Prospectus December 2005

FL GROUP hf Prospectus December 2005 Prospectus December 2005

FL GROUP hf Prospectus December 2005 Table of contents

I STATEMENTS AND NOTICE 3 Statements 3 References and glossary of terms and abbreviations 4 Publication calendar of accounts 5 Notice to investors 5 II OFFERING AND LISTING OF SHARES 7 Issuer 7 Issuer’s operations 7 Managers of offering and listing on ICEX Main List 7 Total share capital 7 Issue, listing and share characteristics 7 Share capital increase – authorisation, sale and listing 7 Cost and cash flow 8 Information 8 III SHARE CAPITAL AND OWNERSHIP 9 Total share capital and own shares 9 Authorisation for further increase of share capital 9 Development of share capital 10 Share performance 10 making 10 Ownership 10 Issue and share rights 12 IV ORGANISATION 14 Historical 14 Key milestones 14 Legal structure 14 Subsidiaries and associates 15 Organisational structure 15 V PRIVATE EQUITY 21 Investment strategy 21 General description 21 Current investments 21 VI ASSET MANAGEMENT 30 Investment strategy 30 Current portfolio 30 VII AIRCRAFT TRADING AND LEASING 31 Aircraft trading 31 Aircraft leasing 31 Aircraft pricing 31 FL Group's tactics and strategy 32 The fleet 32 VIII RISK FACTORS 33 Risks related to investment in the Company’s shares 33 Risks related to the Company 33 Risks related to operating companies 34 IX FINANCIAL HIGHLIGHTS 38 Consolidated Income Statement 38 Consolidated Balance Sheet 41 Consolidated Cash Flow Statement 42 The implementation of IFRS 44

APPENDICES A Articles of association of FL GROUP hf. 47 B Interim Consolidated Financial Statement January 1 - September 30, 2005 53 C Annual Accounts for 2004 71

1 2 I. Statements and notice

Statements

Issuer’s statement The of FL GROUP hf., Icelandic ID-No. 601273-0129, Sudurlandsbraut 12, IS-108 Reykjavík, , hereby declares that, to the best of its knowledge, the information in this Prospectus both accords fully with the facts and no important items have been omitted which could affect the evaluation of the Issuer or its shares.

Reykjavík, 29 December 2005 On behalf of the Board of Directors of FL GROUP hf.

Skarphédinn Berg Steinarsson Hannes Thór Smárason Chairman of the Board of Directors President & CEO Icelandic ID-No. 050763-7819 Icelandic ID-No. 251167-3389

Managers' statement Kaupthing hf. - Investment Banking, Icelandic ID-No. 560882-0419, Borgartún 19, IS-105 Reykjavík, Iceland and Íslands hf. - Corporate Finance, ID-No. 540291-2259, Austurstræti 11, IS-101 Reykjavík, Iceland, hereby declare that in preparing this Prospectus they have gathered the data which in their estimation was necessary to provide a true and fair picture of FL GROUP hf. and its shares. To the best of our knowledge no important items have been omitted which could affect the evaluation of the Issuer or the shares for which listing is sought. Reykjavík, 29 December 2005 On behalf of hf. - Investment Banking On behalf of Landsbanki Íslands hf. - Corporate Finance

Örvar Kærnested Bjarni Thórdur Bjarnason Managing Director of Investment Banking Head of Corporate Finance Icelandic ID-No. 130776-4429 Icelandic ID-No. 110469-5869

Auditors’ statements KPMG Endurskodun hf., Icelandic ID-No. 590975-0449, Borgartún 27, IS-105 Reykjavík, Iceland, has audited and signed without qualification the Consolidated Annual Accounts of FL GROUP hf. for the years 2002-2004. KPMG Endurskodun hf. has compiled the Consolidated Interim Financial Statement of FL GROUP hf. for the first nine months of 2004 and 2005. We confirm that the information in this Prospectus is consistent with the accounts that we have audited or compiled. Reykjavík, 29 December 2005 On behalf of KPMG Endurskodun hf.

Sæmundur Valdimarsson Jón Sigurdur Helgason State authorised public accountant State authorised public accountant Icelandic ID-No. 070263-4409 Icelandic ID-No. 050269-3619

3 References and glossary of terms and abbreviations strued as referring to Kaupthing Bank hf., Icelandic ID-No. 560882- References to the “Issuer” in this Prospectus shall be construed as 0419, unless otherwise clear from the context. References to "Lands- banki Íslands" shall be construed as referring to Landsbanki Íslands hf., referring to FL GROUP hf., Icelandic ID-No. 601273-0129, unless Icelandic ID-No. 540291-2259, unless otherwise clear from the con- otherwise clear from the context. References to “FL Group hf.”, “FL text. The share offering and the listing of the new shares on the ICEX Group”, “FL Group Consolidation”, "the Group" and “the Company” Main List is arranged jointly by Kaupthing Bank hf.'s Investment Bank- shall be construed as referring to FL GROUP hf., Icelandic ID-No. ing division and Landsbanki Íslands hf.'s Corporate Finance division. 601273-0129, and its subsidiaries and affiliates, unless otherwise clear from the context. FL GROUP hf. is the legal Icelandic name of the References to the "Icelandic Takeover Panel" or the "Takeover Panel" Issuer. or the "Panel" in this Prospectus shall be construed as referring to the Takeover Panel established in Iceland on 1 July 2005. The Panel issues References to "Sterling" in this Prospectus shall be construed as refer- statements, provides advice and encourages professional discussion ring to Sterling Airlines A/S, Danish ID-No. 18235404, Sterling Ice- on takeovers and related issues of companies listed on ICEX, but is landic ApS, Danish ID-No. 18647370 and Flyselskabet af 15. juli 2005 independent of ICEX. The founders of the Takeover Panel are ICEX, A/S, Danish ID-No. 28988362 and their subsidiaries and affiliates, Eignarhaldsfélag hlutafélaga (an association of listed companies), the unless otherwise clear from the context. Financial Supervisory Authority, Eignarhaldsfélag lífeyrissjóda um verd- bréfathing ehf. (association of pension funds), the Bankers’ and Secu- References to "Bluebird" in this Prospectus shall be construed as rities Dealers’ Association of Iceland, the Association of Small referring to Bláfugl hf., Icelandic ID-No. 460899-2229 and Flugflutn- Investors, the of Iceland, the Icelandic Chamber of ingar ehf., Icelandic ID-No. 600372-0179 and their subsidiaries and Commerce and the Ministry of Commerce. The Agreement creating affiliates, unless otherwise clear from the context. the Panel is valid for three years. A decision on its continuation will References to "FL Travel Group" in this Prospectus shall be construed be taken in light of the experience gained of its work as referring to Flugfélag Íslands hf., ID-No: 530575-0209, Ferdaskrif- stofa Íslands hf., ID-No: 590670-0149, Íslandsferdir ehf., ID-No: 410791-1379, Kynnisferdir ehf., ID-No: 620372-0489, Bílaleiga Flug- leida ehf., ID-No: 471299-2439 and Flugleidahótel hf. ID-No: Abbreviations used in this Prospectus are listed in the fol- 621297-6949 and their subsidiaries and affiliates, unless otherwise lowing table. clear from the context. References to " Group" in this Prospectus shall be con- CAA Civil Aviation Authority strued as referring to Icelandair ehf., ID-No: 461202-3490, Flugleidir- Frakt ehf., ID-No: 471299-2359, Loftleidir - Icelandic ehf., ID-No: The Companies Act number 2 from 1995 on 571201-4960, Flugthjónustan Keflavíkurflugvelli ehf., ID-No: 551200- actor Act 2/1995 Public Limited Companies 3530 and Tæknithjónustan Keflavíkurflugvelli ehf., ID-No: 511202- DKK Danish krone 2990 and their subsidiaries and affiliates, unless otherwise clear from EBITDA Earnings before interest, tax, depreciation the context. and amortization References to "the share offering" in this Prospectus shall be con- EBITDAR Earnings before interest, tax, depreciation, strued as referring to the offering of new shares in FL Group hf. mortization and rental expense which investors subscribed for on 10 November 2005 and which this PDP Pre-Delivery Payment Prospectus covers, unless otherwise clear from the context. The share offering is described in Chapter II of this Prospectus. GAAP Generally Accepted Accounting Principles ICEX Iceland Stock Exchange References to “ICEX” in this Prospectus shall be construed as refer- ring to the Iceland Stock Exchange, i.e. to Kauphöll Íslands hf., Ice- IFRS International Financial Reporting Standards. landic ID-No. 681298-2829, unless otherwise clear from the context. IRR Internal Rate of Return References to the “listing” and the "listing on ICEX Main List" in this ISD Icelandic Securities Depository Prospectus shall be construed as referring to listing of shares on the Main List at the Iceland Stock Exchange, unless otherwise clear from ISK Icelandic króna the context. JFK John F. Kennedy International Airport References to “ISD” in this Prospectus shall be construed as referring KEF Keflavík International Airport to the Icelandic Securities Depository, i.e. to Verdbréfaskráning LF Load Factor Íslands hf., Icelandic ID-No. 500797-3209, unless otherwise clear LHR Heathrow Airport from the context. LIBOR London Inter Bank Offered Rate References to “the Managers” in this Prospectus shall be construed LTM Last Twelve Months as referring to Kaupthing Bank hf. – Investment Banking division, Ice- PAYE Pay-As-You-Earn landic ID-No. 560882-0419 and Landsbanki Íslands hf. – Corporate Finance division, Icelandic ID-No. 540291-2259, unless otherwise USD or $ US dollar clear from the context. References to "Kaupthing Bank" shall be con-

4 Publication calendar of accounts obtaining of all necessary clearances from the competition authorities FL Group hf. has announced that the Annual Accounts for the year in relevant countries, or if applicable waiting periods have elapsed. The competition authorities in , and have been 2005 are expected to be published in week 10 of 2006, i.e. 6-10 notified of the acquisition and have all decided not to object to the March 2006. In recent years the Annual General Meeting has been acquisition. The competition authorities in Denmark and Iceland have held around 10 March. requested information regarding the acquisition. The Danish authori- ties will not investigate the matter any further but the Icelandic Com- Notice to investors petition Appeals Committee will now consider whether the acquisi- FL Group hf.'s total issued share capital amounts to 5,845,294,118 tion needs to be reported to The Icelandic Competition Council. As shares, each with the nominal value of ISK 1.0. All issued shares of FL of today, 29 December, this means that it cannot be assumed that all Group hf. are listed on the ICEX Main List and are included in the conditions necessary to complete the acquisition will be met in the ICEX-15 index. beginning of January 2006. FL Group hf. and Fons Eignarhaldsfélag hf. have not decided how or if they are going to respond to this. When This Prospectus concerns FL Group hf.'s issuing of 3,235,294,118 their position is clear, ICEX will be notified and an annex to this new shares, which corresponds to 56% of all outstanding shares and prospectus will be issued. represents a 127.5% increase in share capital, and the listing of those new shares on ICEX Main List. The shares were issued to further This Prospectus and any related documents are not being distributed strengthen the equity base, with a special emphasis on reinforcing the and must not be mailed or otherwise distributed or sent in or into Company's private equity and asset management operations. New any country in which distribution would require any additional regis- shares sold amounted to ISK 44 billion. The 3,235,294,118 new tration measures or other measures to be taken, other than as appli- shares were sold at price of ISK 13.6 per share to 73 investors. cable under Icelandic law and regulations, or would be in conflict with Investors subscribed for the shares on 10 November 2005. On 6 any law or regulation in such country. The Prospectus is not being December FL Group hf. issued 73 million shares. The objective of sent out, directly or indirectly, by use of mail or any other means or the increase was to fulfil a part of the terms of employee stock instrumentality (including, without limitation, facsimile transmission, option agreements. The subscription price of the shares was ISK 5.97 electronic mail, telex, telephone and the Internet) in or into the Unit- per share, in accordance with the terms of the option agreements. ed States, Australia, Canada or Japan. Accordingly, the Prospectus, Additional new shares will not be offered by FL Group hf. immedi- and any related documents are not being and may not be mailed or ately following or as a result of the publishing of this Prospectus. otherwise distributed, forwarded or sent in or into the , Australia, Canada or Japan. The shares have not been registered The listing will proceed pursuant to Icelandic law and regulations. under the United States Securities Act of 1933, as amended, or any This Prospectus has been prepared pursuant to the legislation, gov- securities laws of any state of the United States, or the securities laws ernment regulations and ICEX's regulations on the listing of shares of Australia, Canada or Japan or its provinces. Accordingly, such on the exchange. ICEX has reviewed and approved this Prospectus, shares may not be offered, sold, re-sold or delivered, directly or indi- which is only published in English. rectly, within the United States, Australia, Canada or Japan, or to any This Prospectus has been prepared to provide clear and thorough residents of these countries, except pursuant to an exemption from information on the consolidated company FL Group hf., as well as on applicable registration. the shares issued by the Company. Investors are advised to consid- This Prospectus should by no means be viewed or construed as a er statements from the Issuer, the Managers and the Auditors promise by the Issuer, Managers or other parties of future success in regarding the Prospectus. Investors are encouraged to acquaint either operations or return on investments. Investors are reminded themselves thoroughly with the Prospectus and its Appendices. that investing in shares entails risk, as the decision to invest is based Investors are advised to pay particular attention to the chapter Risk on expectations and not promises. Investors must primarily rely on Factors. Investors are reminded of the risk related to the fact that FL their own judgement regarding any decision to invest in FL Group Group hf. has recently changed its focus of operation and undergone hf.’s shares, bearing in mind the business environment in which the fundamental organisational changes which reduces the usefulness of Company operates, anticipated profits, external conditions and the reference to its historical success and could increase the risk of the risk inherent in the investment itself. Prospective investors are advised investment. Also that its main subsidiaries operate in a market that is to contact experts such as licensed financial institutions to assist them highly dependent on the development of external factors that are in their assessment of the shares in FL Group hf. as an investment outside the Company's control and that a high proportion of the option. Investors are advised to consider their legal status, including Company's costs are fixed in the short to medium term. taxation issues that may concern the purchase or sale of shares in FL The information provided in this Prospectus is based on premises Group hf. and seek external and independent advice in that respect. that are current at the date of publication of this Prospectus. These Due diligence reviews were conducted for FL Group hf. on Sterling premises may change from the date of publication. Investors are and Bluebird in connection with the purchase of shares in these com- therefore advised to study all public information issued by or relating panies. The reviews on Sterling, addressed to and for the exclusive to FL Group hf. and not to rely exclusively on information in this use of FL Group hf., were conducted by PricewaterhouseCoopers Prospectus. (limited high level review of specific financial issues) in September and FL Group hf. is not obligated to carry out the acquisition of Sterling October 2005 and Logos sf. in September 2005 and Bech-Bruun if certain conditions are not met including, but not limited to, the Dragsted (limited high level reviews of specific legal issues) in Sep-

5 tember 2005. The reports on Sterling all still in draft form. The due PDP financing in connection with the Company's commitment of diligence reviews on Bluebird were conducted by Pricewaterhouse- acquiring 10 Boeing 737-800 aircraft. The debt arrangement gives the Coopers hf. (finance - review of specific financial and tax issues) in Company a right to draw funds to meet pre-payments in connection July 2005, addressed to Kaupthing Bank, and Logos sf. (legal – review with the acquisition of the aircraft. The maximum amount of the PDP of specific legal issues) in July 2005, addressed to FL Group hf. debt arrangement is USD 190 million, and the loan is repayable at delivery of the aircraft. Kaupthing Bank hf. holds a 2.9% stake in the Due diligence reviews on FL GROUP hf., addressed to the Managers, Company as of 28 December 2005. Landsbanki Íslands hf. holds a were conducted by Deloitte & Touche rádgjöf ehf. (finance) and Lex 29.7% stake in the Company as of 28 December 2005. Thereof, Nestor ehf. which conducted a due diligence review on specific parts according to a major holdings announcement published on ICEX's of the operation of FL GROUP hf. and its subsidiaries (legal) in website on 14 December 2005 17.9% stake is related to forward November 2005. contracts. Of Landsbanki Íslands hf's direct shareholding in FL Group hf. 10% stands as a hedge against derivate contracts. Both Landsban- Attention is drawn to the interests of the Managers of this Prospec- ki Íslands hf. and Kaupthing Bank hf. act as market makers for FL tus. A subsidiary of Kaupthing Bank hf., FIH Erhvervsbank A/S in Den- Group hf.'s shares on ICEX. mark was the advisor to Fons Eignarhaldsfélag hf. on the sale of Ster- ling to FL Group hf. The share offering was, and the listing of the new shares on the ICEX Main List is, arranged jointly by Kaupthing Bank hf.'s Investment Banking division and Landsbanki Íslands hf.'s Corpo- rate Finance division. Kaupthing Bank hf. underwrote 62.5% of the share offering for a maximum of ISK 10 billion to be paid with cash, and Landsbanki Íslands hf. underwrote 37.5% of the share offering for a maximum of ISK 6 billion to be paid with cash. Investors had the choice of paying for the shares in the share offering in cash or with shares in the ten companies which are listed on ICEX and which had the largest weight in ICEX-15 index. Among those ten companies' shares are those of Kaupthing Bank hf. and Landsbanki Íslands hf. FL Group hf. and a subsidiary of Kaupthing Bank hf. have formed a spe- cial holding company for the investment in a Boeing 747 aircraft pur- chased from Singapore Airlines Cargo for ISK 5 billion and leased back to Singapore Airlines Cargo for ten years. Kaupthing Bank hf. and FL Group hf. have agreed upon unbinding heads of terms relat- ing to aircraft investments in 15 Boeing 737-800 aircraft over the next couple of years, whereby FL Group hf. and Kaupthing Bank hf. through a joint venture set up special purpose vehicles for each air- craft. Each aircraft will be 20% financed with equity, and FL Group hf. will own 49% and Kaupthing Bank hf. initially 51%. Both Kaupthing Bank hf. and Landsbanki Íslands hf. act as FL Group hf.'s corporate . Kaupthing Bank hf. has for example provided FL Group with

6 II. Offering and listing of shares

Issuer Share capital increase – authorisation, FL GROUP hf. Icelandic ID-No. 601273-0129 sale and listing Headquarters: Sudurlandsbraut 12, IS-108 Reykjavík, Iceland This Prospectus concerns FL Group hf.'s issuing of 3,235,294,118 new Telephone number: +354 591 4400 shares, representing a 127.5% increase in share capital, and the listing of those new shares on ICEX Main List on 21 November 2005. The Issuer’s operations gross proceeds of the new shares sold amounted to ISK 44 billion. FL Group hf. is registered in Iceland and operates pursuant to Act no. The Board of Directors of FL Group hf. has also on 5 December 2/1995 on Public Limited Companies. FL Group hf. was founded on 2005 exercised an authorization contained in the Company's Articles 20 July 1973 as Flugleidir hf., by Flugfélag Íslands hf. and Loftleidir hf. of Association to increase the Company’s share capital by 73 million and the name was changed to FL Group hf. at the 2005 annual gen- new shares. The objective of the increase was to fulfil a part of the eral meeting. terms of employee stock option agreements. The subscription price of the shares was ISK 5.97 per share, in accordance with the terms of The object of FL Group hf., according to Article 3 of its Articles of the option agreements. Association, is to achieve a return on the investment that sharehold- ers have made in the Company by operating the Company and At a shareholders' meeting of FL Group hf. on 1 November 2005 the investing in subsidiaries and associated companies which primarily shareholders resolved to increase the share capital by ISK operate in the fields of air travel, tourism, transportation and invest- 3,235,294,118 by issuing new shares each with a nominal value ISK 1. ment. Shareholders waived their pre-emptive right of subscription to the new shares. The shares were sold in a private placement directed Managers of offering and listing on ICEX Main List towards institutional investors both within and outside the current shareholder group. The shares were sold for ISK 13.6 per share as Kaupthing Bank hf. – Investment Banking division, decided at the shareholders' meeting in accordance with a proposal Icelandic ID-No. 560882-0419 by the board of directors of FL Group hf. Payment could be made in Address: Borgartún 19, IS-105 Reykjavík, Iceland cash or in shares in Kaupthing Bank hf., Landsbanki Íslands hf., Íslands- Telephone number: +354 444 6000 banki hf., Actavis Group hf., Straumur-Burdarás Fjárfestingarbanki hf., Landsbanki Íslands hf. – Corporate Finance division, Bakkavör Group hf., Össur hf., SÍF hf., HB Grandi hf. and hf., Icelandic ID-No. 540291-2259 based on their closing prices on the ICEX on 9 November 2005, the Address: Hafnarstræti 5, IS-101 Reykjavík, Iceland last trading day before the beginning of the subscription period. The Telephone number: +354 410 4000 minimum subscription amount was ISK 5 million per participant. The whole offering was either committed or underwritten. Kaupthing Total share capital Bank hf. underwrote the offering for a maximum of ISK 10 billion and FL Group hf.'s total issued share capital amounts to 5,845,294,118 Landsbanki Íslands hf. underwrote the offering for a maximum of ISK shares. Each share has a nominal value of ISK 1.0. FL Group hf.'s own 6 billion. Large shareholders had committed to invest ISK 28 billion in (treasury) shares amount to 43,704,232 shares, so that the active the offering. The offering was oversubscribed, as investors subscribed share capital amounts to 5,801,589,886 shares. for more than ISK 69 billion. On 10 November 2005 a total of 3,235,294,118 shares were sold. The new shares are all paid in, and Issue, listing and share characteristics the issue was registered on 18 November on the ICEX Main List. The placement was arranged by Kaupthing Bank's Investment Banking divi- FL Group hf.'s shares are all issued electronically at the ISD and are sion and Landsbanki Íslands' Corporate Finance division. The purpose registered there under the name of the relevant shareholder or their of the offering was to further strengthen the investment activity of FL nominees. The ISIN number of the shares is IS0000000289. Group hf. and to reinforce the equity base. All issued shares of FL Group hf. are listed on the ICEX Main List and At a shareholders' meeting of FL Group hf. on 1 November 2005 the are included in the ICEX 15 index. The shares' ticker symbol in the shareholders resolved to increase the share capital by ISK trading system of ICEX is FL. One Round Lot of the Company's 3,235,294,118 by issuing new shares each with a nominal value ISK 1. shares amounts to 5,000 shares. A Round Lot, as defined in NOREX Shareholders waived their pre-emptive right of subscription to the Member Rules, is the minimum number of shares which can gener- new shares. The shares were sold in a private placement directed ate a Latest Paid Price, as defined in NOREX Member Rules, in con- towards institutional investors both within and outside the current junction with trading on ICEX.

7 shareholder group. The shares were sold for ISK 13.6 per share as Information decided at the shareholders' meeting in accordance with a proposal A hard copy of this Prospectus along with the material publicly cited by the board of directors of FL Group hf. Payment could be made in in it may be obtained at the following locations from the Managers cash or in shares in Kaupthing Bank hf., Landsbanki Íslands hf., Íslands- and Issuer: banki hf., Actavis Group hf., Straumur-Burdarás Fjárfestingarbanki hf., Bakkavör Group hf., Össur hf., SÍF hf., HB Grandi hf. and Marel hf., Kaupthing Bank hf. – Investment Banking based on their closing prices on the ICEX on 9 November 2005, the Address: Borgartún 19, IS-105 Reykjavík, Iceland last trading day before the beginning of the subscription period. The Telephone number: +354 444 6000 minimum subscription amount was ISK 5 million per participant. The whole offering was either committed or underwritten. Kaupthing Landsbanki Íslands hf. – Corporate Finance Bank hf. underwrote the offering for a maximum of ISK 10 billion and Address: Austurstræti 11, IS-101 Reykjavík, Iceland Landsbanki Íslands hf. underwrote the offering for a maximum of ISK Telephone number: +354 410 4000 6 billion. Large shareholders had committed to invest ISK 28 billion in the offering. The offering was oversubscribed, as investors sub- FL Group hf. scribed for more than ISK 69 billion. On 10 November 2005 a total Address: Sudurlandsbraut 12, IS-108 Reykjavík, Iceland of 3,235,294,118 shares were sold. The new shares are all paid in, Telephone number: +354 591 4400 and the issue was registered on 18 November on the ICEX Main List. The placement was arranged by Kaupthing Bank's Investment Bank- A copy of this Prospectus can also be obtained in PDF format on ing division and Landsbanki Íslands' Corporate Finance division. The the following websites: purpose of the offering was to further strengthen the investment Kaupthing Bank hf. www.kbbanki.is or www.kaupthing.net activity of FL Group hf. and to reinforce the equity base. Landsbanki Íslands hf. www.landsbanki.is At a shareholders' meeting on 1 November 2005 the Company’s FL Group hf. www.flgroup.is board of directors was authorized to increase share capital by up to ICEX (news) www.icex.is 330,000,000 shares, each with a nominal value ISK 1, on a non pre- emptive basis at the same price as in the aforementioned private placement, i.e. ISK 13.6 per share. This authorisation, valued at ISK 4,488,000,000, shall be exercised in exchange for shares in Sterling. The authorisation remains valid until 1 November 2006.

Cost and cash flow The aforementioned 3,235,294,118 new shares in FL Group, were sold at ISK 44 billion. The cost of the offering is expected to amount to approximately ISK 1,300,000,000, including underwriting fees, stamp duties, costs incurred at ICEX and ISD, cost of due diligence, printing costs and advertising costs. The Issuer will bear these costs in full. FL Group hf.'s net proceeds from the offering are therefore expected to amount to approximately ISK 42.7 billion.

8 III. Share capital and ownership

Total share capital and own shares The authorisation to increase share capital by 700,000 shares. The FL Group hf.'s total issued share capital amounts to 5,845,294,118 offer price of the shares and the terms of sale shall be decided by the shares. Each share has a nominal value of ISK 1. All issued share cap- board of directors. Shareholders' pre-emptive rights to these shares ital has been paid for. No outstanding loans include terms that affect in the increase in share capital pursuant to the Act on Public Limited the Company's share capital. According to the Company's Articles of Companies and the Company's articles of association shall not apply, Association, the Company may not grant loans or guarantees against cf. authorisation provided in Art. 34 of Act no. 2/1995 on Public Lim- shares in the Company to shareholders, to members of the board of ited Companies. The authorisation can be exercised partly or in its directors, managing directors or managers. This does not prohibit entirety at any time at the discretion of the board of directors. The normal commercial loans or investments made by the Company's authorisation is valid until 18 October 2009. employees or those of a related company in the Company's shares The authorisation to increase share capital by 692,100,000 shares on or investments in shares on their behalf as permitted by law. a pre-emptive basis. The offer price of the shares and the terms of FL Group hf.'s active share capital (i.e. shares that have active voting sale shall be decided by the board of directors. The authorisation can rights) amounts to 5,801,589,886 shares, which is the number of be exercised partly or in its entirety at any time at the discretion of total issued shares excluding the own shares. FL Group hf. holds the board of directors. The authorisation is valid until 18 October 43,704,232 own shares as of 28 December 2005, or 0.7% of total 2009. issued shares. The Annual General Meeting held on 10 March 2005 The authorisation to increase share capital by up to 330,000,000 authorized the Company’s board of directors to buy own shares up shares on a non pre-emptive basis. The price shall be ISK 13.6 per to a maximum of 10% of the total issued share capital. The purchase share. This authorisation, valued at ISK 4,488,000,000, shall be exer- price of the shares may be up to 20% higher than the average selling cised in exchange for shares in Sterling Airlines A/S, Sterling Icelandic price of shares in the Company as registered on the Iceland Stock ApS and Flyskabet A/S. The authorisation shall remain valid until 1 Exchange during the two-week period immediately preceding the November 2006. purchase. No minimum limit applies to this authorisation, regarding The new shares shall belong to the same class and carry the same either the purchase price or the number of shares purchased each rights as other shares in the Company. The new shares shall grant time. The authorization is valid for 18 months. By law, own shares do rights within the Company as of the date of registration of the not bear voting rights. increase of share capital. Authorisation for further increase of share capital The board of directors of FL Group hf. is authorised to increase the share capital of the Company by up to 1,022,800,000 shares, each with a nominal value of ISK 1, on the basis of four distinctive autho- risations granted by shareholders. These are:

9 Development of share capital FL Group hf.'s total issued share capital remained the same from 2000 to 2003. The following table lists the changes from 1 January 2004:

Exhibit 1 – Development of share capital Date Transaction Price (ISK) Change in Number of Number of per share number of shares shares outstanding Own shares shares issued

01.01.2004 Opening balance ...... 2,131,725,000 175,275,000 2,307,000,000 10.11.2004 Increased holding of own shares year 2004 before offering ...... 17,563,541 2,114,161,459 192,838,541 2,307,000,000 10.11.2004 Offering by book building process - new shares sold ...... 9.10 230,000,000 - own shares sold ...... 9.10 190,000,000 2,534,161,459 2,838,541 2,537,000,000 31.12.2004 Increased holding of own shares year 2004 after offering ...... 9,200,000 2,524,961,459 12,038,541 2,537,000,000

10.11.2005 Decreased holding of own shares year 2005 before offering...... 6,803,095 2,531,764,554 5,235,446 2,537,000,000 10.11.2005 Private offering - new shares sold at fixed price...... 13.60 3,235,294,118 5,767,058,672 5,235,446 5,772,294,118 05.12.2005 Shares issued to meet the terms of employees stock-options ...... 5.97 73,000,000 5,841,879,841 3,414,277 5,845,294,118 28.12.2005 Increase holding of own shares 10.11.-28.12.2005...... 40,289,955 5,801,589,886 43,704,232 5,845,294,118

28.12.2005 Share capital outstanding ...... 5,801,589,886 28.12.2005 Holdings of own shares...... 43,704,232 28.12.2005 Issued shares...... 5,845,294,118 5,845,294,118

Share performance 0.9% during the same period. The spread is a good indicator of the On 28 December 2005 the market capitalization of FL Group hf. was liquidity of the stock. ISK 118 billion, according to the latest price paid on ICEX, which was Exhibit 2 sets forth the development of FL Group hf.'s end of day ISK 20.2 per share. share price on ICEX from 28 December 2000 until 28 Decembe The volume of trading in shares for the twelve month period up until 2005. The exhibit also shows the ICEX-15 index and ICEXMAIN, the listing of approximately 3.2 billion shares on 21 November 2005 which is the index for all shares on ICEX Main List during the same amounted to ISK 45.3 billion in trading value and ISK 3.1 billion at period. nominal value, which corresponds to 121% of the total issued shares. The average spread between the bid and ask price at closing was Market making Both Landsbanki Íslands hf. and Kaupthing Bank hf. act as market makers for FL Group hf.'s shares on ICEX pursuant to an agreement Exhibit 2 – Development of FL Group hf.'s share price with Kaupthing Bank on 7 October 2004 and Landsbanki Íslands hf. on 2 November 2005. According to the agreement Kaupthing Bank 800 FL ICEX-15 ICEXMAIN hf. through its own account shall submit daily bids and asks to ICEX 700 for a minimum of 500,000 shares on each side at a price determined by the market maker on any given occasion. The maximum bid/ask 600 spread may not exceed 1.5% and the difference from the last price 500 paid may not exceed 5%. The market maker is obliged to provide liq- 400 uidity for up to ISK 30 million per day. According to the agreement with Landsbanki Íslands hf., the bank shall through its own account 300 submit daily bids and asks to ICEX for a minimum of 500,000 shares 200 on each side at a price determined by the market maker on any giv-

100 en occasion. The maximum bid/ask spread may not exceed 1.5%. The market maker is obliged to provide liquidity for up to ISK 70 mil- lion per day. 28. 12. 2000 04. 09. 2001 15. 05. 2002 17. 01. 2003 31. 05. 2004 05. 02. 2005 13. 10. 2005 24. 09. 2003

10 Exhibit 3 – Twenty largest shareholders of FL Group hf.

FL Group hf. - Share register 28.12.2005 Shareholders Description Shares % Landsbanki Íslands hf.* Bank 1.735,162,624 29.7% Eignarhaldsfélagi› Oddaflug ehf. Holding company 1,158,919,071 19.8% Íslandsbanki hf.* Bank 545,173,018 9.3% Arion safnreikningur Custody account 472,130,644 8.1% Materia Invest ehf. Holding company 404,411,765 6.9% Kaupthing Bank hf. Bank 169,829,531 2.9% Straumur-Burdarás Fjárf.banki hf.* Investment bank 122,132,815 2.1% Gildi - lífeyrissjódur Pension fund 70,890,495 1.2% Saxbygg ehf. Holding company 60,987,713 1.0% Lífeyrissjódur Bankastræti 7 Pension fund 48,383,875 0.8% Ten largest shareholders total 4,788,021,551 81.9% Fjárfestingasjódur Búnadarb. hf. Investment fund 44,684,625 0.8% MP Fjárfestingarbanki hf.* Investment bank 43,521,197 0.7% Lífeyrissjódur verslunarmanna Pension fund 37,122,600 0.6% Sund ehf. Holding company 33,252,204 0.6% VVÍB hf., sjódur 6 Investment fund 26,004,377 0.4% Einar S Ólafsson Individual 25,000,000 0.4% Samvinnulífeyrissjódurinn Pension fund 20,430,510 0.3% Sparisjódur Hafnarfjardar* Savings Bank 19,425,757 0.3% Úlfur Sigurmundsson Individual 18,750,000 0.3% Elías Skúli Skúlason Individual 18,750,000 0.3% Twenty largest shareholders total 5,074,962,821 86.8% Other 4999 shareholders total 726,627,065 12.4% Total active shares 5,801,589,886 99.3% *Including shares whereby the banks may have FL Group hf. Own shares 43,704,232 0.7% entered into forward contracts requiring them to sell Total issued shares 5,845,294,118 100.0% shares at a predetermined future date.

