Icelandair Group Annual Report 2010

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Felling

2010 Report Annual

GROUP Felling og brot Icelandair Group Icelandair 6 mm kjölur Felling og brot

Felling 2010 Report Annual Group Icelandair

FORSÍÐA

Skurður Skurður Skurður Key Figures

ISK million 2010 2009 2008 2007

Operating results Total income 88,015 80,321 72,199 63,477 EBITDAR 21,254 17,435 8,821 11,056 EBITDA 12,578 8,135 3,053 5,477 EBIT 6,254 1,483 -7,351 2,337 EBT continuing operations 6,576 -4,469 -8,985 129 Profit / loss for the year 4,556 -10,665 -7,468 257

Balance sheet Total assets 84,239 89,104 99,947 66,760 Total equity 28,403 14,605 20,080 25,033 Interest bearing debt 24,604 43,163 43,635 25,098 Net interest bearing debt 12,129 41,227 39,570 23,092

Cash flow Net cash from operating activities 14,329 8,781 4,531 3,889 Net cash used in investing activities -4,168 -7,799 -7,452 -5,461 Net cash used in financing activities -49 -3,283 3,171 853 Cash and cash equivalents and marketable securities end of year 12,994 1,909 4,065 2,006

Key Ratios Earnings per share ISK 3.07 -10.94 -7.64 0.25 Equity per share ISK 19.11 14.98 20.53 25.26 Equity ratio 34% 16% 20% 37% Current ratio 1.16 0.58 0.43 0.46 Net tangible worth ISK million 7,191 -8,993 -9,241 -1,813 CAPEX ISK million 5,015 5,922 7,908 9,217 Transport revenue as % of total revenues 61% 59% 58% 57% EBITDAR ratio 24% 22% 12% 17% EBITDA ratio 14% 10% 4% 9% Average number of full time employees 2,129 2,182 2,437 2,544 Table of Contents

Chairman’s Address 02 CEO’s Comment 04 The fleet 06 Financial restructuring of Icelandair Group 08 Icelandair Group 09 The Subsidiaries 10 Financials 18 Risk Management 21 Corporate Governance 24 Shareholder information 27 Financial Statement 28 2 Chairman’s Address

Last year was one of the most remark- Financial restructuring able years in the long and colourful The financial restructuring was the history of Icelandair Group. The fi- most important and most extensive nal steps were taken in the exten- task of the Company’s management sive work of financially restructuring in 2010. New shares were offered the Company, and new sharehold- to professional investors, and the Ice- ers joined the Group. The operating landic Enterprise Investment Fund results turned out to be exceptional became the Company’s largest share- in spite of the severe disruption holder by subscribing to ISK 1.2 billion caused by the volcanic eruption in in new shares at the price of ISK 2.5, Eyjafjallajökull. As a result, the Com- which corresponds to a total of ISK 3 pany finds itself on a much sounder billion. The largest creditors converted footing than a year ago. debts in the amount of ISK 3.6 billion into shares based on a share price of The results of the Company in 2010 ISK 5 per share, which corresponds to were the best in its history, with the a subscription to 720 million shares. Group‘s profits amounting to ISK The total increase in share capital 4.6 billion. The Company‘s total turn- thus amounted to ISK 2.92 billion new over increased by 10% over the year, shares in nominal value in the offer to amounting to ISK 88 billion at year- professional investors. Sigurdur Helgason, end. Earnings before financial items Chairman of the Board taxes and depreciation amounted to At the end of 2010, the general public ISK 12.6 billion, as compared to ISK was invited to subscribe to new shares 8.1 billion in the preceding year. in an open offering, concurrently with a closed offering for employees and The improved performance was pri- shareholders. It was a pleasant experi- marily a result of significant increase in ence to observe the investor response Icelandair’s passenger revenues. Pas- to Icelandair Group’s share offering. senger revenues increased as a result Over 800 investors subscribed to ISK of an improved load factor and good 2.9 billion in nominal value, with de- revenue management in the route mand far exceeding supply, which was network. The number of passengers just over ISK 1 billion. The offer was in the Trans Atlantic market grew sub- made at the price of ISK 2.5 per share, stantially, accounting for 38% of the and demand on the secondary market company’s total number of passen- has been quite strong. It is a welcome gers, as compared to 28% in 2009. sight to see that investors are perceiv- ing a long-term investment opportunity in Icelandair Group’s stock. The financial restructuring was then formally completed on 10 February, when all formalities had been concluded. The current position is therefore that the Enterprise Investment Fund is now the Company’s largest shareholder, with holdings of approximately 29%, followed by Íslandsbanki, with approximately 21%. 3

Clearer focus Following the financial restructuring, it will also increase this year, as an es- is clear that the Company will now be timated 13 airlines will fly to and from based on the values that faded away Iceland next summer. The long-term during the economic upsurge. The prospects of the Company are favour- Company’s business operations will able, as it is well organised and follow- be based on diverse flight and tourist ing financial restructuring the balance services. There is complete consen- sheet is on sound footing and the li- sus within the Board of Directors and quidity position is strong. among the Company’s owners regard- Icelandair Group is the most impor- ing this point. tant travel service company in Iceland. Concurrently with the shift in focus, Through its subsidiaries, the Company Icelandair Group’s business model holds a good position in international will be simplified, and the Company air travel, domestic air travel, the hotel will emphasise on airline and tour- market and various areas of tourist ist services, where Iceland will be the services. We are proud of our position, cornerstone of an international route but we do realise that with this position network. The Company will strive for comes great responsibility, which can organic growth. This work has already best be addressed through continued begun with an increase in the number advances in the interests of Icelandic of Icelandair’s destinations and the tourism. airline’s route network will be served Icelandair Group will continue to be a by 14 Boeing 757, an addition of two strong force in Icelandic travel servic- aircraft. With its continued growth, es. The responsibility of the Company Icelandair will establish itself still fur- consists both in maintaining the flow ther as a strong airline operator in the of tourists to Iceland through vigorous North Atlantic with Iceland as a hub. promotion and in supplying Icelanders I welcome these changes, and I believe with the best available travel services. that they will place the Company in a Notwithstanding the challenging envi- better position to serve its customers. ronment of the near future, I can only From now on we will concentrate on be optimistic on behalf of the Compa- doing what we do best: airline opera- ny. This is due not only to the comple- tions and extensive services to travel- tion of the financial restructuring of lers; our business model reflects these the Company, but also the favourable two pillars of the Company. winds that I believe Icelanders can take advantage of to strengthen the We cannot anticipate that the results country’s tourist industry for the future. of 2011 will match those of 2010. The rising fuel prices will increase cost, and Finally I would like to thank our cus- it is likely that the proposed increases tomers, shareholders, the Board of in tariffs and taxes will have a negative Directors, the management and all impact on demand. In addition, wage employees of Icelandair Group for contracts with all of Icelandair Group’s their contribution to the great results employees have expired, and that situ- of 2010. ation entails significant risk. Neverthe- less, I am optimistic that the conclusion of wage bargaining will lead to an acceptable solution for all. Competition 4 President’s Address

The year 2010 was in many ways a it even more satisfying that the opera- good year in the history of our Com- tions of the Company in 2010 were pany, and business was generally solid. EBITDA for the year was ISK good, notwithstanding the disruption 12.6 billion, far in excess of projec- caused by the Eyjafjallajökull eruptions. The improved performance was tion. The operation of the Company primarily a result of the significant in- was successful, and concurrently with crease in Icelandair’s passenger rev- normal operations the financial foun- enues. dations of the Company were sub- The Company’s success in 2010 has stantially strengthened with the addi- attracted attention and it now ap- tion of new and powerful investors to pears that 13 airlines will be offering our shareholders’ group. Following the flights to Iceland next summer. We changes, the Company is now active welcome the increased competition. in the stock market again. The Com- It is written that the best defence is a pany is currently backed by over 1300 good offence, and we intend to meet shareholders. In reality, the number the increased competition with all of shareholders is far greater, as the our resources. Icelandair recently an- country’s largest pension funds – and nounced a 17% increase in capacity in thereby the majority of the population 2011. We will open a year-round hotel are stakeholders. The Company is now in Akureyri next June, a very welcome well funded, which is extremely impor- addition to our hotel operations. Air tant in our business. Björgólfur Jóhannsson, Iceland has been making good prog- President and CEO There has been turmoil in some parts ress in its flights to Greenland, and of the world significantly impacting Loftleidir-Icelandic has achieved good fuel prices. A recent profit forecast results in its marketing efforts. from Icelandair Group reveals that One of the biggest factors in Iceland- in spite of the announced plans for air Group’s success in 2010 was the growth, EBITDA for 2011 is projected Company’s ability to respond swiftly to at approximately ISK 3 billion short of changed circumstances. Even though the record set in 2010. Fuel costs ac- the flight disruptions resulting from the counted for about 20% of the Group’s volcanic eruptions were costly in the total expenses in 2010, and price in- short term, I am convinced that in the creases have a direct impact on the long term the eruption will increase the Company’s profitability. On the other number of tourists visiting Iceland. hand, the booking status for the summer months is good. The favourable results last year were by no means a self-evident outcome. Even though the world at large may have been taking small but firm steps out of the recession, the going has been rough for many Icelandic companies. We need to face the fact that the resurrection of the Icelandic economy is still in its early stages. This makes 5

After the collapse suffered by the Icelandair Group is a knowledge com- Icelandic stock market in the months pany in the best sense of that concept. before and after the banking collapse, We base our operations on the de- it is clear that it will take some time cades of experience possessed by our to regain the trust that was lost. We staff who for tens of years have been take that role very seriously, and I am improving work processes and dis- of the opinion that improved corporate covering more effective and efficient governance, transparency in business methods in the operation of our busi- operations and clear disclosure of in- ness and development of our route formation to the market is a prerequi- network. This knowledge has been site for investors to put their savings passed down from person to person, in stocks. It is a great responsibility to employee to employee, and the com- manage a company which is listed in pany is still dominated by the pioneer- the Stock Exchange, and I can prom- ing spirit that has characterised it and ise that the Board and management its predecessors. will contribute their every effort. It is on this foundation that Iceland- The Board of Directors of the Com- air Group has built its operations on pany recently began exploring the the eastern and western coast of the possibility of listing Icelandair Group’s United States and throughout Europe. shares in another stock exchange It is on the foundation of the trust that in the Scandinavian countries. This we enjoy in the international market would take the form of a dual listing, that we have succeeded in building up with the Company’s share listed in hotel operations, aircraft charters and two stock exchanges. This decision of tourist offices. And it is on this sound the Board reflects our belief that Ice- foundation that the Company will con- landair Group can compete in the in- tinue to shoulder its responsibility as ternational market, and it is our view the largest and most important travel that there would be demand for a organisation in the country. Last but company like Icelandair Group in the not least I would like to express my ap- Nordic stock exchanges. preciation to all employees of Icelan- dair Group for their outstanding work The economic collapse should teach in the year 2010. Icelanders the importance of spread- ing risk. One of the most important long-term tasks in the Icelandic tourist industry will be to increase the number of tourists visiting Iceland in the fall, spring and wintertime. If we look at Icelandair Group’s history, the first and the last quarter of every year have always been difficult, and the gross margin has been negative. However, the operating results in the last quarter of 2010 show us beyond any doubt that by pooling our efforts we can go from defence to offence in difficult times. 6 The fleet

The fleet is the Group’s largest asset and a core operating resource. In 2010 a total of 34 aircraft were involved in the Group’s operations. The most common type of aircraft in the operation is the Boeing 757. These aircraft are operated in the Icelandair and Icelan- dair Cargo route networks and by Loftleiðir Icelandic. In 2011 two Boeing 757 will be added to the Group‘s fleet. Air Iceland operates six Fokker 50 and two Dash 8-100, all of which are owned by the Company. In March of 2011 one of the Dash aircraft was damaged while landing in Greenland. Air Iceland is working on finding a replacement. Icelandair operates a single-type fleet of Boeing 757 aircraft in its international network. The type fits extremely well with Icelandair‘s route nework. Also, a single-type fleet creates significant cost efficiency in terms of maintenance and training for crew and me- chanics. The Group invests considerably in its fleet in order to sustain and improve passengers‘ flight experience. Aircraft manufacturers, such as Boeing and Airbus, are currently preparing the introduction of the next genera- tion of narrow body aircraft. In due course, Icelandair Group will unveil it‘s plans for the successors of the Boeing 757. Until then the Group intends to keep its current fleet.

Fleet overview summer 2011

GROUP

Owned Leased

B757 200 8 14 B757 300 1 0 B767 200 0 5 Fokker F-50 6 0 Dash 8-100 2 0 Total 17 19

7 8 Financial restructuring of Icelandair Group

Over the past two years the Company has been work- However, the balance sheet of the Group was set in ing on improving its debt maturity profile and equity a period when the owners and the Board of Directors ratio. On 21 October 2010 the Company and its lend- focused on acquisitions and cross-border expansion. ers finalized and signed documentation relating to The balance sheet was not self-sustainable, in par- the restructuring. Formal closing of the financial re- ticular due to the high level of leverage, and it was a structuring took place on 10 February 2011. Since the major problem for the Group even before the financial documents were executed in 2010, the restructuring turmoil in Iceland in the autumn of 2008. Although the is fully accounted for in the Group’s balance sheet at daily operations of the Group largely went according the end of 2010. to plan in 2009, financial expenses were a drain on the Group’s cash flow. It had been evident for some time that the balance sheet needed to be restructured. Background of the Financial Restructuring The collapse of the banking system in Iceland late in The Group undertook major cost-cutting measures in 2008, along with the worldwide recession, also af- the first half of 2008. More than 500 staff redundan- fected the Group’s operational landscape, especially cies were followed by capacity cuts and renegotia- as domestic demand dropped significantly. Strain on tions with suppliers. Around the same time, orders for cash flows followed due to termination of the Group’s four Airbus 330 cargo aircraft were cancelled, which banking services coupled with severe outflows of cash reduced the Group’s commitments by USD 450 mil- to meet an ever-growing demand for cash collateral lion. The cost-cutting measures taken in 2008 were by international financial institutions to replace bank among the main reasons for the Group’s ability to cope guarantees. As a consequence, it became more chal- with the downturn in 2008 and early 2009. lenging for the Group to meet its refinancing needs since its liquidity largely dried up after the financial turmoil of the Icelandic economy in 2008.

Overview of the Financial Restructuring The major components of the financial restructuring of Icelandair Group were: • New shares issued for cash consideration in the nominal amount of approximately ISK 3.3 billion at the price of ISK 2.5, which equals approximately ISK 8.2 billion in market value. • Icelandair Group’s largest creditors converted debt in the amount of approximately ISK 3.6 billion into shares based on a price of ISK 5 per share, which corresponds to a subscription to ISK 720 million new shares. • In 2010 Icelandair Group sold non-core assets to its creditors for the amount of ISK 7.6 billion. The gains on the sale of the assets amounted to ISK 4.2 billion, but taking taxes and translation difference into account, the impact on equity was positive by ISK 1.3 billion. 9 Icelandair Group

Icelandair Group focuses on the international airline and tourism sectors. The operations of the Company are split into two business segments: route network and tourism services. The main focus of the route network is to operate flights based on the Hub and Spoke concept between Europe and across the Atlantic to North America via Iceland. The focus of the tourism services is on catering to the growing demand for extensive services for tourists in Iceland and on offering a wide variety of support services relating to airline operations.

Tourism Holidays in Iceland from Iceland

Icelandair´s Oﬀering broad services Route Network Servicing Icelandic to tourists as a one-stop vacaoners partner

To–V ia–From Services Leasing, trading and ACMI

Opmizing operaons Capacity soluons for internaonal passenger airlines Cargo and tour operators

Ulizing belly space and route network 10 The Subsidiaries

Icelandair Icelandair’s business strategy is based on the geo- Icelandair Technical Services provides maintenance graphical position of Iceland on the flight route be- and technical services for the Icelandair fleet and is tween northern Europe and North America. By an integral part of the company. Most of the work is combining in its aircraft passengers visiting Iceland, performed at the Service Centre at Keflavik Airport, passengers departing from Iceland and passengers but maintenance is increasingly carried out abroad be- travelling across the Atlantic via Iceland, Icelandair has cause of increased international flight operations. managed to expand its network steadily. Icelandair will Operating on three different and independent passen- connect 23 European cities with 8 North American ger markets (The Trans Atlantic market, From Iceland cities through the company‘s hub in Iceland in its 2011 market and To Iceland market) gives the company a summer schedule. The network is based on a 24-hour variety of options in network and revenue manage- rotation, with morning and afternoon connections in ment. Apart from marketing and sales efforts, de- Iceland. mand for air travel mainly depends on the economy, Icelandair is a key component on the scheduled airline exchange rates, destination popularity and the cost side of Icelandair Group. It aims to be the airline of of flying. A key ingredient of a successful airline is its choice for travel to and from Iceland on the grounds network and revenue management, the strategy of of its efficiency and flexibility, and a unique and excit- maximising revenue by controlling capacity, booking ing alternative for air travel across the Trans Atlantic. flow and pricing. Icelandair uses a new and advanced Icelandair’s mission is to operate a first-class airline revenue management system and has recently added and maintain a reliable quality service through the ex- further resources to the revenue management. These perience and knowledge gained throughout the years. implementations have yielded significant revenue im- provements. In 2010 Icelandair carried 1.5 million passengers on its scheduled flights between Iceland, Europe and North Operating in different markets makes the company America to 26 destinations, a significant increase over less vulnerable to fluctuations in demand for any par- 2009. In 2010 the company operated a fleet of 12 ticular market segment. Continued emphasis is placed Boeing 757 aircraft during the summer season, and on a lean organisational structure, quick decision mak- will be operating 14 in the summer of 2011. ing and flexibility as the company works constantly on optimising the route network and looks at new mar- In 2010 Icelandair introduced Brussels (Belgium) and kets. Trondheim (Norway) as new destinations, and as of 2011 Icelandair adds Washington DC, Gothenburg, Volcanic eruption Billund, Hamburg and Alicante to its list of destina- On 14 April 2010 a volcano in the south of Iceland tions. known as Eyjafjallajökull started erupting clouds of Icelandair operates under an Air Operators Certificate black ash. The whole world soon woke up to the con- issued by the Icelandic Civil Aviation Authority and is, sequences, as airspace was closed down all across as such, considered European Aviation Safety Agency Europe, affecting flights throughout the world. For five (EASA) compliant. Icelandair is regarded as an Ice- days it was the world’s biggest media story. All eyes landic carrier and has route rights in accordance with were on the images of the powerful bursts of fire and this status. ash coming out of the crater and on the geographical maps showing the distribution of the ash cloud. With In addition to aircraft flown on its scheduled network, air traffic coming to a standstill, millions of passengers Icelandair operates aircraft on behalf of Loftleidir-Ice- were stranded all over the world. landic and Icelandair Cargo, thus securing economies of scale. The Group foresees the utilisation of the current aircraft fleet for the next 7–10 years. 11

For Icelandair, this was a great threat. On the very first day, as the scale of the situation became known, Ice- landair activated its emergency response system. The strategic decision was made to keep operating the network for as long as possible and to use all available tools and tactics to get the message across that Icelandair was open for business. With triple daily crisis committee meetings at the company’s HQ the flexibility of all was tested as defence was turned to offence. In order to get passengers closer to their destinations special rescue flights were organized to the very few airports that remained open, such as Glasgow in Scotland and Trondheim in Norway. Then, as European air space was opening up, Icelandair’s home hub airport in Keflavik closed down, and the whole hub operation was moved to Glasgow Airport, along with 200 staff to run the temporary operations, for 10 days. Up to 36 flights per day and 4-6 thousand passengers of all nationalities were carried during this 10 day period, with shuttle flights to Akureyri Airport in north Iceland and busses running 24/7 to Reykjavik. With over 150 schedule changes and tens of thousands of passengers affected during a three-week period the importance of communication was piv- otal. Over 80 press releases were issued in several languages during the period, and 250 online web updates were posted on 19 sites in 15 languages. This was supplemented by over 200 updates on Twitter and Facebook and a 200% increase in the number of answered telephone calls and text messages sent to passengers. Regular daily contact was kept with key tour operators and travel agents. Icelandair managed to get the message across that it was doing everything possible to help its customers through the situation and get people to their destinations. Only 20% of passengers needed to cancel their trips during the period, and compensation requests have been minimal. But the volcanic eruption also had the potential to drastically change the perception of Iceland as a tourist destination. It could be seen as dangerous, unsafe, complicated, - a stay-away place. In the world media dramatic scenes from this small area of Iceland were mixed with chaotic queues in major airports. The ques- tion was how this catastrophic event that created an image of a closed and uninviting country would affect 12

Icelandair, with a home airport just 100 kilometres A few days into the eruption, on April 19, Icelandair from the volcano itself. In the short term, all opera- accordingly approached the Icelandic government tions faced the threat of shutdown and abandonment with the idea of joining forces to launch an immediate by customers, with the resulting loss of important rev- communication and marketing campaign to revitalize enues. In the long term, the image of Iceland as a tour- bookings and avoid a potential disaster in the summer ist destination might be irreparably harmed. Therefore high season. Involving the Icelandic government, the the threat concerned not only the entire tourist indus- City of Reykjavik and all the leading players in the Ice- try, but the whole economy of this small country. landic tourist industry, this collaboration was quickly established and the country’s largest-ever campaign Cancellations of Icelandair flights and bookings at was launched in May with a 4.5 million EUR budget hotels, hostels and other tourist services in Iceland – just six weeks after the eruption started. The main from the global market occurred more or less over- message was that Iceland was up and running, more night. Tourist arrivals fell by 22% in April. According to interesting and welcoming than ever. The “Inspired by attitude surveys in Iceland’s main markets, interest in Iceland” drive rested on a belief in a strong, coherent, Iceland as a tourist destination also declined. Incentive innovative and integrated campaign based on conven- trips were relocated or cancelled, and congresses and tional advertisements, social media and PR. conventions saw an immediate drop in delegate num- This was an extraordinary project, and the first time bers. Unless tackled, this trend would have cut tour- ever that a unified and rapid communication response ist numbers by a projected 100 000 in 2010 alone, a to an unprecedented situation by the tourist industry hefty figure for a nation of 320 000 people. Immediate and various government bodies had been accom- action was required. plished. 13

The objective was to mitigate the negative impact of the volcanic eruption on the tourist industry and to maintain the previous season’s high levels of visits. The target markets were in Europe and North Amer- ica. It was intended to enhance Iceland’s image as a tourist destination by taking advantage of the media attention it had gained internationally through the volcanic eruption. The objective of saving the summer high season for tourism was achieved, with figures for travellers coming to Iceland equalling the number for 2009 which was the highest in history. Longer-term results also show that people are now more likely to visit Iceland in the future and are more positive towards Iceland as a travel destination. Birkir Hólm Gudnason is the CEO of Icelandair.

