . 5) BINTER CANARIAS 3 9 . 3 3 8 . 3 1 . 0) 2 . 7) BINTER MEDITERRANEO 4 5 . 1 4 1 . 3 3 . 8) 9 . 3) S PANISH GROUP 1 4 . 6 1 4 . 2 0 . 5 3 . 2

IBERIA, L.A.E. AVI AC O VI V A BI N T E R BI N T E R SPA N IS H + AVI AC O (C H A R T E R ) CA N A R I A S ME D I T E R R A N E O GR O U P

p-163 ANNUAL REPORT 1998 IBERIA GROUP CONSOLIDATED MANAGEMENT REPORT

The detail of the variations in the average yield, by market, in 1998, and of the comparable figures for 1997 is as follows:

AV E R AGE YIELD BY MARKET AV E R AGE YIELD BY MARKET P T A S . / R P K (in Pts. / P K T ) AR I AT I O N AR I AT I O N 1998 1997 1 9 9 8 1 9 9 7 V 98 / 9 7 % V MAD-BCN SHUTTLE 2 7 . 8 2 6 . 2 1 . 6) 6 . 2) MAINLAND-CANARIES 1 1 . 8 1 0 . 9 1 . 0) 9 . 0) CANARY ISLANDS 3 9 . 6 3 8 . 7 0 . 9) 2 . 3) OTHER NAT IO N A L 2 7 . 7 2 6 . 6 1 . 1) 4 . 2) S PAIN TOTA L 2 1 . 6 2 0 . 5 1 . 1 5 . 3 A F R ICA AND MIDDLE EAST 1 6 . 0 1 5 . 5 0 . 5) 3 . 3) E.U. COUNTRIES 2 1 . 2 2 0 . 5 0 . 7) 3 . 6) TOTAL TOTAL TOTAL SPANISH SPAIN EUROPE ATLANTIC GROUP NON E.U. COUNTRIES 2 1 . 9 2 2 . 2 ( 0 . 3 ) ( 1 . 1 ) EUROPE TOTAL 2 0 . 9 2 0 . 3 0 . 6 3 . 2 NORTH AT L A N T IC 8 . 2 7 . 9 0 . 3) 3 . 9) MID AT L A N T IC 8 . 4 8 . 2 0 . 2) 2 . 6) SOUTH AT L A N T IC 8 . 2 8 . 2 0 . 0) 0 . 0) ATLANTIC TOTAL 8 . 3 8 . 1 0 . 2 2 . 2 SOUTHERN AFRIC A 5 . 9 --) -) FAR EAST 1 0 . 3 1 0 . 7 ( 0 . 4 ) ( 3 . 6 ) C H A R T E R 8 . 8 8 . 6 0 . 2) 2 . 0) S PANISH GROUP 1 4 . 6 1 4 . 2 0 . 5 3 . 2

The significant increase of over 3% in the average yield, which was partially (20%) due to the increase in the value of the peseta with respect to the U.S. dollar, was mainly due to the new fares for different markets in response to the higher demand, to the implementation of marketing improvement programs (revenue management tools, the creation of agency services, etc.) and to the greater attention paid to business classes.

p-164 ANNUAL REPORT 1998 IBERIA GROUP CONSOLIDATED MANAGEMENT REPORT

2.5. PASSENGER REVENUES The breakdown of the Spanish Group's passenger revenues in 1998, which amounted to Ptas. 514,469 million (up 9.9% on 1997) is as follows:

PASSENGER REVENUES M I L L I O N S O F P E S E TA S 1 9 9 8 1 9 9 7 VAR I AT I O N 98 / 9 7 % VAR I AT I O N IBERIA, L.A.E. + AV I AC O 4 8 1 , 0 2 6 4 3 6 , 4 1 0 4 4 , 6 1 6 1 0 . 2 AV I ACO (CHARTER) 1 , 7 8 8 3 , 1 0 6 ( 1 , 3 1 8 ) ( 4 2 . 4 ) V I VA 1 8 , 8 0 1 1 6 , 1 5 5 2 , 6 4 6) 1 6 . 4) BINTER CANARIAS 1 0 , 7 8 0 1 0 , 6 4 8 1 3 2) 1 . 2) BINTER MEDITERRANEO 2 , 0 7 4 1 , 8 1 5 2 5 9) 1 4 . 3) S PANISH GROUP 5 1 4 , 4 6 9 4 6 8 , 1 3 4 4 6 , 3 3 5 9 . 9

The variations, by item, in 1998 in passenger revenues with respect to 1997 and the reconciliation to the revenues per books were as follows:

PASSENGER REVENUES WITH RESPECT TO 1997 M I L L I O N S O F P E S E TA S

VARIATION IN C A U S E O F T H E V A R I AT I O N VA R I AT I O N I N PASSENGER REVENUES PER REV E N U E S 98 / 9 7 PR I C E VO L U M E PA R I T Y OT H E R BOOKS 98 / 9 7

DOMESTIC 17,336) 9,128) 7,920) 288 -) -) E.U. COUNTRIES 15,211) 3,571) 10,269) 1,371 -) -) NON E.U. COUNTRIES 3,038) 6) 2,854) 178 -) -) LONG-HAUL 9,031) (585) 8,286) 1,330 -) -) IBERIA, L.A.E. + AVIACO 44,616 12,120 29,329 3,167 14,742 59,356 AVIACO (CHARTER) (1,318) (112) (1,206) - -) (1,318) VIVA 2,646) 213) 2,252) 181 0) 2,646) BINTER CANARIAS 132) 222) (90) - (59) 73) BINTER MEDITERRANEO 258) 144) 114) - (13) 245) SPANISH GROUP 46,335 12,587 30,399 3,348 14,669 61,002

p-165 ANNUAL REPORT 1998 IBERIA GROUP CONSOLIDATED MANAGEMENT REPORT

The detail, by network, of passenger revenues is as follows:

