Delek Group | FINANCIAL STATEMENTS UNAUDITED AS OF SEPTEMBER 30, 2017
FINANCIAL STATEMENTS AnnualUNAUDITED Report 2013 AS OF SEPTEMBER 30, 2017
Annual Report 2013
Official Sponsor of the Israeli Delegation to the Olympic Games, Rio 2016
Delek Group Ltd 19 Abba Eban Blvd, P.O. Box 2054, Herzliya 4612001, Israel Tel: 972 9 8638444, Fax: 972 9 8854955 www.delek-group.com WorldReginfo - c16fd361-de53-4169-8c2c-61d95bc8d7cf
Official Sponsor of the Israeli Delegation to the Olympic Games, Rio 2016
IMPORTANT
This document is an unofficial translation for convenience only of the Hebrew original of September 30, 2017 financial report of Delek Group Ltd. that was submitted to the Tel-Aviv Stock Exchange and the Israeli Securities Authority on November 29, 2017.
The Hebrew version submitted to the TASE and the Israeli Securities Authority shall be the sole binding legal version.
WorldReginfo - c16fd361-de53-4169-8c2c-61d95bc8d7cf FINANCIAL STATEMENTS UNAUDITED AS OF SEPTEMBER 30, 2017
Table of Contents
Chapter A | Corporate Description
Chapter B | Board of Directors Report on the State of the Company’s Affairs
Chapter C | Financial Statements
Chapter D | Report on the Effectiveness of Internal Controls for Financial Reporting and Disclosure WorldReginfo - c16fd361-de53-4169-8c2c-61d95bc8d7cf Chapter A
Corporate Description WorldReginfo - c16fd361-de53-4169-8c2c-61d95bc8d7cf Update of Chapter A (Description of the Company’s Business) to the Board of Directors’ Report of the Delek Group Ltd. (“The Company”) for 20161
Part One – Description of the General Development of the Company's Business:
Referring to Section 1.3 of the Periodic Report - Investments in Company Equity Subsequent to the financial position statement date, on October 24, 2017, the Company's Board of Directors decided to buy back up to NIS 100 million in Company shares in the period up to December 31, 2017. As of the publication date of this report, the subsidiary partnership, Delek Financial Investments (2012) Limited Partnership, which is wholly-owned (100%) by the Company bought 89,923 Company shares on the TASE in consideration for NIS 51 million. For more information, see the Company’s immediate report of October 24, 2017 (ref. no. 2017-01-093313), included herein by way of reference.
Referring to Section 1.4 to the Periodic Report - Distribution of Dividends On August 29, 2017, the Company’s Board of Directors decided to distribute a dividend of NIS 260 million. This dividend was paid on September 26, 2017. For more information, see the Company’s immediate report of August 30, 2017 (ref. no. 2017-01-075715), included herein by way of reference.
Part Three – Description of the Company’s Business by Operating Segment:
1. Energy
A. Referring to Section 1.7.4(d) to the Periodic Report - Planned Work Plan for the Tamar Project
For information concerning the identification of a crack in the exhaust pipe used to discharge natural gas and pressure from the Tamar platform ("the Malfunction") during upgrade and improvement works on the Tamar platform and the receiving facility ("the Upgrade Works") conducted by Noble Energy Mediterranean Ltd. ("the Operator") in September-October 2017, following which the supply of natural gas from the Tamar Reservoir was stopped in a controlled manner on September 21, 2017, and for information concerning renewal of natural gas supply from the reservoir upon completion of the Malfunction's repair by the Operator on September 27, 2017, see the Company's immediate reports of September 24, 2017 and September 27, 2017 (ref. no. 2017-01-083272 and 2017-01-084964, respectively), included herein by way of reference. It is noted that on October 10, 2017, the Upgrade Works were completed as planned.
B. Referring to Section 1.7.5(j) to the Periodic Report - Reserves and Contingent Resources Report and Discounted Cash Flow Data for the Leviathan Leases
For information concerning a reserves and contingent resources report and discounted cash flow data for the Leviathan leases, following preliminary analysis of results from the Leviathan-5 assessment and production well, see the Company's immediate report of September 26, 2017 (ref. no. 2017-01-084235), included herein by way of reference.
1 The update contains material changes or developments in the Company’s business in the third quarter of 2017 and up to immediately prior to the date of this report, in any matter which must be disclosed in the periodic report. The updated refers to the section numbers in Chapter A (Description of the Company’s Business) of the periodic report for 2016 (ref. no. 2016-01-033078), and supplements the content disclosed therein.
A-1 WorldReginfo - c16fd361-de53-4169-8c2c-61d95bc8d7cf C. Referring to Section 1.7.6 to the Periodic Report - License 399/Roy ("the Roy License")
On November 15, 2017, Ratio Oil Exploration (1992) Limited Partnership ("Ratio") announced that the Ministry of National Infrastructures, Energy and Water's Oil Commissioner ("the Commissioner"), had approved the updated work plan for the Roy License, as follows:
Term Key Milestones in the Work Plan 2017 onwards The binding work plan for the Roy License requires the following actions be carried out: • By March 15, 2018 - signing a contract with a drilling contractor and submitting such contract to the Commissioner. • By September 15, 2018 - start of drilling in the Roy License. • Three months from completion of drilling - submitting a summary report of drilling results.
It is clarified, that in light of the fact that Delek Drilling Limited Partnership ("the Partnership") is only granted an option in the Roy License, and it does not have access to information concerning the joint endeavor, the description of the work plan and schedule for the above activities is based solely on publicly available information published by Ratio.
Warning concerning forward-looking information - The above description concerning planned activities in the Roy License, including corresponding schedules, constitutes forward- looking information as defined in the Securities Law, 1968, and is based solely on publications made by Ratio. Actual implementation of the work plan, including its associated timeframes, may differ materially from the above and depends, among other things, on applicable regulation, technical ability, and economic viability.
D. Referring to Section 1.7.7(k) to the Periodic Report - Development Plan for the Aphrodite Reservoir in Cyprus
On September 21, 2017, the partners in the Aphrodite reservoir in Cyprus submitted to the Cypriot government updated chapters from the Aphrodite reservoir's development plan submitted for the Cypriot government's approval on engineering and technical issues. It is noted, that as of the date of this report, the Partnership, together with its partners in the Aphrodite reservoir, continues to conduct various stages of inquiries and/or negotiations concerning the export of significant quantities of natural gas from the Aphrodite reservoir, to regional markets including the Egyptian market.
E. Referring to Section 1.7.11 and 1.7.38(e)(1) to the Periodic Report - License 353/Eran ( "the Eran License")
In accordance with the decision of the Supreme Court of Israel ("the Supreme Court') from June 2, 2016, in the petition filed by the partners in the Eran License with the Supreme Court against the Energy Minister and the Commissioner, concerning the Energy Minister's decision to deny an appeal filed by the partners in the Eran License against the Commissioner's decision not to extend the Eran License, the parties have pursued mediation. Currently, mediation proceedings are still underway, and at the parties' request the Court has permitted them to update on the results of these proceedings no later than January 4, 2018.
F. Referring to Section 1.7.13(e)(2)a to the Periodic Report - Contracts for Exporting Natural Gas from the Leviathan Project
Referring to the fulfillment of the preconditions stipulated in the natural gas supply agreement between NBL Jordan Marketing Limited ("the Distributor") and Jordan's national power utility
A-2 WorldReginfo - c16fd361-de53-4169-8c2c-61d95bc8d7cf (NEPCO), it is noted that in June 2017, the Distributor signed a transportation agreement with Israel Natural Gas Lines (INGL), after the agreement was approved by NEPCO. As a result, as of the date of this report, all preconditions have been met and the parties need only sign the transportation agreement between NEPCO and the Jordanian transportation company (FAJR). It is further noted, that in July 2017, the Leviathan partners approved a budget for completing the Israeli pipeline up to the Israel-Jordan boarder, to the amount of USD 111 million (100%).
G. Referring to Section 1.7.14(b)(1)3 to the Periodic Report - Description of Key Target Markets Available for Exporting Natural Gas by Pipe from the Tamar and Leviathan Projects
Concerning the Partnership's response to media reports on options for exporting natural gas from Israel to Egypt, the Partnership noted that no change has transpired in the Partnership’s assessment concerning options for exporting natural gas from Israel to Egypt. For more information, see the Company's immediate report of November 16, 2017 (ref. no. 2017-01- 100711), included herein by way of reference.
H. Referring to Section 1.7.21(g)(10) to the Periodic Report – Investment in Ithaca – Financing
The financial debt of Ithaca Energy Inc. (“Ithaca”) mainly comprised a bank borrowing facility based on the Company’s oil and gas reserves (Reserves Based Lending – “RBL”) to the amount of USD 375 million, and senior debentures of USD 300 million, payable in June 2019. As of the financial statements’ publication date and subsequent to the financial position statement date, Ithaca completed the refinancing of its bank debt (RBL) to align it with the repayment date of said senior debentures, providing Ithaca with flexibility in financing its development and growth targets. Ithaca extended the repayment date for the bank facilities, which will be repayable by May 2019. The new senior credit facility will be to a total amount of USD 245 million, of which USD 200 million will be used for Ithaca’s current financing needs, and USD 45 million will be used, among other things, to finance the investments necessary to develop the Vorlich oil field (see also Section 1.71(h)(2)e3 to the immediate report of May 4, 2017 (ref. no. 2017-01- 045363), concerning supplementation of the description of Ithaca’s operations).
Furthermore, Ithaca raised an additional loan of USD 140 million, which is also repayable in May 2019 and which is secured by the Company through (1) a loan which the Company provided to Ithaca to the amount of USD 70 million, which was placed in a deposit with a mechanism allowing the funds to be used by Ithaca for new investments, and (2) a Company guarantee for the remaining debt, limited to USD 70 million. The average interest on the two aforesaid bank facilities is LIBOR+2.6%. Furthermore, in the reporting period, the Company provided Ithaca additional loans to the total amount of USD 30 million, to finance Ithaca’s ongoing operations. These loans are USD-denominated, bear 3% interest, and are repayable on June 30, 2019.
I. Referring to Section 1.7.32(a) to the Periodic Report - Gas Outline Plan
Following on Section 1.K to the update of Chapter A (Description of the Company's Business) in the Company's reports for June 30, 2017 (ref. no. 2017-01-075706), as part of the Company's efforts to dispose of the overriding royalties to which it is entitled from the Partnership for oil assets in the Tamar and Dalit reservoirs in which the Partnership has or had an interest, by way of transferring the right to overriding royalties from the Company to a Company-owned subsidiary, and the listing of such subsidiary on the Tel Aviv Stock Exchange or by way of sale to a third party, the Company
A-3 WorldReginfo - c16fd361-de53-4169-8c2c-61d95bc8d7cf considered whether the provisions of the Gas Outline Plan,2 concerning the Partnership's obligation to dispose of its rights in the Tamar reservoir, also require the Company and the companies under its control to dispose of their overriding royalty interests in the Tamar reservoir, within the timeframe specified in the Tamar disposal outline plan, i.e. - by December 17, 2021 (in about 4 years). The Company's discussions with the State indicate that the State argues that the disposal obligation specified under the Gas Outline Plan also applies to the overriding royalty interests of parties related to the Partnership, i.e. - to the Company as well, by December 17, 2021. The Company argues that the phrasing of the Gas Outline Plan, as well as its aim, indicate that the disposal obligation set under the Gas Outline Plan only applies to the Partnership concerning its rights in the Tamar reservoir, and does not apply to the overriding royalty from the Tamar reservoir, which is owned by the Company. Since in any case the Company plans to dispose of its overriding royalty interest in Tamar, with such disposal occurring in the short term, the need to resolve the matter is rendered superfluous.
Warning concerning forward-looking information - The above description of the Company's plans and options for disposing of the overriding royalty constitutes forward-looking information as defined in the Securities Law, 1968. The description is a general description of general goals and intentions, and as such there is no guarantee that it will materialize including in the specified timeframes, among other things, due to changes in market conditions, regulatory changes, changes in the Company's priorities, economic viability, and unforeseeable events.
J. Referring to Section 1.7.37 to the Periodic Report - Royalties from the Tamar Project
Following on footnote 3 to the Company's immediate report of July 2, 2017 (ref. no. 2017-01- 068763) concerning the return of investment date for the Tamar Project used in determining the start of royalty payments to the Company at a rate of 6.5% (instead of 1.5%) (the said royalty rate is after a 50% reduction following the Partnership's merger with Avner Oil Exploration Limited Partnership), it is noted that as of the reporting date, the Company and the Partnership are continuing to study the return of investment date in the Tamar Project which the Partnership estimates will occur in the second half of 2017. Determining the return of investment date as aforesaid, is not expected to have a material, if any, effect on these financial statements.
K. Referring to Section 1.7.38(b) to the Periodic Report - Legal Actions
For information concerning the Supreme Court's decision on the motion for permission to appeal ("MPA") filed by the Partnership together with Noble Energy Mediterranean Ltd., Isramco Negev 2 Limited Partnership, and Dor Gas Exploration Limited Partnership ("the Applicants"), against the district court's decision to deny the Applicants' motion for summary dismissal of the motion to approve a class action filed by a consumer of the Israel Electric Corporation Ltd. ("the Applicant"), to deny the MPA and return proceedings to the district court to hear the motion for approval in depth, see the Company's immediate report of September 28, 2017 (ref. no. 2017- 01-085807), included herein by way of reference. The Company and the Partnership, based on the opinion of their legal counsels, estimate that the probability that the application will be approved as a class action is less than 50%.
L. Referring to Section 1.22.8 to the Periodic Report - Structural Changes
On October 23, 2017, Delek Energy Systems Ltd. ("Delek Energy") announced that it has started studying options for buying from the public participation units granting rights in the
2 Government Decision No. 476 of August 16, 2015, as amended in Decision No. 1465 of May 22, 2016 ("the Gas Outline Plan").
A-4 WorldReginfo - c16fd361-de53-4169-8c2c-61d95bc8d7cf limited partner's rights in the Partnership. Such action may be effected through a purchase offering or through a merger, subject to the requirements of the law, in such manner that the consideration for the participation units will be made in Delek Energy shares.
M. Natural Gas and condensate production data from the Tamar Project for the second and third quarter of 2017:3
Natural gas Condensate
Q1 Q2 Q3* Q1 Q2 Q3 Total output (attributable to equity holders of the Company) for the period (in MMCF for natural 14,970 15,103 11,117 20.1 19.7 14.8 gas and MBBL for condensate) Average price per output unit (attributable to equity holders of the Company) (USD per MCF 5.34 5.31 5.35 46.3 40.2 46.2 and BBL) Average royalties (any payment The State 0.60 0.60 0.6 5.1 4.5 5.3 derived from the output of the Third parties 0.09 0.09 0.11 0.8 0.7 0.9 producing asset, including the gross income from the oil asset) Principal paid per output unit (attributable to 0.14 0.14 0.15 1.2 1.1 1.2 equity holders of the Company) shareholders (USD per MCF and BBL) Proceeds for average royalties (each payment derived from the output of the producing asset, including the gross income from the oil asset) 0.18 0.18 0.20 1.5 1.3 1.6 received per output unit (attributable to the Company’s share) (USD per MCF and BBL) Average production costs per output unit (attributable to equity holders of the Company) 0.4 0.35 0.35 2.2 1.9 1.9 (USD per MCF and BBL)4 Average net proceeds per output unit (attributable to equity holders of the Company) (USD per MCF 4.29 4.31 4.34 38.5 33.3 38.5 and BBL) * Third quarter data are after disposal of 9.25% of the Partnership’s rights in the Tamar reservoir. It is noted that 40% of Tamar Petroleum’s equity is presented under the investment in associates item.
3 Percentage of output, royalties, production costs and net proceeds attributable to holders of the Company's equity rights rounded to two decimal digits. 4 It is emphasized that the average production costs per output unit only include current production costs and do not include reservoir exploration and development costs.
A-5 WorldReginfo - c16fd361-de53-4169-8c2c-61d95bc8d7cf N. Production data for Ithaca’s production-status oil assets:
Production data for the Stella reservoir project (part of the GSA Project), attributed to the Company in the first, second, and third quarters of 2017:
Q1 Q2 Q3 Natural gas Condensate Natural gas Condensate Oil (bbl) Oil (bbl) Oil (bbl) (mcf) (bbl) (mcf) (bbl) Total output in the period 85,225 274,108 859,626 30,456 257,199 2,051,005 28,578 Average price per output unit (attributable to equity holders of the 0* 49.30 4.52 44.80 52.30 5.03 40.00 Company) (USD per output unit) Average royalties to third parties (any payment derived from the output of the producing asset, including the gross income from the oil asset) paid 1.3 1.26 0.12 1.15 1.34 0.13 1.02 per output unit (attributable to equity holders of the Company) (USD per output unit) Average production costs per output 7.4** 12.30 2.05 12.30 20.60 3.43 20.60 unit (USD per output unit) Average net proceeds per output unit (8.7) 35.74 2.35 31.35 30.36 1.47 18.38 (USD per refernced unit) Depletion rate in the reporting period, compared to overall oil quantities in 1.3 4.5 1.7 4.5 4.2 4.1 4.2 the project (%)5 * In the first quarter, no oil was sold from the reservoir, and all production was used as inventory. Sales in April 2017 included the quantities produced in the first quarter of 2017, at an average price of USD 52.7 per barrel. ** This amount represents net costs, excluding a refund of USD 10 per output unit to the owners of the FPF-1 production platform.
5 Depletion rate is the percentage of oil produced in the applicable reporting period, out of the remaining proved and probable reserves at the later of either the start of said reporting period or the start of production date.
A-6 WorldReginfo - c16fd361-de53-4169-8c2c-61d95bc8d7cf Production data for Ithaca’s production-status oil assets outside the GSA Project and the Stella reservoir, attributed to the Company in the first, second, and third qurater of 2017:6
Q1 Q2 Q3
Natural gas Condensate Natural gas Condensate Oil (bbl) Oil (bbl) Oil (bbl) Oil (bbl) Oil (bbl) (mcf) (bbl) (mcf) (bbl)
Total output in the period 689,120 62,805 3,200 711,090 406,773 21,992 609,695 401,871 18,857
Average price per output unit (attributable to equity holders of the 51.39 3.00 36.41 49.99 2.23 40.03 49.74 2.39 36.23 Company) (USD per output unit) Average production costs per 22.1 3.68 22.1 21.17 5.37 27.56 22.45 4.76 23.87 output unit (USD per output unit) Average net proceeds per output 29.29 (0.69) 14.31 28.83 (3.14) 12.47 27.29 (2.37) 12.36 unit (USD per refernced unit) Depletion rate in the reporting period, compared to overall gas 3.15 0.22 0.14 3.5 1.4 1.0 3.0 1.4 0.8 quantities in the project (%)7
6 The share attributed to the equity holders of the Company in the output, royalties, production costs, and net proceeds, has been rounded off to the second decimal place. 7 Depletion rate is the percentage of oil produced in the applicable reporting period, out of the remaining proved and probable reserves at the later of either the start of said reporting period or the start of production date.
A-7 WorldReginfo - c16fd361-de53-4169-8c2c-61d95bc8d7cf 2. Insurance and finance
Referring to Section 1.9 to the Periodic Report:
Referring to Section 3 to the update of Chapter A to the Periodic Report of August 30, 2017 (ref. no. 2017-01-075706) - On September 14, 2017, the Company announced that it had signed a binding agreement with Sirius International Insurance Group Ltd. ("the Buyer"), for selling all of the Company's holdings in The Phoenix Holdings Ltd. (52.25%) ("the Agreement" and "The Phoenix", respectively), for a total consideration of NIS 2.5 billion. Under the Agreement, the transaction will be carried out in two phases. In the first phase, on September 18, 2017, the Buyer bought from the Company in an off- TASE transaction 4.9% of The Phoenix's share capital, at a share price of NIS 16.988, for a total consideration of NIS 208 million. In the second phase, the Company granted the Buyer a call option to buy the remaining shares (47.35%, as of the Agreement date), whereby in the 60 day period from the date on which the Buyer was provided the due diligence materials as agreed by the parties, the Buyer may notify the Company of its intention to buy all the Company's remaining shareholdings in The Phoenix.
On November 23, 2017, the Buyer notified the Company that it had completed the due diligence process, and is exercising its call option under the Agreement, and buying the rest of The Phoenix's shares from the Company in consideration for an additional NIS 2.3 billion plus interest and as stipulated in the agreement. The Buyer further notified of its intention to complete the Agreement subject to its conditions and fulfillment of its preconditions. For more information, see the Company’s immediate reports of September 14, 2017 and November 26, 2017 (ref. no. 2017-01-081796 and 2017-01-104098, respectively), included herein by way of reference.
3. Additional Operations
Part Four – Matters Relating to the Company as a Whole
A. Referring to Section 1.16 of the Periodic Report - Financing
1. Referring to Section 1.16.2(b) to the Periodic Report - In October 2017, the Company repaid NIS 648 million par value of debentures outstanding in circulation (final repayment of Debentures (Series B12 and B15) and partial repayment of Debentures (Series B18). For more information, see the Company's immediate reports of October 18, 2017 (ref. no. 2017-01-091216) and October 31, 2017 (ref. no. 2017-01-095383), included herein by way of reference.
2. Referring to Section 1.16.8 to the Periodic Report - On September 19, 2017, S&P Maalot announced that it was affirming its ilA/Stable rating for the Company's existing debenture series. On October 8, 2017, Midroog announced that it was keeping its A2.il/Stable rating for the Company's debentures. For more information, see the Company’s immediate reports of September 19, 2017 (ref. no. 2015-01-136263) and October 8, 2017 (ref. no. 2017-01-088561), included herein by way of reference.
B. Referring to Section 1.22 of the Periodic Report - Goals and Business Strategy
In keeping with the Company's strategy of identifying opportunities for new investments in energy operations, the Company is in various stages of discussions and/or negotiations with various entities abroad, concerning possible investments in and/or purchase of oil and gas assets in the Gulf of Mexico. As part of these discussions and/or negotiations, the Company signed a non-binding letter of intent for studying a transaction, subject to signing a binding agreement and completion of a due diligence process to the Company's satisfaction. For more information, see the Company’s immediate report of October 24, 2017 (ref. no. 2017-01- 093457), included herein by way of reference.
A-8 WorldReginfo - c16fd361-de53-4169-8c2c-61d95bc8d7cf Warning concerning forward-looking information - The above information concerning discussions and/or negotiations as aforesaid constitutes forward-looking information as defined in the Securities Law, 1968, and there is no certainty that it will materialize, in whole or in part, in such manner as described or in any other manner, and it may materialize in a manner materially different from the aforesaid, and specifically there is no certainty that the said discussions and/or negotiations will result in binding agreements for investing in or buying oil assets, and that the conditions required by law for such agreements, if signed, coming into effect will be met.
Delek Group Ltd. Date: November 28, 2017 Names and titles of signatories: Gabriel Last, Chairman of the Board Asaf Bartfeld, CEO
A-9 WorldReginfo - c16fd361-de53-4169-8c2c-61d95bc8d7cf Chapter B
Board of Directors Report on the State of the Company’s Affairs WorldReginfo - c16fd361-de53-4169-8c2c-61d95bc8d7cf Board of Directors Report Delek Group Ltd.
November 28, 2017
Delek Group Ltd.
Board of Directors' report on the state of the Company's affairs For the nine and three month periods ended September 30, 2017 The Board of Directors of the Delek Group Ltd. ("the Company") hereby presents the Company's Directors' Report for the nine and three month periods ended September 30, 2017.
A) The Board of Directors’ explanations on the state of the Company's affairs
1. Description of the Company and its business environment
The Company engages in oil and gas exploration and production in Israel and abroad through investee companies and an investee partnership, and markets fuel products in Israel. In addition, the Company maintains holdings in several other operations, some of which are in various stages of disposal. The main operations which the Company intends to sell off comprise its Insurance and Finance in Israel segment. In 2015, the Company, through a wholly-owned foreign subsidiary, invested in the international energy company Ithaca Energy Inc. ("Ithaca") with proven operator experience. In the second quarter of 2017, the Group bought an additional 80% of Ithaca's share capital. Following these purchases, Ithaca is wholly-owned by the Group. For more information, see Note 3B to the financial statements. The Group continues to study options for acquiring additional gas and oil assets and/or companies abroad which are synergistic and complementary to the Group's current core operations The Group's financial data and its operating results are affected, among other things, by the financial data and operating results of its investee companies, and by its sale or acquisition of holdings. The Company's cash flow is affected, among other things, by dividends and management fees received from its investees, by inflows originating from the disposal of its holdings therein, by its ability to raise financing in Israel and abroad which depends, among other things, on the value of its holdings, financial market conditions in Israel and abroad, and by investments made by the Group and the dividends it distributes to its shareholders..
B-1 WorldReginfo - c16fd361-de53-4169-8c2c-61d95bc8d7cf Board of Directors Report Delek Group Ltd.
2. Principal Operations
Oil and gas operations in Israel and its surrounding areas
Contribution to operating results In the reporting period, in July 2017, Delek Drilling Limited Partnership (“Delek Drilling” or “the Partnership”) sold 9.25% of its rights in the Tamar and Dalit gas leases. Following these sales, the Group recognized net gains (post-tax) of NIS 873 million, as detailed below.1 Oil and gas exploration and production in and around Israel yielded a profit of NIS 1,116 million in the first nine months of 2017, including gains from the sale of rights in the Tamar and Dalit leases as aforesaid. This, compared to a profit of NIS 307 million in the same period last year.
The Partnerships' merger On May 17, 2017, Delek Drilling and Avner Oil Exploration Limited Partnership ("Avner") announced that all the contractual preconditions (as amended) had been met, for Avner's merger with and into Delek Drilling. For more information on the completion of this merger, see Note 5 to the financial statements.
Gas Outline Plan On May 22, 2016, the government re-affirmed its decision of August 16, 2015 concerning the Gas Outline Plan, and established an alternative arrangement for a 'stable regulatory regime' to guarantee a regulatory regime that would encourage investment in the natural gas exploration and production segment. Delek Drilling, together with its partners in the various projects, is working to implement the Gas Outline Plan (as amended), according to its respective terms and the terms of the leases. According to the terms of the said Gas Outline Plan, in 2016 Delek Drilling disposed of its holdings in the Karish and Tanin leases, and at the start of 2017 adopted an investment decision to develop Leviathan. Furthermore, in July 2017, Delek Drilling sold 9.25% of its rights in the Tamar and Dalit reservoirs, as detailed below. In this regard, it is noted that Delek Drilling continues to study additional ways to further dispose of its rights in the Tamar and Dalit reservoirs.
Disposal of rights in the Tamar and Dalit reservoirs As aforesaid, in July 2017, Delek Drilling sold 9.25% of its rights in the Tamar and Dalit reservoirs by selling the stake to Tamar Petroleum Ltd. ("Tamar Petroleum") and listing Tamar Petroleum on the Tel Aviv Stock Exchange. Consideration from the sale totaled NIS 3 billion in cash, and a 40% stake in Tamar Petroleum's share capital. Following completion of the sale, the Group recognized gains in the third quarter of 2017 from disposal of its holdings in Tamar Petroleum and from measuring the remaining investment in Tamar Petroleum at fair value (after losing control of Tamar Petroleum). Gains totaled NIS 1.5 billion pre-tax (post-tax gain attributable to Company shareholders - NIS 873 million). This amount also includes the fair value estimate for the Group companies' entitlement to royalties based on future production from rights sold to Tamar Petroleum. This entitlement was valued by third-party appraiser at USD 126 million (Group's share in the fair value of royalties, post-tax - NIS 312 million). For more information, see Note 5B(3) to the financial statements.
Leviathan Project • On February 20, 2017, Delek Drilling signed financing agreements with a consortium of local and foreign banks, headed by HSBC Bank Plc and J.P. Morgan Limited. Under these agreements, Delek Drilling would receive a limited-recourse loan of USD 1.75 billion, to finance its share in the remaining investment needed to develop the Leviathan Project. As of the financial position statement date, Delek Drilling had utilized USD 322 million of the loan facility. For more information, see Note 5G to the financial statements. • On February 23, 2017, the Leviathan Partners adopted a final investment decision (FID) to develop Phase 1A of the Leviathan reservoir development plan, with an annual capacity of 12 BCM, at a total budget (100%) of USD 3.75 billion, so as to allow the supply of natural gas from the Leviathan reservoir to start by the end of 2019. For more information, see Note 5A to the financial statements.
1 In this translation of the Board of Directors' Report, all amounts should be understood by the reader to be rounded to the nearest billion, million, or thousand, as the case may be.
B-2 WorldReginfo - c16fd361-de53-4169-8c2c-61d95bc8d7cf Board of Directors Report Delek Group Ltd.
Additional financial investments • In the reporting period, the Company held a 17% stake in the equity of Ratio Petroleum Energy Limited Partnership ("Ratio Petroleum"), which began trading on the Tel Aviv Stock Exchange in January 2017. The total consideration paid for buying participation units totaled NIS 21 million. In addition to issuing participation units, Ratio Petroleum allocated, without consideration, to investors including the Company warrants exercisable into participation units in Ratio Petroleum. For more information, see Note 4 to the financial statements. • In the reporting period, the Company invested an additional NIS 33 million in Faroe Petroleum PLC ("Faroe") shares. Following this investment, the Company holds 15.37% of Faroe's share capital.
Oil and gas operations in the North Sea
On March 14, 2017, DKL Investments Limited (a wholly-owned foreign subsidiary of the Company - "DKL") submitted documents offering to buy all of Ithaca's share capital held by other parties (80%), at a price of CAD 1.95 per share ("the Offer"), following an agreement signed with Ithaca in February 2017 for issuing the Offer as aforesaid. The purchase offer was completed in June 2017 for a total consideration of NIS 1.8 billion, at which time the Company became the sole shareholder in Ithaca and Ithaca’s shares were delisted from the AIM exchange in London and the Toronto Stock Exchange. After assuming control of Ithaca, the Group began to consolidate Ithaca's financial statements, starting from the financial statements for the second quarter of the year. Furthermore, in the second quarter of 2017, the Group recognized gains of NIS 137 million due to measuring its investment in Ithaca at fair value prior to assuming control. For more information, see Note 3B to the financial statements. It is noted that the Group has reached the conclusion that assumption of control in Ithaca constitutes a proforma event as defined in the Securities Regulations (Periodic and Immediate Reports), 1970. Thus, the Group is including proforma financial statements in its financial statements, which have been prepared to reflect the Group's results had Ithaca's financial statements been consolidated in the Group's financial statements in the periods prior to assuming control, based on the proforma assumptions detailed in the proforma statement.
Other Operations
• Developments concerning sale of the Company's investment in The Phoenix: On August 21, 2016, the Company signed a binding agreement for selling all of its holdings (52.3%) in The Phoenix Holdings Ltd. ("The Phoenix"). The buyer in the agreement was Yango Investment PTE. Ltd. ("Yango"), a privately-held company incorporated in Singapore. The consideration under the agreement was set at NIS 1.95 billion, bearing 4.75% annual interest from January 1, 2017 and until the closing date. The agreement included various preconditions, including regulatory approvals such as: control permit from the Ministry of Finance Commissioner of the Capital Market, Insurance and Savings; approval from the Israel Securities Authority; approval from the Tel Aviv Stock Exchange Ltd.; and the lack of any event having a material adverse effect (MAE) on The Phoenix's business as of the transaction completion date. In 2017, several amendments were made to the agreement, including updating the consideration for the sale to NIS 2.2 billion, and extending the agreement term. On June 26, 2017, in light of the protracted efforts to secure approval for transferring control of The Phoenix to the Yango Group, the parties agreed to cancel the agreement. On September 14, 2017, the Company and Sirius International Insurance Group Ltd. ("the Buyer") signed a binding agreement for selling all of the Company's holdings in The Phoenix, for a total consideration of NIS 2.5 billion, plus interest, subject to such adjustments as stipulated in the agreement. To the best of the Company's knowledge, the Buyer is an international insurance company with insurance operations in 140 countries. The transaction will be carried out in several stages: In the first phase, on September 18, 2017, 4.9% of The Phoenix's share capital was sold for a total consideration of NIS 208 million in cash (this consideration will be adjusted by a further NIS 25 million, should the sale of The Phoenix's remaining shares be completed, as detailed below).
B-3 WorldReginfo - c16fd361-de53-4169-8c2c-61d95bc8d7cf Board of Directors Report Delek Group Ltd.
Furthermore, the Company granted the Buyer a call option to buy its remaining holdings in The Phoenix (47.35%), whereby in the 60 day period from the date on which the Buyer was provided the due diligence materials as agreed by the parties, the Buyer may notify the Company of its intention to buy all the Company's remaining shareholdings in The Phoenix ("the Second Phase of the Agreement"). Should the Second Phase of the Agreement be completed, the Company will receive the remaining consideration of NIS 2,284 million in cash, plus interest, subject to such adjustments as stipulated in the agreement. Furthermore, the agreement specifies preconditions for completing the transaction, including receiving a control permit from the Ministry of Finance's Capital Market, Insurance and Savings Commissioner ("the Commissioner"), and receiving the necessary regulatory approvals. The agreement also specified deadlines for meeting these preconditions. As of the financial statements’ approval date, the application has been filed with the Commissioner, as required under the agreement. Furthermore, the Buyer has submitted an irrevocable notice of exercise, specifying its intention to buy the remaining stake in The Phoenix (47.35%). For more information concerning the agreement, see Note 3A to the financial statements. It is noted that The Phoenix's contribution to the net profit attributable to Company shareholders totaled NIS 529 million in the reporting period. For more information, see Note 3A to the financial statements. • On August 24, 2017, a generation license and supply license were granted to IPP Delek Soreq Ltd. ("IPP Soreq"), which is building the Soreq power plant. The power plant began commercial operation in September 2017. For more information, see Note 3C to the financial statements.
Debenture issuance
In February 2017, the Company issued debentures through an expansion of Series B31. Overall consideration (after issuance costs) received for the debentures totaled NIS 1 billion. For more information on these debentures, see Note 6 to the financial statements.
Dividend distributions
On March 29, 2017, the Company’s Board of Directors resolved to distribute a dividend of NIS 200 million. The dividend was distributed in May 2017. On May 28, 2017, the Company’s Board of Directors resolved to distribute a dividend of NIS 200 million. The dividend was distributed in June 2017. On August 29, 2017, the Company’s Board of Directors resolved to distribute a dividend of NIS 260 million. The dividend was distributed in September 2017. Subsequent to the financial position statement date, on November 28, 2017, the Company’s Board of Directors resolved to distribute a dividend of NIS 120 million. The dividend will be distributed in December 2017.
B-4 WorldReginfo - c16fd361-de53-4169-8c2c-61d95bc8d7cf Board of Directors Report Delek Group Ltd.
3. Results of Operations
A) Contribution to net profit attributable to Company shareholders from principal operations (NIS millions):
Q1 2017 Q2 2017 Q3/2017 1-9/2017 Q1 2016 Q2 2016 Q3/2016 1-9/2016 2016 Oil and gas exploration and production operations *) 127 130 84 341 111 72 111 294 413 Fuel operations in Israel 20 26 34 80 4 4 37 45 21 Automotive operations 18 18 14 50 36 - 14 50 80 Contribution of continuing operations before discontinued operations and capital and other gains 165 174 132 471 151 76 162 389 514 Gains on oil and gas asset sales **) - - 873 873 - - - - 253 Finance, tax, and other expenses ***) 55 6 19 80 (66) 4 (77) (139) (142) Net profit attributable to Company shareholders 220 180 1,024 1,424 85 80 85 250 625
*) Also includes the Company's share in the results of development and production operations in oil and gas assets in the North Sea. **) In the reporting period, in July 2017, Delek Drilling Limited Partnership sold 9.25% of its rights in the Tamar and Dalit gas leases. Following this sale, the Group recognized net gains (post-tax) of NIS 873 million (for more information, see also Note 5B to the financial statements). In 2016, the item includes gains on the sale of the Karish and Tanin leases, which were held by Delek Drilling. ***) In the second quarter of the year, NIS 137 million in gains were recognized on the revaluation of the balance of the Group's investment in Ithaca prior to acquiring control of Ithaca.
For information concerning each operating segment's contribution to profits, see this report below.
B) Revenues from operating activities (NIS millions)
The Group’s revenues in the reporting period totaled NIS 4.9 billion, as compared to NIS 4.3 billion in the same period last year, as detailed in the table below (NIS millions):
1-9/2017 1-9/2016 7-9/2017 7-9/2016 2016 Oil and gas exploration and production in and around Israel 1,276 1,358 341 493 1,821 Oil and gas asset development and production in the North Sea 363 - 263 - - Fuel operations in Israel 3,055 2,632 1,076 970 3,588 Other segments including adjustments 243 290 97 91 369 Total revenues 4,937 4,280 1,777 1,554 5,778
See also Note 10 to the financial statements - Information Regarding Operating Segments.
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C) Operating profit (NIS millions):
1-9/2017 1-9/2016 7-9/2017 7-9/2016 2016 Oil and gas exploration and 2,159 876 1,606 331 1,581 production in and around Israel Oil and gas asset development and 96 - 56 - - production in the North Sea Fuel operations in Israel 125 89 56 56 68 Other segments including (100) (33) (146) (35) ( (163) adjustments Total operating profit 2,234 930 1,618 354 1,486
See also Note 10 to the financial statements - Information Regarding Operating Segments.
D) The Group’s share in the profits of associate companies and partnerships, net (NIS millions)
The following table details the Group's share in the results of its principal associates:
1-9/2017 1-9/2016 7-9/2017 7-9/2016 2016 Delek Automotive *) (114) 49 (150) 13 35 Ithaca **) (6) (13) (15) (9) (3) IDE 8 18 2 6 17 Tamar Petroleum 19 - 19 - - Other 2 4 2 5 1 Total (91) 58 (142) 15 50
*) In the reporting period, the item includes a provision for impairment of an investment, to the amount of NIS 164 million. **) Data reflect the Group's share in Ithaca's results (20%) prior to Ithaca becoming a wholly-owned Group company, after which the data reflect Ithaca’s share in the results of its associate.
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E) Highlights from the Company's consolidated income statements (NIS millions):
1-9/2017 1-9/2016 7-9/2017 7-9/2016 2016
Revenues 4,937 4,280 1,777 1,554 5,778 Cost of revenues 3,451 2,742 1,288 986 3,744 Gross profit 1,486 1,538 489 568 2,034
Sales, marketing and gas station 567 426 427 144 145 operating expenses General and administrative expenses 148 131 59 51 182 Other income (expenses), net 1,322 (50) 1,322 (18) 201 Operating profit 2,234 930 1,618 354 1,486
Finance income 250 212 48 53 391 Finance expenses (785) (694) (214) (206) (828) Profit after finance expenses, net 1,699 448 1,452 201 1,049
Gain from disposal of investments in 150 - - - - investees and others, net Group's share in earnings (loss) of (91) 58 (142) 15 50 associates, net Profit before income tax 1,758 506 1,310 216 1,099
Income tax (tax benefit) 96 (48) 39 49 (118) Profit from continuing operations 1,662 554 1,271 167 1,217 Profit from discontinued operations, net 821 196 390 135 343 Net profit 2,483 750 1,661 302 1,560
Attributable to - Company shareholders 1,424 250 1,024 85 625 Non-controlling interest 1,059 500 637 217 935 2,483 750 1,661 302 1,560
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F) Movement in comprehensive income (loss) (in NIS millions):
1-9/2017 1-9/2016 7-9/2017 7-9/2016 2016 Net profit 2,483 750 1,661 302 1,560 Other comprehensive income (loss)
from operating activities (post-tax)
Actuarial gain on defined benefit plans, - - - - - net Gain (loss) from available-for-sale (78) 36 51 15 99 financial assets, net Transfer to profit or loss from disposal (6) (28) (3) (7) (58) of available-for-sale financial assets Transfer to profit or loss for impairment 17 41 - - 41 of available-for-sale financial assets Transfer to profit or loss of adjustments 13 - - - - from translation of overseas operations Gain (loss) from cash flow hedges (35) 5 (7) 7 26 Attribution to the hedged asset from the 20 - - - - results of cash flow hedges Adjustments from translation of (818) (369) 137 (222) (107) overseas operations (*) Group's share of other comprehensive (29) (12) 3 (6) (9) income (loss) of associates, net
Total other comprehensive income (loss) from (916) (327) 181 (213) (8) continuing operations Total other comprehensive income 85 74 71 6 70 from discontinued operations, net Total comprehensive income (loss) 1,652 497 1,913 95 1,622
Attributable to: Company shareholders 866 120 1,176 (27) 669 Non-controlling interests 786 377 737 122 953 1,652 497 1,913 95 1,622
(*) The Group has material investments in investee companies and an investee partnership whose functional currency is not NIS (mainly USD). Thus, changes in currency exchange rates materially affect the Group's other comprehensive income or loss and the equity attributable to Company shareholders. In the reporting period, the USD lost 8.2% against the NIS (as compared to a decrease of 3.7% in the same period last year, and a decrease of 1.5% in all of 2016).
B-8 WorldReginfo - c16fd361-de53-4169-8c2c-61d95bc8d7cf Board of Directors Report Delek Group Ltd.
4. Financial Position
The Group's total assets as of September 30, 2017, amounted to NIS 141.8 billion, compared with NIS 131.4 billion as of December 31, 2016. It is noted that, in light of Company's intentions and actions to sell the Company's holdings in The Phoenix's shares, The Phoenix's assets and liabilities are presented in the financial position statement as of September 30, 2017, and 2016, and as of December 31, 2016, under separate items - held-for- sale assets and corresponding liabilities. After assuming control of Ithaca in April 2017 as aforesaid, the Group has consolidated Ithaca's financial statements for the first time from the date of assuming control.
Below is a description of the principal changes in assets and liabilities as of September 30, 2017, compared with December 31, 2016:
Cash and cash equivalents and short-term investments As of September 30, 2017, the Group had cash and short-term investment balances of NIS 2.9 billion, consisting mainly of balances of NIS 1.2 billion in the headquarters companies, and NIS 1.5 billion in Delek Energy and Delek Drilling. Total current and non-current assets (excluding held-for-sale assets) Assuming control of Ithaca and consolidation of Ithaca's financial statements as aforesaid, has mainly increased the following items: inventory; trade receivables; investments in oil and gas exploration and production, net; investments in associates; goodwill; and deferred tax assets. For more information, see also Note 3B to the financial statements. Short- and long-term financial liabilities (excluding liabilities for The Phoenix assets) Financial liabilities (to banks and others and debenture-holders), as of September 30, 2017, amounted to NIS 20.3 billion, as compared to NIS 17.8 billion as of December 31, 2016. This NIS 2.5 billion increase was due to the raising of debentures in the reporting period (see Note 6 to the financial statements), and due to the first-time consolidation of Ithaca, whose liabilities total NIS 2 billion. The other liabilities item also grew by NIS 1.5 billion, following Ithaca's first-time consolidation, mainly due to asset settlement liabilities. For more information, see also Note 3B to the financial statements. Contingent claims In their review, the Company's auditors draw attention to legal actions brought against Group companies. For details, see Note 7 to the financial statements. Additional information For additional information regarding repayments of principal and interest on the debts of headquarter companies, see Appendix A to the Board of Directors' Report.
B-9 WorldReginfo - c16fd361-de53-4169-8c2c-61d95bc8d7cf Board of Directors Report Delek Group Ltd.
5. Sources of Finance and Liquidity
The net financial debt of the Company and the headquarters companies as of September 30, 2017:(2)
NIS millions Liabilities Debentures 8,386 Bank and other loans 578 Other liabilities 272 Total liabilities 9,236
Assets Cash and deposits 956 Financial investments 635 Loans (*) 1,145 Treasury shares (**) 425 Total assets 3,161
Net financial debt - headquarters companies 6,075
(*) Composition of loans extended as of September 30, 2017:
Loan balance as of Borrower September 30, 2017 (NIS millions) Power Plants 539 Seller loan - Republic 187 Other 419 Total 1,145
(**) As of September 30, 2017, shareholdings total 637,045 shares. Subsequent to the financial position statement date, the subsidiary partnership, Delek Financial Investments 2012 Limited Partnership, a wholly- owned subsidiary partnership of the Company, bought additional shares in the Company. As of the financial statements' approval date, shareholdings total 726,968 shares. For more information, see Section F below.
As of the financial statements’ approval date, the Company and the headquarters companies have liquid balances of NIS 0.5 billion (furthermore and in addition to these liquid balances, the Company has guaranteed, unutilized credit facilities of NIS 0.7 billion).
(1) Headquarters companies: Delek Group, Delek Petroleum, Delek Financial Investments Limited Partnership, Delek Power Plants Limited Partnership, DKL, and Delek Hungary.
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6. Analysis of Operations by Segment
A) Oil and gas exploration and production operations
As of the financial statements' approval date, operations are carried out mainly through the Delek Drilling partnership (following its merger with Avner; see also Note 5 to the financial statements), which mainly engages in the production and sale of natural gas and condensate from the Tamar Project, in promoting and planning the commercialization of gas and development of the Leviathan Reservoir located in the Leviathan South and Leviathan North leases and the Aphrodite Reservoir (in Cyprus), and in exploration activities in oil assets held by the Partnership. In July 2017, the transaction whereby the Partnership sold 9.25% of the rights in the Tamar and Dalit leases to Tamar Petroleum Ltd. was completed (see Note 5B(3) to the financial statements).
Results of the Partnership's oil and gas exploration and production operations as included in the Group's results (NIS millions):
1-9/2017 1-9/2016 7-9/2017 7-9/2016 2016 Revenues from gas sales net of 1,276 1,358 341 493 1,821 royalties Operating profit (adjusted for gains from sale of rights in Tamar and 713 876 160 331 1,581 Dalit) Gain on disposal of 9.25% of the 1,446 - 1,446 - - rights in the Tamar and Dalit leases EBITDA 1,124 1,195 280 450 1,602 Finance expenses, net 147 203 55 67 267 Net profit attributable to Company 1,116 307 914 120 669 shareholders Gas sales in BCM (*) 7.5 7.1 2.6 2.6 9.4 Condensate sales - thousands of 345 341 119 127 448 barrels (**)
(*) The data relate to sales of natural gas (100%) from the Tamar Project, rounded to one tenth of one BCM. (**) The data relate to condensate sales (100%) from the Tamar Project, rounded to thousands of barrels.
Analysis of segment results:
General
Following the sale of 9.25% of the Partnership’s rights in the Tamar and Dalit leases at the start of the third quarter of the year as aforesaid, the Group recognized a corresponding decrease in revenue and expense items. This decrease reflects the fact that the Partnership’s share in the Tamar Project decreased at the start of the third quarter from 31.25% to 22%. The Partnership's share (40%) in the earnings of Tamar Petroleum are included under the Company’s share in the results of associates.
Revenues
Data for the reporting period include revenues from oil and gas sales net of royalties to the amount of NIS 1,276 million, as compared to NIS 1,358 million in the same period last year. Revenues were down in the present period, mainly due to the decrease in the Partnership’s holdings in the Tamar reservoir, offset by greater quantities of natural gas and condensate sold from the Tamar project.
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Operating profit (excluding gains on the sale of 9.25% of Tamar)
Operating profit in the reporting period amounted to NIS 713 million, compared to NIS 876 million in the same period last year. This decrease in operating profit was mainly due to the decrease in the Partnership’s stake in the Tamar reservoir as aforesaid, an update to an obligation to remove oil and gas assets to the amount of NIS 56 million, and a NIS 90 million write-down on the Dolphin well, recognized in the second quarter of 2017.
Finance expenses, net
Net finance expenses in the reporting period amounted to NIS 147 million, compared to NIS 203 million in the same period last year. Finance expenses were down, mainly due to income recognized on a revaluation from the sale of the Karish and Tanin reservoirs, to the amount of NIS 42 million, as well as early repayment of some debentures by the Partnership following the sale of rights in the Tamar and Dalit leases.
