Annual Report 2004 Financial Statements & Management Report 2004 Annual Report Index LETTER FROM THE CHAIRMAN 4 IBERIA, LÍNEAS AÉREAS DE ESPAÑA, S.A IBERIA GROUP Legal Information 7 Legal Information 113 Company Financial Statements 11 - Consolidated Financial Statements 117 - Balance sheets as of December 31, 2004 and 2003 12 - Consolidated balance sheets as of - Statements of income for 2004 and 2003 14 december 31, 2004 and 2003 118 - Consolidated statements of income Notes to Company Financial Statements 17 for 2004 and 2003 120 - Company description 18 - Basis of presentation of the financial statements 18 Notes to Consolidated Financial Statements 123 - Distribution of income 18 - Description of the Parent Company and - Valuation standards 18 of the Group 124 - Intangible assets 24 - Group companies 124 - Property, plant and equipment 26 -Associated companies 126 - Long-term investments 33 - Basis of presentation of the consolidated financial - Treasury stock 39 statements 128 - Inventories 39 -Distribution of the Parent Company’s income 129 - Accounts receivable 39 -Valuation standards 129 - Short-term investments 39 - Intangible assets 135 - Shareholders’ equity 40 - Property, plant and equipment 136 - Provisions for contingencies and expenses 42 - Long-term investments 144 - Payable to credit institutions 43 - Shares of the Parent Company 149 - Convertible debenture issue 44 -Inventories 149 - Financial risk management 44 - Short-term investments 149 - Balances and transactions with Group and - Shareholders’ equity 150 associated companies 47 -Minority interests 153 - Tax matters 48 - Provisions for contingencies and expenses 154 - Revenues and expenses 51 - Payable to credit institutions 155 - Directors’ compensation and other benefits 54 - Convertible debenture issue 156 - Detail of the equity interests held by the Directors - Financial risk management. 156 in companies engaging in similar activities and -Tax matters 159 performance by them, for the irown accountor - Revenues and expenses 162 the account of others, of similar activities 54 - Contribution of Group and associated companies - Environmental information 55 to consolidated in come 164 - 2004 and 2003 Statements of changes in financial -Directors’ compensation and other benefits 165 position 56 - Detail of the equity interests held by the directors in companies engaging in similar activities and Company Management Report 59 performance by them, for their own accountor - Main aggregates 60 the account of others, of similar activities 165 - 2004 Highlights 61 - Environmental information 166 - Operating performance of the management areas 70 -Transition to the International - Resources 93 Financial Reporting Standards (IFRS) 167 - Financial performance 96 - Iberia shares 106 Consolidated Management Report 169 -Main aggregates 170 Governing Bodies 109 - 2004 Highlights 171 - Business performance 181 - Resources 191 - Financial performance 194 4 Dear shareholder, In a business such as air transport, currently undergoing radical change and unprecedented competition, it gives me enormous satisfaction to be able to present the results for 2004, announcing that we have chalked up a net profit of €220 million, up 50.8% year on year and the second highest profit ever posted by our company; that the balance of liquid cash exceeds the short-term interest-earning debt by €1,187 million, up 27%; that the EBITDAR margin was 16%, 0.8 points up on 2003; and that we are still one of the most profitable companies in the sector. This has been no easy task. In recent years, Iberia has been guided by its determination to get ahead of inevitable changes, trying to understand what customers want and give it to them, and this also marked our actions in 2004. A great deal of effort has been made to achieve this, striving to cut costs and control risks, on the one hand, and to improve customer service, on the other. One of the most important factors affecting the results of the year, not only in Iberia but throughout the sector, was the continued hike in oil prices, which soared at times to an all-time high of over 52 dollars/barrel, with an average price for the year of 36.5 dollars/barrel. In Iberia, thanks to the hedging policies negotiated, we have paid the equivalent of 31.5 dollars on average, saving some €81 million over the year. But despite this and the favourable euro-dollar exchange rate, the fuel expense rose by 17.4% over the previous year. The hedging of risks, as in the example of fuel prices, is one of the priorities of the current master plan, though not the only one. The lowering of unit operating costs was and still is also essential, this being the underlying reason for some of the most important measures taken during this year, such as the changes in the travel agency remuneration system and the in-flight service on short and medium-haul flights. The