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EL AL ISRAEL AIRLINES LTD.
2012 ANNUAL REPORT
CHAPTER A - OVERVIEW OF THE ENTITY'S BUSINESS
CHAPTER B - DIRECTORS' REPORT
CHAPTER C - 2012 FINANCIAL STATEMENTS
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2012 ANNUAL REPORT
CHAPTER A OVERVIEW OF THE ENTITY'S BUSINESS
Free Translation of the Hebrew Language 2012 Annual Report - Hebrew Wording Binding
El Al Israel Airlines Ltd
Annual Report For 2012
Chapter A Description of the Corporation’s Business
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Table of Contents
CHAPTER 1: GENERAL ...... 4
CHAPTER 2: DESCRIPTION OF THE GENERAL DEVELOPMENT OF THE CORPORATION’S BUSINESS ...... 7
1. THE CORPORATION’S ACTIVITIES AND A DESCRIPTION OF THE DEVELOPMENT OF ITS BUSINESS ...... 7 1.1. General ...... 7 1.2 Company Holdings ...... 8 1.3 Corporation’s Year and Form of Incorporation ...... 9 1.4 Changes in the Corporation’s Business ...... 9
2. AREAS OF ACTIVITY...... 9
3. INVESTMENTS IN THE CORPORATION’S CAPITAL ...... 10 3.1. General ...... 10 3.2 Options ...... 10 3.3 Shares Held by Company Employees ...... 11 3.4 Changes in Holdings of Interested Parties ...... 11 3.5 Table Summarizing Data on Interested Party Holdings ...... 12
4. DIVIDEND DISTRIBUTION ...... 13
5. FINANCIAL DATA ON THE CORPORATION’S FIELDS OF ACTIVITY ...... 13 5.1 Nature of Consolidation Adjustments ...... 13 5.2 Explanation of Developments Occurring in the Areas of Activity ...... 14
6. GENERAL ENVIRONMENT AND EFFECT OF EXTERNAL FACTORS WITH REGARD TO THE COMPANY ...... 14 6.1 Traffic in the International Aviation Industry ...... 14 6.2 Traffic in the Israeli Aviation Industry ...... 15 6.3 Fluctuations in Jet Fuel Prices ...... 15 6.4 Foreign Currency Rate Fluctuations ...... 16 6.5 Interest Rate Fluctuations ...... 16
CHAPTER 3: DESCRIPTION OF THE CORPORATION’S BUSINESS BY FIELD OF ACTIVITY ..... 17
7. THE FIELD OF PASSENGER AIRCRAFT ...... 17 7.1 General Information on the Area of Activity ...... 17 7.2 Services in the Area of Activity ...... 34 7.3 Analysis of Revenues and Profitability from Services ...... 41 7.4 New Services ...... 42 7.5 Customers ...... 44 7.6 Marketing and Distribution ...... 44 7.7 Reservations Backlog ...... 48 7.8 Competition ...... 48 7.9 Seasonality ...... 50 7.10 Productive Capacity ...... 51 7.11 Aircraft Fleet ...... 52 A-2
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8. CARGO AIRCRAFT FIELD ...... 54 8.1 General Information on the Area of Activity ...... 54 8.2 Services in the Area of Activity ...... 58 8.3 Analysis of Revenues and Profitability from Services ...... 59 8.4 New Services ...... 59 8.5 Customers, Marketing and Distribution ...... 60 8.6 Reservations Backlog ...... 60 8.7 Competition ...... 60 8.8 Seasonality ...... 62 8.9 Productive Capacity ...... 62 8.10 Aircraft Fleet ...... 63 8.11 Raw Materials and Suppliers ...... 64
9. INFORMATION REGARDING BOTH AREAS OF ACTIVITY ...... 64 9.1 Fixed Assets and Installations ...... 64 9.2 Insurance ...... 67 9.3 Intangible Assets ...... 68 9.4 Human Capital ...... 68 9.5 Raw Materials and Suppliers ...... 76 9.6 Working Capital ...... 78 9.7 Investments ...... 81 9.8 Financing ...... 84 9.9 Taxation ...... 85 9.10 Environmental Issues and Corporate Responsibility ...... 86 9.11 Restrictions and Supervision of the Corporation’s Business ...... 90 9.12 Material Agreements ...... 115 9.13 Cooperation Agreements ...... 116 9.14 Legal Proceedings ...... 117 9.15 Goals and Business Strategies ...... 117 9.16 Projected Developments in the Coming Year ...... 121 9.17 Financial Data on Segment-Based Reporting ...... 122 9.18 Discussion of Risk Factors...... 122
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CHAPTER 1: GENERAL
El Al Israel Airlines Ltd. is pleased to present a description of the Corporation’s business for the fiscal year ending December 31, 2012, surveying the Corporation in general and the development of its business, as they occurred during 2012. The report was prepared in accordance with the Securities Regulations (Periodic and Immediate Reports)-1970. The financial data included in the report is in U.S. dollars, unless stated otherwise. The financial data relating to monetary claims are in Israeli shekels (“NIS”) as of the date that the claim was filed, unless stated otherwise.
The percentages of ownership are presented in numbers rounded out to the nearest whole percent, unless stated otherwise.
Data appearing in this report is correct as of the report date, unless stated otherwise. Data appearing in this report as correct as of a date close to the approval of the report, has been updated as of March 12 2013, unless stated otherwise.
The importance of the data included in this Periodic Report, including the description of material transactions, has been assessed from the Company’s point of view, while in some cases, additional descriptive information is given in order to provide a comprehensive picture of the matter being described.
The description of the Company’s business in this periodic report partially includes “forward- looking information” as the term is defined in the Securities Law, 1968. Forward-looking information is a forecast, assessment, estimate or other information constituting uncertain information referring to future events or issues, based on information that existed in the Company near the reported date, unless noted otherwise, and includes estimates by the Company and/or its intentions as they existed near the reported date (unless noted otherwise). Results in practice may be materially different from the results estimated and/or implied from this information, as their realization is influenced, among other things, by factors not under the Company's control. Forward-looking information in this report will be identified by specific statements noting that it is forward-looking information, noting the key facts and data that served as the basis for the information as well as the key factors the Company estimates may lead to the fact that the forward- looking information is not realized.
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Glossary
For the sake of convenience, in this periodic report, the following abbreviations shall be assigned the meaning listed alongside them:
Report of the Board of The Report of the Board of Directors on the State of Corporate Affairs Directors- for the Year Ending December 31 2012.
USD/Dollar - U.S. dollar.
The Stock Exchange- The Tel Aviv Stock Exchange Ltd.
The Financial The Company’s Consolidated Financial Statements for the Year Ending Statements- December 31 2012, unless noted otherwise.
The State - The State of Israel.
The Group - The Company and its subsidiaries
The Authority - The Securities Authority.
The Corporation or the El Al Israel Airlines Ltd. Company or El Al -
Fifth Freedom - Transporting passengers or cargo between two foreign countries by a third-country carrier For instance, El Al transports cargo between Liège and New York
Sixth Freedom - Transporting passengers or cargo between two foreign countries with a stopover in the airborne carrier’s country. For instance, a flight by a European airline from Israel to the U.S through an airport located in that airline’s European country.
The Companies Law - The Companies Law, 1999.
The Government The Government Companies Law, 1975 Companies Law -
The Securities Law - The Securities Law, 1968.
IATA - The International Air Transport Association
The Report Date - December 31, 2012
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K’nafaim - K’nafaim Holdings Ltd.
Date immediately prior March 12 2013, unless noted otherwise. to the approval of the report
Sun D’Or - Sun D’Or International Airlines Ltd.
Income Tax Order - The Income Tax Order (New Wording), 1961.
NIS- New Israeli Shekel
The Reported Year 2012.
2003 Prospectus - The prospectus published May 30 2003, as revised on June 3 2003 and June 4 2003
ASK - Available Seat Kilometer – number of seats offered for sale multiplied by the distance flown.
ATK - Available Ton Kilometer - the available capacity for transport of passengers (translated into tonnage) and cargo multiplied by the distance flown.
RPK - Revenue Ton Kilometer - the number of paying passengers multiplied by the distance flown.
RTK - Revenue Passenger Kilometer - the weight of passengers and cargo multiplied by the distance flown.
FTK- Freight Ton Kilometer – the weight in tons of paid cargo (including mail) multiplied by the distance flown
FLF- Freight Load Factor – the load factor rate on cargo flights.
PLF - Passenger Load Factor – the load factor rate in passenger flights (percentage of seats used).
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CHAPTER 2: DESCRIPTION OF THE GENERAL DEVELOPMENT OF THE CORPORATION’S BUSINESS
1. The Corporation’s Activity and Description of the Development of its Business
1.1 General
The Company is engaged primarily in the air transport of passengers and cargo (including baggage and mail) in Israel and abroad, by means of passenger aircraft and cargo aircraft. The Company’s passenger aircraft carry out scheduled flights as well as charter flights.
The Company serves as the designated air carrier of the State of Israel on most international routes that operate to and from Israel. See Section 7.1.1, 7.1.2, 7.1.10 and 9.11.7.2 below for more on this subject and on the meaning of the term “Designated Carrier”, and on the Government's decision regarding "Open Skies".
The Group is engaged in activities auxiliary to its air transport activity, such as sale of duty-free products, production and supply of food primarily to its aircraft, and in the leasing of aircraft, providing security services, regular maintenance and overhaul services to aircraft of other airlines at Ben-Gurion Airport (“BGN”) and management of travel agencies abroad.
The business environment in which the Company operates is the international and domestic civil aviation sector and tourism to and from Israel, which are characterized by seasonal fluctuations and a high level of competition, which becomes more severe during periods of excess capacity.
In the area of passenger transport, in 2012 the Company competed with two Israeli airlines (Arkia and Israir), 61 foreign airlines operating scheduled flights, and over 50 foreign charter companies, 35 of which operate regular flights. The airlines compete in various areas, principally: fares, frequency and flight times, operational punctuality, equipment type, airplane configuration, passenger service, etc. The competition is with the airlines that maintain scheduled flights between different destinations, charter flights between those destinations and/or Sixth Freedom Flights.
In the field of cargo transport, in 2012 The Company competed with seven airlines operating cargo planes in flights to and from BGN, in addition to C.A.L. Cargo Airlines Ltd. Additionally, the Company competes with most of the scheduled airlines that operate passenger airplanes and transport cargo in their holds.
See Sections 7.8 and 8.7 below for more on competition. A-7
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1.2 Holdings Chart
The following is a chart of the structure of the Company’s holdings in investees active as of the date immediately prior to the approval of the report (the percentages listed in the chart express the Company’s holdings in the investee companies):
El Al Israel Airlines Ltd.
Sun Dor 100%
TAMAM 100%
Katit 100%
Superstar Holidays (Britain) 100%
Bornstein Caterers USA 100%
50% ACI
Tour Air Airtour 50%
Kavei Chufsha 20%
Maman Cargo Terminals and Handeling Ltd. 15%
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1.3 Year and Form of Incorporation
El Al Israel Airlines Ltd was incorporated as a limited liability company on November 15, 1948 under the name of El-Al Israel Airlines Ltd. changing its name to its present name on May 16, 1951.
1.4 Changes in the Corporation’s Business
Until June 6, 2004, the Company was a “Government Corporation” in the process of “privatization” (as these terms are defined in the Government Corporations Law). See Section 9.11 below, “restrictions and regulation of the corporation’s business”, for additional details.
To the best of the Company's knowledge, as of today the State still holds 1.1% of the Company’s issued share capital, and therefore, the Company still has a "mixed company” status. Likewise, the State holds a Special State Share (for information on the Special State Share and its related rights, see Section 9.11.9 below).
2. Fields of Activity
The Group’s headquarters functions on an integrated basis in the fields of activity listed below, including financial management, procurement, human resources, legal counseling, IT, security, maintenance and engineering, sales, customer service, marketing and advertising, land and ground operations and construction.
The Group has two reported operating segments. See Note 32 to the December 31 2012 Financial Statements for further details.
(a) Air Transport in Passenger Aircraft
In this field, the Company transports passengers as well as cargo (including mail and baggage) in the holds of passenger aircraft, as well as providing auxiliary services, such as sale of duty free products and passenger aircraft leasing. Revenues from this area of activity constituted 90.7% of all of the Company’s revenues in 2012.
(b) Air Transport in Cargo Aircraft
In this area, the Company transports cargo in a designated cargo transport plane as well as providing auxiliary services, such as leasing cargo aircraft. Revenues from this area of activity constituted 4% of all of the Company’s revenues in
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2012.Starting June 2011 the Company operates a single leased Boeing 747-400 cargo airplane.
Other than the fields of activity detailed above, the Group has additional activities that are not included in these fields, which are not material to the Company’s activity1, with total revenues from them constituting 5.5% of total Group revenues for 2012.
3. Investments in the Corporation’s Capital
3.1 General
In January 2011 and January 2012 additional batches of 3.75% each of the shares of Maman – Cargo Terminals and Handling Ltd. (hereinafter: “Maman”) were received, for no compensation, by virtue of the framework agreement between the Company and Maman. See Note 12b to the December 31 2012 Financial Statements for further details.
On January 31 2013 the Company signed a letter of understandings with funds from the FIMI Group (hereinafter: “FIMI”) which was extended by the parties on March 11 2013 in the matter of an agreement in which FIMI will invest in the Company’s shares. The letter of understandings defines the basic conditions of the investment agreement, as detailed in the Company’s immediate reports from January 31 2013 (Ref. no. 2013-01- 026886) and March 11 2013 (Ref. no. 2013-01-002329).
According to the letter of understandings, the Company, its executives and its representatives undertook not to negotiate with any third parties in the matter of any other transaction involving the Company shares that would contradict the investment agreement or have a negative impact on it, until April 8 2013.
As of this report, the parties are negotiating ion the matter of the investment agreement, following which changes may occur to investment sums, to its dates and to its stipulations.
3.2 Options
On February 26, 2006, the Board of Directors of the Company resolved to adopt the 2006 option plan for employees and executives of the Company (hereafter: “the 2006 Options Plan”). For details regarding the options plans, their conditions and the number of options see Note 25e to the Financial Statements.
1 The production and supply of meals for flight passengers, providing security services, regular maintenance services and overhaul services for aircraft of other companies at BGN and management of travel agencies abroad. A-10
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On June 24 2009, after receiving the approval of the Company’s Audit Committee and Board of Directors, the general meeting approved a private allocation of 4,650,000 options to the Chairman of the Board of Directors, Mr. Amikam Cohen. As of this report, the Chairman of the Board holds 3,100,000 options (after the remaining portion expired, in accordance with the terms of the plan).
On January 6 2010 the Company’s Audit Committee and Board of Directors approved a private allocation of 9,914,382 options to the Company's CEO, Mr. Eliezer Shekedi.
For details regarding the terms of the options to the Company’s Board of Directors and CEO, see Notes 25.e.2 and 25.e.3 to the December 31 2012 Financial Statements.
In 2012, the Company listed a benefit value of $59,000 for these option plans in question, as salary expenses listed against capital reserves.
3.3 Shares Held by Company Employees
The employees association (Holdings in Trust of El-Al Employees Ltd.) (hereinafter – “the Employees Association”) holds Company shares by virtue of a right to purchase shares granted by the State pursuant to the 2003 prospectus.
As of December 31 2012, the Employees' Association held 29,453,119 ordinary shares, representing 5.94% of the Company's issued share capital (5.76% fully diluted). As of March 12 2013, the Employees’ Association held 29,453,119 ordinary shares, representing 5.94% of the Company's issued share capital (5.78% fully diluted). Various restrictions apply to the sale of the shares that are held by the Employees’ Association.
3.4 Changes in Holdings of Interested Parties
Over the past two years, no material transactions were carried out that constituted changes in interested party holdings. For details regarding interested party holding rates see Section 3.5 below.
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3.5 Table Summarizing Data on Interested Party Holdings and Capital
The following is a table summarizing a number of facts regarding the Company’s securities and the holdings of the principal interested parties2:
March 12 2013 December 31 2012 December 31 2011
Rate of Interested Party Holdings in Issued Capital (Undiluted) The State of Israel3 Special State Share Special State Share Special State Share
K’nafaim 39.33% 39.33% 39.33%
Employees Association 5.94% 5.94% 5.94%
Ginsburg Group 9.75% 9.75% 8.94%
Ms. Tamar Moses Borowitz 0.37% 0.37% 0.37%
A.L. Aviation Assets Ltd. 2.11% 2.11% 2.11%
The Phoenix Holdings Ltd. 4.69% 4.69% 4.34%
Delek Investments and 3.60% 3.60% 3.60% Properties Ltd. Excellence Investments Ltd. 0.64% 0.65% 0.71% Company Equity Listed share capital in NIS 550,000,000 550,000,000 550,000,000 (Not including the Special State Share). Issued share capital in NIS 495,719,135 495,719,135 495,719,135 (Not including the Special State Share). Convertible Securities
Options to the Chairman of the 3,100,000 3,100,000 4,650,000 Company's Board of Directors, Mr. Amikam Cohen. Options to the Company CEO, 9,914,382 9,914,382 9,914,382 Mr. Eliezer Shekedi Options to executives as per the 676,630 2,685,274 5,726,651 2006 and 2007 Option Plans4
2 See Section 9.11.9 below regarding the up to date provisions of the Special State Share. 3 To the best of the Company’s knowledge the State holds 1.1% of the Company’s issued capital. See 1.4 above for details. 4 Less options that have expired and returned to the option reserve for allocation in accordance with the terms of the plan. A-12
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Breakdown of holdings in Company shares as of December 31 2012 and March 12 2013:”
4. Distributions of Dividends
The Company did not distribute dividends in the reported year and in the preceding year. For details regarding the dividend distribution policy see Note 25d to the Financial Statements.
For details regarding the letter from Bank Leumi to K’nafaim upon the latter becoming the Company controlling shareholder, see Note 18.f.3 to the Financial Statements.
5. Financial Data on the Corporation’s Fields of Activity
For details regarding changes to international standards (IFRS) see Note 3 to the Company's December 31 2012 Financial Statements.
5.1 Nature of the Adjustments
The adjustments of the revenues and costs result from additional activities that are not attributable to the principal areas of activity, primarily maintenance services to other airlines.
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5.2 Explanation of Developments Occurring in the Areas of Activity
See the in Section a.3 of the Board of Directors’ Report for an explanation of developments in the Company’s operating results during the reported year compared to last year.
6. General Environment and Impact of External Factors on the Company
6.1 Traffic in the International Aviation Industry
The international aviation industry is affected by the economic and security situation and by unusual events, such as the outbreak of epidemics and natural disasters in the world, in general, and in specific areas in particular.
Competition in the industry, including the slowdown in the global growth rate, the ongoing euro crisis, high fuel prices that lead to increases in input prices and to the diversion of cargo from air to sea and increased activity on behalf of low cost companies forces the airlines to take streamlining steps including reorganization, alliances and mergers, use of more efficient and cost-effective aircraft and careful management of seat capacities to increase aircraft usage, increased revenues from the sale of associated services as well as changes in the operating format. “Legacy” airlines are shifting to the operation of low cost flights, whether as classes in regular aircraft, or in flights to specific destinations with minimal service.
In spite the above, passenger traffic continued to grow at an impressive rate in 2012. The high load factors on passenger flights indicate that airlines managed their seat capacities in a rigorous manner. The increase in traffic along with a high aircraft usage rate helped airlines to achieve an (estimated) profit of $6.7 billion in 2012, in spite of high jet fuel prices.
According to IATA data, total passenger traffic (both international and domestic) increased by 5.3% in 2012, slightly less than the 5.9% increase listed in 2011, but higher than projections pertaining to growth trends in long-range traffic (an average growth rate of 5% for 20 years).Load factors reached near-record levels and amounted to 79.1%. The growth rate in international traffic (only) was higher, reaching 6% compared to domestic traffic, which listed an increase of 4%. In both cases, most of the growth in traffic derived from the emerging markets, including Middle Eastern airlines, which increased their (international) traffic by 15.4%.
On the other hand, total cargo traffic (both international and domestic) listed a drop for the second year in a row. 2012 noted a 1.5% drop relative to 2011, after a 0.6% drop in A-14
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cargo traffic in 2011. The average cargo load factor was just 45.2% compared to 45.9% in 2011.
6.2 Movement in the Israeli Aviation Industry
2012 saw a record number of incoming tourists visits to Israel, with 2.57 million inbound tourists via air were listed (including day visits) in 2012, a 3% increase over 2011.In 2012, 3.86 million outbound Israelis were listed, with no material change compared to the previous year.
According to data provided by the Israeli Airports Authority, total international passenger traffic through BGN increased by 1% in 2012 compared to 2011. 2012 saw a 4% decrease in cargo traffic to and from Israel in comparison to 2011.
In December 2012 the Company reported cancellations and drops in reservations for Company flights (both incoming and outgoing), which to the best of the Company’s understanding can be attributed to Operation Pillar of Cloud. Most of the influence was in the decrease in net revenues (revenue less commission) deriving from cancellations and the drop in orders, ranging between $15 and $17 million. The Company took various steps to minimize the damage, and as a result the Company estimates that as of December 2012 the impact on contributions (revenues less actions to minimize damage less special expenses during the operation) is between $7 and $9 million, which largely impacted Q4 2012 results. The Company estimates that the drop in reservations as a result of the operation and primarily the impact on incoming tourism traffic continued into 2013 and also influenced the Company's financial results.
6.3 Fluctuations in Jet Fuel Prices
Jet fuel is a significant component of the Company’s expenses. The jet fuel prices are characterized by extensive and severe fluctuations. The following data refers to the weighted average of jet fuel market prices (before marketing margins and other tolls) in the various markets in which the Company purchases fuel, as quoted by Platts5. Jet fuel prices (the “markets basket” – the weighted price in accordance with markets in which the Company purchases jet fuel) increased by 1.6% relative to 2011 over the course of 2012. See Sections 9.5.1 and 9.18.6 below for further details. See Sections a.3 and b.1.(3)
5 To the best of the Company's knowledge, Platts is a company from the McGraw-Hill Group that has provided information on the energy industry for over 75 years. The company provides updated information and analyses, among other matters regarding prices and international occurrences in the petroleum, petrochemical, natural gas, electric and nuclear power markets. A-15
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of the Board of Directors' Report for additional details on the financial effect of jet fuel prices, including due to hedging activity.
6.4 Foreign Currency Rate Fluctuations
The Group’s results are affected by a number of currencies, particularly the U.S. dollar. Fluctuations in the exchange rate of the dollar vis-à-vis other currencies are likely to cause an improvement or erosion of the Group’s profitability. As of December 31 2012, the exchange rate of the U.S. dollar vs. the NIS was revalued by 2.3% relative to December 31 2011. As of December 31 2012, the exchange rate of the U.S. dollar vs. the euro was devalued by 2.0% relative to December 31 2011.
6.5 Interest Rate Fluctuations
The Company took loans in a significant amount at variable interest rates that is based upon LIBOR interest, in order to finance the acquisition of aircraft. A change in the LIBOR interest rate could materially affect the Company’s financing expenses. In 2012, the average LIBOR 3-month interest rate increased by 1%, compared with its average rate in 2011.
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CHAPTER 3: DESCRIPTION OF THE CORPORATION’S BUSINESS BY FIELD OF ACTIVITY
The following is a description of the business of the Group for each of the fields of operation separately, with the exception of matters applying to the overall operations of the Group, which are described collectively in the framework of Section 9 below.
7. Passenger Aircraft Activity
7.1 General Information on the Area of Activity
The Company’s principal activity of the in this area is the transport of passengers on scheduled and charter flights. In addition, the Company carries cargo in the holds of its passenger aircraft, an activity auxiliary to the activity of transport of passengers. Additional auxiliary services are associated with the service in this area, including sale of duty free products to passengers. Accordingly, in the context of describing this field of activity, the Company has focused on a description of transport of passengers. Certain matters that relate to the transport of cargo in the holds of passenger aircraft are similar to the service of carrying cargo in cargo aircraft, which are described in Section 8.
The following is a description of trends, events and developments in the macroeconomic environment of the Group, which have or are expected to have a material effect on operating results or on the developments in the field of activity, in the following areas:
7.1.1 Structure of the Field of Activity and Changes Occurring Thereof
As mentioned, the Company's main field of activity is air transport in passenger aircraft in scheduled flights to and from Israel.
In the past, aviation activity was regulated by the resolution of the Ministerial Committee on Social and Economic Affairs near the publication of the 2003 prospectus (May 19 2003 HC/14 Resolution), in the matter of the Company's appointment as a “designated carrier”, and after that date, a number of government resolutions were passed establishing the Israeli aviation policy, regarding the Company’s activity and the State's participation in the security expenses of Israeli airlines. For details regarding regulatory arrangements applicable to aviation activity, including aviation rights granted the Company, see 9.11 below.
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7.1.2 Legislative Restrictions, Regulations and Special Obligations that Apply to the Field of Activity
The field of activity of carrying passengers and cargo in passenger aircraft is distinguished by international and local regulatory restrictions in various areas, which are set in international treaties and agreements and in local legislation. Among other things, authorization is required for operating a flight from one country to another country, as well as approvals in the matter of flight frequencies. For details regarding regulatory arrangements in the matter of their realization, see 9.11 below.
In addition, these international and local arrangements established conditions and arrangements pertaining to the carrier’s operation and liability for damage and flight delays and cancellations.
The Company is also committed to act in accordance with local legislation and relevant government resolutions in the matter of the Company's areas of activity (including in the matter of aviation service security) as received from time to time, as detailed in 9.11.12 below.
7.1.3 Changes in the Volume of Activity and Profitability of the Area
a) International Developments
According to IATA estimates, passenger traffic (both international and domestic) increased by 5.3% in 2012 and international cargo traffic (including in the holds of passenger aircraft) decreased by 1.5%. International traffic (not including domestic traffic) listed a 6% yearly increase and the seat capacity on international flights increased by 4%, lower than the rate of increase in passenger traffic, which led to an increase in load factors on international passenger flights – 78.9% in 2012 compared to 77.4% in 2011.
In December 2012 IATA revised its 2012 profits projection. According to the new estimate, the airlines are expected to present $6.7 billion in profits in 2012.The improvement in the profit forecast derives from good performance on behalf of the airlines in the second and third quarters of the year. The good performance on behalf of the airlines was influenced by a high 5.3% growth rate in passenger traffic and an improvement of 3% in yield per passenger. On the other hand, the cargo market dropped by 2% and the yield per ton of cargo also dropped by a similar rate, as most of the increase in global trade focusing on emerging markets
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let to the preference of cheaper maritime shipping over airborne cargo transportation.
Regional cross-section of international traffic6, 2012 vs. 2011:
As reflected in the above table data, international passenger traffic (not including domestic flights) increased by 6%, with most of the increase deriving from emerging markets, primarily in the Middle East (+15.4%), in South America (+8.4%) and Africa (7.5%). In Europe and North America a significant slowdown was listed in the growth rate of passenger traffic (5.3% and 1.3%, respectively), compared to the growth rate listed in 2011 (9.5% and 4.1%, respectively).
Regarding cargo, a slowdown in the growth rate of international trade and preference for maritime shipping over airborne cargo transport led to a 1.9% drop in cargo traffic on international flights.
IATA projects that in 2013 global airlines are expected to present a net profit of $8.4 billion, which constitutes 1.3% of the airlines’ total revenues).This sum is higher than the forecast published in October 2012, which projected profits of $7.5 billion.
The data in the table below refers to the total activity of international airlines on both international flights and on domestic flights.
The following are the key points of IATA’s 2013 projections:
GDP – the primary factor influencing the forecast is the global growth rate, which is expected to rise slightly and reach 2.3% in 2013.
6 The data in the table refers to traffic in international flights only, not including domestic flights. A-19
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Passengers – passenger traffic is expected to increase by 4.5% (lower than the expected 5.3% growth rate in 2012), and yield per passenger is expected to drop slightly (-0.2%) mainly in response to lower gas prices.
Cargo – cargo traffic (international only) is expected to list a 1.9% increase vs. 2012. The incompatibility between the growth rates for passenger and cargo traffic, leads to increased cargo capacity and as a result, an expected drop of 1.5% in yield per ton of cargo.
Fuel – the average price of a barrel of oil is expected to drop slightly, reaching $104 per barrel ($5.5 per barrel lower than 2012). The price of jet fuel is expected to drop by $5.2 per barrel, reaching $124.3 per barrel.
The following table shows the activity of the international aviation industry (regular flights) over the past four years as well as the industry's revenues and earnings throughout the period.
International operations of the aviation industry and its profitability in the field of passenger aircraft7(scheduled flights) of airlines belonging to IATA:
Year Output Operating Operating Profit (Loss) Income8 (Billions of Dollars) (in Billions of Dollars) RPK10 Yearly RTK9 Yearly Before After Change in Change in Interest Interest (in (in RPK RTK Expenses Expenses Millions) Millions) 201211 2011 2,811,585 6.9% 343,210 7.5% 303.8 10.2 4.3 2010 2,578,510 7.9% 319,399 10.4% 279.1 15.9 9.2 2009 2,373,750 2.9%- 289,213 2.2%- 239.1 2.7- 5.2- 2008 2,436,045 2.4% 295,783 1.3% 275.6 2.9 1.0
7 The source of the data regarding 2008-2012: IATA publications (World Air Transport Statistics) (2012 – 55th edition). 8 Including cargo aircraft revenues. 9 Revenue Ton Kilometer – weight of paid flown cargo in tons multiplied by distance flown. 10 Revenue Passenger Kilometer – number of paying passengers multiplied by distance flown. 11 IATA data, estimates, assessments and projections referring to 2012 are preliminary. Final data for 2012 is expected to be published by IATA in June 2013 within the framework of World Air Traffic Statistics. A-20
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b) Developments in the Israeli Market
International passenger traffic to/from BGN totaled approximately 12.4 million passengers during 2012 which represents an increase of about 1% compared to 2011.
Passenger Traffic to and from Israel (from/to BGN)12
Year Passenger Traffic through BGN
(Millions of Yearly Change Passenger Legs) 2012 12.4 1% 2011 12.2 6.5% 2010 11.4 9% 2009 10.5 -5% 2008 11.0 10%
The table and the graph below reflect the trends of incoming tourist traffic to Israel and the departing residents in recent years via air.13
Year Incoming Tourists (Foreign Departing Residents Passports) (In Thousands of Rate of change (In Thousands Rate of Passengers) of Passengers) change 2012 2,572 2.7% 3,860 0.1% 2011 2,505 5.1% 3,857 7.5% 2010 2,385 16.4% 3,588 5.6% 2009 2,049 (6.4)% 3,397 (4.4)% 2008 2,190 22.0% 3,552 3.5%
According to Company estimates, tourist traffic to Israel is influenced by international passenger traffic trends, the economic situation and mainly by geopolitical processes in Israel or the region, which have affected the security felt by tourists to the region.
The Bank of Israel’s growth projection for 2013 as of December 2012 is 2.8%, and was influenced, among other things, by the downturn in forecasts regarding global activity and the possible and ongoing influence of Operation Pillar of Smoke on incoming
12 Source: Civil Aviation Administration (including non-paying passengers). In addition to the traffic to BGN, tourists in regular and charter flights arrive in Israel through the Eilat airport in minimal amounts as compared to the traffic at BGN. The term “leg” means a flight section from destination to destination. 13 Data from the Central Bureau of Statistics. A-21
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tourism. Indications of the slowdown in growth can also be seen in the decrease of airborne cargo shipping to and from Israel, as mentioned in 6.2 above.
The Company’s forecasts and estimates as well as IATA estimates regarding the volume of passenger traffic to and from Israel as above constitute forward-looking information, as defined in the Securities Law. This information is supported, inter alia, by the Company’s assessments in light of the trends of change in tourism during recent years and expected developments, and in view of the economic, security and geopolitical situation in Israel. Accordingly, the actual change in the anticipated volume of incoming tourists to Israel and the outgoing tourism from Israel may be materially different from that forecast as aforementioned, if the Company's assessments are not realized, and because of a large number of factors, including a change in economic, security and geopolitical conditions in Israel.
7.1.4 Developments in Markets of the Field of Activity or Changes in the Characteristics of its Customers
In recent years, competition has intensified considerably in the passenger aircraft transport field between dozens of international scheduled and charter airlines.
The airlines compete in various areas, principally: fares, frequency and flight times, on- time performance, equipment type, airplane configuration, passenger service. Fare competition is reflected primarily by offering reduced rates to passengers. The competition is present both with relation to direct scheduled flights between various destinations (including extensive activity by foreign airlines in Israel through their home airports to third destination – “Sixth Freedom” flights) and with charter flights to the same destinations. Additionally, during recent years, airlines known as “low cost airlines”, which generally offer competitive prices, have begun operating.14 For details see 7.1.10.(d) below.
The increase in the number of foreign airlines operating out of BGN, in the number of scheduled flights and in the seat capacity of the foreign airlines, has led to a further increase in the level of competition on routes to Israel. See Sections 7.1.10 and 9.11.7.2 below for further details.
14 "Low cost" airlines are relatively new airlines with a low expense structure deriving mainly from direct marketing over the internet and not through distribution systems and travel agents, use of secondary airports, minimal service profile during the flight and operations on short range flights, with no code share agreements with other companies and high utilization of aircraft. A-22
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For details regarding the implementation of the Ministry of Transportation's liberalization policy and the appointment of Israeli airlines as Designated Carriers see Section 9.11.7.2 below.
7.1.5 Technological Changes that could Materially Affect the Field of operations
SAP System: Stage A of the implementation of the financial SAP system has been completed and the Company began using the system on January 1 2013. This stage largely consists of the payment systems (AP) at the main office and at the Company's representatives. CRM system: over the course of 2012, the first stage of the implementation of the assimilation of the CRM system for customer relations in Israel and around the world as well as for the Israeli branch for managing the agency files, sales destinations and performance destinations, and call center contact module, was completed. The advantages of employing the CRM system are the central management of Company customers, improving service and improving sales capabilities. RMS + pricing systems: the Company has decided to implement an innovative revenue management system (RMS) as well as a system for the automated management and distribution of Company prices compared to market prices – Pricing & Fare Management System – which updates the Company's fares automatically in all of its distribution systems, according to strategies and rules dictated by the Company. The systems operate in conjunction with changes in market demand, and respond automatically with up- to-date availability and prices based on the level of demand. The Company has engaged in agreements with Lufthansa Systems AG, whose proposals to implement the systems were selected from a number of proposals submitted to the Company. The pricing system was first activated in July 2012, and the RMS system is expected to begin operations in the first quarter of 2014. Over the course of 2012, online sales on the Company’s website increased by 28% compared to the same period last year. This increase is part of the constant improvements to the Company’s website, both in enriching its content and through the use of new digital tools, including fraud prevention processes, online and call center sales monitoring systems and other improvements. The Company operates in accordance with the work plan it put together on the subject of data security, while focusing on the primary threats identified by the
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Company with the intention to cover all of the threats over coming years. In addition, in recent years the aviation market has geared up to deal with terror events by expanding the use of advanced technological and other means, on land and in the air. Within the scope of these preparations, the Company is working in accordance with the instructions of the General Security Service, inter alia, for evaluating and installing protective measures.
7.1.6 Critical Success Factors in the Area of Activity and Changes Occurring Therein
A number of factors can be pointed to in the operations of the passenger and cargo transport area via passenger aircraft, which affect the competitive position in the field: the economic and security situation in Israel, which influences passenger traffic to and from Israel; the branding of the Company in the eyes of the customers, including matters of safety and quality of service; the ability to offer flights to popular destinations at competitive prices and development of a network of routes independently and in cooperation with other airlines; preservation of aviation rights; the ability to offer flights at the frequency and the capacity demanded; a distribution system; risk management by implementing appropriate risk hedging policies.
7.1.7 Changes in the Supplier and Raw Materials Array for the Area of Activity
Fuel – the primary raw material used by airlines is jet fuel and it represents one any airline's major expense components. See Section 9.5.1 below for details relating to fuel.
Aircraft – as the Company's entire passenger plane fleet was manufactured by the Boeing Corporation, the Company is dependent upon this manufacturer for all matters pertaining to the regular maintenance of its aircraft, the supply of parts, repairs and engineering consulting.
7.1.8 Main Entry and Exit Barriers of the Field of operations and Changes Therein
One of the most significant entry barriers in the area of the international scheduled flights is obtaining the authorization to carry out scheduled flights from one country to another and appointment as Designated Carrier. The more liberal the aviation agreement between the countries, the lower the entry barrier.
In addition to obtaining authorization from the airline's parent country, consent is generally required from the countries to which the airlines wishes to fly with relation to the number of flights and to the capacity of the flight. In addition, each flight is required to have a slot with regard to takeoffs or landings at the airports to or from which it
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operates. An additional significant additional entry barrier is the initial relatively large investment that is necessary in order to establish and operate an airline, including acquisition or leasing of aircraft.
Furthermore, international aviation agreements and regulation at various destinations, may include identity or citizenship requirements as a condition for ownership or actual control of an airborne carrier. These requirements may constitute an entry barrier for authorization to conduct flights. See Section 9.11 below for further details.
Regarding the operation of passenger aircraft on international charter flights, the Company estimates that no significant entry barriers exist, in light of the existing liberal policy of granting authorizations in the area of charter, regarding both Israeli charter airlines as well as foreign charter airlines.
The restrictions placed on the Company by the holder of the Special State Share in the matter of the reduction of the Company's aircraft fleet, constitute an exit barrier. See Section 9.11.1 below for further details.
7.1.9 Substitutes for Services of the Area of Activity and Changes that have Occurred in Them
The alternatives for transport in passenger aircraft are transport by other means (maritime and surface vehicles and cargo aircraft for cargo in the holds of passenger aircraft). Note that Israel has no significant alternative to air passenger transport. In the Company's estimation, the major considerations in preferring flight to sea and/or land transport are the purpose of travel, the passenger’s or cargo's timetable, the distance and the nature of the route.
7.1.10 Structure of Competition in the Area of Activity and Changes Occurring Therein; Developments in Markets of the Area of Activity
a) General – Competition in the Area of Activity
There is severe competition in the passenger aircraft transport field between dozens of international scheduled and charter airlines. The airlines compete in various areas, principally: fares, frequency and flight times, on-time performance, equipment type, airplane configuration, passenger service, bonuses to frequent travelers, commissions and special incentives to travel agents and supply of computerized reservation and distribution systems to travel agents.
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Competition is not only with the Designated Carrier of the country on the other end of the route and with charter airlines that operate on the same route, but also with other airlines, including those not operating flights to Israel (off line airlines), as the result of travelers' diverse alternatives in arranging their own flight schedule, in which a number of airlines participate, and the strengthening of code sharing agreements between airlines (Star, Sky Team, One World)
Additionally, most of the scheduled airlines operating flights to and from Israel also carry passengers on Sixth Freedom Flights, which has led to an increase in foreign airline activity in Israel. Because the flight from the home airport (Europe) to the United States is carried out without any connection to the flight from Israel to Europe, the situation sometimes permits the foreign company to lower the total price for the flight from Israel to the United States (through Europe) without reducing the price for which the airline ticket from Europe to the United States is sold. As a matter of fact, sometimes the foreign airlines offer the airline ticket from Israel to the final destination (the United States, for example) at a price lower than the price which they offer for the flight from the stopover destination (Europe, for example) to the final destination. On the other hand, the Company does not presently enjoy the similar ability to transport passengers between different countries via Israel, primarily because of the current geopolitical situation.
A significant portion of the aviation agreements between Israel and other countries state that the offered capacity must be based on the scope of traffic between Israel and the other country with which the agreement was signed. In recent years, the Ministry of Transportation has begun implementing a policy of increased liberalization in the aviation industry, with the aim of encouraging and increasing tourist traffic to Israel by increasing competition between airlines, and accordingly, requests by foreign airlines to increase frequencies or capacities were approved, even when these were not required by existing bilateral aviation agreements.
Other than this, certain regulatory changes may have an impact on the structure of competition in the area of activity. For further details see Section 9.11 above.
b) “Open Skies” Policy
The Public Commission for Examining the "Open Skies" Issue
The report the key points of the report and recommendations of the public commission for the evaluation of the "Open Skies” was issued on April 16 2007.
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According to the commission's report, the State of Israel is striving to adopt an aviation policy that will serve as a springboard for economic growth and increasing tourism to and from Israel, based on the importance of a national aviation industry that will take part in equal and fair competition, based on the global environmental conditions and transforming the State of Israel, from an aviation standpoint, to a more attractive destination than its competitors, in terms of price and in terms of capacity of the airlines over time.
The report further states that the opening of the skies will bring with it the entry of new operators, a decrease in fares and an increase in the State of Israel's exposure as a competitive destination and consequently, an increase in the number of tourist arriving via air. At the same time, the report noted that policy will also apply to Israeli passengers who will benefit from dropping prices and the more diverse range of services and destinations.
Continued Implementation of the Open Skies Policy
In recent years, aviation talks were held with the civil aviation authorities of several countries and new agreements were signed, in which the liberalization policy in the air transport field was expressed, in accordance with the commission's recommendations, in such a manner that the agreements established multiple Designated Carriers, enabling an increase in the number of airlines that can operate scheduled flights on the routes to and from Israel as well as increasing their frequency.
The following is a description of the primary and material changes deriving from the Ministry of Transportation's Open Skies policy in 2012:
Germany – new aviation agreement was signed between Israel and Germany in April 2012. According to the new agreement, either of the countries can operate up to 36 scheduled weekly flights, instead of 30 flights as things stand. At the same time, the new agreement retains the restriction on the number of flights to Frankfurt and Munich – up to 21 weekly flights to each side, but allows added frequencies for destinations such as Düsseldorf, Cologne and as noted, Berlin. The Netherlands – the Israeli and Dutch aviation authorities agreed, following an exchange of letters, to allow additional airlines to operate scheduled flights between the two countries and significantly increase the weekly frequencies quota. According to the agreement, each side is entitled to appoint an additional airline as a designated carrier for the Tel Aviv-Amsterdam route, with each side’s designated
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carriers allowed to operate up to 30 weekly frequencies on the route (15 frequencies for each side). To date, the aviation agreement between Israel and the Netherlands has allowed one airline form each side to operate scheduled flights on this route (KLM and El Al), with Arkia, Israir and other Dutch airlines operating charter flights on the route.
The Company was appointed designated carrier on flights to Hanoi and Ho Chi Minh City (Saigon), as well as to Grenoble, France. At this stage the Company does not intend to operate a direct flight route between Israel and Vietnam; however, the new approval would allow the Company to cooperate via code sharing agreement with Vietnam Airlines through Hong Kong (a direct Company destination) to each of the destinations approved in Vietnam.
For a list of the destinations to which Israeli airlines were appointed Designated Carriers, see 9.11.7.2 below.
Over the past few years, new aviation agreements have been signed between Israel and a large number of countries (Spain, Italy, France, the UK, Belgium, Russia, Ukraine, Slovakia, Thailand, South Korea, Germany, Switzerland, Brazil, Turkey, the U.S., Greece, Romania, Georgia, Jordan, Hungary, the Czech Republic, the Netherlands and Colombia). All of these new aviation agreements expressed the liberalization of air transportation, via agreements for multiple Designated Carriers for each side as well as a significant increase in frequency allocations for scheduled flights. These agreements allowed an increase in the number of companies operating scheduled passenger flights and the launching of low cost flights to Israel. Furthermore, cancellation of the section of the 2003 government resolution limiting the appointment of Israeli carriers on routes operated by the Company, allowed Ministers of Transportation to appoint Israeli airlines as additional designated carriers on a series of international routes. The prominent routes in 2012 on which the appointment to regular flights was exercised by Aria and Israir over the course of the year are the routes to Paris, Barcelona and Larnaca, which are operated by Arkia, and routes to Moscow, Rome and Berlin operated by Israir.
A number of new airlines began operating on routes to Israel in 2012: Austrian airline Niki, which operates low cost flights, began operating three weekly direct and scheduled flights between Vienna and Tel Aviv; Greek airline Olympic Airways renewed its flights on the Tel Aviv-Athens route starting March 2012 (concurrent with Aegean Airlines’ activity on this route); Turkish airline Pegasus began operating 6-7 scheduled flights on the Tel Aviv-Istanbul route; Scandinavian A-28
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airline SAS gradually renewed its flights to Israel, and in June began operating one weekly flight on the Tel Aviv-Copenhagen route, operated 2 weekly flights during the July-August summer months, and starting November 2012 operates 3 daily flights on this route; Hungarian low cost airline Wizzair replaced Malev, which went bankrupt, and starting December 201 has operated 3 weekly flights on the Tel Aviv0Budapest route; and Ukrainian airline Air Onix, which in December 2012 began operating a weekly flight on the Tel Aviv-Simferopol route.
A number of airlines expanded their activity on routes to Israel by adding destinations and/or increasing frequencies and/or capacity. The airlines that significantly expanded their activity over the course of 2012 are: Air France (+12%), British Airways added a third daily flights but moved to smaller aircraft (+2%), Turkish Airlines (+9%), EasyJet (+41%), Spanish airline Vueling (+50%), Russian airline Aeroflot (+74%) and Ukrainian airline Ukraine Air International (+40%).
The increase in capacity allowed these companies, which operated international hubs at their home airports, to increase the number of passengers flied between Israel and a large number of destinations via indirect flights, taking advantage of their route networks (Sixth Freedom traffic) and that of their partners in global aviation alliances and code sharing agreements.
There were also airlines that significantly reduced their activity on routes to Israel in 2012. The following airlines significantly reduced their activity:
Lufthansa (-7%), Iberia (-11%), KLM (-92%), Meridiana Fly (-35%) and Delta, which discontinued its flights on the Atlanta-Tel Aviv route starting September 2011 (-18%).
A number of airlines operating on routes to Israel discontinued their activities over the course of 2012 due to economic difficulties:
In February 2012 Hungarian airline Malev and Spanish airline Spanair discontinued their activities. In April 2012 Danish airline Cimber Sterling2012discontinued its flights on the Copenhagen-Tel Aviv route, in December 2012 Russian airline Kuban Airlines, which operated flights on the Tel Aviv-Krasnodar route, discontinued its activity. In this regard, note also that in January 2013 Ukrainian airline Aerosvit, which submitted a request for bankruptcy following debts, discontinued its activity on routes between Ukraine and Israel. A-29
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A total 1% increase was listed in passenger volume at BGN in 2012, with a 3% increase occurring in scheduled passenger travel (including the Company) and an 8% decrease in charter flights compared to last year. Overall, charter traffic (including charter flights marketed by Sun D'Or flights) through BGN constituted 14% of all traffic, compared to 15% in 2011.
Passenger traffic through BGN in 2012 15was broken down as follows: the Company (including flights marketed by Sun D’Or) – 33.6%; other scheduled airlines – 54.4%; charter airlines (not including Sun D'Or) – 12.0%.
Foreign airline activity on routes to and from Israel is expected to continue to increase in 2013 as well, as a result of additional increased capacity and/or frequencies and destination expansion by existing airlines, the entry of new airlines as well as the operation of scheduled flights to new destinations by Israeli and other airlines. This trend will be reinforced in the event that an Open Skies agreement is signed with Europe, as detailed below.
From time to time, the Company assesses the possibility of increasing flight frequencies and/or capacities to existing destinations and the possibility of operating flights to new destinations, in accordance with market demand, including through code sharing agreements and other agreements with other airlines.
The Company's estimates regarding increased competition in 2013 and its possible impact on the Company are Forward-Looking Information as defined in the Securities Law based on the influence of the Open Skies policy, including the increase in the number of foreign airlines operating at BGN, and the increase in the capacity of foreign airlines operating today. The actual level of the increase and its impact on the Company are influenced, inter alia, by economic, security and geopolitical factors and by trends in the airline industry.
For regulatory changes that may alter the structure of competition in the field of activity – see Section 9.11.2 below.
The Open Skies Agreement with the European Union
In December 2008, a new aviation agreement ("Horizontal Agreement") was signed between Israel and the EU. The Horizontal Agreement updates the sections of the bilateral aviation agreements between Israel and the EU members referring
15 Information regarding the activity of foreign airlines is based on IAA data.
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to the ownership and control of Designated Carriers (without changing the aviation rights established in the bilateral agreements) and allows airlines controlled and owned in one of the EU members to operated regular flights from any other country in the EU, subject to the bilateral agreement.
The Horizontal Agreement does not influence the aviation rights determined as part of the bilateral agreements. These rights include, inter alia, the right to operate regular flights on agreed-upon routes, the number of companies on each side entitled to operate flights on these routes (Designated Carriers) and the weekly frequency quota granted Designated Carriers. At the same time, the Horizontal Agreement may in the future allow the realization of aviation rights not realized to date on the lines between Israel and the EU and pave the way for a global aviation agreement with the EU.
The first round of talks between Israel and the EU regarding the global agreement ("the Vertical Agreement"), which is designed to replaces all of Israel's bilateral agreements with EU members and to gradually cancel the limitations on the number of carriers, frequencies, capacity and type of aircraft, were held in December 2008. Additional rounds of meetings between the parties were held over the course of 2009 through 2012 and negotiations on a global aviation agreement between Israel and the EU continued, with the final version of the agreement bin question formulated in March 2012.
In July 2012 the Open Skies agreement formulated between the State of Israel and the EU was signed in initials. The agreement distinguishes between groups of destinations, and regarding a number of destinations in which the activity level of foreign airlines is currently not high (“Sixth Freedom Destinations”), it was decided that a moderate increase would take place in the quota of permitted flights, over a number of years. In order for the agreement to come into effect, various regulatory approvals are required, with Israeli airlines requiring suitable preparations expressed in a number of required activities, including a revision to the Restraint of Business Law for the aviation industry; the restoration of Israel's safety rating to Category 1 (on November 1 2012, the safety rating of the State of Israel was restored to Category 1); as well as granting equal opportunity to Israeli airlines vs. their competitors, including in the matter of takeoff and landing rights (“slots”).
In December 2012 the Ministry of Transportation and Road Safety announced that at the instruction of the Prime Minister, the agreement would not be signed prior to A-31
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the elections. Despite this fact, the European Council of Ministers of Transportation ratified the agreement in question on December 20 2012.
Signing the agreement may have a negative impact on Israeli airlines, including the Company, following an additional worsening of the state of competition, multiple carriers and capacity the agreement will bring about and the inability of Israeli airlines to realize the aviation rights resulting from the agreement in an equal manner.
The Company's estimates regarding the possible signing of the “open skies” agreement with the EU over the course of 2013 and its possible impact on the Company Forward-Looking Information as defined in the Securities Law, based on estimates that as a result of the agreement an increase will be noted in the number of foreign airlines operating at BGN, and an increase in the capacity of foreign airlines operating today. The degree at which competition will increase in practice and the expected implications on the Company’s activity are influenced, among other things, by the possibility of a fair and mutual implementation of the agreement, the receipt of takeoff and landing rights at European destinations, the degree of gradualism in implementing the agreement and the scope of the change in the capacity and the frequency of foreign airlines operating to Israel.
c) Charter Airlines
In total, the drop in charter traffic to and from Israel continued in 2012. Charter traffic dropped by 8% relative to 2011, with the share of charter airlines (Israeli and foreign) of total passenger traffic through BGN amounted to 14% in 2012, versus 15% in 2011 as detailed in the following table:
Year Share of Charter Airlines from Total Passenger Traffic through BGN
2012 14% 2011 15% 2010 15%
2009 17% 2008 22%
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d) Low Cost Airlines
Airlines referred to as low cost airlines have become active in recent years. These airlines maintain low costs and generally offer very competitive prices, while providing a low level of service and using alternate, less desirable airports. These airlines have succeeded in growing enormously in the United States, in Canada and in Europe. A stirring in this field has also been felt recently in Asia. The entry of the low cost airlines into certain markets forces the airlines competing in these markets, which do not have a low cost structure like the low cost airlines, to become more efficient in order to reduce costs. In the past, low cost airlines operated on short flights, and did not operate on flights to and from Israel. Starting 2006, several airlines have begun operating as Designated Carriers on routes from various European countries to Israel.
In 2012 the low-cost airlines increased their passenger traffic by 24%, and in total, the foreign low-cost airlines transported 6% of the passenger traffic from BGN.
The activity of these airlines and the entry of others airlines into the Israeli market could have a negative effect on the Company's business results, due to the increased capacity offered by these airlines at reduced prices. The Company estimates that an increase is expected in low cost traffic to and from Israel, and that the rate of passengers on these airlines out of all passengers through BGN is expected to grow in 2013 as well.
The Company's estimate regarding the increase in low cost activity in 2013 and its possible impact on the Company is Forward-Looking Information as defined in the Securities Law based on estimates that the growth in this activity in Israel will continue. The amount of growth in this activity and the expected implications regarding the Company's activity is influenced, among other things, by regulatory changes required for this activity, including the implementation of the Open Skies policy, as well as in light of the fact that the activity is stipulated on certain operational parameters.
e) Domestic Flights
Following the August 2010 resolution of the Minister of Transportation and Road Safety, the Company began operating 3 daily flights on the BGN-Eilat route, in accordance with the terms set in the Minister’s resolution.
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On January 1 2012 an additional resolution was passed by the Minister of Transportation and Road Safety allowing the Company to operate a single additional daily frequency in each direction, a total of 4 flights, and to increase the daily seat capacity from 430 seats to 580 seats in each direction on the BGN-Eilat- BGN route.
In 2012, the Company flew 225,600 passenger legs and its share of domestic traffic to Eilat was in this year was 15.6% compared to 16% in 2011.
7.2 Services in the Area of Activity
a) General
The main services provided by the Company in this field of operations are air transport of passengers and cargo to various destinations by using passenger aircraft. As of a date close to the approval of this report, the Group operates flights using passenger aircraft to 32 destinations in 24 countries in Europe, North America, East and Central Asia and other destinations. As noted above, the Company operates domestic flights on the BGN-Eilat route. In 2012 the Company operated an average of 224 weekly flights on in each direction. In addition to the flights it operates, the Company markets flights in the framework of interline agreements with other airlines, which make it possible for passengers on scheduled flights, subject to certain restrictions, to use airline tickets issued by another airline, for flights of the other airlines. The company whose flights are used by the passenger submits the bill for payment to the company that issued the flight ticket. The accounting between the airlines is done on a monthly basis, generally through IATA's clearinghouse.
The scheduled airlines also operate flights in the context of “code sharing”. The use of the code sharing permits the air carrier to market flights operated by another air carrier as if they were its own flights, so that the passenger orders the flight through one carrier, despite the fact that, in practice, his flight is with another carrier. The code sharing provides the participating carriers with the possibility of increasing the frequency of the flights offered to its customers, accessibility to additional destinations and also marketing advantages, including amplifying the attractiveness of joining the Company’s frequent flyer club. The Company has also operated in this area in recent years.
In its scheduled flights, the Company operates five service sections that are distinct one from the other in the type of seat, the space between the seats, the food and A-34
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beverage menu, the manner of serving, the assortment of convenience and leisure products and the number of flight attendants in relation to the number of passengers. The sections are first class, improved business class - platinum, business class, Economy Plus Class and economy class. The charter flights operate a service profile suitable for charter operations. Not all classes are operated on each flight. All scheduled flights contain a system of programs of audio, films, screened magazine and printed magazine and services are provided for the sale of duty free products.
In addition to its scheduled flights, the Company is engaged, through Sun D’Or, in carrying out charter flights by leasing capacity in aircraft to organizers of charter flights at prices agreed upon in advance, and the sale of blocks of seats to agents.
The Company’s flights are supported by a system of ground services that administers the processes of boarding passengers and their baggage, their alighting at destination airport and unloading their baggage, and cargo handling. The ground services exist at BGN and at each of the destinations at which the Company’s aircraft land. At the same time, the Company, as directed by government security authorities, operates a ground security array in each of the overseas airports at which Israeli airlines land and a system of air security, which operates during the flights of passengers of Israeli airlines (the ground security system at BGN is operated by the Airports Authority).
b) Data Regarding the Company’s Destination Groups
The following is data regarding the Company's market share broken down into groups of key destinations, relative to all passenger traffic to or from BGN, broken down into these destination groups:
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To/From Total Passenger Traffic Through BGN The Company’s Estimates By Destination According to Direct Regarding the Company’s BGN 16 Flights17 (in Thousands of Passenger Market Share (in %) Legs) Change 2012 2011 2010 2012 2011 2010 in % In 2012 North (2.8) 1,595 1,640 1,690 36.7 35.7 38.0 America Europe 1.1 8,525 8,436 7,730 37.3 36.4 40.0 East and 5.8 469 443 437 57.4 57.6 60.0 Central Asia18 Others19 6.0 1,775 1,674 1,593 8.0 12.8 16.0 Total 1.4 12,364 12,194 11,450 33.6 33.9 37.1
c) Routes to North America (to the United States and Canada)
During the height of the 2012 summer season, the Company operated 31 weekly flights to North America and during the winter season, it operated some 23 weekly flights (mostly to New York).
Competition exists between Continental/United, Delta, Air Canada and U.S. Airways on the routes to North America.
16 This data is cross-sectioned by passenger final destination (including final destination in sixth freedom flights). The Company’s estimate concerning the passenger’s final destination is based upon data from global distribution systems. The Company cannot estimate the precision of the data received from the distribution systems, which include paying passengers only. Note that the Civil Aviation Authority publishes data that includes non-paying passengers, which is broken down by the airlines carrying out the flights (and not by destination). Thus, in cases of Sixth Freedom flights of European airlines between Israel and the U.S. through European airlines – the flight shall be attributed to the parent company of the European airline. According to the Company's processing of the Civil Aviation Authority data and cross-sectioning of flights to the airlines’ parent companies, while ignoring Sixth Freedom flights, the Company’s market shares were: in the North America route: 46.0% in 2012 vs. 44.6% in 2011; European routes: 33.4% in 2012 compared to 32.9% in 2011; in East and Central Asian routes: 86.6% in 2012 compared to 86.8% in 2011; other destinations: 9.3% in 2012 compared to 14.2% in 2011. 17 Civil Aviation Authority data refers to the airlines performing the flights and not the flights’ destinations. Therefore, this data constitutes the Company’s estimates based on an analysis of Civil Aviation Authority data. This data has been broken down by the direct flight destination and do not take into account passengers’ real destination in the case of foreign airline Sixth Freedom flights. 18 The Company is unable to assess the precision of its estimate of the market share that includes Sixth Freedom flights in the East and Central Asia market, Africa and regional destinations (such as Turkey, Greece and Cyprus), this in view of the lack of precision of information in the Company’s possession regarding the number of passengers of other airlines in these markets. 19 Others: passengers to regional destinations (Cyprus, Egypt, Greece, Jordan, Malta and Turkey) and Africa. Starting May 2009 until November 2011 the Company operated direct flights to Brazil. Therefore, in 2009-2011, passengers on these flights have been included under “Others" (regional destinations, Africa and Brazil). A-36
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In addition, intensive activity by European airlines taking traffic to the United States and Canada via their home airport (Sixth Freedom) continues. Overall, in 2012 there was a 3% decrease in passenger traffic on direct North American routes compared to 2011, due to the discontinuation of activity by American airline Delta on the Tel Aviv-Atlanta route in September 2011.
The seat capacities of other scheduled airlines on route to the U.S. dropped slightly, by 2%, as a result of the cancellation of flights due to Hurricane Sandy in October 2012.
The Company did not change its seat capacity on routes to the U.S. and Canada and the Company’s passenger traffic remained essentially unchanged.
On the route in question all of the airlines (Israeli and American) had full freedom of action in the matter of rates, frequencies, types of aircraft, aircraft configuration and so on. The Company, as a Designated Carrier to the U.S., has the right to carry passengers, cargo and mail to/from New York and other points in the U.S., some as part of a code sharing agreement with American Airlines. This agreement allows the Company to offer its passengers dozens of central destinations in North America, relying on the Company's network of direct routes.
In November 2012 the U.S. Federal Aviation Administration (FAA) informed the CAA of its decision to cancel the lowering of Israel’s flight safety rating to Category 2 and restore it to the highest flight safety category (Category 1), thus allowing the bilateral activation of the code sharing agreement signed with American Airlines. The Company is in talks with American Airlines for the bilateral implementation of the agreement, so that the American Airlines code will also appear on flights carried out by the Company. In addition, the Company will be able to open new routes in the U.S.
Israel's restoration to the highest safety level will also allow Israel airlines to realize the Open Skies aviation agreement signed in 2010 between Israel and the U.S. for the first time. This agreement, like the previous one, does not limit the number of airlines allowed to fly between the U.S. and Israel. The importance of this agreement is that it allows the signing of code sharing agreements with third countries on routes between Israel and the U.S. and features no restrictions on the number of U.S. destinations to which Israeli airlines may fly, and unlimited stopovers with passengers inside the United States will be allowed.
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d) Routes to Europe
As of this report, the Company has scheduled flights to 23 destinations in Europe, with the key destinations being London, Paris, Moscow, Frankfurt, Rome, Milan, Madrid and Zürich. The Company competes on the routes between Israel and Europe with the national Designated Carriers of the destination country, as well as with other scheduled airlines that take Sixth Freedom traffic to other countries via their home airport, with foreign and Israeli charter airlines that operate charter flights to various destinations in Europe and with companies operating scheduled low cost flights. In this regard, it should be pointed out that European scheduled airlines flying to Israel have an advantage over the Company, since they have the ability to offer connecting flights to destinations to which the Company does not fly. The Company, as a designated carrier, has the right to transport passengers, cargo and mail to/from various European destinations, some applied in effect pursuant to code sharing agreements only. The liberalization of the Israeli aviation industry continued in 2012, with the signing of new aviation agreements as described in 7.1.10 above, the appointment of additional Designated Carriers on these routes and approvals granted by Israeli authorities to increase capacity for foreign airlines.
The foreign scheduled airlines operating on European routes, which are dealing with the ongoing economic crisis in the euro zone, the increase in jet fuel prices and the increased competition from low cost airlines, have taken streamlining measures, with some increasing their activity on these routes by increasing frequencies and/or expanding destinations alongside the use of smaller and more efficient aircraft, and some reduced their activity on routes to Israel.
The prominent airlines that increased their activity on these routes over the course of 2012 are:
Air France which operated 3 daily flights on the Tel Aviv-Paris route during the summer months (July-August) and opened new flight routes, as follows: in April it began operating 3 weekly flights on the Tel Aviv-Nice route and in September began operating 2 weekly flights on the Tel Aviv-Marseilles route. In total, Air France listed a 21% increase in passenger traffic.
EasyJet began operating 9 weekly flights in October (instead of 7) on the Tel Aviv-Luton route, and also began operating a new flight route between Tel Aviv and Manchester, on which it operates 2 weekly flights. In total, on all of these
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routes together (Luton, Manchester, Basel and Geneva), EasyJet increased its passenger traffic by 14% compared to 2011.
British Airways began operating a third daily flight on the Tel Aviv-London route in November, but using smaller planes. As a result, no material change occurred in its passenger traffic (2%).
Spanish low-cost airline Vueling, increased its activity on the Tel Aviv-Barcelona route and operated an average of 3 weekly flights (compared to an average of 2 weekly in 2011), listing in total a50% increase in its passenger traffic.
Russian airline Aeroflot operated larger aircraft in 2012 and in September- October operated 2 daily flights (14 weekly frequencies compared to 7 weekly frequencies in the other months of the year), and its passenger traffic increased significantly by 47%.
Ukraine Air International began in April 2012 to operate 10 weekly frequencies on the Tel Aviv-Kiev route instead of 7 prior to that, in total increasing its passenger traffic by 39%.
As noted above, several airlines significantly reduced their activity on these routes. The airlines that significantly reduced their activity were:
German airline Lufthansa, which, while increasing its activity by adding new destinations (in June 2012 began operating 2 weekly flights on the Tel Aviv-Berlin route and in November began operating 2 flights on the Tel Aviv-Düsseldorf route as well), listed a 7% drop in passenger traffic, following a significant reduction in seat capacity to Frankfurt and Munich, by shifting to smaller aircraft.
Iberia Airlines, which operates smaller aircraft and even reduced the number of its weekly flights on the Tel Aviv-Barcelona route from an average of 16 in 2011 to an average of 14 in 2012, and in total listed an 11% drop in passenger traffic.
KLM operated smaller aircraft on its Amsterdam-Tel Aviv route and its passenger traffic dropped by 29%.
Italian airline Meridiana Fly, which in 2011 operated 6 weekly flights on routes from Milan, Rome and Verona to Tel Aviv, operated just two weekly flights on the Milan-Tel Aviv route as well as one weekly charter flight on the route from Verona to Tel Aviv in May-October. In total, its passenger traffic dropped by 53%.
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In addition to the above, in 2012 several new airlines began operating on routes between Europe and Israel, while on the other hand, other airlines encountered difficulties and discontinued their activities (for details regarding these airlines, see 7.1.10 above).
In total, 2012 saw no material change (+1%) in total passenger traffic to Europe, with foreign scheduled airlines increasing their passenger traffic by 4%, the Company’s passenger traffic to these destinations increasing by 3%, while charter airlines listed a significant 16% drop in passenger traffic on these routes.
Aviation agreements signed in recent years as well as other agreements including the global agreement between Israel and the EU members expected to be signed in the future are expected to lead to the operation of scheduled flights to and from Israel by additional airlines, and to an increase in the capacity and frequency and/or an expansion in destinations among the existing airlines. Therefore, in 2013, a further increase is expected in the competition for traffic on these routes.
The Company's estimation regarding the increased capacity and frequency among the other airlines and the intensifying competition are Forward-Looking Information as defined in the Securities Law. This information relies, inter alia, on the Company's estimates in view of the volume of the Company's current activity and the degree of competition in the markets may not be realized – in full or part – or be realized in a significantly different manner. The actual situation may differ from projections, among other reasons due to the opening of the market to additional competition, regulatory changes, the manner in which the Company deals with competition and the risk factors listed in Section 9.18 below as well as economic, security and geopolitical changes.
e) Routes to East and Central Asia
Other than the Company, which operates on routes to India (Mumbai), Thailand (Bangkok), China (Beijing) and Hong Kong, and Korean Air which operates on the route to South Korea (Seoul), scheduled airlines that operate in Israel operate flights to these destinations in the context of Sixth Freedom traffic.
In total, in 2012 the supply of seats in these routes remained essentially unchanged compared to 2011 and the number of passengers on these routes increased by 6%.In total, the Company did not change list seat capacity on these routes and its passenger numbers increased by 6%.
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f) Other Routes
The other routes that the Company operated during 2012 were Greece, South Africa and Egypt (until May 2012).
On regional routes, most of the increase occurred on traffic to Greece (7%) and Turkey (18%). Note that the route to Istanbul listed a 25% increase in passenger traffic, in light of the significant increase in the activity of Turkish Airlines which gradually added, since September 2012, 7 weekly flights to Israel, and increased its weekly number of flights from 25 to 32 weekly flights. In total, Turkish Airlines listed a 9% increase in its seat capacity and a similar increase in passenger traffic. In addition, in June 2012 Turkish airline Pegasus began operating scheduled flights on the Tel Aviv-Istanbul route, in addition to the charter flights it operates to Antalya. Traffic to Egypt continued to drop (-54%), in light of the political instability in the region. In light of the drop in demand, in the first few months of 2012 the Company operated a limited number of flights on this route, and in the second half of the year did not operate flights at all, due to the lack of economic feasibility and high security expenses.
Note also that a significant increase was listed in traffic between Israel and Ethiopia (+22%) in light of the increase in activity by Ethiopian Airlines, which added an additional weekly frequency and in total operated 5 weekly flights compared to 4 weekly flights in 2011.
In 2012, total passenger traffic on regional routes and on African routes increased by 10% and the number of Company passengers on these routes decreased by 8% compared to 2011.
In addition, from time to time the Company operates unique charter flights or short series of charter flights to various destinations.
7.3 Analysis of Revenues and Profitability from Services
In 2012 no material change occurred in the Company's revenues from this area of activity compared to 2011 revenues, with the rate of increase in passenger traffic through BGN in 2012 being 1.4% versus 2011.
For details regarding the breakdown of the Company’s revenues and profitability (consolidated) by reported operating segments in the area of passenger aircraft see Section a.5 of the Board of Directors Report. A-41
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7.4 New Services
Over the course of October 2012 the King David Lounge at London was renovated and upgraded, with innovative new design, to serve luxury class passengers. The London lounge is one of the Company’s 4 lounges: the Company’s “flagship” lounge at BGN Terminal 3, the Paris lounge and the New York lounge. The renovated lounge matches the designs of the Company’s other lounges and offers a computerized business room sponsored by Bank Leumi and advanced service for luxury customers according to high international standards. The lounge is divided into two compounds, with the main space serving all guests and a separate room for first class passengers.
In early July 2012 the Company launched a new service class (Economy Class Plus), which is located at the front of the Economy Class, for a unique flight experience. The new service class offers improved seats with more leg room, more lean-back space, special check-in counters and other perks.‘ The new class is offered for European destinations and long-distance destinations – North American, East Asia and South America. The new class was initially marketed on Boeing 747-400 aircraft in designated seats. The Company is continuing in its implementation of the new service class, the Economy Plus class, in its 767-300 as well as its 777 fleet, thus expecting to complete the change in all of the Company’s wide-bodied aircraft fleet. The service class was launched in February 2013on 6 767-300 aircraft, and is expected to be launched on 777 planes in 2014.
Over the course of the first quarter of 20103, the process of upgrading and renewing the Company's 767-300 aircraft began, within the framework of which the interior configuration of these aircraft will be redesigned. The process will include, among other things, the seating environment, the entertainment system (which will include the distribution of iPads to luxury class passengers), seats, lighting, storage cells and kitchens. The 767 airplanes are used by the Company for its flights to Beijing, Bombay, Bangkok, Johannesburg, Toronto and London.
The Company has upgraded its website, turning it into an online shopping and information center, which allows Company passengers to order, besides flight tickets, also hotel rooms, insurance and transportation to the airport (in Israel), and to purchase additional goods and services. In order to carry out the step that makes the Company site a one stop shop, the Company signed a collaboration agreement with Booking.com, according to which the Company will market hospitality services in hotels around the world for passengers departing Israel. In addition, new services were added such as El Al Upgrade, which allows tickets to be upgraded to business class at an affordable price A-42
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by filing a bid on the Company’s website, as well as a bid for an empty seat adjacent to a seat purchased by the passenger in economy class. Notice regarding the win is sent to the passenger some 30 hours before the flight.
From time to time, the Company assesses the possibility of increasing the frequency to existing destinations and the possibility of operating flights to new destinations, in accordance with market demand, inter alia, through code sharing agreements and other agreements with other airlines.
The following are updates regarding the Company’s code sharing and cooperation agreements for 2012:
In September 2012 the Company received approval from the Restraint of Business Commissioner for an extension of an exemption from a binding arrangement approval regarding code sharing agreements between the Company and Swissair, Iberia, Czech Airways, Thai Air and American Airlines for a period of three years, and the code sharing agreement with American Airlines for a period of one year (in light of the publishing of the type exemption in the matter of arrangements between air carriers dealing with marketing flight capacity to destinations subject to open skies agreements as detailed in 9.11 below).
In December 2012 the Restraint of Trade Commissioner approved the extension of the exemption from a binding arrangement approval regarding a code sharing agreement between the Company and Air China for an additional three years.