Adjustment of the Partnership’s post-merger results to the Group's share in oil and gas exploration and production operations (NIS millions):
1-9/2017 1-9/2016 7-9/2017 7-9/2016 2016
Net profit from Delek Drilling's 2,719 808 (*) 2,202 311 (*) 1,258 (*) statements Indirect holdings (%) 56.2% 56.2% 56.2% 56.2% 56.2% Group's share 1,528 454 1,237 173 707 Tax expenses (176) (74) (133) (31) (130) Revenues from overriding royalty 28 30 8 11 40 and management fees Results of direct holdings in Yam (7) (6) (6) (1) (8) Tethys (4.44%) Write-down of excess acquisition (40) (74) (9) (26) (98) costs (**) De-recognition of excess costs (535) - (535) - - following the sale of 9.25% of the rights in Tamar and Dalit General and administrative expenses (12) (3) (4) (1) (4) Finance expenses, net (34) (20) (8) (5) (33) Other income (revaluation of 364 - 364 - 195 overriding royalties at fair value) Contribution to net profit from oil 1,116 307 914 120 669 and gas exploration and production
(*) Re-adjusted following Delek Drilling’s merger with Avner. (**) Current write-down of the revaluation attributed to the Tamar Project for the Avner Partnership's holdings in the project prior to the merger (previously recognized as part of the Cohen Development deal).
Additional information For more information concerning oil and gas exploration in Israel, see Notes 5 and 7 to the financial statements.
B-12 WorldReginfo - c16fd361-de53-4169-8c2c-61d95bc8d7cf Board of Directors Report Delek Group Ltd.
B) Oil and gas exploration and production in the North Sea
Ithaca Energy ("Ithaca") is an independent oil and gas operator operating in the North Sea, and holding both production and development oil and gas assets.
In the second quarter of 2017, the Group bought additional shares in Ithaca. Following these purchases, the Group's interest in Ithaca grew from 19.7% to 100%. After assuming control of Ithaca as aforesaid, the Group is consolidating Ithaca's financial statements starting from the second quarter of 2017 (for more information, see Note 3B to the financial statements).
At this time, Ithaca's development operations focus on developing reservoirs in the Greater Stella Area. Production in the Greater Stella Area is conducted through the FPF-1 floating production platform, co-owned by Ithaca (49.9%) and additional partners. Production from the Stella reservoir started in February 2017. Furthermore, in September 2017, the drilling plan for the Harrier reservoir (Ithaca's share - 54.67%) was completed, and production is planned to begin in the second half of 2018. Furthermore, FPF-1 was chosen as the production facility by a partnership holding the Vorlich reservoir (Ithaca's share - 34%). Production from this reservoir is planned to begin in 2020. Over the next few years, Ithaca plans to drill additional wells in the Greater Stella Area, and connect them to FPF-1.
In September 2017, the last works required to connect FPF-1 to the oil pipeline were completed. As a result, transition from transporting oil produced in the facility by tankers to pipeline-based transport was completed. It is noted that this transition will reduce fixed operating costs for the facilities in the region, will improve their operational profile, and will enable more efficient use of the reserves in the production fields through the FPF-1 production facility. In connecting the pipeline as aforesaid, production from the Stella reservoir was shut down for three weeks in September 2017.
Data from Ithaca's financial statements (USD millions):
Statement of financial position
Sept. 30, 2017 Sept. 30, 2016 Dec. 31, 2016
Cash and cash equivalents 20 30 27
Current assets (excluding cash and cash 178 284 198 equivalents)
Investment in oil and gas exploration and 1,224 1,120 1,112 production
Other long-term assets 641 567 594
Total assets 2,063 2,001 1,931
Current liabilities 256 309 245
Long-term financial liabilities 600 620 619
Other long-term liabilities 433 341 323
Equity attributable to Company 774 731 744 shareholders
Total liabilities and equity 2,063 2,001 1,931
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Statement of income
1-9/2017 1-9/2016 7-9/2017 7-9/2016 2016 Revenues from oil and gas sales 149 102 74 45 144 Cost of sales (148) (115) (80) (46) (146) Gross profit (loss) 1 (12) (6) (1) (2) Finance income (expenses) from 6 (25) (5) 3 (40) hedges Other income (expenses), net (7) (5) 1 (1) (6) Finance expenses, net (23) (25) (8) (7) (36) Share in the profits of associates 2 - - - - Loss before taxes (21) (67) (18) (6) (84) Income tax (tax benefit) (48) (3) (21) 64 (30) Net profit (loss) attributable to 27 (64) 3 (70) (54) Company shareholders Average output (Koebd) 12.5 9.6 14.3 10.0 9.3
The first nine months of 2017 were marked by a gradual increase in output, as production from the Stella reservoir ramped up since it first came online in the first quarter of 2017. Average daily production in the nine months ended September 30, 2017, totaled 12.5 Koebd (up 31% from the same period last year). This volume reflects a growth in production capacities from 9.3 Koebd in the first quarter of 2017, to 14.3 Koebd in the third quarter of 2017.
Despite this upward trend over the year, average production in the third quarter of 2017 was more moderate due to a three week shutdown of the Stella reservoir to connect the transportation pipeline, as aforesaid.
Furthermore, output in the third quarter of the year was reduced following planned maintenance shut-downs of the FPSO floating production rigs in the Cook and Pierce fields. These shut downs began towards the end of the third quarter of the year, and will end in October 2017.
In the third quarter of 2017, Ithaca's revenues totaled USD 74 million, as compared to USD 45 million in the same quarter last year (an increase of 64%). This increase was due to greater sales volumes (mainly following the Stella reservoir coming online), coupled with a higher selling price. The selling price was up from USD 44 per barrel in the third quarter of 2016, to USD 51 per barrel in the present quarter, following the increase in Brent prices.
In the nine month period in 2017, revenues grew to USD 149 million (up 46% year-on-year). This increase was due to a 27% increase in sales volumes (mainly due to the start of production in Stella), coupled with a 21% increase in the selling price.
Cost of sales totaled USD 80 million in the third quarter of 2017, as compared to USD 46 million in the same quarter last year (an increase of 72%), mainly due to increased production volumes. In the nine month period in 2017, cost of sales totaled USD 148 million, as compared to USD 115 million in the same period last year.
In the third quarter of 2017, the average operating cost totaled USD 22 per barrel (USD 21 per barrel in the same quarter last year). It is noted that the average cost is expected to go down in the fourth quarter of 2017, as the cost per barrel was adversely affected by third quarter production shut-downs. In the nine month period in 2017, cost per barrel totaled USD 20, as compared to USD 23 per barrel in the same period last year. The decrease reflects the lower production costs in the Stella reservoir, which came online in 2017, and the Company's cost- cutting efforts.
Ithaca conducts hedges on oil and gas prices, as well as currency hedges. In the third quarter of 2017, losses from hedges totaled USD 5 million, as compared to gains of USD 3 million in the same quarter last year. In the nine month period in 2017, Ithaca recorded gains of USD 6 million
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on hedges, as compared to losses of USD 25 million in the same period last year. Furthermore, in 2016, Ithaca's net profit was affected by a reduction in tax rates, which led to recognition of a one-time tax benefit.
As aforesaid, the Company started consolidating Ithaca's financial statements from the date of assuming control. Ithaca's total contribution to the net profit attributable to the Company's shareholders, including the Company's share in Ithaca's results through its investment in Ithaca (19.7%) in the period prior to assuming control, totaled NIS 98 million in the reporting period (considering temporary assignment of excess acquisition costs). Furthermore, in the second quarter of 2017, the Company recognized NIS 137 million in gains upon assuming control (after assignment to profit or loss of capital reserves balances from translation differences, accrued prior to assuming control). In the same period last year, the Group's share in Ithaca's results totaled a loss of NIS 13 million. Ithaca's overall contribution to the net profit attributable to Company shareholders in the third quarter of 2017, totaled (considering temporary assignment of excess acquisition costs) NIS 43 million.
For proforma results reflecting (under certain assumptions) the Group's results had Ithaca's financial statements been consolidated (100%) in the periods prior to assuming control, see the proforma interim consolidated financial statements attached to these financial statements.
Additional information
For more information on Ithaca’s operations, see Note 3 to the financial statements.
B-15 WorldReginfo - c16fd361-de53-4169-8c2c-61d95bc8d7cf Board of Directors Report Delek Group Ltd.
C) Fuel operations in Israel
Data from the financial statements of Delek Israel, a wholly-owned (100%) Group subsidiary (NIS millions):
Statement of Financial Position
September September 2016 30, 2017 30, 2016 Cash and cash equivalents 37 57 44 Current assets (excluding cash and cash equivalents) 1,554 1,321 1,416 Property, plant and equipment 1,310 1,381 1,337 Other long-term assets 519 549 550 Total assets 3,420 3,308 3,347
Short-term credit from banks and others 789 730 858 Current liabilities (excluding credit) 904 823 822 Long-term loans from banks and others 606 682 631 Other long-term liabilities 67 70 68 Equity attributable to Company shareholders 1,049 992 968 Total liabilities and equity 3,420 3,308 3,347
Statement of Income
1-9/2017 1-9/2016 7-9/2017 7-9/2016 2016 Revenues 3,055 2,632 1,076 970 3,588 Gross profit 602 599 221 217 785 Operating profit before other income 126 121 59 56 148 (expenses), net Other income (expenses), net (1) (32) (3) - (80) Operating profit 125 91 56 56 68 EBITDA 198 194 81 78 246 Finance expenses, net 19 34 10 7 48 Net profit attributable to 80 45 34 37 21 Company shareholders
Analysis of the results of fuel operations in Israel
Revenues
Sales net of government fees ("Net Sales") totaled NIS 3,055 million in the reporting period, as compared to NIS 2,632 million in the same period last year, an increase of 16%. Net Sales in the third quarter of 2017 totaled NIS 1,076 million, as compared to NIS 970 million in the same quarter last year, an increase of 11%. This increase was due to a moderate increase in global distillate prices and greater sales volumes.
Sales turnover in self- and franchise-operated Menta convenience stores totaled NIS 340 million in the reporting period, as compared to NIS 332 million in the same period last year, an increase of 2%.
B-16 WorldReginfo - c16fd361-de53-4169-8c2c-61d95bc8d7cf Board of Directors Report Delek Group Ltd.
Gross profit
Delek Israel's gross profit remained stable. In the reporting period, gross profit totaled NIS 602 million, as compared to NIS 599 million in the same period last year. (Adjusted for inventory gains: NIS 605 million and NIS 602 million, respectively).
Gross profit for the third quarter of 2017 totaled NIS 221 million, as compared to a gross profit of NIS 217 million in the same quarter last year (NIS 225 million and NIS 217 million, respectively, adjusted for inventory gains). This increase is mainly attributable to greater sales volumes and profit margins in direct marketing operations, and a moderate increase in profits from commercial refueling station operations.
Finance expenses, net
Net finance expenses in the reporting period amounted to NIS 19 million, compared with NIS 34 million in the same period last year, a decrease of 44%. Net finance expenses were down in the reporting period, mainly due to lower interest rates and lower finance expenses on fuel trades.
Net profit attributable to Delek Israel's shareholders
In the nine month period in 2017, net profit totaled NIS 80 million, as compared to NIS 45 million in the same period last year. Net profit was up mainly due to lower finance expenses, as aforesaid. Furthermore, one-time net expenses were recognized in the last-year period.
Subsequent to the financial position statement date, Delek Israel received a letter from the Ministry of Energy, along with a summary of the Pricing Committee’s discussions of September 27, 2017. In the letter, the Pricing Committee recommends, among other things: reducing the self-service retail margin for 95-octane gasoline. Delek Israel is preparing its reply to the letter through its representatives – which is supported by an economic opinion prepared by an economic expert. In its comments, it will demonstrate that it believes the margin should not be lowered (but rather increased). Delek Israel is studying the implications of these recommendations, should they be implemented according to the Ministry of Energy’s notice.
For more information concerning fuel operations in Israel, see Notes 3 and 7 to the financial statements.
B-17 WorldReginfo - c16fd361-de53-4169-8c2c-61d95bc8d7cf Board of Directors Report Delek Group Ltd.
D) Insurance and finance operations in Israel
As of September 30, 2017, the Group holds 47.35% of the shares of The Phoenix Holdings Ltd. For information concerning the sale of control in The Phoenix, see Note 3A to the financial statements.
Highlights from The Phoenix's consolidated income statements (NIS millions):
1-9/2017 1-9/2016 7-9/2017 7-9/2016 2016
Gross premiums earned 7,370 6,565 2,482 2,301 8,856 Premiums earned in retention 6,737 6,001 2,248 2,104 8,105 Net gains on investments, and 3,184 2,197 1,254 1,252 3,171 finance income Income from management fees 791 681 304 263 940 Payments and changes in liabilities for insurance contracts and 8,198 6,865 3,054 2,715 9,230 investment contracts in retention Commission, marketing, and other 1,168 1,121 421 372 1,527 purchasing expenses General and administrative 865 851 288 293 1,135 expenses Other expenses 18 15 7 8 28 Finance expenses 105 86 31 39 113 Share in the profits of investees accounted for as per the equity 42 35 (4) 3 48 method Net profit for the period 595 312 119 224 621 Net profit for the period attributable The Phoenix 586 300 116 220 608 shareholders
A significant part of The Phoenix's asset portfolio is invested on the capital market. Therefore, capital market returns for the various investment channels have a material effect on the yields achieved for The Phoenix's customers and on The Phoenix's profits.
Gains and losses on investments reflect capital market performance in Israel and abroad, as well as changes in the Consumer Price Index and the NIS exchange rates against the main currencies. The aggregate effect of these factors materially affects the reported results. Revenues from investments, including other comprehensive income (pre-tax), amounted to an income of NIS 3,318 million in the reporting period, as compared to income of NIS 2,311 million in the same period last year. Revenues from investments, including other comprehensive income (pre-tax), amounted to an income of NIS 1,363 million in the third quarter of the year, as compared to income of NIS 1,254 million in the same quarter last year. It is noted that a significant part of the investment gains (losses) is attributable to investment profit-sharing policies and did not directly influence The Phoenix’s results.
Revenues from management fees were up NIS 110 million in the reporting period, as compared to the same period last year. The bulk of this increase was due to growth in variable management fees, which totaled NIS 214 million in the reporting period, as compared to NIS 117 million in the same period last year. The increase was due to higher real yields achieved by The Phoenix as compared to the same period last year. Revenues from management fees were up NIS 41 million in the third quarter of 2017, as compared to the same quarter last year, mainly due to growth in variable management fees.
Results for the reporting period and for the third quarter were materially affected by lower market interest rates. The lower interest rates and liquidity premium in the reporting period increased insurance liabilities by NIS 123 million pre-tax (NIS 80 million, post-tax), and by NIS
B-18 WorldReginfo - c16fd361-de53-4169-8c2c-61d95bc8d7cf Board of Directors Report Delek Group Ltd.
201 million pre-tax (NIS 131 million post-tax) in the present quarter. Interest rate effects in the reporting period and present quarter totaled NIS 65 million, due to the introduction of an investment track for receivers of pensions in 2017.
In the last-year period, the decrease in interest rates increased insurance liabilities by NIS 235 million pre-tax (NIS 151 million post-tax). In the third quarter of 2016, the increase in the risk- free interest rate caused a decrease in insurance liabilities, to the amount of NIS 54 million pre- tax (NIS 35 million post-tax).
Furthermore, results for the last-year period were materially affected by an increase in insurance liabilities in the compulsory auto and liabilities and other insurance segments of general insurance operations, to a total amount of NIS 136 million pre-tax, and NIS 87 million post-tax, following the publication of the Winograd Commission's recommendations.
Results for the last-year period were also affected by a reduction in the corporate tax rate starting January 1, 2016, which caused a NIS 23 million reduction in tax reserves.
Key data according to The Phoenix’s operating segments (NIS millions):
1-9/2017 1-9/2016 7-9/2017 7-9/2016 2016 Profit from life insurance and long term savings segment 204 9 (7) 133 189 Profit from health insurance segment 135 52 58 65 110 Profit from general insurance segment 269 100 73 70 197 Profit from financial services segment 89 90 36 25 96 Total comprehensive income from operating segments 697 251 160 293 592 Profit not attributed to reporting segments 155 138 18 44 182 Company’s share in the net results of investees not included in the reported segments 28 22 (6) (3) 28 Profit before income tax 880 411 172 334 802 Income tax 285 99 53 110 181 Profit for the period 595 312 119 224 621 Net profit for the period attributable The Phoenix shareholders 586 300 116 220 608
For more information on The Phoenix’s operations, see Notes 3 and 7 to the financial statements.
B-19 WorldReginfo - c16fd361-de53-4169-8c2c-61d95bc8d7cf Board of Directors Report Delek Group Ltd.
E) Automotive operations
As of the financial position statement date, the Group holds 22.5% of Delek Automotive Systems Ltd. ("Delek Automotive") (Delek Automotive is a public company which publishes its financial statements). The investment in Delek Automotive is presented as per the equity method.
The results of Delek Automotive’s operations are included under the ‘Group’s share in the profits of associates, net’ item.
The results of Delek Automotive's operations (NIS millions):
1-9/2017 1-9/2016 7-9/2017 7-9/2016 2016 Revenues 2,858 2,933 834 812 3,428 Gross profit 453 539 126 128 609 Sales, marketing, and general and 125 114 41 39 145 administrative expenses Operating profit 340 431 95 95 498 EBITDA 355 446 100 100 519 Finance income (expenses), net (*) 23 (107) 10 10 (12) Net profit 275 243 79 79 370
Breakdown of Delek Automotive's sales by number of cars sold:
1-9/2017 1-9/2016 7-9/2017 7-9/2016 2016 MAZDA vehicles 11,687 12,873 3,313 3,210 14,321 FORD vehicles 2,864 3,644 887 1,175 4,371 BMW vehicles 3,334 3,031 939 804 3,684 Total vehicles sold 17,885 19,548 5,139 5,189 22,376 Delek Automotive's share of all new vehicles sold in Israel (based on 7% 8% 7% 6% 8% Licensing Bureau data)
Analysis of the results of automotive operations:
In the third quarter of 2017, vehicle sales slowed down in Israel, and in the first nine months of 2017, new vehicle sales totaled 238,000 as compared to 245,000 in the same periods last year (according to Licensing Bureau data).
In the nine month period, Delek Automotive launched BMW's 4 and 5 Series, as well as the new MINI Countryman model. The new Mazda CX3 and CX5 models were also launched, as well as the new Ford Kuga.
Revenues
Sales turnover in the first nine months of 2017, amounted to NIS 2,858 million, as compared to NIS 2,933 million in the same period last year (in all of 2016 - NIS 3,428 million). In the third quarter of 2017, sales totaled NIS 834 million, as compared to NIS 812 million in the same quarter last year. In the nine month period in 2017, a total of 17,885 vehicles were sold, as compared to 19,548 vehicles sold in the same period last year. In the third quarter of 2017, 5,139 vehicles were sold, as compared to 5,189 vehicles in the same quarter last year (2016 - 22,376 vehicles).
B-20 WorldReginfo - c16fd361-de53-4169-8c2c-61d95bc8d7cf Board of Directors Report Delek Group Ltd.
Gross profit
Gross profit was down from NIS 539 million in the last-year period, to NIS 453 million in the nine month period in 2017. This decrease was due to lower profits in both vehicle and spare part operations.
Gross profit in the third quarter of 2017 totaled NIS 126 million, similar to the figure for the same quarter last year. In the third quarter of 2017, the gross margin was 15.2%, as compared to 15.5% in the same quarter last year. In the nine month period in 2017, the gross margin was 16%, down from 18% in the same period last year. This decrease in gross profit and gross margin was due to a change in the vehicle sales mix, as well as the fact that sales in the present quarter consisted of vehicles whose cost in Delek Automotive's books was higher due to stronger import currency rates at the time of their purchase.
Net profit attributable to Delek Automotive's shareholders
Net profit attributable to Delek Automotive's shareholders in the nine month period in 2017 totaled NIS 275 million, as compared to NIS 243 million in the same period last year. This increase in net profit was due to higher net finance income, offset by a decrease in gross profit. In the first nine months of 2017, Delek Automotive recorded NIS 22.5 million in net finance income, as compared to net finance expenses of NIS 107.5 million in the same period last year. Fluctuations in finance expenses is mainly due to changes in the exchange rate for the JPY, which is Delek Automotive's import currency (exchange rate was down 4.7% in the first nine months of 2017, as compared to an increase of 14.8% in the same period last year).
Net profit in the third quarter of 2017 totaled NIS 79 million, similar to the figure for the same quarter last year.
For more information on Delek Automotive's operations, see Note 3 to the financial statements.
F) Additional Operations
Infrastructures
The Group’s infrastructures operations are carried out through Delek Power Plants Limited Partnership ("Delek Power Plants"), which coordinates the development and operation of two power plants in Israel (in Ashkelon and Soreq) through its subsidiaries. The Group also holds 50% of IDE Technologies Ltd. ("IDE"). In the reporting period, the infrastructures segment yielded a loss of NIS 30 million, as compared to a profit of NIS 17 million in the same period last year.
For more information on additional operations, see Note 3 to the financial statements.
B-21 WorldReginfo - c16fd361-de53-4169-8c2c-61d95bc8d7cf Board of Directors Report Delek Group Ltd.
B) Market Risk Exposure and Management
1. A) Company operations focus mainly on holding and managing shares in its subsidiaries. These are long-term investments and therefore these holdings are not hedged. Risk management in subsidiary and associate companies is determined and carried out directly by the investees. Some of these companies are public companies and are listed on the stock exchange, and therefore proper disclosure of this subject is made in their financial statements.
B) The currency risk management officer in the Company is Mr. Ido Adar, MBA. In recent years, Mr. Adar has serve as Company Treasurer.
2. Description of market risks A) As stated above, the Group is mainly a holdings and management company, and its principal exposure results from the market risks of its subsidiaries and associates ("Investees").
B) Following on the above, in the second quarter of 2017, the Company started consolidating Ithaca's results in its financial statements. In addition to the disclosure made in the Board of Directors' Report as of December 31, 2016, Ithaca's operations expose the Company to risk from changes in oil and gas prices (Brent barrel prices).
Furthermore, the bulk of Ithaca's revenues are in USD, while its costs are mostly in GBP. As a result, Ithaca is exposed to risk from changes in the GBP-USD exchange rate.
In order to minimize exposure and maximize selling prices, Ithaca conducts hedges on oil and gas prices, and on currencies. These hedges are made with major financial corporations.
C) Other than the above, no material changes occurred in the reporting period in the Company's market risk exposure and its policy to mitigate and manage exposure to market risks, including the effects of sensitivity tests on the Group's reports in this matter in the year ended December 31, 2016.
The following table details Israeli CPI data and exchange rates for the primary currencies used by the Company:
USD representative Known CPI exchange rate As of NIS Points
September 30, 2017 3.529 118.57 September 30, 2016 3.758 118.70 December 31, 2016 3.845 118.34
% Change % %
September 30, 2017 (9 months) (8.2) 0.2 September 30, 2017 (3 months) 0.9 (0.5) September 30, 2016 (9 months) (3.7) 0 September 30, 2016 (3 months) (2.3) 0.4 2016 (1.5) (0.3)
B-22 WorldReginfo - c16fd361-de53-4169-8c2c-61d95bc8d7cf Board of Directors Report Delek Group Ltd.
3. Linkage bases report
Monetary items in overseas Held-for- Non- Other Fair operations sale monetary Unlinked CPI-linked USD currency value (USD) assets item Total Assets
Current assets 2,697 43 396 40 316 2,202 - 899 6,593
Insurance business assets ------108,039 - 108,039
Non-current assets 125 37 627 - 784 1,135 - 24,420 27,128
Total assets 2,822 80 1,023 40 1,100 3,337 108,039 25,319 141,760
Liabilities
Current liabilities 2,748 1,361 449 8 42 2,495 - 13 7,116
Insurance business liabilities ------103,232 - 103,232
Non-current liabilities 5,361 2,659 21 - - 9,568 - 2,336 19,945
Total liabilities 8,109 4,020 470 8 42 12,063 103,232 2,349 130,293
Assets less liabilities, net (5,287) (3,940) 553 32 1,058 (8,726) 4,807 22,970 11,467
B - 23
WorldReginfo - c16fd361-de53-4169-8c2c-61d95bc8d7cf Board of Directors Report Delek Group Ltd.
C) Disclosure relating to the Company's financial reporting
1. Critical accounting estimates
No changes have occurred in the reporting period as compared to the 2016 periodic report.
2. Events after the financial position statement date
For information on material events subsequent to the financial position statement date, see Chapter A to the Board of Directors' Report.
E) Dedicated disclosure for debenture holders
B - 24
WorldReginfo - c16fd361-de53-4169-8c2c-61d95bc8d7cf Board of Directors Report Delek Group Ltd.
Interest Stock Par value Carrying accrued in exchange balance as amount - the books value as of Par value of Sept. 30, Nominal Sept. 30, as of Sept. Repayment September Series Issue date Original 2017 interest rate Linkage 2017 30, 2017 years 30, 2017 Trustee NIS NIS NIS millions NIS millions millions millions Hermetic Trust (1975) Ltd. 113 Non- B11 7/2006 468 357 5.4% Israeli CPI 421 5 2018 Hayarkon St. Tel Aviv Tel: 03-5274867 - marketable Dan Avnon Reznik Paz Nevo RPN Trusts 2007 Ltd., Non- B12 11/2006 1,100 199 5.35% Israeli CPI 235 6 2015-2017 14 Yad Harutzim St., Tel Aviv Tel: 03- marketable 6389200, Elad Sirkis Until listing - Hermetic Trust (1975) Ltd. 113 2015 B13 3/2007 913 548 +5.1%, after Israeli CPI 658 15 715 Hayarkon St. Tel Aviv Tel: 03-5274867 - 2019-2021 listing - 4.6% Dan Avnon Reznik Paz Nevo RPN Trusts 2007 Ltd., 7/2009 B14 419 419 8.5% Un-linked 419 7 2018 442 14 Yad Harutzim St., Tel Aviv Tel: 03- 6/2010 6389200, Elad Sirkis 7/2009 Reznik Paz Nevo RPN Trusts 2007 Ltd., 7/2015 B15 1,486 273 8.5% Un-linked 273 11 2015-2017 284 14 Yad Harutzim St., Tel Aviv Tel: 03- 11/2009 6389200, Elad Sirkis 11/2015 11/2009 Reznik Paz Nevo RPN Trusts 2007 Ltd., B18 6/2010 1,062 885 6.1% Israeli CPI 954 25 2016-2022 1,101 14 Yad Harutzim St., Tel Aviv Tel: 03- 7/2015 6389200, Elad Sirkis Gafni Trusts Ltd. 4 Hataas St., Ramat B19 11/2010 560 560 4.65% Israeli CPI 589 11 2019-2022 651 Gan Tel: 03-6070370 - Tzuri Galili Mishmeret - Trusts Services Company Ltd., 48 Menahem Begin St., Tel Aviv, B22 6/2007 500 375 4.50% Israeli CPI 447 5 2019-2021 492 Tel: 03-6374335/4, Atty. Rami Katzav, CPA. 2/2015 Hermetic Trust (1975) Ltd. 113 6/2015 B31 3,276 3,276 4.3% Un-linked 3,276 16 2020-2025 3,533 Hayarkon St. Tel Aviv Tel: 03-5274867 - 10/2015 Dan Avnon 2/2017 Hermetic Trust (1975) Ltd. 113 Convertible and B32 7/2016 411 411 1.72% 410 1 2019 414 Hayarkon St. Tel Aviv Tel: 03-5274867 - non-linked Dan Avnon Hermetic Trust (1975) Ltd. 113 Convertible and B33 7/2016 705 705 2.8% 705 4 2022 718 Hayarkon St. Tel Aviv Tel: 03-5274867 - non-linked Dan Avnon
B-25 WorldReginfo - c16fd361-de53-4169-8c2c-61d95bc8d7cf Board of Directors Report Delek Group Ltd.
Notes: 1. The Company meets all the terms of the debentures. Furthermore, the Company meets all the terms of its obligations under the deed of trust. 2. Debenture ratings as of the financial statements' approval date:
Rating Rating Rating Current Rating Current Series upon upon company rating company rating issue issue
B11 Midroog A2 - S&P Maalot A AA
B12 Midroog A2 - S&P Maalot A AA
B13 Midroog A2 - S&P Maalot A AA
B14 Midroog A2 A1 S&P Maalot - -
B15 Midroog A2 A1 S&P Maalot - -
B18 Midroog A2 A1 S&P Maalot - -
B19 Midroog A2 A1 S&P Maalot - -
B22 Midroog A2 - S&P Maalot A AA
B31 Midroog A2 A1 S&P Maalot A A
B32 Midroog A2 A2 S&P Maalot A A
B33 Midroog A2 A2 S&P Maalot A A
The current rating reports from Midroog and Maalot are hereby attached by way of reference to the immediate reports of September 19, 2017 (ref. no. 2017-01-083215), and October 8, 2017 (ref. no. 2017- 01-088561), respectively, included herein by way of reference.
Financial covenants
The deed of trust for Debentures (Series B31) issued in 2015, and the deeds of trust for Series B32 and B33 issued in July 2016, specified the following financial covenants: A) Minimum equity: The Company's minimum equity will not fall below NIS 2,400 million according to its audited or reviewed consolidated financial statements, as applicable, for three consecutive quarters.
B) Ratio of equity to balance sheet total: The Company's equity will not fall below 15% of its balance sheet total according to the Company's audited or reviewed separate financial statements, as applicable, for three consecutive quarters.
Equity, meaning the Company's total equity attributable to Company shareholders, excluding minority interests, as defined in GAAP. As of September 30, 2017, and the financial statements' approval date, the Company is in compliance with these financial covenants.
B-26 WorldReginfo - c16fd361-de53-4169-8c2c-61d95bc8d7cf Board of Directors Report Delek Group Ltd.
F) Additional information
1. Buyback of securities
As of September 30, 2017, the subsidiary partnership (wholly-owned by the Company) holds 637,045 shares in the Company. Subsequent to the financial position statement date, in October and November 2017, the subsidiary partnership bought 89,923 shares in the Company, in consideration for NIS 51 million. Following these purchases, the subsidiary partnership holds 726,698 shares in the Company.
2. Company employees
The Board of Directors would like to thank the Company's management, the management of the Company's investees, and to all the employees for their dedicated work and their contribution to the advancement of the Company.
Sincerely
Gabriel Last Asaf Bartfeld
Chairman of the Board CEO
Signature date: November 28, 2017
B-27 WorldReginfo - c16fd361-de53-4169-8c2c-61d95bc8d7cf Board of Directors Report Delek Group Ltd.
Appendix A to the Board of Directors' Report
Breakdown of principal and interest payments on the debentures and bank loans of the headquarters companies as of June 30, 2017 (in NIS millions):
Delek Group - Headquarters
2022 10-12/2017 2018 2019 2020 2021 Total onwards Principal 699 839 1,117 870 870 3,992 8,387 Debentures Interest 183 334 286 239 196 277 1,515 Principal 6 137 12 12 29 83 279 Bank loans Interest 2 4 4 4 3 9 26 Total 890 1,314 1,419 1,130 1,102 4,362 10,207
The Delek Group also has guaranteed, unutilized bank credit facilities of NIS 0.5 billion (as of September 30, 2017). As of the financial statements' approval date, the Delek Group had unutilized credit facilities amounted to NIS 0.7 billion.
B-28 WorldReginfo - c16fd361-de53-4169-8c2c-61d95bc8d7cf Board of Directors Report Delek Group Ltd.
Appendix B to the Board of Directors' Report
Details concerning an extremely material valuation as of September 30, 2017 (Regulation 49(a) to the Securities Regulations (Periodic and Immediate Reports, 1970) 1. Valuation of the royalties stipulated in the agreement for selling 9.25% of the rights in Tamar and Dalit. The Group's financial statements as of September 30, 2017, include an extremely material valuation concerning the royalties to which the Group is entitled from the share of Tamar Petroleum Ltd. ("Tamar Petroleum") in the Tamar lease after selling 9.25% of the rights to the Tamar lease to Tamar Petroleum, and the Group's gains from the said sale. For more information, see Note 5 to the financial statements.
Share attributable Value of Value of to Company Company entitled to royalties royalties royalties shareholders (pre- tax) USD millions NIS millions Delek Energy Systems Ltd. 77 275 243 Cohen Development and Industrial Buildings Ltd. 23 82 42 The Company 26 92 93 Total 126 4493 373
Information concerning the said valuation:
Focus of valuation: Royalties due to the Group from Tamar Petroleum's share in the Tamar lease. Study date: July 20, 2017 Value immediately prior to the N/A valuation date had Israeli GAAP, including depreciation and amortization, not required a change in value pursuant to the valuation: Value following assessment: Royalties were valued at USD 126 million (NIS 449 million), as detailed above. This value was included under the Group's long-term loans and debit balances item. The appraiser: The work was performed by GSE Financial Consulting Ltd., a subsidiary of Giza Singer Even Ltd. The appraisal team was headed by Mr. Nir Harush, CPA. For information concerning the appraiser's experience, see Section 1.3 to the valuation. The appraiser is independent of the Group. The contract with the appraiser includes an indemnification clause as detailed in Section 1.1 to the valuation. The valuation model employed: Discounted cash flow projections method. Assumptions used in the valuation, The main assumptions underlying the valuation include under the valuation model: assumptions concerning annual production volumes and rates, forecasts for natural gas prices, forecasts for condensate prices, oil profits tax, a 7.3% discount rate, and all as detailed in Section 4.2 to the valuation.
3 NIS 449 million in gains from the aforesaid were included under other income, net. See also Note 5 to the financial statements.
B-29 WorldReginfo - c16fd361-de53-4169-8c2c-61d95bc8d7cf Board of Directors Report Delek Group Ltd.
2. Test for the fair value of the Company's investments in The Phoenix's shares The Group's financial statements as of September 30, 2017, include an extremely material valuation testing the fair value of the investment in The Phoenix shares.
Highlights from the economic analysis:
Focus of valuation: Fair value of the Company's investment in The Phoenix's shares. Study date: September 30, 2017. Value immediately prior to the valuation date The carrying amount of the investment as of had Israeli GAAP, including depreciation and September 30, 2017, was NIS 2,196 million. amortization, not required a change in value pursuant to the valuation: Value following assessment: The fair value of the investment ranges from NIS 2,200 million to NIS 2,651 million. The appraiser: Prof. Yoram Eden (for more information, see Appendix A to the economic study). The appraiser is independent of the Company. The valuation model employed: The valuation is based on an integration of two methods: An 'integrated' DCF method: Measuring the enterprise value of insurance operations, provident fund management, financial services and insurance agencies using the DCF method, plus the equity value of The Phoenix's investment in the following companies: (a) AD 120 for Seniors Ltd.; (b) Gamma Management and Settlement Ltd.; and the market cap for The Phoenix's investment in the public company Mehadrin, and net of financial and other liabilities. An approach deriving the company's value from various offers for its purchase, submitted to the Company, and from other recent offers to buy other insurance companies. Assumptions used in the valuation, under The value of life, pension, and healthcare the valuation model: insurance business is based on data from the embedded value report as of December 31, 2016 (as included in The Phoenix's periodic report as of March 31, 2017), subject to various adjustments, including an increase in the discount rate by a 6% risk premium. In implementing the DCF method for other operations, the forecast period was divided in two: The period through 2020, for which detailed profit projections were made; 2021 onwards, for which a 'representative cash flow' was built. The annual discounting rate was estimated at 10.5%. Various key assumptions were also used concerning growth/slowdown rates in various sectors, future inflation rates, yields on assets and investments, policy cancellation rates, etc.
B-30 WorldReginfo - c16fd361-de53-4169-8c2c-61d95bc8d7cf Board of Directors Report Delek Group Ltd.
3. Test for impairment of the investment in an associate - Delek Automotive
Highlights from a material valuation of the Company’s investment in Delek Automotive shares:
Focus of valuation: Test for impairment of the investment in an associate - Delek Automotive. Study date: September 30, 2017. Value immediately prior to the valuation date NIS 734 million. had Israeli GAAP, including depreciation and amortization, not required a change in value pursuant to the valuation: Value following assessment: NIS 570 million. The appraiser: The study was conducted by Fair Value Ltd., a privately-held company specializing in complex professional valuations, financial consulting, and equipment and machinery appraisal. The study was headed by Eli Elal and Ori Snopkowski. The valuation model employed: The recoverable amount of the Company's investment in Delek Automotive was calculated using the discounted cash flow projections method. Assumptions used in the valuation, under In applying the DCF method, Delek Automotive's the valuation model: cash flows were projected through 2022, from which long-term cash flows were derived. The study assumes a gradual decline in Delek Automotive's gross profit margin over the discount period, down to 15.8% in the long term. The pre-tax discount rate was estimated at 12.6%, and the permanent long-term growth rate was estimated at 2.5%.
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Delek Group Ltd.
Valuation of Overriding Royalties for Delek Petroleum Ltd's Share in the I/12 Tamar Lease ****
November 2017
1 WorldReginfo - c16fd361-de53-4169-8c2c-61d95bc8d7cf
Contents
1. Introduction and Limit of Liability ...... 3
2. Executive Summary ...... 5
3. Overriding Royalties ...... 7
4. Valuation ...... 17
2 WorldReginfo - c16fd361-de53-4169-8c2c-61d95bc8d7cf
1. Introduction and Limit of Liability
1.1 General
This paper (the "Paper" and/or "Opinion") was prepared by GSE Economic Consulting Ltd. ("GSE") for Delek Group Ltd. ("Delek Group" and/or "the Company") to evaluate the value of the overriding royalties, as defined in the Company's financial statements to the TASE1, from its holdings in Tamar Petroleum Ltd. ("Tamar Petroleum") from the Tamar lease ("the Lease" and/or "the Reservoir"), as of July 20, 2017 ("the Valuation Date"). We are aware that the Paper is to be used by the Company for quarterly and periodic financial statements, and, therefore, consent to having it cited and/or included in any report published under the Securities Law, 1968, all as set out in the letter of intent dated October 15, 2017.
For preparation of the Paper, we relied on information and/or explanations and/or forecasts and/or presentations ("the Information") received from the Company and/or its representatives. GSE assumes that this Information is reliable and does not review it independently. In addition, nothing was brought to our attention that may indicate that the Information is unreasonable. The Information was not checked independently and, therefore, the Paper submitted to you does not constitute verification of its truthfulness, completeness and accuracy. An economic valuation is supposed to reasonably and fairly reflect the given position at a specific time based on known data, with reference to fundamental assumptions and forecasts.
This Opinion includes a description of the methodology, main assumptions and analyses used to determine the fair value of the overriding royalties to which the Company is entitled. However, it is not full and detailed description of the procedures that we followed during formulation of the Opinion.
This Paper does not constitute and is not in place of due diligence. It is not intended to determine the value of the overriding royalties for a specific investor either and does not constitute any legal advice or opinion.
The Paper does not include a financial audit regarding compliance with accounting rules. GSE Economic Consulting is not responsible for the accounting presentation of the Company's financial statements, the accuracy and completeness of the data and the implications of such accounting presentation, if any.
If the Information and data on which GSE relied are incomplete, inaccurate or unreliable, the results of this Paper may change. We reserve the right to revise the Paper in view of new data not presented to us. For avoidance of any doubt, this Paper is valid only on the date of its signature.
It is emphasized that the information in this Paper constitutes forward looking information, as defined in the Securities Law, 1968, and there can be no certainty that it will materialize, in whole or in part, in the above or any other manner.
This Information might materialize in a substantially different manner due to various factors, including changes in the quantity of natural gas and condensate sold and produced; changes in the prices of natural gas and condensate; etc.
We hereby confirm that we have no personal interest or dependence on the Company other than the fact that we are receiving a fee for this Paper. We also hereby confirm that our fee is not conditional to the results of the Paper.
GSE and any company that it controls directly and/or indirectly and any controlling shareholder, officer and employee of any of them are not responsible for any damage, loss or expense of any kind, including direct and/or indirect, incurred by anyone who relies on all or part of the contents of this Paper.
1 See the financial statements as of December 31, 2016, pages A-16 and A-43. ______
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The Company will not be entitled to receive from us, whether in contract or tort, by law or otherwise, any amount for loss of profits, data or goodwill, any incidental or indirect consequential damage, or as punitive or special compensation associated with claims arising from services provided in this Paper or otherwise associated with the services provided by us as part of this Paper, whether the likelihood of such loss or damage was expected or not, in the event that we did not act negligently and/or maliciously.
Moreover, and without derogating from the generality of the foregoing, if we are required in a final judgment to pay any amount to a third party with respect to performance of the services set out in this Paper, in legal or other binding proceedings, the Company undertakes to compensate us for any such amount paid by us that exceeds the fee paid multiplied by three immediately upon our first written demand and in any event, no later than 14 days from the date of receipt of a letter of demand by registered mail. This compensation undertaking will not apply if it is determined that we acted maliciously or negligently with respect to preparation of the Paper, all according to the contents of the letter of intent dated October 15, 2017.
1.2 Information sources
The main information sources used to prepare the Opinion are as follows: • Periodic reports of the Company and Delek Drilling for 2016, unaudited financial statements as of June 30, 2017 of Tamar Petroleum. • Prospectus published by Tamar Petroleum prior to the issue of its shares. • Open information published on websites, press releases or other public sources. • Internal sources and databases of Giza Singer Even. • Meetings and/or telephone conversations with officers of the Company and Delek Drilling.
1.3 Information on the valuation company
GSE Economic Consulting is a subsidiary of Giza Singer Even Ltd, a leading Israeli financial consulting and investment banking firm. The firm has a wealth of experience in guiding the largest companies, the most prominent privatizations and the most important transactions in the Israeli market, gained over its twenty five years of operation. Giza Singer Even operates in three areas through independent business divisions: Financial Advisory Services; Investment Banking; and Analytical Research and Corporate Governance.
The Paper was prepared by a team headed by Nir Harush, CPA, and Eitan Cohen, CPA:
Nir Harush is a partner of Giza Singer Even and the CEO of GSE Economic Consulting Ltd. Nir holds a BA in business administration and accounting and an MBA in business administration, and has extensive experience in economics and finance. In the past, he served as VP Business Development of an energy company, Manager of the Project Finance Sector in Israel Discount Bank's business division, and head of Transport and Projects of the Accountant General at the Ministry of Finance.
Eitan Cohen is the manager of the finance department at Giza Singer Even and has over ten years experience in financial and business consulting, company valuations and financial instruments. In the past, he served as manager of the finance department at an entrepreneurial infrastructure company and manager of the financial department of KPMG (Somekh Chaikin). Eitan is an accountant with a BA in economics and business administration from Ben-Gurion University and an MBA in financial mathematics from Bar-Ilan University.
Best regards,
GSE Economic Consulting Ltd. November 21, 2017 ______
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2. Executive Summary
2.1 Background
Delek Group Ltd is a public company listed for trading on the TASE. The Company invests in and manages companies dealing primarily in oil and gas exploration and production; the fuel industry; operation of gas stations and convenience stores in Israel; and the automotive and infrastructure segments. The Company's oil and gas exploration and production activities are performed through its holding of 88.23% of the shares of Delek Energy Systems Ltd. ("Delek Energy"), a public company listed for trading on the TASE, engaged mainly in the exploration, development and production of natural gas and condensate in the exclusive economic zones of Israel and Cyprus, and participating units in Delek Drilling Limited Partnership ("Delek Drilling" or "the Partnership"), which is held by the Company, at 25% directly and 75% by Delek Energy.
On May 17, 2017, Delek Drilling merged with Avner Oil Exploration Limited Partnership ("Avner", jointly: "the Partnership") whereby all of Avner's assets and liabilities, including leases, licenses, permits, agreements, including employment agreements of officers and staff, the obligation to pay management fees, the obligation to pay royalties, etc., were transferred as is to the Partnership, resulting in the dissolution of Avner without liquidation. Prior to the merger, each partnership held 15.625% of the Tamar lease and as a result of this merger, Delek Drilling's holdings in the Tamar reservoir increased to 31.25%.
The Company also holds 51.76% of the shares of Cohen Development and Industrial Buildings Ltd. ("Cohen Development"), a public company listed on the TASE that is entitled to part of the overriding royalties for its share of Avner prior to the merger with Delek Drilling.
Under resolutions adopted as part of the gas outline, Delek Drilling is obligated to sell all of its holdings (31.25%) in the Tamar and Dalit leases by December 2021. After reviewing sale alternatives, Delek Drilling resolved to sell 9.25% through a special purpose company, Tamar Petroleum. In July 2017, Tamar Petroleum completed the purchase by issuing debentures and shares to the public. As a result of the transfer of the royalty rights from Delek Drilling to Tamar Petroleum, the Company is required to present the fair value of these royalty assets in its financial statements.
2.2 Valuation results
The value of Delek Group's share of the expected overriding royalties for the sale of gas and condensate from the Tamar reservoir attributable to Tamar Petroleum's share was evaluated using the discounted cash flow (DCF) method based on the assumptions set out in the Paper. Below are the valuation results:
* In USD thousands Delek Energy's share of the overriding royalties (75%) 77,043 Delek Group's share of the overriding royalties (25%) 25,681 Cohen Development's share (related parties, Avner) 23,030 Total overriding royalties 125,754
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Below is a sensitivity analysis of the total value of the overriding royalties with regard to changes in the discount rate and in natural gas prices, in USD thousands:
Changes in the natural gas price vector (USD thousands per mmbtu) 1.0 0.5 - (0.5) (1.0) +100 bp 130,817 123,295 115,863 108,310 100,806 Changes in +50 bp 136,239 128,380 120,612 112,725 104,892 discount rate 7.3% 142,110 133,884 125,754 117,504 109,315 -50 bp 148,476 139,854 131,330 122,687 114,111 -100 bp 155,393 146,340 137,388 128,318 119,321 Below is a sensitivity analysis of the total value of the overriding royalties with regard to changes in the volume of gas in the reservoir and in natural gas prices, in USD thousands: Changes in the natural gas price vector (USD thousands per mmbtu) 1.0 0.5 - (0.5) (1.0) Change in 100% 142,110 133,884 125,754 117,504 109,315 volume of gas in 85% 126,914 120,009 113,000 106,089 99,206 reservoir 80% 120,977 114,437 107,891 101,436 94,848 For information on the sensitivity analysis regarding the relative share of each of the companies, see section 4.4 below.
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3. Overriding Royalties
3.1 General
Delek Group Ltd is a public company listed for trading on the TASE. The Company invests in and manages companies dealing primarily in oil and gas exploration and production; the fuel industry; operation of gas stations and convenience stores in Israel; and the automotive and infrastructure segments. The Company's oil and gas exploration and productions operations are performed through its holdings of participating units in Delek Drilling Limited Partnership.
As of the date of this Paper, the Partnership’s main operations are the production and sale of natural gas and condensate from the Tamar project, advancing and planning of commercialization of gas and development of the Leviathan reservoir, advancing and planning of another expansion of the Tamar project production system, future development of the Aphrodite reservoir (Cyprus), and exploration in oil assets held by the Partnership.
On May 17, 2017, Delek Drilling merged with the subsidiary partnership Avner whereby Avner's assets and liabilities, including holdings, licenses, permits agreements (including employment agreements of officers and staff), obligation to pay management fees, obligation to pay royalties, etc. were transferred as is to the Partnership resulting in the dissolution of Avner without liquidation. Prior to the merger, each partnership held 15.625% of the Tamar lease and as a result of this merger, Delek Drilling's holdings in the Tamar reservoir increased to 31.25%. The Company holds 51.76% of the shares of Cohen Development, a public company listed on the TASE, which is entitled to part of the overriding royalties for its share of Avner prior to the merger with Delek Drilling.
3.2 Tamar Lease
The Tamar oil asset, which comprises the Tamar and Tamar SW natural gas fields, is an offshore oil asset located 90 km west of the Haifa coast covering 250 square kilometers. The Tamar and Tamar SW natural gas fields were discovered in 2009 and 2013, respectively. It is a top quality reservoir on a global scale, containing dry gas composed of 99% methane, high porosity and permeability, and high interconnectivity between the parts of the reservoir. On March 31, 2014, gas supply to consumers started and the present production capacity is 1.1 BCF per day (approximately 11.5 BCM per year).
