BOARD OF DIRECTORS' REPORT FOR THE FINANCIAL YEAR, JAN 1 - DEC 31, 2003
General Review
During a year that was difficult for the whole industry, Finnair expanded its operations by acquiring a Swedish no-frills airline, strengthened its balance sheet but made a loss.
A second quarter collapse in demand and load factors stabilized during the late summer and a gradual recovery, following the ending of the Iraq war and the SARS epidemic, continued during the latter part of the year. Strong demand for Finnair's Asian traffic and the price reform implemented in September contributed to the recovery towards the end of the year. Due to the first part of the year, the passenger load factor for all traffic weakened, however, by 2.3 percentage units to 69.6 per cent during the financial year.
At the beginning of September, Finnair implemented its major price reform. Pricing of domestic and European flights was changed to a flexible flight-based pricing scheme determined by supply and demand that corresponds with customers' expectations and needs.
Finnair has maintained its position among the top European airlines for service quality and punctuality.
Financial Result
The Group's result after financial items was -21.7 million euros. The corresponding figure for 2002 was 54.4 million euros. Operating profit before depreciation, aircraft leasing payments and capital gains (EBITDAR) weakened 26.3 per cent to 155.9 million euros (211.6 million). The EBITDAR margin was 10.0 per cent, compared with 12.8 per cent the previous year.
Turnover fell by 6.0 per cent to 1,557.6 million euros. Unit revenues for passenger traffic declined by 8.5 per cent. This was due to a fall in price levels, the decline in premium class volumes, weak dollar, the price reform implemented in September and growth in the relative share of long-haul traffic. In long-haul traffic the level of prices, but also the level of production costs, is lower than average. Unit revenues for cargo traffic fell by 7.3 per cent, which contributed to a fall in unit revenues overall of 9.1 per cent.
Operating costs fell during the financial year by 2.2 per cent and unit costs of flight operations by 7.2 per cent. The objective of the cost-cutting and operational efficiency programme, initiated in spring 2003, is to reduce unit costs by at least 15 per cent in the years 2003-2005. Overall, the programme has proceeded according to plan and during 2003, approximately one third of the targeted savings were achieved.
There were significant falls in the cost of fuel, maintenance, ground handling, catering and marketing as well as depreciation. The cost of outsourced operations contributed to a rise in other operating costs.
A weaker US dollar also contributed to the decline in operating costs. The Group has clearly more dollar-denominated costs than revenues. The most significant dollar-denominated items are fuels and aircraft leasing payments. Excluding foreign exchange hedging, a ten per cent weakening of the dollar makes an annual positive contribution to the result of around 20-25 million euros.
Personnel costs rose by 1.0 per cent. The proportion of the Group's total operating costs accounted for by personnel costs rose to 30.6 per cent, compared to 29.7 per cent in 2002. In the year under review, contributions to Finnair's pension fund totalled 84.5 million euros, nearly the same as in the previous year. The assets of Finnair's pension fund fully cover its pension liabilities.
Capital gains amounted to 22.1 million euros. The most significant items were a 12.2 million euro capital gain arising from a sale and lease-back arrangement for one MD-11 aircraft and a 2.8 million euro gain from the sale of Finnair Catering Oy's wine wholesaling business. The previous year, capital gains came to 35.5 million euros.
Return on capital employed was 0.0 per cent (7.6%) and return on equity -2.5 per cent (5.9%). Earnings per share were -0.19 euros, whereas the year before the figure was 0.43 euros. Equity per share at the end of the financial year amounted to 7.24 euros, compared with 7.58 euros the year before.
Investment and Financing
Capital investments excluding advance payments for the financial year totalled 82.3 million euros (102.4 million euros). Capital investments included the purchase of one new Airbus A320 aircraft in December 2003. Another five new Airbus A320 aircraft and one MD-11 wide-bodied aircraft delivered were acquired on long-term operational lease agreements.