Icelandair Cargo Icelandair Cargo is an air freight service provider offering services to and from Iceland based on a strong route network. Icelandair Cargo is a low-asset company, leasing aircraft and buying capacity from other sources. The freighters are registered to Icelandair’s Air Operators Certificate (AOC) and crews are leased from Icelandair. Aircraft maintenance, warehousing, cargo handling and part of cargo sales are outsourced. Icelandair Cargo was established in late 1999 and is the largest air freight service provider in Iceland.

The company bases its business on scheduled services between Iceland, Europe and North America supported by charters and wet leases (ACMI). In addition to marketing and selling space on its own freighters, Icelandair Cargo sells cargo space on Icelandair’s passenger aircraft. Icelandair Cargo has 5 Boeing 757-200 freighters in its fleet. The company uses 1-2 cargo aircraft to operate its schedule and 3-4 cargo aircraft to operate its ACMI product offerings. The company offers its customers competitive and quick global services through interline and special pro rata agreements with other airlines. The operation is supported by trucking networks in Europe and in the USA. Sales are mainly handled by Icelandair Cargo staff in Iceland. The New York branch takes care of sales for the Americas. The company has its own subsidiary, Icelandair Logistic, located in Belgium 14

handling sales in the Benelux countries, while Gen- stores, a state-of-the-art cargo centre and a restau- eral Sales Agents (GSAs) oversee other markets. The rant and bar division in the Leifur Eiriksson Air Ter- company has GSAs in all larger and growing markets minal. IGS is a service provider enabling airlines and in Asia and most of Europe. other customers to receive all the services they require through a single provider. Icelandair is by far the Approximately 90% of exports from Iceland consist largest client of IGS, although the company has also of fresh seafood, whereas imports include produce, been contracted by other airlines. Opportunities for high-tech products and spare parts. For a number of growth go hand in hand with the growth in the num- years Icelandair Cargo has carried express freight for ber of flights and the number of passengers passing TNT, DHL and FedEx to and from Iceland and within through the airport. Europe. Gunnar S. Olsen is the Managing Director of IGS. Gunnar Már Sigurfinnsson is the Managing Director

of Icelandair Cargo. Air Iceland

Icelandair Ground Services Air Iceland is a dynamic airline which has set for itself the goal of creating a flexible and powerful airline Icelandair Ground Services (IGS) provides compre- servicing the West Nordic countries and assuming re- hensive airport ground handling services for airlines sponsibility for scheduled domestic flights within Ice- and passengers at Keflavík International Airport. IGS land as well as routes from Iceland to Greenland. Air was formed in 2001, but airport and ground opera- Iceland offers fares, based on codeshare agreement tions in Iceland have been a part of the airline opera- to the Faroe Islands all year round. Air Iceland was tion since the foundation of Icelandair Group’s prede- formed in 1997 when Icelandair Domestic merged cessors. with Flugfélag Nordurlands; thus the airline traces its IGS provides aircraft ground handling services for all roots back to 1937. types of aircraft, a first-class flight kitchen and bonded 15

Air Iceland offers flights to four destinations within Iceland, covering all major towns. Air Iceland flies from Reykjavík to Akureyri, Egilsstadir and Ísafjördur. Air Iceland offers flights to five destinations in Greenland, with year-round routes to Kulusuk, Constable Pynt and Nuuk, the capital of Greenland. In the summer, Air Iceland offer flights to Narsarsuaq and Ilulissat. Air Iceland operated six Fokker 50 and two DASH 8-100 aircraft in 2010. Air Iceland holds a strong position on the Icelandic domestic air transport market. After a stagnating period demand has been growing again on the company’s main routes and is expected to remain so. The busiest routes are from Reykjavík to Egilsstadir and Akureyri. Air Iceland plans to grow and increase profitability by offering the best available services to the Icelandic market and the tourist market in Iceland. Demand is good for all destinations in Iceland and in Greenland, the company’s most promising external market. Air Iceland aims to bolster its position as an airline servicing the West Nordic region. Árni Gunnarsson is the Managing Director of Air Iceland.

Loftleidir-Icelandic Loftleidir–Icelandic is a capacity solution company for the international passenger airlines and tour operators. Loftleidir-Icelandic was formed as a subsidiary of Icelandair (Flugleidir - currently Icelandair) in 2002, although international charter operations had been part of the general operations of the airline and its predecessors for decades. It has developed from being a marketing vehicle operating in the international ACMI (Aircraft Crew Maintenance and Insurance) and charter markets, to become a capacity solution provider. The company has expanded its horizon beyond the aircraft types traditionally operated under the Ice- landair AOC. The company currently operates AM (Aircraft and Maintenance), ACMI and full charter contracts in Eu- rope, Africa, the Middle East and North and South America. Furthermore, Loftleidir-Icelandic has established itself as a VIP business class operator by operating first-class flights around the world where the interior of the aircraft is in an exclusive VIP configura- tion. The company had five Boeing 757-200 and five Boeing 767-300 aircraft at year end 2010. 16

In mid-2003 Loftleidir-Icelandic added its first wide- body aircraft when it introduced a Boeing 767 to its fleet, which opened up new markets. This led to an increase in the proportion of ACMI projects at the expense of all-inclusive projects, which has helped to increase profitability and reduce sensitivity to external fluctuations. This trend has continued, with longer term AM leases becoming ever more prominent in the company’s contract portfolio. The company has been successful in establishing itself on the Europe- an market and enjoys increasing visibility in both the North and South American markets. Furthermore, the company has been successful in penetrating the CIS (Commonwealth of Independent States) market where demand for western-built aircraft continues to grow. Loftleidir-Icelandic will seek to use its extensive market knowledge to widen its spectrum of services further, in order to secure continued growth in revenue and profitability. In addition to the current charter, ACMI and AM operations, the company has increased its brokering activities, both in terms of arranging for third-party dry and wet leases and aircraft brokering. Gudni Hreinsson is the Managing Director of Loftleidir-Icelandic.

Icelandair Hotels Icelandair Hotels is a hotel chain in Iceland, renowned for its continued commitment to extensive and prof- itable hotel operations. The company offers both an international brand (Hilton Reykjavik Nordica) and the well-established domestic hotel brands (Icelandair Hotels and Edda Hotels). Originally, Loftleidir, a pio- neering Icelandic airline, began operating a small hotel at Keflavik Airport in 1962 and subsequently built Hotel Loftleidir in Reykjavik in 1966. After being a part of the airline’s general operations for over 30 years the hotel arm was turned into a separate and distinct subsidiary in 1998. Icelandair Hotels run the Hilton Reykjavik Nordica, 2 Icelandair Hotels and 10 Edda Hotels. In addition 5 Icelandair Hotels and 3 Edda Hotels outside of Reykja- vik are franchised. Therefore Icelandair offers in total 21 hotels. Edda Hotels is a chain of 13 summer hotels which all sit on the doorsteps of the country’s most vis- ited natural wonders and historic sites. Most of Edda 17

Hotels’ facilities serve as student housing at boarding schools during the winter. Icelandair Hotels rents all the facilities that it uses for its operations. The number of tourists visiting Iceland has grown by more than 88% over the last 10 years according to the Icelandic Tourist Board , and Icelandair Hotels has increased its turnover by 50% in the last five years. Magnea Thórey Hjálmarsdóttir is the Managing Director of Icelandair Hotels.

Iceland Travel Iceland Travel is among the largest tour operator companies in Iceland, offering a wide range of high- quality services for travellers from all over the world. Iceland Travel organises a variety of vacation pack- ages, scheduled tours, day tours and cruise services, as well as planning conferences, events and incentive programs. For over 30 years, the company has grown and prospered. Iceland Travel is a member of a number of domestic and international associations, including the Icelandic Travel Industry Association, the Iceland Convention and Incentive Bureau, the United States Tour Operators Association (USTOA), the Japan As- sociation of Travel Agents (JATA), and many more. Iceland Travel also operates VITA travel. VITA’s mission is to offer a variety of leisure tours to Icelanders travelling abroad through a high-quality service offered at a competitive price. VITA takes advantage of opportunities that arise through the company’s partnership with Icelandair, thereby offering a secure and attractive option for Icelanders seeking services and assistance for Icelandair Shared Services organised groups and individual tours, such as vaca- Icelandair Shared Services handles accounting, re- tion tours, golf and ski trips and city breaks. porting and salary processing for the companies with- Helgi Eysteinsson is the Managing Director in Icelandair Group. The company was established in of Iceland Travel. 2002 and operates a support department for finances with the shared services concept as a cornerstone. This service involves accounting, collection, payments, payroll, tax reporting and preparation of financial statements, in addition to other specialised services for managers of the Group. Icelandair Shared Services offers also services to companies outside the Group, mainly through it’s subsidiary Airline Services Estonia. The largest customers outside the Group include airlines, Air Baltic, Smartwings and Estonian Air. Magnús Kr. Ingason is the Managing Director of Icelandair Shared Services. 18 Financials

• Profit after tax ISK 4.6 billion spring of 2010. The total impact of the Ash Crisis on the • EBITDA ISK 12.6 billion Company’s result is estimated around ISK - 1.5 billion. The Company and its staff showed unprecedented resilience • Revenue growth 10% and nerve during the situation. While virtually all airlines in • Gain on sales of assets ISK 4.2 billion Europe were paralysed for about a week, Icelandair Group • Total assets ISK 84.2 billion managed to maintain its schedule by transferring its hub to Glasgow and flying to Akureyri instead of Keflavik. • Equity ratio 33.7% Operating income • Cash and cash equivalents and marketable Total revenue in 2010 amounted to ISK 88 billion, repre- securities ISK 13.0 billion senting an increase of 10% from 2009. Transport revenue in 2010 was ISK 53.9 billion, up by 10% from last year. The increase is explained by a significant growth in Icelandair’s passenger revenues, due to an improved load factor and higher yields. The geographical location of Iceland on the shortest flight Income Statement route across the North Atlantic enables Icelandair to serve Icelandair Group returned the best results in the Com- three main markets: passengers travelling FROM Iceland, pany’s history in 2010; a net profit of ISK 4.6 billion, as passengers travelling TO Iceland and Transatlantic pas- compared to a loss in 2009 of ISK 10.7 billion. senger flying VIA Iceland. The number of passengers on EBITDA amounted to ISK 12.6 billion, ISK 4.4 billion high- the Trans Atlantic market grew substantially in 2010, ac- er than in 2009. The EBITDA ratio was 14%, as compared counting for 38% of the company’s total number of pas- to 10% in the preceding year. This performance was much sengers, as compared to 28% in 2009. Icelandair’s total better than anticipated in the Group’s original budget. The passenger increase was 14%, and the airline reported a improved performance is primarily a result of a significant record load factor of 78.4%. increase in Icelandair’s transport revenues. Aircraft and aircrew lease amounted to ISK 20 billion in Like most European carriers, Icelandair Group was af- 2010, growing by ISK 0.5 billion. Other revenue was ISK fected by the volcanic eruption in Eyjafjallajökull in the 14 billion, up by ISK 0.3 billion between years.

EBITDA REVENUE DISTRIBUTION ISK millionEBITDA ISK million 14% 14% 14000 12000 12,578 20% 19% 10000

8000 8,135 Other 6000 Other operating 5,477 revenue Aircraft and 47% 54% 4000 aircrew lease Charter rev and 2000 3,053 aircraft lease Transport revenue 0 2007 Transport2008 revenue 2009 2010 2009 2010 19

Operating Expenses Depreciation and Amortisation Total operating expenses in 2010 amounted to ISK 75.4 Depreciation and amortisation amounted to ISK 6.3 bil- billion, as compared to ISK 72.2 billion in 2009, an in- lion. Depreciation of operating assets was 5.1 billion of this crease of 5%. The two largest cost items are salaries and amount, amortisation of intangible assets ISK 0.4 billion other personnel expenses and fuel costs. Together they and impairment ISK 0.7 billion. account for 47% of the Group’s operating expenses. Sala- ries and other personnel costs amounted to ISK 20.4 bil- Financial Income and Expenses lion in 2010, increasing by ISK 1.7 billion from 2009 or 9%. Net financial cost in 2010 was ISK 3.5 billion as compared The average number of full time employees grew by 1% to to ISK 6 billion in 2009 a decrease of 41%. Financial in- 2,197. Fuel cost increased by ISK 1.7 billion, which repre- come amounted to ISK 0.3 billion and increased by ISK sents a rise of 13% from the preceding year. The average 0.1 billion from 2009. Financial expenses decreased sig- jet fuel price was 724 USD per ton in 2010, as compared nificantly between years, from ISK 6.1 billion to ISK 3.7 to 568 USD per ton in 2009, an increase of 27%. billion. The biggest contributing factor was the decrease in net foreign exchange loss from ISK 1.9 billion in 2009 to Aircraft and aircrew lease decreased from ISK 12.8 bil- ISK 0.4 billion in 2010. In addition total interest expenses lion in 2009 to 11.9 billion in 2010, or by 7%. The main were reduced by 19%, from ISK 4.1 billion in 2009 to ISK reason is an investment in three aircraft in 2009 which 3.3 billion in 2010. were previously leased. Aircraft servicing, handling and navigation expenses increased by ISK 0.2 billion between years, or 4%, mainly due to the transfer of the Icelandair’s hub to Glasgow during the flight disruptions following the volcanic eruption in Eyjafjallajökull. Maintenance costs decreased by approximately ISK 0.3 billion between years, or 5%. 20

Balance Sheet Equity Assets At 31 December Icelandair Group’s total equity amounted Total assets of Icelandair Group as at 31 December 2010 to ISK 28.4 billion, as compared to ISK 14.6 billion at year- amounted to ISK 84.2 billion, as compared to ISK 89.1 end 2009. The equity ratio was up to 33.7% from 16.4% billion at year-end in the preceding year. Operating assets in 2009. The Company’s share capital amounts to ISK 5 amounted to ISK 27.6 billion, increasing by ISK 0.6 billion billion, increasing by ISK 4 billion shares during 2010 as between years. Intangible assets amounted to ISK 21.2 part of the Group’s restructuring process. The Company billion at year-end 2010 vs. ISK 23.5 billion at the end of held own shares in the amount of ISK 0.25 billion at year- 2009. The decrease is mainly due to sale of assets in con- end 2010. nection with the financial restructuring of the company. Trade and other receivables increased by ISK 4.8 billion Liabilities between years and amounted to ISK 14.6 billion. The in- Total liabilities of the Group amounted to ISK 55.8 billion at crease is mainly due to a share capital subscription of ISK the end of 2010 and were 18.7 billion, or 25% lower than 2.6 billion and an increase in other receivables amounting in the preceding year, the main reason being the financial to 2.1 billion. Assets classified as held for sale at year- restructuring of the Company. Interest-bearing debt was end 2010 are SmartLynx and the remaining share in Travel ISK 24.6 billion at year-end, down from ISK 43.1 billion Service. They amounted to 2.8 billion, down by 14.7 billion from the end of 2009. Liabilities classified as held for sale from year-end 2009 as certain assets which did not form amounted to ISK 2.4 billion at the end of 2010 and consist a part of the Company’s core business were sold in the only of SmartLynx liabilities. At the end of 2009 liabilities course of the financial restructuring. Cash and cash equiv- classified as held for sale totalled ISK 10.6 billion. alents and marketable securities increased significantly, from ISK 1.9 billion at year-end to ISK 13.0 billion at the Cash flow end of 2010 because of divestments and new share capi- Working capital from operations amounted to ISK 12.9 bil- tal paid into the Company in the amount of ISK 5.5 billion. lion in 2010, as compared to 5.4 billion in 2009. Net cash from operations was ISK 14.3 billion, increasing by ISK 5.5 billion between years. Cash and cash equivalents and marketable securitesIntangible at 31 assets December 2010 was ISK 13.0 billion, up by ISK 11.1 billion from year-end 2009.

r er Otherthe Other th O O O pe E r qu at d i in re ty g r e 10% ts 11% A fe m Cash and cash equivalents Deferred income d n s e o le s D c n e n a a i 34% t iv s h u 10% s q a e 33% C Trade and receivables Trade and payables h s 14%

s e

a l

b c Equity and

Assets y

Liability

Distribution Intangible assets Loans and borrowings

17%

Distribution

31.12.10 a

31.12.10

a s

Operating Assets Equity

17%

e e

e a

29%

25%

a s

e w

21 Risk Management

Various sources of financial and enterprise-related risks ments, mainly risk reversals and forwards. Unusual market influence the Group’s operations. The Board of Directors conditions following the 2008 bank crisis and added op- is responsible for defining policy measures to reduce the portunity costs of hedging have limited FX hedging activi- exposure of financial and enterprise risk. They outline the ties for the past two years. However, by the end of 2010 parameters and framework which need to be considered the Company had resumed hedging in accordance with its when managing risk, especially those arising from price policy as banks showed increased interest and motivation volatility, liquidity fluctuations, asset management and and the Group´s liquidity was up to adequate levels. corporate financing. An internal Risk Management Com- mittee, chaired by the President and CEO, endeavours to Fuel price risk reduce the risk exposure to the maximum feasible extent Jet fuel prices remained relatively stable in 2010, despite within the Board’s policy limits. The main policy objectives pressure from a more bullish market environment, as com- outline the methods to be used to reduce costs and dis- pared to the preceding year. Cost and liquidity aspects advantages arising from the unstable environment and prevented the company from following the policy limits of uncertainty. To that end, the financial budget is used as a 40-80% hedge ratios; yet, the seasonally high risk expo- benchmark when evaluating market conditions and hedg- sure over the summer months was covered in accordance ing strategies. In 2010 the Board of Directors updated the with the minimum policy requirements. By the end of 2010 Risk Management Policy by shortening the time horizon the Board of Directors had completed its revision of the for the exposure assessment from 12 to 9 months and by Risk Management Policy by shortening the rolling hedge adding measures to reduce the risk of liquidity side effects period from 12 to 9 months and confining the lower limits caused by hedging. Although the policy revision is rela- of the hedge ratios to the forward ticket sales. The com- tively minor it represents a recognition of the Company’s pany had started hedging part of the Q1 exposure by the improved enterprise flexibility in service provision and pric- end of 2010. ing techniques, which were put to the test in 2010 when an ash cloud impeded European flights and in 2008 when fuel prices reached historical heights and the bank crisis put liquidity under pressure.