Below are the quantities of gas and condensate in the Tamar reservoir, as published in Tamar Petroleum's prospectus of 2017:
Total (Tamar and Tamar Reserve category Tamar Reservoir Tamar SW reservoir SW reservoir) Natural Condensate Natural Condensate Natural Condensate gas Million gas Million gas Million BCF barrels BCF barrels BCF barrels Proved reserves (P1) 7,212.7 9.4 796.4 1.0 8,009.2 9.1 Probable reserves 3,018.1 3.9 203.5 0.3 3,221.6 3.9 Total P2 reserves (proved + 10,230.8 13.3 999.9 1.3 11,230.7 13.0 probable reserves) Possible reserves 1,851.6 2.4 217.6 0.3 2,069.2 2.3 Total P3 reserves (proved + 12,082.4 15.7 1,217.5 1.6 13,300.0 15.3 probable + possible reserves)
Under resolutions adopted as part of the gas outline, Delek Drilling is obligated to sell all of its holdings (31.25%) in the Tamar and Dalit leases by December 2021. After reviewing sale alternatives, Delek Drilling resolved to sell 9.25% through a special purpose company, Tamar Petroleum. Delek Drilling undertook, ______
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subject to fulfillment of the preconditions, to sell and transfer the Partnership's rights at a rate of 9.25% (out of 100%) in the Tamar and Dalit leases to Tamar Petroleum, subject to the existing obligations to pay overriding royalties to related parties and third parties, and the relative share (9.25%) of the rights and undertakings under the joint operating agreement, agreements for the sale of gas from the Tamar lease, the agreement to use Yam Tethys facilities, shares of Tamar 10 Inch Ltd., operating certificate of the Tamar platform, and export permits from Tamar. In July 2017, Tamar Petroleum completed the purchase by issuing securities and shares to the public.
Below is a list of the holding structure of the Tamar lease, as of the valuation date: Name of Partner % holding Noble Energy Mediterranean Ltd. 32.5% Isramco Negev 2 Limited Partnership 28.75% Delek Drilling 22% Tamar Petroleum 9.25% Dor Gas Exploration Limited Partnership 4% Everest Infrastructures Limited Partnership 3.5%
Below are details of the overriding royalties to be paid to the Group and its subsidiaries, from Tamar Petroleum's holdings in the Tamar lease (9.25%), as of the date of this Paper:
Rate of overriding royalties
1.5% before the ROI date2 (25% Delek Group, 75% Delek Energy)
6.5% after the ROI date (25% Delek Group, 75% Delek Energy)
1.4375% (Cohen Development)
The effective overriding royalty rate to be paid will be weighted according to the royalty rate to the state after deduction of expenses for the gas delivery and handling system from the wellhead to the onshore gas receiving terminal. According to the Partnership's assessment, the actual royalty rate to be paid by it to the state is expected to be 11.5% and, therefore, the effective overriding royalty was adjusted with respect to 92% (11.5%/12.5%).
3.3 Description of Operating Segment
3.3.1 General The natural resource exploration, development and production operations in Israel are subject to granting of permits in accordance with the Petroleum Law, 1952 ("the Petroleum Law"), which sets out provisions for the
2 The term "ROI date" means: the date, subsequent to signing of the Rights Transfer Agreement between Delek Drilling ("the Partnership"), Delek Energy Systems and Delek Israel (currently Delek Group) in 1993 (as is revised from time to time) under which the value of revenues (net) which the Partnership received or is entitled to receive for oil and/or gas and/or any other material of value produced and used from the oil asset (i.e. license or lease) under which the discovery is found, calculated in USD, will be equivalent to the full value of the amount expended by the Partnership in that oil asset, calculated in USD. "Net Value of Receipts" means: the value of all the receipts as approved by the Partnership's accountant for oil and/or gas and/or other materials of value produced and used from the oil asset (the lease or license) ("the value of revenues (gross)") less all the production costs and royalties paid for them. "Value of all of the Partnership's Expenses" means: all of the Partnership's expenses arising from the oil asset (license or lease) in which the oil and/or gas and/or other materials of value are produced, except for expenses (up to the Net Value of Receipts), deducted from the Gross Value of Receipts to determine the Net Value of Receipts as approved by the Partnership's accountant. For details, see section 7.27.11 of the Partnership's periodic report for 2015 regarding agreements pertaining to the payment of royalties to the state and interested parties in the Partnership. ______
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segment and defines the types of permits granted for a defined area, subject to the approval of an exploration and production work plan, as follows: ▪ A "preliminary permit" is intended to allow the permit holders sufficient time to conduct tests to assess the likelihood of discovering hydrocarbons (other than exploration drilling) and is granted for a period of up to 18 months. ▪ A "license" entitles its holder to engage in natural gas and oil exploration in the license area and to drill exploration wells. The license is granted for a period of up to seven years. ▪ A "lease" grants its recipient the right to engage in natural gas and oil exploration and production and is valid for 30 years with an extension option for a further 20 years. In addition, the Natural Gas Sector Law, 2000 regulates natural gas transmission, distribution and marketing in Israel.
The natural gas industry in Israel started developing with the discovery of the Noa and Mari-B natural gas reservoirs in 1999-2000. These discoveries allowed companies in the market and firstly Israeli Electric Corporation to transition to wider use of natural gas in place of more expensive pollutant fuels such as coal, diesel fuel and fuel oil. The development of the segment accelerated with the discovery of the Tamar and Leviathan reservoirs and 2009 and 2010, respectively. These discoveries materially affect the energy independence of Israel as well as development and expansion of use of natural gas in the Israeli market.
3.3.2 Exploration and development of natural gas reservoirs Exploration and development of natural gas reservoirs is a long and complicated process characterized by a great deal of uncertainty and substantial capital investments throughout all of its stages. There are material differences between exploration and development of onshore natural gas reservoirs, which are considered relatively simple and safe, and exploration and development of offshore reservoirs, which require the investment of much greater financial inputs and use of special technologies under more complicated and hazardous conditions.
Natural gas exploration, development and production in any area involves several stages, including preliminary analysis of existing geological and geophysical data for the selection of areas showing exploration potential; seismic surveys; drilling of an exploration well and other tests (at this stage, a dry well may be discovered and the process terminated); final analysis of drilling results, and in the event of a natural gas discovery, analysis of economic data and preliminary evaluation of the development format and cost; formulation of a development plan and preparation of an economic plan for the project; final analysis of the data and decision whether the finding (discovery) is commercial (also at this stage, the survey results might indicate that the finding is not commercial and development of the reservoir will be terminated); development works at the reservoir, including production wells, installation of pipelines, construction of treatment facilities, etc.; and ongoing operation and maintenance.
The natural gas market in Israel is in its infancy compared to other gas markets worldwide, and for its optimal development, collaboration with multinational companies is required to provide the local players with the necessary resources, knowledge and experience. In this regard, we emphasize that multinational companies can invest and operate across the globe, and in their cost-benefit calculations, they naturally weigh the potential and actual profitability in different locations around the world compared to the limitations, costs and risks arising from the geopolitical situation and the regulatory environment in each region.
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3.3.3 Benefits The use of natural gas has many benefits for the Israeli market, including:
▪ Saving of energy costs in industry and electricity production - the relatively low price of natural gas compared to the present common alternative fuels, such as fuel oil and diesel fuel, leads to substantial savings in production costs, and as a result to a decrease in the prices of final products whose main production costs are electricity. Most power stations constructed recently in Israel operate with natural gas turbines and are characterized by low construction costs3, shorter construction time, saving of land4, and numerous operating advantages. In addition to the relatively low price, natural gas is a more efficient energy source than other fuels and allows power stations and factories to reach a high energy utilization level, which is also ultimately expressed in saving of costs5. According to the estimates of the Natural Gas Authority6, the total saving in the Israeli market from the transition to using natural gas in 2004-2016 is NIS 36.3 billion in the electricity sector, NIS 12.1 billion in industry and a total of NIS 48.4 billion. ▪ Clean energy - the main substances emitted by burning natural gas are carbon dioxide and steam. Since coal and oil are more complex fuels with a higher ratio of carbon and of nitrogen and sulfur components, when they are burned high levels of pollutants are released, including ash particles of substances that do not burn, but are in the atmosphere and add to air pollution. In contrast, burning gas releases a small quantity of pollutants, thereby reducing air pollution and maintaining a cleaner and healthier environment. ▪ Energy independence - Israel's geopolitical characteristics make it an energy island that cannot import fuels from neighboring countries and for years forced it to rely on the importation of expensive fuels. Israel's energy isolation weakened slightly between 2008 and 2012 with the start of supply of natural gas from Egypt. However, the sudden interruption of supply illustrated the importance of developing local energy sources. Development of the Israeli gas market will provide the country's industry with long-term energy security and reduce its dependence on global energy prices. ▪ Natural gas as a source of government revenue through taxation - the Israeli natural gas industry is expected to improve the local economy directly as well through government revenue from the taxes of the companies and the VAT from the sale to the end user. In addition, the Israeli market has several unique tax systems applicable to the natural gas segment, and as with the other fuel products, natural gas is also subject to excise tax. The excise tax on natural gas is currently NIS 0.35 per MMBTU. Moreover, under the Petroleum Law, the state may charge royalties at a rate of 12.5% of the total natural gas sales at the wellhead, and due to the conclusions of the Sheshinski Commission, will also be entitled to oil and gas profits tax at a rate of 20%-50% (depending on the corporate tax rate) of the revenues of the holders of oil rights less royalties, and operating and developments costs. 3.3.4 Customers The natural gas market in Israel comprises several consumer layers differentiated from each other by the nature of their operations and natural gas consumption characteristics.
▪ Israel Electric Corporation - IEC is a material anchor customer for natural gas suppliers to obtain finance to set up natural gas production infrastructure and develop reservoirs. In fact, without the sale transaction of natural gas to IEC it might not have been possible to secure the finance required to develop the Tamar project. IEC is a government company supervised by the Electricity Authority in terms of cost of inputs for electricity production, especially natural gas.
3 About half of the cost of a coal power station, a third of the cost of a nuclear power station, and 15% of a station powered by wind energy. 4 Natural gas is transmitted through an underground pipe and as opposed to other fuels, does not require storage areas. 5 Power stations operated with coal or fuel oil utilize only 40% of the initial energy allocated for electricity production. A combined cycle power station that integrates both a gas turbine and a steam turbine is more efficient and utilizes 55% of the energy. Cogeneration power stations that utilize the thermal energy produced in the production process reach a utilization level of 80%. 6 Source: Ministry of Energy, Natural Gas Authority - Review of the development of the natural gas market in 2016. ______
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In 2016, the natural gas consumption for electricity production was 83% of the total natural gas consumption in the market compared to 79% of the total consumption in 2015. Most of the increase was from the Minister of Energy's decision to reduce the use of coal for electricity production by 15%. IEC's share constitutes almost 61% of the natural gas consumption for electricity production in 2016 compared to 66% in 2015. The remaining demand is of independent power producers and this trend is expected to continue in the coming years. ▪ Independent power producers - the independent power producer (“IPP”) layer is the second most important in terms of volume of natural gas consumed, after IEC. In 2016, the share of the independent power producers of the electricity production with natural gas increased by 36% compared to 2015 and the consumption amounted to 3.1 BCM. ▪ Independent power producers are classified according to the production technology which they use: conventional power producers, cogeneration plants, hydroelectricity, renewable energy power producers and large plants that constructed independent power stations for which they received an self-production license With regard to the status of independent power producers in the natural gas market, section 93 of the Natural Gas Sector Law stipulates that natural gas sold to independent power producers is a controlled product under the Commodities and Services Price Control Law, 1996. ▪ Large industrial consumers - the consumer layer includes several material consumers that are essential for the development of the Israeli gas market. Most large industrial plants in the market have signed agreements to purchase natural gas as part of establishment of independent power stations to supply the plant's electricity needs, while the excess production of the power station is sold to consumers (other plants) or IEC. Accordingly, the natural gas purchase agreements signed to date by most of the large industrial plants have the characteristics of the agreements with the independent power stations. The total natural gas consumption in the industrial sector in 2016 amounted to 1.62 BCM, similar to 2015. ▪ Medium and small consumers - the distribution network consumer segment, which includes mainly medium and small factories and businesses such as laundries and bakeries, is relatively new in the natural gas market and only recently started signing purchase agreements and converting infrastructures. These consumers are characterized by gas consumption at low pressure, in relatively small and non-continuous quantities throughout the day, while some are not yet connected to the onshore transmission systems and/or distribution systems, and as a result, they consume condensed natural gas (CNG), an interim non-optimal solution, since the cost of consumption can reach double that of liquefied natural gas. ▪ Flow chart 1 - Natural gas consumption in 2004-2016. (source: The Natural Gas Authority)
10.0 9.66 9.0 8.41 8.0 7.57 6.9 7.0
6.0 5.34 4.9 6 5.0 4.18 BCM 3.77 4.0 2.74 3.0 2.29 2.55 1.64 2.0 1.19 1.0 0.0 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
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3.3.5 Demand forecast As noted above, the main demand for natural gas in Israel stems from the needs of the local electricity market. Electricity consumption in the Israeli market is 50% lower than other OECD countries with similar revenue levels and climatic conditions. The reason is the standard of living of the Israeli consumer, which is 30% lower than comparable developed countries. Additional parameters such as the rate of natural increase (the highest among developed countries), GDP growth and increase in disposable income, increase in introduction rate of household electrical appliances and use of electrical appliances to deal with the local climatic conditions, are a potential for substantial increase in demand for electricity in the coming years.
Moreover, other factors such as development and introduction of electrical cars, increased demand in the public and business sectors (resulting from the increase in electricity-intensive services such as airports, hospitals and hotels) and increased use of electricity for desalination, are also expected to lead to a significant increase in demand for electricity in Israel.
According to a review of the electricity market and forecast of its development that were attached the prospectus published by Tamar Petroleum, the total electricity consumption in 2015 was 55.2 kilowatt hours (excluding the Palestinian Authority), whereas the expected consumption for 2040 is 131.1 billion kilowatt hours, an annual growth of 3.5% for the entire market and 1.7% per capita7.
In addition to the increase in demand for electricity, increasing export and changing the mix of fuels used for production are expected to propel growth in demand for natural gas as follows:
▪ Transition to using natural gas by independent power producers and industrial plants - in 2013, independent power producers started using natural gas. Demand in the industrial sector has also increased and recently there is significant conversion from using oil distillates in industry to natural gas. There is also a trend of connecting additional industrial plants to the natural gas distribution network. ▪ Increased demand of IEC - there has recently been a trend of converting from the use of oil distillates and coal at IEC power stations to using natural gas (in December 2015, the Minister of Energy, Dr. Yuval Steinitz, decided on a 15% reduction in the use of coal for electricity production from 2016 onwards compared to 2015). This conversion has several key advantages, including reduction of electricity production costs since natural gas is a more efficient energy source compared to the main energy sources currently used by IEC (coal, diesel fuel and fuel oil). Natural gas is also a cleaner energy source than those above, a fact that increases the continued growth in demand for natural gas on account of more polluting energy sources. ▪ Improved diplomatic relations with neighboring countries - there has recently been a marked improvement in relations with neighboring countries with which business relations are strategic for the Israel in general and the natural gas companies in particular. In this regard, note the export agreement signed on September 26, 2016 between the Leviathan partnerships and the National Electric Power Company of Jordan (NEPCO) for the supply of natural gas for a total amount of USD 10 billion. This trend of improvement has a positive effect on the ability to export Israeli gas and can increase the demand for natural gas produced in the Israeli gas reservoirs. The demand forecast for natural gas published by the Natural Gas Authority8 is based on continued growth in the average multiannual electricity consumption of 3%, with minimum use of fuel oil and diesel fuel, reliance on coal stations in similar volumes to those of now apart from constructing new stations (assuming that the coal units at the Rabin Orot Power Station are not converted to using natural gas), transition to natural gas as the main fuel for the production of electricity as from 2014, and gradual integration of renewable energy. The forecast also takes into account gradual conversion to using natural gas for transport and local production of methanol and ammonia in the petrochemical industry.
According to the Natural Gas Authority's forecasts, the quantity of demand for natural gas in 2020 and 2025 is expected to be 12 BCM and 14.7 BCM, respectively. Forecasts were recently published by different
7 The report was prepared by BDO Ziv Haft Consulting & Management Ltd. and attached to the prospectus published by Tamar Petroleum on the TASE on July 3, 2017. 8 Source: http://energy.gov.il/Subjects/NG/Pages/GxmsMniNGEconomy.aspx ______
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parties in the market, including forecasts included in the Partnership's report to the TASE9. According to these plans, the demand for natural gas in 2020 and 2025 will be 14.3 BCM and 20.5 BCM, respectively. Note that the Natural Gas Authority's forecasts were probably estimated before the decision to convert the coal units to production using natural gas and, therefore, assume reliance on coal stations for a similar volume to that of now, while the forecasts published in the market assume conversion of some of the coal- fired production units to production using natural gas. According to these forecasts, converting the coal-fired production units will contribute to increasing the demand by 1.6 BCM in 2020 and 3.6 BCM in 2025.
Note that the market is currently developing under conditions of lack of infrastructure and reliability, limiting the growth in demand. Improving the transmission infrastructure and establishing another connection to the offshore infrastructure can assist the market in utilizing the potential demand.
3.3.6 Regulatory environment Production and sale of natural gas from reservoirs in State of Israel territorial waters are subject to regulatory restrictions that relate to the volume of gas produced and exporting of gas, as well as the price of gas. Furthermore, production and sale of natural gas from the Tamar, Leviathan, Karish and Tanin reservoirs and/or any other reservoir is subject to further regulatory restrictions under the Gas Outline Plan, as set out below:
▪ Antitrust and exemption of provisions of the Antitrust Law - in 2012, the Antitrust Commissioner declared the Tamar Project partners to be a monopoly in the supply of natural gas in Israel. As a result of this declaration, restrictions can be imposed on the operations of the Tamar project partners, under the Antitrust Law. In addition, in 2011-2014, the Antitrust Commissioner considered declaring the partners in the Leviathan Project as partners in restrictive arrangements with regard to the marketing of natural gas from the Leviathan reservoir. ▪ The Gas Outline Plan grants exemptions to Delek Drilling and Noble Energy Mediterranean Ltd. (“Noble”) with regard to the restrictive arrangements relating to the Leviathan reservoir. The Gas Outline Plan also grants an exemption for the fact that Delek Drilling, Avner and Noble are monopolies with respect to the Tamar and Leviathan reservoirs (the Exemption"). The exemption granted as described above is subject to compliance with the following conditions: • The sale of Delek Drilling, Avner (prior to the merger with Delek Drilling) and Noble rights in the Karish and Tanin reserves to an unrelated third party within 14 months from the date of the exemption or from the publication date of the draft new arrangement by the Commissioner of Petroleum Affairs regarding the qualifying conditions for an operator, whichever is later. The condition defines a minimum price as the lower between USD 40 million or the total consideration paid for all the rights in Karish and Tanin. • Sale of Delek Drilling and Avner’s entire rights in the Tamar reservoir to a third party unrelated to them or to any of the rights holders in the Leviathan, Karish and Tanin reservoirs, and limiting Noble's rights in the Tamar reservoir to a maximum of 25%, within 72 months. • Imposition of restrictions on new agreements to be signed for the supply of gas from the Tamar and Leviathan reservoirs, such as a prohibition on purchasing restrictions from other suppliers, in certain cases granting the consumers the right to unilaterally determine the term of their contract and the unilateral right to change the scope of their supply contract. ▪ Stable regulatory environment - in the original outline plan, the Government of Israel undertook to maintain "regulatory stability" with regard to natural gas exploration and production, for a period of 10 years. In March 2016, the Supreme Court ruled that the regulatory stability issue in the current format of the Gas Outline Plan was not legal. In May 2016, the government adopted the decision regarding the Gas Outline Plan, while setting an alternative arrangement for a "stable regulatory environment" to ensure a regulatory environment that encourages investments in natural gas exploration and production. Royalties to the State of Israel - according to the Petroleum Law, a leaseholder is liable for royalties at the rate of 12.5% of the volume of natural gas or oil produced in the Lease, and the leaseholder will pay
9 See reference no. 7. ______
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the State the market value of the royalties at the wellhead. The method of calculating the value at the wellhead in the Tamar reservoir is under discussion between the Commissioner of Petroleum Affairs and the Partnerships in the Tamar reservoir, and the method of calculation has not yet been determined. At the present time, the Tamar Partnerships make advance payments on account of royalties at a rate of 12% of the Tamar Project's revenues. The method for calculating the royalties for the Leviathan, Karish and Tanin reservoirs has not yet been determined. ▪ The Profits and Natural Resources Taxation Law - The Natural Resources Taxation Law prescribes a levy on oil and gas profits according to a mechanism that links the rate of the levy to the net cumulative ratio of revenues from the oil and gas production project, and the aggregate net investments from the oil and gas production project, (below: “Investment Cover Ratio”). The minimum levy of 20% will be charged when the Investment Cover Ratio reaches 1.5 and will gradually increase to 50% (depending, inter alia, on the corporate tax rate) once the Investment Cover ratio reaches 2.3. The levy will be calculated and imposed on each reservoir separately. ▪ Price control - in the period from the Gas Outline Plan coming into force and full compliance with all the conditions of the exemption, the natural gas sector price control under the Antitrust Law will be limited to imposition of reporting requirements regarding the profitability and price of gas, provided that during this period the holders of the rights in Tamar and Leviathan will offer potential consumers a price based on a weighted average price of the prices of existing agreements of the reservoirs or of export agreements. Below is a breakdown of the price and linkage options published under Government Resolution 476 on August 16, 2015: ▪ Option 1 - a price that will be determined and updated according to the formula P(T)=R(T-2)/Q(T-2); where P(T) is the base price; R(T-2) is total sum of natural gas sales in the quarter preceding the quarter prior to the date of signing the agreement by a leaseholder; and Q(T-2) is the cumulative volume of natural gas supplied to consumers in the quarter preceding the quarter prior to the date of signing of the agreement by a leaseholder. The base price will be updated based on the results of the calculation according to the foregoing formula. ▪ Option 2 - a price that will be determined based on the Brent price per barrel as calculated according to a formula that benefits the consumers that have, at the date of the Government Decision, agreements with the leaseholders for supplying gas from the Tamar field. ▪ Option 3 - the holders of the rights in the leases will offer potential consumers who are independent power producers (“IPPs”) with license to produce revised output of 20 megawatts and more. In addition, the option includes linkage to the weighted production tariff published by the Electricity Authority as follows: • Conventional power producers - a simple average of the prices set in the contracts of the three largest companies, and of the linkage terms in those contracts; • Cogeneration power producers - a simple average of the prices set in the cogeneration contracts on the date of the Government Resolution, linked to the weighted production tariff and the linkage under those contracts. These averages will be calculated by the Natural Gas Authority based on the data it receives from the holders of the rights in the Leases. Linkage formulae for independent power produces as published by the Natural Gas Authority on October 1, 2017: Conventional independent power producer CP$ = 5.71 * (53.3%* Pt/Pt0 + 46.7%* Pt/Pt0 * Ns0/Ns) Cogeneration independent power producer CP$ = 5.81 * (90%* Pt/Pt0 + 10%* Pt/Pt0 * Ns0/Ns) When CP$ - monthly price measured in $/MMBTU Pt - known production tariff on the last date of the month preceding the month for which the price is calculated ______
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Pt0 - base production tariff = NIS 0.3463 per kilowatt hour Ns - monthly average NIS-USD exchange rate as of the month for which the price is calculated Ns0 - base NIS-USD rate = NIS 0.365 per USD The leaseholders will offer consumers a floor price based on the average floor price in existing agreements at increments of USD 5.2 per MMBTU, USD 5 per MMBTU, and NIS 4.7 per MMBTU, and the price updating mechanism will apply according to the last production change. As of October 2017, the floor price is USD 4.7 per MMBTU. ▪ The option of selecting one of the price alternatives set out above will be offered to a buyer only just prior to engaging in a contract. In addition, the holders of the rights in the leases will be entitled to offer potential consumers a discount on the prices resulting from the alternative calculations set out above. Furthermore, the parties to the agreement will be entitled to choose any method for updating the base price, provided that it will be reasonable and generally accepted for natural gas agreements in Israel and worldwide. In such event, the base price will be updated in accordance with the linkage method selected. 3.3.7 Risk and uncertainty factors Exploration and development of oil and natural gas discoveries involve considerable financial costs, under circumstances of uncertainty and consequently, with a high level of financial risk. Below is a breakdown of risk and uncertainty factors that have a material effect on the operations of the buyer of Karish and Tanin reserves and expected proceeds from them:
▪ Changes in the power production tariff, price indices, prices of alternative energy sources - the prices paid by consumers for natural gas are derived, among other tings, from the price of power production, the NIS-USD exchange rate, the US CPI and the prices of fuels that are alternatives for gas, such as fuel oil and diesel fuel. Consequently, any significant change in such energy source alternatives could lead to a change in the IEC's use of gas model so that power plants that operate on alternative energy sources will be given preference to gas. ▪ Competition in the supply of gas - in recent years, several significant gas reservoirs have been discovered in Israel, with volumes far greater than the Ministry of Energy's estimates of the demand for gas for the domestic market needs. Moreover, other discoveries may be made in the future, in Israel as well as in other countries in the Eastern Mediterranean Basin, which if developed could lead to additional competitors entering the market for natural gas supply to the domestic market and to neighboring countries, and thereby increase competition in the sector. ▪ Export restrictions - limiting the amount of gas that can be exported may adversely affect the domestic market supply surplus and cause a decrease in tariffs that could adversely affect the future prices received from the Tamar reservoir. ▪ Dependence on the integrity of the national gas pipeline - the ability to supply the gas that is produced from the reservoirs to the potential consumers depends, among other things, on the proper operation of the national gas pipeline and the regional distribution networks. ▪ Operational risks and absence of insurance cover - oil and gas exploration and production operations are exposed to various risk, such as uncontrolled gushing from the well, explosion, collapse and conflagration of the well, and other events that could impair the performance of the production and delivery system. Any of these could damage or destroy the oil or gas wells, production and delivery facilities, and exploration equipment, etc. Notwithstanding the insurance available in the market, not all possible risks are covered or can be covered. ▪ Costs and time schedules estimates only and possible lack of means - estimated costs and schedules for exploration and development, and estimated schedules for execution, are based on general forecasts only and there could be significant variances. Exploration plans could change significantly, among other things, due to malfunction and/or the findings of such exploration, causing significant deviations in schedules and estimated costs of these operations. In some cases, the buyer may even forfeit certain operations that are required under its work plans, and it could as a consequence lose its rights.
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▪ Regulatory changes - the sector of operations requires numerous regulatory permits, primarily from the competent authorities pursuant to the Oil Law and the Natural Gas Sector Law, as well as permits from state institutions (including the Ministry of Defense, Ministry of the Environmental Protection, Tax Authority and various planning authorities). Over the past few years, a number of proposals have been raised to amend the laws and/or regulations and/or guidelines relevant to the industry and a number of resolutions, laws and guidelines have been issued, which if implemented could have an adverse effect on the operations in the reservoirs. ▪ Additional risk factors - other factors contribute to the uncertainty in the operating sector, such as dependency on subcontractors, difficulties in obtaining financing, dependence on climatic and marine conditions, cancellation or expiration of oil rights and assets, among others.
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4. Valuation
4.1 Methodology
In this valuation we are required to estimate the share of Delek Group, Delek Energy and Cohen Development in the royalties attributed to Tamar Petroleum, as set out below:
Rate of overriding royalties
1.5% before return on investment (25% Delek Group, 75% Delek Energy)
6.5% after return on investment (25% Delek Group, 75% Delek Energy)
1.4375 % (Cohen Development)
The value of the overriding royalties was estimated using the discounted cash flow method (DCF), whereby cash flows were calculated throughout the life of the lease until depletion and exhaustion of all existing gas and oil assets. The discount rate was derived from the market value of Tamar Petroleum (as at the date of this valuation, Tamar Petroleum's principal asset is its holdings in the Tamar lease) and its adjustment to the enterprise value and the projected cash flows published in the prospectus for its issuance. As the cash flow on which the discount rate was calculated is operating cash flow, an adjustment was made in order to neutralize the existing excess risk on the operating cash flow compared with the expected cash flow from royalties (income risk).
4.2 Working presumptions
4.2.1 General The main working assumptions, as set out below, are based on market data from public sources and on the financial model of the lease that was obtained from the Company and we reviewed these main assumptions and found them to be reasonable. It should be emphasized that the assumptions and data set out below constitute forward-looking information, as defined in the Securities Law, 1968, and there is no certainty that it will materialize, in whole or in part, in the foregoing manner or in any other manner.
4.2.2 Valuation date The valuation was conducted on July 20, 2017.
4.2.3 Projected volumes and annual production rate According to the projections received from the Company, the annual natural gas production rate is 10.65 BCM as of 2018 and throughout the life of the project, until the reservoir is depleted, and the annual volume of condensate is derived from the ratio between the total volume of condensate and the total volume of natural gas (for details of the projected annual production rate see Appendix 5.2).
An analysis of the projected domestic market demand as provided by the Natural Gas Authority and as published by the Partnerships’ MAYA system, indicates that aggregate annual demand in 2020 is expected to be in the range of 12 - 14.3 BCM , while in 2025 the demand is expected to be within the range of 14.7 - 20.5 BCM, with the increase in demand mainly due to an increase in power production (natural growth in demand for electricity) and the decrease in the use of alternative fuels such as coal, diesel and fuel oil. It should be noted that in 2025, the Leviathan and Karish reservoirs are expected to be fully developed, however the increase in supply is supported by the level of domestic demand and the export potential of Tamar and these reservoirs.
Based on these forecasts, we found the Partnership's assumption regarding production of 10.65 BCM to be reasonable, and in accordance with the scope of supply and demand in the forecast years.
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4.2.4 Forecast of natural gas prices The price forecast, as published in Tamar Petroleum’s prospectus, was based on the following assumptions: annual increase of 2.2% in the US-CPI; Brent price of USD 52.7 per barrel in 2017 rising to USD 77 per barrel in 2020 and USD 90 per barrel in 2024, and a gradual annual increase of 2.8% in subsequent years; projected power production price based on an exchange rate of NIS 3.65 in 2017 and a long-term average of NIS 4.3 per USD.
The forecast of natural gas prices in our valuation is based on the following assumptions:
▪ The current customer mix of the Tamar reservoir is comprised of the Israel Electric Corporation, independent power producers, cogeneration power producers, industrial customers and others. We assumed that the mix of customers will not change materially compared with the existing mix, i.e. most of the customers are the IEC and independent power producers (about 62%). We assumed that the IEC's share in the mix would drop moderately while the share of the independent power producers would increase, based on the assumption that the increase in demand for electricity would be supplied by the independent producers. ▪ Under the terms of the agreement signed between the Israel Electric Corporation and the Partnership, the price per thermal unit (MMBTU) would be linked to the US CPI with the addition of 1% until 2019, and less 1% from 2020 through 2028. Furthermore, the parties have the option of revising the price (up or down) in two stages, in 2021 and 2024, to 25% and 10%, respectively. In view of this, we assumed that the IEC's tariff will be adjusted downward by 50% of the maximum revision rates due to the weighting of the conditions that we believe will be in effect at the time of the revision and will affect the terms of the negotiations between the parties (including alternative fuel prices, the difference between the IEC price and that for the independent power producers and the alternative that each of the parties will have). At the end of the IEC's contract with the partnership, we assumed that the price that the IEC will pay in the future will be the same as that paid by the independent power producers. ▪ Further in the forecast, we assumed that the prices would be adjusted using the relevant linkage formulae for each type of customer and the following assumptions: i. Forward NIS-USD exchange rates at the date of the valuation. ii. Annual increase in the production price at an annual rate of 2% (nominal) until 2027, except for the years when the IEC price is revised, and increase at annual rate of 1.5% from 2028 onwards. iii. The Brent price per barrel as specified in Section 4.2.5
4.2.5 Forecast of condensate prices The condensate price forecast was based on the average long term oil price forecast of the World Bank10 and the EIA11, and on the basis of the Partnership’s assumption that the price of condensate will be derived from the Brent price adjusted for the differences in oil quality.
4.2.6 Oil profits levy The oil profits levy is a progressive levy that is set according to a mechanism linking the rate of the levy to the ratio of the net cumulative revenues from oil and gas production and the cumulative investments made in exploration and initial development of the reservoir (the “Investment Cover Ratio”). The minimum levy of 20% will be charged when the Investment Cover Ratio reaches 1.5 and will gradually increase to 46.8% (based on the corporate tax rate12) once the Investment Cover Ratio reaches 2.3.
In the cash flow forecast for royalties, we deducted the levy from royalties that the Partnership will receive from the Lease, based on the rate of the levy calculated in the financial model of the Lease.
10 A World Bank Quarterly Report: Commodity Markets Outlook, April 2017 11 U.S Energy Information Administration: Annual Energy Outlook 2017 12 A corporate tax rate of 23% was assumed, based on the known statutory tax rate on the valuation date. ______
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4.2.7 Discount rates The discount rate for royalties was estimated on the basis of the operating discount rate derived from the cash flow forecast published for the Tamar reservoir on July 3, 2017 and the adjustments we made to the price forecast (as set out in section 4.2.4 above) and from the enterprise value of Tamar Petroleum, as follows:
In USD thousands Note Market value 313,482 1 Total net financial debt 653,331 2 Enterprise Value 966,813
Notes:
1. The market value was set based on the average of the 30 trading days following the valuation date and the NIS to USD exchange rates. 2. The financial debt includes the balance of the debentures (at an average market value of the 30 trading days following the valuation date), working capital balances where their realization was not included in the cash flow forecast, and other long-term liabilities. The discount rate derived from the enterprise value and the foregoing forecast is a discount rate that reflects the risk level of the operating forecast. In order to adjust the operating discount rate to the discount rate for royalties - which has the same risk level as that of the revenues – 1.3% was amortized, reflecting the excess risks that apply to the operating cash flows, unexpected expenses, exposure to loss, working capital and disparity in revenues and expenses linked to indices and exchange rates (for further information see Appendix 5.1).
The discount rate for the foregoing royalties is as follows:
Discount Rate The Tamar Petroleum discount rate (operational) 8.59% Adjustments for the risk level -1.3% Discount rate for overriding royalties 7.30%
4.3 Valuation Results
Based on the assumptions set out in the valuation, below is a breakdown of the value of the overriding royalties as at the date of the valuation:
In USD thousands Delek Energy’s share in the overriding royalties (75%) 77,043 Delek Group’s share in the overriding royalties (25%) 25,681 Cohen Development’s share in the overriding royalties (affiliates, Avner) 23,030 Total overriding royalties 125,754
It should be noted that, given the cash flow forecast published by Tamar Petroleum, the discount rate is estimated at 8.06%. (after adjustment of the operational discount rate derived from the enterprise value of Tamar Petroleum) and the value of the overriding royalties is estimated at USD 126,748 thousand.
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4.4 Sensitivity analyses
Below is a sensitivity analysis of the total value of the overriding royalties with regard to changes in the discount rate and in natural gas prices, in USD thousands:
Changes in the natural gas price vector (USD thousands per MMBTU ) 1.0 0.5 - (0.5) (1.0) +100 bp 130,817 123,295 115,295 108,310 100,806 Changes in +50 bp 136,239 128,380 120,612 112,725 104,892 discount rate 7.3% 142,110 133,884 125,754 177,504 109,315 -50 bp 148,476 139,854 131,330 122,687 114,111 -100 bp 155,393 146,340 137,388 128,318 119,321
Below is a sensitivity analysis of the total value of the overriding royalties with regard to changes in the volume of gas in the reservoir and in natural gas prices, in USD thousands:
Changes in the natural gas price vector (USD thousands per MMBTU ) 1.0 0.5 - (0.5) (1.0) Changes in 100% 142,110 133,884 125,754 117,504 109,315 volume of gas 85% 126,914 120,009 113,000 106,089 99,206 in reservoir 80% 120,977 114,437 107,891 101,436 94,848
Delek Energy
Below is a sensitivity analysis of the value of Delek Energy’s share of the overriding royalties with regard to changes in the discount rate and in natural gas prices, in USD thousands:
Changes in the natural gas price vector (USD thousands per MMBTU ) 1.0 0.5 - (0.5) (1.0) +100 bp 80,153 75,533 70,968 66,329 61,721 Changes in +50 bp 83,483 78,656 73,885 69,041 64,230 discount rate 7.3% 87,089 82,037 77,043 71,977 66,947 -50 bp 90,999 85,703 80,468 75,160 69,892 -100 bp 95,247 89,687 84,188 78,618 73,092
Below is a sensitivity analysis of the value of Delek Energy’s share of the overriding royalties with regard to changes in the volume of gas in the reservoir and in natural gas prices, in USD thousands:
Changes in the natural gas price vector (USD thousands per MMBTU ) 1.0 0.5 - (0.5) (1.0) Changes in 100% 87,089 82,037 77,043 71,977 66,947 volume of gas 85% 77,784 73,544 69,239 64,994 60,767 in reservoir 80% 74,148 70,131 66,10 62,146 58,100
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Delek Group
Below is a sensitivity analysis of the value of Delek Group’s share of the overriding royalties with regard to changes in the discount rate and in natural gas prices, in USD thousands:
Changes in the natural gas price vector (USD thousands per MMBTU ) 1.0 0.5 - (0.5) (1.0) +100 bp 26,718 25,178 23,656 22,110 20,574 Changes in +50 bp 27,828 26,219 24,628 23,014 21,410 discount rate 7.3% 29,030 27,346 25,681 23,992 22,316 -50 bp 30,333 28,568 26,823 25,053 23,297 -100 bp 31,749 29,896 28,063 26,206 24,364
Below is a sensitivity analysis of the value of Delek Group’s share of the overriding royalties with regard to changes in the volume of gas in the reservoir and in natural gas prices, in USD thousands:
Changes in the natural gas price vector (USD thousands per MMBTU ) 1.0 0.5 - (0.5) (1.0) Changes in 100% 29,030 27,346 25,681 23,992 22,316 volume of gas 85% 25,925 24,515 23,080 21,665 20,256 in reservoir 80% 24,716 23,377 22,037 20,715 19,367
Cohen Development
Below is a sensitivity analysis of the value of Cohen Development’s share of the overriding royalties with regard to changes in the discount rate and in natural gas prices, in USD thousands:
Changes in the natural gas price vector (USD thousands per MMBTU ) 1.0 0.5 - (0.5) (1.0) +100 bp 23,946 22,584 21,238 19,870 18,511 Changes in +50 bp 24,928 23,505 22,098 20,670 19,251 discount rate 7.3% 25,992 24,502 23,030 21,536 20,052 -50 bp 27,145 25,583 24,039 22,474 20,921 -100 bp 28,397 26,758 25,136 23,494 21,865
Below is a sensitivity analysis of the value of Cohen Development’s share of the overriding royalties with regard to changes in the volume of gas in the reservoir and in natural gas prices, in USD thousands:
Changes in the natural gas price vector (USD thousands per MMBTU ) 1.0 0.5 - (0.5) (1.0) Changes in 100% 25,992 24,502 23,030 21,536 20,052 volume of gas 85% 23,201 21,951 20,681 19,430 18,183 in reservoir 80% 22,113 20,929 19,743 18,574 17,381
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5. Appendices
5.1 Adjustment of the operational discount rate to the discount rate of revenues
The discount rate derived from the enterprise value and the foregoing forecast is a discount rate that reflects the risk level of the operating forecast. Adjustment of the operational discount rate to the discount rate of royalties when its risk level is the same as the risk level of the revenues, is analyzed using two methods described below:
5.1.1 Adjustment of β inherent in the weighted discount rate of the risk level of revenues, using the following steps:
A. Cost of capital inherent in the weighted discount rate : Based on the assumption that the operational discount rate of Tamar Petroleum is in fact the weighted discount rate of operations, the weighted average cost of capital (WACC) we calculated the rate of return on equity based on the normative leverage ratio (debt to enterprise value ratio based on the average of the sample companies13 - 33.78%) and the price of the debt (4.7%) of Tamar Petroleum at the valuation date and the long term tax rate (23%).
B. Specific risk premium: The risk premium was calculated using the means of identity described in the CAPM model, which was used, as aforesaid, to estimate the rate of return on equity:
Ke = Rf + βL ∗ (Rm − Rf) + Srp
Parameter Description Value Source Ke Return on equity rate 11.13% Calculated in step A above
Rf Risk-free interest 2.60% Twenty-year US government bonds
βL (leveraged β) Correlation representing the share 0.94 Based on the leveraged β of the sensitivity to the market portfolio sample companies
Rf Market premium 6.69% Based on Damodaran data
(Srp) Specific risk premium 2.21% Residual value
C. Calculation of the revenues/royalties discount rate: The discount rate adjusted to the risk level of revenues was estimated by adjustment of β in the CAPM model using the identity below14:
13 Ratio Oil Exploration Limited Partnership (1992), Delek Drilling, Delek Energy and Isramco Negev 2 Limited Partnership. 14 Brealey, Richard A., et al. Principles of Corporate Finance. 10th ed., McGraw-Hill Education, 2011
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Where:
Parameter Description βrevenue β revenues βassets β assets PV(fixed cost) Current value of fixed costs when the discount rate is the debt price. PV(asset) Current value of the Company’s assets where the cash flows were discounted at WACC
The discount rate received using this approach is 6.6%, representing a negative premium of 2% compared with the operational discount rate (77%).
5.1.2 Calculation of the discount rate of revenues based on the identity below15:
PV(asset) = PV(revenues) - PV (fixed cost) - PC (variable cost)
Where:
Parameter Description PV(asset) Current value of the Company’s assets where cash flows are discounted at WACC PV(revenues) Current value of revenues, where the discount rate is calculated as P/N by the foregoing identity solution. PV(fixed cost) Current value of fixed costs when the discount rate is the debt price. PV(fixed cost) Current value of the variable costs where the discount rate is equivalent to the discount rate of the revenues calculated as P/N as aforesaid.
The discount rate received using this approach is 7.8%, representing a negative premium of 0.8% compared with the operational discount rate (91%).
From weighting of the results obtained in the two approaches described above, the negative premium relative to the operational discount rate was estimated at 1.3% (ratio of 85%).
15 See footnote 14 ______
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5.2 Cash flow forecast - overriding royalties (in USD millions)
Year 2017 2018 2019 2020 2021 2022 2023 2024 2025 2026 2027 2028 2029 2030 2031 2032 2033 2034 Production Natural gas production (BCM/y) 5.27 10.65 10.65 10.65 10.65 10.65 10.65 10.65 10.65 10.65 10.65 10.65 10.65 10.65 10.65 10.65 10.65 10.65 Condensate production (bbl/y m) 242 489 489 489 489 489 489 489 489 489 489 489 489 489 489 489 489 489 Natural gas price (US$) 5.21 5.39 5.54 5.62 5.38 5.47 5.56 5.50 5.60 5.70 5.80 5.92 6.01 6.10 6.20 6.28 6.36 6.44 Revenues Natural gas revenues 982.6 2,056.4 2,111.8 2,141.5 2,050.2 2,086.2 2,121.7 2,098.9 2,135.7 2,172.2 2,213.1 2,255.8 2,290.1 2,326.3 2,362.6 2,394.7 2,423.4 2,454.9 Condensate revenues 10.98 26.96 29.57 31.50 33.23 34.79 36.11 37.42 39.10 40.79 42.29 43.56 45.09 47.02 48.86 50.87 52.01 53.75 Total gross revenues 993.6 2,083.4 2,141.3 2,173.0 2,083.4 2,121.0 2,157.8 2,136.3 2,174.8 2,213.0 2,255.4 2,299.4 2,335.2 2,373.4 2,411.4 2,445.6 2,475.4 2,508.7 Tamar Petroleum share of revenues 91.9 192.7 198.1 201.0 192.7 196.2 199.6 197.6 201.2 204.7 208.6 212.7 216.0 219.5 223.1 226.2 229.0 232.1 Petroleum Tax - - - (16.9) (43.1) (46.8) (65.7) (62.4) (68.1) (69.4) (70.9) (68.0) (73.6) (75.0) (76.3) (77.4) (74.1) (79.6) Delek Energy Systems share of ORRI 3.07 8.64 8.88 9.01 8.64 8.80 8.95 8.86 9.02 9.18 9.36 9.54 9.69 9.85 10.00 10.15 10.27 10.41 Delek Energy Systems share of ORRI after petroleum tax 3.07 8.64 8.88 7.96 5.94 5.35 4.88 4.71 4.80 4.88 4.98 5.07 5.15 5.24 5.32 5.40 5.46 5.54 Delek Group share of ORRI 1.02 2.88 2.96 3.00 2.88 2.93 2.98 2.95 3.01 3.06 3.12 3.18 3.23 3.28 3.33 3.38 3.42 3.47 Delek Group share of ORRI after petroleum tax 1.02 2.88 2.96 2.65 1.98 1.78 1.63 1.57 1.60 1.63 1.66 1.69 1.72 1.75 1.77 1.80 1.82 1.85 Cohen Pituach share of ORRI 1.22 2.55 2.62 2.66 2.55 2.59 2.64 2.61 2.66 2.71 2.76 2.81 2.86 2.90 2.95 2.99 3.03 3.07 Cohen Pituach share of ORRI after petroleum tax 1.22 2.55 2.62 2.35 1.75 1.58 1.44 1.39 1.42 1.44 1.47 1.50 1.52 1.54 1.57 1.59 1.61 1.63
Year 2035 2036 2037 2038 2039 2040 2041 2042 2043 2044 2045 2046 2047 2048 2049 2050 2051 2052 Production Natural gas production 10.65 10.65 10.65 10.65 10.65 10.65 10.65 10.65 8.87 8.65 7.86 6.43 4.91 3.76 2.32 2.12 1.53 Condensate production 489 489 489 489 489 489 489 489 407 397 361 295 226 173 107 97 70 Natural gas price 6.52 6.61 6.70 6.80 6.91 7.01 7.12 7.22 7.33 7.44 7.55 7.67 7.78 7.90 8.02 8.14 8.26 Revenues Natural gas revenues 2,485.1 2,519.1 2,556.0 2,594.6 2,634.7 2,674.3 2,714.2 2,753.9 2,326.7 2,303.8 2,125.1 1,764.5 1,369.1 1,062.6 667.2 618.7 452.0 - Condensate revenues 55.12 57.31 58.67 60.32 62.24 63.93 65.56 67.05 57.27 57.30 53.45 44.95 35.36 27.68 17.65 16.57 12.18 - Total gross revenues 2,540.2 2,576.4 2,614.7 2,654.9 2,697.0 2,738.3 2,779.7 2,820.9 2,384.0 2,361.1 2,178.6 1,809.4 1,404.5 1,090.3 684.9 635.2 464.2 - Tamar Petroleum share of revenues 235.0 238.3 241.9 245.6 249.5 253.3 257.1 260.9 220.5 218.4 201.5 167.4 129.9 100.9 63.3 58.8 42.9 - Petroleum Tax (80.7) (81.9) (76.3) (75.9) (86.1) (83.1) (88.9) (90.3) (70.9) (74.5) (68.3) (55.6) (41.7) (30.9) (14.4) (12.7) (6.8) - Delek Energy Systems share of ORRI 10.54 14.25 14.46 14.69 14.92 15.15 15.38 15.60 13.19 13.06 12.05 10.01 7.77 6.03 3.79 3.51 2.57 - Delek Energy Systems share of ORRI after petroleum tax 5.61 7.58 7.69 7.81 7.94 8.06 8.18 8.30 7.02 6.95 6.41 5.32 4.13 3.21 2.02 1.87 1.37 - Delek Group share of ORRI 3.51 3.56 3.62 3.67 3.73 3.79 3.84 3.90 3.30 3.27 3.01 2.50 1.94 1.51 0.95 0.88 0.64 - Delek Group share of ORRI after petroleum tax 1.87 1.90 1.92 1.95 1.98 2.01 2.05 2.08 1.75 1.74 1.60 1.33 1.03 0.80 0.50 0.47 0.34 - Cohen Pituach share of ORRI 3.11 3.15 3.20 3.25 3.30 3.35 3.40 3.45 2.92 2.89 2.67 2.21 1.72 1.33 0.84 0.78 0.57 - Cohen Pituach share of ORRI after petroleum tax 1.65 1.68 1.70 1.73 1.76 1.78 1.81 1.84 1.55 1.54 1.42 1.18 0.91 0.71 0.45 0.41 0.30 -
24 WorldReginfo - c16fd361-de53-4169-8c2c-61d95bc8d7cf
5.3 Definitions
The Company / Delek Group Delek Group Ltd.