Ownership Íslands hf. is obligated to sell 1,044,504,817 shares in FL Group hf. or The total number of shareholders in FL Group hf. as of 28 Decem- 17.87% of FL Group hf.'s. total share capital. Of Landsbanki Íslands ber 2005 was 5,019 at the end of the day. The ten largest sharehold- hf's direct shareholding in FL Group hf. 10% stands as a hedge against ers owned the equivalent of 81.9% of total issued shares in the Com- derivate contracts. pany, a total of 4,788,021,551 shares. The twenty largest share- Eignarhaldsfélagid Oddaflug ehf. is the second largest shareholder holders owned a total of 5,074,962,821 shares, or 86.8%. The Com- according to the share register but the largest beneficial shareholder pany is not aware of any shareholder agreements which have been in FL Group hf., with a 19.83% holding. According to major holding made concerning the exercising of voting rights. announcements sent to ICEX, most recently on 14 December 2005, The following shareholders are obligated not to dispose of their the company is owned by Hannes Smárason, CEO of FL Group hf. In shares in FL Group hf. for a certain period of time: Einar S. Ólafsson, addition Eignarhaldsfélagid Oddaflug ehf. bears all financial risk and Elías Skúli Skúlason, Úlfur Sigmundsson and Thórarinn Kjartansson. benefits from what corresponds to the ownership of 292,264,706 Pursuant to a purchase agreement of Flugflutningar ehf. each of these shares by virtue of a issued by Landsbanki Íslands hf. individuals received 23,437,500 shares in FL Group. On 1 July 2005 According to the share register Íslandsbanki hf. is the third largest they were allowed to sell 1/10 of that share capital. Every three shareholder in FL Group hf. with 545,173,018 shares or 9.3%. Islands- months thereafter they will be allowed to sell an additional 1/10 of banki hf. has not made any major holdings announcement on ICEX the share capital they received as a part of the sale. These restrictions regarding this shareholding. According to information from the bank will be fully lifted as of 1 October 2007. on 28 December 2005, the holding of Íslandsbanki hf. in FL Group hf. is to a significant extent due to forward contracts which the bank has The largest shareholders entered into with its customers. The bank said its real shareholding is According to the share register, Landsbanki Íslands hf. (one of the insignificant and under the disclosure limits specified in the securities two Managers) is the largest shareholder in FL Group hf. with transactions act. 1,735,162,624 shares. According to a major holdings announcement The fourth party listed on the share register is an Arion safnreikningur. published on ICEX’s website on 14 December 2005 Landsbanki Ís- These are shares held in nominee accounts on behalf of Arion's lands hf. has entered into forward contracts whereby Landsbanki clients. Arion Verdbréfavarsla hf. is a custody service company fully

11 owned by Kaupthing Bank hf. (one of the Managers). There is no fur- 29 June 1992, and are included in the ICEX-15 index. The Compa- ther information available on the beneficial ownership of these ny's board of directors has not made any resolution on seeking a list- shares. ing for FL Group hf. shares on other stock exchanges. The shares' ticker symbol in the trading system of ICEX is FL. One Round Lot of Materia Invest ehf. is the owner of 404,411,765 shares or 6.9% of FL the Company's shares amounts to 5,000 shares. A Round Lot, as Group hf.'s share capital. According to a major holdings announce- defined in NOREX Members Rules is the minimum number of shares ment sent to ICEX on 18 November 2005, Materia Invest ehf. is which can generate a Latest Paid Price, as defined in NOREX Mem- owned by Magnús Ármann, member of the board of directors of FL ber Rules, in conjunction with trading on ICEX. Group hf., Thorsteinn M Jónsson, member of the board of directors of FL Group hf. and Kevin Stanford. Each of them owns one third of Rights the share capital of Materia Invest ehf. All the shares of FL Group hf. are of one class and carry equal rights. The Company's shares carry no special rights and no restrictions are Important parties not shown in the share register placed on them. Owners of the Company’s share capital have the According to a major holdings announcement in ICEX's news sys- right to vote at shareholders' meetings, the right to receive dividends tem, http://news.icex.is, the following parties not shown in the share when declared, enjoy pre-emptive rights to new shares, unless register have announced their interest in FL Group hf.'s shares. waived, and the right to a portion of the Company’s assets upon liq- hf. has entered into forward contracts to acquire a uidation, all according to share ownership, statutes and the Compa- total of 1,124,670,139 shares or 19.24% of the Company's shares, ny’s Articles of Association in effect at any given time. making Baugur Group hf. the second largest shareholder of FL Group hf. when shares have been delivered according to the terms of these Dividend policy forwards contracts. Baugur Group hf. is an international investment FL Group hf. decided at the Annual General Meeting on 10 March company focusing on retail investments and real estate sectors in 2005 to pay 60% dividend on the nominal value of shares for the year northern . Among other principal assets owned by Baugur 2004 which equalled 44% of the Company's after-tax profit for 2004. Group hf. are Iceland Stores and Booker, a large stake in Mosaic The payment was made on 20. April 2005. It is FL Group hf.'s policy Fashions hf., listed on ICEX which runs womenswear brands, Oasis, to pay out 30-40% of its after-tax profit on average. Coast, Karen Millen and Whistles, Hagar hf., the largest food and spe- ciality retailer in Iceland, the toy company , the Goldsmith Right to dividends jewellery store chain, the MK One fashion chain and Julian Graves, a A resolution on the distribution of dividends shall be made at an speciality food chain. The CEO of Baugur Group hf., Jón Ásgeir annual general meeting which shall be held before the end of May Jóhannesson, is a member of the board of directors of FL Group hf. each year. According to the Company's Articles of Association the and the director of Nordic Investment within Baugur Group hf. dividend payment is presumed due at the annual general meeting, Skarphédinn Berg Steinarsson is the chairman of the board of direc- and any dividends declared shall be paid to parties who are share- tors of FL Group hf. In addition Baugur Group hf. bears all financial holders in the shareholder registry at the annual general meeting risk and benefits from what corresponds to the ownership of which decides on the payment of dividends for the previous account- 292,264,706 shares by virtue of a derivative issued by Landsbanki ing year. Íslands hf. According to Article 4 of the Company's Articles of Association, each Icon ehf. has entered into forward contracts to acquire a total of shareholder shall inform the Company of his/her address. In the event 448,487,889 shares or 7.8% of the Company's shares. According to that shareholders neglect to provide information of such address, a major holdings announcement sent to ICEX on 31 October 2005, they shall neither have any claim towards the Company to receive Icon ehf. is owned by Magnús Ármann, member of the board of any notice or payments which have been miscarried. However, share- directors of FL Group hf., Thorsteinn M Jónsson, member of the holders may collect their dividends at the Company's office within board of directors of FL Group hf., Kevin Stanford and Sigurdur Bolla- four years of payment being due. This provision on the lapse of the son. Each of them owns 25% of the share capital of Icon ehf. right to a dividend that has not been collected is unanimous with pro- According to an announcement of trading by primary insiders dated visions stating that these rights lapse after four years according to Act 3 November 2005, Thorsteinn M Jónsson, member of the board of no. 14/1905 on the Lapse of Debts and Other Claim Rights. directors, is the beneficial owner of 24,771,499 shares in FL Group hf. or 0.4%. Right of ownership and transfer There are no limitations on the authorization to transfer FL Group Issue and share rights hf.'s shares, and shareholders may pledge their shares unless prohib- ited from doing so by law. Nevertheless, it should be noted that indi- Issue and share characteristics vidual shareholders may have agreed that their shares are subject to FL Group hf.'s share capital consists of shares of ISK 1.0 and multiples certain restrictions. A party acquiring a share in the Company cannot thereof. FL Group hf.'s shares are all issued electronically at the ISD exercise its right as a shareholder unless its name has been registered and are registered there under the name and Icelandic ID-Number in the share registry or it has announced and proven its ownership of of the relevant shareholder or their nominee. The shares' symbol in the share. Only general legislative rules apply to the transfer of shares the ISD system is FL. The ISIN number of the shares is in FL Group hf. The electronic registration of securities is governed IS0000000289. by Act no. 131/1997 on electronic registration of securities and Reg- FL Group hf.'s shares have been listed on the ICEX Main List since ulation no. 397/2000 which is based on that Act.

12 A printout from the ISD on the ownership of shares in FL Group hf. the share register. The same applies to financial institutions which are is considered a valid registration of the shares. The Company shall registered as nominees as the shareholder does not have the right to consider the share registry as full proof of ownership to shares and issue a proxy to exercise the voting right. Shares held by a nominee attached rights. Dividends as well as all announcements shall at any do therefore not provide voting rights at shareholders’ meetings. given time be sent to the party registered in the Company’s share Having shares registered by a nominee does not exempt the respec- register as owner of the shares in question. The Company is in no tive shareholder from being subject to the relevant rules relating to way liable if payments or announcements do not reach their recipi- the acquisition and disposal of major holdings in the Act on Securities ents because a change of address has not been notified. Transactions. Customers' ownership in nominee accounts shall be Rights to electronic shares must be registered at the ISD if they are included when assessing the need for disclosing such transactions. to enjoy legal protection against legal executions and disposal by In Article 11, Act no. 33/2003 it is stated that a financial undertaking, means of an agreement. It is forbidden to issue share certificates for which is authorised to hold financial instruments owned by its cus- registered rights according to an electronic share or endorse them, tomers, may hold them in a special account (nominee account) and and such transactions are voided. Registration of the ownership of an accept payment on behalf of its customers from individual issuers of electronic share at the ISD, subsequent to a Securities Depository financial instruments, provided the financial undertaking has explained final entry, formally gives a registered owner legal authorization to to the customer the legal effects of such and the customer has given the rights for which he is registered. Priority of incompatible rights is approval thereto. The financial undertaking must keep a record of the determined by the chronological order of requests from the Banks’ holdings of each individual customer. Article 11 also states that in the Data Central reaching the Securities Depository. event that a financial undertaking is sent into or granted a debt moratorium, or the undertaking is wound up or comparable Tax issues measures taken, the customer can, on the basis of the record provid- The shares of FL Group hf. are subject to taxation according to law ed for in the first paragraph, withdraw his/her financial instruments in effect at any given time. Investors are advised to seek external tax from the nominee account, provided there is no dispute as to the advice on the tax impact of any investment in the shares. holding. The Issuer's shares are subject to stamp duty in Iceland which the Dissolution of the Company Issuer shall pay within a year from the issue of the shares. Stamp duty According to the Company's Articles of Association the dissolution has been paid on all shares that have already been issued. of the Company shall be governed by the current act on public lim- The Company is obliged to retain PAYE taxes on dividend payments, ited companies. The current act is Act no. 2/1995 on Public Limited according to Art. 3, Para. 2 and Art. 5. Para 4. of Act no. 94/1996 on Companies and the provisions are set out in Chapter XIII. The same Capital Income Tax. For Icelandic parties other than those exempt Act shall apply to any type of merger or joining of the Company with from PAYE tax on capital earnings, the PAYE tax is a final taxation. other companies, and to the sale of all of its assets. The meeting that As regards parties living abroad, it must be established whether there has made a valid decision to dissolve or liquidate the Company shall is a double taxation agreement with the state where the party in also decide on the disposal of assets and the payment of debts, cf. question resides and, if so, it must be established whether there is Chapter XIII of Act No. 2/1995 on Public Limited Companies. Chap- any taxation payable in addition to that in Iceland. ter XIII also stipulates that shareholders controlling a minimum of two Profit from the sale of shares in FL Group hf. is taxable in Iceland. As thirds of a company's total share capital can make the decision at a regards parties living abroad, it must be established whether there is shareholders' meeting to the effect that the company shall be dis- a double taxation agreement with the state where the party in ques- solved. Upon the satisfaction of all claims, payments to shareholders tion resides and, if so, it should be determined which state has the shall be in correct proportion to their holdings. right of taxation. Shares in FL Group hf. fulfil the conditions of item 1 of section B of Article 30 of Act. no. 90/2003, with subsequent amendments, on Income Tax and Net Wealth Tax. It discusses the deduction of increased investments in shares before the end of 2002 from the income tax base.

Nominee accounts Provisions on nominee accounts are contained in the Act no. 33/2003on Securities Transactions, the Act no. 131/1997 on Elec- tronic Registration of Title to Securities and the Act no. 2/1995 on Public Limited Companies. In Article 31, Act no. 2/1995 it is stated that those who own shares cannot exercise their rights unless the ownership has been registered in the share register. This does not include the right to dividends or other payments and the right to new shares in the case of a new share issue. According to Article 31 a shareholder does not have vot- ing rights at a shareholders’ meeting unless his name is registered in

13 IV. Organisation

Historical 1953 Loftleidir pioneered low-fare services across the North The story of FL Group hf.'s predecessors dates back to 1937, almost Atlantic. as long as the story of commercial aviation in Iceland which began in 1973 Loftleidir and Flugfélag Íslands merged to form Flugleidir. 1919, less than 16 years after the Wright brothers made the first- 1979 Flugleidir assumed operating responsibilities of its two par- ever powered flight. FL Group hf. which was called Flugleidir hf. at ents, Icelandair becomes its international name. that time, was established in Reykjavik on 20 July 1973 by Flugfélag 1992 Flugleidir becomes listed on the ICEX Main List. Íslands hf. and Loftleidir hf. 1993 Total renewal of older fleet that began 1989 reaches a con- clusion. Today FL Group hf. places its main focus on investment activities. 1997 Flugfélag Nordurlands and Flugleidir domestic flight operation The Company is engaged in three areas of investments; firstly in pri- merged to form Flugfélag Íslands, a wholly owned subsidiary vate equity investments with a focus on operating companies, i.e. of Flugleidir hf. businesses owned by the parent company and strategic investments; 1998 Flugleidahótel hf. founded when the hotels that had been secondly in asset management with a focus on short-term invest- part of Flugleidir hf. became a distinct subsidiary. ments and asset management; and thirdly aircraft trading/leasing with 2000 Flugleidir Frakt ehf. founded when the cargo business of Flug- a focus on buying, selling and leasing aircraft. In addition finance and leidir became a distinct subsidiary. administration takes place at a group level. 2001 Flugthjónustan Keflavíkurflugvelli ehf. founded when the FL Group hf.'s business is largely involved in the private equity seg- ground services of Flugleidir became a distinct subsidiary. ment. The private equity division manages all business operated by 2002 Loftleidir Icelandic ehf. founded when the wet lease and FL Group hf. The largest business in 2005 is Icelandair Group, and charter arm of Icelandair became a distinct subsidiary. the others are FL Travel Group and Bluebird. Sterling is expected to 2003 Flugleidir became a holding company with 11 subsidiaries in join the Group from January 2006. Within Icelandair Group there are travel and tourist industry in Iceland, Flugleidir hf. operations five subsidiaries, whilst there are six subsidiaries within FL Travel was divided into Icelandair, Icelandair Technical Services and Group. FL Group aims to have 50-80% of total assets channelled into Fjárvakur-. Icelandair is the largest subsidiary. private equity investments. 2004 Flugleidir acquires an 8.4% holding in easyJet (current owner- ship 16.2%). As a result of FL Group's recent share issue, through which the Com- 2005 Flugleidir becomes FL Group. The holding company pany raised ISK 42.7 billion to the Company, more funds are available announced its emphasis on investment. This was followed by for investing in new projects. Consequently, a large part of those new increased investment activities and the acquisitions of Blue- funds have currently been invested through the asset management bird and Sterling. side of the Company, while they may at a later stage be transferred 2005 In October fundamental changes took place whereby invest- into private equity projects and strategic investments. FL Group aims ments became the focus of FL Group hf. and its airline and at having 20-50% of total assets invested in a portfolio of listed secu- tourist service operations were divided between two sepa- rities and other short-term investments. rate business units; Icelandair Group and FL Travel Group. The aircraft trading and leasing segment draws on the overall knowl- These business units are then to be made into separate sub- edge of FL Group hf.'s operation, history, contacts and capabilities. FL sidiaries from 1 January 2006. Group hf. has a decade of experience in aircraft trading. Over the last Icelandair has been a member of International Air Transport Associ- 12 months Icelease, which is part of the aircraft trading and leasing ation (IATA) since 1950, a member of Association of European Air- operation of FL Group hf., has been involved in the purchase and sale lines (AEA) since 1957, and a member of Flight Safety Foundation of 25 aircraft in deals worth more than USD 1 billion. (FSF) since 1966.

Key Milestones Legal structure 1937 Flugfélag Akureyrar founded in Akureyri on the north coast The business development of FL Group hf. has made its mark on the of Iceland. Group's legal structure. In the 1990's FL Group hf. (then Flugleidir hf.) 1943 Name changed to Flugfélag Íslands (Icelandair) and head- broadened its scope of operation from being mainly focused on avi- quarters moved to Reykjavík. ation to include cargo and the tourist industry. These additional activ- 1944 Loftleidir founded, later also known as . ities formed either part of the operation of Flugleidir hf.'s parent com- 1945 Flugfélag Íslands made its first international flights and Loft- pany or part of the operation of subsidiaries. In 2003 action was tak- leidir in 1947.

14 en towards differentiating between different operations, whereby FL Legal name Ownership English brand name Group hf. (then Flugleidir hf.) became the holding company of sub- ii no2 Ltd, ii no3 Ltd, ii sidiaries with specific operations. The last changes were implement- no4 Ltd, ii no5 Ltd 100% ed in October 2005 whereby the subsidiaries, excluding those Reg.office: 30 Herbert Street, , Ireland acquired in 2005, are to be categorised and mainly put into two Fjárvakur - 100% Fjárvakur- holding companies: Icelandair Group and FL Travel Group. This Fjármálathjónusta ehf. Financial services change has not yet had its effect on the legal structure but is shown ID-No: 521202-2620, Reg.office: Reykjavíkurflugvöllur pc.101 in the chart under "Position within the organisation". FL Group hf.'s associated companies, both domestic and foreign, are stated at historical cost. The Group holds a share of between 20% Subsidiaries and associates and 50% in fifteen associated companies. The equity of the associat- On 29 December 2005 the following companies are subsidiaries of ed companies in the operating results and financial position of the FL Group. Note that FL Investment hf. will be merged with the par- associated companies are not included in the Consolidated Financial ent company in the last quarter of 2005, and in January 2006 Ster- Statements of FL Group hf. due to the immaterial effect thereof and ling is expected to become part of the Group. Furthermore, as a therefore not included in the legal structure. result of organisational changes made in October, the legal structure of the Group will change from 31 December 2005: In addition to the above mentioned 37 subsidiaries and associates, the Company owns 7 dormant companies not included in the legal Exhibit 4 – Legal structure of FL Group hf. structure. Subsidiaries: The Group's subsidiaries and parent company trade with each other. There are no irregular loan agreements between them of a material Legal name Ownership English brand name nature. Icelandair ehf. 100% Icelandair ID-No: 461202-3490, Reg.office: Reykjavíkurflugvöllur pc.101 Principal Subsidiaries Flugleidir-Frakt ehf. 100% Icelandair Cargo Principal subsidiaries are those in which the issuer holds a proportion ID-No: 471299-2359, Reg.office: Reykjavíkurflugvöllur pc.101 of the capital likely to have a significant effect on the assessment of its Loftleidir - Icelandic ehf. 100% Loftleidir - Icelandic own assets and liabilities, financial position or profits and losses. In all ID-No: 571201-4960, Reg.office: Reykjavíkurflugvöllur pc.101 cases the book value of that subsidiary represents at least 10% of the Flugthjónustan consolidated net assets or accounts for at least 10% of the consoli- Keflavíkurflugvelli ehf. 100% IGS Ground Services ID-No: 551200-3530, Reg.office: Heidarbóli 43 pc. 230 dated net profit or loss of the group. Principal subsidiaries in 2005 are Tæknithjónustan Icelandair ehf. and FL Investment ehf. The operation of the parent Keflavíkurflugvelli ehf. 100% ITS Technical Services company FL Group hf. also falls into the category of a major entity. It ID-No: 511202-2990, Reg.office: Keflavíkurflugvöllur pc. 235 must be noted that FL Investment will be merged with the parent Flugfélag Íslands hf. 100% Air Iceland company before the publication of the annual accounts, and the ID-No: 530575-0209, Reg.office: Reykjavíkurflugvöllur pc.101 organisational structure described later in this chapter has changed Ferdaskrifstofa Íslands hf. 100% (IT - Iceland Travel) since the first nine months of 2005. ID-No: 590670-0149, Reg.office: Pósthólf 8650 pc 128 Íslandsferdir ehf. 100% IT - Iceland Travel Icelandair ehf. ID-No:410791-1379, Reg.office: Lágmúli 4 pc 108 Icelandair ehf. is a 100% owned subsidiary of FL Group hf. The total Kynnisferdir ehf. 96% Reykjavík Excursions share capital of Icelandair ehf. is 3,000,000,000 shares of ISK 1 each ID-No: 620372-0489, Reg.office: Vesturvör 6, pc 200 and has been paid in full. On 30 September 2005, the book value of Bílaleiga Flugleida ehf. 100% Icelandair Hertz Icelandair ehf. capital and reserves amounted to ISK 4,409 million. Ice- Car Rental landair ehf. was incorporated in December 2002. Icelandair ehf. paid ID-No: 471299-2439, Reg.office: Reykjavíkurflugvöllur pc.101 no dividend in 2005 for 2004. Flugleidahótel hf. 100% Icelandair hotels ID-No: 621297-6949, Reg.office: Reykjavíkurflugvöllur pc.101 FL investment ehf. Bláfugl hf. 100% Blubird Cargo FL investment ehf. is a 100% owned subsidiary of FL Group hf. The ID-No: 460899-2229, Reg.office: Bygging 10 pc 235 total share capital of FL investment ehf. is 1,000,000 shares of ISK 1 Flugflutningar ehf. 100% BlueCargo each and has been paid in full. On 30 September 2005, the book val- ID-No: 600372-0179, Reg.office: Hédinsgata 1-3 pc 105 ue of FL investment ehf. capital and reserves amounted to ISK 6,217 FL investment ehf. 100% ID-No: 580204-2790, Reg.office: Reykjavíkurflugvöllur pc.101 million. FL investment ehf. was incorporated in February 2004. FL Investment ehf. paid ISK 350 million in dividend in 2005 for 2004. Icelease ehf 100% ID-No: 670505-0140, Reg.office: Reykjavíkurflugvöllur pc.101 Icecap Insurance PCC Organisational structure Ltd, Cell 1 100% The new organisational structure which was introduced in October Reg.office: Polygon Hall Le Marchantstreet, St'Petersport, Guemsey 2005 is in line with the Group's main focus of an increased emphasis Icelease (Ireland) no 1 on investments. Managing capital between attractive investment Ltd. ("ii no1 Ltd") 100% propositions is the main task ahead. Investment activity is managed by Reg.office: 30 Herbert Street, Dublin, Ireland three distinct divisions: the asset management division managing short

15 term investments and investments in listed securities; Exhibit 5 – FL Group's organisational structure the aircraft trading and leasing division managing

investments and leasing of aircraft; and the private Board equity division managing almost all operating compa- of Directors nies and strategic investments owned by the Group. Private equity will actively participate in the strategic Hannes Smárason CEO development of the Group's companies but will distance itself from day-to-day operations. Each busi- Aircraft ness is managed in accordance with portfolio theo- Private Equity Asset Management Trading/Leasing ries and private equity initiatives, creating value with Jón Sigurdsson Albert Jónsson Halldór Vilhjálmsson strategic and business development decisions. The Finance/Administration • Operating companies • Short-term investments • Buying, selling and leasing Sveinbjörn Indridason • Private equity investments • Asset management of aircraft finance and administration department is a support • Financing • Strategic investments • Investments in listed • Treasury securities division to the parent Company. • Risk management • Internal bank The new organisational structure has also focused on

simplifying the structure of companies managed by Fjárvakur Icelandair Group the private equity division, categorising the existing Finance services Jón Karl Ólafsson subsidiaries into either airline or tourist services FL Travel Group operations. At the moment Icelandair Group and FL Thorsteinn Örn Gudmundsson Travel Group are still only organisational entities but will in the coming months also gain a legal setup Bluebird Thórarinn Kjartansson when many of the existing subsidiaries and opera- tions described in the legal structure section on the Sterling previous page will be transferred into three compa- Almar Örn Hilmarsson nies, Icelandair Group (yet to be founded), FL Trav- el Group (yet to be founded) and Bluebird. Sterling is expected to join the Group from January 2006.

Corporate Governance Corporate governance in FL Group hf. is defined as the framework bers are not being independent of major shareholders and there are by which the Company is directed and controlled and the means by no functional sub-committees that have taken over the responsibili- which relationships between the Company's management, its board ties described in the guidelines. The great majority of the Company's of directors, and its shareholders are conducted. board members are independent of the Company in accordance with the guidelines on corporate governance, paragraph 2.6 which The aim of the board of directors' rules and corporate governance states: programme in FL Group hf. is to ensure disclosure and transparency, define the jurisdiction of the board of directors and its role with A director is not independent of the Company: respect to the management. In the corporate governance program • If he is or has been an employee of the Company, or the conglom- there are rules regarding, among other things, the order of board erate, during the past three years. meetings, rules on board members' qualifications to participate, res- • If he receives compensation from the Company, or from a mem- olutions made, rules on disclosure of agreements between the Com- ber of the operative management, besides the compensation due pany and any board member or the CEO, rules regarding confiden- him as a director, for example as a consultant or contractor. tiality, information to be presented by the CEO to the board of • If he has close family ties with any of the consultants, directors or directors at board meetings, which shall generally be held at least members of the operative management of the Company. monthly etc. • If he is a member of the operative management of a company that The board of directors is ultimately responsible for the Group’s sys- does significant business with the Company. tem of internal controls and for reviewing their effectiveness. How- • If he is a member of the operative management of a company in ever, such a system is designed to manage rather than eliminate the which a member of the operative management of the Company is risk of failure to achieve business objectives, and can only provide a director, reasonable assurance against material misstatement or loss. The • If he does considerable business with, or has significant business board of directors has adopted a code of business conduct, which interests in the Company. provides practical guidance for all staff regarding the principles by • If he participates in a performance-based or a share purchase com- which the Company wants to conduct business. pensation scheme of the Company. • If the board of directors is aware of any other instances wherein In 2004, the Iceland Chamber of Commerce, ICEX and the Confed- the interests of the director and the Company might be in conflict. eration of Icelandic Employers issued guidelines on corporate gover- nance. FL Group hf. has studied these guidelines and believes that it complies with these guidelines apart from the fact that board mem-

16 On 17 August 2005 the Icelandic Takeover Panel made a statement Company’s board of directors directs company affairs and sets its after its examination of whether a takeover obligation had arisen in objective and future vision, deals with the annual budgets and com- FL Group, following substantial changes in ownership or voting rights pany's goals presented by the CEO and the strategy to be taken to in the Company on 1 July 2005. The investigation by the Panel was reach them. The board of directors shall oversee that the Company's directed at two principal points, i.e. at examining whether an agree- strategy is in accordance with its vision and overall goals. The Com- ment had been reached to acquire control or, whether the connec- pany's board of directors ensures the sufficient supervision of the tions between Eignarhaldsfelagid Oddaflug ehf. and Katla Investment accounting and handling of the Company’s funds. S.A. and/or Baugur Group hf. were such that they were deemed to The board of directors makes decisions on all matters that are be acting in concert in the meaning of the above statutory provision. deemed extraordinary or significant. The board of directors can grant The Panel's conclusion, on the basis of the information obtained by the CEO the authority to resolve such issues. The CEO can also exe- the Panel and which was available at that time, that Eignarhaldsfélagid cute such matters if there is not the opportunity to wait for the board Oddaflug ehf. was not obliged to submit a takeover bid for FL Group of directors' approval without great disadvantage to the operation of as a result of the changes in ownership or voting rights of shares in the Company. In such instances the CEO shall report promptly to the the Company which took place on 1 July 2005. chairman of the board of directors. Only the Company's board of On 14 December 2005 the Takeover Panel made a statement after directors can grant power of procuration. its examination of whether a takeover obligation had arisen in FL The board of directors appoints the CEO of FL Group hf. and Group, following substantial changes in ownership or voting rights in decides on the terms of his or her employment or entrusts the chair- the Company as announced in mid-November when the Company's man of the board of directors to complete that task. share capital was increased following a share offering on 10 Novem- ber 2005. The investigation by the panel was directed at whether The Working Procedures of the board of directors state that board Eignarhaldsfélagid Oddaflug ehf. and Baugur Group hf. had been act- members should familiarise themselves with the provisions of law, the ing in concert to acquire control of the Company when they under- Company’s Articles of Association, general securities regulations and took to subscribe for new shares in the share offering. Eignarhalds- the Company's special regulations on the handling of inside informa- félagid Oddaflug ehf. subscribed for shares with a market value of ISK tion and insider trading. 7.5 billion and Baugur Group hf. subscribed for shares with a market The majority of members of the board of directors of FL Group hf. value of ISK 15 billion. The Takeover Panel concluded that Eignar- are independent of the Company, as recommended by the guidelines haldsfélagid Oddaflug ehf. and Baugur Group hf. had been acting in on corporate governance issued by the Iceland Chamber of Com- concert when the allocation of share capital in the offering was merce, ICEX and the Confederation of Icelandic Employers in 2004. decided. The Takeover Panel concluded that Baugur Group hf. was However, there are not two members independent of major share- obligated to make a takeover bid in accordance with the Act no. holders, as recommended by the same guidelines. 33/2003 on Securities Transactions chapter VI and VII to other shareholders. Following the Panel's statement, Baugur Group hf. and The following section lists the current members of the board of direc- Eignarhaldsfélagid Oddaflug ehf. sold 5% each of the share capital of tors and their activities. It is not intended to be exhaustive but details FL Group hf. on 14 December 2005. The Takeover Panel subse- the main occupations and/or other occupations that are linked to the quently announced on 14 December 2005 that since the combined ownership or operations of FL Group hf. Skarphédinn Berg Steinars- holdings of Eignarhaldsfélagid Oddaflug ehf. and Baugur Group hf. in son, Jón Ásgeir Jóhannesson, Magnús Ármann and Thorsteinn M. FL Group hf. was less than 40% after this transaction the Takeover Jónsson were elected as board members on 9 July 2005, whilst Jón Panel concluded that there was no longer an outstanding obligation Ásgeir Jóhannesson was a member of the board of directors from to submit a takeover bid to other shareholders. March 2003 to June 2004. Smári S. Sigurdsson was elected on to the board of directors on 1 November 2005. From July 2005 until that Statutory bodies date he was a substitute board member of FL Group hf. In references The supreme authority in the affairs of FL Group hf., within the lim- made to “related parties” who hold shares in FL Group hf., related its established by its Articles of Association and statutory provisions, parties are linked to board members, where the board members is in the hands of the Company's shareholders’ meetings. Sharehold- have extensive influence over the investment activity of the related ers’ meetings may be attended by shareholders and their represen- party. There are no extraordinary transactions between the board of tatives. ICEX recommends that shareholders’ meetings of listed com- directors and the Company. The board of directors has not received panies be open to representatives of the press and the ICEX. any loans or stock options from the Company. The annual general meeting of FL Group hf. shall be held before the Skarphédinn Berg Steinarsson, ID-No: 050763-7819, Melhagi 1, 107 end of May each year. Reykjavík. Chairman of the board of directors. Occupation: Managing director of Nordic investments at Baugur Group. Own holding and At shareholders’ meetings each share carries one vote. Decisions at holding of spouse and children under 18 years of age in FL Group hf. shareholders’ meetings are made by majority vote unless otherwise 85,000. Related party: Managing director of Nordic investments at provided for in the Articles of Association or prescribed by law. Baugur Group hf. which holds 1,124,670,139 shares in FL Group hf. or 19.24% of the share capital. In addition Baugur Group hf. bears all Board of directors financial risk and benefits from what corresponds to the ownership of The board of directors of FL Group hf. has the supreme authority in 292,264,706 shares by virtue of a derivative issued by Landsbanki the Company’s general affairs between shareholders' meetings and Íslands hf.1) endeavours to keep the organization and operations on course. The

17 Jón Ásgeir Jóhannesson, ID-No: 270168-4509, Sóleyjargata 11, 101 directors of the Company or employees. The qualifications and eligi- Reykjavík. Member of the board of directors. Occupation: President bility of the Auditor at elections are in other respects governed by and CEO of Baugur Group. Own holding and holding of spouse and law. children under 18 years of age in FL Group hf.: 0 shares. Related par- The chartered accountants and registered auditor of FL Group hf. are ty: CEO of Baugur Group hf. which holds 1,124,670,139 shares in FL KPMG Endurskodun hf. ID-no. 590975-0449, Borgartún 27, IS-105 Group hf. or 19.24% of the share capital. In addition Baugur Group Reykjavik, Iceland. The Company's auditors are not allowed to own hf. bears all financial risk and benefits from what corresponds to the stock in the Company. ownership of 292,264,706 shares by virtue of a derivative issued by Landsbanki Íslands hf.1) Compliance Officer As provided for by law a compliance officer is employed within the Magnús Ármann, ID-No: 160574-4969, Laufásvegur 69, 101 Reykja- Company. The compliance officer is directly responsible to and vík. Member of the board of directors. Occupation: Private investor. appointed by the board of directors and is independent in his or her Own holding and holding of spouse and children under 18 years of duties. The compliance officer monitors the implementation of insid- age in FL Group hf.: 0 shares. Related party: one third part owner, er rules adopted by the Company, including rules regarding securities procurator and chairman of the board of directors of Materia Invest trading by employees and primary insiders. The compliance officer is ehf. which holds 404,411,765 shares in FL Group hf. or 6.9% of the responsible for interpreting the rules, and makes decisions based on share capital, 25% owner, procurator and chairman of the board of the rules. The compliance officer makes proposals for improved directors of Icon ehf. which holds 448,487,889 shares in FL Group hf. working procedures for various positions within the Company and or 7.7% of the share capital.2) helps develop and maintain the compliance monitoring system. A substitute compliance officer has been appointed by the board of Smári Sigurdsson, ID-No: 030847-3349, Spordagrunn 1, 104 Reykja- directors. vík, Iceland. Member of the board of directors. Occupation: Manag- ing director of finance and administration of Idntæknistofnun (Tech- In accordance with applicable regulations and recommendations of nological Institute of Iceland). Own holding and holding of spouse the Icelandic Financial Supervisory Authority (FME) the Company has and children under 18 years of age in FL Group hf.: 0 shares. Smári introduced the rules set out by the FME on the handling of inside Sigurdsson is not related to any other parties which own shares in FL information and insider trading. Group hf. Smári Sigurdsson is the father of the CEO Hannes Smára- son. Senior Management The senior management team under the leadership of the CEO Thorsteinn M. Jónsson, ID-No: 180263-3309, Laufásvegur 73, 101 Hannes Smárason comprises four managing directors. All have signif- Reykjavík, Iceland. Member of the board of directors. Occupation: icant management experience in their field of operations. In addition Chairman of the board of directors of Vífilfell hf., the Coca Cola bot- there are three CEOs of subsidiaries who are regarded as senior tler and distributor in Iceland. Own holding and holding of spouse managers. According to the Company's Articles of Association, the and children under 18 years of age in FL Group hf.: 24,771,499 Company may not grant loans or guarantees against shares in the shares. Related party: one third part owner, procurator and member Company to shareholders, to members of the board of directors, of the board of directors of Materia Invest ehf. which holds managing directors or managers. This does not prohibit normal com- 404,411,765 shares in FL Group hf. or 6.9% of the share capital and mercial loans or investments made by the Company's employees or 25% owner, procurator and member of the board of directors of those of a related company in the Company's shares or investments Icon ehf. which holds 448,487,889 shares in FL Group hf. or 7.7% of in shares on their behalf as permitted by law. the share capital.2) Hannes Smárason, CEO, (ID-No: 251167-3389), Address: Fjölnis- Members of the board of directors currently have no stock options vegur 11, 101 Reykjavík, Iceland, joined FL Group hf. as chief execu- or warrants in FL Group hf. tive on 19 October 2005. Previously, he was the chairman of the board of directors of FL Group hf. from 11 March 2004 to 19 Octo- In addition to the five board members there are two substitute ber 2005. He was earlier executive vice president and senior business board members, Kristinn Bjarnason ID-No: 240364-2209 and Thór- officer of deCode genetics Inc. Hannes Smárason worked with Mc- dur Bogason ID-No: 260663-3809. Kinsey & Co. in Boston from 1992 until December 1996 as a consult- 1) Baugur Group hf. through its forward contracts with banks is the second largest ben- ant. He received his B.S. in Mechanical Engineering and Management eficial owner of FL Group hf. with 1,124,670,139 shares or 19.24%. from the Massachusetts Institute of Technology and his M.B.A. from 2) Icon ehf. through its forward contracts with banks is the third largest beneficial own- the Massachusetts Institute of Technology Sloan School of Manage- er of FL Group hf. with 448,487,889 shares or 7.7%. ment. Hannes Smárason's holdings in FL Group hf.: 0 shares, 0 call options, 0 put options. Hannes Smárason, through his controlling Auditors share in the holding company Eignarhaldsfélagid Oddaflug ehf., is the A state authorised public accountant or accounting firm is elected as largest shareholder of FL Group hf. with 1,158,919,071 shares or the auditor at each annual general meeting of FL Group hf. for a term 19.8% of the share capital. In addition Eignarhaldsfélagid Oddaflug ehf. of one year. The Auditor examines the Company’s accounts and all bears all financial risk and benefits from what corresponds to the relevant accounts documents for each year of operation and has ownership of 292,264,706 shares by virtue of a derivative issued by access to all the Company’s books and documents for this purpose. Landsbanki Íslands hf. Holdings of other financially related parties: 0 Auditors are not elected from among the members of the board of shares.