Price of EUR in terms of USD 2006-2010 Foreign currency risk 1,7 The Group seeks to reduce its foreign exchange exposure PX_LAST arising from transactions in various currencies through a 1,6 policy of matching receipts and payments in each individual currency as far as possible. Any mismatch is dealt with 1,5 using currency trades within the Group before turning to outside parties. The biggest currency mismatch is found 1,4 in Icelandair, where the US dollar cash inflow falls short 1,3 of dollar outflow by approximately USD 100 million due to fuel costs, lease payments and capital-related payments, 1,2 which are to a large extent denominated in US dollars. This shortage is financed by a surplus of European currencies, 1,1 most importantly the Euro and Scandinavian currencies. 1,0 The Group follows a policy of hedging 40-80% of a rolling 1.1.06 9 month currency exposure and uses a portfolio of instru- 1.1.07 1.1.08 1.1.09 1.1.10 1.1.11 22

Interest rate risk Credit risk A considerable share of the Group’s outstanding loans Credit risk is linked to the amount of outstanding trade is directly related to aircraft financing and denominated receivables, allocation of liquid funds and financial assets in US dollars. The Group has for some years followed a and agreements with financial institutions relating to fi- policy of hedging 40-80% of the interest rate exposure of nancial operations, e.g. credit support annexes concerning long-term financing, with up to a 5 year horizon. Currently, hedging. The relative spread of trade receivables across foreign loans are hedged against interest rate fluctuations counterparties is also crucial for credit risk exposure. The with fixed-rate loan contracts or swap contracts, where risk involved is directly related to the fulfillment of out- the floating rate is exchanged for fixed interest rates. Ow- standing obligations by the Group’s counterparties. The ing to capital restructuring, the Company has not been in Group is aware of potential losses relating to credit risk a position to observe its risk management policy in 2010 exposure and chooses its counterparties based on busi- but has been revising the hedge position to take account ness experience and satisfactory credit ratings. of the new payment profiles. Currently 20% of the foreign USD loan interest payments are hedged in terms of con- Industry-related risk factors tractual fixed rates or swaps. At Group and subsidiary levels, management monitors and assesses the airline industry risk exposure which has his- Liquidity risk torically posed uncertainty to normal operations. A part of The Group’s policy on liquidity risk extends to three as- the company culture stems from its long history, including set classes determined by duration. Those classes are a general recognition of the value of learning from past matched against the Group’s liquidity preferences laid experience. Yet, in addition to the retrospective view, the down by the Board of Directors on an annual basis. Class- management focuses systematically on potential threats es one and two include the estimated minimum of acces- from a prospective viewpoint as the environment is ever sible funds for immediate operational liquidity and reserve changing. The group operates and thrives on well estab- purposes. Class three includes assets of longer duration lished and defined markets. As such, they can be regarded for strategic liquidity, such as medium-term investments. as invaluable intangible assets which need attention The The amounts in each class of assets are targeted once a credibility and reputation of Icelandair is crucial for its mar- year with reference to a number of economic indicators, ket status and growth. But the markets are also sensitive most importantly the annual level of fixed costs, and turn- to external factors, such as the macroeconomic elements over.

Price of Jet fuel 2006-2010 PX_LAST Price in USD pr. Tonne 6 month USD Libor 2006–2010

1600 6% PX_LAST 1400 5% 1200 4% 1000

800 3%

600 2% 400 1% 200

0 0 1.1.06 1.1.06 1.1.07 1.1.08 1.1.09 1.1.10 1.1.11 1.1.07 1.1.08 1.1.09 1.1.10 1.1.11 23

governing aggregate demand. An economic contraction Enterprise risk management usually reduces the general purchasing power of poten- Risk management has to secure a steady flow of informa- tial customers and the demand for air travel. Airlines are tion about all enterprise-related risks at the Group level and prone to even greater vulnerability when it comes to oth- thus requires centralized mapping and registration of their er types of shocks which are more sudden and forceful. inherent values and potential consequences. The Group’s The current snowy winter in Europe and the ash cloud in Risk Management Committee has placed increased em- early 2010 caused costly and unanticipated disruptions of phasis on enterprise-related risk assessment in collabora- such nature. Terrorist incidents and pandemics are also tion with Internal Audit and has focused attention on align- examples of events which need to be considered at all ing risk registration across all subsidiaries for consistency times. Those factors that can be analyzed and followed and compliance. The objective is to enhance motivation with respect to reasonable risk of occurrence and impact in risk analysis and improve risk awareness, standardize call for close monitoring and readily available contingency risk assessment into numerical values and establish the plans. The ash cloud experience put the risk management Company culture that is needed to promote everyday risk systems of Icelandair to the test and they proved success- awareness and risk-reducing measures. ful. The company seems to owe its adaptive potential and flexibility of operations to its capable human resources, contingency policies and economies of scale. The quality of these responsive processes enable the company to cope with various other incidents and hostile industry factors, such as seasonality, competition, insurance and new taxes, e.g. carbon emission charges.

Operational risk The Group distinguishes between industry-related risks and those which expose the subsidiaries on an individual company level. Methods of coping with threats of disruptions and disturbances are more decentralized when it comes to operational hazards. Again, great value is found in the long and successful history of Icelandair, which serves as the foundation, as well as the benchmark, for many of the policies and contingency plans used across the Group. The computer and communication systems are crucial for sales and market activities but also for undis- rupted internal operations. Productive equipment maintenance is needed to guarantee airworthiness. Third-party services may become bottlenecks in the production chain, whether relating to catering, ground services or flight control. Human resources need to be managed, labour dis- putes resolved and strikes prevented. The management resources constantly evaluate the risks involved and the consequences of the individual events taking place. Sce- nario projections are charted and contemplated and action plans launched based on the estimated outcomes, where collaboration is maintained between the Group and individual companies. 24 Corporate Governance

Icelandair Group holds the view that effective principles provided that such shareholder submits a written request of Corporate Governance are essential to assure share- to this effect to the Board of Directors of the Company holders and other stakeholders that the Company is do- with sufficient advance notice for the item to be included ing its best to ensure sound and effective control of the on the agenda in accordance with the Company’s Articles Company’s affairs and a high level of business ethics. Ex- of Association. ercising good Corporate Governance will, in the long run, Items of business which are not included on the agenda build a solid Company returning shareholders satisfactory may not be accepted for final decision at a shareholders’ profits on their investment. Corporate Governance serves meeting except with the consent of all the shareholders in to ensure an open and transparent relationship between the Company, but a resolution may be passed to provide the Company’s management, its Board of Directors, its guidance to the Board of Directors of the Company. Law- shareholders and other stakeholders. fully submitted motions for amendments may be put to a The guidelines on Corporate Governance issued by the vote at the meeting itself, even if they have not been laid Iceland Chamber of Commerce, NASDAQ OMX Iceland open for inspection by shareholders. An annual general and the Confederation of Icelandic Employers, along with meeting is always permitted to conclude matters which the Company’s Articles of Association, and rules for Is- it is required to address pursuant to statutory law or the suers of Securities listed on the NASDAQ OMX Iceland, Company’s Articles of Association. make up the framework for Icelandair Group’s Corporate Governance practices. Rights, Preferences and Restrictions on Shares All voting shares carry equal rights, and no privileges are It is the opinion of the Board of Directors that Icelandair attached to any shares in the Company. All the shares are Group is in full compliance with the Icelandic guidelines for freely transferable except as otherwise provided by law. Corporate Governance. Actions Necessary to change Shareholders’ rights. Shareholders’ Meetings The Articles of Association may be amended only at a law- Shareholders exercise their powers at shareholders’ meet- ful annual general meeting or extraordinary shareholders’ ings, which represent the supreme authority in all the af- meeting, provided that the notice of the meeting clearly fairs of Icelandair Group within the limits provided for by indicates that such an amendment is proposed and out- the Company’s Articles of Association and statutory law. lines the main substance of the amendment. A decision to All shareholders are permitted to attend shareholders’ amend the Articles is valid only if it has the support of at meetings, express their views and exercise their voting least 2/3 of the cast votes and the support of sharehold- rights. Shareholders may be represented by proxies, and ers controlling at least 2/3 of the share capital represent- they may be accompanied by advisors. The auditors of the ed at the meeting, provided always that no other force of Company and the President and CEO also have full rights vote is required by the Articles or statutory law, as further to speak and submit motions at shareholders’ meetings, provided in Article 93 of the Companies Act. whether they are shareholders or not. The annual general meeting shall be held before the end Notices of shareholders’ meetings must specify the busi- of May each year. ness to be addressed at the meeting. If the agenda includes motions to amend the Articles of Association of the Board Practices Company, the substance of the motion must be included in The Company’s Board of Directors exercises the supreme the notice of the meeting. Seven days before a sharehold- authority in the Company’s affairs between shareholders’ ers’ meeting, at the latest, an agenda, final submissions meetings, and it is entrusted with the task of ensuring that and, in the case of annual general meetings, the annual the organisation and activities of the Company’s operation accounts, report of the Board of Directors and the audi- are at all times in correct and proper order. tor’s report must be laid open for inspection by shareholders at the Company office. The Board of Directors is instructed in the Company’s Arti- cles of Association to appoint a President and CEO for the Each shareholder is entitled to have a specific item of busi- Company and decide the terms of his or her employment. ness included on the agenda of a shareholders’ meeting, 25

The Board of Directors and President and CEO are re- if possible. The outcome of issues is decided by force of sponsible for the management of the Company. vote, and in the event of an equality of votes, the issue is regarded as rejected. The President and CEO attends The Company’s Board of Directors must at all times en- meetings of the Board of Directors, even if he or she is not sure that there is adequate supervision of the Company’s a member of the Board, and has the right to participate accounts and the disposal of its assets and shall adopt in discussions and submit proposals unless otherwise de- working procedures in compliance with the Companies cided by the Board in individual cases. A book of minutes Act. Only the Board of Directors may assign powers of is kept of proceedings at meetings and must be signed procuration on behalf of the Company. The signatures of by participants in the meeting. A Board member who dis- the majority of the members of the Board are required to agrees with a decision made by the Board of Directors is bind the Company. The President and CEO has charge of entitled to have his or her dissenting opinion entered in the day-to-day operation of the Company and is required the book of minutes. The same applies to the President in his work to observe the policy and instructions set out by and CEO. the Company’s Board of Directors. Day-to-day operation does not include measures which are unusual or extraor- Auditing and accounts dinary. Such measures can only be taken by the President An auditing firm is elected at the annual general meeting and CEO with the specific authorization of the Board of Di- each year. The auditor examines the Company’s annual rectors, unless it is impossible to await the decision of the accounts, in accordance with generally accepted account- Board without seriously disadvantaging the operation of ing standards, and has access to all the books and docu- the Company. In such instances, the President and CEO is ments needed for this work. The accounting firm working required to consult with the Chairman of the Board, if pos- for Icelandair Group is KPMG hf, and acting on their behalf sible, after which the Board of Directors must immediately are Jón S. Helgason, and Gudný H. Gudmundsdóttir. be notified of the measures. The President and CEO shall ensure that the accounts and finances of the Company Insider Information conform to the law and accepted practices and that all as- The Board of Directors appoints a Compliance Officer and sets belonging to the Company are securely safeguarded. a Deputy Compliance Officer. The Compliance Officer’s The President and CEO is required to provide the mem- responsibilities are to ensure that all rules set by the Com- bers of the Board of Directors and Company auditors with pany regarding insider trading and insider information are any information pertaining to the operation of the Com- observed at all times. pany which they may request, as required by law. The Company’s Board of Directors consists of five mem- Audit Committee bers and two alternate members, elected at the annual The Group’s Audit Committee oversees how management general meeting for a term of one year. Those who intend monitors compliance with the Group’s risk management to stand for election to the Board of Directors must in- policies and procedures and reviews the adequacy of the form the Board in writing of their intention at least five risk management framework in relation to the risks faced days before the annual general meeting, or extraordinary by the Group. The Group’s Audit Committee is assisted in shareholders’ meeting at which elections are scheduled. its oversight role by Internal Audit. Internal Audit under- Only those who have informed the Board of their candi- takes both regular and ad hoc reviews of risk management dacy are eligible. controls and procedures, the results of which are reported to the Audit Committee. The committee shall oversee the The Board of Directors elects a Chairman and Vice- annual account of the Company and the Groups consoli- chairman from among its members, and otherwise allo- dated accounts. cates its obligations among its members as needed. The Chairman calls Board meetings. A meeting must also be The committee is responsible for evaluation of the inde- held if requested by a member of the Board of Directors pendence and the eligibility of both the Company´s auditor or the President and CEO. Meetings of the Board are valid and auditing firm. The committee shall make suggestions if attended by a majority of its members. However, impor- to the Board of Directors regarding the selection of the tant decisions shall not be taken unless all members of Company´s auditor. the Board have had an opportunity to discuss the matter, 26

The Audit Committee is appointed by the Company’s Board of Directors in accordance with article 8.8 of the Articles of Association of the Company and is composed of three members: Katrín Olga Jóhannesdóttir, chairman, Herdís Dröfn Fjeldsted and Úlfar Steindórsson.

Compensation Committee The purpose of appointing a Compensation Committee was to avoid placing the Company’s managers in control of their own remuneration and, furthermore, to ensure that the management’s remuneration is structured so as to serve the long-term interests of shareholders. The main tasks of the Compensation Committee are policy making with respect to the management’s performance- related bonuses, including stock options. The Committee conducts evaluations of management remuneration and monitors the management’s acquisition of stock in the Company. The members of the committee are: Sigurdur Helgason, chairman and Finnbogi Jónsson. Members of the Board of Directors of Icelandair Group elected at the Annual General Meeting on 21 May 2010: Board members Sigurður Helgason, Chairman Finnur Reyr Stefánsson, Vice Chairman Jón Ármann Guðjónsson Katrín Olga Jóhannesdóttir Pétur J Eiríksson Alternate board members Kristín Einarsdóttir Magnús Magnússon Tómas Kristjánsson On September 15 2010 an extraordinary shareholders meeting was held where the following members were elected to the Board of Directors: Sigurður Helgason, Chairman Finnbogi Jónsson, Vice Chairman Auður Finnbogadóttir Katrín Olga Jóhannesdóttir Úlfar Steindórsson Alternate Board members, chosen without election: Herdís Dröfn Fjeldsted Magnús Magnússon Vilborg Lofts On 30 November 2010, Auður Finnbogadóttir resigned from the Board of Directors. Herdís Dröfn Fjeldsted, alternate Board Member replaced Auður. 27 Shareholder information

Share capital Shareholders Icelandair Group’s share capital as of 31 December 2010 At the end of 2010 Icelandair Group’s shares were held amounted to ISK 5,000 million in nominal value. All shares by 871 shareholders. On 9 March 2011 the shareholders are of the same class and hold equal rights, whereby each numbered 1329. share has a nominal value of ISK 1 and entitles its holder to one vote. Shareholders‘ capital was increased by ISK 4,000 million shares during 2010 as part of the Group‘s 20 Largest shareholders 9 March 2011 restructuring process. The Company held own shares in Shareholder Holdings Shares the amount of ISK 25 million at year-end 2010. The group in % shares are listed under the code ICEAIR on the NASDAQ 1,450,539,559 29.01 OMX Iceland. Framtakssjóður Íslands hf. Íslandsbanki hf 1,047,453,881 20.95 ISK million Share Market Lífeyrissjóður verslunarmanna 603,513,186 12.07 Capital value Lífeyrissjóðir Bankastræti 7 298,000,000 5.96 Glitnir banki hf 182,205,000 3.64 Issued shares as of 1 January 1,000 3,650 Stefnir ÍS-15 143,184,226 2.86 New shares issued 4,000 11,654 Stafir lífeyrissjóður 93,622,567 1.87 Change in market value 446 Sparisjóðabanki Íslands hf 93,572,562 1.87 Issued shares as of 31 December 5,000 15,750 Stefnir ÍS-5 81,212,263 1.62 Landssjóður hf 72,347,900 1.45 Own shares at year end 25 79 Tindar verðbréf 55,727,273 1.11 Sameinaði lífeyrissjóðurinn 53,355,455 1.07 Earnings per share Stefnir – Samval 37,000,000 0.74 The Group reported net earnings of ISK 4,564 million in PÁJ Invest ehf 36,940,318 0.74 2010, corresponding to ISK 3.07 per share. The Group‘s Íslandssjóðir hf 33,839,759 0.68 equity totalled ISK 28.4 billion at year end 2010. Alnus ehf 32,992,831 0.66 2010 2009 MP Banki hf 32,181,114 0.64

Eftirlaunasj. atvinnuflugmanna 29,175,659 0.58 At year end Auður Capital 25,684,641 0.51 Market Capitalisation (ISK million) 15,750 3,650 Icelandair Group hf 25,460,000 0.51 P/E (ISK) 1.03 -0.33 P/B (ISK) 0.55 0.24 Financial calendar Number of issued shares (million) 5,000 1,000 No. of outstanding shares (million) 4,975 975 Q1 2011 Results Week 18 2011

Share price (ISK) 3.15 3.65 Q2 Results Week 32 2011

Within year Q3 Results Week 44 2011

Earnings per share (ISK) 3.07 -10.94 Q4 2011Results Week 6 2012 Average no. of outstanding shares (million) 1,486 975 Highest closing price (ISK) 3.90 13.41 The dates are subject to change Lowest closing price (ISK) 2.80 1.80 28 Endorsement and Statement by the Board of Directors and the CEO

Operations in the year 2010 The financial statements comprise the consolidated are accounted for as equity at year end 2010. The financial statements of Icelandair Group hf. (the “Com- Company has the right to purchase up to 10% of the pany”) and its subsidiaries together referred to as the nominal value of the shares of the Company according “Group”. The Group operates in the airline and tourism to the Company’s Act. sectors. The Company’s Board of Directors comprises five For the past two years the Group has been working members and three alternative members elected on on improving its debt maturity profile and equity ratio. the annual general meeting for a term of one year. On 21 October 2010 the Company and its lenders fi- Those persons willing to stand for election must nalized all documentation related to the restructuring. give formal notice thereof to the Board of Directors Investors have invested ISK 8.1 billion of new equity at least five days before the annual general meeting. which was paid to the Company on 2 November 2010 The Company’s Articles of Association may only be and 6 January 2011. Also as part of the restructur- amended at a legitimate shareholders’ meeting, pro- ing, the Group‘s largest creditors converted debt into vided that amendments and their main aspects are equity amounting to ISK 3.6 billion. Formal closing of clearly stated in the invitation to the meeting. A resolu- the financial restructuring took place on 10 February tion will only be valid if it is approved by at least 2/3 of 2011. More detailed information regarding the restruc- votes cast and is approved by shareholders controlling turing is in note 56. at least 2/3 of the share capital represented at the shareholders’ meeting. According to the consolidated statement of comprehensive income, profit for the year 2010 amounted to Shareholders at the end of the year 2010 were 1,478 ISK 4,556 million. Total comprehensive income for the but were 833 at the beginning of the year, an in- year amounted to ISK 2,144 million. According to the crease of 645 during the year. Two shareholders held consolidated statement of financial postition, equity at more than 10% of outstanding shares each at year the end of the year amounted to ISK 28,403 million, end 2010. They are Framtakssjódur Íslands slhf. with including share capital in the amount of ISK 4,975 mil- 29.0% share and Íslandsbanki hf. with 20.6% share. lion. Reference is made to the notes to the consolidated financial statements regarding information on Information on matters related to share capital is dis- changes in equity. closed in note 33.