Avner Avner Oil Exploration - Limited Partnership
Natural gas A mixture of gases containing mainly methane, which is primarily used for power production and as an industrial energy source.
Delek Energy Delek Energy Systems Ltd.
Delek Drilling / Partnership Delek Drilling Limited Partnership
The Petroleum Law The Petroleum Law, 1952
Cohen Development Cohen Development and Industrial Buildings Ltd.
The Gas Outline Plan or The The decision of the Israeli government regarding drafting of Outline an outline for increasing the volume of natural gas produced from the Tamar natural gas field and swift development of the Leviathan, Karish, and Tanin gas fields and other gas fields.
Noble Noble Energy Mediterranean Ltd.
Condensate A hydrocarbon fluid generated during the production of natural gas, which serves as a raw material for the production of fuels and is a substitute for oil.
Oil Asset A license or a lease under the Petroleum Law in Israel or a right of similar significance granted by the competent body outside of Israel.
BCF Billion Cubic Feet
BCM Billion cubic meters
DCF Discounted Cash Flows
LNG Liquefied natural gas
MMBTU Million BTU - unit of energy used as the basis for determining the price of natural gas.
______
25 WorldReginfo - c16fd361-de53-4169-8c2c-61d95bc8d7cf Jerusalem, November 26, 2017
The Delek Group Ltd. 7 Giborei Yisrael, St. Netanya
Dear Sirs,
Review of the fair value of the investment of Delek Group in shares of The Phoenix Holdings Ltd. Draft 6
1. General
1.1 I the undersigned, Prof. Yoram Eden, CPA, was asked by you to give my professional opinion on the accounting question set out in section 3 below.
2. Background and the relevant facts
2.1 As of September 30, 2017, the Delek Group Ltd. ("Delek Group" or "Delek") holds 47.35%1 of the share capital of The Phoenix Holdings Ltd. ("The Phoenix" or "the Company").
2.2 Through September 17, 2017, Delek held 52.25% of the shares of The Phoenix. On September 14, 2017 Delek signed a binding agreement for the sale of all its holdings (52.25%) to Sirius International Insurance Group ("Sirius") in consideration of approximately NIS 2.5 billion plus interest and subject to adjustments as provided in the agreement. The consideration amount was set on the basis of 90% of the equity attributed to the shareholders of the Company according to the financial statements of The Phoenix as of June 30, 2017 (and see section 2.13 below).
The transaction will be executed in a number of stages:2
2.2.1 In the first stage, on September 18, 2017, Sirius purchased from the Company in an off-board transaction, 4.9% of the share capital of The Phoenix at NIS 16.988 per share for a cash consideration of NIS 208 million. That consideration was final, and is not dependent on completion of the second stage of the Agreement as defined below. Assuming completion of the transaction for the balance of Delek's holdings in The Phoenix as described below, the consideration will be adjusted so that the Company will be paid an additional NIS 25 million in respect of this stage (so that the total consideration will reflect a share price of NIS 19.076). 2.2.2 Delek granted Sirius a call option to purchase the balance of the shares (47.35% on the date of the Agreement), whereby during a period of 60 days from the date on which the due diligence material on the basis of which the parties reached their agreement was made available to Sirius, Sirius could notify the Company of its wish to purchase the entire balance of Delek's shares in The Phoenix ("Stage 2 of the Agreement"). During that period, Sirius would complete its due diligence and could transfer to Delek, at its discretion, an irrevocable notice of its intention to complete the Agreement. 2.2.3 The Agreement includes defined schedules for filing an application for receipt of control from the Commissioner of the Capital Market, Insurance and Savings at the Ministry of Finance, and for obtaining the requisite regulatory approvals. Under the Agreement, Sirius undertook to contact the
1 Delek holds 48.11% of the voting rights in The Phoenix. 2 See also the immediate report published by the Company on November 14, 2017.
1 WorldReginfo - c16fd361-de53-4169-8c2c-61d95bc8d7cf Commissioner without delay and file the application as required by law, by no later than 45 days from the date of execution of the Agreement. At the time of writing, the application has been filed. 2.2.4 On November 23, 2017, after completion of the due diligence, Sirius notified Delek of exercise of the call option granted it under the Agreement.3
2.2.5 Assuming completion of Stage 2 of the Agreement, Sirius will pay Delek the balance of the consideration, NIS 2,284 million, in cash plus interest and subject to the adjustments provided in the Agreement.
2.2.6 At this stage, it is not certain that the transaction will be closed.
2.3 The balance of the equity attributed to the majority shareholders of The Phoenix as of June 30, 2017, was NIS 5,297.7 million, and the market capitalization of The Phoenix on the same date was NIS 3,709.2 million;4 the market capitalization as of September 30, 2017 was NIS 4,054.6 million;5 and as of June 30, 2017, Delek held 52.26% of the issued and paid up capital of The Phoenix. Delek Group's investment in The Phoenix in Delek Group's books as of June 30, 2017 was NIS 2,076 million. The market value of the same date amounts to (52.26%*3,709.2=) NIS 1,938.4 million; the market value of the investment (52.26% immediately prior to the sale of 4.9% to Sirius), calculated at a share price for The Phoenix as of September 30, 2017, is (52.26%*4,054.6=) NIS 2.118.6 million. It should be noted that the market value of the remaining part (47.35%) as of September 30, 2017 is (47.35%*4,054.6=) NIS 1.919.9 million.
2.4 In December 2013 the Knesset enacted the Promotion of Competition and Reduction of Market Concentration Law, 2013 ("Market Concentration Law"), which lays down, inter alia, a duty to separate holdings in substantial non-financial operations from substantial financial operations as they are defined in the Market Concentration Law.
As I understand it, Delek Group has holdings in substantial non-financial companies and in substantial financial companies such as The Phoenix Insurance Co. Ltd. ("The Phoenix Insurance") and its subsidiary Excellence Investments Ltd. ("Excellence"). In view of the provisions of the Market Concentration Law, Delek Group will be required, within six years (from the end of 2013), to separate its substantial non-financial operations from its substantial financial operations. Such separation can ostensibly be achieved in several alternative ways, such as sale of the non-financial operations, sale of companies that have holdings in financial operations, or sale of the operations themselves, certain structural changes, etc.
2.5 In 2014, Delek Group negotiated with a foreign company, Kushner Funding LLC, for the sale of control in The Phoenix, and even signed with that company,6 on July 4, 2014, a non-binding memorandum of understanding which set out the principles for drafting a binding agreement for the sale of control in the Company (approx. 47%). The overall consideration for the shares being purchased was supposed to be a sum equal to the equity of The Phoenix as of December 31, 2013, multiplied by the price of the shares being sold from the issued capital of the Company plus interest at an agreed rate that would be added to the consideration commencing January 1, 2014. However, the negotiations failed.7
2.6 In January 2015 a non-binding memorandum of understanding was signed by the Company and a foreign listed company, Fosun International Limited, ("Fosun"), for the sale of control in The Phoenix to Fosun or any of its subsidiaries. On June 21, 2015 a binding agreement was signed for
3 See the immediate report published by the Company on November 26, 2017. 4 As of June 29, the last trading day in June 2017. 5 As of September 28, the last trading day in September 2017. 6 See the immediate report published by The Phoenix on July 6, 2014. 7 See the immediate report published by Delek on December 14, 2014.
2 WorldReginfo - c16fd361-de53-4169-8c2c-61d95bc8d7cf the sale of all of Delek's holdings in shares of The Phoenix (approx. 52.3%) to Fuson, in consideration of NIS 1,763 million plus 4.75% annual interest from September 30, 2014 to the closing date. The consideration would be paid on the closing date. The agreement contained conditions precedent that included, inter alia, approvals from government authorities, one of which is a permit for control from the Commissioner of the Capital Market.
2.7 In view of the progress in the sale proceeding and the execution of a binding sale agreement, Delek started to present the investment in The Phoenix shares as part of a group of assets available for sale and as part of a liabilities line relating to assets available for sale, commencing with the reviewed financial statements for the interim period ended June 30, 2015. In addition, the results of operations of The Phoenix, including adjustments to fair value net of costs to sell, were presented in the statement of profit and loss as part of the item "Profit (Loss) from terminated operations", net, with the comparison numbers reclassified (see also Notes 3 and 4 to the financial statements of Delek Group as of September 30, 2015).
2.8 On February 16, 2016, Delek published another immediate report in which it announced that since the conditions precedent in the agreement had not yet been met, the parties had agreed, on February 16, 2016, to cancel the agreement between them using the mechanism prescribed in the agreement, and each party irrevocably and unconditionally waived any allegation, claim or loss in connection with the agreement.
2.9 On February 18, 2016 a non-binding letter of understanding was signed by The Phoenix and AmTrust, an American insurance company. The letter of understanding described Amtrust's offer to purchase control in The Phoenix. On March 1, 2016 the parties signed a letter of cancellation for the Letter of Understanding. The letter of cancellation stated, inter alia, that the period of exclusivity granted to Amtrust had ended and the parties would discuss possible alternatives to the transaction.
2.10 On August 21, 2016, Delek entered into a binding agreement for the sale of all its holdings in The Phoenix to Yango Investment PTE Ltd (a private company incorporated in Singapore, which is a subsidiary of Fujian Yango Group Ltd., a holdings company with various operations in China) ("Yango Group"). The consideration, according to the agreement, was set at NIS 1,948 million, bearing interest at 4.75% p.a. from January 1, 2017 through the closing date. Under provisions of the agreement as amended, if by March 31, 2017 the conditions defined in the agreement for closing the transaction had not been met, each of the parties to the agreement would have the right to notify the other of cancellation of the agreement.8
2.11 On April 5, 2017, Delek and Yango Group signed the following amendment to their agreement:
A. The consideration for Delek's holdings in The Phoenix (52.3%) was increased to NIS 2,152 million (compared with NIS 1,971 million under the agreement of March 31, 2017). B. The sum of NIS 1,987 million out of the consideration would be paid in cash on the date of the closing, and the balance in three installments, the first of which would be paid up to 30 days from the closing date and the last no later than April 30, 2019. C. The deadline for completion of the terms for the closing was set at June 4, 2017, so that if by that date the conditions for closing were not met, each of the parties to the agreement would be entitled to notify the other of its cancellation.9
8 For more details, see section 1.9 of Delek's Periodic Report for 2016. 9 For more details, see the immediate report published by Delek on April 6, 2017.
3 WorldReginfo - c16fd361-de53-4169-8c2c-61d95bc8d7cf 2.12 On June 26, 2017, Delek Group published an immediate report advising that in view of delay in the proceeding for obtaining the approval for transfer of control in The Phoenix to Yango Group, the parties had agreed on cancellation of the agreement in the manner provided in the agreement, and each party irrevocably and unconditionally waived any allegation, claim or loss in connection with the agreement.
2.13 On September 14, 2017 Delek signed a binding agreement for the sale of its holdings (52.25%) to Sirius in consideration of approximately NIS 2.5 billion plus interest and subject to adjustments prescribed in the Agreement and as described above in section 2.2.
3. The professional accounting question discussed in this opinion
3.1 I was requested to estimate the fair value of Delek Group's investment in shares of The Phoenix as of September 30, 2017 according to IFRS principles as they apply to public companies in Israel..
3.2 Fair value is defined in IFRS 13 as "The price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date."
4. For the purpose of my work I drew on the following accounting standards, financial statements and data:
4.1 The Phoenix audited financial statements for 2016 and for previous years.
4.2 The Phoenix reviewed financial statements for the interim period ended June 30, 2017.
4.3 International Financial Reporting Standards:
4.3.1 IFRS 5 – Non-current assets held for sale and terminated operations ("IFRS 5"). 4.3.2 IFRS 13 – Measurement of fair value ("IFRS 13").
4.3.3 IAS 36 – Impairment of Value of Assets ("IAS 36").
4.4 An announcement by Maalot dated October 24, 2017, ratifying a rating of ilAA (with stable outlook) for The Phoenix Insurance Co. Ltd., and a rating of ilA+ (with stable outlook) for The Phoenix Holdings Ltd.
4.5 A Midroog announcement, dated June 28, 2017, set a rating of Aa3il (with stable outlook) for an issue of subordinated promissory notes (Series H) that would be issued by The Phoenix. Midroog also retained the rating of Aa1.il for the financial strength of the Company (IFS), as well as ratings of Aa2.il(hyb) for the Company's subordinated promissory notes (combined Tier 1 and Tier 2 capital and Aa3.il(hyb) for the subordinated promissory notes (combined Tier 1 and Tier 2 capital) raised through The Phoenix Capital Raising. The rating is given a stable outlook.
4.6 A presentation to investors of The Phoenix, which was attached to an immediate report published by the Company on August 28, 2017.
4.7 Immediate reports (pursuant to the Securities (Periodic and Immediate Reports) Regulations, 1970, published by Delek and The Phoenix.
4.8 The response of The Companies Department at the Securities Authority, dated March 18, 2014, to the request of Discount Investments for preliminary guidance on accounting questions relating to the Market Concentration Law ("the Authority's First Reply").
4.9 The announcement of the Securities Authority dated March 23, 2016: "Measurement of fair value of a quoted investment – Update on the position of Authority staff as expressed in a response to a preliminary request on March 18, 2014" ("the Authority Staff's Revised Position").
4 WorldReginfo - c16fd361-de53-4169-8c2c-61d95bc8d7cf 4.10 Letter of the Capital Market, Insurance and Savings Authority on "Distribution of a dividend by insurance companies", dated October 1, 2017.
4.11 Prior opinions in which I estimated the value in use of Delek's investment in The Phoenix, which assumed that the Market Concentration Law would require Delek Group to sell its holdings in The Phoenix (which holds, inter alia, the financial companies The Phoenix Insurance and Excellence) in the period allocated by the Market Concentration Law, i.e. within a period of six years from the end of 2013. These opinions were prepared using a methodology that accords with the Authority's original response, and in them I assumed that sale of the investment in The Phoenix at the end of the expected holding period as noted above, would be at the market price known on the measurement date to which the following opinions related:
4.11.1 My opinion dated March 27, 2014, which estimated the value of Delek's investment in The Phoenix as of December 31, 2013.
4.11.2 An update, dated August 27, 2014, of the previous opinion. 4.11.3 My opinion dated March 25, 2015, which estimated the value of the investment as of December 31, 2014.
4.12 An earlier opinion, dated March 29, 2016, in which I estimated the fair value of Delek's investment in The Phoenix as of December 31, 2015 and which was drafted using a methodology that accords with the position of the Authority Staff's Revised Position.
4.13 Damodaran A., "Valuation: Dreams and Delusions" http://www.damodaran.com.
4.14 Insurance circulars and position papers of the Commissioner of the Capital Market published up to the date of preparing this opinion and which can affect the future profitability of insurance companies.
4.15 I wish to point out that in preparing this opinion, I had before me the business results of The Phoenix for the first six months of 2017 and for prior years. For the purposes of this opinion, I requested and received certain data only from the draft financial statements of The Phoenix as of September 30, 2017.
5. I have no knowledge of any information that may indicate the implausibility of the data I have drawn on. I did not consider the data independently, and therefore this opinion does not validate their verity, integrity or accuracy.
6. Use of forward looking information
6.1 For this paper, I assessed the projected profits from the insurance portfolios (life insurance, pension and non-life insurance lines – from both existing portfolios and future portfolios) of the Company in the second half of 2017 and in 2018-2020 ("Forecast Period"). I made the profit estimate in the Forecast Period using forward looking information that included, inter alia, forecasts, assessments and estimates relating to future events or matters, that may or may not come to pass and that are beyond the control of The Phoenix and/or Delek Group. Such forward looking information does not constitute proven fact, and is based solely on my subjective assessment, which relied on general information available to me at the time of writing.
6.2 I also made an estimate of the profits of other companies in The Phoenix Group in the Forecast Period, in which I also related to forward looking information provided by Delek's management, on the expected profit in each of its segments of operation. Such forward looking information is uncertain information as to the future, is based on information in the Company's possession at the time of the valuation, and includes estimations or intentions of the Company's management at the
5 WorldReginfo - c16fd361-de53-4169-8c2c-61d95bc8d7cf time of writing. If these estimations of the management fail to materialize, the actual results may differ materially from the assessed results or the results implied by such information.
7. Unique circumstances of the insurance market in Israel
7.1 In order to decide on the valuation method, I considered the unique circumstances of the insurance market in Israel, including these: - Insurance companies in Israel typically have large controlling stakes. - The controlling stakes are a significant barrier to acquisition of the companies, owing to the shortage of buyers with the necessary capital. - Moreover, the insurance business in Israel is especially supervised, and is subject to frequent regulatory changes.
7.2 This situation leads to uncertainty among potential investors in the insurance companies, and some of the controlling stakes in the insurance companies have been for sale "on the shelf" for a long time. In this context it should be noted that in addition to Delek Group being required, as noted in section 2.4, to sell its holdings in The Phoenix in order to comply with the Market Concentration Law, IDB Development has also been trying, for many years now, to sell its holdings in Clal Insurance Co.
8. Methodology
8.1 In general, there are several valuation methods for companies and businesses. Naturally, each method has its own advantages and disadvantages, and should be applied according to the measure of its applicability to the case and/or to the situation and purpose of the valuation.
8.2 The most widely-accepted approach nowadays for valuations is Discounted Cash Flows – DCF. In this method, the value of operations of a company is derived from the present value of the cash flows expected to stem from it over the balance of its economic life. The unleveraged capitalized present value of the free cash flows reflects the enterprise value of the company. To arrive at the equity value, the sum of the net financial liabilities must be deducted from the enterprise value (and the value of the surplus assets added, if there are any).10
8.3 In this valuation I used two different approaches:
A. DCF-based mixed approach
(1) Initially, I assessed the value of the life insurance, pension and health business, based on the data in the report on the embedded value as of December 31, 2016 (as included in the Periodic Report as of March 31, 2017 published by the Company), subject to adjustments which are described later. In essence, the methodology for calculating embedded value, insofar as it is based on the present value of future profits, accords with the DCF method.
(2) I then estimated the value of the life and non-life insurance businesses, the providence fund management operations, the financial services segment and the holdings in The Phoenix Insurance Agencies Ltd., using the DCF method, where the calculation reflected the general and administrative expenses that are not attributed to the segments of operation, the financial income not attributed to the finance costs stemming from subordinated promissory notes known as hybrid Tier 2 and Tier 3 capital.
10 Surplus assets are assets not taken into account when calculating the enterprise value of the company.
6 WorldReginfo - c16fd361-de53-4169-8c2c-61d95bc8d7cf (3) I added to the enterprise value calculated in the first two stages, the book value of investment in The Phoenix at the following companies (a) Ad 120 Senior Citizens Residential Centers Ltd.11 ("Ad 120"); (b) Gamma Management and Clearing Ltd.; (c) Phoeniclass Ltd., and the market value of The Phoenix investment in Mehadrin, a public company.
(4) From the aggregate value calculated in the first three stages, I subtracted the amount of the financial liabilities (except for subordinated promissory notes known as hybrid Tier 2 and Tier 3 capital) and the other liabilities of the Company as of June 30, 2017.
B. Approach that derives the Company's value from the acquisition offers submitted to Delek Group and described in sections 2.4 – 2.12 above, as well as offers for other insurance companies (mainly Clal Insurance), which were on the cards recently.
8.4 To the best of my understanding, the value derived from the offers made recently to Delek Group reflects the value that would have been paid for the sale of Delek's investment in The Phoenix as a whole, by the relevant market participants. Therefore, the value derived from them is a more appropriate estimate for the fair value of the investment as a whole than the quoted value (the market value on the TASE on June 30, 2017) – which was significantly lower, as noted in section 2.3, even in the absence of other indications for the value of sale of the investment.
8.5 In applying the DCF method I divided the Forecast Period into two:
A. July 1, 2017 – December 31, 2017 and the years 2018-2020 ("Immediate Forecast Period") – for which I prepared a detailed profit forecast.
B. 2021 onwards, for which I prepared a "representative cash flow" (derived from the Company's profits in the Immediate Forecast Period.
9. Summary of the opinion From my examination, as of September 30, 2017 the fair value of the balance of the investment (47.35%) is between NIS 2,200 million and NIS 2,651 million, the value obtained from application of the DCF method. This assessment reflects a value in a range between 87.5% and 105.7% of the share of the Company's shareholders in the equity of The Phoenix as of June 30, 2017.
11 In this context it should be noted that this is because the large part of Ad 120's value stems from investment real estate, which is presented in its financial report at its fair value as estimated by an external assessor, and it can be assumed that the equity value of investment of The Phoenix in Ad 120 is not materially different from its fair value.
7 WorldReginfo - c16fd361-de53-4169-8c2c-61d95bc8d7cf Opinion
10. Results of operations of The Phoenix in the first six months of 2017 and in prior years
10.1 The part of Company shareholders in comprehensive income in the first six months of 2017 amounted to NIS 485.3 million, compared with NIS 151.0 million in the first six months of 2016 and NIS 694 million in the whole of 2016.
10.2 Table 1 shows condensed data for comprehensive income (loss) of the Company in the first six months of 2017 and 2016 and in each of the years 2013-2016.
Table 1 – The Phoenix Holdings Ltd. – Condensed comprehensive income data (consolidated) (in NIS millions)
For the six months ended For year ended June 30 December 31 2017 2016 2016 2015 2014 2013 Comprehensive income from life insurance and long-term savings segment 223 (96) 220 (94) 99 367 Comprehensive income from health insurance segment 83 (1) 122 (51) 41 219 Comprehensive income from non-life insurance 195 57 198 271 286 366 Comprehensive income from financial services segment 53 65 96 96 119 73 Total comprehensive income from segments of operation 554 25 636 222 545 1,025 Profit (loss) not from reported operating segments operating segments 144 130 256 218 129 144 Company’s share of the net results of investee companies that are not from the reporting segments of operation 34 25 28 15 13 28 Comprehensive income (loss) before income tax 732 180 920 455 687 1,197 Income tax 241 20 212 129 214 431 Comprehensive income for the period* 491 160 708 326 473 766 Comprehensive income for period attributed to shareholders of the Company 485 151 694 325 447 744
* In 2015, NIS 163 million (NIS 118 million after tax) from a buildings reassessment fund is included (mainly Beit Havered in Givatayim, the location of the Company's offices).
10.3 Given that a large part of the Group's assets are invested in the capital market, the yields achieved there have a material impact on the Group's profitably. As explained by the Company's Board of Directors,12 the profits and losses from investments reflect the behavior of the capital market in Israel and worldwide, and the behavior of the Consumer Price Index and the shekel exchange rates vis-à-vis the principal currencies, whose aggregate effect on the financial margin is the main reason for the reported volatility.
10.4 The results of operations in the first six months of 2017 were affected by the rise in the economy's interest rate curve. The impact of the increase in interest rates on the decrease in insurance liabilities amounted to NIS 78 million before tax and NIS 51 million after tax. However, the downward trend of the interest rate curve that occurred in the third quarter of the year is expected to lead to an increase in the insurance liabilities.
10.5 In the corresponding period last year, the results were influenced materially by the downward trend of the interest curve. The effect of this on the increase in the insurance liabilities amounted to NIS 289 million before tax and NIS 185 million after tax.
12 See, for example, section 4.1.3 of the Directors' Report attached to its financial statements as of June 30, 2017.
8 WorldReginfo - c16fd361-de53-4169-8c2c-61d95bc8d7cf 10.6 In addition, the results in the corresponding period last year were materially affected by the increase in non-life insurance liabilities to the tune of NIS 131 million before tax (NIS 198 million in the whole of 2016) and NIS 84 million (NIS 127 million in the whole of 2016) after tax, against a backdrop of the publication of standards for the capitalization of National Insurance allowances (following implementation of the recommendations of the Winograd Commission). A change in the capitalization interest rate for allowances had serious implications for the compulsory auto insurance segment and other liability insurances.
10.7 In August 2015 an insurance circular was published on how to calculate the Liability Adequacy Test (LAT) in life insurance and health insurance ("LAT Circular"). The Company reviewed the appropriateness of the reserves, including the supplementary reserve for pensioners, in light of the supervisory directives and its own research. The overall effect in 2015 of the changes described above resulted in recording an expense of NIS 356 million before tax and NIS 222 million after tax.
11. Reorganization in The Phoenix Group
11.1 On December 29, 2016 The Phoenix Group received the approval of the Commissioner of the Capital Market for reorganization of its providence and pension operations.
11.2 As part of the reorganization, the operations of The Phoenix Veteran Balanced Pension Fund Management were merged into The Phoenix Pension so that commencing January 1, 2017, all pension operations of the Company are managed by one managing company (The Phoenix Pension).
11.3 Also, the shares of Excellence Provident that were held by Excellence Investments Ltd. ("Excellence") were transferred to The Phoenix Insurance and in addition, 1% of the shares held by a former employee of Excellence Provident were purchased by The Phoenix Insurance while the provident fund operations of The Phoenix Pension were transferred to Excellence Provident so that commencing January 1, 2017, all provident fund operations of The Phoenix Group are managed by one managing company (Excellence Provident).
11.4 As of the date of publication of this report, the final approval (rulling) of the tax authorities has not been received. However, as the Company describes in the chapter "Description of the Company's Business" that is included in its report for the second quarter of 2017: "In the opinion of the Company and its advisers, approval for the ruling will be received subject to the provisions of the law and the restrictions relating to the holding in the companies participating in the structural change, in the operations that are being transferred and to other restrictions."
12. Required equity
12.1 General
The Phoenix Insurance, like the other insurance companies in Israel, must comply with two types of capital requirements: 12.1.1 Requirements set in accordance with the Control of Financial Services (Insurance) (Minimum Equity Required of an Insurer) Regulations, 1998 and its amendments ("Capital Regulations") and the Commissioner's pertinent directives. 12.1.2 Requirements for required capital for solvency based on Solvency II, which is based on the European Directive (which was adopted by the European Union and has been applied since January 2016 in all its member states). Application of this requirement occurred on June 30, 2017, following publication of directives for implementation of a regimen of economic worthiness of
9 WorldReginfo - c16fd361-de53-4169-8c2c-61d95bc8d7cf Solvency II-based insurance companies ("the New Directives"). A time period was set for full implementation of required equity for solvency by 2024. 12.1.3 The Commissioner of the Capital Market announced that he was acting to amend the Capital Regulations so that after an insurance company receives the Commissioner's confirmation of an audit of application of the New Directives in its financial statements, the Capital Regulations for the matter of minimum required equity would not apply to that company. Accordingly, until receipt of such approval from the Commissioner, the Company must comply with both the Capital Regulations and the New Directives.
12.2 Equity required by the Capital Regulations 12.2.1 The Capital Regulations recognise Tier 1 capital, hybrid Tier 1 capital and capital that was defined as Tier 2 capital and Tier 3 capital.
Hybrid Tier 1 capital: This includes debentures that the insurer offers and for which repayment will be subordinated to all of the insurer's other liabilities except for the shareholders. In addition, it is required that in certain circumstances, an interest payment on the debenture can be cancelled and even repayment of the principal (or conversion of the payment to shares). The first repayment date of the debentures should be at least ten years after the date of their issue.
Tier 2 capital: This includes debentures that the insurer offers and for which repayment will be subordinated to all of the insurer's other liabilities except for Tier 1 capital, and in certain circumstances the interest payments on them can be deferred for an unlimited time. The first repayment date of the debentures should be at least eight years after the date of their issue (or five years where there is an incentive for early redemption).
Tier 3 capital: This includes debentures that the insurer offers and for which repayment will be subordinated to all of the insurer's other liabilities except for Tier 1 capital and Tier 2 capital. The first repayment date of the debentures should be at least five years after the date of their issue (or three years where there is an incentive for early redemption).
12.2.2 The Capital Regulations require of the insurer Tier 1 and Tier 2 capital of at least 60% of the required equity. As a result, they allow it to raise up to 40% of the required equity using Tier 2 and Tier 3 capital.
12.2.3 From Note 5 to the reviewed financial statements of the Company as of June 30, 2017, it transpires that The Phoenix has a capital surplus, calculated according to the Capital Regulations, of NIS 1,896.1 million (including the effect of capital actions taken after the date of the report). This surplus accounts for approximately 54.1% of the required equity, as shown in Table 2:
Table 2 – Calculated capital and required equity according to the Capital Regulations as of June 30, 2017 (in NIS millions) Amount required by Capital Regulations and Commissioner's directives 3,506.0 Amount existing calculated according to the Capital Regulations* 6,048.3 Surplus 2,542.3 Capital actions after June 30, 2017, net 150.8 Less locked in surpluses in respect of investments in subsidiaries (797.0) Surplus after deduction of locked in amounts 1,896.1 Percentage of surplus over required amount 54.1% * Including Tier 2 capital.
10 WorldReginfo - c16fd361-de53-4169-8c2c-61d95bc8d7cf 12.3 Application of Solvency II provisions
12.3.1 General
Solvency II is a regulatory directive that regulates the capital requirements and risk management processes in insurance companies. The directive lays down a uniform set of capital requirements from insurance companies belonging to and outside the European Union.
The directive includes, inter alia, quantity requirements for two levels of required capital, Minimum Capital Requirement ("MCR") and Solvency Capital Requirement ("SCR").
12.3.2 Application in Israel
As mentioned, in June 2017 the New Directives were published for the application of Solvency II- based solvency requirements, including two levels of required capital: MCR and SCR. A time frame was set for full application of SCR. On June 30, 2017 the Company must have capital of not less than 60% of the SCR. This requirement increases gradually until it reaches 100% of the SCR from December 31, 2024.
12.3.3 Solvency ratio and capital threshold of The Phoenix as of December 31, 2016
Table 3 contains data on the solvency ratio and capital threshold of the Company as of December 31, 2016.13
Table 3 – Solvency ratio and capital threshold as of June 30, 2017 (in NIS millions)
A. Solvency ratio Without considering provisions for the scheduling period: Equity with respect to SCR 5,834.8 Equity required for SCR 6,113.4 (deficit) (278.6) Solvency ratio on report date 95% Compliance with milestones in the scheduling period: Equity with respect to SCR in scheduling period 5,749.5 Equity with respect to SCR in scheduling period 3,474.1 Surplus in scheduling period 2,275.4
B. Capital threshold Minimum Capital Requirement (MCR) 4,318.2
12.3.4 According to the information in the Directors' Report attached to the Company's financial statements as of June 30, 2017, the issuances of Tier 2 capital by the Company during 2017, net of the expected payments of the Tier 3 capital, will result in the addition of NIS 619 million to its equity (for the matter of SCR), a sum which is larger than the deficit shown in Table 3.
In addition, in June 2017 the Board of Directors of the Company approved in principle a plan to increase the equity of the Company by an issue of hybrid Tier 1 capital to the Company from internal sources of The Phoenix Group. Under the plan as presented, the amount of the hybrid Tier 1 capital to be issued will be up to NIS 260 million.
13 These data, which were included in the Directors' Report attached to the Company's financial statements as of June 30, 2017, were not reviewed by the auditors of the Company. Pursuant to the Commissioner's directive, in preparation for audited reports, a special report by the auditor (which is neither an audit nor a review) must be submitted to the Commissioner, its purpose being, inter alia, to examine the controls and the integrity of the data used in The Phoenix Insurance's calculation.
11 WorldReginfo - c16fd361-de53-4169-8c2c-61d95bc8d7cf 12.4 Distribution of dividends
12.4.1 Pursuant to a letter published by the Commissioner in August 2016, an insurance company may not distribute dividends unless, after the distribution, the company retains a ratio of recognised equity to required equity of at least 115% according to existing capital regulations. 12.4.2 In view of the application of Solvency II, the regulatory restriction was revised and will be conditional on compliance with a solvency ratio of 100% according to the solvency regime at full calculation (disregarding the time to full compliance), and also compliance with the capital surplus, which will be set by the Board of Directors of The Phoenix Insurance. The Board has not yet set that policy. 12.4.3 The Company's auditors will be required to audit application of the directives of the solvency circular. Only after the Commissioner's confirmation of that audit will the Company be able to distribute a dividend in accordance with section 12.4.2.
12.4.4 However, I believe that taking into account the indications that the Company has in fact already today a solvency ratio of not les than 100%, it will be able to resume the distribution of dividends in the coming years out of its future profits, and to refrain from the distribution of dividends in the immediate future will result in consolidation of a solvency ratio that is higher than 100%.14
12.5 The implications for this report
12.5.1 Later in this opinion, I assume that the Company will meet the required equity requirements of Solvency II in the future and will even be able to distribute dividends from its current profits. 12.5.2 Nevertheless, I assumed that the entire amount of The Phoenix Insurance's financial assets that are not attributed to its segments of operation (NIS 3,067 million as of June 30, 2017, as shown in Table 17), is needed for compliance with the requirements of Solvency II, and does not constitute a "surplus asset" that must be added to the Company's enterprise value.
Expected finance income from investments that are not attributed to the segments of operation is reflected in calculation of the enterprise value of the Company, as shown in Table 18.
12.5.3 I also gave expression to expected finance costs in respect of the subordinated promissory notes recognised as hybrid Tier 2 and Tier 3 capital, as shown in Table 21.
13. Valuation of the life insurance, pension and health businesses of the Company
13.1 General
Valuation of the enterprise value in these areas of operation necessitates the use of a multitude of data derived from the various policies issued by the Company in the past, actuarial, demographic and economic assumptions, and forecasts for expected cash flows over an especially long period. These data, assumptions and forecasts, some of which are out of reach, are expressed in a report on the embodied value. Accordingly, I decided to base the valuation of the life insurance, pension and health segment on the information contained in the embedded value report dated December 31, 2016 (which was published together with financial statements for the first quarter of 2017), subject to a number of changes and assumptions that I describe below. As I noted in section 8.3A(1), in essence, the methodology of calculating embedded value, insofar as it is based on the present value of future profits, concurs with the DCF method. It should also be emphasized that embedded value data are already after-tax data.
14 See also the Maalot rating notice of October 24, 2017 in the explanation for the main considerations for the rating (top of p. 7).
12 WorldReginfo - c16fd361-de53-4169-8c2c-61d95bc8d7cf 13.2 Valuation of existing insurance portfolios
13.2.1 The starting point for the calculation was the calculated datum of "present value of future profits" (in the life, health and savings insurance portfolios) as stated in the embedded value report of December 31, 2016. 13.2.2 I decided to make two adjustments to this figure:
A. While the capitalization rates used for the calculation that appeared in the embedded value report were the interest rates set by the Commissioner and reflected the risk-free interest rate plus an average liquidity premium,15 I decided to include in the capitalization rates a risk premium of 6% over the risk-free interest vector. As I understand it, this additional risk premium is necessary in order to express more appropriately the non-systemic risk component, noting the insurance and operational risks that cannot be hedged and the capital cost required for support of the operations.
Making this adjustment reduced the value of the existing insurance portfolios by 51.4%, as shown in Table 4.
B. Calculation of embedded value is made on a best estimate assumption, in which all the actuarial and demographic assumptions were made at the Company's best discretion based on past experience, and without factors for conservatism. For the sake of caution, I decided to deduct another 7.5% from the standardized value because of a possible rise in the rate of cancellations and redemptions, mainly in life insurance lines.16
Table 4 – Standardized value of the Company's life, health and pension portfolio as of December 31, 2016 (in NIS millions and after tax) Capitalization according to Value after additional 6% rik deduction of As reported* premium additional 7.5% Life and Health 4,639 2,366 2,189 Pension 1,010 381 352 Total 5,649 2,747 2,541
* In the report on embedded value as of December 31, 2016.
13.3 Estimated value of the future insurance lines (life, health and pension) of the Company
13.3.1 I used the Value of New Business (VNB) data that appears in the embedded value report in order to estimate the value of the Company's expected future insurance business in these segments of operation.
13.3.2 The aggregate VNB achieved in 2016 was NIS 520 million (after tax). I made two adjustments to this figure: A. Consistent with the calculation of the value of existing portfolios, I added another risk premium of 8% to the risk-free interest vector.
15 The capitalization interest was set according to a curve representing CPI-linked risk-free interest. In prior years, this curve was based on the yield to maturity of government bonds in Israel after extrapolation and without adjustment. Pursuant to the Commissioner's directive, in 2016 the Company used for the first time an interest curve that was published by the Commissioner to be used in calculations relating to the provisions of Solvency II. The curve is based on the yield to maturity of government bonds in Israel combined with an Ultimate Forward Rate (UFR) assumption of 2.6% (in real terms), plus a Volatility Adjustment (VA), which reflects, in the Commissioner's estimation, an average non-liquidity premium in the debt portfolios of the insurance companies. 16 According to the sensitivity analysis in the embedded value report of December 31, 2016, a rise of 10% in the rate of cancellations (including redemptions and clearances) would reduce the value of the portfolio by 7.3%.
13 WorldReginfo - c16fd361-de53-4169-8c2c-61d95bc8d7cf B. For the sake of caution, I decided to deduct another 15.0% from the standardized value (obtained after making the first adjustment described above), because of a possible rise in the rate of cancellations and redemptions, mainly in life insurance lines.17 13.3.3 The standardized value from new business is NIS 118 million, as shown in Table 5.
13.3.4 I assumed that in the next few years two processes will apply, each of which will offset the impact of the other: A. Income from premiums from new business (mainly from pure risk policies) without a risk component, will increase. B. The rate of insurance profit from new business will fall, mainly as a result of intensifying competition.
13.3.5 I considered the uncertainty involved in estimating the future value of new insurance business, both because of the existence of competitive alternative products and because of regulatory arrangements in the pension and health insurance sectors.
13.3.6 Accordingly, I decided to use a value multiplier of 5 for the value of the new business, as shown in Table 5.
Table 5 – Standardized value of the new business in the Company's life, health and pension insurance as of December 12, 2016 (in NIS millions) Capitalization before risk Value after premium deduction of As reported* additional 6% additional 15.0% VNB 520 139 118 Value according to multiple of 5 5 Total fair value 591
* In the report on embedded value as of December 31, 2016.
13.3.7 The value estimate of the Company's life, health and pension insurance lines, as of December 31, 2016, amounts to NIS 3,132 million, as shown in Table 6. 13.3.8 I brought the value from December 31, 2016 forward to June 30, 2017 at a future value factor of 1.03 (which approximately represents an annual capitalization coefficient of 6%). The result obtained is NIS 3,132 thousand, as shown in Table 6.
Table 6 – Value of life, health and pension lines as of June 30, 2017 (in NIS millions)
Fair value of current insurance portfolios - from Table 4 2,541 Fair value of future insurance portfolio - from Table 5 591 Total 3,132 Progress coefficient from Dec. 31, 2016 to June 30, 2017 1.030 Fair value as of March 31, 2017 3,226
14. Valuation of the non-life insurance business of The Phoenix
14.1 The Company operates in four main non-life insurance segments: a) auto property insurance (Casco); b) compulsory auto insurance; c) other property sectors (mainly comprehensive homeowners insurance, comprehensive business insurance, goods in transit insurance,
17 According to the sensitivity analysis in the embedded value report of December 31, 2016, a rise of 10% in the rate of cancellations (including redemptions and clearances) would reduce the value of the portfolio by 14.6%.
14 WorldReginfo - c16fd361-de53-4169-8c2c-61d95bc8d7cf engineering insurance), and d) other liabilities insurance (mainly results from employers liability, third party liability and professional liability insurance lines).
14.2 Table 7 shows data on the Company's volume of income from premiums, pre-tax profit and insurance reserves (in retention), in each of the four segments of operation in the first six months of each of the years 2017 and 2016 and in each of the years 2013-2016.
Table 7 – Non-life insurance – Income from premiums, reported profit and insurance reserves (in NIS millions)
For six months ended For year ended As of June 30, 2017 December 31 2017 2016 2016 2015 2014 2013 Compulsory auto insurance: Gross premiums 278.9 263.4 481.6 464.8 448.3 424.7 Earned premiums in retention 202.7 226.7 463.1 451.2 425.1 392.6 Pre-tax comprehensive income (loss) in retention 89.9 (23.0) 24.1 148.2 99.6 141.1 Reserve at end of period (in retention) 2,317.1 2,377.1 2,386.5 2,219.5 2,171.0 2,076.2 Auto property insurance Gross premiums 536.2 497.9 973.8 856.4 832.2 821.3 Earned premiums in retention 491.3 432.9 907.7 848.7 823.0 792.2 Pre-tax comprehensive income (loss) in retention 52.0 4.6 8.5 (13.1) 36.0 34.2 Reserve at end of period (in retention) 713.5 713.5 673.8 602.9 566.1 565.9 Other property sectors: Gross premiums 371.9 362.3 656.3 663.5 669.3 662.9 Earned premiums in retention 160.0 159.3 323.7 307.0 296.6 287.7 Pre-tax comprehensive income (loss) in retention 37.1 47.8 90.3 66.6 84.0 24.6 Reserve at end of period (in retention) 262.8 265.1 257.5 261.8 216.7 235.7 Liabilities insurance Gross premiums 224.9 219.6 391.9 381.2 380.5 360.1 Earned premiums in retention 155.0 152.8 313.2 297.9 281.4 270.9 Pre-tax comprehensive income (loss) in retention 16.1 27.7 74.8 69.6 66.5 165.9
Reserve at end of period (in retention) 1,551.2 1,463.4 1,475.5 1,392.3 1,363.7 1,348.9 Total Gross premiums 1,411.9 1,343.2 2,503.7 2,365.9 2,330.2 2,269.0 Earned premiums in retention 1,009.0 971.8 2,007.7 1,904.8 1,826.1 1,743.3 Pre-tax comprehensive income (loss) in retention 195.0 57.0 197.7 271.3 286.0 365.8 Reserve at end of period (in retention) 4,844.7 4,819.0 4,793.3 4,476.6 4,317.6 4,226.7 14.3 A great deal of caution should be used in analyzing the reported results in the compulsory auto and other liabilities lines, because of the following factors: A. The "accumulation" method, which was prevalent in these lines up to and including 2015. By this method, surplus income over expenses less the provision for pending claims ("Accumulation") is not recognized as profit before the end of the third year from the date of the underwriting year of the policies. Pursuant to directives of the supervision of insurance, a real yield of 3% per year is added to the surplus income over expenses (irrespective of actual yield on the investments). As a result of all this, a disconnect was created in the financial statements of the insurance company between the underwriting year and the year in which the profit was recognized, in everything relating to compulsory auto and liabilities insurances. The profit recognized in 2014, for example, actually reflects the profit stemming from underwriting year 2011, together with the investment profits accumulated since 2011, and the additional adjustments in respect of a change in the estimated accumulated cost of claims in respect of prior years.
15 WorldReginfo - c16fd361-de53-4169-8c2c-61d95bc8d7cf B. The Accumulation method was cancelled, and the full amount of the accumulation was "released" to the balance of surpluses of 2015.18 However, commencing from the financial statements as of December 31, 2015, the insurance companies apply a new accounting policy in a "Position of the Commissioner" for an "optimal procedure for calculation of insurance reserves in non-life insurance". Some of the requirements that appear in the Position of the Commissioner are that an assessment of reserves be based on the principle of caution. The significance of this is that the reserves must be calculated in a way that will make it fairly likely that the reserve set in retention will suffice to cover the insurer's liabilities. For pending claims in the compulsory and liabilities lines, the test for "fairly likely" is directed to an estimated likelihood of at least 75% that there will be no shortfall in the reserve at the end of the year. The principle is applied by adding specific margins for conservatism to the reserve (such as a standard deviation). C. As described in section 10.4, the results of operations in the first six months of 2017 were influenced by a rise in the economy's interest curve. The effect of the rise in the interest rate on the decrease in insurance liabilities amounted to NIS 78 million before tax and NIS 51 million after tax. In contrast, and as described in section 10.5, the results of operations in 2016 were influenced materially by an increase in the insurance liabilities in the non-life insurance lines in the amount of NIS 198 million before tax (of which NIS 153 million in the compulsory auto segment and NIS 45 million in the other liabilities segment), and NIS 127 million after tax (of which NIS 98 million in compulsory auto and NIS 29 million in other liabilities), against a backdrop of implementation of the recommendations of the Winograd Commission. D. In the third quarter of 2017 there was a fall in the interest rate curve, which is expected to lead to an increase in the insurance liabilities.
14.4 The reported results in the non-life insurance sector are extremely sensitive to investment profits in the capital market each year.
15. To prepare the forecast for the next periods of operation, the following assumptions were made:
15.1 Compulsory auto insurance 15.1.1 Gross revenues from premiums were NIS 481.6 million in 2016 and NIS 278.9 million in the first six months of 2017. I assumed that the nominal, annual increase in income from premiums will be 5% in 2018, 4% in 2019, and 3% in 2020. These reflect the assumptions for increased premiums in the entire market, where the assumption is that The Phoenix will maintain its relative share (9.8%) in this sector.
15.1.2 In 2017, the Company signed a Quota Share reinsurance agreement and ceded a substantial part of the premiums it collected to reinsurance. I assumed that in the next periods, reinsurance will account for 50% of all gross premiums.
15.1.3 The Company does not publish data for its Loss Ratio (LR) and Combined Loss Ratio (CLR). There is also objective difficulty in “extracting” the LR for the underwriting year from the financial reports. Subject to these limitations, and in light of discussions with the management of Delek and the Company, I assumed that the CLR will be 97.5% in 2017, will increase to 98.5% in 2018, and to 99% in 2019. The expected increase in the LR also reflects deepening competition in the market in this sector, mainly by the direct insurance companies and companies offering price equalization on the internet.
18 In practice, the Commissioner of Insurance allowed the insurance companies to terminate the Accumulation method in financial statements for 2014, provided they applied the optimal custom for calculating the reserves. The Phoenix, like most of the other insurance companies, chose not to do so.
16 WorldReginfo - c16fd361-de53-4169-8c2c-61d95bc8d7cf 15.1.4 I assumed that the Company will receive a reinsurance commission of 26% of the premium transferred to reinsurance. 15.1.5 I considered the composition of the Company’s nostro investment portfolio, and estimated its anticipated yield at 3.0%.19 I therefore assumed that investment profits in the period 2017-2019 will be 3% of the average reserve in retention. I also assumed that due to an anticipated rise in interest rates, the rate of return on the investments will increase to 3.25% from 2020 and thereafter. 15.1.6 Table 8 below presents the projected insurance profit in the compulsory auto sector:
Table 8 - Projected insurance profit in the compulsory auto sector (NIS million)
Jan-June July-Dec 2016 2017 2017 2018 2019 2020 Actual Forecast Gross premiums 481.6 278.9 226.8 531.0 552.3 568.8 Percentage increase compared to prior period 3.6% 5.9% 5.0% 5.0% 4.0% 3.0% Earned premiums in retention 463.1 202.7 111.1 260.2 271.7 281.0 Investment revenues 91.1 51.7 36.2 77.1 80.5 90.3 Income from commissions - 20.6 29.5 69.0 71.8 73.9 Total revenues in retention 554.2 275.1 176.8 406.3 424.0 445.2 Combined Loss Ratio (CLR) 97.5% 98.5% 99.0% 99.0% Expenses in retention 530.1 185.2 137.9 325.3 340.8 352.1 Insurance profit (loss) before taxes 24.1 89.9 39.0 81.0 83.2 93.1
2,386.5 2,317.1 2,505.8 2,631.1 2,736.4 2,818.5 Insurance reserve in retention
15.2 Auto property insurance
15.2.1 Gross revenues from premiums were NIS 973.8 million in 2016 and NIS 536.2 million in the first six months of 2017. Like the assumption regarding the increase in compulsory auto premiums, here too I assumed a nominal, annual increase in income from premiums of 5% in 2018, 4% in 2019, and 3% in 2020. These reflect the assumptions for increased premiums in the entire market, where the assumption is that The Phoenix will maintain its relative share (12.0%) in this sector.
15.2.2 In previous periods, the amount of premiums transferred to reinsurance was negligible and I therefore assumed that in the future too there will be no significant reinsurance arrangements in this sector.
15.2.3 The CLR was 101.6% in 2016 and it declined to 92.5% in the first six months of 2017 (and to 89.6% in the second quarter of 2017). In view of competition in this sector and the data for competing companies, I assumed that the CLR will increase to 97% from 2018 and thereafter.