The Company has entered into a code sharing agreement with Vietnam Airlines Company Limited, the national airline of Vietnam, on Hong Kong-Hanoi and Hong Kong-Ho Chi Minh City (Saigon) routes. The agreement in a free sale format, in which the Company will be able to offer its customers flights from Tel Aviv to Hanoi and Ho Chi Minh City via Hong Kong, and at the same time the Vietnamese airline will be able to offer its customers flights from Vietnam to Tel Aviv on these routes.
In November 2012 the Company signed a new code sharing agreement with Thai Airways. The new agreement will be in a free sale format, and will replace the Company's previous agreement with Thai Airways, which was in a block seats format. The new agreement was ratified by the Restraint of Trade Commissioner in March 2013.
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The Company announced the cancellation of the code sharing agreement with Ukrainian airline Aerosvit following disruptions in its activity and the cancellation of its flights to Israel starting from mid-January 2013.
7.5 Customers
The Company renders its services to passengers who are both members of households and of the business sector. The majority of the Company airline tickets are sold by way of travel agents and marketers of tourism packages, and directly by the Company to institutions and individuals. See Section 7.6 for additional details. For information on the frequent flyer program see Section 7.6.4 below.
In the area of passenger aircraft shipping, the Company does not have a customer, including an agent, whose revenues or sales through them account for 10% or more of total Group revenues. The Company estimates that it is not dependent on any single customer or agent in the passenger aircraft transport field.
7.6 Marketing and Distribution
7.6.1 Travel Agents and Marketers of Tourist Packages
Most travel agents are IATA members and sell flight tickets for a number of airlines. Upon making their sale, the agents are entitled to commissions from the airlines at rates determined by them an in accordance with IATA directives.20 Agents may occasionally be entitled to additional commissions, including sales incentives, as decided by the airlines.
The vast majority of the marketing of airline tickets to passengers is carried out by means of travel agents and marketers of tourism packages. In addition, airline tickets are sold by the sales offices of the Company and by direct sale over the telephone and the Internet. As of the writing of this report, the Company has 4 sales offices in Israel (Tel Aviv, Jerusalem, Beersheba and Eilat) and 29 sales offices and missions abroad (the Brazil office was closed in December 2012 and the sales activity was transferred to a general agent).
In addition, the Company sells airline tickets through 42 overseas general sales agents (GSAs).
Airtour Israel Ltd. (hereinafter- “Airtour”), a company jointly-owned by the Company and by travel agents, is an important marketing channel for the Group in the Israeli
20 For details regarding IATA directives see www.iata.org. A-44
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market, as a distribution arm to all agents in Israel with respect to sales campaigns and packages to all agents in Israel.
Subsidiary Dun D’Or also serves as a marketing arm for Company products, primarily for charter flights and for flights to various destinations.
The Company grants commissions and special incentives to travel agents, primarily based on the sales volume of airline tickets. In principle, the consideration to Israeli agents is divided in two: a fixed component (a basic 7% commission) and a variable commission component, as an incentive. There are various methods in use globally regarding this matter, conforming to market needs. In recent years, a trend has developed in the aviation world of shifting to a reduced commission system, reaching a “net fare” system (fares without commissions) in such a manner that the agents' base commissions are canceled and service fees collected by the agents are added. Foreign scheduled airlines operating in Israel have instituted a similar policy to that of the Company, although starting 2009 the foreign of airlines operating in Israel began reducing the base commissions and most of them canceled it completely.
In January 2013 the Company announced that it would be reducing its base commission from 7% to 5%. The date of the update to the based commission was set, after a delay following requests from travel agents, for July 1 2013. In addition, the Company will offer a mechanism of an additional incentive for an additional period, which will be agreed upon with each of the agents. This step is intended to reduce operating costs in light of increased competition and increased costs. Commissions to agents abroad vary from country to country, according to market conditions.
7.6.2 Computerized Reservations System
The Company’s computerized reservations system is the Amadeus system. This system displays the up-to-date flight schedule of the Company and of foreign airlines, and enables the users to book reservations and ticketing on those airlines’ flights, and includes a check-in system (DCS). The computerized system allows the more efficient use of loading capabilities for Company aircraft by calculating weight and balance using concentrated calculated data as well as more efficient supervision of customer treatment management.
The Company also has agreements with certain international distribution systems that allow sales and direct access to the Carmel system by the users of these systems in order to book reservations for Company flights.
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7.6.3 Marketing and Sales to Passengers
The Company takes action in order to advertise its services to passengers in the Israeli market and in other large markets. The Company also initiates marketing events, sponsorships and joint efforts.
2012 saw a continuation of the trend of global growth in e-ticketing, meaning the direct marketing of flight tickets over the Internet. This trend is intended to reduce airlines' marketing and distribution costs. The Company continues to conform its operations to this trend, by developing means that enable self-service for customers, such as online ticket purchasing, check-in and seat selection, check-in and seat selection at counters in the terminal, and so on.
The Company sells directly to passengers through the Company's reservations department and website. The Company also operates a business desk to promote sales to business entities, mainly in Israel.
Subsidiary Dun D’Or also serves as a marketing arm for Company products, primarily for charter flights and for flights to various destinations, with the flights operated by the Company or other Israeli airlines (primarily on weekends and holidays).
In order to increase the attractiveness of the Company's flights for passengers interested not only in transport services to and from Israel, but also in tourism services, the Company markets a variety of ground services for tourists (hotels, tours, car rental) to individual passengers, directly and through agents. For this purpose, the Company markets packages through Airtour. This activity is marketed abroad through Superstar Holdings (England) at the Company’s branches abroad by independent direct marketing or through travel agents.
On August 6 2012 the Company’s distribution systems published prices of flights from North American destinations to Israel via Europe (code sharing flights) that were significantly lower than the Company’s ordinary prices for these flights. The incorrect prices were posted for several hours, during which thousands of tickets were purchased. On August 9 2012 the Company informed the ticket purchasers that the flight tickets purchased and carded would be honored by the Company. The Company estimates that the event has no material impact on its Financial Statements.
7.6.4 Frequent Flyer Program
As part of its marketing efforts, and in order to reinforce the loyalty of Company passengers, the Company offers special benefits to passengers belonging to its “frequent A-46
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flyer” club, which is based upon a recorded database. The passengers receive points for their flights on all of the international routes carried out by the Company.
These points award passengers with various benefits, including airline tickets at a discount or for free (with the exception of a cash surcharge for port taxes and various extra charges, including a fuel surcharge), upgrades to better classes and access to the Company’s lounges throughout the world.
In recent years, the Company has entered into agreements that allow the accrual and redemption of points in other airlines and/or conversion of points/stars from credit cards and other businesses to the frequent flyers club as well as collaborative agreements allowing the accrual of points and/or the receipt of other benefits as a result of purchases made from various businesses (compensation is generally paid the Company by the business) and agreements for the use of points at various businesses. In addition, agreements have been reached with various non-profit organizations working for social, ethical and humanitarian causes, for the contribution of points to said organizations by club members.
The frequent flyers club has over a million members and is composed of a number of ranks according to the activity level of their members: “Regular Frequent Flyer", “Silver”, “Gold”, “Platinum” and "Top-Platinum".
Concurrent with commercial changes made in recent years in the club's terms, various technological improvements were also made, including upgrading the information system by allowing club members to execute transactions in their accounts through the website, improving the system for routing calls at the service center, improving the format of the customer account statement, and more.
The Company's program for cultivating, retaining and increasing the number of prestigious customers continued in 2012.
The collaboration agreement between the Company’s passenger club and American Express U.S.A. was revised in January 2012. The revision largely pertained to an improvement in the conversion ratio from American Express points to frequent flyer club points, as well as a change in the value of the points.
The “Frequent” ticket abroad is marketed under the GlobaLY brand with the intent to distribute it to all supporters of the State of Israel around the world and create a knowledge base of millions of customers.
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Over 180,000 new members joined in 2012, which reflects an 84% increase compared to the corresponding period last year. The number of frequent flyer club members as of September 2012 amounted to some one million fifty thousand.
Frequent flyer club member traffic during 2012 accounted for 32% of the Company's total passenger traffic similar to 2011.
For details regarding the accounting treatment of the subject of club commitments see Note 2.o.(2) to the Financial Statements.
7.7 Accumulated Orders
The Company has no financial data as to the volume of projected revenues from reservations for future flights. Furthermore, a portion of these tickets may also be redeemed by the customer over an extended period that does not exceed two years. The Company has “unearned revenues” deriving from the receipt of advance payments for flights yet to take place as well as from points accumulated by frequent flyer club members as noted above.
7.8 Competition
7.8.1 General
a) The cargo aircraft transport field is characterized by fierce competition between the airlines that supply transport services between the same destinations or alternative destinations.
b) The Company serves as the Designated Carrier of the State of Israel to most of the destinations from which it operates regular flights to and from Ben Gurion Airport.
c) The Company estimates that, over the course of 2012, competition on flights to and from Israel was with approximately 120 airlines, including Israeli airlines Arkia and Israir (operating both charter flights and scheduled flights to certain destinations), 61 foreign airlines operating scheduled flights to 70 destinations in 40 countries and 50 airlines operating charter flights (of which 35 operated throughout the year and the balance operated individual flights). The competition for cargo transport in the holds of passenger aircraft, which is included in this field, is against airlines that transport cargo in cargo aircraft and in the holds of passenger aircraft. See Section 8.7.1 for additional details.
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See Section 7.1.10 above for details on the competitive structure of this field of operations.
7.8.2 The Company’s Market Share in the Service Categories
According to the Company's estimates, in 2012 the Company's portion of all traffic to and from BGN amounted to 33.6%, compared to 33.98% in 2009.] For the Company's market share of service groups see Section 7.2.(b) above.
7.8.3 Significant Competitors in the Field of Passenger Aircraft Transport
To the best of the Company's knowledge, the Company's major competitors in the passenger aircraft transport field in 2012, in terms of market share, were Continental/United (U.S.), Delta (U.S.), U.S. Airways (U.S.), Lufthansa (Germany), British Airways (UK), Alitalia (Italy), Air France – KLM (France and the Netherlands), Swissair (Switzerland), Transaero (Russia), Aeroflot (Russia), Aerosvit (Ukraine) and Ukraine Air International (Ukraine).
See Section 7.1.10 above for details regarding the intensification of competition in the field in 2012.
7.8.4 Key Methods for Coping with Competition
The Company acts in a number of venues in order to raise profitability, while preserving and increasing its market share and increasing its load factor, including:
a) Conforming the schedule, as much as possible, to the seasonality of traffic and to international events.
b) Increasing the frequency of flights to popular destinations and increasing the number of flight destinations, including by cooperating with other airlines.
c) Striving to constantly improve the service to passengers, including improving seat comfort, food quality and variety, flight entertainment and so on, while focusing on the business class.
d) Providing benefits to frequent flyers club members and to businesses belonging to members of the Company's business desk.
e) Operating through all relevant marketing channels.
f) Addressing the traveling public through advertising campaigns in Israel and abroad.
The positive factors that affect, or are likely to affect the Company’s competitive position include the following: a broad and varied flight structure; a distribution system dispersed widely throughout Israel; the existence of an attractive frequent flyers club; a formidable
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brand in the local market; high level of safety and security; schedule stability and on-time performance; conforming services to market needs and code sharing agreements with other airlines.
The negative factors that affect, or are likely to affect, the Company's competitive position include the following: a geopolitical situation that significantly reduces the Company's opportunities to carry out Sixth Freedom Flights (indirect flights via BGN) as opposed to the expansion of Sixth Freedom Flights by foreign airlines; the possibility of appointing additional competitors as Designated Carriers in Israel to destinations to which the Company flies or to nearby destinations, especially in view of the Government's above decisions; the entry of low cost airlines; membership of foreign airlines in global aviation alliances (STAR, One World, SKY); regulatory changes and legislative restrictions applicable to the area of activity; excess capacity of competitors; the Company's reliance on distribution by means of agents as opposed to the growing trend of direct marketing over the internet; the absence of Company passenger flights on the Sabbath or Jewish holidays and possible worsening of the economic, security and political situation in Israel.
7.9 Seasonal Factors
The Company's activity is seasonal and focuses on peak periods. Heavy traffic of Israeli residents traveling abroad occurs primarily during the summer months and during holidays, while heavy incoming tourist traffic occurs during the summer months and during Jewish or Christian holidays or vacation time in their countries of origin. The Company's peak activity is in the third quarter, when passenger volume in 2012 was 32% and in 2011 was 31% of total yearly passenger traffic.
The following is data on the breakdown of the Company’s quarterly revenues from passenger aircraft21:
Quarter Yearly (In (In Millions of Dollars) Millions of Dollars) Year January- April-June July- October- January- March September December December 2012 382.2 477.7 546.9 421.1 1,827.9 % of 20.9% 26.1% 29.9% 23.1% 100% Area of Activity
21 The Jewish holiday period, according to the Gregorian calendar, varies from year to year; this may have an effect on comparing quarterly operations between one year and another. A-50
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7.10 Manufacturing Capabilities
The accepted indices of output in the world of aviation as regards passenger aircraft are
load factor22 and ASK23. At peak demand (August), the Company’s productive capacity approaches its full potential output. In August 2012 the Company’s ASK was 2,208 million RPK and the Company’s load factor for August 2012 was 86%.
The following graph describes the monthly ASK average and the Company's average load factor over the past five years:
In accordance with the 1982 government resolution, the Company ceased operating scheduled flights on the Sabbath and Jewish holidays, and, accordingly, does not fully utilize its productive capacity. With the conversion of the Company to a “Mixed Company” on June 6, 2004, this prohibition was removed. Pursuant to an agreement reached in January 2007 between representatives of the Rabbinic Committee for Sabbath Observance and Company representatives, the parties agreed that the Company would continue to maintain the status quo which had existed up to then, according to which the Company does not carry out passenger flights of EL Al on the Sabbath and on Jewish holidays, pursuant to the 1982 government resolution. In light of the need that arises from time to time for flights to be carried out on the Sabbath, it was agreed that, prior to such flights, the Company would communicate with the Chief Rabbi, Shlomo Amar, to clarify the position of Jewish doctrine. Additionally, the parties formulated understandings concerning the refund of cancellation fees for portions of kosher meals, in the event that,
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as the result of the breach of this understanding, ultra-orthodox customers would be forced to cancel their flights.
7.11 Aircraft Fleet
7.11.1 As of a date near the approval of the report, the Company makes use of 37 passenger aircraft, of which 22 are owned by the Group and 15 are leased by the Group)24.
7.11.2 The Company's fleet of passenger aircraft was manufactured entirely by Boeing. As a result, El Al is dependent upon the aircraft manufacturer Boeing for all matters related to the supply of aircraft parts, in the event of failures and findings occurring during regular maintenance (as a result of it being the aircraft’s manufacturer) and engineering consulting.
7.11.3 The following table itemizes the fleet of passenger aircraft owned by the Company, as of December 31 2012:
Type of Aircraft Total Average Age Average No. Maximum Flight Range Cargo (in Years) of Seats (Nautical Miles)26 Capacity25
747-400 6 17.3 413 6,400 18.7 757-200ER* 2 19.9 196 3,000 3 737-700 2 13.3 104 2,500 1.5
737-8003 6 8.7 143 2,400 1.5
767-200 ER (E,F) 2 22.5 191 6,200 12.1
777-200ER27 6 9.6 279 7,300 22.4
Total 24 13.6 249.6
* Note that the activity of the two 7587-200 aircraft noted in the table was discontinued in November 2012.
24 As of December 31 2012 the Company owned 24 aircraft, which include two Boeing 757-200 planes that were sold prior to the report’s publication date and therefore are not included in the aircraft count in this paragraph. 25 Cargo capacity of a aircraft full of passengers for a range where the required amount of fuel does not come at the expenses of useful cargo 26 The range is for a plane full of passengers without cargo. 27 Some of the 737-800 and 777 aircraft were purchased via ExIm/using ExIm guarantees and therefore the legal formula states that the aircraft were first leased by the Company, with the Company retaining the option to purchase the aircraft at the end of the period in return for $1. A-52
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Company management is continuing to test, in conjunction with the two leading aircraft manufacturers, Boeing and Airbus, the process of receiving offers for replacing and renewing the Company’s wide-bodied aircraft fleet, as part of the formulation of its strategic plan.
7.11.4 The following table details the fleet of aircraft leased by the Company, as of December 31 2012:
Type of Total Average End of Lease Date Average Additional Details Aircraft Age No. of Seats
737-800 *8 9.5 EKO – November 2015** 157 * An additional aircraft entered EKP – October 2014 service over the course of March 2013 – EKU; EKI – October 2015 ** EKO – the Company has an exit EKS – August 2016 option for November 2014; EKF – December 2016 ** EKT – the Company has an exit EKT - November option for November 2016. 2018*** EKM – May 2018 EKR – May 2018 767-300ER 6 17.3 EAP – November 2014 224 * EAR – the Company has an EAR – November 2016* exit option for November 2014; EAJ – November 2014 ** EAL – both sides an exit option EAL – November 2017** for November 2015; EAM – December 2017 *** EAM – the Company has an *** exit option from February EAK – November 2015. 2016 to December 207 with the exception of December 2016, January, June, July and August 2017. Total 14 12.8 185
Leasing fees for the Company’s aircraft in this area of activity amount to $64 million in 2012 compared to $59 million in 2011 and $58 million in 2010.
7.11.5 Maintenance – General
Following the Company’s 2011 periodic report on the matter of winglet installation (a winglet is a vertical upward extension or backward sweep of the end of the wings of fixed-wing aircraft), the installation of the winglets on 737-800 aircraft has been completed – as part of the steps taken to reduce the influence of increased fuel prices on flight expenses.
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Slide replacement – the Company has begun preparations for the replacement of 60 emergency slides that are expected to expire in the near future. The total cost of the project is estimated at $3.6 million.
For details regarding transactions for the purchase of aircraft, lease of aircraft, sale of aircraft and the extension of agreements regarding aircraft, see Notes 13d and 21(2) to the December 31 2012 Financial Statements.
8. Cargo Aircraft Field
8.1 General Information on the Area of Activity
The following is a description of trends, events and developments in the Company's macroeconomic environment, which have, or are likely to have, a material effect on operating results or on the developments in the entire Company or in the cargo aircraft- field of operations, regarding the following matters:
8.1.1 Structure of the Field of Activity and Changes Occurring Thereof
There are four types of competitors in the cargo air transport market: airlines that carry cargo solely in cargo aircraft; airlines that carry cargo solely in the holds of passenger aircraft; companies, like El Al, that carry cargo both in cargo aircraft and in the holds of passenger aircraft; courier airlines which, in addition to cargo related to courier services, also carry other cargo in their aircraft.
In recent years a constant increase has been evident in the volumes of passenger planes traveling on international routes around the world. This trend increases competition, and as a result, a drop has been evident in air transport prices.
The increasing trend of diverting cargo to maritime shipping continued over the past year.
According to the Company's estimates, its portion of the cargo shipping market in 2012, 2011 and 2010 has been assessed at 33.2%, 33.2.0% and 34.2% respectively, out of all cargo transported to and from Israel (including cargo shipped in the holds of cargo craft. Not including Sixth Freedom and including mail activity).
8.1.2 Legislative Restrictions, Regulations and Particular Considerations Applicable to the Area of Activity
The regulatory restrictions for cargo transportation in cargo aircraft are similar to those applicable to passenger transport in passenger aircraft.
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Regulatory arrangements have also been set for the cargo field relating to a number of operational aspects, such as permissible flight capacity, responsibility of the air carrier for damages, flight safety standards, security and noise. For further details see 9.11 below. Nevertheless, the policies of the global aviation authorities in granting permits for cargo aircraft have tended to be more lenient than in the passenger aircraft field. The situation especially affects the huge opportunity to carry out flights of cargo aircraft using Fifth Freedom and Sixth Freedom.
8.1.3 Changes in the Volume of Activity and Profitability of the Area
a) Scope of Global Cargo Transport
According to IATA estimates, in 2012 global airborne cargo transport (including in the holds of passenger aircraft) decreased by 1.9% (international only). A decrease of 0.1% (international only) was listed in 2011.
In December 2012 IATA published its estimates according to which by 2016 an average annual growth (2012-2016) of approximately 4.5% is anticipated in global airborne cargo transport (including in the holds of passenger aircraft).28 IATA estimated that 2013 will see a growth at a rate of 1.9%.
The following table describes the development of airborne cargo shipping activity between 2008 and 2012, based on IATA data29:
Year Output RTK30 (in Millions) Yearly Change in RTK (%) 2012 No data. No data. 2011 149,890 (0.3) 2010 150,341 20.2 2009 125,075 (11.2) 2008 140,851 (2.6)
28 The IATA projection for up to 2016 refers to increases in the weight of cargo shipped in tons times the distance flown – revenue ton kilometer (RTK). 29 2012 data has not yet been published. 30 Revenue Ton Kilometer – weight uin tons of cargo in cargo craft, paid, times the distance flown. A-55
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b) Volume of Cargo Transported on Aircraft to and from Israel
The following is data on cargo traffic to and from Ben Gurion Airport over the past five years (The data includes cargo carried in cargo aircraft and in the holds of passenger aircraft)31:
Cargo Traffic through BGN (Thousands of Tons) for the Year Ending December 31 Change Change Change Change 2012 2011 2010 2009 2008 from 2011 from 2010 from 2009 from 2008 Exports 147 (5%) 155 (5%) 164 7% 154 (15%) 182 Imports 134 (4%) 139 2% 136 15% 118 (16%) 141 Total 281 (4%) 294 (2%) 300 10% 272 (16%) 322
Aircraft traffic through BGN listed a 4.4% decrease in 2012, constituting 13,000 tons, compared to 2011.32
In addition to Israeli cargo company CAL Cargo Airlines Ltd. (“CAL”), the cargo capacity of foreign airlines included the cargo capacity of passenger flights and capacity in cargo flights by seven airlines: FedEx (U.S.), MNG and Turkish Airlines (Turkey), EAT (Belgium), Royal Jordanian (Jordan) and Korean Air (Korea), and starting October 2012, Lufthansa (Germany). Likewise, unscheduled cargo flights were flown through foreign companies, on an ad hoc basis.
50.2% of the cargo traffic through BGN was flown on cargo aircraft and the remainder (49.8%) was flown in the holds of passenger aircraft (primarily wide- body planes). This data does not include cargo that the Company flew via BGN in the context of Sixth Freedom at a negligible amount33 in 2011-2012 as well as to the amount of 1,000 tons and 500 tons in 2010 and 2009, respectively.
8.1.4 Developments in the Field of Operations' Markets, or Changes in its Customers’ Characteristics
The Israeli market in the field of operations of cargo transport by cargo aircraft is characterized by high seasonal fluctuations, due to the relatively high importance of agricultural exports (carried out primarily in the winter months), out of total exports.
31 Source: the Civil Aviation Authority and the Company’s estimate, which includes the deduction of Sixth Freedom activity by El Al through BGN and the addition of El Al mail activity. 32 Without deducting the Company's Sixth Freedom activity through BGN, the rate of decrease in traffic in 2012 was about 3.8%. 33 Data includes cargo that was carried in cargo aircraft as well as cargo carried in the holds of passenger aircraft. A-56
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See Section 8.5 below for information on the Company's customers in the field of cargo aircraft shipping.
8.1.5 Technological Changes that May have a Material Impact on the Area of Activity
The Company is working to expand and develop advanced IT solutions in the field of airborne cargo, in the field of online trade and in self-service abilities with the goal of improving service and reducing the Company's costs.
The Company successfully completed the development of an interface between the cargo system and Israeli customs, which will be followed by a pilot that is planned to be completed in the third quarter of 2013.
8.1.6 Critical Success Factors in the Area of Activity and Changes Occurring Thereof
A number of factors can be pointed to in the operations of the cargo transport sector via passenger aircraft that affect the field's competitive position: the ability to offer the transport of cargo to popular destinations at competitive prices; development of a network of routes on an independent basis, including the possibility of carrying out Fifth Freedom Flights and Sixth Freedom Flights, both as operations supporting transport to and from Israel; cooperation with other airlines; offering transport at the frequency and quality demanded while meeting time schedules; risk management and risk hedging.
8.1.7 Changes in the Supplier Array and Raw Materials for Areas of Activity
The primary raw material used by airlines is jet fuel and it represents one any airline's major expense components. See Section 9.5.1 below for additional details relating to fuel. In addition, the Company is dependent on Boeing, as detailed in 7.1.7 above.
8.1.8 Main Entry and Exit Barriers of the Field of Operations and Changes that have Occurred Thereof
The regulatory entry barriers (the need for appointment as Designated Carrier and the permits as to frequency, capacity, etc.) for regular flights in cargo aircraft are similar in essence to the regulatory entry barriers for scheduled flights in passenger aircraft, as detailed in 7.1.8 above.
The Company assesses that some countries have a more liberal policy of granting permits in the field of cargo transports. Therefore, in the Company’s assessment, this entry barrier is less significant for some countries in the cargo field.
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Another important entry barrier in the industry is the initial, relatively large investment that is necessary in order to establish and operate an airline, including acquisition of aircraft and other substantial current investments, including aircraft leasing.
The limitations of the holder of the Special Government Share in the matter of the reduction of the Company's cargo fleet constitute an exit barrier. See Section 9.11.1 below for further details.
8.1.9 Substitutes for Services of the Area of Activity and Changes that have Occurred in Them
The principal substitutes for air transport in cargo aircraft are transport in the holds of passenger aircraft, maritime shipping or a combination of maritime shipping to the nearest destination port and from there, shipment overland. There were no substantial changes during 2012 in alternatives to transport by means of cargo aircraft.
8.1.10 Structure of Competition in the Field of Operations and Changes that have Occurred Therein
There has been a structural change in the industry in the Israeli market in recent years, due to increased sources available to customers with the entry of new airlines with cargo aircraft, inter alia, by means of the Fifth and Sixth Freedoms, upgrade of the passenger aircraft of the foreign airlines to broad-body planes capable of carrying more cargo in their holds and also by the entry of an additional Israeli cargo carrier – C.A.L. See Section 8.7 below for further details.
8.2 Services in the Area of Activity
In this area of activity, the Company offers cargo transport services in cargo aircraft from Israel to destinations to and from Israel; cargo transported from one foreign country to another foreign country (Fifth Freedom), for example from Liège to New York; or cargo transported in the context of Sixth Freedom (indirect flights via stopovers in the home country of the airlines), for example from Asia to Europe or the U.S. with a stopover in Israel. The Company transported negligible amounts of cargo in its cargo aircraft using Sixth Freedom rights (in 2009-2012). The Company differentiates between three main destination groups: (1) North America; (2) Europe; (3) East and Central Asia.
During the reported year, the services offered by the Group in this area of activity were cargo transport services to one destination in Europe on scheduled flights, three destinations in Europe on charter flights and one destination in North America. A-58
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Moreover, the Company offers cargo services to many additional destinations using the Company’s passenger aircraft or by means of cooperative arrangements with other airlines and also via land transport from the airport.
The following is a breakdown of the volume of cargo traffic in the Company’s cargo aircraft, by principal destination category, in 2009 to 2012:
Cargo Traffic in the Company's Cargo Aircraft, by Region (Tons), for the Year Ending December 31
2012 2011 2010 2009 Israel to/from Europe 32,533 33,675 36,068 34,796 Israel to/from the U.S. 6,203 7,821 8,310 6,202 Israel to/from the East 122 1,279 1,418 ------and Central Asia
Total 38,858 42,775 45,796 40,998
This data does not include cargo that the Company flew other than via BGN in the context of Fifth Freedom rights and cargo that the Company carried by air, via BGN, in the context of Sixth Freedom rights. The Company flew cargo by Fifth Freedom to the amount of 5 thousand tons, 10 thousand tons, 5 thousand tons, and 3 thousand tons in 2012, 2011, 2010 and 2009, respectively. The Company transported negligible amounts of cargo using Sixth Freedom rights. The chief markets for cargo shipping services are for importers, industrial enterprises and the agricultural sector.
The principal markets for cargo transport services are importers, industrial enterprises and the agricultural sector.
8.3 Analysis of Revenues and Profitability from Services
In 2012 the Group's revenues from this area of activity decreased by 19.1% compared to 2011 revenues, and a 4.4% decrease in cargo traffic through BGN in 2012.
For information regarding the breakdown of the Company’s revenues and profitability (consolidated) by the Company's reported operating segments in the area of cargo aircraft shipping see Section a.5 of the Board of Directors report.
8.4 New Services
From time to time, the Company studies the prospects of operating flights to new destinations and increasing the frequency of the flights to existing destinations, in accordance with market demands.
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The business collaboration venture for flights originating in Europe with the Global GSA Group, which serves as a general cargo agent for various European countries, was not carried out as a result of weakness in the transatlantic cargo market.
8.5 Customers, Marketing and Distribution
Most of the Company's sales in the field of cargo aircraft shipping care to cargo agents, which the Company considers its end customers (some 93.1% in 2012). The remaining sales are made directly to end customers who are not cargo agents.
In the field of transport using cargo carrying planes, the Company does not have any customers the revenues from whom amount to 10% or more of total Company revenues.
In addition, the Israeli company for cargo consolidation (ACI), part of the shares of which are held by the Company (without the right to receive dividends), is engaged in consolidation of air cargo at BGN and its transfer abroad, mainly through the Company. ACI, like other airlines that operate in this field, consolidates the cargo of individual dispatchers into one shipment and, as a dispatcher, transfers it to the Company for shipment. In this way, it avoids interaction with a large number of dispatchers and cargo recipients, leading to cheaper air transport costs of consolidated shipments.
8.6 Accumulated Orders
In general, air transport of cargo in cargo aircraft is carried out near the execution of the service reservation. Therefore, the Company did not have a significant volume of reservations backlog in 2012.
8.7 Competition
8.7.1 Competitive Conditions in the Field of Activity
a) The cargo aircraft transport field is characterized by fierce competition between the airlines that supply transport services between the same destinations or alternative destinations. The airlines compete in different areas, mainly: transport rates, schedule of flights and frequency of flights.
b) In the Israeli area of activity, the Company competes with CAL and with foreign airlines operating cargo planes. As of the date of the report, CAL operates flights to various destinations in the United States and Europe.
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c) In 2012 the Company competed for cargo transport in cargo aircraft to and from Israel with six foreign airlines (in addition to CAL), which operated cargo aircraft in flights to and from Israel.
d) In recent years, the Civil Aviation Authority has tended to approve requests of foreign scheduled airlines to increase the frequency of their flights to Israel. As a result, an increase has been apparent in the capacity of cargo shipping in the holds of passenger aircraft of foreign airlines. This increase has led to intensifying competition in cargo shipping as well.
e) In October 2012 German airline Lufthansa Cargo began operating four weekly cargo flights on the Frankfurt-Tel Aviv-Istanbul-Frankfurt route using a designated MD-11 cargo plane, with a 92 ton cargo capacity.
f) The Company competes with most of the scheduled airlines that operate passenger aircraft and carry cargo in their holds
8.7.2 Major Competitors in the Field of Cargo Aircraft Transport
To the best of the Company's knowledge, its most significant competitor in transport through cargo aircraft, from the standpoint of market share, is CAL.
8.7.3 Key Methods for Coping with Competition
The Company acts on a number of levels in order to raise its profitability, while retaining and increasing its market share and also increasing the volume of the cargo it transports, including:
a) Conforming their timetable, as much as is possible, to the seasonality of traffic and maintaining the timetable's stability.
b) Increasing the frequency of flights to popular destinations and increasing the number of flight destinations by cooperating with other companies.
c) Offering competitive prices.
d) Adding to the frequency of the Company’s cargo flights between two foreign countries.
Positive factors that affect, or are likely to affect, the Company’s competitive position include: operating a designated 747-400 cargo plane; a strong brand name in the local market; a high standard of service, high safety levels; timetable stability and on-time performance. A-61
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Negative factors that affect, or are likely to affect, the Company's competitive position include: the possibility of appointing additional competitors in Israel as Designated Carrier or to additional destinations; regulatory changes that restrict the option of entering into agreements with other airlines or prevent the utilization of flight rights; the entry of new, foreign competitors; increases in flight capacity of foreign airlines (including fifth and Sixth Freedoms); a downturn in the economic, security and political situation in Israel.
8.8 Seasonal Factors
The field of operations is characterized by high seasonal fluctuations due to the relatively strong influence of agricultural exports out of total exports by means of cargo aircraft. The following are data on the breakdown of the Company’s quarterly revenues from the cargo aircraft:
Quarter Yearly (In (In Millions of Dollars) Millions of Dollars) Year January- April-June July- October- January- March September December December 2012 23.5 21.0 17.1 18.8 80.4 % of 29.2% 26.1% 21.3% 23.4% 100% Area of Activity
8.9 Manufacturing Capabilities
The generally accepted output indices for airborne cargo shipping using cargo aircraft are load factor34 and available ton-kilometer (ATK)35. During peak demand (in 2012 – March), the productive capacity of the Company approaches its full potential output. In March 2012 the Group’s ATK was 29,768,000 ATK with a load factor of 80.7%. Note that the load factor indicator is calculated based on the weight of the cargo only and does not take the volume of the cargo into account.
34 The available cargo shipping capacity times the distance flown (available ton kilometer). 35 Calculated by RTK (the weight in tons of the paid cargo times the flight distance) as a percentage of the ATK (the available cargo shipping capacity times the distance flown). A-62
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The following graph describes the Company’s average load factor and ATK index per quarter in 2012:
8.10 Aircraft Fleet
In December 2012 the Company decided to extend the agreement for the leasing of a Boeing 747-400F cargo aircraft (ELF) with Banc of America Leasing Ireland Co. for an additional period of 72 months starting August 1 2013, with the Company given the option to end the lease after 48 months.
In addition, the Company leases cargo aircraft via “wet leases” (aircraft leased with its crew) as needed.
Total leasing costs borne by the Company in this area of activity amounted to $3 million in 2012, $13 million in 2011 and $6 million in 2010.
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8.11 Raw Materials and Suppliers
The principal raw material employed by the Company is fuel. See Section 9.5.1 for further details. In the cargo aircraft field, the Company, in its various stations throughout the world, engages suppliers dealing in unloading and loading aircraft, in cargo storage in warehouses and in land transport of the cargo from the customer to the airport and vice versa. The rate of expenses related to commitments with these suppliers 2012 accounted for some 14% of the operating sector’s expenses. The Company was not dependent on any single supplier in 2012.
9. Information on Both Areas of Activity
9.1 Fixed Assets and Installations
9.1.1 Real Estate:
a) The Company owns an area of 1,560 square meters in the El Al Building on 32 Ben Yehuda St. in Tel-Aviv, which serves as the offices of the Company's Israeli branch (for details see (f) below). The Company also owns offices in Spain (Madrid) and Argentina (Buenos Aires) with a total area of 269 m².
b) The yearly cost for renting areas in Israel is $8,200,000 for built-up property 88,000 m² in size (80,000 m² of which is in the El Al campus). The following are details of material real estate properties rented by the Company in Israel:
Property Parties to the Consideration Contract Period and Option Agreement to Extend
The El Al BGN campus Authorization agreement $3.7 million US for The agreement shall be in effect has a built-up area of between the Airports the ground and until December 31 2010. 80,000 square meters on Authority (authorizing) structure component Furthermore, the option exists to 29 hectares of land. and El Al (recipient). for 2012 (including extend it for an additional 25-year differences for period. The Company announced See (c) below. 2011). its intent to exercise the above option in accordance with the agreement, and is currently negotiating with the IAA to extend the period by an additional term. The SLN warehouse at Authorization agreement Yearly usage fees to The agreement was extended to BGN with a built-up area between the Airports the amount of December 31 2012. The parties are of 2,600 m² plus 1,750 m² Authority (authorizing) $140,000,000. negotiating to extend the of operational grounds. and El Al (recipient). agreement. Areas in BGN Terminal 3: Yearly usage rights: This agreement was extended to a. Area for King David November 1 2013. Authorization agreement A total of 11 million Lounge and other between the Airports NIS per year until A-64
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areas. Authority (authorizing) April 30 2012 and a and El Al (recipient). total of 18 million
See (d) below. NIS per year starting
May 5 2012 (14 million were paid in 2012). Authorization agreement Agreements to grant a permit for b. Other operational between the Airports 7.8 million NIS per the other areas were signed, areas in Terminal 3. Authority (authorizing) year covering a period of 10 years and El Al (recipient). starting November 2, 2004. Areas in BGN for the Agreement between El Yearly usage fees to The agreement was extended to Company’s cargo Al and Maman – Cargo the amount of 0.3 December 31 2014. shipping activity, which Terminals and Handling million NIS in a NIS include the Maman Ltd. contract. Building compound, with a total area of 445 sq. meters. El Al branches throughout Different owners in Total yearly cost of The agreements are for different the country with a total conjunction with the 0.6 million NIS. periods. area of 370 square meters Company.
(not including parking).
c) Land Usage Rights at Ben Gurion Airport (BGN)
Ben-Gurion Airport (BGN) serves as the Company's home port and central base of operations. The Company’s headquarters, hangars, aircraft parking areas, workshops, warehouses and other offices and installations are located at BGN. Most of the offices, hangars and other buildings used at BGN were constructed by the Company on land to which the Company holds long-term usage rights.
By virtue of the agreement dated June 1992 with the Airports Authority (AA), as amended in February 1995, the Company has the usage right (permit) to 29 hectares of land at BGN through December 31, 2010. This period may be extended for an additional 25-year period under the terms of the contract or under other terms as will be agreed upon with the AA. It appears that exercise of the option will be subject to the payment of Purchase Tax. The Company is currently negotiating with the Airports Authority regarding the extension in question.
According to the aforementioned agreement, the AA permits the Company to use the property and the access roads to it and also allows the Company to operate airline services on and/or through the property. The agreement gives the AA the right to demand that the Company vacate space and/or a building that it will need for the operations, safety, development or security of the airport.
In 2005, the Company paid $960,000 in licensing fees for the above usage rights, and starting 2006 onward, the licensing fees will rise by 7.4% per year until the end
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of the contract period, so long as the maximum payment does not exceed $4 million. In accordance with an October 19 2004 revision to the agreement, in addition to the payment for the land, the Company will pay yearly usage fees to the IAA for certain fully depreciated buildings and installations. Payment is at a gradually increasing rate (according and subject to the amount and type of structures finishing the depreciation period each year, according to a depreciation period of 40 years from the structure’s construction). The expense amounted to a total of $3.7 million in 2012.
d) Terminal 3
For details regarding the authorization agreement for the operation of the Company passenger lounge in Terminal 3 and agreements for authorizations in other areas in Terminal 3 see Note 24.c.(4) to the Company’s December 31 2012 Financial Statements.
In the context of the operations of Terminal 3, the Group considered whether to set up an aircraft maintenance center adjacent to Terminal 3. For this purpose and in preparation for the move to Terminal 3, in April 2000 the Company signed an agreement in principle with the IAA to lease an area of 2 hectares in order to set up a maintenance center, a hangar and supporting facilities near Terminal 3. The IAA Board of Directors ratified the transaction but it is subject to the signing of a detailed agreement between the parties and the ratification by the Company's Board of Directors. As of these Statements, no detailed agreement has yet been signed between the parties. The Company has received notice from the IAA, according to which the IAA apparently cannot uphold the agreement and allow the Company to construct a hanger for large aircraft at the location decided upon. In light of this notice, the sides have been holding talks to find an acceptable solution.
e) Global Real Estate Rentals
The following are details of material real estate properties rented by the Group around the world:
Category Area in Square Meter Cost in Thousands of Dollars The middle east 2,150 960 Europe 7,250 3,400 Britain 1,650 1,100 North America 4,100 2,500 Overall Rent paid around the 15,150 7,960 world
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f) El Al Building in Tel Aviv:
The Company intends to move its offices from the El Al Building in Tel Aviv to the Terminal Park in Or Yehuda starting May 2013. The shop was moved to 27 Rothschild Blvd. in Tel Aviv starting from February 2013.
9.1.2 Accessories, Spare Parts and Spare Engines
The Company keeps accessories, spare parts and spare engines in its warehouses, with a total book value of approximately $95.3 million as of December 31 2012. In recent years, the Company has begun to purchase external logistic support services from designated suppliers abroad, to complement the spare parts purchased by the Company. See Note 13 to the Financial Statements for additional details of fixed assets.
9.2 Insurance
The Company’s insurance coverage is mainly related to two aspects: insurance of the different types of Company property and legal liability insurance for property and bodily injury.
El Al’s airline liability insurance is limited to a ceiling of $1,500 million per occurrence, with the insurance coverage for third party damages from terror and war actions amounting to $1,000 million. According to the Company's estimates, this coverage suffices to provide the proper insurance protection for its activity.
The hull all-risk insurance of the aircraft owned by or in the service of the Company, or as regards loss or damage to aircraft for which the Company has agreed to be responsible for their insurance, is based on the “agreed value” of each aircraft and includes deductible levels acceptable in the aviation industry.
Insurance of aircraft hulls against dangers of war and similar risks covers, inter alia, acts of war, terror actions, civil war, strikes, riots, malicious damages, hijackings and confiscation.
The Company is also covered by various insurance policies, which Company assesses are sufficient to provide insurance coverage adequate for the primary risks to which the Company and its employees are exposed. These refer to policies to insure employers’ liability, insurance of buildings against fire, earthquakes and the like, health insurance personal accident insurance for company employees, etc. The policies are renewed on a yearly basis.
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For details regarding engagements with the controlling shareholder – K’nafaim – in a joint insurance agreement see Note 33.c.1.(a) to the Financial Statements.
The overall cost to the Company for insurance premiums during 2012 was $9 million.
9.3 Intangible Assets
The Company owns the “El Al” trademark, which constitutes the Company’s anchor brand, the Company’s name and its logo design. A registered trademark is valid in Israel for limited periods fixed by law, and may be renewed at the end of each period. In addition, the Company owns the trademark for "El Al" (name and designed logo) in the U.S. and in other countries around the world as. In the Company’s assessment, the economic lifespan of the “El Al” trademark covers a multi-year period, being part of the Company’s name, and due to the many years that this symbol has been used and its dominant market position.
Various internet domain names have been listed in the Company’s name in Israel and abroad, valid for variable periods of time, in accordance with registration rules in various countries, with an option to extend.
For details regarding the Company’s rights to the use of security equipment see Note 14 to the Financial Statements.
9.4 Human Capital
9.4.1 Organizational Structure
Determination of the Company's general policies and supervision over the activities of the CEO are the responsibility of the Company’s Board of Directors. Day-to-day management of the Company’s affairs has been assigned to the CEO, who is assisted in his duties by the management team, serving as the Company head office, and comprised of the CFO, the VP of Maintenance and Engineering, the VP of Commerce and Aviation Relations, the VP of Human Resources and Administration, the VP of Service and Customers, the VP of Operations, the VP of Information Technology, the VP of Cargo, the General Counsel and Corporate Secretary and the Company Internal Auditor. For details regarding the CEO's terms of employment see Note 33e to the Financial Statements.
The following chart describes the Company’s organizational structure:
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Board of Directors
President & CEO
General Counsel Chief Audit Officer & Corporate Secretary
Customers Commerce & Maintenance Cargo Operations Global Sales HR & Admin. Finance I.T &Service Industry Affairs & Engineering
Planning & Operations Ground Customers Human Revenue Information Accounts A/C Overhaul Organization Control Operations Service & Sales Resources Management Systems
Flight Administration Budget & Workshops Israel Station Israel Branch Pax Marketing IT Infrastructure Operations Control & Logistics & Comm.
Training & In-Flight North & Central Procurement International A/C *Security Organizational Services America & Supply Affairs Maintenance Development
Commercial * Safety & Customer North Europe * Security Company Planning & Engineering Quality Relations Officer Treasurer Distribution Sys
West Europe Crew Schedule Quality Assignment Planning Control Central Europe & Africa
East Europe
Asia & Oceania
9.4.2 Employees
On December 31 2012 the Company employed 5,775 employees, 3,785 of whom on a regular basis [324 of which in the Company’s overseas offices (including 25 Israelis posted abroad)] and 1,990 temporary employees (115 of them overseas)36. The following are details of regular and temporary employees as of December 31 2012 and December 31 2011:
Position December 31 2012 December 31 2011
Regular employees 3,785 3,836
Temporary employees 1,990 1,955
Total employees 5,775 5,791
The fierce seasonality of the industry requires modulation of personnel, which is carried out, according to demand, through a varying number of temporary employees. Personnel employed by the State also work as part of the Company’s security system, and the
36 The distribution of temporary employees by areas of activity is as follows: flight attendants (874), ground and service operators (665), maintenance and engineering (163), marketing, sales and cargo (32), overseas (115) and the remainder (141) in other positions. A-69
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Company pays part of their salaries (in accordance with the splitting of security costs between the Company and the State - see Section 9.11.12 below for details).
As part of streamlining measures taken by the Company, it was decided in February to dismiss some 200 temporary Company employees as well as a number of employees employed via personal contracts.
The following is a breakdown of the Company's permanent employees in Israel and abroad as of December 31 2012 and December 31 2011, according to their fields of employment:
Position December 31 2012 December 31 2011
Senior employees 43 43 Marketing, sales and cargo 457 470 Pilots 507 511 Flight attendants 382 391 Ground, security, control, 633 637 operations and service operators. Maintenance, renovations, 1,148 1,167 engineering and inspection Auxiliary services 615 617 Total regular employees37 3,785 3,836
9.4.3 Material Dependence on a Specific Employee.
The Company has no material dependence on any specific employee and/or executive.
9.4.4 Training and Instruction
The Company’s training center has been certified as a “Qualification Institute” according to the Aviation Regulations (Inspection Institute, Qualification Institute and Self- Maintenance), 1979. The center trains workers and holds training courses for most of the professions needed by the Company: pilots, aircraft technicians, flight attendants, traffic officers, ground attendants, reservations and ticketing personnel, marketing and sales managers, middle management and so on. In addition, the Company holds courses and study programs for travel agents and cargo agents in Israel and abroad.
The Company invested $9 million in employee instruction and training in 201238.
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9.4.5 Employee Compensation Plans
See Note 25e to the December 31 2012 Financial Statements for further details.
9.4.6 Exemption from the Budget Fundamentals Law
The Company’s request for exemption from Section 29 of the Budget Fundamentals Law was approved by the Minister of Finance, and was ratified by the Knesset’s Finance Committee on March 17, 2005.
9.4.7 Special Collective Agreements
In addition to labor legislation and extension orders, the terms of employment of Company personnel employed in Israel, with the exception of the executives and other personnel employed under personal contracts, are organized in special collective agreements that are signed from time to time between the Company and the New General Workers Histadrut (above and hereinafter – “the General Histadrut”) and also by procedures that are published from time to time by management.
The collective agreement signed in November 2008 expired on December 31 2012. Discussions to renew the agreement were held between November 2012 and February 2013. At the same time, after signing the letter of understanding with the FIMI Fund on January 23 2013 (for details see 3.1 above), on February 11 2013 the workers; representatives announced that it would be freezing talks until the decision of the FIMI Fund, after conducting due diligence, regarding its investment in the Company.
For further details on collective work agreements see Note 19.(c).(12) to the December 31 2012 Financial Statements.
9.4.8 Pension Arrangements
For further details regarding the pension agreement, executive insurance agreement, the deficit on the subject of severance pay and its coverage and details on the Company’s employee benefit obligations, see Note 19.(c) to the Company’s December 31 2012 Financial Statements.
9.4.9 Legislative Amendments Pertaining to Retirement Age and Retirement Arrangements
Amendment to the Worker Employment by Personnel Contractors Law Starting January 1 2012, a provision was added to this law forbidding the receipt of personnel services from personnel contractors, or service from a “service contractor”, and
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forbids engagements with them for the receipt of personnel services, unless the personnel contractor or the service contractor, as the case may be, is licensed in accordance with the law (“receipt of service”, as of today, is defined by law as a contractor providing security services or a contractor providing cleaning services.) In accordance with the amendment, engagement with a personnel contractor or a service contractor without a licenses as required by law, constitutes a criminal offense punished by fine, while receiving service from a contractor lacking a license is an offense punished by a fine for each employee employed within this framework.
Labor Law Enforcement Law The ‘Labor Law Enforcement Law, 2011 was published December 2011. This law does not create new rights beyond those rights currently anchored in existing labor laws, and its sole purpose and goal is increasing enforcement of existing legislation. Two new innovations were anchored in the law: The first innovation is the establishment of a mechanism for placing economic sanctions on employees for violating labor laws. This mechanism will be operated by “senior labor supervisors” who will be appointed for this purpose by the Minister of Industry and Employment, and should be more effective and offer more deterrence than currently existing judicial mechanisms. The second innovation was making those ordering services from contractors directly responsible for upholding the obligations set in labor laws toward contractor workers, which (currently) covers the following areas: security, catering (intended for workers of the party ordering the service) and cleaning.
9.4.10 Eligibility for Flight Tickets
According to IATA regulations, Company employees are entitled to service-vacation flight tickets (free or at a discount), the great majority of which are on an available seat basis for themselves and for their families, including retired employees. This right is anchored in the labor agreements (and in the personal employment agreements of the senior executives (with the exception of directors)), in the personal retirement agreements, in Company procedures and in the professional instructions of the human resources division. The quota of free or discounted flight tickets is limited by the provisions of the labor agreement, of personal agreements or retirement agreements and by Company procedures.
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9.4.11 Voluntary Employee Early Retirement Plans
For details regarding the voluntary employee early retirement plan see Note 19.(e).(1) to the December 31 2012 Financial Statements.
9.4.12 Local Employees at Company Branches Abroad
See Note 19.(c).(9) to the December 31 2012 Financial Statements for further details.
9.4.13 Israeli Employees Posted Abroad
See Note 19.(c).(8) to the December 31 2012 Financial Statements for further details.
9.4.14 Welfare Services and Payments
In addition to salary, part of the Company’s permanent employees also receive welfare services and payments, which include: subsidized meals for employees and gross-up of related taxes, medical examinations of employees, participation in medical and health care insurance and dental insurance for employees, clothing, uniforms, and partial participation in higher education. Some of these benefits are also given temporary employees.
Employees may, under certain conditions, receive guarantees for loans for various purposes. The loans are for periods of up to 60 months and are provided by the Company and Bank Yahav on terms that have been approved by the Ministry of Finance.
9.4.15 Restrictions on Leasing Aircraft via "Wet Lease"
According to a letter dated December 1999 from the Company’s CEO to the Chairman of the Division for Professional Unions of the Histadrut, the Company is to restrict itself in the future to leasing up to 4 aircraft from Israeli airlines, so that the flight hours that will be executed by the Israeli airlines for the Company will not exceed 10% of the Company's total flight hours (including flight hours that will be carried out in wet leases by the Israeli airlines, but not including leased aircraft from foreign companies), and they will operate in specified aircraft models in routes from/to Israel to destinations to which the flight range to them from Israel does not exceed 2,400 nautical miles. The Company will continue to plan the employment of its air crews at a volume of 83 monthly flight hours on an annual average, as it has done until now, and, in the event of a significant change in external circumstances that will create the necessity to change this policy, the CEO will discuss the matter with the Chairman of the Division for Professional Unions of the Histadrut, before deciding on the matter. A-73
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9.4.16 Executives and Senior Management
The members of the Company’s Board of Directors are not Company employees.
The Chairman of the Board of Directors
On January 21 2009 the Company's Board of Directors decided to appoint Mr. Amikam Cohen as Chairman of the Company's Board of Directors, starting February 21 2009. For details regarding the employment agreement of the Chairman of the Company's Board of Directors see Note 25.(e).(2) to the Company's December 31 2012 Financial Statements.
In light of the streamlining and costs savings measures taken by the Company, on November 22 2011 the Chairman of the Company’s Board of Directors announced that he would be unilaterally waiving 20% of the (gross) monthly salary to which he is entitled. The above waiver was for a period from December 1 2011 to December 31 2012.
Directors
As of this report, the Board of Directors consists of 11 members, following the November 29 2012 decision of the general meeting of the Company’s shareholders.
Among others, Mr. Yair Rabinowitz and Prof. Yehoshua (Shuki) Shemer serve as independent directors, as on February 28 2013 the Company's General Meeting approved the extension of the tenure of Mr. Yair Rabinowitz as public director with accounting and financial capabilities for a third 3 year term, starting March 1 2013.
In light of the streamlining and savings measures taken by the Company, the members of the Company’s Board of Directors (with the exception of the external directors) announced that they would be unilaterally waiving 20% of the (gross) yearly remuneration and the per-meeting remuneration to which they are entitled. The above waiver was for a period from December 1 2011 to December 31 2012.
The Company CEO
On October 21 2009, the Company's Board of Directors decided to appoint Mr. Eliezer Shekedi as the Company's CEO; he began serving on January 1 2010.For details regarding the employment agreement of the Chairman of the Company's Board of Directors see Notes 25.(e).(3) and 33(e) to the Company's December 31 2012 Financial Statements..
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In light of the streamlining and savings measured employed by the Company, on November 22 2011 the Company CEO announced that he would be unilaterally waiving 20% of the (gross) monthly salary to which he is entitled. The above waiver was for a period from December 1 2011 to December 31 2012.
For details regarding the Excellence and People CEO fund see Note 33e to the December 31 2012 Financial Statements.
Senior Executives
On November 22 2011, all of the Company’s VPs waived 10% of the monthly (gross) salaries to which each of them was entitled and the heads of the Company’s departments waived between 7.5% and 10% of the (gross) monthly salaries to which each was entitled (in accordance with their pay grade) for the period starting December 1 2011 and ending December 31 2012. In March 2012, holders of personal contracts with the Company waived between 3% and 7.5% of the (gross) monthly salary to which each was entitled (according to their pay grade) for the period ending December 31 2012.
In addition to the CEO, other senior personnel are employed under personal employment agreements. The salary of the senior personnel under personal agreement is updated, so that the overall salary is linked to the CPI and updated each year, in the month of January, after deduction of the cost-of-living increments paid.
In cases where the personal agreement is silent as to eligibility to augmented severance pay, the Company customarily approves incremental severance pay at the rate of one month per year of work.
The following details the number of employees in the category of Company executives and senior management personnel during 2012 and 2011:
Number of Employees39
December 31 2012 December 31 2011 CEO 1 1 Senior management 11 11 Expanded 31 31 management and additional senior employees40
39 According to the organizational structure (as opposed to salary levels). 40 Not including CEO and senior management. A-75
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Internal Enforcement Plan
For details regarding the internal enforcement plan on the subject of securities law and corporate law see Section C.(12) of the December 31 2012 Board of Directors report.
9.5 Raw Materials and Suppliers
9.5.1 Fuel
a) The principal raw material employed by the Company is jet fuel. Jet fuel is one of the Company's main expense components, as it is for every airline. In 2012, jet fuel expenses represented some 40% of the Group’s operating expenses (compared to 39% in 2011).
b) The price of jet fuel has a material effect on the Company’s profitability. The Company estimates that at the operating level as of the date of the report, every change of 1 cent in the price of a gallon of jet fuel over the year increases the Company's fuel expenses by $2.3 million.
c) Since 2001, the Company has taken actions to hedge part of its projected jet fuel consumption. A special committee of the Board of Directors for the management of market risks sets the Company’s policies on the hedging of jet fuel prices, the hedge period and the proportion of the hedge out of total jet fuel consumption for that period. The Company requests proposals for framework arrangements from several financial institutions and fuel companies with which the Company has contacts, carries out commercial negotiations with them and executes the hedge transactions with them. The accounting between the parties is done once each period, and if the average price for the above period in the market is higher than the hedged price, the Company receives a refund in the amount of the price difference multiplied by the quantity for that period; where the average monthly market price is lower than the hedged price, the Company pays the difference multiplied by the quantity for that period. In 2012 the Company received $22.4 million for hedging transactions conducted in the past.
d) In 2012, the average market price of jet fuel rose by 3.8% before hedging transactions. The effect of this price increase on the Company's operating results is substantial.
Following the increase in jet fuel prices, the Company updates from time to time the fuel surcharge paid by passengers as part of their flight tickets. A-76
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e) The Group purchases fuel in Israel and abroad. In 2012, the Company purchased fuel from three Israeli suppliers who were chosen in a tender process, with some 50% of its fuel purchases in Israel being from a single supplier (the Paz Company). For details regarding the Company’s engagements in fuel purchasing agreements in 2012 see 9.12 below.
f) The Company purchases jet fuel abroad from a number of suppliers, including fuel companies that supply jet fuel to a large number of airports. The foreign contracts are for periods of two years, except for cases in which engagements of just one year were possible. Most of the contracts are signed with suppliers after a tender process and after commercial negotiations the Company conducts with the suppliers, except for those stations in which there is only a single supplier. As of immediately prior to the approval of this report, the Company has jet fuel purchasing agreements in most foreign airports in effect until June 30 2013.
g) In February 2013 the Company published a request for proposals (RFP) for overseas fuel supply companies starting July 2013 for a period of two years. The final date set in the RFP for the submittal of the proposals was set at March 15 2013
h) From time to time, the Company reviews the feasibility of importing jet fuel independently as opposed to purchasing from local suppliers, and carries out these activities based upon market conditions. There were no jet fuel imports in 2012.
i) The Company purchased 37% of its total fuel purchases (in Israel and abroad) during 2012 for that year from one supplier (Paz). The Company has seven additional fuel suppliers from which it purchased more than 5% of its total fuel purchases in that year. The Company believes that the scope of purchases from the central supplier in Israel may create a dependence on this supplier insomuch as there are no suitable and immediate alternatives for the supply of jet fuel at BGN.
j) In 2003 the Company initiated a policy of maintaining an inventory of jet fuel, which was purchased from local suppliers. As of December 31 2012, the Company held fuel purchased from suppliers in Israel and abroad to the amount of $12.6 million.
k) In addition to fuel suppliers, the Company receives fueling services in Israel from other suppliers.
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9.5.2 Aircraft
a) All of the aircraft operated by the Company were manufactured by the Boeing Corporation. The Company has a material dependence on Boeing, as detailed in 7.1.7 above. At the same time the Company estimates that the likelihood of termination of engineering support is low.
For details regarding agreements for the purchase and sale of aircraft and engines see Note 13d to the Financial Statements.
9.6 Working Capital
9.6.1 Inventories
The Company has an inventory of raw materials that include jet fuel for consumption, duty-free products to be sold in flight, and expendable inventory (chemicals, food, and supplies.) for the use of passengers during flight. The following is a calculation of average inventory days:
2012 2011 Jet fuel inventory 6 10 Inventory of food and supplies for 47 43 passengers
Duty Free Inventory Purchasing Policy
The Company purchases 80% of its duty-free products from the DFASS Company and the remainder of the products are Israeli products purchased directly from local suppliers (20%).
Alcoholic beverages and cigarettes are provided directly to the duty free warehouse, on a quarterly basis, with the remaining products provided to El Al stations, and the Company shipping them on the basis of available space in Israel.
The Company is entitled to return any product (not food, tobacco or logo products) so long as the product is in its original packaging. The Company is responsible for sending the products including shipping and insurance costs to their point of supply (cigarettes and alcoholic beverages from the duty free warehouse, other products to the Company's overseas station).
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Storing Products in the SLN Warehouse
All purchased products are stored in the duty free warehouse (a separate unit within the SLN warehouse, with restricted access). Products requiring special storage conditions (such as chocolate), are stored in refrigerated conditions. The value of inventory in the warehouse at any given moment averages one and a half million dollars. For details regarding the extent of the inventory see Note 11 to the December 31 2012 Financial Statements.
9.6.2 Reservation Cancellation Policy
In general, Company policy is that a customer is permitted to cancel a reservation, without payment, until the date that the ticket is issued to the customer (hereinafter – “Ticketing”). The customer may cancel certain tickets even after ticketing, at times without the payment of cancellation fees and at times with payment of a cancellation fee. There are certain tickets that the customer may not cancel at all, including after ticketing. Generally, the higher the ticket price, the greater the willingness to allow cancellation of the ticket without cancellation fee or with a low cancellation fee.
The above is subject to the fact that legal requirements do not demand otherwise. In this regard note that as regards certain transactions the Consumer Protection Law, 1981 and the Consumer Protection Regulations (Canceling Transactions), 2010 provide special instructions regarding the possibility of canceled transactions. In addition, a new ordinance of the U.S. Department of Transportation, which that came into effect in January 2012, allows a reservation to be held for 24 hours with no charge, or alternately, allows a reservation to be canceled within 24 hours with no cancellation fees, for reservations made up to 7 days before the flight.
9.6.3 Service Liability Policy
The Company’s responsibility for damages (bodily damages and property damages) caused over the course of international air transport are stipulated in international conventions adopted in the Air Transport Law, 1980 and resulting directives. The Company also operates in accordance with IATA directives on various matters connected to responsibility for passengers and their luggage. The Company’s liability for denial of boarding of passengers due to overbooking of flights is established by the Aviation Services Licensing Regulations, 1985. In addition, in all matters pertaining to bumping passengers from flights, flight delays and flight cancellations to and from countries belonging to the European Union, Regulation 261/04 of the European Union
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applies. For details regarding legislative changes in this area in Israel see 2.11.9.(i) below.
9.6.4 Credit Policy
a) Credit to customers: Travel or cargo agents approved by IATA enjoy special payment arrangements in accordance with IATA regulations (a non-IATA agent is obliged to provide guarantees or pay in cash). The Company grants credit to agents in Israel for periods varying between 15 to 45 days. In general, direct sales of air transport to customers are made in cash, other than credit sales to Government ministries and certain commercial customers.
b) Suppliers’ credit: The Group receives credit from its suppliers in Israel for periods between 30 to 90 days, according to the type of supplier and the arrangement with them (with the exception of fuel suppliers).
c) The following are the average credit volume and credit periods for customers and suppliers of the Group in 2012 and 2011:
2012 2011 Average Credit in Average Average Credit in Average Millions of Dollars Days of Millions of Dollars Days of Credit Credit Customers 158 28 162 28 Suppliers 156 43 171 46
d) Note that the gap between the customer credit policy and its supplier credit policy derives, inter alia, from the fact that the supplier credit policy is set by the Company, taking into account market conditions, liquidity and generally accepted policy. On the other hand, the customer credit policy is largely set according to generally accepted practices in the aviation industry and in accordance with ordinances and procedures accepted by the IATA and travel and cargo agents.
9.6.5 Working Capital Deficit
As of December 31, 2012, the Group had a working capital deficit of $429 million, compared to $395 million at the end of the previous year. The Company current ratio at the end of 2012 is 41% compared to 45% at the end of the previous year.
See Section a.1 of the Board of Directors' Report for details of the factors leading to the decrease in the working capital deficit.
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The working capital deficit consists of three material elements included under the Company’s current liabilities items and characterized by current business cycles: unearned revenues from the sale of flight tickets including port taxes, unearned revenues from frequent flyer clubs, and employee vacation obligations. Therefore, a material part of the capital deficit is not cash-flow based in the short term.
9.7 Investments
See Note 12 to the Financial Statements for details of all of the Company’s investees.
9.7.1 Concise Description of the Businesses of Principal Subsidiaries
a) Sun D’Or International Airlines Ltd. (“Sun D’Or”)
The Company's charter operations, described above and below, are organized and marketed through Sun D’Or (a fully owned El Al subsidiary). Sun D’Or continues to serve as a tourism organizer for wholesalers and individuals, while preserving the “Sun D’Or” label for charter flights it markets and which are carried out by the Company (on weekdays) and by other airlines (on weekend and holiday flights).In addition, the marketed seats are combined by tourism wholesalers as a part of tourism packages.
On March 20 2011 the CAA informed Sun D’Or that it would be revoking Sun D’Or’s operator’s license starting April 1 2011. Following the revocation of Sun D’Or’s operator’s license, and following Sun D’Or’s appointment as “designated carrier” to various destinations by the Ministry of Transportation, these appointments were transferred to the Company, except for the Eilat-Moscow route. As a result of this change in Sun D’Or’s activity, a significant 17% drop occurred in Sun D’Or’s total activity (on routes to Western, Central and Eastern Europe and the regional network).
Sun D'Or's revenues were $75,785,000 in 2012 compared to $75,893,000 in 2011 and 88,638,000 in 2010. As of December 31 2012, Sun D'Or employed 33 employees.
b) Tamam Aircraft Food Industries (BGN) Ltd. ("Tamam")
Tamam (a fully owned El Al subsidiary) is primarily engaged in the production and supply of prepared kosher airline meals. The company has recently expanded its non-aviation activity and it supplies, among other things, institutional catering services. Tamam is located in Israel and its offices are located outside Ben Gurion
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Airport. The Company is the principal customer of Tamam. In 2011, some 85% of its sales were to the Company, with the remainder to other airlines and to other customers. Tamam’s revenues in 2012 totaled $27.2 million compared to $28.3 million in 2011 and $25.1 million in 2010. As of December 31 2012, Maman employed 341 workers.
c) Katit Ltd. ("Katit")
Katit (a fully owned El Al subsidiary), deals mainly in the manufacture and supply of means to Company employees. Katit is based in Israel and its offices are at Ben Gurion Airport. In 2011 86% of its sales were to the Company. Katit's revenues in 2012 amounted to $3,624,000, compared to $3,163,000 in 2011 and 3,546,000 in 2010. As of December 31 2012, Katit employed 107 workers.
d) Bornstein Caterers Inc. (USA) (“Bornstein”)
Bornstein (a fully-owned El Al subsidiary), incorporated in the United States and operating out of New York’s JFK airport, deals mostly in the production and delivery of prepared meals for airlines and other institutions. The Company is Borenstein's primary customer (some 53% of its sales for 2011). Borenstein’s revenues amounted to $12,121,000 in 2012 compared to $11,592,000 in 2011 and $10,713,000 in 2010. As of December 31 2012, Bornstein employed 86 workers.
e) Superstar Holidays Ltd. (Britain) - (“Superstar”)
Superstar (a fully-owned El Al subsidiary), is a tourism wholesaler marketing tour packages to travel agents and individual travelers, and selling airline tickets on Company routes at reduced prices. In recent years, Superstar has become one of the largest tour operators in Great Britain and France for tourism to Israel. The Company has operations in several other countries. Superstar’s revenues amounted to $13,919,000 in 2012 compared to $15,141,000 in 2011 and $15,774,000 in 2010. As of December 31 2012, Superstar employed 4 workers.
9.7.2 The following is a concise description of the businesses of the principal investees that are not subsidiaries:
a) Cargo Consolidation: Air Consolidators Israel Ltd. ("ACI")
ACI (a company in which the Company holds all of its Type B shares, granting the Company the right to appoint one half of the number of directors as well as participate and vote in general meetings) is primarily engaged in the consolidation
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of air cargo at BGN in order to reduce the price of airborne shipments. Air transport is carried out by the Company, at special prices, as well as by foreign companies. The shares do not provide the Company with the right to receive dividends or any other benefit to be distributed by ACI, other than earnings and dividends distributed from capital gains.
In 2012, the Company paid commissions to ACI to the amount of $976,000.To the best of the Company’s knowledge, ACI’s revenues amounted to $32,014,000 in 2012 compared to $30,456,000 in 2011 and $35,226,000 in 2010. As of December 31 2012, ACI employed 20 workers.
b) Flight Marketing: Tour Air (Israel) Ltd. ("Airtour" or "Tour Air")
Airtour (a company 50%-owned by El Al) markets Company flights and special promotions to all Company destinations. The Airtour shares held by the Company grant it the right to participate and vote in shareholders’ meetings and to appoint half of its directors, but do not grant the Company the right to receive dividends or earnings, other than earnings derived from share capital investments of Airtour.
The Company pays Airtour handling fees for certain actions carried out by Airtour for the Company and in addition, participates in one half of its operating expenses. It is Airtour's policy to transfer the lion’s share of the incentives it receives to the travel agents, based on their sales revenues at Airtour, and to distribute the earnings as dividends to its ordinary shareholders (the travel agents) through dividends. To the best of the Company's knowledge, Airtour's revenues were $3,309,000 in 2012 compared to $4,043,000 in 2011. As of December 31 2012, Airtour employed 63 workers.
c) Touring and Hotels: Kavei Chufsha Ltd. ("Kavei Chufsha")
Kavei Chufsha (a company 20%-owned by El Al41) deals in the marketing and sale of tourism services, including as a wholesaler and as an organizer of charter flights to and from Israel. The Company’s investment in Kavei Chufsha was made in order to enlarge its marketing channels in the charter flights sector and to expand the Group's hold on the marketing of tourism traffic. Kavei Chufsha performs its marketing via travel agents and by the distribution of seats and touring packages to the end consumer.
41 To the best of the Company's knowledge, the remainder of the shares is held by A. Arnon Aviation and Tourism Ltd. (44%), Cohen Kana Investments Ltd.(35.2%) and Arnon Englander (0.8%). A-83
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d) Maman – Cargo Terminals and Handling Ltd. ("Maman")
Maman is a public company the shares of which are traded on the Tel Aviv-Jaffa Stock Exchange. The Company holds 15% of Maman’s stock capital and also holds options for 10% more exercisable as Maman shares. Maman’s primary activity is the management and operation of the cargo terminal authorized to handle all import and export cargo at Ben Gurion International Airport, as authorized by the Airports Authority. In addition, Maman is also active in the field of logistical services, real estate property rental and provides aviation services. Maman’s activity takes place in Israel, the Czech Republic and India. To the best of the Company’s knowledge, Maman’s revenues in 2012 were 459,065,000 NIS, compared to 453,584,000 in 2011 and 436,677,000 in 2010. To the best of the Company’s knowledge, as of December 31 2012, Maman employed 1,053 workers.
9.8 Finance
9.8.1 Loans Not for Exclusive Use
For details see Note 18 to the Financial Statements.
9.8.2 Credit Limitations on the Corporation
a) Observance of Collateral Ratio
See Note 18.(f).(1) to the December 31 2012 Financial Statements for further details.
b) Single Borrower and Group of Borrowers Limitation
See Note 18.(f).(2) to the December 31 2012 Financial Statements for further details.
c) Limitations on Transferring Control
See Note 18.(f).(3) to the December 31 2012 Financial Statements for further details.
d) Demand for Immediate Repayment by the Bank
For details on the matter of financial limitations and covenants involving the Company's long term loans, see Notes 18e and 18f to the Financial Statements.
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9.8.3 Credit Frameworks
See Note 30 to the December 31 2012 Financial Statements for further details.
9.8.4 Guarantees for Collaterals
See Note 24b to the December 31 2012 Financial Statements for further details.
As of December 3, 2012 the Company was not required to provide any collateral for its hedging transactions.
9.8.5 Loans Not for Exclusive Use
The Company has taken loans for the purchase of aircraft and engines. For details regarding these loans see Note 18b to the December 31 2012 Financial Statements.
For details regarding liens and collateral see Note 35 to the December 31 2012 Financial Statements.
9.8.6 Financing the Company’s Investment Plan
The Company estimates that an examination may be necessary, from time to time, of the need to raise additional sources of finance the Company’s investment plan and the purchase of aircraft and/or a strategic plan, if the decision is made to purchase them.
The Company's estimates regarding the need to raise additional funds to conduct the Company’s business constitutes forward-looking information, as defined in the Securities Law, which is based upon the price of jet fuel on the date of the report and on the Company’s assessments based mainly on past experience and its experience to date. Therefore, the need to procure additional sources of finance for the Company’s operations may be materially different from the results assessed or implied from this data, as the result of a large number of factors, including changes in jet fuel prices, liquidity considerations, outfitting, unexpected expenses borne by the Company, unexpected events that may have a negative impact on the Company’s activities and changes in interest rates.