PASSENGER REVENUES BY NETWORK M I L L I O N S O F P E S E TA S TOTAL OTHER 6.18 % 1 9 9 8 1 9 9 7 VAR I AT I O N 98 / 9 7 % VAR I AT I O N TOTAL SPAIN TOTAL 37.53 % ATLANTIC MAD-BCN SHUTTLE 2 4 , 0 7 7 2 0 , 4 2 5 3 , 6 5 2) 1 7 . 9) 23.52 % MAINLAND-CANARIES 4 3 , 0 7 5 3 7 , 8 8 0 5 , 1 9 5) 1 3 . 7) CANARY ISLANDS 1 0 , 6 9 9 1 0 , 4 9 4 2 0 5) 2 . 0) OTHER NAT IO N A L 1 1 5 , 2 3 5 1 0 6 , 4 8 6 8 , 7 4 9) 8 . 2)

TOTAL EUROPE S PAIN TOTA L 1 9 3 , 0 8 6 1 7 5 , 2 8 5 1 7 , 8 0 1 1 0 . 2 32.75 % A F R ICA AND MIDDLE EAST 8 , 6 0 6 7 , 2 6 2 1 , 3 4 4) 1 8 . 5) 1998 E.U. COUNTRIES 1 4 7 , 3 3 6 1 3 2 , 1 9 0 1 5 , 1 4 6) 1 1 . 5) SPANISH GROUP: 514,469 NON E.U. COUNTRIES 1 2 , 5 9 3 1 0 , 8 9 9 1 , 6 9 4) 1 5 . 5) EUROPE TOTAL 1 6 8 , 5 3 5 1 5 0 , 3 5 1 1 8 , 1 8 4 1 2 . 1 NORTH AT L A N T IC 3 3 , 5 0 7 3 0 , 8 1 5 2 , 6 9 2) 8 . 7) MID AT L A N T IC 5 2 , 7 5 2 4 6 , 5 8 6 6 , 1 6 6) 1 3 . 2) SOUTH AT L A N T IC 3 4 , 7 6 0 3 3 , 2 9 6 1 , 4 6 4) 4 . 4) ATLANTIC TOTAL 1 2 1 , 0 1 9 1 1 0 , 6 9 7 1 0 , 3 2 2 9 . 3 SOUTHERN AFRIC A 1 , 7 4 7 0 1 , 7 4 7) -) FAR EAST 9 , 4 0 3 1 2 , 4 4 1 ( 3 , 0 3 8 ) ( 2 4 . 4 ) C H A R T E R 2 0 , 6 7 9 1 9 , 3 6 0 1 , 3 1 9) 6 . 8) S PANISH GROUP 5 1 4 , 4 6 9 4 6 8 , 1 3 4 4 6 , 3 3 5 9 . 9

The significant improvement in revenues, mainly due to the increases in demand, was evident in all markets, except for the Far East, where revenues dropped by Ptas. 3,038 mi l l i on, ref l e c t i n g the crisis in Asi a.

[3] SUMMARY BY SUBSIDIARY

3.1. AVIACO In addi t i on to the services prov i ded by Avi aco to IBERIA, under their joint schedu l i n g and marketing arrangement, this company also operated on a marginal basis in the charter flight market, and obtained a variable cost margin of approximately 35% of the revenues earned.

p-166 ANNUAL REPORT 1998 IBERIA GROUP CONSOLIDATED MANAGEMENT REPORT

In 1998 Aviaco substantially completed the process of adapting its structure and organization to its function, approved in the Master Plan, as an IBERIA Group operator.

Pursuant to the Master Plan, and in order to integrate Aviaco’s business activities other than as an operator within the IBERIA Group, in 1998 an internal reorganization of the company was carried out by reducing its labor force and renegotiating the terms of employment in terms of productivity and compensation. The labor force was reduced in two ways: through voluntary redundancies and early retirements under a Labor Force Plan; and through the transfer of certain employees to IBERIA, except Mahón airport, the employees at which are scheduled to be transferred in 1999.

The flight personnel were nor affected by Aviaco’s specialization as an operator, and were actually favored by the increased production deriving from joint scheduling.

Aviaco’s aircraft flew 83,547 block hours under the IBERIA Group’s joint scheduling of scheduled flights. 3,138 block hours were flown on charter flights. A total of 86,685 hours (disregarding nonproductive hours), were flown in 1998, up 4% from 1997 in terms of commercial hours.

In accordance with anti-noise legislation restricting the use of civil subsonic aircrafts, in 1998 the required hush-kits were acquired for four DC-9 aircraft and their spare engines. Installation of the hush-kits was completed in three of the four aircraft whose grace periods expired in 1998, and adaptation of the fourth aircraft will be completed in early 1999.

The main parameters of the company are as follows:

AV I AC O 1 9 9 8 1 9 9 7 VAR I AT I O N 98 / 9 7 % VAR I AT I O N

TOTA L BL O C K HO U R S 86,685 83,348 3,337) 4.0) OPERATING REVENUE (M. PTAS.) 4,092 5,205 (1,113) (21.4) NE T IN C O M E ( LO S S) A F T E R TA X E S (M. PTA S. ) 2,414 3,248 (834) (25.7) EQ U I VA L E N T F U L L-T I M E E M P L OY E E S (NUMBER) 1,719 1,888 (169) (9.0)

p-167 ANNUAL REPORT 1998 IBERIA GROUP CONSOLIDATED MANAGEMENT REPORT

3.2. BINTER CANARIAS The competition from shipping (Fred Olsen, Trasmediterránea and Naviera Armas on the SPC-TFS, LPA-FUE and LPA-TFS routes) in terms of passengers and freight continued in 1998.

Competition from the airline Canarias Regional in this second year of operations focused principally on the ACE-TFN and ACE-LPA routes. However, this airline did not achieve its objective because its market share leveled out at 1997 levels due to the financial difficulties it is experiencing.