18 Sveinbjörn Indridason, Chief Financial Officer (CFO), (ID-No: senior vice president of corporate strategy & business development 140372-3589). He has been responsible for finance and administra- at FL Group on 10 August 2005. Previously he worked as manage- tion since 3 May 2005. He joined FL Group hf. in 1999 in the risk ment consultant at McKinsey & Co. in Scandinavia and Singapore management department and as a director from 2000. Before that between 1999 and 2004. He received his M.Sc. degree in Civil Engi- he worked for Fjárfestingarbanki Atvinnulífsins – FBA hf. (now neering from the Technical University of Denmark in 1999. Íslandsbanki hf.). Sveinbjörn Indridason's holdings in FL Group hf.: Thorsteinn Örn Gudmundsson's holdings in FL Group hf.: 5,000 15,500 shares, 29,500,000 call options, 0 put options. Holdings of shares, 18,000,000 call options, 0 put options. Holdings of financially financially related parties: 0 shares. related parties: 0 shares.

Jón Sigurdsson, Managing Director of Private Equity and Strategic Thórarinn Kjartansson, President and CEO of Bláfugl hf. (ID-No: Investments (ID-No: 180378-4219), joined FL Group as managing 280752-7469). He has been the President and CEO of Bláfugl hf. director on 20 September 2005. He has a relevant private equity since its incorporation in early 2001. Thórarinn Kjartansson has been experience from his earlier work at Landsbanki Íslands hf. - Corpo- involved in the airline business for over two decades working for rate Finance department and Bunadarbanki Íslands hf. (now Loftleidir, Cargolux both in operation, scheduling and marketing and Kaupthing Bank hf.) – Corporate Finance department. He received finally managing director for North America and South America. In his B.Sc. in Business Administration from Reykjavík University. Jón Sig- Iceland he was one of the founders of Flugflutningar ehf., Bláfugl hf. urdsson's holdings in FL Group hf.: 0 shares, 51,500,000 call options, and Vallavinir ehf. (Airport Associates), an independent ground han- 0 put options. Holdings of financially related parties: 0 shares. dling service company. He received his B.Sc. in economics from the University of Gothenburg in 1978. Thórarinn Kjartansson's holdings in Albert Jónsson, Managing Director of Asset Management (ID-No: FL Group hf.: 18,750,000 shares, 18,000,000 call options, 0 put 180562-3119), joined FL Group as managing director on 1 October options. Holdings of financially related parties: 0 shares. 2005. He has gained considerable asset management experience in previous jobs, most recently for the past four years as chief invest- Remuneration ment officer for LSR (Pension Fund for State Employees), Iceland's Remuneration to the board of directors largest pension fund with assets under management of approximate- Remuneration for the board of directors of FL Group hf. for 2004 ly ISK 220 billion. He received his Cand. Oecon from the University totalled ISK 15.3 million. Hannes Smárason, the chairman of the of Iceland in 1986 and certification as a public stockbroker in 1998. board of directors, received ISK 3.6 million, Hreggvidur Jónsson, the Albert Jónsson's holdings in FL Group hf.: 0 shares, 29,500,000 call vice-chairman of the board of directors, received ISK 2.7 million and options, 0 put options. Holdings of financially related parties: 0 shares. the nine other members of the board of directors, five active at any given time, received a total of ISK 12.6 million. Halldór Vilhjálmsson, Managing Director of Aircraft Trading and Remuneration for the board of directors of FL Group hf. for board Leasing (ID-No: 051146-2559). He was appointed managing direc- membership will be ISK 200,000 per month per board member. tor of aircraft trading and leasing at FL Group hf. on 1 May 2005. He There were seven board members between 10 March 2005 and 1 joined FL Group hf. in November 1981 and was most recently the November 2005. According to a resolution passed at a shareholders' finance director for Icelandair ehf. from May 1988. He received his meeting on 1 November 2005 Article 12 of FL Group hf.'s Articles Cand. Oecon from University of Iceland in 1971. Halldór Vilhjálms- of Association was amended so that the board of directors will now son's holdings in FL Group hf.: 8,333,556 shares, 5,500,000 call consist of five members instead of seven, with two substitute mem- options, 0 put options. Holdings of financially related parties: 0 shares. bers. According to the current Articles of Association there will be five board members from 1 November 2005 to mid-March 2006. Jón Karl Ólafsson, President and CEO of Icelandair Group (ID-No: Consequently the total remuneration for board membership will be 120958-2759). He was appointed President and CEO of Icelandair ISK 14.8 million for the term between the annual general meeting in ehf. on 1 June 2005 and later became the President and CEO of Ice- March 2005 for the financial year 2004 and March 2006 for the finan- landair Group after FL Group hf.'s fundamental organisational cial year 2005. changes on 19 October 2005. He joined FL Group hf. in 1984, first- ly in the finance department, then as the manager of Icelandair's On 19 October 2005 Hannes Smárason resigned as chairman of the route network. He then served as the general manager of Icelandair's board and became the CEO of FL Group hf. On 1 November 2005 office in , Germany for 5 years. Before being appointed the Skarphédinn Berg Steinarsson became chairman of the board and President and CEO of Icelandair ehf. he had been managing director Hannes Smárason left the board of directors. The highlights of of Flugfélag Íslands hf. (Air Iceland) since 1999. He received his Cand. Hannes Smárason's terms of employment are described under remu- Oecon from the University of Iceland in 1984. Jón Karl Ólafsson's neration to senior management later in this chapter. Other board holdings in FL Group hf.: 7,988,391 shares, 18,000,000 call options, 0 members this year have not received remuneration from FL Group hf. put options. Holdings of financially related parties: 0 shares. this year apart from the remuneration for board membership speci- fied above. Thorsteinn Örn Gudmundsson, President and CEO of FL Travel Group (ID-No: 211266-4149). He was appointed President and CEO of FL Travel Group after FL Group hf.'s fundamental organisa- tional changes on 19 October 2005. He joined FL Group hf. in Sep- tember 2004 as director of corporate strategy and was appointed as

19 Auditors' fees ent market value, or about ISK 5,000 nominal value. The total value Auditors' fees in 2004 totalled ISK 26 million in 2004: ISK 11 million of the shares distributed among the staff is ISK 170 million or about for auditing, ISK 13 million for reviewing quarterly statements and ISK 12.1 million shares. 2 million for the provision of other services. On 6 December 2005 the Board of FL Group hf. entered into stock option agreements with FL Group hf.'s key employees, in line with a Remuneration to senior management statement made by the Company preceding its share offering in FL Group hf. underwent fundamental organisational changes on 19 November 2005. The number of options varied between key October 2005, which led to changes in the composition and struc- employees, as is usual for key employee stock option plans. The ture of senior management. None of the senior managers held their option agreements were set up so that key employees were allocat- current position within the Group in 2004. The CEO of Sterling is ed a fixed number of options when the agreements were entered expected to join the Group’s senior management from January 2006. into, one third of the allocated options are to be vested between 10 Costs related to the organisational changes which will be expensed November to 10 December each year for three years after the in the fourth quarter of 2005 amounting to ISK 532 million. This agreements were entered into first between 10 November to 10 includes costs associated with the retirement of two former CEOs December 2006. All options are to be exercised at the strike price and recruitment of all senior managers. ISK 13.6 per share which is the same price as in the share offering in The CEO's monthly salary is ISK 4 million. Furthermore, he may November 2005. The total number of allocated options corresponds become entitled to bonus payments which are dependent on results. to 203,000,000 shares. These are the only stock options that will be The amount of the respective bonus payments is to be decided at exercisable at year end 2005. the end of each year by and between the CEO and the chairman of the board of directors. Bonus payments can amount to anything up Employees to three times the CEO's annual salaries. The CEO's term of notice FL Group hf. believes that one of its principal strengths is its employ- is 12 months. The employment agreement provides for no other ees. Its operations require a wide range of knowledge and specialised retirement benefits. personnel within aviation technology, international marketing, finance and management. The total salary package for the other seven key managers, i.e. the four managing directors on Group level and the three CEOs of the Number of employees Group's subsidiaries, is expected to amount to ISK 154 million for The average number of employees at FL Group (then Flugleidir) and the next 12 months. Bonus payments are dependent on results and its subsidiaries in 2004 totalled 2,465 people, which represents an are to be decided at the end of each year. increase by 7.7% compared to the previous year when there were Sigurdur Helgason, former CEO of FL Group hf. (then Flugleidir hf.), 2,289 people. In 2002 the average number of employees was 2,181 retired at the end of May 2005 after 20 years as CEO of the Group. people. At the end of 2004 over 64% of the Group's employees Mr. Helgason agreed to advise and consult the board of directors for were employed by companies within Icelandair Group. Most of the the next few years after his tenure as president. His successor Ragn- remaining 36% were employed by companies within FL Travel hildur Geirsdóttir retired in mid-October 2005 following the funda- Group. mental organisational changes that were announced on 19 October Today FL Group hf. and its subsidiaries, including Bluebird, employ 2005. Sigurdur Helgason will receive ISK 161 million over the next 4- approximately 2,600 people. In addition there are approximately 5 years as retirement benefits and Ragnhildur Geirsdóttir will receive 1,800 people employed by Sterling which are expected to become ISK 130 million over the next 4-5 years as retirement benefits. A part part of the Group from January 2006. of the amount has been expensed in the 9-month results and the remainder will be expensed during the fourth quarter of 2005 and is included in the amount stated above A bonus system based on Economic Value Added (EVA) has been used for executives and amounted to ISK 30 million in 2004.

Employees’ shareholdings and stock options A large number of FL Group hf.'s employees are shareholders in the Company, and the Company believes that employees’ equity inter- est in the Company fosters commitment and personal interest in the success of the Company as a whole. FL Group hf.'s employees cur- rently own 2-3% of the Company. This excludes the CEO who has a 19.8% interest through a company he controls. In 2003 FL Group hf. paid out a bonus to all its employees in the form of shares in FL Group hf., a total of 23 million shares. At the annual general meeting on 10 March 2005 it was announced that the board of directors had decided to reward employees with shares in the Company worth about ISK 70,000 per person at pres-

20 V. Private equity

Private equity operations will be the main activity of FL Group. Today tives to ensure that the interest of management and the owners of there are three main operating companies in the private equity port- the Company are aligned. Utilization of synergies between companies folio, namely Icelandair Group, FL Travel Group and Bluebird. The invested in. fourth unit, Sterling, is expected to be added in January 2006. It is important to note that FL Group's approach to each investment will differ in each case, as the appropriate investment horizon, target Investment strategy returns and risk, etc, will depend on the individual investment case. FL Group aims to have 50-80% of its total assets channelled into pri- vate equity investments. The overall goals of the private equity oper- General description ations can be summarized as follows: In general, private equity investments have a very broad meaning. Performance: Target IRR will in each case depend on level of risk, Most commonly the term refers to private investment partnerships being on average about 20%. that buy up companies, generally in unrelated industries. The aim is Size: Enterprise Value (EV) generally not less than ISK 5 billion consequently to restructure, dispose of incidental assets and improve Geographical focus: Europe operations and management. Investment Horizon: Highly dependent on individual investments The investment horizon differs widely from case to case, but in gen- but on average 3-5 years eral the private equity investor will hold the asset for more than three Post offering FL Group will have considerable capacity for new years. When exiting a private equity investment, there are several investments. Although the Company has traditionally focused on avi- options available. Among those is floating the company on a stock ation and tourism related activities, the focus going forward will be exchange, thereby selling all or part of the company to the public. broader, which means that FL Group will not restrict itself to any Another option is a strategic sale, where the company is sold to specific sectors. When deciding on new investments FL Group will another company operating in the same industry. At the end the utilize the group-wide experience as well as relying on the expertise decision will depend on which option is value maximizing for the that potential co-investors possess. owners of the company today. All new major investment decisions will be based on a set of strict A distinctive aspect of private equity is the ability to make efficient use criteria and all new investments are subject to approval by the board of leverage. The aim of the private equity sponsor is to organise the of directors. funding of each investment in the most efficient way. This entails mak- ing use of different borrowing options from secured bank debt to dif- Exhibit 6 – Decision criteria of new investments ferent forms of mezzanine debt. By organizing the company's debt efficiently, the equity returns are potentially enhanced. Also, because Market growth Each new invest- All decisions the leverage is organized at the company level and not at the fund Market share ment will be pre- of new level, there is a ring fencing benefit: if one company fails to repay its Strength of brand sented to the board investments borrowing, the rest of the portfolio is not contaminated as a result. label ➾➾of directors, ensur- subject to This means that those who invest in private equity funds will benefit Management capa- ing deep involve- board from a leveraged portfolio with less downside risk. bilities ment of board approval Quality of cash flow members in each Current investments Quality of earnings investment decis- The following table is shown for illustrative purposes only, so that the tion reader can better comprehend the importance of FL Group hf.'s dif- ferent business units. The figures are all pro forma. Icelandair Group and FL Travel Group were founded as business units on 19 October Extensive involvement in the operations of each of the companies 2005, but were not operated as such in 2004. Bluebird is a combina- invested in is a key aspect in FL Group's investment strategy. FL tion of two companies Bláfugl hf. and Flugflutingar ehf. Sterling, which Group will aim to increase the value of its investments by: Refinanc- is expected to join the Group in January 2006, has undergone great ing and thereby utilizing an optimal mix of debt and equity for each changes in 2005 in the form of a merger and divestments of business asset. Selling of units and streamlining with sale of non-vital assets and units. Reliable pro forma figures for 2004 and 2005 are not available optimizing cost structure is a key element in enhancing the value of but for demonstrational purpose next year's budget is shown. Ster- acquired companies. Clearer management responsibility and incen- ling's budget is dependent on many variables and the outcome from

21 changes that have been made and are going to be made on the The group traces its roots back to 1937 when Flugfélag Akureyrar operation. The figures below were presented at ICEX, 3 November was founded. Today the group operates daily flights through Ice- 2005. landair both to Europe and North America using Keflavík as its main hub. Today about 2/3 of the Icelandair Group revenues come from Exhibit 7 – FL Group's private equity investments Icelandair.

(ISK millions) Stake Revenues EBITDA EBIT Profit In 2004 the total revenue for the Icelandair Group was ISK 32.5 bil- before lion (based on rough calculation after the group has been divided taxes between FL Travel Group and Icelandair Group, and the associated assets and debt). The revenue growth during the first nine months Icelandair Group1 .... 100% 32,536 2,817 1,560 1,535 2005 compared with 2004 is around 8%. Since the companies in the FL Travel Group1 .... 100% 11,551 1,008 369 394 Inter-company group are all seasonal, each with its own high and low season, it becomes harder to compare the revenues between them when less transactions ...... --1,500--- than a whole year is used for the comparison. Total ...... 42,587 3,825 1,928 1,9292

Bluebird3 ...... 100% 2,660 800 Icelandair Sterling4 ...... 100% 50,047 3,364 Icelandair is the largest subsidiary of Icelandair Group. The company Total ...... 95,294 7,989 is an international service company which services around 1.5 million passengers annually. Today the company offers daily scheduled flights 1 Figures for 2004, in these calculations the Group's revenues and costs have been divided between FL Travel Group and Icelandair Group, as well as the associated from Iceland to Europe and North America to a total of 22 destina- assets and debt. tions. The company operates a fleet of 20 aircraft. Icelandair operates 2 Excluding profits from investments, amounting to ISK 2,157 million in 2004. all the aircraft that Icelandair Group has in service. 3 Figures for 2004. 4 Projections for 2006. Icelandair network Icelandair Group Demand for Icelandair's flights is seasonal. Due to the seasonality in In 2004 Icelandair Group accounted for over 70% of all revenue gen- air travel Icelandair offers almost twice as many flight in the high sea- erated in FL Group. All the subsidiaries of Icelandair Group have son during the summer than in the low season. Icelandair flies to 22 operations related to international flights. Icelandair Group owns a destinations in 13 countries during the summer. During the winter 100% equity share in each of its subsidiaries. The subsidiaries are Ice- the Company offers flights to five cities in the US and nine cities in landair, Loftleidir-Icelandic, Icelandair Cargo, Icelandair Ground Ser- Europe. vices and Icelandair Technical Services.

Exhibit 8 – Icelandair Group's subsidiaries

Icelandair Group

Jón Karl Ólafsson is the CEO of Icelandair Group.

Exhibit 9 – Icelandair Group revenue split between subsidiaries

2004 Jan-Sept. 2004 Jan-Sept. 2005

ITS 7% IGS 2% ITS 2% IGS 2% ITS 2%

IGS 5% Icelandair 65% Lofleidir Icelandic 15% Lofleidir Icelandic 17%

Lofleidir Icelandic 12%

Icelandair Cargo 11%

Icelandair Cargo 13% Icelandair Cargo 11% Icelandair 66% Icelandair 70%

22 Exhibit 10 – Icelandair's network Manchester, , Barcelona and are not morning flights and therefore are not marketed as Via destinations. Due to this network structure Icelandair is able to offer flights on a wider variety of routes than the number of destinations implies. By matching US flights with European flights Icelandair is able to offer flights on 54 routes in the winter and 89 during the summer, with 14 and 22 routes from Iceland respectively.

Exhibit 12 – Icelandair's destinations

Destinations Routes US Europe Across To and from Total the Atlantic Iceland Winter 5 9 40 14 54 Icelandair uses Keflavík International Airport as its main hub. The Summer 6 16 67 22 89 location of the airport in the North Atlantic between North Ameri- ca and Europe is a key to the Company's network strategy. The air- Competition and market port becomes especially busy in the morning when the flights from Icelandair competes on three independent passenger markets which the US arrive within a few minutes of each other. A large number of gives the Company more options when allocating the number of passengers continue to their European destinations within a couple available seats on routes and when pricing them. Demand for air trav- of hours of arriving. In the afternoon the process is reversed when el mainly depends on the economy, exchange rates, destination pop- the planes arrive from Europe and continue to the US. By having all ularity and the cost of flying. Operating in three different markets the flights arriving and departing within a relatively short time the makes the Company less vulnerable to fluctuations in demand for any Company is successfully able to serve three markets segments, i.e. particular route. customers travelling from Iceland, customers travelling to Iceland and customers crossing the Atlantic. By doing this the Company has Travelling from Iceland (about 25% of passengers) increased the frequency of trips to Iceland – which has fuelled the There has been strong demand for air travel from Iceland recently. travel industry in Iceland and made it easier for Icelandic people to This strong demand can partly be explained by the strength of the ISK travel abroad. and the state of the Icelandic economy. On most of its routes from By designing the network so that most of the inbound traffic arrives Iceland the Company is the only airline operating. For most business within a relatively short time period and most of the outbound traf- travellers Icelandair is the only option due to the frequency of flights fic leaves soon after, the Company is able to increase its product and the number of destinations. The frequent flyer program also helps offering considerably. For example, by enabling passengers to catch a attract business travellers. The company's pricing policy is designed to connecting flight in Keflavík, the flight arriving from Boston not only capture some of the value that business travellers see in being able to carries passengers that are going to Iceland but it also transports pas- schedule their trip with short notice and return promptly. sengers heading for other European destinations served by Icelandair. Travelling to Iceland (about 35% of passengers) Exhibit 11 – Passengers coming to Iceland from Boston might be Iceland has enjoyed increasing popularity as a tourist destination for heading for any of Icelandair's European destinations. travellers over the past 25 years. The number of tourists visiting Ice- land has grown from 66,000 in 1980 to 362,000 in 2004, which is an increase of 449%. The company has fuelled this increase by strong marketing efforts in Europe and United States and the high frequency Barcelona of flights to Iceland. Berlin Copenhagen Exhibit 13 – Number of tourists visiting Iceland 1980 - 2004

Frankfurt 400.000

Glasgow 350.000 Helsinki Boston 300.000 London 250.000 KEF Iceland 200.000 Munchen 150.000 Oslo 100.000 50.000 Stockholm 0 1990 1986 1983 1992 1985 1981 2004 1989 1998 1991 1999 1993 1994 2002 1995 1980 2003 1988 1997 1982 2000 2001 1984 1987 1996

23 In 2004 17% of tourists were from the , which was capacity the Company has no pricing power and tries to win cus- the largest single source of visitors. tomers in other areas instead.

Exhibit 14 – Proportion in 2004 split by geographical areas Fleet The fleet of passenger aircraft consists of 14 Boeing 757 aircraft and Rest of the world 14% N. America 15% three Boeing 767. The fleet is used both for scheduled flights and for leasing to airlines or travel agencies through Loftleidir-Icelandic. In addition the Group has three Boeing 757 aircraft which have been converted into cargo planes. The fact that most of the Company's air-

Rest of Europe 16% UK 17% craft are Boeing 757 gives the Company opportunities for cost sav- ing on training the crew, maintenance and scheduling. The Boeing 757 does not have sufficient range to fly to San Francisco. When Ice- landair started flying to San Francisco in May 2005 the Company needed to add the Boeing 767 to its fleet. The Boeing 767 has the Germany 12% same cockpit as the Boeing 757 which reduces the cost of training Scandinavia 27% the crew. As seen above tourists come from all over the world to Iceland In February the Company bought two new Boeing 787-8 Dreamlin- which makes the Company less sensitive to the economy in the areas er wide body aircraft that will be delivered in Seattle in 2010. The list of individual destinations. price of the aircraft is USD 240 million. It is expected that these air- craft will be used in Icelandair's operation. The Company also has an The competition to and from Iceland option on five additional Dreamliners until the end of 2009. If the The company’s main competitor is Iceland Express, as well as char- Company decides to exercise those options the delivery of the addi- ter operators. There are two companies that have announced their tional aircraft will depend on slot availability at Boeing at that time. entrance to the Icelandic market. Recently SAS Braathens announced that it will start flying from Oslo to Iceland three times a week start- Block hours ing 26 March 2006. In addition British Airways will start flying to Ice- The Icelandair network is designed to maximize the utilization of the land in May 2006. fleet. The highest level of utilization is of aircraft crossing the Atlantic Icelandair is by far the largest operator offering flights between from the east coast of the US to Europe. Most of the Boeing 757 air- Europe and Iceland. Icelandair is the only airline that offers scheduled craft are utilized by flying to Europe in the morning and to the US in flights between Iceland and North America. The company is the mar- the afternoon. ket leader in flights to and from Iceland. In the market from Iceland, i.e. customers that are travelling from Iceland, the market share is Exhibit 15 - Example of block hours achieved by Icelandair cross- around 50% and Icelandair's share of the market for trips to Iceland ing the Atlantic example base on LHR-KEF-JFK is about 75% Icelandic time Block hrs Travel agencies are an important part of the distribution network Arrives from the US ...... 06:45 5:30 especially when it comes to selling flights to Iceland. Over 50% of the Departs to Europe ...... 08:00 3:00 flights to Iceland are sold by travel agencies. The competition for Arrives from Europe ...... 16:00 3:00 tourists that end up travelling to Iceland starts when the tourist is Departs to the US ...... 17:00 6:00 choosing his travelling destination. Iceland as a destination is in com- petition with many top destinations all over the world. Total ...... 17:30

Travelling across the Atlantic (about 40% of passengers) The transatlantic market is the second largest market in the world Load Factor after the US domestic market and ahead of the intra western Euro- The load factor follows the seasonality in demand. Icelandair operates pean market measured in revenue passenger kilometres. The market fewer aircraft during low season. Despite these efforts the load fac- over the Atlantic was deregulated in the 1990s, and according to the tor remains lower during low season. US Department of Transportation it resulted in reduced fares, stim- ulated new traffic and shifted traffic more into the hub and spoke sys- tem than point to point. The company's main focus is on city pairs where there are limited direct flights. The transatlantic market is growing, and Boeing Market Outlook forecasts that this market will grow 4.6% annually over the next 20 years. Icelandair's strength in crossing the Atlantic lies in the Company's network. Icelandair's market share on the North Atlantic market is below 1%. Due to small market share Icelandair often faces fierce competition in pricing, especially in winter time (low season). On routes where the Company is competing with direct flights and over

24 Exhibit 16 – Scheduled flights overview: available seats, the Company entered into agreements on flights to Cuba and number of passengers and load factor Venezuela. In mid-2003 the Company changed its policy and added the Company's first Boeing 767 to its fleet which opened up new markets. This led to an increase in the proportion of ACMI projects Number of seats available Number of passengers Load Factor (Aircraft, Crew, Maintenance and Insurance) at the expense of all- 250.000 100% inclusive projects, and the Company aims to continue in that direc- 90% tion. All-inclusive projects have proved to entail more risks due to 200.000 80% fluctuations in the external environment. Introducing Boeing 767 70% planes into the operation and the higher proportion of ACMI proj- 150.000 60% ects have been a significant factor in the improved results of the leas- Load Factor 50% ing operation. The market for charter flights and wet-leases is truly Seats or passengers 100.000 40% international. The Company's competitors are many airlines world 30% wide, including the Icelandic company Avion Group.

50.000 20%

10% Icelandair Cargo The Company effectively offers cargo services to its customers, using 0 0% the belly space capacity in its passenger aircraft. Utilizing the network Jul 2005 Jul 2004 Jun 2005 Jan 2004 Jun 2004 Jan 2005 Feb 2004 Sep 2004 Mar 2004 Mar 2005 Apr 2005 Apr 2004 Oct 2005 Feb 2005 Sep 2005 Dec 2003 Oct 2004 Aug 2005 May 2005 Aug 2004 Dec 2004 May 2004 Nov 2004 Nov 2003 of passenger flights allows the Company to offer quick reliable serv- ices between all of its destinations. In addition the Company operates three Boeing 757 freighters. They are used to fly in Icelandair Cargo's The Company has been successfully loading its planes, with the aver- network to Iceland from North America and Europe. The Company age load factor improving to 76.7% for the last twelve months end- also leases to TNT in Europe Aircraft with Crew Maintenance and ing October 2005, which represents an improvement from the Insurance (ACMI project). 74.1% load factor during the previous twelve months. The break- even load factor rose by 2.6% over the same time period. The break- Icelandair Technical Services (ITS) even load factor is the load factor needed for the airline where rev- ITS provides aircraft maintenance and technical services for Icelandair. enue equals cost. The Company also provides services to aircraft which land in Keflavík, heavy maintenance in Keflavík and technical services for several oper- Human resources ators. ITS's core business is to provide Icelandair with maintenance The Group's staff is the key to success. Icelandair Group’s goal is to and technical services. be one of the most popular companies to work for in Iceland. About 2,000 employees work for Icelandair Group. The Company has sales Icelandair Ground Services (IGS) and marketing offices in several cities in Europe and the US. It is IGS provides comprehensive airport ground services for airlines and becoming increasingly common that a college degree is required to passengers at Keflavík International Airport. IGS operates aircraft serv- qualify for jobs at Icelandair Group. ices, a flight kitchen, a freight centre and a restaurant division in the Leifur Eiriksson Air Terminal. All these units are organised and settled Icelandair Group places emphasis on its employees being service ori- as profit units. ented and ready to work in an exciting and challenging international working environment. The Group encourages and assists its employ- Looking forward ees in seeking further training. Some of the Group's employees are Icelandair Group has many opportunities for growth. Icelandair required by law to get training before they start working for Ice- expects it will continue to grow and improve its current schedule pas- landair Group. Furthermore, some of the Group's employees need senger network. In 2006 its network will be similar in size as in 2005. to attend training periodically. The Company's focus over the next few months will be on simplify- ing processes and products and reducing unit costs within the business Financial performance model as it is today. The company is constantly optimizing the net- The last few years have been particularly difficult for the airline indus- work and looking at new markets. In recent years both the cargo flight try. Icelandair Group has been profitable when the industry in gener- (Icelandair Cargo) and the leasing operation (Loftleidir-Icelandic) have al has been losing value. Icelandair Group has effectively worked on grown considerably. The Group anticipates that this will continue. reducing its fixed costs, which makes the Group more competitive in today's aviation market. The Group is now more flexible and can FL Travel Group more effectively add or reduce capacity depending on market condi- FL Travel Group is mainly involved in tourist services in Iceland. The tions. subsidiaries are Icelandair Hotels, Reykjavik Excursions, Iceland Trav- el, Islandsferdir Group, Icelandair Hertz Car Rental and Air Iceland. Loftleidir - Icelandic Many of FL Travel Group's subsidiaries were established by FL Group Loftleidir – Icelandic is a marketing vehicle operating in the interna- tional charter and wet-lease markets. The Company has eight aircraft in its leasing business which are operated through Icelandair flight operations. The Company has customers worldwide. Most recently

25 Exhibit 17 – FL Travel Group and subsidiaries

FL Travel Group

Thorsteinn Örn Gudmundsson is the President and CEO of FL Travel Group.

in response to the increasing number of tourists visiting Iceland and FL Travel Group operates hotels, a domestic airline, travel agencies, the Company's ability to develop its airline business by offering value a car rental service and a bus service. A common feature of its oper- added complimentary services to travellers. Today the subsidiary ation is a marked seasonality, whereby it experiences considerable with the highest net revenue and the largest share of FL Travel activity during the second and third quarters with less activity during Group's profit is Air Iceland, which handles domestic flights in Iceland. the first and fourth quarters. FL Travel Group is largely dependent on the inflow of tourists to Iceland and in particular those that come by Exhibit 18 – FL Travel Group revenue split between subsidiaries air. The Group is also dependent on travel patterns and general spending of tourists. Over the last ten years to the end of 2004 the Jan.-Sep. 2004 number of tourist has grown 7.3% per annum. Growth this year is flat,

Íslandsferðir 16% which is thought to be because of the strong Icelandic króna. During Air Iceland 27% the same period guest nights in hotels and guesthouses have increased by 7.0% per annum. Iceland Travel 10% The market share for the individual companies is about 50% for all companies except for Air Iceland.