15.2.4 I assumed a 3% nominal yield on investment of the insurance reserve in each of the years 2017- 2019, increasing to 3.25% from 2020 and thereafter (as noted in Section 15.1.5 above). 15.2.5 Table 9 below presents the projected insurance profit in the auto property sector:
19 To test the reasonability of this assumption, I wish to note that according to publications by Sha’arei Ribit, the nominal yield on A-rated bonds with an average duration of 4 years is 2.96%.
17 WorldReginfo - c16fd361-de53-4169-8c2c-61d95bc8d7cf Table 9 - Projected insurance profit in the auto property sector (NIS million)
Jan-June July-Dec 2016 2017 2017 2018 2019 2020 Actual Forecast Gross premiums 973.8 536.2 486.2 1,073.6 1,116.5 1,150.0 Percentage increase compared to prior period 13.7% 7.7% 2.2% 5.0% 4.0% 3.0% Earned premiums in retention 907.7 491.3 472.6 1,043.6 1,091.6 1,130.7 Investment revenues 22.0 14.8 10.7 21.8 22.7 25.5 Total revenues in retention 929.7 506.1 483.3 1,065.3 1,114.3 1,156.2 Combined Loss Ratio (CLR) 101.6% 92.5% 95.5% 97.0% 97.0% 97.0% Expenses in retention 921.3 454.1 451.4 1,012.3 1,058.8 1,096.8 Insurance profit before taxes 8.4 52.0 31.9 53.1 55.5 59.4
Insurance reserve in retention 673.8 713.5 707.5 742.9 772.6 795.8
15.3 Other property insurance 15.3.1 Gross revenues from premiums were NIS 656.3 million in 2016 and NIS 371.8 million in the first six months of 2017. I assumed a 3% nominal annual increase in income from premiums, attributable to the expected increase for the market as a whole where The Phoenix is expected to maintain its relative share (13.5%). 15.3.2 I assumed that the proportion of reinsurance in the next periods will be 55% of all gross premiums.
15.3.3 The CLR in retention was 75.5% in 2016, increasing to 80.5% in the first six months of 2017 (and to 81.2% in the second quarter of 2017). I assumed that the CLR will stabilize at 81.6% throughout the Forecast Period.
15.3.4 I assumed that the Company will receive a reinsurance commission of 18% of the premium transferred to reinsurance. 15.3.5 Moreover, I assumed a 3% nominal yield on investment of the insurance reserve in each of the years 2017-2019, increasing to 3.25% from 2020 and thereafter (as noted in Section 15.1.5 above).
15.3.6 Table 10 below presents the projected insurance profit in the other property sectors:
Table 10 - Projected insurance profit in the other property sectors (NIS million)
Jan-June July-Dec 2016 2017 2017 2018 2019 2020 Actual Forecast Gross premiums 656.3 371.8 304.2 696.3 717.2 738.7 Percentage increase compared to prior period -1.1% 2.6% 3.0% 3.0% 3.0% 3.0% Earned premiums in retention 323.7 159.9 132.3 313.1 322.6 332.3 Investment revenues 10.6 5.2 4.0 8.1 8.3 9.3 Income from commissions 73.8 39.0 30.1 68.9 71.0 73.1 Total revenues in retention 408.0 204.1 166.4 390.1 401.9 414.7 Combined Loss Ratio (CLR) 75.5% 80.5% 81.6% 81.6% 81.6% 81.6% Expenses in retention 317.7 167.7 138.1 324.4 334.2 344.3 Insurance profit before taxes 90.3 36.4 28.3 65.7 67.7 70.4
Insurance reserve in retention 257.5 262.8 265.3 273.2 281.4 289.9
18 WorldReginfo - c16fd361-de53-4169-8c2c-61d95bc8d7cf 15.4 Other liabilities insurance
15.4.1 Gross revenues from premiums were NIS 391.9 million in 2016 and NIS 224.9 million in the first six months of 2017. I assumed a 3% nominal annual increase in income from premiums, attributable to the expected increase for the market as a whole. 15.4.2 I assumed that the percentage of premiums to be transferred to reinsurance will be 22.0% of gross revenues from premiums. 15.4.3 The Company does not publish data for its Loss Ratio (LR) and Combined Loss Ratio (CLR). There is also objective difficulty in “extracting” the LR for the underwriting year from the financial reports. Subject to these limitations, and in view of discussions with the management of Delek and the Company, I assumed that the CLR will be 110% in 2017, and that it will decrease to 105% in 2020 and thereafter.
15.4.4 I assumed that the Company will receive a reinsurance commission of 5% of the premium transferred to reinsurance. 15.4.5 I assumed a 3% nominal yield on investment of the insurance reserve in each of the years 2017−2017 and that it will increase to 3.25% from 2020 and thereafter.
15.4.6 Table 11 below presents projected insurance profit in other liabilities insurance:
Table 11 - Projected insurance profit in other liabilities insurance (NIS million)
Jan-June July-Dec 2016 2017 2017 2018 2019 2020 Actual Forecast Gross premiums 391.9 224.9 178.8 415.8 428.3 441.1 Percentage annual increase 2.7% 13.4% 3.0% 3.0% 3.0% 3.0% Earned premiums in retention 313.2 155.0 137.3 319.3 328.9 338.8 Investment revenues 57.3 32.3 23.0 46.3 47.7 53.2 Income from commissions 3.9 3.0 2.0 4.6 4.7 4.9 Total revenues in retention 374.5 190.3 162.3 370.2 381.3 396.8 Combined Loss Ratio (CLR) 127% 111% 110.0% 107.0% 106.0% 105.0% Expenses in retention 299.7 174.22 153.0 346.3 353.4 360.6 Insurance profit (loss) before taxes 74.8 16.1 9.3 23.9 27.9 36.2
Insurance reserve in retention 1,475.5 1,551.2 1,519.8 1,565.3 1,612.3 1,660.7
15.5 Projected pre-tax profit from non-life insurance business
Table 12 below shows the projected insurance profit (before tax) from the Company’s non-life insurance business:
Table 12 - Projected pre-tax profit from non-life insurance business (NIS million)
Jan-June July-Dec 2016 2017 2017 2018 2019 2020 Actual Forecast
Compulsory auto (from Table 8) 24.1 89.9 39.0 81.0 83.2 93.1
Auto property (from Table 9) 8.4 52.0 31.9 53.1 55.5 59.4 Other property sectors (from 90.3 36.4 28.3 65.7 67.7 70.4 Table 10) Other liabilities (from Table 11) 74.8 16.1 9.3 23.9 27.9 36.2
Total pre-tax 197.5 194.3 108.5 223.6 234.3 259.1
19 WorldReginfo - c16fd361-de53-4169-8c2c-61d95bc8d7cf 16. Provident activity
16.1 The Group’s provident activity includes management of the provident funds, study funds and central severance pay funds. Up to and including December 31, 2016, this activity was managed partly by The Phoenix Pension and mostly by Excellence Investments.
16.2 From January 1, 2017, all the Group’s provident activity was concentrated with Excellence Gemel, a subsidiary of The Phoenix Insurance.
16.3 Table 13 below, shows key data from the financial results of the provident sector, as included in the Company’s Periodic Reports:
Table 13 - Provident activity - Condensed Data (NIS million)
For six months ended For year ended June 30 December 31 2017 2016 2016 2015 2014 Volume of assets under management 27,800 26,300 27,249 25,451 23,201 Benefit contributions 1,564 1,154 2,321 1,582 1,360 Revenues from management fees 93 90 188 193 190 Operating expenses 77 81 165 169 165 Profit before amortization of goodwill 16 9 23 24 25 Amortization of goodwill - - - 21 7 Pre-tax profit 16 9 23 3 18
16.4 In the first six months of 2017, revenues from management fees and profit from provident activity increased significantly compared with the corresponding period last year. This is in contrast with the trend that emerged in 2014−2016, when there was a gradual erosion of profit (before depreciation for goodwill) despite the continuing increase in assets under management, mainly as a result of declining management fees.
16.5 The Company’s Board of Directors explained that the increased revenues and profit from provident activity is mainly attributable to changes in the yields of the performance-linked provident funds and the effect of the growth of the managed asset that was offset from the ongoing decline in management fees. Furthermore, in 2017, general and administrative expenses in provident activity declined compared with the previous year, mainly due to streamlining and taking advantage of economies scale following the restructuring described in Section 11 above.
16.6 Under these circumstances, I assumed that pre-tax profit from The Phoenix’s provident activity will stabilize at NIS 30 million from 2018 and thereafter, as detailed in Table 14 below:
Table 14 - Projected profit from provident activity Jan - July July-Dec 2016 2017 2017 2018 2019 2020 Actual Forecast
Pre-tax profit 23 16 15 30 30 30
17. Financial services segment
17.1 General
17.1.1 The Phoenix operates in the financial services sector through Excellence. Excellence Investments Ltd. is a public company whose shares were listed on the Tel Aviv Stock Exchange (TASE) until June 1, 2016.. The Phoenix then performed a complete tender offer for all its shares and Excellence became a private company wholly owned by The Phoenix. Excellence operates through
20 WorldReginfo - c16fd361-de53-4169-8c2c-61d95bc8d7cf companies that it controls (henceforth, for the sake of convenience, to be called “Excellence”) in a variety of activities in the capital market sector, the most important of which are: (1) investment management (management of mutual funds, and management of investment portfolios for other customers); (2) underwriting and investment banking; (3) the issuance of financial products (mainly ETNs); (4) TASE and trading services; (5) the sale of related products, including through insurance agencies that it established. 17.1.2 Until December 31, 2016, Excellence engaged in the management of provident funds through Excellence Nessuah Gemel Ltd ("Excellence Gemel"). On January 1, 2017, Excellence distributed a dividend in kind of Excellence Gemel shares as part of a re-organization of the pension and provident activity of The Phoenix Group, and from that date on, Excellence Gemel is held directly by The Phoenix Insurance. 17.1.3 A valuation of the provident activity that was previously managed by Excellence is discussed in Section 16 above.
17.2 Table 15 below presents key data on activity in this sector in the four years 2013−2016.
Table 15 - Financial services segment - key data (NIS million)
For year ended December 31 2016 2015 2014 2013 Investment management Total revenues 108 156 154 148 Operating profit net of minority interests 6 8 21 14 Underwriting and investment banking Total revenues 14 10 10 14 Operating profit net of minority interests 7 4 4 7 Issuance of ETNs and deposit certificates Total revenues 146 125 134 122 Operating profit net of minority interests 68 55 70 54 TASE Member and trading services Total revenues 72 58 48 49
Operating profit net of minority interests 23 13 13 15 Total revenues 340 349 346 333 Operating profit net of minority interests 104 80 108 90 Adjustments (8) 17 11 (18) Segment profit, before tax* 96 97 119 72 * As reported in Note 3 (Operating segments) of the Company.
17.3 In the first six months of 2017, pre-tax profit in this segment was NIS 53 million, as against profit of NIS 65 million in the corresponding period last year. In the reviewed reports as of June 30, 2017, the Company did not include details of its revenues in each of the operating sectors listed in Table 14 above.
17.4 Projected profit in the investment management sector
17.4.1 General
This sector includes two principal activities:
A. Portfolio management.
B. Management of mutual funds.
17.4.2 The portfolio management activity was not profitable and even caused operating losses in each of the four years 2013−2016.
17.4.3 As of December 31, 2016, Excellence managed assets of NIS 14,196 million in its mutual funds.
21 WorldReginfo - c16fd361-de53-4169-8c2c-61d95bc8d7cf 17.4.4 Excellence manages three different categories of mutual funds with different profit characteristics:
A. Traditional funds (about 55.2% of the assets of the managed funds - as of December 31, 2016). Excellence’s market segment of the assets in the traditional funds was 4.7%. B. Money market funds (about 17.7% of the assets of the managed funds - as of December 31, 2016). Excellence’s market segment of the assets in the traditional funds was 14.3%. C. Tracker funds (about 27.1% of the assets of the managed funds - as of December 31, 2016). Excellence’s market segment of the assets in the traditional funds was 13.5%.
17.4.5 In 2013-2016, the management fees rate in the traditional funds was stable, varying from 0.80% to 0.84%. In contrast, management fees in the money-market funds at the end of 2016 were just 0.17%. In 2013−2016, the average management fees in the tracker funds were 0%. At the end of 2016, the collection of management fees was introduced on the tracker funds at an average rate of 0.15%. 17.4.6 I assumed that as a result of the collection of management fees in the tracker funds, the streamlining and rationalization in the portfolio management sector, the Company will gradually be able to increase its revenues in this sector from NIS 6 million in 2016 to NIS 10 million in each of the years 2019 and 2020.
17.5 Projected profit in the investment banking and underwriting sector
17.5.1 General
Excellence provides underwriting, management, advice and distribution services for public and private placements of securities in Israel, and is involved in securities transactions and other investment banking activity. The Company’s business also includes participation in managing issuances and it serves as manager of a consortium of underwriters or distributors and/or as underwriter or distributor. 17.5.2 Underwriting activity is highly dependent on key personnel and is strongly affected by capital market fluctuations and regulatory risks. Consequently, in recent transactions in the capital market, the value of underwriting companies was determined according to their balance sheet value.20 17.5.3 Nevertheless, I assumed that as a result of the restructuring, the Company will able to maintain its profits in this sector over the coming years.
17.6 Issuance of ETNs and deposit certificates
17.6.1 General
Over the past decade, ETNs have become an extremely popular investment instrument in Israel. At the end of 2016, some 690 ETNs are traded in Israel. The volume of the ETN market (including reciprocal holdings) was NIS 111.7 million at the end of 2016 (a decline of NIS 6.6 billion compared with 2015).21 After adjustment for the reciprocal holdings, the volume of the ETN market was NIS 96.2 million (see also Section 17.6.2 below).
20 See for example an immediate report of Clal Finance Ltd. dated December 9, 2013, on the sale of its outstanding holdings in Clal Finance Underwriting Ltd., about 10% to a company wholly owned by Mr. Tzachi Sultan; an immediate report by Analyst dated March 20, 2011 on the sale of its share in Analyst Underwriting and Issuing Ltd.; an immediate report of the First International Bank dated March 23, 2011 on the purchase of 20% from Leader Capital Markets. Notably, in another transaction, in which 7.24% of the shares of Clal Finance Underwriting were sold, the sale took place according to market cap that reflects 145% of the equity. In October 2016, Leader Capital Markets sold its holdings in Leader Issuances, where the consideration for the transaction was set according to shareholders equity. 21 Source: Bank of Israel figures.
22 WorldReginfo - c16fd361-de53-4169-8c2c-61d95bc8d7cf Deposit certificates are a financial instrument similar to the money-market funds. However, due to the low interest rates currently prevailing in the market, the issuance of deposit certificates has almost entirely discontinued.
17.6.2 The ETN market, in which only four companies operate, is highly concentrated, as follows: Assets under Issuer management (NIS billion) Market segment Meitav Dash (Tachlit) 28.2 29.3% Excellence (KSM) 27.8 28.9% Psagot 26.9 28.0% Harel 13.2 13.8% Total 96.2% 100.0% Source: Association of ETF Companies.
17.6.3 Restrictions on management fees
Institutional investors generally purchased ETFs in large quantities. This ostensibly created a problem of double management fees: the member pays the management company management fees for its professional management and operating services, and the management company purchases ETNs and pays additional management fees that are then passed on to the member.
In July 2012, the Supervision of Financial Services (Provident Funds) (Direct Expenses on account of Transactions) (Amendment) Regulations, 2011, entered into force, stipulating, inter alia, that financial institutions will not be allowed to collect management fees directly from members’ assets for investments in ETNs that track indices in Israel.
After the regulations were published, and following a request from the Association of ETFs, the Ministry of Finance approved collection to cover expenses only, at a rate that will not exceed 0.1% of the note’s fair value.
To prevent the financial institutions from performing large-scale withdrawals of investments in ETNs, the ETF companies reached agreement with the financial institutions so that they would refund their management fees and absorb this cost.
In April, the regulations were amended as a result of which the Commissioner of the Capital Market issued an amendment permitting further collection of direct expenses for ETNs that track Israeli indices, at a rate of 0.1%.22
The amendment refers to ETNs that track an index which is not one of the following: TA-25, TA- 100, Bond Index, index that tracks companies in the financial services sector, index that comprises less than 15 companies, an index in which more than 50% of the weight of the securities is in respect of companies included in the TA-25 index.23
These regulations adversely affect the profits of the ETN companies, that will be obligated to lower the management fees collected from the provident funds on some of the ETNs, to prevent the diversion of provident fund investments to other channels.
17.6.4 Amendment No. 21 to the Joint Investment Trust Law, 1994 (“Amendment 21”) In July 2012, the Knesset passed a first reading of Amendment 21, the main points of which are to place the ETN sector under the purview of the Securities Authority, by equalizing the regulations that apply to ETNs with those applicable to mutual funds.
22 All this, subject to a limitation that the total management fees to be passed on to the member will not be more than 0.25% of the assets under management. 23 The provisions have not yet been updated to correspond with changes in the TASE indices.
23 WorldReginfo - c16fd361-de53-4169-8c2c-61d95bc8d7cf Amendment 21 regulates a new financial instrument - “ETF” - a closed tracker, mutual fund, which can be traded throughout the trading day (unlike tracker funds that are not listed on the stock exchange and can be bought and sold once a day).
Furthermore, Amendment 21 allows ETN issuers to hold a maximum market segment of 25% of the total ETN market, and 20% of the aggregate market for ETNs and mutual funds together.
17.6.5 ETN rating system
In 2014, the large banks launched new systems for rating investments in ETNs, that take into account parameters that were previously difficult to measure, such as the declared and effective management fees, the quotation spread on which each note is traded and the prices of the transactions relative to fair value, and the frequency of extraordinary events in relation to management of the note. We expect that the system will lead to greater transparency and competition in this sector.
17.6.6 In view of the regulatory and institutional changes described in Sections 17.6.3 − 17.6.5, I expect the Company’s revenues in this area of activity to decline in forthcoming years. It is not inconceivable that another issuer will join the market. In my opinion, the operating profit (net of minority interests) will gradually decline from NIS 68 million in 2016 to NIS 40 million in 2020.
17.7 TASE Member and trading services
17.7.1 General
Performance services in the TASE and regulated markets are affected by the capital market in Israel and around the world, by the volumes of trade on the TASE and fluctuations in the prices of securities.
Revenues from brokerage activity are attributable to performance fees, which include mainly sale and purchase commissions from which commissions paid to the TASE are subtracted, and interest rate margins for credit provided to customers for the purpose of performing securities activity.
17.7.2 TASE and trading services are subject to tight regulatory supervision. Furthermore, there is a regulatory requirement for minimum equity, a requirement which to the best of my knowledge does not constitute an effective restriction to the Company’s activity. 17.7.3 Under these circumstances, I assumed that Excellence will be able to maintain the same level of pre-tax operating profit that it attained in 2016.
17.8 Summary of the profit forecast for the financial services segment
17.8.1 Table 16 below presents the profit forecast for the financial services segment: The Phoenix’s own forecast shows amounts that are 1.5 times higher in view of the streamlining plan that it has already introduced
Table 16 - Projected (pre-tax) profit in the financial services segment July-Dec 2016 2017 2018 2019 2020 Actual Forecast Investment management 6 4 9 10 10 Underwriting and investment banking 7 3 6 6 6 Issuance of ETNs 68 30 55 48 40 TASE Member and trading services 23 12 24 25 25
Total 104 49 94 89 81
24 WorldReginfo - c16fd361-de53-4169-8c2c-61d95bc8d7cf 17.8.2 It is emphasized: Profits in the financial services segment do not include pension activity (which is included in the EV calculation (as noted in Section 13 above), and provident activity which was estimated separately (as noted in Section 16 above)).
18. Investment profit and financing income not attributed to the segments of operation
18.1 The Phoenix Insurance has financial investments and cash balances and cash equivalents that are not attributed to the segments of operation.
18.2 Table 17 below presents data about the sum of the unattributed investments and cash balances and the profits they generated, which are included in the financial statements of The Phoenix Insurance in each of the four years 2013-2016 and in the first six months of 2017.
Table 17 - Financial investments, investment profit and financing income not attributed to the segments of operation (NIS million)
Jan - July 2017 2016 2015 2014 2013 Financial investments 3,067 2,686 2,240 1,916 2,021 Financial revenues 69 121 41 75 200
18.3 I assumed a 3% nominal yield on these financial investments in each of the years 2017-2019 which will increase to 3.25% from 2020 and thereafter (as noted in Section 15.1.5 above).
18.4 Table 18 below presents the projected investment profit and financing income expected to stem from the unattributed financial investments of The Phoenix Insurance.
Table 18 - Financial investments, investment profit and financing income not attributed to the segments of operation (NIS million)
January - July July-December 2016 2017 2017 2018 2019 2020 Actual Forecast Financial revenues 121 69 46 92 92 100
19. General & administrative expenses not attributed to the segments of operation
19.1 Those general and administrative expenses not attributed to the segments of operation that we reviewed above must be subtracted from the Company’s future cash flows.
19.2 These are the unattributed general and administrative expenses included in the consolidated financial statements of The Phoenix Insurance, together with the general and administrative expenses included in the separate financial statements of The Phoenix Holdings Ltd.
19.3 Table 19 presents data for the unattributed expenses in Q1 2016 and 2017, and in each of the years 2013−2016.
Table 19 - Unattributed general & administrative expenses (NIS million)
For six months ended For year ended June 30 December 31 2017 2016 2016 2015 2014 In The Phoenix Insurance reports 17.9 15.0 37.9 38.4 33.2 In The Phoenix separate reports Holdings 1.6 1.2 2.6 2.4 3.2 Total 19.5 16.2 40.5 40.9 36.4
25 WorldReginfo - c16fd361-de53-4169-8c2c-61d95bc8d7cf 19.4 I assumed that these general and administrative expenses will increase by a nominal, annual 3% throughout the forecast period, and as noted in Table 20 below:
Table 20 - Forecast for general and administrative expenses not attributed to segments of operation (NIS million) Jan-June July-Dec 2016 2017 2017 2018 2019 2020 Actual Forecast
Expenses 41 20 22 43 44 46
20. Financing expenses for subordinated liability notes recognized as hybrid tier-2 and tier-3 capital:
20.1 As of June 30, 2017, the outstanding subordinated liability notes recognized as hybrid tier-2 and tier-3 capital is NIS 2,216 million.
20.2 These liability notes are to be settled in at least eight years. I assumed that when the repayment date is reached, they will not be settled but replaced (will be refinanced under similar interest conditions) so that the amount of recognized tier-2 and tier-3 capital will not be reduced.
20.3 It therefore follows that the Company will meet the financing expenses of these liability notes in coming years, as detailed in Table 21 below. To estimate the financing costs, I assumed that the rate of inflation in the second half of 2017 will be 0.2% and from 2018 and thereafter it will be 1.5%.
Table 21 - Forecast for financing expenses for subordinated liability notes which constitute hybrid tier-2 and 3 capital (NIS million)
Jan-July July-Dec 2016* 2017* 2017 2018 2019 2020
72 34 42 95 108 122
21. Tax rate
21.1 The Phoenix Insurance is a financial institution according to its meaning in the VAT Law.
21.2 The statutory tax rates applicable to financial institutions are: 35.04% in 2017 and 34.19% from 2018 and thereafter.
21.3 I assumed that The Phoenix’s profits in the future will be liable for tax at these statutory rates.
26 WorldReginfo - c16fd361-de53-4169-8c2c-61d95bc8d7cf 22. Projected profit from the insurance agencies The Phoenix Insurance holds several significant insurance agencies that are incorporated as companies under The Phoenix Insurance Agencies (1989) Ltd., and listed in Table 22 below:
Table 22 – Insurance agencies held by The Phoenix Insurance Company name % holding Shekel Insurance Agency (2008) Ltd. 100% Agam Leaders (Israel) Insurance Agency (2003) Ltd.* 70% Kela Insurance Agency (1967) Ltd.** 85% The Employee Benefit Experts, Benefits Ltd. 100% Cohen-Givon Insurance Agency Ltd. 52% Ramon Granit Insurance Agency (1994) Ltd.*** 50% Oren Mizrach Insurance Agency Ltd. 50% * Directly and indirectly through Agam Leaders Holdings (2001) Ltd. The Company has an agreement that, under certain conditions, allows it to purchase the remaining shares. ** The Company has an agreement to purchase the remaining shares. *** Directly and indirectly through Granit Insurance Agency HISH (1991) Ltd.
22.1 In the first six months of 2017, the share of The Phoenix in the profit after tax of these companies amounted to NIS 35.6 million. In the whole of 2016 The Phoenix share in the profits of these companies was NIS 65.1 million, compared with NIS 54.0 million in 2015 and NIS 59.0 million in 2014.
22.2 In my estimation, the profitability of The Phoenix Insurance Agencies will be affected in the future by the following factors:
A. A rise in the volume of income from commissions in the sale of executive insurance (in lieu of pension) products, and regulatory changes enabling agencies to collect handling fees from the employers. B. More extensive use of the Internet, which will eventually harm income from commissions.
C. Insurance agencies will focus their efforts on marketing risk-only policies and investment policies.
22.3 Balancing out these considerations, I assumed that the profit of The Phoenix Insurance Agencies will increase over the Forecast Period by a nominal 2% per year.
22.4 Table 23 shows the profit projections for The Phoenix Insurance Agencies.
Table 23 – Projection for profit (after tax) of The Phoenix Insurance Agencies, in NIS millions July-Dec 2016 Jan-June 2017 2018 2019 2020 Actual Forecast
Share of agencies profits 65 36 31 68 69 70
23. Discount rate
23.1 As in the previous report, I assumed that operations would be financed entirely by equity of The Phoenix – 60% Tier 1 capital and 40% Tier 2 capital (and see section 12.2.2 above).
23.2 I estimated the price of the Tier 1 capital using the Capital Asset Pricing Model (CAPM), in which Ke = Rf + β*(Rm-Rf),
Where:
Ke - Price of equity Rf - Risk-free interest rate
27 WorldReginfo - c16fd361-de53-4169-8c2c-61d95bc8d7cf Rm-Rf - Market's risk premium
β - Systemic risk factor – the ratio of the risk that cannot be decentralized of the share to the standard deviation of the market portfolio. This factor expresses the measure of sensitivity of the yield on the share to changes in the yield rate of the market portfolio.
23.3 At the end of September 2013, the nominal yield rate on risk-free assets for a 12-year range, as derives from the publications of Interest Rates Co., was 2.25%. The systemic risk factor of The Phoenix is 1.134;24 the accepted risk premium in the Israeli capital market is 6.60%.25 These data, using the CAPM formula, give an equity price of (2.25% + 1.134*6.60%=) 9.73%.
23.4 On October 24, 2017, Maalot ratified the financial strength rating of The Phoenix Insurance – ilAA+/stable and the rating of the issuer of The Phoenix Holdings – ilA+/stable. Midroog reported at the end of June 2017 on rating action in which it set a rating of Aa3il (with stable outlook) for an issue of subordinated promissory notes (series H) to be issued by The Phoenix. In addition, Midroog kept a rating of Aa1.il for the financial strength of the company (IFS), and also ratings of Aa2.il(hyb) for the subordinated promissory notes of the Company (Tier 2 capital inferior and Tier 3 hybrid), and a rating of Aa3.il(hyb) for the subordinated promissory notes (hybrid Tier 2 capital) that were raised through The Phoenix Capital Raising. The outlook of the rating is stable.
23.5 Even though Midroog's rating of Aa3 (corresponding to AA) for the subordinated promissory notes is higher than that of Maalot, I decided, for the sake of caution, to adopt Maalot's lower rating of A+. The yield rate required for debt rated A+ for a period of 12 years, according to the publications of Interest Rates for the non-tradable market, was, at the end of September 2017, 4.12%. Deducting the tax shield of 34.19%, I found that the debt price is [4.12%*(1.34.19%)=] 2.72%.
23.6 The weighted average cost of capital (WACC) of The Phoenix is therefore (9.73%*60%+2.72%*40%=) 6.93%.
23.7 I decided that the estimated fair value of the operations needed a risk premium of 3.5% added to the WACC, as I did in my previous opinion. This premium reflects also the regulatory risks stemming from operations in a supervised market, and from the claim that there is a bubble in the bonds market due to the low interest rate environment, and other risks.
The weighted cost of capital including a risk premium is (6.93 + 3.5%) = 10.43%, rounded to 10.5%.
24. Assumption of growth rate for retention flow I assumed that the retention flow for the years 2021 onwards would increase by a nominal annual rate of 1.0%. Noting the inflation rates as projected today, this assumption does not foresee real growth of profits from 2021 onwards.
25. Estimated value of operations in the segments of operation and in other areas of the Company's operations
25.1 Table 24 shows expected profits from the segments of operation / other areas of the Company (excluding the life, pension and health segment), and including unattributed income from financial investments and net of unattributed general and administrative expenses, capitalized as of June 30, 2017.
24 An examination based on 104 weekly observations in the two years ended September 30, 2017. The average beta of the five largest insurance groups in Israel (Migdal, Clal Insurance, Harel, The Phoenix and Menorah), calculated in a similar way, is 1.195. 25 Data published on the Damodaran website at the beginning of 2017.
28 WorldReginfo - c16fd361-de53-4169-8c2c-61d95bc8d7cf 25.2 The capitalization expenses indicate a value of NIS 2,884 million as of June 30, 2017.
Table 24 – Estimated value of operations (excluding the life, pension and health insurance segment) in NIS millions
Jan-July July-Dec Segment / sector 2016 2017 2017 2018 2019 2020 2021 Actual Forecast and thereafter Non-life insurance - from Table 12 198 194 108 224 234 259 Provident - from Table 14 23 16 15 30 30 30 Financial services - from Table 16 16 53 49 94 89 81 Financial revenues - from Table 18 121 69 46 92 92 100 Unattributed expenses - from Table 20 (41) (20) (22) (43) (44) (46) Financing expenses* - from Table 21 (72) (34) (42) (95) (108) (122) Interim amount 245 278 154 302 293 302 Net of applicable tax (A) 54 103 100 103 100 199 193 199 Agencies - from Table 23 65 36 31 68 69 70 Profit after tax 131 266 262 269 269 Capitalization coefficient (B) 0.975 0.905 0.819 0.741 7.802 Capitalized amount 128 241 215 200 2,101
Total 2,884 (a) Capitalization at 10.5%. (b) In calculating the retention flow a growth rate of 1% was assumed.
26. Estimated value of the Company's holdings in additional companies
26.1 Value of holdings in Ad 120
26.1.1 The Company holds 100% of the capital of Ad 120, a private company in the protected housing market.
26.1.2 The investment in Ad 120 appears in the Company's financial statements as of June 30, 2017 at a book value of NIS 579 million, compared with NIS 565 million in the financial statements as of December 31, 2016. Most of the book value stems from investment real estate, which is included in those financial statements at its fair value, backed up by the valuation of an external appraiser.
26.2 Value of holdings in Gamma Management and Clearing Ltd. ("Gamma") 26.2.1 The Phoenix holds (through The Phoenix Investments Ltd., a wholly-owned subsidiary), 49% of the shares of Gamma.
26.2.2 The investment in Gamma appears in the Company's financial statements as of June 30, 2017 at a book value of NIS 69 million, compared with NIS 68 million in the financial statements as of December 31, 2016.
26.3 Value of holdings in Phoeniclass Ltd.
26.3.1 The Phoenix holds (through The Phoenix Investments Ltd.), 66.7%26 of the shares of Phoeniclass. 26.3.2 Phoeniclass entered into an agreement with Seminar Hakibbutzim (a teacher training college), in which a combination transaction was agreed between the two parties concerning land owned by Seminar Hakibbutzim in north Tel Aviv. Phoeniclass is currently working to advance the licensing and detailed planning proceedings of the project, while negotiating with Seminar Hakibbutzim on a final agreement of the principles of the transaction and bringing it to fruition.
26.3.3 The investment in Phoeniclass appears in the Company's financial statements as of June 30, 2017 at a negative book value of NIS 14 million, and at a similar negative value in the financial
26 The Company has voting rights with other controlling shareholders in the company.
29 WorldReginfo - c16fd361-de53-4169-8c2c-61d95bc8d7cf statements as of December 31, 2016. I was told by management at Delek that Phoeniclass is expected to benefit, in the near future, from profit of more than NIS 40 million as a result of exercise of its rights. For the sake of caution, I decided to include the investment in Phoeniclass at its (negative) book value as of June 30, 2017, and not to give expression to the expected profit.
26.4 Value of holdings in Mehadrin
26.4.1 The Company holds, through The Phoenix Investments, 41.42% of the share capital of Mehadrin, which is a public company traded on the TASE. 26.4.2 The market value of the investment as of June 30, 2017 was NIS 239 million, compared with NIS 245 million as of December 31, 2016.
26.5 Table 25 shows the value of the investment in the four companies mentioned above.
Table 25 – Investments in other companies
June 30, Dec 31, 2017 2016
Ad 120 579 565 Gamma Management and Clearing Ltd. 69 68 Phoeniclass Ltd. (14) (14) Mehadrin 238 244 Total 871 863
27. Financial liabilities Table 26 shows the financial liabilities of the Company as of June 30, 2017, which I deducted from the amount of the valuation at a liability value of NIS 3,050 million.
Table 26 – Financial liabilities (in NIS millions)
June 30, Dec 31, 2017 2016
Subordinated liability notes* 130 130 Bonds 588 670 Interest owed 34 12 Other** 83 67
Total 834 879 * Subordinated liability notes that are not hybrid second or third tier capital. ** Mainly option to acquire an investee company.
28. Other liabilities I subtracted from the valuation amount the Company's other liabilities (employee benefits – NIS 39.4 million; other accounts payable – NIS 192.0 million, and current taxes – NS 25.5 million) in the amount of (39.4+192.0+25.5=) NIS 257 million.
29. Special provision
29.1 A large number of legal claims are pending against the Company, as they are against all the leading insurance companies in Israel. These include applications for certification of class action suits. In their letter of opinion on the financial statements of the Company, the auditors include a reference to uncertainty because of these claims.
29.2 To the best of my understanding, any reasonable buyer will consider possible losses in respect of these claims, and will demand a price adjustment and/or an indemnity arrangement.
30 WorldReginfo - c16fd361-de53-4169-8c2c-61d95bc8d7cf 29.3 Accordingly, I decided to include in the valuation a special provision of NIS 350 million (after tax) in respect of these contingent liabilities and in respect of topping up the insurance reserves for additional actuarial changes that might be required in the future in the wake of regulatory changes.
30. Financial assets
30.1 The separate balance sheet of The Phoenix Holdings as of June 30, 2017 included "available" financial assets (meaning assets that are not attributed to the segments of operations) in the amount of NIS 58 million.
30.2 I added to the valuation amount the balance of the available financial assets – NIS 58 million.
31. Summary of the valuation by the discounted cash flow method (DCF)
31.1 Table 27 shows the valuation by the (mixed) DCF method.
31.2 The valuation indicates a fair value for investment of NIS 2,925 million at a holdings percentage of 42.26% and NIS 2,651 million at a holdings percentage of 7.35%. As of June 30 2017, these sums constitute 105.7% of the balance sheet value of the investment.
Table 27 – Valuation by the DCF method (in NIS millions)
See above NIS million in Table / Section Life insurance segment 3,226 Table 6 Additional segments of operation 2,884 Table 24 Value of investees 871 Table 25 Financial assets 58 Section 30 Financial liabilities (834) Table 26 Other liabilities (257) Section 27 Special provision (350) Section 29 5,598
Delek Group’s share 47.35%
Fair value of Delek’s investment 2,651
32. Sensitivity analysis
32.1 I analyzed of the sensitivity of the results of the valuation to changes of 0.5% in the discount rate (in the range between 9.5% and 11.5%), and to changes of 0.5% in the growth rate of the retention flow (in the range between 0.0% and 2.0%).
32.2 The results of the sensitivity analysis are shown in Table 28.
Table 28 – Sensitivity analysis of the value of the investment (in NIS millions) to changes in the discount rate and the cash flow growth rate Growth rate Capitalization rate 9.50% 10.00% 10.50% 11.00% 11.50% 0.00% 2,684 2,617 2,556 2,500 2,450 0.50% 2,740 2,667 2,601 2,541 2,486 1.00% 2,804 2,723 2,651 2,585 2,526 1.50% 2,875 2,786 2,706 2,634 2,570 2.00% 2,956 2,856 2,768 2,689 2,618
31 WorldReginfo - c16fd361-de53-4169-8c2c-61d95bc8d7cf 33. Probability test
33.1 As shown in Table 3, the "economic capital" of The Phoenix Insurance as calculated for SCR, as of December 31, 2016, was NIS 5,835 million. As I understand it, this sum (subject to the necessary adjustments described below) can be a significant indication of the fair value of the Company.
33.2 The calculated economic capital includes also the subordinated promissory notes that constitute hybrid Tier 2 and Tier 3 capital. The balance of the subordinated promissory notes as of June 30, 2017 was NIS 2,126 million, as shown in Table 25. Accordingly, in order to estimate the fair value of the Company, that sum should be subtracted from the calculated economic capital.
33.3 The surplus part of the Company's shareholders in the equity of The Phoenix Holdings over the balance of the part of the Company's shareholders in the capital of The Phoenix Insurance, should be added to these amounts, i.e. NIS 1,435 million. Adding these three amounts together teaches of a value of NIS 5,094 million, as shown in Table 29.
33.4 Because the calculated economic capital does not include the value of the new business in life, health and pension insurance, for comparison purposes the sum of NIS 591 million that was attributed in the valuation to the value of new business must be subtracted from the amount of the valuation. The adjusted amount for comparison is NIS 5,007 million (98.5% of the amount of the adjusted calculated economic capital).
Table 29 – Probability test (in NIS millions)
Current “economic” capital in The Phoenix Insurance according to Solvency II 5,835 Net of - subordinated liability notes that constitute tier-2 and 3 capital (2,216)
Plus: balance sheet value of The Phoenix Holdings investments in other companies 1,465 Total 5,084
Results of the valuation (as detailed in Table 26 above) 5,598 Net of future value of life insurance, pension and health business (591) Total 5,007
33.5 Also to be considered is that the amount of the calculated economic capital is correct for December 31, 2016, and does not include the effect of the business operations of The Phoenix Insurance and their results in the first six months of 2017 on the mix of investments and on the insurance liabilities, and the exogenic effects such as a change in the interest rate curve and regulatory changes that impact the business environment.
34. Value of the holdings as derives from the offers made to acquire control in The Phoenix
34.1 As described in sections 2.4 – 2.12 above, the Company has negotiated with several foreign companies that expressed interest in acquiring control in The Phoenix. The consideration for that control as discussed in those offers ranged between 87.5% and 95% of the equity attributed to the shareholders of the Company.
34.2 It should be emphasized that as described in section 2.6, the negotiations with Fuson reached the stage of a binding agreement. It can be assumed that had the approval of the Commissioner of the Capital Market, Insurance and Savings been given, the deal would have been closed and the value
32 WorldReginfo - c16fd361-de53-4169-8c2c-61d95bc8d7cf of the Company as derives from it would have been close to 90% of the equity of The Phoenix (as of September 30, 2015 and before transaction costs). The same is true of the agreement with Yango Group, which also reached a binding agreement, as noted in section 2.10.
34.3 The Commissioner is currently reviewing the offer of Sirius (see section 2.2). The consideration in the transaction was set at 90% of the equity of The Phoenix according to its financial statements as of June 30, 2017.
34.4 We can learn from this that the fair value of the Company, i.e. the price that would be paid for the sale of the holdings in The Phoenix as a whole, by relevant participants in the market at the time of the measurement, would reflect a value in a range between 87.5% and 105.7% of the equity attributed to the Company's shareholders (before transaction costs).
35. Remarks on the gap between the market value of the investment and the results of the valuation of the investment in this opinion
35.1 The market value of the investment of Delek Group in The Phoenix, as of June 30, 2017, was NIS 1,938 million. This is 6.7% lower than the sum at which the investment is included in the books of Delek Group, which is based on a last transaction value of NIS 2,076 million.
35.2 Distinguished scholar Prof. Aswath Damodaran, who is seen today as one of the outstanding and most quoted authorities on valuations, discussed the difference between the intrinsic value and the price quoted on the stock exchange – Price Versus Value. The gap between price and value can go in two directions: sometimes the quoted prices are higher than the economic value of the company, and sometimes the opposite is true. Among the causes of the difference, Damodaran cites problems such as lack of information, liquidity, and corporate governance.
35.3 In my opinion, in the case before us here, there is indeed a significant gap between the share price of The Phoenix and its economic value.
35.4 Therefore it should come as no surprise that the various investors who looked at the purchase of Delek's shares in The Phoenix, as described in sections 2.4 – 2-12, "ignored" the quoted share price of the Company and saw the equity datum as a significant indication for the value of the Company.
35.5 Because it can be assumed in the case before us that Delek Group will aspire to sell its investment in The Phoenix in one transaction, or alternatively to sell a block of shares that will grant effective control in The Phoenix, this means that for reviewing the fair value of the investment as a whole, the value data deriving from the acquisition offers addressed to the Company are more relevant, as I see it, than the quoted share price.
33 WorldReginfo - c16fd361-de53-4169-8c2c-61d95bc8d7cf Summary of the opinion
36. Based on my examination, as of June 30, 2017 the fair value of Delek's investment in The Phoenix is between NIS 2,200 million (before transaction costs) and NIS 2,651 million.
37. I am aware that you wish to use my opinion for preparation of the financial statements of Delek Group as of September 30, 2017, and if necessary also to attach it to the financial statements and publish it, and I give my consent.
38. I wish to note that I have no personal interest in the shares of the companies named in this report. In addition, the payment I receive for preparing it is not contingent upon the results of the valuation.
39. I would add that to the end of 2008, I served as a member of the "extended nostro" investment committee of The Phoenix and that in the past I prepared a number of economic/accounting opinions for The Phoenix Group and for companies under its control on an ad hoc basis. In 2010 I prepared a fairness opinion for Delek Group on Delek Motorway Services, and in 2013 I prepared an economic opinion for Delek on a class action and in connection with a motion for assessment relief filed against the Company following a full tender offer for the shares of Gadot Biochemical Industries Ltd. In addition, I have prepared in the past, on an ad hoc basis, a number of economic opinions for companies in Delek Group, including Delek The Israel Fuel Co. Ltd. and Gadot Biochemical Industries Ltd.
Sincerely, Prof. Yoram Eden, CPA
34 WorldReginfo - c16fd361-de53-4169-8c2c-61d95bc8d7cf Appendix A – Prof. Yoram Eden, CPA
The following are details of my education and professional experience:
Academic education: Full professor, academic track, Administration College
Ph.D. in accounting and financing – Tel-Aviv University
MBA (cum laude) – Tel-Aviv University B.A. in accounting – Tel-Aviv University
B.A. in economics – The Hebrew University of Jerusalem
Training and academic and professional activities: 2.1 Academic activities:
Between 2013 and 2016 I served as Vice President for academic matters in the Academic Track, the Management College. Between 2000 and 2007 I served as dean of the School of Business Administration, the Academic Track, the Management College.
Guest lecturer in Baruch College, City University of New-York. Academic editor of the "Accountant" periodical since October 1991.
Between 2000 and 2006 I served as a senior member of the academic staff on the Auditor's Council. I presently chair the examinations committee of the Auditor's Council.
Between 2000 and 2004, I served as a member of the Education Committee of IFAC (International Federation of Accountants). I have published numerous articles in the professional press and academic periodicals in Israel and overseas.
2.2 Training and professional activities: I have been a licensed CPA since July 1978.
I have been a member of the Institute of Certified Public Accountants in Israel since 1988.
I am a director and chairman of the investment committee of Helman Aldoby IEC Provident Ltd. (management company for the pension fund of Israel Electric Corporation employees).
35 WorldReginfo - c16fd361-de53-4169-8c2c-61d95bc8d7cf Chapter C
Financial Statements WorldReginfo - c16fd361-de53-4169-8c2c-61d95bc8d7cf
Delek Group Ltd.
Consolidated Interim Financial Statements as of
September 30, 2017
Unaudited
Contents
Page
Consolidated Balance Sheets 2-3
Consolidated Statements of Income 4
Consolidated Statements of Comprehensive Income 5
Consolidated Statements of Changes in Equity 6-10
Consolidated Statements of Cash Flows 11-15
Notes to the Consolidated Interim Financial Statements 16-44
1 WorldReginfo - c16fd361-de53-4169-8c2c-61d95bc8d7cf Delek Group Ltd.
Consolidated Balance Sheets
September 30 December 31 2017 2016 2016 Unaudited Audited NIS million Current assets
Cash and cash equivalents 1,799 966 2,730 Short-term investments 1,192 2,891 1,113 Trade receivables 1,827 1,302 1,419 Other receivables 1,264 582 565 Current tax assets 210 123 15 Financial derivatives 21 7 - Inventories 280 197 218 6,593 6,068 6,060 Assets held for sale 108,039 100,941 101,739
114,632 107,009 107,799 Non-current assets
Long-term loans, deposits and receivables 2,537 1,732 2,254 Other financial assets 289 80 343 Investments in associates 2,620 1,627 1,603 Investment property 223 319 224 Investments in oil and gas exploration and production, net 15,888 15,489 15,877 Fixed assets, net 2,456 2,245 2,487 Goodwill 934 820 832 Other intangible assets, net 7 9 8 Deferred taxes 2,174 11 15
27,128 22,332 23,643
141,760 129,341 131,442
The accompanying notes are an integral part of the consolidated interim financial statements.
2 WorldReginfo - c16fd361-de53-4169-8c2c-61d95bc8d7cf Delek Group Ltd.
Consolidated Balance Sheets
September 30 December 31 2017 2016 2016 Unaudited Audited NIS million Current liabilities
Interest bearing loans and borrowings 4,295 3,177 1,966 Trade payables 888 476 502 Other payables 1,654 978 1,044 Current tax liabilities 237 191 236 Financial derivatives 42 17 23 7,116 4,839 3,771 Liabilities attributable to assets classified as held for sale 103,232 96,525 97,886 110,348 101,364 101,657
Non-current liabilities
Loans from banks and others 2,298 1,361 1,567 Debentures 12,635 12,328 13,271 Debentures convertible into Company shares 1,086 1,076 1,080 Liabilities for employee benefits 12 11 12 Provisions and other liabilities (mainly for disposal of assets) 1,912 344 363 Deferred taxes 2,002 2,276 2,215
19,945 17,396 18,508 Capital
Share capital 13 13 13 Share premium 1,917 1,917 1,917 Proceeds for conversion options 27 27 27 Retained earnings 3,443 2,459 2,644 Exchange differences on translation of foreign operations (457) (50) 76 Capital reserve from transactions with holders of non-controlling 108 171 170 Otherinterests reserves 156 150 198 Treasury shares (433) (433) (433)
Total equity attributable to shareholders of the Company 4,774 4,254 4,612
Non-controlling interests 6,693 6,327 6,665
Total capital 11,467 10,581 11,277
141,760 129,341 131,442
The accompanying notes are an integral part of the consolidated interim financial statements.
November 28, 2017 Date of approval of the financial Gabriel Last Asi Bartfeld Barak Mashraki statements Chairman of the CEO CFO Board of Directors
3 WorldReginfo - c16fd361-de53-4169-8c2c-61d95bc8d7cf Delek Group Ltd.
Consolidated Statements of Income
Nine months ended Three months ended Year ended September 30 September 30 December 31 2017 2016 2017 2016 2016 Unaudited Audited NIS million (Other than net earnings per share)
Revenue 4,937 4,280 1,777 1,554 5,778 Cost of revenues 3,451 2,742 1,288 986 3,744
Gross profit 1,486 1,538 489 568 2,034
Selling, marketing and gas station operating 426 427 144 145 567 Generalexpenses and administrative expenses 148 131 59 51 182 Other revenues (expenses), net 1,322 (50) 1,332 (18) 201
Operating profit 2,234 930 1,618 354 1,486 Financial income 250 212 48 53 391 Finance expenses (785) (694) (214) (206) (828)
1,699 448 1,452 201 1,049 Profit from disposal of investments in investees, net 150 - - - - Group’s share in earnings (losses) of associates, net (91) 58 (142) 15 50
Income before taxes on income 1,758 506 1,310 216 1,099 Taxes on income (tax benefit) 96 (48) 39 49 (118)
Profit from continuing operations 1,662 554 1,271 167 1,217 Profit from discontinued operations, net 821 196 390 135 343
Net profit 2,483 750 1,661 302 1,560
Attributable to: Shareholders of the Company 1,424 250 1,024 85 625 Non-controlling interests 1,059 500 637 217 935
2,483 750 1,661 302 1,560 Net earnings per share attributable to shareholders of the Company (NIS)
Basic earnings from continuing operations 78.9 18.7 61.5 5.2 51.5 Basic earnings from discontinued operations 47.9 3.6 29.7 2.5 4.1
Basic earnings 126.8 22.3 91.2 7.7 55.6
Diluted earnings from continuing operations 75.6 18.7 58.8 5.2 51.3 Diluted earnings from discontinued 44.6 3.6 27.6 2.5 4.0 operations Diluted earnings 120.2 22.3 86.4 7.7 55.3
The accompanying notes are an integral part of the consolidated interim financial statements. .