9.9 Taxation
9.9.1 Tax Laws Applying to the Corporation
See Note 23(c) to the December 31 2012 Financial Statements for further details.
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9.9.2 Status of the Corporation’s Tax Assessments
See Note 23(d) to the December 31 2012 Financial Statements for further details.
9.9.3 Tax Laws Applicable to Significant Affiliated Companies Incorporated Abroad
See Note 23(c) to the December 31 2012 Financial Statements for further details.
9.9.4 Reasons for Material Differences Between the Effective Tax Rate and the Statutory Tax Rate
See Note 23(b) to the December 31 2012 Financial Statements for further details.
9.9.5 Accumulated Losses for Tax Purposes
See Note 23(a) to the December 31 2012 Financial Statements for further details.
9.10 Environmental Issues and Corporate Responsibility
9.10.1 Significant Implications of Rules Pertaining to Environmental Matters
Many countries, including Israel, have adopted the conventional international standards regarding engine noise of aircraft and have prescribed additional directives for environmental conservation. Restrictions exist in various airports in the world as to the times of takeoff or landing of aircraft. The schedules of airlines, including those of the Company, are set in accordance with these restrictions.
The Company attributes a great deal of importance to the subject of the environment and invests resources and time to this issue (inter alia through the Company's Safety and Quality Branch, which is responsible for these activities). The Company is undergoing ISO 14001 environmental certification.
The Company is carrying out internal activity to increase environmental awareness, with each area of the Company having a person assigned as responsible for the environment, pollution prevention and careful use of resources.
In the field of waste reduction – paper and cardboard from the Company’s flights and offices is passed on for recycling.
9.10.2 Restrictions in the Operation of Aircraft at Airports and at BGN
Various restrictions exist on the activity of airports in which the Company is active, in particular Ben Gurion Airport, including nighttime hours during which aircraft takeoffs
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are not permitted. Regarding BGN, these restrictions were placed by virtue of government resolutions and the directives of the relevant authorities.
Furthermore, after the new Aviation law was passed, the law in question contained several provisions regarding the subject of aircraft noise, according to which economic sanctions may be placed on the Company in the event of deviation from noise restrictions, as set in law.
9.10.3 Waste Treatment
The Company’s waste is treated at a modern central facility within the confines of BGN, approved by the Ministry of the Environment and operated by the Airports Authority. Furthermore, the Company has been operating a facility at a cost of $600,000 since June 2009. The Company facility, constructed on the Company’s land, serves as an emergency reservoir in the event of problems with the quality of the Company’s waste. The Company pays usage fees to the Airports Authority for the use of the main facility to the amount of $75,000 per year over 22 years (from 2008). At the same time, the toxic waste created by the Company is transported to the Environmental Services Company at Ramat Hovav.
9.10.4 Fuel Tanks
Following the ground contamination surveys the Company conducted in 2011, which discovered contaminated points in various areas in the Company's compound, the Company initiated additional tests over the course of Q2 2012 to examine the findings of the contamination surveys. The Company retained the services of an environmental consulting company, which examines the survey's findings and offers the Company various means of treating the ground. Accordingly, the Company has decided to act to rehabilitate the contaminated ground, despite the fact that the Company did not cause the contamination. The Company reported the survey results to the Ministry of the Environment, and held a tour of the land with representatives from the Ministry of Environment. The Company passed on the recommendations of the environmental consulting elements for the ground treatment using a biological program to rehabilitate the land; however, at this stage the Ministry of the Environment decided that a comprehensive historical survey must be carried out for the compound, and only after the completion of the survey in question will a decision be made how to deal with the polluted areas found. The Company intends to work with the Ministry of the Environment and receive instructions regarding the further treatment of the areas in which pollution was found in the survey conducted, out of a commitment to environmental and social
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values. Carrying out the land rehabilitation plan and following the instructions of the Ministry of the Environment, as above, may involve monetary costs and various requirements on behalf of authorities, regarding which as of this report the Company cannot make any certain estimates.
The Company’s estimate regarding the implementation of actions pertaining to ground rehabilitation as required by the relevant authorities and resulting monetary costs constitutes forward-looking information as the term is defined in the Securities law, based on information existing at the Company and surveys it performed, including the estimates of its consultants in these areas. Therefore, the influences on the Company's activities and the costs involved in treating this subject may be materially different from the results assessed or implied from this data, as the result of a large number of factors, including the demands of the relevant authorities, additional findings pertaining to these activities, unexpected costs the Company will be required to bear and unexpected events that may have a negative impact on the Company’s activities.
9.10.5 Material Environmental Costs and Investments for the Reported Year and Those Anticipated Subsequently
The Company carries out a great number of activities and invests financial expenses in improving environmental elements, including the establishment of a waste removal facility that will collect the Company's wastes in the event of deviation from waste quality (in accordance with its agreement with the Airports Authority), separating oil in the Company's yards and performing local separations between the drainage and sewage systems.
2011 2012 2013 (Projected) Material Costs $75,000 a year $120,000 a year $120,000 a year Material $250,000 a year $250,000 a year $150,000 a year Investments Total $325,000 a year $370,000 a year $270,000 a year
Information concerning the material anticipated environmental costs and investments represents Forward-Looking Information, as defined in the Securities Law. The information is based upon the requirements of the environmental laws presently in effect and on current market prices of the goods and services that the Company must purchase in the framework of the environmental investments. Therefore, the actual costs and investments may vary materially from the forecast as above, as the result of a large number of factors, including legislative changes, requirements of the authorities
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and changes in the prices of the goods and services that the Company will be required to buy in the framework of the environmental investments.
9.10.6 Restrictions on the Level of Engine Emissions
Following growing world awareness to global warming, governments have become interested in monitoring and restricting the level of air pollution produced by engines. During coming years, laws are expected to be enacted on the matter in different countries all over the world.
On January 1 2012 an EU regulation came into effect, establishing conditions for the supervision, reporting and confirmation of gas emission in incoming and outgoing EU flights, this following the inclusion of aviation under emission policies in existence for other branches, as established in the EU decision dated June 26 2008. In addition, an economic remuneration mechanism was established, according to which each Company shall receive an emissions cap in light of past emission data. Exceeding this cap will require the purchase of an additional cap and reduction will allow the sale of the cap. Over the course of 2009 airlines were required to submit supervision programs on the subject of emissions. Such plans were submitted on behalf of the Company and were approved. In accordance with the EU decision, the Netherlands were appointed supervisor of the Company's activities. The reporting obligation, reporting procedures the manner of reporting have been fully established and binding directives on this subject have been published The supervising element has inspected the reporting and set down in writing that the Company has successfully passed the inspection
In order to reduce greenhouse gas emissions, winglets have been installed on some of the Company’s airplanes, in order to improve the aerodynamics of the aircraft and thus also reduce fuel consumption (see 7.11.5 above); in addition, the aircraft engines are washed to improve their efficiency and the aircraft bodies are washed from the outside to lower air resistance.
Starting 2012 the Company will be receiving its free allocation of pollution certificates in accordance with EU rules. This allocation is calculated in advance as a partial allocation on the basis of the performance of the airlines in practice in 2010. In accordance with the planned flight plan, the Company is expected to exceed these quotas on a yearly basis, and thus will be required to purchase appropriate certificates on the free market, according to their cost on the date of purchase. The expected yearly
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expense for the purchase of these certificates as of this report amounts to an estimated sum of $2 to $3 million a year.
Over the course of 2012, resistance increased on behalf of various non-EU countries to the implementation of the plan and the future payments for deviations from approved exempt allocations. The U.S. even anchored its resistance in a law forbidding U.S. carriers from taking part in the ETS venture. In order to prevent the unilateral implementation of ETS on carriers taking off and landing in the EU, the ICAO proposed a global outline, the details of which are yet unclear, which is supposed to be voted by ICAO management in September 2013.As a gesture of good will, the EU nations decided to “stop the clock” on the subject of submitting CO2 emission reports to and from Europe until information is received regarding the ICAO outline, and then decide whether to continue with the first outline or join that of the ICAO. This decision does not exempt carriers flying inside Europe from collecting information and submitting reports on flights from destinations inside the EU.
The degree of the influence of the implementation of legislation on the results of legal proceedings in this matter on the Company's activity may constitute forward-looking information, as defined in the Securities Law, based on Company assumptions and forecasts. Therefore, the actual results of the passing of these legislative changes or legal proceedings as noted above or their impact on the Company's activities may differ materially from the results estimated or implied by this information.
9.10.7 Fly Green
The Company is active in the Fly Green Forum of IATA, and carries out activities with the objective of positioning the Company at the forefront of environmental air protection, inter alia, by using clean fuels (purchasing fuel only from suppliers that comply with the standard's conditions), significantly reducing the use of fuel and reducing the emission of pollutants from the Company's planes, by frequently washing aircraft engines, adopting more efficient operating procedures, etc. The Company has a panel headed by a Company captain guided by the VP of Operations that convenes once a month to deal with this subject.
9.10.8 Corporate Responsibility
9.10.8.1 General
The Company sees itself as committed to the community in which it operates and to the environment, and attributes a great deal of importance to working to promote and
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nourish them. As a result of its “national leader” approach, the Company places the security and safety of its passengers at the top of its priorities, and conducts extensive activity in order to ensure their existence. Furthermore, the Company sees its workers as the source of its strength, and acts to foster an attentive, considerate, safe and fair environment; this arises from an understanding of the affiliation between high-quality business-strategic management and the commitment to act and promote corporate responsibility.
9.10.8.2 The Company is a fellow in the Ma’alah Organization – an umbrella organization of business committed to managing the field of corporate responsibility, which acts to implement social, environmental and ethical considerations in regular corporate activity, and to promote the development and implementation of corporate responsibility strategies as a business approach.
In the 2012 Ma’alah rankings the Company received the “Gold” grade.
9.10.8.3 Ethical Code
In 2012 the Company began a process of implementing an ethical code with the cooperation of employees and executives from the Company and its subsidiaries, and with the assistance of outside consulting firms specializing in the subject.
The code features values, norms, enforcement and assimilation policies and communication channels for reporting violations of the code and of ethical rules, intended to direct the activity of the Company and of all of its worker over the course of their work, and to dictate criteria for their behavior.
9.10.8.4 Community Involvement and Support
The Company attributes a great deal of importance to its responsibility to the community, out of a true and special affinity to the State of Israel. The Company has formulated a community responsibility policy, in which it conducts community contribution and employee volunteering activity, while establishing long-term partnerships with community partners. Included among the groups supported by the Company are: IDF soldiers, students requiring assistance who are active in the community, children with medical difficulties or disabilities and special needs children and families requiring assistance.
As part of its activities, the Company contributed a total of $150,000 in cash and cash equivalents in 2012.
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9.11 Restrictions and Supervision of the Corporation’s Business
9.11.1 General
Most aspects related to the operations of the Company as an air carrier are subject to a system of regulatory arrangements - Israeli and international - which relate, among other things, to flight rights, setting of tariffs, capacity and flight safety standards, security and noise, and are conditional on a commercial operating certificate and an operation certificate.
The Company’s activity, in addition to the operating licenses, is contingent on it being an Israeli air carrier (principal ownership and real control held by the state or its citizens), on its appointment as Designated Carrier and on the permits issued by foreign companies to make use of the aviation rights granted it as Designated Carrier. See Sections 9.11.6 to 9.11.8 below for information on aviation agreements and Israel’s civil and international aviation agreements. In addition, additional restrictions exist on the Company's activity due to the Special State Share.
9.11.2 Regulatory Arrangements
The following are principal regulatory arrangements, Israeli and international, pertaining to the Company's operation as an air carrier.
(For security arrangements see 9.11.12 below, for emergency operations see 9.11.13 below).
a) The Aviation Law, 2011 (hereinafter: “the Aviation Law”)
The law regulates the activities of all factors active in the field of civil aviation – personal licensing of aviation employees (air crews, air traffic controllers, maintenance personnel, trainers and instructors) as well as licensing organizations (aircraft manufacturers, airlines, flight schools and maintenance technical certification institutions, and more). The Aviation Law covers a great deal of subjects in the field of aviation, including those dealing with aviation matters and their obligations, aircraft, the aviation supervision sector, supervision rights, safety incident investigations and establishes directives regarding penalties and financial sanctions due to the violation of the law.
The Flight Regulations (Maintenance Facilities), 2013 (“the New Maintenance Facility Regulations”) were published February 3 2013. The New Maintenance Facility Regulations will apply to the Company within 24 months of their
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publication or on the date of the completion of the maintenance facility’s relicensing, whichever comes first. As required by the New Maintenance Facility Regulations, the Company has started, even before the New Maintenance Facility regulations were published, a process of relicensing the Company's maintenance institute, which includes writing new procedures and adjustments to the New Maintenance Facility Regulations.
b) Aviation Services Licensing Law, 1963 (hereafter - “the Licensing Law”) and the Licensing Regulations
This law regulates the principles of aviation licensing, and El Al’s commercial operation license was issued in accordance with it. Regulations issued under the auspices of the Licensing Law regulate, among other things, overbooking, licenses for operating and leasing aircraft and operations of charter flights.
c) The Air Transport Law, 1980
This law and the orders and the notices issued thereunder adopt a number of international conventions which stipulate various rules relating to international air transport, particularly regarding the air carrier’s liability for damages (bodily damage and property damage), caused during international air transport, and the damages imposed on the air carrier for this liability. This law applies the treaty for the purpose of consolidating certain rules pertaining to international airborne shipping (the Warsaw Treaty), and their revisions. In May 1999 a new treaty was prepared in Montreal establishing rules for international civil airborne transportation (hereinafter: "the Montreal Treaty") the purpose of which is to formulate, update and modernize the existing set of rules, including raising the limits of liability for damage caused a passenger's person or property, adding judicial powers and requiring air carriers to take out insurance. The Montreal Treaty came into effect in Israel starting March 20 2011.
d) Equal Rights for Persons with Disabilities
In the third chapter of the Equal Rights Regulations for Persons with Disabilities (Accessibility Arrangements to Public Transport Services), 2003, provisions were prescribed regarding the obligation to integrate assistance for persons with disabilities in aviation transport, which imposes various obligations on air carriers as a condition for operating aircraft.
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e) The Airport Authority Law – 1977
This law, the regulations and rules issued under its auspices, regulate, inter alia, the following matters: aviation fees, transport by import couriers, entry into restricted territories, licensing fees and the unloading and loading of aircraft.
f) The Civil Aviation Authority Law – 2005
This law designates the functions of the Civil Aviation Authority, which replaced the Civil Aviation Administration. Among the functions of the Authority are: to determine and assure the existence of internal and international flight regulations according to aviation laws; to grant civil aviation licenses, permits and approvals, according to aviation laws; to supervise the civil aviation sector, including maintaining a proper level of flight safety for Israeli aircraft and for aircraft that are present in Israeli air space.
Restoration of the State of Israel's safety rating to Category 1 – on November 1 2012 the Ministry of Transportation announced that the U.S. Federal Aviation Administration (FAA) had restored Israel’s flight safety rating to Category 1. As reported by the Company in the past, following the lowering of the rating in 2008 the Civil Aviation Authority (CAA) was asked to carry out a series of actions, mostly dealing with the regulation of legislation regarding Israeli aviation law (including the passing of the Aviation Law, 2011 and resulting regulations). Furthermore, as required by the CAA, a recertification process for the Company’s operational activities and the Company’s maintenance facilities was initiated. As a result of the lowered rating, restrictions were placed on the Company’s activities in the U.S., including the inability to fully implement the code sharing agreement with American Airlines, the inability to increase activity or add new destinations in the U.S. and additional supervision of the Company’s activities.
Following the restoration of Israel’s high security rating, the restrictions placed on Israeli airlines in the operation of aircraft throughout the U.S. and in code sharing agreements with U.S. airlines will be rescinded, and Israeli airlines will be allowed, for the first time, to realize the Free Skies aviation agreement signed between Israel and the United States in 2010. In this agreement, as well as in the previous agreement, no restrictions have been placed on the number of airlines allowed to fly between the U.S. and Israel; the new agreement is important in that it also allows the signing of code sharing agreements with a third country on routes between Israel and the U.S., meaning the operation of flights from any destination
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in a third country to destinations in the U.S. as well as to destinations to any third country beyond the U.S. In addition, the new agreement features no restrictions on the number of U.S. destinations to which Israeli airlines may try, and unlimited stopovers with passengers inside the United States will be allowed. The Company is examining the financial implications of the period since the lowering of the State of Israel's safety rating to Category 2.
On June 26 2012 the formal stage of the “relicensing” procedure began, for the purpose of re-validating the Company’s operating license as required by FAA from the Civil Aviation Administration as part of the process of restoring the State of Israel’s Category 1 status. On February 1 2012 the formal stage of the “relicensing” procedure for the Company’s maintenance facilities began, as required by FAA from the Civil Aviation Administration as part of the process of restoring the State of Israel’s Category 1 status.
g) The Restraint of Trade Law, 1988
Amendment no. 10 to the Restraint of Trade Law, which canceled the statutory exemption currently granted arrangements between air carriers regarding international shipping, came into effect January 1 2009. As an accompanying step to the statutory exemption, a class exemption was installed by the Restraint of Trade Commissioner (hereinafter: "the Class Exemption" and "the Commissioner", respectively) which exempts various types of arrangements between air carriers, with the goal of preventing sweeping and unwanted incidences of the binding arrangement chapter on the thousands of arrangements which serve as the basis of aviation activity to and from Israel and which pose no risk to competition.
The class exemption deals with a broad range of arrangements and provides an exemption from licensing requirements to various operational arrangements, interline and cargo arrangements which do not include an assurance of a minimal amount of flight tickets or cargo capacity and frequent flyer agreements. The Class Exemption also includes "dry" lease arrangements (leasing the plane alone, without the crew) and non-long term "wet" leasing (leasing the plane, crew included), but sets special restrictions on leasing agreements carried out with Israeli air carriers. The class exemption also applies to code sharing agreements, subject to material limitations and restrictions set in it.
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The Rules of Business Restrictions (Type Exemptions for Arrangements between Air Carriers Pertaining to the Marketing of Flight Capacities to Destinations Subject to Open Skies Agreements), 2012, was published on December 11 2012, and establishes exemptions from the receipt of court approvals for flight capacity marketing arrangements (including code sharing arrangements) under the following conditions: (a) the arrangement deals with flight routes covered by an open skies agreement; (b) the arrangement does not limit competition in a significant portion of the market influenced by it or may increase competition in a significant portion of the market in question, but has no material impact on competition in the market in question; (c) the focus of the arrangement is not the reduction or prevention of competition and it does not include restrictions that are not needed to achieve its focus; (d) the parties to the arrangement have informed the Restraint of Trade Commissioner of its existence.
Decisions and Proceedings on the Subject of Monopolies
On October 27, 2005, the Company received notification from the Restraint of Business Commissioner concerning his designation of the Company as the holder of a monopoly in transporting time sensitive and price sensitive passengers in the civil aviation market to Johannesburg, Hong Kong, Bangkok and Mumbai.
On September 9 2012 the Company received notice from the Restraint of Trade Authority, according to which the Company was declared a monopoly in the supply of aviation security services abroad, according to professional guidelines provided airlines in accordance with the Arrangement of Security in Public Bodies Law, 1998 and in accordance with the Aviation Law (Security in Civil Aviation), 1977, regarding passengers and cargo on passenger flights. On February 3 2013, the Company filed an appeal with the Business Restrictions Tribunal regarding the above Commissioner's decision.
h) Legislative Provisions Applicable to the Company as a “Mixed Company”
(1) Until June 6, 2004, the Company was a “Government Corporation” in the process of “privatization” as these terms are defined in the Government Corporations Law. Starting from June 6, 2004, the Company is a “Mixed Company”, as defined in the Government Corporations Law. In other words, a company no longer a Government Corporation, for which half or less of the voting rights at its general meetings, or the right to appoint half or less than its directors, are held by the State. As a practical matter, as long as
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the State owns shares that provide it with voting rights in the Company, the Company will remain a “Mixed Company”. In June 2007, the State ceased being an "interested party" by virtue of its holdings in the Company, although as of a date immediately prior to the report date, the Company continues to hold 1.1% of the Company's share capital (in addition to the Special State Share in the Company).
As a Mixed Company, the Company is subject to part of the provisions of the Government Corporations Law (as detailed in Section 58 of the Government Corporations Law, which applies various provisions to a Mixed Company).
(2) Chapter H2 of the Government Corporations Law authorizes the Prime Minister and Minister of Finance, with the consent of the Ministerial Committee for Privatization, in consultation with the minister responsible for the company’s affairs, to prescribe instructions by decree designed to protect the vital interests of the State in connection with a company undergoing privatization. These provisions will apply for a specified period, or in general, they might also apply after the company’s privatization, as stipulated in the decree. The definition of vital interests includes various interests, which in part are similar to those which, in order to protect them, led to the issuance of a Special State Share, and also the avoidance of concentration in the economy, damage to the foreign interests of the State, etc. The position of the Government Corporations Authority is that Chapter 2H to the Government Corporations Law also applies to a Mixed Company. On November 17, 2004, a Government Corporations Decree (Declaration of Vital Interest to the State as to El Al Israel Airlines Ltd.), 2004 (hereafter in this paragraph: “the Decree”) was published under the aforementioned Chapter H2. The Decree stipulates that the State has a vital interest with regards the Company, in order to make effective use of vital assets during a time of emergency or for security purposes, to assure the continuation of activities which are vital to the security of the State. The Decree also prescribes that the Company is required to employ, at all times, Israeli air crew members, and Israeli ground crews in Israel, properly qualified and licensed in order to operate the “vital assets” (minimal fleet of aircraft; see “Special State Share”), at sufficient numbers for continuous and simultaneous operation of all of the “vital assets” during a time of emergency or for security purposes. The Decree adds that it does not intend A-97
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to make the Company subject to the provisions of Section 59.i of the Government Corporations Law (which deals with restrictions on the transfer of control), and that the Decree does not intend to detract from the provisions of the Special State Share. See Section 9.11.9 for details of additional restrictions to which the Company is subject under the auspices of the Special State Share.
i) Aviation Services Law (Compensation and Assistance due to Flight Cancellation or Changes in Conditions), 2012
The Aviation Services Law (Compensation and Assistance due to Flight Cancellation or Changes in Conditions), 2012 came into effect on August 16 2012. The Law adopts, with certain adjustments and alterations, the principles of EU Regulation 261/2004, which came into effect in February 2005 and establishes conditions for denied boarding ("overbooking") of passengers from flights, flight delays and flight cancellations.
The law applies to all of the flights (scheduled and charter) departing from Israel, as well as flights arriving in Israel – if their passengers had not received the remedies owed them in accordance with the laws of their countries of origin. In accordance with the law, in cases of flight cancellations, flight delays, the refusal to allow a passenger on board a flight or downgrading a ticket to a lower seating class, according to the terms and circumstances set in the law, passengers shall be entitled to benefits such as free assistance, reimbursements, alternate tickets or even financial compensation.
9.11.3 Business Licenses, Building Permits and Employment Permits
Some of the Company's activities require the obtaining of licenses under the Business Licenses Law, 1968 or the receipt of permits from various regulatory bodies. As of 2003, the Company has filed requests for business licenses for the activities requiring licenses. Within the framework of the arrangement of business licenses, the Company acts to regularize all of the buildings within its properties, including old buildings, for which the Company does not have buildings permits from the period that the Company was a government company. The Company acts in coordination with representatives of the Ministry of Interior, and hires consultants to assist in the process. In this framework, the Company acts according to an orderly Outline Plan to complete the process of obtaining the building permits and conforming them to the existing buildings, and to arrange the licenses for conducting the Company's business. Over recent years (starting in 2008), five
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building permits were received for various compounds including most of the buildings for which no building permit had been issued. The approval and receipt of two additional building permits is currently in the final stages of completing the conditions, prior to receiving the permits in question. In addition, a building permit for a lot containing buildings built before 1965 before being discussed at the regional committee due to a dispute on the matter of receiving an approval and permit for buildings built prior to 1965, and as a result the building licenses of the businesses residing in it were delayed. The committee was provided with legal opinions on the subject, and the Company was informed that the committee gave a positive response on this issue and that temporary business licenses will be approved for businesses defined in this permit. Note that their official written response has yet to be received.
Upon receiving the committee's written response, the permit requests for the buildings in question shall be submitted.
The Company requires 32 business licenses for its activities. As of March 2012, the Company holds 18 permanent business licenses, 6 temporary licenses and 8 requests that are currently undergoing approval. 5 license requests (out of the 8 requests undergoing approval) were submitted to the Committee in 2010, however, the local committee postponed issuing the license due to a dispute on the matter of the receipt of approvals and permits for buildings built prior to 1965 in which these business are located. As noted above, these licenses will be arranged as well upon receiving the committee’s written response.
In the matter of subsidiary Katit – Katit has 5 business licenses and an alcoholic beverages license that are renewed in accordance with the demands of the committee and the authorities.
Regarding the subsidiary Tamam – part of the Tamam factory has an expired business license, and the Licensing Committee is currently considering a new application filed by Tamam for a business license. The position of the Licensing Committee, at this stage, is that a business license for the Tamam factory will only be issued after the subject of building permits for the entire area of the factory is resolved. In accordance with the committee's agreement, Tamam received a temporary license valid until August 20 2013 and it must act to secure a building permit for the structure by that date. In order to submit its final plans to the licensing committee, Tamam must secure the consent of the Airports Authority, the property’s owner. Note that in the material issues, those relevant in terms of health and safety issues, Tamam is in compliance with the required conditions
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and holds approvals both from the Ministry of Health and the approval of the Fire Department.
Failure to receive permits and licenses as noted may place restrictions on the Company's activities pertaining to the buildings covered by the permits and licenses in question, affect the Company's activity and even cause sanctions to be placed on the Company.
Non-receipt of the licenses and permits or failure to meet the terms set in the permits and the resultant implications constitute forward-looking information as defined in the Securities Law, which includes Company estimates or projections as of the report date. Therefore, the actual outcome of the failure to receive business licenses and building permits or the failure to receive the proper permits may be materially different from the outcome that is estimated or that might be deduced from this information as a result of a large number of factors, including among other things the actions of the licensing agencies, changes in legislative provisions and the results of legal proceedings.
9.11.4 Commercial Operating License
The Company has a commercial operating license (No. 1/88 dated August 2, 1988) granted by the Minister of Transportation under the Licensing Law, which includes general instructions regarding the activation of aircraft, including the obligation to operate flights in accordance with a license, the obligation to obey the law and uphold national security and flight safety. The license is valid as long as it has not been revoked or suspended by the Minister of Transportation or the CAA.
The licenses includes a provision according to which the license holder will ensure that at least 51% of the share capital of the license holder is owned by Israeli citizens and permanent Israeli residents and that at least two-thirds of its directors (board members), including the Chairman of the Board of Directors and the CEO, are Israeli citizens and permanent Israeli residents
The services that the license holder is permitted to offer and perform are stated in the addendum to the license, and largely consist of transporting passengers and goods on scheduled flights between Israel and points in foreign countries, and between the points themselves. Note that some of the points are not utilized by the Company due to lack of economic feasibility (and accordingly, the Minister of Transportation may revoke such an appointment; transporting passengers and goods on international charter flights in accordance with the official licensing regulations; special tasks subject to CAA approval.
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9.11.5 Operational Operator's License
The Company has an operational license (no. 1/88) (hereinafter: “license”) which is issued from time to time by the Civil Aviation Authority in accordance with ICAO standards.
The license stipulates, inter alia, that the operator (El Al) is permitted to act as a “Designated Air Carrier” of large airplanes [under Section 13 of the Flight Regulations (Operation of Aircraft and Flight Rules)], and to operate international flights to regions defined in the operating specifications and connecting domestic commercial flights, contingent on the operational restrictions and the conditions listed in the operational specifications that constitute part of the license.
The aircraft recorded in the license have Israeli registration or foreign registration approved by the CAA, fully owned by the license holder, or have been placed at the disposal of the license holder, with the consent of the Civil Aviation Authority and the Minister of Transportation. The operator has an obligation to report every change in the list of aircraft that appears in the operational specifications, such as sale, purchase, lease to another operator and/or lease from any Israeli operator or foreign operator. The report will be submitted to the CAA.
9.11.6 International Regulatory Arrangements
The principle of universality dominates civil aviation, whereby every country is sovereign over its own air space, and therefore, each commercial flight to or over any country requires that country's permission. The permission may be in the form of a bilateral agreement (as is customary for scheduled flights) or for a flight(s) on an ad-hoc basis.
The international civil aviation industry operates in the context of a system of regulatory arrangements that affect most of the operational aspects of the airlines and, in particular, the subjects of flight rights, permissible capacity, fare setting, air carrier’s responsibility for damages (physical and property damage) and flight safety standards, security and noise. This system of arrangements is composed of international conventions, laws, regulations and administrative directives, and bilateral agreements.
The existing basis for the international regulatory arrangement for international civil aviation is the Chicago Convention of 1944.
The International Civil Aviation Organization (ICAO), a United Nations agency, was established in the wake of the Convention. In the framework and under the auspices of ICAO, recommended standards and procedures were prescribed for various areas of A-101
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aviation activities. The rights to transport passengers and cargo between countries for compensation, permissible capacity and rate setting are organized via air transport agreements or aviation agreements (bilateral), which are based on reciprocity and provide fair and equal opportunities to airlines from both countries.
9.11.7 Air Transport Agreements and the Civil and Aviation Policy of the State of Israel
9.11.7.1 Aviation Agreements- General
Most of the aviation rights by which the State of Israel permits a company to transport passengers and cargo on international routes are anchored in aviation agreements between Israel and foreign countries, and a minority (due to the absence of aviation agreements) in agreements between aviation authorities or commercial agreements between the Company and the air carrier of the other country, which require the approval of both countries. The principal elements of air transport agreements include, inter alia, the aviation rights granted, appointment of the Designated Carrier and permitted capacity.
Most of the aviation agreements to which Israel is a party may be terminated or canceled with prior notice of one year. After such notice, negotiations are generally held between the two governments in order to set an interim arrangement or new conditions before the expiration of the agreement.
Several aviation agreements between Israel and a number of countries came into effect over the course of 2012. The various agreements allow the entry of additional Designated Carriers to existing and new destinations, as well as an increase in frequencies allowed the sides' airlines. See 7.1.10 above for further details.
9.11.7.2 Designated Carrier
In aviation agreements, each government grants its counterpart the right to select one or more of its air carriers as Designated Carrier. The Designated Carrier is granted the right to carry passengers and cargo between the two countries. At times, the Designated Carrier also receives the right to operate scheduled flights from the second country to a third country (subject to an agreement with the third country).
In the past, in most aviation agreements between countries, each government appointed an air carrier as a “Designated Carrier” on its behalf that will operate the flights and utilize the traffic rights under the agreement. After the Designated Carrier is selected, it must obtain a permit from the aviation authority of the other country. Until the second half of the 1990’s, the Company was the sole Israeli Designated Carrier for scheduled flights for the transport of passengers and cargo to and from Israel, with the exception of A-102
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Sharm-a-Sheikh. The change in the Company's aforementioned exclusive status occurred after licenses were given additional Israeli carriers as Designated Carriers to several flight destinations, some in the Company’s place.
As of immediately prior to the publication of this report, the other Israeli companies (Arkia and Israir) were appointed Designated Carriers as follows:
Arkia – on routes between Tel Aviv and Sharm-a-Sheikh, Copenhagen, Stockholm, Amman, Dublin, Tbilisi, Larnaca, Paris, Barcelona, Madrid, Kiev, Krasnodar, Yekaterinburg, Düsseldorf, Munich, Baku, Kharkov, Yerevan, Malmö, Oslo, Helsinki and Crete as well on routes between Eilat and Moscow, St. Petersburg, Kiev and Paris and Haifa-Amman and Haifa-Sharm-a-Sheikh;
Israir - Izmir, Ankara, Riga, Lisbon, Ljubljana, Nice, New York, London, Rome, Milan, Berlin, Stuttgart, Geneva, Zürich, Basel, Kiev, Amman, Moscow, Rhodes and Crete as well as the Eilat-Moscow route;
9.11.7.3 Air Carrier Ownership and Control
There is no uniform international arrangement regarding the percentage of the practical ownership and control over an air carrier that must be held by a state or its citizens. The bilateral air transport agreements to which Israel is a party include a provision according to which each of the contracting states maintains the right to suspend or to cancel the permit it gave the airline of the other state, if the “substantial ownership and effective control” are not held by the contracting state or the citizens of the contracting state. The agreements do not include the definitions of substantial ownership and effective control.
The practice in the countries of the Western world is to receive the appointment of an airline as Designated Carrier as if it included an affidavit that the required demand for substantial ownership and effective control is complied with in full, and if it is found that the requirement no longer exists, the state will demand that the situation be rectified.
As part of the liberalization policy being instituted by the Ministry of Transportation and implementation of the "Open Skies" policy, a new aviation agreement was signed between Israel and the European Union in December 2008 (“Horizontal Agreement”). The new agreement updates the sections of the bilateral aviation agreements between Israel and EU members referring to the ownership and control of Designated Carriers. The agreement will allow airlines the ownership and control of which is in one of the EU member states to operate scheduled flights from any other EU member, subject to the bilateral agreement.
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9.11.7.4 Capacity
Most of the aviation agreements to which Israel is a party (excluding the agreement between Israel and the United States and Great Britain) contain limitations on the maximum permissible capacity or frequency that each airline may offer on the agreed routes in order to assure equal opportunities to the air carriers of the two countries that are parties to the agreement. Additionally, a substantial part of the aviation transport agreements between Israel and other states also stipulate that the capacity must be based on the volume of the traffic between Israel and the other state with which the agreement was signed. Accordingly, the policies of the Ministry of Transportation in the past had been to restrict the flight capacity of the foreign airlines to and from Israel.
At the beginning of 2006, and pursuant to the "Open Skies" policies led by the Israeli Ministries of Transport and Tourism, authorizations were granted to the foreign airlines that operate on the routes to and from Israel to add capacity and frequency. This trend of liberalization and "Open Skies" continued in the following years, and is expected to become more significant with the implementation of the Government's decision on "Open Skies" and the continued negotiations in preparation of signing of uniform global agreement between Israel and the EU member states.
9.11.7.5 Flight Rates
The rates for flights on international routes are published within the framework of the IATA, the international association of scheduled airlines. These fares allow passengers to purchase a flight ticket from one company and to utilize it in an additional flight or flights for other companies (within the framework of interline agreements). In addition to the fares within the framework of IATA, which are supervised by aviation authorities, El Al is permitted to set special rates on a unilateral basis.
The Israeli Ministry of Transportation does not generally intervene in setting rates advertised by the Company unilaterally, provided that the level of these rates is not higher than IATA fares. IATA is evaluating the companies' fares, and accordingly, publishing flex fares that serve as interline fares.
Under the aviation agreement between Israel and the United States, the carriers are free to set fares, and only if the two governments oppose a proposed rate (a method known as “double disapproval”) due to its being abnormal (exaggerated or within the boundaries of "dumping”), the new rate will not be approved and it may not be offered to the public.
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Despite the flex fares set by the IATA, most flight tickets and cargo capacity are sold at prices below those that were agreed upon and approved or at conditions different from those prescribed for the various fares. The Company behaves in accordance with general industry practices, while conforming its policies to market conditions and to the actions of the competitors. A substantial part of the Company’s revenues is derived from sales under these conditions.
During recent years, a broader variety of flight ticket fares has been created. In all of the aircraft service classes, there are different types of “reservation classes” (or types of price). Varied demand and different conditions exist for each “reservation class” during different periods of the year.
Charter flight fares are set in a different manner than those for scheduled flights. Every organizer is committed to pay the air carrier for the capacity (number of seats) he has chartered and, on the other hand, he himself sets the price per seat, generally a package price that includes seats and ground arrangements. Organizers requesting authorization to operate a flight or series of charter flights must state the price offered the public and obtain approval to carry out the flights and their prices from the aviation authorities/administrations of the relevant countries. Airlines, including the Company, collect fuel surcharges, which are updated from time to time in accordance with increases and decreases in jet fuel prices. In addition, the airlines charge a security surcharge as part of the flight ticket price.
9.11.8 Israel’s International Civil Aviation Policy
Over the years, the Government of Israel and ministerial committees (privatization or social and economic) have approved a series of decisions pertaining to Israel’s international civil aviation policies. Resolution number 323 HC/14 of the Ministerial Committee for Social and Economic Matters in the matter of "Aviation Policies of the State of Israel on Scheduled Routes" was passed in May 2003, as detailed in 7.1.1 above. A resolution was passed on "Encouragement of Competition in Civil Aviation to and from Israel" in August 2005, and Resolution 441 on the matter of encouragement of competition in civil aviation to and from Israel was passed September 2006, and the decision made by the Minister of Transportation and Road Safety to establish a public committee to examine "Open Skies" policy.
In recent years, the Ministry of Transportation has begun implementing a policy of increased liberalization in the aviation industry, the "Open Skies" policy, with the
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objective of encouraging and increasing tourist traffic to Israel by increasing competition between airlines.
For further details on Government resolutions and the open skies policy see 7.1.10 above.
9.11.9 The Special State Share
9.11.9.1 Close to the publication of the 2003 Prospectus, the Company issued a “Special State Share” to the State. The rights granted to the holder of the Special Share are listed in the Company’s Articles of Association, which also detail the vital interests of the State in the Company, which must be protected by means of the Special State Share. These vital interests are:
Preserving the Company as an Israeli company so that it will remain subject to Israeli law, including legislation that allows equipment to be mobilized for security purposes and legislation for times of crisis, and so that the conditions needed to maintain its operating license and traffic rights should be maintained.
Safeguarding the possibility of ensuring that the operating capability and ability to fly passengers and cargo by the Company will not fall below the capacity detailed in the Company’s Articles of Association, in order to provide the State with effective use of vital assets in times of emergency or for security purposes, as will be determined from time to time by those authorized to do so, all as detailed in the Company’s Articles of Association.
Preventing parties hostile to the State of Israel or persons who could cause damage to the vital interests of the State or to the foreign or security interests of the State or to the aviation ties of Israel with foreign nations, or persons that are found in and/or likely to be found in substantial conflict of interest which could cause damage in one of the areas detailed above, from being an interested party in the Company from influencing its management in any other way.
Fulfilling the security directives and arrangements that apply, or that will apply as a result of Government resolutions or under any law, to the area of security of flights, passengers, baggage, cargo and mail, in Israel and abroad, including in relation to the Company’s operations abroad and to the cooperation needed from local authorities abroad in these areas; in the area of security classification of employees and suppliers of services to the Company; and in the area of security over classified data and protection of security information.
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9.11.9.2 The holder of the Special State Share is the State of Israel through a minister or ministers, and in order to protect these vital interests, directives were set in the Special State Share as to the following matters:
Instructions for the purpose of preserving the Company as an Israeli company, including restrictions as to the citizenship and security clearance of Company executives; Instructions on the matter of compliance with security rules and arrangements; Instructions on the matter of rights to security information and classified information in the Company; Instructions on the matter of the Company’s discussions of security issues; Instructions on the matter of Company discussions on security matters; Directives on the matter of maintaining minimal flight load factors – the Company is not permitted to carry out certain transactions relating to its aircraft without consent of the holder of the Special State Share if, as the result of such transactions, it might reduce the Company's flight capacity below the level that was set by the Special State Share. The acquisition of influence or status in the Company requires the State's consent – in accordance with the Company's Articles of Association, transactions involving the Company’s shares at a certain scope will not grant any right that is derived from holding and/or from purchasing shares in the Company without the prior written consent of the holder of the Special State Share (the State through the ministers designated by the Government).The Articles of Association stipulate a detailed arrangement on the subject of the manner of submitting the request for obtaining the consent to own shares in the Company, in the event such consent is necessary as above. Instructions on the matter of obtaining approval to vote at the General Meeting – the right to vote at the General Meeting requires the Company’s approval. Approval to vote at the General Meeting will not be given when circumstances exist that require the consent of the holder of the Special State Share, and such has not been granted. The articles of association also prescribe special instructions in cases when there is reasonable concern that the ownership of the Company’s shares by foreigners might cause damage to the Company's flight rights or to its operating license.
9.11.9.3 Any change, including an amendment or cancellation, in the Company’s memorandum or bylaws pertaining to the rights granted to and/or ascribed to the Special State Share and to
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its holder, will be ineffective as regards the Company, its shareholders and any third party, without the prior written consent of the holder of the Special State Share.
9.11.10 Regulation
The Company is preparing for the implementation of the Safety Management System plan – SMS. The plan’s implementation constitutes an advanced perception of the Company’s safety management, in a manner compatible with ICAO guidelines. The essence of the plan is the integration of safety issues as an inseparable part of management as a whole. The existence of the SMS plan and its implementation shall have passed the 2012 IOSA inspection.
The Company's maintenance system has been certified by the Israeli Standards Institute to ISO 9001 standards. In addition, the Company's maintenance system has been certified as an maintenance institute, approved by the Civil Aviation Authority in Israel, the U.S. Federal Aviation Agency (FAA) and the EU aviation safety agency (EASA). To be clear, the EASA certification is for the Company's line maintenance array.
The Company underwent an IOSA (IATA Operational Safety Audit) inspection over the course of 2012. The Company has complied with all requirements for the receipt of an extension to the Standards Association stamp granted it and in October 2012 the Company received IOSA certification from the IATA for an additional two years. This standard is an international standard in the area of airline operations, safety and quality assurance that constitutes a precondition for IATA membership. The receipt of this certification places the Company in the forefront of world airlines as far as flight safety is concerned.
In addition, the Company has a “crisis event” array, assembled and practiced in accordance with guidelines set by the IATA, which examined and approved the array in four separate inspections in 2006, 2008, 2010 and 2012. The Company conducts “crisis event” training exercises at the Company level once per period (with the last exercise conducted in late 2011), and updates its procedures according to global developments in the field (booklets, conferences and professional media).
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9.11.11 Quality Control
El Al's maintenance system is monitored by an internal quality control system that operates according to the manufacturer’s specifications and a maintenance program approved by the Civil Aviation Authority.
9.11.12 Security Arrangements
The civil aviation industry, particularly on routes to and from Israel, is a target for attacks by various parties, particularly terror organizations around the world. The Company takes extraordinary security measures, under the guidance of the governmental body responsible for this area.
Following the Company’s reports in its Financial Statements on the announcement from the Russian authorities regarding the start of security checks for Company flights departing from Russia conducted by local security elements and not by El Al security, the date in question was postponed one more time, to March 31 2013.
Following extensive negotiations between Israeli authorities (the Foreign Ministry, the Shin Bet and the CAA) and Russian authorities, the parties reached a settlement according to which Israeli security procedures will be applied by Russian security companies in relevant airports in Moscow and Saint Petersburg, starting April 1 2013.
The State’s Participation in Aviation Security Expenses
Until the early 1980s, the State had covered all of the Company's direct and indirect security costs. Over the years, the State has instituted a policy of reducing the rate of its participation in security expenses. A number of government resolutions were made over the years that changed the State’s participation rate in the security expenses of Israeli airlines and set various terms for their incidence.
On August 3 2011 the Company signed an understanding with the State of Israel, arranging the activity of the Israeli aviation security array (“the Understanding”). The understanding mainly refers to a gradual increase in the State’s participation in the security expense burden of Israeli airlines. Whether or not the understanding came into effect was dependent on the passing of a Government resolution by no later than the end of 2011. The submittal of the understanding to the Government for a resolution, as noted, was subject to signing an additional agreement between the Company and the Foreign Ministry. The additional agreement between the Company and the Foreign Ministry was signed on November 6 2011 and was approved by the Ministry of Finance.
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On December 25 2011, the Government passed Resolution 4026, which validates agreements with government ministries, as detailed below:
“Following Government Resolution 3024 dated January 27 2008, no. 4032 dated August 24 2008 and 4462 dated February 1 2009, regarding the State’s participation in the security expenses of Israeli airlines in international flights, and taking into account the understanding signed between El Air Airlines Ltd. (hereinafter – El Al) and the State on August 3 2011, and the complementary agreement from December 21 2011 (hereinafter – the El Al Understanding), including El Al’s undertaking to continue to provide security services to Israeli airlines in accordance with General Security Services instructions and guidelines:
1. To revise the State’s participation rate in the aviation security budget of Israeli airlines that provide aviation security services in accordance with General Security Services instructions, as detailed below:
a. 65% participation starting January 1 2011 and ending December 31 2011.
b. 70% participation starting January 1 2012.
c. In spite of (a) and (b) above –
1. 75% participation after signing a global aviation agreement with the European Union, in accordance with Government Resolution 441 dated September 12 2006 (hereinafter – the open Skies Agreement).
2. 80% participation rate from the start date of the activities of at least two scheduled airlines that were not operational prior to the signing of the Open Skies Agreement or the expansion of the activity of four existing scheduled airlines, or the start of the activity of at least one scheduled airline that was not operating prior to the signing of the Open Skies Agreement and the expansion of the activity of two existing scheduled airlines, all in accordance with the Open Skies Agreement and whether the agreement allowed them to start or expand their activity.
2. As a result of the aviation security services provided by El Al to other Israeli airlines in accordance with General Security Services instructions, to increase the yearly overhead budget framework for El Al included within the framework of the aviation security budget, by $250,000 U.S., starting 2011, so that it will amount to $2.25 million U.S. The scope of the State's participation within the framework of the yearly overhead budget for El Al shall be prepared in accordance with the participation A-110
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grades detailed above, as the case may be, and subject to the implementation of this sum. Increasing the overhead budget as stated in this item depends on the expansion in practice of El Al's war and terror risk insurance coverage from $1 billion U.S. to $1.5 billion U.S., and proof that these expenses have been carried out.
3. To revise the State’s participation in the aviation security budget of an Israeli airline not covered by Section 1 of the resolution, in accordance with the outline featured in that section, under the following conditions:
a. The airlines will include as part of the insurance policies and coverage expansions of the aircraft in their possession a waiver of the subrogation right against El Al for damages deriving from war and terror risks.
b. The airlines will add El Al as an additional policy holder in the insurance policy and the coverage expansions of the insurance for their liability pertaining to bodily and property harm to passengers and third parties, to the issue of damage and harm caused them as a result of war and terrorism risks, as well as a waiver of the subrogation right against El Al.
4. To compel the General Accountant of the Ministry of Finance to prepare, within four months, a letter of indemnity in accordance with the principles detailed in the El Al Understanding due to harm caused El Al due to the events insured by the insurance policy and the coverage expansions of Israeli airlines.
5. Security instructions received after the approval of the aviation security budget that was not taken into account in the aviation security budget, the cost of the implementation of which exceeds $300,000 U.S. per year, or alternately, new instructions the cumulative cost of the implementation of which exceeds $900,000 U.S. per year (hereinafter – Guidelines), shall be discussed by a joint forum featuring the Deputy Budget Commissioner in the Ministry of Finance, a representative of the General Security Services and a representative of the company providing the security services (hereinafter – the Forum), before they apply to the airlines. The forum shall reach a decision regarding the sources of the financing used for implementing the guidelines. Furthermore, the forum shall convene at El Al’s request in the event of material changes in the cost of implementing the guidelines. In the event that the forum fails to reach an agreement, the issue shall be decided by the Deputy Budget Commissioner at the Ministry of Finance. After determining the financing source, El Al shall carry out the guidelines, and shall bear the expenses involved in their
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implementation in accordance with this agreement, and subject to the decisions of the forum.
6. If the Inter-ministerial Committee for Salary and Benefits Abroad decides that the salaries of the employees or their benefits must be revised retroactively, the aviation security budget (the Company's share and that of the State) will be revised and the salary price list will be changed accordingly, within 30 days of El Al’s request.
7. To establish a forum headed by the Ministry of Transportation and Road Safety and with the participation of El Al and the airlines for the purpose of coordination, raising disputes and resolving them. In the event of discussions of disputes on the matter of costs or the State's participation in aviation security expenses, the representatives of the Budget Commissioner in the Ministry of Finance shall take part in the discussion.
8. For the purpose of examining aviation security costs, an inter-ministerial economic team shall be established with the participation of the representatives of the Budget Commissioner, the Ministry of Transportation and Road Safety, the Foreign Ministry the Restraint of Trade Authority and the General Security Services.
9. In the event that the Government decides to establish a government or other body for the purpose of carrying out the service, in whole or in part, the implementation of the services in question, including the scope of the Government’s participation in the companies’ aviation security budget, shall not be passed on to them unless the companies providing security services and the other airlines are given advance written notice at least 90 days before the transfer date in question. In the event that the Government decides that some of the service will be carried out by the government body in question, this resolution shall apply to the balance of aviation security services not transferred to the body in question.
10. This resolution shall remain in effect until December 31 2017, and Sections 1, 2, 4-6 of the resolution shall not apply to El Al if it does not meet its obligations in the matter of the El Al Understanding, and Sections 1 and 3 of this resolutions will not apply to airlines that do not uphold the conditions featured within.”
Upon passing the Government resolution in question and after an agreement was signed with the Foreign Ministry, which arranged, among other things, the employment of aviation security workers, the conditions for the implementation of the understanding in question were completed.
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The implementation in full of the Government Resolutions and their potential impact on the Company's activities and operating results constitute Forward-Looking Information as defined in the Securities Law. The manner and degree to which the Government Resolutions are actually implemented, the receipt of security expenses funding at the updated rate and the appointment of additional Israeli airlines as Designated Carriers for regular flights and the operating of said flights by additional Israeli airlines as well as the signing and implementation of the open skies agreement with the EU may be carried out differently than as estimated, among other things due to regulatory limitations, economic limitations resulting from the need to purchase equipment needed to operate additional airlines, contractual limitations involved in the alteration of bilateral agreements or other aviation agreements as well as changes in the national security, economic and geopolitical information and their impact on competition as well as changes in Government resolutions.
The following details the direct costs of security of the passengers, aircraft and employees of the Company, divided between the portion financed by the Company and the portion financed by the State:
State Financing Company Share Total (In Thousands of (in Thousands of (In Thousands of Dollars) Dollars) Dollars) 2012 82,999 33,212 116,211 2011 77,719 40,036 117,755 2010 66,390 41,068 107,458
The Company also has indirect security costs that are caused, inter alia, by flying security personnel in seats of paying passengers. Furthermore, beginning October 2001, the Company has been allowed to collect a surcharge for insurance and security of $8 per flight leg.
Aircraft Protection Systems
In January 2009 the Israeli Government approved a project for the installation of electro- optic protection systems in passenger aircraft. The meaning of the government resolution is that the Israeli airlines, including the Company, will be required to participate in the project in question (including installation in Company aircraft). On September 4 2011 the Ministerial Committee for National Defense decided that the State would participate in the Company’s full expenses in financing the costs involved in operating the system and all its derivatives, maintenance and installation.
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The Company is negotiating with the State to regulate various issues including indemnification, insurance and the State’s participation in the Company's expenses in relation to the project in question as well as with Elbit Systems Ltd. regarding the Company's commitment to serve as subcontractor for installing and maintaining the system.
Security Services for Israeli Airlines
In addition, the Company provides security services to Israeli airlines, in return for a refund of the Company's aforementioned costs. Accounting for these services was arranged by use of a "payroll price list" (dated 2008) published by the Ministry of Finance.
For details regarding a summary on the subject of security and updated government decisions as of December 25 2011 on the matter of aviation security services provided by the Company, see above.
9.11.13 Operations during Times of Emergency and for Vital Purposes
Under existing law, during times of emergency, the Israeli airlines, including the Company, may be operated for purposes of national defense or public security or maintaining supplies or vital services. In addition, arrangements exist with the Company as to flights for the security of the State, or at times of emergency, as well as flights for other extraordinary purposes, including the consideration to be paid for them on a commercial basis.
The Law for the Registration and Mobilization of Equipment for the Israel Defense Forces, 1987, empowers the Minister of Defense, if he is convinced that the defense of the State so requires, to declare by decree the need to mobilize equipment (including aircraft). The law relates to equipment owned by the Company during times of emergency. The law obligates the State to pay usage fees for the equipment that was mobilized, and, if the equipment was damaged during the period of emergency - compensation for the damages.
The Law for Work Services during Times of Crisis, 1967, empowers the Minister of Labor to certify an enterprise as “a vital enterprise”, and after such certification, to mobilize all of its workers for vital work service. The Company has been certified a “vital enterprise”. The approval is renewed from time to time at the Company’s request. The current certification is effective through December 31 2013.
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The Law for Supervision of Goods and Services, 1957, grants the minister so empowered by the Government, the authority to issue a “personal decree” or a “general decree” for the performance, inter alia, of a “vital action” for the defense of the State, for the security of the public, to maintain regular supplies or services. This action includes, among other things, the obligation to operate an enterprise or to perform any regulated service.
9.12 Material Agreements
In October 2012 the Company published a Request for Proposals (“RFP”) for fuel companies and for companies performing refueling services for the supply and refueling of jet fuel in Israel for the period beginning January 1 2013. Following negotiations with the companies in the matter of the RFP, in December 2012 the Company's Board of Directors approved engagements with fuel supply companies Paz, Sonol, Dor Alon and Delek, to provide 50% : 20% : 15% : 154% (respectively) of the Company's yearly fuel consumption for 2013. In addition, the Company decided to enter into engagements with companies performing refueling services (Airports Authority concession holders), Paz Aviation Services and Mercury, according to which each would provide 50% of the refueling services for the Company at BGN in 2013. The accumulated yearly scope of these agreements (providing jet fuel and refueling services) amounts to $390 million (according to jet fuel prices as of November 2012).
In June 2012 the Company signed an extension to a maintenance agreement with Israir Aviation and Tourism Ltd. (hereinafter: “Israir”). According to the agreement, the Company will continue to provide maintenance services for the two Israir Airbus planes. The agreement will be in effect until September 2013.
In March 2012 a work agreement for the summer 2012 season was signed with the Taglit organization as a result of which 11,000 passengers were flown over the course of the summer season. The Taglit Organization brings youths age 18 to 26 to Israel for visits that include heritage and Zionism tours, which are financed in full by the organization. The project is a leading and unique operation in the Jewish world, bringing youths form 54 countries. In July 2012 a seasonal agreement was signed with the Taglit organization for the winter 2012-3 season, for the transportation of 6,000 passengers. In addition, in April 2012 a yearly agreement was signed with the Nefesh Benefesh organization, which flies 2,500 new immigrants from North America and the UK each year on special flights and on route flights.
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For details regarding the agreement to purchase Boeing 737-900 aircraft from Boeing see Note 13.d.(1) to the December 31 2012 Financial Statements; for details regarding the Company’s engagement in a loan agreement with a fully owned subsidiary of aircraft manufacturer Boeing, see Note 18.b.(1) to the December 31 2012 Financial Statements.
Over the course of December 2012 and January 2013 the Company engaged with various bodies for the purpose of moving the Israeli branch from the El Al Building. Pursuant to the engagements in question, the Company will rent all of the space in its possession in the El Al building in Tel Aviv, will rent office space in the Terminal Park compound in Or Yehuda for the Israeli branch offices and will rent space for the Israeli branch sales shop on Rothschild Blvd. in Tel Aviv.
In addition, the Company is party to agreements with regard to employees and their rights (see 9.4 above), agreements for the lease of real estate (see 9.1.1 above), agreements for the lease and financing of aircraft (see 7.11 and 8.10 above), loan agreements for a designated purpose (see 9.8.5 above), various agreements with airlines (see 7.2, 7.14, 9.11.7 above and 9.13 below), and insurance agreements (see 9.2 above). The Company also has an obligation to indemnify Company executives. For further details see Section 29a of Chapter D (Further Details on the Corporation's Business).
9.13 Cooperation Agreements
The Company is party to agreements with other airlines (interline agreements) that permit passengers on scheduled flights, subject to certain restrictions, to use flight tickets issued by one airline for the services of another airline. In addition, the Company is party to code sharing agreements, which permit an air carrier to market flights of another air carrier, as if they were its own flights. See Sections 7.2 and 7.4 above for details. For legislative changes that could have a material effect on the Company's ability to enter into “code-sharing" agreements see Section 9.11.2(g) above.
Additionally, the Company has various operational agreements with various airlines, which include, inter alia, technical operations arrangements, leasing arrangements, aircraft maintenance and spare part agreements, mutual assistance in emergencies, the supply of aviation equipment and more. The Company also has arrangements with airlines regarding lounges, regarding frequent flyer collaborations, accounting for connecting flights, on matters of reservations and transport agreements (passengers or cargo).
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9.14 Legal Proceedings
As of December 31 2012, $20 million in legal claims have been filed against the Company, for which the Company has listed an $8 million provision in its Financial Statements, this based on the advice of the Company's legal counsel.
Regarding the motion filed to recognize a claim as a class action against the Company and other bodies to the amount of 100 billion NIS, which was rejected by the District Court and for which an appeal was filed at the Supreme Court, see Note 22.d.a.(7) to the December 3.1 2012 Financial Statements.
Legal claims not quantified in monetary sums have also been filed against the Company. The sum of the provision in the Financial Statements includes provisions for non- quantified claims, as estimated by Company management.
For details on the most significant claims in which the Company and/or its subsidiaries are involved see Note 22d to the December 31 2012 Financial Statements.
9.15 Goals and Business Strategy
The goals of the strategic program adopted in the past by the Company – “El Al 2010” – consisted of: (a) significant improvement in customer service by enhancing the customer's experience in all of the Company's activities according to the needs of specific fields, focusing on the business customer and dealing with his special needs, emphasis on developing customer loyalty, improving the treatment of the incoming tourist and establishing an integrated service center; (b) cultivation of operational excellence, in the dealings with customers and other processes, as well as by striving to reduce the level of fixed assets relative to revenues and investment in systems and processes for optimal management of the organization's resources; (c) business innovation and initiative, including initiatives for developing traffic to and from Israel, development of additional revenue sources in the areas of maintenance, tourist services and ground services, development of BGN as a transit airport for connecting flights and conversion into a global company, advancement of cooperation with aviation wholesalers and development of the Internet as a distribution channel; (d) outfitting, including investment in modern equipment for long range routes, gradual rejuvenation of the aircraft fleet in accordance with financing terms, repayment ability and market development, and weighing continued outfitting based upon market developments; (e) improvements in the areas of cargo and maintenance, through continued growth in cargo operations while, at the same time, evaluating the operational structure, strengthening the ability to sell maintenance services and examining the development of maintenance as a profit center for the Company, and A-117
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investigating cooperative arrangements with Israeli and international airlines for expansion of the ranges and areas of activities; (f) cultivation of human resources by means of updating labor agreements, developing and updating training systems, employee compensation and incentives, and embedding the culture of a private entity in a competitive market.
In 2012 the Company faced the various factors influencing the Company’s activity, including the geopolitical situation and its impact on the aviation industry and on passenger traffic to and from Israel, changes in jet fuel prices and increased competition.
The Company’s key activities in 2012 were as follows:
a) Adapting means of production to the demand environment and profitability of the routes by adapting capacity, in order to optimize the route network.
b) Continued improvement in customer services throughout the entire service chain, while providing an appropriate response to various populations and offering different services to customers (including the development of the Economy Plus class and purchasing preferred seats), carrying out customer preservation actions and developing collaborations in favor of customer service including increasing direct sales, in particular over the internet, and the CRM system, which began operations in the reported year.
c) Reducing the number of aircraft fleets operating in the Company's service and in particular shutting down the Boeing 757 fleet and selling 767-200 aircraft, while placing an emphasis on making the fleet younger and adapting its activity to operational and environmental restrictions.
d) Expanding the various services provided by the Company in Israel and abroad, including expanding the route network by signing code sharing agreements and interline agreements with other airlines and improving existing agreements (for details see 7.4 above).
e) Continuing to provide a response to the extensive regulation applying to the Company in its various areas of activity, including aviation regulation unique to the Company’s activity as an airline and the relicensing process the Company is undergoing as part of the restoration of the State of Israel's safety rating as well as various regulatory directives, and in particular antitrust law specific to the Israeli aviation industry and the Open Skies agreement with the EU, which is approaching completion.
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f) Continuation of equipping activity by purchasing aircraft and leasing aircraft as detailed in the Company's Financial Statements.
g) Continuing the development of sources of income in maintenance areas while providing services to airlines, aircraft manufacturer and other maintenance centers and developing growth engines in areas close to the Company’s area of activity.
h) Thorough treatment of the reduction of the Company's purchasing expenses and the reduction expenses and streamlining, with assistance from outside elements specializing in the fields of purchasing, logistics and spare parts.
i) The continued implementation of technological systems, including technological systems from the field of commerce. A pricing system and an SAP system were implemented during the reported year in various financial areas and the Company is acting to implement a revenues management system (RMS) in the future.
j) Continuing with the comprehensive approach to matters of safety and the environment, including air pollution and noise hazards, in which the Company received various approvals and opens itself to regular inspection.
k) Investment in the field of corporate responsibility and community relations, while preparing an ethical code and continuing extensive cooperation with various bodies in contributing to the community and the environment as well as continuing to nurture the human resource and excellence in the Company, including through the CEO’s “Excellence and People” fund.
l) Implementing the internal enforcement plan in the field of securities and corporate law, in order to ensure the existence and enforcement norms in matters of observing the law, ethical rules and other codes of behavior by the Company, its executives and its employees and to confirm compliance by the Company and by individuals working at it with securities law.
Formulating a New Strategic Plan
Over the past few months, the Company has been working on the development of a medium and long-range business strategy, which is supposed to express the Company's goals and strategies for coming years, while adapting its current situation to developments in world markets and in international aviation. The Company has retained the services of Sheldor Ltd., which specializes in the management of strategy construction processes. In order to manage the process, Sheldor has employed the
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assistance of international external aviation experts and professionals from inside the Company.
As part of the strategy being formed, the Company will act to adapt its activity by increasing frequencies and capacities and adapting its commercial operating model to models practiced in Europe. The new commercial model is intended to be adjustable to passengers’ requirements and provide a better return on their payment, while adapting a modular and flexible pricing model in order to lower flight costs for passengers.
Alongside changes in the operating model, the Company will act to adapt its cost structure in short haul routes, largely based on its narrow-bodied aircraft fleet, to a more effective configuration.
In addition, the Company is examining advanced and innovative service, marketing and sales models in order to improve the structure of costs on these routes.
On long haul routes, the Company will continue to act using the existing operating model, while significantly upgrading the physical product, placing an emphasis on the luxury classes and improving their compatibility with the needs of business customers. In addition, the Company is in advanced stages of planning the renewal and rationalization of its wide-bodied aircraft.
Alongside the commercial changes in aviation activity, the Company will operate the frequent flyer club according to a new format (and as an independent profit center), will expand the variety of partners, realization options and additional associated products, will expand the number of members in the frequent flyer club and will act to invest in the IT capabilities in the frequent flyer club.
As of the reported date, the analysis stage has been concluded and business models have been formulated, along with Company management, for the Company for the coming decade. The models are currently being studied by the Company and the selection of the strategic plan and the approval of the detailed work plan are expected to take place in the next few months, subject to the approval of the relevant Company organs.
Over the course of the first half of 2013, the Company intends to complete its medium and long-term strategic planning, which expresses the Company's strategy for coming years, while adapting its current situation to developments in world markets and in international aviation.
Implementation of the business strategy presented above by the Company constitutes forward-looking information as defined by the Securities Law, and is based upon the A-120
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Company’s assumptions, assessments and forecasts as to its business environment, which could change, in whole or in part, from time to time, thus influencing the achievement of the program's goals and its results. Accordingly, actual results, in whole or in part, may not be realized as above, be realized in part or to be materially different than the results that are estimated, derived or implied from this information, inter alia, for the reasons detailed below.
Application of this strategy may be affected by regulatory changes that may require that actions be taken, inter alia, as regards the route network and the aircraft fleet. In addition, implementation of the strategy is subject to the implications of global economic, political and/or security changes on environmental demands, on increased competition as a result of the State of Israel's aviation policy and the expansion of the activity of low cost airlines or aviation pacts in the Israeli market and the planned implementation of an aviation agreement ("open skies") with the EU. In addition, implementation of the strategy could be affected by fluctuations in jet fuel prices, which constitutes a substantial part of the Company's expenses.
9.16 Projected Developments in the Coming Year
As part of the global aviation industry, the Company deals with exogenous economic factors that include, among other things, a slowdown in global growth rates, the euro crisis, jet fuel prices, currency/interest rates as well as the regional geopolitical situation.
In 2013 the Company is expected to continue dealing with an increase in flight offerings from existing airlines, as well as the entry of new airlines, a trend that will grow stronger in the event that the open Skies agreement with the EU is signed and implemented.
Accordingly, the Company intends to continue studying the compatibility of its activities to trends and developments occurring in the Company's business-economic activity environment and in global aviation. These trends and changes require a constant in-depth examination of the Company’s activities, including an examination of the combination and profitability of the Group's route network in the areas of passengers and cargo and adapting the timetable and prices to the state of the market and competition.
In addition, the Company's activity over the coming year is also expected to be influenced by changes in regulation affecting the activity including the "Open Skies" policy, as described in Section 7.1.10 above.
The goals of the strategic program will be accomplished by taking to account, among other things, the manner in which the Company's outfitting plan is being realized the
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Company's ability to cope with and prepare for toughening competition, and striving to improve the business results in 2013 by enhancing the mix of revenues, improving yields, implementing organizational efficiency measures and cutting expenses.
The information concerning the forecast of developments during the coming year represents Forward-Looking Information, as defined in the Securities Law. The information is supported, inter alia, by the Company’s assessments, forecasts or intentions as of the report date. Therefore, the actual developments during the coming year may be, in whole or in part, materially different than the developments assessed, derived or implied from this information, as the result of a large number of factors, including those listed in Section 9.15 above and the risk factors described in Section 9.18 below.
9.17 Financial Data on Segment-Based Reporting
For data on segment-based reporting see Note 32 to the Financial Statements. For explanations regarding developments in these segments, see Section a.5 of the Board of Directors Report.
9.18 Discussion of Risk Factors
Like other airlines, the Company’s activity is by external and internal factors that could lead to material changes in its profitability (positive or negative). The risk factors may be divided into macro risks, industry risks and risks that are unique to the Company. The major risk factors are:
Macro Risks
9.18.1 Political or Security Events or Terrorist Acts
Political or security events or terrorist acts in the world or in the region have an immediate negative effect on the demand for passenger and cargo transport and influence the price of jet fuel and the Company’s economic condition and the volume of its activity. The risk is that the impact on the Company's revenues will be caused as a result of security and geopolitical events in Israel or in target destinations, among other things in light of geopolitical events in the Syrian arena and the Iranian arena.
9.18.2 Exposure to Currency Risks
Most of the Company’s revenues and expenses are denominated in or linked to foreign currency (mainly the US dollar). The Company is exposed to a rise in the value of the shekel relative to the dollar with respect to current wage expenses and other liabilities A-122
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denominated in shekels in the Company's balance sheet, principally with respect to termination of employee-employer relationships and vacation provisions. The revaluation of the shekel vis-à-vis the dollar increases the Company's current expenses and also increases, in dollar terms (without effecting cash flows), the Company's obligations related to termination of employee-employer relations.
Furthermore, natural internal protection exists for other foreign currencies (pound sterling, euro, rand etc.) carried out by comparing payments and receipts in each currency. In years when the volume of the receipts is not significantly different from the volume of payments in European currencies, the mixture serves as internal protection against exposure to these currencies, whereas in years in which a material difference exists between the payments and receipts and exposure is created for the Company with those currencies (mainly the euro), the Company considers the need to invest in financial derivatives to reduce the exposure created.
For details regarding the actions taken by the Company for hedging the exposure to currency risks see Section b.1.(5) to the Board of Directors’ Report, as well as Note 26f to the Financial Statements.
9.18.3 Changes in Economic Status
The aviation and tourism industries are sensitive to changes in economic activity affecting the demand for passenger and cargo transport. The expense structure of the aviation industry, which includes a high component of fixed expenses, makes it very difficult to implement procedures intended to conform the Company's supply to changes in short-term demand. During periods of an economic slowdown, the demand for air transport is reduced for a variety of reasons, excess capacity is created and labor and flight equipment is underutilized. Consequently, the Company’s economic position may be worsened, as reflected in its business results.
9.18.4 Outbreak of Epidemics and Natural Disasters
Outsides factors such as natural disasters, fires and earthquakes, epidemics and so forth, may harm the Company's normal course of operations. Outbursts of epidemics and natural disasters (such as the Icelandic volcano and Japanese tsunami) have a negative effect on passenger traffic to the disaster areas and therefore may have a similar negative effect on the Company's business results.
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9.18.5 Exposure to Variable Interest Rates
The Company finances part of its investments using credit from banking institutions. The Company’s loans and most of its deposits are in dollars. Most of the loans bear variable interest and, accordingly, any change in interest rates might materially affect the Company’s financing expenses and cash flow. In order to reduce exposure to this risk factor the Company has entered into interest risk hedging agreements. See Section b.1.(4) to the Board of Directors’ Report for details with regard to the actions taken by the Company to hedge the exposure to variable interest rates. These hedging agreements may expose the Company to changes in the fair value of said hedging agreements. For further details see Note 26g to the December 31 2012 Financial Statements.
Industry Risks
9.18.6 Jet Fuel Prices
Jet fuel is a significant component of an air carrier's operating expenses. Jet fuel prices are subject to sharp fluctuations. The Company's profitability may be significantly harmed by changes or severe fluctuations in jet fuel prices. The Company employs hedging activities for part of its projected jet fuel consumption. This policy could change according to circumstances. As a result of this policy the Company faces an accounting risk due to fair value changes in the financial instruments used for hedging as well as the requirement for restricted deposits. Due to the great weight of jet fuel in the Company's operating expenses, every increase in jet fuel prices negatively affects its operating expenses and business results. For details regarding the actions taken by the Company for hedging its exposure to changes in jet fuel prices see Section b.1.(3) to the Board of Directors’ Report as well as Note 26h to the December 31 2012 Financial Statements.
9.18.7 Changes in Competition
The aviation industry is characterized by a high level of competition, which becomes more acute during periods of excess capacity. The entry of additional charter airlines into the market, including the entry of additional foreign scheduled carriers into the Israeli market or an increase in capacity of existing foreign carriers, the entry of additional Israeli carriers into the market and the appointment of additional Israeli carriers as Designated Carriers (in the fields of passengers and cargo), the entry of additional charter and low cost airlines, and the granting of operating licenses to additional Israeli airlines in the passenger and cargo areas, lead to increased competition in the Israeli aviation industry, a situation that creates excess capacity, lowers the level of passenger and cargo transport prices and may reduce the Company’s share in activity in the industry and hurt A-124
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the Company’s business results. This trend of increased competition intensified over recent years, with the entry of new airlines and the increased capacities and frequencies of airlines operating in the Israeli market (see 7.1.10 above for details). Special emphasis must be placed on the activities of the foreign airlines in the three largest aviation alliances, which operate in the Israeli market while cooperating in operations and trade, based on non-Israeli regulation (including competition laws practiced in Europe) allowing them to carry out code sharing agreements, merges and acquisitions and material commercial collaborations. In addition, changes in international agreements, including the implementation of an aviation agreement between Israel and the EU (“Open Skies”), which is undergoing advanced talks in preparation for signing may impact the Company’s activity.