Operational cash flow, excluding capital gains, was 59.6 million euros, compared with 132.7 million euros a year earlier. The Group's liquid assets exceeded interest bearing liabilities at the end of the financial year by18 million euros, compared to net debt of 20 million euros at the beginning of the financial year. The gearing ratio has improved from 3.1 per cent at the beginning of the financial year to -2.9 per cent. The equity ratio, 44.4 per cent, has remained at the same level as it was at the end of the previous year. Both figures are clearly better than the set targets.
At the end of the financial year, the Group had liquid cash reserves of 294.3 million euros, in addition to which there was a total of 197.9 million euros in unused committed loan facilities.
Shares and Share Capital
During 2003 the highest price for the Finnair Plc share on the Helsinki Stock Exchange was 5.58 euros, while the lowest price was 3.20 euros and the average price 4.29 euros. The total market value of the company's shares on December 31, 2003 was 449.1 million euros. At the beginning of the financial year the market value was 317.8 million euros. During 2003 some 17.8 million (16.7 million) of the company's shares were traded on the Helsinki Stock Exchange. At the end of the period under review, the government of Finland owned 58.4 per cent of the company's shares, while 16.6 per cent were held by foreign investors or in the name of a nominee.
If all the convertible debentures and option certificates in circulation on December 31, 2003 were converted into Finnair Plc shares, the Finnish government's holding would amount to 55.2 per cent. On the basis of the unconverted debentures and option certificates in circulation on December 31, 2003, the company's share capital could rise by not more than 4,180,143.60 euros, corresponding to 4,917,816 shares.
On April 9, 2003 the Annual General Meeting authorized the Board of Directors to purchase and dispose of the company's own shares up to a maximum of 4,100,000 shares. The authorizations apply to shares amounting to less than 5 per cent of the total share capital of the company. To date, the authorizations have not been exercised.
Trading in Finnair Plc 2000 A stock options (2,000,000 units) commenced on the Main List of the Helsinki Stock Exchange on May 2, 2003. By December 31, 2003 a total of 2,500 new shares were subscribed for using the A stock options. In the financial statements the new shares are entered in share issues and in the share premium account. The company booked in full a provision for social security expenses arising from A stock options, namely a total of 155,000 euros.
Personnel
During the financial year, the average number of staff employed by the Finnair Group amounted to 9,981 people, which was 4.7 per cent fewer than a year before. The decline in staff numbers is a result of measures implemented under the cost-cutting programme as well as the transfer to partners of certain functions, such as ground handling and loading services at domestic airports.
The company has labour contracts valid until the early part of next year with all the labour unions.
The Finnair Group has a profit bonus scheme that allows the employees of the parent company and certain subsidiaries to participate in a profit bonus payable on the basis of the Group's result and return on capital employed. A profit bonus is paid into a personnel fund, which is obliged to invest part of the bonus in Finnair Plc's shares. The preconditions for the payment of a profit bonus were not fulfilled in 2003.
The Group also operates an incentive scheme based on a balanced scorecard, which is defined separately for each business unit. The total amount of bonuses in 2003 was 1.8 million euros.
Governance
The Annual General Meeting, held on April 9, 2003, decided to abolish the Supervisory Board. The authority to appoint and dismiss the President & CEO was transferred to the Board of Directors and the authority to elect the Board of Directors was transferred to the Annual General Meeting.
The following were re-elected to the Board of Directors: Christoffer Taxell as Chairman, and as members Kari Jordan (Vice Chairman), Samuli Haapasalo, Antti Satuli, Helena Terho and Kaisa Vikkula. Markku Hyvärinen was elected as a new member.
Secretary of State Antti Satuli died of a sudden illness on April 17, 2003
Performance of the Divisions
At the same time as Finnair is preparing to apply the IFRS accounting principles in 2005, a system of four divisional reports will be introduced in external reporting from the beginning of 2004. The reporting segments will be: Scheduled Passenger Traffic, Leisure Traffic, Aviation Services and Travel Services. In 2003 the Cargo and Support Services business areas were also reported on separately in addition to the above.