The drop in Binter’s supply arose basically on the routes involving ACE and on the LPA-FUE and LPA-SPC routes, with supply increasing on the LPA-TFN and SPC-TFN routes. Total passenger demand rose slightly. The biggest drop in passenger numbers was on the ACE-LPA and SPC-TFN routes, but with demand increasing on the FUE-LPA, FUE-TFN and TFN-LPA routes.

The load factor increased from 69% in 1997 to 72% in 1998 on almost all routes. The yield showed a slight improvement on regular flights, from Ptas. 38.7 in 1997 to Ptas. 39.6 in 1998.

Net revenues increased by Ptas. 95 million in 1998, due mainly to the lower availability of hold capacity since the ATR aircraft do not have such large holds as the DC-9 aircraft. Passenger revenues increased by Ptas. 73 million, largely as a result of the increase in passenger numbers and of the fact that fares were Ptas. 1,000 lower per route than in the first quarter of 1997.

In 1998 the quality indicators showed slightly improved regularity and punctuality, from 90% in 1997 to 92% in 1998.

In 1998 the company basically operated nine ATR-72 aircraft, of which six were owned outright and three were leased, except in the first quarter, in which it was still operating a DC-9 plane, and from April 10 through October 12, when it operated a B-727 plane owned by IBERIA.

p-168 ANNUAL REPORT 1998 IBERIA GROUP CONSOLIDATED MANAGEMENT REPORT

The variations in the main parameters in 1998 and 1997 were as follows:

BINTER CANARIAS VARIATION % 1998 1997 98/97 VARIATION

MI L L IO N A S K ’S 3 7 3 4 0 3 ( 3 0 ) ( 5 . 9 ) MI L L IO N R P K ’S 2 7 0 2 7 8 ( 8 ) ( 1 . 1 ) LOA D FAC TO R ( % ) 7 2 . 5 6 9 . 1 3 . 4) 5 . 2) YI E L D ( PTA S. / R P K ) 3 9 . 6 3 8 . 3 1 . 3) 2 . 4) PA S S E N G E R R E V E N U E S ( MI L L IO N S O F PTA S. ) 1 0 , 6 9 9 1 0 , 6 4 8 5 1) 1 . 3) OP E R AT I N G R E V E N U E ( MI L L IO N S O F PTA S. ) 8 1 3 4 0 9 4 0 4) 9 8 . 8) NET INC O M E (L OS S ) AF T E R TAX E S (M IL L IO N S OF PTAS .) 1 , 2 6 8 3 3 2 9 3 6) 2 8 1 . 9) EQ U I VA L E N T F U L L-T I M E E M P L OY E E S ( NU M B E R) 3 0 4 2 9 4 1 0) 3 . 3)

3.3. BINTER MEDITERRANEO Bi n ter Med i t e r r á n eo’s perfor ma n ce on its main route (AGP-MLN) was clearly neg a t i v e un til August, with a mar k et share of only 44%. How e v e r , after the trag i c acciden t involving a PauknAir aircr aft on September 25, the tren d was rev e r s e d , with the mar k et share cl i m b i n g to 55% and, from October onwa rd s , Binter Med i t e r r · n eo was the only operator on this rou t e . On the other route (LEI-MLN) on which the company faces competition, it had a high er mar k et share (57% in August, 65% in September and 100% from October onwa rd s ) .

The company’s overall performance in 1998 was positive, thanks to the recovery in the last quarter. Demand increased by around 12,000 passengers and the load factor by 4 percentage points.

The main parameters of the company are as follows:

BINTER MEDITERRANEO VARIATION % 1998 1997 98/97 VARIATION

MI L L IO N A S K ’S 7 1) 7 1) -) -) MI L L IO N R P K ’S 4 6) 4 4) 2) 6 . 2) LOA D FAC TO R ( % ) 6 5 . 6) 6 1 . 7) 3 . 9) 6 . 3) YI E L D ( PTA S. / R P K ) 4 4 . 7) 4 1 . 6) 3 . 1) 7 . 7) PA S S E N G E R R E V E N U E S ( MI L L IO N S O F PTA S. ) 2 , 0 6 5) 1 , 8 1 5) 2 5 0) 1 4 . 4) OP E R AT I N G R E V E N U E ( MI L L IO N S O F PTA S. ) ( 2 7 8 ) ( 3 4 2 ) 6 4) 1 9 . 0) NET INC O M E (L OS S ) AF T E R TAX E S (M IL L IO N S OF PTAS .) ( 3 9 7 ) ( 3 7 1 ) ( 2 6 ) ( 7 . 0 ) EQ U I VA L E N T F U L L-T I M E E M P L OY E E S ( NU M B E R) 5 5) 6 3) ( 8 ) ( 1 2 . 7 )

p-169 ANNUAL REPORT 1998 IBERIA GROUP CONSOLIDATED MANAGEMENT REPORT

3.4. VIVA AIR Fr om the beginning of the year, Viva Air’s operat io n s were mar k ed by the unce r t a i nt y s u r ro u nd i ng the company’s future, as since mid-1997 it has been hoped to reach an agreement, so far without success, enabling the company’s aircraft to operate scheduled f l ig hts in the IBERIA network. Ac c o rd i ng l y, the company had to operate charter flight s t h ro u g hout 1998, and was unable to inc rease technical crew numbers to meet the g ro w i ng de ma nd. Fina l l y, in October Group ma na ge me nt anno u nced the closure of t he company.

S u p p l y, re v e nues and pro ductivity inc reased notably with respect to 1997. A l t hough this improved earning s, the company’s after-tax loss was still high (Ptas. 1,114 millio n ) .

Throughout 1998 Viva Air had nine B-737/300 aircraft, which flew 27,964 block hours (including 234 chartered block hours). The average daily utilization of the aircraft was 8.51 block hours, and 28,973 block hours of charter flights were sold, making it necessary to charter third-party aircraft (Canarias Regional Air aircraft, among other) to meet a portion (1,927 block hours) of demand.