Hertz Iceland 6% Icelandair Hotels operates and markets two hotel chains: all-year hotels under the trademark Icelandair Hotels, and summer hotels Icelandair Hotels 21% under the trademark Edda Hotels. There are eight Icelandair hotels Reykjavik Excursions 20% and 15 Edda hotels. While the Company itself operates three Ice- landair hotels, five hotels are operated under the trademarks of Ice- Jan.-Sep. 2005 landair Hotels by associated partners around the country under spe- cial franchise agreements. The two hotels that are located in Reyk- Icelandair Hotels 18% javik account for approximately 75% of Icelandair Hotels' revenue, Air Iceland 27% namely Hotel Lofteidir and Nordica Hotel which recently underwent thorough renovations. Icelandair Hotels rents all real estate which the

Reykjavik Excursions 10% Company uses for operations. The main competitors are centrally located hotels in Reykjavík such as Hótel 101, other hotels situated in Reykjavík such as Radisson SAS

Hertz Iceland 6% Hotel Saga, hotels located elsewhere such as Fosshótel, and finally other alternatives such as bed and breakfast accommodation offered Íslandsferðir 20% in rural areas. Iceland Travel 19% Íslandsferdir Group is a leader in the production, marketing and sales In 2004 FL Travel Group total revenue were approximately ISK 11.6 of package tours and the reception of foreign tourists in Iceland. billion. It should furthermore be noted that the revenue generation Its main competitors are Atlantic, Terra Nova, Gudmundur Jónasson, during the first 9-month period is not representative for the full year Allrahanda and Congress Reykjavík. Íslandsferdir has been unprof- results, as the operation of the individual companies is seasonal. itable in recent years but is now being restructured.

The operation of FL Travel Group Iceland Travel (Ferdaskrifstofa Íslands) operates travel agencies which FL Travel Group was founded as a business unit when fundamental are mainly focused on Icelanders travelling abroad. It operates the organisational changes were made on 19 October 2005. The aim of Úrval-Úts‡n and Plúsferdir travel agencies and organises tours for the organisational changes, which brought domestic travel operations business travellers. By placing greater emphasis on the internet as the under one operational unit, was to simplify FL Group's setup, which distribution channel operations have been rationalised. Its main com- will facilitate rationalisation and adaptation of the business towards petitors are Heimsferdir and Sumarferdir. current and future changes in the working environment.

26 Reykjavík Excursions is a travel service company operating group and Bluebird scheduled services to a wide variety of destinations around Iceland, Bluebird was acquired by FL Group in August 2005. Bluebird is based including package, activity, incentive and adventure tours, and the Fly at Keflavík International Airport in Iceland. Bluebird is a synonym for Bus service between Reykjavík and Keflavík International Airport. two of FL Group's subsidiaries: Bláfugl hf. (Bluebird Cargo), which Reykjavik Excursions is a leading company serving foreign tourists operates a fleet of freighter aircraft, and Flugflutningar ehf. (BlueCar- coming to Iceland. As well as being one of the largest organisers of go), which is an air cargo sales agency. day trips for individuals and groups in Iceland, the company is also one of the biggest group tour and bus companies in the country. Its main Exhibit 19 – Blubird and subsidiaries competitors are excursion and bus companies such as Hópbílar and Hópferdamidstödin. Bluebird Icelandair Hertz Car Rental provides vehicles of all sizes for travel around Iceland, with outlets at Keflavík International Airport, in Reykjavík and at several other locations around the country. This operation experiences pronounced seasonal fluctuations. When demand peaks in the summer, it is 15 times higher than during the The CEO of Bláfugl is Thórarinn Kjartansson slowest period in the winter. There are about 50 car rental agencies in Iceland. The four largest car Bluebird Cargo rental agencies have a market share of around 80%. Its main com- Bluebird commenced operations in March 2001 with one Boeing petitors are ALP bílaleiga with AVIS and Budget and Bílaleiga 737-300 freighter aircraft flying daily from Iceland via the United King- Akureyrar/Höldur with National, Alamo and Easy Car. dom to Cologne in Germany. Bluebird has grown fast and currently operates five Boeing 737-300 freighters. Air Iceland is a market-driven service company responsible for eight With a total fleet of five aircraft, Bluebird has around 60 employees, scheduled domestic flights as well as routes from Iceland to the Faroe approximately 30 of whom are pilots. Even though Bluebird operates Islands and Greenland. The company has also administered ambu- daily scheduled flights between Iceland and Europe, around 80% of lance transport in Iceland. About 90% of the company's passenger the operation is outside of Iceland. traffic is on the routes between Reykjavík, Akureyri, Ísafjördur and Egilsstadir. In 2004 flight operations were continued to the Faroe Customers Islands in co-operation with , and to Greenland. Air Four of Bluebird's aircraft are currently operated for UPS in Europe, Iceland has entered a 10-year agreement with Greenland's home making UPS a very important customer of Bluebird. One aircraft is rule in regards to flights between Reykjavík and Kulusuk and Consta- used in projects for Alitalia and one is in scheduled flights ble Point. In 2004 the company acquired three Fokker 50 aircraft and today has six such aircraft in operation. The company is currently Market looking to lease two DASH 8-200 aircraft. In addition the company Bluebird Cargo has a nominal market share in the international cargo operates smaller aircraft, namely Metro 23 and Twin Otter. market. The Company operates in the market of smaller cargo jets where a large part of the customer base is composed of companies Looking forward that offer express delivery services where the speed between any FL Travel Group’s intention is that its companies are strong and inde- two destinations is more important than the lower cost of operating pendent travel service companies. The short term strategy for the larger cargo plane with lower frequency of flights. The Company's next few months will be to increase profitability of all the companies main competitors that operate cargo aircraft of the same size are in the portfolio. FL Travel Group also intends to be active in modify- Avion Group, Channel Express and Atlantic Airways. ing its business, both to optimise its operation and also to fulfil its customers’ needs, which may change. The Company expects that The cargo market is growing rapidly. According to the forecast of tourism in Iceland will continue to grow in the coming years, as in the Boeing, Boeing Market Outlook, the cargo market will increase by an Company's opinion the capacity of the country as a tourist destina- average 6.2% annually over the next 20 years. tion is not fully explored yet. The Company expects to grow with the market and also expects to fuel market growth with new or bet- ter products.

27 Exhibit 20 – Airbus prediction of cargo freight traffic year 2023 (average growth per annum 2004-2023)

9.8% (+4.9%) 0.5% 19.8% 11.5% (+5.0%) (+6.3%) (+4.3%) 2.7% 2.8% 26.28% (+6.5%) 3.0% (+5.5%) (+5 10.2% (+5.6%) (+5.3%) .7%) (+7.3%) 3.6%

Other-flows: 9.9%

It is predicted that the main driver for growth will be in Asia, both Sterling domestic as well as in cargo flight to and from Asia. The main driver Sterling is a low-cost airline operating from Copenhagen. Today Ster- for growth in Asia has been high-value and high-tech goods. Around ling is the fourth largest low-cost airline in Europe. 75% of Asian air freight by value is from high-tech goods. Bluebird's current fleet allows the company to operate in the short range/medi- um range markets, which it is estimated will account for less than 25% of the world market in the future. Almar Örn Hilmarsson is the CEO of Sterling. Future The company has grown fast since it started operations in 2001. About the acquisition There are ambitious goals in place for further growth. To fuel this FL Group acquired Sterling in October 2005. Sterling will become growth Bluebird has signed a letter of intent concerning the lease of part of the Group in January 2006 if certain conditions are met. The two new Boeing 747-400ERF. The aircraft will be delivered in June motivation for the acquisition was first and foremost: 2007 and March 2008. The Boeing 747-400ERF currently has the • An opportunity for FL Group to utilize its expertise within the air- lowest operating cost per ton-mile in the industry as well as long line industry to make a strategic acquisition. range capabilities. The new aircraft allows Bluebird to compete any- • The low-cost business model has been very successful within the where in the fast growing freighter market. A further benefit of the airline industry, and FL Group believes that Sterling has good poten- Boeing 747 freighter is that it is the only aircraft with both a nose- tial. Sterling occupies a key position within the lucrative Scandinavian cargo door and a side-cargo door. This combination enables the air- market craft to fly with a higher yield cargo that is extremely long or tall, and it also shortens loading time for shipments. According to Boeing's Sterling will continue to be operated independently, and no part of own estimates the benefits of the nose door can mean at least an Sterling's operations will be merged with other airline related busi- additional USD 20 million in yield for the operator. ness of FL Group, at least for the time being. On a group level there are several identifiable synergies between the business of Sterling and BlueCargo other aviation related business of FL Group. Theses are primarily BlueCargo offers freight forwarding services to both Icelandic and related to increased purchasing power with respect to key suppliers foreign companies. The company offers services to most destinations such as ground service, maintenance and fuel purchases. in the world utilizing its relationships with Cargolux, UPS Air Cargo It is expected that FL Group will take over control of Sterling in Jan- and LTU. Building on those relationships it is able to offer its Icelandic uary 2006. The highlights of the transaction are summarised as fol- customers freight service to almost any destination in the world uti- lows: lizing Bluebird Cargo's flights to tranship the cargo from Iceland to Europe and then utilize the extensive networks of its partners to ship The total acquisition price is DKK 1,500 million, of which DKK 1,100 the cargo to the final destination. BlueCargo's main competitors are million will be paid in cash when the transaction is closed, while DKK Eimskip Logistics, Icelandair Cargo and Iceland express. In addition 400 million will be paid in FL Group shares. The shares will be issued the company faces competition from the Icelandic cargo liners Eim- at ISK 13.6 per share, and there will be a lock up period until 31 skip, Samskip and Atlantsskip. March 2007, preventing the seller from disposing of them prior to that time.

28 Part of the acquisition price is performance related and can be low- burg. In September 2005 Sterling announced that it was also planning ered or increased by up to DKK 500 million. A correction in the to commence scheduled flights from Helsinki in March 2006. acquisition price will be tied to EBITDA performance in 2006, or 3.5 Sterling flies to the following destinations in Europe: Algarve, Alicante, times any deviation from the budgeted EBITDA of DKK 345 million. Amsterdam, Athens, Barcelona, Berlin, Bologna, Bordeaux, Budapest, At delivery, the cash balance shall be no less than DKK 300 million Cairo, Crete, Dublin, , Frankfurt, , Gran Canaria, and interest bearing debt will be DKK 110 million (asset backed debt Lanzarote, Lisbon, London, Madrid, Malaga, Majorca, Montpellier, due to one aircraft that is owned by Sterling). DKK 275 million have Munich, Nice, Paris, Prague, Rhodos, Rome, Salzburg, Samos, Tallinn, already been established as a restructuring provision as of Septem- Tenerife, Venice and Vienna. ber 2005. Following the acquisition of Mærsk, Sterling has reorganized its whole The acquisition is subject to the approval of competition authorities route network. In particular routes out of Copenhagen have been and local CAA. The competition authorities in Norway, Sweden and reorganized, as Mærsk and Sterling were competing on several Germany have been notified of the acquisition and have all decided routes. The route network today is a combination of pure leisure and not to object to the acquisition. The competition authorities in Den- vacation destinations and large European cities, that appeal to both mark and Iceland have requested information regarding the acquisi- weekend travellers and business passengers. Sterling has furthermore tion. The Danish authorities will not investigate the matter any fur- increased the flight frequency on several routes to attract more busi- ther but the Icelandic Competition Appeals Committee will now ness travellers. consider whether the acquisition needs to be reported to The Ice- Sterling's position in charter operations is strong, as the majority of landic Competition Council. As of today, 29 December, this means the most recognised Danish tour operators have chosen to fly all or that it cannot be assumed that all conditions necessary to complete part of their charter programmes with Sterling. Sterling also performs the acquisition will be met in the beginning of January 2006. FL charter flights on an ad hoc basis for companies, clubs and organisa- Group hf. and Fons Eignarhaldsfélag hf. have not decided how or if tions that have specific requirements. The number of charter passen- they are going to respond to this. When their position is clear, ICEX gers has thus increased considerably in recent years. will be notified and an annex to this prospectus will be issued. The acquisition is also subject to certain conditions that require the cur- Fleet rent management of Sterling to maintain progress on the restructur- Sterling operates a standardised fleet, as only Boeing 737 aircraft are ing of Sterling and Mærsk. utilized in the company's operations. The table below provides an overview of the aircraft employed in Sterling's operations. Operations of Sterling Sterling Airways was founded in 1962. Since its establishment, the Exhibit 21 – Sterling fleet of aircraft company has evolved from being a traditional airline operator to becoming the first Scandinavian low-cost airline. Today the company Boeing 737-500 737-700 737-800 is considered to be the fourth largest low-cost airline in Europe, and No. of aircraft 6 13 10 in 2006 Sterling expects to transport around five million passengers. Sterling is furthermore the second largest airline in terms of trans- The cost advantages of operating a standardized fleet are substantial, ported passengers from Copenhagen, only Scandinavian Airlines has especially with respect to maintenance and training of flying person- a larger market share. Sterling's primary activity is scheduled flights, nel. Sterling has a relatively young, homogenous fleet, in which the but the company is also engaged in charter operations. oldest aircraft is from 1997. Over 3/4 of the fleet is Boeing 737 "New The whole operations of Maersk will have to be aligned to the oper- Generation" which has lower operating and maintenance costs com- ations of Sterling's low cost business model, which implies among pared to older generation aircraft. other things a shift in distribution from traditional distribution through agents to relying on distribution on the internet to a much Looking forward larger extend. Such a shift in distribution strategy always includes a The management of Sterling has forecast sales of DKK 5,133 million risk of loosing customers that prefer alternative ways of distribution. and EBITDA of DKK 345 million in 2006. This forecast is dependent In addition, certain activities, which were conduced in-house with the on factors such as the successful execution of the reorganization former Maersk, will be outsourced in the operations of Sterling going process that was initiated after Sterling acquired Mærsk in September forward. Consequently, a number of employees of the merged 2005. The aim of the restructuring process is primarily to align the organisation will be laid off. Currently it is however unclear as to operations of Mærsk Air to the low-cost business model operated by which extend Sterling is able to terminate collective agreements with Sterling. Aligning the business models entails, among other things, certain groups within Sterling. shifting the distribution from traditional inter-line sales to primarily internet based sales, aggressive outsourcing of non-core activities and Route network optimizing the utilization of the fleet. Sterling has a dense route-network from primary cities in Scandinavia to southern Europe. The main base is Copenhagen airport where the company is the second largest operator only behind SAS. In addition Sterling flies from seven other Scandinavian destinations, which are Billund, Oslo, Stavanger, Bergen, Stockholm, Malmö, and Gothen-

29 VI. Asset management

The asset management division manages FL Group's portfolio of list- Of the total market value of ISK 72.8 billion in listed equities, ISK 29.6 ed stock and other short-term investments. billion were held through forward contracts. With regard to the com- pany's investments in market securities, the overall profitability of the Investment strategy Group will to a large extent depend on the performance of securi- FL Group aims to have 20-50% of total assets invested in a portfolio ties markets, in particular the Icelandic stock market, as the majority of listed securities and other short-term investments. The investment of investments is denominated in ICEX listed stock. strategy devised by the board of directors for FL Group's asset man- The investment operations of FL Group have yielded significant agement operation can be summarized as follows: returns for the Company's shareholders. The largest single invest- • All investments will be carefully evaluated with respect to risk and ment is in easyJet. FL Group started investing in easyJet stock in Octo- return. ber 2004 when it bought an 8.4% share. Since then the Company has • All investments must be liquid enough to allow the Company to accumulated a 16.18% holding in easyJet according to an announce- enter and exit a position without causing a substantial change in ment to ICEX on 18 November 2005. the respective share price. The graph below demonstrates the share price performance for the • FL Group will aim to have a well diversified portfolio. main assets invested in by FL Group on the ICEX over a 14 months • FL Group will invest in Europe, which is the Company's main oper- period. During this period FL Group has steadily increased its invest- ating area. ments in these companies. The graph furthermore depicts the share • FL Group will on some occasions invest in companies where the price performance of easyJet over the period in which FL Group has intention is to seek influence, which consequently means that the invested in the stock. investment will be characterized as a private equity investment. Exhibit 23 - Relative performance of key assets Day-to-day investment decisions will be in the hands of the manag- 22.10.2004-28.12.2005 ing director. However, all major decisions on buying/selling securities 200 in individual companies will be put before the board of directors of STRB FL Group. LAIS 150 Current portfolio ISB Today FL Group's portfolio primarily consists of investments in ICEX 100 KAUP

companies and easyJet. The table below shows an overview of the ICEX15

portfolio as announced on ICEX on 18 November 2005: 50

Exhibit 22 – FL Group's portfolio

Nominal value Market Value Owner- (million shares) mISK ship 18. 08. 2005 22. 10. 2004 30. 01. 2005 10. 05. 2005 26. 11. 2005 ICEX Kaupthing Bank hf...... 21.5 13,792 3.2% 300 Íslandsbanki hf...... 1,120.7 18,492 8.2% FTSE All Share

Landsbanki Íslands hf...... 223.1 5,421 2.0% 250 easyJet Straumur-Burdarás 200 Fjárfestingabanki hf...... 604.3 9,427 5.8%

Other ICEX listed companies.. 3,875 150 Total ICEX ...... 51,007 100 Other assets easyJet ...... 64.8 20,548 16.2% 50 ...... Other 279 0 Total other assets ...... 21,827 22. 10. 2004 10. 22. 22. 04. 2005 04. 22. 22. 07. 2005 07. 22. 22. 10. 2005 10. 22. Total Assets ...... 72.834 2005 01. 22.

30 VII. Aircraft trading and leasing

The aircraft trading and leasing division handles the buying, selling and Aircraft leasing leasing of aircraft on behalf of FL Group and is important to FL Aircraft leasing is large-scale worldwide branch of financial services. Group’s growth with increased focus on investments. Halldór Vil- During the past 25 years the number of aircraft owned by leasing hjálmsson is the managing director of FL Group's aircraft trading and companies has been on the rise. Both the world fleet of aircraft and leasing division. the proportion of the fleet owned by leasing companies have increased in size. Today around 35% of the world's commercial fleet Aircraft trading is owned by leasing companies. Aircraft are critical assets for airlines FL Group was involved in 25 aircraft transactions between Decem- and they pay around USD 115 billion annually in leases. Many compa- ber 2004 and November 2005. During this time the Company has nies have seen opportunities to enter the aircraft leasing business. sold one aircraft and made leasing contracts on 14 aircraft. The deals These companies include General Electric, Daimler and Roy- have so far been in Europe and in Asia. al Bank of Scotland. Boeing Market Outlook forecasts the average annual passenger and cargo growth over the next 20 years at 4.8% and 6.2% respectively. Such growth will in turn increase the size of the aircraft market, result- ing in improved liquidity of assets. Exhibit 24 – FL Group's leasing contracts

Aircraft pricing Aircraft are expensive assets with a long lifespan. The rate of return of aircraft leasing is most sensitive to the purchase price and residual value of an aircraft when it is sold off. Aircraft prices are cyclical and will always be cyclical. The reason is the inertia of changing supply and the cyclical nature of demand.

31 Exhibit 25 : Cyclical nature of aircraft pricing

Demand - Cyclical Supply - Stable Market Prices - Cyclical Depends on Caracterized by: - Impossible to match - State of the Economy supply to demand => - Long lifespan Always cyclical - GDP growth +=- Takes long time to - Cost of flying increase/reduce production

The residual value of an aircraft in addition to market cycles is influ- The fleet enced by the age of the aircraft, characteristics of the aircraft, airline The current fleet consists of six passenger aircraft, one cargo freighter preferences and regulation. and 17 future deliveries of passenger aircraft with additional five pur- chase options. Two of the future deliveries and all five purchase FL Group's tactics and strategy options are B787-8 Dreamliner aircraft, which are expected to be FL Group is fully aware that the success of its operation is highly used in Icelandair Group's operations as discussed above. dependent on the market cycle. The Company intends to utilize the market cycle to maximize the return on equity. The Company seeks In 2006 and 2007 Boeing will deliver 15 new Boeing 737-800 aircraft. long-term leasing contracts on its aircraft, preferably 5-10 year con- The Company has already leased five of them to Air China and four tracts, except in cases when the market is very weak. Having a long- to Hainan Air. The Company reinforced its relationship with Boeing term contract on the aircraft increases the odds that the market will by placing an order for the 737-800 aircraft in the first half of 2005. peak while the asset is under contract. In order to be able to sell an The Company anticipates considerable value in the deal due to the asset with an attached leasing contract in a peak market, the Com- attractive purchase price and the overall appreciation of the aircraft. pany needs to discount it to make up for the difference between cur- At one point a profit of around ISK 3.5-4.5 billion was estimated. If rent market leasing rates and the contract lease rate. It is difficult to this materializes, half of the proceeds will be posted as income in the time the market peak, and therefore the Company reduces its over- company’s books when the aircraft are delivered, the remainder dur- all risk by entering long-term contracts instead of running the risk of ing the lifetime of the aircraft. Ten aircraft will be delivered by Boe- a contract expiring when the market is at a low and no lessee can be ing 2006 and five in 2007. The Company and Kaupthing Bank hf. has found. outlined heads of terms of Joint Venture ownership about this air- craft. The aforementioned heads of terms is not legally binding but The Company will actively search for equity partners in its aircraft states that the joint venture shall incorporate special purpose vehicles investments. The Company ideally wishes to have less than a 50% (SPV) wholly owned by the joint venture, which will own each air- stake in each investment. craft. Equity investment is expected to be 20% in each SPV, and FL Group hf. will own 49% of each SPV. Consequently the aircraft and all related financial obligations will not be consolidated into FL Group hf.'s accounts

Exhibit 26 : Overview of the Company’s aircraft. The grey area denotes future deliveries

Date Aircraft Year # of Current Leasee Length of FL Share of deal Type built Planes Status contract of aircraft Dec-04 B737-500 1991 3 Leased Air Baltic 5 years 49% Jun-05 B757-200 1991 1 Leased FL Group 5 years 49% Jun-05 B757-200 1994 2 Leased FL Group 5 years 49% Jan-05 B737-800 2006 5 Leased Air China 8 years 49%* Jan-05 B737-800 2006 4 Leased Hainan Air 8 years 49%* Jan-05 B737-800 2006 1 To be placed na na 49%* Apr-05 B737-800 2007 5 To be placed na na 49%* Oct-05 B747-400F 1997 1 Leased Singapor Airl. Cargo 10 years 49%

*Currently FL Group owns 100% share in the aircrafts but letter of intent has been signed of selling off 51%

32 VIII. Risk factors

Investing in shares is subject to numerous risks. Prior to making any ing of those who already hold shares in the Company will be reduced investment decision regarding shares in FL Group hf., please consid- accordingly, unless they themselves acquire the new shares pro rata er all the information in this document and, in particular, the risks and to their existing holdings. The purpose of increasing capital is normal- uncertainties described below. The risks and uncertainties described ly to finance projects with the long-term intention of making the below are some of those that may materially affect the Company Company more valuable in the future. Shareholders may therefore and any investment made in its shares. If any combination of these be faced with increased risk for their investment alongside the dilu- events occurs, the trading price of the shares could decline and tion of their shares. It is possible that the Company will consider investors might lose part of their investment or even all of it. Addi- increasing its share capital further in the future in order to finance the tional risks and uncertainties that do not currently exist, that are not Company’s continuing growth. presently considered material, or of which the Company is unaware may also impair the business and operation of the Company. These Shareholder structure risks and uncertainties could have a material adverse impact on the The structure of shareholder ownership can be a risk factor for business, income, profits, assets, liquidity and share price of the Com- investors. A lack of leading investors or large concentrations of own- pany. The following discussion is not exhaustive. ership are examples of circumstances that can have negative effects. Investors should be aware of the fact that ownership of the Compa- Risks related to investment in the ny can change rapidly and without any prior warning. Company's shares Risks inherent in equity investments Risks related to the Company Equity investments involve a variety of risks. Examples of such risk Market risk factors that may have a material effect on the price of the Compa- Currently, the majority of the Company's assets consist of securities ny’s shares, and thereby on the investment value, are market risk, liq- issued by other companies. Should the market value of the securities uidity risk and counterparty risk. The share price can fluctuate con- drop, this could have a significant impact on the Company's profitabil- siderably due to factors such as variations in operating income or ity. In the event of the bankruptcy of the issuers of the relevant secu- cost, changes in the market environment, adverse commentary rities, their value might be eliminated altogether. Furthermore, atten- about the Company and its operations and services in the media and tion is drawn to the fact that some of the individual assets, e.g. the changes to the Company’s competitive position. Moreover, it must Company's shares in easyJet, form quite a substantial portion of the be kept in mind that shares are a subordinated claim on the assets Company's total assests. of companies. This means that in the event of the Company's liqui- dation, the shareholders will receive what is left after all other claims Key employees have been met. In many countries, shares have yielded a better The Company is dependent on its key employees and their willing- return than bonds measured over long periods of time. Neverthe- ness to continue working for the Company. There is, however, no less, long periods can also be found where the return on shares has guarantee that the Company will be able to retain all of them in the been worse than on bonds and even negative. Those who intend to future. Some of them might move on for new challenges or for finan- invest in the Company should know that there is no guarantee of a cially more favourable opportunities. If the Company loses any of its return on their investment in the future and investors should bear in key employees, the Company will most likely be adversely affected. mind that even though stocks can provide a good return in general, The Company offers competitive salary packages to its key employ- there is always a risk that an investment in the shares of individual ees to reduce the risk of losing any of them. Should members of key companies will decline in value. It is therefore suggested that those personnel decide to join competitors or start competing independ- who intend to invest in stocks pay close attention to diversifying their ently with the Company, it may have serious consequences for the risk and seek investment advice. Company's business. Due to the fact that the Company's shares are listed on ICEX, those Exchange rate hedging investing in the Company's shares may thereby become subject to The Company aims to eliminate as much as possible any exchange- such public regulation relating to securities transactions, such as rules rate risk arising within the Group. This includes exchange-rate risk relating to takeover bids, public disclosure of ownership stakes, etc. posed by trading between Group companies with different function- al currencies. Further share capital increase can dilute shareholdings If new shares in the Company are issued, the proportional sharehold-

33 Securities regulation pean Union and the respective countries. Those agreements are peri- Since the Company's shares are listed on the Iceland Stock Exchange, odically subject to renegotiation. Changes in aviation policies of those the Company is subject to the provisions of Icelandic regulations on countries could result in the termination of such agreement and securities, contained i.a. in the Icelandic Act on Securities Transac- adversely affect the Company's operation. Individual airline regulators, tions no. 33/2003, governmental regulations and rules adopted by including the one in Iceland, may impose restrictions and require- the Iceland Stock Exchange. The Company endeavours to comply ments that would impact the Company's profitability. with the said provisions, and any violation of these provisions may Other aspects of the Company's business are subject to various reg- have a financial impact on the Company. Serious breaches may result ulations and public permits having been issued, including the business in the Iceland Stock Exchange ceasing to list the Company's securi- segments relating to tourism. ties. Should the Company violate the respective rules, it may further- more impact the Company's reputation and consequently result in Open skies agreement the price of the shares dropping. The United States and Europe have been in negotiations regarding an "open skies" agreement between the two markets. The agreement Applicable law would bring together the world's two largest aviation markets, allow- The Company and its subsidiaries are subject to different laws and ing EU and US airlines to fly to any destination and charge prices at regulations. Changes to the Group's applicable laws or the Compa- their own discretion. ny becoming subject to different laws might have an impact on how the Company continues to conduct its business. If the agreement materializes, competition on transatlantic flights is likely to increase, which could affect the profitability of aviation relat- Liquidity risk ed business of FL Group that is competing on transatlantic markets The Company faces the risk of having insufficient funds to meet cur- adversely. The exact outcome from the negotiations is, however, rent liabilities and finance future projects, e.g. due to inability or diffi- unclear since negotiations are ongoing. culties in liquidating its assets. This risk is mitigated to some extent by maintaining liquid assets. Slots and airport access In some airports, an air carrier needs landing and takeoff authorisa- Risks related to operating companies tions (slots) before being able to introduce new services or increase the existing one. The Company is dependent on its slots in order to Pricing be able to compete. The Company's inability to secure and retain The airline industry is heavily competitive. Pricing decisions are heav- slots can therefore inhibit the Company's ability to compete in cer- ily dependent on competition from other airlines. In some markets tain markets. Generally, access to airports is furthermore vital to min- that decision is also dependent on alternative ways of travelling, such imize the likelihood of delays taking place, which can be detrimental as train, ferry and private cars. In most of the Company's markets the to the Company's profitability. Company faces stiff competition. In addition to its ability to lower costs, internet sales have increased the price transparency in the mar- Security ket for airfares, which has in turn resulted in more intense competi- Since the terrorist attacks on 11 September 2001, airport security has tion. When a competitor gives a fare discount, the Company needs been increased considerably, creating added cost. The occurrence of to react accordingly. another large scale terrorist attack or similar incidents could depress the aviation industry and affect the Company adversely. Distribution system Increased ticket sales over the internet, have made it easier for price- Diseases sensitive customers to shop around, which can in the long term lead Many airlines were affected by the outbreak of SARS (Severe Acute to lower ticket prices. Internet sales do not involve any material com- Respiratory Syndrome) in 2003. Should there be an outbreak of any missions and therefore it has led to lowered cost of sales and hence disease that may result in fear of travelling, the profit of the Compa- helped the profitability of the Company. This distribution system ny could be affected negatively. relies, however, to a great extent on automation over which the Company may have limited control. Labour The airline industry is an inherently labour-intensive industry. The Regulations majority of the Company's workers are unionized. The workers are Air transportation is subject to intensive regulations. An Air Opera- represented by several unions. Each union has its own contract on tors Certificate has been issued to the Company authorising it to salaries and benefits with the Company. Each contract is up for rene- conduct its airline operations. There is no guarantee, however, that gotiation every few years. Every time a contract is up for renegotia- the Company will be issued such licenses in the future. Occasionally tion there is a risk that the parties will not reach an agreement and the FAA (Federal Aviation and Administration) and its European such situations can end with a strike. A strike can affect the Compa- counterparts issue directives and other regulations relating to the ny heavily and in the worst case halt the operation of one or more maintenance of aircraft that result in significant costs for the Compa- of the Company's subsidiaries. Strikes in the aviation industry can be ny. There is no guarantee that the Company will be compensated for extremely expensive for airlines due to the nature of the business this through higher ticket prices, and so it is likely that the Company which is burdened with high fixed costs. Additionally, the Company is adversely affected. The Company's operating authority is subject to could be adversely affected by strikes of airport employees or any aviation agreements between governmental authorities of the Euro-

34 other employee group that the Company is dependent on but are ny will most likely be negatively affected in the case of a depressed not part of the Company's own staff. economy. In addition to relying on hired personnel, the Company relies on International operations third parties to provide its customers with services on behalf of and Operating in foreign markets exposes the Company to various risks. in cooperation with the Company. Any inability of the respective There is a risk that the Company's prospects in some markets could third parties to provide such services may impact the business. diminish due to various factors, including political changes, exchange controls and taxation. Fuel All the Company's aircraft operations are heavily dependent on jet IT fuel prices and availability. The effects of higher prices on the Com- Information technology is playing an ever increasing role in the Com- pany and its competitors depend on several factors. One of the fac- pany's operations. An increasing proportion of ticket sales takes place tors is hedging. If the prices continue to rise, it will damage the Com- over the internet. The Company's planning, communication and rev- pany's cost structure and its competitiveness towards its competitors enue management systems are computer based as well. Those sys- which have greater hedging. If prices fell at the same time as the tems are vulnerable to disruptions that are beyond the Company's Company had a higher level of hedging than its competitors, it would control. Possible disruptions could result from viruses, hackers, equip- damage its competitiveness. Recently, when high fuel prices have ment failure, power failure, natural disasters and human errors. The prevailed, airlines have been more efficient in passing price increases Company has various initiatives in place to minimize the risk of failure on to its customers through fuel surcharges and other methods. If to those systems but there can be no assurance that those initiatives fuel prices continue to rise there is no guarantee that the increase in will adequately prevent disruption to the Company's systems. cost can be passed on to customers due to the competitive nature of the airline industry, and therefore the Company could be affected Accidents adversely. If fuel prices remain high for an extended period, long dis- If an aircraft is involved in an accident or crashes the Company could tance flights will become proportionally more expensive to operate, be exposed to significant liability. Even though the Company is and therefore leisure travellers may prefer travelling shorter distance insured the insurance coverage may be inadequate. In the event that due to the lower cost involved. FL Group's stated target is to hedge insurance is inadequate the Company might experience significant about 40-80% of all forecast fuel usage for the next 12-18 months. losses. Additionally, if an aircraft from the Company is involved in an The Company mostly uses options when hedging. The forward mar- accident it might create a public perception that the Company's air- ket for the next four months expects a 4% increase in oil prices, craft are not reliable, which in turn could harm the business. while fuel prices have risen by 9.5% since mid-year 2005. Thus increased stability is expected with regards to fuel prices. If the price Agreements with public authorities of oil stabilizes, the Company will increasingly use forward contracts The Company has occasionally received public financial support for to lock in fuel prices. the purpose of strengthening the marketing its services which public authorities believe will promote tourism. There is no certainty that Seasonality the Company will enjoy such support in the future. The Company operates in a seasonal industry where traditionally the higher demand for air travel throughout the summer results in rela- Fluctuations in operating profits tively better results in Q2 and Q3 than Q1 and Q4. Labour actions, The operating results are dependent on several factors that fluctuate weather, terrorism, the fear of war and other factors could affect the and cannot be influenced by the Company. Those factors include seasonal pattern. Seasonality has a proportionately greater impact on fluctuations in fuel, insurance, maintenance and security costs. Cost of the Company during the summer as the Company operates more leasing and fluctuation in aircraft values that have been of a cyclical aircraft during that season than during other seasons. nature in the past. The operating profit also depends on market con- ditions in markets which the Company plans to enter or increased Insurances flight frequency. In addition there are the seasonal effects of lower The Company carries insurance for passenger liability, property dam- demand for air travel during the first and fourth quarters, compared age, public liability and all-risk coverage for damaged aircraft. There to quarters two and three. Weather can halt the Company's sched- may be losses which the business may suffer that are not covered by ules, which can result in higher costs due to delays and flights being insurance. Furthermore, individual losses may exceed the coverage cancelled. In addition bad winter weather can result in higher costs of under applicable insurance. In both cases, losses may subject the de-icing aircraft. Due to seasonality and fluctuations in the Company's Company to considerable financial harm. cost structure, quarter-to-quarter comparisons are not good indica- tors of operating results. Economic situation Generally, the airline industry tends to experience greater profitabil- Competition ity during times of economic prosperity. Similarly the Company is The airline industry is a very competitive industry. The Company dependent on the state of the economy in the countries in which it faces competition from both new and established carriers. The indus- operates. In a depressed economy, consumers are likely to reduce air try is characterized by generally low profit margins and high fixed travel which could affect both load factors and yield as well. Even costs. The cost of an aircraft flight does not vary significantly with the though the Company has worked extensively on reducing its fixed number of passengers carried on it. Therefore the number of passen- cost to reduce the adverse effects of reduced demand, the Compa-