9.18.8 Seasonal Influences
The operations of the Company are seasonal by nature and are focused during peak periods (see Section 7.9 above). Tourism traffic, mostly during the summer season and at holidays (Jewish and Christian), is higher than the annual average. The cargo transport field is also characterized by high seasonal fluctuations (for details see 8.8 above). As the component of the capital expenditures and fixed expenses out of the total Company expenses is significant, the impairment of operations during the peak season (due, for example, to political and security events) or the inability to obtain replacement aircraft, even if concentrated over a relatively short period, can have a substantial negative effect on the business results of that year.
9.18.9 Government Resolutions on Aviation and Licensing the Company as an Air Carrier
a) A change in the Government’s policy with respect to the Company’s status as a Designated Carrier for all or part of the routes on which the Company serves as Designated Carrier could materially affect the Company’s financial results, in general and according to the type of route. Additionally, Government resolutions could change the Company's position and have a negative effect on its financial results.
b) The Company’s operating licenses as an air carrier and its rights as such are conditional upon the practical ownership and the effective control being in Israeli hands. The Company's ability to always know the extent of foreign ownership of its shares is limited to the records it administers, and, accordingly, a situation may exist in which the foreign owners of shares did not report their holdings to the Company (purchase or sale) and were not recorded in the shareholders' registry, so
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foreign ownership will exceed the permissible percentage or will be less than the percentage recorded in the shareholders’ registry, without the Company being aware of it. If the Company becomes aware that foreign ownership exceeds the permissible percentage, it will be able to act in conjunction with the Special State Share to reduce the percentage of foreign ownership. Should it be unable to do so and the foreign holdings in the Company’s shares exceed the permissible percentage, the Company could lose its status as a Designated Carrier. However, whenever the holder of the Special State Share and/or the Minister of Transportation believe that the actual control and the ability to direct the Company’s operations remains in the hands of the Board of Directors, of which two thirds of its members, including the Chairman, the CEO and Company officers, are Israeli citizens and permanent Israeli residents, the risk is minimal that the Company will lose its status as Designated Carrier just because of the rate of foreign ownership in the Company’s shares.
9.18.10 Operations in an Industry with a High Fixed-Cost Structure
The Company operates in the aviation industry, which has a structure of relatively high fixed costs and relatively low profit margins. Therefore, small changes in the level of revenues or expenses could have a direct effect on whether there will be earnings or losses.
9.18.11 Noise and Environmental Restrictions on Flight Operation
Every change in restrictions on night operations at BGN or other airports from/to which the Company flies and each additional restriction or prohibition on the operation of aircraft due to air pollution, noise, etc. might have a material effect on the Company's business results (for details see 9.10 above).
9.18.12 Effect of the Operations of Low Cost Airlines on the Israeli Market
Airlines with a low production cost structure (low cost carriers) have increased their market share substantially in recent years, principally in the United States and in Europe. This growth has negatively affected veteran airlines with higher production cost structures, and has caused a decrease in their market share and a drop in their yield due to fare reductions as the result of competition.
Most low cost airlines specialize in short flight legs. Under the terms of new aviation agreements signed in recent years airlines have begun operating in Israel with a format A-126
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similar to that of low cost airlines which have not operated on Israeli routes before along with low cost airlines such as EasyJet (for details see Section 7.1.10 above). The entry of these and other airlines into the Israeli market could have a negative effect on the Company's business results, due to the increased capacity offered by these airlines at reduced prices.
9.18.13 Impairment of Flight Safety or Flight Security
9.18.13.1 In order to maintain flight security, the Company upholds security arrangements in accordance with the instructions of the authorized governmental agency. In order to maintain flight safety, the Company carries out the instructions and provisions stipulated by the relevant entities, including the instructions of the manufacturer and the Civil Aviation Authority. Damage to the Company's flights and/or its customers and/or its installations and/or its employees, due to an event connected with flight security and/or flight safety is liable to have a material negative effect on the Company's operations, inter alia as a result of harm done to reputation, the loss of revenues and customers and the Company's exposure to legal action.
9.18.13.2 In addition, the Company has a “crisis event” array, assembled and practiced in accordance with guidelines set by the IATA, which examined and approved the array in three separate inspections in 2006, 2008 and 2012. The Company conducts “crisis event” training exercises at the Company level once per period (with the last exercise conducted in late 2011), and updates its procedures according to global developments in the field (booklets, conferences and professional media).
9.18.14 Aviation Regulation
The Company's activities and its ability to expand the scope and layout of its activity, is dependent, among other things, upon various regulatory approvals granted by authorities in Israel and around the world. The absence of proper licensing and the failure to uphold international or local regulations may lead to increases in Company costs, to competitive inferiority in comparison with the Company's competitors and may harm the Company's regular course of activity.
During the reported year, regulatory changes were made to aviation legislation applicable to the Company, and proposals were raised for changes to laws and regulations in the field of aviation regulation, for which the legislative process has yet to be completed. For details regarding aviation regulation see Section 9.11.2 above.
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Risks Particular to the Company
9.18.15 Costs of Maintaining Flight Security
Since the Company is required to maintain security arrangements which are determined by a governmental body and it bears security expenses over which it has no control, most of which do not apply to foreign, competing airlines, this situation hurts its profitability, its competitive ability, and the development of a route network. The Government passed several resolutions starting 2008 altering the rate of the State's participation in Israeli airlines' direct security costs, with the latest decision received on December 25 2011 and setting a gradual increase in the State's participation rate. For details regarding the Government resolution on this subject see 9.11.12 above. The changes in the rate of the State's participation in the Company's flight safety expenses, changes in the extent of safety measures the Company will be forced to take (due to security events or attempted attacks), as well as whether the Company will be forced to discontinue or limit its flights to additional destinations as a result of safety concerns, may have a material impact on the Company's operating results.
9.18.16 Restrictions on the Future Receipt of Credit and Failure to Meet Financial Criteria
The Company has undertaken towards its long-term loan providers to maintain a proper collateral ratio between the unpaid loan balance and the collateral pledged to the bank, as stipulated by each agreement. In addition, the terms stipulated in certain agreements relating to loans taken by the Company include the bank's right to demand immediate repayment of the loan balances owed to that bank if, in its opinion, based on reasonable criteria, a change had occurred that adversely affects the Company’s financial position or its operations or its business or its financial ratios, in a manner endangering or potentially endangering its ability to repay the bank loans. The failure of the Company to comply with financial covenants stipulated in the loan agreements, including with regard to the decrease in market value of the collateral, and/or the demand for immediate repayment of Company loans by the banks, might have a negative effect on the Company’s business results. In addition, single borrower and group of borrower limitations may apply to the Company, as well as limitations on the transfer of control and on changes to its ownership structure, taking the extent of the credit and the identity of the Company's controlling party into account.
9.18.17 Business Restrictions
In light of legislative changes in the field of antitrust laws, the competitive ability of Israeli carriers, among them the Company, may be damaged, and this may lead to a A-128
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negative impact on the Company's activities due to regulatory restrictions on the existence of international agreements in the Company's areas of activity or the non- approval of these agreements (existing or new) by the Restraint of Trade Authority (for details see 9.11.2 above). The gaps between Israeli antitrust law and antitrust law elsewhere in the world may impact the competitiveness of Israeli airlines, in particular in light of the mergers, acquisitions and aviation pacts common in international aviation.
For additional details regarding the impact of antitrust laws on the Company’s activity, including on the subject of monopolies, see 9.11.2 above.
9.18.18 The Municipal Status of BGN
From time to time, the addition of BGN to the jurisdiction of the city of Lod is taken under consideration. If the transfer of BGN to the jurisdiction of any local authority should become a reality, the expenses of the Company might rise (due to the payment of municipal taxes which up to now have not been paid), and the matter will negatively affect its business results.
9.18.19 Labor Relations
Every interruption of operations of an air carrier due to sanctions or a strike causes a non- recoverable loss and damage to customer confidence. The situation in the industry and the increasing rate of competition necessitate continuing efforts to increase Company efficiency and to improve service to the customer public. These depend on stable labor relations in the Company, on the employees' identification with the Company and on readiness to cooperate and in an understanding with management.
Although the “industrial calm” in the Company has been maintained since 1983, excluding a small number of disruptions, the efficiency expressed in structural changes, in the reduction in the number of personnel (with the emphasis on permanent employees), and the reduction of labor costs, could cause a shakeup, even for a short period, in the delicate texture of labor relations in the Company. This could cause damage in the immediate term and hurt the Company’s goodwill over the longer term, and it might have a negative effect on the business results of the Company for that year and thereafter. Additionally, there could be difficulty in utilizing business opportunities and dealing with changes due to limitations in the labor agreements.
9.18.20 Legal Proceedings
The Company is a party to legal proceedings, including claims the court was asked to recognize as class actions in Israel that may cause it to be charged for material amounts A-129
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that cannot be estimated, and for which no provision has been made in the Company’s Financial Statements. The results of these proceedings may have a material impact on the Company due to their results.
9.18.21 Restrictions Due to Certain Provisions of the Special State Share
The restrictions relating to maintaining minimal flight capacity, especially for cargo aircraft, and the prospect of the State demanding to increase the minimal flight capacity with which the Company must comply, diminish operational flexibility and impose burdensome obligations (assurance of fitness). The indemnification in these cases does not cover the Company’s expenses. In addition, the Government Corporations Law gives the government the authority to issue instructions to the Company that are intended to protect the vital interests of the State with respect to the Company, in accordance with decrees resulting from Chapter 2H of the Government Corporations Law, that may restrict the Company's business judgment and, as a result, impact its financial results.
9.18.22 Dependence on Aircraft Manufacturer
The Boeing Corporation manufactured all of the aircraft in the Company's service. The discontinuation of Boeing's operations could cause temporary operational difficulties for the Company. The Company has a material dependence on Boeing both with respect to spare parts as well as with respect to engineering support. At the same time, the Company estimates that the likelihood of the discontinuation of this support is low.
9.18.23 Dependence on Regular Operations at the Home Airport (BGN)
Most of the Company’s activity is carried out at its home airport, BGN. Therefore, an interruption or breakdown in the normal operations of BGN and/or changes in the policies of granting takeoff and landing authorizations (slots) at the central airports in which the Company operates might have a material negative effect on the Company’s operations. Restoration works began on a BGN in 2010, a process expected to last 4 years, during which BGN will contain just one functional runway. In addition, a proposal exists that Ben Gurion Airport be opened for departures throughout the night. Changing the operating hours and changing the activities to accommodate a single runway may have a material impact on the Company's operational abilities and financial results.
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9.18.24 Flights on the Sabbath and Jewish Holy Days
The Company continues to operate pursuant to a 1982 Government resolution and does not operate passenger flights on the Sabbath and on Jewish holidays. For details regarding the agreement between the Company and the Committee of Rabbis for Sabbath Observance see Section 7.10 above. Non-fulfillment of the understandings regarding flights on the Sabbath and Jewish holidays, or a change of the Company's policies with respect to this subject, could cause a dispute with this customer sector, which could affect the Company's results due to a consumer boycott.
9.18.25 Information Systems and Information Security
The current operations of the Company, the business activities and the services that it provides are based upon information systems and databases. Some of the Company’s information systems are at the end of their life cycles and their replacement is not included in the Company’s work plan. The Company has established an IT backup facility, in order to deal with a comprehensive failure situation in the main computer room. Likewise, the Company is preparing a comprehensive plan on the subject of data security as a response to the increase in risk deriving from cyber-attacks. Until the preparations in the fields detailed above are completed, the risk exists of problems and failures in the operation of the Company's information systems, which may lead to the shutdown of crucial systems or to the lack of sufficient support for certain periods of time.
The following table presents the risk factors described above according to their nature (macro risks, industry risks and risks particular to the Company), which have been ranked, as estimated by the Company’s management, according to their effect on the Company’s business as a whole - major, moderate and minor effect. The Company’s assessment as to the ranking of the risks was determined in consideration of the likelihood of the occurrence of the event and the measure of damage that might be caused to the Company, should the event take place.
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Extent of Risk's Effect on the Company
Minor Effect Moderate Major Effect Effect
Macro Risks Political events, security events or terrorist V actions Exposure to currency risks V Changes in the economic situation V Natural disasters and epidemic outbreaks V Exposure to variable interest risks V
Industry Risks Jet fuel prices V Changes in competition V Seasonal influence V Government resolutions on aviation matters
and the Company's licensing as an air V carrier Operations in an industry with a high fixed- V cost structure Noise restrictions and environmental V matters Effect of the activity of low cost airlines on V the market Impairment of flight safety or flight V security Aviation regulation V
Risks Particular to the Company
Minor Effect Moderate Major Effect Effect Costs of maintaining flight security V Restrictions on receipt of credit and failure V to meet financial criteria Business restrictions V Municipal status of BGN V Labor relations V Legal proceedings V Restrictions due to provisions of Special V State Share Dependence on aircraft manufacturer V Dependence on regular operations at home V airport (BGN) Saturday and religious holiday flights V
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2012 ANNUAL REPORT
CHAPTER B DIRECTORS' REPORT
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El Al Israel Airlines Limited Report of the Board of Directors on the State of the Corporation's Affairs for the Period Ending December 31 2012
We hereby present the Report of the Board of Directors on the State of the Corporation's Affairs for the period ending December 31 2012.
1. General
1.1 Changes in International Financial Standards (IFRS)
For further details regarding the changes occurring in international standards and the impact of their application to the Group's Financial Statements, see Note 3 to the December 31 2012 Financial Statements.
1.2 The Company and its Business Environment
The Company serves as the designated air carrier of the State of Israel on most international routes that operate to and from Israel.
The key activities of the Company and its subsidiaries are the transport of passengers and freight on scheduled flights, and on the matter of the transport of passengers, also on charter flights, between Israel and foreign countries and starting August 2010, on domestic flights as well. The Company is also engaged in providing security services and maintenance services, including for other airlines at Ben Gurion Airport, in the sale of duty-free products, in the leasing of aircraft, and through investees - in ancillary activities, mainly the manufacture and supply of airline food and the management of several overseas travel agencies.
The business environment in which the Company operates is the international and domestic civil aviation industry, and inbound and outbound tourism, which is characterized by a seasonal nature and strong competition, which grows stronger in periods of overcapacity, as well as high levels of sensitivity to the economic, political and security situation in Israel and around the world.
The Group has two operating sectors reported as operating segments in the Company's consolidated Financial Statements: a) Passenger aircrafts activity - in this segment, the Company transports passengers, as well as freight in the holds of passenger aircrafts, and provides ancillary services, such as the sale of duty-free products and the leasing of planes. In the field of passenger transport, the Company competes in its flights to and from Israel with 2 Israeli airlines (Arkia and Israir), over 60 foreign airlines that operate scheduled flights and over 50 foreign charter airlines. Revenues from this area of activity constituted 90.7% of all of the Company’s revenues in 2012.
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b) Cargo aircrafts activity – in this segment, the Company transports cargo in cargo aircraft (starting June 2011 the Company has operated a single leased 747-400 aircraft).
In the field of cargo transport, the Company competes with one Israeli airline (CAL) and with 7 foreign airlines operating cargo aircraft on a continuous basis, and with most of the scheduled airlines that operate passenger planes that carry cargo in their holds. Revenues from this area of activity constituted 4.0% of all of the Group’s revenues in 2012.
The Company has additional revenues that are not assigned to its major areas of activity, accounting for 5.3% of its total revenues.
For further details regarding the Company's areas of activity, see Section a5 of the Board of Directors Report.
1.3 Holdings of Company Shareholders
As of December 31, 2012, shareholder holdings in the Company are:
K'nafaim Holdings Ltd. ("K'nafaim") – 39.3%, The Delek Group – 8.9%, the Ginsburg Group – 9.8%, a Company employee corporation called "Holdings in Trust of El Al Employees Ltd." ("Employees Corporation") – 5.9%, others – 2.6%, the public – 33.5%.
Ratio of Holdings in Company Shares as of December 31, 2012 (undiluted):
Knafaim Public 39.3% 33.5%
Delek Group Ginsburg 8.9% Group 9.8% Employees’ Trust Others Holdings 2.6% 5.9%
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Explanations of the Board of Directors for the State of the Corporation's Affairs: a.1 Financial Position (Consolidated Financial Statements)
31.12.2012 31.12.2011 change in in in thousands thousands thousands US dollars US dollars US dollars Current assets Cash and cash equivalents 52,810 85,356 (32,546) Designated cash 1,205 1,827 (622) Short-term deposits 8,570 8,183 387 Restricted deposits 11,456 - 11,456 Trade receivables 129,898 *139,693 (9,795) Other receivables 23,333 27,748 (4,415) Derivative financial instruments 16,672 2,096 14,576 Prepaid expenses 29,442 28,043 1,399 Inventories 22,145 26,481 (4,336) Total current assets 295,531 319,427 (23,896) Non-current assets Long-term bank deposits 1,451 1,473 (22) Investment in affiliated companies 16,747 13,184 3,563 Investments in other company 1,244 1,264 (20) Fixed assets, net 1,128,959 1,192,413 (63,454) Intangible assets, net 9,392 7,995 1,397 Prepaid expenses 9,950 7,547 2,403 Assets due to employee benefits 42,369 39,817 2,552 Total non-current assets 1,210,112 1,263,693 (53,581) Total Assets 1,505,643 1,583,120 (77,477) Current liabilities Short-term borrowings and current maturities 160,316 105,945 54,371 Trade payables 144,832 160,802 (15,970) Other payables 52,243 67,415 (15,172) Provisions 16,333 24,843 (8,510) Derivative financial instruments 126 21,176 (21,050) Employee benefit obligations 97,954 98,502 (548) Unearned revenues 252,915 235,998 16,917 Total current liabilities 724,719 714,681 10,038 Non-current liabilities Loans from financial institutions 474,225 555,770 (81,545) Employee benefit obligations 58,198 57,789 409 Loans from others 2,441 1,869 572 Derivative financial instruments 1,399 - 1,399 Other payables 8,787 7,673 1,114 Provisions - 5,348 (5,348) Deferred taxes 26,173 *28,305 (2,132) Unearned revenues 58,274 51,946 6,328 Total non-current liabilities 629,497 708,700 (79,203) Shareholders’ equity 151,427 *159,739 (8,312) Total liabilities and equity 1,505,643 1,583,120 (77,477)
* Non-material adjustment of comparison numbers – see Note 5 to the Financial Statements.
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The main changes in asset, liability and equity items as of December 31 2012 compared to December 31 2011 are:
Current assets: The Company’s current assets decreased by $23.9 million in 2012 relative to December 31 2011.
Most of the decrease derived from a drop in balances of cash and cash equivalents and short-term deposits which decreased by $32.2 million, mainly as a result of investments in fixed and other assets to the amount of $88.7 million and from the redemption of short-term loans and credit, net to the amount of $28.9 as well as from a sum of $11.5 million pledged as collateral to a banking institution, offset by proceeds from the sale of fixed assets to the amount of $18.5 million and positive cash flows from current activity to the amount of $78.3 million.
A decrease was listed in trade and other receivables, primarily due to a decrease in the activity of subsidiary Sun D’Or and from receipts from the restoration of leased engines.
The following changes occurred to the Company's derivative financial instruments (presented in the Financial Statements under current assets and current liabilities):
The fair value of jet fuel, interest and foreign currency as of December 31 2012 was a positive sum of $15.1 million, a $34.2 million increase compared to the fair value at the end of 2011, mainly as a result of transactions reaching redemption and from additional transactions occurring in the reported period. The increase in the fair value of derivative financial instruments was expressed in a $9.6 million increase (net after tax) in the capital reserve in respect of cash flow hedges charged to equity, in an $3.3 million increase in deferred tax liability, in a $18.5 million net decrease in fuel and financing expenses in the Statement of Operations and in a $2.8 million net decrease in cash balances as a result of the purchase of jet fuel hedging options. For further details regarding hedging transactions conducted by the Company see b.1.(3), b.1.(4) and b.1.(5) below.
The decrease in inventories largely derived from a drop in jet fuel reserves.
Non-current assets:
The Company’s non-current assets decreased by $53.6 million relative to December 31 2011.
Most of the decrease derives from the fixed assets item. The Group’s investments in fixed assets amounted to $85.7 million in 2012, including payments on account of aircraft to the amount of $41.2 million (see Note 13.d.1 to the Financial Statements). Depreciation expenses and spare part and accessory consumption in the reported period amounted to a total of $134.8 million. A net reduction was also listed in fixed assets to the amount of 14.4 million due to the sale of fixed assets.
The investment in affiliate's item saw an increase deriving mainly from the receipt of an additional portion of 3.75% from Maman’s stock capital, so that the Company’s total holdings amount to 15% of Maman's issued and paid-up stock capital. For further details, see Note 12b to the Financial Statements.
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Current liabilities: The Company’s total current liabilities increased by $10.0 million relative to December 31 2011.
Balances of short-term borrowings and current maturities largely increased as a result of an increase in the current maturities of loans, primarily as a result of the receipt of a loan from a Boeing subsidiary (for further details see Note 18.b.2 to the Financial Statements) and bridge loans to finance 737-900 aircrafts from a foreign banking corporation. In addition, an increased occurred in the long-term credit frameworks provided the Company.
Balances of trade payables, other payables and provisions decreased largely due to a drop in activity, a change in the credit conditions of the fuel supplier, payments made on account of cargo claims (see Note 22.d.8 to the Financial Statements) and from the repayment of advance payments received from agents.
Unearned revenues largely increased as a result of an increased in deferred revenues from the sale of flight tickets.
Non-current liabilities: The Company’s non-current liabilities decreased by $79.2 million relative to December 31 2011.
Most of the decrease occurred in loans from banking institutions, as a result of the current repayment of loans.
The decrease in the deferred taxes item derives mainly from the listing of deferred tax revenues as a result of the yearly losses, offset by an increase in deferred tax liabilities following an increased in the fair value of hedging agreements recognized as defensive agreements (see Note 23 to the Financial Statements).
Equity: The Group’s equity as of December 31 2012 decreased by $8.3 million relative to December 31 2011, largely as a result of the loss in the reported period offset by an increase in the capital reserve for cash flow hedging, as a result of an increase in the fair value of hedging transactions recognized as defensive agreements. As of December 31 2012, the Company has a working capital deficit of $429.2 million, compared to a deficit of $395.3 million on December 31 2011. The Company’s current ratio as of December 31 2012 amounted to 40.8% compared to 44.7% as of December 31 2011. Among the main reasons for the increase in the working capital deficit, one might note the increase in short-term borrowings and current maturities, and unearned revenues, as well as the decrease in cash, customers, receivables and inventory. On the other hand, the increase in the fair value of derivative financial instruments and the decrease in the balances of trade payables, other payables and provisions contributed to the decrease in the working capital deficit. The working capital deficit consists of three material elements included under the Company’s current liabilities items and characterized by current business cycles: unearned revenues from the sale of flight tickets including port taxes, unearned revenues from frequent flyer clubs, and employee vacation obligations. Therefore, a material part of the capital deficit is not cash-flow based in the short term. For additional details about the state of the Company’s business see Note 1c to the Financial Statements.
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2. Analysis of Results of Business Activity
a.2.1 Market Data
Passenger and cargo Jan - December Jan - December change traffic at BGA 2012 2011 in thousands in thousands in thousands % Incoming tourists * 2,572 2,505 67 3% Departing Israelis * 3,860 3,857 3 0% Cargo import - tons ** 134.4 138.8 (4.4) (3%) Cargo export - tons ** 147.1 155.8 (8.6) (6%)
* Source: Central Bureau of Statistics. ** Does not include cargo in transit. Incoming Tourist & Departing Israeli Traffic, by Year (In Thousands):
5,000 3,857 3,860 3,552 3,397 3,588 4,000
3,000
2,000 2,385 2,505 2,572 2,190 2,049 1,000
0 2008 2009 2010 2011 2012 Incoming tourists Departing Israelis
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Imports & Exports of Cargo by Air to and from Israel, by Year (in Thousands of Tons):
250
182.3 164.3 200 154.0 155.8 147.1 150
141.4 138.8 135.7 134.4 100 118.4
50
0 2008 2009 2010 2011 2012
Export Import
a.2.2 Company Operating Data*
Jan - December Jan - December change 2012 2011 Passenger leg (scheduled and chartered) - in thousands 4,248 4,199 1% RPK (scheduled) - in millions 17,245 17,245 0% ASK (scheduled) - in millions 20,905 21,477 (3%) Load factor (scheduled) 82.5% 80.3% 3% The Company's market share (scheduled and chartered) 33.6% 33.9% (1%) Flown cargo, in thousand tons 92.8 102.2 (9%) RTK - in millions 485.4 546.4 (11%) Weighted flying hours (including leased equipment) - in thousands (**) 155.2 165.0 (6%) Average man-years (El AL only): Permanent 3,821 3,855 (1%) Temporary 2,099 2,201 (5%) Total 5,920 6,056 (2%)
Aircraft in operation - end of period - number of units 37 37 0 Average age of owned fleet at the end of the period - in years 12.9 12.8 0.1
* Operating data refers both to international and domestic activity.
* Total employees (permanent and temporary) in job slots - as of December 31 2012 - 5,775 and as of December 31 2011: 5,791.
Glossary: Passenger leg – Flight coupon in one direction. RPK – Revenue Passenger Kilometer – number of paying passengers multiplied by distance flown. ASK – Available Seat Kilometer – number of seats offered for sale multiplied by distance flown.
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RTK – Revenue Ton Kilometer – weight of paid flown cargo in tons multiplied by distance flown. Passenger Load Factor (occupancy) – flown passenger-km is expressed as a percentage of available seat- km.
*** Weighted flight hours in Boeing 767/757 terms. Weighted value of the planes: Boeing 767/757 = 1.0; Boeing 747 = 2.0; Boeing 777 = 1.6; Boeing 737 = 0.6. These weighted values were determined based on an estimate of the total expenses of each type of aircraft, and are used consistently to calculate weighted flight hours as an indicator of the volume of aviation activity.
Operating Data, by Year (in Millions):
25,000 100% 21,336 21,477 20,905 20,074 20,261 20,000 17,400 17,245 17,246 90% 16,529 16,410 15,000
80% 82.3% 81.6% 82.5% 10,000 81.0% 80.3%
5,000 70% 2008 2009 2010 2011 2012 RPK ASK L. F.
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a.3 Statement of Operations Data For 2012 (Consolidated Financial Statements):
Jan - December Jan - December change 2012 2011 in % of in % of in thousands operating thousands operating thousands US dollars revenues US dollars revenues US dollars % Operating revenues 2,015,642 100% *2,042,586 100% (26,944) (1%) Operating expenses (1,702,381) (84.5%) (1,764,879) (86.4%) 62,498 (4%) Gross profit 313,261 15.5% 277,707 13.6% 35,554 13% Selling expenses (209,210) (10.4%) (215,926) (10.6%) 6,716 (3%) General and administrative expenses (95,376) (4.7%) (97,392) (4.8%) 2,016 (2%) Other operating income (expenses), net 2,803 0.1% (8,293) (0.4%) 11,096 Operating profit (loss) before financing 11,478 0.6% (43,904) (2.1%) 55,382 Financing expenses (38,413) (1.9%) (20,197) (1.0%) (18,216) 90% Financing income 1,447 0.1% 20,474 1.0% (19,027) (93%) Company's share in earnings of affiliates, net 1,273 0.1% 1,441 0.1% (168) (12%) Profit (loss) before income taxes (24,215) (1.2%) *(42,186) (2.1%) 17,971 (43%) Tax benefit (taxes on income) 5,384 0.3% *(7,650) (0.4%) 13,034 (170%) Loss for the period (18,831) (0.9%) (49,836) (2.4%) 31,005 (62%)
* Non-material adjustment of comparison numbers – see Note 5 to the Financial Statements.
The key factors that influenced the business results in the year ending December 31, 2012 compared with 2011 are:
Operating revenues – operating revenues decreased by 1.3% relative to 2011. Passenger revenues remained essentially unchanged. Cargo shipping revenues decreased largely as a result of the decrease in cargo traffic as well as changes in exchange rates. A decrease was also listed in other Company revenues, mainly from the listing of one-time revenues in 2011.
Operating expenses – a 3.5% decrease occurred in the Company's operating expenses in 2012 relative to 2011, largely as a result of the decrease in salary expenses as detailed below as well as a decrease in “passage fees and aviation communications”, “airport fees and services” and “food and provisions”, as a result of the decrease in flight hours and the devaluation of the exchange rate of the USD relative to the EUR. The rate of operating expenses from the turnover decreased from 86.4% in 2011 to 84.5% in 2012.
• Operating salary expenses decreased over the course of 2012 relative to 2011, with most of the decrease deriving from the revaluation of the average rate of the NIS relative to the USD, from a drop in flight hours and a decrease in the number of employees. Regarding the impact of the changes in the NIS/USD rate of exchange on the Company’s employee benefit obligations, see a.4 below.
• Company jet fuel expenses remained essentially unchanged relative to 2011, in spite of the increase in jet fuel market prices (the “markets basket” – the weighted price in accordance with markets in which the Company purchases jet fuel) by an average of 1.6% relative to 2011, mainly as a result of the drop in flight hours and in the change in the fair value of jet fuel hedging agreements, while on the other hand, a decrease occurred in hedging receipts. The rate of jet fuel expenses from turnover increased from 33.6% in 2011 to 34.0% in the reported year. For further information on jet fuel price hedging see b.1.(3) below.
The drop in operating expenses constituted the key factor in the 12.8% increase in gross profits in 2012 relative to 2011.
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Breakdown of Operating Expenses in 2012
Jet fuel Meals Depreciation lease 40% 3% 6% expenses 5%
Airport fees & service security 10% expenses 2% Other expenses Air crew 2% expenses 3% Maintenance Wages and Air navigation of aircraft social benefits & 6% 18% communication 5%
Sales expenses – sales expenses underwent a 3.1% decrease compared to 2011, mainly as a result of the decrease in salary expenses as well as decrease in advertising and distribution expenses. The total rate of sales expenses from turnover amounted to 10.4% compared to 10.6% of turnover in 2011.
Administrative and general expenses – administrative and general expenses items decreased by 2.1% relative to 2011, primarily due to a drop in salary expenses.
Other net expenses – over the course of 2012 the Company listed other net expenses to the amount of $2.8 million, mainly as a result of listing capital gains from the sale of 737 engines, offset by the impairment of 757 aircrafts that ended their service at the Company. The Company listed other net expenses to the amount of $8.3 million in 2011, mainly as a result of a cargo claim provision. (See Note 22.d.8).
The decrease in the majority of expense components led to an operating profit of $11.5 million in the reported year, 0.6% of turnover, compared to an operational loss of $43.9 million in 2011 2.1% of turnover.
Financing – net financing expenses saw an increase in 2012 relative to 2011, largely as a result of the listing of expenses due to USD-NIS exchange rate hedging agreements and exchange rate differences. In total the group listed net financing expenses of $37.0 million in 2012 compared to net financing revenues of $0.3 million in 2011.
Pre-tax loss for 2012 amounted to $24.2 million compared to a pre-tax loss of $42.2 million in 2011.
Income tax – in 2012 the Group listed a tax benefit of $5.4 million, compared to a tax expense of $7.7 million in 2011, as a result of changes in corporate tax rates as a result of the revision of the Trachtenberg Law from 18% to 25%. (See Note 23 to the Financial Statements).
The yearly loss amounted to $18.8 million, 0.9% of turnover, 62% lower than the loss in 2011.
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Key factors that influenced the business results in the three-month period ending December 31, 2012 compared with the same period last year:
October - December October - December change 2012 2011
in % of in % of in thousands operating thousands operating thousands US dollars revenues US dollars revenues US dollars % Operating revenues 463,931 100% *485,360 100% 3,892 1% Operating expenses (416,743) (89.8%) (402,384) (82.9%) 30,961 (6%) Gross profit 47,188 10.2% 82,976 17.1% 34,853 31% Selling expenses (50,182) (10.8%) (55,263) (11.4%) 2,281 (4%) General and administrative expenses (25,004) (5.4%) (24,457) (5.0%) 914 (4%) Other operating expenses, net (1,209) (0.3%) 4,869 1.0% (471) (125%) Operating ptofit (loss) before financing (29,207) (6.3%) 8,125 1.7% 37,577 (459%) Financing expenses (7,560) (1.6%) (5,635) (1.2%) (8,355) 177% Financing income 1,791 0.4% 1,440 0.3% (7,070) (95%) The Company's share of the profit (loss) of subsidiaries, net of tax (121) (0.0%) 242 0.0% (137) (43%) Profit (loss) before income taxes (35,097) (7.6%) *4,172 0.9% 22,015 79% Tax benefit (taxes on income) 8,609 1.9% *(11,993) (2.5%) (5,518) 77% Loss for the period (26,488) (5.7%) (7,821) (1.6%) 16,497 79%
* Non-material adjustment of comparison numbers - see Note 5 to the Financial Statements.
In the fourth quarter of 2012 the Company listed a loss of $26.5 million, 5.7% of turnover, compared to a loss of $7.8 million, 1.6% of turnover in the same quarter last year.
The key factors behind this increased loss were:
A 3.3% decrease in passenger revenues, primarily as a result of the implications of Operation Pillar of Cloud, and the decrease in yield per passenger-kilometer.
A 7.0% drop in cargo revenues, primarily as a result of a drop in cargo market activity and the decrease in yield per ton-kilometer.
A 7.8% increase in jet fuel expenses, primary as a result of a 2.5% increase in the market price of jet fuel and a decrease in hedging receipts relative to the corresponding quarter last year.
An increase in security expenses, primarily as a result of one-time differences received in the fourth quarter of 2011 due to the increase in the State’s participation in security expenses.
A capital loss listed in the reported quarter from the realization of fixed assets compared to capital gains listed in the corresponding quarter last year.
The operational loss rate in the fourth quarter of 2012 amounted to 6.3% relative to an operating profit of 1.7% in the corresponding quarter last year.
In the reported quarter, the Company listed a tax benefit for tax expenses listed in the fourth quarter of 2011 (following the first-time implementation of the Trachtenberg Law).
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a.4 Effect of Changes in the Exchange Rate on the Company's Accrued Severance Pay Liability
In 2012 the exchange rate of the shekel was revalued against the dollar by 2.3%, compared to a 7.7% decrease in the exchange rate of the shekel vs. the dollar in 2011.
In the three month period ending December 31 2012 the exchange rate of the shekel increased against the dollar by 4.6%, compared with depreciation in the exchange rate of the shekel against the dollar of 2.9% in the same quarter last year.
US Dollar - NIS Exchange Rate:
4.2 3.923 3.912 3.821 3.9 3.712 3.715 3.733 3.549 3.481 3.6 3.415
3.3
3.0 31.12.10 31.03.11 30.06.11 30.09.11 31.12.11 31.03.12 30.06.12 30.09.12 31.12.12
The Company has a net obligation to its employees for severance pay, retirement plans, sick pay, and vacation pay as of December 31 2012 to the amount of $68 million. Since most of these obligations are denominated in shekels, whereas the functional currency of the Company is the dollar, these obligations must be translated into dollars, which causes differences deriving from changes in the exchange rate of the shekel against the dollar. Exchange rate changes are not one-directional, and cause the listing of revenues or expenses in the Company's Financial Statements. These revenues or expenses do not impact cash flow or operating costs of the Company in the short run. In order to enable a comparison of the Company's business results for the long run, these revenues or expenses should be neutralized.
Expenses for this element to the amount of $0.6 million were listed in 2012, compared to 2011, in which the expenses for this element decreased by $4.8 million.
The quarter ending December 31 2012 listed expenses for this component to the amount of $2.6 million compared with the same quarter last year, in which the expenses for this component decreased by $1.7 million.
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Presented below are details of the business results, after neutralizing the effect of the exchange rate on the accrued severance pay element, as described above:
Before After neutralizing the exchange-rate effect For year ended on the accrued severance pay 31 December: 2012 2011 2012 2011 (in thousands US dollars) Operating expenses 1,702,381 1,764,879 1,701,709 1,768,636 Gross profit 313,261 277,707 313,933 273,950 Gross profit rate 15.5% 13.6% 15.6% 13.4% Selling, general and administrative expenses 304,586 313,318 304,568 313,823 Other operating income (expenses), net 2,803 (8,293) 2,666 (8,833) Operating profit (loss) before financing 11,478 (43,904) 12,031 (48,706) Operating profit (loss) rate before financing 0.6% (2.1%) 0.6% (2.4%) Loss for the year (18,831) (49,836) (18,278) (54,638) Loss rate for the period (0.9%) (2.4%) (0.9%) (2.7%)
a.5 Segment Reporting
Presented below is operational segment data on a consolidated basis: a. General:
The Group has applied IFRS 8, "Operating Segments" (hereinafter "IFRS 8") starting January 1 2009.
According to IFRS 8, operational segments are identified based on internal reports on the Group's components, which are reviewed on a regular basis by the Group's chief operating decision maker for the purpose of allocating resources and assessing the performance of the operational segments.
The report array conveyed to the Group's chief operating decision maker, for the purpose of allocating resources and assessing the performance of the operational segments, is based on the distinction between revenues from passenger aircraft, cargo aircraft, charter flights and other revenues. In light of the above, the following are the Company's reported operating segments in accordance with IFRS 8:
Segment A – passenger aircraft activity.
Segment B – cargo aircraft activity. *
In determining the results of the reported operating segments, a number of components not part of the direct costs involved in operating the flights, such as depreciation as a result of aviation equipment, fixed maintenance costs and fixed costs at overseas offices are also included.
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b. Analysis of income and results by operating segments:
For year ended: passenger cargo others Adjustment Total 31.12.2012 aircraft aircraft consolidated in thousands US dollars operating revenues revenue from external customers 1,827,943 80,431 44,603 62,665 2,015,642 inter-segment revenues - - 48,557 (48,557) - Total segment revenues 1,827,943 80,431 93,160 14,108 2,015,642
se gme nt re sults 187,727 (3,827) 26,825 210,725 Unassigned expenses (199,247) Operating profit before financing 11,478 Financing expenses (38,413) Financing income 1,447 The Company's share of the profits of subsidiaries, net of tax 1,273 Loss before income taxes (24,215) Tax benefit 5,384 Loss for the period (18,831)
* Starting June 2011 the Company employs a single leased 747-400 cargo airplane.
For year ended: passenger cargo others Adjustment Total 31.12.11 aircraft aircraft consolidated in thousands US dollars operating revenues revenue from external customers *1,829,492 99,442 45,359 68,293 2,042,586 inter-segment revenues - - 65,919 (65,919) - Total segment revenues 1,829,492 99,442 111,278 2,374 2,042,586
se gme nt re sults *159,045 (678) 31,034 189,401 Unassigned expenses (233,305) Operating loss before financing (43,904) Financing expenses (20,197) Financing income 20,474 The Company's share of the profits of subsidiaries, net of tax 1,441 Loss before income taxes (42,186) Taxes on income *(7,650) Loss for the year (49,836)
* Non-material adjustment of comparison numbers – see Note 5 to the Financial Statements.
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For Nine-mounth period ended: passenger cargo others Adjustment Total 31.12.2010 aircraft aircraft consolidated in thousands US dollars operating revenues revenue from external customers *1,764,489 87,508 38,790 80,659 1,971,446 inter-segment revenues - - 78,573 (78,573) - Total segment revenues 1,764,489 87,508 117,363 2,086 1,971,446
se gme nt re sults *251,032 (264) 28,573 279,341 Unassigned expenses (192,091) Operating profit before financing 87,250 Financing expenses (35,911) Financing income 10,849 The Company's share of the profits of subsidiaries, net of tax 45 Profit before income taxes 62,233 Taxes on income *(5,773) Profit for the year 56,460
* Non-material adjustment of comparison numbers – see Note 5 to the Financial Statements.
No material change occurred in revenues from the passenger plane segment relative to 2011, while on the other hand, the segment’s results improved, from a contribution rate of 8.7% in 2011 to a contribution rate of 10.3% in 2012, mainly as a result of the increase in the yield per passenger- kilometer, from the decrease in flight hours and the drop in salary expenses.
Revenues from the cargo aircraft segment decreased by 19.1% relative to 2011, primarily as a result of the drop in the amount of cargo flown. The contribution from this segment worsened, largely as a result of the drop in the amount of cargo flown and the yield per ton-kilometer.
Other revenues decreased, primarily as a result of a decrease in revenues from charter flights (presented to the organization’s chief operational decision maker as separate activity), with no material change occurring in their contribution.
In total, the contribution increased from $189.4 from all segments in 2011 to $210.7 million in the reported year, an 11.3% improvement.
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c. Analysis of revenues by flight destination:
America Europe Central Asia Rest of Total & Far East the world in thousands US dollars Year 2012 Operating revenues 662,761 936,818 322,307 46,599 1,968,485 Non-segment revenues 47,157 Total consolidated revenues 2,015,642
Year 2011 Operating revenues 694,445 *923,701 313,415 60,298 1,991,859 Non-segment revenues 50,727 Total consolidated revenues 2,042,586
Year 2010 Operating revenues 673,030 *904,789 299,468 50,268 1,927,555 Non-segment revenues 43,891 Total consolidated revenues 1,971,446
* Non-material adjustment of comparison numbers – see Note 5 to the Financial Statements.
2012 saw a moderate increase in revenues from flights to Europe, Central Asia and East Asia, primarily as a result of the increase in passenger numbers, while the average revenue per flight segment decreased. A decrease occurred in flights to the Americas, primarily as a result of the discontinuation of flights to Sao Paolo over the course of the fourth quarter of 2011, as well as the influence of Hurricane Sandy in the fourth quarter of the year. An increase occurred in yield per flight segment in this sector relative to 2011.
a.6 Seasonal Factors The Group's activity is seasonal and focuses on peak periods. Heavy traffic of Israeli residents traveling abroad occurs primarily during the summer months and during holidays, while heavy incoming tourist traffic occurs during the summer months and during Jewish or Christian holidays or vacation time in their countries of origin. The peak of the Group's activity is in the third quarter, when passenger traffic in 2012, 2011, and 2010 constituted 30%, 30%, and 28%, respectively, of total yearly revenues.
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Revenue breakdown by quarters and percentage of turnover in 2012 (in millions of dollars):
700 605.8 50% 600 516.8 463.9 500 429.1 40% 400 30% 300 30.1% 200 25.6% 20% 23.0% 100 21.3% 0 10% Q1-12 Q2-011 Q3-12 Q4-12 revenues % of revenues
a.7 Liquidity and Financing Sources
Jan - December Jan - December change 2012 2011 in thousands US in thousands US in thousands dollars dollars US dollars Cash flows from operating activities 78,270 61,880 16,390 Cash flows used for investing activities (81,938) (40,444) (41,494) Cash flows used for financing activities (28,878) (47,082) 18,204 Decrease in cash and cash equivalents (32,546) (25,646) (6,900)
Operating Activities
The increase in cash flow from current activity in 2012 compared to the previous year derives mainly from the drop in pre-tax loss in the reported period compared to pre-tax loss in 2011, offset by changes in asset and liability items.
Investment Activities
In 2012 the Company used $85.7 million for investment in fixed assets, $11.5 million for investment in pledged deposits and $3.0 million for investment in intangible assets. On the other hand the Company received proceeds of $18.5 million from the realization of fixed assets. In total, the Company used $81.9 million for investment activity in 2012.
In 2011 the Company used $107.4 million for investment in fixed assets and $1.7 million for investment in intangible assets. On the other hand, the Company received $55.4 million from the realization of pledged deposits and $13.0 million from the realization of fixed assets. In total, the Company used $40.4 million for investment activity in 2011.
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Financing Activities
In 2012 the Company repaid loans to the amount of $99.1million. On the other hand, in 2012 the Company received loans to the amount of $60.6 million and net short-term bank credit to the amount of $10.6 million. In total, $28.9 million were used for financing activity in 2012.
The Company repaid loans to the amount of $87.3 million in 2011, while on the other hand, in 2011 the Company received long-term loans to the amount of $33.2 million and net short-term bank credit to the amount of $7.0 million. In total, $47.1 million were used for financing activity in 2011.
The Group’s total cash and cash equivalents and short-term investments as of December 31 2012 totaled $61.4 million, compared to $93.5 million as of December 31 2011.
The average scope of Company bank loans over the course of 2012 amounted to $628 million ($681 million in 2011).
The average scope of trade payables received by the Company during 2012 was $156 million ($171 million in 2011).
The average scope of credit given by the Company to its customers during 2012 was $158 million ($162 million in 2011).
The Company's material loans and credit frameworks:
Following Legal Position 104-15 of the Securities Authority dated October 30 2011, regarding a “reportable credit event”, the Company has established that the threshold of materiality for the purpose of detailing material loans is 5% of the Company’s balance sheet total.
Regarding a table detailing the material loans based on the criteria established above; see Appendix B to the Board of Directors Report below.
Note that the Company has additional loans as of December 31 2012 that are not material as defined above, as detailed in this report.
In the matter of additional details pertaining to the Company’s loans and compliance with financial restrictions and covenants, see Note 18 to the December 31 2012 Financial Statements.
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b. Market Risk Exposure and Management: b.1 Qualitative Reporting on Exposure to and Management of Market Risks
b.1. (1) General – Description of Market risks to which the Company is Exposed
Presented below is a summary of the market risks to which the Company is exposed:
Exposure to changes in prices of jet fuel – changes in prices of jet fuel, which constitutes a significant element of the Company's operating expenses, have a material effect on the Company's profitability. In the Company's estimation, at its current level of activity, every change of $0.01 US in the price of a gallon of jet fuel during an entire year impacts the Company's fuel expenses by $2.3 million. The Company has taken hedging measures to reduce the exposure, as detailed in b.1.(3) below.
In the event of a sharp and continuous drop in jet fuel prices, the Company may be required to provide collateral to jet fuel hedgers.
Exposure to changes in interest rates – most of the Company's long-term loans are at variable interest. Therefore, an increase in the Libor rate could impact the Company's profitability. At the present level of activity, every 1% increase in the Libor rate for a full year increases the Company's financing expenses by $6.2 million. The Company takes hedging measures to reduce the exposure, as detailed in b.1.(4) below.
Currency exposure – most of the Company's revenues and expenses are in foreign currency (mainly the U.S. dollar), except for several shekel expenses, mainly salary expenses and payments to local suppliers in Israel. Accordingly, a change in the shekel/dollar exchange rate influences the Company's shekel expenses in dollar terms. The Company estimates that at present levels of activity, each 1% in appreciation of the exchange rate of the NIS relative to the dollar for an entire year increases the Company's yearly expenses by $4.2 million. Likewise, a surplus of receipts exists for payments in euros, but at insignificant rates.
The Company has adopted hedging measures to reduce the exposure, as provided in Section b.1.(5) below.
Exposure in long-term loan frameworks – according to the provisions of the loan agreements, the Company must maintain a minimal collateral ratio between the market value of the planes and the balance of the loans guaranteed by these aircraft. Likewise, the Company is required to comply with certain covenants, which, if not complied with, can be used to compel the Company to immediately repay the loans. The Company's exposure to market risks in this area derives from the changes that occur in the market value of planes around the world. For further details see Note 31f and Note 18fto the December 31 2012 Financial Statements.
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b.1. b.1.(2) El Al Market Risk Management Policies, Officials Responsible for their Management and Means of Controlling and Executing Policy
The Company’s Board of Directors is responsible for approving a market risk management policy and supervises the implementation of the policy through the Market Risk Management Committee headed by Mr. Nadav Palti.
The Committee is responsible for defining and updating the policy, supervising the policy’s implementation and issuing instructions/approvals for Company management to deviate from implementing the policy in accordance with various developments.
The Company CEO is responsible for making decisions regarding the implementation of hedging agreements in practice in accordance with the Committee’s policy and guidelines.
The Company moderates the influence of these risks through the use of derivative financial instruments in order to hedge its exposure to risk. Use of the derivative financial instruments is in accordance with Group policy approved by its Board of Directors, which sets written principles regarding: currency risk management, interest rate risk, jet fuel price risk, the use of derivative financial instruments and non- derivative financial instruments and the investment of surplus liquidity. Compliance with policy and with permitted exposure levels is supervised by the Risk Management Committee on a regular and continuous basis.
The Market Risk Management Committee allows Company Management from time to time to deviate from said policy for limited amounts of time, in accordance with market developments.
The jet fuel hedging policy is as follows: hedging jet fuel quantities for up to 24 months forward, so that for every period, a minimum and maximum hedging rate would be set out of total expected consumption, in a gradual and decreasing manner. Hedging agreements shall be carried out on a monthly basis. The maximum hedging rate at the beginning of the period is 75% and the minimum hedging rate for the 12th month is 5%. Instruments and hedging levels shall be selected so that the Company limits its maximum exposure to cash securities. Over the course of the reported year the Company adapted the implementation of the jet fuel hedging policy to rapidly-fluctuating market conditions, so that from time to time, a deviation from the policy’s base lines occurs, all of which involves regular reports to the Market Risk Management Committee and to the Board of Directors. As of this report, the Company is hedged according to its policy.
The Company's policy with respect to interest hedging is to hedge half of the credit portfolio for a period of up to 5 years. As of this report, the Company is hedged according to its policy.
The Company’s NIS/USD exchange rate hedging policy was to hedge up to 75% of its cash flow exposure for a 1-year outlook as decided by management. As of this report, the Company is hedged according to its policy.
For details on the policy adopted, see Sections b.1.(3), b.1.(4) and b.1.(5) below.
For details regarding the influence of the changes in the economic environment after the balance sheet date, see Section e.2 below.
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b1. (3) Hedging Jet Fuel Prices
The Company executes financial transactions to hedge against changes in jet fuel prices, in accordance with its policy as described in Section b.1.(2) above.
As of December 31 2012, the Company had several agreements designed for hedging jet fuel prices, at a scope estimated at 37% of expected consumption for 2013. Some of these transactions are recognized as hedging agreements for accounting purposes and some are not. The net fair value of all jet fuel hedging instruments as of December 31 2012 is a sum of $5.6 million, presented in the Financial Statements as part of current assets and non-current liabilities under “derivative financial instruments". The Company listed a net income of $22.4 million for these hedging agreements over the course of 2012. For further details, see Note 26h to the Financial Statements. For details regarding changes occurring to jet fuel prices and additional hedging agreements carried out by the Company subsequent to the balance sheet date, see Section e.2.b of the Board of Directors Report.
b.1. (4) Hedging Interest on Loans
The Company executes hedges of the exposure in its long-term credit portfolio, due to changes in interest rates, in accordance with its policy as laid out in Section b.1.(2) above.
As of the end of 2012 these transactions are recognized as hedging agreements for accounting purposes. The fair value of these instruments as of December 31 2012 is a negative sum of $1.5 million, which is presented in the Financial Statements in the framework of current and non-current liabilities under “derivative financial instruments.”
After executing these hedges, as of December 31, 2012, 45% of the balance of the loans until the end of 2016 is hedged.
The Company listed net expenses of $0.2 million for hedging agreements over the course of 2012.
For additional details on these transactions, see Note 26f to the December 31 2012 Financial Statements.
For information on changes occurring subsequent to the balance sheet date, see Section e.2.c of the Board of Directors Report below.
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b.1. (5) Exchange Rate Hedges
The Company executes hedges to protect its currency exposure due to changes in the exchange rate of the NIS versus the USD, in accordance with its policy as laid out in Section b.1.(2) above.
As of December 31 2012 the Company has entered into several financial transactions, designed to protect the Company from drops in NIS/USD exchange rates until December 2013. These transactions are recognized as hedging agreements for accounting purposes.
The net fair value of these instruments as of December 31 2012 is $11.0 million, presented in the Financial Statements as part of current and non-current assets under "Derivative Financial Instruments".
The Company listed expenses for exchange rate hedging agreements to the amount of $13.5 million over the course of 2012. For additional details on these transactions, see Note 26f to the December 31 2012 Financial Statements.
For information on changes occurring in the NIS-USD exchange rate and additional hedging agreements carried out by the Company subsequent to the balance sheet date, see e.2.d below.
b.1. (6) Sensitivity Analysis Reporting
The following is an analysis of the sensitivity of the fair value of the financial instruments sensitive to changes possible in the risk factors to which they are exposed.
The sensitivity analyses were performed relative to the fair value of the financial instruments as of December 31, 2012.
Below is a description of the models for examining the fair value sensitivity of the various financial instruments:
1. Interest hedge – Interest hedges are executed by means of financial instruments opposite Israeli banks. The base asset for these transactions is the Libor (London Inter-Bank Offered Rate) rate for various periods (3 months, 6 months, one year), according to which the interest return on the Company's variable-interest loans (plus a margin) is set.
Interest hedges are executed "back to back", in order not to create additional exposure of timing differences between the expiration date of the transaction and actual payment against the existing loans, so that the settlement dates match the repayment dates of the loans. On the loan repayment dates, the settlement amount is calculated for the next period, according to the market interest that prevailed on the two prior business days, and based on the structure of the transactions as determined in advance.
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Interest hedge agreements in effect as of the end of 2012 are interest rate fixing transactions (IRS). These transactions are recognized as hedging agreements for accounting purposes.
The fair value of interest hedges is calculated according to the projected Libor rate. In interest hedges in which the interest rate is fixed, the fair value is determined based on the difference between the projected interest and the interest published periodically by the world's leading banks, for the interest stated in the transaction, multiplied by the size of the hedge in each period. In hedge transactions that include options, the fair value is determined based on mathematical formulas for pricing options in recognized models.
2. Exchange rate hedging – exchange rate hedges carried out by the Company are executed using financial instruments in conjunction with banks in Israel and abroad.
The underlying assets for these transactions are the representative exchange rate for dollar/shekel currencies set by the Bank of Israel. Dollar/shekel exchange rate hedges are executed in order to hedge the cash flow exposure to the NIS as detailed in b.1.(5) above.
The yearly exposure rate is 1,600 million NIS. The transactions for hedging this exposure according to the Company's policy are monthly, corresponding with the conversion dates of dollars to shekels for the purpose of paying salaries and suppliers in Israel.
The Company’s transactions as of the end of 2012 are forward transactions according to which the Company fixes the exchange rate to the date on which it is required to perform a currency conversion. These transactions are recognized as hedging agreements for accounting purposes. The fair value of these transactions is calculated based on mathematical formulas for pricing derivatives in recognized models.
3. Jet fuel hedges – Jet fuel constitutes the most material component of Company expenses
Jet fuel hedge transactions are executed by the Company through via in financial instruments taken opposite the leading Israeli and global financial institutions and banks engaged in this market.
The underlying asset in these transactions is jet fuel in the various markets that serve as the basis for determining the jet fuel prices that the Company actually pays, and mainly Jet Aviation FOB Med. In addition to this market, the Company purchases jet fuel according to its price in other markets, of which the key ones are Singapore, US Gulf Coast and North West Europe.
Jet fuel is an essential raw material for the Company for its operations - the Company is obligated to purchase the raw material in order to fly its planes, and there is no substitute or ability to alternate between the costs of these raw materials and other raw materials. The price of jet fuel is very volatile.
This graph shows the fluctuations jet fuel prices (cent/gallon) since the beginning of 2010:
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The market price of jet fuel is determined based on several parameters, including:
Crude oil prices include market expectations and supply and demand. The supply of oil and its products is limited physical and infrastructure factors (oil reserves, production infrastructures, refining, storage, transport, etc.), and by geopolitical and cartel influences of the large oil producers (OPEC). The marginal cost for fuel production is different at various levels of production, increasing along with the required level of production (as an example, the cost of producing a barrel of oil via deep sea drilling is three or four times the cost of producing a barrel of oil from Arabian oil wells). The trend of increased oil prices continued in 2011. The price of a Brent barrel of oil was priced at $111.1 at the end of 2012 compared to $107.4 at the end of December 2011.
Price fluctuations – Due to the meeting of the limited supply and the surging demand in recent years, any change, or expectations for change, in one of these factors, causes strong price fluctuations (such as levels of economic activity and global growth, wars and terrorism, shutdowns and problems at large oil refineries, international relations and more).
Seasonal demand for various crude distillates, including jet fuel (In the winter there is high demand for heating oil; in the summer there is high demand for gasoline. Likewise, transport costs vary, conforming to seasonal risks in sea shipping).
Production cost and infrastructure limitation – Distillate prices vary according to various constraints of the oil refining industry, refining infrastructures, storage and transport of oil and its products are limited, cost of their development is very high and their expansion takes many years (construction of a refinery takes 5-7 years).
Moreover, future prices for oil and its derivatives (including jet fuel) are affected strongly also by the power of the financial demands of institutional investors and speculators, which include these products in their investment portfolios.
In recent years, due to various reasons (including those mentioned above), the risk embedded in the markets and the price fluctuations are very high.
In view of the behavior of the markets, investment houses and the world's leading analysts are having difficulty in precisely and consistently estimating the price-change trends.
The forecasting ability of the various investment houses and analysts represent, at most, the immediate current estimate of the macroeconomic influences prevailing when the estimate was made. Furthermore, these estimates are calculated according to the different economic analyses of each analyst and investment house. Even the Forward curve structures are non-predictive, and at most, they represent the expectation and risk level embedded in the markets.
According to the structure of the Company's hedge transactions, on the settlement date vs. the financial entity with which the hedge was executed (settlement date of the trade), a calculation is made of the transaction's strike price vs. the average monthly price of the underlying asset (Asian options) (published by Platts, a division of McGraw-Hill companies, which is the authorized and leading international party for providing data services on the energy market) and constitutes an accepted point of reference with respect to the trading of oil and its derivatives. The payment or receipt for the transactions is based on the transaction's structure as designated in advance.
The financial instruments traded by the Company (mainly options on jet fuel) are traded over-the-counter (OTC) between the Company and the financial entities opposite which the trade is executed, and are not contracts traded directly on various exchanges.
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The future price of the jet fuel, as traded in these instruments, is comprised of three main elements: crude oil price, the GasOil crack and the jet differential.
Each of these three elements is actually traded separately (between financial institutions and brokers), and priced separately. The pricing of each of the elements is affected by various factors, including the current price, duration, price fluctuations, supply and demand, seasonal factors, storage costs, transport, etc., and has a different effect on the overall price change of jet fuel.
This pricing is done differently by every financial entity, according to models and algorithms that they developed (based on models such as Black & Scholes, Monte Carlo, etc.), opposite the investment portfolio of that party.
As is accepted in this field by global aviation companies, the companies obtain the fair value estimates from the investment houses opposite which they execute the trades. These investment houses use macroeconomic models that take into account the individual behavior of each element, the proportionate mix in the formula among the elements, the individual fluctuation of each element, cross influence between prices and fluctuation and between supply and demand (supply and demand flexibility), future development of production, refining, storage and transport (tankers and pipes) capabilities, geopolitical forecasts in the world and the behavior of the cartels, macroeconomic models of global growth rates and demand for energy sources, forecasts for changes in interest and exchange rates, forecast production of alternative energy sources for the materials being discussed, the behavior of the financial markets in connection with trade in the relevant securities and derivatives and other factors. All the above elements are processed according to economic models that were developed by the different investment houses that own them. These models are capable of generating estimates and forecasts, with the qualification that they are correct as of the moment they are generated. Some of the investment houses use the "Monte Carlo" simulation model on these estimates, in order to predict the future price/value expectancy.
In this report, we rely on fair value calculations made by the various financial entities with which the transactions were executed and which were provided the Company. These value calculations are also validated by feasibility tests conducted by the Company using the models and systems in its possession.
The following is an analysis of the sensitivity of the fair value of the financial instruments sensitive to changes possible in the risk factors to which they are exposed. The analyses pertain to the fair value of the financial instruments as of December 31 2012.
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Presented below are sensitivity analysis tables for instruments sensitive to changes in market factors:
a. Sensitivity to changes in the NIS/USD exchange rate – in thousands of dollars:
Gain (loss) from changes Gain (loss) from changes Increase 10% Increase 5% Fair value Decrease 5% Decrease 10% 4.106 3.920 3.733 3.546 3.360 NIS/$ NIS/$ NIS/$ NIS/$ NIS/$ Cash and cash equivalents (3,127) (1,638) 34,392 1,810 3,821 Designated cash (110) (57) 1,205 63 134 Short-term deposits (779) (408) 8,570 451 952 Restricted deposits (1,041) (546) 11,456 603 1,273 Trade receivables (139) (73) 1,530 81 170 Other accounts receivables (1,114) (583) 12,253 645 1,361 Derivative financial instruments (1,001) (524) 11,006 579 1,223 Long-term bank deposits (132) (69) 1,451 76 161 Total financial Assets (7,443) (3,898) 81,863 4,308 9,095 Borrowings and current maturities 402 211 (4,426) (233) (492) Trade payables 2,507 1,313 (27,579) (1,452) (3,064) Other payables - Current 32 17 (351) (18) (39) Loans from financial institutions 481 252 (5,290) (278) (588) Loan from others 207 108 (2,278) (120) (253) Other payables - Non Current 403 211 (4,437) (234) (493) Total financial liabilities 4,032 2,112 (44,361) (2,335) (4,929) Exposure in linkage balance she e t due to surpl us of financial assets over financial liabilities (3,411) (1,786) 37,502 1,973 4,166
* Does not include exposure for the effect of the changes in the exchange rate on assets and liabilities due to employee benefits, see Section a4.
b. Sensitivity to changes in the EUR/USD exchange rate - in thousands of dollars:
Gain (loss) from changes Gain (loss) from changes Increase 10% Increase 5% Fair value Decrease 5% Decrease 10% 0.835 0.797 0.759 0.721 0.683 Euro/$ Euro/$ Euro/$ Euro/$ Euro/$ Cash and cash equivalents (152) (79) 1,668 88 185 Trade receivables (1,480) (775) 16,276 857 1,808 Other accounts receivables (113) (59) 1,244 65 138 Total financial Assets (1,745) (913) 19,188 1,010 2,131 Borrowings and current maturities 8 4 (84) (4) (9) Trade payables 1,760 922 (19,361) (1,019) (2,151) Other payables 282 148 (3,099) (163) (344) Total financial liabilities 2,050 1,074 (22,544) (1,186) (2,504) Exposure in linkage balance she e t due to surpl us of financial liabilities over financial assets 305 161 (3,356) (176) (373)
* Does not include exposure for the effect of the changes in the exchange rate on assets and liabilities due to employee benefits, see Section a4.
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c. Sensitivity to changes in jet fuel prices on inventory (dollar/gallon) – in thousands of dollars:
Gain from changes Loss from changes Type of instrument Increase 10% Increase 5% Fair value Decrease 5% Decrease 10% 3.483 3.324 3.166* 3.008 2.849 $/gallon $/gallon $/gallon $/gallon $/gallon Jet fuel Inventorie 1,264 632 12,643 (632) (1,264)
* Jet fuel prices according to moving weighted average as of December 31 2012.
d. Sensitivity of jet fuel hedging to changes in jet fuel prices - in thousands of dollars:
According to the model's principles, jet fuel hedges that react in a similar manner to market factors were grouped together, since there was no loss of material information required to understand the Company's exposure to market risks as a result of the grouping. On January 5 2009 jet fuel prices changed by 14%, and therefore the following sensitivity analysis includes a 15% change in jet fuel prices.
Gain from changes Loss from changes Type of instrument Increase 15% Increase 10% Increase 5% Fair value* Decrease Decrease 10% Decrease 15% 5% 3.413 3.265 3.116 2.968 2.820 2.671 2.523 $/gallon $/gallon $/gallon $/gallon $/gallon $/gallon $/gallon SWAP transactions - designed for hedging 22,121 14,747 7,374 2,470 (7,374) (14,747) (22,121) Options - not designed for hedging 12,494 8,134 3,931 3,153 (3,544) (6,875) (10,244) Total transactions - jet fuel hedge 34,615 22,881 11,305 5,623 (10,918) (21,622) (32,365)
* The price of diesel fuel in the Middle East ($2.9675/gallon) as of December 31 2012, according to which the fair value of the Company's hedge transactions is computed. e. Sensitivity of interest hedging to changes in market interest rates – in thousands of dollars:
According to the principles of the model, the Group executed interest hedges that respond in a similar way to market factors (IRS agreements not intended for hedging), since no loss of significant information is sustained that is required to understand the Company's exposure to the market risk, as a result of the grouping. On December 16 2008 a 75% change occurred to the dollar monetary policy, and therefore the following sensitivity analysis led to a 75% change in interest rates.
Gain from changes Loss from changes Type of instrument Increase Decrease Decrease Increase 75% Increase 10% 5% Decrease 5% 10% 75% in interest in interest in interest Fair value * in interest in interest in interest rate rate rate rate rate rate IRS transactions - designed for hedging 776 111 60 (1,482) (48) (106) (790)
* Fair value was calculated according to the market Libor rate as of December 31 2012, at the following rates: 3-month Libor: 0.31%, 6-month Libor: 0.51%, and 12-month Libor: 0.84%, all as applicable and according to the relevant transaction.
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f. Sensitivity of NIS/USD exchange rate hedging to changes in market exchange rates – in thousands of dollars:
Loss from changes Gain from changes Type of instrument Increase 10% Increase 5% Decrease 5% Decrease 10% in exchange in exchange Fair value in exchange in exchange rate rate NIS/$ * rate rate 4.106 3.920 3.733 3.546 3.360 FORWARD transactions - designed for hedging (26,530) (13,268) 11,006 13,263 26,532
* The sensitivity analysis was carried out in shekel terms, and the profit or loss in the event of a 5% or 10% decrease or increase was translated according to an exchange rate of 3.733 NIS per USD on December 31 2012.
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b 2. Linkage Basis Report The following is the consolidated linkage basis report for December 31 2012:
In, or linked to In Israeli In, or linked to In, or linked to Non-monetary Total the US dollar currency the euro the other items currencies (in thousands US dollars) Curre nt a sse ts Cash and cash equivalents 5,771 34,392 1,668 10,979 - 52,810 Designated cash - 1,205 - - - 1,205 Short-term deposits - 8,570 - - - 8,570 Restricted deposits - 11,456 - - - 11,456 Trade receivables 97,740 1,530 16,276 14,352 - 129,898 Other accounts receivables 8,049 12,253 1,244 1,787 - 23,333 Derivative financial instruments 5,666 11,006 - - - 16,672 Prepaid expenses - - - - 29,442 29,442 Inventories - - - - 22,145 22,145 Non-current assets Long-term bank deposits - 1,451 - - - 1,451 Investment in affiliated companies - - - - 16,747 16,747 Investment in other company 1,244 - - - - 1,244 Fixed assets, net - - - - 1,128,959 1,128,959 Intangible assets, net - - - - 9,392 9,392 Prepaid expenses - - - - 9,950 9,950 Assets due to employee benefits 265 42,104 - - - 42,369 118,735 123,967 19,188 27,118 1,216,635 1,505,643 Current liabilities Borrowings and current maturities (155,558) (4,426) (84) (248) - (160,316) Trade payables (88,819) (27,579) (19,361) (9,073) - (144,832) Other payables (45,487) (351) (3,099) (3,306) - (52,243) Provisions (1,478) (14,855) - - - (16,333) Derivative financial instruments (126) 0 - - - (126) Employee benefit obligations (3,535) (93,928) (487) (4) - (97,954) Unearned revenues - - - - (252,915) (252,915) Non-current liabilities Loans from financial institutions (468,935) (5,290) - - - (474,225) Employee benefit obligations (3,876) (49,097) (613) (4,612) - (58,198) Loan from others (163) (2,278) - - - (2,441) Derivative financial instruments (1,399) - - - - (1,399) Other payables (4,350) (4,437) - - - (8,787) Deferred tax - - - - (26,173) (26,173) Unearned revenues - - - - (58,274) (58,274) Shareholders’ equity - - - - (151,427) (151,427) (773,726) (202,241) (23,644) (17,243) (488,789) (1,505,643) Monetary assets, net of monetary liabilities (monetary liabilities, net of monetary assets) (654,991) (78,274) (4,456) 9,875 727,846 -
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The following is the consolidated linkage basis report for December 31 2011:
In, or linked to In Israeli In, or linked to In, or linked to Non-monetary Total the US dollar currency the euro the other items currencies (in thousands US dollars) Current assets Cash and cash equivalents 49,841 23,719 4,900 6,896 - 85,356 Designated cash - 1,827 - - - 1,827 Short-term deposits - 8,183 - - - 8,183 Trade receivables *110,129 875 16,466 12,223 - 139,693 Other accounts receivables 15,649 9,098 1,635 1,366 - 27,748 Derivative financial instruments 2,096 - - - - 2,096 Prepaid expenses - - - - 28,043 28,043 Inventories - - - - 26,481 26,481 Non-current assets Long-term bank deposits - 1,473 - - - 1,473 Investment in affiliated companies - - - - 13,184 13,184 Investment in other company 1,264 - - - - 1,264 Fixed assets, net - - - - 1,192,413 1,192,413 Intangible assets, net - - - - 7,995 7,995 Prepaid expenses - - - - 7,547 7,547 Assets due to employee benefits 908 38,909 - - - 39,817 179,887 84,084 23,001 20,485 1,275,663 1,583,120 Current liabilities Borrowings and current maturities (101,398) (4,547) - - - (105,945) Trade payables (102,235) (27,115) (22,780) (8,672) - (160,802) Other payables (58,017) (4,362) (1,332) (3,704) - (67,415) Provisions (11,465) (13,378) - - - (24,843) Derivative financial instruments (9,159) (12,017) - - - (21,176) Employee benefit obligations (3,001) (94,387) (542) (572) - (98,502) Unearned revenues - - - - (235,998) (235,998) Non-current liabilities Loans from financial institutions (548,017) (7,753) - - - (555,770) Employee benefit obligations (9,421) (43,065) (626) (4,677) - (57,789) Loan from others (233) (1,636) - - - (1,869) Other payables (3,236) (4,437) - - - (7,673) Provisions (5,348) - - - - (5,348) Deferred taxes - - - - *(28,305) (28,305) Unearned revenues - - - - (51,946) (51,946) Shareholders’ equity - - - - *(159,739) (159,739) (851,530) (212,697) (25,280) (17,625) (475,988) (1,583,120) Monetary assets, net of monetary liabilities (monetary liabilities, net of monetary assets) (671,643) (128,613) (2,279) 2,860 799,675 -
* Non-material adjustment of comparison numbers – see Note 5 to the Financial Statements.
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c. Aspects of Corporate Governance
c.1. Charitable Donations and Community Work El Al assigns a great deal of importance to making charitable contributions and assisting the needy and the community. As part of its activities, the Company contributed a total of $85,000 in cash and cash equivalents, as well as 1,500,000 NIS in cash-equivalent donations in 2012.
Over the course of 2012, El Al continued its longstanding tradition of giving back to the community.
The activity continued to focus mainly on two channels:
1. Employee volunteer activities within the scope of the departmental steering committee for weaker populations, including holocaust survivors without relatives, at-risk children, special-needs children, people with disabilities and the infirm, as well as volunteer work by Company employees in education projects such as Together Teachers, El Al in Education and Young Entrepreneurs.