Scheduled Passenger Traffic
This division is responsible for sales, service concepts, flight operations and the procurement and financing of aircraft. Scheduled Passenger Traffic leases to the Leisure Traffic division the crews it requires for its operations. The division also leases cargo capacity for the Group's cargo operations. In 2003 the division's units included Finnair's Scheduled Passenger Traffic and Aero Airlines, which were joined as of December 2003 by Nordic Airlink, which operates in the Scandinavian market.
In financial year 2003, the turnover of the division fell by 9.6 per cent to 1074.5 million euros. The operating loss for the division, excluding capital gains, was 41.7 million euros, compared to a operating profit of 31.7 million euros in the corresponding period last year.
A rise in the relative share of lower price-level, long-haul traffic as well as a more competitive market climate and decline in premium class volumes contributed to a 10.7 per cent fall in unit revenues for scheduled passenger traffic in 2003. The price reform implemented in September had an impact on final quarter unit revenues, which fell 22.6 per cent in scheduled passenger traffic. At the beginning of September, Finnair discontinued the payment of commission fees to travel agencies in Finland, which will reduce distribution costs considerably in future.
Demand for Finnair's scheduled passenger traffic services fell in the first half of the year by 8.7 per cent, but rose in the second half by 13.1 per cent. Finnair's scheduled passenger traffic demand grew by 2.4 per cent over the year as a whole while capacity grew by 6.9 per cent, leading to a fall in passenger load factor by 2.8 percentage points to 62.2 per cent. The Iraq war and the SARS epidemic in particular adversely affected demand at the beginning of the year.
Finnair's market share in traffic between Asia and Europe has grown as a result of increased capacity and new destinations. As competitors strongly increased their capacity, Finnair's market share in domestic and European traffic fell slightly.
The number of business class passengers on Finnair's international scheduled flights fell by 16.7 per cent in January-September. As of September 2003, Finnair no longer reports business class passenger numbers separately. Owing to the price reform and the shift to a one-class service on certain European routes, earlier figures are no longer suitable for comparison purposes.
The punctuality on departure of scheduled passenger traffic improved to 91.0 per cent, compared with 89.3 per cent the previous year.
At the end of the year, Aero Airlines expanded its operations by receiving its second aircraft and starting flights on behalf of Finnair on certain domestic routes suited for turbo propeller aircraft.
As its operations expanded, Finnair founded in December 2003 a new domestic company, Finnair Aircraft Finance Ltd, to which the fleet financing, management and leasing activity practised by Finnair Plc was transferred. The founding of the new company is part of a restructuring in line with the Group's strategy, which aims to improve the productivity of capital committed to flight operations and to make more efficient use of the aircraft fleet.
Leisure Traffic
This division consists of Finnair Leisure Flights' operations and the Aurinkomatkat-Suntours package tour company, which is the biggest in its field in Finland with a market share of more than 35 per cent. Finnair Leisure Flights continues to have a strong, 80 per cent share of leisure travel flights, even though additional players have entered the market.
In financial year 2003, the turnover of the division fell by 0.8 per cent to 327.3 million euros. Reduced leisure flight capacity as well as increased competition in the leisure flight market contributed to the decline in turnover. Unit revenues for leisure traffic declined by 1.3 per cent. The division's operating profit improved to 16.6 million euros (6.6 million).
Demand for leisure traffic decreased by 1.1 per cent, while capacity was reduced by 1.5 per cent. Passenger load factor improved by 0.4 percentage points to 88.7 per cent.
Cargo
Finnair Cargo is responsible for the transport of air freight. In its operations it utilizes capacity on Finnair's scheduled passenger and leisure flights as well as Helsinki's gateway status. If necessary, capacity is also leased from freight operators outside the Group.
In financial year 2003, Cargo Traffic's unit revenues fell by 7.3 per cent and turnover by 0.6 per cent to 121.0 million euros. The operating loss was 1.6 million euros (operating profit 1.2 million).
The number of cargo kilos carried fell by 0.4 per cent. Growth continued to be strong in Asian traffic, where Finnair's MD-11 long-haul aircraft were utilized. Cargo capacity leased from outside the Group declined further, but leased capacity was gradually increased during the autumn.