35 gers on a plane and the pricing is instrumental in the effect on finan- ments the operating cost of the aircraft the Company is operating cial results. The airline industry is highly competitive due to the nom- could increase or decrease depending on the market conditions at inal cost of servicing additional customers on already scheduled that time and affect the profitability of the Company. flights. This nominal cost means that the airline is better off selling The Company furthermore owns a number of aircraft. The value of seats at low prices rather than not selling them at all, which is the rea- the aircraft will have to be tested for impairment when there is an son why price wars are quite common in the airline industry. Should indicator of impairment. Such impairment tests could result in the competition increase even further in any of the Company's key mar- writing down of the aircraft if the market value and the value in use kets, including the Icelandic market, it might have a considerable are below the carrying value of the aircraft. effect on the Company's profitability. Due to Icelandair's favourable market position in Iceland, Icelandair is subject to even more strin- Exchange rate and interest rate gent anti-trust regulations than a company with a smaller market The Company is exposed to the effect of foreign exchange rate and share would be. This places some restriction on the Company's abil- interest rate fluctuations. The Company has put in place a hedging ity to grow in the Icelandic market. This market position of the Com- strategy which, when implemented and adhered to, should limit this pany was the reason why the Icelandic competition authority decid- risk. Such risk will not, however, be eliminated. Fluctuations in ed only to agree to the Company's acquisition Bluebird with certain exchange rates and interest rates can materially impact the Compa- conditions, including a condition which obliged the Company to sep- ny's profitability, e.g. through its contractual relations relating to air- arate the control of Bluebird from the control of its other operations. craft financing. FL Group's target is to hedge 40-70% of all interest The Company is furthermore from time to time involved in disputes rate risk. This year the risk committee decided to deviate from the with its competitors over alleged breaches of anti-trust regulations. overall objective and aim for 85% of all interest rate risk to be hedged Should the competition authorities reach the conclusion that the for the next 3-5 years. Company breached such regulations, it may have serious conse- quences for the Company which may include considerable fines and Covenants – contractual risk affect the Company's ability to conduct its business in the usual man- The Company is contractually bound to honour various contracts in ner. leasing and financing agreements. These include e.g. provisions relat- ing to a change of control of the Group's entities and to what extent A sole supplier for the majority of the Company's aircraft the Company remains the owner of the share capital of its sub- The Company mainly uses Boeing aircraft since the Company sidiaries. Should the Company become unable to or for some reason believes that Boeing aircraft satisfactorily meet its objectives of mini- discontinue to fulfil the respective covenants, the lessors and finan- mizing costs while maximizing passengers' security. Generally, having ciers may become entitled to rescind the agreements which might only one aircraft supplier makes the Company dependent on the said have grave financial consequences for the Company. supplier to a certain extent. Furthermore, the Company has acquired 15 aircraft from Boeing that are to be delivered to the Company in Litigation 2006 and 2007. Should Boeing be unable, for whichever reason, to Given the Company's size and scope of operations, it tends to be deliver the aircraft to the Company, this could materially impact the involved in some form of litigation at any given time. Currently it is operating profits of the Company. involved in various legal disputes. One court case, however, could potentially have a material impact, namely a dispute with MT Höjgaard Maintenance costs Íslandi ehf. which involves a claim brought against FL Group relating Maintenance costs will increase as the aircraft fleet becomes older. to a cargo building construction. The principal of the plaintiff's claim Current costs incurred due to maintenance will consequently amounts to approximately ISK 180 million. Should the plaintiff suc- increase unless the Company acquires new aircraft. ceed, it may furthermore be awarded default interest and expenses. Third party guarantees Trademarks and intellectual property The Company has issued guarantees to third parties where the The Company owns a considerable number of trademarks and oth- Company guarantees the performance of other companies. Such er intellectual property which it relies on in its operations. The Com- guarantees have been given for the purpose of securing the Compa- pany has tried to secure legal rights to such trademarks and intellec- ny's business interests. Should the relevant companies become tual property. Should the Company, for some reason, be unable to unable to fulfil the respective obligations, the Company will need to continue to rely on the respective intellectual property rights, that submit the necessary funds. could impact its business materially. Aircraft pricing Internal controls The Company intends to actively participate in the market for own- The Company is dependent on having sufficient internal controls in ing and leasing aircraft to third parties. Aircraft prices and leasing are place on various dimensions, including controls relating to the han- cyclical by nature. If the value of an aircraft drops due to lower dling of electronic documents. The Company has focused on demand for air travel or any other reason, the value of those planes strengthening such controls. Should such controls prove, however, to and leasing rates will be affected. If this happens the Company's prof- be insufficient, this may have a negative impact on the Company. As itability could be adversely affected. On the other hand when the the Company's balance sheet and its scope of operations grows, the Company needs to replace the aircraft which it is currently operat- need for sound internal controls will grow. ing with newer ones, add new aircraft or renegotiate leasing agree-

36 Tax The Company could be affected by changes in tax legislation in any of the countries that influence the financial results of the Company. FL Group is not aware of any ongoing tax inspection concerning the Group's subsidiaries which may have a material impact on the Com- pany's shares and has no reason to believe that such an inspection is imminent. Investigation of the Company's tax filings, as for any other company, may be initiated at a later stage in accordance with rele- vant regulations and affect the prospects of the Company. The Company and the tax authorities may potentially have different opinions on how various financial arrangements within the Company should be treated from a tax perspective. These include issues such as to what extent a withholding tax is deducted from lease payments to foreign lessors. The Company is of the opinion that it is in all main respects in compliance with the relevant tax regulations and practices and should not expect claims from tax authorities relating to its treat- ment of income or any other financial issues. No re-assurance can be given in that respect, however.

Additionalrisks related to the acquisition of Sterling The success of the acquisition of Sterling is dependent on numerous factors, including the Company's ability to successfully execute the restructuring and integration of Sterling and Maersk. Due to the fact that the Company has not assumed the operations of Sterling, the Company has not been able to review Sterling's operations in full detail, even though it has conducted limited high level review of spe- cific financial and legal issues. The Company cannot, for that reason, exclude the possibility of new information arising which may have a material impact on the operation of Sterling. Such complications may i.a. relate to labour relations, anti-trust issues, and various corporate matters. Should such complications materialize, they may have an impact on the profitability of Sterling. Investors should be aware of the risk relating to merger and integra- tion issues with respect to the Sterling acquisition. This specifically refers to the merging of two different cultures and two different busi- ness models. The value proposition offered by Sterling is different compared to what was offered at Maersk. The competition authorities in Norway, Sweden and Germany have been notified of the acquisition and have all decided not to object to the acquisition. The competition authorities in Denmark and Iceland have requested information regarding the acquisition. The Danish authorities will not investigate the matter any further but the Ice- landic Competition Appeals Committee will now consider whether the acquisition needs to be reported to The Icelandic Competition Council. As of today, 29 December, this means that it cannot be assumed that all conditions necessary to complete the acquisition will be met in the beginning of January 2006. FL Group hf. and Fons Eignarhaldsfélag hf. have not decided how or if they are going to respond to this. When their position is clear, ICEX will be notified and an annex to this prospectus will be issued.

37 IX. Financial highlights

This section on financial highlights will present the consolidated finan- Since the publishing of the third quarter results, FL Group has accu- cial statements for FL Group for the period 2002-2004, and interim mulated further shares in easyJet, and on 18 November 2005 the financial statements for the nine months ending 30 September 2004 total holding amounted to 16.2% of easyJet share capital. It should and 2005. also be highlighted that the Company has made other investments in securities, which are listed in the table on page 30. Given the nature In general the shift in strategy from pure aviation and tourism relat- of FL Group's operations, these holdings are subject to day by day ed activities to a company with greater focus on investments is clear- changes. ly reflected in the Company's consolidated financial statements, as income from investments has gradually become a larger component Since the beginning of 2005 the Company has reported in accor- of overall income and the balance sheet now includes a larger por- dance with IFRS. Thus, the interim financial statements for 2005 pre- tion of non operating assets. This means, that all comparison sented below are in accordance with IFRS, while the full year finan- between years must take into account this change in focus of FL cial statements for the years 2002 – 2004 are in accordance with Ice- Group. landic GAAP at the time of reporting. A more detailed discussion of the effects of IFRS will be presented later in this section. In connec- On the 10 November FL Group completed an equity offering tion with the change in accounting principles, the categorization and amounting to ISK 44 billion. The offering has a substantial effect on line items in FL Group's financial statements have changed somewhat. the financial situation of the Company, as the share capital of FL For the profit and loss statement, the change has been minor, and Group has been increased by 3,235,294,118 shares, or an increase of therefore the 2005 interim numbers are presented with the histori- 127.5%. In accordance with a resolution passed at a shareholders' cal numbers. For the balance sheet and cash flow statement, howev- meeting, subscribers in the offering were authorised to pay for new er, the presentation of the financial statements has been more pro- share capital with shares in the ten largest ICEX-15 companies. 44.3% found, hence historical numbers for the period 2002-2004 are pre- of the total capital raised was paid with shares, while the remaining sented separately from the interim figures. amount was paid in cash. Since the publishing of the third quarter financial statements, the Consolidated Income Statement Company has entered into two engagements which will have an Development of key line items effect on the Company's financial statements. Icelandair is the largest operating company, as it generates about half Firstly, FL Group and a Kaupthing Bank subsidiary have acquired a of all operating income. As depicted in the picture below, Icelandair Boeing 747-400 cargo aircraft for ISK 5 billion from Singapore Air- accounts for 52% of total operating revenue generation for the first lines Cargo and immediately leased the plane back to the same com- nine months of 2005 and together the Icelandair Group companies pany. This is a so-called sale-leaseback contract, which means that generated over 70% of FL Group’s revenue. when the aircraft was bought it was simultaneously leased to Singa- Total operating revenues increase by 9% during the period 2002- pore Airlines Cargo for ten years. The acquisition of the aircraft is 2004. This increase is mostly due to an increase in revenue from therefore made for investment purposes on behalf of FL Group and charter operations. During the first nine months of 2005, passenger Kaupthing Bank, which have formed a special holding company for revenues increased by 15% compared to the first nine months of the aircraft. Kaupthing Bank owns 51% of the holding company and 2004. FL Group 49%. The purchase was financed with assistance from ABC bank in Bahrain, and Icelease, FL Group’s subsidiary. The historical operating performance of FL Group is very seasonal, as most passenger traffic is generated during the summer months, thus Secondly, FL Group has signed a purchase agreement for the acqui- normally the third quarter is the best quarter for the Company. To sition of Sterling Airlines. The details of the contract can be viewed meet this seasonality, Icelandair has focused on increasing the flexibil- on page 28. ity of the Company's fleet by leasing additional aircraft during peak months. With increasing demand for air travel and hence aircraft, it has now become harder to find aircraft for short-term rental at favourable prices than for the last three to four years.

38 Exhibit 27 - Revenue split

Jan.-Sept. 2005 Jan.-Sept. 2004 Other 7% Other 9%

Loftleidir - Icelandic 9% Loftleidir - Icelandic 11%

Islandsferdir 6% Icelandair 52% Islandsferdir 6% Icelandair 49%

Icelandair Cargo 8% Icelandair Cargo 10%

Icelandair Hotels 4% Icelandair Hotels 5% Air Iceland 7% Air Iceland 8% Iceland Travel 5% Iceland Travel 5%

Other 7% 2004 2003 Other 7%

Loftleidir - Icelandic 11% Loftleidir - Icelandic 8%

Islandsferdir 6% Islandsferdir 5% Icelandair 49% Icelandair 51%

Icelandair Cargo 10% Icelandair Cargo 11%

Icelandair Hotels 4% Icelandair Hotels 5%

Air Iceland 8% Air Iceland 8% Iceland Travel 5% Iceland Travel 6%

Note: the operations of Bluebird (included in other) are only included for 11/2 months for the 9m 2005 figures.

With respect to operational costs, aircraft fuel has been the single The shift in strategy for FL Group is clearly reflected in the financial most decisive factor regarding the development of the aviation relat- items. For the first nine months of 2005 the profit from investment ed cost base. Aircraft fuel as a percentage of total operating revenue activities amounted to roughly ISK 6 billion before taxes, which are of the Group has increased from 9% in 2002, to 14% for the first nine mostly in the form of gains on market securities. The investment months of 2005. The market price for aircraft fuel has a major impact activities of FL Group also yielded good returns in 2004, when unre- on overall income and in 2005 fuel prices have soared which has hit alised gains on market securities amounted to ISK 1.7 billion. As profitability negatively. Fuel costs from the beginning of the year until already highlighted in the section on Asset Management, the portfo- the end of September 2005, have almost reached the same level as lio which has generated these returns consists mostly of easyJet and for the full year 2004. Salaries and related expenses are the largest ICEX listed shares. cost item for FL Group. As a percentage of total operating revenue, The step up in interest expenses is also related to increased invest- salaries and expenses have increased from 29% in 2002 to 34% for ment activities, as new investments have to a large extent been the first nine months of 2005, thus negatively affecting profitability. financed with new borrowings. Other cost items have developed in line with increased activity dur- ing recent years. As FL Group carries a substantial part of operating assets off balance sheet (operating leases on aircraft), EBITDAR is used as an approxi- mate measure of operating cash flows. It is also general practice to use EBITDAR as a benchmark indicator when comparing companies that have a substantial part of operating assets financed by off bal- ance sheet operating leases. For FL Group the EBITDAR margin amounts to 13.4% for the first nine months of 2005. This is a sub- stantial decrease from 20.7% in 2002. Reasons for this development are mainly a more competitive environment and adverse develop- ment of external factors such as oil and lease rates, which have grad- ually increased as demand for aircraft has gone up during the recent years. Part of lower EBITDAR margin in 2005 is non-recurring expenses due to structural changes and shares given to employees during first nine months, which is estimated in total at ISK 424 mil- lion.

39 Exhibit 28 – Consolidated Profit and Loss Account* (ISK millions) 2002 2003 2004 2004 2005 Jan-Sept Jan-Sept Operating revenue: Transport revenue: Passengers ...... 22,616 19,228 20,570 17,376 20,059 Cargo and mail ...... 3,500 2,880 3,373 2,500 2,419 Charter revenue and aircraft lease ...... 2,909 3,994 5,595 4,487 4,252 Other operating revenue ...... 9,921 11,459 13,049 9,653 10,108 38,946 37,561 42,587 34,016 36,838

Operating expenses: Salaries and related expenses ...... 11,143 12,200 14,491 10,552 12,404 Aircraft fuel ...... 3,546 3,622 5,582 4,138 5,315 Aircraft lease ...... 2,829 2,157 2,059 1,652 1,955 Aircraft servicing, handling and communication ...... 3,227 3,403 3,923 3,150 2,622 Other operating expenses ...... 12,286 12,389 12,707 10,037 10,785 Depreciation ...... 2,041 1,807 1,896 1,356 1,377 35,072 35,578 40,658 30,885 34,458

Operating profit before financial income and expenses ... 3,873 1,983 1,929 3,131 2,380

Net financial income (expenses) ...... (495) (572) (161) (298) (676) Share of associates ...... ----4 Profit on sale of investments ...... (31) (5) 592 607 212 Unrealised gain on market securities ...... - - 1,727 - 4,155 Net gain on remeasurement of derivatives at fair value .... - - - - 1,955

Profit before deferred income tax ...... 3,347 1,406 4,087 3,440 8,030

Deferred income tax ...... (736) (285) (668) (606) (1,455)

Net earnings for the year ...... 2,611 1,121 3,419 2,834 6,575

Earnings per share ...... 1.21 0.52 1.58 1.34 2.60 Return on Equity ...... 42% 13% 38% Profit (loss) as percentage of operating income ...... 7% 3% 8%

Dividends ...... 365 640 1,515

EBITDA ...... 5,914 3,790 3,825 4,487 3,757 as % of operating revenue...... 15.2% 10.1% 9.0% 13.2% 10.2% EBITDAR ...... 8,064 5,260 5,270 5,644 4,939 as % of operating revenue...... 20.7% 14.0% 12.4% 16.6% 13.4% *Full year financial statements are based on IS GAAP and first nine-month interim financial statements are based on IFRS **Dividends as declared on the Annual General Meeting when the accounts for the respective year are confirmed.

Profitability Bottom line profits have been somewhat volatile in recent years. The during the year. In 2004 the Company managed to grow revenue airline industry is volatile by nature as airlines generally have a high substantially. This revenue growth was however somewhat offset by level of operational gearing, which means that they are very depend- primarily unfavourable external factors such as higher oil prices, as in ent on top line growth for maintaining profitability and demand for 2004 the Company had already made efforts to increase the flexibil- air travel is cyclical. As already mentioned, FL Group has gone ity in capacity. Despite a similar profit from operations in 2003 and through substantial efforts to decrease the level of operational gear- 2004 respectively, the bottom line profits were greatly improved in ing, by leasing further aircraft during peak months. In 2002 bottom 2004, as profits from investment operations, which were initiated in line profits amounted to ISK 2.6 billion and in 2003 the profits 2004, yielded a return of ISK 1.7 billion. During the first nine months amounted to ISK 1.2 billion. This decrease in profitability can partly of 2005 bottom line profits were almost double the full year profits be related to high operational gearing, as in 2003 revenue decreased for 2004. as a result of increased competition and exchange rate movements

40 In terms of earnings per share, which are defined as the ratio Exhibit 29 - Consolidated Balance Sheet –according to IFRS between profit and weighted average number of shares outstanding (ISK millions) during the year, FL Group reported earnings of ISK 2.60 for the first nine months of 2005, which is a substantial improvement from ISK Balance Sheet 2004 2005 1.58 for the full year 2004. 31.Dec 30.Sept Assets: For 2004 FL Group paid a total of ISK 640 million in dividends com- Operating assets ...... 20,522 31,315 pared with ISK 365 million in 2003. No dividends were paid out in Intangible assets ...... 284 3,535 2002. Investments in associates...... 192 305 Investments in other companies ..... 192 261 Consolidated Balance Sheet Long-term receivables ...... 515 686 At 30 September 2005 total assets amounted to ISK 70 billion, com- Non-current assets ...... 21,705 36,102 pared with ISK 43 billion at year end 2004. This large increase can again be explained by the shift in focus for FL Group, as the invest- Inventories ...... 832 912 ment operations have led to an expansion of the balance sheet. Trade and other receivables...... 5,214 8,294 Between 2002 and 2004, total assets increased by 26%. Securities ...... 12,912 20,597 In 2005 FL Group has committed itself to purchasing 15 Boeing 737 Cash and cash equivalents ...... 2,819 4,106 aircraft. This engagement is clearly reflected in the Company's finan- Current assets ...... 21,777 33,909 cial statements, as assets increase by more than 50%. This increase is Total Assets ...... 43,482 70,011 mostly due to prepaid deposits to Boeing. The first deliveries of the aircraft will take place in 2006. FL Group has signed a letter of intent Equity: with Kaupthing Bank on a joint venture ownership of the 15 Boeing Issued capital...... 2,525 2,532 737 aircraft, where FL Group will hold no more than 49% of a spe- Share premium ...... 3,609 3,748 cial purpose company that will own the aircraft. Reserves...... (560) (28) At year end 2004 goodwill amounted to ISK 78 million, while at 30 Retained earnings ...... 9,230 14,339 September goodwill amounted to ISK 3,275 million. The reason for Total equity attributable to equity the increase in goodwill is the acquisition of Bluebird, which was con- holders of the parent ...... 14,804 20,591 solidated into the Group in August 2005. The book value of real Minority interest...... 21 23 estate amounted to ISK 1.6 billion at 30 September 2005. Total equity ...... 14,825 20,614 The amount of securities on FL Group's balance sheet increased sub- stantially during the first nine months of 2005. This is mainly due to Liabilities: increased investment by FL Group in easyJet. At year end 2004 FL Credit institutions ...... 12,100 14,790 Group held 10.1% of easyJet stock, while the position at 30 Septem- Bonds...... - 10,013 ber amounted to 13.89%. Deferred income tax ...... 1,413 2,946 During the period 2002-2004 total equity increased by 73%, while Pension plan obligation...... 191 278 during the first nine months of 2005 the Company's equity base Non-current liabilities ...... 13,704 28,027 increased by 39%. This increase in equity can to a large extent be explained by high returns on equity investments. Credit institutions ...... 3,482 - Current maturities of long-term debt. 1,773 7,893 There was a considerable increase in liabilities during the first nine Trade and other payables...... 7,549 10,014 months of 2005, as long-term liabilities more than doubled during Unearned transportation revenue .... 2,149 3,463 the period, which is mostly due to a bond issued in March 2005. Current liabilities ...... 4,953 21,370 Increased borrowing is mostly related to increased investment activ- ity. Current liabilities increased considerably during the same period, Total liabilities ...... 28,657 49,397 which is primarily due to PDP debt in relation to acquisition of 15 Boeing 737-800 aircraft which is categorized as current maturities of Total equity and liabilities...... 43,482 70,011 long term-debt. Equity ratio...... 34.1% 29.4% During the period 2002-2004 FL Group maintained a prudent equi- Current Ratio...... 1.46 1.59 ty ratio, increasing from 23.4% in 2002 to 32.1% in 2004. At 30 Sep- tember 2005 the equity ratio amounted to 29.4%. With respect to liquidity, the current ratio has been constantly improving over the period looked upon, or from 1.19 in 2002 to 1.59 in 2005.

41 Exhibit 30 - Consolidated Balance Sheet year end 2002 to 2004 – Exhibit 31 - Consolidated Balance Sheet continued according to IS GAAP (ISK millions)

Balance Sheet 2002 2003 2004 Balance Sheet 2002 2003 2004

Fixed assets: Stockholders’ equity and liabilities Intangible assets: Goodwill ...... -78Stockholders´ equity: Other intangible assets ...... 462 557 423 Capital stock ...... 2,153 2,132 2,525 462 557 501 Statutory stock reserve ...... 538 533 3,609 Stock options reserve ...... - 1 213 Property and equipment: Translation reserve ...... - - (735) Buildings ...... 2,048 2,104 1,715 Unrealised gain on market Aircraft and flight equipment .. 20,345 17,715 15,050 securities ...... - - 1,417 Other property and equipment 1,025 1,669 1,883 Retained earnings ...... 5,930 6,544 7,906 23,418 21,488 18,648 Stockholders' equity ...... 8,622 9,210 14,935 Aircraft purchase prepayments 37 Engine overhauls ...... 894 689 508 Obligations: 24,312 22,177 19,893 Pension plan obligation ...... 150 161 180 Deferred income tax ...... 731 989 1,466 Investments: 881 1,150 1,646 Investment in associated companies ...... 217 194 192 Long-term debt: Investment in other companies 229 169 192 Credit institutions ...... 17,964 15,963 12,242 Long-term notes ...... 166 34 139 Deposits and other ...... 330 430 358 Current liabilities: 942 827 881 Credit institiutions ...... - - 6,530 Accounts payable ...... 2,612 3,207 2,947 Fixed assets...... 25,715 23,561 21,275 Current maturities of long-term debt ...... 1,553 1,543 1,773 Current assets: Accrued liabilities and expenses 3,314 4,191 4,331 Inventories ...... 464 707 832 Unearned transportation revenue 1,900 2,032 2,149 9,379 10,973 17,730 Receivables: Accounts receivable ...... 2,921 3,437 3,304 Total liabilities ...... 28,223 28,086 31,618 Notes receivable ...... 378 438 355 Other receivables ...... 634 664 788 Stockholders’ equity and liabilities total ...... 36,845 37,296 46,553 Prepaid expenses ...... 874 747 855 Market securities ...... - - 13,246 Equity ratio ...... 23.4% 24.7% 32.1% Cash and cash equivalents .... 5,859 7,742 5,898 Current Ratio ...... 1.19 1.25 1.43 Current assets ...... 11,130 13,735 25,278

Total assets...... 36,845 37,296 46,553

42 Exhibit 32 - Consolidated Cash flow statement – First nine months Exhibit 33 - Consolidated Cash Flow Statement 2002-2004 of 2004 and 2005 – according to IFRS (ISK millions) – IS GAAP (ISK millions)

Cash flow Statement 2004 2005 Cash Flow Statement 2002 2003 2004 Jan - Sept Jan - Sept Cash flows from operating activities: Cash flows from operating activities: Net earnings for the year ...... 2,611 1,121 3,419 Profit for the period ...... 2.834 6.575 Adjustments to reconcile net earnings to net cash Adjustments for: provided by operating activities: Depreciation...... 1,356 1,377 Depreciation ...... 2,041 1,807 1,896 Operating activities, net ...... 995 (3,652) Capital (gain) loss on sale of assets .. 32 (80) (35) Working captial from operations ... 5,185 4,300 Amortisation and deferred charges.. 1,020 781 1,027 Net change in operating assets Unrealised gain on market securities - - (1,727) and liabilities ...... (4) 592 Other operating activities, net ...... 677 736 807 Net cash provided by operating Working capital from operations... 6,381 4,365 5,387 ...... 5,181 4,892 activities Net change in operating assets and liabilities ...... 34 1,199 (267) Cash flows from investing activities: Acquisitions of intangible assets ...... (844) (242) Net cash provided by operating Acquisitions of operating assets ...... (946) (14,542) activities ...... 6,415 5,564 5,120 Proceeds from the sale of operating assets...... 55 5,239 Cash flows from investing activities: Securities, change ...... - (2,854) Capitalised deferred charges ...... (1,396) (1,076) (1,088) Increase in investments and long- Increase in property and equipment: term receivables ...... 585 (4,348) Buildings ...... (19) (61) (61) Aircraft and flight equipment ..... (3,266) (831) (1,234) Net cash used in investing activities. (1,150) (16,747) Other equipment ...... (209) (993) (834) Cash flows from financing activities: Proceeds from sale of equipment ... 199 138 83 Increase in investments and Own shares, change ...... (188) 41 long-term notes ...... (372) (497) (300) Dividend paid...... (640) (1,466) Proceeds from non-current borrowing 289 19,768 Market securities, increase ...... 160 - (11,519) Repayment of borrowings ...... (1,251) (1,719) Net cash used in investing activites (4,902) (3,320) (14,953) Short-term borrowing, change ...... - (3,482) Net cash (used in) provided by Cash flows from financing activities: financing activities ...... (1,790) 13,142 Dividends paid ...... - (365) (640) Additional paid in capital stock ...... - - 2,025 Net changes in cash and cash Purchase of treasury stock, net ...... (505) (143) 1,445 equivalents ...... 2,241 1,287 Proceeds from long-term borrowings 4,977 1,837 289 Cash and cash equivalents at 1 January 7,742 2,819 Payments and other changes in long-term debt ...... (1,879) (1,690) (1,660) Cash and cash equivalents at Notes payable, decrease ...... (29) - 6,530 30 September ...... 9,983 4,106 Net cash provided by (used in) financing activities ...... 2,565 (361) 7,989 (Decrease ) increase in cash and cash equivalents ...... 4,078 1,883 (1,844) Cash and cash equivalents at beginning of year ...... 1,781 5,859 7,742 Cash and cash equivalents at end of year ...... 5,859 7,742 5,898

43 Consolidated Cash Flow Statement Changes in measurements Operating cash flows for the consolidated company portray a very Some expenses that have been capitalized as intangible assets are cash generative operation. For the period 2002-2004 cash flows from not in compliance with IAS 38 on intangible assets, e.g. pilot training. operating activities have been relatively stable. For the first nine This causes a decrease in the Group's equity by ISK 117 million, with months of 2005 cash from operating activities amounted to ISK 4.9 regards to income tax effects. The comparative figures in the interim billion, which is a marginal decrease compared to the same period in income statements have been adjusted accordingly. 2004. The fair value of stock options was estimated based on the grant Again, as with other aspects of FL Group's financial statements, the date according to IFRS 2. The fair value is measured at grant date and cash flow statement is clearly marked by the change in strategy from spread over the period during which the employees become uncon- operating only aviation and tourism related companies to operating a ditionally entitled to the options. The fair value of the options grant- company with greater focus on investments. In 2004 market securi- ed is measured using the Black Scholes model, taking into account ties increased by ISK 11.5 billion, which is mostly due to the invest- the terms and conditions upon which the options were granted. ment in easyJet. During 2005 FL Group has continued to accumulate FL Group has in previous years expensed estimated costs of future shares in easyJet and ICEX listed companies, which is clearly reflect- overhauls of engines owned by the Company. According to IAS 37 ed in the statement of cash flows. a liability arising from future expenses such as this cannot be recog- During the period FL Group furthermore acquired the operations of nized. As a result, the Group's equity increases by ISK 209 million, Bluebird for ISK 4.1 billion. with regards to income tax effects. The comparative amounts in the interim income statements have been adjusted accordingly. During the first nine months of 2005 cash flows from investment activities showed an outflow of ISK 14.5 billion in relation to the Prepayments recognized among long-term receivables have now acquisition of operating assets. This investment is related to prepay- been stated according to effective interest rates and therefore equi- ments on the previously mentioned 15 Boeing 737-800 aircraft. ty decreases by ISK 40 million, with regards to income tax effects. Cash flows from investment activities provide an overview of changes Pension benefit obligation is recognized according to IAS 19. As a in the debt structure of FL Group during the period 2002 - Q3 2005. result equity decreases by ISK 9 million, with regards to income tax During the period 2002-2004 there were only minor changes in the effects. Company's financial structure. Most noteworthy is a share capital Unsettled derivatives at the end of the year 2004 and some financial increase of ISK 2 billion in 2004. During the first three quarters of assets are recognized at their fair value according to IAS 39. As a 2005 there were, however, substantial changes with respect to result equity decreases by ISK 167 million, with regards to income tax financing, as non-current borrowing is ISK 19.7 billion. Part of this effects. The comparative figures in the income statement have not increase is a ISK 10 billion bond offering that was sold to investors in been adjusted as is permitted in IFRS 1. March 2005. Changes in presentation The implementation of IFRS When adopting the standards some assets, previously presented as operating assets but classified as intangible assets according to IAS 38, In preparing its opening IFRS balance sheet, the Company has adjust- have been transferred to intangible assets. Loan charges previously ed amounts reported previously in financial statements prepared in presented as intangible assets are now subtracted from relevant accordance with its old basis of accounting (previous GAAP). An loans. explanation of how the transition from previous GAAP to IFRS has affected the Group’s financial position, financial performance and cash Next year's use of engine hours has been presented as current assets flows is presented below. but now this item is recognized among operating assets. The Group's securities which were classified as cash and cash equiv- Exhibit 34 - Equity 1.1.2005 (ISK millions) alents on 31 December 2004 do not fulfil the requirements of cash and cash equivalents according to IAS 7 and therefore presentation Changes in measurement: 1.1.2004 1.1.2005 Total has been changed and they are presented as securities in the balance Intangible assets...... IAS 38 (121) 4 (117) sheet. Fair value of stock options ... IFRS 2 1 16 17 Impairment of prepayments.. IAS 36 (44) 4 (40) Shares acquired with a forward contract and presented as securities Pension liabilities ...... IAS 19 (9) - (9) are not recognised in the balance sheet according to IAS 39, instead Engine overhaul liability the net fair value of the forward contract is recognised in the finan- derecognised ...... IAS 16, 37 97 112 209 cial statements. Derivatives and financial In addition, minority interest in the Group's equity, previously includ- assets to fair value ...... IAS 39 (167) (167) ed among current liabilities, is now presented as a separate item in Other changes ...... (24) (24) equity. Net change from previous GAAP to IFRSs...... (76) (55) (131)

44 Exhibit 34 - Balance Sheet 1.1.2005 (ISK millions)

Balance Sheet Icelandic Changes Changes in IFRSs in GAAP presentation measurement Assets:

Operating assets ...... 19,893 374 255 20,522 Intangible assets ...... 501 (74) (143) 284 Investments in associates ...... 192 192 Investments in other companies ...... 192 192 Long-term receivables...... 497 111 (93) 515 Non-current assets ...... 21,275 411 19 21,705

Inventories ...... 832 832 Trade and other receivables ...... 5,302 (90) 2 5,214 Securities ...... 13,246 (147) (187) 12,912 Cash and cash equivalents ...... 5,898 (3,079) 2,819 Current assets ...... 25,278 (3,316) (185) 21,777

Total Assets ...... 46,553 (2,905) (166) 43,482

Equity: Issued capital ...... 2,525 2,525 Share premium ...... 3,609 3,609 Reserves ...... 895 (1,405) (50) (560) Retained earnings...... 7,906 1,405 (81) 9,230 Total equity attributable to equity holders of the parent ...... 14,935 - (131) 14,804 Minority interest ...... 21 21 Total equity ...... 14,935 21 (131) 14,825

Liabilities: Credit institutions...... 12,242 (142) 12,100 Deferred income tax...... 1,466 (53) 1,413 Pension plan obligation...... 180 11 191 Non-current liabilities ...... 13,888 (142) (42) 13,704

Credit institutions...... 6,530 (3,048) 3,482 Current maturities of long-term debt ...... 1,773 1,773 Trade and other payables ...... 7,278 264 7 7,549 Unearned transportation revenue ...... 2,149 - 2,149 Current liabilities ...... 17,730 (2,784) 7 14,953

Total liabilities ...... 31,618 (2,926) (35) 28,657

Total equity and liabilities...... 46,553 (2,905) (166) 43,482

45 Balance sheet changes are presented without the effect of income Net profit attributable to the shareholders of the parent company tax. Changes in equity were presented with regards to income tax increases by ISK 161 million in the comparative figures in the financial effects. statements for the year 2004 due to the adaptation of the standards. In the comparative figures for the first nine months of 2004, net prof- In the interim financial statements of FL GROUP hf. according to it attributable to the shareholders of the parent company increases IFRS the focus is on disclosing significant accounting policies, at the by ISK 151 million according to the income statement above. same time, the effect of the adaptation of IFRS on the financial posi- tion of the Group is disclosed. Salaries and related expenses decrease by ISK 66 million due to changes in the treatment of employee stock options. Other operating expenses decrease by ISK 33 million and exchange Exhibit 35 - Income Statement for the nine months ended 30 Sep- loss by ISK 5 million due to the de-recognition of estimated future tember 2004 (ISK millions) costs of engine overhauls.