4 WorldReginfo - c16fd361-de53-4169-8c2c-61d95bc8d7cf Delek Group Ltd.
Consolidated Statements of Comprehensive Income
Nine months ended Three months ended Year ended September 30 September 30 December 31 2017 2016 2017 2016 2016 Unaudited Audited NIS million
Net profit 2,483 750 1,661 302 1,560
Other comprehensive income (loss) (net of tax effect):
Amounts classified or reclassified to profit or loss under specific conditions:
Profit (loss) for available-for-sale financial assets (78) 36 51 15 99 Transfer to statement of income for disposal of available-for-sale financial assets (6) (28) (3) (7) (58) Transfer to statement of income for impairment of available-for-sale financial assets 17 41 - - 41 Transfer to statement of income for exchange differences on translation of foreign operations 13 - - - - Profit (loss) for cash flow hedges (35) 5 (7) 7 26 Recognition of the hedged asset of cash flow hedging results 20 - - - - Exchange differences on translation of foreign operations (818) (369) 137 (222) (107) Other comprehensive income (loss) attributable to associates, net (29) (12) 3 (6) (9)
Total other comprehensive income (loss) from continuing operations (916) (327) 181 (213) (8) Total other comprehensive income from discontinued operations, net 85 74 71 6 70
Total other comprehensive income (loss) (831) (253) 252 (207) 62
Total comprehensive income 1,652 497 1,913 95 1,622
Attributable to:
Shareholders of the Company 866 120 1,176 (27) 669 Non-controlling interests 786 377 737 122 953
1,652 497 1,913 95 1,622
The accompanying notes are an integral part of the consolidated interim financial statements.
5 WorldReginfo - c16fd361-de53-4169-8c2c-61d95bc8d7cf Delek Group Ltd.
Consolidated Statements of Changes in Equity
Attributable to shareholders of the Company Exchange differences Reserve from Proceeds on transactions for translation with non- Non- Share Share conversion Retained of foreign controlling Other Treasury controlling Total capital premium options earnings operations interests reserves *) shares Total interests capital
(Unaudited) NIS million
Balance as of January 1, 2017 (audited) 13 1,917 27 2,644 76 170 198 (433) 4,612 6,665 11,277 Net profit - - - 1,424 - - - - 1,424 1,059 2,483 Other comprehensive loss - - - - (533) - (25) - (558) (273) (831) Total comprehensive income (loss) - - - 1,424 (533) - (25) - 866 786 **) 1,652 Dividends - - - (625) - - - - (625) - (625) Transactions with holders of non-controlling - interests - - - - (62) (17) - (79) 319 240 Dividend to holders of non-controlling interests ------(1,077) (1,077) Balance as of September 30, 2017 13 1,917 27 3,443 (457) 108 156 (433) 4,774 6,693 11,467
*) Mainly capital reserve for available-for-sale financial assets; as of September 30, 2017, including a credit balance of NIS 157 million for investments held for sale. **) Composition of comprehensive loss of non-controlling interests:
Net profit attributable to non-controlling interests 1,059 Profit from available-for-sale financial assets, net 45 Loss from cash flow hedges (8) Exchange differences on translation of foreign operations (310)
Total comprehensive income attributable to non-controlling interests 786
The accompanying notes are an integral part of the consolidated interim financial statements.
6 WorldReginfo - c16fd361-de53-4169-8c2c-61d95bc8d7cf Delek Group Ltd.
Consolidated Statements of Changes in Equity
Attributable to shareholders of the Company Exchange differences Reserve from Proceeds on transactions for translation with non- Non- Share Share conversion Retained of foreign controlling Other Treasury controlling Total capital premium options earnings operations interests reserves *) shares Total interests capital
(Unaudited) NIS million
Balance as of January 1, 2016 (audited) 13 1,917 - 2,455 170 257 60 (368) 4,504 6,148 10,652 Net profit - - - 250 - - - - 250 500 750 Other comprehensive income (loss) - - - - (220) - 90 - (130) (123) (253)
Total comprehensive income (loss) - - - 250 (220) - 90 - 120 377 **) 497 Dividends - - - (246) - - - - (246) - (246) Proceeds for conversion option in the issue of convertible debentures (net of issue expenses) - - 27 - - - - - 27 - 27 Acquisition of treasury shares ------(65) (65) - (65) Company previously consolidated ------(2) (2) Acquisition of shares from holders of non- controlling interests - - - - - (86) - - (86) (112) (198) Dividend to holders of non-controlling interests ------(84) (84)
Balance as of September 30, 2016 13 1,917 27 2,459 (50) 171 150 (433) 4,254 6,327 10,581
*) Mainly capital reserve for available-for-sale financial assets; as of September 30, 2016, including a credit balance of NIS 115 million for investments held for sale. **) Composition of comprehensive income of non-controlling interests:
Net profit attributable to non-controlling interests 500 Profit from available-for-sale financial assets, net 39 Exchange differences on translation of foreign operations (162)
Total comprehensive income attributable to non-controlling interests 377
The accompanying notes are an integral part of the consolidated interim financial statements.
7 WorldReginfo - c16fd361-de53-4169-8c2c-61d95bc8d7cf Delek Group Ltd.
Consolidated Statements of Changes in Equity
Attributable to shareholders of the Company Exchange Reserve differences from on transactions Proceeds for translation with non- Other Non- Share Share conversion Retained of foreign controlling reserves Treasury controlling Total capital premium options earnings operations interests *) shares Total interests capital Unaudited NIS million
Balance as of July 1, 2017 13 1,917 27 2,665 (526) 149 90 (433) 3,902 6,139 10,041 Net profit - - - 1,024 - - - - 1,024 637 1,661 Other comprehensive income - - - - 69 - 83 - 152 100 252 Total comprehensive income - - - 1,024 69 - 83 - 1,176 737 **) 1,913 Dividends - - - (246) - - - - (246) - (246) Transaction with holders of non-controlling - interests - - - - (41) (17) - (58) 298 240 Dividend to holders of non-controlling interests ------(481) (481) Balance as of September 30, 2017 13 1,917 27 3,443 (457) 108 156 (433) 4,774 6,693 11,467
*) Mainly capital reserve for available-for-sale financial assets; as of September 30, 2017, including a credit balance of NIS 157 million for investments held for sale. **) Composition of comprehensive income of non-controlling interests:
Net profit attributable to non-controlling interests 637 Profit from available-for-sale financial assets, net 34 Loss from cash flow hedges (5) Exchange differences on translation of foreign operations 71
Total comprehensive income attributable to non-controlling interests 737
The accompanying notes are an integral part of the consolidated interim financial statements.
8 WorldReginfo - c16fd361-de53-4169-8c2c-61d95bc8d7cf Delek Group Ltd.
Consolidated Statements of Changes in Equity
Attributable to shareholders of the Company Exchange differences Reserve from on transactions Proceeds for translation with non- Non- Share Share conversion Retained of foreign controlling Other Treasury controlling Total capital premium options earnings operations interests reserves *) shares Total interests Capital Unaudited NIS million
Balance as of July 1, 2016 13 1,917 - 2,449 79 173 133 (433) 4,331 6,241 10,572 Net profit - - - 85 - - - - 85 217 302 Total other comprehensive income (loss) - - - - (129) - 17 - (112) (95) (207)
Total comprehensive income (loss) - - - 85 (129) - 17 - (27) 122 **) 95 Dividends - - - (75) - - - - (75) - (75) Proceeds for conversion option in the issue of convertible debentures (net of issue expenses) - - 27 - - - - - 27 - 27 Acquisition of shares from holders of non- controlling interests - - - - - (2) - - (2) (34) (36) Dividend to holders of non-controlling interests ------(2) (2)
Balance as of September 30, 2016 13 1,917 27 2,459 (50) 171 150 (433) 4,254 6,327 10,581 *) Mainly capital reserve for available-for-sale financial assets; as of September 30, 2016, including a credit balance of NIS 115 million for investments held for sale. **) Composition of comprehensive income of non-controlling interests:
Net profit attributable to non-controlling interests 217 Profit from available-for-sale financial assets, net 2 Exchange differences on translation of foreign operations (97)
Total comprehensive income attributable to non-controlling interests 122
The accompanying notes are an integral part of the consolidated interim financial statements.
9 WorldReginfo - c16fd361-de53-4169-8c2c-61d95bc8d7cf Delek Group Ltd.
Consolidated Statements of Changes in Equity
Attributable to shareholders of the Company Exchange Reserve differences from Proceeds on transactions for translation with non- Non- Share Share conversion Retained of foreign controlling Other Treasury controlling Total capital premium options earnings operations interests reserves *) shares Total interests capital
Audited NIS million
Balance as January 1, 2016 13 1,917 - 2,455 170 257 60 (368) 4,504 6,148 10,652 Net profit - - - 625 - - - - 625 935 1,560 Other comprehensive income (loss) - - - - (94) - 138 - 44 18 62 Total comprehensive income (loss) - - - 625 (94) - 138 - 669 953 **) 1,622 Acquisition of treasury shares ------(65) (65) - (65) Proceeds for conversion option in the issue of convertible debentures (net of issue expenses) - - 27 - - - - - 27 - 27 Dividends - - - (436) - - - - (436) - (436) Dividend to holders of non-controlling interests ------(322) (322) Acquisition of shares from holders of non- controlling interests - - - - - (87) - - (87) (114) (201) Balance as of December 31, 2016 13 1,917 27 2,644 76 170 198 (433) 4,612 6,665 11,277 *) Mainly capital reserve for available-for-sale financial assets; as of December 31, 2016, including a credit balance of NIS 120 million for investments held for sale. **) Composition of comprehensive income of non-controlling interests:
Net profit attributable to non-controlling interests 935 Profit from available-for-sale financial assets, net 42 Profit from cash flow hedges 4 Exchange differences on translation of foreign operations (28) Total comprehensive income attributable to non-controlling interests 953
The accompanying notes are an integral part of the consolidated interim financial statements
10 WorldReginfo - c16fd361-de53-4169-8c2c-61d95bc8d7cf Delek Group Ltd.
Consolidated Statements of Cash Flows
Nine months ended Three months ended Year ended September 30 September 30 December 31 2017 2016 2017 2016 2016 Unaudited Audited NIS million
Cash flows from operating activities
Net profit 2,483 750 1,661 302 1,560 Adjustments to reconcile cash flows from operating activities (a) (1,645) 447 (2,489) (695) 30
Net cash from (used in) operating activities 838 1,197 (828) (393) 1,590
Cash flows from investment activities
Purchase of fixed assets, investment property and intangible assets (283) (508) (88) (124) (641) Proceeds from sale of fixed assets and investment property 31 11 10 1 11 Proceeds from sale of oil and gas assets 2,967 - 2,967 - 154 Proceeds from sale of financial assets, net 46 529 94 29 524 Repayment of loans to associates, net 12 2 7 2 1 Short-term investments, net (177) (426) (86) (464) 846 Investment in long-term bank deposits, net (91) (61) (29) 16 76 Increase in joint ventures for oil and gas exploration (1,293) (415) (635) (70) (554) Cash derecognized from disposal of investments in previously consolidated subsidiaries (b) - (13) - - (13) Investment in associates (2) - (1) - (1) Repayment of loans to others, net 215 26 4 11 801 Acquisition of a company consolidated for the first time (c) (1,829) - - - -
Net cash from (used in) investment activities (404) (855) 2,243 (599) 1,204
The accompanying notes are an integral part of the consolidated interim financial statements.
11 WorldReginfo - c16fd361-de53-4169-8c2c-61d95bc8d7cf Delek Group Ltd.
Consolidated Statements of Cash Flows
Nine months ended Three months ended Year ended September 30 September 30 December 31 2017 2016 2017 2016 2016 Unaudited Audited NIS million
Cash flow from finance activities
Short-term loans from banks and others, net 79 (774) 149 (543) (634) Acquisition of shares from holders of non- controlling interests - (128) - (24) (132) Sale of shares to non-controlling interests 208 - 208 - - Receipt of long-term loans 1,209 618 566 468 781 Repayment of long-term loans (341) (318) (71) (138) (383) Proceeds from disposal of hedging transactions - - - - 46 Dividends paid (625) (246) (246) (75) (436) Dividend paid to holders of non-controlling interests in subsidiaries (1,214) (84) (481) (2) (91) Acquisition of treasury shares by a subsidiary partnership - (65) - - (65) Payment of contingent liability for a put option to holders of non-controlling interests (1) - - - (14) Advance tax payments as part of distribution of profits for non-controlling interests (251) (82) (251) (58) (84) Issue of debentures and debentures convertible into shares (less issuance expenses) 1,780 1,328 318 1,103 2,801 Repayment of debentures (1,695) (498) (1,497) (187) (2,579)
Net cash from (used for) finance activities (851) (249) (1,305) 544 (790)
Exchange differences on cash balances of foreign operations and exchange differences for cash and cash equivalence (88) 10 15 (17) 4
Change in cash and cash equivalents attributable to operations held for sale (426) (146) 573 841 (287)
Increase (decrease) in cash and cash equivalents (931) (43) 698 376 1,721
Cash and cash equivalents at the beginning of the year: 2,730 1,009 1,101 590 1,009
Cash and cash equivalents at the end of the period 1,799 966 1,799 966 2,730
The accompanying notes are an integral part of the consolidated interim financial statements.
12 WorldReginfo - c16fd361-de53-4169-8c2c-61d95bc8d7cf Delek Group Ltd.
Consolidated Statements of Cash Flows
Nine months ended Three months ended Year ended September 30 September 30 December 31 2017 2016 2017 2016 2016 Unaudited Audited NIS million (A) Adjustments to reconcile cash flows from operating activities:
Adjustments to profit or loss Depreciation, depletion, amortization and impairment (elimination of impairment) of assets 588 728 34 301 1,173 Deferred taxes, net 231 47 (33) 164 1 Decrease in employee benefit liabilities, net (3) (62) (10) (73) (67) Increase in the value of loans granted, net (73) (76) (14) (20) (38) Loss (profit) from the sale of fixed assets, real estate and investments, net (154) 4 4 (1) - Group’s share of results of associates, net (1) 174 (18) 211 7 (12) Profit from the sale of oil and gas assets (1,446) - (1,446) - (405) Profit from early repayment of a loan - - - - (116) Profit from disposal of available-for-sale financial assets (5) (30) (2) (9) (58) Impairment of available-for-sale financial assets 17 41 - - 41 Change in fair value of financial assets and financial derivatives, net 35 22 (8) (25) (14) Increase (decrease) in long-term liabilities, net 5 55 (73) (26) 101 Change in deferred acquisition costs (78) (71) (15) (18) (78) Cost of share-based payment 4 (1) - (1) (2) Change in financial investments of insurance companies, net (2,712) (1,735) (1,188) (1,062) (2,472) Investments net of proceeds from the sale of available-for-sale assets in insurance companies, net (2,706) (2,082) (1,266) (1,489) (2,722) Increase in reserves and other provisions in insurance companies 5,463 4,333 1,898 1,686 5,454 Acquisition of investment property for performance-based contracts and other investment property in insurance companies (134) (253) (60) (91) (315) Decrease (increase) in reinsurance assets (248) (11) (79) 28 (1) Change in value of investment property, net 8 (4) 11 (6) 6 Exchange differences for cash and cash equivalents, net 3 (1) (4) 2 16 Revaluation of other long-term assets (38) - (1) - -
Changes in operating assets and liabilities:
Increase in trade receivables (154) (72) (195) (40) (182) Increase in other receivables (440) (274) (315) (43) (24) Decrease (increase) in inventory 153 10 60 15 (11) Increase in other assets, net (416) (105) (149) (40) (201) Increase (decrease) in trade payables (12) 10 (1) 19 (27) Increase (decrease) in other payables 293 (8) 152 27 (17)
(1,645) 447 (2,489) (695) 30
(1) Net of dividends and earnings received 155 75 91 28 86
The accompanying notes are an integral part of the consolidated interim financial statements.
13 WorldReginfo - c16fd361-de53-4169-8c2c-61d95bc8d7cf Delek Group Ltd.
Consolidated Statements of Cash Flows
Nine months ended Three months ended Year ended September 30 September 30 December 31 2017 2016 2017 2016 2016 Unaudited Audited NIS million
(B) Cash derecognized from disposal of investments in previously consolidated subsidiaries Working capital, net - (14) - - (14) Fixed assets - (2) - - (2) Non-current assets - 3 - - 3 Deferred taxes - 2 - - 2 Non-controlling interests - (2) - - (2)
- (13) - - (13)
(C) Acquisition of a company consolidated for the first time Working capital deficit, net (excluding cash) 56 - - - - Investments in oil and gas exploration and production (2,325) - - - - Investments in associates (717) - - - - Deferred taxes (2,140) - - - - Goodwill (131) - - - - Other non-current assets (31) - - - - Loans from banks and others 1,167 - - - - Debentures 1,095 - - - - Provisions and other liabilities 1,197 - - - -
(1,829) - - - -
(D) Significant non-cash activities
Purchase of fixed assets and intangible assets 15 18 15 8 25
Dividend payable by associates 21 - 21 - 23
Loans provided to buyers of an investee - 393 - - 393
Investment in oil and gas assets against liability 665 66 606 66 128
Dividend payable to holders of non-controlling interests in the subsidiary partnership - - - - 137
Proceeds from sale of gas and oil assets 697 - 697 - 785
Sale of available-for-sale financial assets against receivables 17 - 17 - -
The accompanying notes are an integral part of the consolidated interim financial statements.
14 WorldReginfo - c16fd361-de53-4169-8c2c-61d95bc8d7cf Delek Group Ltd.
Consolidated Statements of Cash Flows
Nine months ended Three months ended Year ended September 30 September 30 December 31 2017 2016 2017 2016 2016 Unaudited Audited NIS million
(E) Additional information on cash flows
Cash paid during the period for:
Interest 655 532 210 199 819 Taxes on income 429 93 167 42 195
Cash received during the period for:
Interest 462 440 165 147 599 Dividends 162 117 60 39 137 Taxes 5 2 2 - 3
(F) See Note 3A for information about cash flows from discontinued operations.
The accompanying notes are an integral part of the consolidated interim financial statements.
15 WorldReginfo - c16fd361-de53-4169-8c2c-61d95bc8d7cf Delek Group Ltd.
Notes to the Consolidated Interim Financial Statements
NOTE 1: GENERAL
These financial statements have been prepared in condensed format as of September 30, 2017 and for the nine and three months then ended (“the Consolidated Interim Financial Statements”). The financial statements should be read in the context of the Company’s annual financial statements as of December 31, 2016 for the year then ended, and their accompanying notes (“the Annual Financial Statements”).
NOTE 2: SIGNIFICANT ACCOUNTING POLICIES
A. Preparation format of the Consolidated Interim Financial Statements
The Consolidated Interim Financial Statements have been prepared in accordance with generally accepted accounting principles for the preparation of interim financial statements as prescribed in IAS 34, Interim Financial Reporting and in accordance with the disclosure requirements of Chapter D of the Securities Regulations (Periodic and Immediate Reports), 1970, insofar as the provisions of these standards apply to insurance subsidiaries. The main accounting policy and calculation methods applied in the preparation of these Consolidated Interim Financial Statements are consistent with those applied in the preparation of the Annual Financial Statements.
B. Further to Note 2HH(B) to the Annual Financial Statements regarding the possible effect of IFRS 15, Revenue from Contracts with Customers, on the recognition of revenue in the oil and gas sector, the Group continued to review the implications of application of IFRS 15 at the mandatory adoption date (January 1, 2018). Following the review, at this stage, the Group reached the conclusion that the new standard is not expected to have a material effect on its financial statements, for oil and gas revenue as well. The Group will continue to review relevant developments and publications, and if there is a change in this conclusion, the Group will report this in the subsequent financial statements.
C. Under the Taxation of Profits from Natural Resources Law, 2011 ("the Tax Law"), some Group companies are subject to an oil profit levy on their profits from their various oil and gas reservoirs in Israel. In accordance with the accounting treatment applied by the Group in the past relating to the levy, the Group concluded that the levy is within the scope of IAS 12, Income Taxes (“IAS 12”). In the second and third quarters of 2017, the relevant Group companies rediscussed this issue, including a reexamination of whether the levy is indeed within the scope of IAS 12 or whether it is within the scope of IFRIC 21, Levies (“IFRIC 21”), and the required timing for recognition of the levy in the financial statements. At the beginning of August 2017, Delek Drilling - Limited Partnership (“Delek Drilling” or “the Partnership”), together with the Israeli partners in the Tamar project (which are reporting entities, hereinafter jointly “the Reporting Entities”), expressed their position on the subject to the Israel Securities Authority. After the Reporting Entities reviewed the accounting treatment of the levy, and in particular the question whether in this case, in view of the unique characteristics of the levy, the provisions of IFRIC 21 or the provisions of IAS 12 should be implemented, the Reporting Entities concluded that in this case, it would be more reliable and more relevant to implement the provisions of IFRIC 21 for the accounting of the levy, and the ISA decided not to intervene in their position. Accordingly, in practice, the Reporting Entities will recognize the expense for the levy based on the obligating event approach, meaning, only on the date on which the liability to pay arises (meaning, only as from the actual payment date). The accounting treatment of the levy has no effect on these financial statements, since the obligation to pay the levy has not yet been established for the relevant reservoirs.
16 WorldReginfo - c16fd361-de53-4169-8c2c-61d95bc8d7cf Delek Group Ltd.
Notes to the Consolidated Interim Financial Statements
NOTE 3: INVESTMENTS IN INVESTEES AND PARTNERSHIPS
A. The Phoenix Holdings Ltd. ("The Phoenix")
1) Further to Note 10F(A) to the Annual Financial Statements, on August 21, 2016, the Company signed a binding agreement for the sale of all the Company's holdings (52.3%) in The Phoenix. Under the agreement, the buyer was Yango Investment PTE Ltd. (“Yango”). a private company incorporated in Singapore and a subsidiary of Fujian Yango Group Co. Ltd. a significant holding group incorporated and operating in China in diverse fields, including finance, education, health, real estate and international trading. The consideration as set out in the agreement amounts to NIS 1,948 million plus annual interest at the rate of 4.75% from January 1, 2017, and until the closing date of the transaction. The agreement stipulates terms for its cancellation by the Company or the buyer in the event of various breaches, and it also stipulates that if the terms for completion of the transaction have not been fulfilled within six months after signing the agreement, either of the parties to the agreement may notify the other party that it is canceling the agreement. The agreement included preconditions, which include a control permit from the Commissioner of the Capital Market, Insurance and Savings at the Ministry of Finance. On February 16, 2017, the parties signed an amendment to the agreement which extended the period for the preconditions to March 31, 2017. On April 5, 2017, the parties signed an amendment to the agreement, in which it was determined, among other things, that the consideration for the Company's full holdings in the shares of The Phoenix will amount to NIS 2,152 million. Under the agreement, NIS 1,987 million will be paid in cash at the closing date and the balance will be paid in three payments. The first payment will be paid up to 30 days after the closing date and the last payment will be no later than April 30, 2019. The deadline for completion of the terms for closing has been set for June 4, 2017. After this date, each of the parties may inform the other party of its cancellation.
On June 26, 2017, in view of the prolonged process of obtaining approval to transfer control in The Phoenix to Yango Group, the parties agreed to cancel the agreement in accordance with the mechanism set out in the agreement, and each party irrevocably and unconditionally waives any allegation, claim or loss in connection with the agreement.
2) On September 14, 2017, the Company and Sirius International Insurance Group Ltd. ("the Buyer”) signed a binding agreement for the sale of all of the Company’s holdings in The Phoenix for a total consideration of NIS 2.5 billion plus interest and subject to the adjustments stipulated in the agreement. To the best of the Company's knowledge, the Buyer is an international insurance company with operations in the insurance sector in some 140 countries.
The transaction will take place in several stages, as follows:
In the first stage, on September 18, 2017, the Buyer acquired from the Company 4.9% of the share capital of The Phoenix, in an off-floor transaction, at a price of NIS 16.988 per share and for a total consideration of NIS 208 million in cash. The consideration is final and is not subject to completion of the second stage of the agreement as set out below. Insofar as the transaction for the sale of the balance of the Company's holdings in Phoenix is completed, as set out below, the consideration will be adjusted so that the Company will be paid an additional amount of NIS 25 million for this stage (so that the total consideration will reflect a share price of NIS 19.076). The excess of the carrying amount realized on the consideration attributable to the sold shares in the amount of NIS 52 million was recognized as a decrease in equity attributable to the Company's shareholders (transactions with non-controlling interests). Following the sale, the Company holds 118,375,970 shares of NIS 1 par value of The Phoenix representing 47.35% of the equity rights in The Phoenix shares. Subsequent to the decrease in the rate of holdings, the Company continues to consolidate the financial statements of The Phoenix since it has effective control over The Phoenix, among other things, in view of the rate of the Company's holding in the shares of The Phoenix, distribution of The Phoenix shareholders, participation patterns in general meetings, and the control permit granted to the Group for its investment in The Phoenix.
17 WorldReginfo - c16fd361-de53-4169-8c2c-61d95bc8d7cf Delek Group Ltd.
Notes to the Consolidated Interim Financial Statements
NOTE 3: INVESTMENTS IN INVESTEES AND PARTNERSHIPS (CONTD.)
A. The Phoenix Holdings Ltd. ("The Phoenix") (contd.)
The Company granted the Buyer a call option for the balance of its holdings in The Phoenix (47.35% of the capital of The Phoenix) whereby during a period of 60 days from the date on which the due diligence material agreed upon between the parties was made available to the Buyer, the Buyer may notify the Company of its decision to purchase the balance of the Company’s shares in The Phoenix (“the Second Stage of the Agreement”). In this period, the Buyer will take steps to complete due diligence for The Phoenix, and it is entitled to send the Company, at its discretion, an irrevocable notice of its intention to complete the agreement.
The agreement includes defined timetables to apply for a control permit from the Commissioner of the Capital Market, Insurance and Savings at the Ministry of Finance ("the Commissioner") and to obtain the required regulatory approvals. Under the agreement, the Buyer undertakes to apply to the Commissioner for a permit as soon as possible, in accordance with the law, and no later than 45 days after the agreement was signed, and it will take steps to advance receipt of the permit. As of the approval date of the financial statements, an application was submitted to the Commissioner as required in the agreement, and a notice of irrevocable exercise was received from the Buyer of its intention to acquire the remaining holdings of The Phoenix (47.35%).
Insofar as the Second Stage of the Agreement is completed, the Company will be paid the balance of the consideration of NIS 2,284 million in cash plus interest and subject to the adjustments set out in the agreement.
The agreement includes standard representations of the Company regarding The Phoenix and indemnification undertakings, subject to caps and under the standard terms for this type of transaction. The agreement contains preconditions, which include approvals from governmental bodies, including: a control permit from the Commissioner, approvals from the Israel Securities Authority, Tel-Aviv Stock Exchange Ltd, and the Antitrust Authority, and the absence of a material adverse event (MAE) in The Phoenix until the closing date. Under the agreement, if, four months after the application date, the terms for completion of the transaction are not fulfilled, for the sole reason that the required regulatory approvals have not yet been received, and none of the applications for any of the approvals has been rejected (cumulative terms), then there will be two automatic extensions for completion of the transaction, for another three months and a further month, for the purpose of obtaining the regulatory approvals, provided that no rejection notice has been received prior to the end of each period. If, at the end of these periods, and no later than eight months after submitting the application, the terms for completing the transaction have not been met, the agreement for acquisition of the balance of the Company's holdings in The Phoenix (47.35%) will be null and void. If the regulatory approvals are obtained within eight months from the application date, the transaction will be completed in accordance with the timetables set out in the agreement, even if there is a deviation from the eight-month period.
18 WorldReginfo - c16fd361-de53-4169-8c2c-61d95bc8d7cf Delek Group Ltd.
Notes to the Consolidated Interim Financial Statements
NOTE 3: INVESTMENTS IN INVESTEES AND PARTNERSHIPS (CONTD.)
A. The Phoenix Holdings Ltd. ("The Phoenix") (contd.)
(3) In view of the Company’s efforts and commitment to sell its holdings in The Phoenix in accordance with the Concentration Law, including the aforesaid sale agreement, and in view of the Company’s assessment regarding the expected disposal of the Company’s investment in The Phoenix shares, the Company believes that it is still in compliance with the criteria set out in IFRS 5, Non-current Assets Held for Sale and Discontinued Operations (“IFRS 5”) regarding the classification of its investment in The Phoenix as assets and liabilities held for sale. Accordingly, as of September 30, 2017, the investment in shares of The Phoenix is recognized in accordance with the provisions of IFRS 5 as part of a group of assets held for sale and under liabilities attributable to assets held for sale. In addition, the operating results of The Phoenix, including fair value adjustments of the investment, are recognized in the statement of income under profit from discontinued operations, net. As of September 30, 2017, the Company's investment in The Phoenix (47.35%) amounts to NIS 2,196 million, which represents the fair value estimate net of costs to sell of the investment, in accordance with the consideration set out in the agreement signed with the buyer as set out above, and further to the valuation that the Company received from an independent external assessor as set out below. In the reporting period, the Company included its share in the profits of The Phoenix amounting to NIS 312 million and its share in the other comprehensive loss of The Phoenix amounting to NIS 49 million. In addition, in the reporting period, the Company recognized a gain, arising from elimination of the provision for impairment amounting to NIS 217 million, due to its estimated fair value less costs to sell of the investment in The Phoenix, as set out above.
In accordance with the valuation, the fair value of the Company's investment in the shares of The Phoenix (before costs to sell) was estimated at between NIS 2,200 million and NIS 2,651 million. The Company set the fair value at NIS 2,230 million (proximate to the lower level in the valuation), also in view of the fact that this value is similar to the amount set in the agreement for the sale of The Phoenix shares as set out above. The lower level in the valuation is based on the prices set out in the agreements with third parties to which the Company is a party. The lower level in the valuation is mainly based on discounting the future cash flows expected from the insurance sectors of The Phoenix (life insurance and long-term savings, healthcare insurance, general insurance, and activities of insurance agencies) plus the fair value of other holdings of The Phoenix and less financial liabilities, net.
The valuation takes into account an annual discount rate of 10.5% and it includes key assumptions regarding rates of growth/slowdown in various sectors, future inflation rates, rates of return on assets and investments and cancellation rates of policies. For further information, see the valuation attached to the Group's Periodic Report. As of September 30, 2017, the value of the Company's investment in The Phoenix shares at the TASE price of a single share of The Phoenix, ("the Market Value"), amounts to NIS 1,920 million (shortly before the approval date of the financial statements, the Market Value of the Company's investment in the shares of The Phoenix amounts to NIS 2,055 million).
19 WorldReginfo - c16fd361-de53-4169-8c2c-61d95bc8d7cf Delek Group Ltd.
Notes to the Consolidated Interim Financial Statements
NOTE 3: INVESTMENTS IN INVESTEES AND PARTNERSHIPS (CONTD.)
A. The Phoenix Holdings Ltd. ("The Phoenix") (contd.)
(3) Financial information for The Phoenix (contd.)
A) Group of assets and liabilities relating to the operations of The Phoenix classified as held for sale:
At September 30 December 31 2017 2016 2016 Unaudited Audited NIS million
Current assets Cash and cash equivalents 960 638 1,040 Performance-based cash and cash equivalents 6,344 6,111 5,839 Short-term investments of the finance sector (mainly exchange-traded funds and deposits) 28,166 28,409 28,752 Short-term investments 1,284 362 385 Short-term investments in insurance companies 1,853 2,192 1,913 Insurance premium receivable 756 690 638 Other receivables 332 395 334 Current tax assets 105 40 21 Reinsurance assets 372 397 386 Deferred acquisition costs 562 532 513 40,734 39,766 39,821 Non-current assets Financial investments of insurance companies 59,043 52,610 54,252 Long-term loans, deposits and receivables 3 4 3 Investments in associates 617 613 619 Investment property 3,517 3,270 3,376 Reinsurance assets 1,069 806 807 Fixed assets, net 385 372 378 Deferred acquisition costs 1,055 1,000 1,026 Structured bonds 303 337 345 Goodwill 925 922 929 Other intangible assets, net 380 339 172 Deferred taxes 8 3 11 67,305 60,276 61,918
Total assets 108,039 100,042 101,739
20 WorldReginfo - c16fd361-de53-4169-8c2c-61d95bc8d7cf Delek Group Ltd.
Notes to the Consolidated Interim Financial Statements
NOTE 3: INVESTMENTS IN INVESTEES AND PARTNERSHIPS (CONTD.)
A. The Phoenix Holdings Ltd. (“The Phoenix”) (contd.)
(3) Financial information for the Phoenix (contd.)
A) Group of assets and liabilities relating to the operations of The Phoenix classified as held for sale (contd.):
At September 30 December 31 2017 2016 2016 Unaudited Audited NIS million
Current liabilities Interest bearing loans and borrowings 212 491 414 Trade payables 104 150 117 Other payables 2,034 1,822 1,968 Exchange-traded funds and deposit 26,755 27,137 27,387 Current tax liabilities 8 7 46 Liabilities for insurance contracts 4,658 4,270 4,480
33,771 33,877 34,412 Non-current liabilities Debentures 2,881 2,248 2,247 Structured bonds 301 344 341 Liabilities for employee benefits 45 53 142 Liabilities for insurance contracts 65,574 59,178 60,194 Provisions and other liabilities 119 134 495 Deferred taxes 541 500 55
69,461 62,457 63,474
Total liabilities 103,232 96,334 97,886
21 WorldReginfo - c16fd361-de53-4169-8c2c-61d95bc8d7cf Delek Group Ltd.
Notes to the Consolidated Interim Financial Statements
NOTE 3: INVESTMENTS IN INVESTEES AND PARTNERSHIPS (CONTD.)
A. The Phoenix Holdings Ltd. ("The Phoenix") (contd.)
3) Financial information for The Phoenix: (contd.)
B) The table below presents information on the results of operations attributable to the discontinued operations of The Phoenix:
Nine months ended Three months ended Year ended September 30 September 30 December 31 2017 2016 2017 2016 2016 Unaudited Audited NIS million
Revenue 11,218 9,307 3,998 3,751 12,768 Cost of revenues 8,198 6,865 3,054 2,714 9,230
Gross profit 3,020 2,442 944 1,037 3,538
Sales expenses 1,168 1,121 422 373 1,527 General and administrative 287 expenses 877 853 291 1,143 Other expenses, net 6 1 3 4 7
Operating profit 969 467 228 373 861
Finance expenses, net 105 86 31 40 114 Share in earnings of associates 42 35 2 3 48
Income before tax 906 416 199 336 795 Taxes on income 295 97 63 106 174 Increase (decrease) in the value of the investment in The Phoenix shares 217 (123) 262 (95) (278)
Income from operations of The Phoenix 828 196 398 135 343
Attributable to: Shareholders of the Company 529 40 324 26 46 Non-controlling interests 299 156 74 109 297
828 196 398 135 343
22 WorldReginfo - c16fd361-de53-4169-8c2c-61d95bc8d7cf Delek Group Ltd.
Notes to the Consolidated Interim Financial Statements
NOTE 3: INVESTMENTS IN INVESTEES AND PARTNERSHIPS (CONTD.)
A. The Phoenix Holdings Ltd. ("The Phoenix") (contd.)
3) Financial information for The Phoenix: (contd.)
C) Composition of net cash flows attributable to the discontinued operations of The Phoenix:
Nine months ended Three months ended Year ended September 30 September 30 December 31 2017 2016 2017 2016 2016 Unaudited Audited NIS million
Net cash flows from (used in) operating activities 141 393 (654) (769) 608 Net cash used in investment activities (108) (155) (34) (50) (220) Net cash from (used for) finance activities 393 (92) 115 (22) (112)
426 146 (573) (841) 276
B. Ithaca Energy Inc. ("Ithaca")
1. Further to Note 10F(l) to the Annual Financial Statements, on March 14, 2017, DKL Investments Limited (a wholly-owned foreign subsidiary of the Company, hereinafter "DKL") submitted an offer to acquire the entire share capital of Ithaca not held by DKL (80%), for CAD 1.95 per share ("the Offer"), following the agreement with Ithaca in February 2017 to publish the Offer. The Offer was open to acceptance notice until April 20, 2017, and after it was accepted for the most part, it was extended mandatorily until May 3, 2017. The Offer was accepted by the holders of 318,833,909 ordinary shares and DKL acquired their shares for a total consideration of CAD 622 million (approximately NIS 1,685 million). Following the sale, DKL held 400,699,334 ordinary shares of Ithaca, representing 94.2% of its ordinary share capital.
On May 12, 2017, DKL announced that, in accordance with the terms of the Offer, it intends to carry out a compulsory acquisition of the remaining ordinary shares of Ithaca that are not held by DKL, so that following the acquisition, DKL will hold the entire share capital of Ithaca, at the price per share set out in the Offer and for a total consideration of CAD 48 million (approximately NIS 126 million) On June 5, 2017, the compulsory acquisition was completed, after which Ithaca's shares were delisted from the AIM in London and the Toronto Stock Exchange.
It should be noted that following the Offer, Ithaca received waivers from banks and other entities holding short- to medium-term liabilities that include change of control items, according to which these entities will not exercise their right for immediate payment due to the change of control following the Offer.
2. In view of the gain of control in Ithaca, the Group consolidates Ithaca's financial statements as from the date control was gained (April 21, 2017). In addition, in accordance with IFRS 3 regarding a step acquisition, the Group’s investment in Ithaca shares prior to gaining control is measured at its fair value, while the difference between the fair value and its carrying amount will be recognized in the statement of income. The difference (profit) (after recognition in the statement of income of capital for translation differences accrued up to the date of gain of control) amounted to NIS 137 million and was included in the Group's statement of income under profit from realization of investments in investees, net.
23 WorldReginfo - c16fd361-de53-4169-8c2c-61d95bc8d7cf Delek Group Ltd.
Notes to the Consolidated Interim Financial Statements
NOTE 3: INVESTMENTS IN INVESTEES AND PARTNERSHIPS (CONTD.)
B. Ithaca Energy Inc. ("Ithaca") (contd.)
3. Ithaca's financial debt consisted mainly of a bank debt based on the its oil and gas reserves (reserves based lending, “RBL”) of USD 375 million and a senior note of USD 300 million payable in June 2019. Subsequent to the balance sheet date, Ithaca has completed the refinancing of its bank debt (RBL) so that it is aligned with the repayment date of the senior note and will allow it flexibility to finance its development and growth objectives. Ithaca extended the repayment date of the bank facility, which will be repaid by May 2019. The new senior credit facility will amount to USD 245 million, of which USD 200 million will be used for Ithaca's current financing and USD 45 million will be used, amount other things, to finance the investments required to develop the Vorlich oil field. In addition, Ithaca raised an additional loan of USD 140 million, which is also repayable in May 2019 and which is guaranteed by the Company through (1) a loan of USD 70 million provided by the Company to Ithaca, which was deposited in a deposit with a mechanism allowing the use of funds for new investments; (2) the Company's guarantee on the balance of the debt, meaning a guarantee limited to USD 70 million. The average interest for the two banking facilities set out above is Libor plus a margin of 2.6%. In addition, in the reporting period, the Company provided Ithaca with additional loans amounting to USD 30 million to finance Ithaca's operating activities. The loans are in USD, bear interest at a rate of 3% and are repayable by June 30, 2019.
4. The Company recognized the fair value of the assets acquired and the liabilities assumed in the business combination on a temporary basis, based on the draft valuation performed by an external appraiser for the fair value of the identifiable assets acquired and the liabilities assumed. The consideration for the acquisition and the fair value of the acquired assets and liabilities are adjustable finally up to twelve months from the acquisition date.
Fair value of the identifiable assets acquired and liabilities assumed in the business combination at the date of obtaining control, in accordance with the draft valuation:
USD million Unaudited
Current assets 182 Investments in oil and gas exploration and production 632 Investments in associates 314 Deferred taxes 581 Other non-current assets 8
1,717
Current liabilities 191 Loans from banks and others 317 Debentures 298 Provisions and other liabilities (mainly for disposal of assets) 325
1,131
Identifiable assets, net 586 Goodwill arising on acquisition 36
Total cost of acquisition 622
The total cost of the acquisition includes the cash consideration of USD 503 million (approximately NIS 1,851 million) and USD 119 million (approximately NIS 436 million), reflecting the fair value of the prior investment on the date of obtaining control, after being revalued to fair value at that date. The costs of the transaction amounted to NIS 17 million, which were recognized in the statement of income.
For information about Ithaca's contribution to the Group's revenue and net profit as from the acquisition date, see Note 10, Operating Segments.
24 WorldReginfo - c16fd361-de53-4169-8c2c-61d95bc8d7cf Delek Group Ltd.
Notes to the Consolidated Interim Financial Statements
NOTE 3: INVESTMENTS IN INVESTEES AND PARTNERSHIPS (CONTD.)
C. Power stations
1. On August 24, 2017, the Sorek power station, which was constructed by a subsidiary (IPP Delek Sorek Ltd.), was granted a production license and a supply license and the subsidiary started to take steps to operate the power station. In an accompanying letter, the Electricity Authority noted that failure to comply with the provisions of Article 14(A) of the Electricity Market Regulations (Conventional Private Electricity Producer), 2005, according to which electricity will be transmitted from a facility over the electrical grid of the holder of the transmission or distribution license, is a violation of the provisions of the law and grounds for annulling the licenses. The Electricity Authority further clarified that the license does not exempt the subsidiary or any of its customers from payment of infrastructure fees or any other fee in accordance with the fees set by the Authority. It should be noted that the power plant was designed to supply electricity to the nearby desalination plant through a direct connection and not through the electricity grid. The Group is reviewing the contents of the Electricity Authority’s letter and it believes, at this stage, based also on the opinion of its legal counsel, that it has solid defense arguments against the position of the Electricity Authority.
2. Further to Note 13A(c) to the Annual Financial Statements regarding the assessment of the recoverable amount of the Sorek power station, the Group assessed the recoverable amount as of September 30, 2017 in view of the increase in construction costs and the electricity transmission costs of the station.
For the purpose of this assessment, the Group engaged an independent external assessor that calculated the recoverable amount using the discounted cash flow method. When determining the recoverable amount, the following parameters were taken into account: The estimated revenue from the sale of electricity up to 2037 (when the concession expires) The projected fixed and variable expenses as well as costs of periodic maintenance of the station turbines A discount rate of 7%.
The carrying amount of the power station (including advance maintenance expenses) amounted to NIS 762 million, and when assessing the value, it was determined that the recoverable amount is NIS 712 million. Accordingly, as aforesaid, the Group recorded a provision for impairment of the station in the amount of NIS 50 million, under other revenue (expenses), net.
D. Delek Israel
Subsequent to the balance sheet date, on October 3, 2017, Delek Israel received a letter from the Ministry of Energy, together with a summary of the price committee meeting held on September 27, 2017 and a draft report of attribution of Delek Israel’s costs with regard to updating the marketing margin of 95-octane gasoline under price supervision, based on a review of the monetary data for 2015 and 2016. In the summary of the meeting, the price committee made the following recommendations: To reduce the self-service marketing margin of 95-octane gasoline by 8 agorot and to reduce the full-service surcharge (including VAT) by 4 agorot. Delek Israel (as well as the other fuel companies) was given the option to respond to the draft cost attribution report by November 15, 2017 and it was noted that the parties that submit a written response, and are interested, will be invited to state their claims orally before the price committee members based on the considerations of the Price Committee. Delek Israel is preparing its response through its attorneys - supported by an economic opinion by an economic expert - in which it will demonstrate its position that the margin should not be reduced (rather, on the contrary). Delek Israel is assessing the implications of the recommendations, insofar as they will be implemented in accordance with the announcement of the Ministry of Energy.
25 WorldReginfo - c16fd361-de53-4169-8c2c-61d95bc8d7cf Delek Group Ltd.
Notes to the Consolidated Interim Financial Statements
NOTE 3: INVESTMENTS IN INVESTEES AND PARTNERSHIPS (CONTD.)
E. Delek Automotive Systems Ltd. (“Delek Automotive”)
1. The Group holds 22.5% of the shares of Delek Automotive. The Group’s investment in Delek Automotive is accounted for using the equity method. Following is condensed information from the financial statements of Delek Automotive for each reporting period:
September 30 December 31 2017 2016 2016 Unaudited Audited NIS million
Current assets 1,367 1,399 1,710 Non-current assets 1,069 994 1,048
Current liabilities 1,604 1,553 1,885 Non-current liabilities 167 160 168 Equity attributable to shareholders of the investee 665 680 705
Nine months ended Three months ended Year ended September 30 September 30 December 31 2017 2016 2017 2016 2016 Unaudited Audited NIS million
Revenue 2,858 2,973 834 824 3,428 Gross profit 453 538 126 128 609 Operating profit 340 431 85 95 498 Finance income (expenses), net 22 (107) 19 10 (12) Net earnings attributable to shareholders of the investee 275 243 80 79 370
2. Further to Note 10F(k) to the Annual Financial Statements regarding the valuation of the investment in Delek Automotive and the decline in the value of Delek Automotive shares in the reporting period and in view of the difference between the value of the Group's investment in Delek Automotive shares and its market value as of September 30, 2017, in view of the decrease in the operating profits of Delek Automotive, the Group estimated the recoverable amount (value in use) of its investment in Delek Automotive. The value in use was estimated by an independent external assessor, estimating the net value in use of the Company's investment of NIS 570 million in Delek Automotive (based on discounting the cash flow net of tax, at a discount rate of 12.6%, assuming the representative cash flows as from the sixth year will increase by 2.5% annually). Due to the difference between the value of the investment in Delek Automotive in the Group's financial statements and its recoverable amount, the Group included a provision of NIS 164 million in its financial statements for impairment of its investment in Delek Automotive, which was recognized in the Group's share in earnings (losses) of associates. As of September 30, 2017, the market value of the investment in Delek Automotive amounted to NIS 556 million and shortly before the approval date of the financial statements, NIS 580 million).
26 WorldReginfo - c16fd361-de53-4169-8c2c-61d95bc8d7cf Delek Group Ltd.
Notes to the Consolidated Interim Financial Statements
NOTE 4: INVESTMENTS IN AVAILABLE-FOR-SALE FINANCIAL ASSETS
A. On November 27, 2016, the Company signed an agreement with Ratio Petroleum Energy - Limited Partnership ("Ratio Petroleum"), whereby the Company will invest in the participation units of Ratio Petroleum. The agreement will come into effect after their issue on the Tel Aviv Stock Exchange. On January 23, 2017, the participation units were listed on the TASE. The total consideration for the acquisition of 20,069,392 participation units, representing 17% of the partnership's capital, amounted to NIS 21 million. Concurrently with the issue of the participation units, Ratio Petroleum allotted options exercisable for the participation units of Ratio of Petroleum to investors, including the Company, for no consideration. The Company may appoint one director to serve on the board of directors of the general partner, Ratio Petroleum, so long as it holds 10% of the participation units of Ratio Petroleum. These securities are locked up in accordance with the guidelines of the TASE.
B. Further to Note 9 to the Annual Financial Statements regarding the Company's investment in Faroe Petroleum PLC (“Faroe”), in the second quarter of 2017, the Company invested an additional NIS 33 million in Faroe shares. Subsequent to the acquisition, the Company holds 15.37% of the shares of Faroe.