Aviation Services
This division comprises aircraft maintenance services, ground handling and the Group's catering operations.
The turnover of the Aviation Services division fell by 9.2 per cent to 387.5 million euros. The decline in the division's turnover was a result of customers' lower level of activity and a fall in the price level of services as well as concept changes implemented both in catering operations and in ground handling. The cost-cutting programme and implemented adjustment measures led to an improvement in operating profit, excluding capital gains, to 6.8 million euros (3.8 million euros).
The operations of the Swedish subsidiary Finnhandling AB, founded earlier in the summer by the Group's business unit Finnair Ground Handling, have made a good start. In cooperation with partners, the company provides ground handling services flexibly and cost-effectively at Stockholm's Arlanda Airport.
Finnair Catering Oy and the leading Finnish alcoholic beverage company Altia Oyj founded a joint-venture company, SkyCellar Oy, to which Finnair Catering transferred its wine wholesaling business in May. Finnair Catering Oy owns 19.9 per cent of the company. Through the arrangement, Finnair improved the cost-effectiveness of its wine delivery logistics, while maintaining high quality and reliability.
Travel Services
The division consists of the Group's domestic and foreign travel agency operations as well as the operations of the reservations systems supplier Amadeus Finland Oy.
The turnover of the Travel Services division fell by 10.9 per cent to 87.4 million euros. The decline in turnover was due to the general weakness in demand, the lower price level of flight tickets and to the fact that Finnair followed the example of many other airlines and discontinued the payment of commission fees. As a result of adaptation measures, the division's operating result remained positive at 3.5 million euros (3.5 million).
During the latter part of the year, after commission fees were discontinued, the charging of service and transaction fees from customers became established in line with general international practice. At the same time the travel agencies have developed new additional services and have invested in centralized service centre operations.
Support Services
Those functions which support Group business operations, such as various financial and personnel management services, come under the Support Services division. In addition, the Group's property holdings and the management and maintenance of properties relating to the Group's operational activities, as well as office services, are functions of this division.
The turnover of the Support Services division fell by 25.7 per cent to 53.9 million euros. Turnover is made up almost entirely of sales to other units of the Group. The operating loss, excluding capital gains, was 24.6 million euros (22.3 million).
Services and Products
Finnair's service in European scheduled passenger traffic is based on the morning-evening concept favoured by business passengers. In a comparison of service quality among European airlines, Finnair has maintained its position among the top performers, even though services on flights have been altered in order to cut costs. Owing to low business class demand, a one-class service concept was introduced on flights to Eastern European destinations in September.
At the beginning of September, Finnair implemented its biggest ever price reform. Pricing of domestic, Scandinavian and European flights was changed from prices based on rules and restrictions to flight-based pricing determined by supply and demand.
Towards the end of the year, passenger volumes on Finnair's scheduled passenger flights clearly grew more strongly than on other European airlines' flights, which shows that the price reform has fulfilled customers' expectations and needs. It has also brought additional clarity, flexibility and choice both to business and to leisure travel.
In September, in order to improve transparency in flight pricing and comparability of service, Finnair introduced in connection with ticket sales a service fee consisting of the costs relating to booking, pricing and ticket writing. The size of the fee varies, depending on the mode of transaction and the distance travelled. At the same time, a fee also began to be charged for telephone service.
Demand in Asian traffic, which declined due to the SARS epidemic, returned to a growth trend during late summer-early autumn. Capacity removed from the Helsinki-Beijing route in the early summer was gradually restored. From the beginning of April 2004, Finnair will operate a daily flight service to Beijing.
The Asian route network was supplemented by three flights a week to Osaka from June and to Shanghai from September. From June 2004 the addition of a sixth MD-11 wide-bodied aircraft to Finnair's fleet will enable flight frequency on the Shanghai route to be increased to five flights a week.