2. Support with money or money-equivalents, for the needy:
a. By management – within the framework of the Contributions Committee, the Company contributes donates sums of money, and in addition contributes assistance in the form of money equivalents, such as dozens of hot meals daily, free flight tickets, transport of special cargo free of charge and distribution of food containers. In addition, El Al has donated to organizations assisting the mentally disabled (AKIM, Etgarim, Pitchon Lev, Larger than Life, the Israeli Youth Diabetes Association), and El Al has adopted the soldiers of the IDF’s 201st Battalion as part of the Adopt a Warrior program. Within the framework of the Friendly Club, El Al transfers points for the purchase of flight tickets to the Make-a-Wish Foundation to fulfill the wishes of young cancer patients, to the AWIS in order to assist single soldiers and to Taglit project in order to bring Israeli youths to Israel. El Al has donated scholarships for the Heseg Fund for single soldiers who have been discharged from the military and are starting academic studies.
b. By the employees themselves – whether in money or money-equivalents (home electrical appliances, clothing, books, games, etc.) to preschools for special-needs children, at-risk children’s homes and more. c 2. Directors with Accounting and Financial Capabilities Board members the Board of Directors considers to possess accounting and financial expertise in light of their estimated education, experience, skills and knowledge of business/accounting subjects and financial statements are Mr. Nadav Palti, Mr. Yair Rabinowitz, Professor Jhoshua (Shuki) Shemer, Mr. Pinchas Ginsberg, Ms. Yael Andoren and Mr. Avraham Bigger. For details see Regulation 26 of Part D (Additional Details on the Corporation) of the periodic report.
c 3. Disclosure Regarding Independent Directors The Company has not adopted in its bylaws the ordinance regarding the number of independent directors, in accordance with Section 219 (a) of the Companies Law, 1999. At the same time, as of the approval of the statements, the number of independent directors, as defined by the Company, is 4 out of 11, meaning over one third of the directors are considered independent directors.
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c 4. Disclosure Regarding the Corporation's Internal Auditor 1. Information Regarding the Internal Auditor and Compliance with Conditions 1.1.1. Name of Auditor: Gil Berr. 1.1.2. Beginning of term in office: June 1 2008. 1.1.3. Qualifications: accountant, with a degree in accounting and business administration and certified in public administration and auditing (with honors). Holds CIA (Certified Internal Auditor – U.S.) and CRISC certificates, and has 16 years’ experience in auditing, in financial statements and in risk management. Until his appointment Mr. Berr was a partner in Cost Forrer Gabai & Kasierrer, Ernst & Young responsible for auditing and risk management, and served as internal auditor for various companies and organizations. A regular lecturer at the Academic Track of the College of Management on budgeting and control subjects and a member of the Ilan Audit Committee. The Internal Auditor meets all compliance requirements set in Section 3(a) of the Auditing Law, 1992. The Internal Auditor complies with Section 146(b), 1999 of the Companies Law and Section 8 of the Internal Auditing Law, 1992. 1.1.4. The Internal Auditor has no holdings in Company securities or holdings in any related body in the reported year. 1.1.5. Starting from the date of his appointment, the Internal Auditor has had no business connections of any sort with the audited corporation or with any related body, with the exception of serving as Internal Auditor of Group subsidiaries. 1.1.6. The Internal Auditor is employed by the Company as a full-time Company employee.
2. The Internal Auditor's Appointment 2.1. The appointment of the internal auditor was approved by the Audit Committee on its April 21 2009 meeting and by the Company's Board of Directors on its April 30 2009 meeting and after considering the Auditor's education, skills and experience in corporate auditing and risk management to material degrees. 2.2. The Auditor was given duties and authorities in accordance with the Company's auditing procedure, the directives of which are based on the laws of the State of Israel. Pursuant to this, the Internal Auditor was tasked with proposing a work plan, to carry out an auditing plan accordingly and to distribute, in writing, reports containing findings, conclusions and recommendations.
3. The Internal Auditor's Supervisor 3.1. The Internal Auditor is subordinate to the Chairman of the Board of Directors and the Company CEO, in accordance with the Company's bylaws.
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4. Work Plan 4.1. The Internal Auditor's work plan is on a yearly basis. 4.2. The Internal Auditor's work plan is determined based upon the following considerations: 4.2.1. The risk embodied in an area of activity and profitability of the Company. 4.2.2. The existence of appropriate controls, applicability and efficiency in the audited area. 4.2.3. Proposals by VPs and branch managers. 4.2.4. Previous audit findings and pace at which the recommendations submitted were implemented. 4.2.5. The effect of the subject on Company profitability, passenger service, the safety and security of passengers, employees and aircraft. 4.2.6. The need for follow-up in order to ensure a proper auditing process. 4.3. Establishment of the work plan involves the Chairman of the Company's Board of Directors, the members of the Audit Committee and the Company CEO. 4.4. The work plan proposal is received on a yearly basis from by the Chairman of the Company's Board of Directors, the members of the Audit Committee and the Company CEO. All of them approve the proposal in accordance with Section 149 of the Companies Law, 1999. 4.5. The work plan allows the Internal Auditor to exercise his judgment in deviating from the plan. 4.6. The Company Auditor is present at Board meetings in which material transactions are approved.
5. Overseas Audits for Subsidiaries 5.1. The Company Auditor also serves as the Internal Auditor for all active subsidiaries and therefore the Auditor's work plan takes these companies into account. The Auditor's work plan also includes reviews of the Company's overseas activities.
6. Treatment of Complaints Pertaining to Faults in the Management of the Company’s Business The Company Auditor was assigned the task of concentrating and presenting to the Audit Committee the method of treatment of complaints by Company workers regarding flaws in the manner in which it conducts its business. For this purpose, a regular mechanism has been established at the Company to handle these matters. This is to ensure that the subject would be examined and controlled on a regular basis.
7. Scope of Employment 7.1. The Internal Auditor is employed full time by the Company and subordinate to him are eight full time auditors. 7.2. The following work hours were invested in auditing the Company and its overseas subsidiaries in 2012:
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Work hours for the Work hours due to investee Company's activity Work hours for the corporations ** abroad * Company's activity in Israel 1,300 1,750 12,250
* 70% of the Company's work hours for activities abroad were carried out in Israel. ** Audits were carried out for 4 subsidiaries.
8. Auditing Proceedings 8.1. The Company's Internal Auditor conducts his work in accordance with the Companies Law, 1999, the Internal Audit Law, 1992 and generally accepted professional standards. 8.2. The Chairman of the Board holds a monthly meeting with the Internal Auditor regarding his work and regarding the professional standards according to which the Auditor operates. 8.3. The Audit Committee holds meetings in which it discusses the Internal Auditor's work and the audit standards. 8.4. Prior to the approval of the yearly audit plan the Chairman of the Board meets with the Internal Auditor to discuss the standards according to which the work plan was formulated, following which the audit committee discussed the proposed yearly audit plan and the standards according to which the proposal was formulated and approves it.
9. Access to Information 9.1. The Internal Auditor has free, continuous and direct access to any document or information held by the Company or by any of its employees, as well as access to any ordinary or computerized information listings, to any database and to any automatic data processing system in the Company, including for financial data, as noted in Section 9 of the Internal Audit Law, 1992.
10. Internal Auditor Reports 10.1. The audit reports are submitted in writing. 10.2. The Internal Auditor prepared 33 audit reports in 2012. The audit reports were submitted to the Chairman of the Board, the members of the Audit Committee of the Board of Directors, and to the Company's CEO. 10.3. In 2012, the Audit Committee convened 16 times to discuss the internal audit reports.
11. Board of Directors' Evaluation of the Internal Auditor's Activity In the opinion of the Board of Directors, the scope, nature and continuity of the internal auditing activities and work plan are reasonable under the circumstances, and they achieve the internal audit objectives of the corporation, as they relate to all of the Company’s material and key activities.
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12. Remuneration 12.1. The compensation of the internal auditor is based on the salary and associated benefits granted members of the senior management group and in accordance with Company policy. 12.2. In the opinion of the Company's Board of Directors, the compensation given to the Internal Auditor and its components do not impair his ability to use independent judgment in carrying out his assignments, inter alia, in view of the fact that the audit work is performed through several Internal Auditors.
c 5. Disclosure Regarding Independent Auditors' Fees
Below are the Company's fee expenses to the accounting firm of Brightman Almagor Zohar & Co. for auditing, tax services and other services:
Auditing and Tax Services
Hours Thousands of Dollars
2012 7,169 323
2011 9,083 368
The drop in auditing and tax service hours in 2012 compared to 2011 largely derives from a decrease in hours of supervision of internal auditing invested in 2011 compared to 2012, as part of the implementation of I-SOX regulations.
These fees were approved by the Company's Board of Directors and are reasonable and acceptable according to the nature of the Company and the extent of its activities.
c 6. Financial Statement Approval Procedure The body charged with ultimate control in the Company regarding the approval of the Financial Statements is its Board of Directors. Starting from the approval of the 2010 yearly Financial Statements the financial statement approval process is covered by directives set in the Companies Regulations (Directives and Conditions for the Financial Statement Approval Process), 2010 (hereinafter – “the Regulations”).
Within the framework of the Board of Directors, the Company operates several committees, including the Audit Committee, the Market Risks Management Committee, the Personnel Committee, the Finance and Budget Committee, the Balance Sheet Committee, the Security Committee, the Corporate Governance Committee and the Government Affairs and Regulations Committee. In the Board meeting held on September 15 2011 it was decided to split the Finance, Budget and Balance Sheet Committee to two committees: the Finance and Budget Committee, which will discuss various financial issues, including the Company’s budget, as well as a Balance Sheet Committee that will serve as a Financial Statements examination committee. At the head of both committees is the external director Mr. Yair Rabinowitz.
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As of the approval of the Financial Statements, the Audit Committee (the Financial Statements Examination Committee) consists of five members (a majority of whom are independent): Mr. Yair Rabinowitz, Professor Jhoshua Shemer, Mr. Pinchas Ginsburg, Ms. Yael Andoren and Mr. Avraham Bigger. For details regarding the experience and education of the directors in question see Regulation 26 of Part D (Additional Details on the Corporation) of the periodic report.
The Balance Sheet Committee meets for extensive and thorough discussion of the draft Financial Statements, in the presence of the auditing accountant. The Chief Executive Officer and the Chief Financial Officer present the members of the committee with extensive details on the Financial Statements, including detailed financial analyses about the Company's performance during the reporting period.
The Balance Sheet Committee studies the material issues of the financial reporting and formulates a recommendation for the Company’s Board of Directors pertaining to, among other things, the following issues: (a) estimates and evaluations made pursuant to the Financial Statements; (b) internal controls pertaining to financial reporting; (c) the comprehensiveness and propriety of disclosure in the Financial Statements; (d) the accounting policy adopted and the accounting treatment applied to material Group issues; (e) value estimates, including underlying assumptions and estimates, on which the data in the Financial Statements was based. The Committee also reviews different aspects of control and risk management, both those reflected in the Financial Statements and those impacting the reliability of the Financial Statements.
When complex or material issues are on the agenda, special discussions are held by the Balance Sheet Committee on the issues on the agenda with the participation of the independent auditor.
The Company’s Board of Directors is the organ responsible for discussing and approving the Financial Statements, after the members of the Board receive the draft Financial Statements and the recommendations of the Financial Statements Examination Committee at least two business days prior to the meeting.
Over the course of the Board meetings in which the Financial Statements are discussed and ratified, the Company CFO provides a detailed review of the key points of the Financial Statements and the Company’s accounting policy. The CEO also reviews the Company's current activity and the influence of this activity on the Company’s Financial Statements and emphasizes material issues. In addition, the Chair of the Financial Statement Examination Committee reviews the key points of the Committee’s recommendations.
At the Board meeting in which the Financial Statements are discussed and ratified are representatives of the Company’s independent auditor, who provide remarks and clarifications to the Financial Statements and who are at the Board members’ disposal to answer questions and provide clarifications regarding the reports prior to their approval.
The Balance Sheet Committee convened on March 17 2013 to formulate recommendations for the Board of Directors. Taking part in the meeting in question were the Committee members: Yair Rabinowitz, Professor Jhoshua Shemer, Mr. Pinchas Ginsburg, Ms. Yael Andoren and Mr. Avraham Bigger. Also taking part in the meetings in question were the Company's CEO, Mr. Eliezer Shekedi, the CFO, Mr. Nissim Malki, the Company Legal Counsel and Secretary, Mr. Omer Shalev, Esq., and representatives of the independent auditor.
The Balance Sheet Committee held a discussion about the Financial Statements presented to it, including directing questions to the members of management present and to the independent auditor. Likewise, the independent auditor is asked to present his comments, if any, to the committee members, including accounting policy applied and special events that arose during the review of the Financial Statements.
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The following are details of the processes taken prior to the approval of the December 31 2012 Financial Statements. a) The draft Financial Statements were provided to the members of the Board of Directors to study on March 14 2013. b) Committee members are welcome to contact the Company CFO at any time with any question or clarification they require prior to the meeting. c) Over the course of the Committee meeting, the Committee reviewed the Company’s financial results and viewed comparisons between the reported period and corresponding periods and the work plan, presented by the CFO. d) Pursuant to its meeting, the Committee studied the estimates and assessments carried out in relation to the report for the reported quarter, the wholeness and propriety of disclosure in the Financial Statements for the reported quarter, the accounting policy adopted and accounting treatment implemented regarding the Company's material issues. e) The Committee discussed the effectiveness of internal controls on the matter of financial reporting and disclosure in the Company. The Committee was also presented with the actions taken by the Company to verify that its reports had been prepared in accordance with the law. f) At the conclusion of the discussion and after it has been clarified that the Financial Statements adequately reflect the state of Company affairs and its operating results, the Committee recommended that the Board of Directors approve the Financial Statements. g) The drafts for the Financial Statements were provided to the members of the Board of Directors to study on March 14 2013, meaning 6 days before the discussion by the Board of Directors. h) The Committee’s recommendations were provided to the members of the Board of Directors in writing on March 17 2013, meaning 3 business days before the discussion by the Board of Directors. The Company’s Board of Directors is of the opinion that in light of the scope and complexity of the recommendations and the time deemed reasonable by the Board of Directors to transfer the draft Financial Statements and recommendations as noted above, they were passed on to the directors for study a reasonable amount of time prior to the Board of Directors discussion. i) On March 20 2013 a discussion was held by the Company’s Board of Directors regarding the recommendations of the Financial Statements Examination Committee. At the conclusion of the Board meeting, the December 31 2012 Financial Statements, prepared on the basis of IFRS rules, were approved unanimously. Present at the Board of Directors Meeting in which the Financial Statements were approved, were the following Board members: Amikam Cohen, Tamar Moses-Borovitz, Yehuda Levi, Nadav Palti, Yair Rabinowitz, Professor Jhoshua Shemer, Pinchas Ginsburg, Shlomo Hannael, Sofia Kimmerling, Yael Andoren and Avraham Bigger.
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c 7. Use of Securities Proceeds Pursuant to the commitment given by the Company and by the State of Israel, as expressed in the 2003 prospectus, the proceeds of the State's and the Company's offerings in recognized severance funds are recognized for securing severance payments.
After making these deposits and covering the full deficit in the severance fund as required by the agreement, the Company deposited a sum of 32.0 million NIS (including interest accrued to as of this report) constituting the balance of the offering proceeds, in a separate account (included in short-term deposits as of December 31 2012). The Company is evaluating the existence of limitations related to its ability to use the proceeds balance, pursuant to the aforementioned agreement, between it and the State and the employees' representatives, and in this connection, the Company communicated to the State. As of the date of the report, negotiations are taking place with the General Comptroller’s Office at the Ministry of Finance to examine entitlement to issue surpluses. For further details see Notes 7 and 19.c.(3).b to the December 31 2012 Financial Statements.
c 8. Disclosure Regarding Consent to Perform Peer Review On July 28, 2005, the Securities Authority issued a guideline under Section 36a of the Securities Law, 1968 regarding disclosure of consent given to perform peer review, the objective of which, according to this guideline, is to spur the process of controlling the work of accounting firms and testing the existence of requisite procedures during the audit work performed, which will contribute to the existence of an advanced capital market.
On March 29 2006, the Company Board of Directors provided the necessary consent for undertaking the peer review.
c 9. Negligible Transactions For details regarding the determination of negligible Company transactions see Note 33d to the periodic report. c.10 Remuneration of Interested Parties and Senior Executives For details regarding the remunerations given senior Company executives in accordance with agreements with the Company, see Regulation 21 in Chapter D of this periodic report.
Upon their approval, the considerations guiding the Company's Board of Directors in determining salary payments to Company executives, were made after examining their contribution to the development of the Company's business, taking into account the provision of services required for the Company, particularly in light of the current need to develop its business, as well as taking into account the knowledge, experience and skills possessed by these executives in the Company’s areas of activity, the state of its business and its financial results, as well as the payment given executives in corresponding positions at companies with characteristics similar to those of the Company.
Pursuant to the 2012 periodic report approval process, a discussion was held at the Company’s Board of Directors on the terms of employment and service of each executive, detailed in Regulation 21 of the Securities Regulations (Periodic and Immediate Reports) 1970 (“the Reporting Regulations”). The Board of Directors discussed, among other things, the relationship between the sum of remunerations given in 2012 to each of the executives and their contribution to the Company in the reported period. For the sake of the discussion, the Board of Directors was presented with relevant data regarding each of the Company’s
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executives, as required in accordance with Regulation 21 of the Reporting Regulations and in accordance with Parts B and C of the Sixth Addendum to the Reporting Regulations as well as comparative data regarding payments given executives in similar positions after examining the Company's chief characteristics including the nature of its activities, its operating cycle and the number of employees in companies with a yearly income turnover of a scope similar to that of the Company.
The Board of Directors determined that remuneration given each member of the Company's senior management is reasonable and fair in accordance with the following criteria: (a) the scope and areas of responsibility and complexity of the position they fulfill; (b) the executive's education, training and professional experience; (c) the key terms of their employment, including conditions for ending the commitment; (d) components of the remuneration given the executive in the reported period; (e) the contribution of the executive to the Company's business, its operating results, its stability and its compliance with the work plan in the reported year; (f) the executive's contribution to projects and unique tasks give them pursuant to their duties in the reported period; (g) the Company’s need to continue retaining the executive as possessor of unique capabilities, knowledge and expertise; (h) the executive’s meeting the Company's expectations regarding the position in which they serve; (i) the executive's compliance with agreements made with them and (j) generally accepted terms of employment in the Israeli economy in the reported period, in positions similar to those filled by those executives (benchmarks).
In addition, the Board of Directors sought to note that when determining the reasonableness and fairness of the remuneration of senior executives, one must take into account the complexity of the Company's activity, its uniqueness and the responsibility borne by senior executives serving at the Company when carrying out their duties.
Summary of the Board of Directors’ Arguments Regarding the Remuneration of the Five Highest Recipients at the Company a. Company CEO – Mr. Eliezer Shekedi
The Board of Directors examined the actions and contribution of Company CEO Mr. Eliezer Shekedi to the Company over the course of his service in 2012. The Board of Directors reviewed the CEO’s chief actions and achievements, and among other things his continued activities in the field of equipping, including aircraft sales and leasing transactions, managing commercial policy, responsibility for managing the jet fuel risk, exchange rate and interest hedging array, expanding collaborations with other airlines, dealing with regulation in areas of activity in which the Company is active, developing growth engines, dealing with security issues, leading the process of formulating a strategic plan as well as the day-to-day management of the airline, while ensuring safety and security. In the opinion of the Company's Board of Directors, taking the above into account, taking into consideration, among other things, the Company’s operating results in 2012, the activities and scope of the contribution of Mr. Eliezer Shekedi and the comparative remuneration data presented to the Board of Directors, the Board of Directors decided that the remuneration paid Mr. Eliezer Shekedi in practice for 2012 is fair and reasonable. b. Chief Financial Officer – Mr. Nissim Malki
The Board of Directors has studied the work and contribution made by Mr. Nissim Malchi to the Company over the course of 2012, including in all matters pertaining to the management of the Company's financial array, preparation of the Company's Financial Statements, implementation and assimilation of the SAP
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financial management system, managing the jet fuel, exchange rate and interest risk hedging array, managing the Company's insurance array, managing the Company’s investor relations, managing the Company's budget, pricing and business controls, managing the Company’s cash flow and financing proceedings, managing the integration of the Company's equipping actions and activating safety teams at the Company to reduce its expenses. The Company's Board of Directors has determined that Mr. Nissim Malchi has met the conditions required from him and the demands of his position in a professional, loyal and responsible manner. In the opinion of the Company's Board of Directors, taking the above into account, taking into consideration, among other things, the Company’s activities and comparative remuneration data presented to the Board of Directors, the remuneration paid Mr. Nissim Malki for 2012 is fair and reasonable. c. VP of Operations – Mr. Benjamin Livneh
The Board of Directors reviewed the actions and contributions of Mr. Benjamin Livneh to the Company in 2012, particularly the execution of the Company's complex flight schedule in a safe, secure and economic manner, the management and control of exceptional incidents, the concentration of staff work of the Company's operational array, his handling of and responsibility for the Company's security issues (including its security budget) and his handling of the Company's operational precision. Mr. Benjamin Livneh also acts as the acting CEO in the CEO’s absence and serves as the Company’s liaison with the Civil Aviation Authority (including in the Company’s re-licensing process) and other external operational elements. The Board of Directors has determined that Mr. Benjamin Livneh has met the demands of his position in a professional, loyal and responsible manner. In the opinion of the Company's Board of Directors, taking the above into account, taking into consideration, among other things, the Company’s activities and comparative remuneration data presented to the Board of Directors, the remuneration paid Mr. Benjamin Livneh for 2012 is fair and reasonable. d. VP of Human Resources – Mr. Reuven Virovnik
The Board of Directors examined the work and contribution of Mr. Reuven Virovnik to the Company in 2012, particularly in all matter pertaining to the management of the Company’s human resources array in Israel and abroad, including in the matter of collective agreements, which includes, among other things, leading talks with employee representatives in preparation for formulating a new collective work agreement, managing administration units including the Company’s construction and assets array in Israel and abroad, and comprehensive responsibility for the training array. The Company's Board of Directors has determined that Mr. Virovnik has met the conditions requested from him and with the demands of his position in a professional, loyal and responsible manner. In the opinion of the Company's Board of Directors, taking the above into account, taking into consideration, among other things, the Company’s activities and comparative remuneration data presented to the Board of Directors, the remuneration paid Mr. Reuven Virovnik for 2012 is fair and reasonable.
e. VP of Commerce and Aviation Relations – Mr. David Maimon
The Board of Directors has studied the actions and contributions of Mr. David Maimon in 2012, and in particular the formulation of the Company’s commercial plan, long-term commercial planning, managing revenues and managing marketing and advertising at the Company. The Company's Board of Directors has determined that Mr. Maimon has met the conditions requested from him and with the demands of his position in a professional, loyal and responsible manner. In the opinion of the Company's Board of Directors, taking the above into account, taking into consideration, among other things, the Company’s
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activities and comparative remuneration data presented to the Board of Directors, the remuneration paid Mr. David Maimon for 2012 is fair and reasonable.
f. Chairman of the Board of Directors – Mr. Amikam Cohen
The Board of Directors examined the actions and contribution of Mr. Amikam Cohen to the Company in 2012, his contribution to the Company Board of Directors and Board committees on which he serves as chair and the level of cooperation between him and the Company CEO, in light of his extensive business experience and his leadership of the process of formulating the Company’s strategic plan. In the opinion of the Company's Board of Directors, after reviewing the contribution and actions of the Chairman of the Board of Directors, taking the above into account, taking into consideration, among other things, the Company’s activities and comparative remuneration data presented to the Board of Directors, the remuneration paid Mr. Amikam Cohen for 2012 was fair and reasonable.
c.11 Internal Enforcement Plan
In December 2011 the Company’s Board of Directors approved, after receiving the recommendations of the Corporate Governance Committee, the key points of the Company’s internal enforcement plan in the field of securities and corporate law (hereinafter: “the Internal Enforcement Plan”).
The internal enforcement plan expresses the Company’s recognition of the importance of compliance with the law on behalf of Company employees, executives, Board members and relevant service providers and concentrates the Company's policy on the subject of preventing and treating violations, including a policy for the evaluation of the damages of violations and preventing their recurrence.
The goal of the internal enforcement plan is to assimilate and enforce norms in matters of observing the law, ethical rules and other codes of behavior by the Company, its executives and its employees and therefore to confirm compliance with securities law on behalf of the Company and by individuals working at it.
The enforcement plan includes means for the internal identification of potential violations and failures, the purpose of which, among other things is to locate and correct failures, improve reporting processes, identify and treat cases of conflict of interest, prevent the loss of internal information out of the Company and to prevent prohibited influence on trade in Company shares. To be clear, the internal enforcement plan may constitute a tool employed by the CEO and the Board of Director pursuant to the observance of their oversight obligation and may be held in the Company’s favor in the event of any violation of securities law.
The internal enforcement plan adopted by the Company includes an outline for the activities of the Company’s internal enforcement array and key procedures including: the Board of Directors’ work procedure; the procedure for defining the positions and authorities of the Audit Committee; the procedure for transactions with related parties; the Board of Directors’ conflict of interest procedure; the executive
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remuneration procedure; the reporting (non-financial) procedure; internal information procedure; as well as the delivery of information to the media and to the capital markets.
The Company's Board of Directors approved and adopted the internal enforcement plan and its central procedures and also, at the recommendation of the CEO, appointed the Company’s legal counsel and secretary, Omer Shalev, as the Company’s internal enforcement supervisor.
The Company is acting to implement and assimilate the internal enforcement plan among its workers as well as to establish mechanisms for appropriate assimilation of the plan at the Company.
As a part of the assimilation of the enforcement plan at the Company, over the course of 2012 instruction was provided on the subject of internal enforcement by the Employees and Executives Supervisor at the Company and the subsidiaries. In addition, courses on the subject of administrative enforcement were launched over the course of 2012 on the Company's intranet (off-site learning via computer) for Company Board members, executives and employees, at the Company and its subsidiaries, which included a presentation on the subject of internal enforcement, a description of the principles of the Company’s internal enforcement plan as well as key enforcement procedures. c.1.2 Effectiveness of Internal Controls of Financial Reporting and Disclosure
Management, under the supervision of the Board of Directors, conducted an examination and evaluation of its internal controls over financial reporting and disclosure in the corporation and its effectiveness. The assessment of the effectiveness of internal controls over financial reporting and disclosure carried out by management under the Board of Directors’ supervision included:
1. Updating the scoping document prepared by the Company in 2011 for 2012 in order to verity the material processes intended to be included in the current mapping.
2. Determining the processes and controls in the areas determined to be the most material in the Company’s activity, as follows: (a) organization-level controls, including controls of the process of preparing and completing financial reporting and general controls of information systems; (b) controls of passenger revenues from the sale of flight tickets (with the exception of subsidiaries); (c) controls of the frequent flyer club; (d) controls for fixed assets – aircraft, engines and spare parts; (e) controls for derivative financial instruments; (f) controls for agent commission expenses (Israeli branch); (g) controls for fuel expenses; (h) controls for salary expenses for employees in Israel (with the exception of senior employees and executives); (i) controls for actuary calculations for Israeli employees (with the exception of senior and employees and executives).
Based on the this assessment, the Corporation’s Board of Directors and management have reached the conclusion that the Corporation's internal controls over financial reporting and disclosure as of December 31, 2012 are effective.
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d. Disclosure Provisions with Regard to Financial Reporting by the Corporation d 1. Events Subsequent to the Balance Sheet Date Regarding events subsequent to the balance sheet date, see Note 36 to the December 31 2012 Financial Statements.
d 2. Disclosure on Critical Accounting Estimates The implementation of accounting standards by Company management upon preparing financial statements occasionally involves various assumptions, assessments and estimates influencing levels of the assets and liabilities and the business results reported in the Financial Statements. Some of the assumptions, assessments and estimates are critical to the financial position or operating results reflected in the Group's Financial Statements, due to their materiality, the complexity of the calculations or the likelihood of realization of uncertain matters.
For details on the material estimates included in the Financial Statements see Note 4 to the December 31 2012 Financial Statements. d 3. Explanation of the Matters to which the Company's Independent Auditors Draw Attention in their Opinion on the Financial Statements The Company's accountants draw attention, in their opinion attached to the Financial Statements, to Note 1.c.(1) to the Financial Statements regarding the signing of the “open skies” agreement and to the fact that at this stage, Company management cannot estimate the impact of the agreement on its financial status and operating results. At the same time, as the required legal and administrative procedures for the ratification of the agreement have not yet been completed, Company management estimates, at this stage, that there will be no negative impact on its financial status and on the Company’s operating results in the foreseeable future, as well as to Note 1.c.(2) to the Financial Statements regarding the actions the Company is carrying out in order to deal with the state of the Company’s business and management’s estimates regarding the Company’s ability to uphold its commitments in the foreseeable future, as well as to Notes 22d and 36 to the Financial Statements regarding exposure the approval of class actions against the Company and the Company’s exposure to these class actions.
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e. Additional information: e.1 Dividend Distribution Policy On November 20, 2007, the Company's dividend policy was updated. Pursuant to the new dividend policy, the Company will distribute dividends from time to time at the discretion of the Board of Directors and subject to the Company's needs. On the issue of the dividend distribution policy, see Note 25d to the December 31 2012 Financial Statements. e.2 Disclosure regarding Changes in the Economic Environment, the Implications of the Capital Market Crisis and Market Risks a. The international aviation industry is affected by the economic and security situation and by unusual events, such as the outbreak of epidemics and natural disasters in the world in general, and in specific areas in particular, as well as by the economic situation in Israel and around the world.
The following are changes occurring to jet fuel prices, interest rates and NIS exchange rates from the end of the year until immediately before the publication of the December 31 2012 Financial Statements: b) As of the reported date (December 31 2012), the market price of jet fuel (before fees and supplier margins) weighted according to the markets in which the Company purchases jet fuel, was 298.9 cents per gallon, while as of a date immediately prior to the approval of the report this price was 287.1 cents per gallon, a 4% decrease; note that jet fuel expenses constitute nearly 34% of the Company's turnover, and therefore changes in price may have a material impact on its financial results. Since the beginning of 2013 the fluctuations in jet fuel trading has continued and the average effective price the Company is expected to pay for jet fuel consumption (after hedging) in January and February 2013 is higher than the average effective price it paid during the fourth quarter of 2012. At the same time, the fair value of jet hedging instruments shall be set in accordance with price changes which occurred since the end of the year and the completion of accounting for some of the transactions. As of December 31 2012, the Company had agreements designed for hedging jet fuel prices, at a scope estimated at 37% of expected consumption for 2013. Subsequent to the balance sheet date, the Company performed additional financial transactions to protect it from increased jet fuel prices in accordance with its hedging policy, and as of a date near the publication of this report, it is hedged at a rate of 36% of the expected consumption for the period from March 2013 to March 2014. c) The three-month LIBOR interest rate dropped by 8% from 0.31% as of the report date to 0.28% near the approval of the Statements; the impact of the change in LIBOR rates in the payment of interest on loans will be evident in the next repayment period of each loan. The interest payments on Company loans for the first quarter of 2013 shall be made according to interest rates in previous quarters. The Company possesses hedging agreements for Libor rates (see Section b.1.(4) above), the fair value of which is expected to drop as a result of the decrease in Libor interest rates.
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d) Subsequent to the balance sheet date, a 1.4% decrease occurred in the exchange rate of the NIS vs. the USD. The Company has hedging agreements on the NIS/USD exchange rate (see b.1.(5) above), the fair value of which may change according to changes in exchange rates. Note that the impact of exchange rates on next quarter's operating results shall be determined based on exchange rates in effect throughout the quarter and at its conclusion (March 31 2013).
The Board of Directors thanks the Company's management and employees for their devoted work and efforts for the development of the Company and promoting its businesses.
Eliezer Shekedi Amikam Cohen Chief Executive Officer Chairman of the Board
March 20 2013
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Appendix A to the Report of the Board of Directors on the State of the Corporation's Affairs for the Period Ending
December 31 2012
Minimal Disclosure Required for Value Estimates and in their Regard, and Rules Pertaining to their Addition to Reports as per Securities Authority Guidelines in Accordance with Section 8b of the Securities Regulations (Periodic and Immediate Reports), 1970. Assessment of the Total Value of the 777-200 and 747-400 Fleets a. Introduction
International Accounting Standard 36 establishes rules regarding the accounting treatment, presentation and disclosure required in the event of the impairment of assets.
The purpose of the standard is to establish procedures the corporation must implement in order to ensure that these assets are not presented in sums higher than their recoverable amount. An asset is presented in the Financial Statements at higher than its recoverable amount when its book value is higher than the sum received from the use or sale of the asset. In the event that the asset is impaired, IAS 36 demands that the corporation to recognize an impairment loss.
The following document presents the key points of the value estimate performed by El Al Israel Airlines Ltd. (hereinafter "El Al" or "The Company") in order to determine whether the depreciation of its 777-200 and 747-400 fleets (hereinafter "the Fleets") was to be recognized according to IAS 36, in accordance with Securities Authority directives.
This document was prepared in accordance with guidelines from the Securities Authority as per Section 8b of the Securities Regulations (Periodic and Immediate Reports), 1970, regarding minimal required disclosure for value assessments and in their regard and rules regarding their addition to reports.
b. Specification and Identification of Asset Group
The asset group for which the test was conducted includes the 777-400 fleet which consists of 6 aircrafts owned by the Company and the 747-200 fleet which consists of 6 aircrafts owned by the Company.
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c. Opinion Validity Date
March 2013.
d. Value Assessor
The value assessment was performed by El Al management.
e. Circumstances under which the IAS 36 Value Assessment was Conducted
The book value of the aircraft fleet is higher than its market value as appearing in price lists published by AVAC – the Aircraft Value Analysis Company and Airclaims - ASCEND World Wide.
Note that use of the market value of the aircrafts on the basis of AVAC and Airclaims price lists is common practice among airlines around the world as well as among financing banks and has been used by El Al in its various commitments with banks.
IAS 36 states that a provision for impairment must be made when the book value of an asset surpasses its recoverable amount. A recoverable sum is calculated as asset's the fair value less costs to sell, or its value in use, whichever is higher.
Fair value less costs to sell is the sum that may be received from the sale of the asset in a good faith agreement between a willing buyer and a willing seller. The value in use of an asset is the current value of estimated future cash flow expected to derive from continuous use of the asset and its sale at the end of the period of use. The Company considers the market value of the assets as published by AVAC and Airclaims as representing the fair value of these aircrafts. As of this value assessment, the Company has examined the value in use of the aircrafts in its possession and in its service, the depreciated value of which in the Company's December 31 2012 Financial Statements exceeds their fair value less costs to sell.
As of this value assessment, the fair value less costs to sell of the 777-200 fleet amounts to a total of $405 million, compared to the depreciated retained cost in the books of those aircraft as of December 31 2012, which amounts to a total of $469 million.
The fair value less costs to sell of the 747-400 fleet amounts to a total of $135
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million, compared to the depreciated retained cost in the books of those aircraft as of December 31 2012, which amounts to a total of $206 million.
f. Assessment Method
The value assessment was conducted according to the discounted cash flow method. According to this approach, assessed cash flows expected for the Company from the use of the aircraft fleet were discounted. The following are key assumptions used in calculating value:
The expected contribution from the aircraft fleet is based on results in practice for 2012, and is projected forward unchanged across the economic life span of the entire aircraft fleet, unless expressly noted otherwise. The Company implements this system systematically in assessing the value of the aircraft fleet.
The Company believes that based, among other things, on an examination of estimates included in value assessments in the past, the best estimate for the expected contribution from the aircraft fleets is the Company’s results in practice for the previous year, unless if the Company knows of any exceptional events on the date the value assessment was prepared.
Useful life: for the 777-200 fleet - 11 years of activity (and sale of the aircraft at fair value less cost to sell at the end of the 11 year period), for the 747-400 fleet - 6 years of activity (and sale of the aircraft at fair value less cost to sell at the end of the 6 year period).
Cash flow expected from activity: management calculated that the net cash flow from the operation of the 777-200 aircraft fleet is expected to amount to $81 million in 2012 ($61 million after imputed tax), and the cash flow from the operation of the 747- 400 aircraft fleet is expected to amount to $103 million ($77 million after imputed tax). This cash flow was calculated based on revenues from the aircraft fleet less commissions and variable expenses that may be assigned to the fleet in question and less fixed cash flow expenses such as security, maintenance, operation and sales expenses that may be allocated relative to the cost of these aircrafts' operation. During the reported period, additional indirect costs were attributed that may be allocated on a reasonable basis to the Company’s existing aircraft fleet. In addition, the Company examined whether the attribution of these costs in the comparison periods could influence the Company’s conclusion regarding the impairment of the above aircraft fleets examined in the periods in question. Following this examination, the Company
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reached the conclusion that the attribution in question cannot lead to the recognition of the impairment of the aircraft fleets in question in the comparison periods.
Scrap value at the end of useful life (meaning after 11 years for the 777-200 fleet and 6 years for the 747-400 fleet): calculated based on AVAC and Airclaims projections and totaling $162 million for the 777-200 fleet (after capitalization and after an imputed tax of $67 million) and $62 million for the 747-400 fleet (after capitalization and after an imputed tax of $34 million).
Capitalization rate: for the purpose of capitalizing cash flows expected from the operation of the aircraft fleet and capitalizing their scrap values, use was made of a discount rate that reflects the operational risk of the aircraft fleet, based on the Company’s weighted discount rate.
As a rule, and based on past equipment, aircrafts purchase largely takes place (some 85%) through bank loans, with the balance of the price after discounts (some 15%) from the Company's means (in the last financing transactions conducted by the Company, the portion of the component financed until then by equity, was also financed by foreign capital).
This model makes use of a capitalization rate that reflects the time value of the money and the specific risks embodied in the activity. The capitalization rate is estimated according to the following formula:
D= discount rate that reflects the operational risk of the aircraft fleet.
D= Ke*(e%) + Kd*(d%)*(1-Tc)
Equity Price = Ke
Rate of equity out of total equity and debt = e%
Debt price = Kd
Rate of debt out of total equity and debt = d%
The Company’s long-term effective tax rate = Tc
The average weighted capitalization interest rate after tax according to this calculation amounted to 5.5%.
The capitalization interest after tax of 5.5% is equivalent to the capitalization interest before tax of 16% for the 747-400 fleet and 11% for the 777-200 fleet, which would have produced a similar result in the value in use calculation of the aircraft fleet.
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The price of equity (Ke) is determined using the Capital Asset Pricing Model (CAPM) according to the following formula:
Ke=Rf +β * (Rm-Rf) + α when:
Rf= rate of risk-free interest based on the average interest rate of dollar debentures over the course of the average period of expected cash flow, some 3%.
β= the relative risk coefficient reflecting the relative risk involved in a certain investment and based on the level of correlation between the activity’s yield and the yield of the capital market as a whole – 0.52.
(Rm-Rf) = the average risk premium on the market – 7.3%
α= added risk specific to the Company – 2%.
The price of equity according to the above formula amounts to 8%.
Debt price (Kd): use was made of a 6.6% debt price, constituting a worthwhile interest rate on a long-term debt for the Company.
Tax rate (Tc): use was made of the Israeli corporate tax rate – 25%.
The Company assumes that the aircrafts in question shall be used as passenger aircrafts for the next 6-11 years.
The Company did not assume the need to make any unexpected investments in these aircrafts in order to permit their continued use.
g. Value set using the Discounted Cash Flow Method for the 777-200 fleet (in millions of dollars): 1 2 3 4 5 6 7 8 9 10 11 Total Total discounted 59 56 53 50 47 45 43 41 39 37 35 505 cash flow Total Capitalized Scrap 67 67 Value (After 11 Years)
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Total value of the above assets based on the discounted cash flow method: $572 million.
The following is a sensitivity analysis of the value of these aircrafts for changes in discount price, changes in jet fuel prices and for changes in the contribution of cash which according to the Company constitute key elements that may alter value in use projections:
Discount 4% 4.5% 5% 5.5% 6.0% 6.5% 7.0% Rate After Tax
Yearly Contribution After Tax
In Millions of Dollars
52 540 525 510 496 483 470 458
56 581 565 549 534 520 506 493
61 621 604 588 572 557 543 529
65 662 644 627 610 594 579 564
70 703 684 665 648 631 615 599
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Fuel price sensitivity analysis, use of the asset across 11 years:
Fuel Price Yearly NPV Reduced Difference of Contribution Value NPV Vs. (Cent per Reduced Gallon) Value
In Millions of Dollars
275 65 608 469 139
290 63 590 469 121
305 61 572 469 103
320 59 554 469 85
336 56 536 469 67
h. Value set using the Discounted Cash Flow Method for the 747-400 fleet (in millions of dollars):
1 2 3 4 5 6 Total
Total discounted cash flow 75 71 67 64 61 57 395 Total capitalized residual value (after 6 years) 34 34
Total value of the above assets based on the discounted cash flow method: $429 million.
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The following is a sensitivity analysis of the value of these aircrafts for changes in discount price, changes in jet fuel prices and for changes in the contribution of cash which according to the Company constitute key elements that may alter value in use projections: Discount 4% 4.5% 5% 5.5% 6.0% 6.5% 7.0% Rate After Tax
Yearly Contribution After Tax
In Millions of Dollars
66 387 381 376 370 365 359 354
71 418 412 406 400 394 388 383
77 449 442 436 429 423 417 411
83 480 473 466 459 452 446 440
89 511 503 496 489 482 475 468
Fuel price sensitivity analysis, use of the asset across 6 years:
Fuel Price Yearly NPV Reduced Difference of Contribution Value NPV Vs. (Cent per Reduced Gallon) Value
In Millions of Dollars
275 81 451 206 245
291 79 440 206 234
306 77 429 206 223
321 75 419 206 213
337 73 408 206 202
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i. Summary
The following table presents the summarized value assessment as of December 31 2012 for the 777-200 fleet:
Recoverable Sum – Fair Value Whichever is Work Carried Assessment Relevant Work Less Costs to Value in Use Higher Out Date Regulation Method Sell for El Al for El Al
In Millions of Dollars
Examination 31.12.2012 Accounting Discounted 405 572 572 of aircraft fleet Standard 36, cash flow investment Impairment (DCF) impairment (6 of Assets. aircrafts)
Should an Impairment be listed in the Books?
The Aircrafts' Depreciated The Recoverable Amount Should an Retained Cost as of of the Same Aircrafts to Impairment be Listed December 31 2012 El Al, as of December 31 in the Books? 2012
In Millions of Dollars
469 572 No
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The following table presents the summarized value assessment as of December 31 2012 for the 747-400 fleet:
Recoverable Sum – Fair Value Whichever is Work Carried Assessment Relevant Work Less Costs to Value in Use Higher Out Date Regulation Method Sell for El Al for El Al
In Millions of Dollars
Examination 31.12.2012 Accounting Discounted 135 429 429 of aircraft fleet Standard 36, cash flow investment Impairment (DCF) impairment (6 of Assets. aircrafts)
Should an Impairment be listed in the Books?
The Aircrafts' Depreciated The Recoverable Sum of Should an Retained Cost the Same Aircrafts to El Impairment be Listed As of December 31 2012 Al, in the Books? As of December 31 2012
In Millions of Dollars
206 429 No
This value estimate is accurate as of the balance sheet date.
The expected contribution from the aircraft fleet is based on results in practice for 2012, which are projected forward unchanged across the economic life span of the entire aircraft fleet, unless expressly noted otherwise.
Changes in the projected assessments detailed above may alter the value assessment and the Company may subsequently be required to perform depreciation due to impairment.
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Appendix B to the Report of the Board of Directors on the State of the Corporation's Affairs for the Period Ending December 31 2012
The Company’s Material Loans and Credit Frameworks - As of December 31 2012*
Clearance Board Financial Covenants
Ratio of Value of Requirement Scope of Scope of Collateral Unpaid Principal Balloon Final Loan to Attribute Loan Aircraft Loans Principal Loan to Balance and Interest Balance Repayment Value of Characteristics Loans (Thousands Securities Interest Repayment Start Uncleared (Thousands Repayment (Thousands Date Collateral to of Dollars) (Thousands of Date Balance as of Dollars) Frequency of Dollars) Uncleared Dollars) of Balance December 31 2012 Local banking 737 ,777 490,000 203,698 3 777-200 Variable: Quarterly Between: 6,700 77,800 January July 27 2017 13 ל - institution (***) aircrafts, Libor + 9,570 3 737-800 margin 2000 131% aircrafts, 1 2.31%- (**)125% Upholds 737-700 2.75%. financial aircraft covenants 2 747-400 aircrafts Foreign banking 777 219,419 161,845 2 777-200 Variable: Quarterly Between: 2,376 59,299 July 23 July 23 2019 2007 ל - institution with aircrafts Libor + 4,466 EXIM guarantee margin (- - - 0.01%) to 0.8% EXIM (***) 737-800 113,261 80,226 3 737-800 Fixed Quarterly 2,360 April April 15 aircrafts 3.62%- 17 2021 4.01% 2009 - May 20 May 20 - - 2009 2021 June 22 June 22 2009 2021 * The credit currency of all of the loans detailed above is the U.S. dollar. ** With the exception of one 747-400 aircraft, taken as collateral at a ratio of 50%. *** A cross default mechanism exists between the various loans of the same banking institution.
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Appendix B to the Report of the Board of Directors on the State of the Corporation's Affairs for the Period Ending December 31 2012
The Company’s Material Loans and Credit Frameworks - as of March 20 2013*
Clearance Board Financial Covenants
Ratio of Requirement Value of Scope of Scope of Unpaid Principal Balloon Final Loan to Attribute Collateral Loan Aircraft Loans Principal Loan Balance and Interest Balance Repayment Value of to Characteristics Loans (Thousands Securities Interest Repayment Start (Thousands Repayment (Thousands Date Collateral to Uncleared of Dollars) (Thousands Date of Dollars) Frequency of Dollars) Uncleared Balance as of Dollars) Balance of March 20 2013 Local banking 737 ,777 490,000 196,785 3 777-200 Variable: Quarterly Between 77,800 January July 27 institution (***) aircrafts, Libor + 6,700 and 13 2017 3 737-800 margin 9,570 2000 135% aircrafts, 1 2.31%- (**)125% Upholds 737-700 2.75%. financial aircraft covenants 2 747-400 aircrafts Foreign banking 777 219,419 158,705 2 777-200 Variable: Quarterly Between 59,299 July 23 July 23 institution with aircrafts Libor + 2,376 and 2007 2019 EXIM guarantee margin (- 4,466 - - 0.01%) to 0.8% EXIM (***) 737-800 113,261 78,657 3 737-800 Fixed Quarterly 2,360 April April 15 aircrafts 3.62%- 17 2021 4.01% 2009 - May 20 May 20 - - 2009 2021 June 22 June 22 2009 2021
* The credit currency of all of the loans detailed above is the U.S. dollar. ** With the exception of one 747-400 aircraft, taken as collateral at a ratio of 50%. *** A cross default mechanism exists between the various loans of the same banking institution.
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______
2012 ANNUAL REPORT
CHAPTER C 2012 FINANCIAL STATEMENTS
Free Translation of the Hebrew Language 2012 Annual Report - Hebrew Wording Binding
El Al Israel Airlines Limited
2012 Consolidated Financial Statements
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El Al Israel Airlines Limited
2012 Consolidated Financial Statements
Table of Contents
Page
Independent Auditors' Report C - 1 - C - 2
Financial Statements
Consolidated Balance Sheets C - 3 - C - 4
Consolidated Statements of Operations C - 5
Consolidated Statement of Comprehensive Income C - 6
Consolidated Statement on Changes in Equity C - 7 - C - 9
Consolidated Cash Flow Reports C-10 - C-11
Notes to the Consolidated Financial Statements C-12 - C-100
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Independent Auditors' Report to Shareholders of EL AL Israel Airlines Ltd. On the Matter of the Auditing of Components of Internal Controls of Financial Reporting In Accordance with Section 9.b.(c) of the Securities Regulations (Periodic and Immediate Reports), 1970
We have inspected components of the internal controls of the financial reporting of El Al Israel Airlines Ltd. and its subsidiaries (hereinafter together “the Company”) as of December 31 2012. These control components have been determined as explained in the following paragraph. The Company's Board of Directors and management are responsible for maintaining effective internal controls over financial reporting, and for evaluating the effectiveness of the internal controls over financial reporting attached to the periodic report for the date in question. Our responsibility is to express our opinion on the Bank's internal controls of the Company’s financial reporting, based on our audit. Components of internal control of financial reporting inspected were determined according to Audit Standard 104 of the Institute of Certified Public Accountants in Israel “Inspection of Components of Internal Controls for Financial Reporting”, and its amendments (hereinafter “Audit Standard 104”). These components are: (1) organization-level controls, including controls of the process of preparing and closing financial reporting and general controls of information systems; (2) controls of passenger revenues from the sale of flight tickets (with the exception of subsidiaries); (3) controls of frequent flyer club; (4) controls for fixed assets – aircraft, engines and spare parts; (5) controls for derivative financial instruments; (6) controls for agent commission expenses (Israeli branch); (7) controls for fuel expenses; (8) controls for salary expenses for employees in Israel (with the exception of senior employees and executives); (9) controls for actuary calculations for Israeli employees (with the exception of senior employees and executives) (all of the above together are referred to as the “Audited Control Components”). We have conducted our audit in accordance with Audit Standard 104. According to this standard, we were required to plan the audit and carry it out with the aim of identifying the inspected control components and achieve a reasonable level of assurance as to whether these control components were upheld effectively in all material aspects. Our audit included achieving an understanding of the internal controls over financial reporting, evaluation of the risk of the presence of any material weakness in the inspected control components, as well as testing and evaluating those control components based on the evaluated risk. Our audit, regarding those control components, also included additional procedures that we believed to be necessary under the circumstances. Our audit referred solely to the audited control components, unlike an internal audit on all processes material to financial reporting, and therefore our opinion refers to the audited control components only. Furthermore, our audit did not refer to mutual influences between audited and unaudited control components and therefore, our opinion does not take such negative impacts into account. We believe that our audit provides a sufficient basis for our opinion in the context described above. Due to their understandable limitations, internal controls over financial reporting in general, and components thereof in particular, may fail to prevent or discover a misrepresentation. Likewise, conclusions regarding the future on the basis of any present effectiveness assessment may be exposed to the risk that the controls become inappropriate due to changes in circumstances or that the application of the policy or the procedures change to the worse. In our opinion, the Company has upheld in an effective manner, in all material aspects, its audited control components as of December 31 2012. We have also conducted an audit, in accordance with generally accepted Israeli auditing standards, of the Company’s Consolidated Financial Statements for December 31 2012 and 2011 and for each of the three years of the period ending December 31 2012 and our report, published March 20 2013, includes our unreserved opinion of those Financial Statements, as well as directing attention to the signing of the Open Skies Agreement, to the state of the Company’s business and exposing the Company to class actions, based on our audit and on the reports of the other auditing accountants. Brightman Almagor Zohar & Co. Certified Public Accountants
Tel Aviv, March 20, 2013
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Independent Auditors' Report to Shareholders of El Al Israel Airlines Ltd.
We have audited the consolidated balance sheets of El Al Israel Airlines Limited (hereinafter – "the Company") as of December 31 2012 and 2011 and the Statements of Operations, Statement of Comprehensive Income, Changes in Shareholders' Equity and Cash Flow for each of the three years in the period ending December 31, 2012. The Company's Board of Directors and management are responsible for these Financial Statements. Our responsibility is to express an opinion on these financial statements based on our audit. We did not audit the financial statements of subsidiaries, whose assets included in consolidation constitute 0.7%, and 1.5% of total consolidated assets as of December 31 2012 and 2011, respectively, and whose revenues included in the consolidation constitute 0.8%, 1.2% and 1.0% of total consolidated revenues for the years ending December 31 2012, 2011 and 2010, respectively. Furthermore, we did not audit the financial statements of an associated company on a book value basis, the investment in which amounted to a total of $13,552 thousand and $10,120 thousand as of December 31 2012 and 2011, respectively, and the Company's share of its results for the years ending December 31 2012 and 2011 amounted to a total of $1,313 thousand and $1,336 thousand, respectively. The financial statements of those companies have been audited by other accountants, whose reports have been submitted to us, and our opinion, to the extent that it relates to the sums consolidated in respect of such companies, is based on the reports of those other accountants. We have conducted our audit according to generally accepted Israeli audit standards, including regulations included in the Accountants’ Regulations (the Accountant’s Method of Operation), 1973. These Standards require that we plan and perform the audit with the aim of obtaining reasonable assurance that the Financial Statements are free of any material misrepresentations. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. The audit also contains an examination of the accounting rules implemented and of the material estimates made by the Company’s Board of Directors and management, as well as an evaluation of the propriety of presentation on the Financial Statements as a whole. We are of the opinion that this audit, and the reports of the other accountants, provide an adequate basis for the provision of our professional Opinion. In our opinion, based on our audits and reports of other accountants, the Financial Statements referred to above adequately reflect, in all material respects, the financial status of the Company and its subsidiaries as of December 31 2012 and 2011 and the results of their actions, changes to their equity and their cash flows for each of the three years in the period ending December 31, 2012, in accordance with International Financial Reporting Standards ("IFRS") and with the provisions of the Securities Regulations (Yearly Financial Statements), 2010. Without qualifying the above conclusion, we direct your attention to the following: To Note 1.c.(1) to the Financial Statements regarding the signing of the “open skies” agreement and to the fact that at this stage, Company management cannot estimate the impact of the agreement on its financial status and operating results. At the same time, as the required legal and administrative procedures for the ratification of the agreement have not yet been completed, Company management estimates, at this stage, that there will be no negative impact on its financial status and on the Company’s operating results in the foreseeable future. To Note 1.c.(2) to the Financial Statements regarding the actions the Company is carrying out in order to deal with the state of the Company’s business and the Company’s estimates regarding the Company’s ability to uphold its commitments in the foreseeable future. To Note 22d and 36 to the Financial Statements regarding exposure to the approval of lawsuits as class actions and the Company’s exposure to these class actions. We have also audited, in accordance with Audit Standard 104 of the Institute of Certified Public Accountants in Israel “Inspection of Components of Internal Controls for Financial Reporting”, and its amendments, components of internal controls of the Company’s financial reporting as of December 31 2012, and our March 20 2013 report includes an unreserved opinion regarding the effective existence of those components. Brightman Almagor Zohar & Co. Certified Public Accountants
Tel Aviv, March 20, 2013
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EL AL Israel Airlines Ltd. Consolidated Balance Sheets
As of December 31 Note 2 0 12 2 0 11 Thousands of Thousands of Dollars Dollars
Assets
Current Assets Cash and cash equivalents 6 52,810 85,356 Designated cash 6 1,205 1,827 Short-term deposits 7 8,570 8,183 Restricted deposits 6 11,456 - Trade receivables 8 129,898 *139,693 Other receivables 9 23,333 27,748 Derivative financial instruments 26 16,672 2,096 Prepaid expenses 10 29,442 28,043 Inventories 11 22,145 26,481 Total current assets 295,531 319,427
Non-Current Assets Long-term bank deposits 1,451 1,473 Investment in affiliated companies 12 16,747 13,184 Investment in another company 1,244 1,264 Fixed assets, net 13 1,128,959 1,192,413 Intangible assets, net 14 9,392 7,995 Prepaid expenses 10 9,950 7,547 Assets due to employee benefits 19 42,369 39,817 1,210,112 1,263,693 Total non-current assets
Total assets 1,505,643 1,583,120
Non-material adjustment of comparison numbers – see Note 5.
The accompanying Notes constitute an integral part of the Consolidated Financial Statements.
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EL AL Israel Airlines Ltd. Consolidated Balance Sheets
As of December 31 Note 2 0 12 2 0 11 Thousands of Thousands of Dollars Dollars Liabilities and Equity
Current Liabilities Short-term borrowings and current maturities 15 160,316 105,945 Trade payables 16 144,832 160,802 Other payables 17 52,243 67,415 Provisions 22 16,333 24,843 Derivative financial instruments 26 126 21,176 Employee benefit obligations 19 97,954 98,502 Unearned revenues 20 252,915 235,998 Total current liabilities 724,719 714,681
Non-Current Liabilities Loans from banking institutions 18 474,225 555,770 Employee benefit obligations 19 58,198 57,789 Loans from others 2,441 1,869 Derivative financial instruments 26 1,399 - Other payables 17 8,787 7,673 Provisions 22 - 5,348 Deferred taxes 23 26,173 *28,305 Unearned revenues 20 58,274 51,946 Total non-current liabilities 629,497 708,700
Total liabilities 1,354,216 1,423,381
Equity 25 Share capital 155,012 155,012 Share premium 28,007 28,007 Capital reserve from transactions with a former 237,122 237,122 controlling shareholder Capital reserve in respect of share-based payment 7,547 7,488 Capital reserve in respect of cash flow hedging 8,996 (557 ) Capital reserve in respect of translation differences of foreign activity (97) (1,004) Accumulated loss (285,160) *(266,329) Total equity 151,427 159,739
Total liabilities and equity 1,505,643 1,583,120
Non-material adjustment of comparison numbers – see Note 5.
Amikam Cohen Elyezer Shkedi Nissim Malki Chairman of the Board of Directors Chief Executive Officer Chief Financial Officer
Certification date of Financial Statements: Ben-Gurion Airport, March 20, 2013.
The accompanying Notes constitute an integral part of the Consolidated Financial Statements.
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EL AL Israel Airlines Ltd. Consolidated Statements of Operations
For the Year Ending December 31 Note 2 0 12 2 0 11 2 0 10 Thousands of Thousands of Thousands of Dollars Dollars Dollars
Operating revenues 27a 2,015,642 * 2,042,586 * 1,971,446 Operating expenses 27b (1,702,381) (1,764,879) (1,584,557)
Gross Profit 313,261 277,707 386,889
Selling expenses 27c (209,210 ) (215,926 ) (214,755 ) Administrative and general expenses 27d (95,376 ) (97,392) (96,153 ) Other revenues (expenses), net 27e 2,803 (8,293) 11,269
(301,783) (321,611) (299,639)
Profit (loss) from regular activities 11,478 (43,904 ) 87,250
Financing expenses 28 (38,413 ) (20,197 ) (35,911 ) Financing revenues 29 1,447 20,474 10,849 Financing revenues (expenses), net (36,966) 277 (25,062)
The Company's share of the profits of subsidiaries, net of tax 1,273 1,441 45
Profit (loss) before taxes on income (24,215 ) *(42,186 ) * 62,233
Tax benefit (taxes on income) 23 5,384 *(7,650) *(5,773)
Income (loss) for the year (18,831) *(49,836) *56,460
Profit (loss) per 1 NIS NV ordinary share. (In USD) Basic profit (loss) per share 31 (0.04) (0.10) *0.11
Diluted profit (loss) per share 31 (0.04) (0.10) *0.11
Weighted average of number of shares (in thousands) used in the calculation of profit (loss) per share Basic 495,719 495,719 495,719 Diluted 495,719 495,719 496,793
Non-material adjustment of comparison numbers – see Note 5.
The accompanying Notes constitute an integral part of the Consolidated Financial Statements.
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EL AL Israel Airlines Ltd. Consolidated Statement of Comprehensive Income
For the Year Ending December 31 2 0 12 2 0 11 2 0 10 Thousands of Thousands of Thousands of Dollars Dollars Dollars
Profit (loss) for the year (18,831) *(49,836) *56,460
Other comprehensive earnings (loss)
Exchange rate differences due to the translation of foreign activity, net of tax 907 (1,004 ) -
Earnings (loss) in respect of cash flow hedging, net of tax 9,553 (35,639) 65,904
Other comprehensive income (loss) for the year, net of tax 10,460 (36,643) 65,904
Total comprehensive income (loss) for the year (8,371) (86,479) 122,364
Non-material adjustment of comparison numbers – see Note 5.
The accompanying Notes constitute an integral part of the Consolidated Financial Statements.
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El Al Israel Airlines Ltd. Consolidated Statements of Changes in Equity
For the Year Ending December 31 2012 Capital Reserve from Capital Transac- Capital Reserve in tions with a Reserve in Capital Respect of Former Respect of Reserve in Translation Controlling Share- Respect of Differences Share Share Share- Based Cash Flow of Foreign Accumulated Capital Premium holder Payment Hedging Activity Loss Total Thousands of Dollars
Balance as of January 1 2012 155,012 28,007 237,122 7,488 (557) (1,004) *(264,292) 161,776 Non-material adjustment of comparison numbers ------(2,037) (2,037) Balance as of January 1 2012 after non-material adjustment of comparison numbers 155,012 28,007 237,122 7,488 (557) (1,004) (266,329) 159,739
Loss for the year ------(18,831 ) (18,831 ) Earnings in respect of cash flow hedging, net of tax - - - - 9,553 - - 9,553 Exchange rate differences due to the translation of foreign activity - - - - - 907 - 907 Total comprehensive earnings (loss) for the year - - - - 9,553 907 (18,831) (8,371)
Share-based payment - - - 59 - - - 59 Total transactions with parent company shareholders pursuant to their position as shareholders - - - 59 - - - 59
Total equity as of December 31 2012 155,012 28,007 237,122 7,547 8,996 (97) (285,160) 151,427
*Non-material adjustment of comparison numbers – see Note 5.
The accompanying Notes constitute an integral part of the Consolidated Financial Statements.
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For the Year Ending December 31 2011 Capital Reserve from Capital Transac- Capital Reserve in tions with a Reserve in Capital Respect of Former Respect of Reserve in Translation Controlling Share- Respect of Differences Share Share Share- Based Cash Flow of Foreign Accumulated Capital Premium holder Payment Hedging Activity Loss Total Thousands of Dollars
Balance as of January 1 2011 155,012 28,007 237,122 7,198 35,082 - *(214,897) 247,524 Non-material adjustment of comparison numbers ------(1,596) (1,596) Balance as of January 1 2011 after a non- material adaptation of comparison numbers 155,012 28,007 237,122 7,198 35,082 - (216,493) 245,928
Loss for the year ------*(49,836 ) (49,836 ) Loss in respect of cash flow hedging, net of tax - - - - (35,639 ) - - (35,639 ) Exchange rate differences due to the translation of foreign activity - - - - - (1,004) - (1,004) Total comprehensive loss for the year - - - - (35,639) (1,004) (49,836) (86,479)
Share-based payment - - - 290 - - - 290 Total transactions with parent company shareholders pursuant to their position as shareholders - - - 290 - - - 290
Total equity as of December 31 2011 155,012 28,007 237,122 7,488 (557) (1,004) (266,329) 159,739
*Non-material adjustment of comparison numbers – see Note 5.
The accompanying Notes constitute an integral part of the Consolidated Financial Statements.
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For the Year Ending December 31 2010 Capital Reserve from Transac- Capital tions with a Reserve in Capital Former Respect of Reserve in Controlling Share- Respect of Share Share Share- Based Cash Flow Accumulated Capital Premium holder Payment Hedging Loss Total Thousands of Dollars
Balance as of January 1 2010 155,012 28,007 237,122 6,414 (30,822) *(271,952) 123,781 Non-material adjustment of comparison numbers - - - - - (1,001) (1,001) Balance as of January 1 2010 after non-material adjustment of comparison numbers 155,012 28,007 237,122 6,414 (30,822) (272,953) 122,780
Yearly profit - - - - - * 56,460 56,460 Profit due to cash flow hedging, net of tax - - - - 65,904 - 65,904 Total comprehensive earnings for the year - - - - 65,904 56,460 122,364
Share-based payment - - - 784 - - 784 Total transactions with parent company shareholders pursuant to their position as shareholders - - - 784 - - 784
Total equity as of December 31, 2010 155,012 28,007 237,122 7,198 35,082 (216,493) 245,928
*Non-material adjustment of comparison numbers – see Note 5.
The accompanying Notes constitute an integral part of the Consolidated Financial Statements.
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El Al Israel Airlines Ltd. Consolidated Statement of Cash Flow
For the Year Ending December 31 2 0 12 2 0 11 2 0 10 Thousands Thousands of Thousands of Dollars Dollars of Dollars
Cash Flows from Operating Activities Yearly profit (loss) (18,831 ) (49,836 ) 56,460 Adjustments Required for the Presentation of Cash Flows from Operating Activities 97,101 111,716 146,831
Cash deriving from operating activities, net 78,270 61,880 203,291
Cash Flows for Financing Activity Acquisition of fixed assets (including general engine overhauls and (85,672) (107,388 ) (46,548 ) payment on account of aircraft) Proceeds from realization of fixed assets 18,533 12,972 2,802 Investment in intangible assets (3,007 ) (1,714 ) (3,054 ) Realization (investment) in restricted deposits (11,456 ) - 7,003 Decrease (increase) in short-term deposits, net (387 ) 55,382 (55,632 ) Investment in deposits for service providers and long-term (255 ) (252 ) (157 ) Repayment of deposits for service providers and long-term 305 556 354
Cash used for investment activity, net (81,938) (40,444) (95,232)
Cash Flows for Financing Activity Payment for loan raising costs (1,007 ) - - Receipt of loans from banking institutions 56,377 28,779 - Repayment of loans from banking institutions (95,343 ) (85,886 ) (77,804 ) Receipt of loans from others 4,239 4,391 2,568 Repayment of loans from others (3,773 ) (1,367 ) (1,596 ) Increase (decrease) in short-term credit, net 10,629 7,001 (26,912)
Cash used for financing activities, net (28,878) (47,082) (103,744)
Increase (decrease) in cash and cash equivalents (32,546) (25,646 ) 4,315
Balance of cash and cash equivalents at the beginning of the year 85,356 111,002 106,687
Balance of cash and cash equivalents at the end of the year 52,810 85,356 111,002
The accompanying Notes constitute an integral part of the Consolidated Financial Statements.
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El Al Israel Airlines Ltd. Consolidated Cash Flow Reports
For the Year Ending December 31 2 0 12 2 0 11 2 0 10 Thousands of Thousands Thousands Dollars of Dollars of Dollars Appendix A
Income and expenses not involving cash flows: Depreciation and amortization (including disposal of accessories, disused components and consumables used and impairment of fixed and intangible assets) 138,655 142,568 130,580 Adjustment of value of deposits to service providers and long term (8 ) 58 (98 ) The Company's share of the profits of affiliates, less dividends received, (124) (1,441 ) (45 ) net of tax Deferred taxes, net (5,563 ) 7,578 5,900 Decrease in liabilities in respect of employee benefits and in provisions (16,549 ) (23,777 ) (495 ) Net capital gain from the sale of fixed assets (4,177 ) (3,520 ) (672 ) Benefit value of employee stock option program 59 290 784 Loss (gain) from adjustment of fair value of derivatives via gain/loss (18,469 ) (16,829 ) 555 Purchase of jet fuel hedging options (2,774 ) (21,150 ) - Receipts from the sale of jet fuel hedging transactions - 34,300 - Profit from shares and options received for no return (2,442 ) (3,542 ) (11,145 ) Revaluation of options received for no return (130 ) 1,865 821 Change in designated cash 622 (1,827 ) -
Changes in asset and liability items: Decrease (increase) in trade receivables 9,795 (8,861 ) (20,081 ) Decrease (increase) in other accounts receivable 4,455 (6,923 ) (4,725 ) Increase in prepaid expenses (3,802 ) (474 ) (7,665 ) Decrease (increase) in inventories 4,336 (7,725 ) 3,191 Increase (decrease) in trade payables (15,970 ) 2,890 28,942 Increase (decrease) in other payables (14,058 ) 12,963 (6,430 ) Increase in unearned revenues 23,245 5,273 27,414
97,101 111,716 146,831
Appendix B – Payment (Receipt) of Interest, Taxes and Dividends, Classified Under Cash Flow from Operating Activities
Interest payments 26,573 26,986 25,138
Interest receipts (1,333) (2,542) (2,817)
Tax payments – advances in respect of extraneous expenses 372 168 334
Dividend receipts (1,149) (20) (20)
The accompanying Notes constitute an integral part of the Consolidated Financial Statements.
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El Al Israel Airlines Ltd. Notes to the Consolidated Financial Statements
Note 1 – General
a. General description of the Company and its activities:
El Al Israel Airlines is the Israeli designated carrier on most routes to and from Israel, other than a number of routes on which other Israeli carriers were granted the status of designated carriers. The Company is primarily engaged in the transport of passengers and cargo, including luggage and mail, on scheduled flights and charter flights between Israel and foreign countries. The Company is also engaged in leasing flight equipment, providing luggage handling and maintenance services at its home airport, sale of duty-free products and - through investees - in related activities, mainly production and supply of airline meals and management of several travel agencies in Israel and abroad.
b. Failure to Include Separate Financial Information:
In accordance with Regulation 4 of the Periodic and Immediate Reports Regulations, the Company did not include in its periodic report for the year ending December 31 2012 separate financial information as per Regulation 9c of the Securities Regulations (Periodic and Immediate Reports), 1970. The reason no separate information was included by the Company was in light of the negligible impact the financial statements of the investee companies have on the Consolidated Financial Statements. The parameters used by the Company in order to establish the impact in question are: revenues, profits and cash flows from operating activities of up to 5% of all assets, revenues, profits and cash flows from operating activities in the consolidated statements – accordingly, ignoring the impact of uncommon exceptional occurrences. For information regarding transactions and commitments between the Company and its consolidated companies see Note 34.
c. 1) On July 30 2012, the State of Israel and the European Union had signed, in initials, a uniform global aviation agreement with the EU, known as the Open Skies Agreement.
The announcement made by the Ministry of Transportation stated that after completing the required legal and administrative proceedings, the agreement would be submitted for the final approval of the government of Israel and of the European Parliament and that the agreement was expected to come into effect within a number of months. As of this report, the Open Skies Agreement has yet to be ratified by the Israeli government. Note that the European Council of Ministers of Defense ratified the agreement in question on December 20 2012. The Open Skies agreement is intended to replace all of Israel’s bilateral agreements with EU states and gradually cancel existing restrictions on aviation rights, including the number of air carriers allowed to operate flights on these routes, the amount of weekly frequencies allowed and the total capacity allowed on these routes.
The agreement distinguishes between groups of destinations, and regarding a number of destinations in which the activity level of foreign airlines is currently not high (“Sixth Freedom Destinations”), it was decided that a moderate increase would take place in the quota of permitted flights.
This will probably take place over the course of a number of years. In order for the agreement to come into effect, various regulatory approvals are required, with Israeli airlines requiring suitable preparations expressed in a number of required activities, including a revision to the Restraint of Business Law for the aviation industry (in this regard, as type exemption draft was published for public remark); the restoration of Israel's safety rating to Category 1 (on November 1 2012, the safety rating of the State of Israel was restored to Category 1); as well as granting equal opportunity to Israeli airlines vs. their competitors, including in the matter of takeoff and landing rights (“slots”). The Company is preparing to deal with the situation in light of its estimate that signing the agreement may have a negative impact on Israeli airlines, including the Company, following an additional worsening of the state of competition, multiple carriers and capacity the agreement will bring about and the inability - C 12 - Free Translation of the Hebrew Language 2012 Annual Report - Hebrew Wording Binding
of Israeli airlines to realize the aviation rights resulting from the Open Skies Agreement in an equal manner.
The Company intends to continue to act in order to protect the interests of Israeli aviation and those of the Company and in order to allow fair competition.
At the same time, as the required legal and administrative procedures for the ratification of the agreement have not yet been completed, as well as taking into account the fact that a certain amount of compensation will be received in security expenses, Company management estimates at this stage that there will be no negative impact on the Company’s financial status and operating results in the foreseeable future.
2) During the reported year, the Company listed a loss of $18.8 million, and in addition, the Company ended the reported year with a $429.2 million working capital deficit, a $78.3 million positive cash flow from ongoing activity and $151.4 million in equity.
Over the course of the past year the Company dealt with increased competition, with Operation Pillar of Smoke and the increase in input prices and adjusted the scope of its operational activity to the scopes of commercial demand. The Company is currently acting to put together a long-term strategic plan, which has been presented to the Board of Directors.