NOTE 5: INVESTMENTS IN OIL AND GAS EXPLORATION AND PRODUCTION IN ISRAEL AND ITS SURROUNDINGS
The Group operates mainly through Delek Drilling, subsequent to the merger with Avner Oil Exploration - Limited Partnership, as described below, in a number of joint ventures for the exploration, development, and production of oil, natural gas, and condensate in the exclusive economic zone of Israel and Cyprus, and sells natural gas and condensate to a variety of customers (see also Note 12 to the Annual Financial Statements).
Further to Note 12(N) to the Annual Financial Statements, regarding the merger of Delek Drilling and Avner, on May 17, 2017, the merger was completed. As part of the merger, Delek Drilling allocated its participation units to all holders of Avner's participation units and all Avner's assets and liabilities were transferred to Delek Drilling. After completion of the merger, the Group holds 56% of Delek Drilling's participation units (linked). The merger did not have a material effect on the Group's financial statements, other than a decrease of NIS 21 million in equity attributable to the shareholders of the Company against a corresponding increase in the balance attributable to non-controlling shareholders. See also Note 7D below regarding the motion for certification as a class action in connection with the merger transaction. The main changes in the reporting period appear below:
A. Ratio Yam joint venture
1. Plan for development of the Leviathan reservoir Further to Note 12E to the Annual Financial Statements, on February 23, 2017, the Leviathan partners made a final investment decision (FID) for the development of Stage 1A in the development plan of the Leviathan reservoir, with an annual capacity of 12 BCM, at a budget of USD 3.75 billion, to allow the supply of natural gas from the Leviathan reservoir to start by the end of 2019.
2. Appraisal, development and production drillings under the development plan:
A) In December 2016, the Leviathan partners made a decision regarding the appraisal and production drilling of Leviathan-5 in the area of the I/15 Leviathan North lease ("the Well"). The Well is also planned to be used as a production well in the future. In July 2017, drilling was completed, after reaching the final planned depth and verification of the existence of natural gas in three layers of the Leviathan reservoir (Sands A, B, and C), in accordance with the operator’s preliminary estimate of the Well. As of the balance sheet date, the cost of the Well is USD 94 million (100%, the Partnership's share is USD 42.6 million), excluding the cost of its completion and connection to the production system of the Leviathan reservoir.
27 WorldReginfo - c16fd361-de53-4169-8c2c-61d95bc8d7cf Delek Group Ltd.
Notes to the Consolidated Interim Financial Statements
NOTE 5: INVESTMENTS IN OIL AND GAS EXPLORATION AND PRODUCTION IN ISRAEL AND ITS SURROUNDINGS (CONTD.)
A. Ratio Yam joint venture (contd.)
2. Appraisal, development and production drillings under the development plan (contd.)
B) In March 2017, the Leviathan partners made a decision regarding the development and production drilling of Leviathan 7 in the area of the I/14 Leviathan South lease (below in this section: “the Well”). The Well is a development well and it will be connected as a production well to the Leviathan project production system at a later stage. In July 2017, after the upper part of the Leviathan 7 well was drilled continuously together with the Leviathan 5 well, the drilling operator terminated the agreement with the Atwood Advantage drilling rig and engaged another drilling rig, the Ensco DS-7, to redrill the lower part of the Leviathan 7 well and the lower part of the Leviathan 3 well, and subsequently to perform completion of the production wells in the Leviathan project, as from the first quarter of 2018. As of the balance sheet date, the cost of the Leviathan 7 well is USD 16 million (100%, the Partnership's share is USD 7.3 million). It should be noted that the cost of the wells, as set out above, is included in the budget for development of Stage 1A in the development plan.
C) Following the FID for the development of Phase 1A in the Leviathan project, as set out above, in September 2017, the subsidiary partnership received a report on the reserves and contingent resources in the leases from Netherland Sewell & Associates Inc. (“NSAI”), an independent, expert and certified reserves and resources appraiser, based on the guidelines of SPE-PRMS, updated as of August 31, 2017. In accordance with the report, the amount of reserves approved for development, classified as proved reserves, is 266.5 BCM and the amount of reserves classified as proved + probable reserves is 354.3 BCM.
In addition, the amount of condensate reserves in the Leviathan lease, classified as reserves approved for development classified as proved reserves is 16.9 barrels and the amount of reserves classified as proved + probable reserves is 22.5 million barrels.
In addition, according to the report, the amount of contingent resources in the Phase 1A category is between 340 BCM (high estimate) and 207.3 BCM (low estimate). In addition, the amount of contingent resources in condensate in this category is between 21.6 million barrels (high estimate) and 13.1 million barrels (low estimate). The total amount of reserves classified as proved + probable reserves and the amount of contingent resources in the Phase 1A category and their future developments (best estimate) is 604.9 BCM.
The estimates of the natural gas and condensate reserves in the leases are partially based on geological, geophysical, engineering and other information received from the drillings and from the operator in these rights. These estimates are the professional estimates and assumptions only of NSAI and there can be no certainty in respect of them. Actual quantities of natural gas and condensate consumed may be different from these estimates and assumptions, partly due to technical and operational conditions and/or regulatory changes and/or the supply and demand conditions in the natural gas and/or condensate market and/or commercial conditions and/or as a result of actual performance of the reservoirs. The estimates and assumptions may be revised if additional information becomes available and/or as the result of a range of factors related to oil and natural gas exploration and production projects.
28 WorldReginfo - c16fd361-de53-4169-8c2c-61d95bc8d7cf Delek Group Ltd.
Notes to the Consolidated Interim Financial Statements
NOTE 5: INVESTMENTS IN OIL AND GAS EXPLORATION AND PRODUCTION IN ISRAEL AND ITS SURROUNDINGS (CONTD.)
A. Ratio Yam joint venture (contd.)
3. In the reporting period, the Israeli partners in the Leviathan project provided a company guarantee in favor of the Israeli Tax Authority (Customs) for equipment purchased by the operator for development of the Leviathan project. The Company's share in the guarantee was NIS 172 million.
B. Michal Matan joint venture (Tamar and Dalit Leases)
1. Estimated natural gas and condensate reserves in the Tamar gas field:
According to a report prepared on July 2, 2017 by NSAI, based on the guidelines of SPE- PRMS, following the information received from the Tamar-8 development and production wells, which indicated a significant increase in the volume of reserves in the Tamar project, the natural gas reserves in the Tamar project (which includes the Tamar and Tamar SW reservoirs) classified as on-production reserves, as of June 30, 2017, and classified as proved reserves, are 226.8 BCM and the volume of reserves classified as proved + probable reserves is 318.1 BCM. In accordance with this report, the condensate reserves in the Tamar and Tamar SW reservoir, classified as approved for production, as of June 30, 2017, which are classified as proved reserves, amount to 10.4 million barrels and the reserves classified as proved + probable reserves amount to 14.6 million barrels. The above reserves do not include the reserves migrating to the Eran license. In view of the adjusted reserves estimate, the depletion rate was adjusted accordingly.
The estimates of the natural gas and condensate reserves in the leases are partially based on geological, geophysical, engineering and other information received from the drillings and from the operator in these rights. These estimates are the professional estimates and assumptions only of NSAI and there can be no certainty in respect of them. Actual quantities of natural gas and condensate consumed may be different from these estimates and assumptions, partly due to technical and operational conditions and/or regulatory changes and/or the supply and demand conditions in the natural gas and/or condensate market and/or commercial conditions and/or as a result of actual performance of the reservoirs. The estimates and assumptions may be revised if additional information becomes available and/or as the result of a range of factors related to oil and natural gas exploration and production projects.
2. In October 2016, development and production drilling began at Tamar-8, which is designed, among other things, to increase the redundancy in the production system and allow maximum supply from the Tamar reservoir during peak demand. The drilling was completed (including completion and connection to the production system) in April 2017 and natural gas started to flow from the well. The total cost of the drilling, including the completion and development of the subsea system and connection of the well to the existing infrastructure of the Tamar project, is USD 240 million (100%, the Partnership’s share is USD 52.8 million).
29 WorldReginfo - c16fd361-de53-4169-8c2c-61d95bc8d7cf Delek Group Ltd.
Notes to the Consolidated Interim Financial Statements
NOTE 5: INVESTMENTS IN OIL AND GAS EXPLORATION AND PRODUCTION IN ISRAEL AND ITS SURROUNDINGS (CONTD.)
B. Michal Matan joint venture (Tamar and Dalit Leases) contd.)
3. On September 20, 2017, the operator began upgrade and improvement works on the Tamar platform and the receiving terminal ("the Upgrade Works"), during which natural gas from the Tamar field to the Tamar project production platform was planned to flow through only one of the two pipelines, at half of the maximum production capacity. During the Upgrade Works, a crack was discovered in the exhaust pipe used to release natural gas and pressure from the platform routinely and in emergencies ("the Malfunction"), following which, in accordance with the procedures in place at the Tamar platform, the supply of natural gas from the Tamar reservoir was suspended in a controlled manner on September 21, 2017. Following a comprehensive engineering analysis, the operator decided to continue the planned Upgrade Works, while repairing the Malfunction. After completing the repair of the malfunction, on September 27, 2017, the operator announced that the flow of natural gas from the Tamar reservoir had been resumed, while continuing the Upgrade Works. On October 10, 2017, the Upgrade Works were completed as planned. The costs of repairing the Malfunction and its effect on profit in the reporting period are not material.
4. Sale of the Partnership's rights at a rate of 9.25% of the rights in the Tamar and Dalit reservoirs
A) On July 2, 2017, the Partnership signed a sale agreement ("the Sale Agreement" or "the Agreement") with Tamar Petroleum Ltd. ("Tamar Petroleum") for the transfer of 9.25% of the rights in the Tamar and Dalit leases to Tamar Petroleum. The sale of the rights in the leases was carried out through the raising of debt and capital. The transaction underlying the Sale Agreement was completed on July 20, 2017, in a cumulative amount of NIS 3 billion (“the Consideration of the Issuance”). The Consideration of the Issuance was used by Tamar Petroleum for the purchase of the Object of the Sale (as defined below) from the Partnership.
The main points of the Sale Agreement are as follows:
1. The Partnership undertook to sell and transfer to Tamar Petroleum the participation rights at a rate of 9.25% (out of 100%) in the Tamar and Dalit leases, subject to the existing commitments to pay overriding royalties to the Group and its subsidiaries and to third parties, as well the proportionate share (9.25%) of the rights and undertaking under the joint operating agreement, the agreements for the sale of gas from the Tamar lease, the agreement for the use of the Yam Tethys facilities, shares of Tamar 10 Inch Ltd., approval for the operation of the Tamar platform and the export approvals from Tamar (above and below: “the Object of the Sale”). 2. The consideration of the Object of the Sale paid to the Partnership included an amount of NIS 3 billion in cash and shares at a rate of 40% of the capital of Tamar Petroleum, recognized under investments in associates. 3. Tamar Petroleum has undertaken to take steps to allow the Partnership to perform a shelf (sale) offering, subject to certain qualifications and restrictions, including a lock- up period that will apply to the shares as set out below. 4. Of the amount of the cash consideration due to the Partnership, Tamar Petroleum was provided a loan of USD 34 million, bearing annual interest at a rate of 3%. During the months up to and including October 2017, Tamar Petroleum repaid the entire loan plus interest accrued. 5. The record date for calculation of the amount of the consideration and transfer of the rights and obligations for the Object of the Sale to Tamar Petroleum is July 1, 2017 (“the Record Date”).
30 WorldReginfo - c16fd361-de53-4169-8c2c-61d95bc8d7cf Delek Group Ltd.
Notes to the Consolidated Interim Financial Statements
NOTE 5: INVESTMENTS IN OIL AND GAS EXPLORATION AND PRODUCTION IN ISRAEL AND ITS SURROUNDINGS (CONTD.)
B. Michal Matan joint venture (Tamar and Dalit Leases) contd.)
4. Sale of the Partnership's rights at a rate of 9.25% of the rights in the Tamar and Dalit reservoirs
A. (contd.) 6. The agreement stipulates that the Partnership will continue to be responsible for the following issues, also after the closing date of the transaction: the arbitration for the production component tariff (see section K below), the appeal regarding the royalties for the sale of gas from the Tamar project to customers of the Yam Tethys project, including for any liability in connection with these proceedings incurred subsequent to the Record Date; the motion for certification of a class action filed by a consumer of the IEC against the Tamar partners (see Note 7E below), for amounts received by the Partnership in the period prior to the Record Date; the liability for taxes and royalties to the State for the period prior to the Record Date, or for any profit, income or receipt of the Partnership in connection with the Object of the Sale (including if such tax assessment was made subsequent to the Record Date), with the exception of taxes relating to reports submitted prior to the Record Date to the tax authorities in connection with the Taxation of Profits from Natural Resources Law, 2011; taxes applicable to the Partnership in connection with the transfer of the Object of the Sale to Tamar Petroleum, liabilities to the Partnership’s suppliers or customers for the Object of the Sale relating to the period up to the Record Date, unless provisions were made for such liabilities in the financial statements of Tamar Petroleum; and any liabilities in connection with Delek and Avner (Tamar Bond) Ltd. 7. Tamar Petroleum paid all the payments, expenses and fees to the State (with the exception of taxes as aforesaid) for the transfer of the Object of the Sale to Tamar Petroleum and receipt of the approvals. Tamar Petroleum also paid all the expenses and costs related to the issuance of the debentures. The Partnership paid all the expenses and costs of consultants and experts in connection with the prospectus and all expenses in connection with the issue of the shares of Tamar Petroleum. 8. In the agreement for the Object of the Sale, various representations were made by the Partnership, as is customary in transactions of this type, including an undertaking for indemnification for breach of representations. Additional provisions were also prescribed, as is standard in agreements of this type, including for resolution of disputes, interpretation and delivery of notices.
31 WorldReginfo - c16fd361-de53-4169-8c2c-61d95bc8d7cf Delek Group Ltd.
Notes to the Consolidated Interim Financial Statements
NOTE 5: INVESTMENTS IN OIL AND GAS EXPLORATION AND PRODUCTION IN ISRAEL AND ITS SURROUNDINGS (CONTD.)
B. Michal Matan joint venture (Tamar and Dalit Leases) contd.)
4. Sale of the Partnership's rights at a rate of 9.25% of the rights in the Tamar and Dalit reservoirs
A. (contd.) 9. The Sale Agreement also stipulates that if the Partnership holds shares of Tamar Petroleum subsequent to completion of the share issuance, the Partnership unilaterally waives all the voting rights attached to all the shares that it holds over and above shares in a number equalling 12% of the shares of Tamar Petroleum after completion of the issuance. To remove all doubt, it was clarified that all the equity rights attached to the shares held by the Partnership will remain in full force, including: the right to receive dividends, bonus shares, rights and the right to receive surplus assets upon dissolution of Tamar Petroleum. The surplus shares above 12% (“the Surplus Shares”) will be deposited with a trustee who will act in accordance with an irrevocable letter of instructions, which will determine, among other things, that: the Surplus Shares will also include bonus shares or rights, or shares deriving from such rights, which will be allotted to the Partnership for the Surplus Shares as part of the issuance of bonus shares and/or rights to all of the shareholders of Tamar Petroleum. In terms of any future issuance of rights, the Partnership will instruct the trustee whether to exercise or sell the right. The trustee will transfer to the Partnership any dividend it receives for the Surplus Shares. At any time when the Partnership wishes to sell the Surplus Shares, in whole or in part, to a third party, the trustee will transfer the shares to whoever the Partnership so instructs in writing, against receipt of the full consideration (unless the Partnership instructs transfer of the shares prior to receiving the consideration), provided that the Partnership submits written notification to the trustee of the details of the transferee and signs any document required for such transfer. Upon the sale or transfer of the Surplus Shares from the Partnership to a third party as aforesaid, they will be entitled to all rights attached to ordinary shares in Tamar Petroleum. The Partnership has undertaken to first sell the Surplus Shares (the sale of which will confer on the buyer all of the rights attached to them, including voting and equity rights, as set out above) and has further undertaken that as long as it did has not sold the Surplus Shares, it will not acquire additional shares of Tamar Petroleum. It is clarified for this purpose that shares to be allotted to the Partnership as part of an issue of bonus shares or a rights issue will not be considered to be a purchase for the purpose of this undertaking. It should be noted that the TASE lock-up provisions will apply to the shares of Tamar Petroleum to be allotted to the Partnership. In addition, in accordance with the distribution agreement of the Partnership and Tamar Petroleum with HSBC and JP Morgan dated July 18, 2017, in the period ending 180 days after trading in the shares of Tamar Petroleum begins, the Partnership undertook (A) not to offer, sell, pledge or make any other disposition in shares or in securities convertible to the shares of Tamar Petroleum; (B) not to carry out swap transactions or other similar arrangements whose economic nature is the performance of such a disposition; or (C) not to propose a resolution at a general meeting or to convene a general meeting in which the agenda includes the approval of an allotment of shares or securities convertible to shares; other than in the following cases: (1) receipt of the written consent of the international distributors; (2) allotment of the shares in accordance with the distribution agreement; (3) a disposition in response to a merger proposal; (4) a disposition as part of a general buyback plan of Tamar Petroleum; (5) a disposition by virtue of the law or under a court order; (6) a disposition of shares as part of a private sale, provided that the transferee assumed the restrictions in sections (1) to (5) above. The sale of these rights was contingent upon fulfillment of preconditions, which were met in full.
32 WorldReginfo - c16fd361-de53-4169-8c2c-61d95bc8d7cf Delek Group Ltd.
Notes to the Consolidated Interim Financial Statements
NOTE 5: INVESTMENTS IN OIL AND GAS EXPLORATION AND PRODUCTION IN ISRAEL AND ITS SURROUNDINGS (CONTD.)
B. Michal Matan joint venture (Tamar and Dalit Leases) contd.)
4. Sale of the Partnership's rights at a rate of 9.25% of the rights in the Tamar and Dalit reservoirs
A. (contd.) The Partnership also undertook not to propose more than one director at the general meetings convening for the purpose of appointing directors. The articles of association of Tamar Petroleum set out provisions establishing the Partnership’s waiver of voting rights attached to shares to be held at a rate exceeding 12% of the issued share capital and several provisions that will apply as long as the Partnership holds 25% or more of the issued and paid-up share capital of Tamar Petroleum, including: provisions regarding an appointments committee to be set up if the Company wishes to propose candidates for the appointment of directors in Tamar Petroleum at a general meeting of shareholders; restrictions on the eligibility of directors according to which all but one of the directors will not have an interest in the Partnership; and a restriction on the manner of approving transactions with the Group or a corporation under its control. On July 20, 2017, all the preconditions set out in the Sale Agreement were fulfilled, including receipt of approval from the Commissioner of Petroleum Affairs for the transfer of rights in the Tamar and Dalit leases and their listing in the Oil Register, following which the rights were transferred at a rate of 9.25% (out of 100%) in the Tamar and Dalit leases for a cash consideration of NIS 3 billion (approximately USD 850 million) (not including expenses related to the issuance of the shares of Tamar Petroleum) in return for the allocation of 19,990,000 ordinary shares of NIS 0.1 par value each of Tamar Petroleum (“the Cash Consideration”). Of the total Cash Consideration, the Partnership repaid USD 320 million for partial early repayment of four series of debentures issued in the past (Series 2018, 2020, 2023 and 2025), representing 20% of the unpaid balance of each of the debenture series (meaning, USD 80 million in each of the series), plus accrued interest of USD 1.1 million, all in accordance with the provisions of the deed of trust of the debentures.
B) On July 20, 2017, a tax decision was received from the Tax Authority, determining, among other things, the date of the tax payment for the Consideration in Shares, according to which, subject to the terms and instructions set out therein: 1. The Partnership will pay advance tax payments according to the law for the capital gain that the Partnership will derive from the Cash Consideration. 2. The payment date of the tax for the capital gain arising from the Consideration in Shares will be deferred until the occurrence of one of the following (“the Deferred Tax"): a) On the exercise date of the shares of Tamar Petroleum, the Deferred Tax will be paid for the portion of the exercised shares out of the total shares held prior to the exercise; on the date on which the rate of the Partnership's holding in the shares of Tamar Petroleum falls to 5% or less, the full balance of the Deferred Tax will be paid. b) If the Partnership declares the distribution of a dividend after August 1, 2017, in an amount exceeding the amount of the capital gain from the sold rights, net of the tax paid for it, an amount equal to 25% of the declared distribution will be paid out of the Deferred Tax, and no more than the balance of the Deferred Tax (distribution of profits declared prior to that date will not bring forward payment of the Deferred Tax). c) When Tamar Petroleum distributes a dividend to its shareholders, the Deferred Tax will be paid in an amount equal to 25% of the dividend received by the Partnership and no more than the balance of the Deferred Tax that has not yet been paid. 3. The Partnership is entitled to bring forward the payment date of the Deferred Tax, at its sole discretion.
33 WorldReginfo - c16fd361-de53-4169-8c2c-61d95bc8d7cf Delek Group Ltd.
Notes to the Consolidated Interim Financial Statements
NOTE 5: INVESTMENTS IN OIL AND GAS EXPLORATION AND PRODUCTION IN ISRAEL AND ITS SURROUNDINGS (CONTD.)
B. Michal Matan joint venture (Tamar and Dalit Leases) (contd.)
4. Sale of the Partnership's rights at a rate of 9.25% of the rights in the Tamar and Dalit reservoirs (contd.)
B. (contd.) 4. To allow holders of the Partnership's participation units to benefit from the tax deferral arrangement established in the tax decision, it was determined that the tax certificates to be issued to eligible holders for the tax year will report only the capital gain due for that tax year according to the tax decision. It was further agreed that the capital gain, including the capital gain to be reported in the following years as a result of the sale of the shares of Tamar Petroleum, will be subject to the tax rates that apply in 2017. A holder may only offset the profit against a loss incurred up to and including the 2017 tax year. In August 2017, the Partnership paid advance tax payments in the amount of NIS 557.5 million (approximately USD 156 million) on account of the capital gain.
C. As a result of the aforesaid completion of the sale of the shares of Tamar Petroleum, in the third quarter of 2017, the Group recognized a profit from the exercise of its holdings in Tamar Petroleum and from the fair value measurement of the investment in Tamar Petroleum (in view of the loss of control over Tamar Petroleum), amounting to NIS 1.5 billion before tax (profit net of tax attributable to the shareholders of the Company amounted to NIS 873 million). This amount also includes the estimated fair value of the rights of the Group companies to royalties based on future production for the rights sold to Tamar Petroleum, which was estimated by an external assessor at USD 126 million (approximately NIS 449 million). Below are the main parameters of the valuation used to measure the fair value: The discount rate is estimated at 7.3%, the annual production rate of natural gas is 10.65 BCM from 2018 throughout the project life until depletion of the reservoir. The investment in Tamar Petroleum is accounted for using the equity method. The difference between the fair value of the investment in Tamar Petroleum and the Group's share in the net assets of Tamar Petroleum as of the date of the sale was mainly due to oil and gas assets and is amortized in accordance with the rate of amortization of these assets. The balance of the investment as of September 30, 2017 amounted to NIS 442 million.
C. As part of the Company’s efforts to dispose of the overriding royalty to which it is entitled from the Partnership for oil assets in which the Partnership holds or held an interest, by way of transferring the right to overriding royalties from the Company to a wholly-owned subsidiary, and the listing of that company on the Tel Aviv Stock Exchange, the Company discussed whether the provisions of the Gas Outline Plan as set out in Note 12M(1) to the Annual Financial Statements, regarding the Partnership's obligation to dispose of its rights in the Tamar reservoir, also require the Company and companies under its control to dispose of their rights to the overriding royalty from the Tamar reservoir, within the period specified in the outline plan for the disposal of Tamar, meaning by December 17, 2021 (within 4 years). From the Company's discussions with the State, it arises that the State's position is that the obligation to sell in accordance with the Gas Outline Plan also refers to rights for the overriding royalties of parties related to the Partnership, that is, the Company as well, until December 17, 2021. The Company's position is that in accordance with the wording of the Gas Outline Plan, as well as its purpose, the obligation to sell in accordance with the Gas Outline Plan refers only to the Partnership in respect of its rights in the Tamar reservoir and does not apply to the overriding royalty from the Tamar reservoir, which is owned by the Company. Since the Company intends to dispose of the overriding royalty to which it is entitled from Tamar in the near future, a decision on this matter is unnecessary.
34 WorldReginfo - c16fd361-de53-4169-8c2c-61d95bc8d7cf Delek Group Ltd.
Notes to the Consolidated Interim Financial Statements
NOTE 5: INVESTMENTS IN OIL AND GAS EXPLORATION AND PRODUCTION IN ISRAEL AND ITS SURROUNDINGS (CONTD.)
D. In respect of the agreement for the payment of royalties according to which the Partnership undertook to pay royalties at a rate of 6.5% (instead of 1.5%) to the Company and to the companies it controls (the rate of the royalty is after a reduction of 50% following the merger of Delek Drilling and Avner), it should be noted that as of the approval date of the condensed interim financial statements, the Company and the Partnership are continuing to assess the return on investment in the Tamar project, which the Partnership believes will be achieved in the second half of 2017. The date of the return on the investment is not expected to have any material effect on these financial statements.
E. Block 12, Cyprus
Further to Note 12H to the Annual Financial Statements regarding the application for a production license in the Aphrodite reservoir in Cyprus, on September 21, 2017, the Aphrodite reservoir partners in Cyprus submitted revised engineering and technical sections of the Aphrodite reservoir development plan to the Government of Cyprus. It should be noted that as of the approval date of the condensed interim financial statements, the Partnership, together with its partners in the Aphrodite reservoir, is continuing to advance connections and/or negotiations, at various stages, for the export of large volumes of natural gas from the Aphrodite reservoir to regional markets, including the Egyptian market.
F. Further information about the licenses of the Partnership
1. Further to Note 12B to the Annual Financial Statements, and in accordance with the ruling of the High Court of Justice regarding the petition to the High Court of Justice filed by the Eran partners against the Minister of Energy and the Commissioner, on the Minister of Energy's decision to dismiss the appeal filed by the Eran partners on the Commissioner's decision not to extend the Eran license, the parties turned to mediation. At this time, the mediation process has not yet been exhausted. At the parties' request, the Court allowed them to report the results of the mediation process by January 4, 2018.
2. Further to Note 12F(7) to the Annual Financial Statements regarding an appeal filed by the partners in the 351/Hanna license (“the Hanna License”), in June 2017, the Minister of Energy informed the partners in the Hanna License of his decision to dismiss the appeal. As a result, in the second quarter of 2017, the Partnership deducted NIS 90 million (approximately NIS 40 million attributable to the shareholders of the Company) for the costs of the Dolphin well under depreciation and amortization in the statement of income 3. In August 2017, the Minister of Energy notified the partners in the 367 /Alon D license ("the License") of its decision according to which the license will continue to be valid for 32 months from the decision date, subject to the receipt of certain clarifications, undertakings and approvals from the License partners. In September 2017, the partners in the license submitted a letter to the Minister of Energy, which includes the clarifications, undertakings and approvals as aforesaid.
35 WorldReginfo - c16fd361-de53-4169-8c2c-61d95bc8d7cf Delek Group Ltd.
Notes to the Consolidated Interim Financial Statements
NOTE 5: INVESTMENTS IN OIL AND GAS EXPLORATION AND PRODUCTION IN ISRAEL AND ITS SURROUNDINGS (CONTD.)
G. Agreement to finance the Partnership's share in the costs of developing the Leviathan project
On February 20, 2017, Delek Drilling signed the financing documents ("the Financing Agreement" or "the Agreement") with a consortium of local and foreign financers headed by HSBC Bank Plc and JP Morgan Limited ("the Lenders”). Under the Financing Agreement, Delek Drilling will receive a limited- recourse loan of USD 875 million ("the Loan") to finance its share in the investment in the development of the Leviathan project ("the Leviathan Project"). Concurrently with the signing of the Financing Agreement by Delek Drilling, a financing agreement was signed with the same terms and for the same purposes between the Lenders and Avner for a loan of the same amount. The loans provided to Delek Drilling (after its merger with Avner) amount to USD 1.75 billion.
The Loan is divided into facilities, in accordance with the dates and conditions in the agreement.
The Loan agreement includes another facility of USD 750 million for each Partnership (a total of USD 2.5 billion), which is contingent on signing agreements for the supply of gas at a minimum total annual volume defined in the Agreement, and a decision to increase the capacity of the production and transmission system to Phase 1B of the development plan or its alternative, which may be given by the Lenders, in whole or in part, or by other lenders, however, there is no undertaking by the Lenders to provide this facility. For further information about the terms of the Loan, see Note 12J(3) to the Annual Financial Statements.
As of the reporting date, the Partnership withdrew USD 322.3 million from the loan funds.
Under the terms of the Financing Agreement as set out above, the Partnership is exposed to potential changes in cash flows that may arise from changes in the Libor interest rate. As part of the risk management policy of the Partnership, in April 2017, the Partnership entered into IRS cash flow hedges for changes in the Libor interest rate, amounting to USD 1,100 million. The hedges are for changes in the Libor interest rate (three months) from the dates of the transactions until the expiry dates of the hedge transactions (October 2017). These transactions hedge against interest rate changes until the expected settlement of the transaction. In September 2017, the Partnership redeemed the hedge transactions at a loss of USD 4 million, due to a decrease in the interest rate, which was recognized in the statement of other comprehensive income for cash flow hedging transactions.
H. Further to Note 12K(2) to the Annual Financial Statements, on January 16, 2017, the Leviathan partners and Edeltech Ltd. signed a non-binding letter of intent, in which the parties confirmed their intention to negotiate for an agreement to supply natural gas from the Leviathan project to the Buyer, in an estimated scope of 14.8 BCM over 17 years. The binding agreement, if signed, is in addition to the supply agreements signed in January 2016. As of the approval date of the financial statements, the Leviathan partners continue to hold negotiations, at various stages, with the aim of signing binding agreements for the supply of natural gas from the Leviathan project to the local market.
36 WorldReginfo - c16fd361-de53-4169-8c2c-61d95bc8d7cf Delek Group Ltd.
Notes to the Consolidated Interim Financial Statements
NOTE 5: INVESTMENTS IN OIL AND GAS EXPLORATION AND PRODUCTION IN ISRAEL AND ITS SURROUNDINGS (CONTD.)
I. Agreement for the export of natural gas from the Leviathan project to the National Electric Power Company of Jordan
Further to Note 12K(2)(b) to the Annual Financial Statements regarding an agreement with the National Electric Power Company of Jordan, the following should be noted:
1. In February 2017, the Commissioner approved the export of natural gas under this agreement.
2. In respect of fulfillment of the preconditions under the agreement, it should be noted that in June 2017, a transmission agreement was signed between the marketing company, NBL Jordan Marketing Limited (a company in which the shareholders are the Leviathan partners holding shares according to the rate of their holdings), and Israel Natural Gas Lines Ltd. ("INGL") (“the Transmission Agreement”). Accordingly, as of the approval date of the financial statements, all the preconditions in the agreement have been fulfilled, with the exception of the signing of a transmission agreement between NEPCO and the Jordanian Egyptian Fajr for Natural Gas Transmission & Supply Co. Ltd. (FAJR).
3. In the reporting period, the Leviathan partners provided a company guarantee in accordance with their proportionate share in the Leviathan leases, in the amount of USD 18 million (100%, the Partnership's share is USD 8 million) to Israel Natural Gas Lines Ltd. ("INGL"), in accordance with the terms of the transmission agreement between the marketing company and INGL.
4. In July 2017, the Leviathan partners approved a budget for completion of the Israeli transmission system up to the Israel-Jordan border, amounting to USD 111 million (100%, the share of the Partnership is USD 50.3 million).
J. Further to Note 12K(2) to the Annual Financial Statements, on May 4, 2017, the Partnership together with the Leviathan partners ("the Sellers") notified their customers in the local market that all the preconditions of the Sellers have been fulfilled, as set out in the natural gas supply agreements signed with them. It should be noted that following the notice to Paz Ashdod Refinery Ltd. ("Paz"), all the preconditions in the gas supply agreement of November 24, 2016 between the Leviathan partners and Paz were fulfilled.
K. Further to Note 12K(1)f to the Annual Financial Statements, in June 2017, the Partnership, together with the other Tamar partners, applied for international arbitration with one of the transaction customers. The partners believe, based also on the opinion of their legal counsel, that it is more likely than not that the partner's position, according to which the last agreed price of electricity production applied prior to the split will apply to the gas quantities supplied between May 2013 and February 2015, will be accepted.
L. Royalties to the State
1. In February 2017, a letter was received from the Ministry of Energy regarding advances on royalties for 2017, stating that the effective royalty rate to be paid as advances in 2017 in the Tamar project will amount to 11.65%. It was further clarified that this rate was set as an advance payment alone. The Operator and the other Tamar partners believe that calculation of the actual royalty rate to the state for revenue from the Tamar Project, should reflect the complexity and risks involved in the project, and the scope of investments in the project, compared to the Yam Tethys Project.
2. In February 2017, a letter was received from the Ministry of Energy regarding advances on royalties for 2017, stating that the royalty rate for the Yam Tethys project in 2017 will be 0%. It is noted that, if during the year, production will be significantly higher in the reservoir, this rate will be adjusted.
37 WorldReginfo - c16fd361-de53-4169-8c2c-61d95bc8d7cf Delek Group Ltd.
Notes to the Consolidated Interim Financial Statements
NOTE 5: INVESTMENTS IN OIL AND GAS EXPLORATION AND PRODUCTION IN ISRAEL AND ITS SURROUNDINGS (CONTD.)
M. In the reporting period, the contingent consideration for the rights from the sale of the Karish and Tamar leases was amended by the Company and the Partnership as set out in Note 12G to the Annual Financial Statements. The amendment was mainly due to the passage of time and the depreciation of the USD. The profit arising from the amendment in the reporting period, attributable to the shareholders of the Company (after tax) amounted to NIS 16 million, and on the other hand, an impairment loss of NIS 22 million was recognized for the depreciation of the US dollar, and was recognized in the statement of comprehensive income.
N. Further to the motion to the Court for instructions about the interpretation and manner of implementation of Section 19 of the Taxation of Profits from Natural Resources Law, 2011, which was filed by the supervisor of Avner Partnership in October 2016, on November 1, 2017 (subsequent to the balance sheet date), the Court handed down a judgment on the motion. To the best of the Partnership’s understanding, the judgment stipulates the following”
1. Section 19(A) of the Taxation of Profits from Natural Resources Law, 2011 ("Section 19(A)") does not address the arrangement of the relations between the holders of the participation units in the Partnership, but only how the tax is collected. As such, payment of the tax under Section 19(A) should not be considered as a distribution, and payment of the tax is not subject to the distribution tests. 2. It is not possible to accept the proposal of the General Partner whereby together with the tax payment, a tax certificate will be issued to the holders with a uniform tax rate for each holder, without taking into consideration their status, since this proposal includes a tax payment deficit for "individuals", which will require additional collection activities and harms the purpose of Section 19(A), which is to streamline tax collection. 3. The Court sees no justification for intervening in the management of the Partnership's matters and for requiring the Partnerships to pay an amount exceeding what is required in the provisions of Section 19(A)(6) to the holders of the participation units or to the Income Tax Authority. 4. As long as the collection arrangement set out in Section 19(A) is in force, the Partnership and/or the General Partner must find the appropriate balance between the additional expense involved in the tax rate applicable to individuals holding participation units and that applicable to companies holding participation units. One option is for the General Partner to determine a balancing distribution that may be conceptual (recognized until actual distribution and accounting) to holders of participation units with a tax rate lower than the tax rate applicable to individuals. The Court does not place itself instead of the General Partner and insofar as another arrangement is found that meets the requirements of the law (the Partnership Agreements and the Partnerships Law) applicable to the Partnership and the General Partner, it is entitled to apply it. As of the approval date of the financial statements, the Partnership is assessing whether to appeal the judgment.
O. The right of the Group companies to royalties based on future production was measured at fair value and was classified, at this stage, as a financial asset. The Group is assessing the continuation of classification in the subsequent financial statements as a financial asset or as a gas and oil asset. It should be noted that this classification has no material effect on the profit included in the financial statements as set out above. See sections B and M above.
NOTE 6: DEBENTURES
As set out in Note 19E to the Annual Financial Statements, on February 21, 2017, the Company issued NIS 995,933,000 par value Debentures (Series B31) by way of expansion of the existing series for NIS 1,006 million (after offsetting issuance expenses of NIS 10 million). The effective annual interest rate of the debenture is 4.2%.
38 WorldReginfo - c16fd361-de53-4169-8c2c-61d95bc8d7cf Delek Group Ltd.
Notes to the Consolidated Interim Financial Statements
NOTE 7: CONTINGENT LIABILITIES
There are contingent claims against the Company and certain investees for significant sums, including certification for class actions that might reach hundreds or billions of shekels. In some cases, it is not possible to assess their outcome at this stage, and therefore no provision was recorded in the financial statements, as set out below (see Note 23A to the Annual Financial Statements).
A. Further to Note 23A(2) to the Annual Financial Statements, several lawsuits have been filed against The Phoenix, its investees and others, including motions for certification of class actions, amounting to significant sums (for further information see also the reports of The Phoenix, which are available to the public).
B. Further to Note 23A(4) to the Annual Financial Statements, on May 20, 2014, a claim and motion for certification as a class action was filed against the Company, the chairman of the board of directors and the CEO of the Company, for alleged impairment of the value of the shares of the subsidiary Delek Energy Systems Ltd. The relief requested in the class action is financial compensation estimated at NIS 100 million (which was subsequently amended). On October 20, 2014, the applicant petitioned the court to amend the motion so that the controlling shareholder in the Company will be added to the respondents. In December 2014, the court hearing was held and shortly thereafter, a ruling accepted the motion for the amendment. In January 2015, the applicant filed an amended motion for certification and an amended statement of claim, including amendments that were not in the original motion, including an increase of the amount of the claim to NIS 400 million. In 2016, evidentiary hearings were held and summations were submitted to the court in respect of the motion for certification.
On February 20, 2017, the Tel Aviv District Court handed down a ruling in respect of the motion for certification as a class action. In accordance with the court ruling, the motion for certification against the Company was accepted on the grounds of discrimination of the minority, and against the CEO of the Company and the chairman of the board of directors on the grounds of breach of duty of care and fiduciary duty. The Court dismissed the motion for certification against the controlling shareholder. In accordance with the Court's ruling, the hearing of the claim will be postponed until the ruling of the Supreme Court on the appeal and the rehearing filed by the respondents. In April and May 2017, the applicant filed an appeal at the Supreme Court in connection with the dismissal of the motion against the controlling shareholder of the Company, as well as a motion to reduce the amount of the guarantee set in the appeal and to extend the date for its deposit. On November 22, 2017, the Court dismissed the motion. On July 5, 2017, the Company filed a motion for a re-hearing on its behalf, and a similar application was filed simultaneously on behalf of the officers. On July 9, 2017, a ruling was handed down according to which the hearing of the motions for a re-hearing filed on behalf of the Company and on behalf of its officers will be consolidated. On November 15, 2017, a single response was submitted on behalf of the respondent to the motion for a re-hearing. At the same time, the respondent filed an "urgent motion to dismiss or strike out the motions for a re- hearing and as an alternative only, a motion to delete the opinion that was attached and to delete sections of the motion”. The Company will file its response within 14 days of November 19, 2017. At this stage, the results and risks of these proceedings cannot be assessed.
C. Further to Note 23A(3) to the Annual Financial Statements, on September 2, 2012, a motion for certification of a class action was filed against Cohen Development and Industrial Buildings Ltd (“Cohen Development"), the Company and some members of the Cohen and Tadmor family, former controlling shareholders of Cohen Development ("the Respondents") regarding the procedure for acquiring control in Cohen Development and Industrial Buildings Ltd. by the Company. The remedies sought in the class action include monetary relief, which the applicant estimates at no less than NIS 49 million and declaratory relief that the shares acquired from the Respondents shall not confer any rights and shall be dormant shares as long as they are held by Delek Group.
After litigation at the Tel Aviv-Jaffa District Court (Economic Division), in April 2014 the court dismissed the motion for certification as a class action against Cohen Development and the Company, regarding the procedure for the transaction to gain control in Cohen Development, but partially upheld the motion for the Cohen family.
39 WorldReginfo - c16fd361-de53-4169-8c2c-61d95bc8d7cf Delek Group Ltd.
Notes to the Consolidated Interim Financial Statements
NOTE 7: CONTINGENT LIABILITIES (CONTD.)
C. (contd.) On June 12, 2014, the applicants appealed the decision of the District Court at the Supreme Court, raising claims against the partial approval of their application and against the dismissal of the motion for certification regarding the Company and Cohen Development. In addition, on June 26, 2014, the Cohen and Tadmor families filed a petition for a rehearing of the ruling of the District Court. On November 26, 2014, the Supreme Court ordered that the hearing of the appeals of the applicants and the Cohen and Tadmor families should be joined. In 2015, mediation failed, and as a result, the appeal was heard at the Supreme Court in June 2016. On May 16, 2017, the Supreme Court handed down its judgment in which the applicant’s appeal was partially accepted and the claim was certified as a class action against the Company on grounds of breach of statutory duty (due to the failure to publish a tender offer under section 328 of the Companies Law when acquiring control in Cohen Development) and against members of the Cohen family on grounds of unjust enrichment (according to which the consideration of the sale of control in Cohen Development was received by them). The motion for certification in the matter of Cohen Development was dismissed. On May 21, 2017, the plaintiffs filed a notice regarding the Supreme Court's judgment on the appeals, and on June 6, 2017, the plaintiffs filed an amended statement of claim that conformed (according to the plaintiffs) to the judgment of the Supreme Court. A statement of defense on behalf of the Company (as well as a statement of defense by the Cohen and Tadmor families) was filed at the Court on October 16, 2017. The pre-trial hearing of the claim was scheduled for January 4, 2018.
The Company believes, based on the opinion of its legal counsel, that at this stage, the chances that the claim against it will be accepted or the extent of any financial liability cannot be determined, therefore, no provision has been included in the financial statements.
D. Further to Note 23A(8) to the Annual Financial Statements regarding the motion for certification of a class action in connection with the merger of Delek Drilling with Avner and in accordance with the court ruling of May 9, 2017, responses to the motion for certification of a class action (“the Motion for Certification") were filed in connection with the merger of the partnerships, which was filed against Avner Partnership, the general partner in Avner Partnership and members of its board of directors, Delek Group as the controlling shareholder in Avner Partnership (linked), and against PricewaterhouseCoopers Consulting Ltd. (PWC), as the economic advisor of an independent board committee established by Avner Partnership. It should be noted that on June 28, 2017, a motion to join as a respondent to the Motion for Certification was filed on behalf of the Partnership. On July 5, 2017, responses to the motion to join were filed, and on July 6, 2017, the Court ruled that the Partnership would join as a respondent. On November 13, 2017, the subsidiary partnership filed its response to the motion for certification. The pre-trial hearing of the Motion for Certification will be held on January 31, 2018. As of the approval date of the financial statements, the applicants are required to submit their response to the Partnership's response by January 14, 2018. The Company and the Partnership believe, based on the opinion of their legal counsel, that it is unlikely that the claim will be certified as a class action.
E. Further to Note 23A(5) to the Annual Financial Statements regarding the motion for certification of a class action filed at the Tel Aviv District Court by a consumer of IEC against the Tamar partners, the subsidiary partnership, Noble Energy Mediterranean Ltd., Isramco Negev 2 - Limited Partnership, and Dor Gas Exploration - Limited Partnership, on September 28, 2017, the Supreme Court handed down a judgment on the motion for permission to appeal the ruling of the District Court whereby the motion for certification should not be dismissed in limine, stipulating that there is no cause to intervene in the ruling of the District Court and that the appeal should be denied. Following the ruling, on October 18, 2017, a pre-trial hearing was held at the District Court, and cross-examinations of experts and affidavits in the case were scheduled for January and February 2018. On October 29, 2017, the subsidiary partnership filed an application to summon witnesses in the case on behalf of the State and a motion to add evidence. As of the date of the financial statements, a ruling has not yet been handed down. The Partnership believes, based on the opinion of its legal counsel, that it is unlikely that the claim will be certified as a class action.
40 WorldReginfo - c16fd361-de53-4169-8c2c-61d95bc8d7cf Delek Group Ltd.
Notes to the Consolidated Interim Financial Statements
NOTE 8: CAPITAL
1. On March 29, 2017, the Company declared the distribution of a dividend of NIS 200 million. The dividend was paid in May 2017. The dividend per share is NIS 16.6895. An amount of NIS 11 million was distributed to a wholly-owned subsidiary partnership, Delek Financial Investments - Limited Partnership (“the Subsidiary Partnership”.
2. On May 28, 2017, the Company declared the distribution of a dividend of NIS 200 million. The dividend was paid in June 2017. The dividend per share is NIS 16.6895. NIS 11 million was distributed to the Subsidiary Partnership.
3. On August 29, 2017, the Company declared a dividend of NIS 260 million, which will be paid in September 2017. The dividend per share is NIS 21.6963. NIS 14 million will be distributed to the Subsidiary Partnership.
4. Subsequent to the balance sheet date, on November 28, 2017, the Company declared a dividend of NIS 120 million, which will be paid in December 2017. The dividend per share is NIS 10.0137. NIS 7 million will be distributed to the Subsidiary Partnership.
5. Subsequent to the balance sheet date, on October 24, 2017, a plan for buyback of the Company's shares was approved the period up to December 31, 2017, in an amount of up to NIS 100 million. In October and November, a wholly-owned subsidiary partnership of the Company, Delek Financial Investments - Limited Partnership, acquired 89,923 Company shares of NIS 1 par value each, for a total consideration of NIS 51 million. Subsequent to these acquisitions, the subsidiary partnership holds 726,968 shares of the Company.
NOTE 9: TAXES ON INCOME
A. Further to Notes 31C and 31D to the Annual Financial Statements, regarding the best judgment tax assessments (Stage A, Assessment 03), which were issued to the Company in March 2016 for the 2011-2013 tax years, according to which most of the Company’s finance expenses for these years were not approved, in April 2017, the Company reached an agreement with the Income Tax Authority for these tax years. According to the agreement, most of the finance expenses were permitted and it was determined that part of the finance expenses will only be permitted upon the disposal of certain assets. In view of the agreement, as of December 31, 2016, carryforward losses amounted to NIS 2.3 billion. The agreement had no material effect on the Group's financial statements.
B. In April 2017, assessments (Stage A, Assessment 03) for the 2012-2014 tax years were issued for the subsidiaries (Delek Petroleum Ltd. and Delek Europe Holdings Ltd.).
The dispute is in the assessments is mainly about the tax liability for revenue from dividends between Group companies, which were received from the profits for which corporate tax was paid in Israel. However, it should be noted that the Income Tax Authority believes that a credit can be granted for the disputed taxes paid by the companies. The assessments amount to hundreds of millions of NIS, and on the other hand, the amount of the credit may also amount to hundreds of millions of NIS, based on the opinion of the legal counsel and the tax advisors of the companies.
The subsidiaries dispute the income tax position, among other things, because they believe it involves double taxation, and they have submitted objections to these assessments. At this stage, the subsidiaries believe, among other things, based also on the opinion of their legal counsel, that the tax assessments are not expected to have a material effect on the Group's financial statements.
41 WorldReginfo - c16fd361-de53-4169-8c2c-61d95bc8d7cf Delek Group Ltd.
Notes to the Consolidated Interim Financial Statements
NOTE 10: OPERATING SEGMENTS
A. General
In accordance with IFRS 8, the Group’s operating segments are determined on the basis of management reports, which are mainly based on the investments in each subsidiary.
Prior to the gain of control of Ithaca, the Group reported the following operating segments: Oil and gas exploration and production in Israel, automotive and spare parts and others.
Upon the gain of control in Ithaca, which operates in the development and production of oil and gas assets in the North Sea, the Company decided that Ithaca’s operations constitute a separate operating segment. Accordingly, subsequent to the acquisition, the operating segments are as follows:
Oil and gas exploration and production in Israel and its surroundings: The main operation is in the Tamar joint venture, the Ratio Yam joint venture, the Yam Tethys joint venture, and other oil rights, mainly offshore the coast of Israel.
Development and production of gas and oil assets in the North Sea: The activity is carried out by Ithaca, which owns rights in oil and gas assets in the North Sea region. The activity includes mainly production and marketing of oil and gas from the producing reservoirs and the development of additional reservoirs. The Company's share in the results of Ithaca in comparative periods was reclassified from other segments to the development and production of gas and oil assets in the North Sea sector.