The Board of Directors proposes that no dividend will Statement by the Board of Directors and the CEO be paid to shareholders in the year 2011. The annual consolidated financial statements for the year ended 31 December 2010 have been prepared Share capital and Articles of Association in accordance with International Financial Reporting The share capital amounted to ISK 5,000 million at Standards (IFRSs) as adopted by the EU and addition- the end of the year, from which the Company held al Icelandic disclosure requirements for consolidated own shares in the amount of ISK 25 million. The share financial statements of listed companies. capital is divided into shares of ISK 1, each with equal rights within a single class of shares listed on the Ice- According to our best knowledge it is our opinion that landic Stock Exchange (OMX Iceland). At year end the annual consolidated financial statements give a investors had unconditionally subscribed for 1,059 true and fair view of the consolidated financial perfor- million of new shares at the prize 2.5. The new shares 29

mance of the Company for the financial year 2010, its assets, liabilities and consolidated financial position as at 31 December 2010 and its consolidated cash flows for the financial year 2010.

Further, in our opinion the consolidated financial statements and the endorsement of the Board of Directors and the CEO give a fair view of the development and performance of the Group’s operations and its position and describes the principal risks and uncertain- ties faced by the Group.

The Board of Directors and the CEO have today discussed the annual consolidated financial statements of Icelandair Group hf. for the year 2010 and confirm them by means of their signatures. The Board of Di- rectors and the CEO recommend that the consolidated financial statements will be approved at the annual general meeting of Icelandair Group hf.

Reykjavík, 14 February 2011

Board of Directors: Sigurður Helgason, chairman of the board Finnbogi Jónsson Herdís Dröfn Fjeldsted Katrín Olga Jóhannesdóttir Úlfar Steindórsson Magnús Magnússon Vilborg Lofts

CEO Björgólfur Jóhannsson 30 Independent Auditors’ Report

To the Board of Directors and Shareholders of Icelandair counting principles used and the reasonableness of Group hf. accounting estimates made by management, as well as evaluating the overall presentation of the financial Report on the Consolidated Financial Statements statements. We have audited the accompanying consolidated financial statements of Icelandair Group hf., which comprise We believe that the audit evidence we have obtained the consolidated statement of financial position as at 31 is sufficient and appropriate to provide a basis for our December 2010, the consolidated statements of com- audit opinion. prehensive income, changes in equity and cash flows for the year then ended, and notes, comprising a summary Opinion of significant accounting policies and other explanatory In our opinion, the consolidated financial statements give information. a true and fair view of the consolidated financial position of Icelandair Group as at 31 December 2010, and of its Management’s Responsibility for the Financial consolidated financial performance and its consolidated Statements cash flows for the year then ended in accordance with Management is responsible for the preparation and International Financial Reporting Standards as adopted fair presentation of these consolidated financial state- by the EU. ments in accordance with International Financial Re- porting Standards as adopted by the EU, and for such Report on the Board of Directors report internal control as management determines is neces- Pursuant to the legal requirement under Article 106, sary to enable the preparation of consolidated finan- Paragraph 1, Item 5 of the Icelandic Financial State- cial statements that are free from material misstatement Act No. 3/2006, we confirm that, to the best of ment, whether due to fraud or error. our knowledge, the report of the Board of Directors accompanying the financial statements includes the infor- Auditor’s Responsibility mation required by the Financial Statement Act if not Our responsibility is to express an opinion on these disclosed elsewhere in the Financial Statements. consolidated statements based on our audit. We conducted our audit in accordance with International Reykjavík, Standards on Auditing. Those standards require that 14 February 2011 we comply with ethical requirements and plan and KPMG ehf. perform the audit to obtain reasonable assurance Jón S. Helgason whether the consolidated financial statements are Guðný H. Guðmundsdóttir free from material misstatement.

An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the consolidated financial statements. The procedures selected depend on the auditor’s judgment, including the assessment of the risks of material misstatement of the financial statements, whether due to fraud or error. In making those risk assessments, the auditor considers internal control relevant to the entity’s preparation and fair presentation of the consolidated financial statements in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the entity’s internal control. An audit also includes evaluating the appropriateness of ac- 31 Consolidated Statement of Comprehensive Income for the year 2010

Notes 2010 2009 Continuing operation Operating income: Transport revenue 10 53,944 47,139 Aircraft and aircrew lease 19,972 19,425 Other operating revenue 14,099 13,757

88,015 80,321

Operating expenses: Salaries and other personnel expenses 11 20,415 18,652 Aircraft fuel 14,927 13,250 Aircraft and aircrew lease 11,866 12,797 Aircraft handling, landing and communication 6,103 5,881 Aircraft maintenance expenses 6,475 6,825 Other operating expenses 15,651 14,781 75,437 72,186

Operating profit before depreciation and amortisation (EBITDA) 12,578 8,135 Depreciation, amortisation and impairment losses 13 ( 6,324 ) ( 6,652)

Operating profit (EBIT) 6,254 1,483 Gain on disposals in relation to financial restructuring 7 4,245 0 Profit before net finance expense 10,499 1,483 Finance income 255 163 Finance costs ( 3,787 ) ( 6,163 ) Net finance costs 14 ( 3,532 ) ( 6,000 )

Share of (loss) profit of associates, net of income tax 24 ( 391 ) 48

Profit (loss) before income tax 6,576 ( 4,469 ) Income tax 15,16 ( 1,458 ) 485

Profit (loss) from continuing operations 5,118 ( 3,984 )

Discontinued operation Loss from discontinued operation (net of income tax) 6 ( 562 ) ( 6,681 )

Profit (loss) for the year 4,556 (10,665 )

Other comprehensive income Foreign currency translation differences from foreign operations ( 615 ) 477 Foreign currency translation differences reclassified to profit or loss (2,120 ) 0 Net profit on hedge of net investment in foreign operation, net of tax 49 ( 16 ) Net investment hedge transferred to profit or loss 0 825 Effective portion of changes in fair value of cash flow hedge, net of tax 274 5,005

Other comprehensive (loss) income for the year ( 2,412 ) 6,291 Total comprehensive income (loss) for the year 2,144 ( 4,374 ) Profit (loss) attributable to Owners of the Company 4,564 ( 10,319 ) Non-controlling interest ( 8 ) ( 346 )

Profit (loss) for the period 4,556 ( 10,665 )

Total Comprehensive income (loss) attributable to Owners of the Company 2,152 ( 4,919 ) Non-controlling interest ( 8 ) 545

Total comprehensive income (loss) for the year 2,144 ( 4,374 )

Earnings per share: Basic earnings per share (ISK) 34 3.07 ( 10.94 ) Diluted earnings per share (ISK) 34 3.07 ( 10.94 ) Earnings per share from continuing operations Basic earnings per share (ISK) 34 3.45 ( 4.09 ) Diluted earnings per share (ISK) 34 3.45 ( 4.09 )

The notes on pages 35 to 75 are an integral part of these consolidated financial statements.

Amounts are in ISK million 32 Consolidated Statement of Financial Position as at 31 December 2010

Notes 2010 2009

Assets: Operating assets 18-21 27,594 27,014 Intangible assets 22-23 21,212 23,598 Investments in associates 24 178 545 Prepaid aircraft acquisitions 25 0 1,134 Long-term cost 26 918 1,347 Long-term receivables and deposits 27 1,424 3,449 Deferred tax asset 41 0 140 Total non-current assets 51,326 57,227

Inventories 28 1,580 1,393 Trade and other receivables 29 14,574 9,725 Prepayments 30 950 1,350 Assets classified as held for sale 9 2,815 17,500 Marketable securites 31 1,306 0 Cash and cash equivalents 32 11,688 1,909 Total current assets 32,913 31,877

Total assets 84,239 89,104

Equity: Share capital 4,975 975 Share premium 19,013 25,450 Reserves 4,387 6,899 Accumulated deficit 0 ( 18,755 )

Total equity attributable to equity holders of the Company 33 28,375 14,569 Non-controlling interest 28 36 Total equity 28,403 14,605

Liabilities: Loans and borrowings 35-38 21,356 13,676 Prepayments 39 0 2,254 Long-term payables 40 4,745 3,688 Deferred income tax liability 41 1,267 0 Total non-current liabilities 27,368 19,618

Loans and borrowings 35 3,248 22,714 Trade and other payables 43 14,048 14,392 Deferred income 44 8,807 7,178 Liabilities classified as held for sale 9 2,365 10,597 Total current liabilities 28,468 54,881

Total liabilities 55,836 74,499

Total equity and liabilities 84,239 89,104

The notes on pages 35 to 75 are an integral part of these consolidated financial statements.

Amounts are in ISK million 33 Consolidated Statement of Changes in Equity for the year 2010

Attributable to equity holders of the Company

Accumu- Non- Share Share Other lated controlling Total capital premium reserves deficit Total Interest equity

2009 Equity 1.1. 2009 975 25,450 1,856 ( 8,216 ) 20,065 15 20,080

Total comprehensive income 5,400 ( 10,319 ) ( 4,919 ) 545 ( 4,374 ) Share based payments ( 53 ) 86 33 33 Sale of non-controlling interest ( 304 ) ( 306 ) ( 610 ) ( 524 ) ( 1,134 )

Balance at 31 December 2009 975 25,450 6,899 ( 18,755 ) 14,569 36 14,605

2010 Equity 1.1. 2010 975 25,450 6,899 ( 18,755 ) 14,569 36 14,605

Total comprehensive income ( 2,412 ) 4,564 2,152 ( 8 ) 2,144 Share capital increase 4,000 7,654 11,654 11,654 Share premium transferred to accumulated deficit ( 14,091 ) 14,091 0 0 Share based payments reversed (100 ) 100 0 0

Balance at 31 December 2010 4,975 19,013 4,387 0 28,375 28 28,403

Changes in other reserves are shown in note 33.

The notes on pages 31 to 71 are an integral part of these consolidated financial statements.

The notes on pages 35 to 75 are an integral part of these consolidated financial statements.

Amounts are in ISK million 34 Consolidated Statement of Cash Flows for the year 2010

Notes 2010 2009

Cash flows from operating activities: Profit (loss) for the year 4,556 ( 10,665 ) Adjustments for: Depreciation and amortisation 13 6,324 6,652 Depreciation and amortisation of discontinued operations 428 265 Other operating items 53 1,581 9,121 Working capital from operations 12,889 5,373

Net change in operating assets and liabilities 54 1,440 3,408 Net cash from operating activities 14,329 8,781

Cash flows from investing activities: Acquisition of operating assets 18 ( 2,190 ) ( 2,226 ) Proceeds from the sale of operating assets 3,487 942 Acquisition of intangible assets 22 ( 214 ) ( 92 ) Prepaid aircraft acquisitions, increase ( 38 ) ( 61 ) Cash of disposed subsidiaries, change ( 1,530 ) ( 1,413 ) Cash of subsidiaries held for sale, change ( 22 ) ( 221 ) Acquisition of long-term cost ( 2,573 ) ( 3,543 ) Long-term receivables, decrease (increase) 218 ( 1,185 ) Marketable securites, change ( 1,306 ) 0 Net cash used in investing activities ( 4,168 ) ( 7,799 )

Cash flows from financing activities: Paid in share capital 5,407 0 Proceeds from non-controlling interest 0 262 Proceeds from long term borrowings 0 4,211 Repayment of long term borrowings ( 5,063 ) ( 3,355 ) Proceeds from long term payables 252 248 Repayment of short term borrowings ( 645 ) (4,649 ) Net cash used in financing activities ( 49 ) ( 3,283 )

Increase (decrease) in cash and cash equivalents 10,112 ( 2,301 ) Effect of exchange rate fluctuations on cash held ( 333 ) 145 Cash and cash equivalents at beginning of the year 1,909 4,065

Cash and cash equivalents at 31 December 32 11,688 1,909

Investment and financing without cash flow effect: Issued share capital 6,247 0 Changes in borrowings ( 11,199 ) 0 Disposals of subsidiaries 7,600 0 Other receivables ( 2,648 ) 0 Interests paid and received are shown in note 55.

The notes on pages 35 to 75 are an integral part of these consolidated financial statements.

Amounts are in ISK million 35 Notes

1. Reporting entity Icelandair Group hf. (the “Company”) is a limited liability company incorporated and domiciled in Iceland. The address of the Company´s registered office is at Reykjavíkurflugvöllur in Reykjavík, Iceland. The consolidated financial statements of the Company as at and for the year ended 31 December 2010 comprise the Company and its subsidiaries, together referred to as the “Group” and individually as “Group entities” and the Group´s interests in associates. The Group´s operations are in the airline transportation and tourism industry. The Company is listed on the Iceland Stock Exchange.

2. Basis of preparation a. Statement of compliance The consolidated financial statements have been prepared in accordance with International Financial Reporting Standards (IFRSs) as adopted by the EU. The financial statements were approved and authorised for issue by the Board of Directors on 14 February 2011.

b. Basis of measurement The consolidated financial statements are prepared on the historical cost basis except that derivative financial instruments are stated at their fair value. The methods used to measure fair values are discussed further in note 4.

c. Functional and presentation currency These consolidated financial statements have been prepared in Icelandic krona (ISK), which is the Company’s functional currency. All financial information presented in ISK has been rounded to the nearest million.

d. Use of estimates and judgements The preparation of the consolidated financial statements in conformity with IFRSs requires management to make judgements, estimates and assumptions that affect the application of accounting policies and the reported amounts of assets, liabilities, income and expenses. Actual results may differ from these estimates. Estimates and underlying assumptions are reviewed on an ongoing basis. Revisions to accounting estimates are recognised in the period in which the estimate is revised and in any future periods affected. Significant areas of estimation uncertainty and critical judgements in applying accounting policies that have the most significant effect on the amount recognised in the consolidated financial statements are: business combinations, measurement of the recoverable amounts of cash-generating units, utilisation of tax losses, accounting for an arrangement containing a lease, long-term cost, provisions and valuation of financial instruments.

3. Significant accounting principles The accounting policies set out in this note have been applied consistently to all periods presented in these consolidated financial statements, and have been applied consistently by Group entities.

a. Basis of consolidation (i) Subsidiaries Subsidiaries are entities controlled by the Group. Control exists when the Group has the power, directly or indirectly, to govern 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. The accounting policies of subsidiaries have been changed when necessary to align them with the policies adopted by the Group.

Amounts are in ISK million 36 Notes, contd.:

3a. contd.:

(ii) Loss of control Upon the loss of control, the Group derecognises the assets and liabilities of the subsidiary, any non-controlling interests and the other components of equity related to the subsidiary. Any surplus or deficit arising on the loss of control is recognised in profit or loss. If the Group retains any interest in the previous subsidiary, then such interest is measured at fair value at the date that control is lost. Subse- quently it is accounted for as an equity-accounted investee.

(iii) Investments in associates Associates are those entities in which the Group has significant influence, but not control, over the financial and operating policies. Sig- nificant influence is presumed to exist when the Group holds between 20 and 50 percent of the voting power of another entity. Associ- ates are accounted for using the equity method and are initially recognised at cost. The Group´s investment includes goodwill identified on acquisition, net of any accumulated impairment losses. The consolidated financial statements include the Group’s share of the total recognised profit or loss and other comprehensive income 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 including any long-term investments is reduced to nil and recognition of further losses is discontinued except to the extent that the Group has an obligations or made payments on behalf of the investee.

(iv) Transactions eliminated on consolidation Intra-group balances and transactions, and any unrealised income and expenses arising from intra-group transactions, are eliminated in preparing the consolidated financial statements. Unrealised gains arising from transactions with associates are eliminated against the investment 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.

b. Foreign currency (i) Foreign currency transactions Transactions in foreign currencies are translated to the respective functional currencies of Group entities at exchange rates at the dates of the transactions. Monetary assets and liabilities denominated in foreign currencies at the reporting date are retranslated to the functional currency at the exchange rate at that date. The foreign currency gain or loss on monetary items is the difference between amortised cost in the functional currency at the beginning of the year, adjusted for effective interest and payments during the year, and the amortised cost in foreign currency translated at the exchange rate at the end of the year. Non-monetary assets and liabilities denominated in foreign currencies that are measured at fair value are retranslated to the functional currency at the exchange rate at the date that the fair value was determined. Non-monetary items in a foreign currency that are measured in terms of historical cost are translated using the exchange rate at the date of the transaction. Foreign currency differences arising on retranslation are recognised in profit or loss, except for differences arising on a financial liability designated as a hedge of the net investment in a foreign operation that is effective (see (iii) below), or qualifying cash flow hedges, which are recognised in other comprehensive income.

(ii) Foreign operations and Icelandic subsidiaries with foreign functional currency The assets and liabilities of foreign operations and Icelandic subsidiaries with functional currency other than Icelandic krona, including goodwill and fair value adjustments arising on acquisitions, are translated to Icelandic kronas at exchange rates at the reporting date. The income and expenses of foreign operations are translated to Icelandic kronas at exchange rates at the dates of the transactions. Foreign currency differences arising on retranslation are recognised in other comprehensive income. When a foreign operation is disposed of, in part or in full, the relevant amount in the foreign curreny translation reserve (FCTR) within equity is transferred to profit or loss as part of the profit or loss on disposal.

Amounts are in ISK million 37 Notes, contd.:

3b. (ii) contd.:

Foreign currency differences are recognised in other comprehensive income, and presented in the foreign currency translation reserve (translation reserve) in equity. However, if the operation is a non-wholly-owned subsidiary, then the relevant proportionate share of the translation difference is allocated to the non-controlling interests. When the settlement of a monetary item receivable from or payable to a foreign operation is neither planned nor likely in the foreseeable future, foreign exchange gains and losses arising from such a monetary item are considered to form part of a net investment in a foreign operation and are recognised in other comprehensive income, and presented in the translation reserve in equity.

(iii) Hedge of net investment in foreign operations The Group applies hedge accounting to foreign currency differences arising between the functional currency of the foreign operation and the Company’s functional currency (ISK), regardless of whether the net investment is held directly or through an intermediate parent. Foreign currency differences arising on the retranslation of a financial liability designated as a hedge of a net investment in a foreign operation are recognised in other comprehensive income to the extent that the hedge is effective, and are presented within equity in the translation reserve. To the extent that the hedge is ineffective, such differences are recognised in profit or loss. When the hedged net investment is disposed of, the relevant amount in the translation reserve is transferred to profit or loss as part of the profit or loss on disposal.

c. Financial instruments (i) Non-derivative financial assets The Company initially recognises loans and receivables and deposits on the date that they are originated. All other financial assets including assets designated at fair value through profit or loss are recognised initially on the trade date at which the Company becomes a party to the contractual provisions of the instrument. The Company derecognises a financial asset when the contractual rights to the cash flows from the asset expire, or it transfers the rights to receive the contractual cash flows on the financial asset in a transaction in which substantially all the risks and rewards of ownership of the financial asset are transferred. Any interest in transferred financial assets that is created or retained by the Company is recognised as a separate asset or liability. Financial assets and liabilities are offset and the net amount presented in the statement of financial position when, and only when, the Company has a legal right to offset the amounts and intends either to settle on a net basis or to realise the asset and settle the liability simultaneously. The Company classifies non-derivative financial assets into the following categories: financial assets at fair value through profit or loss and loans and receivables.

Financial assets at fair value through profit or loss A financial asset is classified at fair value through profit or loss if it is classified as held for trading or is designated as such upon initial recognition. Financial assets are designated at fair value through profit or loss if the Company manages such investments and makes purchase and sale decisions based on their fair value in accordance with the Company’s documented risk management or investment strategy. Attributable transaction costs are recognised in profit or loss as incurred. Financial assets at fair value through profit or loss are measured at fair value, and changes therein are recognised in profit or loss.