Icelandic Changes IFRSs Depreciation decreases by ISK 54 million due to changes in the meas- GAAP urement of previously capitalized cost due to changes in the evalua- Operating revenue: tion of operating assets and amendments to previously capitalized Transport revenue: cost cf. discussion on the evaluation of assets. Passengers ...... 17,376 17,376 Cargo and mail ...... 2,500 2,500 Changes in income tax for the period result from the changes dis- Charter revenue and aircraft lease... 4,487 4,487 cussed here above. Other operating revenue ...... 9,653 9,653 Minority interest in the performance for the period is now present- 34,016 - 34,016 ed separately among profits for the period but the minority interest Operating expenses: was previously expensed among financial income and financial Salaries and related expenses ...... 10,618 (66) 10,552 expenses. Aircraft fuel ...... 4,138 4,138 Aircraft lease ...... 1,652 1,652 Future outlook Aircraft servicing, handling and The future prospects for each of the individual operating companies communication ...... 3,150 3,150 within FL Group have been outlined in previous sections. However, Other operating expenses ...... 10,070 (33) 10,037 given the nature of the Group with increased emphasis on invest- Depreciation ...... 1,410 (54) 1,356 ments, the overall performance and profitability will to a large extent 31,038 (153) 30,885 be driven by the development of domestic and European securities markets. Operating profit before financial income and expenses ...... 2,978 153 3,131

Net financial income ...... 304 5 309

Profit before deferred income tax 3,282 158 3,440

Income tax expense ...... (600) (6) (606)

Net earnings for the year ...... 2,682 152 2,834

Attributable to: Equity holders of the parent...... 2,682 151 2833 Minority interest...... -11 Profit for the period ...... 2,682 152 2,834

46 Appendix A

Translated from the Icelandic This is an unauthorised translation of the Icelandic original Articles of Association In the event of any discrepancies the original Icelandic version shall prevail.

Articles of association of FL GROUP hf.

I. The name, address and object of the company.

II. Share capital and handling of share capital.

III. Shareholders' meetings.

IV. The company's board of directors etc.

V. Annual accounts, auditing etc.

VI. Dissolution of the company etc.

5 December 2005

47 Articles of association of FL GROUP hf. The new shares shall grant rights in the company from the date on which they are registered and they shall be governed by the compa- Section I ny's articles of association. The name, address and object of the company The offering price of the shares and the rules of sale shall be deter- mined by the board of directors in accordance with section V of Act Art. 1 no. 2/1995 on Public Limited Companies. This authorisation shall be Name exercised within five years of being approved. The authorisation may be exercised in its entirety or in part as decided by the board of The name of the company is FL GROUP hf. directors.

Art. 2 Share capital is divided into shares of one króna or multiples thereof. Address Any increase in share capital must be approved by a shareholders' meeting. The address of the company is Sudurlandsbraut 12, 108 Reykjavík. Shares Art. 3 The company's shares are issued electronically in accordance with the Object provisions of legislation on the electronic registration of title to secu- The object of FL GROUP is to achieve a return on the investment rities. which shareholders have made in the company by operating the company and investing in subsidiaries and associated companies Voting weight which primarily operate in the fields of air travel, tourism, transporta- All voting shares which have unrestricted voting rights have equal tion and investment. rights, and there is one vote for each króna of share capital in the company. Section II Share capital and the handling of share capital The voting rights of share classes with different voting weights depend on the decision of a shareholders' meeting on the issue of Art. 4 such classes.

Share capital, shares and classes Classes of shares The share capital of the company is ISK 5,845,294,118 – five billion Classes of shares with different rights to dividends and voting rights eight hundred and forty five million two hundred and ninety-four may be issued. It is permitted to issue classes of shares without vot- thousand one hundred and eighteen Icelandic krónur. ing rights. The board of directors of the company is authorised to increase the company's share capital by up to ISK 1,022,800,000 by the sale of Pre-emptive rights to new shares new shares in such a way: Parties who own shares in the company when the increase takes The company's board of directors shall be authorised to increase the place have pre-emptive rights to the new shares in direct proportion share capital by ISK 700,000. Shareholders' pre-emptive rights to to their shareholdings in the company. these shares in the increase in share capital pursuant to the Act on In the event that a shareholder does not wish to exercise the pre- Public Limited Companies and these articles of association shall not emptive right, other shareholders have increased subscription rights. apply, cf. authorisation provided in Art. 34 of Act no. 2/1995 on Pub- lic Limited Companies. Register of shares The company's board of directors shall be authorised to increase the A register of shares, cf. provisions of the act on the electronic regis- company's share capital by ISK 692,100,000. Shareholders shall have tration of title to securities, is considered full proof of ownership of pre-emptive rights to these shares in the increase in share capital shares in the company, and dividends at any given time and all pursuant to the Act on Public Limited Companies and the compa- announcements shall be sent to the party which at any given time is ny's articles of association. the registered owner of the shares in question in the company's reg- The company's board of directors shall be authorised to increase the ister of shares. The company bears no responsibility if payments or company's share capital by up to ISK 330,000,000 at nominal value announcements do not reach the intended recipient because of a fail- by issuing new shares. Shareholders do not have pre-emptive rights ure to notify the company of a change of address. to the new shares, which shall be handed over as part of the pur- chase price in return for shares in Sterling Airlines A/S, Sterling Ice- Restrictions on selling shares to foreign parties landic ApS and Flyselskabet A/S. Notwithstanding the provisions of The sale of shares to foreign parties is governed by the provisions of paragraph 4, article 4 of the articles of association the price of the Icelandic law as valid at any given time. new shares shall be ISK 13.6 for each króna nominal value and the board shall exercise this authorisation within one year of it being approved.

48 Change in ownership Shareholders' exercise their executive power at shareholders' meet- ings. The change in ownership and execution thereof is governed by the existing legislation on the electronic registration of title to securities Proxy and regulations based thereupon. Shareholders can arrange for proxies to attend shareholders' meet- Ban on granting credit ings on their behalf. The proxy attending a meeting must provide a written and dated proxy. The company is not permitted to grant credit against its shares. The company is not permitted to grant credit to shareholders, board Legitimacy and arrangement of shareholders' meetings members, the chief executive officer or management of the compa- A shareholders' meeting is legitimate regardless of attendance if it is ny, nor to provide collateral for them. The provisions of this article rightfully called. Attendance shall be calculated by the number of vot- do not apply however to normal business loans or investments by ing slips handed out. company employees or those of a related company in the company or investments in shares on their behalf as permitted by law. The chairman of the company or an elected person shall chair share- holders' meetings and shall oversee the election of a secretary to the Art. 5 meeting. The chair of the meeting shall ascertain at the beginning of the meeting whether the meeting is legitimate and will announce if The company's own shares this is the case. The company is permitted to buy own shares to the extent allowed Discussions and voting are carried out in accordance with decisions by law. The company can only acquire shares in accordance with the of the chair of the meeting. authorisation granted to the board of directors by a shareholders' meeting. The authorisation granted to the company's board of direc- Calling a meeting tors to buy own shares may not be valid for more than 18 months Shareholders' meetings shall be called by means of an advertisement at a time. No voting rights are attached to the company's own in a daily newspaper or in another verifiable manner, with at least one shares. week's notice. Art. 6 An annual general meeting shall be called with at least two weeks' notice. The rights and obligations of shareholders The invitation to the meeting shall specify the agenda of the meeting. Shareholders are obliged without any specific commitment to abide If a proposal to amend the articles of association is to be put forward, by the company's articles of association, both in their current form the main subject of the motion shall be specified in the invitation to and any form which may be established legally at a later date. Share- the meeting. holders will not be obliged, neither by the articles of association nor by amendments to the law, to increase their shareholdings in the Right of shareholders to raise issues for discussion company. Shareholders are not obliged to redeem their shares unless the company is dissolved, the share capital is reduced or in accor- All shareholders are entitled to raise particular issues for discussion at dance with a specific authorisation provided for in the act on public shareholders' meetings provided that they send a written request to limited companies. the board of directors with sufficient notice so that the matter can be included in the agenda of the meeting. Shareholders are not responsible for the company's liabilities in excess of their holdings in the company. This provision may not be Agenda and final proposals at shareholders' meetings amended by any kind of resolution at a shareholders' meeting. The agenda and the final proposals to be dealt with at the meeting Art. 7 shall be made available to shareholders at the company's offices at least seven days before a shareholders' meeting. Pre-emptive rights The company's annual accounts, the report of the board of directors No special rights are attached to the shares in the company other and the auditors' report shall be made available to shareholders at than the pre-emptive right to subscribe for new shares. the company's offices at least seven days before a shareholders' meeting. Section III Additional and amended proposals which have been legitimately Shareholders' meetings raised may be put forward at the meeting itself, even if they have not been made available to shareholders. An annual general meeting can Art. 8 always deal with matters which must be handled according to legisla- Jurisdiction of shareholders' meetings tion or the company's articles of association. A legitimate shareholders' meeting is the supreme authority in all the company's affairs, within the limitations set out in the articles of asso- Matters not specified in the agenda ciation. Matters which have not been specified on the agenda cannot be

49 decided upon at a shareholders' meeting without the approval of all Art. 10 shareholders in the company, but a resolution thereon may be made for the guidance of the board of directors. Dividends Dividends are considered due on the day of the annual general meet- When shall a shareholders' meeting be called ing and shall be paid to those who are considered shareholders. Pay- The company's board of directors shall call a shareholders' meeting ment of dividends shall take place no later than three months after it when it decides it is necessary, in accordance with a resolution was determined at the annual general meeting. passed at a meeting, or when shareholders controlling 1/10 (one tenth) of the share capital request a meeting in writing. They shall Art. 11 also send a report to the board of directors specifying why they request the meeting and the board of directors shall inform the Amendments to the articles of association shareholders of the topic of the meeting in the invitation to the The company's articles of association may only be amended at a legit- meeting. imate shareholders' meeting, provided that this is clearly stated in the When a legitimate request to hold a meeting has been put forward, invitation to the meeting that it is intended to amend the articles of the board of directors is obliged to call the meeting within at least 14 association and what the main aspects of such amendment are. A res- days of receiving the request. If the board of directors has not called olution will only be valid if it is approved by at least 2/3 of votes cast the meeting within this period, shareholders can demand that a and is approved by shareholders controlling at least 2/3 of the share meeting be called pursuant to the provisions of the act on public lim- capital represented by votes at the shareholders' meeting. ited companies. Qualified majority of votes for approval Weight of votes The approval of all shareholders or a qualified majority is necessary One vote is attached to each króna owned in the company in those to approve special proposals on amendments to the articles of asso- classes which have unrestricted voting rights, but otherwise as is ciation and this depends on the provisions of current legislation on specified for such classes of shares. public limited companies.

Casting votes Section IV At shareholders' meetings all normal business is decided by voting, The company's board of directors etc. unless otherwise provided for in these articles of association.

Art. 12 Book of minutes Board of directors and terms of the board of directors A short report of what occurs at shareholders' meetings and all res- olutions passed at the meeting and the result of voting shall be The company's board of directors shall comprise five members and entered in special book of minutes. two substitutes, elected at an annual general meeting for a period of one year at a time. The competence of board members is set down The minutes of the meeting shall be read aloud at the end of the in legislation. meeting and shall be signed by the chair of the meeting and the sec- retary to the meeting. This report on the meeting shall be full docu- The election of a board of directors takes place as follows: mentation of what occurs at meetings. Those who wish to be considered for a seat on the board of direc- tors shall inform the board thereof in writing at least five days before Art. 9 the annual general meeting. The only people eligible for election at Annual general meeting the annual general meeting are those who have put themselves for- The annual general meeting shall be held before the end of May ward as a candidate in this way. every year. At annual general meetings only those who have put themselves for- The following matters shall be discussed at an annual general meet- ward as a candidate with the stipulated notice can be voted. ing: Art. 13 1. The company's board of directors reports on the financial posi- tion of the company and activities during the past operating year. Scope and tasks of board of directors and chief executive officer 2. The audited annual accounts are submitted for approval. The company's board of directors is the supreme authority in the 3. How the company's profit or loss during the fiscal year shall be company's affairs between shareholders' meetings and shall ensure handled. that the organisation and activities of the company are generally in 4. Decision shall made on remuneration to the company's board of correct and good order. directors. 5. Election of the company's board of directors pursuant to Art. 12. The board of directors appoints the chief executive officer of the 6. Election of auditors pursuant to Art. 16. company. 7. Discussion of, and voting on, other business which may be legiti- mately raised by the meeting.

50 The board of directors and the chief executive officer are responsi- tant decision may not be made, however, unless all board members ble for managing the company. have been able to discuss the matter, if possible. The company's board of directors establishes a strategy for the com- Voting pany and sets its targets with the interests of shareholders as a guid- ing principle in accordance with the company's object. The compa- A simple majority decides issues at board meetings. ny's board of directors works in accordance with working rules which the board of directors establishes on the basis of the act on public Obligating the company limited companies. The signatures of the majority of board members obligate the com- The company's board of directors shall ensure that there is sufficient pany. supervision of the company's accounts and the handling of the com- pany's funds. Section V Only the company's board of directors can issue the power of Annual accounts, auditing etc. procuration. The chief executive officer undertakes the day-to-day management Art. 16 of the company and shall adhere to the policy and instructions set out by the company's board of directors. Day-to-day management Fiscal year does not include measures which are considered of an unusual or The company's fiscal year is the calendar year. major nature. The chief executive officer can only take such meas- ures in accordance with special authorisation from the company's The annual accounts shall be audited by an auditing company. board of directors, unless it is not possible to wait for the decision of An auditing company shall be elected for one year at a time at the the company's board of directors without considerable inconven- annual general meeting. ience to the company's operations. In such instances the chief exec- utive officer shall consult the chairman of the board of directors, if Section VI possible, and the board of directors shall immediately be informed of such measure. Dissolution of the company etc. The chief executive officer shall ensure that the company's accounts be entered in accordance with legislation and customs and that the Art. 17 company's assets are handled securely. Dissolution of the company, division or merger Art 14. The dissolution, division or merger of the company is governed by current legislation on public limited companies. Meetings of the board of directors The board of directors elects a chairman from its members but in Art. 18 other respects it delegates tasks between its members as necessary. Other provisions The chairman will call board meetings and ensures that other board members are invited to attend. Where the provisions of these articles of association provide no guid- ance, the provisions of the current legislation on public limited com- A meeting shall also be held at all times if requested by a board panies shall apply. member or the chief executive officer.

The chief executive officer attends meetings of a company's board of The memorandum of association and the articles of association of directors even though he or she is not a board member, and he or Flugleidir hf. were approved at the establishment meeting of the com- she has the right to debate and to submit proposals there, unless the pany on 20 July 1973, and the founders signed the articles of associ- company's board of directors decides otherwise in individual ation in accordance with the authorisation provided at the annual instances. general meetings of Flugfélag Íslands hf. and Loftleidir hf., which were A book of minutes shall be kept to record what occurs at board held on 28 June 1973. meetings and this shall be signed by those attending a meeting. A board member or the chief executive officer who are not in agree- ment with a decision by the board of directors are entitled to have their dissenting opinion entered in the book of minutes.

Art. 15 Decisions of the board of directors The company's board of directors is competent to make decisions when the majority of board members attend a meeting. An impor-

51 The company's articles of association have been amended several times since then.

At a shareholders' meeting on 4 March 1976 At a shareholders' meeting on 8 June 1976 At an annual general meeting on 24 May 1977 At an annual general meeting on 14 April 1978 At an annual general meeting on 28 April 1980 At an annual general meeting on 24 April 1981 At an annual general meeting on 24 March 1983 At an annual general meeting on 29 March 1984 At an annual general meeting on 28 March 1985 At a shareholders' meeting on 15 May 1986 At an annual general meeting on 20 March 1987 At an annual general meeting on 22 March 1988 At an annual general meeting on 21 March 1989 At an annual general meeting on 22 March 1990 At a shareholders' meeting on 23 October 1990 At an annual general meeting on 21 March 1991 At an annual general meeting on 19 March 1992 At an annual general meeting on 16 March 1995 At an annual general meeting on 14 March 1996 At an annual general meeting on 19 March 1998 At an annual general meeting on 15 March 2001 At an annual general meeting on 11 March 2003 At an annual general meeting on 11 March 2004 At a shareholders' meeting on 18 October 2004 At a meeting of the board of directors on 3 November 2004 At an annual general meeting on 10 March 2005 At a shareholders' meeting on 1 November 2005 At a meeting of the board of directors on 5 December 2005 The above articles association are now the currently valid articles of association of the company with entered amendments which have been approved. The headings to sections in these articles of association do not form part of the articles of association but are for purposes of convenience only.

The above articles association are now the currently valid articles of association of the company.

Reykjavík, 5 December 2005 FL GROUP hf.

______Hannes Smárason, CEO

52 Appendix B Interim Consolidated Financial Statements January 1- September 30, 2005 Endorsement and Signatures of the Board of Directors and the Managing Director

The Company's Interim Consolidated According to the income statement net Reykjavík, November 18, 2005 Financial Statements are for the third time profit for the period amounted to ISK 6,575 prepared in accordance with International million. According to the balance sheet, The Board of Directors and Alternate board Financial Reporting Standards. The Com- equity at the end of the period amounted to members: pany's financial statements for the previous ISK 20,591 million. Reference is made to the years have been prepared in accordance Notes to the financial statements regarding Skarphé›inn Berg Steinarsson, Chairman with the Financial Statements Act and changes in equity during the period. fiorsteinn M. Jónsson, vice Chairman accounting principles in Iceland. The total The Board of Directors and the Managing Jón Ásgeir Jóhannesson effect of IFRS adoption on the Company's Director of FL GROUP hf. hereby confirm Magnús Ármann financial statements is that equity decreases the Interim Consolidated Financial State- Smári S. Sigur›sson by an amount of ISK 131 million, from ISK ments of the Company for the nine months Kristinn Bjarnason 14,935 million to ISK 14,804 million. The ended September 30, 2005, by means of fiór›ur Bogason effect of IFRS adoption is further explained their signatures. in the financial statements. The Interim Managing Director: Consolidated Financial Statement comprise Hannes Smárason the consolidated financial statements of FL GROUP hf. and its subsidiaries, which were seventeen at the end of the period.

Auditors’ Report

The Board of Directors and Shareholders of FL GROUP hf.

We have compiled the Interim Consolidated that is the representation of management. consolidated interim financial information are Balance Sheet of FL GROUP hf. and its sub- We have not audited or reviewed the necessary when it prepares its first IFRS finan- sidiaries as of September 30, 2005 and the accompanying Interim Consolidated Financial cial statements as of 31 December 2005. related Consolidated Income Statement and Statements and, accordingly, do not express Statement of Cash Flows for the nine months an opinion or any other form of assurance on Reykjavík, November 18, 2005 then ended. These Interim Consolidated them. As explained in the notes, figures might Financial Statements are presented in accor- change during the year, mainly because the Jón S. Helgason dance with International Financial Reporting Consolidated Annual Financial Statements will Gu›ni S. Gústafsson Standards and is this the third time the be made according to IFRS in force at year- Company presents its financial statements in end. KPMG Endursko›un hf. that manner. All information included in these As explained in Note b, that explains the Interim Consolidated Financial Statements is Company's transition to International the representation of the management of FL Financial Reporting Standards (“IFRSs”), there GROUP hf. is a possibility that the Company's manage- A compilation is limited to presenting in ment may determine that changes to the the form of Financial Statements information accounting policies adopted in preparing the

All amounts are in ISK million 54 Income Statement For the Nine Months Ended September 30, 2005

3rd Quarter Year to Date July 1 - September 30 January 1 - September 30 Notes 2005 2004 2005 2004

Operating revenue: Transport revenue:

Passengers ...... 9,474 8,177 20,059 17,376

Cargo and mail ...... 843 821 2,419 2,500

Charter revenue and aircraft lease ...... 1,814 1,632 4,252 4,487

Other operating revenue ...... 4,643 4,529 10,108 9,653 16,774 15,159 36,838 34,016

Operating expenses: Salaries and related expenses ...... 4,444 3,663 12,404 10,552

Aircraft fuel ...... 2,359 1,810 5,315 4,138

Aircraft lease ...... 677 497 1,955 1,652

Aircraft servicing, handling and communication ...... 1,189 1,250 2,622 3,150

Other operating expenses ...... 4,571 4,142 10,785 10,037

Depreciation ...... 475 463 1,377 1,356 13,715 11,825 34,458 30,885

Operating profit before net financing income...... 3,059 3,334 2,380 3,131

Net financial income (expenses) ...... 3 2,624 (42) 5,646 309

Share of associates ...... 11040

Profit before tax ...... 5,694 3,292 8,030 3,440

Income tax expense ...... (1,052) (575) (1,455) (606)

Profit for the period ...... 2 4,642 2,717 6,575 2,834

Attributable to:

Equity holders of the parent ...... 4,638 2,716 6,571 2,833

Minority interest ...... 4141

Profit for the period ...... 2 4,642 2,717 6,575 2,834

Earnings per share:

Basic earnings per share (ISK) ...... 1.84 1.28 2.60 1.34

Diluted earnings per share (ISK) ...... 1.80 1.27 2.55 1.32

All amounts are in ISK million 55 Balance Sheet September 30, 2005 Assets Notes 30.9.2005 31.12.2004

Operating assets ...... 31,315 20,522

Intangible assets ...... 3,535 284

Investments in associates ...... 305 192

Investments in other companies ...... 261 192

Long-term receivables ...... 686 515 Non-current assets 36,102 21,705

Inventories ...... 912 832

Trade and other receivables ...... 8,294 5,214

Securities ...... 20,597 12,912

Cash and cash equivalents ...... 4,106 2,819 Current assets 33,909 21,777

Total assets 70,011 43,482

Equity:

Issued capital ...... 7 2,532 2,525

Share premium ...... 3,748 3,609

Reserves ...... (28) (560)

Retained earnings ...... 14,339 9,230 Total equity attributable to equity holders of the parent 20,591 14,804 Minority interest 23 21 Total equity 9 20,614 14,825

Liabilities:

Credit institutions ...... 14,790 12,100

Bonds ...... 10,013 0

Deferred income tax ...... 2,946 1,413

Pension plan obligation ...... 278 191 Non-current liabilities 28,027 13,704

Credit institutions ...... 0 3,482

Current maturities of long-term debt ...... 10 7,893 1,773

Trade and other payables ...... 10,014 7,549

Unearned transportation revenue ...... 3,463 2,149 Current liabilities 21,370 14,953

Total liabilities 49,397 28,657

Total equity and liabilities 70,011 43,482

All amounts are in ISK million 56 Statement of Cash Flows For the Nine Months Ended September 30, 2005

3rd Quarter Year to Date July 1 - September 30 January 1 - September 30 Notes 2005 2004 2005 2004

Cash flows from operating activities: Profit for the period ...... 2 4,642 2,717 6,575 2,834 Adjustments for:

Depreciation ...... 475 463 1,377 1,356

Operating activities, net ...... (1,625) 806 (3,652) 995 Working captial from operations 3,492 3,986 4,300 5,185

Net change in operating assets and liabilities ...... (2,815) (2,497) 592 (4)

Net cash provided by operating activities 677 1,489 4,892 5,181

Cash flows from investing activities: Acquisitions of intangible assets ...... (122) (110) (242) (844)

Acquisitions of operating assets ...... (2,908) (204) (14,542) (946)

Proceeds from the sale of operating assets ...... 208 2 5,239 55

Securities, change ...... (3,038) 0 (2,854) 0

Increase in investments and long-term receivables ...... (102) 94 (4,348) 585 Net cash used in investing activities (5,962) (218) (16,747) (1,150)

Cash flows from financing activities: Own shares, change ...... 0 1 41 (188)

Dividend paid ...... 0 0 (1,466) (640)

Proceeds from non-current borrowing ...... 1,373 72 19,768 289

Repayment of borrowings ...... (302) (308) (1,719) (1,251)

Short-term borrowing, change ...... (2,572) 0 (3,482) 0 Net cash provided by (used in) financing activities (1,501) (235) 13,142 (1,790)

Net changes in cash and cash equivalents ...... (6,786) 1,036 1,287 2,241

Cash and cash equivalents at 1 January ...... 10,892 8,947 2,819 7,742

Cash and cash equivalents at 30 September ...... 4,106 9,983 4,106 9,983

All amounts are in ISK million 57 Notes

Significant accounting policies

FL GROUP hf.'s legal residence is at Sudurlandsbraut 12, Reykjavík. The consolidated interim financial statements of the Company for the nine months ended 30 September, 2005 comprise the Company and its subsidiaries and the Group's interest in associates.

The interim financial statements were authorised for issue by the directors on November 18, 2005.

a. Statement of compliance The consolidated interim financial statements have been prepared in accordance with International Financial Reporting Standards (IFRSs) on interim financial statements passed by the International Accounting Standards Board (IASB). These are the Group's third consolidated interim financial statements prepared according to IFRS and the nine months ended September 30, 2005 are a part of the Group's first full year consolidated financial statements prepared according to the standards. IFRS 1, First-time Adoption of IFRS, has been applied. The consolidated interim financial statements include all relevant information regarding the Company's operations and its financial position but not all the disclosures required in consolidated financial statements for a full year.

An explanation of how the transition to IFRSs has affected the reported financial position, financial performance and cash flows of the Group is provided in note 11. In the report, the changes in equity's comparative figures and the Group's results as they were disclosed according to Icelandic GAAP for the year 2004 and as they are according to IFRS, are explained.

b. Basis of preparation The Consolidated Interim Financial Statements presented in Icelandic kronas, rounded to the nearest million. They are prepared on the historical cost basis except that securities and derivative financial instruments are stated at their fair value.

The preparation of financial statements in conformity with IAS 34, Interim Financial Reporting, requires management to make judgments, estimates and assumptions that affect the application of policies and reported amounts of assets and liabilities, income and expenses. Actual results may differ from these estimates.

These consolidated interim financial statements have been prepared on the basis of IFRSs in issue that are effective or available for early adoption at the Group's first IFRS annual reporting date, 31 December 2005. Based on these IFRSs, the Board of Directors has made assumptions about the accounting policies expected to be adopted when the first IFRS annual financial statements are prepared for the year-ended 31 December 2005.

The IFRSs that will be effective or available for voluntary early adoption in the annual financial statements for the period ended 31 December 2005 are still subject to change and to the issue of additional interpretations and therefore cannot be determined with cer- tainty. Accordingly, the accounting policies for that annual period that are relevant to this interim financial information will be determined only when the first IFRS financial statements are prepared at 31 December 2005.

The preparation of the consolidated interim financial statements in accordance with IAS 34 resulted in changes to the accounting policies as compared with the most recent annual consolidated financial statements prepared under previous GAAP. The accounting policies set out below have been applied consistently to all periods presented in these consolidated interim financial statements. They also have been applied in preparing an opening IFRS balance sheet at 1 January 2004 for the purposes of the transition to IFRSs.

The accounting policies have been applied consistently throughout the Group for purposes of these consolidated interim financial state- ments.

c. Basis of consolidation (i) Subsidiaries Subsidiaries are entities controlled by the Company. Control exists when the Company has the power, directly or indirectly, to gov- ern the financial and operating policies of an entity so as to obtain benefits from its activities. In assessing control, potential voting rights that presently are exercisable or convertible are taken into account. The financial statements of subsidiaries are included in the consolidated financial statements from the date that control commences until the date that control ceases.

All amounts are in ISK million 58 Notes, cont.:

(ii) Associates Associates are those entities in which the Group has significant influence, but not control, over the financial and operating policies. The consolidated financial statements include the Group's share of the total recognised gains and losses of associates on an equity accounted basis, from the date that significant influence commences until the date that significant influence ceases. When the Group's share of losses exceeds its interest in an associate, the Group's carrying amount is reduced to nil and recognition of further losses is discontinued except to the extent that the Group has incurred legal or constructive obligations or made payments on behalf of an associate.

(iii) Transactions eliminated on consolidation Intragroup balances and any unrealised gains and losses or income and expenses arising from intragroup transactions, are eliminated in preparing the consolidated financial statements. Unrealised gains arising from transactions with associates and jointly controlled enti- ties are eliminated to the extent of the Group's interest in the entity. Unrealised losses are eliminated in the same way as unrealised gains, but only to the extent that there is no evidence of impairment. d. Foreign currency (i) Foreign currency transactions Transactions in foreign currencies are translated at the foreign exchange rate ruling at the date of the transaction. Monetary assets and liabilities denominated in foreign currencies at the balance sheet date are translated to Icelandic kronas at the foreign exchange rate ruling at that date. Foreign exchange differences arising on translation are recognised in the income statement. Purchase of oper- ating assets is translated using the exchange rate at the date of the transaction. Operating expenses and income originating in foreign currencies are converted at the actual daily rate of the business transactions.

(ii) Financial statements presented in foreign currencies, and of foreign operations The Parent Company and two domestic subsidiaries keep their records in USD and present their financial statements in that curren- cy. The Group also includes a few foreign subsidiaries. The assets and liabilities of the Group are translated to Icelandic kronas at for- eign exchange rates ruling at the balance sheet date. The revenues and expenses of the Group are translated to Icelandic kronas at average exchange rates for the period. Foreign exchange differences arising on retranslation are recognised directly in a separate com- ponent of equity. e. Derivative financial instruments The Company uses derivative financial instruments only for the purposes to hedge its exposure to interest rate risk, foreign exchange rate risk, and fluctuation of fuel prices, arising from operational and financing activities. The Company has also entered into forward contracts regarding the acquisition of shares. The contracts are stated at fair value but the underlying asset is not recognised in the balance sheet.

Derivative financial instruments are recognised at fair value. The gain or loss on remeasurement to fair value is recognised immediately in profit or loss. However, where derivatives qualify for hedge accounting, any resultant gain or loss is recognised directly in equity.

The fair value of derivatives is the price which would be quoted in an exchange between informed, willing and unrelated parties. The fair value of derivatives listed on an active market is their market price at the balance sheet date. If derivatives are not listed on an active mar- ket their fair value is estimated according to recognised valuation methods, for example present value calculations and valuation models. The fair value of derivatives is mostly based on information provided from active markets and all factors that market participants would take into account in the pricing of derivatives under normal circumstances. f. Hedging (i) Cash flow hedges Where a derivative financial instrument is designated as a hedge of the variability in cash flows of a recognised asset or liability, or a highly probable forecasted transaction, the effective part of any gain or loss on the derivative financial instrument is recognised direct- ly in equity. The associated cumulative gain or loss is removed from equity and recognised in the income statement in the same peri- od or periods during which the hedged forecast transaction affects profit or loss. The ineffective part of any gain or loss is recognised immediately in the income statement.

All amounts are in ISK million 59 Notes, cont.:

g. Operating assets (i) Aircrafts and flight equipment Aircrafts and flight equipment, e.g. aircraft engines and aircraft spare parts, are stated at cost less accumulated depreciation. When aircrafts are acquired the purchase price is divided between the aircraft itself and engine hours. Aircrafts are depreciated over the estimated useful live of the relevant aircraft until a residual value is met. Engine hours are depreciated according to flown hours. When an engine is overhauled the cost of the overhaul is capitalised and the remainder of the cost of the previous overhaul that has not already been depreciated, if there is any, is expensed in full.

Prepayments for undelivered aircrafts are recognised among aircrafts and related assets. The Company capitalises the financing costs arising from these prepayments according to the Company's average cost of debt. At the beginning of the year the Company entered into an agreement with Boeing regarding the purchase of ten 737-800 aircrafts to be delivered in the year 2006. Recently a contract was confirmed regarding the purchase of five additional Boeing 737-800 aircrafts to be delivered in the year 2007. The intention is to lease out these aircrafts. In February 2005 the Company entered into an agreement with Boeing regarding the purchase of two Boeing 787 Dreamliner large jets to be delivered in the year 2010. The intention is to use these airplanes for Icelandair's scheduled flights.

(ii) Buildings and other property and equipmen Buildings and other property and equipment are stated at cost less accumulated depreciation.

(iii) Subsequent costs The Company recognises in the carrying amount of an item of operating assets the cost of replacing part of such an item when that cost is incurred if it is probable that the future economic benefits embodied with the item will flow to the Group and the cost of the item can be measured reliably. All other costs are recognised in the income statement as an expense as incurred.