In the maintenance area, Viva Air maintained an average of 12.8 aircraft (annual average of 9 proprietary aircraft, 5 Air Europa aircraft from April and one CRA aircraft in the summer).

The main parameters of the company are as follows:

V I VA AIR VARIATION % 1998 1997 98/97 VARIATION

BL O C K HO U R S 2 9 , 6 5 7) 2 6 , 6 4 4) 3 , 0 1 3 1 1 . 3 AV E R AG E R E V E N U E/ BL O C K HO U R 6 4 8 , 9 2 3) 6 2 3 , 4 2 6) 2 5 , 4 9 7 4 . 1 OP E R AT I N G I N C O M E ( MI L L IO N S O F PTA S. ) ( 1 , 0 2 0 ) ( 1 , 5 2 1 ) 5 0 1 3 2 . 9 NE T IN C O M E A F T E R TA X E S ( MI L L IO N S O F PTA S. ) ( 1 , 1 1 4 ) ( 1 , 5 9 4 ) 4 8 0 3 0 . 1 EQ U I VA L E N T F U L L-T I M E E M P L OY E E S ( NU M B E R) 4 3 0) 4 2 1) 9 2 . 0

p-170 ANNUAL REPORT 1998 IBERIA GROUP CONSOLIDATED MANAGEMENT REPORT

3.5. SAVIA In line with the technological renewal policy, 5,000 computers were replaced in 1998. To cater for the increase in demand at agencies which wish to connect with the service provided by SAVIA, the company continued its policy of investing in computer equipment. The number of agencies connected to the system rose by 7% from 4,040 in 1997 to 4,317 in 1998. The number of terminals increased from 9,448 in 1997 to 11,392 in 1998. Flight and hotel reservations and car rentals increased by 7.1% to 21.4 million, and revenues rose by around 6%.

Amadeus became a company shareholder in 1998 with a 34% holding.

In 1998 Savia-Amadeus started to operate in the Portuguese market, where it currently operates through one branch.

The main parameters of the company are as follows:

SAVIA VARIATION % 1998 1997 98/97 VARIATION

OP E R AT I N G R E V E N U E ( MI L L IO N S O F PTA S. ) 8 , 2 6 8 7 , 8 2 0 4 4 8) 5 . 7) OP E R AT I N G I N C O M E ( MI L L IO N S O F PTA S. ) 4 2 8 3 8 0 4 8) 1 2 . 7) EQ U I VA L E N T F U L L-T I M E E M P L OY E E S ( NU M B E R) 5 4 3 2 2 2) 6 9) NE T IN C O M E A F T E R TA X E S ( MI L L IO N S O F PTA S. ) 2 3 8 2 7 0 ( 3 2 ) ( 1 1 . 6 )

p-171 ANNUAL REPORT 1998 IBERIA GROUP CONSOLIDATED MANAGEMENT REPORT

3.6. IBER-SWISS CATERING In October 1997 Sociedad Estatal de Participaciones Industriales (SEPI) authorized the construction of a new workplace in Barcelona to provide catering services at Barcelona airport. The inauguration of this location is scheduled for the beginning of 1999. As of December 31, 1998, 246 employees had been hired at this workplace.

The company’s volume of business in 1998, measured in terms of the number of trays, was 21.6% higher than in 1997, due mainly to the higher demand from IBERIA and the full inclusion of Aviaco, despite the elimination by Asian airline customers of their Madrid routes.

This Company’s main parameters are as follows:

IBER-SWISS CATERING VARIATION % 1998 1997 98/97 VARIATION

PR O D U C T IO N O F F O O D-T R AY S (T HO USA N D S) 8 , 3 6 7 6 , 8 8 0 1 , 4 8 7 2 1 . 6 PL A N E S S E R V E D (U N I TS) 9 7 , 5 3 4 7 0 , 6 5 2 2 6 , 8 8 2 3 8 . 0 AV E R AG E H E A D-C O U N T 1 , 0 7 6 9 4 2 1 3 4 1 4 . 2 FO O D-T R AY S P E R E M P L OY E E 7 , 7 7 9 7 , 3 0 6 4 7 5 6.5 OP E R AT I N G R E V E N U E S ( MI L L IO N S O F PTA S. ) 7 , 6 3 5 6 , 5 2 6 1 , 1 0 9 1 7 . 0 OP E R AT I N G I N C O M E ( MI L L IO N S O F PTA S. ) 3 9 7 1 4 8 2 4 9 1 3 . 5 NE T IN C O M E A F T E R TA X E S ( MI L L IO N S O F PTA S. ) 2 6 5 7 5 1 9 0 2 5 3 . 7

3.7. CACESA

As scheduled, this company built a warehouse and offices at the new Madrid-Barajas Air Freight Center and moved out of the premises that it rented in Coslada. These new buildings were added in April 1998.

The company’s total sales did not vary significantly from those achieved in 1997, a year in which the sale of atypical products (livestock boarding) and the effect of the air transport strike led to a considerable increase in sales.

Sales of the Ibexpress service increased by 1,7%. The incorporation in the second half of the year of airport-to-airport wholesaler customers generated significant billings. Ibexpress Internacional services grew by 40% and billings by 25%.

p-172 ANNUAL REPORT 1998 IBERIA GROUP CONSOLIDATED MANAGEMENT REPORT

Sales of the Ibertras product dropped slightly with respect to the previous year, despite the lack of atypical product sales in 1998. Work continued on developing the international network, and certain agreements are currently in force in the main Latin American countries.