Loans and receivables Loans and receivables are financial assets with fixed or determinable payments that are not quoted in an active market. Such assets are recognised initially at fair value plus any directly attributable transaction costs. Subsequent to initial recognition loans and receivables are measured at amortised cost using the effective interest method, less any impairment losses. Loans and receivables comprise cash and cash equivalent and trade and other receivables.

Cash and cash equivalents comprise cash balances and call deposits with original maturities of three months or less.

Amounts are in ISK million 38 Notes, contd.:

3c. contd.:

(ii) Non-derivative financial liabilities The Company initially recognises debt securities issued and subordinated liabilities on the date that they are originated. All other financial liabilities including liabilities designated at fair value through profit or loss are recognised initially on the trade date at which the Company becomes a party to the contractual provisions of the instrument. The Company derecognises a financial liability when its contractual obligations are discharged or cancelled or expire. The Company classifies non-derivative financial liabilities into the other financial liabilities category.Such financial liabilities are recognised initially at fair value plus any directly attributable transaction costs. Subsequent to initial recognition these financial liabilities are measured at amortised cost using the effective interest method. Other financial liabilities comprise loans and borrowings and trade and other payables.

(iii) Derivative financial instruments, including hedge accounting The Group generally holds derivative financial instruments to hedge its foreign currency, fuel price and interest rate risk exposures (see note 45). Derivatives are recognised initially at fair value; attributable transaction costs are recognised in profit or loss as incurred. Subse- quent to initial recognition, derivatives are measured at fair value, and changes therein are accounted for as described below. The Group holds no trading derivatives. On initial designation of the hedge, the Company formally documents the relationship between the hedging instrument(s) and hedged item(s), including the risk management objectives and strategy in undertaking the hedge transaction, together with the methods that will be used to assess the effectiveness of the hedging relationship. The Company makes an assessment, both at the inception of the hedge relationship as well as on an ongoing basis, whether the hedging instruments are expected to be “highly effective” in offsetting the changes in the fair value or cash flows of the respective hedged items during the period for which the hedge is designated, and whether the actual results of each hedge are within a range of 80-125 percent. For a cash flow hedge of a forecast transaction, the transaction should be highly probable to occur and should present an exposure to variations in cash flows that could ultimately affect reported net income.

Cash flow hedges When a derivative is designated as the hedging instrument in a hedge of the variability in cashflows attributable to a particular risk associated with a recognised asset or liability or a highly probable forecast transaction that could affect profit or loss, the effective portion of changes in the fair value of the derivative is recognised in other comprehensive income and presented in the hedging reserve in equity. Any ineffective portion of changes in the fair value of the derivative is recognised immediately in profit or loss. When the hedged item is a non-financial asset, the amount accumulated in equity is included in the carrying amount of the asset when the asset is recognised. In other cases the amount accumulated in equity is reclassified to profit or loss in the same period that the hedged item affects profit or loss. If the hedging instrument no longer meets the criteria for hedge accounting, expires or is sold, terminated or exercised, or the designation is revoked, then hedge accounting is discontinued prospectively. If the forecast transaction is no longer expected to occur, then the balance in equity is reclassified in profit or loss.

Economic hedges Hedge accounting is not applied to derivative instruments that economically hedge monetary assets and liabilities denominated in foreign currencies. Changes in the fair value of such derivatives are recognised in profit or loss as foreign currency gains and losses.

Other non-trading derivatives When a derivative financial instrument is not designated in a hedge relationship that qualifies for hedge accounting, all changes in its fair value are recognised immediately in profit or loss.

Amounts are in ISK million 39 Notes, contd.:

3c. contd.:

(iv) Compound financial instruments Compound financial instruments issued by the Group comprise convertible notes that can be converted to share capital at the option of the holder, and the number of shares to be issued does not vary with changes in their fair value. The liability component of a compound financial instrument is recognised initially at the fair value of a similar liability that does not have an equity conversion option. The equity component is recognised initially at the difference between the fair value of the compound financial instrument as a whole and the fair value of the liability component. Any directly attributable transaction costs are allocated to the liability and equity components in proportion to their initial carrying amounts. Subsequent to initial recognition, the liability component of a compound financial instruments is measured at amortised cost using the effective interest method. The equity component of a compound financial instruments is not remeasured subsequent to initial recognition.

(iv) Share capital Ordinary shares Ordinary shares are classified as equity. Incremental costs directly attributable to the issue of ordinary shares are recognised as a deduction from equity, net of any tax effects.

Repurchase of share capital When share capital recognised as equity is repurchased, the amount of the consideration paid, which includes directly attributable costs, is deducted from equity. Repurchased shares are classified as treasury shares and are presented as a deduction from total equity. When treasury shares are sold or reissued subsequently, the amount received is recognised as an increase in equity, and the resulting surplus or deficit on the transaction is transferred to / from share premium.

d. Operating assets (i) Recognition and measurement Items of operating assets are measured at cost less accumulated depreciation and accumulated impairment losses. Cost includes expenditure that is directly attributable to the acquisition of the asset. The cost of self-constructed assets includes the cost of materials and direct labour, any other costs directly attributable to bringing the assets to a working condition for their intended use, the costs of dismantling and removing the items and restoring the site on which they are located, and capitalised borrowing costs. Cost also may include transfers from equity of any gain or loss on qualifying cash flow hedges of foreign currency purchases of property, plant and equipment. Purchased software that is integral to the functionality of the related equipment is capitalised as part of that equipment. When parts of an item of operating assets have different useful lives, they are accounted for as separate items (major components) of operating assets. Gains and losses on disposal of an item of operating assets are determined by comparing the proceeds from disposal with the carrying amount of operating assets and are recognised net within “other operating revenue” in the statement of comprehensive income.

(ii) Aircrafts and flight equipment Aircrafts and flight equipment, e.g. aircraft engines and aircraft spare parts, are measured at cost less accumulated depreciation and accumulated impairment losses. When aircrafts are acquired the purchase price is divided between the aircraft itself and engines. Aircrafts are depreciated over the estimated useful life of the relevant aircraft until a residual value is met. Engines are depreciated according to flown cycles. 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.

(iii) Subsequent costs The cost of replacing a component of an item of property, plant and equipment is recognised in the carrying amount of the item if it is probable that the future economic benefits embodied within the component will flow to the Group, and its cost can be measured reliably. The carrying amount of the replaced component is derecognised. The costs of the day-to-day servicing of property, plant and equipment are recognised in profit or loss as incurred. 40 Notes, contd.:

3d. contd.:

(iv) Depreciation Depreciation is based on the cost of an asset less its residual value. Significant components of individual assets are assessed and if a component has a useful life that is different from the remainder of that asset, that component is depreciated separately. Depreciation is recognised in profit or loss on a straight-line basis over the estimated useful lives of each component of an item of property, plant and equipment. Leased assets are depreciated over the shorter of the lease term and their useful lives unless it is reasonably certain that the Group will obtain ownership by the end of the lease term. The estimated useful lives for the current and comparative periods are as follows: Useful life Aircrafts and flight equipment 4-20 years Engines Cycles Buildings 17-50 years Other property and equipment 3-8 years Depreciation methods, useful lives and residual values are reviewed at each financial year-end and adjusted if appropriate.

e. Intangible assets (i) Goodwill and other intangible assets with indefinite useful lives All business combinations are accounted for by applying the purchase method. Goodwill represents amounts arising on acquisition of subsidiaries. In respect of business acquisitions 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 tested annually for impairment. Negative goodwill arising on an acquisition is recognised directly in profit or loss. Goodwill, trademarks and slots with indefinite useful lives are stated at cost less accumulated impairment losses.

(ii) Other intangible assets Other intangible assets that have finite useful lives are measured at cost less accumulated amortisation and accumulated impairment losses. Amortisation is recognised in profit or loss on a straight-line basis over the estimated useful lives since this most closely reflects the expected pattern of consumption of the future economic benefits embodied in the asset. The estimated useful lives for the current and comparative periods are as follows: Useful life Software 3 years Customer relations 7-10 years Favourable aircraft lease contracts 2-3 years Other intangible assets 6-10 years Amortisation methods, useful lives and residual values are reviewed at each financial year-end and adjusted if appropriate.

(iii) Subsequent expenditure Subsequent expenditure is capitalised only when it increases the future economic benefits embodied in the specific asset to which it relates. All other expenditure, including expenditure on internally generated goodwill and brands, is recognised in profit or loss as incurred.

f. Prepaid aircraft acquisitions Prepaid aircraft acquisitions consist of pre-payments on Boeing aircrafts that are still to be delivered. Borrowing cost related to these pre-payments is capitalised based on the interest rate on the directly related financing.

Amounts are in ISK million 41 Notes, contd.:

3. contd.:

g. Leased assets All leases are operating leases and the leased assets are not recognised in the Group’s statement of financial position.

h. Inventories Goods for resale and supplies are measured at the lower of cost and net realisable value. The cost of inventories is based on first-in first-out principle and includes expenditure incurred in acquiring the inventories in bringing them to their existing location and condition. Net realisable value is the estimated selling price in the ordinary course of business, less the estimated costs of completion and selling expenses. Aircraft equipment is capitalised at the foreign exchange rate ruling at the date of acquisition.

i. Impairment (i) Financial assets A financial asset not carried at fair value through profit or loss is assessed at each reporting date to determine whether there is objective evidence that it is impaired. A financial asset is impaired if objective evidence indicates that a loss event has occurred after the initial recognition of the asset, and that the loss event had a negative effect on the estimated future cash flows of that asset that can be estimated reliably. An impairment loss in respect of a financial asset measured at amortised cost is calculated as the difference between its carrying amount and the present value of the estimated future cash flows discounted at the asset’s original effective interest rate. Losses are recognised in profit or loss and reflected in an allowance account against receivables. Interest on the impaired asset continues to be recognised through the unwinding of the discount. When a subsequent event causes the amount of impairment loss to decrease, the decrease in impairment loss is reversed through profit or loss.

(ii) Non-financial assets The carrying amounts of the Group’s non-financial assets, other than inventories and deferred tax assets, are reviewed at each reporting date to determine whether there is any indication of impairment. If any such indication exists, then the asset’s recoverable amount is estimated. For goodwill, and intangible assets that have indefinite useful lives or that are not yet available for use, the recoverable amount is estimated each year at the same time. An impairment loss is recognised if the carrying amount of an asset or its related cash-generating unit (CGU) exceeds its estimated recoverable amount. The recoverable amount of an asset or CGU is the greater of its value in use and its fair value less costs to sell. In assessing value in use, the estimated future cash flows are discounted to their present value using a pre-tax discount rate that reflects current market assessments of the time value of money and the risks specific to the asset or CGU. For the purpose of impairment testing, assets that cannot be tested individually are grouped together into the smallest group of assets that generates cash inflows from continuing use that are largely independent of the cash inflows of other assets or CGU. Subject to an operating segment ceiling test, for the purposes of goodwill impairment testing, CGUs to which goodwill has been allocated are aggregated so that the level at which impairment testing is performed reflects the lowest level at which goodwill is monitored for internal reporting purposes. Goodwill acquired in a business combination is allocated to groups of CGUs that are expected to benefit from the synergies of the combination. An impairment loss is recognised if the carrying amount of an asset or its cash-generating unit exceeds its estimated recoverable amount. Impairment losses are recognised in profit or loss. Impairment losses recognised in respect of cash-generating units are allocated first to reduce the carrying amount of any goodwill allocated to the units and then to reduce the carrying amount of the other assets in the unit (group of units) on a pro rata basis. The Group’s corporate assets do not generate separate cash inflows and are utilised by more than one CGU. Corporate assets are allocated to CGUs on a reasonable and consistent basis and tested for impairment as part of the testing of the CGU to which the corporate asset is allocated.

Amounts are in ISK million 42 Notes, contd.:

3i. (ii) contd.:

An impairment loss in respect of goodwill is not reversed. In respect of other assets, impairment losses recognised in prior periods are assessed at each reporting date for any indications that the loss has decreased or no longer exists. An impairment loss is reversed if there has been a change in the estimates used to determine the recoverable amount. An impairment loss is reversed only to the extent that the asset’s carrying amount does not exceed the carrying amount that would have been determined, net of depreciation or amortisation, if no impairment loss had been recognised.

j. Non-current assets held for sale Non-current assets, or disposal groups comprising assets and liabilities, that are expected to be recovered primarily through sale or distribution rather than through continuing use, are classified as held for sale or distribution. Immediately before classification as held for sale or distribution, the assets, or components of a disposal group, are remeasured in accordance with the Group’s accounting policies. Thereafter generally the assets, or disposal group, are measured at the lower of their carrying amount and fair value less costs to sell. Any impairment loss on a disposal group is first allocated to goodwill, and then to remaining assets and liabilities on pro rata basis, except that no loss is allocated to inventories, financial assets, deferred tax assets, employee benefit assets or investment property, which continue to be measured in accordance with the Group’s accounting policies. Impairment losses on initial classification as held for sale or distribution and subsequent gains and losses on remeasurement are recognised in profit or loss. Gains are not recognised in excess of any cumulative impairment loss.

k. Employee benefits (i) Defined contribution plans Obligations for contributions to pension plans are recognised as an expense in the statement of comprehensive income when they are due. (ii) Share-based payment transactions The grant date fair value of share-based payment awards to employees is recognised as an employee expense, with a corresponding increase in equity, over the period in which the employees become unconditionally entitled to the awards. The amount recognised as an expense is adjusted to reflect the actual number of awards for which the related service and non-market vesting conditions are met. The fair value of employee share-based payment awards is measured using a binomial lattice model. Measurement inputs include share price on measurement date, exercise price of the instrument, expected volatility based on weighted average historic volatility adjusted for changes expected due to publicly available information, weighted average expected life of the instruments based on historical experience and general option holder behaviour, expected dividends, and the risk-free interest rate based on government bonds. Service and non-market performance conditions attached to the transactions are not taken into account in determining fair value. Share-based payment arrangements in which the Group receives services as consideration for its own equity instruments are accounted for as equity-settled share-based payment transactions, regardless of how the equity instruments are obtained by the Group.

l. Provisions A provision is recognised in the statement of financial position 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. Provisions are determined by discounting the expected future cash flows at a pre-tax rate that reflects current market assessments of the time value of money and the risks specific to the liability.

(i) Onerous contracts A provision for onerous contracts is recognised when the expected benefits to be derived by the Group from a contract are lower than the unavoidable cost of meeting its obligations under the contract. The provision is measured at the present value of the lower of the expected cost of terminating the contract and the expected net cost of continuing with the contract. Before a provision is established, the Group recognises any impairment loss on the assets associated with that contract.

Amounts are in ISK million 43 Notes, contd.:

3l. contd.:

(ii) Overhaul commitments relating to aircrafts under operating lease With respect to the Group´s operating lease agreements, where the Group has a commitment to maintain the aircraft, provision is made during the lease term for the obligation based on estimated future cost of major airframe and certain engine maintenance checks by making appropriate charges to the statement of comprehensive income calculated by reference to the number of hours or cycles operated. Provisions are entered into the statement of financial position among non-current and current payables.

m. Deferred income Sold unused tickets, fair value of unutilized frequent flyer points and other prepayments are presented as deferred income in the statement of financial position.

Icelandair’s frequent flyer program Frequent flyer points earned or sold are accounted for as a liability on a fair value basis of the services that can be purchased for the points. The points are recognized as revenue when they are utilized or when they expire.

n. Operating income (i) Transport revenue Passenger ticket sales are not recognised as revenue until transportation has been provided. Sold refundable documents not used within twelve months from the month of sale are recognised as revenue. Sold not used, non-refundable documents are recognized as revenue two months after expected transport. Revenue from mail and cargo transportation is recognised after transportation has been provided. For customer loyalty programmes, the fair value of the consideration received or receivable in respect of the initial sale is allocated between the award credits (frequent flyer points) and the other components of the sale. Awards can also be generated through transportation services supplied by the Group. Through transportation services the amount allocated to the points is estimated by reference to the fair value of the services for which they could be redeemed, since the fair value of the points themselves is not directly observable. The fair value of the services is estimated taking into account the expected redemption rate and the timing of such expected redemptions. Such amount is deferred and revenue is recognised only when the points are redeemed and the Group has fulfilled its obligations to supply the services. The amount of revenue recognised in those circumstances is based on the number of points that have been redeemed in exchange for services, relative to the total number of points that is expected to be redeemed.

(ii) Aircraft and aircrew lease Revenue from aircraft and aircrew lease is recognised in profit or loss when the service has been provided at the end of each charter flight.

(iii) Other operating revenue Revenues include revenues from tourism, sales at airports and hotels, sold maintenance revenues and other revenues. Revenue is recognised in profit or loss when the service has been provided or sale completed by delivery of product. Gain on sale of operating assets is recognised in profit or loss after the risks and rewards of ownership have been transferred to the buyer.

o. Lease payments Operating lease payments Payments made under operating leases are recognised in profit or loss on a straight-line basis over the term of the lease. Lease incen- tives received are recognised as an integral part of the total lease expense, over the term of the lease.

p. Finance income and finance costs Finance income comprises interest income on funds invested, dividend income, foreign currency gains, and gains on hedging instruments that are recognised in profit or loss. Interest income is recognised as it accrues in profit or loss, using the effective interest method. Divi- dend income is recognised in profit or loss on the date that the Group´s right to receive payment is established.

Amounts are in ISK million 44 Notes, contd.:

3p. contd.:

Finance costs comprise interest expense on borrowings, unwinding of the discount on provisions, foreign currency losses, impairment losses recognised on financial assets, and losses on hedging instruments that are recognised in profit or loss. Borrowing costs that are not directly attributable to the acquisition of a qualifying asset are recognised in profit or loss using the effective interest method. Foreign currency gains and losses are reported on a net basis.

q. Income tax Income tax on the profit or loss for the year comprises only deferred tax. Income tax expense is recognised in profit or loss except to the extent that it relates to items recognised directly in equity or other comprehensive income. Deferred tax is recognised in respect of 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, the initial recognition of assets or liabilities that affect neither accounting nor taxable profit, 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 or substantively enacted at the reporting date. A deferred tax asset is recognised for unused tax losses and deductible temporary differences, to the extent that it is probable that future taxable profits will be available against which they can be utilised. Deferred tax assets are reviewed at each reporting date and are reduced to the extent that it is no longer probable that the related tax benefit will be realised

r. Discontinued operations A discontinued operation is a component of the Group’s business that represents a separate major line of business or geographical area of operations that has been disposed of or is held for sale, or is a subsidiary acquired exclusively with a view to resale. Classification as a discontinued operation occurs upon disposal or when the operation meets the criteria to be classified as held for sale, if earlier. When an operation is classified as a discontinued operation, the comparative statement of comprehensive income is re-presented as if the operation had been discontinued from the start of the comparative period.

s. Earnings per share The Group presents basic and diluted earnings per share (EPS) data for its ordinary shares. Basic EPS is calculated by dividing the profit attributable to ordinary shareholders of the Company by the weighted average number of ordinary shares outstanding during the year, adjusted for own shares held. Diluted EPS is determined by adjusting the profit or loss attributable to ordinary shareholders and the weighted average number of ordinary shares outstanding, adjusted for own shares held, for the effects of all dilutive potential ordinary shares.

t. Segment reporting An operating segment is a component of the Group that engages in business activities from which it may earn revenues and incur expenses, including revenues and expenses that relate to transactions with any of the Group’s other components. An operating segment’s operating results are reviewed regularly by the CEO to make decisions about resources to be allocated to the segment and assess its performance, and for which discrete financial information is available. The major revenue-earning assets of the Group are the aircraft fleet, the majority of which are registered in Iceland. Since the Group’s aircraft fleet is employed flexibly across its route network, there is no suitable basis of allocating such assets and related liabilities to geographical segments. Inter-segment pricing is determined on an arm’s length basis. Segment results, assets and liabilities include items directly attributable to a segment as well as those that can be allocated on a reasonable basis. Unallocated items comprise mainly investments and related revenue, loans and borrowings and related expenses, corporate assets and head office expenses, and income tax assets and liabilities. Segment capital expenditure is the total cost incurred during the period to acquire property, plant and equipment, and intangible assets other than goodwill. Amounts are in ISK million 45 Notes, contd.:

3. contd.:

u. New standards and interpretations not yet adopted A number of new standards, amendments to standards and interpretations are not yet effective for the year ended 31 December 2010, and have not been applied in preparing these consolidated financial statements. None of these will have material effect on the consolidated financial statements of the Group.