After this increase to capacity, Finnair will provide 31 connections per week to Asian destinations. In the summer months of 2003, the service to Tokyo Narita was supplemented by one extra flight per week. In connection with last spring's capacity arrangements, a decision was made to fly to Miami twice a week during the winter season. Due to the popularity of the route, it has been decided to fly to Miami again in winter 2004/2005.
In Europe Finnair's network was expanded through new codeshare destinations agreed with SWISS, British Airways, SN Brussels Airlines and Air France. It is now possible to fly with Finnair route codes via Zurich, Manchester, Paris and Brussels to, for example, destinations in the UK, the South of France and Spain. Finnair, for its part, offers its partners good connections to its Asian routes.
Towards the end of 2003, Finnair acquired an 85 per cent shareholding in the Swedish airline Nordic Airlink, which began operating budget flights from Stockholm Arlanda to Oslo, Copenhagen, Gothenburg and Luleå. During 2004 the number of routes will be increased. Operating from main airports, Nordic Airlink will offer good connections between cities to business and leisure passengers alike. Nordic Airlink is the largest budget airline operating between the Scandinavian countries.
As a result of oneworld cooperation, two new sales products have been developed for member companies. The eventflyer product is intended for the conference travel market. The businessflyer product consists of a series ticket aimed at small and medium-sized enterprises. In addition, Finnair aims to develop the electronic ticket concept during 2004 so that a passenger can travel seamlessly on alliance airline flights using an e-ticket.
SWISS announced that it will accept an invitation to become a member of the oneworld alliance, which has important implications for Finnair. SWISS will be a significant partner, offering Finnair good connections to its Central and Southern European network.
Finnair has improved its own electronic customer service by developing the functionality of its automated check-in machines. At Helsinki-Vantaa and Stockholm Arlanda, passengers can perform check-in themselves also for connecting flights. The service works with both electronic and traditional tickets. Passengers travelling to London and Stockholm can buy a ticket for an airport train in connection with their air ticket purchase.
Introduction of IFRS rules
Finnair began preparing at the end of 2002 for the introduction of the IFRS financial statement. During 2003 the effects of forthcoming changes in accounting practice were clarified and the Group's accounting and reporting procedures renewed. Training within the organization has begun and further development of accounting preparedness will take place to enable comparative data for 2005 Group reporting to be produced quarterly from 2004.
Finnair will produce its first full IFRS financial statement from 2005. In the light of data currently available, the key changes to accounting principles relate to pension arrangements, maintenance capitalization of the Group's own fleet, maintenance provisions for leased aircraft, goodwill and impairment testing of assets and accounting of financial instruments. Finnair will not apply hedge accounting for the comparison year 2004. Operational leasing liabilities for aircraft on the transition date of January 1, 2004 shall be treated as off-balance sheet liabilities.
In terms of the opening IFRS balance sheet to be prepared for the transition date of January 1, 2004, Finnair shall provide information about the most important effects on financial indicators of the changes in accounting principles in the first quarter interim report of 2004.
Short Term Outlook
There is a strong growth in demand for Finnair services during the first quarter. The capacity of the Finnair Group's airlines is expected to grow in the first half of 2004 by more than 15 per cent. A significant increase in long-haul traffic capacity, particularly in Asia, as well as Nordic Airlink's capacity in Scandinavia contribute to growth in capacity.
In 2004 Finnair will purchase two and lease two new Airbus A320 series aircraft, bringing the total number of Airbus aircraft in the fleet to 29. Capital expenditure for the year is expected to total around 120 million euros.
The market situation continues to be tight and as a result the average price level is expected to fall clearly. Overcapacity and weak dollar have an impact on the decline in price level.
The company's operational efficiency programme will proceed in accordance with a strategy of focusing on core operations. The number of Group employees is expected to decline further to approximately 9,400 at the end of the year, which compares with a figure of 9,850 at the end of 2003.
The result for the full year 2004 is expected to improve clearly from the previous year and to be a profit. Possible materialization of an external factor, that would have an adverse impact on the results, is not included in the estimate. These include pandemic, political conflicts or other comparable events.
FINNAIR PLC
Board of Directors |