As of this date, in order to continue with the Company’s business activity, the Company is acting in the following manner:
Arranging its sources of financing, among other things, by completing a series of agreements with suppliers and financing banks to renew the Company’s fleet of aircraft, in such a manner that will allow the Company to meet the terms of the aircraft financing agreement with Boeing, as detailed in Notes 18.b.1 and 18.b.2 to these Financial Statements, as well as to finance the advance payments for the purchase of these aircraft, without the Company being forced to make extensive use of its independent sources from its ongoing activity.
As noted in Note 18 to these Financial Statements, some of the credit agreements require compliance with a certain ratio of loan balances to securities (the balance of the debt to the bank compared to the market value of the pledged aircraft). In the event that the Bank fails to meet the ratio in question, the Company may be required to provide additional collateral. Note that as of the balance sheet and near the signing of the Financial Statements, the Company is upholding the required ratio. Company management estimates, taking into account the difference between loans and existing securities, and based on international airplane price lists, as is generally accepted in the aviation industry, and which are used by financial institutions, the Company will not be required to provide additional collateral in the foreseeable future.
Company management estimates that carrying out these actions as well as the Company’s cash flow deriving from its ongoing activity, if the Company's commercial forecasts for the period in question are met, will allow the Company to meet its obligations in the foreseeable future.
Note 2 – Principal Accounting Policies
a. Statement regarding the implementation of International Financial Reporting Standards (IFRS):
The Group's Consolidated Financial Statements have been compiled in accordance with International Financial Reporting Standards (IFRS) and interpretations thereof issued by the International Accounting Standards Board (IASB).
b. The Financial Statements have been prepared in accordance with provisions of the Securities Regulations (Annual Financial Statements), 2010 (hereinafter “Financial Statement Regulations").
c. Balance sheet presentation format:
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The Group presents assets and liabilities in the Balance Sheet divided into current and non-current items.
d. The Company’s operating cycle is 12 months.
e. Format of analysis of expenses recognized to gain/loss:
The Company’s expenses in its Statement of Operations/Report on Comprehensive Income are presented based on the activity characteristic.
f. Foreign currency:
(1) Functional and Presentation Currency
The financial statements of each Group company are compiled in the currency of the major economic environment in which it operates (hereinafter: "the Functional Currency"). For the purpose of financial statement consolidation, the financial standing and results of each Group company are translated to the USD, which is the Company's functional currency. The Company's Consolidated Financial Statements are presented in USD. On the matter of exchange rates and changes thereto during the periods presented, see Note 2x.
(2) Translation of Transactions in Currencies other than the Functional Currency
When compiling the financial statements of each Group company, transactions executed in currencies other than said company's functional currency (hereinafter: "Foreign Currency") are recorded at the exchange rates effective as of the transaction date. Upon each balance sheet date, monetary items denominated in foreign currency are translated using the exchange rate effective as of that date; non-monetary items measured at historical cost are translated using the exchange rate effective as of the date of the transaction involving the non-monetary item.
(3) Recognition of Exchange Rate Differentials
Exchange rate differences are recognized in the Statement of Operations in the period in which they were generated, with the exception of exchange rate difference for transactions intended to hedge certain foreign currency risks, see Note 2n.
(4) Translation of Financial Statements of Investees the Functional Currency of which is Not the USD
In order to present the Consolidated Financial Statements, the assets and liabilities of foreign activity, including goodwill and attributed cost surpluses, are presented according to the exchange rates in effect as of the end of the reported period. Income and expense items are translated according to the average exchange rates in the reported period, unless a significant fluctuation has occurred in exchange rates. In such a case, these items are translated according to the exchange rates on the date the transactions took place, and the translation differences are recognized in other comprehensive earnings under “exchange rate differences from the translation of foreign activity.” These exchange rate differences are charged to gain/loss upon the realization of the foreign activity due to which the translation differences were created as well as upon the loss of control, joint control or a material influence in foreign activity.
g. Investments in affiliated companies:
An affiliated company is an entity in which the Group has material influence and which is not a consolidated company. Material influence is the power to participate in decision making with regard to financial and operational policies of the affiliated company, which does not constitute control or joint control of said policies. In testing the existence of material control, potential voting rights, which can be realized or immediately converted to the shares of the held entity, are taken into account. The Group examines the existence of signs of decreased value of investments treated according to the
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book value method. Such impairment occurs when there is objective evidence that expected future cash flow from investment in such asset has been negatively impacted.
h. Cash and cash equivalents:
Cash and cash equivalents include bank deposits available for immediate withdrawal as well as limited term deposits the use of which is unrestricted and whose term to maturity, at the time of investment, is no greater than three months. Deposits the redemption date of which on the date of investment in them exceeds three months and is no greater than one year are classified under short term deposits. Deposits intended for a defined purpose are classified under designated cash.
i. Fixed assets:
(1) General:
Fixed assets are tangible items held for use in providing services or for leasing to others which are expected to be used for more than one period.
The Company presents its fixed asset items using the following cost model: Fixed asset items are presented in the balance sheet at cost, net of accumulated amortization and net of accumulated impairment, if any. The cost includes the acquisition cost of the asset, as well as costs than can be directly attributed to bringing the asset to the location and state required for its operation in the manner intended by management. On the matter of testing the amortization of fixed assets see Note 2k.
(2) Amortization of fixed assets:
Fixed assets are amortized separately for each component of depreciable fixed asset item having a significant cost relative to the total item cost. Amortization is carried out systematically using the straight line method over the expected useful life span of the item components starting on the date on which the asset is ready for its intended use, taking into account for the expected residual value at the end of its useful life. Assets under a financial lease are amortized over their expected useful life on equivalent basis of owned assets, or over the term of the lease, if shorter.
The cost of overhauling aircraft engines is recognized as an asset on the balance sheet, amortized over the period of economic benefit expected from said overhaul (based on estimated number of engine hours). The residual values, depreciation method and useful life span of the asset are reviewed by Company management at the end of each financial year. Changes are treated as changes in estimates, on a prospective basis. Gain or loss generated from sale or obsolescence of an asset is determined by the difference between receipts from its sale and its book value, on the date of sale or removal from use, and is charged to gain/loss.
The cost of accessories and spare parts included with fixed assets is determined using the weighted moving average method. Accessories and spare parts attributed to a specific fleet are amortized over the average remaining life time of said fleet. Accessories and spare parts not attributed to a specific fleet are amortized according to the balance of the average life time of the Company's entire aircraft fleet. Accessories and spare parts with no movement or slow movement are included at depreciated values according to management estimate. Regarding the Company’s depreciation rates see Note 13.b.2. (3) Consecutive costs:
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The cost of replacing part of a fixed asset item capable of being reliably estimated is recognized as an increase in carrying amount upon creation, although future economic benefits attributed to the item are expected to flow to the entity. Regular maintenance costs are charged to the Statement of Operations upon creation.
j. Intangible assets:
Rights for the use of security equipment are included at their cost to the Company, and are amortized using the straight line method based on the anticipated period of economic use, subject to impairment review. The life span estimate and amortization method are reviewed at the end of each fiscal year, with the impact of changes to the estimate treated on a prospective basis. Software is included at its cost to the Company and is amortized using the straight line method based on its expected period of economic use.
k. Aircraft impairment:
On each balance sheet date, the group evaluates the book value of its aircraft fleets, with the aim of establishing whether there are any signs pointing to an erosion in the value these fleets. If any such indications exist, the fleet's recoverable sum is estimated in order to determine the impairment loss, if any. The recoverable sum is the fleet’s fair value or its value in use, whichever is higher. When estimating value in use, aircraft fleet contribution estimates are discounted to their present value using a (post-tax) discount rate that reflects the current market estimates for time value of the money and the specific risks for the fleet for which the contribution estimate has not been adjusted. If the recoverable sum for the aircraft fleet is estimated to be lower than its book value, the book value of the fleet is depreciated down to its recoverable sum. Impairment loss is immediately recognized as an expense in the Statement of Operations. Company management believes that recoverable amounts for aircraft should be studied relative to their depreciated cost after grouping aircraft fleets, and that it is incorrect to review the recoverable amount of each aircraft separately relative to its depreciated cost. Regarding the determination of the recoverable sum, see Note 4.b.(3).
l. Financial assets measured at depreciated cost and the effective interest method:
(1) Financial Assets Measured at Depreciated Cost and the Effective Interest Method
The Group's financial assets in this category include trade receivables, deposits and other accounts receivable at fixed or fixable installments which have no quote on an active market. Loans and accounts receivable are measured at depreciated cost using the effective interest method, net of any impairment, if such exists. Interest revenues are recognized using the effective interest method, except for short-term trade receivables and other accounts receivable – when interest amounts to be recognized in respect thereof are not material.
The effective interest method is the method for calculating the depreciated cost of a debt instrument, as well as for the allocation of interest income across the instrument’s life span. The effective interest rate is the rate that precisely capitalizes future projected cash flow (including commissions, transaction costs and so on), throughout the debt instrument’s life span, or (when more correct) a shorter period, to the current value of the instrument upon first recognition.
(2) Impairment of Financial Assets Measured at Depreciated Cost
These financial assets are reviewed for indications of impairment upon each balance sheet date. Such impairment occurs when there is objective evidence that expected future cash flow from the investment has been negatively impacted due to one or more events that have occurred subsequent to the initial recognition of the financial asset.
Indications of impairment may include, among other things:
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. Significant financial difficulties on behalf of the issuer or the debtor; . Failure to make current principal or interest payments; . Expectation that the debtor would become bankrupt or would restructure their debt;
For financial assets measured at amortized cost, impairment is recognized as equal to the difference between the financial asset's carrying amount and the present value of future cash flow expected there from, discounted using its original effective interest rate.
As for trade receivables, their book value is decreased, if necessary, using a provision for doubtful debt. The provision is calculated specifically. When trade receivables are not collectible, they are written off against the provision account. Collection, in subsequent periods, of amounts previously written off is credited against the provision account. The changes in the book value of the provision account are charged to the Statement of Operations.
m. Financial liabilities:
Financial liabilities include credit and loans, trade receivables and other accounts receivable. These liabilities are initially recognized at fair value, net of transaction costs. Subsequent to initial recognition, other financial liabilities are measure at depreciated cost using the effective interest method.
The effective interest method is a method for calculating the net depreciated cost of a financial liability, and of the allocation of interest income or expenses over the relevant period. The effective interest rate is the rate that precisely discounts the projected flow of future cash receipts or payments over the course of the expected life span of the financial liability to its book value, or, as the case may be, for a shorter period.
n. Derivative financial instruments and hedge accounting:
(1) General
The Group uses a range of derivative financial instruments to manage exposure to changes in price of jet fuel, interest rates and foreign currency exchange rates. Derivative financial instruments are initially recognized at their fair value upon the contracting date and at each subsequent balance sheet date. Changes to the fair value of derivative financial instruments are generally recognized in the statement of operations. The timing of recognition in the statement of operations of changes in fair value of derivative financial instruments designated as hedging, when such hedging is effective and meets all conditions for qualification as a hedging relationship, depends on the nature and type of hedging, as set forth below.
The balance sheet classification of derivative financial instruments is determined based on the contractual term of the derivative financial instruments. If the remaining contractual term of the derivative is longer than 12 months, the derivative is stated as a non-current item on the balance sheet; if the remaining term is shorter than 12 months, the derivative is classified as a current item.
(2) Hedge Accounting
The Company applies cash flow hedge accounting, and to this end the Company has designated certain derivative financial instruments in respect of exposure to jet fuel prices and to interest rate changes.
In order to hedge jet fuel prices, the Company has entered into multiple transactions in respect of expected fuel purchases for terms of up to one year from the balance sheet date.
In order to reduce exposure to adjustable interest rates applicable to Company loans, the Company has entered into multiple contracts designated to fix interest rates. Interest hedging instruments
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used by the Company are aligned with repayment schedules of the loans they are designated to hedge in the related periods.
In order to reduce exposure do to the USD/NIS exchange rate, the Company conducted several transactions the purpose of which was to hedge several of the Company's expected NIS payroll payments.
The hedging relationships are documented by the Company upon contracting the hedging transaction. Documentation includes identification of the hedging instrument, the hedged item, the hedged risk, the hedging strategy applied, and tests the degree to which the strategy matches the Group's general policy for each type of hedging. Furthermore, starting on the start date of hedge relationship and throughout its term, the Company documents the degree to which the hedging instrument is effective in offsetting exposure to changes in cash flow due to the hedged risk for the hedged item.
The effective portion of changes in value of financial instruments designated as cash flow hedges is immediately recognized in equity under “capital reserve in respect of cash flow hedging" and the non-effective portion is immediately recognized in the Statement of Operations.
Cash flow hedge accounting is discontinued when the hedging instrument expires, is sold or realized or when the hedging relationship no longer meets the minimum hedging conditions. Subsequent to discontinuation of hedge accounting, the amounts charged to equity are charged to gain/loss when the hedged item or the hedged anticipated transactions are recognized in the Statement of Operations.
o. Revenue recognition basis and attributing commissions to agents:
(1) Revenues from sale of flight tickets are included as unearned revenues under current liabilities until the service is provided or up to 2 years from the sale date, whichever is earlier.
Air passenger revenues also include revenues where the service is provided by the Company, whereas flight tickets are sold by other airlines.
Furthermore, air passenger revenues also include revenues due to code sharing agreements with other airlines. In these cases, when the service is provided by the other airlines, while the sale is made by the Company, revenues are stated on net basis, which means that the group collects he receipts deriving from the transportation of passengers, passes on the share of the other airline, and lists revenue for the difference between them only.
(2) Regarding the frequent flyer programs, the Company applies IFRIC 13 – Customer Loyalty Programs. Accordingly, service sales transactions in which the Group grants its customers bonuses are treated as multiple-element transactions, and the payment received from the customer will be allocated to its different components based on the fair value of the credit award. The proceeds charged to the bonus are recognized as income when the points are redeemed and the Company's obligation to provide the service is upheld. Revenues from the sale of frequent flyer club points to business partners are largely included under unearned revenues until their use.
(3) Air cargo revenues are charged as revenue in the Statement of Operations when the service is provided.
(4) Agent commissions referring to revenues not yet recognized are included in the Financial Statements under "prepaid expenses", and will be recognized as selling expenses in the Statement of Operations concurrent with the recognition of revenue.
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p. Engine maintenance and refurbishment expenses:
Engine maintenance and refurbishment expenses not constituting an overhaul are charged to the Statement of Operations upon the actual execution of the engine maintenance or refurbishment work.
In cases where the Company has entered into agreements of an insurance nature, the Company records expenses as specified in the insurance agreements, and the cost of refurbishment is incurred by the insurer.
q. Expenses for securing company services:
Company contribution to government expenses for securing company services are recognized in the statement of operations when incurred, based on the Company's share of said expenses.
r. Leases:
General
Lease agreements are classified as financial leases when terms of the contract transfer all material risk and rewards arising from ownership to the lessee. All other leases are classified as operational leases.
Financing Lease
In financing lease transactions in which the Group leases assets from a different entity, the Group recognizes the asset on the date of the beginning of the lease at its fair value or the current value of the minimum lease payments, whichever is lower. The commitment to provide minimum lease payments to the lessor is presented in the Balance Sheet as a financial liability due to a lease. In consecutive periods, current payments are allocated due to the financial lease between the financing component and the liability component, in such a manner that a fixed interest rate is received calculated according to the balance of the liability. The part allocated to the financing component is charged to gain/loss.
Operating Lease
Rental fee expenses in respect of operational leases (primarily aircraft leases) are recognized based on the straight line method over the term of the lease. In lease agreements where no leasing fee, or a reduced leasing fee, is paid at the start of the leasing period and where other benefits are obtained from the lesser, the Company recognizes expenses based on the straight line method for the duration of the lease.
s. Provisions:
(1) General
Provisions are recognized when the Group has a legal or implied obligation due to a past event, where use of reliably measurable economic resources is expected to discharge said obligation.
The sum recognized as a provision reflects management's best estimate of the amount needed to settle the current obligation on the balance sheet date, accounting for risk and uncertainty associated with said obligation. When the provision is measured using expected cash flows for settlement of the obligation, the carrying amount of the provision is the present value of expected cash flows. When the amount required to settle the current obligation, in whole or in part, is expected to be reimbursed by a third party, the Group recognized an asset, in respect of said reimbursement, up to the amount of the provision recognized, only when it is virtually certain that such indemnification would be received and when it may be reliably measured.
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(2) Lawsuits
These Financial Statements include appropriate provisions with regard to lawsuits filed against Group companies which Group management believes would not be rejected or eliminated, although Group companies contest these claims.
These lawsuits are treated in accordance with IAS 37. Pursuant to these provisions, provisions are included in respect of claims likely to materialize (probability higher than 50%), which Group management believes, based on advice of legal counsel, to be appropriate to the circumstances of each and every case.
t. Share-based payments:
Share-based payments to employees, settled using Group equity instruments, are measured at fair value upon their grant date. The Group measures, upon the grant date, the fair value of equity instruments granted by using the Black & Scholes model. When the equity instruments granted do not vest until employees complete a defined period of service, the Group recognizes the share-based payment agreements in its financial statements over the vesting period against an increase in equity, under “capital reserve in respect of share-based payment”. Upon each balance sheet date, the Company estimates the number of equity instruments expected to vest.
u. Deferred taxes:
Group companies generate deferred taxes in respect of temporary differences between the value of assets and liabilities for tax purposes and their carrying amount in the financial statements. The deferred tax balances (assets or liabilities) are calculated using the tax rates expected upon their realization, based on the tax rates and taxation legislation enacted, or effectively enacted, by the balance sheet date. Deferred tax liabilities are usually recognized in respect of all temporary differences between the value of assets and liabilities for tax purposes and their book value in the Financial Statements. Deferred tax assets are recognized in respect of all deductible temporary differences up to the sum for which taxable revenue is expected to allow for the utilization of the deductible temporary difference.
Deferred tax assets and liabilities are stated on an offset basis, when an enforceable legal right exists to offset tax assets against tax liabilities, and when they refer to taxes on revenue imposed by the same tax authority, where the Group intends to settle the tax assets and liabilities on net basis. The Company and several subsidiaries are jointly assessed for taxes on revenue, therefore deferred tax assets and deferred tax liabilities of said companies are presented on offset basis.
v. Employee benefits:
(1) Post-Employment Benefits
Post-employment benefits at the Group include: pensions, severance pay liability, adjustment pay to executives, redemption of sick pay and certain benefits to Company retirees. Some post- employment Company benefits are defined contribution plans and some are defined benefit plans. Expenses in respect of Company liability to deposit funds to a defined contribution plan are recognized in the statement of operations upon provision of employment services for which the Company is liable to make said deposit.
Expenses in respect of defined benefit plans are recognized in the statement of operations based on the Projected Unit Credit Method, using an actuarial estimation prepared upon each balance sheet date. The present value of Company obligations in respect of defined benefit plans is determined by discounting expected future cash flows expected from the plan using market yield of government bonds denominated in the currency in which plan benefits are to be paid, and having a term to maturity approximately equal to the expected plan settlement date. Actuarial gain or loss in excess of 10% over the present value of the obligation in respect of a defined benefit plan and the fair value of plan assets as of the start of the period, whichever is
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higher, are amortized over the remaining average service duration expected for employees participating in the plan. Company liability in respect of a defined benefit plan, presented on the Company balance sheet includes the present value of the liability in respect of defined benefit, plus actuarial gain (less actuarial loss) yet to be realized, net of the fair value of plan assets.
(2) Other Long-Term Employee Benefits
Other long-term employee benefits are benefits expected to be utilized or payable in a period over 12 months from the end of the period in which the service qualifying for the benefit was rendered. Other employee benefits at the Company include an anniversary bonus. This benefit is charged to the Statement of Operations according to the Projected Unit Credit Method, using actuarial estimates prepared upon each balance sheet date. The present value of Company obligations in respect of the benefit in question is determined by discounting expected future cash flows expected from the plan using market yield of government bonds denominated in the currency in which benefits are to be paid, and having a term to maturity approximately equal to their expected settlement date.
(3) Short-Term Employee Benefits
Short-term employee benefits are benefits expected to be utilized or payable in a period within 12 months from the end of the period in which the service qualifying for the benefit was rendered. Short-term employee benefits at the Company include Company liability in respect of wages, bonuses and paid leave. These benefits are recognized in the statement of operations when generated. The benefits are measured according to the non-capitalized sum the Company projects it will pay for realization of this entitlement. The difference between the short-term benefits to which an employee is entitled and the amount paid for them is recognized as a liability. Accumulated entitlement to compensation due to absences shall be classified as short term employee benefits, or as long term employee benefits based on the date on which the employee received the right to the benefit. As a result, the Group presents vacation benefits as short term employee benefits, measured at the height of the non-capitalized sum the Group expects to pay for the realization of this right.
(4) Early Retirement Plans
Company liability in respect of early retirement plans are recognized in the statement of operations when the Company is committed to a formal employment termination plan, including, at least, the site, position and estimated number of employees to be terminated, the benefits to which terminated employees are eligible and the date on which the plan would be executed. Furthermore, the time until implementation is complete should be such that material changes to the plan are unlikely. The benefit level is determined using the discount rate for government bonds. On the recognition date, the Company recognizes a liability at its current value for the completion of employee pension payments until the statutory retirement age, and attributes expenses to the Statement of Operations throughout the plan period.
w. Earnings per share:
The Company calculates basic earnings per share as regards gain or loss, attributed to holders of Company shares by dividing the income or loss attributed to holders of Company ordinary shares by the weighted average number of ordinary shares outstanding during the reported period. In order to calculate diluted earnings per share, the Company adjusts the earnings or loss attributed to holders of ordinary shares, and the weighted average number of shares outstanding, for impact of all potentially dilutive shares.
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x. Exchange rates and linkage bases:
(1) Balances in foreign currency, or linked to foreign currency, are included in the Financial Statements according to official exchange rated published by the Bank of Israel and in effect as of the balance sheet date.
(2) Balances linked to the Consumer Price Index are presented using current CPI for December.
(3) Below is data on dollar exchange rates and the CPI in Israel:
As of December 31 2 0 12 2 0 11 2 0 10
Consumer Price Index – in points 122.3 120.4 117.8 USD/NIS exchange rate 3.733 3.821 3.549 USD/EUR exchange rate 0.759 0.774 0.749 USD/pound sterling exchange rate 0.618 0.649 0.646
For the Year Ending Rate of change in %: December 31 2 0 12 2 0 11 2 0 10
Consumer Price Index 1.6% 2.2% 2.6% USD/NIS exchange rate (2.3% ) 7.7% (6.0 %) USD/EUR exchange rate (1.9% ) 3.3% 7.9% USD/pound sterling exchange rate (4.8% ) 0.5% 4.5%
Note 3 - New Financial Reporting Standards and Clarifications Published
New standards and clarifications published and not yet in effect, and not adopted early by the Group, which are expected to have or may have an impact on future periods:
. IAS 1 Revision (Revised) “Presentation of Financial Statements” (Regarding the Presentation of Other Comprehensive Income Items in the Report on Comprehensive Income)
This revision states that items included in the Report on Other Comprehensive earnings will be separated and presented in one of two groups:
. Items classified to gain/loss in the future, . Items not classified to gain/loss in the future.
In addition, the revision states that in the event that the Other Comprehensive Earnings items are presented before tax influence, the tax influence shall be presented separately for each of the groups. This Standard shall be applied retroactively to yearly reporting periods starting January 1 2013 or subsequently. Early application is possible.
. IAS 19 “Employee Benefits”
This standard alters the provisions of IAS 19 “Employee Benefits” in its current format, in terms of the following aspects:
. Actuary gains or losses will be charged to other comprehensive income and will not be classified to gain/loss at a later date. Accordingly, the alternatives of assigning actuary profits or losses to gain/loss immediately, or in accordance with the strip method, were canceled immediately. . Interest revenues from the assets of a defined benefit plan shall be recognized on the basis of the - C 22 - Free Translation of the Hebrew Language 2012 Annual Report - Hebrew Wording Binding
debited party, and not according to the expected yield from the assets. . Short-term employee benefits will include benefits that are expected to be cleared in full within 12 months from the end of the year in which the crediting service was granted by the employee. . Severance pay as a result of a voluntary retirement encouragement offer shall be recognized as a liability on the date on which the reporting entity cannot withdraw the offer.
This standard shall be applied retroactively, with the exception of certain cases detailed in the standard, to yearly reporting periods starting January 1 2013 or subsequently. Early application is possible. The Company estimates that canceling the alternative of charging actuary profits or losses in accordance with the strip method, instead of charging them to Other Comprehensive Earnings, would lead to a decrease in the Company’s equity, with the reduction in question estimated at $16 million (after tax influence) as of December 31 2012. Implementation of the standard has accounting and recording implications only.
. IAS 1 (Revised), “Presentation of Financial Statements” (on the matter of presentation of the balance sheet for the beginning of the previous period)
This revision states that in cases in which an entity implements an accounting policy retroactively and/or restates and/or reclassifies items in its Financial Statements, which has a material impact on the balance sheet from the beginning of the period prior to the reported year, it must present a balance sheet as of that date. In addition, the clarification made clear that companies are not required to present notes regarding that additional balance sheet. The revision shall apply retroactively to yearly reporting periods starting January 1 2013 or subsequently. Early application is possible.
. IAS 16 “Fixed Assets” (Classification of Spare Parts, Backup Equipment and Accessories)
This amendment states that spare parts, backup equipment and accessories that meet the definition of fixed assets in IAS 16 will be presented in accordance with its provisions, while such items that do not meet this definition will be presented in accordance with IAS2 “Inventory”. This amendment canceled the instruction that spare parts and accessories that can only be used with a fixed asset item be classified as fixed assets. This revision shall be applied to yearly reporting periods starting January 1 2013 or subsequently. Early application is possible. In the opinion of Company management, implementation of this standard has no impact on its financial status and operating results.
Note 4- Critical Accounting Considerations and Key Sources for Estimates of Uncertainties
a. General:
In applying Group accounting policy, as set forth in Note 2 above, Company management is sometimes required to exercise considerable judgment with regard to estimates and assumptions about the carrying amount of assets and liabilities, which may not be available from other sources. These estimates and related assumptions are based on past experience and other factors deemed relevant. Actual results may differ from these estimates.
Estimates and underlying assumptions are regularly reviewed by management. Changes in accounting estimates are only recognized in the period in which a change was made to the estimate, if the change only affects that period, or are recognized in said period and in subsequent periods in cases where the change affects both the current period and the subsequent periods.
b. Critical accounting considerations and key sources for estimates of uncertainties:
(1) Provisions for Legal Proceedings
For claims quantified and not quantified in monetary sums, pending against the Company as of December 31 2012, see Note 22d.
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In order to review of the legal validity of the aforementioned claims, as well as to determine the probability of their realization to the Company's detriment, Company management relies on the opinion of legal and professional counsel. After the Company's counsel have formed their legal opinion and the Company's probability with regard to the claim subject, whether the Company would have to bear its outcome or may postpone it, Company management estimates the amount to be included in the financial statements, if any. As the outcome of these lawsuits would be determined by the Court, said outcomes may differ from the Company’s estimates and thus have a material impact on the Company’s financial status and operating results.
(2) Employee Benefits
The present value of the Company's severance pay liability, as well as that of a pension plan and other employee benefits, is based on multiple data determined based on actuarial estimate, using multiple assumptions, including with regard to discount rate. Changes in actuarial assumptions may impact the carrying amount of the Company's severance pay and pension liabilities. The Company estimates the discount rate annually, based on the discount rate for government bonds. Other key assumptions are made based on prevailing market conditions, as well as on the Company's past experience. For further details of assumptions used by the Company, see Note 19.
(3) Aircraft Impairment
As noted in Note 2j above, if signs indicating deterioration are evident in an aircraft fleet, the Company conducts an estimate of the recoverable sum of than aircraft fleet. The recoverable sum is the fair value of the aircraft less sales costs or its value in use, whichever is higher. In estimating value in use, the Company estimates future cash flows and deducts them to their current value using a discount rate reflecting the operational risk of the aircraft fleet based on the Company’s weighted discount rate. Regarding the key assumptions used in calculating the cash flow capitalization, see Note 13e. Material differences in these estimates, or in part of them, may impact the value of the recoverable sum of these aircraft.
(4) Frequent Flyer Clubs
As stated in Note 2o, for establishing the balance of unearned revenues for frequent flyer points accumulated as of the report date and yet unused, the Company based its calculations on the sales prices of frequent flyer points to business partners (after adjustments) and on the Company's experience on the matter of point usage projections. Changes in Management’s estimates regarding point values may impact the Company's revenues.
(5) Useful Lifespan of Fixed Assets and Parts
Company aircraft are amortized throughout their useful lifespan. Flight equipment such as accessories and parts is amortized throughout the lifespan of the relevant fleet of aircraft. As stated in Note 2.i.s, Company Management studies the useful lifespan of all fixed asset items once per year. Actual changes in the balance of useful lifespan will lead to changes in impairment rates.
(6) Fair Value of Financial Instruments
The Company presents derivative financial instruments at fair value. As stated in Note 2l, the fair value of financial instruments classified as first grade is based on the use of prices quoted in active markets, the fair value of financial instruments classified as second grade is based on the use of observed data, direct or indirect, while the fair value of financial instruments classified as third grade is based on the use of data not based on observed market data, see Note 26l.
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Note 5 – Non-Material Adjustment of Comparison Numbers
Pursuant to an accounting audit conducted at Sun D’Or International Airlines Ltd. (hereinafter: “Sun D’Or”), a private company fully owned by the Company, it was found that no provision was made in Sun D’Or’s Financial Statements for 2007-2011 for a $580,000 debt of a Sun D’Or agent, this despite the fact that Sun D’Or’s attempts to collect the debt had been unsuccessful. In addition, Sun D’Or credited that agent to the amount of $755,000 due to an incorrect debt, when in lieu of reducing the income item as required by the accounting rules, the port tax liability item was reduced instead. In light of the discovery of the errors to the accounting records and the failure to make a provision to doubtful debt as detailed above, the inventory of Sun D’Or's debts and debt aging as of June 30 2012 and September 30 2012 were examined and as a result of this examination, additional debts were found, created in 2007-2011 to the amount of $1,381,000, for which no provision was made to doubtful debt as required and therefore, Sun D’Or made the requisite provisions in its Financial Statements.
As part of the treatment of the events detailed above, Sun D’Or carried out a number of actions, key of which were organizational and personal changes, reexamination of financial procedures and reinforcement of accounting controls.
The impact of the non-material adaptation on balance sheet items:
Effect of After the Effect As Reported in Retroactive of Retroactive the Past Adaptation Adaptation Thousands of Dollars As of December 31 2011: Trade receivables 142,409 (2,716 ) 139,693 Deferred taxes 28,984 (679 ) 28,305 Surpluses (264,292) (2,037 ) (266,329 )
The influence of the non-material adaptation on gain/loss items: Effect of After the Effect As Reported in Retroactive of Retroactive the Past Adaptation Adaptation Thousands of Dollars For the Year Ending December 31 2010 Operating revenues 1,972,239 (793 ) 1,971,446 Profit before taxes on revenue 63,026 (793 ) 62,233 Taxes on income (5,971 ) 198 (5,773 ) Yearly profit 57,055 (595 ) 56,460
Effect of After the Effect As Reported in Retroactive of Retroactive the Past Adaptation Adaptation Thousands of Dollars For the Year Ending December 31 2011 Operating revenues 2,043,174 (588 ) 2,042,586 Loss before taxes on income (41,598 ) (588 ) (42,186 ) Taxes on income (7,797 ) 147 (7,650 ) Loss for the year (49,395 ) (441 ) (49,836 )
Influence of non-material adaptation on the capital’s opening balance as of January 1 2010:
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Equity Thousands of Dollars
Balance as of January 1 2010 123,781 Non-material adjustment of comparison (1,001) numbers Balance as of January 1 2010 after non-material adjustment of comparison numbers 122,780
Influence of non-material adaptation on the capital’s opening balance as of January 1 2011:
Equity Thousands of Dollars
Balance as of January 1 2011 247,524 Non-material adjustment of comparison (1,596) numbers Balance as of January 1 2011 after a non-material adaptation of comparison numbers 245,928
Note 6 - Cash and Cash Equivalents
a. Composition: As of December 31 2 0 12 2 0 11 Thousands of Dollars
Cash and bank balances 45,989 56,547 Short-term deposits 6,821 28,809 Total cash and cash equivalents 52,810 85,356
b. Designated cash – as of December 31 2012 the Company has a balance of designated cash to the amount of $1,205,000, originating from the establishment of the “Excellence and People” fund. For further details, see Note 33e.
c. Pledged deposits – as of December 31 2012 the Company has a balance of pledged deposits to the amount of $11,456,000, originating from a deposit the Company provided as collateral in favor of a banking institution, in return for a loan received from that institution. See also Note 18.f.1.
Note 7 - Short-Term Deposits
As of December 31 2012 – an NIS deposit worth $8,570,000 (including accrued interest) deriving from the proceeds of option (Series 1) exercises received by the Company, greater than the sum of the "deficit" in the compensation fund of the entitled employees – as stated in Note 91.c.(3).b (as of December 31 2011 the deposit in question amounted to $8,183,000).
The Company is studying the existence of limitations regarding its ability to make use of the above balance of the proceeds according to the agreement with the State and with the workers' representatives. The Company approached the Accountant of the Ministry of Finance on this matter. As of the publication of the Financial Statements negotiations are - C 26 - Free Translation of the Hebrew Language 2012 Annual Report - Hebrew Wording Binding
taking place with the General Comptroller's Office at the Ministry of Finance in order to examine entitlement to issue surpluses. Until the matter is resolved, the deposit is presented against an obligation to the State of Israel.
Note 8 - Trade Receivables
a. Composition: As of December 31 2 0 12 2 0 11 Thousands of Thousands of Dollars Dollars
Open accounts 93,959 * 110,930 Credit card companies 28,653 21,029 Airlines (see 1 below) 10,973 10,326
133,585 142,285 Less - provision to doubtful debt (3,687 ) (2,592 )
129,898 139,693
Non-material adjustment of comparison numbers – see Note 5.
1. Most accounts between airlines are settled through the International Air Transport Association (IATA) clearing system. 2. The average credit period for Company services provided is 28 days (in 2011: 28 days). Group customers are not required to pay interest for this period. The Group has, in general, several types of trade receivables in Israel and abroad: IATA agents, non-IATA agents and business customers. The credit rating of IATA agents is established in accordance with BSP parameters for passenger agents and CASS for cargo agents. The bodies in question require bank guarantees for these agents in accordance with IATA rules. In addition, the Company holds insurance for the credit risk of IATA agents in Israel. This insurance does not cover all the Company's exposure to credit risk. As of non-IATA agents, the Company requires guarantees and/or collateral, while for its business customers the Company holds credit risk insurance. The balance of Group trade receivables as of December 31 2012 includes a total of $4,079,000, the repayment date of which has passed (as of December 31 2011: $2,924,000), but the Group, based on its past experience and on the payables' credit rating, has not made a provision to doubtful debts for them, as in its opinion they are collectible. The Group does not hold collateral for these debts.
The average debt period of trade receivable debts the repayment date of which has passed as of December 31 2012 is 56 days (as of December 31 2011 – 57 days).
b. Age of customer debts deviating from credit days established for which no provision to doubtful debts has been included:
As of December 31 2 0 12 2 0 11 Thousands of Thousands of Dollars Dollars
0-30 days 2,363 1,052 31-60 days 540 325 61-90 days 677 740 Over 90 days 499 807 Total 4,079 2,924
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c. Movement in provision to doubtful debt: As of December 31 2 0 12 2 0 11 Thousands of Dollars
Balance at the beginning of the year 2,592 2,418 Loss from impairment due to receivables 1,247 1,000 Doubtful debts erased - (760 ) Sums recovered over the year (152) (66) Balance at the end of the year 3,687 2,592
In determining the likelihood of payment of trade receivables, the Group reviews changes in customer credit quality from when the credit was extended through the reporting date. Concentration of credit risks is limited in light of the large customer basis and its distribution into various branches and geographical regions.
d. Age of trade receivable debts for which a provision for doubtful debts was made:
As of December 31 2012 2011 Thousands of Dollars
0-30 days 320 17 31-60 days 45 62 61-90 days 73 42 Over 90 days 3,249 2,471 Total 3,687 2,592
Note 9 - Other Receivables
Composition: As of December 31 2 0 12 2 0 11 Thousands of Dollars
Government institutions 11,552 10,364 Receivables due to renovation of leased engines - 6,898 Receivables due to jet fuel hedging transactions 830 340 Deposits at trade payables 2,264 2,217 Other receivables 8,687 7,929
23,333 27,748
Note 10 - Prepaid Expenses
Composition:
Current As of December 31 2 0 12 2 0 11 Thousands of Dollars
Commissions due to unused flight tickets 15,988 16,616 Frequent flyer point commissions 1,360 1,483 Aircraft and engine leases 5,792 5,181 Others 6,302 4,763
29,442 28,043
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Non-Current As of December 31 2 0 12 2 0 11 Thousands of Thousands of Dollars Dollars
Frequent flyer point commissions 2,121 2,101 Aircraft leases 7,829 5,446
9,950 7,547
Note 11 - Inventory
Composition:
As of December 31 2 0 12 2 0 11 Thousands of Thousands of Dollars Dollars
Jet fuel for consumption 12,643 16,394 Materials and foodstuff 6,006 6,598 Chemicals 3,303 3,315 Other 193 174 22,145 26,481
Note 12 - Investment in Investees
a. Subsidiaries:
The Group's subsidiaries:
Country of Incorporati Holdings in Equity of Extant of Investment in Company name on Subsidiary Subsidiary (*) As of December 31 As of December 31 2 0 12 2 0 11 2 0 12 2 0 11 % % Thousands of Dollars Held Directly Tamam (1) Israel 100% 100% 994 691 Borenstein (2) U.S.A. 100% 100% 4,966 4,670 Superstar (3) U.K. 100% 100% (105 ) (315 ) Sun D'Or (4) Israel 100% 100% 3 3 Katit (5) Israel 100% 100% - -
(*) The extent of the investment in a company held directly is calculated as a net sum based on the consolidated statements, charged to the shareholders of the parent corporation, of total assets less total liabilities, plus loans given investees,
(1) Tamam Aircraft Food Industries (BGN) Ltd. ("Tamam")
Tamam is primarily engaged in the production and supply of prepared kosher meals for airlines. Most of Tamam’s sales are to the Company and a small fraction to other airlines and customers. Tamam provides the Company with catering and food services on its aircraft at prices specified by agreements. In accordance with its agreement with the Israel Airports Authority ("IAA"), TAMAM may use the area owned by IAA in exchange for agreed-upon authorization fees based on Tamam's turnover. Tamam estimates that it will have to relocate its plant from its present location and move to a new location. This move is not expected to occur prior to 2017.
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(2) Borenstein Caterers Inc. (USA) - (“Borenstein”)
Borenstein, incorporated in the United States and operating out of New York’s JFK airport, deals mostly in the production and delivery of prepared meals for airlines and other institutions. The Company is Borenstein’s main customer, and all of its shares held by the Company.
(3) Superstar Holidays Ltd. (England) – (“Superstar”)
Superstar – a company registered in England and Wales and fully owned by the Company, is a tourism wholesaler, marketing tourism packages as well as airline tickets to travel agents and individual travelers. Superstar has a branch in Israel, as well as branches in several cities abroad.
(4) Sun D'Or International Airlines Ltd. ("Sun D'Or")
The Group's charter operation are carried out through Sun D’Or. Sun D'Or leases the entire capacity of aircraft to third parties, or the capacity of part of an aircraft to a number of partners at prices agreed upon in advance. In addition, Sun D'Or also deals in the sale of tour packages by way of tourism wholesalers as well as online sales. Sun D’Or has an unlimited commercial operator’s license. On March 20 2011 the CAA informed Sun D’Or that it would be revoking Sun D’Or’s operator’s license starting April 1 2011. Following the revocation of Sun D’Or’s operator’s license, and following Sun D’Or’s appointment as “designated carrier” to various destinations by the Ministry of Transportation, these appointments were transferred to the Company, except for the Eilat-Moscow route. Following the revocation of its operator’s license, Sun D’Or continues to serve as a tourism organizer, while preserving the “Sun D’Or” label for charter flights it markets and which are carried out by the Company (on weekdays) and by other airlines (on weekend and holiday flights). Sun D’Or recently submitted an official request to the CAA to receive a new license. The outline of the activities and timetables allowing Sun D’Or to return to operational activity have yet to be established.
(5) Katit Ltd. ("Katit")
Katit is a fully-owned Company subsidiary which operates several restaurants for Company employees at Ben Gurion Airport, commissaries in the Company's office buildings and the King David Lounge at BGA. In return for the services Katit provides the Company, the Company covers the surplus of operating costs over expenses created by Katit at any time.
b. Affiliated companies:
The Group's material affiliated companies:
Cargo Terminals and Handling Ltd. ("Maman")
The Group’s chief activity is the management and operation of the cargo terminal authorized to handle all import and export cargo at Ben Gurion International Airport, as authorized by the Airports Authority. In addition, the Group is active in the field of logistical services, real estate property rental and the provision of aviation services. Maman’s activity takes place in Israel, the Czech Republic and India.
Composition of Investment in Maman As of December 31 2 0 12 2 0 11 Thousands of Thousands of Dollars Dollars
Cost of shares 12,135 9,733 Option warrants exercisable as shares 2,436 2,266 Portion of profits accumulated from purchase date, net 1,500 1,336 Capital reserve from translation differences (82) (949) Total investment in Maman 15,989 12,386
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Framework Agreement with Cargo Terminals and Handling Ltd. ("Maman")
On November 3 2010 Maman’s special general meeting approved a material private offer, pursuant to which Maman’s securities would be allocated to the Company in the following manner: up to 7,000,000 ordinary shares worth 10 NIS NV each constituting up to 15% of Maman’s issued and paid-up capital, as well as options exercisable as regular shares at a rate close to 10% of Maman’s issued and paid-up capital. Following this, as of December 31 2010 the Company was issued 2,837,837 ordinary Maman shares, constituting 7.5% of Maman’s issued and paid-up capital, as well as the aforementioned options. Furthermore, the general meeting approved the appointment of Mr. Amikam Cohen, Chairman of the Company's Board of Directors, as member of Maman’s board of directors, starting November 7 2010 and the appointment of Mr. Yehuda (Yudi) Levi, Deputy Chairman of the Company’s Board of Directors, as member of Maman’s Board of Directors, starting January 1 2011. In January 2011 the Company was allocated an additional 1,598,783 shares free of charge, constituting 3.75% of Maman’s issued and paid-up share capital, so that the Company’s total holdings after this allocation amounted to 11.25% of Maman’s issued and paid-up share capital. As a result the Company listed a sum of $3.5 million in its books for 2011. Furthermore, in 2011 the Company listed in its books receipts to the amount of $2.4 million for discounts received pursuant to the Maman transaction. These sums reduced the Airport Fees and Services item under operating expenses in the Company’s 2011 Statement of Operations. Starting January 2011 as a result of first achieving material influence over Maman, the Company included an allocation of the purchase price (PPA) for the proceeds in its Financial Statements for the first quarter of 2011, in accordance with IAS 28. Regarding the accounting policy implemented by the Company due to the first-time achievement of material influence over Maman, see Note 2g.
In January 2012 the Company was allocated an additional 1,739,852 shares free of charge, constituting 3.75% of Maman’s shares, so that the Company’s total holdings after this allocation amount to 15% of Maman’s issued and paid-up share capital. As a result, the Company listed a reduction of expenses in its books for the first quarter of 2012 under “airport fees and services” within the framework of operating expenses, to the amount of $2.4 million NIS.
The value of the Company’s holdings in Maman as of December 31 2012, in accordance with prices on the Tel Aviv Securities Exchange, amounts to $9,446,000 (not including holdings in options exercisable as ordinary shares).
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Note 13 - Fixed Assets and Flight Equipment a. Composition: Payments On Aircraft Account Vehicles Buildings and Flight Of Aircraft Machinery Computers and and Equipment and and Ground and Office Garage (1) (2) (3) Facilities Engines Equipment Furnishings Equipment Total Thousands of Dollars Cost As of January 1 2012 114,658 2,300,073 33,646 62,505 140,023 8,479 2,659,384 Reclassification - 1,941 (1,941 ) - - - - Additions 1,885 41,730 36,606 1,631 3,620 200 85,672 Disposals (44) (129,409) - (1,167) (91) (74) (130,785)
As of December 31 2012 116,499 2,214,335 68,311 62,969 143,552 8,605 2,614,271
Accrued Depreciation As of January 1 2012 80,432 1,192,925 - 54,861 130,780 7,973 1,466,971 Yearly depreciation 3,104 98,350 - 925 5,510 141 108,030 Disposals (44) (88,822) - (658) (91) (74) (89,689)
As of December 31 2012 83,492 1,202,453 - 55,128 136,199 8,040 1,485,312
Depreciated Cost: As of December 31 2012 33,007 1,011,882 68,311 7,841 7,353 565 1,128,959
Cost As of January 1 2011 110,533 2,320,699 14,526 61,822 133,876 8,185 2,649,641 Reclassification - 1,000 (1,000 ) - - - - Additions 4,125 75,206 20,120 1,337 6,291 309 107,388 Disposals - (96,832) - (654) (144) (15) (96,645)
As of December 31 2011 114,658 2,300,073 33,646 62,505 140,023 8,479 2,659,384
Accrued Depreciation As of January 1 2011 77,400 1,153,133 - 54,083 125,506 7,832 1,417,954 Yearly depreciation 3,032 98,390 - 984 5,418 156 107,980 Disposals - (58,598) - (206) (144) (15) (58,963) As of December 31 2011
80,432 1,192,925 - 54,861 130,780 7,973 1,466,971
Depreciated Cost: As of December 31 2011 34,226 1,107,148 33,646 7,644 9,243 506 1,192,413
Yearly depreciation rate 5%-8% See B2 - 5%-20% 5%-33% 10%-20% (Largely (Largely 33%) (Largely 15%) 10%)
(1) See h. below. (2) See b. below. (3) See c. below.
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b. Boeing aircrafts and flight equipment:
1 . Composition: 2 0 1 2 2 0 1 1 Amou nt Opera Aircraft Fleet Accumulated Accumulated ted and Model Cost Depreciation Balance Cost Depreciation Balance As of Dec. 31 2012 Thousands of Dollars
747-400 6 Passenger aircrafts 487,279 326,617 160,662 485,220 301,614 183,606 Spare engines 6,600 5,307 1,293 6,600 5,089 1,511 Engine overhauls 94,179 43,520 50,659 92,980 40,973 52,007 588,058 375,444 212,614 584,800 347,676 237,124
747-200F - Cargo aircraft 41,916 41,916 - 41,916 41,916 - Spare engines 17,481 17,481 - 17,481 17,481 - Engine overhauls 15,684 15,684 - 15,684 15,684 - 75,081 75,081 - 75,081 75,081 -
757-200 * - Passenger aircrafts 70,565 67,984 2,581 108,543 93,253 15,290 Engine overhauls 17,106 9,788 7,318 24,402 13,379 11,023 87,671 77,772 9,899 132,945 106,632 26,313
737-700/800 ** 8 Passenger aircrafts 276,311 86,411 189,900 273,538 75,493 198,045 Spare engines 5,961 794 5,167 11,978 3,463 8,515 Engine overhauls 39,562 23,176 16,386 46,021 23,024 22,997 321,834 110,381 211,453 331,537 101,980 229,557
767 2 200ER (passenger 120,672 112,796 7,876 156,377 143,028 13,349 aircrafts) Spare engines 1,649 1,327 322 1,649 1,272 377 Engine overhauls 35,742 26,081 9,661 36,708 25,380 11,328 158,063 140,204 17,859 194,734 169,680 25,054
777-200 *** 6 Passenger aircrafts 668,620 228,162 440,458 667,648 201,714 465,934 Spare engines 11,395 4,545 6,850 11,395 3,904 7,491 Engine overhauls 62,242 31,121 31,121 62,242 31,121 31,121 742,257 263,828 478,429 741,285 236,739 504,546
22 1,972,964 1,042,710 930,254 2,060,382 1,037,788 1,022,594
Accessories and Spare Parts - 241,371 159,743 81,628 239,691 155,137 84,554 General 2,214,335 1,202,453 1,011,882 2,300,073 1,192,925 1,107,148
* The activities of two aircrafts (EBU and EBV) were discontinued in November 2012, see Note 13.d.4. ** Including three aircrafts leased via financial lease. *** Including three aircrafts leased via financial lease.
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2. Depreciation Rates:
The yearly depreciation rate of each aircraft is determined taking into account its residual value, as it appears in the prevailing aircraft price list, which estimate the value of an aircraft for the year management assesses the use to the Company of that aircraft will end.
The following are depreciation rates for Company aircraft relative to cost (after deduction of residual value) for the year 2012:
Average Annual Aircraft Fleet Depreciation Rate
737 5.3% 747-400 6.7% 757 7.2% 767 8.4% 777 5.1%
As of December 31 2012, the balance of years remaining for the Company's aircraft fleet is between 5 months and 17 years.
The annual depreciation rate of the spare engines (engine body) was determined according to the average number of years remaining for that fleet of aircraft to which the engines are allocated.
Engine overhauls are depreciated according to potential engine hours that the overhaul added to that engine, and according to an estimate of the projected engine hours for that aircraft fleet in the coming years.
As of December 31, 2012, the balance of years remaining for general engine overhauls ranges between 5 months and 12 years.
Accessories and spare parts allocated to a specific aircraft fleet are depreciated over the average remaining life of that fleet. Accessories and spare parts that are not allocated to a specific fleet are depreciated at according to the average remaining life of the entire Company fleet.
c. Payments on Account of Aircraft and Flight Equipment – Composition:
As of December 31 2012 2011 Thousands of Dollars
Advance payment on account of the future purchase of aircraft from Boeing, see Note 13.d.1. 68,286 31,705 Advance payment for the purchase of winglets for 737 aircraft. 25 1,941 68,311 33,646 d. Aircraft and Engine Purchase and Sales Agreements:
1. In February 2011 an agreement was signed with aircraft manufacturer Boeing for the purchase of three new Boeing 737-900ER aircraft and two additional aircraft of the same model convertible to purchase options. In addition, the Company was granted the option to purchase two additional aircraft of this model. In addition, the Company’s Board of Directors approved the purchase of an engine to serve as an additional reserve engine for the aircraft fleet from CFM International SA. In this Agreement the Company was granted conversion rights for other models as well as associated rights. The comprehensive value of the agreement is estimated at between $215 million and $320 million (respectively for four to six aircraft, as purchased in practice, without the option).
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Furthermore, the parties agreed upon conditions for the use of advance payments made by the Company to Boeing for previous agreements. According to the agreement, the aircrafts are expected to join the Company’s aircraft fleet between late 2013 and 2016.
In July 2012 an agreement was signed confirming the purchase of two additional Boeing 737-900ER aircrafts (hereinafter: “the Fifth and Sixth Aircraft”). This purchase constitutes a waiver of the Company’s conversion right from purchase to the purchase option of the Fifth and Sixth Aircraft and comes ahead of the option's expiry date on October 15 2012. In October 2012 a revision was signed to the agreement on the subject of bringing forward the arrival date of the fifth 737-900ER aircraft from October 2015 to March 2014 as well as adapting the terms of the advance payments (PDPs) for the fifth aircraft while changing the payment dates in accordance with the terms agreed upon by the parties.
Pushing forward the delivery of the aircraft in this manner allows the receipt of 4 new aircrafts starting October 2013 to July 2014 within an eight month period and thus lowering the fleet’s age and continuing to reduce the size of the fleets. In addition, the Company is expected to receive two additional aircrafts in February and March 2015. The aircrafts are expected to serve the Company in short and medium ranges (Europe and regional destinations). Note that these are aircrafts of a new and advanced model, with modern engines and advanced internal configurations. In 2012 the Company made advance payments for the transaction to the amount of $36.6 million. In the matter of the loan agreement signed by the Company with a foreign in March 2012 bank to finance the advance payments for the purchase of the first two 737-900ER aircrafts, see Note 18.b.1.
2. In February 2012 an agreement was signed to sell two CFM 56-7B engines manufactured in 1998 and 2000 owned by the Company and to lease them back to the Company. The following are the key points of the transaction: a. The total proceeds for the engines are $13-$14 million U.S. The Proceeds were set according to market prices accepted in the industry for engines of an identical model and age and according to its maintenance condition upon delivery and were paid upon delivery. b. The lease period is for 7 years. c .The monthly payments to the lessor include the monthly leasing fees including the deposit of reserves for repairs for the engines activities in the leasing period, as required in accordance with the leasing agreement, which together constitute 0.75%-1.2% of the proceeds. d. The Company was granted an option to extend the leasing period by two additional extension periods, of three and two years, respectively, in accordance with market conditions on the extension date. The lease was classified as an operational lease in the Financial Statements. The Company listed capital gains of $9.4 million in its 2012 Financial Statements for the transaction.
3. In February 2012 an agreement was signed with TES Parts Limited (connected to DVB Bank) for the sale of a Boeing 757-200 aircraft (EBT) for disassembly into parts in return for $4.6 million. The consequential impact of the transaction on the Company’s financial statements is not material.
4. In October 2012 the signing of the agreement papers for the sale of two Boeing 757-258ER aircrafts manufactured in 1993 and two spare Rolls Royce engines to a foreign company was completed. The proceeds set in the agreement papers for the aircraft and the spare engines were determined according to market prices accepted in the industry for engines of an identical model and age and according to their maintenance condition upon delivery. The aircrafts were delivered in January 2013. The Company listed a capital loss of $5.9 million (before tax) in 2012 for the transaction. Following the sale of the aircrafts, the liens on the aircrafts were removed and the Company provided alternative collateral to a banking institution, See Section g. and Note 35 below. This transaction was carried out as part of the Company’s policy to lower the age of the Company's aircraft fleet and upon its completion, all of the Company's Boeing 757 aircrafts have been removed from service, and as reported by the Company, the aircraft have been replaced by newer and more efficient Boeing 737 aircrafts, following the agreement signed between the Company and Boeing, as noted above. e. Aircraft Impairment
As noted in Note 2k above, if signs indicating of impairment exist in an aircraft fleet, the Company conducts an estimate of the recoverable sum of than aircraft fleet. The recoverable sum is the fair value of the aircraft less sales costs or its value in use, whichever is higher. In estimating value in use, the Company estimates the expected contribution and
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deducts it to its current value using a discount rate reflecting the operational risk of the aircraft fleet based on the Company’s weighted discount rate. The following are key assumptions used in calculating value in use: 1. The expected contribution from the aircraft fleet is based on results in practice for 2012, and is projected forward unchanged across the economic life span of the entire aircraft fleet, unless expressly noted otherwise. The Company uses this method consistently in its value estimates of its aircraft fleets. The Company believes that based, among other things, on an examination of estimates included in value assessments in the past, the best estimate for the expected contribution from the aircraft fleets is the Company’s results in practice for the previous year, unless if the Company knows of any exceptional events on the date the value assessment was prepared. 2. Useful life – for the 777-200 fleet - 11 years of activity on average, for the 747-400 fleet - 6 years of activity on average. 3. The operational discount rate amounted to 5.5% after tax (discount rate before tax: 747-400 fleet – 16%, 777- 200 fleet 11%). Material differences in these estimates, or in part of them, may impact the value of the recoverable sum of these aircraft.
Over the course of the reported period, the Company examined the recoverable value of aircraft fleets in which signs of deterioration were evident. It was found that the recoverable sum for each aircraft fleet surpasses its depreciated cost as of that date. Accordingly, no provision for the impairment of aircrafts was made in these Financial Statements. f. Ratio of Loan Balance to Collateral
As of this report, no difference exists in the loan balance to guarantee ratio, see Note 18.f.1. g. Unrestricted Assets
The value of the Group's total fixed assets as of December 31 2012 is $1,129 million. The Group's key assets are aircraft and spare engines, the depreciated cost of which as of December 31 2012 is $930 million. The depreciated cost of the Group's main assets, as stated, that are not restricted by a third party amounts to a total of $31 million. In addition, as of the balance sheet date, the Group possesses parts and fixed assets to the amount of $199 million, free of any encumbrance. Over the course of May 2012 three 767-200ER aircrafts were freed of liens (EAD, EAE and EAF). Over the course of December 2012 two 757-200 aircrafts were freed of liens (EBU and EBV). h. Buildings and installations: As of December 31 2 0 1 2 2 0 1 1 Cost Accumulated Balance Cost Accumulated Balance Depreciation Depreciation Thousands of Dollars
Building, aircraft hangers, warehouses, workshops and offices at BGN. 78,246 49,890 28,356 76,757 47,799 28,958 Leasehold improvements of rented 23,758 19,822 3,936 23,423 18,916 4,507 offices Freehold offices 2,971 2,256 715 2,954 2,193 761 Passenger and cargo terminals 11,524 11,524 - 11,524 11,524 - 116,499 83,492 33,007 114,658 80,432 34,226
i. Assets Pledged as Collateral
For details regarding the Group's assets pledged as collateral for the Group's liabilities, see Note 35 below.
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Note 14: - Intangible Assets
Composition: Usage Rights to Security Software Equipment (*) (**) Total Thousands of Dollars Cost Balance as of December 31 2012 4,544 13,276 17,820
Depreciated Cost As of December 31 2012 1,318 8,074 9,392
Cost Balance as of December 31 2011 4,507 9,444 13,951
Depreciated Cost As of December 31 2011 1,638 6,357 7,995
Yearly depreciation rate 7%-20% 20%
(*) Usage rights for security equipment
The Company pays a relative portion of the security costs of the Government of Israel pertaining to safeguarding the Company's passengers and aircraft from acts of war and terror, as set from time to time in Government resolutions. Accordingly, the Company lists under intangible assets the payments made for its share in financing the protective systems and security inspection equipment. The Company has an arrangement with the Ministry of Defense, according to which this equipment will be used by the Company exclusively over its anticipated useful economic life. (**) Software:
This section mainly covers the Amadeus Project and the SAP Project. Stage A of the implementation of the financial SAP system has been completed and the Company began using the system on January 1 2013. This stage largely consists of the payment system (AP) at the main office and at the Company's representatives.
Note 15 - Short Term Borrowing and Current Maturities a. Composition:
As of December 31 2 0 12 2 0 11 Thousands of Thousands of Dollars Dollars
Current maturities of long-term loans 139,374 95,526 Current maturities of other loans 2,021 2,127 Bank overdraft 18,921 8,292 160,316 105,945
Yearly interest (in %) 0.3-6.1 0.4-6.7
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b. Liens and collateral – see Note 35.
Note 16 - Trade Accounts Payable a. Composition: As of December 31 2 0 12 2 0 11 Thousands of Thousands of Dollars Dollars
Open accounts 133,593 153,262 Airlines 11,239 7,540 144,832 160,802 b. The average credit period granted as a result of goods purchasing is 43 days (2011: 46 days), for which the Group does not pay interest.
Note 17 - Other Payables
a. Current Liabilities
Composition: As of December 31 2 0 12 2 0 11 Thousands of Thousands of Dollars Dollars
Airport fees and taxes 25,485 24,485 Interest payable on long term loans 2,418 2,749 Deposits received for passenger groups 11,552 9,901 Payables due to cargo claims 4,331 3,258 Advance payments from customer for future flights - 13,500 Other accounts payable 8,457 13,522 52,243 67,415
b. Non-Current Liabilities
Composition: As of December 31 2012 2011 Thousands of Thousands of Dollars Dollars
Payables due to cargo claims 4,350 3,236 Lease incentives (See Note 24c). 4,437 4,437 8,787 7,673
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Note 18 - Long-Term Loans
a. Composition:
As of December 31 2 0 12 2 0 11 Thousands of Thousands of Dollars Dollars
Loans at variable interest 542,540 570,967 Loans at fixed interest 83,293 93,366 625,833 664,333 Less – current maturities (141,395) (97,653) 484,438 566,680
Less – balance of loan arrangement costs (7,772) (9,041) 476,666 557,639
Yearly interest from banks and others (in %) 0.3-6.1 0.4-6.7
Effective yearly interest from banks and others (in %) 0.7-5.5 0.7-6.0
b. Additional information:
1. In March 2012 the Company signed a loan agreement with a foreign bank to finance the advance payments for the purchase of the first two 737-900ER aircrafts, which were purchased in February 2011 from aircraft manufacturer Boeing, in return for a total of up to $46 million. The loan is in USD and bears interest of Libor plus a margin. Loan interest payments are semiannual payments. The principal shall be repaid upon receiving the long-term loan for financing the purchase agreement. The financing period is up to the date set in the new agreement for the arrival of the two aircraft at the Company (over the course of the last quarter of 2013). To guarantee the loan’s repayment, the Company shall assign its rights to the two aircrafts in accordance with the new agreement to the foreign bank. The loan agreement includes a commitment by the parties to finance the purchase agreement for the two aircrafts (under the condition that Exim’s guarantee for the purchase agreement is received, which Exim estimates will be granted by March 21 2013), unless the Company decides to finance it through some other factor, in accordance with the terms set between the Company and the foreign bank. A sum of $26.4 million was received over the course of the reported period.
2. In August 2012 the Company signed a loan agreement with a fully owned subsidiary of aircraft manufacturer Boeing. The sum of the loan is $40 million. A total of $30 million of the sum of the loan was provided in August 2012 and the balance of the loan will be provided in July 2014. The loan is a dollar loan for a period of 8 years from the date the first part of the loan is taken and bears interest of Libor plus a margin. The loan will be repaid in monthly payments over 8 years, with the Company paying only interest payments in the first two years, followed by principal and interest payments. As a guarantee for the payment of the loan the Company placed a lien on a 777-200RE aircraft purchased in 2002 (hereinafter: “the Aircraft”). The Aircraft was pledged to a foreign banking institution pursuant to receiving a loan for its purchase, and upon signing the loan agreement, the priorities of the liens on the plane were arranged. According to the loan agreement, provision of the loan depended, among other things, on the terms detailed below: (a) Signing an agreement by December 31 2012, or a later date agreed upon by the parties for the lease of two 787 aircrafts or alternately, an agreement to purchase one or more 787 aircraft. In the event that the Company fails to uphold this condition and/or the Company violates agreements for the purchase of other aircraft from Boeing that have yet to be received by the Company, according to the agreement a fully-owned subsidiary of Boeing shall be entitled to
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demand the immediate repayment of the loan, including the interest and margin for it and plus a redemption commission. (b) Waiving the Company’s conversion right from purchase to the purchase option of two additional Boeing 737-900ER aircrafts.
Due to the stipulations listed above, this loan is presented in the December 31 2012 Financial Statements under Short-Term Borrowing and Current Maturities.
Following that stated in (a) above, the parties agreed to extend the signing date of an agreement for the lease of two 787 aircrafts or alternately, an agreement to purchase one or more 787 aircraft, to June 30 2013 or some later date, as agreed by the parties.
3. In December 2012 a loan to the amount of 15 million NIS received from a credit card company was repaid, with a new loan to the sum of 15 million NIS provided by the same credit card company. The credit card company undertook to make future purchases of frequent flyer points, with the points within the framework of the future purchase constituting collateral for the loan. The loan was granted for a period of two years in monthly principal and interest payments at an interest rate of Prime plus a margin.
c. As for hedging transactions to fix variable interest rates – see Note 26g.
d. Financing the Company’s Investment Plan:
The Company estimates that an examination may be necessary, from time to time, of the need to raise additional sources of finance the Company’s investment plan and the purchase of aircraft and/or a strategic plan, if the decision is made to purchase them.
e. Early repayment:
All existing loans as of December 31, 2012 may be repaid early by the Company. In addition, some of the loan agreements taken by the Company feature the right on behalf of the bank to immediately redeem the balances of the loan toward the relevant bank in the event of actions such as mergers or transfers of control without the bank's advance written consent, and the agreements also include the bank's right to demand the additional repayment of the balances of the loan in the event of other standard occurrences generally accepted in financing transactions.
f. Restrictions and financial covenants of long-term loans:
1. Ratio of loan balance to collateral:
Some of the credit agreements set a ratio of loan balances to securities, see table below (the balance of the debt to the bank compared to the market value of the pledged aircraft at a ratio of between 65% and 80%)*. An examination of compliance with the ratio should be conducted once a year (in some agreements – twice a year) based on certain stipulated international professional publications. The Company has also undertaken that should the actual ratio be lower than the above ratio, the Company will provide additional collateral, or repay its bank loans earlier, in order to fulfill the ratio requirement. The Company has provided aircrafts in its possession as additional collateral for loans taken by the Company to finance its aircraft fleet. For further details, see Note 35.
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Uncleared Scope of Unpaid Balance to Loans Balance Final Loan Loan Aircrafts as Loan Start Value of (Thousa (Thousan Repayment Characteristics Collateral Date Collateral nds of ds of Date Ratio Dollars) Dollars) Requirement 3 777-200 aircrafts, 3 737-800 aircrafts, 1 Local banking 490,000 203,698 737-700 13/01/2000 27/07/2017 80% institution (**) aircraft
2 747-400 aircrafts (*) 1 747-400 aircraft Local banking 150,000 41,667 1 737-700 20/05/1999 16/08/2017 65% institution aircraft (***)
(*) With the exception of one 747-400 aircraft, taken as collateral at a ratio of 50%.
(**) A cross default mechanism exists between the various loans of the same banking institution.
(***) Over the course of December 2012, following their sale, two 757-200 aircrafts (EBU and EBV) were freed of liens. As a result, the Company made a deposit as collateral in favor of the banking institution.
2. Single borrower and group of borrowers limitation:
The directives of the Supervisor of Banks in Israel include restrictions according to which the debt of a “single borrower” and of a ”group of borrowers” to a bank in Israel shall not exceed a given percentage of that bank’s shareholders’ equity. From time to time, these directives may affect the ability of some of the banks in Israel to grant additional credit to the Company. Due to the change in the holdings in the Company, whereby K’nafaim is the controlling shareholder and holds more than 25% of the Company’s issued share capital, the Group is considered a part of the K’nafaim group with respect to the borrower-group restriction placed on the granting of bank credit. In addition, in light of the weight of the Company’s long-term liabilities to banks in Israel, the Company may encounter difficulties raising additional credit in significant amounts from Israeli banks.
3. Arrangement with banks prior to privatization:
a. In 2004, management requested that BLL agree that the transfer of control to K’nafaim would not give the BLL the right to demand immediate repayment. In this regard, BLL informed the Company that it had no objection to the change of control in the Company whereby K’nafaim would increase its holdings in the Company in a manner that would cause it to be the controlling party in the Company.
BLL’s consent is contingent upon the fulfillment of the following conditions:
1. The controlling parties in K’nafaim will be the Borowitz family. The term “control” for this purpose is as defined in the Banking Law (Authorization), 1981.
2. The change in ownership referred to above would take place no later than June 5, 2007. Subject to the above, it was agreed that BLL would not exercise its right to demand immediate repayment of the Company’s outstanding debts and liabilities solely as the result of the above change in control. - C 41 - Free Translation of the Hebrew Language 2012 Annual Report - Hebrew Wording Binding
b. Within this framework, K’nafaim informed BLL that, in light of the Company’s present outstanding debt to BLL, and due to the fact that the Company’s Board of Directors will, from time to time, formulate a profit distribution policy for the Company, then as long as the open principal balance of the outstanding debt of the Company to BLL is not less than $50 million, K’nafaim will not support a resolution for profit distribution at a rate exceeding 60% of distributable retained earnings of the Company from time to time, unless following consultation with BLL regarding any amount in excess of 60%.
g. Liens and collateral – see Note 35.
Note 19 -Employee Benefit Liabilities
a. Composition: As of December 31 2 0 12 2 0 11 Thousands of Thousands of Dollars Dollars
Post-employment benefits within the framework of defined benefits plans: Retirement benefits 6,266 6,065 Liability due to retirement and severance pay (34,416 ) (33,907) Pension funds 3,369 3,484 Redeemed sick pay 39,178 37,083 14,397 12,725 Other long term employee benefits: Benefits due to anniversary grant 1,283 996 Other 1,585 1,695 2,868 2,691 Termination benefits At-will retirement plans (1,332 ) 2,946 Less current maturities (104) (390) (1,436) 2,556 Short term employee benefits: Wages, salaries and social benefits 44,628 45,815 Vacation and rest days 53,325 52,687 97,953 98,502 Presentation in balance sheet: Assets due to employee benefits: Non-current, net 42,369 39,817 42,369 39,817 Employee benefits obligations: Current 97,953 98,502 Non-current, net 58,198 57,789 156,151 156,291
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b. Division by Linkage Conditions
As of December 31 2012 As of December 31 2011
In Other In Other In Dollars Currencies In Dollars Currencies Thousands of Dollars Thousands of Dollars
Post-employment benefits within the framework of defined benefits plans 6,739 7,659 6,644 6,081 Other long term employee benefits 1,046 1,822 1,168 1,523 Termination benefits - (1,436) - 2,556 Short term employee benefits - 97,953 - 98,502 Total employee benefit obligations 7,785 105,998 7,812 108,662
c. Post-Employment Benefits:
(1) Defined Deposit Plans
Retirement and Severance Compensation Plans
Israeli labor and severance compensation laws require that the Company and its subsidiaries pay compensation to employees upon retirement or dismissal. The calculation of liability as a result of the termination of employee-employer relationships is carried out in accordance with the valid employment agreement and is based on the employee's salary which, in management's opinion, creates the right for compensation.
The Company and its subsidiaries have approval from the Ministry of Labor and Welfare in accordance with Section 14 of the Severance Pay Law 1963, according to which its current deposits in pension funds and insurance policies exempt it from any additional obligations towards its employees, for whom the aforementioned sums were deposited. The Group shall have no legal or implied obligation to make additional payments if the plan has insufficient assets to pay for all employee benefits pertaining to the employee's service in the current and in previous periods. The total sum of expenses charged to the Statement of Operations for defined deposit plans in the year ending December 31 2012 is $15,336 thousands (2009: $14,354, 2010: $12,926).
(2) Defined Benefit plans
a. Severance and Retirement Compensation Obligations
Israeli labor laws and the Severance Pay Law require that the Company and its subsidiaries pay compensation for employees upon dismissal or retirement (including employees departing from the workplace under other specific circumstances). The calculation of the liability for the discontinuation of the employer-employee relationship is carried out in accordance with the valid employment agreement and is based upon the employee's last salary payment, which, in management's opinion, creates the right to receive compensation, taking his years of employment into consideration.
The obligation in question was calculated using actuary tables. Actuary estimates were also conducted by Ogen Ltd., a member of the Israeli Actuary Association. The present value of a defined benefit liability and the costs relating to current service and past service were measured using the Forecast Entitlement Method.
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b. Pension Agreement
Starting September 1992, the social rights of part of the Company’s employees have been regulated within the context of a pension agreement. Pursuant to this agreement, an employee joining the comprehensive pension plan must insure a portion of his salary in the pension plan and the balance can be directed to executive insurance or to the provident fund of the Company's employees. After the agreement was signed, new employees must be insured by the comprehensive pension. The agreement stipulates that the Company's payments to the pension fund and an approved fund (executive insurance or provident fund) for an employee joining the pension plan, will come in lieu of its severance pay obligation to that employee, pursuant to Section 14 of the Severance Pay Law, 1963, for that part of the salary and for that period as to which the payments were made. Up to the date of joining, the employee is entitled to severance pay based on his last salary.