4. Determination of fair values A number of the Group’s accounting policies and disclosures require the determination of fair value, for both financial and non-financial assets and liabilities. Fair values have been determined for measurement and / or disclosure purposes based on the following methods. When applicable, further information about the assumptions made in determining fair values is disclosed in the notes specific to that asset or liability.

(i) Operating assets The fair value of operating assets recognised as a result of a business combination is based on market values. The market value of aircrafts and properties is the estimated amount for which they could be exchanged on the date of valuation between a willing buyer and a willing seller in an arm’s length transaction after proper marketing wherein the parties had each acted knowledgeably and willingly. The fair value of items of equipment, fixtures and fittings is based on the market approach and cost approaches using quoted market prices for similar items when available and replacement cost when appropriate.

(ii) Intangible assets The fair value of intangible assets acquired in a business combination is based on the discounted estimated royalty payments that have been avoided as a result of the trademark being owned. The fair value of other intangible assets is based on the discounted cash flows expected to be derived from the use and eventual sale of the assets.

(iii) Inventories The fair value of inventories acquired in a business combination is determined based on its estimated selling price in the ordinary course of business less the estimated costs of completion and sale, and a reasonable profit margin based on the effort required to complete and sell the inventory.

(iv) Receivables The fair value of receivables is estimated as the present value of future cash flows, discounted at the market rate of interest at the reporting date. The fair value is determined for disclosure purposes.

(v) Derivatives The fair value of forward exchange contracts is based on their listed market price, if available. If a listed market price is not available, then fair value is estimated by discounting the difference between the contractual forward price and the current forward price for the residual maturity of the contract using a risk-free interest rate based on government bonds. The fair value of interest rate swaps is based on broker quotes. Those quotes are tested for reasonableness by discounting estimated future cash flows based on the terms and maturity of each contract and using market interest rates for a similar instrument at the measurement date. Fair values reflect the credit risk of the instrument and include adjustments to take account of the credit risk of the Group entity and counterparty when appropriate.

(vi) Non-derivative financial liabilities Fair value, which is determined for disclosure purposes, is calculated based on the present value of future principal and interest cash flows, discounted at the market rate of interest at the reporting date. In respect of the liability component of convertible notes, the market rate of interest is determined by reference to similar liabilities that do not have a conversion option.

Amounts are in ISK million 46 Notes, contd.:

4. contd.:

(vii) Deferred income The amount allocated to the frequent flyers points is estimated by reference to the fair value of the discounted services for which they could be redeemed, since the fair value of the points themselves is not directly observable. The fair value of the discounted servicess for which the points, granted through a customer loyalty programme, can be redeemed takes into account the expected redemption rate and the timing of such expected redemptions. Such amount is recognised as deferred income.

5. Segment reporting Segment information is presented in the consolidated financial statements in respect of the Group’s business segments, which are the primary basis of segment reporting. The business segment reporting format reflects the Group’s management and internal reporting structure and is divided into two segments; Route network and Tourism services. As a part of the restructuring plan, the Board of Directors redefined the business model of the company, leading to subsidiaries being split between core and non-core. Accordingly the main focus of the Group will be on scheduled airline operations and tourism evolving around Ice- land, and related services. Bluebird Cargo ehf., IG Invest ehf. and 67% share in Icelease ehf. were divested at year end 2010 and are therefore included in the segment reporting. Smartlynx Latvia and the 30% share in Travel Service are defined as non-core, leading to reclassification on these companies as discontinued and held for sale. Inter-segment pricing is determined on an arm’s length basis. Segment results include items directly attributable to a segment as well as those that can be allocated on a reasonable basis.

Route network Four companies are categorised as being part of the Route Network focus of the Group: Icelandair, Icelandair Cargo, Bluebird Cargo and Icelandair Ground Services.

Tourism services Seven companies are catagorized as being part of the Tourism Services focus of the Group: Iceland Travel, Icelandair Hotels, Air Iceland, Loftleidir-Icelandic, Icelandair Shared Services, Icelease, and IG Invest.

Information about reportable segments Route network Tourism services Total 2010 2009 2010 2009 2010 2009

External revenues 63,693 56,609 24,233 23,712 87,926 80,321

Inter-segment revenue 17,120 16,617 1,667 935 18,787 17,552

Segment EBITDAR* 14,806 11,346 6,792 6,792 21,598 18,138 Segment EBITDA 10,986 7,087 1,936 1,751 12,922 8,838

Finance income 721 1,033 251 208 972 1,241 Finance costs ( 1,756 ) ( 1,768 ) ( 868 ) ( 436 ) ( 2,624 ) ( 2,204 ) Depreciation and amortisation ( 4,531 ) ( 4,520 ) ( 1,786 ) ( 2,034 ) ( 6,317 ) ( 6,554 ) Discontinued operation 0 0 0 (335 ) 0 (335 )

Reportable segment profit (loss) before income tax 5,420 1,832 (467 ) (846 ) 4,953 986 Reportable segment assets 49,968 54,930 14,395 18,600 64,363 73,530 Investment in associates 4 4 125 421 129 425 Capital expenditure 3,532 4,201 1,298 1,087 4,830 5,288 Reportable segment liabilities 38,035 47,606 11,502 17,620 49,537 65,226

*EBITDAR means EBITDA before operating lease expenses.

Amounts are in ISK million 47 Notes, contd.:

5. contd.:

Reconciliation of reportable segment revenues, profit or loss, assets and liabilities, and other material items 2010 2009

Revenues Total revenue for reportable segments 106,713 97,873 Other revenue 89 0 Elimination of inter-segment revenue ( 18,787 ) ( 17,552 )

Consolidated revenue 88,015 80,321

Profit or loss Total profit for reportable segments 4,953 986

Unallocated amounts: Gain on disposals in relation to financial restructuring 4,245 0 Corporate expenses ( 2,622 ) ( 5,455 )

Consolidated profit (loss) from continuing operations before tax 6,576 ( 4.469 )

Assets Total assets for reportable segments 64,363 73,530 Other assets 19,747 15,149 Investments in equity-accounted investees 129 425

Consolidated total assets 84,239 89,104

Liabilities Total liabilities for reportable segments 49,537 65,226 Other liabilities 6,299 9,273

Consolidated total liabilities 55,836 74,499

Other material items 2010 Reportable Consolid- segment Adjust- ated totals ments totals

Segment EBITDAR 21,598 ( 344 ) 21,254 Segment EBITDA 12,922 ( 344 ) 12,578

Finance income 972 ( 717 ) 255 Finance costs ( 2,624 ) ( 1,163 ) ( 3,787 ) Depreciation and amortisation ( 6,317 ) ( 7 ) ( 6,324 )

Capital expenditure 4,830 185 5,015

Amounts are in ISK million 48 Notes, contd.:

6. Discontinued operation As stated in the financial statements for the year 2009 the Group classified its subsidiaries, Travel Service, SmartLynx, Siglo FIU, Siglo FIJ and Siglo FIR as discontinued operations. During the first quarter 2010 the Group reclassified its ownership in the Siglo companies as part of continuing operations (see note 8). SmartLynx is still classified as discontinued and is therefore not part of the continuing operations. SmartLynx’s off balance sheet obligations were ISK 4.8 billion at year end 2010, payable in 2011 and 2012. The results of the discontinued operation are specified as follows:

Results of discontinued operation 2010 2009

Revenue 8,495 56,192 Expenses ( 9,767 ) ( 59,325 )

Results from operating activities ( 1,272 ) ( 3,133 ) Net finance costs ( 196 ) ( 536 ) Income tax 0 229

Results from operating activities, net of income tax ( 1,468 ) ( 3,440 ) Loss on sale of discontinued operation 0 ( 687 ) Guarantees of discontinued operation reversed 906 ( 1,806 ) Impairment on shares 0 ( 748 )

Loss for the year ( 562 ) ( 6,681 )

Basic loss per share ( 0,38 ) ( 6,86 ) Diluted loss per share ( 0,38 ) ( 6,86 )

Cash flows used in discontinued operation Net cash used in operating activities ( 789 ) ( 31 ) Net cash used in investing activities ( 335 ) ( 2,510 ) Net cash from financing activities 1,146 673

Net cash from (used in) discontinued operation 22 ( 1,868 )

7. Disposals As a part of the Group’s restructuring process, as stated in note 56, the Group reduced interest bearing debt by ISK 9.4 billion by selling Blue- bird Cargo ehf., and the economical benefits from IG Invest. The stake in Travel Service and the assets and liabilities of Bluebird Cargo ehf. were classified as held for sale at year end 2009. The disposal reduces total assets at year end by approx. ISK 8.5 billion and total liabilities by approx. ISK 9.6 billion. Total gain from the disposal amounts to ISK 4.2 billion and is presented seperately in the Statement of Comprehensive Income. The Group will keep the shares in Travel Service but they are still classified as asset held for sale and a sale process will be initiated in 2011. The Group will keep the first ISK 0.5 million of the potential sale price, the creditors will receive proceeds between ISK 0.5 billion ISK and ISK 1.6 billion ISK and the Group proceeds above ISK 1.6 billion. At year end the Group sold 67% of its shares in Icelease ehf. Accordingly the assets and liabilities of Icelease is not part of the consolidated statement of financial position as at 31 December 2010.

Amounts are in ISK million 49 Notes, contd.:

8. Reclassification of subsidiaries In July 2009 the Group acquired 51% in the companies Siglo FIU, Siglo FIJ and Siglo FIR. Previously the Group owned 49% of the shares and accounted for them as shares in associates. At the date of acquisition the companies were classified as discontinued operations since the ownership was considered as temporary and process of disposal had commenced. Assets and liabilities were accounted for at fair value less cost to sell at year end 2009. During the first quarter of 2010 the Group reclassified its shares in Siglo FIU, Siglo FIR and Siglo FIJ as part of the continuing operations. Following are the effects on the financial position in the year 2010.

Following are the effects on the financial position in the year 2010: Operating assets 4,053 Intangible assets 60 Trade and other receivables 10 Cash and cash equivalents 18 Loans and borrowings ( 3,527 ) Trade and other payables ( 4 )

Net assets and liabilities 610

9. Assets and liabilities classified as held for sale On 31 December 2009 assets and liabilities classified as held for sale consisted of the assets and liabilities of SmartLynx (classified as discontinued opertation, see note 6), Bluebird Cargo (disposed in 2010, see note 7), Siglo Companies (classified as continuing operations, see note 8) and the remaining 30% share in Travel Service. At year end 2010 only the assets and liabilities of SmartLynx and the remaining share in Travel Service, were classified as held for sale.

Assets and liabilities classified as held for sale are specfied as follows

2010 2009

Assets classified as held for sale Operating assets 1,012 11,080 Intangible assets 20 2,793 Other non-current assets 682 2,258 Investment in other companies 500 0 Inventories 71 106 Trade and other receivables 436 1,042 Cash and cash equivalents 94 221

2,815 17,500

Liabilities classified as held for sale Non-current loans and borrowings 1 4,025 Deferred income tax liability 0 298 Current loans and borrowings 517 2,722 Trade and other payables 1,700 3,184 Deferred income 147 368

2,365 10,597

Amounts are in ISK million 50 Notes, contd.:

10. Operating income

2010 2009

Transport revenue is specified as follows:

Passengers 48,634 41,581 Cargo and mail 5,310 5,558

Total transport revenue 53,944 47,139

11. Operating expenses

Salaries and other personnel expenses are specified as follows: Salaries 13,118 12,286 Equity-settled share based payment transactions 0 33 Contribution to pension funds 1,811 1,656 Other salary-related expenses 1,722 1,114 Other personnel expenses 3,764 3,563

Total salaries and other personnel expenses 20,415 18,652

Average number of full year equivalents 2,197 2,182

12. Auditors’ fees Fees to the Group’s auditors is specified as follows:

Audit of financial statements 35 35 Review of interim accounts 10 25 Other services 15 15

Total auditors’ fees 60 75

The abovementioned figures include fees to the auditors of all companies within the Group. Fees to auditors, other than the auditors of the Parent Company amounted to ISK 10 million during the year 2010 (2009: ISK 25 million).

13. Depreciation and amortisation The depreciation and amortisation charge in profit or loss is specified as follows: Depreciation of operating assets, see note 18 5,188 4,611 Amortisation of intangible assets, see note 22 418 494 Impairment, see note 22 718 1,019 Impairment on assets held for sale 0 528

Depreciation, amortisation and impairment losses recognised in profit or loss 6,324 6,652

Amounts are in ISK million 51 Notes, contd.:

14. Finance income and finance costs

2010 2009

Finance income and finance costs are specified as follows: Interest income on bank deposits 102 52 Other interest income 153 111

Finance income total 255 163

Interest expense on loans and borrowings 3,239 3,669 Other interest expenses 134 484 Net foreign exchange loss 414 1,984 Loss from sale of derivatives 0 26

Finance costs total 3,787 6,163

Net finance costs ( 3,532 ) ( 6,000 )

15. Income tax Income tax recognised in profit or loss is specified as follows: Deferred tax expense Origination and reversal of temporary differences 1,331 ( 547 Change in tax rate from 18% to 20% / 15% to 18% 127 62

Total income tax in profit or loss 1,458 ( 485 )

In December 2010, the Icelandic Parliament approved to increase the income tax ratio from 18% to 20% as of 1 January 2011 and the change comes into effect for the tax assessment in the year 2012. The effect thereof has been recognised in the financial statements for the year 2010 and the increase in deferred income tax liability amounts to ISK 127 million.

16. Reconciliation of effective tax rate: 2010 2009

Profit (loss) before tax and discontinued operation 6,576 ( 4,469 )

Income tax according to current tax rate 18.0% 1,184 15.0% ( 670 ) Change in tax rate from 18% to 20% / 15% to 18% 1.9% 127 ( 1.4% ) 62 Tax exempt revenues ( 4.0% ) ( 264 ) 0.2% ( 10 ) Non-deductible expenses 9.1% 596 ( 4.7% ) 211 Other items ( 2.8% ) ( 185 ) 1.7% ( 78 )

Effective tax rate 22.2% 1,458 10.9% (485 )

Amounts are in ISK million 52 Notes, contd.:

17. Income tax recognised directly in equity:

2010 2009

Operating assets ( 249 ) 0 Derivatives 77 332 Other items 40 0

Total income tax recognised directly in equity ( 132 ) 332

18. Operating assets Operating assets are specified as follows: Aircrafts Other prop- and flight erty and Gross carrying amounts equipment Buildings equipment Total

Balance at 1 January 2009 38,830 3,443 2,798 45,071 Additions during the year 1,941 47 238 2,226 Sales and disposals during the year (1,555 ) 0 ( 58 ) ( 1,613 ) Exchange rate difference 1,162 74 18 1,254 Assets classified as held for sale ( 8,835 ) ( 897 ) ( 294 ) ( 10,026 )

Balance at 31 December 2009 31,543 2,667 2,702 36,912 Additions through business combinations 6,861 0 0 6,861 Additions during the year 1,757 222 211 2,190 Sales and disposals during the year ( 4,592 ) ( 53 ) ( 595 ) ( 5,240 ) Exchange rate difference ( 2,196 ) 0 ( 15 ) ( 2,211 )

Balance at 31 December 2010 33,373 2,836 2,303 38,512

Depreciation and impairment losses Balance at 1 January 2009 7,043 356 874 8,273 Depreciation for the year 4,055 141 415 4,611 Depreciation for the year of discontinued operations 150 35 43 228 Sales and disposals during the year ( 1,085 ) 0 ( 49 ) ( 1,134 ) Exchange rate difference 371 4 9 384 Assets classified as held for sale ( 2,228 ) ( 74 ) ( 162 ) ( 2,464 )

Balance at 31 December 2009 8,306 462 1,130 9,898 Depreciation for the year 4,649 148 391 5,188 Depreciation for the year of discontinued operations 94 300 24 418 Sales and disposals during the year ( 3,104 ) ( 343 ) ( 595 ) ( 4,042 ) Exchange rate difference ( 533 ) 0 ( 11 ) ( 544 )

Balance at 31 December 2010 9.412 567 939 10.918

Carrying amounts At 1 January 2009 31,787 3,087 1,924 36,798

At 31 December 2009 23,237 2,205 1,572 27,014

At 31 December 2010 23,961 2,269 1,364 27,594

Depreciation ratios 5-25% 2-6% 13-33% Amounts are in ISK million 53 Notes, contd.:

19. Mortgages and commitments The Group’s operating assets are mortgaged to secure debt. The remaining balance of the debt amounted to ISK 22,834 million at the end of the year 2010 (2009: ISK 28,379 million).

20. Insurance value of aircrafts and flight equipment The insurance value and book value of aircrafts and related equipment of the Company at year-end 2010 are specified as follows::

Insurance Carrying value amount

Boeing - 8 aircrafts 35,871 19,195 Other aircrafts 6,805 1,164 Flight equipment 5,913 3,602

Total aircrafts and flight equipment 48,589 23,961

21. Insurance value of buildings and other operating assets The principal buildings owned by the Group at 31 December 2010 are the following:

Official assessment Insurance Carrying value value amount

Maintenance hangar, Keflavík Airport 1,657 3,141 773 Freight building, Keflavík Airport 388 736 334 Office building, Reykjavík Airport 711 1,177 264 Service building, Keflavík Airport 412 670 200 Hangar 4 and other buildings, Reykjavík Airport 570 1,025 285 Other buildings 370 1,008 413

Buildings total 4,108 7,757 2,269

Official valuation of the Group’s leased land for buildings at 31 December 2010 amounted to ISK 806 million and is not included in the statement of financial position. The insurance value of the Group’s other operating assets and equipment amounted to 4,743 million at the end of the year 2010. The carrying amount at the same time was ISK 1,364 million.

Amounts are in ISK million 54 Notes, contd.:

22. Intangible assets Intangible assets are specified as follows: Trademarks Customer Other Gross carrying amounts Goodwill and slots relations intangibles Total

Balance at 1 January 2009 26,001 7,048 1,832 2,278 37,159 Additions during the year 0 0 0 92 92 Sales and disposals during the year ( 1,468 ) ( 564 ) ( 212 ) ( 542 ) ( 2,786 ) Discontinued operation ( 1,818 ) ( 1,784 ) ( 1,014 ) ( 725 ) ( 5,341 ) Exchange rate difference 323 105 33 35 496

Balance at 31 December 2009 23,038 4,805 639 1,138 29,620 Additions during the year 0 0 0 214 214 Sales and disposals during the year ( 4,395 ) ( 315 ) ( 19 ) ( 190 ) ( 4,919 ) Exchange rate difference ( 692 ) ( 149 ) ( 12 ) ( 12 ) ( 865 )

Balance at 31 December 2010 17,951 4,341 608 1,150 24,050

Amortisation and impairment losses Balance at 1 January 2009 5,182 884 721 1,066 7,853 Amortisation for the year 4 0 158 332 494 Amortisation for the year of discontinued operation 0 0 0 37 37 Impairment loss 1,019 0 0 0 1,019 Sales and disposals during the year ( 1,468 ) ( 564 ) ( 212 ) ( 542 ) ( 2,786 ) Discontinued operation ( 12 ) 0 ( 287 ) ( 303 ) ( 602 ) Exchange rate difference 1 ( 1 ) 0 7 7

Balance at 31 December 2009 4,726 319 380 597 6,022 Amortisation for the year 17 0 119 282 418 Amortisation for the year of discontinued operation 0 0 0 10 10 Impairment loss 322 370 26 0 718 Sales and disposals during the year ( 3,664 ) ( 370 ) ( 127 ) ( 189 ) ( 4,350 ) Exchange rate difference 0 0 29 ( 9 ) 20

Balance at 31 December 2010 1,401 319 427 691 2,838

Carrying amounts At 1 January 2009 20,819 6,164 1,111 1,212 29,306

At 31 December 2009 18,312 4,486 259 541 23,598

At 31 December 2010 16,550 4,022 181 459 21,212

Amounts are in ISK million 55 Notes, contd.:

23. Impairment test Goodwill and other intangible assets that have indefinite live are tested for impairment at each reporting date. These assets were recognised at fair value on acquistion dates. Goodwill and other intangible assets with indefinite live are specified as follows:

2010 2009

Goodwill 16,550 18,312 Trademarks and slots 4,022 4,486

Total 20,572 22,798

For the purpose of impairment testing on goodwill, goodwill is allocated to the subsidiaries which represent the lowest level within the Group at which the goodwill is monitored for internal management purposes. The aggregate carrying amount of goodwill allocated to each segment (group of units) are as follows: 2010 2009 2010 2009 Goodwill Trademarks and slots

Route network 9,200 8,816 2,925 2,925 Tourism services 7,350 9,496 1,097 1,561

Total goodwill 16,550 18,312 4,022 4,486

The recoverable amounts of cash-generating units was based on their value in use. Value in use was determined by discounting the future cash flows generated from the continuing use of the units. Cash flows were projected based on actual operating results and a 5-year business plan. Cash flows were extrapolated for determining the residual value using a constant nominal growth rate which was consistent with the long-term average growth rate for the industry. Management believes that this forecast period was justified due to the long-term nature of the business.