This Company’s main aggregates are as follows:

C AC E SA VARIATION % 1998 1997 98/97 VARIATION

IB E X P R E S S R E V E N U E S ( MI L L IO N S O F PTA S.) 1 , 2 6 4 1 , 2 4 3 2 1) 1 . 7) IB E R T R A S A É R E O R E V E N U E S ( MI L L IO N S O F PTA S. ) 2 , 0 3 9 2 , 1 5 5 ( 1 1 6 ) ( 5 . 4 ) IBERTRAS MARÍTIMO REVENUES (MILLIONS OF PTAS.) 8 3 7 5 8) 1 1 . 2) EQ U I VA L E N T F U L L-T I M E E M P L OY E E S 1 2 3 1 2 5 ( 2 ) ( 1 . 4 ) OP E R AT I N G I N C O M E ( MI L L IO N S O F PTA S. ) 7 4 7 2 2) 3 . 0) NE T I N C O M E A F T E R TA X E S ( MI L L IO N S O F PTA S. ) 5 2 4 4 8) 1 8 . 1)

3.8. CAMPOS VELAZQUEZ The main event in 1998 was the discontinuation of the company’s operations as of December 31, 1998.

The decrease in operating results was due to the personnel expenses incurred as a result of the unforeseen extraordinary employee terminations and, mainly, of the provision recorded for the termination indemnity payments that will be made in the first few months of 1999.

On December 30, 1998, the deposit of Ptas. 3,000 million made at Infoinvest, S.A. was canceled on maturity. The Special Shareholders’ Meeting resolved to distribute voluntary reserves, prior years’ retained earnings and an interim dividend totaling Ptas. 3,360 million among the shareholders.

The company’s main aggregates are summarized as follows:

CAMPOS VELAZQUEZ VARIATION % 1998 1997 98/97 VARIATION

EQ U I VA L E N T F U L L-T I M E E M P L OY E E S 9) 1 0) -) -) OP E R AT I N G R E V E N U E S ( MI L L IO N S O F PTA S. ) 2 5 8) 2 4 4) 1 4) 5 . 7) OP E R AT I N G L O S S ( MI L L IO N S O F PTA S. ) ( 8 8 ) ( 4 ) ( 8 4 ) N . K .) NE T I N C O M E A F T E R TA X E S ( MI L L IO N S O F PTA S. ) 1 9 1) 2 5 2) ( 6 1 ) ( 2 4 . 2 )

p-173 ANNUAL REPORT 1998 IBERIA GROUP CONSOLIDATED MANAGEMENT REPORT

[4] RESOURCES

4.1. FLEET The detail of the aircraft operated by the Group as of December 31, 1998, is as follows:

F L E E T AI R C R A F T BI N T E R BI N T E R TOTA L TY P E IB E R I A AV I AC O VI VA CA N A R.ME D I T.OW N E D W E T B - 7 2 7 25 - - - - 2 5 - B-737 - - 9 - - 93 B-747 7 - - - - 7 2 B-757 8 - - - - 8 6 B - 7 6 7 ------2 A- 3 0 0 6 - - - - 6 - A-320 2 2 - - - - 2 2 - A-340 8 - - - - 8- DC-9 6 19 - - - 2 5 - DC-10 4 - - - - 4- OT H E R ------1 D C - 8 ------2 MD-87 24 - - - - 2 4 - There are also two inactive A-300 aircraft. MD-88 -13 - - - 1 3 - There is one inactive Binter Canarias CN-235 aircraft. CN-235 - - - - 3 3- In addition to those shown above, there are two CN-235 leased to Austral. ATR-72 - - - 9 - 9- One Iberia DC-9 has been TOTAL 110 32 9 9 3 1 6 3 16 inactive since November.

These numbers are the result of the following changes in 1998:

p-174 ANNUAL REPORT 1998 IBERIA GROUP CONSOLIDATED MANAGEMENT REPORT

The usage of the Spanish Group’s aircraft, in terms of total block hours per aircraft per day, was as follows:

FLEET UTILIZAT I O N 1 9 9 8 1 9 9 7 B - 7 2 7 4 . 9 5 . 2 B-737 (VI VA) 8 . 5 8 . 3 B-747 1 0 . 5 1 1 . 5 B-747M 7 . 8 1 1 . 6 B-757 7 . 5 6 . 9 DC-8 (F R E IG H T) 4 . 7 7 . 6 DC-9 IB E R I A 5 . 1 4 . 9 DC-9 AV I AC O 7 . 1 7 . 6 DC-10 1 0 . 5 1 2 . 7 MD-87 6 . 9 7 . 4 MD-88 7 . 8 7 . 6 A- 3 0 0 6 . 4 6 . 9 A-320 7 . 0 8 . 0 A- 3 4 0 1 0 . 3 1 1 . 7 CN-235 BI N T E R ME D I T E R R Á N E O 4 . 5 4 . 5 ATR-72 6 . 2 5 . 7

4.2. PERSONNEL In performing a comparative analysis of the headcount, it should be taken into account that, pursuant to the management system defined in the Master Plan, from the beginning of 1998 the figures reflect the decentralization of functions in the personnel, administration, economic control and procurement areas from the Central Services to the Maintenance, Handling, Systems and Freight Divisions and, in addition, that in 1998 Aviaco employees were transferred to IBERIA’s Commercial, Revenue Management, Systems and Handling Departments (except at Mahón airport).

p-175 ANNUAL REPORT 1998 IBERIA GROUP CONSOLIDATED MANAGEMENT REPORT

4.2.1. HEADCOUNT T he detail of the avera ge and year-end he a dc o u nt in 1998 and 1997 is as fo l l o w s :

AVERAGE ANNUAL HEADCOUNT

G R O U N D F L I G H T T OT A L 1 9 9 71 9 9 811 9 9 71 9 9 8 1 9 9 7 1 9 9 8 1 9 9 7

IBERIA, L.A.E. 17,540 17,100 4,525 4,424 22,065 21,525 AVIACO 836 1,036 883 852 1,719 1,888 VIVA 235 229 195 192 430 421 BINTER CANARIAS 156 151 148 143 304 294 BINTER MEDITERRANEO 25 28 30 35 55 63 CAMPOS VELAZQUEZ 9 9 9 9 CACESA 122 124 122 124 IBER-SWISS 1,068 942 1,068 942 SAVIA 54 32 54 32 AIR TRANSPORT GROUP 20,045 19,651 5,781 5,646 25,826 25,297