During 2005, amendments were made to the Income Tax Regulations (Rules for Approving and Managing Provident Funds), which change the rules for deposits and withdrawals of monies in pension insurance plans, inter alia, with regard to the reduction of the maximum sum that may be insured in capital insurance. In June 2005, the Company, the New Workers’ Histadrut – Professional Union Department and the Employees' Association of El Al Employees signed a special collective agreement that enables the adjustment of the provisions to the new rules, as selected by the employees.
c. Executive Insurance Agreement
The agreement between the Company and the Phoenix Israeli Insurance Company Ltd., which became effective December 1, 1990, was extended until the end of the effective period of the executive insurance policies that were issued under its auspices to employees. According to the stipulations of the pension agreement, redirecting part of the pension salary to executive insurance is conditional upon joining comprehensive pension. Executive insurance may be considered solely a savings plan or a savings plan with specified insurance (insurance against work disability and/or life insurance). The provisions for insurance are at the rate of 18.33% of the insured salary, of which 18.33% is for severance pay, 5% for a provident fund on the Company’s account and 5% for a provident fund on the employee’s account.
(3) Severance Pay
a. General:
Employees who received tenure by September 1992 are entitled to severance pay for their employment until then, computed on the basis of one month for each year of employment. With regard to the employment period thereafter, the above employees are entitled to severance pay if they have not joined a pension plan, or a combined plan of pension, managers' insurance and savings in a provident fund (at their personal selection) according to the rules set in the collective labor agreement. Employees who subsequently received permanent status in the Company were then obligated to join the pension plan by selecting the appropriate pension combination, but are not entitled to severance pay. Prior to the privatization date, the Company had concluded arrangements with the employees for assuring severance pay and with the State of Israel to assure financing sources. See b. below.
b. Arrangements with the employees for assuring severance pay and with the State of Israel to assure financing sources:
Until the pension agreement was signed, Company personnel employed in Israel who were covered by the collective agreement had no pension insurance. According to the provisions of the collective agreement, since January 1983, the Company makes deposits (for employees who did not join the pension) of 8.33% of the current wages of the employees in a provident fund for severance pay in Israeli banks. The deposits are in the Company’s name. Since the Company did not deposit monies for severance pay in a severance pay provident fund until January 1983, and since January 1983, severance pay was paid to retired employees from the money accrued in the provident funds for severance pay, a substantial shortfall was created in the provident fund
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for severance pay, which was filled in by deposits from the Company’s and the State’s option money by virtue of the stock issue. In June 2003, an agreement was signed between the State, the Company and the employees’ association, according to which the State and the Company agreed to act to cover the deficit between the provisions for severance pay recorded in the Company’s accounts (“Provision”) and the monies actually deposited into the severance pay provident fund (“Fund”) and which is connected to the eligibility of employees who had been employed by the Company at the date that the Company entered receivership in 1982 and who continued to be employed in June 2003 ("the Eligible Employees"). On the date of the agreement, the deficit amounted to 516,240,000 NIS and was CPI-linked linked bearing 5.05% yearly interest, starting June 1, 2003. Under this agreement, the State and the Company transferred the immediate proceeds which they received from the sale of securities in the pursuant to the 2003 Prospectus (“the initial offering”), less expenses, to the severance pay fund for the eligible employees (the balance of the severance pay funds includes the above proceeds). The State and the Company also undertook to transfer to the severance pay fund of the eligible employees, any amount that was raised from the conversion of convertible securities that were issued in the initial offering or from the sale of securities in other offerings which would be executed through the date of the end of the last exercise date (June 5, 2007). After making the above State and Company deposits, the deficit in the fund for eligible employees, as defined in the agreement between the Company and the State signed on the eve of the Company's privatization, was covered. After making the above deposits and fully covering the deficit in the severance pay fund, as required by the agreement, the Company deposited 32 million NIS (including interest accrued as of the reporting date), representing the balance of the offering proceeds, in a separate account (included in short-term deposits as of December 31, 2012 – see Note 7 to the Financial Statements). As part of the restatement of the Financial Statements on December 31 2007, the capital reserve from transactions with a former controlling party was reduced in return for a liability listed to the State of Israel. The Company is assessing whether limitations exist to its ability to use the said balance of proceeds, pursuant to the agreement between it and the State, and in this context, it has requested a response from the General Comptroller of the Ministry of Finance. As of this report, negotiations are taking place with the General Comptroller’s Office at the Ministry of Finance in order to examine entitlement to issue surpluses.
(4) Redemption of Sick Pay
Pursuant to the collective labor agreement, employees are entitled to 30 fully paid sick days per year, which may be accrued throughout the employee’s employment at the Company. Upon retirement from the Company, via mandatory retirement or retiring after reaching the age of 45, permanent employees (other than executives, beginning from their transition to personal employment contracts) are entitled, if they retired under terms entitling them to severance pay, to receive a grant for unused sick days, at a rate of up to 26.6% of the value of the unused days. The liability for this bonus was determined on the basis of the rights accrued for those eligible employees who reached the age of 45 as of the Financial Statements date (except for new employees, for whom the accumulation is limited), plus an estimate regarding younger employees who will also achieve the conditions granting the right to receive sick day pay.
(5) Temporary Employees
Pursuant to the labor agreement signed by the Company and the temporary employees, these employees have joined the comprehensive pension plan, and the Company deposits monthly amounts for them on a current basis. These deposits cover the Company’s obligations for the termination of employee-employer relationships for its temporary employees. As regards the special collective labor agreement signed between the Company's employees, the workers' representatives and the Histadrut – see Note 19.c.(12) below.
(6) Flight Crew Personnel
Flight-crew personnel are entitled, according to an agreement, to receive severance pay for their period of employment through December 1979, computed on the basis of their last salary, or their salary for the
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month of December 1979 (net of the part of the salary for which severance pay had been paid in the past - 20%), linked to the Israeli CPI, whichever is higher. As for the period subsequent to December 1979, the Company's liability for severance pay is calculated on the basis of their last salary. As to the lawsuit filed against the Company as a result of the change in retirement ages – see Note 22.d.1 below.
(7) Senior Company Executives
Company executives are employed under personal employment agreements. These employees, with the exception of one, are entitled to receive additional severance pay for the period of their employment of 100%, in excess of the balances accumulated in the provident funds and/or insurance companies.
(8) Employees Posted Abroad
The Company employs abroad, among others, permanent workers, consisting of Israeli residents dispatched to fill managerial positions abroad (“posted’). As of December 31 2012, 25 employees out of all of the Company's overseas employees (324) were Israelis posted abroad. Similar to State emissaries abroad, the salaries of those posted during their service abroad (hereinafter “Salary Abroad”) are also different from Israeli salaries, considering the standard of living and taxation abroad, and also the fact that the salary is subject to income tax and social taxation, both abroad and in Israel. The salary abroad, including participation in car maintenance, is paid to the posted employee based on “net salary” (taxes, including social taxation and the grossing-up abroad, are paid by the Company). If the salary abroad or special payments in excess of the tax-exempt ceiling are subject to tax in Israel, the Company assumes the Israeli tax. In addition to the salary abroad, the Company also bears the rental costs of those posted as well as tuition expenses for their children. These payments (up to a certain ceiling) are tax-exempt in Israel, but are liable for tax according to the laws of the different countries. The Israeli salary of the posted employee (salary according to rank and position, had they been employed in Israel) serves as the determining salary by the Company for the purpose of making provisions for severance pay, for compensation (or pensions and or executive insurance) and to an advanced education fund, as is stipulated in the posting letter. Benefits after the termination of employee-employer relationships for those employees are determined on the basis of wages paid to employees of the same rank employed in Israel.
(9) Local Employees in Company Branches Abroad
Most Company employees abroad, other than the Israeli posted employees, are employed under collective labor agreements between the Company and the union in that country, or under employment agreements with the employees’ representatives, with a few under agreements between the employers' organization (foreign airlines) and the umbrella organization of airline employees, or under other agreements. The employment terms of Company personnel in certain countries are not covered by a collective agreement but rather stipulated by the Company, in accordance with the acceptable practice in the airline industry or the national airlines in those countries. In some branches, the employees are engaged under personal contracts or through a contractor.
Some of the branches are committed to pay severance pay according to law or agreement while other are obliged to adhere to national or other pension insurance. The Company transfers regular payments to pension insurance.
Some of the local Company employees who are residents of the U.S. and the U.K benefit from pension plans ("the Plans"), with the pension cost of the branch employees being paid for by the Company. The cost of the pension is calculated as a multiple of the "years of eligibility" for the pension multiplied by the rate of salary determining the pension. Retirement starting from the age of 65 ordinarily entitles the employee to full benefits. The pension plan assets, which are invested mainly in tradable securities, are not owned by the Company. The Company is obliged to cover any deficit that would be created in the value of the funds’ assets relative to any actuarial obligation, should such a deficit be created. An extension was signed to the agreement with the U.S. trade union on February 15 2011 for the period between January 1 2011 and December 31 2013.
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Regarding the pension fund in the UK, starting from 2005 the fund does not accept new workers and no addition rights are accumulated pursuant to the principal.
(10) Security Personnel
Payments for the discontinuation of employee-employer relationships to personnel employed by the Company or by a government entity providing protection for the Company's services are paid from the State’s aviation security budget. Regarding security personnel employed directly by the Company, a provision is made for the discontinuation of employer-employee relations, less the State's participation in these expenses. Most of the security workers employed by government bodies have is no employee- employer relationship with the Company, and accordingly, no provision was included in these Financial Statements to cover such payments. For details regarding the security personnel suit, see Note 36c.
(11) Employees of Subsidiaries
Terms of employment in the Company's main subsidiaries in Israel are regulated by labor agreements, pursuant to which the obligation for termination of employee-employer relationships is calculated on the basis of their last salary and of pension arrangements, as applicable. The employment conditions of the main foreign subsidiaries are regulated by collective labor agreements in those countries and in accordance with local laws and practices.
(12) Collective Agreement
a. General
In addition to labor legislation and extension orders, the terms of employment of Company personnel employed in Israel, with the exception of the executives and other personnel employed under personal contracts, are organized in special collective agreements that are signed from time to time between the Company and the New General Workers Histadrut (above and hereinafter – “the General Histadrut”) and also by procedures that are published from time to time by management.
Section 6(e) of Chapter A of the collective agreements states that “During the negotiations period, but for no more than six (6) months from the date on which it is no longer in effect, this agreement shall remain in effect and at the conclusion of the 6 months in question, shall be considered a collective agreement for an unspecified period and shall be covered by Section 14 of the Collective Agreements Law, 1957.
Company management has informed the workers’ representatives of its request to engage in negotiations to renew the work agreement, noting the key subjects regarding which Company management intends to negotiate.
In the event that the negotiations do not lead to a binding agreement, Section 6(e) shall apply, meaning that after June 2013 the collective agreement shall become an agreement for a non-specified period, and according to Section 14 of the Collective Agreements Law, each party may cancel it with two months advance notice.
The collective agreement signed in November 2008 expired on December 31 2012. Discussions to renew the agreement were held between November 2012 and February 2013. At the same time, after signing the letter of understanding with the FIMI Fund on January 23 2013 (for details see 36b below), on February 11 2013 the workers; representatives announced that it would be freezing talks until the decision of the FIMI Fund, after conducting due diligence, regarding its investment in the Company.
b. Special Collective Agreement for Generation A Employees (hereinafter – “Generation A Agreement”)
The special collective agreement applies to all of the Company’s permanent employees in Israel, including air crews. The agreement does not apply to senior employees (executives and others), who have personal employment agreements, nor to temporary employees who have their own special collective agreement.
The agreement regulates all of the terms of employment of the permanent employees, and stipulates, inter alia, work procedures, basic rights and obligations, productivity incentives, appointments and stationing
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abroad, internal tenders, insurance, pension arrangements, dismissal procedures, response to disciplinary violations, rights to free and discounted airline tickets and a conflict resolution apparatus.
The agreement forbids strikes and sanctions, unless the strike has been declared by the Histadrut in compliance with the Law for Settling Labor Disputes, 1957, and subject to the Histadrut constitution, including a vote via secret ballot by all employees.
According to the agreement, all permanent employees of the Company are ranked based on an enterprise wage ranking, which has no connection to national rankings. There are a number of rankings: ground employee ranking; “veteran” air crew personnel ranking; a separate ranking at lower wages for “new” air crew personnel; “veteran” flight attendant crew personnel ranking and a separate ranking at lower wages for “new” flight attendant crew personnel.
In addition, the agreement includes a commitment to maintain work discipline, references to bonuses and salary additions dependent on the Company’s profitability, instructions regarding the discontinuation of work, shifts, rest times and promotion plans.
c. Special Collective Agreement for the Employment of Temporary Personnel (“the Temp Agreement”)
The terms of employment of the temporary employees have been arranged in a special collective agreement that, on May 20, 2004 was extended to December 31, 2008. The agreement stipulates the maximum length of employment of temporary employees, in accordance with the type of work and the department in which the worker is employed. The agreement regulates all of the terms of employment of temporary employees, including wages, bonuses, provisions for comprehensive pensions, insurance, sick leave, rights to airline tickets, etc. The agreement was extended as part of the Special Collective Agreement on November 2 2008 to December 31 2012.
As special collective agreement pertaining to temporary flight attendants and temporary employees in the administrative sector was signed in February 2011. According to the agreement, a special reserve of 150 employees from each sector shall be established, who shall remain employed for an additional period of up to ten years as temporary employees. The working conditions of these employees shall be equivalent to full-time second generation workers, with the exception of the education fund. These employees shall adhere to the second generation employee disciplinary code. Dismissal of such employees due to incompatibility shall be via a consensual on par committee or following arbitration. The agreement shall remain in effect for three years with the option of extending it by an additional two.
Note that most of the Company’s service personnel are employed as temporary workers and this agreement constitutes a significant milestone regarding aspects of service quality and is expected to reduce personnel turnover, increase profitability with the aim of achieving service excellence, as a material value in the Company’s approach.
d. Special Collective Agreement (Ground Crew- “Permanent Intermediate Generation”).
The agreement was signed on May 20, 2004. It pertains to employees who began working prior to January 1, 1999 and is intended to apply different terms to them than those stipulated in the agreement for Generation A and those stipulated for the Next Generation. The agreement was extended as part of the Special Collective Agreement on November 2 2008 to December 31 2012.
e. Special Collective Agreement (Air Steward Crew Personnel -“Permanent Intermediate Generation”).
The agreement was signed May 20, 2004, and pertains to flight attendants who began employment prior to September 1, 1996 and flight attendants who commenced employment between January 1, 1996 and December 31, 1997, and is intended to apply different terms to them than those stipulated in the agreement for Generation A and for those stipulated for the Next Generation. The agreement was extended as part of the Special Collective Agreement on November 2 2008 to December 31 2012.
f. Special Collective Agreement (Securities)
The agreement was signed on May 20, 2004. It obligates the Company to act to create balance among all personnel whose employment is organized by special collective agreements (Generation A, Interim - C 48 - Free Translation of the Hebrew Language 2012 Annual Report - Hebrew Wording Binding
Generation, Next Generation), in order to avoid the preference of one field over another and also regards granting future wage increments to different fields. The agreement stipulates, inter alia, that the number of permanent employees in certain professions may not be less on various dates than those stipulated in the agreement. The agreement was extended as part of the Special Collective Agreement on November 2 2008 to December 31 2012.
g. Special Collective Agreements for Ground Crews and Air Steward Crews (Shortening Stay Over)
In July 2006 and in July 2007, a number of special collective agreements were signed between the Company and the New General Workers Histadrut - the Division for Professional Unions and the employees' representatives, relating to ground crews and flight attendant crews for improving the Company's operational flexibility by removing existing restrictions on flying direct flights without any intermediate stopover and shortening the stay of the crews in North America. The agreement was extended as part of the November 2 2008 Special Collective Agreement to December 31 2012.
h. Special Collective Agreement for Finding Agreed-Upon Solutions for the Company’s Streamlining in All Segments
The agreement was signed on May 9 2011 and allows changes to the terms of employment of technicians, in that technicians who are not signing technicians will be certified as signing technicians in Israel only, for Boeing and Airbus planes only, and will as a result carry out tasks detailed in the agreement, beyond those defined in their duties prior to signing the agreement, in return for salary increases, for a restricted period of time. The agreement shall remain in effect until December 31 2012.
i. Special Collective Agreement for 1st Generation Employees for the Deposit of Severance Pay in a Fund in the Employee’s Name
The agreement was signed on December 22 2011, in light of a legislative arrangement that came into effect on January 1 2011, and which no longer allows the deposit of severance pay in the main compensation fund. In accordance with the agreement, 1st Generation employees for whom severance pay was deposited in the main fund as of December 31 2010, shall have money deposited starting January 1 2011 in the compensation component in the provident fund in the employee’s name.
(13) Chief Actuary Assumptions as of the Balance Sheet Date
As of December 31 2 0 12 2 0 11 2 0 10 % % %
Discount rates 3.2% 3.9% 4.2% Projected yields on the plan's assets 3.2% 3.9% 4.2% Projected salary increase rates 3.5% 3.7% 3.7% Replacement and departure rates: Until 39 years of age 4.1% 5.0% 5.0% Between the ages of 40 and 49 2.8% 3.0% 3.0% Between the ages of 50 and 54 2.0% 2.0% 2.0% Between the ages of 55 and 59 1.0% 1.0% 1.0% Between 60 and retirement 0.5% 0.5% 0.5%
The assumptions regarding future mortality rates (including reductions in future mortality rates) are based on statistical data published by the Capital Markets, Insurance and Savings Branch of the Ministry of Finance in Circular 80-2012 from November 2012. The Group makes use of a discount rate appropriate to the market's yields from government bonds.
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In the event that use is made of the discount rate of corporate bonds, this is expected to have a material impact on the Group's Financial Statements. A decrease shall occur in the sum of the defined benefit plan to the amount of $11,671 thousands (2011: $14,040 2010: $13,188) as well as a $936 thousands increase in employee benefit plans (2011: $1,140 2010: $1,066).
(14) Sums Recognized in the Statement of Operations for Defined Benefit Plans
For the Year Ending December 31 2 0 12 2 0 11 2 0 10 Thousands of Dollars
Current service cost 6,252 6,285 8,167 Interest cost 9,547 10,713 11,794 Projected yield on the plan's assets (9,143 ) (10,787) (11,352) Real yield transferred from compensation to remuneration 349 276 273 Exchange rate differences 1,526 778 10,155 Deviation from strip 2,001 989 815 Changes in the period 197 4,627 (576) 10,729 12,881 19,276
The expense was included in the following items: Operating expenses 8,615 10,344 15,479 Selling expenses 601 721 1,079 General Administrative and expenses 1,513 1,816 2,718 10,729 12,881 19,276
(15) Movement in the Current Value of Obligation due to Defined Benefit Plan
For the Year Ending December 31 2 0 12 2 0 11 Thousands of Dollars
Opening balance 244,381 250,672 Current service cost 6,252 6,285 Interest cost 9,547 10,713 Actuarial losses 2,277 5,212 Changes in the period 197 4,627 Benefits paid (19,662) (19,394) Exchange rate changes 5,957 (13,734) Closing balance 248,949 244,381
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(16) Movement in the Fair Value of the Plan's Assets
For the Year Ending December 31 2012 2011 Thousands of Dollars
Opening balance 200,921 230,671 Projected yield on the plan's assets 9,143 10,787 Actuary gains (losses) 10,866 (20,406) Employer’s contributions 5,614 8,056 Benefits paid (17,379) (13,399) Real yield transferred from compensation to remuneration (349) (276) Exchange rate changes 4,433 (14,512) Closing balance 213,249 200,921
(17) Adjusting the current value of the commitment for the defined benefit plan and the fair value of the plan's assets to assets and liabilities recognized in the balance sheet:
As of December 31 2012 2011 Thousands of Thousands of Dollars Dollars
Current value of financed liabilities 194,074 192,191 Less - fair value of the plans’ assets (213,249) (200,921) (19,175) (8,730) Current value of unfinanced liability 54,875 52,190
Net unrecognized actuary losses (21,303) (30,735) Net liability deriving from defined benefit commitments 14,397 12,725
(18) Composition of the plan's assets: Fair Value of the Plan's Assets as of December 31 2012 2011 Thousands Thousands of Dollars of Dollars
Shares 64,473 38,487 Government bonds 54,127 62,883 Corporate bonds 56,629 58,964 Cash, cash equivalents and deposits 21,397 23,734 Other investments 16,623 16,853 213,249 200,921
The total projected yield rate is the weighted average of the projected yields of all types of assets constituting the plan's assets as detailed above. The projected yield rate for the plan's assets in the reported year is 3.2% (in 2011: 3.9% and in 2010: 4.2%).
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(19) Actual Yield from the Plan's Assets and Compensation Rights
For the Year Ending December 31 2012 2011 Thousands of Thousands of Dollars Dollars
Projected yield on the plan's assets 9,143 10,787 Actuary gains (losses) 10,866 (20,406) Actual yield on the plan's assets 20,009 (9,619)
(20) Actuary Gains/Losses Not Yet Recognized For the Year Ending December 31 2012 2011 Thousands of Dollars
Actuary losses not recognized as of January 1 (30,735) (6,489) Actuary losses created in the current period due to the liability and due to plan assets 8,590 (25,618 ) Deviation from strip 2,001 989 Exchange rate changes (1,159) 383 Actuary losses not recognized as of December 31 (21,303) (30,735) d. Other Long-Term Employee Benefits
(1) General
Employees reaching 20, 30 and 40 years of seniority at the Company are entitled to a gift granted during the yearly “decades ceremony” held by the Company.
(2) Chief Actuary Assumptions as of the Balance Sheet Date – see Note 19.c.(13) above.
(3) Sums Recognized in the Statement of Operations for Long Term Employee Benefits
For the Year Ending December 31 2012 2011 2010 Thousands of Dollars
Current service cost 60 68 64 Interest cost 47 47 56 Actuary gains recognized in gain/loss - - 20 Exchange rate changes 38 (131) 104 Changes in the period 146 (1,472) 799 291 (1,488) 1,044
The expense (income) was included in the following items: Operating expenses 234 (46) 838 Selling expenses 16 (3) 58 General Administrative and expenses 41 (8 ) - Other expenses and revenues - (1,431) 148 291 (1,488) 1,044
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(4) Movement in the Current Value of Obligation due to Other Long Term Employee Benefits
For the Year Ending December 31 2012 2011 Thousands Thousands of Dollars of Dollars
Opening balance 2,691 4,341 Current service cost 60 68 Interest cost 47 47 Actuary gains recognized in gain/loss - - Benefits paid (115) (162) Changes in the period 146 (1,472) Exchange rate changes 39 (131) Closing balance 2,868 2,691 e. Termination Benefits
(1) General
Between 2000 and 2012, the Company's management adopted resolutions relating to early retirement programs for 703 employees, for which provisions were recorded in the Company's accounts. As of December 31, 2012, all the employees had concluded their actual retirement from the Company within the framework of the above programs. The December 31 2012 Financial Statements include the balance of a provision to a total amount of $15.4 million for financing the retirement of 218 employees. Within this framework the Company deposited funds for assuring early retirement pension payments to employees. The balance of the deposits as of December 31 2012 was $16.7 million. The total net provision for retirement plans as of December 31 2012 is $1.3 million. As part of the Company's privatization, the State of Israel provided guarantees to uphold the Company's commitments, in favor of Mivtachim and Clal with respect to the retirement programs, which amounted as of December 31 2012 to a total of $1.9 million. As the Company formulates and decides upon consensual retirement programs in the future, subject to the cooperation of the employees’ representatives, the Company will not be entitled to receive additional guarantees from the State of Israel. Additional retirement programs will be executed with Company guarantees.
In order to carry out the retirement plans, agreements were reached between the employees and the Company, between the employees and financial institutions, and between the Company and financial institutions. In the framework of these agreements, the financial institutions serve as the payer, making the pension payments to the retirees. As security for the Company’s obligations to the retirees, the State provided guarantees, according to which, inter alia, the Company will make periodic deposits (mostly, for one year in advance) to the financial institutions or will pledge a deposit in a commercial bank, a sum identical to the total sums that the Company must pay as pension to its retirees for the coming year, and the Company’s payments to the retirees will be made from these monies. From time to time, the financial institutions estimate the anticipated costs of the retirement plan, and the Company updates its estimates to the extent necessary, according to actual costs and the experience gained on the subject. As of December 31 2012 the Company has not furnished guarantees to third parties to secure the employee retirement plan.
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(2) Composition of Balance Sheet Balance As of December 31 2012 2011 Thousands of Thousands Dollars of Dollars
Termination benefit obligation 15,394 23,283 Assets of plan to finance obligation (16,726) (20,337) (1,332) 2,946
(3) Presentation in Statement of Operations For the Year Ending December 31 2012 2011 2010 Thousands of Thousands of Thousands of Dollars Dollars Dollars
Other expenses 444 1,835 5,106
(4) Chief Actuary Assumptions as of the Balance Sheet Date – see Note 19.c.(13) above. f. Short-Term Employee Benefits
(1) Paid Vacation
According to the Yearly Vacation Law, 1951, Company employees are entitled to a number of paid vacation days for each work year. In accordance with the law in question and an amendment thereof established in the agreement between the Company and its employees, the number of vacation days to which each employee is entitled is determined in accordance with the employee's seniority.
Employees are entitled to 22 vacation days per year (with the exception of a minority entitled to 30 days per year), and to accrue the balance of unused vacation days. Vacation days are first used from the current year's allotment and later from a balance passed forward from the previous year (on an LIFO basis). Employees who have left the Company prior to making use of the balance of his accrued vacation days is entitled to payment for the balance of these vacation days upon leaving.
(2) Composition
As of December 31 2012 2011 Thousands of Thousands of Dollars Dollars
Wages, salaries and social benefits 44,628 45,815 Vacation and rest days 53,325 52,687 Total 97,953 98,502
g. Further Information - Related Parties
For information on current employee benefit obligations given to related parties see Note 33.
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Note 20 - -Unearned Revenues
a. Current Liabilities
Composition: As of December 31 2 0 12 2 0 11 Thousands of Thousands of Dollars Dollars
From the sale of flight tickets 215,541 199,302 For frequent flyer points 37,374 36,657 Others - 39
252,915 235,998
c. Non-Current Liabilities
Composition: As of December 31 2 0 12 2 0 11 Thousands of Thousands of Dollars Dollars
For frequent flyer points 58,274 51,946
Note 21 - Operational Leasing Arrangements
(1) As of December 31 2012, the Company holds 15 leased aircraft.
(2) Aircraft and Engine Leases in the Reported Period
a. In July 2011 the Company signed an agreement with ILFC to lease a 767-300ER aircraft (EAM), manufactured in 1998, for a period of 72 months, and an early departure option after 48 months. The airplane was received by the Company on December 30 2011 and began operating in its service in January 2012. The lease was classified as an operational lease in the Financial Statements.
b. The lease for a Boeing 747-400 cargo plan (ELF) was extended by an additional 12 months in February 2012, to July 2013. The monthly leasing fees did not undergo any material changes following this extension. The lease was classified as an operational lease in the Financial Statements. For updates regarding the lease, see Note 36f.
c. For details regarding the sale and lease back of the two CFM 56-7B engines in February 2012, see Note 13.d.2.
d. In March 2012 lease agreements were signed for two Boeing 737-800 aircraft – one contract (EKM) with NBB Britannia Leaser Partnership One and an additional contract (EKR) with the NBB Vega Lease Partnership. The aircrafts are leased for periods of 72 months each. The aircrafts began operating over the course of May 2012. The leases were classified as operational leases in the Financial Statements.
e. Regarding the agreement signed by the Company in January 2013 for the lease of a Boeing 737-800 aircraft (EKU), see Note 36a.
f. Regarding the extension of the agreement to lease a Boeing 767-300ER aircraft (EAP), see Note 36e.
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For the Year Ending December 31 2012 2011 Thousands of Dollars Aircraft and engine leases 80,774 71,827 Land and structure usage rights (*) 3,707 2,871 84,481 74,698
(*) The Company has a land and structure lease agreement with the Israel Airport Authority; see Note 24c.
(4) Commitments for Minimal Future Leasing Payments for Non-Revocable Operational Leases
Minimal leasing fee obligations do not include payment for maintenance reserves for operational aircraft and engine leases.
Regarding minimal future lease payment liabilities for irrevocable operational leases, the Group recognized the following liabilities:
As of December 31 2012 2011 Thousands of Dollars
2012 - 53,061 2013 62,802 50,241 2014 58,640 45,884 2015 49,827 37,071 2016 onward 222,099 181,490 393,368 367,747
As of December 31 2012 2011 Thousands of Dollars Lease incentives (see Note 24c).
Presented under other payables – non-current 4,437 4,437
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Note 22 - Provisions
a. Current Liabilities
Composition: Total As of December 31 2012 2011 Thousands of Dollars
Civil cargo claim provision (see Note 22.d.8) - 9,770 Legal proceedings (see d.) 7,763 6,670 The State of Israel (see Note 19.c.(3).b). 8,570 8,183 Other - 220 16,333 24,843
b. Non-Current Liabilities
Composition:
As of December 31 2 0 12 2 0 11 Thousands of Thousands of Dollars Dollars
Civil cargo claim provision (see Note - 5,348 22.d.8)
c. Movement: Provisions to Salaries Civil and Legal Cargo The Institu- Procee- Claim State of tions dings Provision Israel Other Total Thousands of Dollars
Balance as of January 1 2011 27,114 1,493 4,000 8,565 3,767 44,939 Additional provisions recognized - 206 11,118 243 - 11,567 Updating existing provisions - 3,882 - - - 3,882 Sums used during the period (17,941) (140) - - - (18,081) Sums canceled during the period (5,033) (191 ) - - (3,547) (8,771) Classified from employee benefit obligations - 1,441 - - - 1,441 Classified to other payables (3,209) - - - - (3,209 ) Exchange rate influence (931) (21) - (625) - (1,577) Balance as of December 31, 2011 - 6,670 15,118 8,183 220 30,191
Balance as of January 1 2012 - 6,670 15,118 8,183 220 30,191 Additional provisions recognized - 1,244 - 190 - 1,434 Updating existing provisions - 544 - - - 544
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Sums used during the period - (572 ) (9,800) - - (10,372) Sums canceled during the period - (287) - - (220) (507) Classified to other payables - - (5,318 ) - - (5,318 ) Exchange rate influence - 164 - 197 - 361 Balance as of December 31 2012 - 7,763 - 8,570 - 16,333
d. Legal Proceedings
As of December 31 2012, claims filed against the Company amount to a total of $20 million, for which the Company listed an $8 million provision in its financial statements ($0.3 million of which is under non-current employee benefit liabilities), this based on the advice of the Company's legal counsel. In addition, a motion was filed to recognize a claim as a class action against the Company and other bodies to the amount of 100 billion NIS, which was rejected by the District Court and for which an appeal was filed at the Supreme Court; see Note 22.d.7 below. Legal claims not quantified in monetary sums have also been filed against the Company. The above provision in the Financial Statements also includes provisions for these claims, as estimated by Company management. In the opinion of Company management, based upon the opinions of its legal counsel, it is not anticipated that the Company will be exposed to an additional loss with respect to the above claims in excess of the sums of the provisions listed in the Financial Statements.
The following is a detailed summary of material legal and financial claims:
1. In June 2006, a suit was filed against the Company and against the State of Israel – Ministry of Finance in the Tel Aviv District Labor Court by 94 claimants who had been employed by the Company and who had taken early retirement between 2001 and 2003. The claimants in their suit have appealed for declaratory relief/order of performance to amend their retirement agreements in a manner in which the retiree will receive the early pension stipend, including fringe benefits, until the legal retirement age, instead of until the age of 65. Alternatively, the claimants appealed to revoke the retirement agreements. Alternately, the claimants appealed to revoke the retirement agreements. The claimants quantified the claim at 18.2 million NIS ($4.9 million). In January 2009 the court ordered that this claim be consolidated with two additional claims. In addition, 9 similar claims were filed. The total sum of the additional claims is 3.3 million NIS (some $0.9 million as of the balance sheet date). In October 2010 a partial ruling was issued, stating that early retirement agreements must be reinterpreted, so that instead of 65 years of age they shall be considered valid until 67. The partial ruling also stated that within 60 days of the ruling, basic agreed-upon calculation principles shall be submitted to calculate the sums. On June 25 2012 a final ruling was given on the case and the Company was compelled to pay the plaintiffs a total of 20 million NIS. The Company has appealed the ruling and the National Court delayed its execution until a ruling was made on the appeal. The Company made a suitable provision for this claim in its Financial Statements.
2. On May 15 2011 Company’s main office received a motion to approve a claim as a class action (hereinafter: “the Motion”), which was filed against the Company in the Tel Aviv District Court on May 9 2011. The motion was filed by a Company passenger, whose flight had been canceled on May 5 2011 following the contamination found in the jet fuel. In the motion, the sum of the claimant’s personal claim was set at a total of 5,000 NIS and the general damage estimated by the claimant for the entire Group including all purchasers of flight tickets from the Company whose flights had been canceled under the circumstances in question (estimated by the claimant at some 2,500 passengers) amounts to 12.5 million NIS for the entire Group. In the opinion of Company management, based upon the advice of its legal counsel, the Company is not expected to be found liable in this claim. The case was sent to arbitration. No provision was made for this claim in the Financial Statements.
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3. Regarding the motion to approve a suit as a class action, which was rejected in June 2012 by the Haifa District Court, an appeal of the court ruling in question was filed on October 9 2012. This motion was on the matter of plaintiff's argument according to which the Company is overcharging cancellation fees for off-site transactions at a rate exceeding the maximum rate permitted in accordance with the Consumer Protection Law, for which no precise sum was set, but which was estimated by the plaintiff at “tens of millions of NIS at the least.” No provision was made for this claim in the Financial Statements.
4. In March 2012, a motion was filed to approve the filing of a derivative suit to the Economic Department of the Tel Aviv District Court by a Company shareholder. The sum of the claim amounts to 120 million NIS. The motion includes a request that the Court approve the claim as a derivative action against a number of executives serving in the Company in 2003 and who no longer serve in the Company, on the grounds that these executives involved the Company in fixing one or more price component in the field of airborne cargo shipping to and from the United States in the relevant period. According to the motion, the Company was caused damage to the sum of the Claim, on the basis of the settlement the Company reached in its legal proceedings in the U.S. The Company has filed its response.
5. Regarding a suit filed in February 2013 against the Company at the Tel Aviv District Labor Court by 130 security personnel, regarding the arrangement of their rights and employment conditions, see Note 36c.
6. In the matter of a motion to approve a class action, filed in February 2013 at the Central District Court against the Company and against British Airways, Lufthansa and Swissair. In the matter of fixed various components of cargo shipping prices, see Note 36d.
7. A motion to approve a claim as a class action was filed in December 2012 against the Airports Authority, the Company, Israir Aviation and Tourism Ltd., Arkia Israeli Airlines Ltd. and the General Security Services, at the Nazareth District Court, and was rejected in December 2012. An appeal was filed before the Supreme Court in February 2013. The subject of the motion is the plaintiff’s claim that Israeli Arabs, while departing and/or arriving at Israel, are discriminated against due to the unique security screening they undergo. The personal sum of each plaintiff’s claim amounts to 100,000 NIS. The number of potential plaintiffs is estimated by the plaintiffs at one million Arab citizens. No provision was made for this claim in the Financial Statements.
8. Regarding the civil suit filed in New York against the Company and 38 other airlines on the matter of air cargo shipping prices, which alleged that the defendants were partners in a conspiracy to fix prices for air cargo transport services, beginning in 2000, while violating competition and other laws in Europe and the United States, on August 6 2012 the New York court approved the December 31 settlement agreement signed between the Company and the plaintiffs according to which the Company would pay the plaintiffs a total of $15.8 million US, in installments. The first payment to the sum of $9.8 million U.S was paid by the Company in January 2012 and the balance of the sum to the amount of $6 million US will be paid in five equal payments of $1.2 million US each until December 31 2016. It was also agreed that the settlement would not be interpreted as the admission on behalf of Company to the claims made by the claimants or evidence of their veracity. In return for the Company upholding its obligations in accordance with the arrangement, the claimants (with the exception of entities that expressly announced that they were not included in the group and some of whom approached the Company with monetary requests, and negotiations are being conducted with them) retracted their claim against the Company and undertook not to file any additional claim or make any additional demand from the Company regarding the direct purchase of air cargo transportation from the Company, inside the U.S., to and from the U.S., in the period prior to signing the settlement.
9. In September 2012 the appeal filed at the Supreme Court by the plaintiffs in a class action against the ruling of the Jerusalem District Court to reject the class action motion against the Company on the matter of collecting a security surcharge in code sharing flights, was dismissed.
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Additional legal claims totaling $10.7 million exist against the Company, for which the Company has made provisions in its Financial Statements based on the advice of its legal counsel.
Note 23 - Taxes on Income
a. Deferred Tax Balances
The composition of deferred tax liabilities (assets) are detailed below:
Charged Transferred to Other from Other Balance as of Comp- Comprehensive Balance as of January 1 Charged to rehensive Earnings to December 31 2012 Gain/Loss Earnings Gain/Loss 2012 Thousands of Thousands of Thousands Thousands of Thousands of Dollars Dollars of Dollars Dollars Dollars Timing differences Cash flow hedges 435 (710) (3,431) 710 (2,996) Fixed assets (242,330 ) 13,295 - - (229,035) Financial assets at fair value via gain/loss 2,208 (2,997) - - (789) Provisions, doubtful debt and employee benefit obligations 26,325 (3,926) - - 22,399
Total (213,362) 5,662 (3,431) 710 (210,421)
Unused tax losses and benefits Losses for tax purposes ** *185,057 (809) - - 184,248
Total (28,305) 4,853 (3,431) 710 (26,173) Charged Transferred
to Other from Other
Balance as of Comp- Comprehensive Balance as of
January 1 Charged to rehensive Earnings to December 31
2011 Gain/Loss Earnings Gain/Loss 2011 Timing differences Cash flow hedges (11,099 ) (79) 11,532 81 435 Fixed assets (193,766) (48,564) - - (242,330) Financial assets at fair value via gain/loss 5,442 (3,234) - - 2,208 Provisions, doubtful debts and employee benefit obligations 28,556 (2,231) - - 26,325 Frequent flyer plan 651 (651) - - -
Total (170,216) (54,759) 11,532 81 (213,362)
Unused tax losses and benefits Losses for tax purposes ** *137,956 *47,101 - - *185,057
Total (32,260) (7,658) 11,532 81 (28,305)
* Non-material adjustment of comparison numbers – see Note 5.
** The balance of income tax losses as of the end of the 2012 and 2011 tax years amounted to a total of $723 million and $721 million, respectively. - C 60 - Free Translation of the Hebrew Language 2012 Annual Report - Hebrew Wording Binding
b. Effective Tax 2012 2011 2010 Thousands of Thousands of Thousands of Dollars Dollars Dollars
Profit (loss) before taxes on income and before profits of affiliates according to Statement of Operations ()25,488) *(43,627 * 62,188
Statutory tax rate 25% 24% 25%
Tax expenses (revenues) according to statutory tax rate ()6,372) (10,470 15,547
Tax surcharge (savings) due to: Nondeductible expenses 988 312 717
Adjustments due to changes in tax rates - 17,808 (10,491 )
Total taxes on income (tax benefit) presented in Statement of Operations (5,384) *7,650 *5,773
Non-material adjustment of comparison numbers – see Note 5.
c. Tax Laws Applicable to Group Companies
On February 26, 2008, the Knesset passed the third reading of the Income Tax Law (Inflationary Adjustments) (Amendment No. 20) (Limitation of Effective Period), 2008 ("the Amendment"), whereby the Adjustments Law will cease being effective in the 2007 tax year, and starting from the 2008 tax year, the provisions of the law will not apply, except for the transitional provisions, the purpose of which is to prevent distortions in the tax computations.
In accordance with the Amendment, starting from the 2008 tax year, the adjustment of taxable income to a real basis of measurement shall no longer be calculated. In addition, depreciation of fixed assets and sums of losses transferred for tax purposes shall no longer be linked to the CPI, in such a manner that these sums will be adjusted to the CPI of the end of the 2007 tax year, and their link to the CPI shall be discontinued from that date onward.
The Dollar Regulations will continue to apply to the Company even after the effective period of the Adjustments Law ends.
According to the Income Tax Regulations (Rules Concerning the Maintenance of Accounting Records of Airlines with Foreign Investments and of Certain Partnerships and the Determination of their Taxable Income), 1986, the results of the Company and some of its subsidiaries are measured for tax purposes on a dollar basis. Some of the subsidiaries are assessed jointly with the Company.
The Company is deemed an industrial company under the Law for the Encouragement of Industry (Taxes), 1969 and, accordingly, is entitled to accelerated depreciation rates on aircraft and equipment.
Pursuant to the Income Tax Regulations - Depreciation, 1941, the Company is entitled to depreciate the cost of owned aircraft and spare engines at a yearly rate of 30% and 40% of cost, respectively.
Overseas subsidiaries are subject to the tax codes in effect in their countries of residence.
Most of the countries in which the Company operates representative offices are signatories to treaties or mutual arrangements for the prevention of redundant taxation, which exempt the Company from income taxes on their operations in these countries.
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On February 13 2013 Tax Authority published an income tax circular (01/2013) on the matter of generally accepted accounting rules regarding yearly financial statements in accordance with Section 131 of the Income Tax Ordinance (New Version), 1961. Regarding all companies, the Tax Authority's position is that the generally accepted accounting rules for tax purposes include, among other things, the International Financial Reporting Standards (IFRS) – standards and interpretations adopted by the International Accounting Standards Board (IASB).
In accordance with the Value Added Tax Law, 1975, transactions for the sale of flight tickets to and from Israel, or from one destination abroad to another, as well as cargo transport by air to and from Israel, have been defined as transactions regarding which the VAT rate is zero.
The recommendations of the Commission for Economic and Social Change headed by Professor Manuel Trachtenberg were published on September 26 2011 Subsequently, the Tax Burden Alteration Law (legislative Changes), based on the recommendations of the taxation chapter of the Trachtenberg Commission Report, was published on December 6 2011, after passing its third vote in the Israeli Knesset the day before. The following are the key changes in the new law in the field of corporate taxation: 1. Cancellation of reductions planned for the coming few years in income tax and corporate tax starting from 2012. 2. Raising the corporate tax rate to 25% in 2012. 3. Raising the capital gains tax rates and betterment tax rates to the rate detailed in Section 2 above.
As the legislative process was concluded in the final quarter of 2011, the Group updated its deferred tax balances as of its balance sheet date, as a result of the changes in question in question in tax rates in the years in which the temporary differences for which the Group recognized the deferred taxes will be reversed. Accordingly, as of December 31 2011 the Group recognized a $9 million increase in liabilities, in return for a tax expense charged to the Statement of Operations in 2011.
d. Final Tax Assessments
The Company has received final tax assessments up to and including 2002.In addition, the Company has received tax assessments considered final up to and including the 2008 tax year. Key subsidiaries have received tax assessments considered final for up to and including the 2008 tax year.
Note 24 - Pending Liabilities, Guarantees and Commitments
a. Pending Liabilities
In the matter of lawsuits see Note 22d above.
b. Guarantees
The Company provided guarantees to third parties to the amount of $2,401 thousands (2011: $5,233 thousands).
c. Engagements with the Israel Airports Authority (IAA)
1. The Company has a usage right (permit) to 29 hectares of land at BGA until December 31 2010 (with an option to renew it for an additional 25-year period. The Company announced its intent to exercise the above option in accordance with the agreement, and is currently negotiating with the IAA to extend the agreement by an additional term.
2. On October 19, 2004, an amendment was added to this agreement, according to which in addition to the payment for the land, the Company will pay the IAA annual usage fees for certain fully depreciated buildings and installations. An expense of $3.7 million was listed in the Company’s books in 2012 for the land and building component.
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3. The Company has a usage fee agreement (permit) with the IAA for a passenger service warehouse in BGN 4,350 m² in size. The yearly usage fees are 2.5 million NIS ($0.7 million). The agreement shall be in effect until December 31, 2012. The Company is currently negotiating with the IAA regarding the extension of the agreement.
4. On November 1 2011 the Airports Authority announced that it would be extending and amending the contract for the operation of the Company's passenger lounge in Terminal 3 by an additional two years to November 1 2013 under the following conditions: until April 30 2012 at a yearly cost of 11 million NIS ($2.9 million NIS as of the report date).
The yearly cost was revised based on the CPI and in accordance with indices of El Al passenger traffic through BGN. Starting May 1 2012, at a yearly cost of 18 million NIS ($4.8 million NIS as of the report date). The yearly cost is revised based on the CPI only. Additionally, agreements were signed to grant permission for other areas in Terminal 3 until November 2014, in return for rental fees of 7.8 million NIS a year ($2.1 million as of the report date).
Note 25- Equity
a. The Company's share capital:
Registered Issued and Paid-Up Share Shares Share Shares Special Ordinary Special Ordinary 1 NIS NV 1 NIS NV 1 NIS NV 1 NIS NV NIS NIS NIS NIS
Balance as of December 31 2012, 2011 and 2010 1 550,000,000 1 495,719,135
b. The rights accompanying the Special State Share:
On May 18, 2003 the Company issued the State of Israel a special, unsellable, nontransferable share. This share was designed to protect the State’s vital interests, in accordance with the following Government resolutions:
Maintaining the Company as an Israeli company, subject to Israeli law; Keeping the operating capability and the flight capability of carrying passengers, and cargo, above a minimum established level; Preventing any hostile interests from taking over the Company; Maintaining security and safety arrangements as determined by state bodies on behalf of the State.
In addition, on October 12, 2004, the Knesset’s Finance Committee approved the issuance of an order under the Government Corporations Act requiring the Company to employ, at any time, Israeli crew members, and – in Israel – Israeli ground personnel, in a number not lower than that required for continuous and simultaneous operations in an emergency of all the aircraft fleets constituting the minimal flying capacity which the Company is required to maintain as stipulated by directives of the Special State’s Share. As of the signing of the Financial Statements, the provisions of this order did not obligate the Company to make any changes in its method of operations or composition of employees.
c. Shares Held by Company Employees
The employees’ association (Holdings in Trust of El Al Ltd. Employees) (hereinafter – “the Employees’ Association”) holds the Company’s shares by virtue of the right to purchase shares granted by the state as part of the 2003 prospectus.
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As of December 31 2012, the Employees' Association held 29,453,119 ordinary shares, representing 5.94% of the Company's issued share capital (5.76% fully diluted). As of March 12 2013, the Employees’ Association held 29,453,119 ordinary shares, representing 5.94% of the Company's issued share capital (5.73% fully diluted). Various restrictions apply to the sale of the shares that are held by the Employees’ Association.
d. Dividend Distribution Policy
Pursuant to this policy, the Company will distribute a dividend from time to time, at the discretion of the Board of Directors and subject to the Company's needs. Implementation of this policy is subject to any relevant law provisions as well as the assessment of the Company's Board of Directors of the Company’s ability to meet its present as well as projected liabilities and taking into account its liquidity, and present as well as future business plans and activities. The adoption of this policy does not diminish the authority of the Board of Directors of the Company to decide upon a change, amendment and/or abolition of the currently established dividend policy and/or to approve any additional distributions that comply with the law and/or to decide on a reduction of actual distributions or to preclude them altogether should it be warranted by changes from time to time in the Company’s liquidity, operations and conditions. For details regarding arrangements with Bank Leumi regarding the distribution of dividends, see Note 18.f.3.b.
g. Senior Employee Option Plan
1. In February 2006, May 2006 and November 2007 the Company adopted 3 worker option plans, which were granted to Company senior executives and managers. The amount of options allocated in each plan was: 17,092,129, 3,072,536 and 2,195,852, respectively. Each option is exercisable into one ordinary Company share worth 1 NIS NV. The theoretical exercise price of one option into one share in each plan is 2.9733 NIS, 1.8894 NIS and 2.01 NIS, respectively. The options’ vesting period in each plan is: 4 years starting from January 1 2007 (with one quarter of the options vesting each year), 3.5 years (one quarter will be unfreezed on June 30 of each year from 2007 to 2010) and 3.5 years (one quarter will be unfreezed on July 1 of each of the years from 2008 to 2011), respectively. All options granted but not exercised will expire and be nullified 3 years from the date each option vested.
Number of Options Plan A Plan B Plan C
Outstanding as of January 1 2011 6,653,429 1,160,826 1,121,538 Expired (2,305,063) (492,808) (411,271) Outstanding and exercisable as of December 31 2011 4,348,366 668,018 710,267
Outstanding as of January 1 2012 4,348,366 668,018 710,267 Expired (2,383,352) (334,009) (324,016) Outstanding and exercisable as of December 31 2012 1,965,014 334,009 386,251
2. Service agreement and option allocation to the Chairman of the Company's Board of Directors:
On January 21 2009 the Company's Board of Directors decided to appoint Mr. Amikam Cohen as Chairman of the Company's Board of Directors (hereinafter: “the Chairman”), starting February 1 2009.
On April 30 2009 the Audit Committee and the Company's Board of Directors approved a service agreement with the Chairman (hereinafter: "the Service Agreement"). On June 24 2009 the General Meeting of the Company's shareholders ratified the Service Agreement.
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According to the Service Agreement, the Chairman shall provide the Company with active Chairman services as expected in publicly-owned companies in the field of activity of the Company and of its subsidiaries, as they exists on the date the service agreement was made and as may be from time to time (hereinafter – "the Services"). In return for the services, the Chairman shall be entitled to the following: (a) a monthly salary of 90,000 NIS plus VAT linked to the CPI (hereinafter – "the Remuneration"); (b) 4,650,000 non-tradable options exercisable as 4,650,000 regular 1.00 NIS NV Company shares; (c) benefits pertaining to the receipt of flight tickets; and (d) reasonable expense reimbursements for travel, hosting and mobile telephone expenses made by the Chairman in the context and for the purpose of providing the services subject to the law and in accordance with Company procedure. The remuneration and the remaining benefits and payments detailed above constitute full remuneration to the Chairman for the provision of services, including for his services as Company director, and with the exception of these he shall be entitled to no additional benefit and/or wage and/or remuneration from the Company of any form, including directors' salary (participation remuneration and yearly remuneration) for his as a Company director. In the event that the Chairman ceases serving as Chairman or the Board and continues serving as a director at the Company, he shall be entitled only to a Director's salary (participation remuneration and yearly remuneration) in accordance with the remuneration paid Company directors at the time as well as flight ticket entitlements awarded Company directors. The aforementioned options constituted, as of the signing of the Agreement, 0.95% of the Company's issued and paid-up share capital. As of December 31 2012 3,100,000 options are still outstanding. The options were granted as part of the Company's 2006 option plan and were issued to the Trustee for the Chairman in accordance with Section 102 of the Income Tax Ordinances (New Version), 1961, in the capital gains track and may be exercised as Company shares, subject to adjustments and as detailed below: The exercise price of each option shall be NIS 0.885, the closing price of a Company share on February 1 2009, which is when the Chairman of the Board began his tenure. The right to exercise the options shall vest in three equal yearly portions (one third each year) throughout the Chairman’s first three years. The number of options and/or the vesting price, as the case may be, shall be subject to adjustments as detailed in the Service Agreement, including adjustments due to dividends, due to mergers/acquisitions or acceleration due to changes in control. The Chairman of the Board of Directors shall be entitled to exercise any option portion vesting as Company shares, starting from the vesting date of each portion until 26 months from the vesting date of each portion (hereinafter as regards vested options – "the Exercise Period"), except if the options or any portion thereof expired prior to the exercise period, all in accordance with the Options Plan. All options granted to the Chairman of the Board and not exercised by him into Company shares by the end of the exercise period shall expire and may not be exercised. As of this report the Chairman of the Board of Directors holds 3,100,000 options, after some have expired in accordance with the terms of the plan. In accordance with the value assessment provided by an independent outside value assessor, and in accordance with the calculation made by the value assessor in accordance with the Black & Scholes model (as well as reference to Binomial options pricing model for comparison), the value of the options, based on the following parameters, for the date on which the option plan was approved by the Company's General Meeting on June 24 2009 was 1,310 thousand NIS. The parameters used by the assessor to determine the value assessment were, among other things, the value of the Company's stock on June 24 2009 (0.879 NIS), the exercise price set at 0.885 NIS, the options' average lifespan, the fact that the options are granted in three portions and the fluctuations of the Company's share throughout the vesting period. An expense of $1,000 was listed in 2012 for the options granted the Chairman of the Board of Directors. The parties' entry into the Service Agreement was retroactive starting February 1 2009 until the date the Chairman ends his service as Chairman of the Company's Board of Directors for any reason. In spite of the above, the Service Agreement can be revoked by either of the parties for any reason with advance written notice of 90 (ninety) days. In light of the streamlining and costs savings measures taken by the Company, on November 22 2011 the Chairman of the Company’s Board of Directors announced that he would be unilaterally waiving 20% of the (gross) monthly salary to which he is entitled. The above waiver is for a period from December 1 2011 to December 31 2012.For further details, see Note 33h.
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3. Allocation of Options to the Company CEO
The Company granted the CEO 9,914,382 options exercisable as 9,914,382 ordinary 1.00 NIS NV Company shares, which constituted, as of the signing of the option agreement (approved pursuant to the approval of the Employment Contract) (“the Options Agreement”), 2% of the Company's issued and paid- off stock capital, 1.90% fully diluted. The options were granted on February 7 2010 in accordance with the Company's 2006 option plan and in accordance with the Options Agreement with the CEO. The options were placed in trust for the CEO in accordance with Section 102 of the Income Tax Ordinance, on a capital gains track, and are exercisable as Company shares, subject to adjustments and as detailed below: The right to exercise the option shall vest in three equal yearly portions (one third each year) throughout the CEO's first three years. In the event of the discontinuation of the CEO's employment within six months after a change of control event (as defined in the Options Agreement), all options allocated to the CEO the vesting date of which has yet to be reached shall vest immediately, and they shall be exercisable within 12 months from the date on which the CEO stopped working in practice. The exercise price of each option shall be 0.965 NIS, the closing price of a Company share on November 1 2009, which is when the CEO began his tenure. Any portion of options vested may be exercised up to six months from the vesting date of that portion, or at the end of twelve months from the actual end of the CEO's employment, whichever comes first. The amount of options and/or the exercise price, as the case may be, shall be subject to adjustments as detailed in the Options Agreement, including adjustments due to dividends and due to merger/sales agreements. In accordance with the value assessment provided the Company by an independent outside value assessor, and in accordance with the calculation made by the value assessor in accordance with the Black & Scholes model (referring to Binomial options pricing model for comparison), the value of the options as of January 6 2010 is 3,847 thousands NIS (on the date of the approval of the commitment the value of the options was 3,293 thousands NIS). The parameters used by the assessor to determine the value assessment were, among other things, the value of the Company's stock on January 6 2010, the exercise price set at 0.965 NIS, the options' average lifespan, the fact that the options are granted in three portions and the fluctuations of the Company's shares throughout the vesting period. An expense of $58,000 was listed in 2012 for the options granted the CEO.
Note 26 - Financial Instruments
a. Composition:
Derivative Financial Assets Current Assets Non-Current Assets Total Assets As of December 31 As of December 31 As of December 31 2 0 12 2 0 11 2 0 12 2 0 11 2 0 12 2 0 11 Thousands of Dollars Derivative financial instruments, intended as hedging items: Jet fuel hedging agreements 2,470 1,770 - - 2,470 1,770 Forward agreements for the purchase of foreign currency 11,006 - - - 11,006 - 13,476 1,770 - - 13,476 1,770 Derivative financial instruments measured at fair value via gain/loss: Jet fuel hedging agreements 3,196 326 - - 3,196 326
Total derivative financial assets: 16,672 2,096 - - 16,672 2,096
Derivative Financial Liabilities
Current Liabilities Non-Current Liabilities Total As of December 31 As of December 31 As of December 31 2012 2011 2012 2011 2012 2011 - C 66 - Free Translation of the Hebrew Language 2012 Annual Report - Hebrew Wording Binding
Thousands of Dollars
Derivative financial instruments designated as hedging items Interest rate swap agreements 126 - 1,356 - 1,482 - Forward agreements for the purchase of foreign currency - 12,017 - - - 12,017 126 12,017 1,356 - 1,482 12,017 Derivative financial instruments measured at fair value via gain/loss: Interest rate swap agreements - 9,152 - - -9,152 Jet fuel hedging agreements - 7 43 - 43 7 - 9,159 43 - 43 9,159
Total other financial liabilities 126 21,176 1,399 - 1,525 21,176
b. Capital Management Policy
The Group manages its capital in order to ensure that the Group's entities may continue to exist as "going concern" while increasing the yield of its shareholders, by preserving an optimal ratio of debt to capital. The capital structure of the Company consist of net debt, which includes the loans detailed in Note 18, less cash and cash equivalents and shareholders' equity which includes issued capital, capital reserves and retained earnings as detailed in the Report of Changes in Shareholders' Equity.
c. Principal Accounting Policies
Details regarding principal accounting policies and methods adopted, including recognition conditions, the basis of measurement and the basis according to which revenues and expenses were recognized relative to each group of financial assets, financial liabilities and capital instruments, are presented in Note 2.
d. Financial Risk Management Goals
The Company’s Board of Directors is responsible for approving a market risk management policy and supervises the implementation of the policy through the Market Risk Management Committee headed by Mr. Nadav Palti. The Committee is responsible for defining and updating the policy, supervising the policy’s implementation and issuing instructions/approvals for Company management to deviate from implementing the policy in accordance with various developments. The Company CEO is responsible for making decisions regarding the implementation of hedging agreements in practice in accordance with the Committee’s policy and guidelines. The Company's financial sector provides services to its business activity, provides access to local and international financial markets, supervises and manages the financial risks involved in the Company's activities by way of internal reports that analyze levels of exposure to risk according to degree and strength. These risks include market risks (currency risk, interest rate risk and jet fuel price risk) and liquidity risk. The instructions regarding hedging activities are given by the Company CEO and are carried out by the Finance Department. The Company moderates the influence of these risks through the use of derivative financial instruments in order to hedge its exposure to risk. Use of the derivative financial instruments is in accordance with Group policy approved by its Board of Directors, which sets written principles regarding: currency risk management, interest rate risk, jet fuel price risk, the use of derivative financial instruments and non- derivative financial instruments and the investment of surplus liquidity. Compliance with policy and with permitted exposure levels is supervised by the Risk Management Committee on a regular and ongoing basis. The Market Risk Management Committee instructs Company Management from time to time to deviate from said policy for limited amounts of time, in accordance with market developments.
e. Market risk
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The Group's activity primarily exposes it to financial risks of changes in the prices of jet fuel (see h. below) in the exchange rates of foreign currency (see f. below), and changes in interest rates (see g. below). The Group holds a variety of derivative financial instruments in order to hedge its exposures to market risks, which include:
. Swap agreements and options for projected purchases of jet fuel for the reduction of exposure to changes in jet fuel prices.
. Forward agreements for swapping foreign currency for the reduction of the Company's exposure from salary and local supplier payments in NIS. . IRS swap agreements to reduce the risk deriving from increases in interest rates.
Over the course of the reported period, no change occurred in market risk exposure factors. As for changes occurring in hedging policy in the reported year, see 26f, 26g and 26h below.
f. Currency Risk
Most of the Company's revenues and expenses are in dollars, and the Company is exposed to changes in the rate of the USD vs. other currencies in which it has revenues and expenses, primarily for most salary expenses paid in Israel in NIS. Accordingly, a change in the shekel/dollar exchange rate influences the Company's shekel expenses in dollar terms. In addition, in the case of a devaluation of the euro in relation to the dollar, the excess of receipts over payments in euro reduces the Company's revenues. The Company also has balance sheet exposure to a devaluation of the dollar vis-à-vis the NIS due to the excess of financial liabilities over financial assets denominated in a currency other than the dollar (mostly, the NIS).
The book values of the Group's chief financial assets and liabilities denominated in a currency that are not its operating currency are as follows:
Assets Liabilities As of December 31 As of December 31 2012 2011 2012 2011 Thousands of Dollars
In or linked to the EUR 19,188 23,001 22,544 24,112 NIS 81,863 45,175 53,247 61,867
Foreign Currency Sensitivity Analysis
The Group is exposed primarily to the euro and the NIS. The following table details sensitivity to a 10% increase or decrease in the appropriate exchange rate. 10% is the sensitivity rate used in reports to key administrative personnel, and this index represents Management's estimates regarding the likely possible change in exchange rates. The sensitivity analysis includes existing balances of financial items denominated in foreign currency and adapts their translation at the end of the period to a 10% change in foreign currency rates.
A positive number in the table represents an increase in gain/loss and an increase in equity, and a negative number represents a decrease in gain/loss and a reduction in capital.
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The influence of a 10% increase in the dollar versus the other currencies, before tax influence:
NIS Influence Euro Influence As of December 31 As of December 31 2012 2011 2012 2011 Thousands of Dollars
Profit or (loss) (2,601) 1,516 297 101
Forward Agreements for Foreign Currency Swaps
From time to time, the Company examines the need to invest in derivative financial instruments to reduce its exposure to currency risks. When it holds a derivative financial instrument, the Company is exposed to changes in the fair value of these financial instruments resulting from changes in their market value. Starting from late 2010 the Company hedges its expected cash flow exposure at a rate of 75% for the coming 12 months on a monthly basis. The extent of the hedging shall be determined by management.
In order to reduce its cash flow exposure due to the USD/NIS exchange rate, the Company from time to time enters into hedging agreement; these agreements are recognized as cash flow hedging for accounting purposes. The fair value of the forward agreements for foreign currency swaps as of the balance sheet date was established using published future exchange rates and yield curves deriving from published interest rates matching the repayment dates of the contracts denominated in foreign currency.
Cash Flow Hedging
The following table details the base sums of the transactions and the remaining terms of forward agreements for foreign currency swaps, as they exist as of the balance sheet date:
Sums of Asset Exchange Rate Transactions Fair Value USD – NIS Thousands of Dollars Cash Flow Hedging
Up to 12 months 3.79-4.06 264,226 11,006
Regarding the Group's accounting policy in the matter of cash flow hedging, see Note 2.
Over the course of the year, capital increased by a sum of $17,267 thousands after tax, due to the effectiveness of cash flow hedging as a defense against cash flow risk due to exchange rates.
In 2012 the Company entered into a number of additional financial transactions intended to protect the Company from drops in the exchange rate of the USD vs. the NIS for periods ending October 2013.These transactions are recognized as cash flow hedges for accounting purposes.
Sensitivity Analysis of Forward Agreements for Foreign Currency Swaps
The sensitivity analysis is determined on the basis of exposure to foreign currency exchange rates of derivative and non-derivative financial instruments as of the balance sheet date. The sensitivity analysis was prepared under the assumption that the sum of assets as of the balance sheet date remained unchanged throughout the entire reporting period. For the purpose of internal reports on foreign currency rate risk for key management personnel, an increase or decrease rate of 10% was used, representing Management's policy regarding reasonable changes in foreign currency exchange rates.
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Assuming that the NIS/USD exchange rates increased/decreased by 10% (2011: 10%) with all other parameters remaining fixed, the influence on pre-tax equity would be as follows:
Capital reserves as of December 31 2012 would increase/decrease respectively by $26.5 million (as of December 31 2011 they would increase/decrease respectively by $32.7 million).
g. Interest Risk
The Group is exposed to interest risk as the Company has taken loans at variable interest rates. The risk is managed by the Group by maintaining an appropriate ratio between variable interest and fixed interest loans, by making use of interest rate swap contracts. The hedging actions are evaluated regularly in order to adapt them to projections regarding the desired interest rate and hedged risk. An optimal hedging strategy is ensured by adapting the Group's loan mixture and conducting back to back hedging against the payoff tables of existing loans.
In accordance with the Company’s interest hedging policy, the Company hedges its cash flow exposure to the LIBOR interest rate (exposure deriving from Company loans), at a scope of up to 50% of its total exposure for a horizon of up to 5 years. Interest rate hedging shall is carried out using financial instruments (such as IRS) or by taking some of the loans at fixed interest.
The Group's exposure to interest rates for financial assets and liabilities is described in the section on liquidity risk management in this Note below.
Over the course of the reported year no material change occurred in interest risk exposure factors or in the way the Group manages or measures risk.
Interest Rate Swap Agreements
Within the framework of interest rate swap agreements, the Group entered into contracts to replace differences between fixed and variable interest rate sums calculated for agreed-upon listed principal sums. These contracts allow the Group to reduce the risk from variable interest rates to the fair value of an issued debt at fixed interest and exposure of the cash flow of a debt issued at variable interest. The fair value of the interest rate swaps as of the balance sheet date is established by capitalizing future cash flows using curves as of the balance sheet date and the credit risk inherent in the contract as stated below. The average interest rate is based on the balances existing at the end of the year.
Cash Flow Hedging
All of these transactions are recognized as hedging agreements for accounting purposes as of December 31 2012. The following tables detail the fixed contractual interest rate, unpaid balance and the fair value of the interest rate swap agreements of hedging agreements recognized as cash flow hedging for accounting purposes, which existed as of December 31 2012 (as of December 31 2011 there were no interest hedging agreements recognized as cash flow hedging for accounting purposes):
Paying Fixed Interest Interest Rate Receiving Fixed Interest Fixed by Contract Unpaid Balance Fair Value – Liability As of December 31 As of December 31 2012 2011 2012 2011 2012 2011 % % Thousands of Dollars
Up to one year 0.81 - 34,475 - (126 ) - Between one and two years 0.67 - 161,845 - (669) - Between two and three years 1.10 - 134,298 - (687) - 330,618 - (1,482) -
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The interest swap agreements are cleared on a quarterly or semiannual basis according to the payoff table of the loan for which the hedging agreement was made. The Group intends to pay off the differences between variable and fixed interest rates on a net basis.
Regarding the Group's accounting policy in the matter of cash flow hedging, see Note 2n.
Interest Rate Swap Agreements Not Recognized as Financial Hedging
In three agreements not recognized for accounting purposes as hedging transactions which were made with an Israeli banking corporation, the Libor variable interest rate was exchanged for a fixed rate. These transactions were carried out on an opening principal amount of approximately $276 million, gradually decreasing based on the loan amortization schedules. This is for periods of one to two years, starting from the second half of 2010. These three transactions concluded over the course of October 2011, January 2012 and October 2012.
The fair value of these interest rate swap instruments, not recognized as hedging for accounting purposes, as of December 31 2011 was a $9,152 thousands liability. As of December 31 2012 there are no interest rate hedging agreements not recognized as economic hedges.
Interest Rate Swap Agreements Recognized as Cash Flow Hedges for Accounting Purposes
Over the course of 2012 three agreements were signed with an Israeli banking corporation, which are recognized for accounting purposes as hedging transactions, in which the variable Libor interest component was replaced by a fixed component. These transactions were carried out as follows: the first on an opening principal balance of approximately $35 million, gradually declining based on a loan amortization schedule over a one year period starting November 2012. The second transaction on an opening principal balance of $162 million, gradually declining based on the loan’s amortization schedule, over a period of one year and three months starting January 2012. The third transaction on an opening principal balance of $111 million, gradually declining based on the loan’s amortization schedule over a one year period starting January 2014.
The fair value of these interest rate swap instruments recognized as cash flow hedging for accounting purposes as of December 31 2012 is a $1,482 thousands liability (there were no transactions recognized as hedges for accounting purposes as of December 31 2011). Over the course of the year, equity decreased by $1,110 thousands after tax, due to the effectiveness of cash flow hedging as protection against cash flow risk due to interest rates (in 2011: an increase in equity after tax to the amount of $225 thousands).
Interest Rate Sensitivity Analysis
The sensitivity analysis is determined on the basis of exposure to interest rates of derivative and non- derivative financial instruments as of the balance sheet date. The sensitivity analysis with regard to liabilities bearing variable interest has been prepared assuming that the sum of the liability as of the balance sheet date was the same throughout the reported year. For the purpose of reporting internally to key management personnel on interest rate risk , use was made of increases and decreases of 75% (in 2011 – increases and decreases of 75%), representing Management's estimates regarding likely changes in interest rates.
Assuming that interest rates increase/decrease by 75% in 2012 and the remaining parameters remain unchanged, the pre-tax influence was as follows:
- Capital reserves due to interest hedging rates as of December 31 2012 would increase/decrease by $776 thousands and $790 thousands, respectively.
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- The yearly loss would have remained unchanged as there are no open transactions not recognized as cash flow hedges as of December 31 2012.
Assuming that interest rates increase/decrease by 75% in 2011 and the remaining parameters remain unchanged, the pre-tax influence was as follows:
- The loss for the year ending December 31 2011 would increase/decrease by $593 thousands and $590 thousands respectively.
- The capital reserves would have remained unchanged as there were no open transactions recognized as cash flow hedges as of December 3 12011.
h. Jet Fuel Price Risk
The Market Risks Management Committee prescribes the scope and manner of hedging of future consumption of jet fuel (hereinafter: jet fuel). The significance of the financial hedging of jet fuel prices is to guarantee the range of jet fuel purchase prices. In the event of a decrease in jet fuel prices, which is guaranteed beyond the range, then the Company pays the difference. In the event of an increase in jet fuel prices, the Company receives the difference from the guaranteeing company (mainly banks). The goal of the hedge of jet fuel prices is to hedge the Company's exposure to changes in global jet fuel prices. The Company is exposed to changes in the fair value of these financial instruments as a result of changes in market prices.
Starting from the end of 2010, the Company’s jet fuel hedging policy is as follows: Jet fuel hedging will be carried out for a period of 12-24 months forward, on a monthly basis and at decreasing rates; For the coming month the Company shall hedge at least 60% and at most 75% of its jet fuel consumption. These percentages will decrease by 5% each month until the 12th month. For the 13-18th months Company management will be given the option of hedging up to 20% of the Company’s expected jet fuel consumption (with no minimum hedging obligation). For the 19-24th months Company management will be given the option of hedging up to 10% of the Company’s expected jet fuel consumption (with no minimum hedging obligation). Hedging shall be carried out using various financial instruments as decided by management (price fixing, options and various option structures), using appropriate base assets such as jet fuel, crude oil or refined oil. At least 20% of the hedging shall be carried out using options, and the balance via options and/or price fixing, at Company management’s full discretion.
In March 2011 the Company conducted sales and purchases of jet fuel hedging transactions for the period between September 2011 and March 2012, mainly consisting of replacing some of the financial instruments used to hedge jet fuel in the period in question with other financial instruments, while making an early realization of hedging revenues to the amount of $31 million and purchasing other financial instruments worth $6 million in such a manner that the total result of the actions in question derived a cash bonus of $25 million that entered the Company's accounts.
Hedging revenues to the amount of $31 million were recognized in the Company’s Statements of Operations based on the original repayment dates of the transactions of which $5.4 million and $16.4 million were recognized as income in the third and fourth quarters of 2011, respectively, and the balance to the amount of $9.2 million was recognized as income in the first quarter of 2012.
Over the course of the reported year the Company adapted the implementation of the jet fuel hedging policy to rapidly-changing market conditions, so that from time to time a deviation is created from the policy’s base line, all of which involves regular reports to the Market Risk Management Committee and to the Board of Directors. As of December 31 20, the Company had several agreements for the purpose of hedging jet fuel prices, at a scope estimated at 37% of expected consumption for 2013. Subsequent to the balance sheet date, the Company performed additional financial transactions to protect it from increased jet fuel prices in
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accordance with its hedging policy, and as of a date near the publication of this report, it is hedged at a rate of 36% of the expected consumption for the period from March 2013 to March 2014.