The values assigned to the key assumptions represent management’s assessment of future trends in the airline, transportation and the tourism industry and are based on both external sources and internal sources (historical data). Value in use was based on the following key assumptions: Route Tourism network Services

Long term growth rate 4.0% 4.0% Revenue growth: Weighted average 2010 14.1% 5.0% 2011 - 2014 5.1% 8.0%

WACC 8.3–12.4% 8.9–10.9% Debt leverage 52.2% 54.7% Interest rate 3.9–4.5% 3.3–5.3%

Changes in key assumptions would have the following impact on the carrying amount of goodwill:

WACC +3% ( 196 ) 0 EBITDA - 25% ( 156 ) 0

Impairment loss amounting to ISK 718 million is recognised on the Tourism service segment.

Amounts are in ISK million 56 Notes, contd.:

22. Investments in associates Summary of aggregate financial information for significant associates, not adjusted for the percentage ownership held by the Group: Ownership 2010 2009

Barkham Associates SA – 49% EBK ehf. 25% 25% Gufa ehf. 27% – Icelease ehf., sold 67% at 31 December 2010 33% – Icesing ehf. 49% 49% Tjarnir ehf. 22% 22%

Assets 388 3,006 Liabilities 150 2,306

Revenues 66 473 Expenses 61 359 Net profit 5 114

Share of (loss) profit of associates ( 391 ) 48

25. Prepaid aircraft acquisitions Prepaid aircraft acquisitions in the statement of financial position is for the purchase of four Boeing 787 Dreamliner aircrafts to be delivered in the year 2012, 2013 and 2014. The Company has capitalised borrowing cost related to these prepayments based on the average USD interest rate. The Company also has an option to purchase three additional 787 Boeing Dreamliner aircrafts. These contracts do not form a part of the Group at year end 2010 after the disposal of IG Invest ehf. (see note 7).

26. Long-term cost Long-term cost corresponds to amounts paid for heavy maintenance of leased aircraft and is expensed over the life of the lease of the aircraft. Long-term cost will be specified as follows:

2010 2009

Long-term cost 1,498 2,208 Expensed in 2011 / 2010, classified as prepayments ( 580 ) ( 861 )

Total long-term cost 918 1,347

Long-term cost will be expensed as follows:

Expensed in 2010 – 861 Expensed in 2011 580 608 Expensed in 2012 442 313 Expensed in 2013 271 160 Expensed in 2014 147 175 Expensed in 2015 46 79 Subsequent 12 12

Total long-term cost, including current maturities 1,498 2,208

Amounts are in ISK million 57 Notes, contd.:

27. Long-term receivables and deposits Long-term receivables consist of notes, deposits for aircraft and engine lease and various other travel related security fees.

Long-term receivables and deposits are specified as follows: 2010 2009

Loans, effective interest rate 7.2% / 7.3% 70 476 Deposits 1,581 3,032

1,651 3,508 Current maturities of long-term receivables ( 227 ) ( 59 )

Long-term receivables and deposits total 1,424 3,449

Long-term receivables contractual repayments are specified as follows: Repayments in 2010 – 59 Repayments in 2011 227 505 Repayments in 2012 159 291 Repayments in 2013 475 322 Repayments in 2014 540 2,091 Repayments in 2015 8 8 Subsequent 242 232

Total loans, including current maturities 1,651 3,508

Long-term receivables and deposits denominated in currencies other than the functional currency comprise ISK 1,629 million (2009: ISK 3,277 million).

28. Inventories

Inventories are specified as follows: Spare parts 1,196 957 Other inventories 384 436

Inventories total 1,580 1,393

In 2010 the write-down of inventories to net realisable value amounted to ISK 80 million (2009: 518 million). The write-down is included in aircraft maintenance expenses and other operating expenses.

29. Trade and other receivables Trade and other receivables are specified as follows: Trade receivables 5,525 6,613 Restricted cash 2,879 1,875 Share capital subscription 2,648 0 Current maturities of long term-receivables 227 59 Other receivables 3,295 1,178

Trade and other receivables total 14,574 9,725

Amounts are in ISK million 58 Notes, contd.:

29. contd.:

At 31 December 2010 trade receivables are shown net of an allowance for doubtful debts of ISK 1,074 million (2009: ISK 448 million).

Receivables denominated in currencies other than the functional currency comprise ISK 2,911 million (2009: ISK 4,666 million) of trade receivables.

The Group’s exposure to credit and currency risks, and impairment losses related to trade and other receivables is disclosed in note 45.

30. Prepayments Prepaid expenses which relates to subsequent periods amounted to ISK 950 million (2009: ISK 1,350 million) at year end. The prepayments consist mainly of insurance expenses and prepaid rental expenses.

31. Marketable securities Marketable securities at year end consist of securities listed on the OMX Nordic and are accounted for at fair value at year end.

32. Cash and cash equivalents Cash and cash equivalents are specified as follows: 2010 2009

Bank deposits 9,645 1,877 Marketable securities 2,002 0 Cash on hand 41 32

Cash and cash equivalents total 11,688 1,909

33. Equity (i) Share capital The Company’s share capital amounts to ISK 5,000 million as decided in its Articles of Association. The holders of ordinary shares are entitled to receive dividends as declared from time to time and are entitled to one vote per share of one ISK. Shareholders capital was increased by ISK 4,000 million shares during 2010 as part of the Group’s restructuring process. Firstly, investors paid on 2 November ISK 5.5 billion in new shares at the price of ISK 2.5 per share corresponding to 2.2 billion new shares. At the same time the Group’s largest creditors converted debt in the amount of ISK 3.6 billion into shares at the price of ISK 5.0 per share which corresponds to 720 million new shares. Secondly, on 22 December, the Group sold new shares to current shareholders, employees and new investors for 2.6 billion at the price of ISK 2.5 which corresponds to 1.1 billion new shares. This was paid to the Group on 6 January 2011 and is therefore included in Trade and other receivables at year end 2010. The Company held own shares in the amount of ISK 25 million at the year end 2010 (2009: ISK 25 million).

(ii) Share capital and share premium Share premium represents excess of payment above nominal value (ISK 1 per share) that shareholders have paid for shares sold by the Company. According to Icelandic Companies Act, 25% of the nominal value of share capital must be held in reserve which can not be paid out as dividend to shareholders. Expenses directly attributable to the share capital increase in 2010 amounted to ISK 146 million and are deducted from share premium.

Amounts are in ISK million 59 Notes, contd.:

33. contd.:

(iii) Other reserves The share option reserve includes the accrued part of the fair value of share options. This reserve was reversed during the year as all share options forfeited in the beginning of 2010.

The hedging reserve comprises the effective portion of the cumulative net change in the fair value of cash flow hedging instruments related to hedged transactions that have not yet occurred.

The translation reserve comprises all foreign currency differences arising from the translation of the financial statements of foreign operations, as well as from the translation of liabilities that hedge net investment in a foreign operation.

Other reserves are specified as follows: Share option Hedging Translation Total reserve reserve reserve reserves

Balance 1 January 2009 153 ( 4,207 ) 5,910 1,856 Foreign currency translation differences for foreign operations 686 686 Net profit on hedge of net investment in foreign operation, net of tax ( 16 ) ( 16 ) Net investment hedge transferred to profit or loss 825 825 Effective portion of changes in fair value of cash flow hedges, net of tax 3,905 3,905 Share based payment ( 53 ) ( 53 ) Sale of non-controlling interest ( 304 ) ( 304 )

Balance at 31 December 2009 100 ( 302 ) 7,101 6,899

Balance at 1 January 2010 100 ( 302 ) 7,101 6,899 Foreign currency translation differences for foreign operations ( 615 ) ( 615 ) Foreign currency translation differences reclassified to profit or loss ( 2,120 ) ( 2,120 ) Net profit on hedge of net investment in foreign operation, net of tax 49 49 Effective portion of changes in fair value of cash flow hedges, net of tax 274 274 Share option reserve reversed ( 100 ) ( 100 )

Balance at 31 December 2010 0 ( 28 ) 4,415 4,387

(iv) Dividends No dividend was paid during the years 2010 and 2009 and the Board of Directors proposes that no dividends will be paid to shareholders in the year 2011.

34. Earnings per share Basic earnings per share is calculated by dividing the net profit attributable to equity holders of the Parent by the weighted average outstanding number of shares during the period and shows the earnings per each share. The calculation of diluted earnings per share takes into consideration the issued convertible notes when calculating the share capital.

Amounts are in ISK million 60 Notes, contd.:

34. contd.:

Basic earnings per share: 2010 2009

Profit (loss) for the period attributable to equity holders of the Parent 4,564 ( 10,319 ) Average share capital 1,485 975

Profit (loss) per share of ISK 1 3.07 ( 10.94)

Diluted earnings per share is equal to earnings per share as the conversion of convertible notes is not dilutive.

Profit (loss) attributable to ordinary equity holders of the parent company: Profit (loss) for the year attributable to equity holders of the Parent 4,564 ( 10,319 ) Discontinued operations 562 6,681

Total 5,126 ( 3,638 )

Weighted average number of ordinary shares in million shares

Issued ordinary shares at beginning of year 975 975 Effect of new shares sold in November 2010 485 0 Effect of new shares sold in December 2010 26 0

Weighted average number of ordinary shares at 31 December 1,486 975

Earnings per share: Earnings per share (ISK) 3.07 ( 10.94 ) Diluted earnings per share (ISK) 3.07 ( 10.94 )

Earnings per share from continuing operations: Basic earnings per share (ISK) 3.45 ( 4.09 ) Diluted earnings per share (ISK) 3.45 ( 4.09 )

35. Loans and borrowings This note provides information about the contractual terms of the Group´s interest-bearing loans and borrowings, which are measured at amortised cost. For more information about the Group´s exposure to interest rate, foreign currency and liquidity risk, see note 45.

Non-current loans and borrowings are specified as follows: Secured bank loans 22,834 11,211 Unsecured loans 1,770 2,727 Convertible notes 0 1,947

24,604 15,885 Current maturities ( 3,248 ) ( 2,209 )

Total non-current loans and borrowings 21,356 13,676

Amounts are in ISK million 61 Notes, contd.:

35. contd.:

2010 2009

Current loans and borrowings are specified as follows: Current maturities of non-current liabilities 3,248 2,209 Short-term notes 0 1,160 Short-term loans from credit institutions 0 19,345

Total current loans and borrowings 3,248 22,714

Total loans and borrowings 24,604 36,390

36. Secured bank loans are specified as follows: Nominal Total Total interest remaining remaining rates year Year of balance balance Currency end 2010 maturity 2010 2009

Secured bank loan USD 4.3% 2013-2018 15,638 10,936 Secured bank loan EUR 5.4% 2013-2017 3,699 0 Secured bank loan ISK 8.0% 2013-2017 3,227 0 Secured bank loan, indexed ISK 7.1% 2012-2028 270 275 Unsecured bond issue, indexed ISK 5.7% 2012-2023 1,770 1,731 Unsecured bank loan ISK 0 2,697 Short-term notes ISK 0 1,160 Short-term notes from credit institutions ISK/EUR/USD 0 17,644 Convertible notes ISK 0 1,947

Total interest-bearing liabilities 24,604 36,390

37. Repayments of loans and borrowings are specified as follows: 2010 2009

Repayments in 2010 - 22,714 Repayments in 2011 3,248 6,310 Repayments in 2012 3,099 1,741 Repayments in 2013 7,820 1,886 Repayments in 2014 4,242 3,530 Repayments in 2015 1,033 15 Subsequent repayments 5,162 194

Total loans and borrowings 24,604 36,390

Amounts are in ISK million 62 Notes, contd.:

38. Convertible notes

2010 2009

Convertible notes are specified as follows:

Proceeds from issue of convertible notes - nominal amount 2,000 2,000 Transaction cost ( 39 ) ( 39 )

Net proceeds 1,961 1,961 Amount classified as equity ( 110 ) ( 110 ) Expensed transaction cost 149 96 Refinancing settlement ( 2,000 ) 0

Carrying amount of liability 0 1,947

Convertible notes were issued in October 2006. As part of the refinancing structure, in note 56, the convertible note was refinanced in full.

39. Prepayments Prepayments at year end 2009 consisted of deposits from 3rd party in relation to future aircraft transactions.

40. Long-term payables Long-term payables corresponds to estimated cost of overhauling engines of leased aircraft and security deposits from charter contracts. Long term obligation at year end 2010 amounts to ISK 4,745 million (2009: ISK 3,688 million) and short term obligation, which is included in other payables amounts to 1,249 million (2009: ISK 1,589 million).

41. Deferred income tax asset (liability) The deferred income tax asset (liability) is specified as follows:

Deferred income tax liability 1.1. 140 ( 23 ) Exchange rate difference ( 48 ) ( 143 ) Income tax recognised in profit or loss ( 1,458 ) 485 Income tax recognised in equity 132 ( 332 ) Assets held for sale ( 33 ) 153

Deferred income tax (liability) asset 31.12. ( 1,267 ) 140

Amounts are in ISK million 63 Notes, contd.:

41. contd.:

Deferred tax assets and liabilities is attributable to the following: Assets Liabilities Net 2010 2009 2010 2009 2010 2009

Operating assets 0 0 ( 2,091 ) ( 1,801 ) ( 2,091 ) ( 1,801 ) Intangible assets 0 0 ( 11 ) ( 195 ) ( 11 ) ( 195 ) Derivatives 0 67 ( 7 ) 0 ( 7 ) 67 Deferred gains 0 0 ( 555 ) 0 ( 555 ) 0 Trade receivables 173 6 0 0 173 6

173 73 ( 2,664 ) ( 1,996 ) ( 2,491 ) ( 1,923 ) Tax loss carry-forwards 1,314 2,096 0 0 1,314 2,096 Other items 0 0 ( 90 ) ( 33 ) ( 90 ) ( 33 )

Deferred income tax 1,487 2,169 ( 2,754 ) ( 2,029 ) ( 1,267 ) 140

Recognised Exchange Transferred 31 1 January in income rate to assets Recognised December 2010 statement difference held for sale in equity 2010

Operating assets ( 1,801 ) ( 809 ) 0 270 249 ( 2,091 ) Intangible assets ( 195 ) 184 0 0 0 ( 11 ) Derivatives 67 0 3 0 ( 77 ) ( 7 ) Deferred gains 0 ( 555 ) 0 0 0 ( 555 ) Trade receivables 6 168 0 ( 1 ) 0 173 Tax loss carry-forwards 2,096 ( 503 ) ( 46 ) ( 233 ) 0 1,314 Other items ( 33 ) 57 ( 5 ) ( 69 ) ( 40 ) ( 90 )

140 ( 1,458 ) ( 48 ) ( 33 ) 132 ( 1,267 )

Additions Recognised Exchange through 31 1 January in income rate business Recognised December 2009 statement difference combination in equity 2009

Operating assets ( 1,788) ( 365 ) 2 350 0 ( 1,801 ) Intangible assets ( 38 ) ( 157 ) 0 0 0 ( 195 ) Derivatives 420 (13 ) (8 ) 0 ( 332 ) 67 Trade receivables 17 17 0 ( 28 ) 0 6 Tax loss carry-forwards 1,200 1,014 ( 106 ) ( 12 ) 0 2,096 Other items 166 ( 11 ) ( 31 ) ( 157 ) 0 ( 33 )

( 23 ) 485 (143 ) 153 (332 ) 140

Amounts are in ISK million 64 Notes, contd.:

42. Share-based payments The number and weighted average exercise price of share options is as follows in thousands:

Weighted Weighted average Number average Number exercise of options exercise of options price 2010 2010 price 2009 2009

Outstanding at 1 January 27.5 14,126 27.5 28,253 Forfeited during the year 27.5 ( 14,126 ) 27.5 ( 14,127 )

Outstanding at 31 December 27.5 0 27.5 14,126

Exercisable at 31 December 0 0

There were no outstanding options at year end 2010. All outstanding options at year end 2009 were forfeited in January 2010. There were no recognised expenses for the year arising from share-based payment transactions (2009: ISK 33 million).

43. Trade and other payabless Trade and other payables are specified as follows:

2010 2009

Trade payables 3,298 3,464 Derivatives used for hedging 53 369 Other payables 10,697 10,559

Total trade and other payables 14,048 14,392

The Group’s exposure to currency and liquidity risk related to trade and other payables is disclosed in note 45.

44. Deferred income Sold unused tickets, fair value of unutilized frequent flyer points and other prepayments are presented as deferred income in the statement of financial position.

45. Financial risk management Overview The Group has exposure to the following risks from its use of financial instruments: – credit risk – liquidity risk – market risk This note presents information about the Group’s exposure to each of the above risks, the Group’s objectives, policies, and processes for measuring and managing risk, and the Group’s management of capital. Further quantitative disclosures are included throughout these consolidated financial statements. Risk management framework The Board of Directors has overall responsibility for the establishment and oversight of the Group’s risk management framework. The Board has established the Risk Management Commitee, which is responsible for developing and monitoring the Group’s risk management policies. The committee reports regularly to the Board of Directors on its activities.

Amounts are in ISK million 65 Notes, contd.:

45. contd.:

The Group’s risk management policies are established to identify and analyse the risks faced by the Group, to set appropriate risk limits and controls, and to monitor risks and adherence to limits. Risk management policies and systems are reviewed regularly to reflect changes in market conditions and the Group’s activities. The Group, through its training and management standards and procedures, aims to develop a disciplined and constructive control environment in which all employees understand their roles and obligations. The Group Audit Committee oversees how management monitors compliance with the Group’s risk management policies and procedures and reviews the adequacy of the risk management framework in relation to the risks faced by the Group. The Group Audit Committee is assisted in its oversight role by Internal Audit. Internal Audit undertakes both regular and ad hoc reviews of risk management controls and procedures, the results of which are reported to the Audit Committee.

Credit risk Credit risk is the risk of financial loss to the Group if a customer or counterparty to a financial instrument fails to meet its contractual obligations, and arises principally from the Group’s receivables from customers. Trade and other receivables The Group’s exposure to credit risk is influenced mainly by the individual characteristics of each customer. Credit risk is linked to trade receivables, investment of liquid assets and agreements with financial institutions related to financial operations, e.g. hedging. The relative spread of trade receivables across counterparties is also crucial for credit risk exposure. The risk involved is directly related to the fulfilment of outstanding obligations of the Group’s counterparties. The Group is aware of potential losses related to credit risk exposure and chooses its counterparties subject to business experience and satisfactory credit ratings. The Group establishes an allowance for impairment that represents its estimate of incurred losses in respect of trade and other receivables and investments. The main components of this allowance are a specific loss component that relates to individually significant exposures, and a collective loss component established for groups of similar assets in respect of losses that have been incurred but not yet identified. The collective loss allowance is determined based on historical data of payment statistics for similar financial assets.

Guarantees The Group’s policy is to provide financial guarantees only to wholly-owned subsidiaries. However at year end 2010 the Group is still guar- anteeing from divested companies (see note 7), the PDP payments of 4, 787 Boeing Dreamliner orders but the economical proceeds from these orders have been sold to the creditors in relation to the financial restructuring explained in note 56.