YEAR-END HEADCOUNT

G R O U N D F L I G H T T OT A L 1 9 9 71 9 9 811 9 9 71 9 9 8 1 9 9 7 1 9 9 8 1 9 9 7

IBERIA, L.A.E. 19,139 18,023 4,827 4,449 23,966 22,472 AVIACO 565 965 876 880 1,441 1,845 VIVA 237 224 177 187 414 411 BINTER CANARIAS 161 150 145 146 306 296 BINTER MEDITERRANEO 24 27 27 33 51 60 CAMPOS VELAZQUEZ 9 9 9 9 CACESA 121 123 121 123 IBER-SWISS 1,337 987 1,337 987 SAVIA 61 47 61 47 AIR TRANSPORT GROUP 21,654 20,555 6,052 5,695 27,706 26,250

p-176 ANNUAL REPORT 1998 IBERIA GROUP CONSOLIDATED MANAGEMENT REPORT

4.2.3. PRODUCTIVITY The percentage variations in the productivity of the Air Transport Group companies, measured in terms of ASK/employee, were as follows:

PRODUCTIVITY A S K / E M P L O Y E E G R O U N D TE C H N I C A L CR E W C A B I N C R E W TOTA L 9 8 9 7 9 8 9 7 9 8 9 7 9 8 9 7 I B E R I A + AV I AC O 2 . 4 9 2 . 3 5 2 5 . 3 5 2 3 . 8 0 1 2 . 7 0 1 2 . 2 9 1 . 9 2 1 . 8 2 V I VA 1 1 . 3 7 1 0 . 6 0 3 8 . 5 2 3 4 . 8 1 2 1 . 3 0 1 9 . 7 8 6 . 2 2 5 . 7 6 BINTER CANARIAS 2 . 4 2 2 . 6 7 5 . 3 1 6 . 5 0 4 . 9 3 4 . 9 8 1 . 2 4 1 . 3 7 BINTER MEDITERRANEO 2 . 7 9 2 . 5 3 3 . 5 5 2 . 8 6 7 . 4 3 7 . 0 1 1 . 2 9 1 . 1 3 AIR TRANSPORT GROUP 2 . 6 0 2 . 4 6 2 4 . 8 7 2 3 . 3 7 1 2 . 8 1 1 2 . 3 7 1 . 9 9 1 . 8 9

[5] OPERATING INCOME AT AIR TRANSPORT GROUP

5.1. OPERATING INCOME BY COMPANY Total operating income for 1998 amounted to Ptas. 52,461 million, and the detail by company is as follows (in millions of pesetas):

BY COMPANY M I L L I O N S O F P E S E TA S 1 9 9 8 1 9 9 7 I B E R I A 4 7 , 9 7 9) 3 5 , 9 5 0) AV I AC O 4 , 0 9 2) 5 , 2 0 5) V I VA ( 1 , 0 2 0 ) ( 1 , 5 2 1 ) BINTER CANARIAS 8 1 3) 4 0 9) BINTER MEDITERRANEO ( 2 7 8 ) ( 3 4 2 ) C AC E SA 7 4) 7 2) C A R G O S U R 1 0 0) ( 1 8 6 ) SAV I A 4 2 8) 3 8 0) I B E R S W IS S 3 9 8) 1 4 8) CAMPOS VELAZQUEZ ( 8 8 ) ( 4 ) AIR TRANSPORT GROUP 5 2 , 4 6 1 4 0 , 0 4 7 (Excluding the results of the consolidation adjustments).

p-177 ANNUAL REPORT 1998 IBERIA GROUP CONSOLIDATED MANAGEMENT REPORT

T he summarized detail of the Air Tra nsport Group’s opera t i ng account fo r management accounting purposes, which differs from the statement of income in the Group’s financial statements because the revenue and expense items are aggregated using management accounting criteria, is as follows (in millions of pesetas):

O P E R ATING ACCOUNT M I L L I O N S O F P E S E TA S 1 9 9 8 1 9 9 7 % VARIATION O P E R ATING REVENUES PA S S E N G E R 5 2 9 , 7 5 7 4 6 8 , 7 5 5 1 3 . 0) FR E IG H T A N D E XC E S S BAG GAG E 3 9 , 3 2 0 4 0 , 9 7 7 ( 4 . 0 ) HA N D L I N G 3 9 , 5 3 0 4 0 , 8 7 1 ( 3 . 3 ) MA I N T E N A N C E 1 8 , 7 1 2 1 4 , 3 3 9 3 0 . 5) SA L E S C O M M IS S IO N S 1 0 , 0 0 1 8 , 1 0 9 2 3 . 3) CAT E R I N G SA L E S 3 , 8 7 0 3 , 8 9 9 ( 0 . 7 ) OT H E R O P E R AT I N G R E V E N U E S 2 3 , 6 3 9 3 2 , 2 3 9 ( 2 6 . 7 ) 6 6 4 , 8 2 9 6 0 9 , 1 8 8 9 . 1 O P E R ATING EXPENSES FU E L 5 8 , 4 6 5 6 0 , 2 2 8 ( 2 . 9 ) PE R S O N N E L E X P E N S E S 1 9 7 , 0 4 3 1 9 0 , 4 5 1 3 . 5) TR A F F IC S E R V IC E S 5 1 , 6 3 8 4 5 , 6 5 7 1 3 . 1) IN-F L IG H T S E R V IC E S 1 2 , 0 7 0 1 1 , 9 3 7 1 . 1) CO M M IS S IO N S 7 3 , 7 4 2 6 5 , 6 1 1 1 2 . 4) NAV IGAT IO N A I D S 2 7 , 9 7 0 2 3 , 7 4 9 1 7 . 8) AI R C R A F T M A I N T E N A N C E 4 0 , 4 8 4 3 0 , 9 9 3 3 0 . 6) AI R C R A F T L E A S E E X P E N S E S 4 5 , 9 9 7 2 7 , 2 5 8 6 8 . 7) PE R IO D D E P R E C I AT IO N A N D A MO R T I Z AT IO N 2 6 , 3 2 7 3 7 , 5 7 8 ( 2 9 . 9 ) BO O K I N G SY S T E M 1 4 , 9 9 0 1 2 , 2 4 4 2 2 . 4) ROYA LT I E S 5 , 2 5 9 1 0 , 0 0 7 ( 4 7 . 4 ) OT H E R O P E R AT I N G E X P E N S E S 5 8 , 3 8 3 5 3 , 4 2 7 9 . 3) 6 1 2 , 3 6 8 5 6 9 , 1 4 1 7 . 6 O P E R ATING INCOME 5 2 , 4 6 1 4 0 , 0 4 7 3 1 . 0