- Fuel in Israel: The main operation is marketing and sale of fuels and commodities at gas stations and other outlets, and storage and production of fuels in facilities.
- Automotive and spare parts: The main operation is importing and marketing of Mazda, Ford and BMW vehicles and spare parts, through the associate Delek Automotive.
Other: The main operation is investment in infrastructure, including mainly desalination and establishment of power stations, trading in derivatives through Barak Capital and the biochemical operation that includes mainly production and marketing of fructose, citric acid and ingredients for nutritional additives.
It is noted that following recognition of the operating results of The Phoenix under income from discontinued operations, see also Note 3, The Phoenix is not presented as a reportable segment.
42 WorldReginfo - c16fd361-de53-4169-8c2c-61d95bc8d7cf Delek Group Ltd.
Notes to the Consolidated Interim Financial Statements
NOTE 10: OPERATING SEGMENTS (CONTD.)
B. Segment reporting
1) Revenue
Nine months ended Three months ended Year ended September 30 September 30 December 31 2017 2016 2017 2016 2016 Unaudited Audited NIS million
Revenue from external sources
Oil and gas exploration and production in Israel and its surroundings 1,276 1,358 341 493 1,821 Development and production of oil and gas assets in the North Sea 363 - 263 - - Fuel in Israel 3,055 2,632 1,076 970 3,588 Other segments 267 307 104 96 390 Inter-segment *) (27) (19) (8) (7) (21) Adjustments 3 2 1 2 -
Total in statement of income 4,937 4,280 1,777 1,554 5,778
*) Inter-segment sales are mainly for the sale of natural gas to other segments.
2) Segment results
Nine months ended Three months ended Year ended September 30 September 30 December 31 2017 2016 2017 2016 2016 Unaudited Audited NIS million
Oil and gas exploration and production in Israel and its surroundings 2,159 876 1,606 331 1,581 Development and production of oil and gas assets in the North Sea 96 - 56 - - Fuel in Israel 125 89 56 56 68 Other segments (68) (2) (53) (16) (71) Adjustments *) (78) (33) (47) (17) (92)
Operating profit 2,234 930 1,618 354 1,486
*) Mainly administrative and general expenses attributable to headquarter companies
43 WorldReginfo - c16fd361-de53-4169-8c2c-61d95bc8d7cf Delek Group Ltd.
Notes to the Consolidated Interim Financial Statements
NOTE 10: OPERATING SEGMENTS (CONTD.)
B. Segment reporting (contd.)
3) Contribution to net profit from continuing operations attributable to shareholders the Company
Nine months ended Three months ended Year ended September 30 September 30 December 31 2017 2016 2017 2016 2016 Unaudited Audited NIS million
Oil and gas exploration and production in Israel and its surroundings 1,116 307 914 120 669 Development and production of oil and gas assets in the North Sea 98 - 43 - (3) *) Fuel in Israel 80 45 34 37 21 Automotive (114) 49 (150) 13 35 Other segments (76) (12) (61) (22) (41) *) Adjustments **) (218) (179) (89) (89) (102)
Net profit from continuing operations attributable to shareholders of the Company 886 210 691 59 579
*) Reclassified **) Mainly administrative and general expenses, financing and taxes attributable to headquarter companies and gain from disposal of certain investments and changes in the value of investments.
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E:\Alan Clayman\Delek\2017\Q3\Formatted\Delek Q3 2017 - Consolidated_Formatted.docx
44 WorldReginfo - c16fd361-de53-4169-8c2c-61d95bc8d7cf .
Delek Group Ltd.
Financial Information from the Interim Consolidated Financial Statements Attributed to the Company
as at September 30, 2017
Unaudited
WorldReginfo - c16fd361-de53-4169-8c2c-61d95bc8d7cf
Special Report in accordance with Regulation 38D
Financial Figures and Financial Information from the Interim Consolidated Financial Statements
Attributed to the Company
Below are the separate figures and financial information attributed to the Company from the interim consolidated financial statements of the Group as at September 30, 2017, published as part of the periodic reports ("Consolidated Reports"), and presented in accordance with Regulation 38D of the Securities Regulations (Periodic and Immediate Reports), 1970:
3 WorldReginfo - c16fd361-de53-4169-8c2c-61d95bc8d7cf Delek Group Ltd.
Breakdown of Financial Information from the consolidated statement of financial position attributable to the Company
At At September 30 December 31 2017 2016 2016 Unaudited Audited NIS millions Current assets
Cash and cash equivalents 927 746 750 Short-term investments 294 744 541 Trade receivables 2 2 2 Current tax assets 29 - - Financial derivatives 5 1 - Other receivables 282 214 393
1,539 1,707 1,686 Asset held for sale 2,076 1,730 1,739
Total current assets 3,615 3,437 3,425
Non-current assets
Investments in investees and partnerships 6,497 6,559 6,940 Loans and capital notes to investees 2,891 1,035 1,074 Financial assets 277 - 235 Long term loans and debit balances 362 1,210 451 Investments in oil and gas exploration and production 1 3 2 Investment property 176 267 175 Fixed assets, net 52 4 52
Total non-current assets 10,256 9,078 8,929
13,871 12,515 12,354
The accompanying additional information is an integral part of the financial information and of the separate financial information.
4 WorldReginfo - c16fd361-de53-4169-8c2c-61d95bc8d7cf Delek Group Ltd.
Breakdown of Financial Information from the consolidated statement of financial position attributable to the Company
At At September 30 December 31 2017 2016 2016 Unaudited Audited NIS millions Current liabilities
Current maturities of debentures 1,539 700 698 Current bank and other borrowings and loan maturities 436 - 12 Other payables (particularly interest payable) 196 164 172
Total current liabilities 2,171 864 882
Non-current liabilities
Long term loans from banks and others 143 119 268 Debentures 5,656 6,182 5,475 Debentures convertible into Company shares 1,086 1,076 1,080 Deferred taxes 17 - 17 Other liabilities (primarily liability for decommission of long term assets) 24 20 20
Non-current liabilities 6,926 7,397 6,860
Equity attributable to equity holders of the Company
Share capital 13 13 13 Share premium 1,917 1,917 1,917 Proceeds for conversion option 27 27 27 Retained earnings 3,443 2,459 2,644 Adjustments from the translation of financial statements of foreign operations (457) (50) 76 Reserve from transactions with holders of non-controlling rights 108 171 170 Other reserves 156 150 198 Treasury shares (433) (433) (433)
Total capital 4,774 4,254 4,612
13,871 12,515 12,354
The accompanying additional information is an integral part of the financial information and of the separate financial information.
November 28, 2017 Date of approval of the financial Gabriel Last Asi Bartfeld Barak Mashraki statements Chairman of the Board CEO CFO of Directors
5 WorldReginfo - c16fd361-de53-4169-8c2c-61d95bc8d7cf Delek Group Ltd.
Breakdown of Financial Information from the consolidated statement of income attributable to the Company
Nine months ended Three months ended Year ended September 30 September 30 December 31 2017 2016 2017 2016 2016 Unaudited Audited NIS million
Revenue from overriding royalties and gas sales (net of royalties) 13 15 4 5 19 Company's share in earnings of partnerships and investees, net 1,170 431 700 155 735 Management fees from investees 3 2 1 1 5
Total revenue 1,186 448 705 161 759
Production cost of gas sold 14 15 8 4 21 General and Administrative Expenses 41 24 21 11 38 Other expenses (income), net (67) 2 (70) 4 4
Operating profit 1,198 407 746 142 696
Net financing income (expenses) with respect to loans to investees and others 28 94 27 15 253 Financing income (expenses) (mainly for financial investments), net (9) 8 15 14 56 Financing expenses (mainly with respect to debentures) (329) (298) (95) (112) (408)
Pre-tax income 888 211 693 59 597
Taxes on income 2 1 2 - 18
Profit from continuing operations 886 210 691 59 579 Income from discontinued operations, net 538 40 333 26 46
Net earnings attributed to Company shareholders 1,424 250 1,024 85 625
The accompanying additional information is an integral part of the financial information and of the separate financial information.
6 WorldReginfo - c16fd361-de53-4169-8c2c-61d95bc8d7cf Delek Group Ltd.
Breakdown of Financial Information from the consolidated statement of comprehensive income attributable to the Company
Nine months ended Three months ended Year ended September 30 September 30 December 31 2017 2016 2017 2016 2016 Unaudited Audited NIS million
Net earnings attributed to Company shareholders 1,424 250 1,024 85 625
Other comprehensive income (loss)
Amounts classified or reclassified to profit and loss under specific conditions:
Profit (loss) for available-for-sale assets, net (84) 29 48 19 88 Transfer to the statement of income for disposal of available-for-sale financial assets (3) (28) (3) (7) (60) Transfer to the statement of income for impairment of available-for-sale financial assets 17 41 - - 41 Adjustments for translation of financial statements of foreign operations 3 (10) - (6) - Transfer to statement of income for exchange differences on translation of foreign operations 13 - - - Profit (loss) for cash flow hedges (20) - - - Attributed to the hedged asset for results of cash flow hedging 20 - - - Other comprehensive income (loss) attributable to investees and partnerships (after tax effect) (553) (200) 70 (119) (66)
Total other comprehensive income (loss) from continuing operations (607) (168) 115 (113) 3
Total other comprehensive income from discontinued operations 49 38 37 1 41
Total other comprehensive income (loss) (558) (130) 152 (112) 44
Total comprehensive income (loss) attributed to Company shareholders 866 120 1,176 (27) 669
The accompanying additional information is an integral part of the financial information and of the separate financial information.
7 WorldReginfo - c16fd361-de53-4169-8c2c-61d95bc8d7cf Delek Group Ltd.
Financial Information from the consolidated statements of cash flows attributable to the Company
Nine months ended Three months ended Year ended September 30 September 30 December 31 2017 2016 2017 2016 2016 Unaudited Audited NIS million
Cash flows from the Company's operating activities
Net income attributable to Company shareholders 1,424 250 1,024 85 625 Adjustments to reconcile statement of cash flows from the Company's continuing operating activities (a) (488) (383) (501) (150) (794)
Net cash from (used for) continuing operations 936 (133) 523 (65) (169)
Cash flows from the Company's investment activities
Investments in property, plant and equipment and investment property (12) (149) (10) (5) (151) Proceeds from disposal of financial assets 20 271 19 111 490 Proceeds from sale of investments in investees 208 137 208 - 137 Short-term investments, net 154 (171) - (207) (141) Investment in available-for-sale financial assets (70) - (21) - (201) Collection of loans for others, net 200 8 7 - 783 Provision of loans and capital investments of investees, net (1,896) (139) 25 (4) (164)
Net cash from (used for) the Company's investment operations (1,396) (43) 228 (105) 753
Cash flows from the Company's financing activities
Dividend paid to shareholders of the Company (660) (260) (260) (80) (460) Short term borrowings from banks and others, net 300 (485) - (222) (486) Issue of Debentures 1,006 1,103 - 1,103 1,103 Loans received from banks and others - - - - 160 Repayment of long-term bank loans and debentures (6) (41) - (41) (740)
Net cash from (used for) the Company's financing operations 640 317 (260) 760 (423)
Increase in cash and cash equivalents 180 141 491 590 161
Balance of cash flow and cash equivalents for beginning of period 750 605 432 156 605
Exchange differences for cash balance and cash equivalents (3) - 4 - (16)
Cash balance and cash equivalents at end of period 927 746 927 746 750
The accompanying additional information is an integral part of the financial information and of the separate financial information.
8 WorldReginfo - c16fd361-de53-4169-8c2c-61d95bc8d7cf Delek Group Ltd.
Financial Information from the consolidated statements of cash flows attributable to the Company
Nine months ended Three months ended Year ended September 30 September 30 December 31 2017 2016 2017 2016 2016 Unaudited Audited NIS million
(A) Adjustments to reconcile statement of cash flows from the Company's continuing operating activities:
Adjustments for profit and loss items of the Company:
Depreciation, depletion and amortization 1 - - - 3 Deferred taxes, net - - - - 17 Profit from early repayment of a recognized loan - - (116) Decrease (increase) of loans granted, net 2 (92) (24) (13) (34) Impairment (appreciation) of investments and loans provided, net - - - - (17) Company's share in the expenses of subsidiaries*) (484) (324) (395) (150) (634) Cost of share-based payment - (1) - - (2) Increase (erosion) in value of liabilities, net 27 17 (9) 23 12 Change in fair value of short-term investments, net - - - 1 - Change in fair value of financial derivatives, net 3 (18) (9) (16) (14) Other income (relating to the sale of gas and oil assets) (92) - (92) - (47) Revaluation of long-term loans 5 - 3 - (19) Earnings from disposal of investment in available-for-sale financial assets (2) (28) (2) (7) (60) Impairment of available-for-sale financial assets 17 41 - - 41 Exchange differences for cash balance and cash equivalents, net 3 - (4) - 16 Loss from impairment in investment property 11 - 11 - 45
Changes in the Company's asset and liability items:
Decrease in other receivables 7 13 1 - 7 Increase in other payables 14 9 19 12 8
(488) (383) (501) (150) (794)
*) Net of dividends received 1,224 147 638 31 147
The accompanying additional information is an integral part of the financial information and of the separate financial information.
9 WorldReginfo - c16fd361-de53-4169-8c2c-61d95bc8d7cf Delek Group Ltd.
Financial Information from the consolidated statements of cash flows attributable to the Company
Nine months ended Three months ended Year ended September 30 September 30 December 31 2017 2016 2017 2016 2016 Unaudited Audited NIS million
(B) Company's significant non-cash activities
Receipt of a sellers' loan due to liquidation of an investee - 393 - - 393
Dividend receivable from investees 21 - 21 - 53 Acquisition of Company shares by a subsidiary - 65 - - 65 Loan repayment against investment in a financial asset 8 - 8 - - Exercise of available-for-sale financial assets against trade receivables 17 - - - -
(C) Additional information on cash flows
Cash paid by the Company during the period for:
Interest 292 276 99 81 377
Cash received by the Company during the period for:
Interest 1 2 - - 3
Dividends 1,230 163 641 38 162
The accompanying additional information is an integral part of the financial information and of the separate financial information.
10 WorldReginfo - c16fd361-de53-4169-8c2c-61d95bc8d7cf Delek Group Ltd.
Additional Information
NOTE 1 – GENERAL
This separate financial information was drafted in a condensed format pursuant to the provisions of article 38D of the Securities Regulations (Periodic and Immediate Reports), 1970. This separate financial information should be reviewed in conjunction with the separate financial information to the annual financial statements as of December 31, 2016, and for the year then ended and their accompanying notes, and in conjunction with the consolidated interim financial statements as of September 30, 2017 ("Consolidated Interim Financial Statements").
NOTE 2 – CONTINGENT LIABILITIES
There are certain contingent claims against the Company and certain investees for significant sums, including petitions to grant class actions, that might amount to anywhere from hundreds of million to several billions of shekels. In some cases, it is not possible to assess their outcome at this stage, and therefore no provision was recorded in the financial statements as set forth in Note 7 to the consolidated interim financial statements.
NOTE 3 – INVESTMENTS IN INVESTEES
In the reporting period the Company acquired, through its wholly owned foreign subsidiary DKL Investments Limited (“DKL”) the remaining holdings in Ithaca Energy Inc. (“Ithaca”) for a total consideration of NIS 1,851 million. For further information see Note 3B to the Consolidated Interim Financial Statements.
NOTE 4 – CAPITAL
For further information concerning distributions of dividends by the Company in the Reporting Period and buy back of the Company's shares by subsidiaries, see Note 8 to the Consolidated Financial Statements.
------
11 WorldReginfo - c16fd361-de53-4169-8c2c-61d95bc8d7cf
Delek Group Ltd.
Additional Data Concerning the Proforma Consolidated Interim Financial Statements As of September 30, 2017
1. The Company's Board of Directors hereby presents the Company's proforma consolidated interim financial statements as of September 30, 2017, and for the nine and three month periods then ended ("Proforma Statements"), as well as additional data connected to the Proforma Statements. This report should be read in conjunction with the Board of Directors Report on the Company's consolidated interim financial statements for the said periods. 2. As detailed in Note 1 to the Proforma Statements, on March 14, 2017, DKL Investments Limited (a wholly-owned foreign subsidiary of the Company - "DKL") submitted documents offering to buy the entire share capital of Ithaca Energy Inc. ("Ithaca" or "the Acquired Company") held by other parties (80%), at a price of CAD 1.95 per share ("the Offer"), following an agreement signed with Ithaca in February 2017 for issuing the Offer as aforesaid. The Offer was open for subscription until April 20, 2017. After securing majority acceptance, the Offer was automatically extended for another period until May 3, 2017. The Offer (including in the said extension period) was accepted by the holders of 318,833,909 ordinary shares, and DKL bought these shares for a total consideration of CAD 622 million (NIS 1,685 million). Following this purchase, DKL holds 400,699,334 ordinary shares in Ithaca, accounting for 94.2% of its ordinary share capital. On May 12, 2017, DKL announced that, under the terms of the Offer, it plans to perform a forced purchase of Ithaca's remaining ordinary shares not held by DKL, so that after such purchase DKL will hold all of Ithaca's share capital. The forced purchase will be made at the share price specified in the Offer and for a total consideration of CAD 48 million (NIS 126 million). The forced purchase was completed on June 5, 2017, at which time Ithaca's shares were delisted from the AIM exchange in London and the Toronto stock exchange. 3. Following these purchases, the Group holds 100% of Ithaca's share capital. After assuming control of Ithaca, the Group is consolidating Ithaca's financial statements starting from the date when it assumed control (April 21, 2017). The Proforma Statements were prepared to reflect the effect of the said purchases on the Group's results, assuming that Ithaca's statements had also been consolidated with the Company's financial statements in the reporting periods prior to the purchase, as detailed in Notes 2 and 3 to the Proforma Statements below. 4. The Proforma Statements were prepared based on the Company's consolidated interim financial statements, with retrospective consolidation of Ithaca's financial statements for all relevant reporting periods, using the assumptions detailed in Note 3 to the Proforma Statements. 5. Ithaca is an independent oil and gas operator operating in the North Sea, holding both production and development assets. According to the Company's policy for defining operating segments, based mainly on investments in each investee, the Company considers Ithaca's operations a separate segment - Oil and gas asset development and production in the North Sea. Highlights of Ithaca's effect on the Group's income statements, as reflected in the Group's proforma results for each of the periods included in the Proforma Statements, under the proforma assumptions (NIS millions):
1-9/2017 1-9/2016 7-9/2016 2016
Revenues from oil and gas sales 539 395 171 552
Operating profit (loss) 164 (36) (1) (9)
Contribution to net profit 159 (230) (269) (186)
For explanations concerning Ithaca's results, see the Board of Directors' Report on the Company's consolidated financial statements as of September 30, 2017. WorldReginfo - c16fd361-de53-4169-8c2c-61d95bc8d7cf It is further noted that Ithaca's consolidation, including the adjustments detailed in Note 3 to the Proforma Statements, led to a NIS 99 million reduction in net profit attributable to Company shareholders in the reporting period, as compared to a decrease of NIS 269 million in the same period last year, and a decrease of NIS 245 million in all of 2016. This decrease in proforma net profit in the reporting period was mainly due to reversal of NIS 150 million in gains from assuming control, and other ancillary costs which were included in the Company's results in the reporting period. This effect was offset by Ithaca's positive contribution to net profit, as detailed in the table above. In light of the fact that proforma data, by nature, are based on various assessments and judgments and in light of changes that have occurred in Ithaca's operations, the reported proforma data should not necessarily be construed as indicative of Ithaca's contribution to the Group's representative and/or future results following the acquisition.
Sincerely
Gabriel Last Asaf Bartfeld
Chairman of the Board CEO
Signature date: November 28, 2017
WorldReginfo - c16fd361-de53-4169-8c2c-61d95bc8d7cf
Delek Group Ltd.
Pro Forma Consolidated Interim Financial Statements
September 30, 2017
Unaudited
Contents
Page
Pro Forma Consolidated Statements of Income 2-4
Pro Forma Consolidated Statements of Comprehensive Income 5 -7
Notes to the Pro Forma Consolidated Interim Financial Statements 8 -12
1 WorldReginfo - c16fd361-de53-4169-8c2c-61d95bc8d7cf Delek Group Ltd.
Pro Forma Consolidated Statements of Income
Nine months ended September 30 2017 2016 Actual Pro forma Pro forma Actual Pro forma Pro forma data reconciliations data data reconciliations data Unaudited NIS million (Other than net earnings (loss) per share)
Revenue 4,937 176 5,113 4,280 395 4,675 Cost of revenues 3,451 114 3,565 2,742 411 3,153
Gross profit 1,486 62 1,548 1,538 (16) 1,522
Selling, marketing and gas station operating expenses 426 - 426 427 - 427 General and administrative expenses 148 7 155 131 17 148 Other revenues (expenses), net 1,322 13 1,335 )50( (3) (53)
Operating profit 2,234 68 2,302 930 (36) 894 Financial income 250 17 267 212 12 224 Finance expenses )785( (53) (838) )694( (256) (950)
1,699 32 1,731 448 (280) 168 Profit from disposal of investments in partnerships and investees, net 150 (150) - - - - Group’s share in profits of associates, net )91( (23) (114) 58 13 71
Income before taxes on income 1,758 (141) 1,617 506 (267) 239 Taxes on income (tax benefit) 96 (42) 54 )48( 2 (46)
Profit from continuing operations 1,662 (99) 1,563 554 (269) 285 Profit from discontinued operations, net 821 - 821 196 - 196
Net profit 2,483 (99) 2,384 750 (269) 481
Attributable to: Shareholders of the Company 1,424 (99) 1,325 250 (269) (19) Non-controlling interests 1,059 - 1,059 500 - 500
2,483 (99) 2,384 750 (269) 481 Net earnings (loss) per share attributable to shareholders of the Company (NIS):
Basic net earnings (loss): Earnings (loss) from continuing operations 78.9 )8.8( 70.1 18.7 )23.9( )5.2( Earnings (loss) from discontinued operations 47.9 - 47.9 3.6 - 3.6 126.8 )8.8( 118.0 22.3 )23.9( )1.6(
Diluted net earnings (loss): Earnings (loss) from continuing operations 75.6 )8.2( 67.4 18.7 )23.9( )5.2( Earnings (loss) from discontinued operations 44.6 - 44.6 3.6 - 3.6 120.2 )8.2( 112.0 22.3 )23.9( )1.6( The accompanying notes are an integral part of the pro forma consolidated interim financial statements.
November 28, 2017 Date of approval of the financial Gabriel Last Asi Bartfeld Barak Mashraki statements Chairman of the CEO CFO Board of Directors
2 WorldReginfo - c16fd361-de53-4169-8c2c-61d95bc8d7cf Delek Group Ltd.
Pro Forma Consolidated Statements of Income (contd.)
Three months ended September 30, 2016 Pro forma Actual data reconciliations Pro forma data Unaudited NIS million (Other than net earnings (loss) per share)
Revenue 1,554 171 1,725 Cost of revenues 986 168 1,154
Gross profit 568 3 571
Selling, marketing and gas station operating expenses 145 - 145 General and administrative expenses 51 4 55 Other expenses, net 18 - 18
Operating profit 354 (1) 353 Financial income 53 8 61 Finance expenses (206) (38) (244)
201 (31) 170 Group’s share in profits of associates, net 15 9 24
Income before taxes on income 216 (22) 194 Tax expenses 49 251 300
Profit (loss) from continuing operations 167 (273) (106) Income from discontinued operations, net 135 - 135
Net profit 302 (273) 29
Attributable to: Shareholders of the Company 85 (273) (188) Non-controlling interests 217 - 217
302 (273) 29 Net earnings (loss) per share attributable to shareholders of the Company (NIS)
Basic and diluted earnings (loss) from continuing operations 5.2 )24.3( )19.1( Basic and diluted earnings from discontinued operations 2.5 - 2.5
Basic and diluted earnings 7.7 )24.3( )16.6(
The accompanying notes are an integral part of the pro forma consolidated interim financial statements.
3 WorldReginfo - c16fd361-de53-4169-8c2c-61d95bc8d7cf Delek Group Ltd.
Pro Forma Consolidated Statements of Income (contd.)
Year ended December 31, 2016 Pro forma Pro forma Actual data reconciliations data Audited NIS million (Other than net earnings per share)
Revenue 5,778 552 6,330 Cost of revenues 3,744 527 4,271
Gross profit 2,034 25 2,059
Selling, marketing and gas station operating expenses 567 - 567 General and administrative expenses 182 21 203 Other revenue, net 201 (13) 188
Operating profit 1,486 (9) 1,477 Financial income 391 17 408 Finance expenses (828) (359) (1,187)
1,049 (351) 698 Group’s share in profits of associates, net 50 4 54
Income before taxes on income 1,099 (347) 752 Tax benefit (118) (102) (220)
Profit from continuing operations 1,217 (245) 972 Profit from discontinued operations, net 343 - 343
Net profit 1,560 (245) 1,315
Attributable to: Shareholders of the Company 625 (245) 380 Non-controlling interests 935 - 935
1,560 (245) 1,315 Net earnings per share attributable to shareholders of the Company (NIS)
Basic earnings from continuing operations 51.5 )21.8( 29.7 Basic earnings from discontinued operations 4.1 - 4.1
Basic earnings 55.6 )21.8( 33.8
Diluted earnings from continuing operations 51.3 )21.6( 29.7 Diluted earnings from discontinued operations 4.0 0.1 4.1
Diluted earnings 55.3 )21.5( 33.8
The accompanying notes are an integral part of the pro forma consolidated interim financial statements. .
4 WorldReginfo - c16fd361-de53-4169-8c2c-61d95bc8d7cf Delek Group Ltd.
Pro Forma Consolidated Statements of Comprehensive Income
Nine months ended September 30 2017 2016 Actual Pro forma Pro forma Actual Pro forma Pro forma data reconciliations data data reconciliations data Unaudited NIS million
Net profit 2,483 (99) 2,384 750 (269) 481 Other comprehensive income (loss) (net of tax effect):
Amounts classified or reclassified to profit or loss under specific conditions:
Profit (loss) for available-for-sale financial assets (78) - (78) 36 - 36 Transfer to statement of income for disposal of available-for-sale financial assets (6) - (6) (28) - (28) Transfer to statement of income for impairment of available-for-sale financial assets 17 - 17 41 - 41 Transfer to statement of income for exchange differences on translation of foreign operations 13 (13) - - - - Profit (loss) for cash flow hedges (35) 20 (15) 5 - 5 Recognition of the hedged asset of cash flow hedging results 20 (20) - - - - Exchange differences on translation of foreign operations (818) (145) (963) (369) (99) (468) Other comprehensive loss attributable to associates, net (29) - (29) (12) - (12)
Total other comprehensive loss from (426) continuing operations (916) (158) (1,074) (327) (99) Total other comprehensive income from discontinued operations, net 85 - 85 74 - 74
Total other comprehensive loss (831) (158) (989) (253) (99) (352)
Total comprehensive income 1,652 (257) 1,395 497 (368) 129
Attributable to:
Shareholders of the Company 866 (257) 609 120 (368) (248) Non-controlling interests 786 - 786 377 - 377
1,652 (257) 1,395 497 (368) 129
The accompanying notes are an integral part of the pro forma consolidated interim financial statements.
5 WorldReginfo - c16fd361-de53-4169-8c2c-61d95bc8d7cf Delek Group Ltd.
Pro Forma Consolidated Statements of Comprehensive Income
Three months ended September 30, 2016 Pro forma Actual data reconciliations Pro forma data Unaudited NIS million
Net profit 302 (273) 29 Other comprehensive income (loss) (net of tax effect):
Amounts classified or reclassified to profit or loss under specific conditions:
Profit from available-for-sale financial assets 15 - 15 Transfer to statement of income for disposal of available-for-sale financial assets (7) - (7) Profit from cash flow hedges 7 - 7 Exchange differences on translation of foreign operations (222) (58) (280) Other comprehensive loss attributable to associates, net (6) - (6)
Total other comprehensive loss from continuing operations (213) (58) (271) Total other comprehensive income from discontinued operations, net 6 - 6
Total other comprehensive loss (207) (58) (265)
Total comprehensive income (loss) 95 (331) (236)
Attributable to:
Shareholders of the Company (27) (331) (358) Non-controlling interests 122 - 122
95 (331) (236)
The accompanying notes are an integral part of the pro forma consolidated interim financial statements.
6 WorldReginfo - c16fd361-de53-4169-8c2c-61d95bc8d7cf Delek Group Ltd.
Pro Forma Consolidated Statements of Comprehensive Income
Year ended December 31, 2016 Pro forma Pro forma Actual data reconciliations data Audited NIS million
Net profit 1,560 (245) 1,315 Other comprehensive income (loss) (net of tax effect):
Amounts classified or reclassified to profit or loss under specific conditions:
Profit from available-for-sale financial assets 99 - 99 Transfer to statement of income for disposal of available-for-sale financial assets (58) - (58) Transfer to statement of income for impairment of available-for-sale financial assets 41 - 41 Profit from cash flow hedges 26 - 26 Exchange differences on translation of foreign operations (107) (37) (144) Other comprehensive loss attributable to associates, net (9) - (9)
Total other comprehensive loss from continuing operations (8) (37) (45) Total other comprehensive income from discontinued operations, net 70 - 70
Total other comprehensive income 62 (37) 25
Total comprehensive income 1,622 (282) 1,340
Attributable to:
Shareholders of the Company 669 (282) 387 Non-controlling interests 953 - 953
1,622 (282) 1,340
The accompanying notes are an integral part of the pro forma consolidated interim financial statements.
7 WorldReginfo - c16fd361-de53-4169-8c2c-61d95bc8d7cf Delek Group Ltd.
Notes to the Pro Forma Consolidated Interim Financial Statements
NOTE 1: GENERAL
A. As described in Note 3B to the Company’s consolidated interim financial statements as of September 30, 2017, on March 14, 2017, DKL Investments Limited (a foreign subsidiary, wholly owned by the Company, "DKL") filed an offer to acquire the entire share capital of Ithaca Energy Inc. ("Ithaca" or "the Acquired Company") that it does not hold (80%) at a price per share of CAD 1.95 ("the Offer"), further to the agreement signed with Ithaca in February 2017 to publish the Offer. The Offer was open to acceptance notice until April 20, 2017, and after it was accepted for the most part, it was extended mandatorily until May 3, 2017. The Offer (including the extension period) was accepted by the holders of 318,833,909 ordinary shares and DKL acquired their shares for a total consideration of CAD 622 million (approximately NIS 1,685 million). Following the sale, DKL held 400,699,334 ordinary shares of Ithaca, representing 94.2% of its ordinary share capital.
On May 12, 2017, DKL announced that, in accordance with the terms of the Offer, it intends to carry out a compulsory acquisition of the remaining ordinary shares of Ithaca that were not held by DKL, so that following the acquisition, DKL will hold the entire share capital of Ithaca, at the price per share set out in the Offer and for a total consideration of CAD 48 million (approximately NIS 126 million) On September 5, 2017, the compulsory acquisition was completed, after which Ithaca's shares were delisted from the AIM in London and the Toronto Stock Exchange.
It should be noted that following the Offer, Ithaca received waivers from banks and other entities holding short- to medium-term liabilities that include change of control items, according to which these entities will not exercise their right for immediate payment due to the change of control following the Offer.
B. In view of the gain of control in Ithaca, the Group consolidates Ithaca's financial statements as from the date control was gained (April 21, 2017). In addition, in accordance with IFRS 3 regarding a step acquisition, the Group’s investment in Ithaca shares prior to the offer was measured at fair value and the difference between the fair value and its carrying amount will be recognized in the statement of income. The above (profit) after recognition of the profit or loss of the balance of the capital reserve for translation differences accumulated until the date of the gain in control) amounted to NIS 137 million.
The gain of control in Ithaca constitutes a pro forma event as defined in the Israel Securities Regulations (Periodic and Immediate Reports), 1970.
The pro forma consolidated financial statements were prepared to reflect the effect of the pro forma event (an increase to a rate of 100% of the share capital of Ithaca) on the results of the Company's operations (consolidated), under the assumption that Ithaca's financial statements were consolidated with the Company's financial statements in the reporting periods prior to the acquisition as well, in accordance with Notes 2 and 3 below.
NOTE 2: SIGNIFICANT ACCOUNTING POLICIES
The accounting policy applied in the pro forma consolidated interim financial statements is consistent with that applied in the preparation of the Company’s consolidated interim financial statements as of September 30, 2017 and for the nine and three months then ended (“the Consolidated Interim Financial Statements”). These pro forma consolidated interim financial statements are prepared in accordance with Regulation 38B of the Israel Securities Regulations (Periodic and Immediate Reports), 1970. The pro forma consolidated interim financial statements should be read in the context of the Company's consolidated interim financial statements and the annual financial statements as of December 31, 2016 and the year then ended and their accompanying Notes.
8 WorldReginfo - c16fd361-de53-4169-8c2c-61d95bc8d7cf Delek Group Ltd.
Notes to the Pro Forma Consolidated Interim Financial Statements
NOTE 3: ASSUMPTIONS USED IN THE PREPARATION OF THE CONSOLIDATED INTERIM PRO FORMA FINANCIAL STATEMENTS
1. The pro forma consolidated interim financial statements are based on the consolidated financial statements of the Company and on the financial statements of the acquired company for the relevant reporting periods, which were prepared in accordance with IAS 34, Interim Financial Reporting.
2. The pro forma consolidated statements of income and the pro forma consolidated statements of comprehensive income for the nine- and three-month period ended September 30, 2017 and 2016 and for the year ended December 31, 2016 were prepared on the assumption that the acquisition of the acquired company (an increase to a holding of 100%) occurred at the beginning of the earliest presented period (meaning, January 1, 2016).
3. The results of the Company's investment in Ithaca, as included in accordance with the equity method in each of the reported periods, were eliminated in the pro forma consolidated statements of income and pro forma statement of comprehensive income.
4. In the pro forma profit or loss information for the nine months ended September 30, 2017, profit from the step acquisition was offset by NIS 137 million, as set out in Note 1B above, as well as the losses associated with the transaction costs. In addition, in the pro forma other comprehensive income information for the period, movements in capital reserves associated with the acquisition of control was offset.
5. The acquisition cost in the total amount of NIS 1,851 million was financed from the Group's liquid resources as at the acquisition date (a decrease in cash and cash equivalents), which arose, among other things, from raising debentures in the periods prior to this date. The pro forma statements of income included notional finance expenses at an annual rate of 4.3% until the date the debentures were raised, to reflect in these reports the effects if such financing had been made on January 1, 2016. The pro forma consolidated statements of income did not include a tax benefit for these finance expenses.
6. The pro forma statements of income for all reported periods included the amortization of excess costs arising from the acquisition, based on a provisional measurement of the fair value of Ithaca's assets and liabilities, in accordance with the draft valuation prepared by an external appraiser, as set out in Note 3B to the Company's consolidated interim financial statements. Tax expenses that were computed based on Ithaca's effective tax rate, as stated in Note 5 below, were recognized for the amortization.
7. Since the pro forma information is inherently based on various assessments and estimates, and due to the changes in Ithaca’s operations, the reported pro forma information is not necessarily an indication of Ithaca's contribution to the representative and/or future results of the Group subsequent to acquisition of the operations.
8. For information about the financial data for the three months ended September 30, 2017, see the Company’s consolidated financial statements.
9 WorldReginfo - c16fd361-de53-4169-8c2c-61d95bc8d7cf Delek Group Ltd.
Notes to the Pro Forma Consolidated Interim Financial Statements
NOTE 4: OPERATING SEGMENTS
A. General
In accordance with IFRS 8, the Group’s operating segments are determined on the basis of management reports, which are mainly based on the investments in each subsidiary.
Prior to the gain of control of Ithaca, the Group reported the following operating segments: Oil and gas exploration and production in Israel, automotive and spare parts and others.
Upon the gain of control in Ithaca, which operates in the development and production of oil and gas assets in the North Sea, the Company decided that Ithaca’s operations constitute a separate operating segment. Accordingly, subsequent to the acquisition, the operating segments are as follows:
Oil and gas exploration and production in Israel and its surroundings: The main operation is in the Tamar joint venture, the Ratio Yam joint venture, the Yam Tethys joint venture, and other oil rights, mainly offshore the coast of Israel.
Development and production of gas and oil assets in the North Sea: The activity is carried out by Ithaca, which owns rights in oil and gas assets in the North Sea region. The activity includes mainly production and marketing of oil and gas from the producing reservoirs and the development of additional reservoirs.
Fuel in Israel: The main operation is marketing and sale of fuels and commodities at gas stations and other outlets, and storage and production of fuels in facilities.
Automotive and spare parts: The main operation is importing and marketing of Mazda, Ford and BMW vehicles and spare parts, through the associate Delek Automotive.
Other: The main operation is investment in infrastructure, including mainly desalination and establishment of power stations, trading in derivatives through Barak Capital and the biochemical operation that includes mainly production and marketing of fructose, citric acid and ingredients for nutritional additives.
10 WorldReginfo - c16fd361-de53-4169-8c2c-61d95bc8d7cf Delek Group Ltd.
Notes to the Pro Forma Consolidated Interim Financial Statements
NOTE 4: OPERATING SEGMENTS (CONTD.)
B. Pro forma segment reporting
1) Revenue
Three months Nine months ended ended Year ended September 30 September 30 December 31 2017 2016 2016 2016 Unaudited Audited NIS million Revenue from external sources Oil and gas exploration and production in Israel and its surroundings 1,276 1,358 493 1,821 Development and production of oil and gas assets in the North Sea 539 395 171 552 Fuel in Israel 3,055 2,632 970 3,588 Other segments 267 307 96 390 Inter-segment *) (27) (19) (7) (21) Adjustments 3 2 2 -
Total in statement of income 5,113 4,675 1,725 6,330 *) Inter-segment sales are mainly for the sale of gas to other segments.
2) Segment results
Three months Nine months ended ended Year ended September 30 September 30 December 31 2017 2016 2016 2016 Unaudited Audited NIS million
Oil and gas exploration and production in Israel and its surroundings 2,159 876 331 1,581 Development and production of oil and gas assets in the North Sea 164 (36) (1) (9) Fuel in Israel 125 89 56 68 Other segments (68) (2) (16) (71) Adjustments *) (78) (33) (17) (92)
Operating profit 2,302 894 353 1,477 *) Mainly administrative and general expenses attributable to headquarter companies
11 WorldReginfo - c16fd361-de53-4169-8c2c-61d95bc8d7cf Delek Group Ltd.
Notes to the Pro Forma Consolidated Interim Financial Statements
NOTE 4: OPERATING SEGMENTS (CONTD.)
3) Contribution to net profit from continuing operations attributable to the Company’s shareholders
Three months Nine months ended ended Year ended September 30 September 30 December 31 2017 2016 2016 2016 Unaudited Audited NIS million
Oil and gas exploration and production in Israel and its surroundings 1,116 307 120 669 Development and production of oil and gas assets in the North Sea 159 (230) (269) (186) Fuel in Israel 80 45 37 21 Automotive (114) 49 13 35 Other segments (76) (12) (22) (41) Adjustments *) (378) (218) (94) (164)
Net profit from continuing operations attributable to shareholders of the Company 787 (59) (215) 334 *) Mainly administrative and general expenses and financing attributable to headquarter companies
NOTE 5: TAXES ON INCOME
Ithaca is subject to UK tax laws, which include corporate tax income, supplementary charge tax and petroleum revenue tax. As of September 30, 2017, the effective tax rate including corporate tax and the additional tax levy applicable to oil and gas companies in the UK was 40%, the tax on oil revenues was 0% (after being fully depreciated as from January 2016) and the supplementary tax rate was 10% (after being depreciated by 20% in September 2016).
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12 WorldReginfo - c16fd361-de53-4169-8c2c-61d95bc8d7cf Chapter D
Report on the Effectiveness of Internal Controls for Financial Reporting and Disclosure WorldReginfo - c16fd361-de53-4169-8c2c-61d95bc8d7cf
Delek Group Ltd Quarterly report on the effectiveness of internal control for financial reporting and disclosure, pursuant to Ordinance 38C(a):
Management, under the supervision of the Board of Directors of Delek Group Ltd. ("the Corporation"), is responsible for setting and maintaining an appropriate internal control for financial reporting and disclosure in the Corporation.
For this matter, the members of Management are: 1. Asaf Bartfeld, President & CEO 2. Barak Mashraki, CFO 3. Leora Pratt Levin, Chief General Counsel 4. Tamar Rosenberg, Controller
Internal control of financial reporting and disclosure includes controls and procedures existing in the Corporation, which were planned or overseen by the CEO and the most senior financial officer or under their supervision, or by whoever fulfills those functions in practice, under the supervision of the Board of Directors of the Corporation, and were designed to provide reasonable assurance as to the reliability of the financial reporting and the preparation of the reports in accordance with the provisions of the law, and to ensure that information that the Corporation is required to disclose in the reports it publishes in accordance with the provisions of the law is collected, processed, summarized and reported on the date and in the format laid down in law.
Internal control includes, inter alia, controls and procedures planned to ensure that the information that the Corporation is required to disclose as aforesaid, is accumulated and forwarded to the Management of the Corporation, including to the CEO and the most senior financial officer or to whoever fulfills those functions in practice, in order to enable decisions to be made at the appropriate time in relation to the disclosure requirements.
Due to its structural limitations, the internal control of financial reporting and disclosure is not intended to provide absolute assurance that misstatement in or omission of information from the reports will be prevented or will be discovered. The Phoenix Insurance Company Ltd. (Phoenix Insurance), a subsidiary of the Corporation, is an institutional body, which is subject to the rulings of the Commissioner for the Capital 1
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Market, Insurance and Savings at the Treasury, in respect of an assessment of the effectiveness of the internal controls on financial reporting. In respect of Phoenix Insurance, the management of Phoenix Holdings, under the supervision of the Board, carried out a check and assessment of the internal controls on the financial reporting and its effectiveness, based upon the provisions of Institutional Bodies Circular 2009-9-10, "Responsibility of Management for Internal Controls on Financial Reporting", Institutional Bodies Circular 2010-9-6, "Responsibility of Management for Internal Controls on Financial Reporting - Modified", and 2010-9-7, "Responsibility of Management for Internal Controls on Financial Reporting, Financial Reporting and Disclosures". Based upon this assessment, the Board of Directors and management of Phoenix Investments reached the conclusion that the internal controls on financial reporting, in respect of Internal Controls in an Institutional Body as of December 31, 2016, was effective.
In the annual report on the effectiveness of internal control for financial reporting and disclosure, which was attached to the Periodic Report for the period ending December 31, 2016 ("the Last Annual Internal Control Report"), the Board of Directors and Management assessed the internal controls within the Corporation; based upon this assessment, the Board of Directors and Management of the Corporation have concluded that the said internal controls, as of December 31, 2016, were effective.
Up until the date of this report, no event or matter was brought to the attention of the Board of Directors and Management that leads them to change the assessment of the effectiveness of the internal controls, as reported in the Last Annual Internal Control Report.
For the period of this report, based upon the effectiveness assessment of the internal controls in the Last Annual Internal Control Report, and based upon information brought to the attention of Management and the Board of Directors as stated above, the internal controls are effective.
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Declaration of the CEO in accordance with Ordinance 38C(d)(1):
Declaration of Executives
Declaration of the CEO
I, Asi Bartfeld, declare that:
(1) I have reviewed the quarterly report of Delek Group Ltd. ("the Corporation") for Quarter 3 of 2017 ("the Reports");
(2) To the best of my knowledge, the reports do not include any representations that is not correct and do not lack any representation of any vital, material fact, so that was has been presented, within the context in which they have been provided, shall not be misleading in respect of the period covered by the reports;
(3) To the best of my knowledge, the financial statements and other financial information in the Reports reflect fairly, from all material aspects, the financial condition, the results of operations and the cash flows of the Corporation at the dates and for the periods to which the Reports relate:
(4) I disclosed to the auditor of the Corporation, to the Board of Directors, to the Audit and the Financial Statements Committees of the Board of Directors of the Corporation, based on my latest assessment of the internal control of the financial reporting and disclosure:
(i) all the significant flaws and material weaknesses in the determination or operation of the internal control of the financial reporting and disclosure that could reasonably have an adverse effect on the ability of the Corporation to collect, process, summarize or report on financial information in a way that could cast doubt on the reliability of the financial reporting and the preparation of the financial statements in accordance with the provisions of the law; and -
(ii) any deception, whether material or not material, in which the CEO or anyone directly subordinate to him is involved, or in which other employees are involved who fulfill an important function in the internal control of the financial reporting and disclosure;
(5) I, alone or together with others in the Corporation:
(i) set controls and procedures or ascertained the setting and upholding of controls and procedures under my supervision, designed to ensure that material information
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relating to the Corporation, including its subsidiaries as defined in the Securities (Annual Financial Statements) Ordinances, 2010, is brought to my knowledge by others in the Corporation and in the subsidiaries, particularly during the period of preparation of the Reports; and -
(ii) I set controls and procedures or ascertained the setting and upholding of controls and procedures under my supervision, designed to reasonably ensure the reliability of the financial reporting and the preparation of the financial statements in accordance with the provisions of the law, including in accordance with accepted accounting principles.
(iii) No event or matter has been brought to my attention during the period between the Last Report and the date of this report that changes the conclusion of the Board of Directors and Management in respect of the effectiveness of the internal controls on the Corporation's financial reporting and disclosure.
Nothing in the foregoing shall derogate from my responsibility or that of anyone else in law.
November 28, 2017 ______
Asaf Bartfeld President & CEO
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Declaration of the most senior financial officer pursuant to Ordinance 38C(d)(2):
Declaration of Executives
Declaration of the most senior financial office
I, Barak Mashraki, declare that:
(1) I have reviewed the interim financial statements and other financial information of Delek Group Ltd. ("the Corporation") for Quarter 3 of 2017 ("the Reports" or "the Reports for the Interim Period");
(2) To the best of my knowledge, the interim financial statements and other financial information included in the Reports for the Interim Period do not include any representations that is not correct and do not lack any representation of any vital, material fact, so that was has been presented, within the context in which they have been provided, shall not be misleading in respect of the period covered by the reports.
(3) To the best of my knowledge, the interim financial statements and other financial information in included in the Reports for the Interim Period reflect fairly, from all material aspects, the financial condition, the results of operations and the cash flows of the Corporation at the dates and for the periods to which the Reports relate:
(4) I disclosed to the auditor of the Corporation, to the Board of Directors, to the Audit and the Financial Statements Committees of the Board of Directors of the Corporation, based on my latest assessment of the internal control of the financial reporting and disclosure:
(i) all the significant flaws and material weaknesses in the determination or operation of the internal control of the financial reporting and disclosure insofar as they refer to the financial statements and other financial information included in the Reports for the Interim Period that could reasonably have an adverse effect on the ability of the Corporation to collect, process, summarize or report on financial information in a way that could cast doubt on the reliability of the financial reporting and the
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preparation of the financial statements in accordance with the provisions of the law; and -
(ii) any deception, whether material or not material, in which the CEO or anyone directly subordinate to him is involved, or in which other employees are involved who fulfill an important function in the internal control of the financial reporting and disclosure.
(5) I, alone or together with others in the Corporation -
(i) set controls and procedures or ascertained the setting and upholding of controls and procedures under my supervision, designed to ensure that material information relating to the Corporation, including its subsidiaries as defined in the Securities (Annual Financial Statements) Ordinances, 2010, is brought to my knowledge by others in the Corporation and in the subsidiaries, particularly during the period of preparation of the Reports; and -
(ii) I set controls and procedures or ascertained the setting and upholding of controls and procedures under my supervision, designed to reasonably ensure the reliability of the financial reporting and the preparation of the financial statements in accordance with the provisions of the law, including in accordance with accepted accounting principles.
(iii) No event or matter has been brought to my attention during the period between the Last Periodic Report and the date of this report that refers to the interim financial statements and all financial information included in the Reports for the Interim Period that changes the conclusion of the Board of Directors and Management in respect of the effectiveness of the internal controls on the Corporation's financial reporting and disclosure.
Nothing in the foregoing shall derogate from my responsibility or that of anyone else in law.
November 28, 2017 ______
Barak Mashraki
CFO
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