Exposure to credit risk The carrying amount of financial assets represents the maximum credit exposure. The maximum exposure to credit risk at the reporting date was: Notes 2010 2009

Long-term receivables and deposits 27 1,424 3,449 Trade and other receivables 29 14,574 9,725 Marketable securities 30 1,306 0 Cash and cash equivalents 31 11,688 1,909

28,992 15,083

Amounts are in ISK million 66 Notes, contd.:

45. contd.:

Impairment losses The aging of trade receivables at the reporting date was:

Gross Impairment Gross Impairment 2010 2010 2009 2009

Not past due 4,089 ( 45 ) 5,302 ( 27 ) Past due 0-30 days 1,199 ( 293 ) 380 ( 9 ) Past due 31-120 days 837 ( 394 ) 773 ( 71 ) Past due 121-365 days 184 ( 107 ) 288 ( 162 ) More than one year 290 ( 235 ) 318 ( 179 )

Total 6,599 ( 1,074 ) 7,061 ( 448 )

The movement in the allowance for impairment in respect of trade receivables during the year was as follows:

2010 2009

Balance at 1 January 448 825 Discontinued operations 0 ( 313 ) Impairment loss recognized (reversed) 626 ( 64 )

Balance at 31 December 1,074 448

Based on historical default rates, the Group believes that no impairment allowance is necessary in respect of trade receivables not past due or past due by 30 days; a significant part of the balance relates to customers that have a good track record with the Group. The allowance account in respect of trade receivables is used to record impairment losses unless the Group is satisfied that no recovery of the amount owing is possible; at that point the amount is considered irrecoverable and is written off against the financial asset directly.

Liquidity risk Liquidity risk is the risk that the Group will encounter difficulty in meeting the obligations associated with its financial liabilities that are settled by delivering cash or another financial asset. The Group’s approach to managing liquidity is to ensure, as far as possible, that it will always have sufficient liquidity to meet its liabilities when due, under both normal and stressed conditions, without incurring unacceptable losses or risking damage to the Group’s reputation. The Group policy is to divide liquid assets into three classes depending on duration and match them against the Group’s liquidity preferences laid out by the management on annual basis. Classes one and two include the estimated minimum of accessible funds for operational liquidity, but differ in terms of asset duration. Class three includes assets of longer duration for strategic liquidity, such as medium term investments. The amounts in each class of assets are targeted once a year with reference to a number of economic indicators, most importantly the annual level of fixed costs, and turnover. The following are the contractual maturities of financial liabilities, including estimated interest payments and payments of off-balance sheet items.

Amounts are in ISK million 67 Notes, contd.:

45. contd.:

Carrying Contractual Within 12 1-2 2-5 After 2010 amount cash flows months years years 5 years

Financial liabilities Unsecured bank loans 1,770 ( 2,600 ) ( 247 ) ( 205 ) ( 586 ) ( 1,562 ) Secured bank loans 22,834 ( 27,549 ) ( 4,275 ) ( 4,053 ) ( 14,691 ) ( 4,530 ) Payables & prepayments 18,793 ( 18,793 ) ( 14,048 ) ( 2,010 ) ( 2,109 ) ( 626 )

43,397 ( 48,942 ) ( 18,570 ) ( 6,268 ) ( 17,386 ) ( 6,718 )

Off balance sheet liabilities Operating lease payments 0 ( 30,005 ) ( 7,657 ) ( 6,556 ) ( 7,343 ) ( 8,449 )

Exposure to liquidity risk 43,397 ( 78,947 ) ( 26,227 ) ( 12,824 ) ( 24,729 ) ( 15,167 )

2009 Financial liabilities Unsecured bond issue 22,694 ( 22,694 ) ( 22,694 ) 0 0 0 Secured bank loans 11,211 ( 13,266 ) ( 2,884 ) ( 2,161 ) ( 8,004 ) ( 217 ) Convertible notes 1,947 ( 2,344 ) ( 229 ) ( 2,115 ) 0 0 Payables & prepayments 20,334 ( 20,334 ) ( 14,392 ) ( 2,252 ) ( 3,690 ) 0

56,186 ( 58,638 ) ( 40,199 ) ( 6,528 ) ( 11,694 ) ( 217 )

Off balance sheet liabilities Operating lease payments 0 ( 38,137 ) ( 12,502 ) ( 10,939 ) ( 13,489 ) ( 1,207 ) Pre delivery payments 0 ( 18,531 ) ( 839 ) ( 1,966 ) ( 15,726 ) 0

0 ( 56,668 ) ( 13,341 ) ( 12,905 ) ( 29,215 ) ( 1,207 )

Exposure to liquidity risk 56,186 ( 115,306 ) ( 53,540 ) ( 19,433 ) ( 40,909 ) ( 1,424 )

Unused loan commitments at year end 2010 amounted to ISK 500 million (2009: ISK 155 million).

Market risk Market risk is the risk that changes in market prices, such as foreign exchange rates, interest rates and fuel price will affect the Group’s operations. The objective of market risk management is to manage and control market risk exposures within acceptable parameters, while optimising the return. The Group uses derivatives in order to manage market risks. All such transactions are carried out within the guidelines set by the Board of Directors. The Group seeks to apply hedge accounting in order to manage volatility in profit or loss.

Currency risk The Group is exposed to currency risk on sales, purchases and borrowings that are denominated in a currency other than the respective functional currencies of Group entities.

Amounts are in ISK million 68 Notes, contd.:

45. contd.:

The Group seeks to reduce its foreign exchange exposure arising from transactions in various currencies through a policy of matching receipts and payments in each individual currency. Then internal trades across the range of subsidiaries are arranged by the Group as possible. Nevertheless, the USD cash inflow falls short of USD outflow due to fuel costs, lease and capital related payments which are to a large extent denominated in USD. This shortage is financed by a surplus of European currencies, most importantly EUR and Scandinavian currencies. The Group follows a hedging policy of 40-80% of net exposure with a 9 month horizon and uses a portfolio of instruments, mainly forwards and options. Market failures as well as added opportunity costs has jeopardized hedging activities and currently no FX hedge contracts are in place.

Exposure to currency risk The Group’s exposure to foreign currency risk was as follows based on notional amounts in major currencies:

2010 USD EUR DKK SEK NOK

Net balance sheet exposure ( 283 ) ( 3,607 ) 392 488 767 Forecast revenue 29,276 13,060 3,011 3,536 3,182 Forecast purchases ( 39,635 ) ( 8,775 ) ( 1,270 ) ( 341 ) ( 423 ) Forward FX contracts 520 ( 520 ) 0 0 0

Net currency exposure ( 10,122 ) 158 2,133 3,683 3,526

2009 USD EUR DKK SEK NOK

Net balance sheet exposure 1,786 ( 2,199 ) 279 337 331 Forecast revenue 27,302 15,356 3,618 3,220 2,985 Forecast purchases ( 40,850 ) ( 5,675 ) ( 1,644 ) ( 340 ) ( 455 )

Net currency exposure ( 11,762 ) 7,482 2,254 3,218 2,861

The following significant exchange rates applied during the year: Reporting Average rate date spot rate 2010 2009 2010 2009

USD 122.53 123.93 115.34 125.21 EUR 162.62 172.99 154.36 180.41 DKK 21.84 23.26 20.71 24.25 SEK 17.07 16.35 17.2 17.63 NOK 20.24 19.86 19.77 21.77

Sensitivity analysis A 10% strengthening of the ISK against the following currencies at 31 December would have increased (decreased) post-tax equity and profit or loss by the amounts shown below. This analysis assumes that all other variables, in particular interest rates, remain constant. This analysis is performed on the same basis for 2009.

Amounts are in ISK million 69 Notes, contd.:

45. contd.:

Profit or 2010 Equity loss

USD 830 1.071 EUR ( 13 ) ( 37 ) DKK ( 175 ) ( 175 ) SEK ( 302 ) ( 302 ) NOK ( 289 ) ( 289 )

2009 USD 964 1.018 EUR ( 614 ) ( 642 ) DKK ( 185 ) ( 185 ) SEK ( 263 ) ( 263 ) NOK ( 235 ) ( 235 )

A 10% weakening of the ISK against the above currencies would have had the equal but opposite effect on the above currencies to the amounts shown above, on the basis that all other variables remain constant.

Interest rate risk The largest share of outstanding long term loans, carrying 3-6 months floating interest rates are directly related to aircraft financing and denominated in USD. That is a consequence of the fact that the most liquid market for commercial aircraft denominates prices in USD. The Group follows a policy of hedging 40-80% of interest rate exposure. Swap contracts are mainly used to exchange floating rates for fixed up to 5 years ahead, which currently amounts to USD 10 million and carries on average 4.65% interest rates. Due to financial market circumstances, extensions of current swap contracts have not been made available and they will expire in 2011. At the reporting date the interest rate profile of the Group´s interest bearing financial instruments was:

Carrying amount 2010 2009

Fixed rate instruments Financial assets 1,424 3,449 Financial liabilities ( 4,381 ) ( 331 )

( 2,957 ) 3,118

Variable rate instruments Financial liabilities ( 20,223 ) ( 36,059 )

Fair value sensitivity analysis for fixed rate instruments The Group does not account for any fixed rate financial assets and liabilities at fair value through profit or loss, and the Group does not des- ignate derivatives (interest rate swaps) as hedging instruments under a fair value hedge accounting model. Therefore a change in interest rates at the reporting date would not affect profit or loss. A change of 100 basis points in interest rates would have immaterial effects on the fair value.

Amounts are in ISK million 70 Notes, contd.:

45. contd.:

Cash flow sensitivity analysis for variable rate instruments A change of 100 basis points in interest rates at the reporting date would have increased (decreased) equity and profit or loss by the amounts shown below. This analysis assumes that all other variables, in particular foreign currency rates, remain constant. The analysis is performed on the same basis for 2009.

Equity 100 bp 100 bp increase decrease

2010 Variable rate instruments 11 ( 5 )

Total 11 ( 5 )

2009 Variable rate instruments 49 ( 50 )

Total 49 ( 50 )

Other market risk Fuel price risk The Group maintains a policy of hedging fuel price exposure by a ratio reflecting forward sales of trickets and up to 60% of the fuel exposure by using swaps and options. Financial market conditions and the cost of hedging the fuel price has been such that the Group deviated from its policy in 2010, except for a minimum cover for the summer season. The company resumed systematic hedgeing activities to comply with the policy by the end of the year.

Sensitivity analysis The following table demonstrates the sensitivity of financial instruments to a reasonably possible change in fuel prices, with all other variables held constant, on profit before tax and equtiy:

2010 2009 2010 2009 Effect on profit Effect on equity before tax

Increase in fuel prices by 10% 30 0 30 0 Decrease in fuel prices by 10% ( 30 ) 0 ( 30 ) 0

Capital management The Board’s policy is to maintain a strong capital base so as to sustain future development of the business.

The Board seeks to maintain a balance between the higher returns that might be possible with higher levels of borrowings and the advantages and security afforded by a sound capital position.

Amounts are in ISK million 71

46. Financial instruments and fair values The fair values of financial assets and liabilities, together with the carrying amounts shown in the statement of financial position, are as follows:

2010 2009 Carrying Carrying amount Fair value amount Fair value

Loans and receivables 15,998 15,998 13,174 13,174 Marketable securities 1,306 1,306 0 0 Cash and cash equivalents 11,688 11,688 1,909 1,909 Unsecured bond issue ( 1,770 ) ( 1,770 ) ( 23,232 ) ( 23,232 ) Secured bond loans ( 22,834 ) (22,834 ) ( 11,211 ) ( 11,211 ) Convertible notes 0 0 ( 1,947 ) ( 1,947 ) Payables and prepayments ( 18,793 ) ( 18,793 ) ( 20,334 ) ( 20,334 )

Total ( 14,405 ) ( 14,405 ) ( 41,641 ) ( 41,641 )

The basis for determining fair values is disclosed in note 4.

47. Off-balance sheet items As a lessee the Group has in place operating leases for 18 aircrafts at the end of December 2010. The leases are for thirteen Boeing 757 aircrafts and five Boeing 767 aircrafts. The Group also has in place operating leases for storage facilities, accommodations, equipment and fixtures for its operations, the longest until the year 2032. At the end of December 2010 the leases are payable as follows:

Total Total Real estate Aircrafts Other 2010 2009

In the year 2010 – – – – 12,502 In the year 2011 902 6,506 249 7,657 10,939 In the year 2012 889 5,651 16 6,556 8,967 In the year 2013 828 2,924 12 3,764 3,779 In the year 2014 787 1,121 0 1,908 741 In the year 2015 736 934 0 1,670 715 Subsequent 7,808 642 0 8,450 494

Total 11,950 17,778 277 30,005 38,137

Amounts are in ISK million 72

48. As a lessor the Company leases aircrafts on wet, dry and other various leases, both on short and long term leases. Lease income for the year 2010 amounted to ISK 19,972 million (2009; ISK 19,425 million). Contracted leases at year end were as follows:

2010 2009

In the year 2010 – 12,921 In the year 2011 12,908 10,009 In the year 2012 10,911 5,649 In the year 2013 5,683 1,392 In the year 2014 3,064 172 In the year 2015 2,689 0 Subsequent 961 0

Total 36,216 30,143

49. Capital commitments IG Invest, former subsidiary of the Company, has agreements with Boeing regarding the purchase of four Boeing 787 Dreamliner aircrafts to be delivered in the year 2012, 2013 and in 2014. IG Invest also has an option to purchase three additional 787 Boeing Dreamliner aircrafts. After the disposal of IG Invest, Icelandair Group is still the guarantor for these capital commitments but as part of the restructuring the Group sold the economical proceeds of those orders to its creditors.

50. Litigations and claims During the first half of 2007 the Icelandic Competition Authorities fined the subsidiary Icelandair ehf. due to an alleged breach of the Ice- landic Competition law. The penalty amounts to ISK 130 million after it was lowered by 30% after a decision by the Competition Appeals Committee. Icelandair ehf. took this case to the District Court of Reykjavik which ruled in February 2010 to dismiss the penalty. The court ruling was appealed to the Supreme Court of Iceland which ruled in January 2011 that due to formalities the District Court should reopen the case. The Group considers that this case will end up in favour of the Group but to be precautious ISK 65 million has been expensed in the income statement.

51. Related parties Identity of related parties The Group has a related party relationship with its shareholders with significant influence, subsidiaries, associates, and with its directors and executive officers.

Transactions with management and key personnel Salaries and benefits of management paid for their work for Group companies during the year 2010, share option agreements and shares in the Company are specified as follows:

Amounts are in ISK million 73

51. contd:

Salaries Shares held Share held and at year-end by related benefits 2010 parties

Board of Directors: Sigurður Helgason, chairman of the board 3.8 * 0.5 Finnbogi Jónsson 0.6 ** Herdís Dröfn Fjeldsted 0.3 ** Katrín Olga Jóhannesdóttir 1.9 0.2 Úlfar Steindórsson 0.6

Magnús Magnússon, alternative board member 0.6 * Vilborg Lofts, alternative board member 0.1

Auður Finnbogadóttir, former board member 0.4 Finnur Reyr Stefánsson, former board member 1.4 33.1 Jón Ármann Guðjónsson, former board member 1.4 0.2 Pétur J. Eiríksson, former board member 1.4 Kristín Einarsdóttir, former alt. board member 0.5 Tómas Kristjánsson, former alt. board member 1.0 12.1

Key employees: Björgólfur Jóhannsson CEO of Icelandair Group hf. 39.1 1.0 Sigþór Einarsson, Deputy CEO of Icelandair Group hf. 22.8 1.1 Bogi Nils Bogason, CFO of Icelandair Group hf. 21.3 1.0 Birkir Hólm Guðnason, CEO of Icelandair ehf. 22.9 Guðni Hreinsson, MD of Loftleidir - Icelandic ehf. 15.9 Gunnar Már Sigurfinnsson, MD of Icelandair Cargo ehf 19.4 0.1

Eight MD of group companies 129.4 6.0

Included in the above mentioned list of shares held by management and directors are shares held by companies controlled by them.

Transaction with associates During the year 2010 the Group did not purchase any services from associates (2009: ISK 358 million), but the Group’s revenues were ISK 6 million from associates (2009: ISK 5 million). The Group has not granted any loans to its associates. Transactions with associates are priced on an arm’s length basis.

Transaction with shareholders Shareholders with significant influence at year end 2010 are Framtakssjóður Íslands slhf. and Íslandsbanki hf. Transactions with these shareholders mainly consist of transaction in relation to the Group’s financial restructuring, disclosed in note 56.

At year end 2010 borrowings from Íslandsbanki hf. amounted to ISK 5.4 billion.

* Two board members have dismissed their rights to salaries so instead the board agreed to pay the same amount to Icelandair’s Special Children’s Travel Fund. ** The salaries of two board members are paid to Framtakssjódur Íslands slhf.

Amounts are in ISK million 74

52. Group entities The Company holds eleven subsidiaries at year end 2010 which are all included in the consolidated financial statements. They are:

Ownership interest 2010 2009

Route network: Bluebird Cargo ehf. – 100% Icelandair ehf. 100% 100% Icelandair Cargo ehf. 100% 100% Icelandair Ground Services ehf. (IGS) 100% 100%

Tourism services: Air Iceland ehf. 100% 100% Iceland Travel ehf. 100% 100% Icelandair Hotels ehf. 100% 100% Icelandair Shared Services ehf. 100% 100% Icelease ehf. – 100% IG Invest ehf. 50% 100% Loftleiðir - Icelandic ehf. 100% 100% Other operation: IceCap Ltd., Guernsey 100% 100% Discontinued operation: Smart Lynx, Latvia 100% 100%

The subsidiaries own 25 subsidiaries that are also included in the consolidated financial statements.

At year end the shares in the subsidiaries in Route Network and Tourism services are pledged as mortage against the Group’s borrowings.

53. Statement of cash flows Other operating items in the statement of cash flows are specified as follows:

Expensed long term cost 4,618 3,972 Exchange rate difference and indexation of liabilities and assets 193 2,146 Gain on disposals in relation to financial restructuring ( 4,246 ) 0 Loss from assets held for sale ( 906 ) 3,241 Loss (gain) on the sale of operating assets 162 ( 30 ) Share of (loss) profit of associates 391 ( 48 ) Income tax 1,458 ( 163 ) Other items ( 89 ) 3

Total other operating items in the statement of cash flows 1,581 9,121

Amounts are in ISK million 75

54. Net change in operating assets and liabilities in the statement of cash flows is specified as follows:

2010 2009

Inventories, (increase) decrease ( 187 ) 385 Trade and other receivables, decrease 654 437 Trade and other payables, increase ( 656 ) ( 61 ) Deferred income, increase 1,629 2,647

Net change in operating assets and liabilities in the statement of cash flows 1,440 3,408

55. Additional cash flow information: Interests paid 1,703 3,083 Interests received 219 113

56. Restructuring The resturcturing of the Group’s Financial Position was finalized on 21 October 2010. The financial restructuring is based on three components: • Firstly, investors have invested ISK 8.0 billion in new shares at the price of ISK 2.5 per share corresponding to a subscription of 3.2 billion new shares in Icelandair Group. • Secondly, the Group’s largest creditors converted debt in the amount of ISK 3.6 billion into new shares at the price of ISK 5.0 per shares which corresponds to 720 million new shares. • Thirdly, the financial restructuring of the Group reduces interest bearing debt by ISK 9.4 billion through the transfer and sale of certain assets which formed a part of the Group’s core business. The sales and purchase contracts relating to these assets contained standard reservations regarding the approval of relevant authorities. All conditions were met on 10 Febuary 2011 and the effects of the restructuring is included in the Financial Statements. Capital gain from the sale amounts to ISK 4.3 billion and equity increased by ISK 1.3 billion.

57. Ratios 2010 2009

Working capital ratio 1.16 0.58 Equity ratio 0.34 0.16 Intrinsic value of share capital 5.71 14.98

Amounts are in ISK million 76

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2010 Report Annual

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Felling 2010 Report Annual Group Icelandair

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