new model of remuneration for travel agencies in Spain came into force on 1 January 2004, contemplating a scaled reduction of commissions from 6.5% in 2003 to 1% as from July 2005. This measure has not only brought savings of over €74 million in 2004, which will be raised to over €100 million in 2005, but also puts us in a position to compete more effectively with the new carriers, which have traditionally much lower distribution expenses than Iberia. The new model of in-flight service introduced in March 2004 was an important measure designed to bring our costs in line with those of our principal rivals on European routes. Since then, on flights of less than three hours food and drink are not included in the price of the ticket, so customers only pay for what they consume. This combines cost savings and, therefore, a better position to establish competitive prices, with the possibility of offering our customers a more personal, higher quality service. These are just two examples, but are by no means the only measures taken during 2004 to reduce the cost gap with our rivals and improve customer service. In the first case, we should also mention staff productivity, which rose 7.7% during 2004 and is expected to continue improving in 2005; or aircraft utilisation, which improved by 7.5% on long-haul and 2.5% on short-haul flights. These and other measures explain how the company managed to cut its unit operating costs by 5.1% (which would have been 7% had it not been for the fuel prices), which is greater than the drop in unit income, of 4.3%. Despite the positive trend of these indicators, one of the principal objectives set by the company for forthcoming years is to continue improving the utilisation of its human and material resources. This measure contemplates a process of fleet renewal and reduction of models of aircraft used by Iberia. 2004 was also an important year in our consolidation as leading carrier between Europe and Latin America; the Air France-KLM merger temporarily robbed us of that leadership, although we are now recovering it. The start-up of flights to Montevideo, direct routes to Guatemala, Costa Rica and Panama, with a 5 considerable improvement on the service previously offered via Miami, and the signing of code sharing agreements with several Latin American companies, including TACA, Mexicana de Aviación or Avianca, for the local distribution of air traffic boosted Iberia’s position on that market. On these routes, Iberia increased its market share in both total traffic and business traffic, to 17.2% and 18.8%, respectively, 0.9 and 0.4 percentage points higher than in 2003, broadening the spread with our rivals. The launching of the new Business Plus class for long-haul routes, to be put on the market in May 2005, has arisen out of a firm commitment to quality and this type of customers, which appreciates Iberia’s dense network, the wide array of frequencies and direct flights and the comfort and additional services provided for this new class. The redesigning and refurbishing of the inside of Airbus A340 aircraft to include the new class, in which Iberia will invest €100 million, will be done over the entire year. The long-haul sector recorded the largest growth in 2004, in both supply and demand, increasing by 10.5% and 12.0%, respectively, in Available Seat Kilometres and Passenger Revenue per Kilometre, compared to 8.8% and 9.1% in the overall network. An average annual occupation of almost 82% was achieved on this long-haul network, unprecedented in Iberia. In total, Iberia carried 27 million passengers, up 4.2%, with 75.2% occupation, 0.2 percentage points more, a record level for the company. After a satisfactory close to 2004, 2005 promises to be full of new aspects and challenges, both within and outside the company. The commercial air transport model that has existed up to now is undergoing a thorough transformation, not only in Spain but worldwide. In Iberia, we are convinced that the time is up for static enterprises, which put their model of company before what customers want and choose. And with this idea of competing and being where and how customers prefer, we will, during 2005, design a new Master Plan for the period 2006-2008. We trust that, as has occurred with the present Master Plan, the new Plan will enable us to keep ahead of inevitable changes and endeavour to preserve our leadership of the sector, in both profits and innovation. At the same time, we will also have to face several important challenges during 2005, such as getting ready for the move to the new terminal area at Barajas Airport, to which Iberia will transfer all its operations, foreseeably in early 2006. This entails redesigning all the work procedures, reviewing flight schedules and the interconnection system and an intense training and information plan for employees, customers, suppliers and shareholders.