(iv) Depreciation Depreciation is charged to the income statement on a straight-line basis over the estimated useful lives of each part of an item of operating assets, taking into consideration the asset's residual-value. The estimated useful lives and estimated residual value are as fol- lows: Useful life Residual value

Aircrafts and flight equipment ...... 10-25 years 10% Engine hours ...... est. flight hours 0 Buildings ...... 20-50 years 10% Other property and equipment ...... 5-8 years 0-10%

The residual value is estimated annually

h. Intangible assets (i) Goodwill Goodwill represents amounts arising on acquisition of subsidiaries and entity. Goodwill represents the difference between the cost of the acquisition and the fair value of the net identifiable assets acquired. Goodwill is stated at cost less any accumulated impairment losses. Goodwill is allocated to cash-generating units and is no longer amortized but is tested annually for impairment.

Negative goodwill arising on an acquisition is recognized directly in profit or loss.

(ii) Other intangible assets Other intangible assets that are acquired by the Group are stated at cost less accumulated amortization. Amortization is charged to the income statement on a straight line basis over the estimated useful life of the relevant asset. Estimated useful life is specified as follows::

Useful life Software ...... 3 years

All amounts are in ISK million 60 Notes, cont.: i. Investments in other companies and long-term receivables Investments in other companies are classified as financial assets available for sale and are stated at cost because their fair value has not been estimated. Available-for-sale assets are recognized / derecognized by the Group on the date it commits to purchase / sell the asset.

Long-term receivables comprise prepayments, insurance fees, term deposits and bonds that are defined as financial assets held to matu- rity. Long-term receivables are recognised according to the effective interest rate method. j. Inventories Goods for resale and supplies are stated at the lower of cost and net realisable value. Net realisable value is the estimated selling price in the ordinary course of business, less the estimated costs of completion and selling expenses. Flight equipment expendable parts are val- ued at the actual daily rate of purchase.

The cost of inventories is based on the first-in first-out principle and includes expenditure incurred in acquiring the inventories and bring- ing them to their existing location and condition. k. Trade and other receivables Trade and other receivables are stated at their cost less impairment losses. l. Securities Securities comprise of shares and of various short-term securities which the Company acquires to get a return on liquid assets. Also pre- sented among securities is the fair value of derivatives relating to shares. Listed securities are stated at their latest qouted price and the change in their fair value recognised in the income statement. m. Cash and cash equivalents Cash and cash equivalents comprises cash balances and call deposits. n. Impairment The carrying amounts of the Group’s assets, other than inventories and securities are reviewed at each balance sheet date to determine whether there is any indication of impairment. If any such indication exists, the asset’s recoverable amount is estimated.

An impairment loss is recognized whenever the carrying amount of an asset or its cash-generating unit exceeds its recoverable amount. Impairment losses are recognized in the income statement. (i) Calculation of recoverable amount The recoverable amount of the Group’s long-term receivables is calculated as the present value of estimated future cash flows, dis- counted at the original effective interest rate. Receivables with a short duration are not discounted.

The recoverable amount of other assets is the greater of their net selling price and value in use. In assessing value in use, the estimat- ed future cash flows are discounted to their present value using a discount rate that reflects current market assessments of the time value of money and the risks specific to the asset. o. Share capital (i) Repurchase of share capital When share capital recognized as equity is repurchased, the amount of the consideration paid, including directly attributable costs, is recognized as a change in equity. Repurchased shares are classified as treasury shares and presented as a deduction from total equity. p. Interest-bearing borrowings Interest-bearing borrowings are recognized initially at fair value less attributable transaction costs. Subsequent to initial recognition, inter- est-bearing borrowings are stated at amortized cost with any difference between cost and redemption value being recognized in the income statement over the period of the borrowings on an effective interest basis.

All amounts are in ISK million 61 Notes, cont.:

q. Employee benefits (i) Retirement benefit obligation The company has entered into pension plan agreements with some of its former employees. The obligation is presented in the bal- ance sheet. The increase or decrease of the obligation is recognised in the income statement. The obligation is estimated according to average life expectancy and its present value calculated using 2% interest rates. Obligations arising from retirement agreements with former management personell are also recognised among retirement benefit obligations wich present value is calculated using 2% inter- est rates.

(ii) Share-based payment transactions The share option agreements entered into during the year 2003, allow Company employees to acquire shares of the Company. The fair value of options granted is recognised as an employee expense with a corresponding increase in equity. The fair value is measured at grant date and spread over the period during which the employees become unconditionally entitled to the options. The fair value of the options granted is measured using the Black Scholes model, taking into account the terms and conditions upon which the options were granted.

r. Provisions A provision is recognised in the balance sheet when the Group has a present legal or constructive obligation as a result of a past event, and it is probable that an outflow of economic benefits will be required to settle the obligation.

s. Revenue Passenger tickets sales are not recognized as revenue until transportation has been provided. Sold and unused documents are shown in the balance sheet as unearned transportation revenue. Sold documents not used within nine months from the month of sale are recog- nized as revenue.

Revenue from mail and cargo transportation is recognized in the income statement after transportation has been provided. Revenue from aircraft lease is recognized in the Income Statement at the completion of the leased flights. Revenue from rendering services is recognized in the income statement after performance of the services.

t. Expenses (i) Operating lease payments Payments made under operating leases are recognised in the income statement on a straight-line basis over the term of the lease.

(ii) Net financing income Net financing income comprise interest payable on borrowings calculated using the effective interest rate method, interest receivable on funds invested, dividend income, foreign exchange gains and losses, gains and losses on derivative financial instruments that are recognised in the income statement, and fair value changes of securities.

Interest income is recognised in the income statement as it accrues, using the effective interest method. Dividend income is recognised in the income statement on the date the entity’s right to receive payments is established.

u. Income tax Income tax on the profit or loss for the period comprises current and deferred tax.

Deferred tax is provided using the balance sheet liability method, providing for temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for taxation purposes. The following temporary differences are not provided for: goodwill not deductible for tax purposes, and differences relating to investments in subsidiaries to the extent that they will probably not reverse in the foreseeable future. The amount of deferred tax provided is based on the expected manner of realisation or settlement of the carrying amount of assets and liabilities, using tax rates enacted at the balance sheet date.

v. Segment reporting A segment is a distinguishable component of the Group that is engaged either in providing products or services which is subject to risks and rewards that are different from those of other segments.

All amounts are in ISK million 62 Notes, cont.:

Segment reporting 1. Summary of the Group's operating results for the first nine months of the year specified according to business segments:

International Tourism Financial services flights services and investments Eliminations Consolidated 2005 2004 2005 2004 2005 2004 2005 2004 2005 2004 1.1.-30.9 1.1.-30.9 1.1.-30.9 1.1.-30.9 1.1.-30.9 1.1.-30.9 1.1.-30.9 1.1.-30.9 1.1.-30.9 1.1.-30.9 Revenues from external customers ...... 26,874 24,604 9,774 9,412 19000036,838 34,016 Inter-segment revenue ...... 9,581 9,985 351 239 2,033 1,913 (11,965) (12,137) 0 0

Total revenue of segment ..... 36,455 34,589 10,125 9,651 2,223 1,913 (11,965) (12,137) 36,838 34,016 Segment expenses ...... (34,958) (32,844) (9,650) (8,858) (1,826) (1,325) 11,976 12,142 (34,458) (30,885)

Operating profit ...... 1,497 1,745 475 793 397 588 11 5 2,380 3,131 Net financing costs ...... (23) 119 (83) (32) 5,756 293 0 (71) 5,650 309 Profit after net financing costs 1,474 1,864 392 761 6,153 881 11 (66) 8,030 3,440 Income tax ...... (250) (327) (77) (143) (1,128) (136) 0 0 (1,455) (606)

Profit for the period ...... 1,224 1,537 315 618 5,025 745 11 (66) 6,575 2,834

Quarterly Statements 2. Summary of the Group's operating results by quarters: Q3 Q4 Q1 Q2 Q3 2004 2004 2005 2005 2005

Operating revenue ...... 15,159 8,571 7,816 12,248 16,774 Operating expenses excluding depreciation and aircraft lease ...... (10,993) (8,840) (8,660) (10,557) (12,682) Operating profit (loss) excluding depreciation and aircraft lease (EBITDAR) ..... 4,166 (269) (844) 1,691 4,092 Aircraft operating lease ...... (369) (288) (296) (328) (558) Operating profit (loss) excluding depreciation (EBITDA) ...... 3,797 (557) (1,140) 1,363 3,534 Depreciation...... (463) (465) (426) (476) (475)

Operating profit (EBIT) ...... 3,334 (1,022) (1,566) 887 3,059 Net financing costs ...... (42) 1,841 1,597 1,425 2,624 Share of associates ...... 0 0 (3) (4) 11

Profit before tax ...... 3,292 819 28 2,308 5,694 Income tax ...... (575) (72) (3) (400) (1,052)

Profit for the period ...... 2.717 747 25 1,908 4,642

Attributable to: Equity holders of the parent ...... 2,716 747 26 1,907 4,638 Minority interest ...... 1 0 (1) 1 4 Profit for the period ...... 2,717 747 25 1,908 4,642

All amounts are in ISK million 63 Notes, cont.:

Net financing income 3. Net financing income is specified as follows: 2005 2004 2005 2004 1.7.-30.9. 1.7.-30.9. 1.1.-30.9. 1.1.-30.9.

Interest income ...... 289 124 665 299 Interest expenses ...... (479) (228) (1,309) (639) Exchange rate difference ...... 225 16 (42) (25) Dividend income ...... 0 0 10 67 Profit on sale of investment ...... 0 46 212 607 Net gain on remeasurement of market securities at fair value ... 1,489 0 4,155 0 Net gain on remeasurement of derivatives at fair value ...... 1,100 0 1,955 0

Net financing income ...... 2,624 (42) 5,646 309

Changes in the Group 4. In February 2005 the Company acquired all outstanding shares in Bláfugl hf. and Flugflutningar hf. On August 16, 2005 the acquisition was finalized. The companies are therefore part of FL GROUP hf.´s consolidated financial statements as of that date.

Comparative amounts in the Consolidated Financial Statements do not contain amounts from the Financial Statements of the aforemen- tioned companies.

The acquisitions, accounted for according to the purchase method, had the following effect on the Group’s assets and liabilities:

Operating assets ...... 1.988 Long-term recivables ...... 192 Current assets ...... 360 Cash and cash equivalents ...... 153 Deferred income tax ...... (71) Non-current liabilities ...... (1,274) Current liabilities ...... (455)

Net identifiable assets and liabilities ...... 893 Goodwill on acquisition ...... 3,233

Consideration paid ...... 4,126 Consideration satisfied by share issue ...... (1,350)

Consideration satisfied in cash ...... 2,776

Included in the consideration paid are acquisition related expenses, for example expert advisors fees and other fees.

Allocation of the consideration paid to recognisable assets and liabilities has not been finshed and therefore the amount of goodwill recog- nised is subject to change. The intention is to conclude the allocation in the Group's financial statements for the whole year.

Investments in subsidiaries 5. The Parent, FL GROUP hf., owns 17 subsidiaries. The subsidiaries, which are all included in the Consolidated Financial Statements, are as follows: International flights: Share Icelandair ehf...... 100% Fluglei›ir - Frakt ehf...... 100% Flugfljónustan Keflavíkurflugvelli ehf...... 100% Loftlei›ir - Icelandic ehf...... 100% Icelease ehf...... 100% Tæknifljónustan Keflavíkurflugvelli ehf...... 100% ICECAP, Guernsey ...... 100% Bláfugl hf...... 100% Flugflutningar ehf...... 100% All amounts are in ISK million 64 Notes, cont.:

5. Cont.: Tourism services: Share Bílaleiga Fluglei›a ehf...... 100% Fer›askrifstofa Íslands hf...... 100% Flugfélag Íslands hf...... 100% Fluglei›ahótel hf...... 100% Íslandsfer›ir ehf...... 100% Kynnisfer›ir ehf...... 96% Financial services and investments: Fjárvakur - fjármálafljónusta ehf...... 100% Fluglei›ir fjárfestingafélag ehf...... 100%

The Company's subsidiaries own thirteen subsidiaries which also are a part of the consolidated financial statements.

6. In October 2005 the Company acquired all the shares in the company Sterling Airlines A/S. According to acquisition agreement the con- sideration paid for Sterling is DKK 1,500 million, a portion of the consideration will vary in relation to the performance of Sterling Airlines A/S. The consideration paid will be settled with DKK 1,100 in cash and DKK 400 million in shares in FL Group hf. The acquisition is sub- ject to approval of competition authorities and various conditions in the contract. FL Group hf. will take over the operation of Sterling on January 1, 2006.

Equity 7. Issued shares are specified as follows: Amounts Ratio Total issued shares at the end of the period ...... 2,537 100.0%

Own shares ...... (5) (0.2%) 2,532 99.8%

8. A shareholders meeting on November 1, 2005 approved an increase in share capital for the maximum of ISK 3.2 billion nominal value or ISK 44 billion at market value. Also approved was an increase in share capital amounting to ISK 330 million nominal value to fulfil the acqui- sition agreement for Sterling Airlines A/S. This share increase permission is valid for one year. The Board of Directors was also given per- mission to increase share capital by ISK 73 million nominal value to fulfil employee stock option agreements. This permission is valid for five years.

9. Summary of equity: Share Share Stock Hedging Translation Unrealised Retained Share- Minority Total capital premium option reserve reserve gain on earnings holders of interest equity reserve shares the Parent Equity 1.1 2004 ...... 2,132 533 1 6,544 9,210 20 9,230 IFRS adoption ...... 6 (75) (69) (69)

Equity 1.1.2004, restated ...... 2,132 533 7 6,469 9,141 20 9,161 Shares issued ...... 230 1,795 2,025 2,025 Dividends to shareholders ..... (640) (640) (640) Own shares, change ...... 163 1,281 1,444 1,444 Net profit (loss) for the period 156 223 (958) 3,580 3,001 1 3,002

Equity 31.12.2004 ...... 2,525 3,609 163 223 (958) 9,409 14,971 21 14,992 Adoption of IAS 32 / 39 ...... (323) 335 (179) (167) (167)

Restated equity 1.1.2005 ...... 2,525 3,609 163 (100) (623) 0 9,230 14,804 21 14,825

Cont.:

All amounts are in ISK million 65 Notes, cont.:

9. Cont.: Share Share Stock Hedging Translation Unrealised Retained Share- Minority Total capital premium option reserve reserve gain on earnings holders of interest equity reserve shares the Parent Equity 31.12.2004 ...... 2,525 3,609 213 223 (958) 1,417 7,906 14,935 21 14,956 IFRS adoption ...... (50) (323) 335 (1,417) 1,324 (131) (131)

Equity 31.12.2004, restated .... 2,525 3,609 163 (100) (623) 0 9,230 14,804 21 14,825

Dividend to shareholders ...... (1,466) (1,466) (1,466) Own shares, change ...... 734 41 41 Net profit (loss) for the period .. 105 (60) 735 (143) 6,575 7,212 2 7,214

Equity 30.9.2005 ...... 2,532 3,748 103 635 (766) 0 14,339 20,591 23 20,614

Non-current liabilities 10. Loans from credit institutions are specified as follows: Loans in foreign currency Loans in USD ...... 21,847 Loans in EUR ...... 274 Loans in CHF ...... 73 Loans in JPY ...... 66 Loans in GBP ...... 27 22,287 Loans in ISK Indexed loans ...... 396

Long term debt, including current portion ...... 22,683 Current portion ...... (7,893)

Total long-term debt according to the balance sheet ...... 14,790

Changes due to Adoption of International Financial Reporting Standards 11. As stated in notes regarding significant accounting policies, these are the Group’s third consolidated financial statements prepared in accor- dance with IFRSs.

The accounting policies set out in notes regarding significant accounting policies have been applied in preparing the financial statements for the year, the comparative information presented in these financial statements for the year ended 31 December 2004 and in the prepara- tion of an opening IFRS balance sheet at 1 January 2004 (the Group’s date of transition).

In preparing its opening IFRS balance sheet, the Group has adjusted amounts reported previously in financial statements prepared in accor- dance with its old basis of accounting (previous GAAP). An explanation of how the transition from previous GAAP to IFRSs has affected the Group’s financial position, financial performance and cash flows is set out in the following tables and the notes that accompany the tables.

Equity 1.1. 2005: Equity according to previous GAAP 31.12.2004 ...... 14,935 Equity according to IFRS 1.1.2005 ...... 14,804 Net change from previous GAAP to IFRSs ...... (131)

Changes in measurements: 1.1.2004 1.1.2005 Total Intangible assets ...... IAS 38 (121) 4 (117) Fair value of stock options ...... IFRS 2 1 16 17 Impairment of prepayments ...... IAS 36 (44) 4 (40) Pension liabilities ...... IAS 19 (9) 0 (9) Engine overhaul liability derecognised ...... IAS 16, 37 97 112 209 Derivatives and financial assets to fair value ...... IAS 39 (167) (167) Other changes ...... (24) (24)

Net change from previous GAAP to IFRSs ...... (76) (55) (131) All amounts are in ISK million 66 Notes, cont.:

11. Cont.: Changes in equity are stated after the deduction of income tax

Changes in measurements Some expenses that have been capitalized as intangible assets are not in compliance with IAS 38 on intangible assets, e.g. pilot training. This causes a decrease in the Group's equity by ISK 117 million, with regards to income tax effects. The comparative figures in the inter- im income statements have been adjusted accordingly.

The fair value of stock options was estimated based on the grant date according to IFRS 2. The fair value is measured at grant date and spread over the period during which the employees become unconditionally entitled to the options. The fair value of the options grant- ed is measured using the Black Scholes model, taking into account the terms and conditions upon which the options were granted.

The Company has in previous years expensed estimated costs of future overhauls of engines owned by the Company. According to IAS 37 a liability arising from future expenses such as this can not be recognized. As a result, the Group's equity increases by ISK 209 million, with regards to income tax effects. The comparative amounts in the interim income statements have been adjusted accordingly.

Prepayments recognized among long-term receivables have now been stated according to effective interest rates and therefore equity decreases by ISK 40 million, with regards to income tax effects.

Pension benefit obligation is recognized according to IAS 19. As a result equity decreases by ISK 9 million, with regards to income tax effects.

Unsettled derivatives at the end of the year 2004 and some financial assets are recognized at their fair value according to IAS 39. As a result equity decreases by ISK 167 million, with regards to income tax effects. The comparative figures in the income statement have not been adjusted as is permitted in IFRS 1.

Changes in Presentation When adopting the standards some assets, previously presented as operating assets but classified as intangible assets according to IAS 38, have been transferred to intangible assets. Loan charges previously presented as intangible assets are now subtracted from relevant loans.

Next years use of engine hours has been presented as current assets but now this item is recognized among operating assets.

The Group's securities which were classified as cash and cash equivalents on December 31, 2004 do not fulfil the requirements of cash and cash equivalents according to IAS 7 and therefore presentation has been changed and they are presented as securities in the balance sheet.

Shares acquired with a forward contract and presented as securities are not recognised in the balance sheet according to IAS 39, instead the net fair value of the forward contract is recognised in the accounts.

In addition, minority interest in the Group's equity, previously included among current liabilities, is now presented as a separate item in equity.

All amounts are in ISK million 67 11. Cont.:

Balance Sheet 1.1.2005 Icelandic GAAP Changes in Changes in 31.12.2004 presentation measurement IFRSs Assets: Operating assets ...... 19,893 374 255 20,522 Intangible assets ...... 501 (74) (143) 284 Investment in associates ...... 192 192 Investment in other companies ...... 192 192 Long-term receivables ...... 497 111 (93) 515 Total non-current assets 21,275 411 19 21,705

Inventories ...... 832 832 Trade and other receivables ...... 5,302 (90) 2 5,214 Market securities ...... 13,246 (147) (187) 12,912 Cash and cash equivalents 5,898 (3,079) 2,819 Total current assets 25,278 (3,316) (185) 21,777 Total assets 46,553 (2,905) (166) 43,482

Equity: Issued capital ...... 2,525 2,525 Share premium ...... 3,609 3,609 Other equity ...... 895 (1,405) (50) (560) Retained earnings ...... 7,906 1,405 (81) 9,230 Total equity attributable to equity holders of the parent ...... 14,935 0 (131) 14,804

Minority interest ...... 21 21 Total equity 14,935 21 (131) 14,825

Liabilities: Credit institutions ...... 12,242 (142) 12,100 Pension plan obligation ...... 1,466 (53) 1,413 Deferred income tax ...... 180 11 191

Non-current liabilities ...... 13,888 (142) (42) 13,704

Credit institutions ...... 6,530 (3,048) 3,482 Current portion of non-current liabilities ...... 1,773 1,773 Trade and other payables ...... 7,278 264 7 7,549 Prepaid income ...... 2,149 0 2,149 Current liabilities 17,730 (2,784) 7 14,953 Total liabilities 31,618 (2,926) (35) 28,657 Total equity and liabilities 46,553 (2,905) (166) 43,482

Balance sheet changes are presented without the effect of income tax, changes in equity were presented with regards to income tax effects.

In the interim financial statements of FL GROUP hf. according to IFRS the focus is on disclosing significant accounting policies, at the same time, the effect of the adoptation of IFRS on the financial position of the Group is disclosed.

All amounts are in ISK million 68 11. Cont.:

Income Statement for the nine months ended September 30, 2004

Icelandic GAAP Changes IFRSs Operating revenue: Transport revenue: Passengers ...... 17,376 17,376 Cargo and mail ...... 2,500 2,500 Charter revenue and aircraft lease ...... 4,487 4,487 Other operating revenue ...... 9,653 9,653 34,016 0 34,016

Operating expenses: Salaries and related expenses ...... 10,618 (66) 10,552 Aircraft fuel ...... 4,138 4,138 Aircraft lease ...... 1,652 1,652 Aircraft servicing, handling and communication ...... 3,150 3,150 Other operating expenses ...... 10,070 (33) 10,037 Depreciation ...... 1,410 (54) 1,356 31,038 (153) 30,885

Operating profit before net financing income ...... 2,978 153 3,131 Net financing income ...... 304 5 309

Profit before tax ...... 3,282 158 3,440

Income tax expense...... (600) (6) (606)

Profit for the period ...... 2,682 152 2,834

Attributable to: Equity holders of the parent ...... 2,682 151 2,833 Minority interest ...... 011

Profit for the period ...... 2,682 152 2,834

Earnings per share: Basic earnings per share (ISK) ...... 1.27 1.34 Diluted earnings per share (ISK) ...... 1.25 1.32

Net profit attributable to the shareholders of the Parent Company increases by ISK 161 million, in the comparative figures in the financial statements for the year 2004 due to the adoptation of the standards. In the comparative figures for the 3rd quarter, net profit attribut- able to the shareholders of the Parent Company increase by ISK 151 million according to the income statement above.

Salaries and related expense decrease by ISK 66 million due to changes in the treatment of employee stock options.

Other operating expense decrease by ISK 33 million and exchange loss by ISK 5 million due to the derecognition of estimated future costs of engine overhauls.

Depreciation decreases by ISK 54 million due to changes in the measurement of previously capitalized cost due to changes in the evalu- ation of operating assets and amendments to previously capitalized cost cf. discussion on the evalutaion af assets.

Changes in the income tax for the period result from the changes discussed here above.

Minority interest in the performance for the period is now presented separately among profits for the period but the minority interest was previously expensed among financial income and financial expenses.

All amounts are in ISK million 69 Ratios 12. The Group´s primary ratios are specified as follows: 2005 2004 1.1.-30.9.2005 1.1.-30.9.2005 Working capital from operations ...... 4,300 5,185

30.9.2005 31.12.2004 Current ratio - current assets / current liabilities ...... 1.59 1.46 Current ratio - excluding unearned transportation revenue ...... 1.89 1.70 Equty ratio - equity / capital employed ...... 29.4% 34.1% Total equity to issued capital ...... 8.13 5.86

All amounts are in ISK million 70 Appendix C Annual Accounts for 2004

71 Signatures of the Board of Directors and the President and CEO

The Consolidated Financial Statements of In February 2004, one subsidiary, Flugleidir ing the year. Three stockholders owned more Flugleidir hf. (the Icelandair parent company) Investments, was founded. One subsidiary, than 10% of the Company’s outstanding capi- are prepared in accordance with the Financial Íslandsferdir ehf., became a subsidiary of tal stock at the end of 2004. They were: Statements Act and the Regulation on the Flugleidir hf. as of 1 January 2004. Íslandsferdir Oddaflug ehf., holding a 29.4% share, Saxbygg Presentation and Contents of Financial ehf. was formerly a subsidiary of Icelandair ehf., with 25.6%, and Skildingur ehf., holding a Statements and Consolidated Financial and, thus, part of the Group. After the change, 10.1% of the outstanding shares at the end of Statements. The Company predominantly Flugleidir hf. is a holding company presently the year 2004. uses the same accounting principles as in pre- controlling the operations of thirteen inde- The Board of Directors recommends pay- vious years, except that inflation accounting pendent subsidiaries, and therefore the ing a 60% dividend on the nominal value of has been discontinued as the transitional pro- amounts shown are only from the Group’s the capital stock to stockholders in the year vision in the Act on Financial Statements Consolidated Financial Statements. 2005 for the operating year 2004, i.e. ISK allowing companies to use inflation accounting In 2004, the Company purchased market 1,515 million on stock outstanding at year-end was repealed as of year-end 2003. In addition, securities in listed companies for ISK 11,519 2004. The dividend distribution amounts to the parent company and one of its sub- million. Their value at year-end 2004 was ISK 44% of the net earnings for the year 2004. sidiaries received permission to maintain their 13,246 million. At year-end 2004, the Changes in the stockholders’ equity section accounts and prepare their Financial Company acquired 49% of the shares in during the year 2004 are shown in the Notes Statements in US dollars as of 1 January 2004. Barkham Associates SA. That company leases to the Financial Statements. The Group’s Financial Statements are pre- aircraft. The Board of Directors and the President sented in millions of Icelandic kronas (ISK). In November 2004, the Company sold new and CEO of Flugleidir hf. hereby confirm the Comparative amounts in the Financial capital stock for a nominal value of ISK 230 Consolidated Financial Statements for 2004. Statements have not been changed. The million and treasury stock for a nominal value Reykjavik, 24 February 2005. changes are further explained in Note 22. The of ISK 190 million or a total nominal value of total results for the subsidiaries and ownership ISK 420 million. The shares were sold at the Board of Directors: are explained in the Notes to the Financial rate 9.1. Hannes Smárason, Chairman Statements. At the beginning of the year 2005, the Árni Oddur Thórdarson According to the Statements of Earnings, Company concluded an agreement with the Benedikt Sveinsson the operating revenues of the Group amount- Boeing aircraft manufacturer for the purchase Gunnar Thorláksson ed to 42,587 million in 2004. Net earnings of ten new Boeing 737-800 aircraft. The air- Gylfi Ómar Hédinsson from the Group’s operations for the year 2004 craft will be delivered to the Company in the Jón Thorsteinn Jónsson were ISK 3,419 million. According to the year 2006, and the intention is to lease them Ragnhildur Geirsdóttir Balance Sheet, the Group’s stockholders’ equi- to third parties. ty amounted to ISK 14,935 million at the end The total number of stockholders was President and CEO: of 2004, including ISK 2,525 million in capital 4,133 at the end of 2004, compared with Sigurdur Helgason stock, or 32% of the total capital employed. 4,619 at the end of 2003, down by 486 dur-

Auditors’ Report

To the Board of Directors and We conducted our audit in accordance In our opinion, the Consolidated Financial Stockholders of Flugleidir hf. (the Icelandair with generally accepted auditing standards. Statements present fairly the financial position parent company): Those standards require that we plan and of Flugleidir hf. at 31 December 2004, as well perform the audit to obtain reasonable assur- as its operating results and cash flows for the We have audited the accompanying ance about whether the Financial Statements year then ended, in accordance with the law Consolidated Financial Statements of are free of material misstatements. Our audit and generally accepted accounting principles Flugleidir hf. for the year 2004. The Financial includes examining, on a test basis, evidence in Iceland. Statements consist of the Signatures of the supporting the amounts and disclosures in the Board of Directors, Statements of Earnings, Financial Statements. Our audit also includes Reykjavik, 24 February 2005. Balance Sheet, Statements of Cash Flows and assessing the accounting principles used and Notes 1-61. The Financial Statements are the Gudni S. Gústafsson significant estimates made by management, as responsibility of the Company's management. Jón Sigurdur Helgason well as evaluating the overall presentation of Our responsibility is to express an opinion on the Financial Statements. We believe that our KPMG Endurskodun hf. these Financial Statements based on our audit. audit provides a reasonable basis for our opin- ion. 72 Statements of Earnings for the year 2004

Notes 2004 2003 Operating revenue: Transport revenue:

Passengers ...... 6 20,570 19,228

Cargo and mail ...... 7 3,373 2,880

Charter revenue and aircraft lease ...... 7 5,595 3,994

Other operating revenue ...... 24 13,049 11,459 42,587 37,561

Operating expenses: Salaries and related expenses ...... 25 14,491 12,200

Aircraft fuel ...... 5,582 3,622

Aircraft lease ...... 2,059 2,157

Aircraft servicing, handling and communication ...... 3,923 3,403

Other operating expenses ...... 27 12,707 12,389

Depreciation ...... 9, 10, 31 1,896 1,807 40,658 35,578

Operating profit before financial income and expenses ...... 1,929 1,983

Net financial income (expenses) ...... 29 431 (577)

Unrealised gain on market securities ...... 16, 46 1,727 0

Profit before deferred income tax ...... 4,087 1,406

Deferred income tax ...... 20, 52 (668) (285)

Net earnings for the year ...... 23 3,419 1,121

Net profit per share ...... 8 Net profit per each ISK of capital stock ...... 1,58 0,52

Diluted profit per each ISK of capital stock ...... 1,56 0,52

All amounts are in ISK millions 73 Balance Sheet

Assets Notes 2004 2003 Fixed assets: Intangible assets:

Goodwill ...... 78 0

Other intangible assets ...... 9, 30 423 557 501 557

Property and equipment:

Buildings ...... 38 1,715 2,104

Aircraft and flight equipment ...... 37 15,050 17,715

Other property and equipment ...... 1,883 1,669 9, 31 18,648 21,488

Aircraft purchase prepayments ...... 32 737 0

Engine overhauls ...... 11, 37 508 689 19,893 22,177

Investments:

Investment in associated companies ...... 13, 40 192 194

Investment in other companies ...... 13, 41 192 169

Long-term notes ...... 139 34

Deposits and other ...... 43 358 430 881 827

Fixed assets 21,275 23,561

Current assets: Inventories ...... 14, 44 832 707

Receivables: 15, 45

Accounts receivable ...... 3,304 3,437

Notes receivable ...... 355 438

Other receivables ...... 788 664

Prepaid expenses ...... 11, 37 855 747

Market securities ...... 16, 46 13,246 0

Cash and cash equivalents ...... 17, 47 5,898 7,742 Current assets 25,278 13,735

Total assets 46,553 37,296

All amounts are in ISK millions 74 31 December 2004

Stockholders’ equity and liabilities Notes 2004 2003 Stockholders´ equity: Capital stock ...... 48 2,525 2,132

Statutory stock reserve ...... 3,609 533

Stock options reserve ...... 213 1

Translation reserve ...... (735) 0

Unrealised gain on market securities ...... 1,417 0

Retained earnings ...... 7,906 6,544 Stockholders' equity 18, 49 14,935 9,210

Obligations: Pension plan obligation ...... 19, 50 180 161

Deferred income tax ...... 20, 52, 53 1,466 989 1,646 1,150

Long-term debt: Credit institutions ...... 54 12,242 15,963

Current liabilities: Credit institiutions ...... 6,530 0

Accounts payable ...... 2,947 3,207

Current maturities of long-term debt ...... 55 1,773 1,543

Accrued liabilities and expenses ...... 4,331 4,191

Unearned transportation revenue ...... 6, 7, 56 2,149 2,032 17,730 10,973

Total liabilities 31,618 28,086

Stockholders’ equity and liabilities total 46,553 37,296

Commitments and contingencies ...... 34, 36

All amounts are in ISK millions 75 Statements of Cash Flows for the year 2004

Notes 2004 2003 Cash flows from operating activities: Net earnings for the year ...... 23 3,419 1,121 Adjustments to reconcile net earnings to net cash provided by operating activities:

Depreciation ...... 9, 10, 31 1,896 1,807

Capital (gain) loss on sale of assets ...... 33 (35) (80)

Amortisation and deferred charges ...... 11 1,027 781

Unrealised gain on market securities ...... 16, 46 (1,727) 0

Other operating activities, net ...... 807 736 Working capital from operations 5,388 4,365

Net change in operating assets and liabilities ...... (267) 1,199

Net cash provided by operating activities 5,121 5,564

Cash flows from investing activities: Capitalised deferred charges ...... 11, 30 (1,088) (1,076) Increase in property and equipment: 31

Buildings ...... (61) (61)

Aircraft and flight equipment ...... (1,234) (831)

Other equipment ...... (834) (993)

Proceeds from sale of equipment ...... 33 83 138

Increase in investments and long-term notes ...... (300) (497)

Market securities, increase ...... 46 (11,519) 0 Net cash used in investing activites (14,953) (3,320)

Cash flows from financing activities: Dividends paid ...... 49 (640) (365)

Additional paid in capital stock ...... 48 2,025 0

Purchase of treasury stock, net ...... 18 1,445 (143)

Proceeds from long-term borrowings ...... 289 1,837

Payments and other changes in long-term debt ...... (1,660) (1,690)

Notes payable, decrease ...... 6,530 0 Net cash provided by (used in) financing activities 7,989 (361)

(Decrease ) increase in cash and cash equivalents ...... (1,844) 1,883

Cash and cash equivalents at beginning of year ...... 17, 47 7,742 5,859

Cash and cash equivalents at end of year ...... 17, 47 5,898 7,742

Supplemental information: Interest paid on long-term debt ...... 581 613

Interest income received ...... 456 439

Income tax paid ...... 20 22

All amounts are in ISK millions 76 Notes to Financial Statements

Summary of Accounting Policies

Basis of preparation 1. The Financial Statements of Flugleidir hf. (the Icelandair Parent Company) contain the Consolidated Financial Statements of the Group; where all major inter-Group transactions are eliminated. The Financial Statements are prepared in accordance with the Financial Statements Act and the Regulation on the Presentation and Contents of Financial Statements and Consolidated Financial Statements. The Financial Statements are based on historial cost accounting. The Company predominantly uses the same accounting principles as in previous years apart from the changes in accounting policies explained in Note 20. The Consolidated Financial Statements of the Group are prepared in the Icelandic currency and amounts are presented in millions of Icelandic krónur (ISK).