The main comments on the operating account are as follows:

A)AIR TRANSPORT GROUP OPERATING REVENUES Operating revenues increased by 9.1% in 1998. The main variations were as follows:

- Passenger revenues The difference between the passenger revenue figure shown above and that shown in the activity tables is due to the fact that the latter relates directly to the actual

p-178 ANNUAL REPORT 1998 IBERIA GROUP CONSOLIDATED MANAGEMENT REPORT production for each year and does not reflect accounting adjustments and revaluations. The breakdown of the Ptas. 61,002 million increase in passenger revenues is as follows:

PASSENGER REVENUES M I L L I O N S O F P E S E TA S

VA R I AT I O N I N C A U S E O F T H E V A R I AT I O N VA R I AT I O N I N PA S S E N G E R REV E N U E S PE R REV E N U E S 98 / 9 7 PR I C E VO L U M E PA R I T Y OT H E R* BOO K S 98 / 9 7

IBERIA, L.A.E. + AVIACO 44,616 12,120 29,329 3,167 14,742 59,356 AVIACO (CHARTER) (1,318) (112) (1,206) - -) (1,318) (*) The “Other” column reflects the variation in the difference between revenues per books VIVA 2,646) 213) 2,252) 181 0) 2,646) and revenues by network, caused by passenger ticket revenues not allocable to airlines, BINTER CANARIAS 132) 222) (90) - (59) 73) charter revenues, IB Plus point revenues and the recovery of Ptas. 14,470 million of revenues BINTER MEDITERRANEO 258) 144) 114) - (13) 245) from the “Unused Tickets” account included in 1998 in passenger revenues, as compared SPANISH GROUP 46,335 12,587 30,399 3,348 14,669 61,002 with the Ptas. 9,000 million recorded in 1997 under the “Other Operating Revenues” account.

The difference in volume is due to the sharp increase in demand of 6.5% in terms of RPK. The price variation was the result of several factors affecting the yield, such as the fare mix, with sales of higher-class fares increasing by 4.6% with respect to those of economy-class fares, and commercial yield enhancement policies, (redesigned fares, revenue management computer tools, etc.).

- Freight revenues The 4% (Ptas. 1,658 million) drop in freight revenues was due mainly to the 1.9% reduction in IBERIA’s demand, which was not offset by the slight increase (0.4%) in the yield, largely as a result of a decrease of 0.3% in the average haul and to the parity effect.

- Handling revenues Handling revenues continued to fall as a result of the fall in billings to third parties due to the entry into the market of second operators with the consequent loss of market share for IBERIA and price cuts. However, it should be noted that the loss of market share recorded in 1998 was significantly lower than expected, and that the decrease in the yield was smaller than initially feared.

- Maintenance Aircraft maintenance revenues increased by Ptas. 4,373 million in 1998, due mainly to the implementation of the measures envisaged in the Master Plan, under which work for third parties should focus on products with the greatest value added.

- Sales commissions The increase in activity in the industry led to an increase of Ptas. 1,892 million in sales commission revenues.

p-179 ANNUAL REPORT 1998 IBERIA GROUP CONSOLIDATED MANAGEMENT REPORT

- Other operating revenues The main reason for the Ptas. 8,599 million drop in other operating revenues was that in 1997 this caption included the approximately Ptas. 9,000 million of revenues recovered from the balance of the “Unused Tickets” account. In net terms, the variations in the balance of this account showed an increase of Ptas. 401 million due among other reasons to the increase in billings for Iberswiss catering and in-flight sales services of Ptas. 1,066 million, partially offsetting the decrease in revenues from communications (Ptas. 595 million).

B) OPERATING EXPENSES The 7.6% (Ptas. 43,228 million) increase in operating expenses was lower than the increase in operating revenues. This figure is basically the result of an increase in aircraft lease expenses arising from wet leases, the increase in maintenance costs, which was partially offset by the increase in billings to third parties, the cost of the approach charge and the increase in personnel expenses, due to implementation of the collective labor agreements and the rise in flight and ground (handling and maintenance) employee numbers. The variations in the main expense items were as follows:

- Fuel Total fuel expenses in 1998 were 2.9% lower than 1997 (Ptas. 1,763 million), due mainly to the drop in fuel prices, despite the 3.7% rise in the value of the U.S. dollar. The fuel expense per block hour was reduced by 8.1%, a saving higher than the 5.6% increase in activity (469,861 block hours in 1998 and 444,636 block hours in 1997). Also, more efficient consumption as a result of using the more modern aircraft must be taken into consideration.

- Personal expenses Personnel expenses increased by 3.5% with respect to 1997, due mainly to the following: Wage rise of variation in CPI for 1997 and 1998 under the collective labor agreement for pilots (IBERIA and Aviaco) Wage rise for 1998 under the collective labor agreement for ground personnel Increases in the flight personnel headcount (cabin crews 3.6%; technical crews 0.8%) and in ground personnel headcount (2.1%) Long-service, promotions, etc. and 1% increase in social security costs There was a decrease in earnings-related bonus expenses due to the lower provision required as a result of lower-than-expected earnings.