The total net fair value of the jet fuel hedging agreements as of December 31 2012 amounted to $5.6 million (of which $2.5 million was for transactions recognized as cash flow hedging for accounting purposes), compared to a total of $2.1 million as of December 31 2011. The change in fair value derives mainly from the purchase and expiry of jet fuel hedging agreements over the course of 2012.
Over the course of the year equity after tax decreased by $6,604 thousands, due to the effectiveness of cash flow hedging as protection against cash flow risk due to changes in jet fuel prices (in 2011: a decrease in equity after tax to the amount of $17,665 thousands).
Sensitivity Analysis of Jet Fuel Prices
The following sensitivity analysis was established based on the exposure to fuel price risks on the reported date. Use was made of increase and decrease rates of 15%, which represent Management's estimates regarding possible changes in jet fuel prices.
If jet fuel prices were 15% higher/lower in 2012 (2011: 15%), the pre-tax influence would be as follows:
- The loss for the year ending December 31 2012 would have increased/decrease by $12.5 and $10.2 million, respectively (for the year ending December 31 2011 the loss would have increased/decreased by $1.1 and $0.1 million, respectively); and capital reserves for jet fuel hedging agreements would increase/decrease by $22.1 million as of December 31 2012 (increase/decrease by $8.2 million as of December 31 2011).
- Regarding the liquidity risk of the derivative agreements for the reduction of the exposure due to changes in jet fuel prices, see j. below.
i. Credit Risk Management
Credit risk refers to the risk that the opposite side fails to meet its contractual obligations and cause a financial loss to the Group.
The Company and its subsidiaries have cash, cash equivalents and long and short-term investments deposited mainly with large, highly rated financial institutions. The Company and its subsidiaries do not anticipate any losses resulting from credit risk. Most of the revenues earned by the Company and its subsidiaries are derived from a large number of customers (mainly travel and cargo agents), characterized by their dispersal throughout several countries. Exposure to risk from the extension of credit to customers is limited because of their relatively large number and dispersal, as mentioned above. In Israel, insurance on credit (limited in sum) is granted to travel and cargo agents. Overseas agents are covered by collateral to the extent generally accepted in that country. The Company regularly examines customer compliance with credit terms and includes an appropriate allowance for doubtful debts in its financial statements.
The book values of financial instruments listed in the Financial Statements presented net of devaluation represent the Group's maximum exposure to credit risk, this without taking the value of any security achieved into account.
Regarding the aging of delayed financial assets as of the report date the value of which remains unharmed, see Note 8.
j. Liquidity Risk Management
Liquidity risk is the risk that the corporation has difficulty meeting its financial obligations when payment for them is due. The corporate approach for the management of liquidity risks is to ensure, as much as possible, a sufficient level of liquidity to uphold obligations on time. The corporation ensures the
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presence of sufficient levels of cash on demand to pay for expected operating costs, including the sums needed to uphold financial obligations. The above does not take into account the potential influence of extreme scenarios that cannot be easily predicted.
Interest and Liquidity Risk Tables
1. Financial Assets and Liabilities Not Constituting Derivative Financial Instruments
The following tables list the Company's outstanding contractual maturities in respect of financial assets (liabilities) that do not constitute financial derivatives. These tables were prepared based on the non-capitalized cash flows, based on the earliest date by which the Group may be required to receive the asset or repay the liability. The table contains cash flows both for interest and for principal.
Fourth Fifth Year First Year Second Year Third Year Year Onward Total Thousands of Dollars As of December 31 2012:
Interest instruments (155,360) (92,319) (82,689) (89,500) (266,353) (686,221)
Trade payables (144,832) (144,832)
Trade receivables 129,898 129,898 As of December 31 2011:
Interest instruments (110,588) (96,065) (89,699) (82,657) (355,952) (734,961)
Trade payables (160,802) (160,802)
Trade receivables *139,693 139,693
- For details regarding the Company's financing, see also Note 30.
Non-material adjustment of comparison numbers – see Note 5.
2. Derivative Financial Instruments
The following table details the Group's liquidity analysis regarding its derivative financial instruments. The table was prepared based on cash receipts (payments) for derivative instruments repaid on a net basis and non-discount gross cash receipts/payments for those derivatives requiring net payoffs. When the payment or receipt sum is not fixed, the sum for which disclosure was made is set taking into account projected interest rates as described by the interest receipt curve in effect on the balance sheet date.
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Over 3 Over 1 Months Year and Up to 1 1 to 3 and Up to Up to 4 Month Months 1 Year Years Total Thousands of Dollars
As of December 31 2012:
Foreign currency swap 804 897 10,630 - 12,331 agreements Interest rate swap (147) - (518 ) (976 ) (1,641 ) agreements Agreements to reduce the 1,035 1,313 1,502 - 3,850 exposure from changes in fuel prices
1,692 2,210 11,614 (976) 14,540
As of December 31 2011:
Foreign currency swap (1,064) (2,784 ) (7,302 ) - (11,150 ) agreements Interest rate swap (4,144) (2,110 ) (4,130 ) - (10,384 ) agreements Agreements to reduce the 1,261 1,692 - - 2,953 exposure from changes in fuel prices (3,947) (3,202) (11,432) - (18,581)
k. Analysis of Financial Instruments by Linkage Instrument and Type of Currency As of December 31 2012 2011 In NIS, Non- In NIS, In USD Linked In USD Non-Linked Derivative Financial Assets Derivative financial instruments, intended as hedging items: Contracts to reduce the exposure from changes in fuel prices 2,470 - 1,770 - Foreign currency swap agreements - 11,006 - - 2,470 11,006 1,770 -
Derivative financial instruments measured at fair value via gain/loss: Contracts to reduce the exposure from changes in fuel prices 3,196 - 326 - Total derivative financial assets: 5,666 11,006 2,096 -
Derivative Financial Liabilities Derivative financial instruments, intended as hedging items: Foreign currency swap agreements - - - (12,017) Interest rate swap agreements (1,482) - - - (1,482) - - (12,017) Derivative financial instruments measured at fair value via gain/loss: Contracts to reduce the exposure from changes in fuel prices (43) - (7) - Interest rate swap agreements - - (9,152) -
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Total Derivative Financial Liabilities (1,525) - (9,159) (12,017) l. Financial Instruments not Presented at Fair Value in the Balance Sheet:
Other than as set forth in the table below, the Company believes that the book value of the financial assets and liabilities presented at depreciated cost in the Financial Statements are approximately equal to their fair value:
Book Value Fair Value Book Value Fair Value As of As of As of As of December 31 December 31 December 31 December 31 2012 2012 2011 2011 Thousands of Dollars Thousands of Dollars
Long term fixed interest loans 83,293 89,682 93,366 89,828
The fair value of these loans is based on calculating the current value of cash flows according to an interest rate of 1.85% used for similar loans with similar characteristics.
m. Financial Instruments Presented at Fair Value in the Balance Sheet
For the purpose of measuring the fair value of its financial instruments, the Group classifies the instruments, measured at fair value in the balance sheet, on a scale consisting of these three levels:
Level 1: Quoted prices (unadjusted) in active markets for identical financial assets and liabilities. Level 2: Data not quoted prices included in Level 1, observed, directly (meaning prices) or indirectly (data deriving from prices) as regards financial assets and liabilities. Level 3: Data regarding financial assets and liabilities not based on observed market data.
Classification of financial instruments measured at fair value is based on the lowest level significant use was made in measuring the fair value of the instrument as a whole. Below are details of the Group's financial instruments measured at fair value, by level:
Financial assets at fair value:
Level 2 2012 2011 Thousands of Dollars Derivative financial instruments, intended as hedging items: Jet fuel hedging agreements 2,470 1,770 Forward agreements for the purchase of 11,006 foreign currency - 13,476 1,770 Derivative financial instruments measured at fair value via gain/loss: Jet fuel hedging agreements 3,196 326 Total derivative financial assets: 16,672 2,096
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Financial liabilities at fair value: Level 2 2012 2011 Thousands of Dollars Derivative financial instruments, intended as hedging items: Forward agreements for the purchase of foreign currency - (12,017 ) Interest rate swap agreements (1,482) -
Financial liabilities measured at fair value via Statement of Operations: Interest rate swap agreements - (9,152 ) Jet fuel hedging agreements (43) (7) (43) (9,159) Total Derivative Financial Liabilities (1,525) (21,176)
Chief assumptions used to determine the fair value of financial instruments:
The fair value of financial assets and liabilities is determined as follows: The fair value of financial assets and liabilities with standard conditions traded on active markets is determined based on quoted market prices. The fair value of other financial assets and liabilities (with the exception of derivatives) is determined using accepted pricing methods based on the analysis of capitalized cash flows analyzed through the use of prices from current observed market transactions and quotes from traders in similar instruments. The fair value of derivative financial instruments is calculated using quoted prices. When such prices are not available, use is made of the analysis of capitalized cash flows while using the appropriate yield curve for the lifespan of the instruments for derivatives not consisting of options and for derivatives consisting of options use is made of option pricing models.
Note 27 - Statement of Operations Details
a. Operating Revenues:
1. Composition: For the Year Ending December 31 2012 2011 2010 Thousands of Dollars
Flying passengers 1,762,394 * 1,772,765 * 1,728,322 Less – discounts (6,788) (18,728) (18,880) 1,755,606 1,754,037 1,709,442 Flying cargo and mail 188,717 211,336 195,100 1,944,323 1,965,373 1,904,542 Others 71,319 77,213 66,904 2,015,642 2,042,586 1,971,446
Non-material adjustment of comparison numbers – see Note 5.
2. Operation Pillar of Cloud
In December 2012 the Company reported cancellations and drops in reservations for Company flights (both incoming and outgoing), which to the best of the Company’s understanding can be attributed to Operation Pillar of Cloud. Most of the influence was in the decrease in net revenues (revenue less commission) deriving from cancellations and the drop in orders, ranging between $15 and $17 million. The Company took various steps to minimize the damage, and as a result the Company estimates that the impact on contributions (revenues less actions to minimize damage less special expenses during the - C 77 - Free Translation of the Hebrew Language 2012 Annual Report - Hebrew Wording Binding
operation) is between $7 and $9 million, which largely impacted Q4 2012 results. The Company estimates that the drop in reservations as a result of the operation and primarily the impact on incoming tourism traffic continued into 2013 and also influenced the Company's financial results.
b. Operating expenses:
1. Composition: For the Year Ending December 31 2012 2011 2010 Thousands of Dollars
Fuel 686,169 686,375 584,260 Salary and associated * 299,332 331,099 307,537 Airport fees and services 166,928 174,598 159,394 Maintenance of aircraft, flight and ground 103,026 100,640 89,429 equipment Air navigation and flight communications 92,325 105,335 98,168 Depreciation 109,676 107,980 105,333 Insurance 6,062 7,080 6,812 Aircraft leasing fees 77,192 71,827 64,147 Meals and supplies 41,483 45,396 44,192 Air crew expenses 45,487 46,268 44,315 Participation in security expenses (see 2. 33,212 40,036 41,068 below) Cost of duty-free products 10,606 11,426 10,572 Other expenses 30,883 36,819 29,330 1,702,381 1,764,879 1,584,557 * including expenses due to employee benefits
2. Participation in security expenses:
Pursuant to the Government resolutions dated January 27 2008 and August 24 2008 regarding the participation of the State of Israel in the Company's security costs, on August 3 2011 the Company signed an agreement with the State of Israel, regulating the activity of the Israeli aviation security system. On December 25 2011 the Government passed a resolution validating the understanding with the Government ministries, mainly pertaining to the continued provision of aviation services by the Company to Israeli airlines and a gradual increase in the State’s participation in the security expense burden of Israeli airlines, from 60% (the current rate) to rates of 65% (for 2011), 70% (for 2012), 75% (upon the signing of the open skies agreement with the European Union) and 80% upon the implementation of the open skies agreement (as agreed upon in the understanding). Upon passing the Government resolution in question and after an agreement was signed with the Foreign Ministry, which arranged, among other things, the employment of aviation security workers, the conditions for the implementation of the understanding in question were completed. On July 30 2012 the State of Israel and the European Union signed, in initials, a uniform global aviation agreement with the EU, known as the Open Skies Agreement. As of this report, the Open Skies Agreement has yet to be ratified by the Israeli government. Note that the European Council of Ministers of Defense ratified the agreement in question on December 20 2012.
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c. Sales expenses:
Composition: For the Year Ending December 31 2012 2011 2010 Thousands of Dollars
Agent commissions 123,965 124,617 124,887 Salary and associated * 49,591 53,628 51,062 Advertising and public relations 8,005 9,710 11,047 Others 27,649 27,971 27,759 209,210 215,926 214,755
d. Administrative and general expenses:
Composition: For the Year Ending December 31 2012 2011 2010 Thousands of Dollars
Salary and associated * 61,540 64,527 65,123 Professional services 6,509 6,930 5,574 Communications 2,113 2,201 2,318 Rental fees and office maintenance 12,093 10,281 10,380 Insurance 2,138 2,231 1,993 Other expenses 10,983 11,222 10,765 95,376 97,392 96,153
* Including expenses due to employee benefits
e. Other expenses (incomes), net:
1 . - Composition For the Year Ending December 31 2012 2011 2010 Thousands of Dollars
Expenses in respect of employee retirement plans, net (See Note 19e and section 2 below) 307 1,295 5,106 Expenses due to legal actions (see Notes 22d) 848 14,879 4,264 Capital gains from the realization of fixed assets (see 3 below) (4,182 ) (3,520 ) (672 ) Update of provision due to settlement with Social Security and Income Tax - (5,034 ) (22,250 ) Amortization of assets - - 1,594 Others 224 673 689 Total (2,803) 8,293 (11,269)
2. The Company had no new retirement plans in 2012 and 2011. In 2010 a retirement plan was included for 11 employees for whom a provision was made to the amount of $2.0 million. The retirement plan expenses also includes the revaluation of liabilities for existing retirement plans following the yearly revaluation of the stipend as well as the revaluation of the shekel vis-à-vis the dollar as well as a capitalization coefficient for the retirement plans. - C 79 - Free Translation of the Hebrew Language 2012 Annual Report - Hebrew Wording Binding
3. Capital gains to the amount of $9.4 million were included in 2012 mainly from the sale and re- lease of two CFM 56-7B engines, see Note 13.d.2, and a capital loss of $5.9 million from the sale of two Boeing 757-200ER aircraft, see Note 13.d.4, as well as capital gains to the amount of $0.4 million from the sale of a Boeing 757-200, see Note 13.d.3.
Capital gains to the amount of $3 million were included in 2011 mainly from the sale and lease back of a Trent 895 engine. In 2010 capital gains were included to the amount of $0.4 million from the sale of spare parts. .
Note 28 - Financing Expenses For the Year Ending December 31 2012 2011 2010 Thousands of Dollars
Interest with respect to loans 16,475 13,076 13,967 Expenses due to interest hedging agreements 238 1,396 11,894 Expenses due to the revaluation of Maman options and shares, see Note 12b. - 1,865 821 Exchange rate hedging expenses 13,533 - - Commissions and other bank expenses 4,201 3,856 4,024 Exchange rate differences due to balances not in the Group's functional currency 3,966 4 5,205 38,413 20,197 35,911
Note 29 - Financing Income
For the Year Ending December 31 2012 2011 2010 Thousands of Dollars
Interest due to short term bank deposits 594 1,594 1,259
Income from foreign currency hedging agreements - 14,343 7,902 Exchange rate differences due to balances not in the 445 3,922 - Group's functional currency Revenues due to the revaluation of Maman options and 130 - - shares, see Note 12b. Others 278 615 1,688 1,447 20,474 10,849
Note 30 - Means of Finance
As of December 31 2012, the Company's credit frameworks amounted to a total of $47 million ($35 million as of December 31 2011). In addition, the hedging institutions provided the Company with unguaranteed frameworks to the amount of $43 million. As of December 31 2012 the Company was not required to provide any collateral for its hedging transactions.
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Note 31 - Earnings per Share For the Year Ending December 31 2012 2011 2010 a. Base Profit per Share
Earnings (loss) per year charged to the shareholders of the parent company (in (18,831) *(49,836) *56,460 thousands of dollars)
Weighted average of number of ordinary shares used to compute basic earnings per share (in thousands) 495,719 495,719 495,719
b. Diluted Profit per Share
Earnings (loss) used to calculate diluted earnings per share (in thousands of (18,831) *(49,836) *56,460 dollars)
Weighted average of number of ordinary shares used to compute basic earnings per share (in thousands) 495,719 495,719 495,719 Adjustments: Options (in thousands) - - 1,074 Weighted average of number of ordinary shares used to compute diluted earnings per share (in thousands) 495,719 495,719 496,793
Non-material adjustment of comparison numbers – see Note 5.
c. Instruments that could potentially dilute basic earnings per share in the future, but which were not included in the calculation of the diluted revenue per share as their influence was anti-diluting: For the Year Ending December 31 2012 2011 2010
Number of options issued in the framework of share-based payment arrangements (in thousands) 17,250 20,291 15,545
Note 32 - Segment-Based Reporting
a. General:
The Group has applied IFRS 8, "Operating Segments" (hereinafter "IFRS 8") starting January 1 2009. According to IFRS 8, operational segments are identified based on internal reports on the Group's components, which are reviewed on a regular basis by the Group's chief operational decision maker for the purpose of allocating resources and assessing the performance of the operational segments.
In light of the above, the following are the Company's reported operating segments in accordance with IFRS 8:
Segment A – passenger aircraft activity. Segment B – cargo aircraft activity.
Passenger aircraft activity includes revenues (without deducting discounts) from the transport of passengers including baggage, transporting freight in the belly of passenger aircraft, mail transport and the contribution from the sale of duty free products.
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Cargo aircraft activity includes revenues from airborne cargo shipping fees. In this area of activity, the Company offers cargo transport services in cargo aircraft from Israel to destinations to and from Israel; cargo transported from one foreign country to another foreign country (Fifth Freedom), for example from Liège to New York; or cargo transported in the context of Sixth Freedom (indirect flights via stopovers in the home country of the airlines), for example from Asia to Europe or the U.S. with a stopover in Israel. During the reporting year, the services offered by the Group in this field of operations were cargo transport services to one destination in Europe on scheduled flights, three destinations in Europe on charter flights and one destination in North America. Moreover, the Company offers cargo services to many additional destinations using the Company’s passenger aircraft or by means of cooperative arrangements with other airlines and also via land transport from the airport.
Starting June 2011 the Company employs a single leased Boeing 747-400 cargo airplane. An additional 747-200 cargo plane owned by the Company was decommissioned in late May 2011.
The Company’s other activities include revenues from charter flights via subsidiary Sun D'Or (which are written off in the "Adjustments" column), revenues from maintenance service provided to outside elements as well as a broad variety of services and revenues such as equipment leasing, frequent flyer membership fees, loading and unloading services and more.
The Company's chief operational decision maker does not receive reports regarding measurement of segment assets and therefore, in accordance with the revision to IFRS-8, this information is not included in the segment reporting.
b. Analysis of revenues and results according to operating segments:
Segment-based earnings represent the contribution made by each segment. Each segment's contribution is determined as follows: revenues created from operating segments less variable expenses involved in the operation of passenger airplane and cargo airplane flights, which include, inter alia, fuel expenses (not including fair value changes of jet fuel hedging agreements); airport fees and taxes, variable maintenance costs, air navigation and communication, passenger food and supplies, aircraft leasing fees, discounts and commissions granted passengers or paid to travel agents, air crew expenses including salaries and variable security costs. Unassigned costs primarily include salary costs (with the exception of air crew costs), changes in the fair value of hedging transactions not recognized for accounting purposes and other fixed costs.
For the Year Ending December 31 2012 Passenger Cargo Adjust- Aircraft Aircraft Others ments Total In Thousands of Dollars Revenues Revenues from outside customers 1,827,943 80,431 44,603 62,665 2,015,642 Inter-segment revenues - - 48,557 (48,557) - Total segment revenues 1,827,943 80,431 93,160 14,108 2,015,642
Segment results 187,727 (3,827) 26,825 - 210,725
Unassigned expenses (199,747)
Operating profit 11,478
Financing expenses (38,413) Financing income 1,447 The Company's share of the profits of subsidiaries, net of tax 1,273 Loss before taxes on income (24,215) Tax benefit 5,384 Yearly loss (18,831)
In 2012 the Company attributed depreciation expenses to the amount of $92.2 million to the passenger aircraft segment did not attribute depreciation expenses to the cargo aircraft segment. - C 82 - Free Translation of the Hebrew Language 2012 Annual Report - Hebrew Wording Binding
For the Year Ending December 31 2011 Passenger Cargo Adjust- Aircraft Aircraft Others ments Total In Thousands of Dollars Revenues Revenues from outside customers *1,829,492 99,442 45,359 68,293 2,042,586 Inter-segment revenues - - 65,919 (65,919) - Total segment revenues 1,829,492 99,442 111,278 2,374 2,042,586
Segment results *159,045 (678) 31,034 - 189,401
Unassigned expenses (233,305)
Operational loss (43,904)
Financing expenses (20,197) Financing income 20,474 The Company's share of the profits of subsidiaries, net of tax 1,441 Loss before taxes on income (42,186) Taxes on income (7,650) Yearly loss (49,836)
In 2011 the Company attributed depreciation expenses to the amount of $90.3 million to the passenger aircraft segment and $2.6 million to the cargo aircraft segment.
* Non-material adjustment of comparison numbers – see Note 5.
For the Year Ending December 31 2010
Passenger Cargo Adjust- Aircraft Aircraft Others ments Total Thousands of Dollars Revenues Revenues from outside customers *1,764,489 87,508 38,790 80,659 1,971,446 Inter-segment revenues - - 78,573 (78,573) - Total segment revenues 1,764,489 87,508 117,363 2,086 1,971,446
Segment results *251,032 (264) 28,573 - 279,341
Unassigned expenses (192,091)
Operating profit 87,250
Financing expenses (35,911) Financing income 10,849 The Company's share of the profits of subsidiaries, net of tax 45 Profit before taxes on income 62,233 Taxes on income (5,773) Yearly profit 56,460
In 2010 the Company attributed depreciation expenses to the amount of $85.4 million to the passenger aircraft segment and $5.6 million to the cargo aircraft segment.
- C 83 - Free Translation of the Hebrew Language 2012 Annual Report - Hebrew Wording Binding
Presentation by Geographical Segments East and The Rest North Central of the America Europe Asia World Total In Thousands of Dollars 2012 Revenues-
Segment revenues 662,761 936,818 322,307 46,599 1,968,485 Revenues not attributed to segments 47,157 Total revenues in the consolidated report 2,015,642
2011 Revenues- Segment revenues 694,445 *923,701 313,415 60,298 1,991,859 Revenues not attributed to segments 50,727 Total revenues in the consolidated report 2,042,586
2010 Revenues- Segment revenues 673,030 *904,789 299,468 50,268 1,927,555 Revenues not attributed to segments 43,891 Total revenues in the consolidated report 1,971,446 Non-material adjustment of comparison numbers – see Note 5.
Note 33 - Agreements with Related and Interested Parties
a. General:
The Company's parent company is K'nafaim Holdings Ltd. (hereinafter “K’nafaim”), which is under the control of the controlled by the Borowitz family.
b. K’nafaim and its Controlling Shareholders
In June 2004, K’nafaim became an interested party in the Company. Starting January 2005 K’nafaim became the Company’s controlling shareholder As of December 31, 2012, K'nafaim holds 39.3% of the Company's shares. The following is a general description of the transactions, their characteristics and scopes: included in the framework of operating revenues in 2012 was a revenue of $215,000 from a company controlled by K’nafaim, in 2011 income was included to the amount of $151,000 and in 2010 income was included to the amount of $93,000.
Within the framework of operating expenses, transactions with K'nafaim and companies in which its controlling parties have a personal interest to the amount of $711,000 were included in 2012. Expenses totaling $1,143,000 were included in 2011 and $584,000 were included in 2010.
Within the framework of sales expenses, transactions via a third party with Company in which the controlling parties at K’nafaim have a personal interest, in the field of advertising, to the amount of $587,000 were included in 2012. Expenses totaling $966,000 were included in 2011.
General and administrative expenses include $0.1 million in expenses for directors’ insurance in 2012 (sums of $0.1 million in 2010 and 2011). Regarding the collective insurance agreement, see f. below.
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c. Transactions with additional related and interested parties:
1) Transactions Listed in Section 270(4) of the Companies Law, 1999
a) The inclusion of K’nafaim, the Company’s controlling shareholder, in the Company’s aviation insurance – following the Company's report from November 26 2009 on the matter of the Company’s engagement with its controlling shareholder K’nafaim Holdings in a joint transaction for the purchase of aviation insurance for a period of five years (hereinafter respectively: “the Original Report”, “K’nafaim” and “the Joint Transaction”), on November 21 2012 the Audit Committee approved the feasibility of the engagement period in the joint transaction in accordance with Section 275.(a).(2) of the Companies Law, which allows that approval of exceptional transaction of a public company with its controlling shareholder for a period exceeding three years in cases in which the Audit Committee approved that the engagement in the period in question is feasible under the circumstances. As detailed extensively in the original report for the approval of by the joint transaction, the Company purchases a certain amount of insurance coverage for K’nafaim within the framework of its insurance policies. The Company’s Audit Committee reexamined the terms of the joint transaction and confirmed that the five-year engagement was reasonable under the circumstances, for the following reasons: no material changes occurred in the insurance coverage or in the premium paid by the Company due to the inclusion of the K’nafaim insurance policies in the entire period in which such coverage existed for K’nafaim; no change is expected in the terms of the insurance for the period until the conclusion of the joint transaction (until the end of 2014); the Company was given the right to discontinue the engagement at any time subject to 60 days advance notice; at the conclusion of the engagement period, and in the event that the parties are interested in continuing with the joint transaction, the engagement will be presented for re-approval as required by law.
b) The rights of the retiring Chairman of the Board of Directors Prof. Israel (Izzy) Borowitz to Company flight tickets for himself and his family – Prof. Israel (Izzy) Borowitz is one of the controlling shareholders of K’nafaim, the Company’s controlling shareholder. The transaction was approved by the Audit Committee, the Company's Board of Directors as well as by the general meeting convened on December 30 2008.
c) Approval of financial compensation to the Company’s directors (including directors considered Company controlling shareholders) – the transaction was approved by the Audit Committee, the Company’s Board of Directors and by the Company’s general meeting, which convened on March 4 2009.On May 16 and following the provisions of Amendment 16 to the Companies Law the general meeting ratified the compensation (including the right to flight tickets for reduced prices) to which the members of the Company’s Board of directors serving now and/or which will service from time to time at the Company are entitled, including directors constituting Company controlling shareholder and excluding external directors and directors the terms of the remuneration of which was arranged specifically for three additional years.
d) The employment of Mr. Nimrod Borowitz as the manager of the Company's Strategic Partnerships Project – Mr. Nimrod Borowitz is the son of Mr. David Borowitz (a controlling shareholder of K’nafaim, the Company’s controlling shareholder, and husband of Tamar Moses Borowitz, the Deputy Chairman of the Board of Directors and a controlling shareholder of K’nafaim). The transaction was approved by the Audit Committee, the Company’s Board of Directors and by the general meeting, which convened on March 4 2009.On May 2 2012 and following the provisions of Amendment 16 to the Companies Law, the general meeting approved the extension of the terms of the employment of Mr. Nimrod Borowitz, C.P.A, as manager of the Company's Strategic Partnerships Project by an additional 3 years.
2) Non-Exceptional (Not Listed in Section 270(4) of the Companies Law, 1999) and Non- Negligible Transactions
a) On June 26 2012 the Company’s Board of Directors approved the Company’s engagement with Kenes International Conferences Ltd. (“Kenes”) in a business customer agreement for the purchase of flight tickets, starting April 2012 until December 2013, as well as engagements in - C 85 - Free Translation of the Hebrew Language 2012 Annual Report - Hebrew Wording Binding
similar formats with Kenes from April 2010. Note that the transaction was classified as a transaction in which a controlling shareholder has a personal interest, as Prof. Israel (Izzy) Borowitz, a controlling shareholder in K’nafaim (the Company’s controlling shareholder) served on the Kenes board of directors (the Company was informed that as of this report, Prof. Borowitz no longer serves on the Kenes board). The Company’s Board of Directors examined the engagements in question and came to the conclusion that the engagements benefit the Company, taking into account the terms of the agreement and the financial advantage involved in adding an additional business client to the list of the regular business clients that make use of the Company’ services. The Audit Committee determined that the Company engagements in question do not constitute exceptional transactions as the term is defined in the Companies Law, as the engagements are transactions over the normal course of the Company's business, are under market conditions and do not have a material impact on the Company’s profitability, assets or liabilities.
b) On May 23 2012 the Company's Board of Directors approved the Company's engagement with the Yediot Acharonot Group for the transportation of cargo (newspapers) from Tel Aviv to JFK Airport in the U.S., for 2012 to 2013.In addition, the Company Board of Directors approved the engagement of subsidiary Sun D’Or with the Yediot Group to purchase advertising space on the Ynet website for Sun D’Or, for 2012 to 2014. Taking the terms of the agreements into account and in light of the fact that the agreements were carried out for economic reasons, the Company Board of Directors determined that the engagements in question benefited the Company. The Board of Directors also established mechanisms for supervising the implementation of future cargo transportation agreements with Yediot Acharonot under market prices and conditions. The Audit Committee determined that the engagements do not constitute exceptional transactions as the term is defined in the Companies Law, for the following reasons: a. The Company and/or Sun D’Or, over the normal course of their business, engage in transactions for transporting cargo and purchasing advertising space (respectively) for the purpose of marketing their activity. b. Engagements with Yediot Acharonot to purchase advertising space, as above, were and are carried out under generally accepted conditions and market prices taking into account, among other things, the rating data, exposure and market conditions of the website as well as Sun D’Or’s marketing needs. On the matter of cargo shipping – these are direct agreements (not through cargo agents) and at prices similar to those given other Company customers, taking the transportation conditions and the type and amount of cargo into account. c. The agreement between the Company and Sun D’Or and Yediot has no material impact on the Company's profitability, assets or liabilities.
c) On March 20 2012 the Company’s Board of Directors approved engagements for the purchase of advertising space in newspapers, magazines and websites owned by Yediot Acharonot Ltd. (“Yediot Acharonot”) for 2012 and 2013 as well as engagements for the purchase of newspapers and magazines from Yediot Acharonot in the period in question. Pursuant to the Company’s marketing activity, the Company enters into agreements, from time to time, through the Company’s advertising agency, with various bodies in the field of media. Within this framework, the Company purchases advertising space from entities in the Yediot Acharonot Group in the field of written press and the internet. Note that the selection of suppliers for each publication follows consultations between the Company, external media and control consultants and the advertising agency. In addition, as part of its services for the Company’s passengers, the Company purchases various newspapers and magazines for the passengers, including newspapers and magazines published by Yediot Acharonot. In light of the fact that Yediot Acharonot is a company owned by the brother of Ms. Tamar Borowitz (Deputy Chairman of the Board of Directors and a controlling shareholder of K'nafaim holdings Ltd.), the engagements in question were approved by the Company’s Board of Directors as non-exceptional transactions, in which Company executives and shareholders may have an interest, after being classified as such by the Audit Committee. In the Audit Committee's decision regarding the classification of the transactions, the Committee stated that such engagements were carried out as part of the Company’s normal business and under market conditions, according to comparative data presented the Committee. Furthermore, the Committee was also presented with a mechanism for controlling and supervising market conditions, in relation to future transactions for the purchase of advertising space from Yediot Acharonot, which will ensure that these transactions are conducted at market conditions over the course of the engagement period in question. The Committee also established that in accordance with the expected purchases as presented it, both in the field of advertising space purchases and in the field of newspaper and magazine purchases, they will not have a material impact on the Company’s profits, assets and liabilities. The Board of Directors’ stated reasons for approving the engagements in question in the field of advertising - C 86 - Free Translation of the Hebrew Language 2012 Annual Report - Hebrew Wording Binding
space purchases were that the engagements are for the Company’s benefit, taking into account its marketing needs, market conditions and the advantages embodied in each of the advertising measures in question. The Board of Directors’ arguments for approving the engagement in the field of newspaper and magazine purchases were that the engagements benefited the Company, taking into account the contribution their granting has to service provided Company customers on the one hand and the price at which the Company purchases the newspapers and magazines on the other. In addition, and seeing as the terms of the Company’s engagements with Yediot for the purpose of purchasing advertising space are not set in advance, the Company Board of Directors has established mechanisms for supervising the implementation of the advertising agreements with Yediot Acharonot under market conditions and prices.
d) On December 26 2011 the Company’s Board of Directors approved the extension of the engagement to receive advertising services from billboard company CTV Media Israel Ltd. (CTV) to 2012-2013; pursuant to the Company’s marketing activity, the Company enters into agreements, from time to time, through the Company’s advertising agency, with various bodies in the media field. Within this framework, the Company purchases advertising services from CTV and as Ms. Tamar Borowitz, Deputy Chairman of the Board of Directors and a controlling shareholder of K'nafaim and the Company and Mr. Nadav Palti, a Company director, indirectly hold part of its shares and serve on its board of directors, and likewise Professor Israel Borowitz, a K'nafaim controlling shareholder, indirectly holds some of CTV’s shares, the engagement in question was approved by the Company's Board of Directors as a non-exceptional transaction in which Company executives and controlling shareholders may have a personal interest, after it was classified as a non-exceptional transaction by the Audit Committee.
e) On December 26 2011 the Company Board of Directors approved the terms of the Company’s engagement in an agreement to purchase flight tickets as a business customer with Yediot Acharonot Ltd. (“Yediot Acharonot”), as well as the extension of the engagement with them until the end of 2013, as part of the update of the terms of the Company's agreements with all of its business customers, pursuant to which the Company grants benefits to these customers in the purchase of flight tickets, inasmuch as they choose to make use of the Company’s services. The update in question was prepared in a manner identical to the updates prepared in the agreements with the Company’s other business customers with a similar scope of purchases, in accordance with the Company’s policy in its engagements with these customers. In light of the fact that Yediot Acharonot is a company owned by the brother of Ms. Tamar Borowitz, Deputy Chairman of the Board of Directors and a controlling shareholder of K'nafaim and the Company, the engagement in question was approved by the Company’s Board of Directors after being as a non-exceptional transaction by the Audit Committee, in which Company executives and shareholders may have a personal interest.
f) On December 26 2011 the Company Board of Directors approved the terms of the Company’s engagement in an agreement to purchase flight tickets as a business customer with the law firm of Goldfarb & Zeligman, as well as the extension of the engagement with them until the end of 2013, as part of the update of the terms of the Company's agreements with all of its business customers, pursuant to which the Company grants benefits to these customers in the purchase of flight tickets, inasmuch as they choose to make use of the Company’s services. The update in question was prepared in a manner identical to the updates prepared in the agreements with the Company’s other business customers with a similar scope of purchases, in accordance with the Company’s policy in its engagements with these customers. As Mr. Yehuda (Yudi) Levi is the managing partner of Goldfarb & Zeligman and serves as Deputy Chairman of the Board of Directors at the Company and is an interested party in E.L. Aviation Assets, which is considered the controlling shareholder for K'nafaim and the Company, the engagement was approved by the Company Board of Directors after it was classified by the Audit Committee as a non-exceptional transaction, in which a Company executive and Company controlling shareholders may have a personal interest.
g) On June 29 2011 the Company's Board of Directors ratified an engagement with the Dori Media Group (“Dori Media”) in a business customer agreement under generally accepted terms for business customers with similar scopes of activity, according to which the Company will grant benefits to the Firm’s employees in the purchase of flight tickets, if they choose to make use of the Company’s services, starting May 2011 and ending May 2012 as well as for an additional extension period of one year under the same terms. On May 23 2012 the Company's Board of Directors approved the extension of the Company's engagement with Dori Media. The extension was classified by the Audit Committee as a non-exceptional transaction, in which Company's - C 87 - Free Translation of the Hebrew Language 2012 Annual Report - Hebrew Wording Binding
executives and the Company’s controlling shareholders may have a personal interest, as the Deputy Chairwoman of the Board of Directors at the Company and the Company’s controlling shareholder, Mrs. Tamar Moses Borowitz, is the indirect controlling shareholder of Dori Media and sits on the Dori Media board of directors. In addition, the Deputy Chairman of the Company’s Board of Directors, Mr. Yehuda (Yudi) Levi – is a member of Dori Media’s board of directors and Board member Nadav Palti is the CEO and President of Dori Media and holds Dori Media shares indirectly.
h) On October 26 2010 the Company Board of Directors approved the engagement of with QAS Israeli Ltd. (“QAS”), in which the Company controlling shareholder has a 50% stake, in an agreement to provide ground services at BGN by the Company to QAS. The Company provides QAS with ground services at Ben Gurion Airport in return for a payment reflecting the market price for similar services, at non-material amounts. QAS deals in the supply of ground services to foreign airlines at Ben Gurion Airport and is interested in the Company carrying out some of the services QAS provides the airlines, such as towing aircraft, providing electrical power to aircraft and providing aircraft accessories. The agreement is for an unlimited term and each party may terminate it with 60 days’ notice. This agreement was approved by the Company Board of Directors as a non-exceptional transaction.
i) On January 21 2009 the Company’s Board of Directors approved a commitment with the law firm of Goldfarb, Levi, Eran, Meiri, Tzafrir & Co. for the treatment of various legal issues. The engagement was brought to the approval of the Board of Directors as a transaction in which a controlling shareholder has a personal interest, as the Company's controlling shareholder, the Deputy Chairman of the Board Yehuda (Yudi) Levi, Esq., has a personal interest due to the fact that he is a partner-manager of the law firm in question. The Board of Directors approved the engagement as a non-exceptional transaction.
d. Negligible Transaction
On November 26 2009, the Company Board of Directors decided to adopt rules and guidelines for the classification of a transaction made by the company or one of its affiliates with an interested party (hereinafter: "an Interested Party Transaction") as a negligible transaction as defined in Regulation 41(a)(6)(a) of the Securities Regulations (Yearly Financial Statements), 2010. The Company's Board of Directors has determined that in the absence of special qualitative considerations deriving from the circumstances of the issue, an Interested Party Transaction shall be considered a "negligible transaction" if: (a) The transaction takes place over the Company's normal course of business and (b) the transaction is under market conditions and its terms are acceptable to the relevant market; and (c) the relevant criteria for the transaction, one or more, whether it is a single commitment or a series of commitments on the same issue over the course of the same year, is at an extant of no greater than 200,000 NIS in any interested party transaction the classification of which has been considered as a "negligible transaction" on the basis of the Company's latest audited consolidated yearly financial statements. Relevant criteria for the determination of a transaction are, for instance: Relevant criteria for the determination of a transaction are, for instance: (1) total sales the subject of the Interested Party Transaction; or – (2) the total cost of the sales the subject of the Interested Party Transaction; or – 93) the extant of assets the subject of the Interested Party Transaction; or – (4) the extant of liabilities the subject of the Interested Party Transaction; or – (5) the extent of the expense or yield the subject of the Interested Party Transaction. In this regard - in the event the Company does not have full rights to a certain transaction, the transaction shall be determined based on the Company's relative portion of the transaction. In cases in which, according to the Company's judgment, all of the aforementioned criteria are irrelevant for the determination of the negligibility of the Interested Party Transaction, the transaction shall be considered negligible, in accordance with a different relevant criterion, determined by the Company, so long as the relevant criterion used for this transaction shall not exceed 200,000 NIS. Over its regular course of business, the Company carried out, during the reported year or as of the date the report was filed or which are still in effect as of the report date, transactions with controlling shareholders defined as “negligible transactions”, of the following types and with the following characteristics: catering services for passengers whose flight has been delayed; security screening services for VIP travelers in the Masada Lounge; undercover inspections on Company flights and during security screening for Company flights; controls for the Company’s website, transportation services for passenger boarding and disembarkation, and providing various food-related services via subsidiary TAMAM.
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e. Agreement with the Company CEO:
On October 21 2009, the Company's Board of Directors decided to appoint Mr. Eliezer Shkedi as the Company's CEO; he entered his office on January 1 2010. On January 6 2010 the Company’s Audit Committee and Board of Directors approved the engagement with the CEO via the employment contract (hereinafter: “the Employment Contract”) which came into effect retroactively starting November 1 2009, the key points of which being the following: The CEO shall be subordinate to the Company’s Board of Directors. The CEO's gross monthly salary shall be 115,000 NIS, linked to the Consumer Price Index on the basis of the known index, with the basis index being the CPI published December 15 2009.
The CEO shall be entitled to a bonus comprised of the following three components: "Profit bonus" - a sum equal 2.0% of the Company's yearly pre-tax profit as it appears in the Company's consolidated and audited yearly Financial Statements (“the Yearly Statements") for each calendar year during the CEO's tenure as Company CEO ("the Tenure"), starting 2010, when such a profit was achieved and for any portion of such a calendar year; as well as: "One-time bonus" – a one-time bonus to the amount of two million NIS for the first calendar year over the course of the tenure in which the Company achieved a pre-tax yearly profit, this in accordance with the yearly statements for the year in question ("the base year") and an additional (and final) one-time sum of one million NIS for an additional calendar year over the course of the tenure, in which the Company achieved a pre-tax yearly profit, this in accordance with the yearly statements for the year in question; as well as – "A result improvement bonus" - a sum of 2.0% of the aggregate improvement to the Company's yearly pre-tax profit, starting from the base year until the end of the tenure, according to the yearly statements. This bonus shall be paid the CEO for the base year and for each subsequent calendar year in which an improvement occurred (if any) in the yearly profit in question compared to the previous peak year in the tenure, with "previous peak year" in this regard being a previous calendar year, starting from the base year, in which the Company's highest pre-tax profit was achieved to date for which the bonus in question is paid. Eligibility for this bonus shall apply only if (a) a pre-tax yearly profit was achieved for the calendar years during the tenure in accordance with the relevant yearly reports; as well as – (b) under the condition that the profit in question is larger than the pre-tax profit achieved in the previous peak year, and – (c) due to the difference (delta) only between the two profit sums in question (with the exception of for the base year in which the bonus in question is calculated for the entire pre-tax yearly profit for that year). The CEO shall be entitled to social benefits such as executive insurance provisions or pension funds, loss of work ability and education fund, as are commonly granted Company senior executives. In addition, the CEO shall be entitled to 30 paid sick days per year (which may be accumulated to up to 120 days, but not redeemed), 16 recovery days per year, as well as 25 vacation days per year (which may be accumulated, unlimited in amount and redeemable). In addition, the CEO shall be entitled to reasonable personal and hospitality expenses, spent as part of his duties and in return for appropriate receipts/ invoices. The employment contract was set for an unlimited term and established that each party may discontinue the agreement subject to providing advance notice as follows: (a) during the first year of work – if the Company has discontinued the agreement or if the discontinuation received both parties’ consent, the advance notice period shall be 3 months from the end of work in practice or by December 31 2010, whichever is later, and if the agreement is discontinued by the CEO the period shall be 3 months in length; (b) if advance notice on the agreements discontinuation is delivered during the second year of work – if the Company has discontinued the agreement or if the discontinuation received both parties’ consent, the advance notice period shall be 152 months from the end of work in practice, and if the agreement is discontinued by the CEO the period shall be 6 months in length; (c) if the advance notice regarding the discontinuation of the agreement is delivered after the completion of the second year of work, the advance notice period shall be 12 months from the end of work in practice, whether it was discontinued by the Company, by the CEO or with their mutual consent. In this regard, the “end of work in practice” means the date set by the Board of Directors (or a Board committee) as the date on which the CEO’s work at the Company ended in practice. Upon the discontinuation of the CEO's employment, for any reason, with the exception of criminal circumstances, the CEO shall be entitled to, in addition to the payments specified above, a retirement bonus to the amount of a single monthly salary multiplied by the
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amount of years he worked at the company (not including the advance notice period), including for a portion of a work year, this according to the CEO's last pay slip. This agreement includes confidentiality and non-compete clauses, according to generally accepted practice, for a 12 month period from the actual discontinuation of work. The Company shall provide the CEO with a mobile phone, a telephone line and home fax machine and shall bear full maintenance and usage costs as well as payments for calls. The Company shall provide the CEO and his household with a Licensing Group 6 vehicle. The Company shall bear all costs involved in the use and maintenance of the vehicle, according to Company practice and its procedures as updated from time to time. The Company shall pay the tax payments borne by the CEO for the vehicle and telephone at his disposal. The CEO shall be entitled to flight tickets for himself and for his family according to Company practice regarding any person serving as CEO, this according to existing Company procedures, updated from time to time. Regarding options granted the Company CEO, see Note 25.e.3.
In light of the streamlining and savings measured employed by the Company, on November 22 2011 the Company CEO announced that he would be unilaterally waiving 20% of the (gross) monthly salary to which he is entitled. The aforementioned waiver is for a period beginning December 1 2011 and ending December 31 2012. For further details, see h. below.
Excelling Employees Fund As part of the terms of the Company CEO’s employment and at the CEO's request, the Board of Directors approved the establishment of a CEO fund for the remuneration of excelling employees, to the amount of 2 million NIS. This fund was established after the Company's financial results in 2010 showed an improvement of over 50% over 2009. In addition, on March 22 2011 the Company CEO informed the Company Board of Directors, at his own initiative, that he had decided to transfer to the Excellence and People fund, established in 2011, a sum equal to 50% of the yearly bonus owed him for 2010, in accordance with the term of his employment, meaning a total of 5.7 million NIS (gross). It was decided that use of this fund shall be at the discretion of the CEO to provide incentives to excelling Company employees who are not Management members, and its goal shall be the development, encouragement and promotion of the subject of excellence in the Company and personal excellence. The purpose of the fund was to create a challenging environment that encourages excellence, to systematically and continuously encourage the fulfillment of the personal and team capabilities and the accomplishment of exceptional achievements, to encourage personal and group investigation that will lead to progress in thought and action and to advance individual creative and progressive thought.
The fund is intended for advancing and realizing three main areas:
. The person/team behind the excellence – 10 El Al CEO prizes for excellence for employees/teams each year for the next three years who will prove a “final result” in one of the following indices: increasing profitability, improving service, reducing expenses, increasing revenues, improving products, increasing customer numbers, improving availability, improving precision, improving processes, streamlining and safety improvement suggestions.
. Supportive environment – creation of a positive dynamic at the Company for encouraging excellence by compensating the group from which the excellence arose in the nearby work circle
. Excelling in all of the Company’s profession – 56 of the Company's workers were selected each year and are granted monetary awards in order to encourage long-term excellence.
. High-value education– reinforcing affiliation of Company members to history, heritage and Jewish values. The goal is for all Company members tour Jerusalem through the fund and visit Yad Vashem over the next few years.
The Company established a committee to study the proposals made by the Company’s employees including their compliance with criteria set for the purpose of winning prizes. The Company CEO, in a special ceremony, awards the CEO’s prizes for excellence to the winning proposals. The fund’s activity is expected to continue in the future and the budget earmarked for the fund is designated for this purpose and is not dependent on the Company's business results.
- C 90 - Free Translation of the Hebrew Language 2012 Annual Report - Hebrew Wording Binding
f. Directors’ and Executives’ Insurance and Indemnification
Group directors and executives are insured by director and officers' liability insurance in the framework of the insurance coverage arranged with K'nafaim, in accordance with an agreement with K'nafaim.
The General Meeting of Company shareholders, held on May 10 2005, ratified the following decisions: a. The advance commitment to indemnify executives (no exemption to executives was approved). According to this decision, the extant of the indemnification shall be 25% of the Company’s equity according to its December 31 2004 Financial Statements or 25% of its the Company’s equity reported in the latest yearly consolidated financial statements upon payment of the indemnification, whichever is lower. b. To approve framework agreements for ongoing executive insurance and for run-off executive insurance. The premium that will be paid by the Company for self-insurance plus the premiums for run-off insurance will not exceed $450,000 a year.
On December 29 2011 the Company's general meeting ratified the revision to the letters of indemnification for Company directors and executives (serving now or who will serve in the future, including directors and executives who are Company controlling shareholders, in order to reflect, mainly, the provisions of the Managerial Enforcement Law. In addition, the General Meeting approved the Company’s engagement, from time to time, in policies insuring the liability of directors and executives in the Company, its subsidiaries and affiliates (including directors and executives who are controlling shareholders and their representatives), for an accumulated period of three years from the general meeting’s ratification. During the period in question the Company shall be entitled, from time to time, and without requiring additional approvals from the general meeting, so long as the Company's’ Audit Committee and Board of Directors confirm that the policies purchased meet the terms of the framework agreement and are compatible with market conditions and the Company receives no objections in accordance with Section 1c of the Relief Regulations, to renew the policy in effect or replace it, with the same insurer or another insurer, whether by itself (“Independent Insurance”) or by joining an insurance policy purchased by K'nafaim Holdings Ltd. (“K'nafaim”) for subsidiaries and related companies (“Group Insurance”), for all of the directors and executives serving at the Company, at its subsidiaries as well as executives operating on behalf of the Company or on behalf of its subsidiaries in affiliates (including controlling shareholders), all in accordance with the terms detailed in the meeting assembly papers.
On October 21 and 24 2012 the Company’s Audit Committee and Board of Directors (respectively) approved an engagement, through the Company's controlling shareholder K'nafaim Holdings Ltd. (“K'nafaim”), with Menorah Mivtachim Insurance Ltd. for the renewal of the director and executive insurance policy for an additional period. This insurance is within the framework of a collective insurance policy prepared by K'nafaim for its executives, in subsidiaries and affiliates, in accordance with the framework agreement ratified by the general meeting of the Company's shareholders on December 29 2011 (“the Framework Agreement”). The engagement is subject to the approval of the appropriate K'nafaim elements. The limit of liability pursuant to the purchased insurance policy matches the liability limit set in the insurance policy in effect as of today and the terms of the framework agreement, and amount to $100 million as well as an added 20% from the above limit for legal defense expenses in Israel. The policy period extends from October 1 2012 to January 31 2014. In accordance with the terms of the policy, the Company's share of the insurance fees is a sum of $161,000 a year (and relative to an 16 month period - $215,000), which constitutes 72% of the insurance fees for the group policy, a sum lower than the maximum premium sum set for the Company’s share in accordance with the framework agreement.. The deductible is between $10,000 and $75,000 US (according to the type and nature of the suit) and is lower than the maximum sum set in accordance with the terms of the framework agreement. The Audit Committee and Company Board of Directors approved the engagement in accordance with Regulation 1(3) of the Companies Regulations (Relief in Transactions with Interested Parties), 2000 and determined that the engagement is compatible with the terms set in the framework transaction. A summary of the arguments presented by the Company’s Audit Committee and Board of Directors to approve the engagement: Entering into the insurance policy benefits the Company as it allows its directors and executives to fulfill their duties properly, taking the risks involved in their duties and the legal responsibilities borne by the directors and executives into account; the very act of purchasing the insurance policy reduces the - C 91 - Free Translation of the Hebrew Language 2012 Annual Report - Hebrew Wording Binding
Company’s indemnification obligation toward the directors and executives in accordance with the letters of indemnification granted the directors and executives by the Company; the engagement matches the terms set in the framework agreement. The cost of the policy premium, as described above, is lower than the policy cost ceiling as set in the terms of the framework agreement; engagements in executive liability insurance agreements are generally accepted engagements with Israeli public companies; the terms of the engagement are identical for all of the Company’s executives, including executives who are also controlling shareholders, as they were in the past and as they will be from time to time; furthermore, engagement in the insurance policy is carried out in accordance with market conditions and will have no material impact on the Company’s profitability, property or liabilities.
g. Transactions between the Company and Board member Pinchas Ginsburg (hereinafter: “Ginsburg”) or persons operating on his behalf (including corporations under his control):
Pinchas Ginsburg (serving on the Company's Board of Directors) and I. Hillel & Co. Ltd. (“I. Hillel”), in his full possession, received the approval of the Holder of the Special State Share on September 3 2006 according to which the Holder agrees that individuals members of Pinchas Ginsburg’s family and I. Hillel may hold the Company’s shares together at a rate lower than 15% of the Company’s issued stock value. Note that Pinchas Ginsburg has a personal interest, directly or indirectly, in various transactions carried out by the Company and/or related companies, as detailed below: (a) I. Hillel carries out, from time to time, transactions with the Company and with Sun D’Or for the purchase of flight tickets for Company and Sun D’Or flights as well as Sun D’Or charter flights; (b) the Company and Sun D’Or enter, from time to time, into transactions with Airtour, half of the shares of which are held by the Company and the other half are held, to the best of the Company's knowledge, by travel agents, including I. Hillel. Mr. Ginsburg also serves on the Board of Directors of Air Tour. These transactions are essentially the purchase of flight tickets, providing outsourcing services by Airtour in ticketing areas, making reservations and providing ground services; (c) Pinchas Ginsburg acts as the general sales agent for Thai Airways (“Thai”) in Israel. Ginsburg’s compensation is based on commissions deriving from the sale of Thai flight tickets in Israel. Agreements are in place between the Company and Thai regarding the transport of passengers and the transport of cargo, including code sharing and interline agreements. In light of Mr. Ginsburg’s personal interest in all of the transactions in question, the Company's Board of Directors approved, as non-exceptional transactions, the transaction procedure pertaining to commitments between the Company and Thai as well as the transaction procedure between the Company and Airtour and between Sun D’Or and Airtour as well as framework agreements between I. Hillel and/or Mr. Ginsburg (hereinafter – “the Interested Party”) and the Company and Sun D’Or (all of the transactions in question shall hereby be referred to as “the Commitments”). The basic principles of the transaction procedures and framework agreements are as follows: (1) once per year the Company’s Board of Directors shall set the maximum yearly proceeds for transactions with the interested party (hereinafter – “the Maximum Sum”); (2) all commitments pursuant to the maximum sum shall be at market prices and under market conditions; commitments not under market conditions shall require the advance approval of the Audit Committee and Company Board of Directors; (3) a supervising element shall be appointed to supervise that all of the commitments are carried out under market conditions and who shall provide the Company's Audit Committee, at the end of each calendar half, a written report regarding commitments carried out in the previous half and their conditions; (4) insomuch as the Audit Committee determines that a deviation had occurred from market prices and conditions in any of the commitments (“Deviating Commitments”), the discussion of these Deviating Commitments shall be passed on to the Company’s Board of Directors for its decision on the steps required for their approval. Note that as of this report, no deviating transactions have been found; (5) extending the commitments shall be subject to the approval of the Company's authorized organs.
h. Salary and Remuneration Waiver
On November 22 2011 the Company CEO Mr. Eliezer Shekedi and the Chairman of the Company’s Board of Directors Mr. Amikam Cohen announced that they would be unilaterally waiving 20% of the (gross) monthly salary to which they are entitled. In addition, the other members of the Company’s Board of Directors (with the exception of the external, directors) announced that they would be unilaterally waiving 20% of the (gross) yearly remuneration and the per-meeting remuneration to which they are entitled. The aforementioned waiver is for a period beginning December 1 2011 and ending December 31 2012. The Company’s Audit Committee and Board of Directors explained their decision by declaring this
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to be a unilateral waiver on behalf of the Chairman and the other members of the Board of salary and remuneration owed them by the Company, in return for no other compensation from the Company, and therefore the engagement in question in purely beneficial to the Company. Note that as reported by the Company, all of the Company’s VPs waived 10% of the monthly (gross) salaries to which each of them was entitled and the heads of the Company’s departments waived between 7.5% and 10% of the (gross) monthly salaries to which each was entitled (in accordance with their pay grade) for the aforementioned period.
In addition, holders of personal contracts with the Company waived between 3% and 7.5% of the (gross) monthly salary to which each was entitled (according to their pay grade) for the period beginning March 1 2012 to December 31 2012.
The above waiver on behalf of executives and employees as noted above is for the salary and remuneration to which they are entitled, as the case may be, and will not impact all of the other associated benefits to which the executives and workers in question are entitled, including social provisions.
i. Remuneration of Key Management Personnel For the Year Ending December 31 2012 2011 2010 Thousands of Thousands of Thousands of Dollars Dollars Dollars
Short-term benefits 3,990 4,476 8,252 Post-employment benefits 541 525 1,266 Share-based payment 59 283 745 4,590 5,284 10,263
j. Benefits Granted Interested Parties 2012 2011 2010 Thousands of Thousands Thousands Dollars of Dollars of Dollars
Chairman services and commissions fees (including bonuses due to options) to interested parties employed by the 249 358 411 Company Number of people to whom the benefit refers 1 1 1 Remuneration for directors not employed by the 418 457 404 Company Number of people to whom the benefit refers 13 13 11
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k. Balances with Interested and Related Parties
As of December 31 2012 2011 Thousands of Thousands of Dollars Dollars
Other interested parties /related parties
Within the framework of current assets -
Customers Related party – affiliate 3,615 3,693 Related party and interested party 101 570 3,716 4,263
Total highest debit balances in the account 7,988 9,709 year
As of December 31 2012 2011 Thousands of Thousands of Dollars Dollars
In the framework of current liabilities -
Related party and interested party 719 205
Current Liabilities due to Employee Benefits
Related Party 50 27
As of December 31 2012 2011 Thousands of Thousands of Dollars Dollars Affiliates
In the framework of non-current financial assets -
Investment in shares and options 16,747 13,184
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l. Transactions with Interested and Related Parties 2012 2011 2010 Thousands of Thousands of Thousands of Dollars Dollars Dollars Interested Parties/Related Parties
Revenues from interested and related parties
Flight tickets 36,756 38,851 35,972 Cargo transport 21,796 24,367 20,447 Maintenance services 215 151 93
Operating Costs - Transactions with controlling party 711 1,143 584 Services from interested party 2,454 1,229 332 Receipt of shares and options from affiliate free (2,442) (3,542 ) (11,145 ) of charge
Sales expenses - Primarily commissions and marketing fees 3,503 3,060 3,326 (subsidiaries) Primarily agent commissions (to interested - 415 63 parties) Advertising services from interested party (via 587 966 759 third party)
Administrative and general expenses 1,393 1,770 5,835
Note 34 - Transactions and Engagements with Subsidiaries
1. As stated in Note 1b, the Company did not include separate financial information in its 2012 and 2011 periodic reports in accordance with Regulation 9c of the Securities Regulations (Periodic and Immediate Reports), 1970, due to the negligibility of the added information. The Company fully owns several companies the activity of which complements the primary activity conducted within the framework of the Company. These companies do not act independently, but are in effect specific components of the Company's array of activities consolidated in the form of companies and this from regulation and other administrative reasons (salary agreements etc.). These companies are not material relative to the Company as the extant of assets, liabilities and revenues managed as part of the subsidiaries are negligible relative to the extent of the assets, liabilities and revenues managed within the framework of the Company. Therefore, publication of separate Financial Statements will not provide additional material information to the reasonable investor.
2. The Company has entered into agreements with its subsidiaries as follows:
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a. Activity between the parent company and its subsidiaries:
Investment Credit/Debit Account as Company Type of Activity Yearly Turnover Account of 2012 2011 2012 2011 31.12.2012 31.12.2011 Thousands of Dollars Leasing of aircraft and providing Sun D’Or associated services. 48,557 65,919 3 3 528 12,378 Commissions 63 772 Purchasing food for Company Tamam flights from BGN 22,697 23,973 994 691 2,604 2,759 Purchasing food for Company Borenstein flights from New York 6,336 6,179 4,966 4,670 703 (80) Dividend - 20 Managements fees 197 403 Loan to parent company (1) 3,000 3,000 Interest from parent company (1) 69 60 Sale of flight tickets and ground Superstar arrangements 10,094 10,869 (105) (315) 322 (431) Loans from parent company (2) 914 486 Purchasing food for employees and food services in the King David Katit Lounge in Terminal 3 3,153 3,286 - - 1,112 1,048
(1) In December 2011 the Company received a $3,000,000 loan from Borenstein for a period of three years, at a 2.3% yearly interest rate paid December 15 every year.
(2) In September 2007 the Company provided Superstar with a £205,000 loan. In October 2010 the Company provided an additional a £110,000 loan. In November 2012 the Company provided an additional a £250,000 loan. The three loans have no repayment date and bear no interest.
b. Mutual activity between subsidiaries:
Credit/Debit Account as Company Type of Activity Yearly Turnover of 2012 2011 31.12.2012 31.12.2011 Thousands of Dollars Thousands of Dollars TAMAM-Katit Food purchasing 230 132 113 90 Superstar – Sun Flight Ticket D'Or Purchasing 2,189 2,180 86 94
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Note 35 - Liens and Collateral
As stated in Note 13g above, the Company's assets free of liens as of December 31 2012 are aircraft and reserve engines worth $31 million as well as parts and other fixed assets to the amount of $199 million. With the exception of these assets, the assets are restricted in favor of loans granted by the lending banks.
The following details the Company’s liabilities secured by liens:
Type of Plane Registry Year of Lien Details Plane Code Manufacture Fixed and specific first-tier pledge and lien in favor of banks in Israel on all of the Company's rights to the aircraft. The pledge and lien include all the engines, the rights deriving from the lease or use of the aircraft or contracts or insurance policies and rights to ECA indemnification or insurance proceeds for the aircraft in question. In 777-200ER ECB 2001 addition, a first-tier floating lien was registered on all the engines and ECC auxiliary equipment installed on the above aircraft from time to time, as well as the insurance rights with respect to them. No additional lien may be registered on those assets and the assets may not be transferred without the bank’s advance written consent. Fixed and specific first-tier pledge and lien in favor of a trustee for collateral (for ECD). The pledge and lien include all the rights deriving from contracts connected to the plane, rights to ECD 2002 indemnification or insurance proceeds for the aircraft or their 777-200ER ECE 2007 engines, or any part related to it and all rights deriving from the lease ECF 2007 agreement for the aircraft. In addition, the Company assigned by way of a pledge in favor of a foreign company, all of the existing and/or future rights arising from insurance policies for the aircraft. Fixed and specific first-tier pledge and lien (for ELA and ELB for an overseas banking corporation, for ELC and ELE for an Israeli bank and for ELD for Israeli banks) on all of the Company's rights to the ELA 1994 planes. The pledge and lien include all the engines, the rights ELB 1994 deriving from the lease or use of the aircraft or contracts or insurance ELC 1995 policies and rights to indemnification or insurance proceeds for the 747-400 ELD 1999 aircraft in question. In addition, a first-tier floating lien was ELE 1994 registered on all the engines and auxiliary equipment installed on the ELH 1996 above aircraft from time to time, as well as the insurance rights with respect to them. No additional lien may be registered on those assets and the assets may not be transferred without the bank’s advance written consent. Fixed and specific first-tier pledge and lien for an Israeli bank on all of the Company's rights to the planes. The pledge and lien include all the engines, the rights deriving from the lease or use of the aircraft or EKA contracts or insurance policies and rights to indemnification or EKB 737-800 1999 insurance proceeds for the aircraft in question. In addition, a first-tier EKC 737-700 floating lien was registered on all the engines and auxiliary EKD equipment installed on the above aircraft from time to time, as well EKE as the insurance rights with respect to them. No additional lien may be registered on those assets and the assets may not be transferred without the bank’s advance written consent. Fixed and specific first-tier pledge and lien in favor of a trustee for collateral on all of the Company's rights to the planes. The pledge EKH 2009 and lien include all the rights deriving from contracts connected to 737-800 EKJ the plane, rights to indemnification or insurance proceeds for the EKL aircraft, engines, or any related to it and all rights under from the lease agreement for the aircraft.
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In addition, the Company assigned by way of a pledge in favor of a foreign company, all of the existing and/or future rights arising from insurance policies for the aircraft.
Over the course of May 2012 three 767-200ER planes were freed of liens (EAD, EAE and EAF). Over the course of December 2012 two 757-200 planes were freed of liens (EBU and EBV).
Additional liens:
1. In order to secure the Company’s liabilities for the utilization of credit lines provided to it by an Israeli banking corporation (including the furnishing of bank guarantees), the Company signed agreements to place specific liens in favor of a banking institutions on the Company's right to receive money from the sale of flight tickets from a limited number of agents. In addition, the Company placed a lien on its property on 32 Ben Yehuda St. in favor of this banking institution.
2. A lien in favor of a foreign bank on a spare engine for the 777-200 fleet, purchased with the financing of an overseas bank, for which the foreign bank provided collateral. The lien includes rights deriving from insurance, compensation and remuneration.
3. Regarding the leased aircraft in the 737-800 fleet (marked EKS and EKF), liens on all of the insurance policies pertaining to the asset for a foreign company. No additional lien may be registered on those assets or the assets may not be transferred without the owner's consent.
4. A lien in favor of the Exim American Import and Export Bank on a spare engine for the 737 fleet, purchased with a direct loan from Exim, for which the bank provided collateral. The lien includes rights deriving from insurance, compensation and remuneration.
Note 36 - Events Subsequent to the Balance Sheet Date
a. In January 2013 the Company signed a memorandum of understandings with Wells Fargo Bank Northwest, National Association for the lease of a 737-800 (EKU) aircraft for a period of 72 months (with the option of departing with advance notice after 48 months). The plane was manufactured in 2006 and was received at the Company in March 2013. The plan is planned to start its commercial activity before the Passover holiday and will be used by the Company for short-range destinations. The lease shall be classified as an operational lease in the Financial Statements.
b. On January 31 2013 the Company signed a letter of understandings with funds from the FIMI Group (hereinafter: “FIMI”) in preparation for an agreement in which FIMI will invest in the Company’s shares, as detailed below. The Company Board of Directors approved the progress of the negotiations with FIMI, and accordingly, a letter of understandings was signed between the parties that defines the basic terms of the investment transaction, as follows:
In the first stage, FIMI will invest $5 million in the Company in return for the allocation of Company shares at a price of 0.625 NIS per share. Based on the exchange rate of the USD on the date of the transaction, these are 30 million shares that will constitute, after their allocation, 5.71% of the Company's shares (all of the percentages noted in this transaction are not fully diluted); at the same time, FIMI will purchase an additional number of shares from K'nafaim at the same price per share, in return for an additional $5 million, in such a manner that after this stage is completed FIMI will hold 11.41% of the Company’s shares.
In the second stage, FIMI will invest $30 million in the Company no later than August 30 2013, in return for an additional allocation of Company shares at a price of 0.625 NIS per share. Based on the exchange rate of the USD as of the transaction date, this amounts to 180 million shares, which after their allocation will constitute 25.5% of the Company’s shares. FIMI’s obligation to perform the second stage of the investment is stipulated on the fact that the Company signs a new collective agreement with its employees with terms satisfying FIMI at its sole discretion. FIMI may extend the date on which it implements the second stage to the end of 2013.
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FIMI will also be issued two options, which it may exercise if the second stage of the investment takes place:
(a) An option exercisable up to June 30 2014 to invest $10 million in the Company in return for an allocation of Company shares at a price of 0.65 NIS per share. Based on the exchange rate of the USD as of the transaction date, this amounts to 58 million shares, which after their allocation will constitute 7.56% of the Company’s shares; (b) an option exercisable up to June 30 2016 to invest $10 million in the Company in return for an allocation of Company shares at a price of 1 NIS per share. Based on the exchange rate of the USD as of the transaction date, this amounts to 37.5 million shares, which after their allocation (assuming the exercise of the above option) will constitute 4.7% of the Company’s shares.
It was agreed that during the 45 days following the signing of the letter of understandings, FIMI would perform due diligence regarding the Company and the parties will conduct negotiations on a binding contract for the investment agreement in question. The Company undertook that during this period, the Company, its executives and its representatives would not negotiate with any third parties in the matter of some other transaction involving the Company shares that would contradict the investment agreement or have a negative impact on it.
The letter of understandings made clear that it does not constitute a binding agreement (with the exception of the Company's obligations as denoted above to refrain from negotiating with other parties during the following 45 days), and that engagement in a binding agreement will take place after the completion of due diligence by FIMI.
The transaction is subject as noted, to the signing of a binding agreement under conditions satisfactory to the Company and FIMI. The transaction shall be stipulated on closing terms that will be detailed in the binding agreement, including the approval of the State of Israel, the Antitrust Commissioner and other regulatory approvals needed as well as the approval of the general meeting of the Company's shareholders.
The agreement is also stipulated on the signing of a shareholders agreement between K'nafaim and FIMI. In this regard, K'nafaim has informed the Company that the letter exchanged between itself and FIMI formalized various principles of the shareholders agreement in question (inasmuch as it is signed between them and subject to the required approvals), according to which K'nafaim and FIMI would vote through their shares in the Company for the appointment of directors, half of whom will be recommend by K'nafaim and half by FIMI. K’nafaim’s right to appoint directors shall be reserved so long as its stake does not drop below a certain threshold set in the shareholders’ agreement. K'nafaim and FIMI agreed that they would negotiate the wording and the details of the arrangements included in the shareholders agreement, concurrent with managing the negotiations on the binding investment agreement between the Company and FIMI.
As K'nafaim has a personal interest in the transaction, the binding agreement, if and when it is reached will be brought before the organs required by the Companies Law for approval.
On March 11 2013 the Company and FIMI agreed to extend the date for the completion of the due diligence for the Company by FIMI and the signing of the agreement between the parties, by April 8 2013. Note that during this extension period the commitment undertaken by the Company, its executives and its representatives not to negotiate with any third parties in the matter of some other transaction involving the Company shares that would contradict the investment agreement or have a negative impact on it, will remain in effect.
As of this report, the parties are negotiating ion the matter of the investment agreement, following which changes may occur to investment sums, to its dates and to its stipulations.
c. On February 4 2013 the Company received a statement of claim filed against it at the Tel Aviv District Labor Court by 130 security personnel who, as alleged in the statement of claim, were/are employed by the Company as assistant security officers sent from time to time to various destinations as needed, to perform flight security tasks. The claimants are asking that the Court rule in favor of declaratory damages according to which it would rule that the collective work agreement arranging the rights of Company employees applies to the claimants and therefore monetary remedies be given for various salary components. The Company has yet to perform an estimate regarding its monetary exposure to the claim and it is examining the claim and will submit its response as needed.
d. On February 7 2013 the Company received at its offices a motion to approve a class action (hereinafter: “the Motion”), filed at the Central District Court against the Company and against British Airways,
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Lufthansa and Swissair. The Motion was filed by a non-profit organization, Success the Consumers Movement for the Promotion of a Fair Economic Society, on behalf of customers shipping cargo to or from Israel (except for shipments to and from the U.S.), as no other claimant was found as noted in the Motion. The Motion alleges the existence of a binding arrangement to fix various components of cargo shipping prices, published by various authorities around the world in February 2006 and the cost of the claim is in accordance with the Restraint of Business Law. The total damages noted in the suit amount to 613 million NIS, of which a total of 473 million NIS is attributed to the Company. The Company is studying the motion and will file its response as needed.
e. In March 2013 the Company signed an extension and revision to the agreement to lease a 737-300ER aircraft (EAP) from CIT Aerospace International for an additional period ending November 19 2014, while waiving the exercise of the early exit option in the agreement between the parties. The lease was classified as an operational lease in the Financial Statements.
f. In March 2013 the Company approved the extension of an agreement for the leasing of a Boeing 747-400F cargo aircraft (ELF) with Banc of America Leasing Ireland Co. for an additional period of 72 months starting August 1 2013, with the Company given the option to end the lease after 48 months. The lease was classified as an operational lease in the Financial Statements.
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