2. The Company’s assets in aircraft and related loans are recorded predominantly in the parent company’s Balance Sheet. The parent com- pany and one of its subsidiaries maintain their accounts and prepare their Financial Statements in US dollars as of 1 January 2004. In preparing the Group’s Consolidated Financial Statements, which are prepared in Icelandic krónur, the Balance Sheet of those two com- panies is translated to Icelandic krónur at the exchange rate of the Icelandic krónur to the US dollar at the end of the year. Income and expenses are converted into Icelandic krónur at the average exchange rate for the year. All resulting krónur translation differences are posted to a separate component of stockholders’ equity as “translation reserve”.

3. Subsidiaries are companies in which the Company holds a controlling interest, directly or indirecly. A controlling interest exists when the Company has significant influence over the financial and operational polices of a subsidiary. The Financial Statements of the subsidiary are included in the Group's Consolidated Financial Statements from the acquisition of the controlling interest until the interest is no longer held. All material balances between the Group companies, transactions and profits created in transactions between Group companies are elim- inated in the Consolidated Financial Statements.

Foreign currency 4. All business transactions originating in foreign currencies are converted at the spot rate on the transaction date. Exchange rate difference is posted to the Statements of Earnings. Purchase of fixed assets is converted at the spot rate of the purchase. Operating expenses and income originating in foreign currencies are converted at the spot rate of the business transactions. Monetary assets and liabilities denom- inated in foreign currencies are stated in ISK at the latest official exchange rate for December 2004.

Derivatives 5. Currency swap and option trading contracts are shown in the Financial Statements at market value at 31 December 2004. Contracts with a positive market value are shown in the Balance Sheet as current assets, and contracts with a negative value are shown in current liabilities. Changes in the market value of these contracts are recognised in the Statements of Earnings when contracts are settled. Changes in the market value of unrealised gain or loss on these contracts are, on the other hand, posted to the stockholders’ equity sec- tion as “currency derivatives”.

The value of interest swap and forward rate agreements at 31 December 2004 is not shown in the Balance Sheet. Accrued interest due to these contracts is included in the Financial Statements and their effect is included in the calculation of average weighted interest on the Company’s long-term debt.

To limit the risk of fluctuation in aircraft fuel prices, the Company has entered into both swap and option contracts. The value of the fuel derivatives is reflected in the Financial Statements for the same period that the use of the fuel under the contracts takes place.

Revenue recognition 6. Passenger tickets and cargo sales are not recognised as revenue until tranportation is provided. Sold and unused documents amounting to ISK 1,683 million at 31 December 2004 are shown in the Balance Sheet as unearned transportation revenue. Sold documents not used within nine months from the month of sale are recognised as revenue. All amounts are in ISK millions 77 Notes, cont.:

7. Revenue from mail and cargo transportation is recognised in the Statements of Earnings after transportation has been provided. Revenue from aircraft lease is recognised in the Statements of Earnings on completion of the leased flights. Revenue from services is recognised in the Statements of Earnings after providing the service.

Earnings per share 8. Earnings per share is the ratio between profit and weighted average capital stock during the year and shows the profit per each ISK 1 of capital stock. Net earnings for the year 2004 amounted to ISK 3,419 million and the weighted average number of outstanding shares amounted to ISK 2,167 million, taking into consideration new shares and the Company's transactions with treasury shares. The nominal value of each share is ISK 1. Earnings per share thus amounted to ISK 1.58. In calculating diluted earnings per share, option contracts con- cluded with Company employees in the amount of ISK 98 million have been taken into account. The Company has not taken any con- vertible loans.

Intangible assets 9. Included in other intangible assets in the Balance Sheet are training costs of crew members, software systems and loan expense in rela- tion to the purchase of new aircraft. The cost of training crew members and software systems is amortised to expense over three years, whereas the loan expense is amortised to expense over the life of the loans.

Property and equipment 10. The net book value of property and equipment is based on historical cost less depreciation. Depreciation is calculated on a straight-line basis according to the estimated service life of the asset until a 10% residual value is reached. Estimated service life is as follows:

Buildings ...... 25-50 years Aircraft and flight equipment ...... 10-25 years Other property and equipment ...... 3-8 years

11. The Company capitalises engine overhauls when incurred and amortises such cost to maintenance expense over their estimated service lives on a usage basis. The remaining portion, ISK 958 million, is shown in the Balance Sheet both as prepaid expenses and specified under property and equipment. The effect of changes in the exchange rate of the US dollar are posted as currency difference in the Statements of Earnings.

Subsidiaries 12. Investments in subsidiaries are capitalised at a value that corresponds to the Company's share in their stockholders' equity, including the difference between the purchase price and the Company's share in their stockholders' equity at the acquisition date.

The Financial Statements of foreign subsidiaries are converted to ISK using the accounting methods and principles valid in Iceland. Currency exchange difference resulting from translation into ISK is posted to a separate component of stockholders’ equity as “transla- tion difference and currency hedging”.

Associated companies and other companies 13. The investment of the Group in domestic and foreign companies is stated at historical cost. The Group holds a share between 20% and 50% in fourteen associated companies. Its equity in the operating results and financial position of its associated companies is not includ- ed in the Consolidated Financial Statements due to the immaterial effect thereof.

Investment in other domestic and foreign companies is stated at cost value, taking portfolio reserve into account.

Inventories 14. Flight equipment expendable parts are capitalised at the spot rate of purchase and are, as other inventories, valued at the latest purchase price.

Accounts receivable 15. Allowance has been made for doubtful notes and accounts receivable. This entry does not represent a final write-off, but only a reserve to meet possible losses, and is deducted from the appropriate Balance Sheet items. All amounts are in ISK millions 78 Notes, cont.:

Market securities 16. Listed shares are shown in the Balance Sheet as market securities. The shares are posted at their listed market price at year-end 2004. Changes in the market value are entered as unrealised gain in the Statements of Earnings and shown as a special item in the Stockholders' Equity section.

Cash and cash equivalents 17. Cash and cash equivalents consist of short-term securities, cash and bank deposits. Short-term securities include short-term notes of finan- cial institutions, government and municipal securities listed on the Iceland Stock Exchange and bonds of unit trusts.

Purchase of treasury stock 18. When treasury stock is purchased, the total purchase price, including related expenses, is posted as a deduction from stockholders' equi- ty. When treasury stock is sold, the sale is posted as an increase in stockholders' equity. Capital gain or loss is not recorded. Cost of issu- ing and selling new capital stock is posted as a decrease in the stockholders’ equity section.

Pension plan obligation 19. The Company has entered into pension plan agreements with some of its former employees. These obligations are presented in the Balance Sheet as a separate line item, and the change in the obligation is included in the Statements of Earnings.

Deferred income tax liability 20. The deferred income tax liability is calculated and entered in the Financial Statements. It is mainly a result of timing difference between Icelandic financial accounting and tax accounting, primarily from the valuation of fixed assets and their depreciation.

International Financial Reporting Standards 21. According to the rules on the presentation of Financial Statements of companies registered on the Iceland Stock Exchange, the Company will adopt the International Financial Reporting Standards as of the beginning of 2005. The Company has already begun preparing for this change. The possible effect of the change on stockholders' equity has not been estimated.

Change in accounting principles: inflation accounting discontinued

22. The Company has, pursuant to an Act passed by the Icelandic Parliament at year-end 2001, discontinued inflation accounting. The effects of price level changes are no longer entered in the Company’s Statements of Earnings. The Company’s aircraft are no longer revalued based on the value of the US dollar. Intangible assets, property, equipment and shares in associated companies and other companies, pre- viously adjusted according to changes in the general price level, are now valued at cost price. Depreciaton and amortisation are now cal- culated based on historical cost instead of revalued historical cost, and inflation adjustment is no longer calculated nor posted to the Statements of Earnings. As a result of these changes, operating results are no longer shown at the average price for the period, and assets are not valued at the 31 December 2004 price level.

In accordance with international accounting standards regarding the change to non-inflation adjusted accounting, comparative amounts in the Financial Statements have not been changed.

The parent company and one of its subsidiaries have received permission to maintain their accounts and prepare their Financial Statements in US dollars as of the beginning of the year 2004. In the Group's Consolidated Financial Statements, which are prepared in Icelandic krónur, the Balance Sheet of those two companies is translated into Icelandic krónur at the ISK exchange rate to the US dollar at the end of the year. Income and expenses are converted to ISK at the average exchange rate for the year.

All amounts are in ISK millions 79 Notes, cont.:

Quarterly summary

23. The Group's operations are specified as follows by quarters: Q 1 Q 2 Q 3 Q 4 Total 2004 2004 2004 2004 2004

Operating revenue ...... 7,280 11,577 15,159 8,571 42,587 Operating expenses excluding ...... depreciation and aircraft lease ...... (7,696) (9,766) (11,009) (8,846) (37,317) Operating profit (loss) excluding depreciation and aircraft lease (EBITDAR) ...... (416) 1,811 4,150 (275) 5,270 Aircraft lease ...... (381) (407) (369) (288) (1,445)

Operating profit (loss) excluding ...... depreciation (EBITDA) ...... (797) 1,404 3,781 (563) 3,825 Depreciation ...... (445) (477) (488) (486) (1,896)

Operating profit (loss) (EBIT) ...... (1,242) 927 3,293 (1,049) 1,929 Net financial income (expenses) ...... 157 191 (44) 127 431 Unrealised gain on market securities ...... 0 0 0 1,727 1,727 Deferred income tax ...... 194 (215) (579) (68) (668)

Net earnings (loss) for the period ...... (891) 903 2,670 737 3,419

Operating revenue

Other operating revenue 24. Other operating revenue is specified as follows: 2004 2003

Restaurant and Saga Boutique sales at airports and on board aircraft ...... 1,636 1,354 Sold maintenance ...... 711 420 Aircraft handling ...... 297 319 Freight handling and service fees ...... 888 597 Travel agency revenue ...... 4,850 5,123 Hotel revenue ...... 1,358 1,114 Excursions and car rental revenue ...... 1,121 761 Commission ...... 380 390 Gain on the sale of assets ...... 35 80 Miscellaneous income ...... 1,772 1,301 13,049 11,459

Operating expenses

Salary and related expenses 25. Salaries and related expenses are specified as follows:

2004 2003

Salaries ...... 10,173 8,443 Salary-related expenses ...... 2,048 1,617

Salaries and salary-related expenses total ...... 12,221 10,060 Other personnel expenses ...... 2,270 2,140

Salaries, salary-related expenses and other personnel expenses, total ...... 14,491 12,200

Average number of employees for the year ...... 2,465 2,289

All amounts are in ISK millions 80 Notes, cont.:

26. Remuneration to the Board of Directors and the CEO in relation to their work for companies within the Group, their stock options and shareholdings in the Company are specified as follows: Salaries and Call Shareholdings fringe benefits options at year-end

Sigurdur Helgason, President and CEO ...... 25 13 34 Sixteen managing directors of Icelandair and subsidiaries ...... 199 80 221

Directors: Hannes Smárason, Chairman ...... 0 0 743 Hreggvidur Jónsson, Vice-Chairman ...... 000 Árni Oddur Thórdarson ...... 000 Benedikt Sveinsson ...... 100 Gylfi Ómar Hédinsson* ...... 000 Jón Thorsteinn Jónsson* ...... 000

Former Directors: Einar Thór Sverrisson ...... 100 Gardar Halldórsson ...... 100 Grétar Br. Kristjánsson ...... 200 Hördur Sigurgestsson ...... 302 Ingimundur Sigurpálsson ...... 100 Jón Ásgeir Jóhannesson ...... 100 Jón Ingvarsson ...... 101 Pálmi Haraldsson ...... 200

Remunerations to Directors are determined in arrears at the Company’s Annual General Meeting.

The Company entered into stock option contracts with the CEO and other managing directors for a nominal value of ISK 93 million at the end of 2003, which are based on the exercise price 5.97.

Included in the column “Shareholdings at year-end” are shares in the Company held by companies controlled by Board members and managing directors of Flugleidir hf.

*Gylfi Ómar Hédinsson and Jón Thorsteinn Jónsson are shareholders in companies that control Saxbygg ehf., which held a 25.6% stake in Flugleidir hf. at year-end 2004.

Other operating expenses 27. Other operating expenses are specified as follows: 2004 2003

Cost of goods sold ...... 679 600 Aircraft maintenance expenses ...... 1,824 1,949 Buildings and interior expenses ...... 1,402 1,272 Communication expenses ...... 1,141 1,081 Advertising expenses ...... 1,014 888 Booking fee and commission expenses ...... 1,599 1,622 Travel agency expenses ...... 2,182 2,397 Excursions and car rental expenses ...... 448 353 Passenger and hotel guest service expenses ...... 737 703 Insurance and claim expenses ...... 399 377 Miscellaneous expenses ...... 1,282 1,147 12,707 12,389 All amounts are in ISK millions 81 Notes, cont.:

Auditors’ fees 28. Remuneration to the Company’s Auditors are specified as follows: 2004 2003

Audit of Financial Statements ...... 11 10 Review of Interim Financial Statements ...... 13 11 Other services ...... 22 26 23

Net financial income (expenses)

29. Net financial income (expenses) are as follows: 2004 2003

Interest earned ...... 477 485 Interest expenses ...... (927) (845) Currency fluctuations ...... 218 2,079 Dividend income ...... 71 0 Gain (loss) on sale of investment ...... 592 (5) 431 1,714

Calculated inflation income entry – monetary items ...... 0 443 Calculated inflation expenses adjustment due to revaluation of aircraft and flight equipment in accordance with changes in the USD rate ...... 0 (2,734) Total inflation expense ...... 0 (2,291)

Net financial income (expenses) ...... 431 (577)

Fixed assets

Intangible assets 30. The book value of other intangible assets is specified as follows: 2004 2003

Other intangible assets 1.1...... 557 462 Currency difference ...... (26) 14 Additions during the year ...... 129 270 Amortised during the year ...... (237) (189) Other intangible assets 31.12...... 423 557

Amortisation factor ...... 6-33% 6-33%

Property and equipment 31. Property and equipment are specified as follows:

Aircraft Other and flight property and Buildings equipment equipment Total

Total value 1.1.2004 ...... 3,772 23,090 3,419 30,281 Total depreciated 1.1.2004 ...... (1,668) (5,375) (1,750) (8,793) Net book value 1.1.2004 ...... 2,104 17,715 1,669 21,488 Currency translation differences during the year ...... (324) (2,194) 0 (2,518) Additions during the year ...... 61 591 821 1,473 Sales and disposals during the year ...... 0 (16) (120) (136) Depreciation during the year ...... (126) (1,046) (487) (1,659) Net book value 31.12.2004 ...... 1,715 15,050 1,883 18,648 All amounts are in ISK millions 82 Notes, cont.:

31. Cont.

Aircraft Other and flight property and Buildings equipment equipment Total

Total value 31.12.2004 ...... 3,314 20,267 3,863 27,444 Total depreciated 31.12.2004 ...... (1,599) (5,217) (1,980) (8,796)

Net book value 31.12.2004 ...... 1,715 15,050 1,883 18,648

Depreciation factor ...... 2-4% 4-10% 12-33%

Depreciation as shown in the Statements of Earnings is segregated as follows:

Depreciation of property and equipment ...... 1,659 Amortisation of other intangible assets, see note 30 ...... 237

Total depreciation ...... 1,896

32. Prepayments in relation to the purchase of aircraft include ISK 614 million for an agreement to purchase ten Boeing 737-800 aircraft, which will be delivered to the Company in 2006. In addition, ISK 74 million are entered in relation to the purchase of two aircraft around mid-year 2005. The two aircraft have been leased and used in the Company's operations during the past years. The intention is to sell the aircraft along with the third aircraft owned by the Company at year-end 2004. The effect of the transaction on the Group's Statements of Earnings in 2005 will be immaterial.

33. In the year 2004 the parent company sold property and equipment for ISK 83 million. Capital gain on the sale was ISK 35 million and is included under other operating income in the Statements of Earnings.

Operating lease agreements 34. The Group had operating lease agreements for fourteen aircraft at 31 December 2004. The aircraft are nine Boeing 757, three Boeing 767 and two smaller aircraft. The Group also leases premises and equipment for its operations under operating leases expiring in the year 2018. At 31 December 2004, approximate future rental payments according to those agreements totalled ISK 10,035 million, which is specified as follows:

Buildings Aircraft Other Total

Year 2005 ...... 559 1,212 262 2,033 Year 2006 ...... 559 825 126 1,510 Year 2007 ...... 551 647 75 1,273 Year 2008 ...... 551 106 66 723 Year 2009 ...... 551 0 56 607 Subsequent years ...... 3,809 0 80 3,889

Total ...... 6,580 2,790 665 10,035

35. Lease expenses in the year 2004 included in the Financial Statements of the Group amounted to ISK 3,152 million.

Mortgages and commitments 36. Mortgages by the Group with remaining balances in foreign currencies are ISK 13,927 million at year-end 2004.

All amounts are in ISK millions 83 Notes, cont.:

Insurance value of aircraft and flight equipment 37. The insurance value and book value of aircraft and related equipment of the parent company at year-end 2004 are specified as follows:

Insurance value Book value

Boeing 757-200 / 300 - six aircraft ...... 16,938 12,760 Other aircraft ...... 1,798 702 Flight equipment ...... 2,025 1,588 Aircraft and flight equipment ...... 20,761 15,050 Engine hours ...... 2,578 958 23,339 16,008

Unused engine hours are shown in the Balance Sheet both as prepaid expenses and specified under property and equipment.

Real estate insurance value 38. The principal buildings owned by the Group at 31 December 2004 are the following:

Official premises Insurance Book valuation value value

Maintenance hangar, Keflavík Airport ...... 1,166 1,882 589 Freight building, Keflavík Airport ...... 303 486 352 Office building, Reykjavík Airport ...... 574 731 152 Service building, Keflavík Airport ...... 303 467 143 Hangar 4 and other buildings, Reykjavík Airport ...... 230 357 136 Vesturvör 6, Kópavogur ...... 82 85 97 Other buildings ...... 335 516 246 Buildings total ...... 2,993 4,524 1,715

Official valuation of the Group's leased land for buildings at December 31, 2004 amounted to ISK 132 million, and is not included in the Balance Sheet.

Investments

Subsidiaries 39. The parent company, Flugleidir hf., now owns thirteen subsidiaries, after one new subsidiary, Flugleidir Fjárfestingafélag ehf. (Flugleidir Investments), was established and began operation at year-start 2004. Flugleidir hf. also took over Icelandair ehf. shares in Íslandsferdir ehf. The subsidiaries, which are all included in the Consolidated Financial Statements, are the following: Share Airlines: Flugfélag Íslands hf. (Air Iceland) ...... 100% Icelandair ehf. (Icelandair) ...... 100% Travel agencies Ferdaskrifstofa Íslands hf. (Iceland Travel) ...... 100% Íslandsferdir ehf. (Íslandsferdir) ...... 100% Kynnisferdir ehf. (Reykjavik Excursions) ...... 96% Other subsidiaries: Bílaleiga Flugleida ehf. (Icelandair Hertz Car Rental) ...... 100% Fjárvakur - fjármálathjónusta ehf. (Icelandair Shared Services) ...... 100% Flugleidahótel hf. (Icelandair Hotels) ...... 100% Flugleidir Fjárfestingafélag ehf. (Flugleidir Investments) ...... 100% Flugleidir - Frakt ehf. (Icelandair Cargo) ...... 100% Flugthjónustan Keflavíkurflugvelli ehf. (Icelandair Ground Services) ...... 100% Loftleidir-Icelandic ehf. (charter and leasing) ...... 100% Tæknithjónustan Keflavíkurflugvelli ehf. (Icelandair Technical Services) ...... 100% All amounts are in ISK millions 84 Notes, cont.

39. Cont.

The parent company’s equity in the operating results of the subsidiaries for the year 2004 was a net profit of ISK 3,030 million. The minor- ity interest in the operating results of the subsidiaries is a net profit of ISK 19 million for the year. The minority interest in the stockhold- ers' equity of the subsidiaries was ISK 21 million at 31 December 2004, and is included in accrued liabilities and expenses in the Balance Sheet.

Associated companies 40. Investment in associated companies is specified as follows: Share % Book value

Ásgardur hf...... 50.6% 54 Median - Rafræn midlun hf...... 20.1% 53 Sérleyfisbílar Keflavíkur hf...... 31.0% 23 Ferdaskrifstofa Akureyrar ehf...... 30.0% 18 Íshestar ehf...... 19.2% 16 Tjarnir hf...... 21.9% 6 Flugbúnadur ehf...... 22.7% 5 Flugskóli Íslands hf...... 24.4% 7 Viking K.K., Japan ...... 40.0% 4 Nordland Tours Gmbh, fi‡skalandi ...... 50.0% 3 Other companies (4 companies) ...... 3

Investment in associated companies ...... 192

Other companies 41. Investment in other companies is specified as follows: Share % Book value

Tölvumyndir hf...... 10.2% 178 Dalagisting ehf...... 9.6% 5 Anza ehf...... 0.3% 4 BSÍ hf...... 4.0% 3 Other companies (23 companies) ...... 7

Investment in other companies, total ...... 197 Portfolio reserve ...... (5)

Investment in other companies ...... 192

42. At the annual Board meeting of SITA SC, a subsidiary of SITA foundation, in the year 2000, a decision was made to change the organi- sational structure of the company by establishing a new entity, SITA Information Networking Computing N.V. The goal is to expand the activity of SITA in the fast-growing market in communications and Internet services. Shares in the new SITA company have been distrib- uted to Flugleidir based on the volume of business with SITA in the years 1998 and 1999. The market value of the 65,566 shares issued to Flugleidir is not known due to sales restrictions in effect. Additional distribution of shares in the new SITA Company to Flugleidir will be based on the volume of business with SITA SC in the years 2000 to 2003.

All amounts are in ISK millions 85 Notes, cont.:

Deposits and other 43. Included in deposits and other in the Balance Sheet are deposits in relation to aircraft lease and lease of premises. Deposits and other is segregated as follows: 2004 2003

Aircraft lease deposits ...... 208 156 Bank guarantees ...... 98 150 Other deposits ...... 52 124

Deposits and other total ...... 358 430

Financial institutions have guaranteed aircraft lease and other obligations of the Group for the amount of ISK 504 million.

Current assets

Inventories 44. Inventories are specified as follows: 2004 2003

Flight equipment expendable parts ...... 587 476 Fuel inventories ...... 6 11 Other inventories ...... 239 220

Total inventories ...... 832 707

Receivables 45. Allowance for doubtful notes and accounts receivable is deducted from the appropriate Balance Sheet items. Activity in this account is segregated as follows: 2004 2003

Allowance for doubtful accounts 1 January ...... 165 457 Bad debts during the period ...... (73) (521) Increase in provision, recorded as expense ...... 130 229

Allowance for doubtful accounts 31 December ...... 222 165

Market securities 46. Market securities are specified as follows: Market value Share 31.12.2004

easyJet plc...... 10.1% 9,599 Other market securities ...... 3,647 13,246

Cash and cash equivalents 47. Cash on hand, bank deposits and all highly liquid debt instruments are segregated as follows: 2004 2003

Cash on hand and bank deposits ...... 3,114 2,007 Highly liquid debt instruments ...... 2,784 5,735

Total cash and cash equivalents ...... 5,898 7,742

All amounts are in ISK millions 86 Notes, cont.:

Stockholders' equity

48. The Company’s total capital stock amounts to ISK 2,537 million, as stipulated in its Articles of Association. Each share of one ISK in the Company carries one vote. During the year 2004, the Company’s capital stock was increased by a nominal value of ISK 230 million, from ISK 2,307 million to ISK 2,537 million. The Company purchased treasury stock for the nominal value of ISK 35 million for ISK 279 million. The Company also sold treasury stock for the nominal value of ISK 198 million for ISK 1,723 million. Capital stock according to the Balance Sheet amounts to ISK 2,525 million and is segregated as follows:

Capital stock issued and outstanding, according to Articles of Association ...... 2,537 Treasury stock ...... (12)

Capital stock according to Balance Sheet ...... 2,525

49. Changes in stockholders' equity are specified as follows: Translation Unrealised Stock reserve and gain on Capital Statutory options currency market Retained stock reserve reserve derivatives securities earnings Total

Balance 1.1.2004 ...... 2,1325331006,5449,210 Dividend paid ...... (640) (640) Additional paid in capital stock ... 230 1,795 2,025 Treasury stock, purchased ...... (35) (244) (279) Treasury stock sold ...... 198 1,525 1,723 Cost of stock options ...... 212 212 Currency derivatives ...... 223 223 Currency translation differences .. (958) (958) Net earnings for the year ...... 1,417 2,002 3,419

Stockholders’ equity 31.12.2004 .. 2,525 3,609 213 (735) 1,417 7,906 14,935

Obligations

Pension plan 50. The company has entered into pension plan agreements with some of its former employees. This obligation at 31 December 2004 is esti- mated at approximately ISK 224 million, calculated at a 3% interest rate. This amount is presented in the Balance Sheet as ISK 180 mil- lion in long-term obligations and ISK 44 million in current liabilities. The increase in the obligation is included in the Statements of Earnings.

Stock option contracts 51. At year-end 2003, stock option contracts were concluded with the President and CEO, managing directors and employees for a nomi- nal value of ISK 98 million at the rate of 5.97. The stock options will become effective on 1 December 2005 and are redeemable within four weeks from that date. If employment is terminated prior to that time, the stock option is cancelled in full. Approximately ISK 212 million are expensed in the Statements of Earnings regarding the contracts, as the market value of the shares exceeds the stock option price.

Deferred income tax liability 52. The deferred income tax liability of the parent company was ISK 1,466 million at year-end 2004. The change in this item is segregated as follows:

Deferred income tax liability 1.1.2004 ...... 989 Currency adjustment ...... (191) Calculated deferred income tax, increase ...... 668

Deferred income tax liability 31.12.2004 ...... 1,466

All amounts are in ISK millions 87 Notes, cont.:

53. The Company’s deferred income tax liability is attributable to the following items:

Property and equipment ...... 1,041 Market securities ...... 310 Investments ...... 73 Accounts receivable ...... 91 Other Balance Sheet items ...... (28) 1,487 Loss carry-forward ...... (21)

Deferred income tax liability 31.12.2004 ...... 1,466

Long-term debt

54. Long-term debt and interest rate terms are as follows: Interest Loan balance Loans in ISK: Indexed loans ...... 6.2% 439 439

Loans in foreign currencies: Aircraft purchase, bank loans, USD ...... 3.9% 12,974 Loans in other currencies ...... 3.2% 601 13,575

Long-term loans total including current maturities ...... 14,015 Current maturities ...... (1,773)

Long-term debt 31.12.2004 ...... 12,242

The above interest rates represent weighted average rates at 31 December 2004. Interest on the Company’s long-term debt in foreign currencies amounting to ISK 7,944 million varies according to foreign loan market rates.

55. Annual maturities of long-term debt by the Group at 31 December 2004 are as follows:

Year 2005 ...... 1,773 Year 2006 ...... 1,213 Year 2007 ...... 1,248 Year 2008 ...... 2,827 Year 2009 ...... 1,418 Subsequent years ...... 5,537

Total long-term debt, including current maturities ...... 14,015

Current liabilities

Deferred income 56. Deferred income is specified as follows: 2004 2003

Unearned transportation revenue, see Note 6 ...... 1,683 1,572 Other prepayments ...... 466 460

Total deferred income ...... 2,149 2,032

All amounts are in ISK millions 88 Notes, cont.:

Derivaties

57. The Company has entered into derivatives contracts with financial institutions to limit its risk regarding currency, interest rates and fluc- tuation in aircraft fuel prices.

To limit its currency risk, the Company has entered into both swap and option contracts to trade currencies for ISK 3,040 million based on exchange rates at 31 December 2004. The contracts are made to reflect the forecast currency risk in relation to cash flows in foreign currrencies for the next 12 months. The market value of these contracts at 31 December 2004 is negative by approximately ISK 112 mil- lion and is included in the Financial Statements.

To limit its interest rate risk, the Company has entered into both swap and option contracts changing the inerest rate of the long-term loans from variable interest to fixed. The notional principal amount of these agreements is approximately ISK 5,046 million at 31 December 2004, and the market value of these contracts is positive by approximately ISK 6 million at 31 December 2004. Accrued inter- est due to these contracts is included in the Financial Statements, and the effect of these contracts is included in the calculation of the average weighted interest rate of long-term debt stated in Note 54.

To limit the risk of fluctuations in aircraft fuel prices, the Company has entered into both swap and option contracts to buy aircraft fuel at a certain price. The principal amount of these contracts is ISK 188 million at 31 December 2004. The market value of these contracts is positive by approximately ISK 6 million at 31 December 2004, and is not included in the Financial Statements. The value of the fuel derivatives is reflected in the Financial Statements for the same period that the use of the fuel under the contracts takes place.

Taxes

58. Taxes for the operating year 2004, such as income tax, net worth tax and industrial tax, have been calculated and entered in the Financial Statements. The Company will not have to pay income tax in the year 2005 due to carry-forward losses. The Parent and all local limit- ed liability subsidiaries may file a joint tax return. The Parent Company and its local subsidiaries have loss carry-forwards of approximate- ly ISK 132 million at December 31, 2004. Tax loss carry-forward can only be utilized to offset future taxable income over the next ten years after the tax loss is incurred.

Five-year summary

59. Five-year summary of the Group in ISK million:

2004 2003 2002 2001 2000 Operation: Operating revenue ...... 42,587 37,561 38,945 37,971 34,552 Operating expenses excluding depreciation and aircraft lease ...... (37,317) (32,301) (30,881) (33,747) (31,126) Operating profit excluding depreciation and aircraft lease (EBITDAR) ...... 5,270 5,260 8,064 4,224 3,426 Aircraft lease ...... (1,445) (1,470) (2,150) (2,890) (2,815)

Oprating profit excluding depreciation (EBITDA).. 3,825 3,790 5,914 1,334 611 Depreciation ...... (1,896) (1,807) (2,041) (2,099) (1,576) Operating profit (loss) before net financial

expenses and taxes (EBIT) ...... 1,929 1,983 3,873 (765) (965) Net financial expenses ...... 431 (577) (526) (892) (380) Unrealised gain on market securities ...... 1,7270000

Profit (loss) before deferred income tax ...... 4,087 1,406 3,347 (1,657) (1,345) Deferred income tax ...... (668) (285) (736) 445 406 Net earnings (loss) for the year 3,419 1,121 2,611 (1,212) (939)

All amounts are in ISK millions 89 Notes, cont.:

59. Cont. 2004 2003 2002 2001 2000

Balance Sheet: Fixed assets ...... 21,275 23,561 25,715 29,042 22,043 Current assets ...... 25,278 13,735 11,130 7,635 8,340 Total assets 46,553 37,296 36,845 36,677 30,383

Stockholders' equity ...... 14,935 9,210 8,622 6,373 7,328 Obligations ...... 1,646 1,150 881 132 586 Long-term debt ...... 12,242 15,963 17,964 19,802 13,320 Current liabilties ...... 17,730 10,973 9,378 10,370 9,149 Stockholders' equity and total liabilities 46,553 37,296 36,845 36,677 30,383

Ratios

60. Main ratios for the Group:

Working capital from operations ...... 5,388 4,365 6,381 1,300 983

Current ratio-current assets / current liabilities ... 1.43 1.25 1.19 0.74 0.91 Current ratio-excluding unearned transportation revenue ...... 1.62 1.54 1.49 0.89 1.14 Debt-equity ratio (stockholders' equity / total liabilities) ...... 0.32 0.25 0.23 0.17 0.24 Total stockholders' equity / capital stock ...... 5.91 4.32 4.00 2.85 3.18

Corporate Governance

61. The Board of Directors of Flugleidir hf. places emphasis on maintaining good corporate governance. The Board of Directors has laid down comprehensive guidelines defining the Board’s authority and its purview vis-à-vis the CEO. These rules include, inter alia, rules on proce- dure, comprehensive rules regarding the competence of directors to participate in discussions on issues, rules on confidentiality, rules regarding the disclosure of information by the CEO to the Board of Directors, etc. The Company Board of Directors determines the CEO’s terms of employment, meets regularly with Company Auditors and has hired internal auditors. The Company's Board of Directors fulfils the independence requirements specified in Article 2.6 of the Guidelines on Corporate Governance. It will be the task of the new Board of Directors, which is to be elected at the Company's Annual General Meeting on 10 March 2005, to decide upon other issues discussed in the Rules for Issuers of Securities Listed issued by the Iceland Stock Exchange, which took effect on 1 January 2005 and are based on the Guidelines on Corporate Governance issued in 2004 jointly by the Iceland Stock Exchange, the Iceland Chamber of Commerce and the Federation of Icelandic Employers.

All amounts are in ISK millions 90 Prospectus December 2005

FL GROUP hf Prospectus December 2005 Prospectus December 2005

FL GROUP hf Prospectus December 2005