- Traffic service expenses Following up on the cost saving measures envisaged in the PREGA program, contracts relating to expenses controllable by the Company, such as aircraft cleaning and handling on international stopovers, continued to be renegotiated. This, however, contrasts with the significant increase in expense items subject to official prices, such as landing rights and approach fees, or in expenses subject to regulatory prices, such as aircraft handling expenses, which are difficult to negotiate because they depend on handling operators protected from competition at certain European airports. The main variations were in landing rights (an average increase of 4%), crew hotel expenses and costs arising from interrupted journeys, due to the drop in the quality of certain aspects of the operation.

p-180 ANNUAL REPORT 1998 IBERIA GROUP CONSOLIDATED MANAGEMENT REPORT

- Commercial expenses (commissions, overcommissions and advertising) Th e incr ease in net passenger and freig h t rev e n ues lay behind the rise in commerc ia l exp e n ses; commerc i al costs as a perce nt a g e of operat i n g rev e n ues incr eased by 3%, due mainly to the incr eased exp e n ses trigge r ed by IBERIA’s sales dri v e , which incre a s e d ad v e r t i s i n g and publicity exp e n ses at Group level by Ptas. 648 million with respect to 1997. In 1998, as in prior years, commissions as a percentage of passenger revenues decreased, due to greater use of the TNM (net market price) method and the drop in overcommissions, particularly in Japan. This decrease is being achieved through the introduction of new direct sales and sales information systems such as telephone sales, distribution on the Internet and the introduction of ticketless flights. Under the Master Plan, the Valor 98 plan is being implemented for Spanish travel agencies, enabling commercial costs to be reduced by means of commercial management by the Spanish agencies that is focused much more on the provision of incentives.

- Navigation aids Air traffic control expenses increased by 17.8% (Ptas. 4,221 million), higher than the increase in activity in terms of block hours (5.6%), due to the increase in prices charged by the European air traffic control agency (Eurocontrol), and the introduction in January of the approach charge (totaling a little over Ptas. 2,000 million) at Spanish airports.

- Aircraft maintenance In 1998 aircraft maintenance expenses rose by Ptas. 9,491 million with respect to 1997 due, inter alia, to the performance of additional work on aircraft in compliance with air safety regulations and, above all, to the outsourcing of engine maintenance work. Also, the costs of maintaining the Air Europa planes operated led to an increase of almost Ptas. 3,000 million in the balance of this caption with respect to 1997.

- Aircraft lease expenses The significant increase of Ptas. 18,739 million in aircraft lease expenses was due mainly to: · A higher amount incurred in operating A-340 aircraft under operating lease agreements as a result of the new additions (Ptas. 4,143 million), although the lease exp e n ses fell by Ptas. 1,433 million for the A-320, B-727, B-757, MD-87 and B-747 aircra f t . · The higher cost (Ptas. 2,560 million) incurred in wet lease transactions with Air Atlanta, BCM and Challengair, but mainly due to Air Europa’s B-737, B-757 and B-767 contract amounting to Ptas. 10,623 million, as compared with Ptas. 693 million in 1997. · The increase of Ptas. 2,438 million in the price of the freight aircraft and hold lease contracts entered into in 1998.

- Period depreciation and amortization There was a significant drop in the depreciation charge for 1998 as a result of the reduced impact (Ptas. 5,000 million) of the asset revaluation made in 1996, the nonrecurring effect (Ptas. 3,500 million) in 1998 of the depreciation of the B-727 aircraft in 1997, and the effect of the assets which became fully depreciated in 1997 or in the first few months of 1998.

p-181 ANNUAL REPORT 1998 IBERIA GROUP CONSOLIDATED MANAGEMENT REPORT

- Other operating expenses The breakdown by major items is as follows: a) Reservation system distribution expenses rose by Ptas. 2,747 million, due largely to the inclusion of the franchise agreement with Air Nostrum and the growth in activity. b) Royalties decreased by Ptas. 4,748 million due to the change in the method used to record the increase in operating levies from May 1997 (with the same effect on revenues).

5.2. AIR TRANSPORT GROUP STATEMENTS OF INCOME

S TATEMENTS OF INCOME M I L L I O N S O F P E S E TA S 1 9 9 8 1 9 9 7 O P E R ATING INCOME 5 2 , 4 6 1 4 0 , 0 4 7 FI N A N C I A L R E V E N U E S 7 , 3 4 1) 9 , 6 5 4) FI N A N C I A L E X P E N S E S ( 6 , 5 8 0 ) ( 9 , 8 1 6 ) PR O V IS IO N TO P E N S IO N A L L O WA N C E ( 3 , 4 7 2 ) ( 3 , 7 5 2 ) EXC H A N G E GA I N S 6 , 5 7 2) 1 1 , 4 4 8) EXC H A N G E L O S S E S ( 8 , 8 5 1 ) ( 1 5 , 4 6 4 ) FINANCIAL LOSS ( 4 , 9 9 0 ) ( 7 , 9 3 0 ) LOSS ON SECURITIES PORTFOLIO ( 6 0 2 ) ( 1 , 4 0 7 ) A M O R T I Z ATION OF GOODWILL ( 1 8 3 ) - E X T R AORDINARY INCOME 1 9 , 2 8 2 ( 9 , 9 2 9 ) NET INCOME BEFORE TA X E S 6 5 , 9 6 7 2 0 , 7 8 1 TA X E S ( 1 2 , 7 9 6 ) ( 3 , 6 7 2 ) INCOME BEFORE MINORITY INTERESTS 5 3 , 1 7 1 1 7 , 1 0 9 INCOME AT T R I B U TABLE TO MINORITY INTERESTS ( 1 4 6 ) ( 5 9 ) INCOME ATTRIBUTED TO THE CONTROLLING COMPANY 5 3 , 0 2 5 1 7 , 0 5 0

p-182

SOCIEDAD ESTATAL DE PARTICIPACIONES INDUSTRIALES

DESIGN: CUATRO TINTAS COMUNICACION, S.A. · PRINTING: TORREANGULO ARTE GRAFICO S.A. · D.E.: 0-00.000-0000